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A bank, an IPO and an Oil & Gas Driller all potentially have that one key characteristic of the astronomical black hole – a massive implosion sucking everything close enough to them into the abyss.

First the bank — JPMorgan Chase

This week’s news included the analysis that the hedging unit which lost $ 2 BILLION-with-a-B dollars of asset value faces a loss that is growing and likely to continue to grow. Most recent estimates are around $5 BILLION. Recall that when this story first broke, there was a total bet… uh, I mean trade, on the table of around $100 Billion in the “risky” category. Now that the whole world knows the situation, you can bet…. uh, I mean trade, on the prospect that there will be no takers on the other side should the bank try to unwind its position. Do you see the black hole now?  So if a 2 to 5 percent loss in this position wipes out about $20 Billion of shareholder value in JPMorgan Chase then what would a 50% loss do? Poof. No more bank. And who could possibly come to the rescue in order to prevent the next world wide financial meltdown? Hmmm.

And by the way, remember how banks can regulate themselves? It turns out that the 3 JPMorgan Chase directors who had responsibility for risk evaluation and the oversight thereof don’t really have the experience to do that. One is the head of a museum.

Ethical Analysis: As commented on in earlier posts, fiduciary responsibility to one’s shareholders – F; professional codes of ethics for financial advisors – F; adherence to the ethical expectations of the investing public and general citizenry – F.

Next the IPO – Facebook, Morgan Stanley, the NASDAQ

Before its IPO, Facebook was heralded as the largest IPO ever. Now it may be a major IPO bust, with stock hitting its peak on the day of the IPO and down since. The NASDAQ apparently could not keep track of all the individual investor trades, with news in the past two days that some of those investors had money removed from their account to support the purchase but found no shares of FB appearing in their account to reflect that purchase. Morgan Stanley is planning to dole out millions of its underwriting fees to those investors. How long do you think it will be before Morgan sues the exchange? In the meantime, Facebook is considering a move off the NASDAQ to a competing exchange and everyone seems to be questioning the company’s valuation. Then there is the allegation that the underwriters went forward with the IPO even though new financial data was bringing the IPO price into question. Not to mention that only some (I believe they were at first called “preferred”) potential investors were informed of this news. How do you spell SEC?

Morgan Stanley and the NASDAQ have big black eyes over this one, but with a likely SEC investigation, shareholder lawsuits already launched and the prospect of continued sell-off in the shares, this mess can only get bigger, nastier and more expensive.

Ethical Analysis: My jury is still out on Facebook, although their leadership clearly consented to go forward with the IPO in spite of changing financial data. NASDAQ appears thus far to be an operational blunder. Morgan Stanley and the underwriting team may have broken securities laws, certainly didn’t maintain a level playing field for the retail investors and should have delayed the IPO for few days. I would give them an F in meeting the ethical expectations of investors and in conducting a professional financial underwriting operation.

Finally the Oil and Gas Driller – Chesapeake Energy

The major news this week was that Carl Icahn is/has accumulated over 4% of the shares of Chesapeake. Also, two of the nine board members are up for re-election at the annual shareholders meeting in early June.

So why do I consider this one a potential black hole?

Where is the money? All that money that founder and CEO Aubrey McClendon borrowed from various entities using his personal interest in company wells totals to somewhere well north of $ 1 Billion-with-a-B dollars. At one point (2008) he even got the company to buy his map collection for $12 million in addition to paying him an annual bonus of $75 million. Where is all this cash going? The guy seems to have an amazing appetite for cash. That tells me that something is going on behind the curtain. His investment (and the company’s too, of course) in the Oklahoma City Thunder pro basketball team isn’t nearly enough to account for all these loans.Maybe it’s his hedge fund that he’s been running out of his CEO offices at Chesapeake. Maybe he has personal margin calls on his stock in the company. I don’t know and nothing has been coming out in the press.  What I do know is that there is another big piece of this story that is yet to come out and that Chesapeake’s investments and Mr. McClendon’s appear very much intertwined.

The potential black hole has similarities with the one that took down Skilling, Fastow and all of the Enron shareholders and employees. It is related to the value of the company’s shares which have fallen with the abundance of natural gas. In Enron’s case, there were off balance sheet liabilities that were tied up in deals with Fastow’s friends. Those deals started to unravel when the stock dropped below a certain value. I’m not saying that’s the mechanism involved here, but I am saying that McClendon’s personal need for cash accelerated as Chesapeake’s share value went down, a sign that he is over leveraged somewhere in his financial picture. The company may be as well, since almost everything that the CEO is involved in personally has company involvement as well. That may be why McClendon, who has known Icahn for many years, is now eager to have a financial white knight come to the table.  Stay tuned.

Ethical Assessment: Conflicts of Interest abound like a mound of fire ants. F-.


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Another exciting week for corporate ethics watchers!

