Friday, December 07, 2012
The Cats In The Hat Won't Be Coming Back
It is no coincidence then, on the anniversary, that I have just finished reading Mr. Woodford's account entitled "Exposure" published by Portfolio Penguin. It is a good read. Not because it is well-written (few, if any, business biographies are). Not because good triumphs over evil. Not because we like him (I am agnostic, not having met him), nor because he is a superhero (which by most measures, he is not). It is a worthy read because at its essence, it is a good story - one that has the requisite suspense and that, in the end, satisfies the reader because Truth, with an upper-case "T") DOES resoundingly trump Deceitful Lies. While it is billed as a story where virtuous David will be victorious over Goliath, in reality, Goliath, (to mix metaphoric fables) is felled by a mouse who shoves a proverbial thorn into his foot, after which Goliath brings about his own syphilitic-like misfortune before committing seppuku. Given the current state of financial markets, corporate governance and transparency in Japan, the triumph of Truth is a moderate victory, albeit within a seemingly endless losing war.
Whatever else Michael Woodford may or may not be, he is earnest. He defines the word. He does everything correctly (even his eventual defiance is diplomatic with the perfect amount of rectitude) respecting convention and culture, from the non-Japanese corporate point of view. From where I sit, as a jaded, borderline-cynic, financial-markets person, this is both refreshing and amusing. He is parachuted into boardroom-central from the periphery, oblivious of what is about to hit him. His first surprise and disappointment: despite the billing and the hype, he's not really CEO. The wily Chairman has given Mr Woodford a title, the grunt work, while keeping the cat-bird's seat for himself. Woodford is perplexed, but not as much as the curious reader who is wondering why these details weren't agreed before. Surely Nissan's Ghosn and Sony's ex, Howard Stringer, despite Japanese cultural aversion to litigiousness have quite detailed contracts. This and a few other slights, seemingly causes Woodford to change his opinion of his former mentor, Mr Kikukawa. Twenty years is a long time to work with someone, get drunk with them, and still not know *who* they are. I joke sometimes that one doesn't really *know* someone until they come and stay at one's house for a while, nonetheless two decades of corporate carousing salary-man-style seems like plenty of time to peer inside your bosses character and realize that he is a dick (even if he was your protector), and you should watch your back. Was the cultural gulf THAT wide?
Earnestness is not far removed from naiveté. Woodford comes across as being an uncomplicated person, seemingly giddy that he has arrived at the top. Perhaps because of his humble origin, he's fearful of risking or losing it all. Iconoclasts, in any event, rarely rise to the top from within Japanese organizations. Mr Woodford, it appears, hasn't violated this rule and rose to his level having respected protocols and conventions in a way necessary to fit in and adapt. Woodford, by his own account makes it clear from early in the story that he isn't The Boss - which miffs him, but not enough to make a stand. He rationalizes, but whatever he does appears to be from a point of weakness because it's a plum job, and he is now in rarefied air that few gaijin have reached. Likewise, despite voicing his concerns about the Gyrus acquisition, he backed off and didn't press the issue - one that if he had, might have brought the affair to conclusion several years prior. By comparison, FDR was reported to have respected General Marshall because even though FDR was known to be bully, making demands and getting his way, Marshall apparently could NOT, would not, be bullied by his boss (or anyone), such that Marshall would threaten to withdraw his services if his wishes were not acceded-to - threats FDR knew to be serious, and that resulted almost universally in FDR's (rare) retreat. One wonders if Kikukawa would have treated him so, had Mr Woodford displayed more of that mettle.
The book's billing readies the reader for the heroic fight of a virtuous whistle-blower pit against the nefarious greedy forces trying to silence him. The actual details, however, differ and complicate the story, First, Mr Woodford wasn't the whistleblower. An anonymous loyal, but conscience-troubled Japanese employee provided the information to an investigative journalist who exposed the scandal in his magazine, Facta. Facta broke the story, revealing the allegations, which got sufficient traction to not only impact the share price, but cause some large shareholders (including Nippon Life) to ask the company for clarification. At this stage, it is unlikely the affair would have gone away. The numbers were too large. The details provided and published by Fatca, too specific. More importantly, the truth was too pregnant, and the scheme to dispose of the losses, too half-baked and ridiculous to stand up to outside scrutiny. The newly appointed Woodford, excluded from any prior knowledge about the zaitech losses or earlier and repeated attempts to repair and prevent discloure, was quickly caught in the cross-fire as the revelations were made shortly after his appointment. Here, we must be clear, that as a result, he was fighting for HIS life and reputation, and new position at the pinnacle, as much as that of the Company. For HIS sake as an officer and director and now man-sort-of-in-charge, he needed answers, for which there no reasonable ones provided or, for that matter available.
