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Highlights from the three-day event include:

• A taped presentation by Securities and Exchange Commission Chairman Mary Schapiro regarding the role of proxy advisory firms, as well as new procedural guidelines surrounding director nominations and securities lending.
• The replacement of ICGN Chairman Peter Montagnon by former California Public Employees’ Retirement System Senior Investment Officer Christianna Wood.
• Creation of a task force to address corporate board risk oversight
• The presentation of the ICGN Award to Swiss governance fund Ethos for its successes in convincing UBS to adopt say on pay measures.

The ICGN will next meet on November 18 and 19 in Washington DC. 2010 meetings include March 4 and 5 in London and next year’s annual meeting on June 28 through 30 in Toronto.

Directorship will become NACD Directorship, the magazine of the National Association of Corporate Directors. It will be distributed to NACD members as a benefit of membership and will continue to be circulated to Directorship’s current paid customers.

“As the organization that convenes directors to research, develop, and disseminate leading boardroom practices, it makes sense for NACD to align with a strong editorial brand such as Directorship so that we can better deliver that value to our 10,000 members, said Kenneth Daly, president and CEO of NACD. “I look forward to working with Jeff Cunningham and his highly skilled team to provide these additional educational and editorial forums that will give directors a greater voice in the marketplace”

Directorship and NACD will produce co-branded conferences, including the Global Issues Forum, Directorship 100, and Boardroom Leaders, as well as a series of peer-to-peer exchanges.

“Our mission has always been around ‘boardroom intelligence’ so this collaboration is one that we are truly excited by and one that we believe will have a lasting impact on the corporate governance community,” said Jeffrey M. Cunningham, chairman, CEO, and editorial director of NewsMarkets, which publishes NACD Directorship and the influential Global Proxy Watch newsletter.”

The conference was hosted and organized by Brazilian president Luiz Inácio Lula da Silva, who went so far as to shuttle in foreign leaders using his own country’s air force, according to the Times. The conference addressed the credit crisis and its ramifications across Latin America, and was largely condemnatory of the United States.

A popular sentiment among attendees was that the United States should abandon its nearly 50 year-old embargo on Cuba, and work to include the country into the global dialogue. “This is a further step in the process of ensuring that Cuba occupies its rightful place of dignity in the region and throughout the world,” said Jamaican prime minister Bruce Golding.

Many countries also blamed the United States for stoking the current downturn, with Cuban president Raúl Castro labeling the U.S. “neo-liberalist” in regards to its economic attitudes. “In the middle of an unprecedented global crisis, our countries are discovering that they aren’t part of the problem,” said da Silva, implicitly blaming the United States.

The Brazil conference comes four months prior to the next Summit of the Americas, a meeting that convenes most countries in North and South America, excluding Cuba. Observers claimed that Brazil was attempting one-upsmanship in hosting its own meeting so close to the approaching Summit. “There is no question that this is about exclusion, about excluding the United States,” said Peter Hakim, president of the Inter-American Dialogue, a policy research group in Washington. “Brazil is demonstrating its enormous convening power.”

According to Bill Baxley and Jeff Stein at King & Spalding, directors have less opportunities to draw on significant resources and contribute to corporate strategy. CEOs suggest that participating in corporate strategy is the second most important activity that their boards undertake, yet CEOs give directors only the 11th highest grade for their performance on this realm.

The Lead Director Network, a group of lead directors, presiding directors, and non-executive chairmen from many of America’s leading companies created by King & Spalding and Tapestry Networks, met on November 3, 2008, to discuss the role of the board in corporate strategy, according to The Harvard Law School Corporate Governance Blog.

King & Spalding and Tapestry Networks published the ViewPoints report, presenting highlights of the subject.

Boards have become more involved in corporate strategy in recent years. The Lead Director Network also found that boards being more proactive—especially in the aftermath of corporate scandals—the rise of activist investors, and directors’ own efforts to become more engaged in corporate strategy, even when companies are in constant flux and facing uncertain economic times.

“The emerging countries are the solution to the overall global slump,” said Josep Piqué, chairman of Barcelona’s Vueling airliner, who noted that emerging markets like China, India, and Brazil controlled 30 percent of the world’s economic power. Another participant, Claude Begle, chairman of Swiss Post, claimed that Asian nations would be the first to recover from the economic slump and lead the world to recovery.

The “Global China Business Meeting,” sponsored by the Geneva-based consulting firm Horasis, is the fourth annual meeting between executives, regulators, and economists, whose shared goal is increased business between China and Europe. Since China’s export market boomed in the early 1980s, the nation has seen astounding growth, with their GDP now ranked fourth among countries worldwide, making up 6 percent of the world’s total.

Detractors at the meeting, however, were quick to point out that China itself has its problems even without the global economic crisis. One financial advisor pointed out that China had key weaknesses in its infrastructure that would undermine future economic expansion, particularly a lack of emphasis on research and development and post-secondary education. Another difficulty was that the strength of the Chinese Renminbi has so overpowered European currencies that its exports to Europe aren’t capable of besting local competition.

A government official, Xu Kuangdi, chairman of the China Federation of Industrial Economics, cited the inner strength of the Chinese people as proof enough of the country’s resilience, claiming that, “Confidence and cooperation are worth more than money and gold.”

With the opportunities created by a rapidly evolving spectrum of technology and a global economic frontier that is continually opening its borders to new players, today’s executives and directors must be willing to adapt to a business and governance environment that is constantly shifting. One of the most effective ways of adapting is through the pursuit of professional development offered by executive education programs at top universities around the country.

Successful directors have all spent several thousands of hours in high-pressure, high-impact work environments in which the combined knowledge and instinct of a company’s management team must be shaped into a very specific plan of action. With this kind of real-world experience, in combination with advanced degrees already held by most directors, one might question the practical advantages of going back to the classroom.

The answer is new perspective. “Knowledge has a way of moving at a clip that eclipses very quickly that which was gained in prior formal education,” says Dr. Constantine Konstans, executive director of the Institute for Excellence in Corporate Governance at the University of Texas at Dallas. “Real-world experience is invaluable, but it tends simply to repeat the same processes and outlooks rather than expanding one’s exposure to new ideas.”

Charles Breckling, managing director of marketing at Harvard Business School Executive Education, echoes this sentiment: “The half-life of any educational experience is short. If you’re on a board and received an MBA twenty or thirty years ago, the business climate has changed to the point where you need exposure to new ideas in order to stay sharp.”

The benefits of executive education are worthwhile and far-reaching. In addition to the inherent benefits of gaining access to relevant and new information, the opportunities afforded by working with one’s peers in a “professional classroom” setting are unparalleled. “Our courses have great convening power,” says Breckling. “We bring board members from all over the world, and they in turn bring a broad global outlook you can’t find anywhere else.” In addition to the expertise of the professors, students in these programs often instruct and learn from each other, as their shared experiences provide plenty of case studies.

The range of topics covered by executive education programs entirely encompasses the modern-day business climate. Established programs at Harvard Business School Executive Education, for example, include courses in leadership, strategy, corporate governance, finance, technology management, marketing, negotiation, and personal development—not to mention custom programs designed for a specific company’s needs.

Improved Ratings

While pursuing executive education is certainly beneficial for the individual who takes the course, it also strengthens the board on which he or she sits—and not just by virtue of having the insights of this newly enhanced individual in the company. Many governance ratings agencies look kindly upon boards whose members have participated in executive education programs, and take completion of these programs into consideration when rating companies’ boards.

One such ratings agency is RiskMetrics, whose ISS Corporate Governance Services department determines the best director education programs. “The types of issues that boards are confronted with today—governance fallouts, the mortgage crisis, options backdating scandals—are so new that it’s important for directors to be able to meet with their peers to discuss and strategize,” says John Deosaran, head of product and business development, ESG Analytics, at RiskMetrics Group. “We grant accreditation to those executive education programs that allow directors to tackle the challenging problems of today.”

