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I am
delighted to be with you today at this timely symposium on
current regulatory issues affecting the Property and Casualty
Insurance Industry – especially given the highly charged
atmosphere prevailing in the wake of Tuesday’s U.S. Election.
Thank you very much for inviting me.
I am a keen
admirer and supporter of your industry and have spent much of my
legal career practising insurance law and representing insurers
and underwriters based mainly in the London, Canadian and New
York Markets ! Since being named to the Canadian Senate in June
1993, I have served on the Senate ‘s Committee on Banking Trade
and Commerce. In this capacity, I have had frequent contacts
with the officers of The Insurance Bureau of Canada and am even
sometimes referred to as the IBC’s « Mole » in the Senate ! In
short, I am a friend and have a reasonable understanding of your
industry, how your markets function and what issues, including
regulatory ones, concern you at any given time.
Early last
July, my friend and client, Nick Smith of Lloyd’s came by my
office in Montreal and put the arm on me to be your Luncheon
Speaker today, adding that my subject matter would be
« Corporate Governance ». « What a boring and over-worked
subject !». I protested after extracting my aching arm from his
vice-like grip. – Get away ! he exclaimed, I know you will find
a way to make it interesting for us…….and he left. The summer
and fall came and went and I worried through many sleepless
nights as to how to make my speech today relevant and fun for my
friends in the insurance industry.
And
then…..BOOM !
The Attorney General of New York came to
the rescue, so much so that I hasten to suggest we all raise a
glass in an enthusiastic toast to Eliot Spitzer…….. Not because
he is an aggressive, blatantly ambitious, outspoken
anti-business crusader or a « friend » of the insurance
industry, but rather, because by taking the extraordinary and
high profile action he did on October 14th against Marsh & MacLennan
Ltd,
and referring as he did in his claim, to AIG, ACE, Hartford
Financial Services Group and Munich Re – he brought corporate
governance in the insurance industry right on to the front
burner and handed me on a silver
platter, some juicy and relevant subject matter for my talk
today, which I have entitled :
« Lessons Learned From The Enron Scandal : Three Years Later »
or «Eliot
Spitzer’s Folly »
Mr. Eliot
Spitzer’s assault on the insurance industry took the form of a
massive civil lawsuit against the world’s largest insurance
broker and implicated several insurance companies with whom it
was doing business. It came suddenly, but only after months of
exhaustive investigation by the Attorney General’s staff, aided,
we are led to believe, by one or more « whistle blowers » (you
will perhaps recall that when Enron and WorldCom finally fell,
whistle blowers were involved in each case !) The Statement of
Claim contained scathing and far reaching allegations which, of
course, will need to be proven in Court if the case is not
settled or otherwise dispensed with short of trial.
These
allegations suggested that Marsh and the insurers or some of
them, were engaged in improper, fraudulent and undisclosed
business practices all to the detriment and financial
disadvantage of their client policy holders. Mr. Spitzer claims
the Defendants were routinely making clandestine use of
« contingent commissions » or « profit-sharing agreements » (PSAs)
in an improper and fraudulent way; that illegal bid-rigging and
price-fixing was taking place and that senior management at
Marsh was shamelessly condoning and turning a blind-eye to these
nefarious practices.
These
allegations sent shock waves through your industry and led to an
immediate and massive sell-off of insurance stocks. Forty-one
billion dollars of market cap. of leading insurance companies’
and brokerage firms’ value evaporated into thin air in just a
few hours. A true business and financial crisis was created.
Damage control teams swung into immediate action. Literally,
within hours, the Defendant and many others in the industry
announced a complete moratorium, if not abandonment of the long
accepted practice of paying and receiving « contingent
commissions ».