Early-on, there is a question that keeps popping into my mind. What would Mr Woodford have done if Chairman Kikukawa, upon offering him the job - but before official appointment - had sat him down, confided in him, and said "this is the situation, my boy". "It's a mission you do not have to choose to accept, but we're up to our necks in nattō*, and we need you to tow the line. No hard feelings if you don't accept, but for the sake of everyone, we need your silence if you balk..." Would he have walked away quietly and acquiesced, given he wasn't under personal attack? Would he have been content to remain European Chairman and await a moment of revelation that might be another opportunity lead the company in the future? Would he have kept the confidence for the sake of friends and colleagues? It's easier to be brave when you're cornered and have no other reasonable course of action. I cannot say with honesty what I would do, despite what I think my moral compass would tell me to do. Mr Woodford may not honestly know the answer. I would suggest that few could answer it until they are actually there, however well-intentioned or perfect their hindsight.
* * * * * * *
The Investigation Report dated January 12, 2012, available on Olympus' official website here: http://www.olympus-global.com/en/corc/ir/tes/pdf/nr120110_2.pdf is the apex of investigative forensic accounting. It resembles an epic tragedy, both in terms of its cast of characters and plots twists. The report was a formidable effort, completed in less than two months. It displays the single-mindedness that the company applies to its product engineering combined with Japanese thoroughness and wholesale effort in pursuit of a goal. No detail, however small, is excluded. Only after reading, can one imagine how many people must have been complicit. Clerks, lawyers, accountants, bankers, advisors. And however discreet and loyal they may be, one cannot help wondering what a payment is for, why an entity is being created, whether a circular collateral arrangement isn't odd. Only after reading the report can one realize how much effort and expense they went to hide to prevent disclosure of the losses - both in terms of time, and money. This metaphorical financial bath-tub ring (original zaitech losses) like the one in "The Cat & Hat Comes Back", will not go away as they try to clean up what is a simple (though significant) problem, only to see it morph, and grow into a larger more intractable problem with the application of each half-baked solution, until it is so bad they need the extraordinary "Voom!". But Michael Woodford was NOT Voom! There is no Voom! for what ails the Japanese system. In the Olympus case, Voom! was old Japan, the status quo of time-honored alliances and obligation between banks, industrial enterprise and government, sending out the army of little Cats in the Hat, to repair the exterior as quickly as possible, and so, making it disappear from view, back under the Hats of the Cats, after which it looks clean, it looks as it was, and if we didn't KNOW it was there, we would be none the wiser. "That's right...nothing here to see...move on please!" But the behaviour that felled Olympus is not gone - just hidden, again, in order to remove the unpleasantness from public consciousness.
There are numerous important lessons here for readers in general and managers, and traders in particular. Others may have touched upon a few. But many of the most important ones have been ignored, I think. These include: (1) Never, ever, EVER try and trade yourself out of a loss; (2) Operating companies should not speculate outside their area of expertise for speculating is hard-enough for dedicated speculators; (3) Coming clean early with mistakes almost always trumps getting caught later with dishonesty. (4) If following the herd down a perditious route, one must take care not to be the last one left; (5) Listen to all approaches by investment bankers with the utmost of cynicism; (6) There are few free lunches. (7) If your excuse is too implausible or convoluted to convince your old schoolteacher, it is half-baked and you will be caught in your deception. Japanese organizational inertia carries unstoppable forces that can be harnessed for much good, but, when it goes awry, is capable unthinkable stupidity.