Because of the knowledge and new energy that a well-educated director or executive can bring back to a management team, it’s not uncommon for a company to grant time off and foot some or all of the bill for an executive going “back to school.” Since these courses can range from one-day intensive sessions to several weeks, and because enrollment fees can range from a few thousand dollars to hundreds of thousands for large groups, it certainly doesn’t hurt to have the blessing (and backing) of the corporation.

When it comes to choosing the path to continued education, options facing the knowledge-hungry officer or director are diverse and plentiful. The two main categories are open-enrollment courses and custom-built programs.

Open-enrollment courses tend to take more time than their custom counterparts, and typically are offered in a more traditional classroom setting. Institutions that offer these programs— typically universities, director groups, or other similar organizations—advertise their courses to the public, and students register independently. Open-enrollment courses tend to assume the traditional forms of a collegiate classroom, with lectures, guest speakers, open discussions, and even campus housing. The Wharton Center for Leadership and Change Management, for example, offers open-enrollment courses that feature a multi-layered classroom experience based on case studies, team exercises, peerto- peer exchange, and other methods of instruction that facilitate dialogue and shared experience between students and faculty. When class concludes, students have access to a guest room and all the amenities of college life, though likely in a slightly more upscale environment than former undergrads may remember.

Custom Fit

Custom-education courses are tailored to the requirements of the company taking the course. The “student body” of a custom program will be composed almost exclusively of executives and directors from a single company. Unlike open enrollment, custom- education programs are organized and shaped through communication between the educational institution offering the program and a representative from the company. The institution determines the needs of a company and then draws up an appropriate program, assembling a curriculum, class site, and instructors selected from a wide pool of available professors, litigators, board members, and regulators.

Because custom programs hinge so directly on the needs of the company taking them, the array of possibilities for educational expansion is literally endless. Most prominent institutions that offer custom programs have worldwide facilities and an international staff of instructors, allowing for truly global educational perspectives.

One such institution, Duke Corporate Education—a not-for-profit owned by Duke University—offers programs throughout the world. “Our business model has cut itself off geographically from the school,” says marketing director Paul Baerman, “allowing us maximum versatility in going where our clients need to be. A narrow perspective in the boardroom can be greatly enhanced by exposure to broader international territories.”

While some executive education programs take a straightforward instructional path, some push the boundaries well past the familiar. Baerman recounts a custom program in which members of a boardroom were brought to a hospital and told to don the uniform of the hospital’s employees. They were separated and individually greeted by an oncologist who gave them the weighty task of informing a patient (actually an actor) that he had cancer. In nearly all of the cases, the student was unable to break the bad news, and either circumvented the facts or retreated for “further information.” The lesson? “Even in a life-or-death situation, the director was unable to address that which needed to be addressed,” says Baerman. “After the ploy was revealed, these directors discussed and came to the conclusion that honesty and straightforwardness are the most important aspects of communication. This is a revelation that has an immediate effect in the boardroom.”

Despite the myriad programs, instructional methods, and offerings available, executive education programs all share a common purpose: better boardroom and executive performance. This goal is facilitated by a well-designed program led by engaging, knowledgeable instructors with real-world as well as theoretical understanding, but the key to improvement may in fact lie within the students themselves.

“What we teach isn’t so much an academic or professional solution to a problem, but rather a personal one,” explains Baerman. “One of our sayings is ‘the answer is often in the room, which means that we don’t so much teach you something new, but we guide you through finding it within your own capabilities and experiences.”

For program details visit:

UCLA’s Director Education & Certification Program

October 27-29, 2008

UCLA Anderson

Florida’s Directors’ Institute

Friday November 7, 2008

The University of Tampa

The Directors’ Consortium

February 25-27, 2009

Stanford,CA

Harvard Business School Executive Education

Audit Committees in a New Era Of Governance

July 2009

Compensation Committees: New Challenges, New Solutions

July 2009

Making Corporate Boards More Effective

July 2008

At Directorship’s inaugural “Directors to Watch” Forum, hosted by Nasdaq OMX on June 30, Charles Elson quipped “solvency.” The chair of the University of Delaware’s Weinberg Center for Corporate Governance warned the more than 80 attendees that directors should be paying attention to new regulations on executive compensation likely to be included in any Congressional bailout package, and, in particular, severance packages.

Elson, in a panel moderated by PricewaterhouseCoopers’ partner Catherine Bromilow, also said that the Sarbanes-Oxley Act of 2002, passed to restore investor confidence in the aftermath of corporate accounting scandals, may also be subjected to renewed scrutiny.

“SOX and in particular 404 came up with internal controls to mitigate risk…but when highly regulated companies such as banks and insurance companies start to fail, where was SOX? How effective was that?” David Swinford, president and CEO of Pearl Meyer & Partners, an executive compensation consulting, said that the recent collapse or near collapse of so many once venerable firms serves to remind directors that “preserving the corporation” should be their top concern. To do that, he suggested that boards work to avoid “group think.”

The upcoming January through March “pay decision-making season” should also see directors “worried about how to balance pay for non performance,” Swinford said.

Julie Hembrock Daum, an executive recruiter who leads Spencer Stuart’s North American Board Services Practice, said concerns of governance committee members in particular should center on board recruitment and succession planning. Some boards are seeking younger directors while others are pushing the mandatory retirement age for directors up to 75 in an effort to retain their experience.

Daum also noted that one-third of all newly appointed directors have no prior board experience, which underscores the need for boards to understand what makes a good director. She expects boards to become more proactive in succession planning, and said she is being called upon more frequently to help with internal candidate assessment.

Elson pointed out that the level of anger and mistrust being directed at corporate management and boards of directors is nearly unprecedented. “We need to restore confidence in the system,” he said.

Private-equity titan Stephen Schwarzman speaking at a forum on Tuesday provided a sweeping explanation of how the United States arrived at its current state of economic turmoil. The panel, organized by the Yale School of Management Senior Associate Dean for Executive Programs Jeffrey A. Sonnenfeld and the Wall Street Journal, took place at New York’s Waldorf-Astoria hotel.

In explaining the credit crisis, the Blackstone chairman started with the excess granting of subprime loans and the amassing of debt securities, and moved into the massive write-offs by the banking community and the failure to amass new capital. “We now find ourselves with a liquidity crisis,” concluded Schwarzman, “where fundamentally the cost of money for financial intermediaries is significantly in excess of their cost of lending it.”

Yale economist Robert Shiller described the crisis more succinctly—“a real mess”—but the overwhelming sentiment among the panelists was that a solution to the economic crisis would be hard-fought. A secret ballot taken among the panelists as to whether the $700 billion government bailout would work was split down the middle 50/50.

“When they started defaulting, out of bad luck or bad judgment, we implemented fair-value accounting….You had wildly different marks for this kind of security, which led to massive write-offs by the commercial-banking and investment-banking system.” -Stephen Schwarzman

Schwarzman, a Yale alumnus, was among thirty-two corporate leaders involved in the discussion. Other attendees were ex-SEC chairman William Donaldson and investor Wilbur Ross.

Schwarzman’s full comments follow:

“It’s a perfect storm. It started with Congress encouraging lending to lower-income people. You went from subprime loans being 2% of total loans in 2002 to 30% of total loans in 2006. That kind of enormous increase swept into the net people who shouldn’t have been borrowing.

“Those loans were packaged into CDOs rated AAA, which led the investment-banking firms [buying them] to do little to no due diligence, and the securities were distributed throughout the world, where they started defaulting.

“When they started defaulting, out of bad luck or bad judgment, we implemented fair-value accounting….You had wildly different marks for this kind of security, which led to massive write-offs by the commercial-banking and investment-banking system.

“In the face of those losses…you needed to raise new equity…which came from sovereign-wealth funds, in part, which then caused political resistance to sovereign-wealth funds, who predictably have withdrawn from putting money into the system….It seemed pretty obvious that would happen. We now find ourselves with a liquidity crisis where fundamentally the cost of money for financial intermediaries [such as investment banks] is significantly in excess of their cost of lending it. So several institutions found themselves in a structurally impossible position. …Goldman reverted to a banking charter for a lower cost of funds, which today is still not low enough for the business.

“So that’s the story of how we got there.”

