Jeff Cunningham (left) and Robert Greifeld (photo by David Nicholas/Longview)

As Nasdaq OMX celebrates its 40th anniversary, what aspect of the global financial markets concerns you most?
When you’re looking at the markets around the world, they have routinely done a very good job with large companies. With the advent of electronic trading, with fair access standards, which Nasdaq pioneered back in 1971, you see the actively traded cycles treated very well. Where we have issues on a global basis is the SMEs, the smaller companies. We have not yet solved what is the proper market structure and what is the proper ecosystem to make sure those companies have truly the best capital markets experience possible.

What is the upside of all the exchange merger activity, cost synergies or revenue enhancement?
When exchanges went to electronic markets, they became dictated by the laws of the transaction-processing business. With the technology I built in our data center in New Jersey I have enough computer power today to process every single equity transaction in the world. So obviously, as we put more volume against that relatively fixed cost platform, the marginal revenue tends to drop to the bottom. There are fairly valid reasons for exchanges to want to come together. What has not worked with exchange transactions in any noticeable fashion are revenue synergies. Our transaction in the Nordics happened four years ago, and we’re only now seeing some real revenue synergies from that. So revenue synergy is somewhat uncertain; expense synergies are fairly straightforward.

After your attempted takeover of the New York Stock Exchange, what did you discover about the way our antitrust laws work?
With our approach to the New York Stock Exchange, we certainly went into it with our eyes wide open—it was opportunistic. Working with the antitrust process—and it wasn’t my first time through—you realize there is typically more art than science. At the end of the day, especially in the U.S., there is one person who has the vote. Depending on who that person is, there are different ways to take a look at the elephant.

The credit crisis was an opportunity to lay blame at the feet of many constituents. Do you have any advice for directors whose role is to reduce risk?
What you see evolving is the concept of risk being managed on a holistic basis. We at Nasdaq OMX have clearly evolved in the last two to three years, and we have our clearinghouse risk, but then we also have business risk. We produce a report to our audit committees and our directors. If we come out with a new product, we put it through a risk filter today, and a lot of these projects are not things you intuitively think about from a risk point of view, but every activity has the opportunity to introduce a new incremental risk into the organization, so you have to have that kind of discipline. When you look at our product release schedule, the risk component of it is as important to us as the product management. I think you’ll see that as an emerging best practice. It’s up to directors to insist upon that. It’s another area of frustration for line management because they feel like they are giving up some autonomy with a risk committee. Like anything else, the risk committee has to be balanced in their viewpoints. It’s the same thing with information security—that’s its own topic right now, and we’ve got our own army of people trying to protect everything we do so the overall risk committee doesn’t have to spend a lot of time on that. It’s about finding pockets of latent risks that people have not thought about before.

As a clearinghouse, you do take on some of your customers’ risks? How do you manage that less transparent aspect of the equation?
We’re at a certain tension with our customers. The clearinghouse services we think of as a fundamental reduction of risks that takes the notional and gets it down to a net number. It demands margin— there’s just no way around that. So when you look at the large over-the-counter market that exists in the world today, the large banks have increased their notional risk by 50 or 60 percent on these over-the-counter derivatives. The question is what percentage of those are actually margin, because a lot of times they are done in the context of an overall relationship. So we’re self-interested when we say that we believe the financial players are misadvised to be having this type of off-balance-sheet risk. For us who run a clearinghouse, we’ve obviously had some interesting calls as we went through 2008. It’s about managing the margin properly by taking signals from the market. As we’ve just had the MF Global situation, we’ve assessed our margin that we had against that, and that margin was, in a sense, assessed against how liquid and deep the market was for us to liquidate positions. We said, “Okay we’re fine.” So clearinghouses bring that discipline all day, every day.

To what extent is the U.S over-regulated relative to the rest of the world?
I’m a little different than most on this. I’m calling for some changes to Sarbanes-Oxley, but a lot of that is about the perception and not the reality. My personal view is that Sarbanes-Oxley has been a net benefit to our corporate governance standards. Boards are more fruitfully engaged. When you look at the developed markets around the planet, they have all basically followed our lead with Sarbanes- Oxley. The notable exception is Section 404. I certainly believe that if we were to have Section 404 for those companies that have successfully negotiated in the past be an every two-year requirement, just the publicity around that would address the perception issue. I think it’s a proper modification of the 404. We called for 404 [to exempt] companies below the $700 million market cap, and I think we’d be happy to see that the presidential commission’s even thinking about a billion dollars. Clearly, the European folks back in the day were using that against us, and that’s fine enough, but that wasn’t really where our international market was. We’ve done particularly well in Israel and China. Those markets were not as developed, and they’re anxious to come to the U.S., and I never heard of SOX being an item of substance against us.

Will China create a robust, regulated and reliable domestic market?
I’d say China and Hong Kong have tougher listing standards than we do. It comes back to when I claimed Nasdaq invented the modern IPO. What we meant by that is we were successful in letting companies that had an unproven business model come to market, but the absolute requirement was that they had solid accounting and governance behind them. We believe investors should be able to make an investment on the success of the next Apple or Groupon. That investor cannot be making a bet on whether the numbers and accounting are good, and the management honest and ethical. When we look at the Chinese companies, concentrated in one province and in reverse mergers, then obviously they violated that sacred trust, so we had to make sure that we had that much more rigor to the process. We’ve put a seasoning requirement that doesn’t just apply to Chinese companies because we don’t want to be profiling, and it’s a good improvement for all of our companies.

South Carolina Gov. Nikki Haley (left) and Attorney General Alan Wilson are sworn in before testifying at a hearing on an NLRB complaint against Boeing. (photo by Associated Press)

The agency last spring filed a complaint—since dropped—on behalf of the 31,000-member International Association of Machinists and Aerospace Workers, siding with the union. Boeing contested the charges on the grounds that opening up an assembly line in South Carolina, where it already had a facility, was in fact a business decision and not antilabor.

Lafe Solomon, NLRB acting general counsel, testified that he issued the complaint to encourage the company and union to reach a settlement. Yes, we know what kind of settlement he had in mind.

Where a company does business is a decision that managements make all the time—in the best interests of their shareholders. But, apparently, not unionized company management under the Obama administration NLRB.

Jeff Cunningham is managing director and senior advisor to NACD. He is nationally known for his views on boards and corporate governance. Prior to starting Directorship magazine, he was publisher of Forbes and managing partner of the U.K. private equity firm Schroders. He has served as an independent board chair or director of 10 public companies.

Lehman’s new board has been tasked with overseeing the planned distribution of $65 billion to creditors over the next three years. Korn/Ferry International advised Lehman on assembling its newly constituted board of seven, which is heavy on restructuring, real estate and derivatives expertise.

When facing an asset distribution, directors must have extensive knowledge of technical finance, legal literacy and a comfort in highly regulated environments, says veteran director Michael Pocalyko, who writes and consults on corporate turnarounds. “It’s easy to get caught up in ‘I’ll do what the lawyers tell me to,’ but directors cannot rely solely on that,” he says. “We are directors because we are expected to exercise our judgment.”

In contrast to Lehman’s asset distribution situation, which requires independent leadership, American Airlines and AMR opted to promote from within as AMR entered Chapter 11 reorganization. CEO Gerard Arpey retired, and AMR and American Airlines President Thomas W. Horton added the CEO and chairman roles. Horton was CFO at AT&T Corp., where he managed strategic alternative evaluations, leading to the 2005 merger with SBC Communications. Horton currently serves on the Qualcomm board, and also recently succeeded Arpey as chairman of oneworld, the global airline alliance.

Kathleen M. Wailes

The subsequent stock rise at both companies suggests the perception of value creation for both Vulcan investors and investors in the reconstituted company. In fact, Martin Marietta estimates cost savings of as much as $250 million and various other benefits that justify the relatively high premium in a depressed industry.

Yet this proposed deal is just the tip of a very interesting iceberg.

Bloomberg reports that 31 percent of publicly disclosed hostile or unsolicited bids for U.S. companies were completed between 2000 and 2010. Hostiles certainly have their advantages, including lower acquisition premiums and reduced transaction costs. But one real allure of hostiles is that acquirers can also circumvent the board. They likewise do not often provide retention agreements for existing management.

Current data underscore the resurgent popularity of hostile takeovers, confirming a 19.8 percent increase in 2011, to $80.45 billion. (The number of such deals was also up from 55 to 58 over the prior year.) The current environment augurs further increases in 2012 because U.S. companies hold record amounts of cash—$2.12 trillion as of the third quarter— even as stock prices are depressed. Private equity firms, hedge funds and activist shareholders will all get in on the game, with pharmaceutical and mining companies especially in play.

Meanwhile, traditional takeover defenses, such as staggered boards and poison pills, have declined significantly. In fact, the number of staggered or classified boards among the S&P 500 has fallen to 25 percent since 2002, down from 62 percent. The number of poison pills over the same period closely tracks that decline. Efforts to shield directors from removal and avoid special meetings called by acquirers are likewise less frequent these days.

We see here the impact of a movement fired by institutional investors to avoid entrenched boards that purportedly do not always represent the best interests of the shareholder. Statistics show that companies that become hostile targets often have a higher number of outside directors with lower ownership stakes and fewer additional outside directorships.

What does all of this mean for the boards themselves? It is a prolonged wakeup call, a clear message that they must begin to view value creation through the eyes of their investors, and measure the company’s performance accordingly.

The more boards listen to the opinions of their shareholders, the less vulnerable they are to surprise attacks. Similarly, they must pay more attention to changes in how the company’s stock is trading. There are proxy-solicitation firms that can advise the board on share movements without having to wait for SEC disclosure filings to reveal new positions.

It is also essential that boards and managers better articulate the value proposition of their companies and lay out a realistic strategy to build that value. They can set up working groups to fend off inadequate offers and determine what advance options they have. The decision to resist a takeover or to better serve shareholders by negotiating a friendly deal must be made dispassionately. Resistance, if that’s the choice, must be based on strong factual arguments and supported by credible third-party allies.

If investors are to be persuaded to stay the course in an age of resurgent hostiles, boards must take the most aggressive good-faith steps to retain their trust.

Kathleen M. Wailes is senior vice president at Levick Strategic Communications. She has also served as chief communications officer for a number of Fortune 500 companies.

Dennis T. Whalen

1. Stay focused on the audit committee’s top priority: financial reporting and related internal control risk. The challenges of ongoing economic uncertainty and volatility, coupled with the impact of cost-reductions, major public policy initiatives, and an uncertain yet clearly more complex regulatory environment, will require the attention of every audit committee. Meeting this workload challenge will require focused (yet flexible) agendas, with an eye on the company’s key financial reporting and related internal control risks.