In the first
day or two of the crisis, there were fears in some quarters,
albeit unfounded, that the venerable Marsh might be brought down
« à la » Arthur Anderson in the Enron scandal. Such fears were
quickly allayed by Marsh’s prompt and effective damage control
which included the resignation of its CEO Jeffrey W. Greenberg
plus other admissions and undertakings they apparently made to
Mr. Spitzer’s team. In turn, Mr. Spitzer announced there would
be no criminal suit against Marsh and the insurers involved, but
rather only against a few clearly culpable individuals. It
remains to be seen whether there will be a financial settlement
and/or whether the lawsuit will be dropped. Figures as high as
US $500,000,000.00 have been mentioned in the American financial
press as the potential price Marsh may have to pay to buy its
peace.
Rumours
abound that other lawsuits are about to follow and major brokers
Aon and Willis, plus other smaller brokers and insurance and
re-insurance companies have been in damage control modes as
well. A highly inflamatory and probably misleading article
about Aon and its CEO Pat Ryan, appeared in last Sunday’s New
York Times under the banner headline « Spitzer Goes Hunting for
His Next Trophy » and a huge contrived colour photo of Mr.
Spitzer pointing his finger at Mr. Ryan. The rumours include
suggestions that Mr. Spitzer is about to launch an all-out
attack on the so-called practice of « tying » or « tied
selling » allegedly done in connection with the conditional
placing of re-insurance having regard to the placement of the
primary coverage.
It is too
early to tell where all this will lead and there is already
growing criticism of Mr. Spitzer’s dramatic and broad-brush
methods. What sector of the insurance industry will be next ?
Will it be health insurance ? life insurance ? D & O ?
professional liability ? re-insurance ? The entire industry is
on edge and much collateral damage has occurred and is
continuing apace. Many thousands of small insurance brokers
across North America, for example, rely on « contingent
commissions » to make them profitable. (I am told there are
some 33,000 such small brokers in Canada and over 150,000 in the
US). They, along with the large global brokers like Marsh, Aon
and Willis, claim the practice is completely legitimate and has
been going on for years. Many of these smaller brokers could
well go out of business if they are forced to lose the benefits
of these profit sharing schemes or if the insurance companies
flat out arbitrarily stop paying them contingent commissions.
Mr. Spitzer
alleges that the practice has not been adequately disclosed,
that it has actually been hidden from policy holders and has
been subject to very substantial abuses in recent years. He
cites alleged examples of price-fixing and anti-competitive
conduct by brokers and insurers to support his case. He has
failed to acknowledge that the abuses are relatively few and far
between.
All in all,
it is not a pretty picture - but it sure does serve to
illustrate the kind of fall-out that has come about as a result
of « Enronitis ». As you know, Mr. Spitzer first went after the
big investment bankers, particularly their analysts. He
succeeded in extracting massive fines from some of America’s
most prestigious financial firms. What he called abusive and
fraudulent practices designed to defraud, bilk or otherwise
disadvantage investors, shareholders, and consumers generally
were consequently terminated and cease and desist orders agreed
to. Senior executives were forced to resign, many are facing
criminal prosecutions and may go to prison. Some are already
there ! Next came the New York Stock Exchange probe and the
fiasco involving Mr. Grasso’s exhorbitant compensation package
and pension arrangement. This matter remains before the Courts,
but Grasso has already agreed to forego or repay millions and
millions of dollars. Where there is smoke…there is usually fire
and Mr. Spitzer and his team are seen by the consumer public as
having achieved substantial and positive results and he appears
to have widespread and unequivocal support at the public level.
The Mutual
Fund Industry was the next one to come under the Spitzer gun.
The investigators came up with allegations of widespread and
unconscionable abuses through alleged improper market timing and
late trading activities. Mr. Spitzer was particularly outraged
in these cases, because relatively small and unsophisticated
investors were the holders of the mutual fund units which
depreciated in value, whereas a few « sharp » traders and market
operators cashed-in big time at their expense. Based on the
settlements achieved and the fines paid willingly and quickly,
it appears Mr. Spitzer had a point with the mutual funds.
Marsh’s prominent Putnam Fund was a major case in point.
But has Mr.