The report’s central recommendations are as follows: monitor securities holdings to ensure that activists aren’t consolidating their strength through equity swaps; maintain communication with investors and respond to requests for change; ensure a fair and transparent proxy vote; and oversee the management of hedge funds and work to understand its motivations.

Recent unrest at public companies like Yahoo, CSX, and Motorola was cited as inspiration for the report. “There is so much fear, loathing and misinformation in the marketplace that it has made constructive engagement between companies and hedge funds difficult,” said Jon Lukomnik, co-chair of the group. “This Report demystifies hedge fund activism and, by so doing, should improve the communication between companies and hedge funds.”

Among the companies participating in the Working Group were Alcoa, Coca-Cola, and Pfizer. Two institutional investors contributing to the report were Barclays and Managed Funds Association.

The report’s recommendations were endorsed by the National Investor Relations Institute (NIRI), the largest U.S. association of investor relations officers. The report was authored by research director Matteo Tonello.

Former Securities and Exchange Commission Chairman Arthur Levitt will chair the new working group of governance experts.

Kayla Gillan, chief administrative officer for RiskMetrics, emphasized the need for an open forum. “This is an opportunity for people who are well-regarded in their field to get together without any kind of restraint,” says Gillan.

RiskMetrics has been criticized for being too insular. To combat this perception, Gillan says that the board has been considering an open discussion forum since February. “We can get experts and they can talk and we can listen as to what they think governance will be in the next decade,” she says. “If this U.S.-focused panel works, we can then go global.”

In addition to Levitt, members of the RiskMetrics Governance Leadership Council include:

• Mark Anson, president, Nuveen Investments
• Peggy Foran, general counsel and corporate secretary, Sara Lee
• Charles Elson, director of the John L. Weinberg Center for Corporate Governance, University of Delaware
• John F. Olson, partner, Gibson Dunn & Crutcher, and professor, Georgetown University Law Center
• Harvey Goldschmid, former SEC Commissioner, senior counsel to Weil Gotschal & Manges, and Columbia University Law School professor
• David Hirschmann, president and CEO, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
• Dana Mead, chairman, MIT Corp
• James Robinson, III, former chairman and CEO, American Express
• Reuben Mark, chairman, Colgate-Palmolive
• Peter Clapman, former corporate governance head at TIAA-CREF, and partner at Governance for Owners
• Stephen Kaufman, senior lecturer, Harvard Business School

All members of the GLC will be appointed to two-year terms and the group will meet three times a year. Members will receive no compensation for their services.

“This leadership initiative will provide a forum to identify and discuss a wide range of global governance policy topics of interest to institutional investors, corporations, and governance constituents,” said Rich Leggett, head of RiskMetrics’ Governance unit, in a statement. “The work of the GLC will enrich our corporate governance thought leadership, as well as inform our policy formulation process by focusing on forward-looking implications of today’s real world corporate governance challenges.”

In short, Akin Gump’s Top Ten issues are:

• 1) Rising Shareholder Activism – 2007 saw a record number of shareholder proposals, activist campaigns and proxy fights. As these actions tend to increase when the economy and the stock market falter, boards should plan in advance for a busy calendar.

• 2) Hedge Funds at the Gate – During 2007 hedge funds were involved in more than half of the record 501 activist campaigns and two thirds of the record 110 proxy fights. Boards must be proactive in their strategies to engage with this growing bread of corporate player.

• 3) Where Have all the Mergers Gone? – The freezing of the credit market in the second half of 2007 has brought corporate M&A activity to a halt. As a result, directors will need to reassess acquisition and divestiture plans. At the same time new SEC rules may catalyze the market for private capital. Of major concern however will be the outcome of litigation that will define the limits that deal participants can exit transactions as a result of “Material Adverse Change (MAC)” clauses, and the potential for a Democratic administration to impose a more restrictive antitrust environment in 2009.

• 4) A Better Way to Proxy? – New SEC “E-Proxy” rules in 2007 have altered the proxy voting landscape by allowing proxy materials to be posted online instead of sent through the mail. The results of the program have been mixed and clear lessons are not yet discernible.

• 5) Meet the New Boss – In a challenging economic environment, CEO changes can be expected to increase. Boards should have succession plans in place to meet unexpected challenges.

• 6) Pay Practices Under the Microscope – SEC policies adopted in 2007 will place additional burdens on boards to justify executive pay packages. Already 350 corporations have been asked for greater clarity as to how compensation was determined. In such an environment, compensation committees can leave nothing to chance and must act proactively to diffuse potential problems.

• 7) Say on Pay – Proposals that would give shareholders a more direct influence on executive pay packages gathered significant support in 2007. Although passed in only a handful of occasions, boards should prepare for a continuing groundswell of support for these initiatives.

• Recession Planning – History shows that when the economy goes down, corporate shareholder lawsuits go up. Boards should plan accordingly. Of particular concern to financial firms will be lawsuits related to losses on subprime mortgage investments.

• 9) Environmental and Corporate Responsibility Initiatives – Popular campaigns for corporations to alter policies on energy use and social issues have greatly increased their support in recent years. Surprisingly, these initiatives have not been restricted to energy and large manufacturing companies, but to retailers and homebuilders as well. As a result, corporate boards will be dealing with issues such as carbon emissions for years to come.

• 10) Insider Trading – After a December 2006 study revealed that Rule 10b5-1 trading plans may fail to insulate selling from insider knowledge, the SEC began devoting much more attention to how these plans are constructed and executed. In addition, boards should be aware of how an energized SEC with better technological tools is detecting insider trading activities in areas that have been previously impenetrable.

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Kathleen Friday is partner and Tracy Crum is senior counsel in the Dallas office of Akin Gump Strauss Hauer & Feld LLP.

]]> http://www.directorship.com/top-10-topics-for-directors/feed/ 0 http://www.directorship.com/non-public-firms-also-face-exposure/ http://www.directorship.com/non-public-firms-also-face-exposure/#comments Thu, 01 Jan 1970 00:00:00 +0000 Judy Warner http://www.directorship.com/?p=4160 Public company board directors dream of takingtheir company private to escape onerous regulation,the high cost of compliance, and the sometimesconflicting demands of different shareholdergroups.

Our recent Directorship Boardroom Roundtable,“Private Companies: Compliance and Liabilities,”convened a group of leading directors andexecutives to look into this issue and answer suchquestions as whether private companies would bewell served to remain private, especially in the currentenvironment. In the absence of shareholderlawsuits, what are the real liabilities for privatecompanies? What are the best practices public andprivate companies can learn from each other, andwhat types of issues should directors and advisersbe attuned to?

Leading the discussion was Brian Inselberg, whoserves as president of AIG Executive Liability’s CorporateAccounts and Private & Non-Profit divisions.He quickly listed the primary reasons forbecoming a publicly traded company: access tocapital, new forms of compensation for employees,a potentially higher profile and wider following, thediversification of personal holdings, among others.Inselberg noted that liability exposure remains afunction of size and structure and that being privatedoesn’t translate to reduced compliance risk.

While the risks are typically smaller for privatecompanies, he noted there are potential areas ofcompliance risk that private-company managementand board directors would be well advised to payparticular attention: data breach and data privacy;transparency and independence of board; regulatoryissues; and the Foreign Corrupt Practices Act(FCPA), which makes it unlawful for a U.S. personand certain foreign issuers of securities to bribe aforeign official for the purpose of attracting orretaining business. (For more information on theFCPA, go to www.usdoj.gov/criminal/fraud/fcpa.)

The Public/Private Debate

The decision to go public or stay private (or go privatevia a private-equity firm) comes with a set ofpros and cons. Robert La Blanc, a former partnerat Salomon Brothers, and now an active directoron multiple boards of public and private companies,was asked how going public changed theonce venerable Wall Street investment bank. “Themanagement committee at the time only had partnershipmoney and they were looking at the modelof a Citigroup which had a larger base ofclients…The desire to go public was access to capitalso that we could play among these big players.”Indeed, access to capital is usually first on the listof benefits to going public.

