When the boss is always right

Let me start with a familiar scene. Suppose the boss says “I don't like his face.” His sidekicks exchange quick looks and leave the room without a word. They clearly understand what their boss means and promptly kill the guy in cool mafia fashion.

You probably relate this scene to classic Hollywood mafia movies, in which the sidekicks usually flee the scene right after the murder. When the police show up to find whodunit, nobody including the boss remembers what happened. Unconventional corporate governance combined with plausible deniability.

That is exactly what seems to have happened at the British banking giant Barclays, starring its recently-departed chief executive Robert E. Diamond, Jr. and several former deputies whose casting roles and special appearances have yet to be confirmed.

Just like the mafia boss and his cinematic sidekicks who know exactly what happened but display confused innocence, Diamond has insisted he had no clue that his deputies took him so seriously and acted on his cue, implicitly putting the blame on them. And more remarkably, Diamond had no knowledge of the consequences of what he said to his sidekicks. Or at least that was what he claimed.

It all started in the autumn of 2008 just around the time Wall Street icon Lehman Brothers collapsed in the midst of the financial crisis. At that time, the Bank of England's executive director of markets, Paul Tucker, told Diamond he had received calls from several senior figures from Whitehall who were questioning why Barclays was consistently quoting the London interbank offer rate - Libor - at the top end of the daily scale, according to documents released by the bank. Tucker is now a deputy governor of BOE.

Libor is the benchmark used between banks to set interest rates, or costs, of hundreds of trillions dollars worth of financial products. The high quotes suggested the high cost of Barclays’own funding and therefore indicated the poor health of the bank, since interest rate spreads are an indication of risk.

The exchange with Tucker reportedly prompted Diamond to relay to his deputies the concerns of the central bank: that the bank had been submitting high Libor rates. According to various media reports, Diamond's top deputies took the cue and told their employees to report artificially low interest rates in line with those of its rivals.

This eventually forced Barclays to agree to a US$450 million settlement earlier this month in response to US and UK probes and accusations that the bank had tried to manipulate key interest rates for its own benefit and to mask its true financial standing. Local and municipal governments and private borrowers today all over the planet are lining up to sue major Wall Street and London banks over allegations that the manipulated interbank rate had cost them billions in additional interest rate costs. That is because the local governments often bought derivatives called interest-rate swaps to protect themselves. The swaps, which they bought from the same banks they are now suing, protected them when Libor rose, but cost them when the interbank rate fell.

Already a flock of cities, states and municipalities in the United States have filed suits in the Manhattan Federal Court against the banks that set Libor.

Diamond, who stepped down early this month, never specifically instructed anyone to manipulate the Libor, according to the regulatory records released. And he was “disappointed and angry” that his deputies took his comments as a cue to rig the Libor.

When Diamond gave evidence earlier this month to the UK Parliament's Treasury Select Committee in London, he blamed a group of 14 traders for the rate rigging. He said he was not aware of their activities till a week before regulators published their findings, including the email exchanges between Barclays traders which made him “physically ill” after reading them.

The Barclays scandal prompted British Prime Minister David Cameron to tell lawmakers it would be completely wrong if people leaving under these circumstances were given some vast payoff, referring to the severance package Diamond may receive.

Perhaps Cameron should actually thank Diamond as this scandal and the resulting public outrage offer a golden opportunity to rein in the much needed and overdue reforms of the banking system. What happened at Barclays was essentially a major failure in a very important aspect of corporate governance: the disclosure of any material events, which in this case is even more spectacular.

“Either you were grossly negligent, grossly incompetent, or you did not know what was going on,” said Labor MP John Mann in one of the grilling sessions Diamond faced earlier this month. Sound familiar? Think of media tycoon Rupert Murdoch, yet another recent case of top level C-suite executives seemingly seeking to get around and away by claiming to have not a single clue of what happened under their watch, including material events in their core business.

These problems are obviously not just confined to the UK but have seemingly plagued many developed economies and global financial centers. Corporate governance is here to stay but it regularly hits the headlines for the wrong reasons.

As Professor Wayne Yu, who specializes in corporate governance issues at the Graduate School of Business at the Hong Kong Polytechnic University, explains, trust is the very corner stone of a financial market. The company's top executives have significant discretion on how to use the money provided by the capitalists, being the debt holders and shareholders of the company.

These capitalists are ultimately and always at the mercy of the executives on the fate of their investments so they would understandably prefer to put their money where their investments are better protected. In this sense, competition among different financial markets boils down to competition on corporate governance, which includes not only legal protection of private properties but also internal mechanisms such as a competent board of directors, independent auditors and effective internal control systems, he said.

Who knows, with some serious major reforms and beefing up on good corporate governance practices, bosses may suddenly realize their memories came back much more easily.

(Vanson Soo runs an independent business intelligence practice specialized in the Greater China region. Email: soovans@gmail.com. A different version of this appears in The Standard of Hong Kong.)