JPMorgan Chase competes with Facebook for the top financial news story of the week as the major bank’s exposure to losses from its London hedging unit has a strong probability of growing. While the news for Facebook is almost totally upbeat, the combination of troubles in Europe and losses at one of the most reputable of the biggest banks has been bad news for the stock market all week.

Here are the highlights on JPMorgan Chase:

  • Last weekend saw speculation that the entire London hedging unit would be closed down, and that the Chief Investment Officer, Ina Drew, would be asked to resign. There were also calls for Dimon to resign his position at the New York Fed.
  • On Monday, Ina Drew announced that she would retire from the bank.
  • On Tuesday, Jamie Dimon was facing his shareholders at their annual meeting in Tampa. Shareholders there defeated a proposal to separate the roles of Chairman and CEO, a proposal that would have meant the loss of one of those positions for Mr. Dimon.
  • On Wednesday, several shareholder lawsuits against the bank were announced. The suits were focused on the bank’s alleged failure to appraise shareholders of the level of risks being taken.
  • But the real news, reported early this morning in the Financial Times, is that JPMorgan Chase’s hedging unit may be sitting on a total exposure of $100 BILLION in risky trades, trades that it will be challenged to unwind. That provides the possibility of total losses multiple times larger than the $2 Billion that came to the CEO’s attention over a week ago.

Ethical assessment: As noted in prior posts the real issue here is fiduciary responsibility to shareholders and, due to the bank’s scale and role in the global economy, the investing public and the general public. The bank may not have broken any laws but the behavior of this particular part of the organization appears to not meet the professional ethical standards of any financial analyst, banker or licensed stockbroker. It does not meet the ethical standards of the communities (investing public, general public) that it serves.

In Brief

Chesapeake Energy – Corporate “raider” Carl Icahn was reported to be positioning himself for a move on the company. This may provide some temporary relief to Chesapeake’s employees’ retirement savings at the company which are estimated to be 38% invested in shares of the company. When are we going to stop using company shares as the basis for employee retirement programs? Isn’t it a principal of sound financial management to not put all of the eggs in the same basket?

News of the World – Rebekah Brooks, her husband and four others were charged in the UK phone hacking scandal. It also came out that, guess what, Ms. Brooks managed to cart off seven boxes of papers relevant to the case from her News of the World offices as the investigation was beginning last July. Hmmm. Hasn’t this been tried before?

Delete, shred, carry away. Rarely works in these high profile cases. Besides, if a physical document exits, there are multiple electronic versions out there all over the place. Yep, those electrons may be hard to see but they are also hard to destroy.

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With the nation’s first potential $100 billion IPO just around the corner and with that IPO based upon the premier and best social networking site, one has to recognize that this event is symbolic of a very new age in human interaction. At the same time, it should also remind us of a key challenge of the digital age: maintaining respect for the privacy of the individual.

Lest you think that I am about to attack Facebook, I have previously commended Mark Zuckerberg for defending that privacy. I am referring to the unbelievable requests made by potential employers for job candidates to provide their Facebook user ID and password to the interviewer. Zuckerberg rapidly responded to that news and stood up for his users’ privacy. Bravo!

Unfortunately our digital privacy dilemma does not hinge on Facebook’s founder alone. Information technology combined with mathematics and statistics has opened the door for corporations, governments and other individuals to find more information about you than you can imagine. Tracking your searches, learning your buying preferences, determining your likelihood of having particular medical problems, even observing you eating a hamburger in your backyard patio are all things we can now do.

The time for a national discussion of our right to privacy and what that really means is long overdue. I will try to contribute to that discussion in a series of posts on digital privacy. Particular points I will discuss include the following:

  • That the right to privacy has already been established as a constitutional right;
  • That technology assisted statistics has already made protecting and hiding your personal identity and personal identification information impossible;
  • That the data that is collected on you in database warehouses around the globe is and ought to be yours and yours alone to surrender, no matter how it was collected;
  • That the economic size and scale of companies such as Google renders “opting out” impractical and our laws ought to recognize that reality;
  • That therefore the burden of maintaining privacy and security of identification should be on the organizations and corporations that provide services, not the individual; and
  • That these principles must be established not just on the federal level but on the international level.

One of my first posts (My Big Data Footprint) opened the discussion of privacy in the digital world. Following the Seven Layers of Integrity® framework, we should start with the law. Let’s first briefly review the historical basis for the constitutional right to privacy.

The concept of a right to privacy is commonplace in our thinking, but unlike many of our other rights (freedom of speech, right to peaceably assemble, right to bear arms), privacy is not actually enumerated in our constitution. However, the Ninth Amendment, part of the Bill of Rights, provides recognition of other individual rights without specific identification in the constitution itself: “The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people.”  Privacy as a matter of physical space (versus digital) can also be read into the 4th Amendment: “The right of the people to be secure in their persons, houses, papers, and effects, against unreasonable searches and seizures, shall not be violated….”

