Prior to this proposed rule, a slate of directors was nominated and included in the proxy materials and it was difficult to influence this process. Now, there are no restrictions on the relationship between the nominating shareholder and the nominee. However, candidates must satisfy standards of being independent as well as must satisfy specific director qualifications established by the board.

Stuart R. Levine

This new rule requires boards to become knowledgeable about how they conduct their nominating and governance processes, as well as the implications for maintaining director standards and a productive board culture that enables them to be effective in both stable and challenging times.

How ready is your board? Obtaining both qualitative and quantitative research on this subject, in addition to your annual board evaluations, will help to protect and position your board as a “blue ribbon” governance company and keep you out of the limelight on issues that will not serve to protect your shareholders and increase value for your organization.

This increased involvement and engagement of shareholders will require new approaches and a systematic review of a board’s preparedness in response to risk and potential crises, with a strong board culture where clear and effective communications strategies can be developed and presented. Laying the groundwork to get in front of a crisis, before it becomes one, is just smart risk management for independent board members, CEOs and boards as a whole. When a shareholder can own as little as 3 percent and be put on the board, this may open the boardroom up to potential disruptions and potentially competing strategic agendas.  Both boards and CEOs will be defined by the way they prepare and respond to potential crises.

Just as independent directors request that consultants and attorneys be retained to assist in ensuring that their decision-making is sound and protected, I strongly suggest that you consider retaining a firm to assist you with facilitating high-level enterprise risk management discussions at the board level, which include the subject of reputational risk.

The first step is education about and understanding of these new regulations and forces that will affect your board in serious ways. Then put into place an assessment process that identifies critical gaps between where your board is and where it should be. The next step is to close these gaps and prepare for any potential incidents or movements that might take you away from creating value for your shareholders.

How can boards exercise their fiduciary responsibility or intelligent risk management as it relates to the board nominating process, board membership and board culture? This is not a one size fits all process. The goal should be to establish levels of trust on your board to ensure that honest communication can exist on a board without retribution. If and when a crisis comes every few years, due to product error, succession planning or a shareholder event, your board has the strength of character to respond appropriately and be sheltered from any losses due to reputational risk.

Strengthening your board culture before any incidents, with the assistance of an independent consulting firm, (not as a budget line item) will serve to start the conversation about these new levels of risk and will help your board stay highly focused and get to the right outcome in a highly volatile and highly charged political environment.

Here are the five questions and conversations your board should be asking and having:

• Board Culture: How effective is your board’s culture? Can it sustain a challenging conversation or a crisis? Are you comfortable engaging in a succession discussion with your CEO?
• Understanding of Proxy Access Regulations: Is your board up to date on the new proposed Proxy Access regulations and how they will require major changes in the preparation of your proxies, nominating process and director qualifications? Are they aware of the new current realities and their implications?
• New Levels of Accountability: What is the increased level of accountability required by board members in this new environment? Are you bringing the right issues to the table? Is your board engaged at the level they need to be?
• Readiness Preparation/Reputational Risk: Is your board effectively prepared for a “disruptive event”? How would it perform under this kind of pressure and what impact would this have on your company’s reputation, which impacts your company’s financial bottom line?
• Strategic Business Planning: Are the assumptions that you are working with for strategic planning being evaluated and re-evaluated to ensure keeping up with the changing times?

These issues should not be viewed in a limited traditional PR or investor relations bucket. Board culture, establishing the right skills sets and qualifications for directors founded on continuous director education that ensures currency and intelligent responses are all on the horizon for director service in the new decade. Start thinking about your role in bringing your board to this new level of competency and engagement.

Stuart R. Levine, the founder, chairman and CEO of Stuart Levine & Associates (www.stuartlevine.com) is a director of Broadridge Financial Solutions and chairman of the governance and nominating committee and lead director for J. D’Addario & Company.  He serves on the Advisory Council: The Directorship/NYSE Boardroom Guide for the New Director.

On December 16, 2009, the SEC amended its rules governing executive compensation and corporate governance disclosures in proxy statements.  Among other things, the amendments require new disclosure about the effect of compensation policies on risk taking, director qualifications, board oversight of risk, and independence of compensation consultants.  The new rules also require that reporting companies engage their directors in discussions about risk oversight, among other topics.

This direction indicates a regulatory thrust in acknowledging a full understanding of risk and financial performance as the core of enterprise risk management.  The ideas contained in this area are meant to provide both a common sense approach to financial discussions as well as an encouragement to elevate your level of financial understanding, even if you don’t serve on the audit committee.