Georges Ugeux, chairman and CEO of GalileoGlobal Advisors and former head of the internationaldivision of the New York Stock Exchange,countered that going public doesn’t always have apositive effect. He said going public “completelychanged” the culture of Salomon, which was laterbought by Smith Barney, and eventually becamepart of the corporate structure its former managementhad aspired to emulate: Citigroup. “It changedfrom a culture where people worked for the good ofthe company to one where people worked for whatwas good for the individual. Within six months, itwas a totally different firm,” Ugeux asserted.

And companies that go private or stay private toavoid compliance and regulation headaches mightbe engaging in a bit of wishful thinking. “You arestill going to have regulatory exposure and you stillhave the need for a compliance program,” notedDirectorship Publisher Christopher Clark. Forexample, he said that any company that has $5million or more in government contracts needs tohave a compliance program. And in certain industries,he said, class actions and antitrust issues canbe as significant for private companies as they arefor public companies.

“What you’re saying then,” said Jeffrey M. Cunningham,chairman and CEO of NewsMarkets, theparent company of Directorship magazine andGlobal Proxy Watch, “is that there isn’t a huge differencein liability, but as a private-equity investor whatI need to carefully assess is the risk-control environmentfor private companies.”

Some Roundtable participants pointed out thatprivate companies and especially non-profits andfamily-owned businesses are often guilty of lessvigorousor even sloppy financial controls and bookkeeping,raising the specter of liability and risk.Joseph Fichera, the founder and CEO of Saber Partners,offered the contrasting view that from a riskstandpoint, private companies backed by venturecapital might actually be in a better position thanpublic companies.

“When they [the venture capitalists] interact withthe CEO and management, they’re armed withbetter information than the board…whereas publicboard members may lack the resources as well as theindependent judgment to view company data,”Fichera said. “We should ask, ‘Are you doing yourown analysis and, if not, are you getting all of yourinformation from management?’”

Murphy’s Law

“That’s a valid point,” Inselberg said. “You want tohave a process in place, as all risk-managementoriented companies should have, that assumes thatanything that could go wrong, will go wrong. Whenthe inevitable happens, your organization needs tobe able to limit its exposure.”

Some directors said they would not serve on a privateboard that did not offer directors’ and officers’(D&O) insurance. Even serving on the board of alocal nonprofit, whether a small charity or a largehospital, has risks that should not be underestimated.Case in point: A lawsuit brought against alocal hospital and its board raised questions abouthow profitable the nonprofit was, according to oneRoundtable participant, and left him feeling vulnerable,even though serving on the board seemed likean act of social mindedness.

One important instructional note: All companies,whether public, private, or nonprofit, should agreeto indemnify their executives and officers under apolicy of “mandatory advancement” (of legal fees)prior to the benefit of knowledge of guilt or innocence.The rationale for this is that the board willnot likely be able to assess guilt or innocence in anycase, but particularly not at the time the decision onwhether to cover legal costs needs to be made.

The further implication is that assuring adequatecoverage for directors and officers is of paramountimportance, as it is possible for one so-called “badactor” receiving legal fees to use up all the coverage.The bottom line: board directorships carryrisks, to be sure, but if properly understood and adequatelycovered, they should not stand in the wayof directors doing their job both independently andappropriately.

Leading the DirectorshipRoundtable titled “DrivingEnterprise Innovation &Growth” at New York’sLotos Club in Decemberwas Gap International VicePresident Dr. Eric Jackson.On a personal level, Jacksonis the quintessential innovator.Prior to joining GapInternational as a consultantspecializing in enterpriseperformance management,he worked as both a psychologistand a dentist, and at one time was an internationalaward-winning choral director. This unusualblend of skills and experience made him a perfectmatch for Gap International, which has a 30-yearhistory of partnering with boards and chief executivesto help them develop more effective ways to growtheir enterprises.

Gap International makes a distinction betweeninnovative ideas, which must be collected and harvested,and the environment or culture in which theinnovative ideas either languish or flourish. “Doesthe CEO create an environment in which innovativeseeds, or ideas, are being planted and nurtured?That is the most important role the board can playwith regard to driving innovation,” Jackson said.“The innovative seed occurs at a very early stage ofthe thought process, which is at once both a very vulnerableand very critical element of innovation success.What distinguishes highly innovative companiesis how nurturing their environments are to innovativethinking. Directors should consider this characteristica vital precondition for having an innovativeorganization.

“To be innovative,” Jackson continued, “is to execute.The most important question for the board is,‘Are the conditions right for high-level, rapid executionof innovative ideas?’”

That comment spurred KayKoplovitz, the founder and formerchairman and CEO ofUSA Networks, to recall theearly days of the cable networkformed in 1977 under the auspicesof Madison Square GardenSports. “Even though itwas a private company, everyperson there felt that theyowned it and the team felt itwas important to deliverresults…Risk was somethingwe were all born to, and if youdidn’t take a risk, you weren’tbeing aggressive enough.”

In publicly traded companies,however, risk in the context of innovation islikely to be influenced by short-termism, or thedesire to keep investors happy by delivering results.How can boards best help a CEO to innovate?

William Roskin, now a senior adviser to Viacomand director of ION Media Networks, said theboard’s role is to make sure the company has theright CEO and then let them do their job. He hasworked for both Sumner Redstone, the legendaryfounder and chief executive of Viacom, and the lateSteven J. Ross, the creator of Time Warner and thecatalyst in the launch of MTV and Nickelodeon.

“Going back to 1981, Steve Ross had a way of hiringpeople who were on the payroll but who were freelancethinkers,” Roskin said. “Did Steve have avision to create what became MTV? No, but he supportedit, and he lent his support…He believed incable. And his boards had to be supportive.”

“That’s a different task in a large corporationwhere people are territorial,” Koplovitz replied.“How do you break down those barriers so thatpeople can innovate?” She cited the failed merger atParamount and Universal Studios as an example.Roskin, who was a senior executive at Time Warnerwhen it joined forces with Viacom, recalled that“what started as two warring companies werebrought together because the CEOs of both thosebusinesses worked together.”

Noting that “tone” and “sponsorship” must start atthe top, Laurence Charney, a director of MarvelEntertainment, believes in the power of creative tension.“I recall working with a young, bright colleaguewho challenged everything I said. I learnedthat both of his parents were professors who believedin creative tension. I believe that creative tensionbuilds the best products and that you have to build aculture from the top down that allows people tomake mistakes.”

At least one participant recounted how compensationplans mitigated a company’s ability to take risk.“I also tried to drive down P&L ownership for thesame reason,” said Richard Daly, CEO of BroadridgeFinancial Solutions. “I want to know who goesto bed at night and gets up in the morning thinkingabout the company. You have to be in a position tocreate a financial environment that will support thatmindset.”

Gap International has researched critical factorsthat create an environment for sustainable innovation.The company advises directors and officers tofocus on the following five factors:

Purpose—which drives energy and focus. Doesthe executive team have a clearly defined strategyand are the people in the organization connected tothe company’s purpose?

Ownership—which predicts reliability for producingresults. Is the executive team committed toand holding themselves personally responsible forachieving the company’s overall goals in addition totheir own functional/business goals?

Interdependence—which drives the quality ofexecution. Do the top leaders work collaborativelyand contribute to one another throughout the variousstages of their work?

Affinity—which impacts the speed of execution.Is the executive team connected to one another andto the CEO? Are the channels of communicationopen and is there a sense of ease and freedom intheir relationships?

Risk—which unleashes creativity. Are leaders freeto think and speak in unconventional ways? Is managementwilling to take chances and allow for failure?

“As we study innovation, it is the company’s cultureand the environment it creates that ultimatelybecome the paramount factors in running and growinga successful business,” concluded Jackson.

You’re arguing the case against the PCAOB. Tell us what the issue is and why you got involved.

I was asked to join a legal team that is looking into the composition of the PCAOB. This five-member board, very interestingly and exotically, has enormous power and is appointed by the commissioners of the Securities and Exchange Commission. At a minimum, we should have Congress, or the President, or Chris Cox, the current chairman of the SEC, appoint these individuals to this board. We’re not a parliamentary democracy. Congress cannot choose to do anything it wants and it cannot, in our view, deprive the president of the United States of the opportunity to appoint these individuals or, at a minimum, have the SEC chairman appoint individuals to this board.

