Illustration by Gregory Copeland

Yet few things are further from the mind of this globe-trotting, retired four-star general who is so prepossessing in appearance it seems he was sent up from central casting. Although he counts as close friends Saudi princes and sovereigns, there is not even a hint of a star-struck hero. Like an earlier great American general, William Tecumseh Sherman, if asked to self-promote, Shelton would simply refuse.

Shelton was born Jan. 2, 1942, in Tarboro, N.C., and raised in nearby Speed. Like these modest-sounding place-names, he has never quite left his roots. Following a family tradition, he attended North Carolina State University, majoring in the regional specialty, textile engineering, and enrolled somewhat prophetically in the ROTC program. In 1963, as he was about to leave on his first tour in Vietnam, he married his wife, Carolyn; together they have three sons, all of whom have served in the military.

To learn more about NACD’s newly launched “From the Battlefield to the Boardroom” educational program, visit NACDonline.org/Military.

Right after his retirement from the Joint Chiefs of Staff in 2002, Shelton was trimming trees in his yard when, to avoid a wayward limb, he dropped from a six-foot ladder, snagged his boot on a fence post and landed headfirst, seriously injuring his spine. The irony of a paratrooper who made more than 450 successful jumps from as high as 24,000 feet was not lost on him as he spent three months in the hospital, proving to the medical establishment that a man did not have to be paralyzed for life if he truly believed in his own recovery. Shelton gives all the credit to Dr. Jim Ecklund, chief of neurosurgery at Walter Reed Army Medical Center, who would come by daily to grab Shelton’s right big toe and tell him, “Move it for me,” and, of course, to his wife, Carolyn. Today, he is almost completely recovered—the only long-term consequence is that Carolyn has decreed that all future yard work be conducted as a ground-level operation.

ROTC, 1960

Shelton was America’s 14th chairman of the Joint Chiefs of Staff, serving from 1997 to 2001. The role was conceived in principle under President Franklin D. Roosevelt to better coordinate World War II activities, although the first official officeholder was General of the Army Omar N. Bradley, appointed in 1947. Shelton served as chairman under Presidents Bill Clinton and George W. Bush, leading the planning for such events as the Kosovo war and the early stages of the Iraq war. He was in some ways the “accidental” Joint Chiefs chair. Asked if he had ambitions to the role, he demurs: “When I was at ROTC at NC State, I wasn’t even sure I’d make it through summer camp.”

In his military career he served two tours in Vietnam and commanded the much-heralded 82nd Airborne Division, Operation Uphold Democracy in Haiti and the U.S. Special Operations Command (SOCOM), which conducts covert and clandestine missions and oversees the operations of such vaunted units as Delta Force, Seal Team 6, Army Rangers and Special Forces (aka Green Berets).

What drove him? A sense of obligation to do his duty and always to do the right thing, he says—feelings that would accompany him from Vietnam through his role as Joint Chiefs chair. “Throughout my career, the one focus I had was to be prepared to do the best job I could,” he says. “I would glance up at whoever my boss was from time to time and say to myself, ‘If I were ever put in that position, what would I need to be prepared to take his place?’ But never beyond that.” In Shelton’s way of looking at things, field promotion took the place of self-promotion. Doing the right thing became his calling, and he measured his success only by how his troops performed and the level of their morale.

Shelton is also gifted—or plagued—by a strong sense of fair play. Early in his career, he and his wife moved to their new home near Fort Benning, Ga., and he decided to go early on a Saturday morning to get ahead on some paperwork so that he could hit the ground running on Monday. Instead, the sergeant in charge told him that under no uncertain terms would he be returning home. He said that if Shelton wanted to quit the military he was welcome to go back. In the days before cellphone service, that meant leaving his wife in the dark for two days at a new home in a new location. In looking back at this episode, Shelton says he learned an important lesson: “If you don’t take care of your people and you leave them hanging like he did, you’re history, because we don’t need people in leadership positions that don’t care. As I became more senior in rank, I tried to set the tone within the command that any leader exhibiting that behavior would be fired.”

Inconvenient Truths

Shelton in meetings with the National Security Council during the Clinton (top photo) and Bush administrations.

Shelton’s last bosses were President Bush and Secretary of Defense Donald Rumsfeld. Judging from his comments in the interview with NACD Directorship that follows and from his autobiography, Without Hesitation: The Odyssey of an American Warrior (St. Martin’s Press, 2010), Shelton feels the 43rd president was misled both by advisors and faulty intelligence, and driven by a mania for retribution sparked by the brutality of 9/11. With Rumsfeld, Shelton pulls no punches. He is unremittingly critical of the oldest secretary of defense in U.S. history, commenting on Rumsfeld’s Teflon reputation and ability to sidestep criticism while at the same time riding roughshod over his generals and countermanding or ignoring their advice.

Yet Shelton waited 10 years from his retirement from the Joint Chiefs in October 2001 before he would allow his memoir to be published. The reasoning is vintage Sheltonesque: “I wasn’t kind to Rumsfeld, but I didn’t want to be a distraction. He had enough on his mind already. But if I was going to be frank and candid, I didn’t feel like I could write it differently than I did, so I held off until they were all out of office intentionally for that reason.”

For exemplary service to his country, Shelton was awarded the Congressional Gold Medal in 2002.

In the board world, Shelton was a director of Anheuser-Busch up until its acquisition by InBev. He currently serves as chairman of Red Hat and is a director of L-3 Communications.

His Word Is His Bond

Directors are always interested in driving superior performance in an organization. What factor plays the most important role in motivating combat troops?
In a word, leadership. A single individual can establish an organizational climate that will cause people to want to pull together to be the best. The same applies to both civilian and military organizations. For example, I found at Red Hat we have a tremendous number of brilliant young people competing against Microsoft and Oracle, but it is their belief in the company and what it stands for in the open-systems world that unites them and makes them so determined that Red Hat is going to be the leader.