When Lehman Brothers raised dividends in the first quarter of 2009 and bought back shares, the whole board had to vote.  This was approved 9 months before its failure.  What questions should board members have been asking about leverage and debt?  Lehman’s leverage before bankruptcy was an irresponsible 30 to 1.

Ford’s saavy cash management by former CFO, Don Leclair, and CEO, Alan Mulally, began in late 2006.  Prior to the recession, the company loaded up on $23 billion in debt at a time when credit was cheap.  This was both “brave and prescient.” Their decisions not only helped Ford to gain market share for the first time since 1995, moving its stock to a near five-year high, but generated tremendous public goodwill in their avoidance of bailouts and bankruptcy protection.

Some companies grow too fast and don’t finance the growth effectively. Asking questions about how growth is being financed is one that all board members should consider.

Having the confidence to seek second opinions can strengthen decision making. According to Warren Buffet, as published in his latest annual Berkshire Hathaway shareholders letter, “Don’t ask the barber whether you need a haircut.”  Directors should be aware that banker’s incentives to complete deals are high – it’s an all-or-nothing game.  Without a deal, bankers don’t get paid. Improper incentives can make advice suspect.  Whether hiring counsel for independent directors or additional bankers, this is common sense intuition put into action.

James L Orsini, EVP, director of finance and operations at Saatchi & Saatchi, New York, defines a perfect starting point for enhancing financial discussion: “If directors are going to invest time in financial understanding, I strongly feel the best use of their time is in learning more about how cash flows through an organization and how the corporate treasury functions.”

Net income should always convert to cash and at some point that ends up on a bank statement, which is extremely difficult to manipulate.  That’s why bank reconciliations are so important to auditors.  Being able to ask questions about the build-up of receivables or ones that are aging too long, leads to better board understanding and discussion.

Understand how your company’s gross margin compares to your competitors.  If they exceed industry standards, ask why.  Are inventory levels tracking with accounts receivables?  Is there additional data to demonstrate that goods are being shipped? If there is a significant jump in account receivables, how many accounts contributed to this increase?  Were any special discounts or unusual return policies provided?  What were the payment terms? Becoming more well-versed in balance sheet language and questions, will help to ensure your common sense questions on financial matters are addressed.

Building your financial understanding will continually sharpen your insight.  Consider participating in audit committee conversations to increase your performance as a director.  Audit firms provide board member education.

As a corporate director, the removal of “silo” thinking is important.  There is a shared responsibility for results around the table.  To that end, for those who do not serve on the audit committee, you still have a greater responsibility today to be able to converse on topics that are outside of your field and know how to ask good questions that will have a positive impact on the quality of financial board conversations.

Stuart R. Levine, the founder, chairman and CEO of Stuart Levine & Associates, is a director of Broadridge Financial Solutions, and chairman of the governance and nominating committee and lead director for D’Addario & Company.  He serves on the Advisory Council: The Directorship/NYSE Boardroom Guide for the New Director.

Consider these highlights from the Spencer Stuart study of the S&P 500 companies for 2009.

• Classified board elections have been almost completely eliminated.

• Many more companies are setting a ceiling on how many boards their directors can serve.

• Companies are receiving more direct communication on issues from shareholders.

• The number of boards with only one insider rose 6 percent in a single year.

• Ninety-four percent of boards do some type of performance evaluation on either director performance or the board’s performance (quality on these evaluations varies, but 94 percent is a very big number).

The bottom line is that shareholders are demanding an effective board to ensure that directors are performing well, are appropriately independent, and have enough time to really deliver on their responsibilities.  These are healthy and important trends, but we’re missing the key piece.

It’s tempting to think that benchmarking to the never-ending flow of governance best practices that come across our desks will be the answer.  The foundation is data-driven, the process is well defined and the results measurable.  As business people, we find all three aspects of this approach very appealing.  But the key to aligning with evolving expectations requires something more of us as leaders.  We must redefine our cultures.

An organization’s culture is defined by the behaviors it accepts as normal–it is set and led from the top.  If you’re leading meetings where directors are on their Blackberrys throughout the discussion, where certain members regularly leave meetings early, where major issues are decided without input from all directors–take steps to strengthen the culture.  Define two to three specific behaviors that you believe should be the norm.  Have an open, respectful conversation with directors to communicate expectations and then enforce them.  Here are several to consider.

Full Inclusion
Require that all directors comment on key decisions.  I mean 100 percent inclusion of thinking.  Close each important discussion by saying, “I want to hear a few words from everyone on this issue.”  I know very few professionals who will not be prepared to contribute something smart if there’s a clearly communicated expectation that they will be asked to speak in front of their peers on an important subject.  Directors will quickly realize they must be prepared to comment meaningfully.  This sets the standard for professional behavior on the board.

