June 15, 2010

What have Jérôme Kerviel, Dick Fuld, Tony Hayward, Marc Zuckerberg and Eric Schmidt in common?

At first glance not much. They hail from industries as different as banking, oil and information services. Their professional accomplishments are as varied as their ages, which range from 26 to 64, although no direct relationship appears to link together those two variables.

Their current situations are quite as contrasted. Today Jérôme Kerviel is in the dock, "charged with falsifying documents, breach of trust and unauthorized use of computers", as Katrin Bennhold reports from Paris (*). Two weeks ago Eric Schmidt was the honored guest of the Editor of the Financial Times. To be sure all five have caught the eye of the international media and its glare always causes some level of unease.

Perhaps Jérôme Kerviel would gladly exchange being tried in court for being tried in the media. But what fun can it be for Tony Hayward, BP's CEO, to hear "President Obama [say] he would have sacked [him] if he had the chance", as politely quoted by Christopher Hughes and Antony Currie (**)? Or for Dick Fuld, former Lehman Brothers' last CEO, to read "Anton Valukas, the court-appointed examiner, concluded that there was a sufficient evidence to support a claim that [he] breached [his] fiduciary duties", as commented upon by Francesco Guerrera (***)?

When however Miguel Helft wrote Mark Zuckerberg "was visibly uncomfortable and sweating profusely" at a recent "onstage interview" (****), his target is bound to take his gentle rib as a right of passage appropriate for someone who left college only a few years ago. And Eric Schmidt may have welcome, indeed sollicited, the opportunity to have the Financial Times spread his interpretation of the StreetView data sweepers' activities.

Yet, beyond these obvious differences, Jérôme Kerviel, Dick Fuld, Tony Hayward, Marc Zuckerberg and Eric Schmidt are all rogues, i.e. they have sought large rewards for themselves and their companies in association with large risks with which they have managed to burden society.

I hasten to reject any claim of moral superiority over these gentlemen. Being spared the temptation is not the same as having the fortitude to overcome it. Not for nothing has Jérôme Kerviel titled his recent book "L'engrenage" (1). Neither is it for me to substitute myself to his judges and accept his defense "pour argent comptant". What bankers' paper trades at face value nowadays?

Still Kerviel did not rob his bank like a thief. He simply played loose with the rules with an eye on his bonus. Today he contends "his management knew about his risky trades and turned a blind eye while he was making money", Scheherazade Daneshkhu writes from Paris (*****). At the very least "Jean-Pierre Mustier, the former head of Société Générale's investment bank [...] acknowledged "weaknesses" in the bank's control system".

Society's tacit complicity enables rogues to thrive until their bills come due. The maturity of the latter is the true differentiator in my rogue gallery.

Kerviel's bill was settled for 4.9 billion euros. I will not try to fathom Dick Fuld's bill. When I read "Lehman had used Repo 105 to move $49bn off its balance sheet in the first quarter of 2008", I realize I am out of my depth, as apparently is Tony Hayward whose bill keeps running up so visibly as you read. The issue with Mark Zuckerberg and Eric Schmidt is that their own bills won't be known until some catastophic event uncovers them.

Expect the latter two to take exception with my calling them rogues. They will deny society runs any risk from their cavalier approach to eprivacy. They will put down as minor annoyances the all too human tendancy of employees to peek at the confidential profile of famous people, pass on the rogue label down the ranks to lowly programmers and blithely ignore how fast a vibrant democracy can turn into a most vicious dictatorship.

What then is society to do to avoid the accusation of tacit complicity?

Looking back at BP's disastrous oil leak, David Leonhardt stresses how difficult it is to estimate "low-probability, high-costs events" (******). It will stay that way unfortunately, no matter how many crises befall us. But society should never let its own risk be managed by the rogue who will reap the reward which goes with the risk. Doing so creates a conflict of interest. The rogue may demand it in the guise of self-regulation. There is nothing wrong in his pursuing his own self-interest. But in sheepishly acceding to his wishes society becomes the wolf's accomplice.

The second lesson is a matter of scale. Here Lehman is the better lesson. Despite his avowed ignorance of his own business, Dick Fuld was likely banking on the gambler's eternal hope to get back into luck. As long as one is able to raise the stakes as needed, it is a winning strategy. Ours is a finite world however and, once in a while, money runs out before luck comes back. The longer the game, the bigger the final losses. Society must even face the fact risks may be magnified by scale faster than any corresponding reward.

Can rules provide the solution? But first how do rules work? Some are mere tripwires intended to sound a warning call. One can of course elude alarms. A former compliance agent at Société Générale, Jérôme Kerviel had a head start. But to claim society is complicit when one knowingly disarms its alarms is a moral stretch. Still, since nothing untoward happens immediately when they are breached, are such rules useless to begin with, besides helping to prove a rogue's guilt? No, but society's guilt is to rest content. Without due vigilance, even ringing alarms prove insufficient.

Other rules are last-ditch measures. Unfortunately runaway scale twists them into single moments of failure. With companies too large to fail, bankruptcy rules for instance are similar to BP blowup preventers. Their name belies their function. Again this does not mean last-ditch measures are useless. But society's guilt is in letting babies grow up to be bullies. The real strategist discerns the future when he can still influence it and refuses to be put in a position of being influenced by it.

What is needed is a mechanism which would oppose a growing resistance to scaling up both rewards and risks when they fall unevenly, rewards on rogues, risks on society. Why not follow the lead of AT&T as it attempts to curb its iPhone line hogs? For example tax all data aggregators in proportion of their data accumulation. Define a generous threshold to protect all innovators but the 20% data hogs which prey on us. Put the money into a "social security" account to tap when the data bubble bursts. As Joseph advised, fill up granaries before the famine, not after it has struck.

By discouraging data centralization, such a mechanism would mitigate the risks. Let Mark Zuckerberg sweat a solution for Facebook. It can be done. As for Eric Schmidt, he may find the search ad business is good enough for Google not to covet personal, private information the world over.

Such proposals no doubt would make some business plans more risky. It is high time rogues bet at their own risks to deserve their high rewards.

Philippe Coueignoux

• (*) ........... Trial Begins for French Trader Accused of Costing a Bank Billions, by Katrin Bennhold (New York Times) - June 9, 2010
• (**) ......... A Slip Too Many For BP's Chief, by Christopher Hughes and Antony Currie (Reuters as carried by the New York Times) - June 9, 2010
• (***) ....... Questions over whether Fuld knew of 'accounting gimmick', by Francesco Guerrera (Financial Times) - March 13, 2010
• (****) ..... Privacy Questions Dog Facebook, by Miguel Helft (New York Times) - June 7, 2010
• (*****) ... Mustier accuses Kerviel of lying, by Scheherazade Daneshkhu (Financial Times) - June 10, 2010
• (******) . Underestimating risk, by David Leonhardt (New York Times Magazine) - June 6, 2010
• (1) this French word combines the meaning of a trap with the picture of Charlie Chaplin in "Modern Times", haplessly carried away by gigantic gears.