Question

What risk, if any, are being taken in their individual capacity by the six independent directors of friends investment Bank?

Case study:

It took Kamal Khan over five hours of intense thinking and research to come up with a six line memo for his bank's chairman. After reading the memo for umpteenth time, he finally decided not to submit a memo at all. He was aware that Qaiser Qureshi, chairman and chief executive officer of Friends Investment Bank Ltd (FIB) was allergic to having papers in his files that showed dissent, however well-intentioned it may be. Talking to Qaiser Qureshi was easy; opposing his views at a one-to-one meeting didn't pose much of a problem either, but writing him a memo stating that you differ from him on a given issue was not something that particularly pleased the chairman.

Three of the bank's directors were retiring at the end of the next quarter. Ahmad Ali, Dilawar Dar and Haji Habib were decent people but held no more than 500 shares in the bank. Their appointment to the board of Friends Investment Bank was largely due to their close friendship with Qaiser Qureshi. Ahmad Ali was a retired civil servant, Dilawar Dar was a retired engineer and Haji Habib was a property developer based in Dubai who seldom attended any board meetings. As far as Kamal Khan, the Chief Operating Officer and Executive Director of Friends Investment Bank was concerned, these gentlemen made no contribution whatsoever to the affairs of the bank. They came to the meetings when invited, always agreed with whatever was proposed by the management, or more particularly by Qaiser Qureshi, and never took any meaningful part in the board's discussions. In fact, it was Kamal Khan's observation that average duration of FIB's board meetings was around 30 minutes, excluding the time for tea break which was often longer than the meeting itself.

FIB's board was what is known commonly as a staggered board. It had nine members; each held office for three years at a time. Each year three directors retired and were almost always reelected. Kamal Khan was elected a director a year ago when the previous COO left to join another bank. Kamal Khan was of the opinion that Messrs Ahmad Ali, Dilawar Dar and Haji Habib did not deserve re-election. He had very good reasons to support his view point, but the real problem was to convey that view point to Qaiser Qureshi without offending him - i.e. without jeopardizing Kamal's own employment with FIB.

History of Friends Investment Bank

Friends Investment Bank was founded in mid eighties. It was not hugely successful. Its promoters, an industrial group, expected to get it converted into a commercial bank within five years. When they found out that this was not likely to happen, they lost interest in it. By end 1991, the bank's Profit & Loss showed a small accumulated loss. At that time, the sponsors held only 52% of the bank's shares, the rest were held in small numbers by a large number of individual investors. Only NIT held a sizeable percentage of its shares and but even they were not interested in nominating a director on FIB's board.In 1992, Qaiser Qureshi, the then SEVP of the bank, bought all the 52% shares from the bank's original owners. He was assisted in this takeover by a Middle East based friend. The bank's president was asked to resign and Qaiser Qureshi assumed the office of the CEO and vice chairman of the board. In mid-1995, he was able to buy back the shares from his Middle East friend and became the chairman of the bank. In 1992, the bank's share sold at Rs 9.85 at the KSE, in 1995 it had risen to Rs. 10.50 and in June 2007 it was quoted at Rs. 14.50.

Financial Performance of the Bank

Over the past eight or so years, the bank had made modest profits but was regular in paying dividends. The volume of trading in FIB's shares at the KSE was generally not large. At end 2007, the bank's paid up share capital consisted of Rs 300 million, divided into 30 million shares. 57% of the bank's shares were held by Qaiser Qureshi and his family while NIT held 8% and the rest were distributed among some 1,520 shareholders. The book value of the bank's share was Rs 16.12 at the end of 2007.

One of the reasons that had prompted Kamal Khan to accept an employment with Friends Investment Bank was his opinion of the bank's tremendous growth potential. He had studied the past financial statements of the bank and found them to be remarkably consistent. A small but steady growth was maintained in both profits and dividend payments. Yet in his 16 months stay in the bank, he had noticed no desire on the part of the bank's management to expand its operations and seek new avenues of earning revenue.

The main sources of income to the bank were net interest/mark up, financial advisory services, underwritings and related services (called non-funded facilities), and return on investments. One thing that Kamal Khan observed from the analysis of the past financial statements was the fact that while the Profit Before Tax and Return on Equity figures were fairly consistent over the years, the composition of bank's PBT differed significantly from year to year. For example, income from financial advisory services as a percentage of PBT was 7% in 2002, 21% in 2003, 2% in 2004, 26% in 2005 and 11% in 2006. On his inquiry, Malik Majid, the bank's CFO, had told him in a meaningful tone that Mr Qureshi does not like to inflict surprises on his shareholders and depositors.