2. Continue to monitor accounting judgments and estimates, and prepare for accounting changes. Monitor fair value estimates, impairments and management’s assumptions underlying critical accounting estimates. Recognize that the company’s greatest financial reporting risks are often in areas where there is a range of possible outcomes, and where management is called upon to make difficult judgments and estimates.

3. Consider whether the financial statements and disclosures tell the company’s story. Given the importance of transparency to the investor community, as well as the Securities and Exchange Commission’s ongoing focus on financial disclosures, consider how disclosures can be improved to better address expectations.

4. Focus on the company’s plans to grow and innovate. Growth, strategy and innovation will be front and center as companies search for top-line growth and look beyond the recessionary environment. A key challenge will be monitoring and calibrating growth plans to appropriately balance risk and reward. Given historically low valuations and high levels of corporate cash on hand, understand the company’s position in the M&A “ecosystem.”

5. Reassess the company’s vulnerability to business interruption and its crisis readiness. The global inter-connectivity of business, markets and risk poses challenges for virtually every company. Ensure that management is weighing a broad spectrum of “what-if” scenarios. Is the company’s crisis response plan robust and ready to go?

6. Understand how technology change and innovation are transforming the landscape—and impacting the company. IT risk discussions should be moving (rapidly) beyond “defensive” issues to address the critical challenge today: understanding the transformational implications of IT and emerging technologies—the cloud, social media, mobile technologies and data— and the strategic issues they present.

7. Focus on asymmetric information risk and seek out dissenting views. Is the audit committee hearing views from those below and beyond senior management – e.g., from middle management and business unit leaders, sell-side analysts and critics, and other third parties—about the risks and challenges facing the company? Recognize when asymmetric information risk—the over-reliance on senior management’s information and perspective—is too high.

8. Consider the impact of the regulatory environment on compliance programs and business plans. The increasing complexity of the global regulatory environment—including compliance challenges posed by the Foreign Corrupt Practices Act and the U.K. Bribery Act, the SEC’s whistleblower program, and Dodd-Frank provisions on conflict minerals and compensation clawbacks— will require continued attention. The right tone at the top and throughout the organization is critical.

9. Understand the company’s significant tax risks and how they are being managed and modeled. To stay abreast of critical tax risks—including internal control, compliance and disclosure issues—establish a clear communications protocol for management to update the audit committee on tax risk-management activities.

10. Monitor the PCAOB’s initiatives on auditor independence and transparency, and consider the implications for the audit committee. PCAOB initiatives designed to promote auditor independence, objectivity and professional skepticism have potentially significant implications for the audit process and the role of the audit committee. Consider how the audit committee currently reinforces auditor independence and skepticism, and whether a more robust audit committee report would be beneficial to investors.

The full text of “Ten To-Do’s for Audit Committees in 2012” is available at www.auditcommitteeinstitute.com.

Dennis T. Whalen is partner in charge and executive director of KPMG’s Audit Committee Institute.

Jeffrey M. Cunningham

Placing energy and fuel sanctions on Japan was the key factor leading Emperor Hirohito to approve Admiral Yamamoto’s plan to attack Pearl Harbor on Dec. 7, 1941. Sanctions may seem a lesser evil to war, but the other side may not find the idea quite as appealing an alternative.

Jeff Cunningham is managing director and senior advisor to NACD. He is nationally known for his views on boards and corporate governance. Prior to starting Directorship magazine, he was publisher of Forbes and managing partner of the U.K. private equity firm Schroders. He has served as an independent board chair or director of 10 public companies.

Jeffrey M. Cunningham

The no-shows are the United States, China, Russia, Brazil, Japan, and most of industrial Europe including Austria and France. Consequentially, capital costs will rise for these countries. Call us sluggish, not sluggers. (On the business side, ExxonMobil, Johnson & Johnson, Microsoft and ADP are the only U.S. companies to enjoy AAA ratings.)

Jeff Cunningham is managing director and senior advisor to NACD. He is nationally known for his views on boards and corporate governance. Prior to starting Directorship magazine, he was publisher of Forbes and managing partner of the U.K. private equity firm Schroders. He has served as an independent board chair or director of 10 public companies.

Harvard Business Review Press, 2012

Family members might have fueled Anthony’s early interests, but he enthuses that anyone can reach their full potential and innovate. Anthony is managing director of Innosight Asia-Pacific, and this book is his latest in a series of innovation-themed publications. He is jazzed about innovation, and thinks you should be too. According to Anthony and others who make innovation their business, to thrive in today’s marketplace, you need to remain competitive and adapt, and to do that, you need to be able to innovate.

What is innovation? Anthony cites one innovation blog that has 25 definitions for the term. He settles on one from the New Oxford American Dictionary: to “make changes in something established, especially by introducing new methods,” and distills that down to “something different that has impact.” The notion that innovation is creative thinking alone is thus dispensed with. Ideas are good, but “innovation is a process that combines discovering an opportunity, blueprinting an idea to seize that opportunity, and implementing that idea to achieve results.” Hence, “no impact, no innovation.” The playing field is open to anyone with the “right mind set” and the right tools.

Anthony profiles some “Masters of Innovation,” including Thomas Edison and Columbia University President and author Rita McGrath. One premise she teaches is “Your first idea is wrong, so, as quickly as possible, implement a careful plan to learn which of your assumptions is flawed.” The late Steve Jobs’ enduring message applies: “Think Different.”

Along with the seven deadly sins of innovation and how to avoid them, Anthony introduces a “28-Day Innovation Program,” segmented into weekly assignments. In the first week, the reader is coached on how to discover opportunities, while week two offers exercises on blueprinting ideas. The third week outlines how to assess and test those ideas. The program concludes with “moving forward” in the fourth week and incorporating a disciplined approach to the innovation process. At just 304 pages and about 6-by-9 inches in size, you can easily take this book places—and it may do the same for you.

The second edition of Frank K. Sonnenberg’s Managing with a Conscience: How to Improve Performance Through Integrity, Trust, and Commitment advocates that business cultures recognize the value of “intangibles” as the foundation of successful innovation for a competitive business.

The author, a marketing strategist and partner at Sonnenberg & Partners, was the national director of marketing at Ernst & Young for more than a decade.

Because of the speed with which companies can replicate products made by their competitors, the value of “intangibles”— such as customer service, reputation, brand recognition, customer loyalty and product innovation—is what distinguishes one company from another, says Sonnenberg. He examines nine “intangible” factors for cultivating innovation in a competitive company in the 21st century. These include supporting “employees who will be deeply committed to the organization’s mission and values… and passionate about reaching its goals”; nurturing a culture that “stimulates creativity and innovation and reinvents itself every day”; building a “flexible organization by collaborating with other organizations”; and recognizing that “a foundation of trust between an organization and its employees, suppliers and clients is what brings and keeps people together.” This highlights one of the book’s themes: “What goes around comes around.”

Stephen M. Shapiro’s Best Practices Are Stupid: 40 Ways to Out-Innovate the Competition rivals The Little Black Book in size, but the latter outlines a 28-day program, whereas Best Practices breaks down its advice into 40 tips.

According to Shapiro, one of the key reasons to innovate is to end the game of catch-up with competitors and invest in long-term growth, because “the organization that adapts and evolves to address ever-changing market conditions will thrive in the long run.” Open source innovation, challenge-driven innovation, competitive innovation and “innovation tournaments” are some of the techniques profiled. Open innovation refers to accessing expertise outside a given field. That’s what Unilever did when it developed a whitening toothpaste using expertise gleaned by its laundry unit to make clothing whites appear whiter. NASA also used this approach to develop a model for detecting solar activity by employing a retired engineer whose expertise was in dropped cellphone calls.

Not every attempt at innovation succeeds. Failure is written into the process, but it’s all a matter of perspective. Shapiro quotes Thomas Edison: “I have not failed seven hundred times. I have not failed once. I have succeeded in proving that those seven hundred ways will not work. When I have eliminated the ways that will not work, I will find the way that will work.” Shapiro suggests that with challenge- driven open innovation the iterations and costs associated with unsuccessful ventures can be reduced. Creativity can be stimulated, Shapiro says, by “including all employees in the innovation process” and by decentralizing control of that process. “Innovation,” he adds, “will organically emerge once you treat your employees as owners of the business.”

All this time you’ve been reading, your company has been aging. That’s the message from author Claudio Feser in Serial Innovators: Firms That Change the World. Serial Innovators employs sociology, psychology, neuroscience, academic studies and more to look at why some firms are able to regenerate, while others spark and burn out, go bankrupt or fold. Throughout, the tale of a newly minted CEO named Carl unfolds as a detailed case study on how to make headway when you join a company whose board and senior management are rigid and reluctant to adapt to change.

Feser, a McKinsey & Co. director who leads its Swiss office, includes a chart comparing the top 50 companies from 1960 and 2010, and examples of how fresh thinking was brought into their innovation processes. One Swiss company, for example, annually invites a handful of outside experts to “shoot holes in the group’s strategy.” Dysfunctional corporate cultures and the predilection for leaders to make “satisfactory” (as opposed to “optimal”) decisions are also explored.

Companies age when performance deteriorates and “culture lock-in” takes hold, while new firms mimic the older ones and innovate. Hewlett-Packard cofounder David Packard’s speech to employees in 1960 is excerpted. His overall message, writes Feser, was that “people have a desire to do something of value, to fulfill a mission, to give meaning to their lives.” Ultimately, Feser concludes, it comes down to the person at the top: “If company leaders do not accept challenge and diverging views, neither will the organization.”

There is no age limit on innovation, however. In a Dec. 11, 2011, Washington Post article, Vivek Wadhwa shares the results of a study he conducted of U.S.- born CEOs, engineers and product developers that found that “twice as many founders” of companies “were older than 50 as were younger than 25.” Thomas Edison, ubiquitous in seemingly every book about innovation, was 46 when he discovered electricity, and Ray Kroc built McDonald’s when he was in his early 50s. With discipline, motivation and the right resources, innovation is possible at any age.

Suzanne L. Meyer is an editor with NACD.

Benefits of an Independent Investigation
Conducting an independent investigation yields significant and tangible benefits to the company. Both the Securities and Exchange Commission and the Department of Justice place a premium on robust independent investigations overseen by audit committees and reward such action through reduced sanctions or, in some notable cases, by not charging the company despite clear violations of the law. Indeed, the SEC’s policy on providing leniency to companies (the Seaboard Report) credits cooperation where independent directors oversaw an investigation and utilized counsel that had not previously represented the company. The Federal Sentencing Guidelines provide for reduced criminal sanctions for similar forms of cooperation. In addition, a well-conducted independent investigation can help to rebuff shareholder claims that inevitably arise against the board for allegedly failing to respond adequately to allegations of internal misconduct, and an independent investigation will provide the steps for remediating the cause of the misconduct.

