Citigroup, J&J: Real Reasons for Strong Regulation

Citigroup, J&J: Real Reasons for Strong Regulation

iStockphoto/The Fiscal Times

Yesterday, two settlements were announced within hours of each other, both involving toxic products that have caused problems for Americans. In one case, Citigroup (C) announced it would pay $590 million to settle allegations by investors that it had misled them about the extent to which it had loaded its balance sheet with structured securities tied to subprime mortgages. In the other, New York’s Attorney General, Eric Schneiderman, announced that Janssen Pharmaceuticals and its corporate parent, Johnson & Johnson (JNJ), had reached an agreement with 37 states and the District of Columbia to fork over $181 million to settle claims it deceived consumers by marketing anti-psychotic drugs like Risperdal for “off-label” uses.

Two utterly different matters? Not at all. None of the companies admitted to any wrongdoing as part of the settlements, but in both cases, what is involved is mismanagement and poor governance on the part of the companies involved. Both cases point clearly to the need for effective governance – and for effective regulation to step in when governance fails.

Earlier this month, Elisabeth Murdoch, the eldest daughter of media tycoon Rupert Murdoch, made waves when she delivered a speech in Edinburgh, Scotland, during which she commented that “profit without purpose is a recipe for disaster.” And yet profit that is accompanied by willful blindness by those generating it to the risks they are causing is perhaps more egregious still. And that’s what we’re talking about in both instances.

Caveat emptor – buyer beware – is a great mantra for every consumer to bear in mind. We know how to evaluate what seems to be a great deal – how many sheets does that roll of paper towel contain compared to the one that is on sale, and how does the quality differ? When does a fabulous deal seem too good to be true? (Hmm, wonder if that “hotel right on the beach in Miami” offering rooms during the high season for $35 a night is in the midst of construction, or being treated for a roach infestation?) Savvy consumers are increasingly aware of common scams, to the point that any adult of sound mind who loses some of his savings to a persuasive e-mail from Nigeria isn’t going to get much sympathy.

But there are some parts of the corporate universe that simply can’t be left to march to their own drummer – parts where even hyper-vigilance on the part of consumers may not be enough. Two of these are finance and the pharmaceutical industry, both of which require a disproportionate amount of specialized knowledge and which rely heavily on a corporation’s willingness to disclose fully and completely the risks associated with its “product.”

In both industries, the repeated nature of the offenses showcased in Thursday’s settlements is disturbing, to say the least. Citigroup isn’t the first bank to be hit with fines, penalties and other kinds of legal decisions, judgments or settlements related to mismanagement in the years leading up to the crisis. (And as more recent events involving JPMorgan Chase (JPM), Barclays (BCS) and HSBC (HBC) – to name a few – have shown, the financial industry is still pushing the envelope when it comes to “toxic behavior” if not “toxic products.”)

The same is true of the pharmaceutical industry. It has been less than two months since Schneiderman announced the largest healthcare fraud settlement in the country’s history, with GlaxoSmithKline (GSK) agreeing to pay a massive $3 billion fine to get New York, 43 other states, the District of Columbia and the federal government to drop charges that the pharmaceutical giant engaged in a host of “illegal schemes related to the marketing and pricing of drugs” including depression medications and drugs treating asthma and seizures. Glaxo SmithKline also was accused of offering kickbacks to doctors to prescribe its drugs. Schneiderman was correct in describing the activities as “breathtaking in … scale and scope.”

When a patient goes to their doctor in search of medication to treat an illness or when an investor relies on the financial statements of an organization like Citigroup or its disclosures about the financial products it makes available to clients, there are limits to the degree of due diligence a consumer can conduct. Plenty of doctors prescribe drugs for off-label uses – and plenty of patients are happy with the results. But fully understanding whether it’s really OK for your doctor to suggest you take Wellbutrin to help you lose weight or to take a seizure drug to help you manage your bipolar depression is probably beyond the competence of the average patient.

Similarly, can investors be expected to treat every piece of disclosed information from a major investment bank as if it were flawed, incomplete or simply fraudulent? Should they have to conduct forensic audits of firms like Citigroup to determine whether the claims made for their products or their assertions about their own financial health are fair representations of reality? Being skeptical is one thing; feeling as if you have to hire an independent medical advisor or forensic accountant is something else altogether.

In both cases, toxicity can be extraordinarily damaging. In the case of Paxil, for instance, the FDA and other agencies has have warned against children and adolescents taking the medication as it can increase depression and even suicidal thoughts. (As far back as 2004, European regulators warned doctors against prescribing products containing paroxetine, its active ingredient, to those under 18.) Nonetheless, the list of allegations against GlaxoSmithKline included one claiming the firm specifically marketed Paxil to this group, via physicians. Encouraging physicians to violate the Hippocratic Oath, a key provision of which is to do no harm, is the epitome of toxic behavior.

It’s true, investors probably won’t lose their lives. But losing a chunk of their retirement savings can still be problematic. Certainly, anyone who relied on the veracity of statements made by Citigroup about the health of its balance sheet has lost some 90 percent of the value of their investment in the banking stock. In the period covered by the lawsuit that has just been settled, the value of Citigroup shares was cut by more than half, with $110 billion wiped off the value of the company’s equity.

This goes straight to the heart of the matter. When a teenager commits suicide because a physician has chosen to succumb to a pharmaceutical company’s aggressive marketing campaign, or an investor loses hundreds of dollars and is finally awarded only pennies in damages, there is no way to reverse the full amount of the damage that has been done, just as there is no reasonable way for those consumers to become expert enough to understand the risks they were taking. Admittedly, not every investor hung on for the full downward plunge; not every teenager taking Paxil experienced suicidal urges, much less acted on them. But the consequences of misleading consumers about the nature of the risk are far more serious than, say, packaging cereal into a box that contains less than its exterior suggests, or cutting back on the number of raisins packed into each box.

It’s long past time for these industries to behave as if they recognize their role in our lives. By the time the class-action lawyers or the regulators kick into action to punish toxic misbehavior, it’s too little, too late. The onus is on both industries – and their investors – to demand that managers bear in mind every day the true nature of the risks they are asking others to run.