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Who’s independent?
That question hovers over everything as Wall Street and America’s corporations dig out of the wreckage caused by the scandals of the past 13 months. Everywhere we hear demands for more independent research by Wall Street analysts. Citigroup’s Sandy Weill has just made an audacious move to get off the defensive on this issue, saying he’ll separate the company’s stock research, in its Smith Barney unit, from its investment banking, in its Salomon Brothers unit. He has hired Sallie Krawchek, former chief of the Sanford C. Bernstein research house—widely regarded as independent—to head the new Citigroup research business.
We’re also hearing loud calls for more independent directors on corporate boards. The New York Stock Exchange will soon institute new rules for all companies traded on the exchange, requiring a certain number of independent directors on each company’s board and defining just what independent means.
All this is understandable. Because e-mails don’t usually disappear from computer memories even after people think they’ve been deleted, we now know for sure that stock analysts at firms with big investment banking arms — like Merrill Lynch, CSFB, and Citigroup’s own Salomon Smith Barney — were pressured to recommend stocks of client companies, even when the analysts believed they were losers.
We also know that at some of the corporate disasters of the past year, such as Adelphia and Tyco, certain directors were far too cozy with management, sometimes because of financial relationships they had with the company. So lots of people want new rules to require analysts and directors to be independent.
If only it were that simple.
For example: Finding directors who are independent by the NYSE standard isn’t easy. They must not have any significant business relationship with the company on whose board they serve, nor have had any such relationship for five years. At big companies like General Motors, General Electric, Citigroup, or Wal-Mart, that requirement rules out huge numbers of otherwise qualified people. Two sources of directors who meet the new independence requirement are universities and foundations, and we should expect to see many more directors coming from these places.
Now ask yourself this question: When it comes to asking tough questions at a board meeting, who’s more independent? A professor who fits the new criteria but who has little experience in real companies and for whom the director’s fees are a significant source of income? Or an independently wealthy CEO who doesn’t fit the criteria because of a business relationship -- which may no longer exist -- involving his company?
Or how about this: The new Smith Barney unit at Citigroup will exist entirely on its own, performing equity research and offering brokerage services to individuals. Investment banking will operate separately, as Salomon Brothers. Yet both units will report to the same person, the CEO. Are they really independent if one person is giving directions to both of them?
The answers aren’t obvious, and that’s the point: People are looking for mechanical, structural solutions to a problem that is essentially human and character-based. That makes it hard to measure and analyze. It means checking boxes on a form doesn’t get you very far.
In reality, professors can be milquetoasts as directors — boards are full of them already — but a professor with a lot of character can be a terrific director. Exhibit A is Charles Elson, a professor who was invited by Chainsaw Al Dunlap to be on the Sunbeam board and was criticized by governance activists as a “lapdog.” But Elson was the director who formally made the motion to fire Dunlap.
And successful business people can be conscientious directors — plenty are — or can be scoundrels, as some at Tyco apparently were.
Citigroup’s new structure is a help, but whether the firm’s equity research is truly independent really depends on the personal qualities of the top executives who direct both sides of the company.
Who’s independent? The answer is important in directors and in research operations. We all want to know. What’s so frustrating is that the answer is rarely to be found on paper. Independence exists — or doesn’t — inside individuals.
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