Complete Attention
Turn off the Blackberrys during board meetings.  Today’s shareholder doesn’t want directors multi-tasking while making strategic decisions on the deployment of capital.  Clear thinking requires focused attention.  Make it the norm.

Highest Ethical Standards
Stressing ethical behavior in corporate governance is fundamental to the leader’s role and a review of ethics in governance should be done annually.  Board leadership should send a clear signal that anything below the highest ethical standards will not be tolerated.  Sometimes we get into denial and we convince ourselves that no director we serve with needs to have an ethics review.  But distractions and stress drive good people to rationalize, blurring the lines of right and wrong.  Recent alleged events at Galleon remind us how people may be drawn off course.  Repeated discussions on values and the reputational risk we all share are key to a solid culture.

Choices Impact Company Culture
Beyond defining norms, review the cultural impact of your decisions.  Consider these two scenarios.  Two different boards decide to gather their directors for dinner the night before their respective board meetings.  Chairman A gets a private room and conducts a closed-door discussion about important industry trends.  He asks directors what they are experiencing in their own professional lives and how what they are seeing relates to the board’s work.  Chairman B gets a large table in the main dining room of a trendy restaurant and encourages directors to relax and have a social evening together.  Which sets a tone for high-level productive relationships and discussion?  All choices send a signal.  There’s nothing wrong with social evenings out, but make choices consciously because they will influence the company culture you are building.

We’re serving in a time when shareholders are demanding fully engaged directors and frankly, they have that right.  We should absolutely continue to benchmark best practices, but on its own, this will not be enough.  We must build and maintain a strong, open governance culture in the United States that makes ethical behavior, full engagement, and personal responsibility the norm.  Cultural alignment is the foundation. Without a strong culture, nothing else will have a chance to work.

Stuart R. Levine, the founder, chairman and CEO of Stuart Levine & Associates, is a director of Broadridge Financial Solutions, and chairman of the governance and nominating committee and lead director for D’Addario & Company.

Research released this quarter showed that 30 percent of directors surveyed believe there is a director on their board who should be replaced. Of those who said yes, 46 percent cited a lack of needed skills, 38 percent pointed to a lack of engagement, 34 percent said the director(s) was on the board too long, 28 percent indicated they were unprepared at meetings, and 17 percent said the director was simply too old.

Let’s face it. While there has been a lot of talk about how people will leave board service as accountability and personal liabilities increase, the truth is that there is very little director turnover. To perform at consistently high levels, boards need to be refreshed. Right now, the pressure-filled business environment is providing the perfect moment to have those difficult conversations and set policies that increase director excellence.

Looking around the boardroom, I see three practical steps that boards should consider: setting term-limits, a mandatory retirement age, and creating an effective director evaluation process.

Term Limits
Without terms limits, you could end up with someone serving on a board for 30 years. It’s difficult to believe that after three decades, a director maintains the fresh perspective and independence that made him or her an asset in the first place. That kind of comfortable tenure often leads to status quo thinking which doesn’t serve the shareholder. Conversely, the infusion of new thinking into board discussion stretches and elevates the conversation. A clear policy will de-personalize and simplify the process of ending service when a person no longer adds value.

Mandatory Retirement Age
Often senior directors have distinguished themselves as valuable and capable men and women over a lifetime of accomplishments. That’s why they’ve been at it for so long. Their compelling careers are part of what makes transitioning them out an emotionally difficult decision that gets deferred year after year. Still, I have been in more than one board meeting during which an elderly director fell asleep for an extended time and that is simply not fair to shareholders. Establish a mandatory retirement age. My recommendation is 72 years old, but the key is to define it proactively so you don’t find yourself having the discussion based on one person’s service which is uncomfortable for everyone involved.

Effective Director Evaluation
Here’s the good news. Many more boards are conducting assessments. The percentage of boards conducting full-board performance evaluations went from 33 percent in 2002 to 88 percent in 2007. Some studies suggest that number may be as high as 94 percent today. The bad news? Quality is all over the map.

Forty-six percent of directors polled in the aforementioned 2009 Q4 study, thought their board’s evaluation process was effective or very effective. More than half of the respondents viewed their process as less than effective. There’s a big difference between doing a board evaluation and doing it right. There are many excellent models to employ. In my experience, there are several key components:

• Ensure that the discussion is criteria-based, data-driven, and effectively executed. Conduct interviews using standards rooted in best practices and approved by the full board.

• Seek input that is actionable. The primary purpose of the assessment is to improve performance. Most directors are sophisticated professionals capable of putting useful feedback to work. Make sure the information you gather serves this purpose.