Board's Structure

The board had nine members: three executive directors and six non-executive directors who were all classified as independent directors. The chief executive officer (Qaiser Qureshi), the chief operating officer (Kamal Khan) and chief financial officer (Majid Malik) were the executive directors. Kamal Khan had joined this bank only last year after serving another investment bank for over 10 years. At 43, Kamal Khan was the youngest member of the board. Malik Majid had been promoted as CFO when Qaiser Qureshi assumed the presidency of the bank in 1992. He was a chartered accountant with over 35 years banking and finance experience. However, now at 63 years of age, he was neither active nor very efficient. He was able to retain his job mainly because he enjoyed the trust of the chairman and CEO.

In addition to three directors who were due to retire at the end of the next quarter, the other three "independent" directors were Bashir Baig, Jamil Jaffri and Dr Nasima Naqvi. Bashir Baig was a building contractor who had served for about two years as a cashier in a nationalized bank at the early stage of his career. This fact was prominently splashed in his bio-data. as comprehensive exposure to banking at operational level. Jamil Jaffri was a now-not-so-famous actor who was more interested in narrating tales of his female conquests than to pay any attention to the agenda items at board meetings. Dr Nasima Naqvi, a distant cousin of Mr Qureshi, was a professor of chemistry at a government college.

Board Proceedings

The board was run single-handedly by Qaiser Qureshi. He did not believe in bothering the board with any information that in his opinion did not concern them. Board meetings were generally of less than one hour duration. With the change in SECP regulations, FIB had started holding quarterly meetings, yet there was no change in the manner of the meetings' conduct. Proceedings were strictly regulated. Kamal Khan had noticed none of the six so called independent directors took any pain to engage in any discussion whatsoever. And he didn't really blame them either. These directors were paid a fee of only Rs 1,000 for the attending the meeting. Perhaps, they were justified in thinking that their views and professional advice merited a payment much larger than the measly fee being paid to them.

The first board meeting that was attended by Kamal Khan had a proposal for issuing a bank guarantee to a spinning mill. The amount of guarantee was quite close to 20% of bank's equity and required the approval of the board. The proposal had been hastily prepared and in Kamal's opinion did not merit approval as it was based on inadequate and unverified information. Again, spinning was not exactly the hottest sector of the textile industry at the time. Kamal was quite certain that the proposal will be shot down by the board; but to his surprise it was approved without any discussion. Kamal had feared that this guarantee will soon be called, exposing the bank to serious Cashflow problems. This happened within three months. The bank ended up creating a forced loan account against very inadequate security. While technically the Bank did not suffer a loss and the loan was now being regularly serviced by the client, it was a poor transaction to have entered into.

Qaiser Qureshi's Style of Management

Qaiser Qureshi firmly believed that as long as he was showing a profit, keeping the assets of the bank safe and paying a decent dividend each year, no investor or outside party had any right to pry into the affairs of the bank. He did not think much of the caliber of his board members - neither did he want them to have any real abilities. He had handpicked all the six "independent" directors to ensure that he faced no dissent at the board meeting.

He was essentially an honest and hard working man. He was also a very persuasive person and board members found it difficult to differ with him. It was his philosophy that success requires harmony at decision-making forums. While he was prepared to discuss any issue in a one-to-one meeting, he was not tolerant of dissent memos or opposing views being put forward at formal meetings.

Kamal Khan's Dilemma

Kamal Khan had an MBA in finance and had attended several courses in bank management as well as corporate governance. He believed in a greater and more effective role of the board. He had no doubts about the personal integrity and intentions of his chairman, but he differed with his attitude towards the board. He was convinced that a better selection of directors could greatly assist the bank in expanding its operations and improving its profits. He wanted to use the up-coming elections to bring in three truly independent directors who had the right blend of experience, knowledge and connections to promote the bank's business. He had spent five hours drafting a proposal, outlining the advantages of a truly independent and effective board, but in his attempt to ensure that the contents were politically correct he had ended up with only a six line memo. After reading that memo for several times, he decided to bring the matter up with the chairman in a personal meeting.

The Meeting

When Kamal Khan finally gathered courage to put forward his views to Qaiser Qureshi he was pleasantly surprised. He was told by Qaiser Qureshi that he was already aware of all the points enumerated by Kamal in favor of an active board, but on balance he considered such a board more of a burden than a help. "First of all," said the chairman, " it was futile to expect any real contribution from directors when they were being paid only Rs. 1,000 per meeting. Paying them huge salary would simply curtail the bank's profits while the benefits will arrive much, much later." He was also of the view that it would be very difficult, if not impossible, to find suitable applicants.

When Kamal Khan drew his attention to the Code of Corporate Governance issued by Securities and Exchange Commission of Pakistan, Qaiser Qureshi simply smiled. Without mincing his words, he said that his company was fully compliant with the Code - at least in words. That he considered to be sufficient because, according to him, no one can truly comply with all the provisions of the Code in spirit. He was pretty sure that even the larger financial institutions in the country were only paying lip service to the Code.

In any case, against all norms, he asked Kamal Khan to prepare a detailed proposal (to be submitted to him informally) on how a gradual change may be brought into the FIB's board and what would be the tangible (financial and others) advantages of the same.