Spitzer gone too far this time ? Has he finally « lost it » and
gone over the top with his aggressive and highly public probings
into the insurance industry ?? Is it right that by his zealous
prosecutions and allegations, he can « willy-nilly” strip as
much as 30% or more off corporations’ market valuations, put
innocent companies out of business; destroy the sterling
reputations of prominent business persons – heretofor pillars of
their communities, all in the name of weeding out a few bad
apples and stopping some isolated cases of abusive or improper
practices ?? This is one of, if not
the key
question emerging from all of this and one that should be
debated fully and publicly ………. although not here today !
I will only
say this. Your industry is based on trust and confidence. The
contract of insurance is one of the utmost of good faith. Once
the policy holders – your customers – start losing confidence
and faith in their insurance advisors and providers, big trouble
for the industry lies ahead. Spitzer has certainly created
major doubt in their minds. If indeed improper practices abound
on a widespread scale, as Mr. Spitzer suggests, they should be
stopped forthwith by the appropriate regulatory agencies, and
punished accordingly. If we are only talking of isolated
instances of clandestine greedy conduct, fraud and other crooked
behaviour, this must be made clear in a well documented and
effective public relations exercise. If it turns out to be
systemic, then, that is another story – in my view, a highly
improbable one.
This matter
is crucial for all of us : brokers, insurers, regulators,
legislators and policy holders alike. It should not be left to
fester and be dramatized on a daily basis by the media.
As you are
all fully aware, Mr. Spitzer’s actions vis à vis the insurance
industry, have already had significant reverberations here in
Canada. One clear example is that late last week, insurance
regulators across our nation commenced an extensive
investigation into all relationships between insurance companies
and brokers, including corporate links which, I understand, are
fairly prevalent in the P. and C. sector as well as in the life
and health sectors. Where will this investigation lead ? what
will be its short and longer terms costs ? and how will it
ultimately affect the manner in which Canadian brokers and
insurers carry on their business ?? Is it even necessary ? or
will an entirely new paradigm
emerge ? and of course, will
this lead to any significant regulatory reform ? Frankly, as I
have said repeatedly today, this is all about ongoing disclosure
and transparency coupled with an environment which fosters
integrity and good corporate governance rather than the reverse.
The
Corporate Governance Debate came to the fore in corporate Canada
following a TSE Study in the early nineties, which resulted in
the issuance in December 1994 of The Dey Report entitled « Where
Were the Directors ? » The report contained a series of 14
« Guidelines » designed to foster good or better corporate
governance. Canadian public companies were urged by the
regulators to implement these and/or at least to indicate in
their annual reports to what extent they were observing the
« Guidelines ». It was in the wake of The Dey Report that the
Federal Minister of Industry, in August 1995, asked the Standing
Senate Committee on Banking Trade and Commerce to hold hearings
with senior business people and investors across Canada on a
number of Corporate Governance issues and to determine whether
or not the TSE « Guidelines » worked or were effective in
practice, in the « real » corporate world. The Minister wanted
our Report to include advice as to whether we found the
« Guidelines » adequate to « get the job done » or did they need
beefing-up by legislative provisions in a modernized Canada
Business Corporations Act which the Government of the day was in
the process of preparing. Our Committee’s First Report on
Corporate Governance was issued in August 1996. We followed
this up shortly thereafter with an extensive study on Corporate
Governance of Canada’s Institutional Investors and our Report
entitled «The Governance Practices of Institutional Investors »
was issued in November 1998.
I believe
the tone for our overall findings in these two studies was set
by one of our very first witnesses, Mr. J.P. Bryan (President
and Chief Executive Officer at the time of Gulf Canada Resources
Ltd), who appeared before the Committee in Calgary on February
13th, 1996. He declared for openers:
« In my opinion, Corporate
Governance is, for the most part, just a load of Guacamole. I
am totally opposed to the idea of governance. What is needed is
leadership in business. As far as I am concerned, the provision
of good corporate performance through the governance of a board
of directors is a concept which could only be found in some
form of bureaucracy. It may work in Alice in Wonderland, but it
will not work in the real world ».