• Put the right person in charge. It’s difficult for the CEO to drive this conversation. Depending on the circumstance, it could be the chairperson, the lead director, or the nominating or governance committee chair. If the chair is also the CEO, it should be the lead director.

• Build a culture of trust and respect to promote candor and collegiality throughout the process.

All four of these steps move a board forward on the path to excellence, but none are easy to take. The urgency created by current regulatory pressures offers an opportunity to push through the difficult conversations and define a new standard for director performance. It’s up to us.

Stuart R. Levine, the founder, chairman and CEO of Stuart Levine & Associates, is a director of Broadridge Financial Solutions, and chairman of the governance and nominating committee and lead director for D’Addario & Company.

While regulators and investors deserve to be reassured, I grow concerned that loud, public cries to better manage risk, will effectively diminish our capacity to take risks.  Ironically, this potential pendulum-swing of reaction becomes a new risk in and of itself.  An overly conservative approach will tamp down innovation and growth.  Too much board time focused on risk will draw directors’ attention away from other issues more important to long-term value creation.  And perhaps most importantly, if directors slip into an operational risk management role, it will undermine the CEO’s authority to lead his or her company.  Put simply, with reward requires risk and the oversight for those risk profiles must be reasonable. Corporate leaders have to get this balance right.

It’s time to move beyond risk modeling, which clearly has its place.  To get this right, we need a practical process that will add insight and quality judgment to the mathematical models.  As with all results-focused processes, it must be built on specific expectations, clear roles and responsibilities, and accountability.

There’s no one-size-fits-all approach, but here’s my take on the major components.

Define your tolerance for risk and how you’ll gauge it. The board establishes risk parameters and defines a dashboard of metrics that demonstrate adherence to the policy.  Directors must understand all of the material risks to the corporation and they need it all in one report so oversight quality is clear.  At a minimum, the view should include reputational risk, operational risk, and human capital risk.  This type of report will enable appropriate discussions on risk / reward correlation with a sharp focus on mitigating risk.

Put the CEO in charge. Performing within the parameters of the risk policy needs an owner and in my view, that should be the CEO.   There is a role for a Chief Risk Officer going forward, but without clear ownership, there is no accountability.  The CEO owns this issue.

Hire a Chief Risk Officer. The CRO reports to the CEO, but the board should have a role in selecting this person and ensuring this role’s incentives are in line with its primary responsibility which is to identify significant threats to long-term growth and value creation.

Connect the risk officer to the board, but not in a way that weakens the CEO. By creating a separate reporting link for the Chief Risk Officer to the board, you strengthen his or her internal position and make it easier for the CRO to get needed data and insight.  But nothing should be put in place to weaken the CEO’s authority.  Some will say that a CRO should report directly to the board to “keep the CEO honest.”   For me, if you don’t trust the CEO, that is a separate issue.  Discuss replacing the CEO with other directors.  If you find you’re alone in your assessment, resign from the board.  Your own reputational risk is too great.

Establish a risk committee. Many are calling for board-level risk committees, but I believe this is a senior management committee.  The CEO chairs this committee which reviews risk data, makes recommendations to the board on the most effective ways to balance the potential risk and reward of specific strategies, and provides the requested dashboard data.  Working with this Committee, the CRO defines ERM program objectives, assessment framework, and a common “risk” language for the organization.  The board will define the risk profile, but determining how to execute risk management initiatives within the organization is the Risk Committee’s job.

Ensure the full Board is engaged in this discussion. All directors should receive and evaluate this data.  If this conversation gets delegated to a board-level committee, director accountability will be diminished.  Effective enterprise management is a vital and shared responsibility.  It’s too tempting for directors to think it’s “handled” if it’s taken up by a board committee.  This is a full board issue.

Hold the CEO accountable. Unjustified variance from the risk parameters must have consequences.  At a minimum, the compensation committee should imbed adherence to the risk policy into the CEO’s compensation structure.   If a CEO cannot get results within reasonable risk parameters, then it’s the board’s responsibility to replace him or her.

In the end, moving forward requires risk.  Every time we get in a car, there’s risk.  But we mitigate risk by having a clear destination, getting input if we need it, reading the dashboard data, and making judgments.  That enables us to move forward with confidence.   A clear process, with the right roles, will focus corporations on what shareholders truly care about — long-term value creation.  It would be a mistake for us as corporate leaders to participate in a discussion about throwing away the keys to the car.

Stuart R. Levine, the founder, chairman and CEO of Stuart Levine & Associates, is a director of Broadridge Financial Solutions, and chairman of the governance and nominating committee and lead director for D’Addario & Company.