In litigation, we say there are victories and there are developments. We had a development in the district court in March where the district judge ruled against us and also ruled in our favor. Only a lawyer would say something like that. What he said is that the plaintiff is on to something here; the decision should have been the chairman’s, but the judge saw no real injury to these particular plaintiffs. We have filed our notice of appeal and we’re optimistic that the D.C. Circuit, which tends to be very sensitive to these foundational issues of separation of power, will listen. We think the court will rule our way, which would declare unconstitutional the composition of the PCAOB.

Tell us about the current Supreme Court. What’s in store for business?

It is a new day at the Supreme Court with the leadership of this great, young 52-year-old John Glover Roberts, Jr. What I see happening is a greater sensitivity to common-sense issues of fairness and efficiency. In the last week, I have begun referring to this Supreme Court as our ‘Chicago School Supreme Court,’ cutting across the usual philosophical and ideological lines. This is a very business-sensitive court. You have Justice Souter, who tends to ride along the liberal wing of the court, writing an opinion that was so very strong. The ruling in the case was that if you’re going to sue a large company, you’re going to have to be very particular in spelling out a factual basis for the complaint. Why? Because these suits are protracted and costly. He went on at length to praise by name individuals in the Chicago School, [a brand of economic theory associated with Milton Friedman that favors free-market libertarianism]. Recent cases are illustrative of a very savvy, business-sensitive court that is much more skeptical about litigation in the civil arena.

You commented that “the Constitution is business’s friend.” Would you translate that for us?

Think about what Henry Paulson [Secretary of the Treasury] has said about class-action [lawsuits] and their dangers. The Constitution speaks to class action and it’s called due process. Think of punitive damage awards and the Constitution. One of the areas that the Constitution speaks to is what is quaintly called the dormant commerce clause or the somnolent commerce clause. A long time ago, in 1824, the commerce clause was important because it prevented states from closing down their marketplaces in order to protect local industries. It’s part of the genius of our Republic. Justice Robert Jackson said a half century ago that every farmer and craftsman has the assurance that his or her product can get to market. As vigorously interpreted, the Constitution protects businesses against protectionist legislation that state legislatures are very quick to enact.

Who do you admire most among historic Supreme Court justices?

My default position is John Marshall, who was a quasi-legitimate midnight appointee in 1801. It was a bitter time, and there’s a new chief justice, who is a federalist and a rising star. John Marshall was John Adams’s John Roberts. Marshall then proceeded to serve on the court for more than 30 years and to build the court into this magnificent institution that held firm against the vicissitudes of the day. They too needed to speak with one voice, to find unanimity rather than cacophony.

How much progress have we made as a society on tort reform?

It is a constant battle because tort reform and the strength of the judiciary is going to be determined, by and large, by the states. The conversation between Alexander Hamilton and Thomas Jefferson continues to echo through the corridor of time. I’m pleased to say that this Supreme Court tends to be much more Hamiltonian, that we are a national marketplace. That’s a good thing, strengthened by the arrival of Justices John Roberts and Samuel Alito, but you’ve got to be prepared to fight in Sacramento and Austin and other state capitals.

Why do we have judicial hellholes and why can companies be dragged down into jurisdictions?

Very simply: You do business everywhere and can be sued anywhere.

You’ve had a succession of careers that is extraordinary. Which has been the most interesting?

Obviously, the most challenging time was the Whitewater investigation as it evolved into Lewinsky. because it was impossible to effectively explain to the American people what was going on and why. Congress passed a law. That law then ushered in this thing called the independent counsel. The attorney general initiated this investigation when she read that law and said, under this law, I must investigate whether Bill Clinton, Monica Lewinsky, and others have violated the law. I don’t think—and I’m painting now with a very broad brush—that the American people ever understood that basic foundational fact. I was not a rogue prosecutor. Instead, a charter came pristinely from the attorney general of the United States to a three-judge court that reviewed that charter and said here’s your job: to find out whether the president of the United States committed perjury or obstructed justice or intimidated witnesses. It was all lost in a miasma of irrelevancies.

Board members spend a lot of time paying attention to the Delaware Chancery Courts. What can we take from that?

The Delaware Supreme Court and the Chancery Courts have been protective of the business judgment rule. The Disney litigation showed that as long as diligence is shown, directors can sleep at night. The problem for large corporations in light of Enron is excessive litigation. There needs to be a culture of integrity, rather than the endless rule of regulation that has become the American way. We need a culture of integrity and honesty, but we also need to get Washington off our backs.

Return on Education

If you look at studies showing the rates of return for government investments in education, you will find that the highest rate of return comes from early childcare education and the second highest is from elementary school. Government investments in high school have a higher rate of return than college. Investing in elementary school computes to 18 percent over a 40-year period or 1,000 times your money. These are amazing rates of return and, as we know, government investments generally don’t achieve those rates.

Now, look at the private sector, or your own investment in your child’s education. It is estimated that $1 million will be invested in the education of a child born in America in 2007. With 4.6 million people expected to be born this year, we are talking about a $4.6 trillion investment over their lifetimes. Who’s going to pay? The parents, the grandparents, aunts and uncles, the state, local governments, federal governments, employers, and the individuals themselves. Looking at this as an asset, it represents an enormous investment with a very high rate of return.

As most of you know, in the United States particularly, jobs have changed dramatically and today’s labor market is totally different than it was a couple of decades ago. But in 1950, when I was young, most of the jobs were unskilled. You could work for the United Auto Workers, you could work for the United Steelworkers, or you could have many other jobs and achieve a middle-class life without any significant skills. A willingness to work hard was enough.

But that is no longer the case. Today, more than 85 percent of jobs require at least some higher level of skills. This century, in my opinion, will be defined by a worldwide competition for human capital. But when you recognize that two-thirds of the children in Los Angeles cannot read at the basic level—and by basic I mean they can not read simple three- and four-letter phrases: “Where is your mother? Is your Dad at home?”—you can see they are at a huge disadvantage. The result is that of these children, 50 percent will not graduate and probably 60 to 65 percent will never really be educated or prepared for the work force. So we have enormous challenges in our system, and we’re looking for the wake-up call in education.

Global Competition for Leaders

The Biopolis in Singapore, headed by Philip Yeo, is rushing to become the world’s leader in medical research. They’ve also recruited two of the leading scientists in the United States in stem cell research at the National Institute of Health. In fact, many of the leading scientists there are from different countries. And they are not alone. Imperial College, one of the two leading science colleges in the United Kingdom today, has enjoyed great success recruiting foreign students, for example. It has 14 Nobel Prize winners, almost as many as Berkeley. (I went to Berkeley, so there’s some bias here.) In the years from 2000 to 2006, largely because of the immigration difficulties in the United States after 9/11 and the difficulty for foreign students to come into the United States, there’s been an eight-fold increase in students from China going to the United Kingdom. Many of those students would have been here. The future has already been changed. The thousands of young scientists and young scholars who didn’t come to the United States that might have, in the last years—their lives have been changed. Any breakthroughs that they might have achieved or contributed to will happen somewhere else.

There is an example that is relevant to this point. There are two countries, both part of the British Commonwealth and both given their independence, Singapore and Jamaica. Lee Kuan Yew, who was the prime minister of Singapore, actually went and visited Jamaica and looked at Jamaica. They were very similar. They both had per- capita income in 1960 of $1,900. Both focused on tourism and agriculture. They had similar weather. But one managed to grow per-capita income at 12 percent per year for the last 47 years, while the other grew at about 1.5 percent. One chose to build a society based on human capital; and one continued with tourism and agriculture. And there’s almost nothing in common today with Jamaica and Singapore except the weather, because of decisions that were made based on human capital.

