Is Countrywide a Governance Train Wreck?

Just four years ago, Countrywide, and its cofounding CEO, Angelo Mozilo, seemed positively prescient. Quickly seizing on the popularity of [...]

June 2 2008 by Chief Executive


Just four years ago, Countrywide, and its cofounding CEO, Angelo Mozilo, seemed positively prescient. Quickly seizing on the popularity of adjustable rate mortgages in 2004, the firm came up with a smorgasbord of new alternative loan products, diving into the subprime market and quickly grabbing share from competitors. Countrywide leapt out in front as the nation’s No. 1 mortgage originator that year, revenue soared, and Mozilo won numerous accolades and awards for his savvy strategy and execution.

Since then, of course, the picture has drastically changed. In the wake of the mortgage market collapse, Countrywide’s previously lauded practices have been recast as at best overzealous and, at worst, criminal. The company has been the target of numerous lawsuits across the country that accuse the lender of predatory lending, among other sins. In March, the Justice Department and the FBI opened a criminal investigation into possible securities fraud, and the United States Trustee filed its second lawsuit against the lender, accusing it of abusing the bankruptcy process.

Mozilo, staunchly unapologetic, has come under fire personally for presiding over Countrywide’s subprime mess, poorly managing risk and for selling off stock worth $129 million from 2006 to 2007; those stock sales have been under SEC investigation since last year. Countrywide’s board, meanwhile, fended off shareholder demands for a change at the top and stood by both its CEO and his enormous pay. (It defended, for example, its decision to hire a second compensation consultant for Mozilo when the CEO refused board attempts to rein in his pay in 2006.)

Governance experts say a closer look at the Countrywide spiral reveals a board that either did not understand the business or that could not stand up to the founder when it mattered. Though Bank of America’s pending purchase of the troubled lender ultimately will put Countrywide’s governance woes on the agenda of a new board, there may be some governance lessons to learn from the debacle. To unearth them, Chief Executive asked 10 governance critics and visionaries to weigh in on Countrywide’s governance performance as it related to compensation, business strategy and change in leadership.

Countrywide Board of Directors

Angelo R. Mozilo
Chairman and Chief Executive Officer
Countrywide Financial Corporation
Chairman Countrywide Bank, FSB

Martin R. Melone
Retired Partner
Ernst & Young LLP

Keith P. Russell
President and Chief Executive Officer
Russell Financial, Inc.

Jeffrey M. Cunningham
Chairman & Chief Executive Officer
NewsMarkets LLC

Robert T. Parry
Retired President and
Chief Executive Officer
Federal Reserve Bank of San Francisco

David Sambol
President and Chief Operating Officer
Countrywide Financial Corporation
President and CEO Countrywide Bank, FSB

Robert J. Donato
Retired Executive Vice President, Los Angeles Branch
UBS Financial Services

Oscar P. Robertson
President and Chief Executive Officer
Oscar Robertson Solutions LLC

Harley W. Snyder
President
HSC, Inc.

John F. Sandy Smith, partner, Morris, Manning & Martin, and advisor to boards on corporate governance

Yes, [it is a train wreck]. The fact that they hired a second consultant shows that the collegiality of this board is overcoming the structure of corporate governance. Rather than fight this guy, it’s, “Lets go hire him another consultant.” You would think that by hiring another consultant, you’re meeting your fiduciary duties, you’re covered as the audit committee. But to me it says they couldn’t stand up to Mozilo. It just shows a fear of the founder by the board. It doesn’t show the independence that you look to see. That they would do this also shows the board has a real tin ear for what’s going on in the world since last August. On the other hand, they’re not the first ones. When [former New York Stock Exchange CEO Richard] Grasso was negotiating his exit after the dotcom meltdown, the board gave him a big exit as well. The amazing thing is that nobody seems to learn from all this. This is not the “left-wing press hammering on boards,” as Mozilo says. This whole industry is bringing the whole economy down and nobody should get a gold star. If the coach has a losing season you don’t give him a goodbye kiss.