In Ha Thanh, Vietnam

Can an organization develop a leadership culture that is sustainable?
Yes, and the 82nd Airborne is a good example. They call it the All-American division because it has representatives from every state in the nation, and when you get all of them bonded together, you’ve got diversity spread throughout and leadership that says, “Let’s get everybody pulling together and we’ll be the best in the world.” In the business world, the same rules apply. I think the only time you see it go awry is when self-interest or greed starts to drive individuals in leadership positions.

In your book Without Hesitation, you refer to military duty as “selfless service.” Does this come from a sense of purpose or the Army culture itself?
Both, actually. From my first days on active duty, it was the old adage that in the Army your word is your bond. Integrity is the foundation upon which everything else is built. Everything you did had to be in done in an ethical manner and with the view that what is best for your troop is the right thing to do. If an officer had an integrity issue, colored the truth or made decisions in a self-centered way, he was history.

Meaning he’d be finished, right? From below or above?
He would be fired from above, but the recognition would be among his or her peers who would have nothing to do with him.

In the military you are fighting for freedom and our way of life. Is it realistic to expect business executives to be as motivated?
In war, it’s true you’re motivated by the severity of the consequences, and while in the business world, although you’ve got a different set of objectives such as shareholder value and a profit that you need to make, you can still develop that team to be the best. And I think the same rules apply; they converge downstream. You have to have a conviction and unshakable belief in the rightness of your mission. Different goals maybe, but the same techniques.

Wouldn’t most people question whether executives can be as inspired by making a profit as soldiers by saving lives?
To me there are very important similarities. I look at Enron and, while lives were not lost, the number [of lives] that were destroyed when it went under, the amount of personal savings that disappeared and caused retired employees to have to work for the rest of their lives—I easily see a situation that was equal to what we face in the military in terms of leader responsibility. And I feel that responsibility very strongly as a board director.

Business schools try to teach ethics, but the reality suggests it can’t be taught, only inspired. Do you agree?
I think you can teach it to a degree. I think by teaching, I mean including it in every course that you have, and by leaders emphasizing its importance on a day-to-day basis, the leader in the unit – making sure that everyone understands that we’re going to be a company that’s known for its integrity. Emphasizing compliance with the Foreign Corrupt Practices Act is a great example. The secret really is the tone from the top. It has to flow down through each leader and say in the strongest way possible, “This is part of who we are and what we are, and therefore this is the way we operate.”

Speaking of ethics, what about the unfortunate Abu Ghraib prison case? What is the most effective way to deal with cases where our ethical standards are at risk?
I believe it was a major ethical lapse, and the only way to deal with it is to hold the right people accountable at the levels where they should be held accountable, and not simply spread blame indiscriminately. For example, let’s start with the brigadier general who was in charge of this prison. If she didn’t know what was going on in the interrogation of prisoners, then she needs to be held accountable. And my second immediate question would be, did her boss ever walk through that prison to get a sense of how things were going? I think an investigation should show where the whole thing started breaking down, and assign accountability and appropriate penalties from there. But I don’t agree that the secretary of defense or the chairman ought to be fired because we had a breakdown, which violates common sense as well as the correct chain of command.

In the case of morality versus mortality, is it realistic to expect troops to focus on ethical issues at the same time they are facing dangerous combatants and insurgents?
Actually, it’s even more important. When we went into Haiti we immediately set up a prisoner-of-war camp, to house the thugs we knew were in the street and would shoot us if they had a chance. After we captured a number of them and put them in this compound, I immediately sought out the International Red Cross representative, and said, “I’d like you to go over and inspect our compound. Make sure that everything we’re doing is being done in a humane manner, in accordance with international regulations and rules.” And they went over, and the only suggestion they had was that you ought to put a five-gallon water can out there, just to make sure they can never claim they didn’t have water. So we did that. It’s just not that complicated to act ethically and fulfill a combat objective.

Can you expand on the point you make about [H. R.] McMaster’s book Dereliction of Duty, which concerned the lessons we learned from the Vietnam War? Our country has an uncanny ability to investigate and inquire into our history regardless of the embarrassment it may cause, unlike many less democratically governed nations. This allows us to understand what really took place, and in the case of the Vietnam War, as McMaster pointed out in Dereliction of Duty, it showed that the military did not advise the political establishment forcefully enough and that the political establishment did not do its job either. Our task in the military was similar to those financial executives in the ’07–’08 crisis, whose responsibility was to advise their company CEOs on the risk in their portfolios, regardless of how unwelcome that news would be. History shows they failed to do that, and our military leaders at the time also failed to carry out their obligation to our civilian masters to make sure that we give them our best military advice. Having learned these lessons the hard way, today I tell our officers, “Don’t take no for an answer. Keep pushing so that you can get it as close as we can to what’s best for our men and women in uniform if we’re going to be fighting a war, and certainly watch out for people who lie, cheat and steal.” The deceit and the deception that was going on during the Vietnam War in the Johnson administration was something that I wanted to make sure did not happen during my and [former Secretary of Defense William] Bill Cohen’s watch. We both were very conscious to watch for that when we were over at the National Security Council meetings…for people that might not be entirely candid and working their own agenda.

So more recently, what lessons have we learned from the Iraq War?
In Iraq, we have seen that while you can extrapolate lessons from other military engagements, you can’t take a cookie-cutter approach. We had a very successful operation going into Afghanistan, and it was successful because on the ground in Afghanistan was the Northern Alliance, the indigenous fighters, and they had been at war for years. They could get close to winning against the Taliban, but they could never quite get over the hump, so the idea [former CIA Director] George Tenet and I had was take our special ops guys—who were the only troops in the world trained to go in—and take over an indigenous force and fight with them, and bring the high-tech pieces of the battle to them. When we went into Iraq, Secretary of Defense Donald Rumsfeld took some of that logic but applied it to a very different set of circumstances when he said, in effect, “We don’t need all these troops, so we’ll pare down this war plan that’s on the shelf and get it down to almost nothing and go in and we’ll kick Saddam Hussein out.” But as King Abdullah of Jordan told me, “What you need in order to stabilize Iraq is an individual that has some of Saddam Hussein’s ability to manage these different religious and cultural factions but who is a good leader who doesn’t abuse his people—if you can find someone like that. But you’ve got to have a strong man to keep them apart because if you don’t, they’ll go to war with each other.” Rumsfeld just didn’t want to hear that—he had a different mission and that was to prove to the world that he could go in and win this war with a small force. As he and General Tommy Franks [of the United States Central Command] both found out, it fell apart days after we beat Saddam, because no one could keep these factions apart. We also took out their police, dismantled their military, and now we wonder who runs the country? If you break it, you own it!