The right to privacy as a legal issue remained largely dormant until the Civil War, when the 14th Amendment provided an opening to the legal evolution of this right with these words “No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.” (Fourteenth Amendment, Section 1)

The first Supreme Court case involving the right to privacy was Griswold v. Connecticut, which centered on a Connecticut law forbidding the sale of contraceptives. In this 1965 case, Estelle Griswold, the executive director of the Planned Parenthood League of Connecticut, and another individual had been fined for violating the state law against sale of contraceptives. After taking the case to the state’s supreme court without success, Griswold filed at the Supreme Court, arguing that the Connecticut law was unconstitutional under the 14th Amendment. As part of the court’s favorable ruling, it established that the Connecticut law had violated a “right to privacy.”

The second major case that cited a right to privacy was the very case that established a woman’s right to an abortion: Roe v Wade (1973). In that landmark decision, the court ruled that that the right to privacy was protected under the “due process” clause in the 14th Amendment, and that this right to privacy included a woman’s right to an abortion.

The Constitution’s Bill of Rights, the Fourteenth Amendment and two pivotal Supreme Court cases in relatively recent decades have established a right to privacy. As with freedom of speech and freedom of the press, our starting point should always be to place a burden of compliance with that right not on the individual but on those who would restrict the individual’s rights. To do otherwise in the case of privacy would be unacceptable.

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JPMorgan Chase

The world of banking gave us more drama this week in the form of Jamie Dimon’s usually well-managed JPMorgan Chase. While it is not certain that wrong doing occurred, even Dimon admits the $ 2 BILLION trading loss in their London hedge fund unit was “eggregious,” “a mistake” and “almost inexecusable.”  Perhaps the “almost” applies to himself, Jamie Dimon, as reports this morning are that the entire unit may be out the door along with the unit’s leader. Political as well as financial fallout is already running high with the SEC announcing an investigation, voices of regulation speaking out on a return to the Glass Steagall days and Elizabeth Warren, consumer advocate and candidate for the US Senate, demanding that Dimon resign from his position on the New York Fed.

Ethical Assessment: It is not clear that the law was broken. On the other hand, this was not the bank’s money the bank was gambling with, as discussed in a prior post. And the size and scale of the bank involved (“too big to fail”) has implications beyond shareholders and depositors. Standards of financial and fiduciary responsibility have, in my opinion, been compromised.

In addition, the fact that Dimon sits on the New York Fed is reminiscent of Goldman Sach’s influence just prior to our last meltdown. For me there is a potential conflict of interest in having the CEO of a “too big to fail” international bank so closely involved with the Fed.

On the positive side I give Jamie Dimon credit for releasing this news as soon as he knew of it, admitting that a huge mistake had been made and taking swift action in holding his personnel accountable. All too often these things are left to drag out, no one loses their job immediately or ever and PR machines are cranked up to spin the story. Not so with Mr. Dimon.

Chesapeake Energy

Earlier in the week it was revealed that only days before the announcement that CEO Aubrey McClendon had borrowed about $ 1.1 Billion against his personal interests in Chesapeake well properties, he was busily arranging another $ 450 Million of similar loans. Not only that, but he was arranging these loans from the same investment management firm that was also putting together a $1.25 Billion loan for the company.

At the end of the week, Chesapeake announced that it had arranged a $ 3 Billion loan for the company itself.

While the company’s loan appears to be related to refinancing opportunities we as yet have no explanation as to McClendon’s need for such large loans. The fact that he has a hedge fund makes one curious as to whether there is some big unraveling going on in that operation and he may be borrowing to keep that afloat. Also Chesapeake shares had dropped from around 34 last August to the 25 area before all this news broke. Perhaps he had his company ownership leveraged too high. Either way it looks like a day of reckoning is coming for Mr. McClendon. Stay tuned.

In Brief

Avon, who is considering a possible merger with Coty, Inc., announced they are cooperating with an SEC probe into “suspicious” trading centering around the merger news.

Former News of the World executive and arrestee Rebekah Brooks was testifying again, but downplayed her relationship with David Cameron, the Prime Minister.

And finally, Tyco surfaced one more time as former CFO and still imprisoned felon Mark Swartz is now suing the company, claiming they owe him $60 Million in retirement benefits and something to do with his taxes. Would those be the taxes on all the money he stole?

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In this morning’s news: JPMorgan Chase reports a $ 2 BILLION trading loss from it’s overseas hedging unit. Bad news, but what does this have to do with corporate ethics?

The Bloomberg article states that CEO Jamie Dimon “had transformed the unit in recent years to make bigger and riskier speculative trades with the bank’s money,” according to former employees. The key phrase is “with the bank’s money” and the question is: Was it really the bank’s money?