To Investigate or Not?
Not all circumstances require an audit committee to commence an independent investigation. Investigations into several forms of misconduct can and should remain within the purview of management and company counsel. Directors should consider the following factors when determining whether to conduct an independent investigation:

• The Persons Involved in the Conduct. An independent investigation is necessary where management (including the head of a country, region, subsidiary or business line) may have directed, condoned, or knew or should have known about the misconduct. The SEC remains focused on bringing enforcement actions against managers, so an independent investigation is warranted whenever managers could face regulatory scrutiny. Suspected misconduct confined to lower-level nonmanagerial employees likely will not warrant an independent investigation.
• The Nature of the Conduct. Allegations relating to potential violations such as bribery of foreign officials, violations of laws or regulations applicable to the company or its industry, accounting misconduct, efforts to inflate or smooth earnings, false or misleading statements in disclosures to investors, and defrauding investors are best investigated through the audit committee using independent counsel. On the other hand, if the suspected misconduct clearly does not involve possible violations of criminal law or federal securities laws by the company (such as employment issues not involving senior management), then a management-led investigation may be appropriate.
• Materiality. Misconduct that could result in a financial statement restatement or otherwise be deemed material under securities laws weighs in favor of an independent investigation. An audit committee, usually in consultation with its own counsel, must assess the potential impact based on indicia such as the nature of the misconduct, scope and duration, persons involved and potential monetary impact. Any misconduct that has remained undetected for extended periods also could signal material weaknesses with internal controls and necessitate remediation within the purview of the audit committee’s charter.
• Possibility of Regulatory Sanctions. In light of the DOJ’s and SEC’s strong preference for independent investigations, any misconduct that could result in an enforcement action by the DOJ or SEC likely warrants an independent investigation. Robust independent investigations led by the audit committee or an equivalent committee of independent directors yield tangible benefits for a company through reduced sanctions or complete avoidance of charges and effective remediation. While not all forms of suspected misconduct warrant an independent investigation, independent directors in consultation with their counsel should remain vigilant in exercising their fiduciary duty to open an investigation where necessary.
  

Contact Bradley J. Bondi at bradley.bondi@cwt.com and Martin T. Biegelman at martin.biegelman@navigant.com. Access other GC Corner articles by visiting www.navigant.com/gccorner.

Image from Images.com

The Dodd-Frank Wall Street Reform and Consumer Protection Act created Section 14A of the Securities Exchange Act of 1934, which requires most public companies to conduct a shareholder advisory vote on executive compensation not less frequently than every three years; and to allow stockholders to vote once every six years on whether the “say-on-pay” vote should occur every one, two or three years. The compensation arrangements subject to vote include those paid to the chief executive officer, the chief financial officer and the three other highest-paid executive officers.

Section 14A specifically provides that these resolutions will not overrule the board’s compensation decisions or create or imply any change to or any additional fiduciary duties for the issuer or board.

Despite disclaimers by Congress, at least 10 companies are now facing one or more derivative lawsuits following negative stockholder votes. These complaints set forth similar allegations, including claims for breach of the fiduciary duty of loyalty against the company’s current directors, claims against the recipients of the pay raises for unjust enrichment, and claims against the company’s compensation consultant for aiding and abetting breaches of fiduciary duty.

Most interesting, the complaints also allege that the “no” vote constitutes “direct and probative evidence” that the pay decisions were not in the best interests of the company’s stockholders. This allegedly overcomes the business judgment rule and shifts the burden to the defendants to prove that the challenged compensation decisions were made in good faith and in the stockholders’ best interests.

It may seem difficult to understand how a nonbinding stockholder vote that, by its terms, was not to overrule the board’s compensation decisions or impose any new or enhanced fiduciary duties, could alone be sufficient to defeat the business judgment rule. One federal court, however, has found the argument persuasive, at least at the motion-to-dismiss stage. In NECA-IBEW Pension Fund v. Cox, Cincinnati Bell shareholders brought suit after the directors, inter alia, granted $4 million in bonuses, plus $4.5 million in salary to the CEO, in the same year that the company incurred a “$61.3 million decline in net income, a drop in earnings per share from $.37 to $.09, [and] a reduction in share price from $3.45 to $2.80.” Sixty-six percent of the voting shareholders voted against the plan. The court recognized that the negative vote was not binding nor should it alter the directors’ fiduciary duties, but nonetheless held that, under Ohio law, the business judgment rule did not apply because the factual allegations raised “a plausible claim that the multimillion dollar bonuses approved by the directors in a time of the company’s declining financial performance violated Cincinnati Bell’s pay-for-performance compensation policy and were not in the best interests of … [the] shareholders and therefore constituted an abuse of discretion and/or bad faith.”

As the business judgment rule “imposes a burden of proof, not a burden of pleading,” it may be that the plaintiffs are ultimately unable to prove the directors acted with “a deliberate intent to cause injury” or “reckless disregard for the best interests of the corporation” at trial, but their allegations were sufficient at the pleading stage.

The Georgia Superior Court reached the opposite conclusion in Teamsters Local 237 Additional Security Benefit Fund v. McCarthy et al. There, the directors of Beazer Homes recommended that the shareholders approve the 2010 compensation plan, which included raises for executives in a year in which the company suffered a $34 million net loss and a 17 percent decline in share price. The shareholders rejected the recommendation.

The complaint alleged, inter alia, that by approving the plan, recommending that the shareholders approve the plan and failing to rescind the plan after the negative vote, the directors breached their fiduciary duties to the company.

The court disagreed, holding under Delaware law that neither the negative vote nor the directors’ decision not to rescind the plan rebutted the business judgment rule. The directors could not have considered the results of the February 2011 vote when they approved and recommended the plan in 2010. As such, the vote failed to cast doubt that the directors acted on an informed basis, in good faith and in the company’s best interests a year earlier. “Hindsight second-guessing and Monday morning quarterbacking of the sort [the stockholders] urge are fundamentally inconsistent with the business judgment analysis,” the Georgia court wrote.

Even prior to this uncertainty, other suits had settled, encouraging more suits. In March 2011, KeyCorp, after being sued under a similar provision found in the Troubled Asset Relief Program (TARP), agreed to make changes to its compensation practices and to pay $1.75 million to the plaintiffs’ law firms. Recently, perhaps as a consequence of the unfavorable decision received in the Ohio federal court, Cincinnati Bell announced that it had reached a settlement in another lawsuit, pending in Ohio state court, involving its compensation plan.

In light of these varying outcomes, companies should recognize that they could be targets of similar litigation and take steps that may reduce the risk of such suits.

Know your constituents. Prior to any vote, consider: Have significant institutional investors previously indicated that they are unhappy with the company’s compensation practices or decisions? Have any of these same institutions voted “no” at other companies or filed suit, and if so, why? Are there aspects of the company’s recent performance that could be characterized (rightly or wrongly) as “disappointing”? Can the company take steps by way of additional communication, disclosure or the like, to address these risk factors proactively and render a positive vote more likely?

Be prepared. If there is genuine risk of a “no” vote, have a plan. Will the compensation committee revisit a rejected decision and adjust it, or will only prospective adjustments be considered? What are the ramifications (accounting and otherwise) of a retroactive adjustment? As a matter of good corporate housekeeping, the minutes of compensation committee and board meetings should capture and accurately convey the rationale for any action or nonaction that is taken in light of a negative vote.

Review your disclosures. Consider explaining what is meant by “pay for performance.” The plaintiffs’ bar often seeks to use the company’s Compensation Discussion & Analysis to support their claims, usually relying upon language that the company has a pay-for-performance policy. This argument is based on the latent ambiguity in terms that may not be defined or described in detail in the CD&A. Companies should consider explaining whether “pay for performance” means that pay is based solely upon total shareholder return, or whether it takes into account other considerations. Disclosing what goes into executive compensation decisions can provide defense counsel with more robust disclosures to rely upon, including in seeking to have claims dismissed at the outset.

Potential Impact on Compensation Advisors
The plaintiffs’ bar is also pursuing “aiding and abetting” claims against compensation advisors. As a result, companies should review whether, and to what extent, they have indemnification obligations, whether such obligations are insured, and what impact a lawsuit might have on their relationship with their advisor.

Roger A. Lane is a partner in law firm Foley & Lardner’s Securities Enforcement & Litigation Practice. He can be reached at rlane@foley.com. Courtney Worcester is senior counsel in the Boston office of Foley & Lardner. Her practice focuses on complex commercial litigation involving corporations, venture capital and private equity firms, financial institutions and their directors and officers. She can be reached at cworcester@foley.com.

John Napoli (left), Robert Master and Anthony Saitta (photos by David Nicolas/Longview)

At a recent roundtable of REIT directors hosted by Seyfarth Shaw and moderated by partner John Napoli, who heads the law firm’s national tax practice, those issues included say on pay, director compensation, balancing dividend yield versus stock performance and investor expectations of REIT boards in the new year.

The Current Environment
An investment memo issued in November by Cohen & Steers reported that U.S. REITs had a negative total return after posting a strong gain in October. The report stated: “Macro uncertainty, primarily regarding how Europe would handle its debt crisis, drove market volatility that had a bias to the downside. But REITs and other stocks surged at the end of the month—bringing year-to-date returns back to positive—when global monetary authorities provided much needed liquidity to European banks. Also fueling the late rally were better-thanexpected U.S. economic data and China’s decision to lower its reserve requirement ratio for the first time in three years.” In addition, the third-quarter earnings season for real estate companies, according to the investment advisor, “generally exceeded expectations. Guidance for 2012 was modestly lowered, which was more a reflection of global economic uncertainty than a change in real estate fundamentals. REITs continued to demonstrate good access to capital at attractive rates.”

Global uncertainty has led to “basically a fear factor in the general economy…and the compression of the business cycle is starting to make REITs think differently about their real estate assets,” said Seyfarth Shaw Partner Blake Hornick, who chairs the firm’s national securities practice. Hornick noted that the traditional REIT buys, holds and manages assets that in a static economy “may not lead to much positive growth.” Among the consequences is that shareholder value may not be as great as in the past and REITs may have to be more active managers of their portfolios amid a sea of economic, regulatory and other changes.

Having a Say on Pay
For instance, the 2011 proxy season was the first Dodd-Frank mandated but nonbinding say-on-pay votes were in place. In the main, the vast majority of these votes were favorable to the executive compensation program of the issuer. However, litigation stemming from negative say-on-pay votes has resulted in suits against some 10 companies, according to Seyfarth Shaw. Hornick opened the discussion by asking what the effect of say-on-pay votes has been for directors.