Doesn’t it always seem that politics trumps good policy?
It’s up to who’s in command as well as the risks the leader is willing to take to do the right thing. I carried a force to Miami after Hurricane Andrew; I was told they could carry weapons but no ammunition. So we started patrolling the streets where there was no law enforcement. Then the gangs started moving in. So I told them, distribute the ammunition but here’s the rule everyone will follow: Make sure there’s an imminent threat before you fire, period. Then, afterwards, be prepared to tell me why it was an imminent threat. I wasn’t going to have a service member killed on my watch by a gang member because we didn’t give them ammunition to fire back. And I felt that the American people would be solidly behind me. It worked because our great soldiers in the 82nd were properly trained and disciplined and could follow orders very well. That’s how these cases should be handled.

You were critical of the detainee program in Guantanamo. The flip side says the federal courts will tie it up forever. What’s the right way to deal with this?
It’s not a simple issue, but the problem I have with Guantanamo is we should not bring people, terrorists or anyone else, into Guantanamo and let them serve the rest of their life there without some kind of due process. I fully agree with bringing prisoners, of bringing individuals that have been captured like in Afghanistan that we think are terrorists, into Guantanamo, but we need to move faster to produce the evidence, bring charges against them, try them and dispose of them in a just manner, whether it’s to the gallows or whether it’s to freedom, but not keep them there for five or 10 years without some kind of process. That bothers me. I picture myself, for example, being thrown into an Iranian prison…

Meaning what happens when the tables are turned? Yes. And I think it’s the same thing when it comes to waterboarding. It comes down to one fact that concerns me greatly: I don’t want to see our own troops waterboarded. I think we need to comply with the Geneva Convention and the rules of land warfare.

Our intelligence apparatus has been faulted for coming apart under the Carter administration, particularly in the Middle East, starting with Iran. Do you agree?
I think the big mistake that we made with the intelligence services was we thought peace was going to break out all over the world, and we really started drawing down, particularly our human intelligence, around the globe. That was particularly true for what were labeled as Tier Three and Tier Four countries— countries whose names you will recognize, like Haiti, Colombia, Afghanistan and Iraq….Because technology was going to replace the humans…and so it really meant that we had a big void in our intelligence, in our ability to transform the information into something that a commander can use.

Speaking of Iran, do you have any sense for what is happening there and how concerned should we be?
Well, I think first and foremost we need to recognize that Iran is the most terrorist-exporting nation in the world today. A nation that’s on the brink of developing a full-scale nuclear weapon. In fact, my guess is that they probably have the capability right now to pull it together.

What about Pakistan?
Pakistan is a nation that really concerns me. It’s a nation that I think could very easily disintegrate on us if we aren’t careful, and the al-Qaeda elements, and the Taliban, would be very quick to move in and take control. And we know where they stand, relative to the U.S. I think we need to do everything possible to work with the Pakistanis and remain a friend. The same is true for the Indians, because they’re a friend of ours as well.

On the subject of global politics, how concerned are you about WikiLeaks?
The fact that a young specialist could have access to the highest level State Department documents that were derogatory, had derogatory information about world leaders in it, just blows my mind.

Let’s switch to a subject that all directors have to deal with—diversity. How has the military made it work so effectively?
I grew up in an era that was racist, frankly, and in my early childhood I can still remember specific doors being marked “colored” or “white.” And when I’d go to the movies on Saturday, the blacks sat up in the balcony and the whites sat down below. And I remember even as a child thinking, “This is not right.” But in the Army, by 1963, that had gone away. The Army started putting a lot of emphasis on training and using situational vignettes, if you will, to train our people as to what constituted racism and how it might not be self-evident when you first looked at it, but ultimately it was.

Directors have ongoing issues with management compensation. Is compensation of our military and flag officers a similar concern?
I had lunch with the late [former Yankees owner] George Steinbrenner down in Tampa when I had just been promoted to four stars, and he asked me, “General, how much do you make?” and I said, “George, I make $150,000.” And he said, “Holy…$150,000 a month? Well, we gotta do something about that.” I said, “George, I said per year, not per month.” And he went ballistic. I thought the guy was going to have a heart attack. Then he turned to me and said, “You’ve got to do something about that,” and I said, “George, that’s not the way we operate in the military. Those guys are not motivated by pay, they just aren’t. They’ve done it all their lives, you know, they love what they do. They have a great sense of accomplishment at what they do.” In fact, by law, all of the four-stars are limited to the pay of the newest-serving member of Congress. That’s as high as you can ever get as a general. It’s not an easy problem to resolve, but again, monetary compensation is just not the key motivator in the military.

You became a corporate board director not long after your retirement. What’s your recommendation to future flag officers with their sights set on the boardroom?
Well, I think the first thing they need to do is take off the stars—leave ’em home, you are now general or admiral “retired”— and try to bring some humility with you when you come to the boardroom. You know, almost everyone respects flag officers for what they’ve achieved, and the skills they bring are just incredible skills that will be very adaptable to the corporate world. But I think from their perspective, there are lots of things that are different in the corporate world that they need a better understanding of. For example, as we talked about earlier, compensation. I think that each of these individuals, when they come into the business world, they need to understand there is more give-and-take; the rules are not quite as cut-and-dried as they are in the Defense Department. Sarbanes-Oxley, SEC rules clearly are, and they won’t have any problem dealing with that, but I think a greater understanding of board dynamics can be achieved by going to NACD-sponsored events and listening to the dialogue that goes on, and don’t go in with a mind-set of “This is the way it ought to be.” So I believe going to NACD-type courses as quickly as possible will help bridge that gap and bring them up to date and up to speed in some of these areas.