Nell Minow, editor and cofounder of the Corporate Library, a pro-investor research firm

If the board’s No. 1 job is risk management, it’s fair to say they’ve failed miserably. They could have done a much better job of tying pay to performance. This company has been high risk from our perspective for a long time and the reason is the pay-performance link has been completely out of whack. Over and over again our data show that companies where there is the greatest disparity between pay and performance are most likely to get into one or another kind of trouble. And in general, CEOs should not be allowed to hire competing consultants on the shareholders’ dime when they do not agree with what the comp committee’s consultant recommends. Any committee that permitted that-and any committee that agreed to that appalling compensation-by definition was a failure.

 Josh Weston, retired chairman and CEO of ADP and member of the advisory board for the Institute for International Corporate Governance & Accountability

Let’s put it this way-there are a fairly large number of companies, including Countrywide, that have very serious problems. Everyone in that industry, including Countrywide, was being very sloppy and greedy in looking at the creditworthiness of whom they were lending to, in a big hurry to close in on deals. As regards their CEO, it’s the board’s responsibility to oversee the veracity and risk aspects of whatever the CEO is doing. I have to believe the audit committee at Countrywide didn’t do their job. And if they did their job, they should have reported it to the whole board. And if they reported it to the board, with due appreciation to any founder, if a founder is off the deep end in the risk-reward balance, first the board should rein him in and if they don’t know how, they should get a different CEO.

 Larry Mitchell, founding director of the Institute for International Corporate Governance and Accountability at George Washington Law School

Under the circumstances, the board ought to have at least seriously considered removing the CEO. But you don’t necessarily have to can the guy. You can suspend him. If it’s a question of whether or not his managerial decisions are right, you can’t rush to can someone unless it’s very obvious that they’re leading you down the tubes.  But if we’re dealing with questions of integrity, as long as there are questions or the accusations have some credibility, then the board has a responsibility to conduct an internal investigation and to suspend the CEO while that is going on. Probably when you have a founding CEO, other senior executives tend to go along, but it does become more complicated than simply, “Things are going badly, let’s fire the CEO.” That’s an easy solution, but not always the best solution and not always the required solution. So a lot depends on what they knew and when they knew it. If dishonesty is a suspected factor, then that changes everything. 

Eric Pan, assistant professor of law and director of The Samuel and Ronnie Heyman Center on Corporate Governance at the Cardozo School of Law

The board did not distinguish itself. That’s clear. There is a real question as to whether stock options as incentive compensation are really doing their job and whether we should be structuring compensation a different way. But that said, stock options were given to [Mozilo] and he had the right to claim them.

The consultant issue is a big problem. Boards spend too much time deferring certain decisions to outside consultants. Rule No. 1 for the board is to ensure that if they’re going to get outside advice, that it’s independent outside advice. Finally, if the company is being led down the wrong path, to what extent are we going to expect the board to be responsible for that? That’s the really tough question. On the one hand we don’t want boards to be overly intrusive. We don’t want them to be running the companies. That’s not what they’re there for. They’re there to monitor what the CEO is doing, to ensure the CEO is doing the best he or she can, but not to micromanage.

On the other hand, a board that has serious disagreements with where the CEO is leading the company should say something. The directors would be remiss in their duty to the shareholders if they stayed silent.

Bruce Ellig, author of the expanded and updated The Complete Guide to Executive Compensation

There are two major players in the subprime issue: one is top executives and the other is the boards. The top executives are looking to increase their bonuses and the boards are looking to get better earnings that hopefully translate into better share prices and happy shareholders. So when the subprime opportunity came around, the executives saw a great opportunity to increase their bonuses and the board saw an opportunity to increase earnings and no one really identified the degree of risk.