“If you look at the whole spectrum of publicly traded companies,” said Jeff Morgan, president and CEO of the National Investor Relations Institute, “only about 40 companies had negative pay votes. That’s a huge success. And I think what it has shown is that companies have been better communicators or become better communicators of their compensation packages, and investors—as you said—have an up or down vote.”

So few negative votes on say on pay was an indication that the majority of shareholders think boards are doing a good job, said Robert Masters, general counsel and chief compliance officer at Acadia Realty Trust, a value-focused REIT that went public in 1998. “That there were such a tiny number of objections to what the boards had put into place says to me that boards are doing a very good job, and the majority of shareholders understand and like what boards are doing,” Masters said, adding that “you don’t need shareholder access to the proxy to know whether the board or management is doing a good or bad job—that’s reflected in the stock market.”

One effect of say on pay is that it forces directors to communicate. While the golden rule of real estate is location, location, location, Donald E. Ellison, a Board Leadership Fellow of the NACD who has been non-executive chair of numerous boards, said directors should adopt a new motto: “communicate, communicate, communicate.”

Rather than an up or down vote, Masters suggested that communications should be more of a dialogue and proxy statements clearly written. Concurred veteran director Carlos C. Campbell: “Communications is a requirement on both sides. From the standpoint of the proxy originators, you have to be very clear and the executive summary must be precise.” This becomes particularly important for REITs that are “value plays rather than profit plays,” Campbell says. “If you are a value play and you’re going out over several years and have an outstanding record of increasing shareholder value, that has to be clearly communicated so that shareholders understand the business model.”

However, new regulations requiring greater disclosure about director qualifications and compensation consultants have added further layers of information to the proxy statement. Has the pendulum on regulation swung too far? Keith Locker, non-executive chairman of the board of Sunstone Hotel Investors, was among the participants who think so. “You can get so lost in 30 pages of disclosure relating to the compensation consultants’ report that it may be a challenge for investors to focus on the main points, the key metrics and assumptions that go into a compensation plan, and what are the ranges of compensation calculated,” Locker said.

One participant asked for clarification on the SEC’s proxy access rules, specifically the differences between Rules 14a-8 and 14a-11. The D.C. Circuit Court in September invalidated the SEC’s Rule 14a-11, which would have allowed shareholders who own 3 percent or more of a company’s voting shares for more than three years to nominate director candidates. Even so, investors may still challenge board elections on a nonbinding basis under Rule 14a-8. “What it leaves is the ability for shareholders to propose proxy access and put it on the proxy,” Morgan said. Use of that rule is expected to be limited.

Napoli asked: “What questions should the board be asking management about capital market activities and plans to enhance shareholder value?” Michael Torres of Adelante Capital responded that “Generally, once a year we bring in an independent research firm” to help the board evaluate various capital opportunities.

“If you go back a number of years,” Hornick recounted, “REITs were supposed to be a nice, stable dividend, a chance for capital appreciation—a sort of a hybrid, if you will, between bonds and a pure equity play. Well, the world has now turned upside down, and shareholders want more equity appreciation because interest rates are so low, but what you need to do to increase the stock price may require an investment that might lower your dividend yield.”

The reality, offered one participant, is that it depends on your shareholder base—retail versus institutional. Institutional investors tend to be more forgiving about a lower dividend policy. Yet, according to Locker, you need to start with a strategic plan to determine what the company’s capital needs will be. “The dividend yield to some extent,” said Masters, “reflects the quality of the portfolio. What’s the strength and quality of that dividend over the long term?”

More companies, particularly REITs, are paying closer attention to the relationship between their dividend and net income. Said another director: “For some time we didn’t pay too much attention to that, but now we’re saying, ‘I only have to pay out this much, why don’t we only pay out that much?’”

Too Much Compensation?
Napoli redirected the conversation from dividends paid to shareholders to compensation paid to directors. “What is considered adequate compensation? The reality is that it seems directors are more engaged and devoting more time to their director duties, preparing for and attending meetings and getting out to interact with customers, management and investors to better understand the business,” he said.

“It’s a different conversation than executive compensation,” noted Anthony Saitta of FTI Consulting, “because clearly directors are performing an oversight role, so the stock price on a one-year or three-year basis will be reflected in what they’re doing….I think that as directors get more involved and that as the rules continue to evolve and there are more compliance requirements, there’s more risk associated with being a director and compensation should continue to rise. But I think compensation should increase in terms of equity, giving directors more of a stake in the company so they receive the same benefit as well as pay the same price as shareholders based on how well the company performs.”

At what point does compensation then become high enough that a director is no longer independent? “I think that’s an individual question,” said Suzanne Hopgood, who has served on a number of boards in turnaround situations. “I’ve been on boards with people who said, ‘I can’t afford to lose this board position.’ And my immediate response is, ‘Well, then, you’re not independent.’” Optics are often the issue, she added: “I have been on workout boards, which typically are lower-paying, and the last thing in the world we would do is raise director compensation because regardless of how much time we put in or how much effort it would be a poke in the eye to the shareholders.”

When companies are dealing with uncertainty or financial difficulty, everyone from management to the board is working harder. “In fact,” said one participant, “our board chair generally says to us that ‘Effort is rewarded in heaven, and results are rewarded on earth.’”

Participants
Leigh J. Abrams: Director, Impac Mortgage Holdings

Pike Aloian: Director, EastGroup Properties, Brandywine Realty Trust Partner, Rothschild Realty

Carlos C. Campbell: Director, Resource America, Pico Holdings

Christopher Y. Clark: Publisher, NACD Directorship magazine and Directorship.com

William M. Diefenderfer III: Chairman, CubeSmart

Donald E. Ellison: CEO, Chairman Government Relations, LLC

Michael F. Foust: Director, Digital Realty Trust

Suzanne Hopgood: Director, The Hopgood Group

Blake Hornick: Partner, Seyfarth Shaw

Andrew S. Levine: Director, SL Green Realty Corp.

Keith M. Locker: Non-executive Chairman, Sunstone Hotel Investors

Robert Masters Sr.: Vice President, General Counsel, Chief Compliance Officer, Acadia Realty Trust

Jeff Morgan: President, CEO National Investor Relations Institute (NIRI)

John P. Napoli: Co-Managing Partner, New York Seyfarth Shaw

Frank Poli: General Counsel, EVP and Secretary Cohen & Steers

Anthony Saitta: Managing Director, FTI Consulting

Robert S. Smith: Managing Director, National Capital Merchant Banking Director, Tower Group Former COO, Friedman Billings Ramsey

Michael A. Torres: CEO, Adelante Capital Management

Larry Smith (left), Terry Iannoconi and Rosalie Wolf (photos by Jacuqulyn Maisonneuve)

One key area of interest was the need for detailed disclosures of corporate political contributions in light of the Citizens United case, and “robust oversight” of donations. A clear policy on the reporting is necessary for any company, participants said, with some investors calling for a “no-donations” policy at some firms.

Company policies were widely approved by shareholders in 2011, with ISS’s final U.S. Postseason Report noting that proxy contests were less prevalent in the past year. Only nine contested meetings went to a shareholder vote during the first half of 2011, compared to 14 and 25 for the same periods in 2010 and 2009, respectively.

This article is adapted from the “Summary of Proceedings of the 2011 Audit Committee Chair Advisory Council,” available free to all NACD members at NACDonline.org.

“Say-on-pay” proposals were voted down at 1.6 percent of the Russell 3000 firms reporting results, involving only 38 companies through September 2011, and pay programs received an average of 92.1 percent support from investors. As say-on-pay votes gave shareholders an alternative to voting against compensation committee members, the number of Russell 3000 directors failing to garner majority support fell by nearly half.

An SEC update to the Advisory Council highlighted a number of issues upper most on the Commission’s agenda with key implications for audit committee oversight—including Dodd-Frank rulemaking on conflict mineral disclosures, clawbacks of executive compensation and median-pay calculations, as well as offshore cash and the use of non–GAAP metrics in SEC filings.

Advisory Council delegates expressed particular concern over future clawback provisions. They agreed on the importance of ensuring a clear, unambiguous tone at the top and expectations that all relevant facts are considered when making a restatement decision. Yet some noted that the clawback provisions raise some problematic questions, including: Do companies have the systems to implement this? What are the metrics being used? And, if earnings per share (EPS) is used, will it create measurement challenges related to shares outstanding, timing and other inputs to the EPS metric?

In addition, the SEC update noted that the Commission may consider allowing statistical sampling to alleviate possibly cumbersome calculations of median pay, and is examining material disclosures regarding cash held offshore.

Auditors emphasized the need to consider the potential impact of accounting changes on IT systems. In order to avoid “Y2K-like scrambles,” Advisory Council delegates agreed that both audit committees and management should begin identifying what the company needs for implementation, including processes and resources.

Concern about the volume of disclosures required in SEC filings was a particular sticking point. Participants noted the ongoing problem of “disclosure overload,” compounded by the widespread use of boilerplate disclosures driven largely by the fear of litigation. “Telling investors that if the company doesn’t sell products its performance could suffer, doesn’t tell them anything, really,” said one participant.

The Public Company Accounting Oversight Board has a number of initiatives underway, including possible changes to the auditor’s traditional “pass/ fail” reporting model and mandatory audit firm rotation. There was general agreement that a more robust audit committee report—describing in more detail what the audit committee does—would be beneficial. However, the scope of an expanded audit committee report may be limited to what corporate counsel is comfortable saying in the proxy. Attendees also expressed desire for more communication and transparency about the PCAOB inspection process and the significance of inspection findings.

Regarding auditor independence and skepticism, participants noted the difficulty of challenging the auditors. Using executive sessions effectively and meeting with the auditor informally, outside of regular meetings, may be invaluable solutions. While informal meetings may provide additional nuance, in formal meetings the auditor should provide views and perspective, not simply “We did the audit, and it complies with accounting standards.”

Citing the 2011 KPMG Audit Committee Institute survey that revealed that IT risk and emerging technologies are the top issues that audit committee members want to devote more time to over the next 12 months, participants discussed the significant— and accelerating—challenge of effectively overseeing IT risk and governance.

Boards (often with the audit committee taking the lead) are delving deeper into the risks posed by IT and emerging technologies that are transforming the business landscape, from cloud and social media to mobile devices and data analytics. “Defensive” IT risks—data security and privacy, compliance, business continuity and the integrity of financial reporting system—are in the forefront, but boards are also increasingly concerned about strategic IT risks— those posed by the failure to leverage technology to innovate and build competitive advantage. As a leading practice, companies are putting “governance frameworks” into place for IT, data and social media to help manage and oversee these assets as a risk and an opportunity. “Any board that’s not focused on this is missing the boat,” noted one audit chair.