How did you manage your transition from chairman of the Joint Chiefs, the highest-ranking military officer, to the collegial world of the boardroom?
Jeff, I really did not find it difficult, and it’s the way I have always been. The first thing I did when I joined a board was to ask my board colleagues not to use my former title, but to call me Hugh (although they don’t always listen). And even during my service I preferred to be called “Dad” rather than “General” by my sons when they were in the military. And my grandchildren call me “Gramps.”

So now that you have been officially promoted to “General Gramps,” my final question: Are you optimistic about America’s future?
From a personal and personnel standpoint, I am extremely optimistic. I mean, we talk about the threats we have from other nations and our educational challenges particularly in the areas of math and science, but when I walk among the Shelton Scholars, Park Scholars and Caldwell Scholars at NC State, my alma mater, I walk away from there saying, “Boy, they are dynamite.” We won’t have any trouble producing future leaders because we seem to have an unlimited supply of really smart individuals. I guess my greatest concern for America right now deals with the economy. I get a little more concerned about our economy than I did in the past because I see it every day now that I am retired. But I’m also confident that we have individuals graduating from our universities with the right ethics, attitude and conscientiousness to figure out how to bring it back. To me, that’s the American way.

Doug Oberhelman

A lot has been written and discussed about the role of the board in strategy, especially in this time of economic uncertainty, changing customer dynamics and increased governmental and regulatory scrutiny. Oberhelman shared his perspectives during a recent NACD Chicago chapter meeting before a distinguished group of directors and governance professionals, including Theodore L. (Ted) Dysart, vice chairman of Heidrick & Struggles, and NACD Chapter President Michele J. Hooper. Oberhelman both spoke and responded to questions about the challenges of operating in today’s public policy environment; the importance of focusing on the customer, particularly in the current global environment; and the value that boards can and do bring to the strategy process.

Oberhelman is a director for the boards of Eli Lilly and Co. and The Nature Conservancy’s Illinois chapter. He is a member of the boards of directors of the National Association of Manufacturers, the Manufacturing Institute and the Wetlands American Trust. In addition, he is a member of the Business Roundtable and The Business Council. He is a former director for the board of Ameren Corp.

I. Succession Planning
I want to discuss several things, starting with succession planning and Caterpillar’s leadership development philosophy of promoting from within. We’ve never had an outside CEO or chairman in the history of our company; we’ve been public since 1929. Sometimes that brings great things, and sometimes that can bring an inward focus. But we’ve always done it that way, and I would say that CEO succession at Caterpillar is an outflow of the way we do succession planning throughout the year and over a long period of time. We really have a solid succession planning process, both internally and with our board.

We spend time throughout the year on succession planning, leading up to a session with the board in October of every year. But the way it starts is from the bottom up. Every one of our officers sits down at least once a year with their management teams, and then as a group, and talks through all of their people and assesses their long-term potential. That’s an active process—a minimum of once a year. We follow a similar process in the executive office. And that process takes most of the year to work its way through. We just finished that this summer, and by the time we get to the board in October, we—the six of us in the executive office at Caterpillar—have a good understanding of the highest-potential candidates out of the top 3,000 positions within our company. And over a period of years we get to develop the people who are in these positions—whether they’re in China, Russia, the United States or anywhere—we prepare them to be senior leaders. By the time we get to the board in October, we spend time mostly on our officer level, which would be about 35 people—who’s going to retire, what’s our succession plan for each of those jobs, who are our functional experts, who are the best high-performers to serve in that leadership role. We talk a lot about developing diverse candidates to fill these roles, and I will tell you, that’s a challenge for our company at the officer level and across the board in all facets of having a diverse and inclusive leadership team, but we really work hard on it. We brought together a process that I think will help us down the road, but it’s a continuing challenge—and by that I mean developing and placing Asian leaders in Asia, European leaders in Europe, U.S. minorities and females for positions everywhere we do business, and on and on.

I give a great deal of credit to our board for managing this over the years, for the most part very quietly. My predecessor, Jim Owens, is a great guy. I worked for him off and on for 15 years, and between Jim and our board, they devised a succession plan for me that resulted in my ascension to the CEO position that was very quiet, very orderly, and over a year’s period of time. Every one of our executive officers that was there before the transition is here today. We operate as a team, and I give the board and Jim great credit in making sure that was the case so that we did not hit The Wall Street Journal for things that a lot of companies go through on CEO and succession transition, which I think is very unhealthy for an organization. It essentially allowed me to hit the ground running.

Now I’ll take my CEO hat off and cross the table as an outside board member of some experience—to make sure that when management is working on succession planning for the CEO, that it’s a much deeper process, something along the lines of what I just described. I don’t think enough companies really spend enough time on that. I think many companies do, but if you don’t start from the bottom up and work it all the way through, it’s going to be very difficult to do that at the CEO level as well. I think that’s where a lot of companies get into trouble. Certainly one where the candidate can come from within—if it works within that organization—and sometimes it doesn’t—can be healthy; sometimes change is needed.

II. Setting the Strategic Goals
Switching gears a little bit to strategy. We’ve had a good CEO tradition at Caterpillar that the first few months or year of a new CEO is a time to think about strategy. No surprise—everyone probably does it that way. But in my succession, Jim provided me with six months to head the strategy group, which I did. He continued being CEO and chairman of the company and held off all the other things that come at a new CEO from day one, and I think that was great. Jim’s predecessor had done that when he came in as CEO; it was fabulous, and to the extent that you can get that done, it works, and it sure worked for us.

