Citigroup Shareholders Meeting: Lessons in Corporate Governance

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Includes: C
by: Rick Konrad, CFA

Corporate governance has always been an important part of value investing. Obviously, most of us hate waste when precious company resources are squandered to build executive dreams rather than shareholder capital. Misallocation of capital and failure to optimize returns on capital have led me at times to conduct activist campaigns with some managements. This can lead to stormy verbal exchanges, but occasionally, has led to real change in management strategy, abandonment of some projects, and greater focus.

Though managements can ignore shareholders for a period of time, the annual meeting of shareholders allows investors an opportunity to vent, to express opinions, and to make suggestions.

Today, I attended the Citigroup (NYSE:C) annual meeting, as you can imagine, a very raucous affair.

I thought readers may find it helpful to see a question that I posed to Richard (Dick) Parsons, the chairman of Citi. Much of the board of Citigroup has been in place for many years, and though management has started to slowly bring in some new board members (with actual banking experience) some of the "deadwood" remains.

Mr Chairman, my question relates to the effectiveness and qualifications of our Audit and Risk Management Committee.

On page 35 of our proxy, we have the Report of our Audit Committee which indicates that the Committees meetings facilitate communication among members of the Committee, management, independent risk managers, internal auditors, and Citi's independent auditors.

On page B-3, Annex B of the proxy, the Committee is charged to review and discuss with management, at least annually:

"Developments and issues with respect to reserves" and "Off balance sheet structures and their effect on Citigroups consolidated financial statements." as well as

"Effectiveness of the bank's advanced systems for the calculation of risk-based capital requirements"

Under the section regarding the "Oversight of Risk Management", the audit committee is charged with responsibility to review with management the categories of risk the company faces including financial, operational, reputational risk AND

Review the risk policies and procedures adopted by management.

No one can deny that risk management at Citi has been an abysmal failure. It seems that the mission of this company was a Star Trek mission..."To boldly go where no man has gone before."

This company lived under an illusion of prosperity...an illusion that has been endorsed by the lack of oversight and ability of the Audit Committee to fulfill its responsibilities.
Over the last five years, the Chairman of our Audit Committee was Mike Armstrong, who at the same time served on the Executive Committee. That same committee was chaired by none other than Bob Rubin whose hypocrisy and denial of the risks that have taken this company down, all shareholders are suffering for.

I am at a loss to understand how someone who was on an Executive Committee, supposedly steering this lumbering ship, could maintain independent judgment by chairing the Audit Committee. Obviously, someone here, most likely the Nominating Committee agrees since:

Mr. Armstrong, who has been a director since 1989 is no longer part of the Audit Committee, as of this year, continues his "service" to our Company on the Nomination as well as the Compensation Committee. Much as this company has suffered under an illusion of prosperity, it appears to continue to suffer under an illusion of competence.

During Mr. Armstrong's tenure as the Audit Committee chairman, the incalculable loss in shareholder value due to his failure, and the Committee's failure to properly manage risk has led to some of the spirited discussion that you are experiencing today. I applaud Mr. Armstrong's removal but wonder about how much more damage is feasible after his 20 years on this board.

I see we have now appointed John Deutch to chair the Audit and Risk Committee.

John has been part of the board for two tenures, initially between 1987 and 1993 and currently since 1996. John is a brilliant scientist who has served this nation with distinction as an Undersecretary in the Department of Energy as well as the Director of Central Intelligence. It seems that one of the things most lacking at Citi is central intelligence.

John apparently did a BA in History and Economics back in 1961, presumably he may have studied some accounting back then, perhaps Accounting 100, though unlikely to have studied anything about risk management or auditing.

John has served on the Audit Committee of our Company since 1997 and hence, likely drank the Kool-Aid as to the Illusion of Prosperity.

John has served on other boards, mostly as a member of the nominating committee or technology committee but I see that he has served on the Finance Committee of Cummins Engine.

The last time that Citi had a Finance Committee, it was chaired by Jamie Dimon in the mid-90's...I hear he's done pretty well since.

John's only other service on an audit committee was at CMS Energy where while under his tenure, where:
-the Company had to restate its financials for its energy trading business a la Enron
-it had inflated its revenues by $5.3 Billion
-had to engage in major asset sales in order to survive, selling off most of its foreign operations in India, Brazil, Australia...unusual for a funny little utility in Midland Michigan
-and presided over the CMS stock falling to an 18 year low and down some 90% peak to trough.

I suppose that in some ways, John may be imminently qualified to add value given his experience, nevertheless, it does seem odd to offer an audit committee post to someone who presided over disaster in his only prior "at bat."

It is surprising to look at the current board, outside the new additions, and see so many characters,who though they may have a lot of management experience and executive expereince, seem to lack accounting or audit or even finance credentials. As Buffett has said, there are many banks but few bankers. It appears that none of our existing audit committee members have any prior financial services experience!

I note that the audit and risk management committee has many members who, like Mr Deutch and MrArmstrong presided over this seemingly out of control disaster.

Andrew Liveris since 2005 on Audit

Ann Mulcahy since 2007 on Audit

Dr Judith Rodin since 2004 on both Executive and Audit Committees

Shareholders can no longer countenance the shameful incompetence of our Audit and risk committees financial expertise where it is clear that there is none.

Rather than your vote, they deserve a dressing down that would knock years off their lives. We have been victims of their steely eyed stare into nothingness.

Mr Chairman, is it not time that the same standard applies to our board as has been applied to some former members of management...the standard that sent our Chief Risk Officer in 2007 to the dugout to contemplate the meaning of "sub-prime"...the same standard that sent Chuck Prince into a glorious retirement at huge expense to shareholders...out presumably for dance lessons.

Mr. Chairman, I respectfully submit that it IS time for meaningful change in our Audit and Risk Management Committee.

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Most of us investors tend to vote with our feet and simply sell the stock. I urge you to read the proxy statements and if there is something egregious that you see, to let the board know and to let it be known in a public forum. Stupidity needs to be aired out and benign neglect needs to be addressed.

Change, though glacial and slow can be achieved.

Disclaimer: I, my family and clients may have a position in certain securities mentioned in this post.