Recognizing that information prepared and presented by management can dominate the boardroom agenda and dialogue, attendees discussed the ongoing challenge of “asymmetric information risk,” as well as clues or indicators of when this risk is too high. While clearly a full board issue, audit committees—given their inclination to view information through a “risk lens”—may be in the best position to monitor this issue.

The group discussed what actions would be meaningful countermeasures to asymmetric information risk, with much of the dialogue focusing on the importance of bringing third-party information and “dissenting views” to the board.

Takeaways
NACD identified three action items stemming from the dialogue to advance audit committee practices and address the common objectives of Advisory Council representatives:

• Identify and facilitate opportunities for audit committee chairs to meet with the PCAOB and exchange views on a more regular and proactive basis.
• Draft a model or template for an expanded audit committee report.
• Develop a board-level educational resource to help directors better understand—and stay apprised of—IT risks and emerging technologies.

Participants
Charles E. (Eddie) Adair: Audit Committee Chair, Tech Data Corp.

James B. Bachmann: Audit Committee Chair, Nationwide Insurance

Joseph R. Bronson: Audit Committee Chair, Jacobs Engineering Group

Meredith B. Cross: Director, SEC Division of Corporation Finance

Gerald M. Czarnecki: Audit Committee Chair, State Farm

Kenneth Daly: President and CEO, National Association of Corporate Directors

Cynthia A. Fornelli: Executive Director, Center for Audit Quality

Peter Gleason: CFO, Managing Director, National Association of Corporate Directors

Daniel L. Goelzer: Member, PCAOB

Judith Richards Hope: Audit Committee Chair, General Mills

Sherrill Hudson: Audit Committee Chair, Publix Supermarkets

Terry Iannaconi: Senior Technical Partner, KPMG LLP

James P. Liddy: U.S. Vice Chair, Audit, KPMG LLP

Mary Pat McCarthy: U.S. Vice Chair, KPMG LLP, Executive Director, KPMG’s Audit Committee Institute

Patrick S. McGurn: Special Counsel, Institutional Shareholder Services

George Muñoz: Audit Committee Chair, Marriott International

Charles H. Noski: Audit Committee Chair, Microsoft

Michael J. Passarella: Audit Committee Chair, Unum Group

David Y. Schwartz: Audit Committee Chair, Walgreen

Lawrence W. Smith: Member, FASB

J.W. Mike Starr: Deputy Chief Accountant, SEC

Richard G. Tilghman: Audit Committee Chair, Sysco Corp.

Rosalie J. Wolf: Audit Committee Chair, TIAA-CREF

Ann Yerger: Executive Director, Council of Institutional Investors

Richard Steinberg

It’s becoming increasingly clear that the landscape has changed—permanently. That means it won’t go back to the way it was. In other words, ensuring compliance with the letter and spirit of the new requirements will continue to require attention going forward. This is not a case of “done once and forget about it.” Sarbanes-Oxley, stock exchange listing requirements, SEC rules, Dodd-Frank and other rules and expectations of investors—especially institutional investors and other major shareholders—require ongoing diligence.

But experienced directors and senior executives recognize that the requirements, for the most part, deal with issues of form, not function. Yes, they are important because they’re now legal or regulatory mandates, and also can serve as enablers to effective board performance. But as noted, some boards that have always done these things still have not been very effective, while others had few of the now-mandated practices in place yet have been highly effective. What makes a board truly effective is something else entirely. Experienced directors—having spent a disproportionate amount of time on the new mandates that deal for the most part with additional disclosures to and empowering shareholders and imposing checks and balances on management—want to get back to the business of providing the chief executive and senior management team with value-added advice, counsel, and direction on critical issues facing the business.

So where is board attention needed? That will depend on each company, of course. But based on my experience, there are eight principal areas of responsibility where the value-add takes place, outlined here in high-level summary.

1. Strategy. Making sure the company gets strategy right is absolutely critical. Effective boards carefully analyze proposed strategy plans and management’s rationale for its recommendation. These directors bring experience and insight into the constructive debate, focusing on markets, competitors, risks, resources and interdependencies. It is of critical importance that resource allocation, business processes and senior executives’ buy-in all are positioned to drive successful strategy execution.

2. Risk management. The board must be comfortable that management is identifying and appropriately responding to risk, and that the board itself is apprised of the most significant risks facing the company. To reach this comfort level, effective boards ensure that management has in place an effective risk-management process, and the directors assess whether risks are undertaken and managed consistent with the established risk appetite.

3. Tone at the top. Management establishes the corporate culture, but effective boards ensure that the desired integrity and ethical values are present. Of course, that includes a robust code of conduct, a whistleblower channel, feedback protocols and related elements comprising a cohesive program, and also means the board must ensure the culture is driven not only by the words of management, but their actions as well.

4. Measuring and monitoring performance. The board must ensure that performance measures are linked to strategy, tactics and the real value drivers.

Metrics should balance financial performance with forward-looking, nonfinancial information. And performance awards should be aligned with company goals.

5. Transformational transactions. Directors must be truly comfortable with the business justifications for a proposed deal, whether it be a merger, acquisition, alliance partnership or joint venture. Effective directors critically evaluate management’s data, projections and assumptions—particularly when it comes to “synergy” and integration assumptions. The board should apply lessons learned from past transactions, and should have the courage to walk away from a bad deal.

6. Management evaluation, compensation, and succession planning. Effective boards and compensation committees, especially under the current governance spotlight, ensure that performance criteria and targets for management are linked to strategic goals and desired behavior. Compensation should be crafted to retain the best talent while paying for performance. The best boards don’t wait for signs of a departure before having succession plans in place.

7. External communications. Corporate boards— particularly their audit committees—continue to struggle to understand what entails “appropriate oversight” of financial reporting and related processes. Effective audit committees ensure they have requisite information from management and auditors, and the committee members gain sufficient understanding and insight and challenge critical judgments, resulting in the necessary comfort with the reliability of financial reports, internal control and related matters.

8. Board dynamics. This involves the ways in which the board itself operates. The most effective boards forge the right relationships, processes and constructive engagement to carry out the above responsibilities effectively.

Potential Pitfalls
For corporate boards to be well positioned to effectively carry out their responsibilities, directors must bring needed knowledge, skill and experience to the companies they oversee. We see boards of many companies do well, for instance, in selecting a CEO and senior management team, and making sure the right strategy is in place along with organizational, financial and human resources for effective implementation. But too many other boards have struggled to do the job, for any number of reasons.

One underlying cause is devoting insufficient time to dissecting and debating issues requiring the board’s attention. Being inside boardrooms, we see some directors operate on tight schedules, leaving them unable or unwilling to give needed time and attention to board matters—and they go through the motions without proper deliberation of risks, issues and events that drive company success or failure.

Board agendas typically are set far in advance of meetings, based on expected needs and historical patterns. Travel arrangements are made and directors schedule other commitments around the established board schedules. As such, a fixed amount of time is set aside for board business, with discussion time shoe-horned into the predetermined schedule. Of course, in times of crisis directors’ commitments expand significantly, with other commitments adjusted accordingly. But too often the time set aside for board and committee meetings simply isn’t sufficient, especially in light of the current regulatory environment and stakeholders’ heightened expectations. Some boards find it useful to build cushions into meeting schedules to deal with matters requiring additional discussion, but this hasn’t become a common practice.

Exacerbating this circumstance is the fact that demands on directors’ time continue to increase, with data showing that total time devoted annually to board responsibilities has doubled in recent years to about 250 hours. Much of the additional expenditure is due to boards’ expanded monitoring duties emanating from compliance-related requirements. But while the time commitment has surged, attention to critical strategic and related matters that create or destroy shareholder value has not always kept pace.

My experience is that many if not most directors of public companies not only have the requisite expertise, attributes, and characteristics commensurate with their tremendous responsibilities, they also devote the time and energy needed to drive corporate success. They extend themselves as needed to guide, counsel, and when necessary direct the CEO and senior management team toward attaining established growth and return goals. But in truth some directors fall short.

Directors must delve deeply enough into significant issues. By accepting board seats, directors already have put their reputations on the line and accepted responsibility to carry out their fiduciary duties. It behooves every board member to work with sufficient diligence to see that the company succeeds.

With that said, let’s look at a number of pitfalls boards have fallen into. We’ll do this in David Letterman top-10 style, finishing with those most threatening to a company’s success. You’ll note that there’s a natural parallel to some of the eight keyboard responsibilities outlined earlier.

10. Falling prey to governance ratings. Boards are cognizant of scores disseminated by a number of organizations providing some sort of rating. And if the investor community sees these ratings as accurate indicators of future company performance, a good deal more attention will be paid. But such correlation has yet to be proved, and spending undue attention on ratings can be counterproductive. This is because criteria used are, with few exceptions, based on information obtained from publicly available data, rather than knowledge of what goes on inside the boardroom. Yes, some information garnered in the ratings process can in certain cases, as some suggest, serve as a window onto board effectiveness. But how well the board truly operates in carrying out its responsibilities to help grow share value is more important than driving up externally developed scores.

9. Looking at the wrong performance measures. Boards review data provided by management, and in many cases it’s the right information to examine. But when it’s not, performance too often deteriorates long before directors realize it’s too late to fix what needs to be fixed and value has been eroded. Historical financial and share price data are not enough. Measures must be aligned with the company’s strategy and be sufficiently forward looking— including key nonfinancial data—to enable realtime appraisal of how the company is really doing.

8. Insufficient discipline in director selection. Having the same directors sitting in the same board seats for a long time has its benefits, but can also have major shortcomings—board membership that might have been right for a company years ago could be wrong for today and, more importantly, for tomorrow. But haphazard selection of new directors won’t ensure the right mix—the process requires thoughtful needs analysis and skills matching. Directors will want to consider not only process in selecting new board members, but also to look around the boardroom and ask: Is this the group with which I want to work, and when necessary, go to war?

7. Preoccupation with potential liability. Boards and individual directors today are increasingly concerned with personal liability, and justifiably so. Marketplace expectations for directors have risen dramatically, to the point where it may be impossible to satisfy them all. And with the new and still untested federal requirements, our increasingly litigious society and limitations of many directors-and-officers insurance policies, directors should be concerned about liability. But attention must be paid to fundamental board responsibilities—making sure the company has the right strategy and implementation plan; relevant and aligned performance metrics; strategically and economically sound business partners; effective ethics, control and compliance programs; sound financial reporting; sensible and effectively motivational compensation programs; and the like. Frankly, if the board does its job well in carrying out its core responsibilities and the company is successful, there is little likelihood of being sued in the first place.