We appointed a group of 16 to our strategy group, six of whom were in the executive office that I mentioned, our group presidents that report to me, and myself, and then 10 others from around the world—the most diverse group we had ever put together. We sat down in November of 2009 and wanted to be finished by May of 2010. We asked, “What do we want to do with our company?” We had fairly modest expectations to begin with, and as we sat down and looked at all of the things we were doing and needed to do, we quickly realized we needed to make some fairly deep cultural changes. Caterpillar has a culture that is very, very deep and very, very strong, but very hard to change. And while we did a lot of things very well—and always had—and were performing relatively well, we were just in the thick of the recession, which provided a great sense of urgency and a great burning platform to really attack the way we looked at what we were going to be when we grew up—this team. Our strategy-planning group met for about six months, two weeks a month, and really dissected the company. We hired two outside advisors, one a professional consulting firm we had worked with and knew us very well, and one from HR to help us on the culture change and where we drive the company. I would do this again, and if I went to another company, I would do it there because this process was really effective and top-notch.

The other thing that helps get strategy right is to take what I call a board-level view. I firmly believe the words have to be direct and as plain-language as possible. If you can’t explain it at a board level that makes sense, you aren’t going to be able to explain it to your own people. That was very helpful to us, and that’s the lesson I learned out of that process. You’ve all been on both sides of the table of management and a board—you’ve got to put it in a way that members who meet every 60 days for a board meeting can get enough into it without too much detail and without being too high-level. And that’s really an art to get that right.

When we wrapped up that strategy, we put it all on an 8 1/2- by-11 card. We’ve explained that now, for almost two years, what it is we want everybody to do. And one of the key communication pieces by management is communicate, communicate and communicate that strategy, whatever it is.

In our case, it’s back to the basics of Caterpillar: make greatquality products; get everyone to want your brand, to be associated with it because they love your brand; make sure it offers the lowest owning and operating costs; if you’re a contractor, make sure he or she has the lowest owning and operating costs he or she can get; and when it comes time to resell that product, make sure it has the highest resale value. And when it comes time for service, it happens instantly. We basically refurbished that strategy and realigned all kinds of things to do that. It’s no different than the strategy that whoever it was back in the ’40s and ’50s made for Caterpillar. It wasn’t all that far off from “back to the basics.” In fact, we talked about naming it that, but we didn’t.

III. Changing the Culture
As part of that, we decided that the culture had to be changed. And we decided we were going to shock the culture. And one of the great cultural strengths of Caterpillar is it was a promote-from-within company. And one of the great cultural weaknesses it brought was a sense of job entitlement until retirement. And it had gotten more and more ingrained with time, so we said, in order to get everyone’s attention, we are going to realign the company. We formed business units—we already had business units, but we formed them at a higher level and were careful they were “in charge” of all levels, end to end. We put the P&L leader in the executive office, and we essentially reduced 20 percent of the officer ranks in one fell swoop. And that got everybody’s attention, because we hadn’t done that, ever. Once that group was in place, we replaced another 17 percent of the next level down, and that really emphasized we were serious. Those two single moves got everybody sitting up in their chair, and then we started talking about a key piece of our new strategy, which was accountability and personal ownership for results. That has really helped, and we communicated that.

Then we got into strategy implementation, and this is where we had more help from the board. I would say this led up to our acquisitions of last year—we have spent almost $11 billion. But that puts pressure on a board. And that was a big, big change for us, because we had not typically been an acquirer; the biggest deal we had ever done prior to that was for about one and a quarter billion for an engine company 13 years ago.

But part of what we did with our strategy was to identify key industries where our customers make a lot of money, where we think we can make a lot of money and add value, and where people appreciate the Cat brand and what we can bring to it, and that are growing. So we identified oil and gas, mining and rail, electric power and a couple of others, but the big three as key to our future long term. So our first moves with this new team last summer and fall were right in those sweet spots—our rail, mining and gas-engine acquisitions. And we committed to the board and our people that we were going to grow where it made sense with our strategy, and we really worked hard on that. As a result, when it came time to take these acquisitions to the board, they could connect the dots back to what we talked about, almost two years ago now, when we originally took them through our strategy build-up.

But having said that, the few key things—again, board-level communication— we tried to do all the way through. We were in the throes of the Bucyrus acquisition last fall, and our board, to their credit, put us through the paces: “Why do you think coal mining is going to be so good when everybody hates coal mining?” All we saw was everybody burning coal and electricity and so on. And it forced us to really dig in to coal mining and also what we’re going to have to do around clean coal. And that single piece to me more than paid for the board’s salaries for many years, because it forced us into deep thinking. We went back to customers, we went back to think tanks, we went back to NGOs to talk about coal, the whole thing. And that single question really helped us with this, because we understood now where coal mining was going, what we have to do to address this going forward and the risks that come from that. It’s also made us a believer in clean coal and helping to find ways to improve its use. So that’s just a one example where I thought our board was very helpful as we pushed through an $8.8 billion acquisition.

IV. The Role of the Board
Just a note about our board: we have, I think, one of the strongest and have had a reputation for a strong board for years. Six of our board members have been with us over 10 years, and we typically have long-standing, deep expertise on our board—not unlike what we do in our company—and we really work on that as well. It takes a while to get to know a company our size, with nearly 150,000 in our workforce. Like any global business, we’ve had ongoing challenges in certain areas. Our board helps us with those, and, in our case, I’m a big fan of that outside perspective coming in to help us.

If you have a strong, diverse board, and we do—we have a member from Mexico, the U.K., we have retired CEOs, active CEOs, just nobody close to our business—and if you listen carefully, you’ll get lots of input and won’t become internally focused. And I have found that’s very helpful. Of course, I’ve been associated with the audit committee of Caterpillar since I was CFO, so I’m a little partial to that one, but that one is the wake-up call you can get, and as an audit committee member you should give, because that’s really the most responsible place for financial reporting, integrity, values and, really, the core backbone of your company. So I had some good training in that for a long period of time, and that’s one that I view at the top. You really have to be sure when you assign audit committee members that they can really stand up and have the gravitas to get into it, especially at a big company like ours where things can get really complicated.