During these
studies on corporate governance issues during the pre-Enron
period, we found Mr. Bryan’s sentiments, at least in part, to be
reflected by actual practice and outlook in corporate Canada.
We found, for example, that most experts on the subject in this
country were against over-regulation via a set of detailed and
« picky » rules which are often costly and complicated to
implement and enforce. We found too, that during the 1995 –
2000 period, the TSE « Guidelines » had a relatively modest
impact. Although some TSE listed companies made genuine efforts
to strengthen their corporate governance practices, I believe it
fair to say that most Canadian public companies basically only
paid lip-service to the TSE « Guidelines ».
At the same
time, however, shareholders’ rights activists were becoming more
active and outspoken in Canada and elsewhere. They knew a
serious problem existed and was coming to a head. They provided
the « squeaking wheel » denouncing the lack of proper corporate
accountability to and transparency for shareholders and other
key stakeholders. They promoted an under-current of unease and
protest against the absence in the corporate world of healthy
governance cultures characterized by transparency, independence
and ongoing disclosure. The perception – an accurate one , it
turned out – was that many Boards were not sufficiently
independent of management and that abusive and improper
practices were going on routinely at the expense of
shareholders. These included cosy and sometimes conflicting and
undisclosed relationships, accounting methods and business
practices. The « old boys » network was still alive and well in
corporate boardrooms and the self-interest of inside players
frequently took precedence over the interests of the
shareholders. Rich compensation packages and excessive
corporate « perks » for senior executives were coming to light
and in some cases were justly characterized as « obscene ».
During the
period leading up to the Millenium, two conflicting forces were
at work. On the one hand, the capital markets were booming, the
tech boom was in full flight – the bubble expanding dangerously
on a daily basis. People were making fortunes in the stock
markets and CEOs were laughing all the way to the bank with
their plush compensation packages and stock option schemes.
Federal Reserve Chairman, Alan Greenspan called it « Irrational
Exhuberance », but investors were happy and carefree, in some
cases, ignoring even the most basic rules of investing. Can you
believe people were routinely buying stock in companies that had
no assets, no earnings and no cash flow ? It seemed that
literally money was « growing on trees » ! Of course, it wasn’t,
as we all know – there simply is no such thing as a « free
lunch »! The system was so out of control and times seemed so
good, that most of the abuses and instances of bad governance
were masked and not obvious to shareholders or even bleaky-eyed
regulators ! Consumer and investor confidence were at an all
time high…..albeit for the wrong reasons…and Corporate
Governance was at rock bottom !!
At the same
time, another view as reflected by Chairman Greenspan’s
utterances, was striving for attention. In Canada, there was an
awareness the TSE « Guidelines », as such, were not working.
New studies on Corporate Governance were conducted but they all
were decried as being much too « vanilla » by leading
institutional investors such as « Omers » and « Teachers » here
in Ontario, and the crusading minority shareholder champion in
Montreal, Stephen Jarislowsky. They pointed out the need for
stronger and tougher penalties for corporate fraud. For them,
the status quo was not good enough. They warned that the
« Roaring Bull Market » would soon come to an end and investor
confidence would erode to zero with perhaps disastrous
consequences for our financial markets. As well corporate
scandals were coming to light with disturbing frequency both in
Canada and the United States. Canadian examples include Phillip
Services, Bre-X, Cinar, Livent, Dylex, Laidlaw, Nortel and JDS
Uniphase, whereas in the U.S., the cases of Martha Stewart, Tyco
and Adelphia were, as it soon turned out, only the « tip of the
iceberg ».