6. Blatantly ignoring institutional investors. Owners of significant amounts of a company’s stock increasingly want, and expect, to be heard, and boards disregarding these requests are asking for trouble. If the media get involved, the spotlight becomes bright and hot, creating headaches for the board and company that can be intense and long lasting. Boards certainly shouldn’t allow institutional investors to dictate what needs to be done, but allowing major shareowners to raise issues and offer input and suggestions—and ensuring any information provided complies with Reg. FD and other rules—enables those investors to participate in the governance process without voting with their feet.

5. Thinking you’re apprised of critical risks when you’re really told about problems. With all the talk about the importance of being risk-focused, many boards are informed of business issues after the “bad stuff” has already occurred, rather than of where the potential exists for things to go seriously wrong. You want to know—far in advance—where the dangers lie that can derail key initiatives and strategic objectives, and to make sure those risks are being identified early and properly managed.

4. Presuming top management knows what the critical risks are. For the board to have any reasonable chance of being informed by management of key risks facing the company, management itself needs to have processes in place to ensure it can identify newly emerging risks. As such, effective boards ensure the company has an effective risk management process where each level of management identifies, analyzes and manages risk, and communicates upward. Only through such a process and culture can the board be comfortable that the most critical risks and related actions are presented to the board in timely fashion.

3. Focusing too much on rules and not enough on other important responsibilities. A tremendous amount of attention is being given to new legal requirements, the exchanges and the SEC, and ensuring compliance with these requirements is essential. But as noted, those rules tend to deal with matters of form, structure and disclosure, and a board can follow every rule and still be ineffective. Yes, boards must carry out their responsibilities and act as an effective check and balance on management—a basic thrust behind the new rules and compliance requirements. But the board also must operate effectively as a unit, providing the needed advice, counsel and direction to management to grow share value.

2. Signing off on bad strategy. Many boards do the right thing, carefully assessing strategic plans— often at an offsite retreat—reviewing market, competitive and other relevant information before approving the company’s strategy. But too many boards don’t go deep enough. They don’t see management’s plan for implementation of the strategy and ensure that the plan is supported by the needed organizational structure, resource allocations and buy-in of key managers who truly will make it happen—or not.

1. Making bad decisions about the CEO. It’s fair to say that a board’s most important responsibility is choosing the right chief executive. But that can also be the most difficult decision to get right. It’s only after the fact that one truly knows whether the selection was good or bad. Some boards have waited too long to make a change, and some appear to have pulled the trigger too quickly. Boards that do the best jobs know their company, its needs, the environment in which it operates, and its culture and direction. They carefully identify criteria for the person needed to get the company to where it needs to be, cast a wide net internally (preferably with sound succession planning in advance) as well as externally, and—most important—they have the business acumen, instinct and judgment to select the right individual to lead the company. And then the board puts in place the right motivations and measures, and provides the right level of oversight— neither abdication nor micromanagement—to help and allow the CEO to do the job.

The recovery phase of the cycle has played out rather differently in the U.S. as well, with nearly all of the rebound reflecting gains in output per worker. Indeed, as of Q3 2011, while the decline in real GDP had been fully reversed, the level of employment remained nearly 5 percent below its pre-recession peak.

What explains this? According to Barclays Capital, there are cyclical and structural components.

Short-term movements in productivity (over the course of a cycle, say) are best thought of as reflecting the relative shifts in output and employment and, in particular, how firms adjust their labor resources in response to changes in demand. During a downturn the degree of labor market flexibility plays a role in how much firms can trim their payrolls, and is likely to explain some of the difference in the recent productivity experience in the U.S. and continental Europe, where firms face greater barriers to rapidly shedding labor.

The rebound in corporate profits since the recession’s end underscores the point (as of Q3 2011 they stood 19.4 percent above the pre-recession peak). This compares favorably with many postwar cycles, despite the relatively tame rebound in output.

The mild dip is U.S. productivity reflects flexibility in labor markets and the decision by U.S. firms to aggressively shed rather than hoard labor resources in response to the cyclical decline in demand.

It also points to a structural adjustment. The sharp decline in productivity partly reflected a transition to a higher level of structural unemployment not just a cyclical, or temporary, loss of demand, Barclays Capital reports.

Takeaways
Productivity fell less during the recession in the U.S. than elsewhere, and rebounded much more sharply in the early phase of recovery.

The flexibility of the U.S. labor market was one reason.

An apparent decision to shed, rather than hoard, labor resources was another factor.

Source: Barclays Capital

Alexandra R. Lajoux (photo by Peter Krogh)

Pay Rules Pending
To finish up its implementation of Dodd-Frank, the SEC must produce final rules on investment manager pay votes, compensation committee and advisor independence (proposed but not yet final), pay for performance, CEO-to-median employee pay ratios, executive compensation clawbacks, and disclosure of hedging by employees and directors. Any one of these could create compliance challenges for boards—a truth admitted even by board critics.

At a Dec. 12 conference hosted by the Americans for Financial Reform at the headquarters of the AFL-CIO, investors, academics and advisors expressed hope that the pending rules would thwart excessive CEO pay—and thus help directors to do so. In a keynote address, Rep. Elijah Cummings (D-MD) advised that the SEC should continue what Dodd-Frank started. In response to charges throughout the day that directors “failed” to prevent runaway pay, Professor Robert J. Jackson Jr., associate professor at Columbia Law School, argued that directors are far more vigilant than ever about pay—a point reinforced by Anne Sheehan, director of corporate governance with the California State Teachers’ Retirement System (CalSTRS). Jackson wants to see more disclosures about trader-level compensation in financial firms.

Social Rules Ahead
The three social rules pending at the SEC involve disclosures about conflict minerals, mine safety and resource extraction. The conflict minerals rule, which affects not only products but also packaging and potentially equipment and machinery, has a broad impact (see “Keeping Count,” December 2011). Comments are still being received for this rule.

In one recent comment letter, Sen. Olympia Snowe (R-ME), ranking member of the U.S. Senate Committee on Small Business and Entrepreneurship, urged the SEC to consider a principles-based approach drawn from the guidelines given by the Organisation for Economic Co-operation and Development: Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas. The OECD report provides “guidance regarding due diligence rather than a bright-line approach to compliance, as proposed,” according to the Snowe letter.

Whistleblower Redux
Meanwhile, congressional review may curb a rule already signed, sealed and delivered. In mid-December, the Capital Markets and Government Sponsored Enterprises subcommittee, chaired by Rep. Scott Garrett (R-NJ) began marking up the proposed Whistleblower Improvement Act of 2011 (H.R. 2483), sponsored by subcommittee member Michael Grimm (R-NY), and aimed at improving the whistleblower provisions of Dodd-Frank. The bill, to be approved and fine-tuned by the committee, would amend securities laws to require would-be whistleblowers to report the alleged misconduct first to the company, as long as the company has an anonymous reporting system and anti-retaliation policy. Under the bill, awards would be discretionary, not mandatory, and they cannot go to wrongdoers or to front-line compliance personnel—compliance staff and advisors can’t be rewarded for simply doing their jobs. Finally, the bill would require the SEC to notify a company of its investigation, unless notice would compromise it.

Clearly, the SEC is having a major impact these days. Corporate directors would be wise to keep their eyes on the agency’s unfolding agenda.

Checks and Balances
Nor are the courts out of the SEC’s loop. Courts may review SEC decisions, and the SEC may review court decisions.

In November, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York rejected a proposed settlement agreement between the SEC and Citigroup. Under the agreement, Citigroup would have paid a $285 million fine to the agency without admitting guilt. Judge Rakoff claimed that the agreement, lacking sufficient details on the allegations against Citigroup, was “not in the public interest.” The matter will now go to trial, which is set for July 16.

Still to come is an SEC review of a key court decision. As directed under Dodd-Frank, the SEC in January will tell the world what it thinks of Morrison v. National Australia Bank Ltd, a 2010 U.S. Supreme Court decision that upheld current restrictions against U.S. investors from filing securities lawsuits against foreign-listed companies operating in the U.S. If the SEC finds the decision unfair to U.S. issuers, it could make foreign companies a lightning rod for securities suits.

Q3 marked the BCI’s most severe decline to date, a drop of more than 15 points to 47.5. The Q4 increase to 54.7 suggests that directors feel slightly better than uncertain about the economy. The United States did not demonstrate any further proof of economic recovery in the last quarter—the debt-reduction “super committee” in Congress failed to deliver a solution by its Nov. 21 deadline. However, attitudes on the economy shifted only from “moderately worse” to “same.” Additionally, business leaders have had to divide their focus between the European financial crisis and the uncertain fate of the euro and the 2012 presidential election on the horizon.

The BCI represents confidence snapshots across five different areas. While confidence improved across the board, the most notable improvements were seen in directors’ short-term view of the economy. It should be noted, however, that this is a small victory. When asked about progress made over the past three months, confidence improved to 47— suggesting that directors feel present conditions are nearly the same as Q3’s all-time low. Looking three months ahead, directors predict little change as well, with a score of 53.

Directors consistently feel better about long-term progress than short term. Yet uncertainty still reigns. Compared to last year, boardroom leaders feel economic conditions are nearly the same, at 53. When asked to forecast one year ahead, directors responded that conditions would be slightly better, with 59. The smallest companies (those with revenues under $1 billion) are generally more optimistic about both short- and long-term prospects, a trend that developed last quarter.

Despite the general malaise, directors tend to view their own industries more favorably relative to the overall economy. Those representing industrial and information technology companies were more likely to feel their sectors were “substantially better” or “moderately better” than others. Directors from companies in the consumer discretionary sector were more likely to respond that conditions were “moderately worse” or “substantially worse.”

Consumers mirrored this improved perspective. According to The Conference Board’s Consumer Confidence Index, American confidence improved to 56 in November from 40.9 the previous month. That marks the index’s largest jump in more than eight years. The Thomson Reuters/University of Michigan peer survey noted a similar trend: consumer sentiment improved to 67.7 from 64.1, a six-month high. Economists cite falling gasoline prices, the drop in the nation’s unemployment rate to 8.5 percent and a rebounding stock market for bolstering consumer confidence.