I want to step back for a moment and talk about a change in my own life. There was something called Sputnik that went up in 1957. The general reaction was that this was a great victory for the Soviet Union and for the Communist system. And those of you in school will remember our duck-and-cover drills. I went to school in the San Fernando Valley and had this fifth-grade teacher who kept trying to convince me that if a nuclear bomb hit Hesby Street School, I’d be safe under my desk. And if I wasn’t under my desk, that was it for me. We argued back and forth until we reached a compromise: I wouldn’t disrupt the class anymore and she wouldn’t try to convince me that I would be safe under my desk.

But the Soviet Union thought that the day that Sputnik launched was their great day. It was not. It was the end of the Soviet Union. This was the first step, because it woke up a sleeping giant here in the United States. It focused a whole nation on science and mathematics. We had a president say we were going to send someone to the moon. And so you’ll find today, if you go to a company like Lockheed, that almost 50 percent of their mathematicians and physicists went into those fields because of Sputnik. That was the wake-up call. And I think one of the things I want to say is: Where is Sputnik today? Where are these wake-up calls today that could mobilize an entire nation to focus on some of our big challenges?

The Laws of Economic Growth

Let’s look at some of the economies of the world today. The United States is the largest, Japan second, Germany is third. China is probably going to be moving up to fourth by the end of this year, passing the United Kingdom and France. What countries will be the largest economies in the future? You can take our projections at the Milken Institute or others, but China will become the world’s largest economy some time in the next few decades. The United States will then be second, India third, Japan fourth. Brazil, Russia, Indonesia, and Mexico will replace France, Italy, Spain, and Canada as next in line.

It might surprise some to hear that in 1820, China was the world’s largest economy. For most of the last 3,000 years, China has been the world’s largest economy. India is a similar situation: if you went to sleep in 1820 and woke up after 200 years, you’d think that nothing happened, nothing changed. But the United States, this amazing country with property rights, rule of law, freedom, democracy, and a bunch of other things, went from 1.8 percent of the world’s economy to 40 percent of the world’s economy at the peak, with only 5 percent of the people on the planet during that time. So we have to remember the lessons of what fueled that growth.

The two things that changed the world more than anything are advances in telecommunications and computing power. Some companies thought telecom was a for-profit business, not recognizing it was foreign aid, and a trillion dollars was lost in telecom overbuilding. But the beneficiaries were the rest of the world, particularly India, where the cost of a telephone call went from $10 a minute to four cents in 2007, and it is going to zero. So one of the things to focus on in change that’s going to occur, is that telecommunication costs are going to zero. You’ll be able to call anybody, any place on the planet, for zero—or at a cost so low it’s equivalent to zero. (Unless you stay in a hotel room and use the hotel’s phone.) So therefore, at the speed of light, you can send your digital output any place on the planet. A brilliant young mathematician in India doesn’t have to leave India and come to the United States anymore. They can stay right where they are—or in Kenya, or any place else on the planet.

The other thing that happened is the growth of computing and data storage power. The supercomputer that I moved onto my trading floor in 1976—the first one on any trading floor—was easily surpassed. The iPod today stores 7,500 times as much data as my supercomputer did then. The cost of data storage is now fractions of what it was 30 years ago. So you’ll be able to move anything that exists digitally to any place in the world for zero, or close to it; store any quantity of digital data for close to zero; and analyze it at trillions of calculations a second.

Access to Capital

It is amazing when I think of these events in my life and what has changed. I came home to Los Angeles in 1965 and it was on fire. It was the middle of the Civil Rights movement and the draft for Vietnam. But you didn’t have to go to Vietnam; you could see armed personnel carriers right there in Los Angeles. And why was Los Angeles burning? I had to know, so I met an African-American, a young man, who told me he wasn’t part of the American dream. And he taught me that civil rights were not just about where you could sit on a bus, or where you can go to school, or where you can go to the bathroom, or where you can eat, but part of the American dream is having access to money and capital based on your ability, not what you look like, not who your parents were, not even what school you went to. And he didn’t have that. He wasn’t part of the American dream. So I had to change my major again. I had to go back to Berkeley and switch to business.

I put a formula together that basically said prosperity was dependent on financial technology, access to capital—which has a multiplier affect on human capital, the world’s biggest asset—social capital, and real assets. Without access to financial capital, the greatest ideas might never have come to fruition. Most of you don’t remember who created air conditioning in 1835 because he died broke–no one would give him any money–but we think 70 years later that it was Carrier, because he got access to capital.

So what are all these financial technologies that today we take for granted, that didn’t exist when I was at Berkeley or Wharton? They all changed the world greatly. And this democratization of capital– there are more financial institutions listed on the New York Stock Exchange today than there are industrial companies. When I went to Wall Street, 10 or 12 people decided who got money. Today, there are tens of thousands of people making those decisions. No one can control access to capital, because there are all these points of light, and this democratization of financial assets leads to democratization of companies and creates a lot of jobs.

As you think of people who became household names, you can see how big a role the democratization of capital has played: Ted Turner; Bill McGowan from MCI, who really changed telecommunications for all of us; Craig McCaw, who changed cellular; Reg Lewis, the first African-American ever to borrow a billion dollars and buy a company [TLC Beatrice International]; Kevork Hovnanian, thrown out of the Middle East because of his religion, who came here with nothing, and built one of the largest home builders in America [Hovnanian Enterprises]; or Steve Wynn—the Walt Disney for adults. All of them had fantastic ability, but what they all needed was capital.

Part three of “A Capitalist’s Manifesto” will appear in the December/January issue of Directorship.

But putting in the eight hours a year pays off in more than just CGQ. Directors who periodically reenter the classroom also get a chance to rub elbows with the movers and shakers of governance, from regulators to activists to mold-breaking chief executives. “You have a unique collection of leaders in the same room that you could never achieve otherwise,” says Roger Maclean, associate dean of executive education at the University of Wisconsin-Madison. The university’s two-day Director’s Summit has been offered every fall for six years and ties with Harvard’s governance course for the number of Fortune 500 CEOs who attend.

Hobnobbing with peers at the summit can prove at least as valuable as listening to the exalted speakers. “There’s a lot of networking,” says Tammy Thayer, president of Wisconsin’s Center for Applied Studies in Business. “You may be an experienced board member and think you’re doing everything right. Then you have a conversation with another director and find you’d be more effective if you did something different.” Director’s Summit alumni include Cisco Chairman John Morgridge, Kimberly-Clark Chairman and CEO Thomas J. Falk and former Autodesk CEO Carol Bartz.

Sarbanes-Oxley does not require education for public-company directors. The New York Stock Exchange requires only that listed companies address director education in their corporate governance guidelines. The Securities and Exchange Commission does no more than recommend that companies encourage continuing education for directors.

Yet since SOX was passed, ISS-accredited governance programs have multiplied, and enrollment is on the rise. “I started the Directors’ Education Institute five years ago because of all the scandals,” says Stephen Wallenstein, executive director of the governance program at Duke University’s Fuqua School of Business. Originally offered twice a year, the program now takes place each spring. In 2006, the program had 110 registered participants and 35 speakers—its biggest session yet.

The Duke program has shifted emphasis somewhat since its inception, from analyzing the waves of new governance rules to sharing best practices. “It’s a cross between executive education and a conference,” Wallenstein says.

These combination think tanks-job fairs-schmooze fests don’t come cheap. Harvard Business School’s flagship two-day governance course, “Making Corporate Boards More Effective,” costs $6,750, and you pay a $750 premium to take it on the West Coast. (The La Jolla sessions are geared toward recently or soon-to-be public companies, as befits California’s corporate demographic.)

Harvard’s core program has been around since 1992. Since then, the governance series has been updated with “Audit Committees in a New Era of Governance” (June 24-26 and Sept. 30-Oct. 2, $4,250) and “Compensation Committees: New Challenges, New Solutions” (June 27-29, Oct. 3-5, $4,250).

As you would expect, the courses use Harvard’s signature case-study method. According to B-school spokesman Charles Breckling, that means the curriculum is constantly refreshed. “The folks at HBS are writing new cases all the time. It’s an evolving product.”

