Risk Management

Marsh & McLennan Companies

After several decades of considerable growth and reputation-building, Marsh & McLennan Companies were faced with the dramatic events of 2003-2004 years. Actively running six businesses in financial services industry under distinguish subsidiaries the company over-nightly became the object of media attacks for unethical business conduct and practices, SEC allegations for legal violations against Putnam, Mercer and Marsh and a sharp decline in stock prices. Since general reputation in the market place represents the main factor of success the company’s losses are classified as deriving from the reputational risk that had a material adverse effect on the Marsh & McLennan’s assets. Arising from questionable management style of Jeffrey Greenberg, combining with pursue of increased performance the overall business model in Marsh & McLennan Companies lacked true leadership and was unable to make necessary changes in business practices in order to meet new challenges imposed by the altering social environment and attitude to a corporation. Instead of strengthening its reputation during 2000-2003 when the company underperformed prevailing management style was facilitating the reputational risk which had never been correctly assessed leading to the lax public relationships and a necessity to restore public confidence.

Putnam Investments

A number of underlying causes that interfere with the social purposes of the corporation were violated by Marsh & McLennan’s mutual funds manager, Putnam Investments, resulting in assets and reputation losses and further decision to sell the division. Improving its financial performance Putnam’s management was ignoring the strategic and reputation risks that come from ethical and behavioral standards which if violated and disclosed lead to the massive social blame of all constituents involved. The primarily causes can be named the following:

• Double standards practice that implies unequal attitude towards ordinary and favored investors, resulting in violated fiduciary duty and higher transaction fund costs for common investors, increasing the reputational risk by biased attitude towards certain clients;
• Unethical activity of individual fund managers late-trading their own accounts, that hurts company’s reputation by either evident lack of control and inability to prevent unauthorized actions of its own employees or the aiding in the conflict of interests;
• A developing culture of corporate greed coming down from top-management, including Lasser’s compensation package, bonuses, hence aggressive and questionable growth tactics, breaking the image of trustful fund manager;
• Declared avoidance of “market timing” practices and broken trading policies showed that the company was not stick to its words and mission, damaging reputation by misleading investors;
• Legal and ethical violations scandal destroyed reputation and if was not handled properly could have led to a huger devastating outflow of assets. Week Lesser’s leadership and decisiveness in dealing with conflict contributed to the facilitation of his resignation.

A combination of internal factors and misconducts in business with dictatorial leadership style of top management weakened the company making it unable to defend itself from SEC and media attacks and save its image and reputation that was already damaged by frauds and violated fiduciary duty.

Mercer Human Recourses Consulting Business

Probably in the case of Mercer the damage was not so huge as for Putnam or Marsh but it also addresses the sensitive reputation issues that contributed to the overall bad performance of the Marsh & McLennan Companies. While the corporate strategy was to achieve the profits at the first place Mercer was not as profitable as other subsidiaries. Mercer was caught in a pitfall of own unethical behavior that negatively affected the reputation by providing financial analysis with inaccuracies and lack of relevant information that resulted in losses of consulting fees. Mercer in providing advisory services for NYSE harmed reputation by:

• Mischaracterizing Grasso’s compensation to the NYSE board by keeping confidential an internal memo about Grasso’s cash compensation, i.e. leading to informational asymmetry of the board members;
• Not disclosing and providing all the relevant information to the NYSE board many members of which were unfamiliar with terms and proposed payments;
• Involving itself in a conflict of interests and deception, where on the one hand Mercer had to defend the interests of NYSE as a corporation and on the other was approached by Grasso to help him to validate his pay demand. This raises the question of personal interest of Mercer’s consultant/consultants whether they were forced by Grasso to do this or received a kickback or simply behaved in an unprofessional way;
• Not conducting a proper inquiry, not gathering all necessary information to provide a fair calculation, not checking all the assumptions to present a hi-quality service Mercer was hired for.

This case demonstrates that reputation can be stained by even a very low-probability evens as such when governmental official becomes engaged in executive pay issues. Although the firm ‘didn’t make recommendations regarding the structure of compensation’ it should not put itself in an awkward position by concealing information or providing inaccurate reports breaking the rules of ethics that can result in a much bigger reputational losses than in this situation.