A couple of things I’ll throw in that I’ve learned the last year and a half or so on leading the board, and we’ve kind of waded our way through this a little bit. We try to listen to what everybody likes to do—and I do this at Eli Lilly as well—and tell management what we like to hear and not hear on both sides of the table. But we’ve really stepped up our board attention at Caterpillar. Our process for how we deal with the board—their advance material, how we get them to our meetings, how we manage a meeting and so on— was kind of splintered at Caterpillar. So we immediately, under our general counsel, set up a very focused board group. I now have one person, the assistant general counsel, who I go to for everything about the board. And it’s his responsibility to make sure the advance material is complete. That has been a tremendous help to me as chairman of the board and CEO, because in the past we had three or four people helping, and now it’s—I would hope like everything else at Caterpillar—one accountable person for that. I think that’s important, and I think our board would tell you that’s helping them as well. That means we can focus on the things that are most important.

We’ve also gone to more private sessions, with the board and myself and with the board alone. And I think that’s important because typically at Caterpillar, we had invited, which I think is also very good and it needs to happen, the executive office to participate as liaison to the committees, the dinner and the board meeting with very little time of private discussion among the board. One of the pieces of feedback I got early on from the board was, “Let us have more time with you,” and, “Let us have more time by ourselves.”

That didn’t scare me a bit; in fact, it’s helped us. Now we start with an hour-long executive session with me before the board meeting, where I review what I’ve been doing, the challenges I’ve worried about, the things we’re thinking about, maybe tee up a couple of subjects that are going to be tough for the board meeting. Then at the end of the board meeting, I go in with the board for a few minutes; they get to shoot and pick, then I leave them alone, and then our presiding director will talk to me afterwards about anything that would have come out of that. I think that’s a great process—it’s essentially a Lilly process that they use as well—and we’ve had good feedback on that. Again, that was a change. It does compress the board session a bit, and you have to be crisp because the number of hours you have to get through the big stuff is short. It has helped the board to feel like, so far, they’re more tuned in and know what’s going on.

VERBATIM

Jeffrey M. Cunningham: In a company as dynamic as Caterpillar, the expectations for board performance are equally great. How do you assess board candidates?

Doug Oberhelman: We have just added four new members to our board, and we went through a formal process. I think the most important piece of selecting new board candidates is having some connection to that person by someone you know or trust. The other nice thing about a strong, diverse, well-placed board that we have is that they know a lot of people, and that network can really help you when it comes time for that.

JC: Let’s turn to one of your favorite subjects, strategy. How did you discover you needed more emphasis on strategy?

DO: When we asked 300 of our leaders what the Caterpillar business model was, we had 301 answers. I thought, Wow, we’ve really got an issue here. We went through some union negotiations last year, and I grabbed one of our visitor tour guides who takes our customers through our plants, and I said, “Let’s walk in the back door and tour a plant and just walk down the assembly line. And that had never happened—well, I’m sure it happened back in the ’50s, but it hadn’t happened in a long, long time. And I learned more from that experience of walking up to a guy on the line, and stopping and saying, “I’m Doug Oberhelman, the new CEO of the company. What do you want to tell me?” Two reactions: one was “You’re kidding me, man,” and the second was a 20-minute download on everything we’d ever done in the factory that was bad. But it was great.

JC: How difficult is it to assess strategic ability at the board level?

DO: It’s a tough call to make both on our board and at Eli Lilly. Frankly, there’s never enough strategy discussion. But yet, on the flipside, you can go overboard with details that don’t help. And that’s a fine line. It’s an art, not a science.

JC: Are you surprised by people’s understanding of strategy?

DO: It’s surprising to me how many senior leaders struggle with strategy. In my own case, I never looked at myself as a trained strategic thinker. And as I entered the strategy-planning process, we made sure we had what I thought was the best outside consultant in strategic thinking and that two or three of our people on the committee had some strategic accomplishment or strategy planning in their background, and I found that experience invaluable.

JC: How is government involvement, whether through regulation or politics, affecting competitiveness and a CEO’s ability to run a global business?

DO: This is one of the things about being CEO and chairman that I am surprised about—that is, the amount of time required to influence public policy. Now, is that an indication of the current administration’s attitude or where we are, or timing, or place in the world? I don’t know. I have been amazed, frankly, with the amount of time I’ve had to spend on government policy.

JC: You went from CEO designate to CEO and president, and from there to CEO, president and chairman. How has the combined role made a difference?

DO: I was CEO for four months while Jim Owens was chairman for those four months at the end of the transition period. And we both agreed at the end of that, there is no way ever that we should split those roles. And the reason was that he was getting questions as chairman that he couldn’t answer about the day-to-day operations of the company, and I was getting questions about governance and things he had responsibility for as chairman that I couldn’t answer. For our company, the way we’re managed, the way we have come down through the ages, I am an opponent, for us, of separating chairman and CEO. It’s not too big of a job; we’ve got a very strong presiding director. He’s very independent and that job will always be. I listen to him, I talk to him. It works very, very well for us.

JC: How do you stay in touch with the rank and file, who are at the heart of Caterpillar’s culture?

DO: One of our big, big customers gave me a little plaque about my second month in and said, “Doug, you know I read about what you’re trying to do, and I thought about this for you.” This plaque said, “A desk is a dangerous place from which to view the world.” I made that into a sign, which I put right outside our executive office door that you have to pass on your way in. I’m going to have it there as long as I’m CEO. So one of the commitments I made to our management team was that I would visit a customer face-to-face, once a week, since the first of 2010— which, at the time, I thought, Boy, that will be easy. Those of you that have tried it, it’s hard. It is really hard. I also spend as much time as I can visiting Caterpillar facilities and just talking to our people. It’s amazing how smart they are!

JC: Your passion is running Caterpillar, but you also have a passion for nature. Are people surprised when they learn this?