Regarding hiring practices, directors indicated that their companies maintained the status quo in Q4. Given the choices of “resulted in a net gain,” “remained the same” or “resulted in a net loss,” nearly half of respondents (48 percent) indicated their company’s hiring remained the same as for Q3. However, perhaps reflecting more positive unemployment news, over a third responded their company’s hiring resulted in a net gain. In addition to a more positive outlook, the smallest companies were more likely to have hired in Q3. Looking ahead to the next quarter, the majority of directors (53 percent) forecast their company would retain the same number of employees.

Kate Iannelli is an NACD research analyst.

BCI Increases From Q3 to Q4
2010: 56.6 – Q3, 64.4 – Q4
2011: 64.9 – Q1, 63.1 – Q2, 47.5 – Q3, 54.7 – Q4

Source: NACD Board Confidence Index

Originally introduced in June 2009, Rule 14a-11 was part of the Securities and Exchange Commission’s proposed rules on facilitating shareholder director nominations. It allowed for direct shareholder access to proxy materials, with eligibility dependent on specific stock ownership and holding thresholds.

Today, this modified rule requires inclusion of any shareholder proposals that either amend, or request an amendment to, the company’s bylaws concerning the director nomination process. Eligibility to submit proposals is considerably lower than Rule 14a-11’s ownership of 3 percent for three years. As for all shareholder proposals, the requirement for ownership is $2,000 or 1 percent of shares—whichever is less—for at least one year.

Not every shareholder proposal will be eligible. When removing the general “election exclusion,” the SEC added several further exclusions protecting directors. A proposal can be omitted if it would:

• disqualify a nominee who is standing for election;
• remove a director from office before his or her term expired;
• question the competence, business judgment or character of one or more nominees or directors;
• seek to include a specific individual in the company’s proxy materials for election to the board of directors, or otherwise affect the outcome of the upcoming election of directors.

Some companies can challenge the proposals as a violation of state law. Delaware corporations cannot use this argument, however, as the state’s law was changed in 2009 to allow companies to amend bylaws to provide shareholders access to proxy materials concerning the director nomination process.

Effective shareholders now have indirect access to the board’s nomination process. However, they must first change the company’s bylaws. The investment community has taken to the new rule. The U.S. Proxy Exchange (USPX), an advocacy group for retail investors, has already developed a model proposal for shareholders to use. The model asks companies to adopt proxy access bylaws that allow director nominees from any party of one or more shareholders that has owned—for two years—1 percent of the company’s securities eligible to vote for the election of directors, and/or any party of shareowners of whom 100 or more satisfy the Rule 14a-8 eligibility requirements. Any party can submit one nomination or 12 percent of the current number of directors, whichever is greater.

Investors to date have publicly announced 11 proxy access resolutions for the 2012 proxy season. Five of these resolutions came from a single retail investor— using the USPX model—and were submitted at such companies as Bank of America, Sprint Nextel and Textron. The remaining six resolutions were filed by Norges Bank Investment Management at companies including Wells Fargo, Charles Schwab, Western Union and Staples. NBIM’s proposals set a lower threshold, 1 percent ownership for one year, and place a 25 percent cap on the number of nominees a shareholder can submit.

In its policy updates for the 2012 proxy season, Institutional Shareholder Services announced it will still evaluate shareholder proposals for proxy access on a case-by-case basis, taking into account the ownership threshold proposed, the maximum proportion of directors that can be nominated by shareholders, and the method for determining which proposals should appear if multiple shareholders submit nominations. This marks a departure from ISS’s previous approach, which took into account the shareholder’s rationale behind the proposal and the company’s corporate governance practices.

While not “one size fits all,” as had been a boardroom concern, the current method of private ordering allows shareholders the ability to establish proxy access at companies of their choice. Despite the absence of Rule 14a-11, proxy access should remain a boardroom focus in the coming proxy season.

Kate Iannelli is an NACD research analyst.

Reuters

In one of the most egregious examples, Bernard Madoff pleaded guilty in 2009 for his role in a multibillion-dollar Ponzi scheme, but neither admitted nor denied the allegations in a settlement with the SEC.

“It was ludicrous to say the defendant does not admit charges that he’s already pled criminally guilty to,” John Coffee, a professor at Columbia Law School, told the Chicago Tribune.

The practical impact of the change could be limited. Since defendants will not be required to admit to allegations beyond those in a criminal case, it may do little to help private litigants sue on similar grounds, a concern companies have long raised. “It is a very small, marginal change,” but it “does make them look more flexible,” Coffee said.

In a separate action, the SEC filed FCPA charges against eight former Siemens executives, marking the first charges against a board member of a Fortune Global 50 company. The decade- long bribery scheme was aimed at establishing and protecting a $1 billion contract to produce national identity cards for Argentine citizens. “Our investigation reveals that there were few lines the executives were unwilling to cross to win the contract,” Khuzami said in a conference call on the charges in early January, noting that Siemens executives allegedly approved up to $100 million in bribes.

Recipients of those bribes allegedly included two presidents and cabinet ministers in two Argentinean administrations between 1996 and 2007. Of the funds used in the scheme, approximately $31.3 million were made after March 2001, when Siemens became a U.S. issuer.

Law Firm Warns of ‘Time Bomb’ After Comcast’s Roberts Is Fined
Comcast CEO Brian L. Roberts faces a $500,000 fine for acquiring Comcast stock between 2007 and 2009 and failing to notify the Federal Trade Commission and the Department of Justice before receiving voting shares beyond Hart-Scott-Rodino Antitrust Improvement Act (HSR Act) limits. Roberts originally obtained and made appropriate HSR filings for restricted Comcast stock units in connection with the company’s 2002 merger with AT&T. The shares vested to voting shares in 2007, while his approval expired in September of that year. He continued to obtain Comcast shares after the expiration without notifying the FTC or DOJ until August 2009, when he made a corrective filing and admitted to inadvertently violating the requirements due to faulty advice from outside counsel. Roberts did not gain financially from the violation, and reported the issue once it was discovered, according to the FTC. Considering these factors, the FTC opted not to seek the daily fine option authorized under the HSR Act, which could have totaled almost $9 million, according to a Latham & Watkins client advisory. “This case is a reminder for executives that they must be careful to avoid passive and inadvertent violations of the HSR Act. Counsel should also keep this cautionary tale in mind when advising companies and executives on compensation issues, including awards that will convert automatically into voting shares, to be sure that they are not setting time bombs,” the law firm advised.

Shareholders, Firms Disagree on Frequency of Votes
Seventy-two percent of shareholders called for annual compensation votes in the 2011 proxy season, the first in which the Dodd-Frank Act mandated nonbinding “say-on-frequency” votes, finds GMI in the final report in its say-on-pay series. Only 53 percent of management teams recommended annual votes, while 42 percent recommended the maximum triennial votes, citing the need for extra time to evaluate the programs, review shareholder input and implement changes. At the time of GMI’s study, 40 percent of companies had not yet decided which voting frequency to use, 10 percent had adopted a triennial policy, 50 percent had adopted an annual schedule, and just 0.37 percent chose biennial.

GMI also released its 2011 CEO Pay Survey, which found that total realized compensation in the S&P 500 and the Russell 1000 rose by 36 and 38 percent, respectively. Of the 10 highest-paid CEOs in 2010, three were from the health care providers and services industry, including the top two (John H. Hammergren of McKesson at $145.3 million and Joel F. Gemunder of Omnicare at $98.3 million). Russell 3000 companies saw a median increase in total realized compensation of 27.19 percent, in contrast to a 6.38 percent drop in 2008 and another decrease of 0.28 percent in 2009, often fueled by larger stock option exercises and vested stock profits in 2010.

Global M&A Slow to Return
Limited economic growth and sovereign debt concerns may prevent global mergers and acquisitions from returning to the $4 trillion volume level seen in 2007, according to Bloomberg’s 2012 Global M&A Outlook Survey. Forty percent of those surveyed viewed the energy and power industries as capable of the biggest jump in deal making, while basic materials and financial companies were also expected to succeed in M&A. While the 2011 study found that more than 40 percent of respondents expected equity to be the largest source of M&A funding, the majority of this year’s respondents believed internal cash reserves will be the main source.

Yahoo Explores New Directors
Yahoo Inc. is searching for several board candidates to replace possible outgoing directors, including Chairman Roy Bostock, The Wall Street Journal reported in early January. The executive search firm Heidrick & Struggles International has been hired to help in the effort. Yahoo director Patti Hart, head of the board’s nominating and corporate-governance committee, is spearheading the search. According to the WSJ, directors including Bostock and Yahoo co-founder Jerry Yang have been criticized by some shareholders who have complained about Yahoo’s handling of a strategic review and other issues, including its decision to rebuff a 2008 takeover.

Facebook Aside, Market for IPOs to Stay Cool
A Renaissance Capital study finds more than 200 American firms are waiting to go public, but fragile conditions and a significant backlog of initial public offerings highlight the tepid market, The New York Times reported. Facebook’s upcoming IPO has a market value estimated at $100 billion, but analysts say it will take more than that to heat up the market for IPOs. Nearly 70 percent of companies that went public in 2011 are trading below their offering prices.

Class Actions Stay Steady, Foreign Issuers Scrutinized
The number of shareholder class-action lawsuits filed in 2011 is likely to be on par with annual levels between 2008 and 2010, reports the NERA’s Recent Trends in Securities Class Action Litigation: 2011 Year-End Review. The report projects that there will be 232 shareholder class-action filings in 2011, while 2010 saw 241, 218 were filed in 2009, and 245 were filed in 2008. The study’s authors found that the number of filings remained steady but the composition of shareholder suits changed. Sixty- four cases were filed against foreign issuers, with a particular surge in the number of Chinese companies listed in the U.S. (at 29). Average settlement value decreased to $31 million from the 2010 average of $108 million.

Norway Fund Targets Staples, Schwab, Other U.S. Firms
Norges Bank Investment Management, managers of the $550 billion Norwegian Government Pension Fund Global, is calling on U.S. companies in which they invest to ease their director-replacement processes following financial performance and governance concerns. The fund has asked Charles Schwab, CME Group, Pioneer Natural Resources, Staples, Western Union and Wells Fargo to give shareholders proxy access, allowing them to list director candidates on proxy ballots along with management’s nominees. The Norwegian fund has $98 billion invested in U.S. firms, and is the 19th-largest Wells Fargo shareholder.

China Fund ‘Keen’ to Invest in West’s Infrastructure
China’s sovereign wealth fund, China Investment Corp., has expressed interest in improving infrastructure in the U.S. and Europe to help global economic growth. The fund, established in 2007 to invest abroad and which holds mostly U.S. and European government bonds, reportedly plans to begin the program in Britain. Some Chinese commentators have criticized the fund for investing in only government bonds, and have called for fewer bond purchases with a focus on individual projects in the hopes of being less affected by the sovereign debt crisis.

