Business

A BANK’S ENRON BOMB

The US$2.4-billion lawsuit settlement buys a clean slate for CIBC’S new CEO, but at grievous cost

KATHERINE MACKLEM August 15 2005
Business

A BANK’S ENRON BOMB

The US$2.4-billion lawsuit settlement buys a clean slate for CIBC’S new CEO, but at grievous cost

KATHERINE MACKLEM August 15 2005

A BANK’S ENRON BOMB

Business

The US$2.4-billion lawsuit settlement buys a clean slate for CIBC’S new CEO, but at grievous cost

KATHERINE MACKLEM

IT’S A NUMBER Bay Street won’t soon forget. On the first business day following John Hunkin’s exit as CEO of Canadian Imperial Bank of Commerce, the bank settled a lawsuit with Enron shareholders, who had accused CIBC of being involved in the shady business that led to the U.S. energy firm’s stunning collapse in 2001. To make the suit go away, CIBC agreed to pay the mountainous sum of US$2.4 billion. Later in the week, the bank agreed to another US$250 million settlement for a different Enron-related suit, this one from the company itself.

To put the US$2.4 billion in perspective, it’s not only more money than the bank made last year, it’s the largest single hit in Canadian banking history, ever. While the bank did not admit wrongdoing, the settlement’s sheer size raised eyebrows up and down Bay Street. “You don’t pay US$2.4 billion if you didn’t think there was potential you were going to be found to be wrong,” says Richard Powers, a University of Toronto professor specializing in business ethics.

The size of the whopper payout appears to have surprised the bank, too, which earlier had put aside a woefully inadequate $300 million to cover the lawsuit’s cost. In an early morning conference call with analysts on his second day as CEO, Gerry McCaughey explained the settlement was intended to “reduce the uncertainty of protracted litigation.” The bankers realized too, he added, that the longer they let this drag on, the more expensive it would become. The goal was to make the best of a bad

situation. “We believe we are optimizing our situation by settling,” McCaughey said. “This was the price we had to pay to do so.”

What a price it is. Consider the fact that CIBC’s profits last year were near $2 billion. Use that as a benchmark, and “for the next year, CIBC is in effect working for the Enron shareholders,” Powers points out.

CIBC’s investors immediately felt pain as the bank’s share price dropped $6.09 in a day to $74.55, albeit less than the $7.25 an analyst pegged as the settlement’s cost per share. Other analysts downgraded the stock. But that’s just the beginning of the repercussions. While the bank might not slash dividends—a key component of many investors’ portfolios—it will be hard-pressed to raise them. The deal leaves CIBC with a seriously weakened balance sheet. To maintain earnings growth of 10 per cent, a target McCaughey called “intact,” it will have to cut costs, which could well mean jobs. And if the merger dance returns soon to the banking sector, CIBC won’t be much

THE BANK decided

it was better to settle than fight. ‘This was the price we had to pay,’ as the new CEO put it.

of a player. It’ll just be an easy target.

And then there are the lawsuits. Already shareholders are clamouring for Hunkin, who led the bank through its deal-making with Enron, to part with some of his $52 millionplus exit package. Some want to know when the bank realized how much the settlement might cost. Did it wait for Hunkin to leave before closing the deal? Others wonder if Hunkin left when he did because he saw the damage coming. If the hit had come earlier, say in the 2004 fiscal year, and caused a loss, Hunkin’s retirement package would have taken a hit, says compensation expert Luis Navas of Executive Risk Services Ltd.

Many investors are asking what the board was doing when the bank got into this mess. At the time, CIBC was trying to position itself as a player in the big leagues of the U.S., where the stakes are high and the competition powerful. Under Hunkin’s leadership and that of his now-departed protege, David Kassie, getting cosy with major companies like Enron was part of the strategy. The risk was enormous, as was the potential reward. For a while, CIBC’s share price, which doubled under Hunkin’s tenure, reflected that reward. But as it’s turned out, many believe ambition got in the way of good judgment. Now what’s left, days after Hunkin’s departure, is the super-sized cost of the risk: a diminished company with a damaged reputation, a massive payout, and the potential of more shareholder lawsuits. U]

katherine.macklem@macleans.rogers.com