Ethics and governance in the European Financial centers

In an interview one month ago, Serge Allegrezza analysed without kindness the Crisis. If the financial sector had, in the Eighties, taken over from the iron and steel industry, he cannot see any new sector.


In the Eighties Luxembourg had actually implemented what Spencer Johnson explained in his famous book “Who Moved My Cheese”. In the style of a parable, Spencer Johnson described what is to be done to face change.

The process is the following as described in the book:

1. Change Happens
They Keep Moving The Cheese
2. Anticipate Change
Get Ready For The Cheese To Move
3. Monitor Change
Smell The Cheese Often So You Know When It Is Getting Old
4. Adapt To Change Quickly
The Quicker You Let Go Of Old Cheese, The Sooner You Can Enjoy New Cheese
5. Change
Move With The Cheese
6. Enjoy Change!
Savor The Adventure And Enjoy The Taste Of New Cheese!
7. Be Ready To Change Quickly And Enjoy It Again & Again
They Keep Moving The Cheese.

This is exactly what Luxembourg did to replace the iron and steel industry.

Luxembourg imagined new activities, and became a great financial center.

Luxembourg has always had a taste for niche opportunities, in fact selling its sovereignty.
Examples:
RTL
SES
Cargolux
Shipping Register and of course the
Financial Center.

When in 1974-75 the steel crisis broke out, it made socially and economically good decisions: creating the DAC, Division Anti Crise, and the BED or Board of Economic Development. Two remarks though: DAC was needed because nobody had seen the Cheese moving, and BDE failed to diversify because the actors saw the easy Cheese in Finance.

As far as the financial center is concerned, the problem is that the actors defined the center with specific parameters that were their cheese for business success:
- banking secrecy (despite the fact that it was not a tradition in Luxembourg contrary to Switzerland)
- little control and little sanctions compared to other jurisdictions (it may be proven with ratios)
- a trend to hush up issues or dysfunctions with a press that does not really act as a watchdog
- specific pragmatism with the meaning of laxism
- no fear of international sanctions thanks to the memberships : FATF, OECD, European Union.
- …

Since 2004-2005 I called to make an aggiornamento because the world was visibly changing and the parameters of development of the Luxembourg financial center were dramatically overhanging: in other words their “cheese” was becoming dangerous for the jurisdiction.

In a book that was published in 2006, I noticed that professionals in Luxembourg were self-satisfied with a lack of positive pragmatism as they were unable to see that the reality of the world was changing.

The cabal against the OECD, the G20… while they are not questioning the dysfunctions of the jurisdiction, demonstrates that the Luxembourg authorities and professionals do not want to adapt the cheese to the reality of today’s world.

The CSSF published last Wednesday two press releases to state that two Luxembourg-domiciled investment funds that had money invested with Bernard Madoff are to be wound up. The first one for Luxalpha SICAV and the second one for Herald (Lux) SICAV.

In both cases it is stated that "The judgment specifies, that the liquidators represent the company as well as its investors and creditors and, that their powers will be exercised in the Grand Duchy of Luxembourg and abroad pursuant to the unity and universality principle [règle de l'unité et universalité] of the judicial winding-up of a company, having its registered office in Luxembourg. This rule applies to all moveable property and immoveable property of the wound up company, even if these properties are abroad.
The judgment states that the unitholders shall be considered as shareholders which will share the surplus of the winding-up. According to the judgment, they do not need in these circumstances to file their statement of claims in order to assert their rights. At least once a year, they will be convened by the liquidators in a general meeting in order to be informed of the results of the winding-up and the reasons why the winding-up procedure has not been terminated. The first general meeting will be held before 31 October 2009. During this meeting the possibility to constitute a committee of creditors/investors could be discussed."

As I already wrote, the Luxembourg authorities and professionnels are handling in a very bad way the Madoff case:
- they did not tell the truth about the legal and regulatory framework in Luxembourg that did not transpose faithfully the European Directive : the synoptic table is clear enough.
- they did not take the initiative at the beginning to compensate clients. Should they have compensated the clients, the issue would be over. The reality is that for clients recovering their money lost is a "long shot" with expenses to pay for the lawyers that anyway will not be included in the surplus of the winding-up.

As the fund industry is a key success for the jurisdiction I cannot understand the reason why almost everyone in the jurisdiction is doing wrong.

Or rather I understand very well: it is perfect illustration of what Sydney Finkelstein described:

· Flawed executive mind-sets that throw off a company's perception of reality

· Delusional attitudes that keep this inaccurate picture of reality in place

· Breakdowns in communication systems that were developed to handle potentially urgent information

· Leadership qualities that keep a company's executives from correcting their course

· Long before obvious danger signs appear, several of these syndromes can take hold of executive behavior. People might continue to do business the way they always have, maybe even doing it extremely well. But when a problem develops and things stop working the way they did before, managers have no way of knowing because they are largely cut off from the outside information they need

Luxembourg as a jurisdiction is a perfect illustration of what Sydney Finkelstein described for companies.


Flawed executive mind-sets that throw off a company's perception of reality

Whenever there is an international issue involving Luxembourg, rather than questioning the weaknesses of the center, leaders deny and/or state that those who question are jealous of the center’s success.