The answer to it is better corporate governance. The board has to have somebody sitting there who raises his or her hand and says, I don’t really understand it-can somebody explain it to me? What’s our degree of risk? Going back to Enron, how many members of the board understood what they had gotten into? Very few. It’s the same here. 

Bennett Stewart, chairman and CEO of EVA Dimensions LLC, and chairman and CIO of EVA Advisers LLC, and an expert in business valuation and performance measurement

I really can’t get upset over CEOs who want to hire their own pay consultants. I don’t blame a CEO for wanting to get the best deal for himself. Alex Rodriguez has his agent to negotiate with George Steinbrenner and his crew. [Regarding performance], there are many businesses where you can look good in the short term and look real bad in the long term. At Countrywide, you can be really imaginative in coming up with all kinds of products and book all kinds of profit for a long time when the economy is doing well and then it can really come home to slam you. Boards of directors have to insist that bonuses that are based on any one year’s results not be fully paid in that year and that with any kind of bonus that is extremely large, a portion is paid but a large part is banked forward and subject to forfeit if the results aren’t sustainable.

Same thing with stock options and restricted stock-you want to force a CEO in particular to have a very long holding period where he or she can only sell the stock in bite-size drivels over a long period of time. The problem is not him selling the shares-it’s the board allowing it. That’s a governance issue, but it’s a common governance issue. I wouldn’t call that a train wreck.

William Patterson, executive director, CtW Investment Group, a pension fund advisory group

Mozilo clearly demonstrated a leadership failure. He was given a substantial amount of time to demonstrate his ability to redirect the company and failed to do so. Divesting his own holdings seemed to be a clear measure of where he was.

There was an enormous board failure-a compensation failure, a risk management failure-at Countrywide that shouldn’t be repeated at Bank of America or the other banks. We’re intent on pressing for stronger internal control and risk management oversight across the financial sector. Bank of America just got hammered at their annual meeting at Charlotte on the question of how they’re going to manage the acquisition, so they’re on notice. 

Richard M. Steinberg, governance consultant and a former senior partner and the corporate governance practice leader of PricewaterhouseCoopers

Boards of any public company, and those in the financial services industry certainly included, have a responsibility to oversee the operations of that business. They have a duty of loyalty, and more pertinent here, a duty of care. In that duty of care is a responsibility to be comfortable that the company has an effective risk-management process in place. The board needs to be satisfied that management is proactively identifying major risks, analyzing those risks and taking appropriate action to manage them. It’s evident in the subprime mess that a number of boards had not been focusing sufficiently on their companies’ ability to identify, assess and manage risk. For a number of companies caught up in the subprime mortgage debacle, either senior management was not sufficiently aware of the risks the company had taken on and/or did not communicate those risks effectively to their boards.

Regarding the compensation consultant issue, no, I don’t like the idea of dueling compensation consultants in the same company. There is no doubt that best practice today is for a compensation committee to engage its own independent compensation consultant. And in my view it’s inappropriate for a CEO to engage a compensation consultant on the company’s dollar to negotiate his/her own pay.

Dan Dalton, founding director of the Institute for Corporate Governance, Dean Emeritus, and the Harold A. Poling Chair of Strategic Management in the Kelley School of Business, Indiana University

We have a CEO who by all accounts has failed. On his watch, Countrywide went from one of the premier mortgage companies in the world to basically nonexistence. He cost shareholders hundreds of millions of dollars, and yet after all that walked away from the enterprise with what most of us would believe is a fortune. When the board puts together compensation packages, they have to look forward. They have to look at what the scenarios are and what would happen to us if in 10 years the company did so and so, what would our CEO and executive officers get, and that’s part of the compensation planning. If the number is silly-people refer to this as the “holy cow” approach-if those numbers look holy cow-ish, you should be doing something about it. In that regard the board failed. There were a number of issues that, any one of them, you might be able to forgive for various reasons. But taken in concert, you really do have to wonder what was going on on their watch.