DO: Jim Owens, my predecessor, called me Caterpillar’s tree hugger at one point. My real hobby is restoring a coal mine in central Illinois that my wife and I bought a number of years ago. It was reclaimed by the coal company to some degree, and I’m trying to get it to zero erosion. It will be my retirement project, and I love it.

JC: What difference has it made that your company is headquartered in our nation’s heartland in Peoria, Illinois?

DO: Actually quite a few companies are headquartered in small towns—John Deere over in Moline and Cummins down in Columbus, Indiana. I’d say there’s a great benefit and a great distraction. The real challenge and distraction we have is—and we get accused of it all the time—of being Peoria, Illinois, Midwest, U.S.-centric. And with almost three-fourths of our sales offshore, that’s a challenge. What we’ve tried to do and what we’re doing every day are twofold. Of the six of us in the executive office, two are offshore—one is in Hong Kong and just moved over, and one is in Geneva, where we’ve had a presence for a long time. Almost 20 percent of our officer group resides in Asia, so we’re really working to establish regional headquarters almost around the world, and we’re having good luck with that. And then we’ve also brought in more mid-level hires in the last three years than we ever have, and a lot of these are automotive people, to help us with manufacturing, and they’re really good. But we still have this balance of what’s too much Midwest and what isn’t. I think we’ll continue that migration, which I think will be healthy. But American, Midwest values aren’t all bad either.

Corporate Governance Highlights

1974 Code of Worldwide Business Conduct first published to establish a high standard for honesty and ethical behavior by every employee.

1992 Caterpillar board adopts a confidential voting policy for shareholders. While not required by law, Caterpillar established share ownership guidelines in connection with stock option grants for corporate officers and directors more than a decade ago. All of Caterpillar’s equity-based compensation plans have been approved by shareholders. Furthermore, the company has never offered golden parachutes to any officer and has never repriced stock option grants.

1993 Caterpillar’s board adopts written charters for each of its committees, in advance of a mandate by the Sarbanes- Oxley Act of 2002.

1999 Caterpillar board publishes guidelines on corporate governance, which include establishment of an independent board of directors, with sole exception of chairman, and a fully independent compensation committee.

1999 In advance of NACD Blue Ribbon Committee on Audit Committee Effectiveness, Caterpillar implements many of its recommendations, including a fully independent audit committee with a financial expert as chairman.

2005 Caterpillar executes a fourth amended and restated version of its Shareholder Rights Plan with Mellon Investor Services. The modified agreement moves the final termination date of the Shareholder Rights Plan from December 11, 2006, to June 30, 2005, ending the Shareholder Rights Plan approximately 17 months earlier than the original agreement and subsequent amendments had specified. Company policy requires former senior manager-level (or higher) employees of outside auditor to wait three years before being eligible for certain management-level positions at the company, and requires rotation of outside auditor partners in compliance with the requirements of SOX. 2010 Amends Code of Worldwide Business Conduct.

Caterpillar’s Board of Directors

David L. Calhoun, CEO (since May 2010) and executive director (since January 2011) of Nielsen and chairman of the executive board and CEO of The Nielsen Co.; former vice chairman of General Electric and president/CEO of GE Infrastructure. Other current directorships: Medtronic, The Boeing Co. and Nielsen Holdings. Calhoun became a director effective June 8, 2011.

Daniel M. Dickinson, managing partner of HCI Equity Partners, former co-head of global M&A at Merrill Lynch. Other current directorships: IESI-BFC, Mistras Group and HCI Equity Partners. Dickinson has been a director since 2006.

Eugene V. Fife, managing principal of Vawter Capital, and former interim CEO and president of Eclipsys Corp. and non-executive chairman (2001– 2010) when Eclipsys merged with Allscripts Healthcare Solutions; former partner of Goldman Sachs & Co. Other current directorships: Allscripts Healthcare Solutions. Fife, a director since 2002, chairs the governance committee.

Juan Gallardo, chairman of Grupo Embotelladoras Unidas; formerly chairman and CEO (1986–2007). Other current directorships: Lafarge SA. Other directorships within the last five years: Grupo Mexico. Gallardo has been a director since 1998.

David R. Goode, former chairman (1992–2006), president (1992–2004) and CEO (1992–2004) of Norfolk Southern Corp. Other current directorships: Delta Air Lines and Texas Instruments. Other directorships within the last five years: Norfolk Southern and Georgia-Pacific. Goode, a director since 1993, chairs the compensation committee.

Jesse J. Greene Jr., former vice president of financial management and chief financial risk officer (2009– 2010) and vice president and treasurer (2002–2007), IBM. Greene became a director effective Jan. 1, 2011.

Peter A. Magowan, former president and managing general partner (1993–2008) of the San Francisco Giants and chairman (1980–1998) and CEO (1980–1993) of Safeway. Directorships within the last five years: DaimlerChrysler AG, Safeway and Spring Group. Magowan has been a director since 1993.

Dennis A. Muilenberg, executive vice president of The Boeing Co. and president and CEO of Boeing Defense, Space & Security since September 2009. Muilenburg became a director effective June 8, 2011.

William A. Osborn, retired chairman (1995–2009) and CEO (1995–2008) of Northern Trust Corp. and The Northern Trust Co. Other current directorships: Abbott and General Dynamics. Other directorships within the last five years: Nicor, Tribune Co. and Northern Trust Corp. Osborn, a director since 2000, chairs the audit committee.

Charles D. Powell, chairman of Capital Generation Partners, LVMH and Magna Holdings. Other current directorships: LVMH Moët- Hennessy Louis Vuitton and Textron. Powell, a director since 2001, chairs the public policy committee.

Edward B. Rust Jr., chairman, CEO and president of State Farm Mutual Automobile Insurance Co. Other current directorships: Helmerich & Payne and The McGraw-Hill Companies. Rust has been a director since 2003.

Susan C. Schwab, professor, University of Maryland School of Public Policy, and strategic advisor, Mayer Brown. Former U.S. Trade Representative (2006–2009) (member of the President’s cabinet) and Deputy U.S. Trade Representative (2005–2006). Other current directorships: FedEx and The Boeing Co. Schwab has been a director since 2009.