Many universities have similarly expanded their original governance courses to address specialized issues. For instance, the University of Chicago and Wharton both offer one-day “immersion” courses in finance ($1,500 and $1,000, respectively) that can be taken separately or after the core programs.But ISS doesn’t accredit just any seminar. To qualify:

• The program must be at least eight hours long and be open to all directors.u The course cannot be sponsored exclusively by service providers such as auditors, compensation consultants, executive search firms and the like—that is, at least one sponsor must be an academic institution or professional association.

• No more than 25 percent of speakers may represent such service providers.

• At least 25 percent of presenters must be current or former public-company directors.

• The curriculum must address governance practices (for example, D&O insurance is specifically excluded).

“The criteria evolved to help ensure a focus on contemporary governance issues,” says John Deosaran, vice president for Corporate Ratings at ISS. “We are generally looking for a program that goes beyond simple recitation of regulations. We are also wary of programs that appear to be an extended sales pitch on behalf of service providers.”

That’s not to say that the legal, audit, insurance and search professions don’t contribute hugely to governance education. Last November, the Yale School of Management renamed its governance center in honor of Weil, Gotshal & Manges senior partner Ira Millstein. Top compensation consultants like Pearl Meyer and Steven Hall frequently lecture at ISS-accredited programs. And the Big Four audit firms often host mini-conferences that, co-sponsored by other organizations, may qualify for ISS credit.

Some governance programs award a certificate upon completion. Certification confers no legal benefit, yet directors who pass the test may in some cases be eligible for discounted D&O insurance. The National Association of Corporate Directors offers a certification course, given in four cities, that also functions as a networking opportunity for the association’s 17,500 members.

A more exclusive option is the Director Training and Certification Program at UCLA’s Anderson School of Management. The biannual course teaches both the basics of governance and the latest twists and turns of regulation; specialty modules for committee members drill deeper into those duties. Senior Associate Dean Alfred Osborne believes the teaching methodology makes for an active rather than passive learning experience. “It’s different from other programs,” he says. “We put people in mock situations where they get to try out issues and see how they react.” A bonus of UCLA’s course is the Director Match Service, a placement database.

Governance experts caution that even the finest education program can’t substitute for experience. “I’ve gone to a lot of them, and that doesn’t make me qualified to serve on a board,” says Julie Daum, leader of the North American Board Services practice at executive search firm Spencer Stuart and a frequent speaker at director seminars. But continuing education can give directors an extra degree of confidence that is more than just intellectual. Says Duke’s Wallenstein: “If you’re a director of a public company and there’s a problem, you want the protection of the business judgment rule. You want to be able to say, ‘I did my due diligence. I went to the Duke program.’ The question isn’t, did you prevent the fraud, but did you do your best? So for directors, education becomes a defense.” Ladies and gentlemen, choose your weapons.

Regardless of size, the companies that insureindividual board members against legal damages vastly outnumber thosethat do not—87 percent to 13 percent, in fact. And a full 64 percent ofrespondents said their companies had increased D&O coveragerecently.

Perhaps quite obviously, firms as well asindividual board members are growing increasingly cognizant of therisks. Nevertheless, well over half (59 percent) of board memberspolled said they obtain coverage above and beyond what their companiessupply, such as umbrella insurance, Side A insurance or errors andomissions coverage. The significant number who do not may feel thattheir corporate coverage is adequate, or they may be aware that manyindividual umbrella policies specifically exclude accusations offinancial wrongdoing, such as inappropriate or misleading disclosure ofinformation. “Untested and unknown,” one respondent wrote. Thus, manydirectors may feel such insurance doesn’t offer much of a shield.

At the same time, many feel the need to protecttheir personal assets from potential seizure as a result of litigation.Fully 34 percent of polled board members maintain some kind of trust,and a further 16 percent say they place personal assets in a spouse’sor another person’s name. And 10 percent say they have “other” plans ormechanisms that protect assets from garnishment or seizure, such as”entering into indemnification contracts with the company and inappropriate circumstances having the company create a rabbi trust orother bankruptcy remote mechanism and placing sufficient assets inthem,” one respondent wrote.

Thus, 60 percent of directors are worried enoughabout losing personal wealth as a direct result of board service thatthey try to shield at least some assets from lawsuits. Clearly, theyhave a reason, because 38.5 percent have either been named in a suitwhile serving on a board or think they are currently at legal risk.

Board members also have given thought to howcompanies can make their jobs less dangerous as individual directors.When asked to choose the best ways to lower risk, 64 percent saidcorporations should establish a central spokesperson and eliminate anyand all director contact with the public, and 56 percent said companiesshould impose stricter controls over both external and internalcommunications. And half thought investor relations education for boardmembers would help them avoid lawsuits.

All three responses suggest that public relationsis a field much on directors’ minds. A majority still seem to believethat careful image management is key to limiting risk. Yetincreasingly, shareholders are sensitive to being locked out ofdialogue with directors—witness the uproar after Home Depot’s annualmeeting. And many investors dislike being “spun.” So, puttingcommunications through too many filters could wind up causing moreproblems than it solves.

Currently, almost 53 percent of respondents—afairly high percentage—said all external communications were vetted bythe CEO. Fellow directors approved a third of communications. Butanother third said “nobody” cleared communications before disseminationto the public. Again, that’s a big percentage, and a surprising onegiven the prevailing legal environment. Another 18 percent said aninvestment relations officer approved them; 5 percent said “other”; andin at least one case, a respondent interpreted that to mean thatdirectors “don’t speak to the press at all unless there is a divergenceof defense.”

Half of the polled directors weighed in withadditional suggestions for reducing risk. They include outside legaland audit reviews of board and committee procedures to ensure fiduciaryduty compliance, companywide risk management systems with boardinvolvement and “better qualified directors.”

When asked the most likely source of futurepotential lawsuits, almost 80 percent named investors. Only about 8percent named the SEC or NASD, and 5 percent feared that suits mightoriginate from employees; nearly 3 percent cited fellow officers anddirectors, suggesting a new dynamic that not only do board members haveto maintain a high level of diligence for their own conduct but also intheir interactions with each other.

And as for the potential causes of such suits, anoverwhelming 76 percent ranked making decisions in conjunction with theboard as their primary or secondary source of concern. The increasedcirculation of board minutes, due to the Internet and other venues, aswell as increased scrutiny of board meetings by the press, seems tohave heightened such fears. Some 58 percent of respondents cited jointdecision-making with another party and the scrutiny it would attract asa primary or secondary concern.

Another 30 percent of respondents cited relationsand interaction with the public as a primary or secondary concern.Those who ranked another concern as their primary or secondary—51percent—picked filing requirements and scrutiny from the SEC and NASD.Just 30 percent picked public relations as primary or secondary, thelower number perhaps reflecting the fact that board members view thechief executive as the company’s public mouthpiece. Another 17 percentchose internal communications with employees as their primary orsecondary concern for the source of a potential suit.

So, how to avoid all this paranoia in the firstplace? Most directors (86 percent) think improving corporate culture iskey, and in particular emphasizing honesty and integrity in order toprevent misconduct, including detailing potential conflicts of interestwith greater frequency. The remaining directors polled said eitherusing an outside auditor as an additional policing vehicle or imposingrestrictions on internal and external communications would be mostbeneficial. Very few said they would encourage the practice of”whistleblowing” as a top priority.

But they did note overwhelmingly (72 percent) thatpreparedness prior to board meetings was key to best practices and toensuring that the necessary documentation of board decisions anddiscussions are being made.

More broadly, however, directors had somesuggestions for how to protect themselves if board decisions are laterquestioned or scrutinized. They include increasing transparency ofrationales in decision-making, as well as publishing quarterly reportsand employing software tools that allow collective keeping of files andnotes. But other responses diverged, ranging from “Keep excellentminutes!” to advocating that directors not make their recordkeeping toodiligent lest they attract culpability. “Do not leave notes to yourselfin files that could become damaging when taken out of context duringlitigation,” one respondent wrote.

Others suggested that there’s not much a directorcan do to avoid scrutiny, other than to behave above reproach andmaintain the highest ethical standards. “The curious and ‘anti’ crowdwill always ask and probe,” one respondent said.

