The Short-Term Memory Problems at AIG (and other Boardrooms)

February 12, 2008

Until directors actually do their jobs when it comes to risk, instead of merely boasting about them, disaster will be the inevitable intruder in the slumbering boardroom.

AIG, the giant insurance company which specializes in the assessment of risk, has accounting problems –again. This time, auditors discovered “material weaknesses in its internal controls.” The cost of that weakness comes in the form of a $4.88 billion write-down. It is nearly four times the earlier estimate given by the company. Just last year, AIG paid $1.6 billion to settle state and federal charges that it engaged in deceptive accounting practices to mislead investors and regulators. The payout set a record at the time.

You might wonder how a company that went through such a wrenching and costly experience over poor accounting practices finds itself in another accounting pickle so soon. The answer is that directors have a short-term memory problem. Merrill Lynch also went afoul of regulators in the early 21st century and had to pay out a huge amount to settle. Citigroup had to set aside millions in connection with Enron and WorldCom lawsuits. CIBC, the giant Toronto-based bank, also paid millions to settle regulatory charges that it acted improperly in its Enron dealings. All of these institutions are posting record losses and write-downs related to defective credit instruments. And once again, questions are being raised about whether management and directors are really on top of the affairs of the company.

One might have expected a prudent boardroom to be scrupulous, and more successful, in avoiding mishaps so soon after a previous embarrassment. In AIG’s case, it was required to issue an apology last February, which stated in part:

Providing incorrect information to the investing public and regulators was wrong and is against the values of our current leadership and employees.

But in the modern boardroom, where historically the preferred posture has been lateral for most of the time, there is a tendency to overstate the rejuvenating effects of reform while quickly slumping back into somnolence. The scandals of the Enron era revealed major weaknesses in the accounting and internal controls of many companies. Sarbanes-Oxley was passed in 2002 to address some of the most glaring defects, and companies responded by trumpeting how much more engaged their boards were. But in a few short years, the world has once more been forced to witness the spectacle of boards that did not properly oversee the risks their companies were incurring and ensure that adequate controls were being followed. Shortcomings in internal controls and the managment of risk were also at the heart of the $7 billion trader fraud at Société Générale. They are now featuring prominently in connection with the subprime-prompted credit crisis in many financial institutions.

Until directors actually do their jobs, instead of merely boasting about them, and remember the lessons of the past when risk became a corporate orphan for which no one would take responsibility, disaster will be the inevitable intruder in the slumbering boardroom.

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