Ultimately all of any bank’s money belongs to two key parties: depositors and shareholders.  But in the case of a major international bank such as JPMorgan Chase and many others, what happens to that money also indirectly, yet very significantly, impacts hundreds of millions of people around the world who are neither depositors nor shareholders. We know that is the case because we experienced if first hand, and still are experiencing it, in the 2008 global melt-down.

“Too big to fail” means that failure is a calamity. Banks play a vital role in the world economy and any careless risk-taking can affect all of us. For U.S. depositors the direct risk is mitigated by institutions such as the FDIC. Shareholders are always taking a risk on a corporation’s performance, but did bank management tell them that the risk curve was going up? Many of those shareholders are individuals with retirement assets holding shares of JPMorgan Chase either directly or indirectly via mutual funds and pension funds. In addition, when risk taking results in huge losses it is ultimately the citizenry that bears the brunt with a weakened economy. That is why regulation is appropriate and necessary.

So what does this have to do with corporate ethics? The answer lies in the term “fiduciary responsibility.” In our Seven Layers of Integrity®  model, corporate ethical failure occurred in two layers. Bank management and specific individuals failed to maintain the fiduciary responsibility called for by their profession (professional codes of ethics) and their lack of full transparency with investors failed the investment community and the general public (community standards).

Fiduciary responsibility is owed to one’s depositors and shareholders. It is their money, not “the bank’s money,” that is at risk. A major international banking organization should also have a fiduciary responsibility to the nations and people that rely upon banking stability. In this instance, bank management allegedly pushed the hedging unit to increase the size and risk of the trading positions involved. Was that prudent fiduciary responsibility? The investments they took positions in are called “synthetic credit securities.” Remember “collateralized debt obligations” and “credit default swaps?”  Here we go again.

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Corporate ethics news the past few weeks has been just like a soap opera.  Here we go.

Walmart:  Two congressmen announced that they will launch an investigation into the bribery allegations reported by The New York Times. The Washington Post reported that the federal Department of Justice has been investigating this case since last December. And a major pension fund has filed a suit against the company, claiming “gross misconduct” by the board of directors and executive officers.

BP’s Deepwater Horizon Gulf of Mexico Oil Spill: A former BP engineer was arrested for obstruction of justice. I believe this is the first BP (ex) employee placed under arrest in connection with the oil spill.

News Corp. Phone Hacking Scandal: Testifying under oath, Rupert Murdoch dismissed phone hacking as a “lazy way of reporters not doing their job properly.” He apparently didn’t comment on whether or not it was illegal too.

Chesapeake Energy: One hardly knows where to start on this matter as it is far more complicated than a simple case of allegedly violating the Foreign Corrupt Practices Act. Chesapeake Energy’s co-founder and CEO, Aubrey McClendon, was found to have taken out loans against his personal interest in the company’s various oil and gas wells, as reported by Reuters. We are not talking about borrowing money to buy a house – this was about $ 1.1 Billion with a B over 3 years. This in itself raises various questions, not the least of which is how much does one have to spend per day to need $1.1 Billion in only three years. But the more important questions are how did the board allow this to go on? Where was the oversight? Chesapeake was no longer a privately held Oklahoma based oil-catter where co-founder loans against interest in well sites are just part of the glamour. It became a Publicly Held company, with stock traded on a major exchange.

But the story gets more juicy by the day. First the company argued that there was no conflict of interest as the company had first lien on the wells and McClendon’s loans were his own problem. Sure. So I am the CEO making decisions every day as to which wells to invest more money in and which to shut down and the fact that I have over a BILLION dollars of personal debt collateralized against my ownership interest in those same properties is not a conflict of interest? Holy Muckraker!

Then it also turned out that

  • McClendon ran a separate business of his own, a $200 million hedge fund that, guess what, traded in the very same commodities that are produced by Chesapeake.
  • McClendon sold $88 million of his interests in company wells to Wachovia for use as investment vehicles only a few weeks after committing (with his CEO hat on) to a similar deal with Wachovia for $600 million of company well interests.

Of course none of these activities were conflicts of interest either.  Now the company has taken some action with respect to its co-founder and CEO. They have removed him from the Chairman of the Board position and they have eliminated the program under which the two co-founders could participate in direct investment in company wells.  In the meantime, the company has announced that the SEC has begun an “informal inquiry” with respect to both McClendon and the company.

Commentary: If I had ever done anything like this at any company I have worked for I would have been out the door that very day. Where is the board? If I had ever spent as much time running an outside business from my employer’s office as McClendon allegedly did with his hedge fund, I would have been dismissed immediately. He even had the hedge fund’s mail coming to his Chesapeake office. Where is the board?  I’ll tell you where they are going to be – spending lots of hours in their attorneys’ offices.   As a dear departed friend of mine used to say, “It’s better than TV.”

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