In general, however,directors are feeling somewhat victimized. “I do find it ironic,” onerespondent wrote, “that at the very time that many are criticizingboards and senior management for what they believe are excesses incompensation, not only is much more being asked of senior managers anddirectors, but their exposure to significant liability is increasingpretty dramatically.” That sums it all up right there.

]]> http://www.directorship.com/more-protection-can-only-be-good/feed/ 0 http://www.directorship.com/-wanted-more-director-education/ http://www.directorship.com/-wanted-more-director-education/#comments Thu, 01 Jan 1970 00:00:00 +0000 Directorship Editors http://www.directorship.com/?p=4095 CHALK IT UP TO THE increasing complexityand scrutiny of financial reporting and accounting issues: Auditcommittee members today undoubtedly spend more time “doing theirhomework.” But chances are they’re not following a formal curriculum.In ACI’s annual survey of audit committee members, more than 60 percentsay their companies do not provide periodic in-house education. Atcompanies that do, more than 80 percent of committee members devotefewer than eight hours to it.

Robust orientation and ongoing education areessential to ensure audit committee members have the depth and breadthto carry out oversight. (The New York Stock Exchange requires listedcompanies to address director orientation and education in theircorporate governance guidelines.)

Topics will vary, of course— from industry andregulatory issues to business and accounting practices—but thehallmarks of a good education program are participation of management,internal and external auditors, corporate counsel, and outside”experts,” as well as a curriculum to meet members’ needs.

Also, new-member orientation— or “on-boarding”—canbe key to helping new members become familiar with the workings of thecommittee and the board, as well as the company’s financial management,operations and key areas of risk.

The three patterns of risk assessment strengths and weaknessesare impressionists, encyclopedists, and amnesiacs.

Let’s flesh out the three types a little more and then do some troubleshooting.

Impressionists
Impressionists anchor on strong experiences and then apply thembroadly. The problem is that they apply them too broadly. Thememorability of their experiences is much greater than the relevance oftheir experiences.

What makes for a strong impression? The essential element of strong impressions or experiences is improbability. We don’t really learn that much from experiences we expect.

Improbable experiences have a strong impact on usfor a very good reason. Surprising experiences tell us that somethingwas wrong with our expectations. Surprising experiences may not revealthe future. But they show us what’s wrong with our view of the present.

The impressionist’s highly memorable experiences are misleading when they are not relevant to a particular problem or the risks underlying it.

How can we test the relevance of a very memorableimpression? The risk intelligence score shows how to measure therelevance of an experience to a set of risks. That measure is thesensitivity of the experience to different factors that might drive therisk. More precisely, it’s the range of probabilities of the experienceif different possible factors really applied. If our experience wouldhave been unimaginable under some factors but a dead certainty givenothers, then the experience is relevant to determining what reallydrives the risk.

The impressionist’s experience is weaker thanaverage in its relevance to different risks. This might be because itis restricted to a very narrow set of risk factors that don’t applywidely to other business problems. Think of an industrial engineerfocused closely on specific design failures, for example.

How can impressionists enhance the relevance oftheir experience without sacrificing its memorability? The three mostimportant practical steps impressionists can take fall under three ofthe elements of the risk intelligence score: relevance itself,diversity of experiences, and record keeping.

One way to address a “relevance gap” in ourorganizational experience is to widen that experience. In general,tackle a problem that seems to share root causes with the new risks youare evaluating.

Another way to fight a tendency towardimpressionism is consulting the record. You may not recall or know ofexperience in your organization relevant to a new risk, but it may bethere. The biggest risk assessment failure most executives report isforgetting to ask other managers about their problem, however novel orunprecedented it seems to be.

The one thing not to do is back off from those memorable experiences.They have and should have enormous power in guiding ourjudgments where they apply. Anchoring on these kinds of experiencesmisleads us only where the experiences lack relevance. Thetrick is to be careful in applying them.

Encyclopedists
Encyclopedists have lotsof experience that applies to the risks underlying new projects orrisky decisions, but the experience teaches nostrong lessons. The encyclopedist’s experience applies to many risksbut lacks impact because it suggests nothing about the risks that wewould not have guessed.

The key gap in the encyclopedist’s experience is surprise orimprobability. Both military planners and businesses operatingin sectors with lots of strategic uncertainty often find themselves inthe position of the encyclopedist. No matter how many facts and figuresthey have mastered about opponents or competitors, the civilianpopulation or customers, force requirements or costs, they don’t haveinsight into how their challengers see the world and think. Or at leastthey haven’t had a chance to battle-test their theories about how thosechallengers think.

The case of the encyclopedist is more general thanthat, however. In fact, it is a brand of inexperience. As academic andon-the-job training gets better and better, it’s possible for peoplechanging occupations or entering the workforce to learn huge amounts offacts that bear on the projects or decisions confronting anorganization.

But that training cannot replace the memorability of a few shocking experiences that give us our strongest sense of how the world is not. This is the predicament of the encyclopedist.

What can the encyclopedist do? The three principleremedies reflect elements of the risk intelligence score, but theremedies differ from the impressionist’s: amount of experience, thememorability of that experience itself, and record keeping.

Raising the raw amount or frequency of one’sexperience related to a problem is rarely a practical solution forsystematic weaknesses in risk assessment capabilities. But if our riskscores suggest we are encyclopedists, it means we are in some sense alittle wet behind the ears in a variety of areas that matter. It meanswe haven’t been shocked.

The next remedy is to increase thememorability or content of the experiences you are already bound tohave. The best way to do that, if you have the opportunity, is to focusyour time on people with unpredictable or even outright contrarianpointsof view.

Since those small surprises and explanations addup, record keeping looms large in improving the risk intelligence ofthe encyclopedist. But the reason is different from the importance ofrecords to the impressionist. Here it’s because it isn’t always easy toidentify common threads among past experiences that can bind together aclear and well-informed worldview in a new problem area.

Amnesiacs
The amnesiac has surprising,memorable experiences relevant to a broad variety of project choices,risky decisions, and problems challenging an organization. So what’snot to love about the experience base of the amnesiac? The problem forpeople with this pattern of risk intelligence strengths and weaknessesis not just forgetting what they learn. It’s failing to record it in aformat others can use.

So amnesiacs have loads of raw experience. In fact, these “experience mines” are often useful to their organizations preciselybecause of their experience. But what they know cannot really acceleratethe performance of a colleague unless it can reduce thecolleague’s personal dependence on them. In other words, amnesiacsmust find ways to enrich their colleagues’ experience with whatthey know or learn rather than just provide their colleagues withaccess to it.

Karl Popper made a distinction between what we knowand the actual records we make of what we know. He calls what we know,together with all our thoughts, the second world (as opposed to a firstworld of physical things). He distinguishes it from a thirdworld of what we record so that others can use it. Popper thinks it isthe latter that makes scientific advance possible. But for Popper, theimportance of a clear record is that it encourages objective criticism.

What can the amnesiac do about record keeping? The only answer is systematicallycapturing the amnesiac’s rich experience in a way that others canuse.

Rather than assume amnesiacs jealously guard their knowledge, organizations should ask other employees to debrief theiramnesiacs through a formal interview process. The interviewers mayeven be in a better position than the amnesiacs they interview to recognizewhat matters and distill it.

Putting All Three To Work
The encyclopedist, the impressionist, and the amnesiac representthree stages in a life cycle of risk assessment skills and the experienceunderlying them. Encyclopedists have lots of what may often resemblebook knowledge, but lack memorable experiences that sharpenjudgment. Impressionists have highly memorable knowledge but apply it indiscriminately in cases where it doesn’t apply. Amnesiacshave rich stores of relevant, memorable experience but do not reliablyrecord it for others to use. Together, they represent the youth,adulthood, and old age of risk intelligence.

And yet encyclopedists need not be young, and amnesiacs neednot be old. We experience many cycles of learning throughout ourlives, and we are likely to veer into these three risk intelligence trapsat many times. The trick is to recognize them.

Above all, the three ages of risk intelligence can overcome theirweaknesses by working closely together. “Enhancing Risk IntelligenceThrough Teams” explains how you can actually balance a team’s riskintelligence.