All these lessons are highly pertinent. There were warrant bonds issued (free money). They could have arbitraged a reasonable profit with no risk. They got greedy and speculated. And lost, bearing witness to the maxim: pigs get slaughtered. They then threw good after bad. Lost again. Then they tried to repair with risk of loss, and lost. They tried to hide them (their only success), but this was costly, and time consuming, and in any event, hiding is NOT the same thing as settling or disposing. To continue the deception, the circle of trust necessarily must be enlarged making it ever-more risky. Several times in the interim, other listed companies confessed to the same, and came clean clean. Olympus missed or willfully ignored all of them. Time, can be your your friend in deception, but it is just as often your enemy. Laws change. Windows of opportunity close. Auditors change. Comrades leave. You look around...you are now all that's left of the herd. Oooops. The rest is history.
Despite the foregoing, having downplayed Mr Woodford as The Hero, one must ask whether Kikukawa and the other co-conspirators are truly villains, rats or fraudsters? Let's try and see it from their perspective. Consider if revelation at the time of incurring them would have caused bankruptcy or similar? Have Olympus' constituents (employees, suppliers, bankers, customers, service providers, shareholders) - which it was Kikukawa's role and duty to shepherd - of which shareholders are but one, done better in the long run with the scheme? Does it not bear some similarity to what governments and monetary authorities did in 2008, and continue to ("extend and pretend", or "kick the can down the road")? To be clear, this is not a question about judging or exonerating Olympus corporate behavior. Laws were, of course, transgressed. But it feels like it needs to be asked...if only to establish intention, and by extension, shades of guilt. The world has been harsh in the language used in describing events, and to some extent it clouds their predicament, response and attempted resolution. There is a harsh linguistic for malfeasance and cheating for parochial gain. There is something again for bad behaviour involving organizational gain but NOT involving personal gain, and something wholly other - something the descriptive english language not yet invented, something peculiarly Japanese which relates to actions meant to protect one's affiliated organization and constituents against organizational harm and loss. I posit that Olympus' management and board, being guilty of the latter, have been universally accused and vilified for the former - of being John Grisham-like villains, where in reality, they were Laurel & Hardy-ish in their buffoonery and cock-ups - each action intended to make it better, but in practice, as events conspired, literally compounding the problem. Never failing to miss an opportunity to miss an opportunity to come clean, it festered like a huge repugnant white zit until ooooozensplattersploozing over the guilty.
Enron, Adelphia, Tyco, Worldcom, by contrast, were entirely different. They were frauds. They were driven by the parochial greed of likely sociopathic individuals, in a zero-sum war of "For me and mine at the expense of everyone else". Kikukawa and Olympus, for all their flaws and even personal his vanity as described by Mr Woodford was, at worst unrelated to such motivations, and at best the complete opposite of the sociopath driven by individual greed. Mr Kikukawa, and the other complicit officers and directors, rather than being hung and quartered as racketeering fraudsters, might be seen through an entirely different lens, one in which they were, in their own albeit warped and twisted way, defending the complex web of affiliations and obligations called Olympus - something bigger than any of them, to which individually honest men will conspire to no end in order to protect the honor of the organization. Their crime(s) - reflecting a society where a proposed marriage of relations might get torpedoed due to the stigma of family member's affiliation with a disgraced organization, or that spawned The Seven Samurai - through this lens, are poor judgment, and despite intentions that could be seen as not less-than-self-serving, being inept in failing to achieve their objective of repairing losses, and missing the opportunity to come clean and spare greater shame, once the initial bankruptcy threat had passed.
Entertaining such thoughts is undoubtedly repulsive to western shareholder-first and good corporate governance sensibilities. But it must be remembered that in the early 1990s, Olympus was a much smaller company. The zaitech losses were sufficient to, if not bankrupt then threaten the company's independence, and certainly its honor. S.O.P. at the time, all across Japan, was to defer losses and pray. The entire system was designed to support them in such efforts - Japanese brokers had special departments dedicated to helping clean up similar problems - as did foreign banks and brokerage firms including our most venerable. Olympus' FIRST repair-bonds, if my information is correct (overlooked by the Jan 12th 2012 Report and Mr Woodford), were structured by foreigners, lest we in the west be become too moralistically hypocritical, as the recent ex-smoker chides the one unable to find the fortitude to quit just yet. For it was, and probably still is, the Americans, British and French bankers who possess the most questionable morality, most devious know-how in circumventing global audit firms, along with the wherewithal to conjure appropriate supporting opinions from well-known law firms, such as those supplied to Lehman's Repo 105, or dubiously-disclosed Synthetic CDO structures, and off-balance sheet SIVs with far less socially-minded intention. Again, despite what is laid out above, I am not condoning their actions. But as history is written by the victors, those wanting a more complete picture must take care not to succumb to righteous revisionism from which crucial context is lost.