More Funds Divest From Companies With Iranian Ties
The Massachusetts public employees pension fund has divested all of its stakes in companies with major ties to Iran’s energy industry, according to a story published by Reuters. The decision by Pension Reserves Investment Management follows similar divestitures by other states, most notably Florida, Georgia and New York. In total, a half-dozen companies were divested in accordance with a new Massachusetts law, including Gazprom, Hyundai Heavy Industries and Siemens Ltd.

Expanding Ranks Not in Cards For 2012, Say CEOs
Only 35 percent of U.S. CEOs surveyed by the Business Roundtable in its fourth-quarter CEO Economic Outlook Survey expect to increase their company’s employment rankings over the next six months, down 1 percent from 3Q 2011. Forty-two percent of respondents expected employee populations to remain constant, while 24 percent planned to cut jobs. Fifty-two percent expected capital spending also to stay constant, and 32 percent expected an increase. In contrast, 68 percent expected an increase in company sales in the first half of 2011. The survey found that CEOs’ highest cost pressures stemmed from materials (25 percent), regulation (24 percent) and health care (20 percent).

CEO Safety Net Invites Risk Taking
CEO severance packages can decrease a company’s stock performance by as much as 4 percent over the three years after the agreements are established, finds a new study by Tulane University’s Freeman School of Business Assistant Professor of Finance Peggy Huang.

Those that averaged a 4 percent underperformance rate were companies that offered cash-only contracts, while overall severance agreement establishment resulted in a 1.6 percent rate of underperformance. During the period studied, 1993 to 2007, the number of S&P 500 companies offering CEO severance payments more than doubled, to 56 percent.

New Slate at FASB
Thirteen new members have been appointed to the Financial Accounting Standards Advisory Council, effective Jan. 1. Charles H. Noski, vice chairman of Bank of America, was named chairman for a one-year term that began on Jan. 1.

The Council advises the Financial Accounting Standards Board, the private-sector organization responsible for setting accounting standards for U.S. companies, on technical issues related to FASB’s agenda, project priorities and other issues.

Noski’s appointment was made by John J. Brennan, chairman of the board of trustees of the Financial Accounting Foundation. The FAF is responsible for the oversight, administration and financing of the FASB and its counterpart for state and local governments, the Governmental Accounting Standards Board.

The FASB Advisory Council is comprised of:

• Kay Ryan Booth, managing director, Golden Seeds Fund
• Peter Carlson, EVP and chief accounting officer, MetLife
• Susan S. Coffey, SVP-Public Practice and Global Alliances, American Institute of CPAs
• Kenneth Daly, president and CEO, NACD
• Anthony J. Dowd, chief of staff and special assistant to the chairman, President’s Economic Recovery Advisory Board, Office of Paul A. Volcker
• Cynthia M. Fornelli, executive director, Center for Audit Quality
• Jan Hauser, partner, PwC
• Patrick E. Hopkins, professor of accounting and Deloitte Foundation Accounting
• Adam G. Hurwich, portfolio manager, Ulysses Management
• Joseph Longino, principal of Investment Strategy, Sandler O’Neill + Partners
• Patrick T. Mulva, VP and controller, Exxon Mobil
• James R. Taylor, partner in charge – Assurance, Hogan Taylor; faculty fellow, Kelley School of Business, Indiana University
• John W. White, partner, Cravath, Swaine & Moore

Barbara Hackman Franklin

One main reason is the extreme uncertainty and volatility of the current time. The U.S. is recovering from the recession and the economy is growing, though not robustly. The euro zone has sovereign debt problems. Japan has suffered severe natural disasters. World economic growth has slowed, and global stock markets go up and down seemingly on a whim.

Add to this mix the passage of the Wall Street Reform and Consumer Protection Act (a.k.a. Dodd- Frank)—the most sweeping financial reform legislation in 50 years— which requires federal agencies to craft 400 new rules. Nearly a quarter of these were assigned to the Securities and Exchange Commission, including some directly aimed at greater transparency into the workings of the boardroom and the qualifications of directors.

There are a several specific challenges to keep in mind for the year ahead—challenges that have been dogging boards for quite some time.

The Issues
Executive compensation is a continuing challenge. Public concern about “excessive” CEO compensation just won’t go away. “Say on pay,” the nonbinding advisory shareholder vote on executive compensation, went into effect for the 2011 proxy season. And even though the say-on-pay votes were overwhelmingly positive, we shouldn’t take much comfort in that. I believe there will be closer scrutiny of executive compensation in the year ahead. As long as the U.S economy is soft and unemployment remains too high, there is the risk that another scandal or other spark could ignite yet another big wildfire around executive compensation. That would extend an invitation to government to once again step into the boardroom. As directors, it’s imperative that we endeavor to pay for performance—not nonperformance— and really mean it.

The second issue is diversity. Broadly speaking, this includes diversity of thought, experience, skills, gender and race. The NACD co-hosted two events last year with governance and governance-related experts and experienced officers and directors to try to better understand the dynamics of diversity. A key challenge: What is holding women back? I spoke at a session in New York aimed at promoting more women on boards and finding ways to crack the 15 percent barrier. That’s the percentage of board seats held by women on Fortune 500 boards. (The percentage is even lower for the boards of smaller companies, according to NACD’s Public Company Governance survey, released in November.) That 15 percent figure has remained pretty much unchanged for the better part of the last decade. The challenge is to understand why and then to do something about it.

I’m a fervent believer in the power of diversity, broadly defined, because I have seen the results first-hand. A more diverse group can bring new ideas to the board table as well as new ways of looking at old ideas and old problems. This, together with enlightened leadership, can bring more value not only to the board but also to the company.

In the year ahead, I look forward to continuing NACD’s mission to “move the needle.” One key to this movement is annual board and director self-assessments. Clearly, these are essential elements in ensuring board renewal. Such assessments can illuminate any gaps in experience and expertise that changes in strategy may make desirable.

The third issue is new technology—mobile, social, the cloud, plus emerging technologies whose names we do not yet know. There are young people in my company, the 20-somethings, who think I am “out to lunch” on these technologies and their growing influence. They have challenged me to get up to speed, and I’m working hard to better understand, for example, how social media can be used to communicate with and listen to shareholders, customers and employees. That’s the positive side of these wonderful new discoveries.

There is the other side, though, and that’s the risk side. It means that a company’s internal control structure must run constantly to keep up with the advances. We as directors need to run to keep up with what is going on, too, if we are to do a proper IT oversight job. We must help companies guard against the cybercrimes that can result in the theft of identity or intellectual property—or entire system meltdowns. It’s a tall order for those of us over 30, but it is well worth reaching for.

Working Together
Please consider NACD your partner as you work to meet the challenges of today’s corporate environment— to understand fully the businesses you serve, how they make money, their strategies and risks— and as you continue to build strong, diverse boards whose members work well together in a culture of openness and candor. NACD is committed to keeping you at the forefront of knowledge by giving you the tools you need to be the best you can be.

The NACD is the only membership organization for public company directors—now more than 11,000 strong—that is operated as a not-for-profit 501(c)(3). Ken Daly is our energetic president and CEO, and the NACD staff is eager to be of service. The NACD board is strong, independent, diverse and as committed a group as I have ever served with in the not-for-profit sector. NACD will celebrate 35 years of service to directors in 2012. It’s a record we are proud of, and will continue to build on.

NACD offers:
Educational experiences, which include courses, webcasts and webinars on substantive areas, such as doing in business in China, as well as on leading practices in governance. Many experienced directors are qualifying to become NACD Board Leadership Fellows, showing their commitment to continuing education.

Resources through the NACD library, which has the best collection of governance publications and other resources on the planet, assembled and embellished over the past 35 years. When you’re a member, these resources are only a phone call or a few clicks away. The daily emailed news summary is one of my favorites.

Peer-to-peer convocations nationally and within our 22 chapters allow directors to network, share experiences and learn from each other.

Advisory Councils were convened nationally last year to bring board audit, compensation and nominating and governance committee chairs together with key institutional shareholder representatives and regulators. Each of these three sessions sought to foster a more productive dialogue around such complex issues as risk oversight, executive pay and transparency.

The Voice of the Director Initiative brings the views of directors to the public policy process where otherwise directors have no voice at all. In 2011, for example, on behalf of our membership, the NACD’s Ken Daly testified before a congressional subcommittee on the consequences of the SEC’s whistleblower proposal. We provided written comment on that issue and on the Public Company Accounting Oversight Board’s (PCOAB) concept releases about mandatory audit firm rotation and revisions to the audit report. And we commented for the first time on a non-U.S. proposal—the European Commission’s “green paper” on audit policy.

Using technology, we can tap into what you, our members, think about issues. So, if you get survey questions via email, please answer them. They help NACD formulate positions on your behalf. Let me conclude with a last thought from the American philosopher Yogi Berra: “If you don’t know where you’re going, you might not get there.” Well, I think we know where we’re going. We know as directors that the work we are doing is essential—for our companies, our shareholders, our stakeholders, our countries’ economies, as well as the global free market system of capitalism. We will carry on with this vital work. Let’s pledge to be the best we can be.

The Honorable Barbara Hackman Franklin is chairman of the board of NACD, former U.S. Secretary of Commerce, and president and CEO of Barbara Franklin Enterprises in Washington, D.C. She serves as an independent director of Aetna and Dow Chemical Co., and as a director of three funds in the American family of mutual funds.

Judy Warner (photo by David Nicholas/Longview)

Jeff also contributes an opinion piece on the new book written by former Forbes editor Stewart Pinkerton, The Fall of the House of Forbes. He again brings considerable firsthand experience to his reading, and assessment, of Pinkerton’s story and the Forbes saga—as only he can.

Launching new programs and features is part of our charge as we work to help elevate the role of the director, while providing a blend of informative, interesting and one-of-a-kind stories to our NACD member readership. Nowhere else will you find the nuances of committee work explored in such rich and regular detail. See, for instance, the excerpt from the proceedings of our Advisory Council on Audit Committees, and take a look at who was there—I think you’ll agree that the assemblage is a testament to the strength of NACD’s convening power.

Since this is the first issue of the new year, there are some forward-looking perspectives as well. In her annual State of Corporate Governance address, NACD Chairman Barbara Hackman Franklin flags key issues for boards in 2012. We also hear from Nasdaq CEO Bob Greifeld about what’s happening with the ever-dynamic stock exchange, and ISS’s Patrick S. McGurn provides a spirited, comprehensive preview to this year’s proxy season.

We hope you read and take something away from each and every story, and, as always, I welcome your feedback.

Judy Warner is managing editor of Directorship.com and NACD Directorship.