See for example
What was said in 2002 by the Luxembourg authorities after the French MPs report.
What was said in 2006 by bankers after the study carried out by the Utrecht School of Economics .
What was said in 2007 by Prime Minister Juncker after the ridiculous French TV report.

Delusional attitudes that keep this inaccurate picture of reality in place

Many dysfunctions, that are perfectly known, were never corrected: the abuse of offshore scams , the role of statutory auditors, dubious bankruptcies...

Compared to the European benchmark, the financial centre of Luxembourg is intensely missing ‘drivers – locomotives’ (only 8% have a reference value of 21%) as well as ‘critics’ (only 4% have a reference value of 13%); instead of having 1 employee out of 3 who are motivated and convinced of the performance of the centre, the survey reveals that there is only 1 in 8.

Additionally for a long time, local media did not play their role of Fourth Estate. Because of its public financing, the press does not act as a watchdog in Luxembourg because of the pressure arising from conflicts of interest due to the country’s small size. There is no culture of investigation. This was stated by the GRECO in a report early 2001: “the press, which has strong political affiliations, does not seem to exercise its role of public watchdog with the same vigour as in other countries.” (GRECO Report dated 15 June 2001).
This was stated as well by the OECD in a report in 2004: “The “watchdog” role of the media is also very limited in Luxembourg, although in some cases they have played a part, when detailed information fell in to their hands, in bringing to light suspicious behaviour. (…) According to media representatives interviewed, the shortage of financial and human resources available to the Luxembourg media generally preclude investigative journalism and consequently prevent the revelation of bribery cases” (OECD Report dated 28 May 2004).

To be honest there is a recent change.

Media that are doing a good job by accepting to publish those who raise issues are: Paperjam, Lëtzebuerger Land, Lëtzebuerger Wort, l'Essentiel. I would add Nicolas Group (L’Investigateur, Privat) that was the only critical publication for a long time, even though I do not agree with the editorial line and somehow the rude wording.
Media that are not doing a good job are: Agefi (it used to do a good job: my articles were removed after I stated in May 2007 that Luxembourg is a tax haven, which was not “politically correct”), Codex-online (it used to do a good job: my articles were removed after I stated early 2009 that Luxembourg authorities and professionals did not tell the truth on the legal and regulatory framework for UCITS in Luxembourg, which was not “politically correct”), EditPress group (Le Jeudi, Tageblatt).

Breakdowns in communication systems that stop important information from getting through

There are many business taboos and a trend to hush up issues: many actors believe that if an issue is hushed up it does not exist
Many actors “in” the system do not dare to report some sensitive information as they fear exclusion. The consequence is that the decision-making process is corrupted.
That is the reason why the paradigm shift was ignored.

A typical example is a parliamentary question (N°1826) from Laurent Mosar in July 2007 about the project of Stop Tax Haven Abuse Act.
Laurent Mosar asked two questions:
1. What is the attitude of the government in front of the draft law?
2. What necessary steps are planed to protect the interests of the financial center?

The second question is the wrong one. The relevant question should have been "What is to be done to correct the dysfunctions which definitely harm the reputation of the financial center ?"

Luc Frieden’s answer was a perfect example of the wrong perception of the environment as he stated that the draft text does not reflect the policy of the US Government and that the fact that Luxembourg is quoted in the draft law does not reflect the positive assessment on the cooperation that is expressed by the American authorities.

Leadership qualities that keep a company's executives from correcting their course

“We want to remain what we are” is the motto. Therefore top leaders persist is their mistakes.
Cf. Lucien Thiel, former chairman of the ABBL for whom it is not the duty of the jurisdiction to check if the taxpayer was honest.
Cf. his successor Jean-Jacques Rommes, who stated that if banks help to commit fraud they did not start it. But the banker went farther by suggesting a scam through Panama.

Nobody repudiated Thiel’s statement in february 2008. Jean-Jacques Rommes and the ABBL did not repudiate officially the bank that helped to commit fraud in February 2009.

This is as well visible in the way the Madoff case was handled since the beginning. Despite the fact that the synoptic table of the UCITS directive and the Luxembourg law demonstrates that the directive was not faithfully transposed, everyone agrees to change the story and to insist on its "faithful transposition".

Long before obvious danger signs appear, several of these syndromes can take hold of executive behavior. People might continue to do business the way they always have, maybe even doing it extremely well. But when a problem develops and things stop working the way they did before, managers have no way of knowing because they are largely cut off from the outside information they need.

The paradigm shift in the world was visible mid 2000 as I explained as of the first articles of this blog in July 2006:

To ensure the sustainability of the financial center, Governing authorities must be aware of the changes to the geopolitics and the geoeconomics: we live at a time of transparence and governance with various programs (OECD, World Bank...).

Governing authorities must ask questions and accept questions especially on compliance issues. They must tighten up the ship on issues all the more than there are alternative financial centers for investors and head offices of banks. Otherwise they weaken their international credibility.

The failure to ask or to answer questions allows these authorities (either political or professional) to operate with a distorted sense of reality. In fact, Finkelstein calls companies that are unable to question their prevailing view of reality zombies. A zombie company, he says, is “a walking corpse that just doesn’t yet know that it’s dead—because this company has created an insulated culture that systematically excludes any information that could contradict its reigning picture of reality”.

This is true as well for a financial center.




The world goes faster than cultural changes. A couple of years were lost and will never be recovered.