Some will vilify the Olympus old guard on grounds of violating the primacy of shareholders' interests. Despite the dramatic drop in the share price as a result of the revelations, such critics might evaluate outcomes under alternative scenarios. Original losses were equivalent to the prevailing market cap Olympus. At the time, this would have resulted in either bankruptcy (less likely given the underlying business), a huge dilution to raise sufficient capital to continue independently; or a forced merger, likely on poor terms with another Sumitomo-group firm. All would likely have compromised shareholder value for shareholders at that time. Jobs - both in Japan and abroad would have been at risk; growth of the crown jewel (med tech) might even have been jeopardized or never evolved the way it did had Olympus lost independence. Management, quite literally, cheated death, and legacy core shareholders were likely better served. Subsequent investors acquiring shares regretfully won't be as thankful. Deferring recognition for a decade, the company grew large enough to absorb losses without threatening the existence of the firm.
It was 2001 when Kikukawa took the helm, and if we are to believe him (according to testimony at his autumn trial), this is when he found out. At that time, he claimed that HE suggested 'fessing-up, but, was allegedly told by by the CFO (who was very culpable) that this would "be crazy". Apparently disagreement exists in Japan too, though in this case, he acquiesced. Sadly, for most involved, he didn't confess when he could have. They missed the chance when Yakult and a dozen others DID were forced to come forward, caught up in the SECs case against PEI's Martin Armstrong and Cresvale for their loss-hiding and repair-bond transgressions. THIS may prove the most fatal error in management judgement. For after Enron, and uproar resulting from the sheer number of companies that had done exactly the same thing - zaitech spec, resulting losses, and subsequent loss concealment - laws changed. Now, culpability involved more than a deep bow and a pay-cut. Now, continuing loss deferral was no longer just organizational loyalty, and shame avoidance, but self-interested prison avoidance. Ultimate disposal took on new and urgent meaning. This was still a different motive than the American Gang of Four, but over time became no less parochial in nature.
Deferral is not disposal. Disposal meant figuring a way to move a billion through the income statement so it could match the needed write-down in the balance sheet. Disposing of a billion-plus dollars in extraordinary losses without transgressing laws that would result in prison was always going to be tricky. Now, I would have thought IF you were going to try to do it, then the Camera division might have been plausibly large enough to provide cover. But this would have required much wider spread complicity. The "kitchen sink method" used by western companies for decades whereby one searches high and low for any write-down to get it all out might have been an option during this time for an enterprise with 8, 9, $10 billion in revenue.
Those are the limits of my contrapreneurship. It is likely that disposal was impossible. It is just harder to keep a secret in modernity with the internet, globalization, and increasingly electronic slime trails. Having said that, whoever hatched Olympus' hare-brained scheme to use elephantine advisory fees tied to flea-sized acquisitions deserves whatever fate they receive. What were they thinking? No one would notice? It was so weird and obviously wrong it challenged deeply-held feelings of loyalty resulting in a leaked revelation. This is where the previous analogy with the Kurosawa's Seven Samurai stops. Olympus' guilty should have figuratively fallen on their ritual swords for the sake of the company - even if it meant jail. Here, by this time, given the absurdity and preposterousness of the dispoal efforts, Mr Woodford, by being earnest and diligent and staying the course was always going to win. He makes it sound like a dead heat, and it probably felt like that to him and his family, under siege as they were. But since the stakes, for the system were high, authorities and old Japan had to give the appearance of being concerned with international norms and foreign shareholders - especially the good long-term ones like Southeastern and Harris Associates - (as opposed to carpetbagging activists). With enough attention, this was always going to be greater than the inclination to rally behind Olympus. He really needn't have worried (unless Yakuza's pension funds were heavily long Olympus and...). And in a small way, this is progress, if not for honest business practice, then for Truth.