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Schwab Makes His Move

The inside story on how Charles Schwab and his board finally agreed it was time for the fatigued founder to step aside.

Charles Schwab has had a lot to be proud of for many years. But for all his accomplishments, Schwab seemed unable to transcend the limitation that has snared almost every company led by its founder: an inability to let go of the reins.

That’s why the news in late January that Schwab, 65, was relinquishing his role as co-CEO of The Charles Schwab Corp. was so intriguing. The decision was the clearest signal that Charles Schwab was finally ready to start trusting other people to be stewards of his name, his legacy and his chief investment (the 25 percent of the company he controls is currently worth more than $2 billion, down from $10 billion a few years ago).

The decision to relinquish the executive role he has shared with co-CEO David Pottruck since January 1998 was slow in coming, to put it mildly. For many years Schwab opposed giving up day-to-day management of the company and resisted the periodic efforts by his board of directors to discuss the issue. But in late January, Schwab announced that Pottruck would be named president and CEO. Both decisions will take effect in May at the Charles Schwab Corp. annual meeting.

The announcement caught most Schwab watchers by surprise. Even as recently as a few months ago, Schwab told interviewers that he had no plans to change his status with the company or reduce his engagement.

So what changed? One piece of the explanation is that the underlying business is in trouble. The discount brokerage he founded in 1971 is in the worst tailspin of its history. Every indication was that Schwab’s goal was to wait out the downturn and retire when the company was on its way back up. But that clearly is not happening, so what combination of forces compelled him to make this decision now?

The company claims it’s simply good governance to keep the titles separate. “As many experts have suggested, from regulators to Congress to independent blue ribbon panels, it is important in today’s environment that the positions of CEO and chairman be distinct and that the chairman play a central role,” Schwab said in a statement.

It’s true that governance is a hot topic and the board had been paying more attention than before. But ultimately, that had little bearing on Schwab’s decision. “The current and much-needed debate on governance served as a fortuitous context of this decision, but it really wasn’t the driving factor,” a member of the Schwab board of directors told CE on the condition of anonymity. “I’m glad we got some points for jumping on the governance bandwagon, but the background of Chuck’s decision-and it was Chuck’s decision-was much more mundane.”

It’s extremely unlikely that Pottruck forced Schwab’s hand. While it is true that the original co-CEO arrangement was a product of a Pottruck ultimatum, all evidence suggests that he had been satisfied recently with the status quo.In late 1997, discussions had led Pottruck to believe he would be named CEO. But at the last minute, Schwab balked at relinquishing the title. It was only at that point, with Pottruck threatening to walk, that the board intervened to hammer out the co-CEO arrangement, according to sources close to the board.

Hard feelings aside, the problem wasn’t with the co-CEO structure, per se. A number of such partnerships at Goldman Sachs and other financial services firms had demonstrated that the structure was not only viable, but offered a number of benefits. But the arrangement required the partners to be equals. About the only tangible concession Schwab made to equality was that Pottruck’s pay would be raised to equal his own. “If you’re co-chief executives, you get paid the same,” said Anthony Frank, former U.S. postmaster general and a Schwab director.

Yet even casual observers understood that the co-CEO arrangement at Schwab wasn’t 50-50. “Nothing really will change for me,” Chuck told the San Francisco Chronicle a day after the 1997 announcement. “I don’t think anybody who knows me personally thinks Chuck is going to be retiring anytime soon.”

Pottruck would go out of his way to acknowledge that Chuck Schwab was the senior member, saying he was happy being No. 2. “I would consider myself unrecruitable,” he said. “I have too much sense of ownership. There’s no position anyone could offer me, including a CEO position, which would make me leave.”

But the pretense of equality debilitated the organization. Schwab’s unwillingness to take himself out of operating responsibility created a vacuum that distorted relationships among the executive committee. Recruitment and retention of top talent became difficult, and healthy executive development almost impossible. Tensions between the men increased. The board of directors became nervous, but didn’t know how to resolve the conflict. Most directors had little faith in the co-CEO arrangement. “The co-chief executive thing is a contraption; it keeps the trains running,” said a board member. “Pottruck is obsessed with the title and Chuck is obsessed with not giving it up.”

The toxic management environment claimed a number of promising Schwab executives and scared off a number of other potential recruits. Among the former was Steven L. Scheid, a vice chairman and head of the retail investing division, who resigned in February 2002 after serving just two years. Scheid went on record as quitting because of autonomy issues: Pottruck, he said in an unusually frank statement, insisted on exercising too much control over his division. Said Pottruck: “We had different views about the level of autonomy that was appropriate.”

Scheid joined an impressive roster of executives who have left Schwab after locking horns with Pottruck. This turnover was of enormous concern to the directors. “The board feels helpless that the company develops people and moves them up and then Dave finds a way to knock them down,” said one director.

The fact that the business started deteriorating in 2000 put pressure on the board to act. Within three years, Schwab lost 80 percent of its market capitalization and, thanks to a series of layoffs, reduced headcount from 25,000 to 16,700. Though part of that was due to the financial markets themselves, Schwab was also losing market share.

But ultimately the board didn’t have to force a resolution. The reality behind the CEO’s decision to give up day-to-day control is far more mundane and predictable: Schwab, who turned 65 in the summer of 2002, was simply tired.

The co-CEO arrangement required him to attend too many meetings, according to a board member. Both Pottruck and Schwab were committed to making periodic visits to hundreds of Schwab branch offices and service centers around the country. “Chuck doesn’t want to show up as much as he did,” a board member says.

While the Schwab board is a little more closely aligned to the currently fashionable ideals of director governance, there are still several other outstanding issues that it might consider.

The first is the issue of interlocking, quid-pro-quo directorships. Currently, Charles Schwab serves on The Gap board while Donald G. Fisher, chairman of The Gap, serves on Schwab’s. This kind of structure is increasingly criticized by regulators and governance reformers.

The second issue is the board’s lack of a nominating committee, the venue in which strategic succession issues traditionally get discussed. When a board member periodically inquired about why the company did not have a nominating committee, Schwab simply said, “I don’t want one” and changed the subject, according to the source. Now is the time for a more rational process.

Schwab’s decision, however belated, to take a giant step back represents progress, putting the company that bears his name on a more credible management path. Despite years of what critics might call foot-dragging, his decision in the end was consistent with his lifelong dedication of putting the customer first. That’s a legacy worth protecting, even if it means someone else gets to call the shots.

John Kador is the author of Charles Schwab: How One Company Beat Wall Street and Reinented the Brokerage Industry.

About John Kador

John Kador
John Kador is a business author based in Lewisburg, PA. His last book is What Every Angel Investor Wants You to Know: An Insider Revels How to Get Smart Funding for Your Million Dollar Business (with Brian Cohen, McGraw-Hill).