Then the
bubble burst – Enron and WorldCom imploded in rapid succession
around Easter 2002, allegations of fraud, greed, flagrant
conflicts of interest, breaches of trust, obscene compensation
packages and generally abominable corporate practices were
rampant. No one was immune. Directors, senior mangement,
outside auditors, analysts, all were swept up in the maelstrom
of accusations and recriminations. One incredible result was
the total ruin and ultimately disappearance of the major
accounting firm Arthur Anderson. Investor confidence hit the
skids in a big way and the light began to shine brightly on the
need to end corporate fraud; to ensure full and proper
accountability to shareholders through transparent disclosure of
all material information; revised accounting rules and
standards for auditors as well as strict third party oversight
of the auditing profession; new and strict requirements for
independent directors and for management compensation packages
to be aligned with performance and shareholder reward, the whole
plus a vigorous regime for enforcement and punishment by much
more than simple raps on the knuckles.
In the
U.S., President Bush demanded immediate action and the
extraordinary and far-reaching Sarbanes-Oxley Act was enacted on
July 30th, 2002 going through by Congress in record time. It
provided for sweeping new penalties to root out executive
corruption, doubling prison terms for executives convicted of
cooking the books and prescribed a very tough list of measures
designed to make corporations more accountable and transparent
and their boards and advisors more independent. The
investigative budget of the SEC was increased by US $100
Million. A whole new cottage industry of corporate muck-raking
started up in the US led by the insurance industry’s new best
friend, Mr. Eliot Spitzer, the Attorney General of New York.
In
Canada, there has been much consequential legislative and
regulatory activity as well. Whereas there has been general
agreement here that stricter measures were and are needed to
obviate corporate abuses, a Sarbanes-Oxley type solution is not
really appropriate for us and that one-size does not fit all.
The rationale for this is that our Canadian economy is based on
small and medium-sized companies (SMEs), rather than « Fortune
500 » corporations like in the USA. Our major corporations
interlisted in the USA on NASDAQ and the NYSE are subject to
Sarbanes-Oxley in any event. For the SME’s, many of them cannot
afford the costs involved in strict compliance with
Sarbanes-Oxley. The Ontario Government acted swiftly with Bill
198 and related legislation, first providing for strict new
penalties and sanctions for corporate fraud and followed up with
broad new investigative powers for the Ontario Securities
Commission. A number of new corporate governance rules and
regulations mostly relating to disclosure and accounting
practices, were enacted as well. The Federal Government is
currently in the process of introducing its own set of measures
to fight corporate fraud.
Ladies and
Gentlemen, the process of investigating, with a view to cleaning
up corporate abuses, continues apace. Even before the insurance
industry fell afoul of Mr. Spitzer last month, the financial
press continued to titillate us with a daily menu of corporate
horror stories and scandalous behaviour. In Canada, one needs
look no further than downtown Toronto and the troubling
revelations concerning Nortel, Lord Conrad Black’s Hollinger and
The Royal Group and their senior executives and Boards of
Directors. In Europe, the story is not dissimilar, with recent
examples being the shocking Parmalat Case in Italy, the
Mannesmann Affair in Germany and the CP Ships accounting blip in
London. In the U.S. the examples are legion. If it is not
Martha Stewart slipping into her medium security Club-Fed before
dawn, it is some CEO or CFO being paraded to court in handcuffs
or a major financial institution buying peace by agreeing to pay
some astronomical fine in the millions of dollars. The
insurance industry denouement most likely will continue for
months to come. Mr. Spitzer’s investigators and his
counterparts in Connecticut, Massachussets, California and
elsewhere, seem poised to swoop down on other brokers and
insurance companies in areas of the industry far removed from
property and casualty business. No matter what happens, one
thing seems clear, the insurance business as we have known it
will be conducted in a much more transparent way going forward.
Will this be better for policy holders and other consumers ?
Only time will tell.
Following
the Enron and WorldCom meltdowns, our Senate Banking Committee
was once again asked by Industry Canada to conduct a study to
determine what had happened and why and what lessons could be
learned by Canadian regulators and legislators wishing to
prevent similar scandals in this country and to promote a
culture of integrity and good governance in corporate Canada.
We commenced this fascinating study in May of 2002 and produced
our Report entitled « Navigating Through The Perfect Storm :
Safeguards to Restore Investor Confidence » in June of 2003. I
commend this Report to any and all of you interested in the
subject. It can be obtained on the Senate Website (www.parl.gc.ca)
or by calling the clerk of the Senate Banking Committee.