Marsh

As long as the company was able to settle the scandal with Putnam and gained the immunity from legal actions for Mercer the next scandal with Marsh in the center really put the company at risk. Marsh’s reputation was damaged dramatically by a SEC lawsuit and disclosed unethical practices the company was engaged in. Marsh that was providing commodity services in its corporate governance totally forgot the reason its clients go to big insurance firms. The answer is the Marsh’s reputation to insure against the risks, the reputation that Marsh & McLennan has build during the years and which was seriously hit. The reasons that led to this negative situation can be classified as following:

• Frauds of executives who participated in bid rigging schemes and encourage their partners and employees to do so. If bid rigging was not approved at the highest levels of firm’s management it’s very unlikely that employees were uncontrollably fixing bids; 
• Desire for profit and usage of illegal and unethical practices to profit from them. The evident conflict of interests is between Marsh’s clients and Marsh executives’ actions. Contingency agreements that formed the big stake of Marsh’s income were knowingly undisclosed to clients, together with ‘a Marsh protocol designed to prevent clients from obtaining the accurate information” about commissions represent the violation of fiduciary duty to the highest extent, unfulfillment of Marsh’s liabilities to its customers and risk of reputation capital loss;
• Marsh’s dominance at the market that allowed it to break the rules and set noncompeting agreements.

Totally, Marsh’s reputation was hurt primarily not by the fact that the company was getting commission payments from insurance carriers, but from the extent and familiarity of these actions that made retail and corporate clients to carry additional costs and receive incorrect information.

Corporate Culture

However, the reason that formed these three crises is lying much deeper than the unfortunate course of events. The failure of the subsidiaries’ governance can be basically attributed to the general corporate structure that was dominant in the Marsh & McLennan Companies and associates with the leadership of Jeffrey Greenberg, who alongside with the positive contributions as the expansive growth through mergers and acquisitions had a negative impact on the whole corporation and risked its reputation. 

Firstly, the overall corporate culture was facilitating the aggressive cross-selling of the products from different divisions, which obviously was leading to the conflict of interests and being based on weak or incorrect motivation tools supported the obsessive focus on secrecy and information disclosure prevention about any misdeeds such as kickbacks, frauds or confidential financial agreements. To achieve Greensberg’s financial goals and growth rates the potential of the new conflicts was getting even tighter and the pressure to bend the rules grew. Evidently, that market-timing and late-trading could have been prevented if managed top-down from the highest echelons but top-management was at contrast supporting and encouraging this.

Secondly, Greenberg and his team lacked the understanding that commodity business is distinguished based not only on the performance but on the reputation as well. The possible loss of reputational capital can come from all constituency groups the company was dealing with, including unsatisfied customers, broken ethical rules of business conduct or violated society’s generally accepted values, such as trustworthiness and confidence. Despite of the fact, that Marsh was not the only one blamed for bid rigging or market timing and late trading and the fact that Marsh was well diversified the combined effect damaged the company and compounded its state. The market and regulatory nature changes such as demand for higher attention to legislation and customer’s higher expectations from their insurance or brokerage firm were not anticipated by the top management, thus, increasing the reputation risk.

Thirdly, company was not taking the path towards constant re-evaluation of corporate culture and value system. Additionally, well-defined ethical practices were not deeply integrated in the corporate culture and since being invisible in day-to-day organization’s behavior were violated by both employees and executives. Internal control and audit as well as the updated system of reputation risk management were not effective in reducing reputational exposure or at least were absent that jointly with poor administration, personal greed, conflicts of interests and legal breaches led to the total management failure with some of the executives being imprisoned and some retired. 

Warmed by the negative publicity of Marsh & McLennan business practices the scandals of 2003-2004 only aggravated the company’s bad performance. Taking this into account the negative consequences of such corporate policy affected the company’s market capitalization. In addition to this, company lost some key employees, important clients, gained negative outlook for shareholders and increased the costs because of the regulatory actions. Nevertheless net income increased in 2003 by 13% compared with 2002, but the decrease in 2004 was equal to 88,6% since 2003. Regulatory and other settlements in 2004 were equal to $969 million while in 2002 they were zero, and in 2003 — $ 10 million. Return on average shareholders’ equity in 2004 was 3% compared with 29% in 2003 and 27% in 2002. The stock prices in 2004 were reaching the lowest level of 2001-2005 of $ 22,75 per share. In October, 2003 when the Securities and Exchange Commission announced actions against Putnam Investment Management LLC market capitalization of MMC decreased by 10,2% (from 25,4 billion to 22,8 billion). The next sharp decrease was connected with October, 2004 civil lawsuit against Marsh with the decrease in market capitalization of 39,55% (from 24,1 billion to 14,55 billion) . 

Summing up, the negative events and bad publicity affected primarily the reputation of Marsh & McLennan Companies, resulting in company’s downgraded rating, income decrease and market capitalization losses.