I read couple articles on Merrill and Stan O'Neil after the story broke out over the past weekend. Mr. O'Neil only has himself to blame for his demise and Merill's write-down of over 8 billion $ for the past quarter. The article from WSJ pointed out his managerial style and his obsession to match Merill's financial results to Goldman Sach. It's weird that you don't hear about the "Dark side" of a CEO untill bad news arrive.

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If one reads the book F.I.A.S.C.O (I read it after seeing online where Charlie Munger recommended it as a must read for those wanting to learn about investing) then one can conclude there could be more exposure than MER is leading on. No telling the potential derivative fall outs still looming.

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Buffett was right about Derivatives, weapons of mass destruction !

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The CEO implicitly accept accountability and culpability when they accept their huge salary packages. They are the ones who define the company's culture and can make a difference. The CEO defines where the lines drawn in terms of acceptable business ethics, risk and vision. See what replacing Fiorina with Hurd did for HP and the steps Buffett took when turning Solomon around. O'Neill may have worked real hard and may have turned it around if given the chance, however a person in that position is paid very well to see the rocks ahead and make decisions before they are forced on him/her. O'Neill didn't see the rocks and made some serious mistakes which someone in his position just wouldn't have made.

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Nelson,

I know they teach that in many business schools, but the reality of the board room is that the CEO is part of a team — a team that oversees (sometimes) hundreds or thousands of "managers" in a complex web of authority and accountability. More times than not, the CEO is surprised by these "scandals" (unless he directly initiates them a la Enron).

I am not removing all blame from O'Neil; still, his ousting was more of a public relations move than a "here's-the-problem-and-solution" move — i.e., more noise than news.

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Without offshore sport gambling, my life would be boring.
Let us entertain! Join us:)

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Joe, allow me to politely disagree.

The military has a long-standing convention that a commander is responsible for all his / her unit does or fails to do. This compels the commander to take one of several tacts.

The commander may elect to delegate and trust those conducting day-to-day operations, under the theory that you can't do everything and be everywhere as operational decisions are made.

The alternative extreme is to take the position of a micro-manager, delegating little and retaining authority over nearly every decision. This may work at the lower ranks within an organization, but it is the primary cause of the Peter Principle (rising to one level beyond your competence), and spells disaster the higher up the organization an executive advances.

Neither of these models works successfully.

So, how does the military split the atom and advise their leadership to avoid O'Neil-like situations? Well, it is embodied in the 9th Leadership Principle, taught to every newly-commissioned 2nd Lieutenant; although, most forget it until their training prior to assuming battalion-level command.

The 9th is, "Ensure the task is understood, supervised, and accomplished." While this seems simple, it is filled with nuance. An understood task is one where the person tasked can repeat ("back brief") the order without error or embellishment. Supervised means that recurrent status updates on progress take place from start to finish. Accomplished means that the end result is not blessed / approved by the commander until the product fully meets (at minimum) the professional standard. This allows the commander to delegate authority, retain responsibility, and deliver an outcome that is not the product of auto-pilot / fire-and-forget oversight or, alternatively, micro-management.

What does this have to do with the CEO of MER?

Well, as you progress higher up the ladder (the equivalent of three stars for O'Neil, if he was overseeing a workforce of 20,000 to 50,000), the commander is obliged to prioritize that which is recurrently reported, monitored, and approved. The CEO will not (indeed, can not) exercise / retain approval authority for $5,000 capital budget expenses or decisions concerning to whom a $100,000-a-year employee reports. The consequences of error in such cases constitute less than rounding variation for the larger organization. But, on the other hand, SIV's, and sub-prime, and derivatives exposure, because they constitute large sums and leverage, represent a larger threat to whether MER wins the war (rather than the confined skirmish), and closer retention of oversight is warranted.

[Which leads us to the Corkey Bruce postulate that "a unit does well that which the commander inspects."]

The strongest retort to this, of course, is the argument that the CEO can not be sufficiently expert at all the unit does to competently exercise oversight of specialized areas, requiring expert training and competence. In fact, John Kenneth Galbraith argued that specialization is a function of increasing complexity. For example, the Field Artillery general can't claim adequate expertise to second guess the rocket scientists developing the next generation of howitzers. Simlarly, the hospital-system CEO can't intelligently second guess the latest approach to organ transplant, tumor excision of the brain, and selection of optimal physical therapy for a sports-related injury. And O'Neil can't be an expert in derivatives, CDOs, options, marketing, finance, strategic positioning, operations, etc. ... simultaneously, in the same lifetime.

Despite this, the CEO can selectively hire or outsource the second-opinion "gadfly" -- whose singular roles is to declare "Not only is the king naked, but he is poorly endowed." This can come in the form of an internal Carl Icon, an appointed ombudsman for that specialized area of importance, a staff of roving inspector generals, or the hiring of an external, nay-saying consultant, whose mission is simply "Tell me what my internal proponents will not."

More importantly, this need not happen for every department or product offering -- just those that pass the 80/20 threshold of predicting a firm's success or failure. With the benefit of hind-sight, we now know that this is just such an area. So, should he have known that this represented such a substantial risk?

Several years ago, I became enamored with complexity theory, and the work of John Holland and the Santa Fe Institute. Holland is one of the fathers of artificial intelligence (primarily neural networks, as opposed to genetic algorithms), on which much of programmatic trading on Wall Street is based. A short time later, I met some of the programmers on Wall Street through my brother, who was then a VP for sell-side equities analysis.

After a social gathering, where an AI expert and I talked at some length, my brother took me aside and said, "Bright fellow, but his systems are so complex that not even he knows how it works and, if it doesn't, why it doesn't work." Well, as usual, my brother was only half right. We do know how it works, but we haven't a clue why it doesn't if, in fact, it doesn't. (e.g., "the underlying environment changed, negating the validity of the data on which the model was created" isn't an acceptable response when 25 percent of accumulated shareholder's equity is wiped-out, as it was with MER this week.)

My brother and others on Wall Street have known for some time that AI and derivatives and SIVs and CDOs were a threat due to their ephemeral nature -- even when you own them, you don't know your risk (can't touch them, see them, taste them, or throw them at your mother-in-law). He even published an article on the subject, making this salacious argument.

This now strikes me as interesting because another relative created a significant portion of what is now known as CDO's -- which she believed served as a means for limiting risk, by combining and diversifying a combination of risky and less risky aggregations of bonds.

Ultimately, a commander is responsible for all the unit does or fails to do, and, if the commander is not competent to provide informed oversight, there are options for addressing this shortfall, even on Wall Street. Can I prove it? Absolutely:

Goldman posted profits, despite sub-prime exposure, by shorting sub-prime. MER did not. One commander did his job competently. The other now benefits us by his example of what not to do.

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