Our
investigation included an extraordinary fact-finding week in New
York and Washington. We were fortunate to have full and frank
meetings in New York with Attorney General Spitzer, who was
clearly focussed, serious and determined to wipe out fraud and
shareholder abuse in record time. We also met senior officers of
the New York Stock Exchange (although, we did not meet the now
infamous Mr. Grasso). In Washington, we met with Senator Paul
Sarbanes, Congressman Michael Oxley and new SEC Chairman William
Donaldson. We also had most instructive exchanges with the
Chairman of the Financial Standards Accounting Board (FASB), the
Council of Institutional Investors and members of the new
Accounting Standards Oversight Council and many other
politicians, think tanks and financial consulting organizations
who were only too happy to describe the post-Enron governance
environment in the USA. The whole experience was a real
« eye-opener ».
For me,
however, the highlight was a private Round Table Session we had
with Federal Reserve Chairman Alan Greenspan in New York. I may
be breaching slightly the « Fishing Club or Chatham House
Rules » we agreed to, but I cannot resist sharing with you the
following tid-bit.
When
asked if he felt the Sarbanes-Oxley Act would restore investor
confidence, Mr. Greenspan quickly retorted – « Hell no – it
might serve as a deterrent the next time the cycle brings us an
environment conducive to corporate scandals – but restoring
investor confidence now : No.! What we need are several
quarters of good, solid earnings and a substantial rise in the
Dow, coupled with a dozen or so CEOs and other senior executives
in orange suits and handcuffs on the 10 o’clock TV News – that
will do it! ». How right he was !!
The
over-riding lesson that comes out of all this is that, in the
future, for public companies at least, business will need to be
done much differently. Old and accepted practices will no
longer pass the smell test if exposed to the bright glare of
ongoing disclosure and total transparency. In like manner,
relationships which were common place in former corporate life,
just won’t wash away anymore. CEOs and their senior management
teams will no longer be able to fix their own compensation and
perks. There will need to be genuine independence between
directors and the management they are there to direct.
Relationships with suppliers and business partners will have to
be at arms length. Insider trading practices which are still
more prevalent than regulators would like to think, must be done
away with completely. We already have laws to deal with them.
Corporations should adopt ethical standards and business and
governance practices, which are conducive to a culture of
integrity and the creation of value for shareholders. Business
leaders will need to understand that rewards for themselves must
be aligned with performance and positive returns for
shareholders and other stakeholders, such as the policy holders
in the case of insurers.
Human nature
being what it is, there unfortunately and inevitably will
crop-up from time to time, corrupt individuals who are bent upon
beating an otherwise sound and well-motivated system established
within a corporation structure. To deal with these individuals,
there is a need for strongly deterrent penalties, plus a legal
regime which sets out some basic safeguards for good corporate
governance, including rules which protect “whistle-blowers” from
negative recriminations and encourages them to come forward when
it is appropriate for them to do so.
These,
Ladies and Gentlemen, appear to me to be the lessons we can most
usefully take from The Enron Scandal – Three Years Later.
Another way of putting it, I feel, is that to avoid trouble in
the future, our corporations will have to adopt some good old
fashioned values involving top-level ethical, moral and
integrity standards. The people in the corporations must
remember adages like “a full day’s work for a full day’s pay”
and “never do anything in business that they would not feel
comfortable reading about on the front page of the Globe and
Mail, La Presse or the New York Times”.
In
conclusion, let me suggest that perhaps our investigators and
enforcers should also have a modern and fair set of standards to
govern their activities – not to impede or obstruct their work,
but to safeguard many hard-working, productive corporate
citizens and their shareholders from sometimes misguided
overkill. Isn’t there another old adage, Ladies and Gentlemen,
that says “you do not need a sledge hammer to kill an ant” ?
Take note Mr. Spitzer, before you spoil a good thing and « throw
the baby out with the bath water ».
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