Joshua I. Smith, chairman and managing partner of the Coaching Group. Other current directorships: Comprehensive Care Corp., FedEx and The Allstate Corp. Smith has been a director since 1993.

Miles D. White, chairman and CEO of Abbott Laboratories. Other current directorships: McDonald’s Corp. Other directorships within the last five years: Motorola and Tribune Co. White became a director effective Jan. 1, 2011.

Source: Caterpillar website

Illustration by JT Morrow

Critics of the rules tend to view internal compliance efforts as adequate but broadly threatened by the prospect of whistleblower bounties and direct reporting to the SEC, whereas advocates for the Dodd-Frank rules tend to view existing internal compliance efforts and reporting channels as inadequate or insubstantial in too many instances.

On a similar note, the importance of improving the ways in which companies manage their internal reporting mechanisms—encouraging adequate resourcing, board-level oversight, more consistent and professional investigation protocols, and more meaningful protection of internal whistleblowers from retaliation, all of which require strong, independent leadership in the role of the chief ethics and compliance officer (CECO)—cannot be understated.

These are the key issues to consider when making internal corporate reporting more robust and in reducing the attractiveness of or need for an external whistleblowing pathway for employees. Some of the ensuing discussions touched on the specific role of boards in dealing with whistleblower issues, the independence of the CECO and how that particular management role relates to whistleblower issues, and the connection between whistleblowing (whether internal or external) and corporate culture. The reality that corporate misbehavior and ethically dubious conduct remain serious problems in the United States and abroad, despite widespread awareness and recent scandals, was also a significant theme.

Session participants generally agreed on several points:

• Boards of directors play an important role in reinforcing internal reporting mechanisms and ethical culture.
• Empowered leadership for internal reporting, in the form of a senior-level experienced CECO, is vital to the success of C&E programs and internal reporting mechanisms.
• Creating a culture in which internal reporting is valued—and in which those who report are protected— is critical to preventing and detecting misconduct internally.
• Financial and non-financial incentives could be used by corporations to make internal corporate reporting mechanisms more effective.
• From the perspective of the employee, trust in the system is a key motivator in coming forward and reporting internally.

Reinforcing an Ethical Culture
One major theme involved the role of boards of directors in dealing with, supporting, or otherwise responding to corporate whistleblowers. In principle, internal whistleblowers ought to be an important resource to boards and senior management, one that can provide an early warning of instances of material fraud or misconduct within companies.

At the same time, concerns about opportunistic whistleblower litigation also rise to the board level, based on fears that such litigation might affect corporate bottom lines, even when specific claims are without merit. The challenges posed by whistleblowers and effective internal reporting arise against a backdrop of boards’ increasing responsibility for a range of C&E matters. Recent revisions to the Federal Sentencing Guidelines for Organizations notably emphasized the role of the board and the CECO in contributing to effective corporate compliance.

And several major common-law precedents in Delaware, including In re: Caremark and Stone v. Ritter, have established that corporate boards are at risk for personal liability if they neglect to fulfill a duty of oversight connected with the compliance function. Taken together, these various strands underscore the fact that internal reporting and external whistleblower issues are closely tied to the responsibilities of persons serving in corporate boardrooms.

The perceived independence of the board and its availability as the ultimate recipient of internal reports of corporate wrongdoing are important factors contributing to an effective internal reporting process and a strong ethical culture. One participant suggested that visible board-level support for compliance programs and internal reporting conveys a message to corporate employees that “the company cares” and that there is meaningful substance to the internal reporting channel.

Board involvement in internal reporting was tied to a range of other issues, including appropriate compensation incentives, related performance metrics and non-retaliation. The board potentially has some involvement in all of these matters, either by contributing to internal policy or by ensuring that appropriate performance data and information are flowing back up to the board.

In turn, the board’s engagement with these issues contributes to a strong “tone at the top” and the messages conveyed to employees about the fundamental values of the organization (i.e., regarding its “culture”). Ultimately, the discussion about the role of the board also revisited the basic tension over whether the Dodd-Frank whistleblower provisions are a good idea. Although participants continued to express different opinions about this, one of the most striking comments during the session was the suggestion that boards could view the new whistleblower regime as representing an opportunity rather than a catastrophe—an opportunity in which to reinforce the strength of internal reporting mechanisms, to visibly align with anti-corruption and anti-retaliation efforts, and to recognize that employee reporting on fraud is potentially a valuable resource, rather than a threat, to the company.

The Importance of the CECO
Internal reporting is a primary element of effective compliance and, in turn, the CECO is the driver of both a strong program generally and a robust internal reporting mechanism in particular. It was observed that the CECO is the single person in the company who has the expertise and responsibility to articulate the necessary features of an effective internal reporting program and who can educate and inform both the board and senior management on these issues.

The CECO notably serves as the agent of the CEO and the board in heading the internal reporting pipeline and managing related investigations; the CECO can also report findings back to the CEO and the board in a way that protects internal whistleblowers from retaliation. One person commented that the CECO is the visible person at the management level who “stands between the whistleblower and retaliation, without any conflicting duties.” Another observed that the term “anti-retaliation” is often perceived as empty by corporate employees, absent the demonstrated commitment of the CECO to standing behind confidential reporting.

In the context of allegations of misconduct against powerful figures within management, the CECO role may some times involve confronting senior executives to ensure that the confidentiality and integrity of the reporting process is maintained, despite strong pressures to violate it. This is one of the major reasons that the CECO position can be a very challenging one to fulfill and why there is strong policy momentum to create a robust CECO role with “adequate autonomy from management.”

The necessary features of the CECO role sparked discussion. Several participants alluded to the language of the recent OECD guidance, suggesting that a “senior-level, experienced CECO with adequate autonomy from management” is vital to the success of C&E programs and internal reporting mechanisms. Multiple participants also commented on the importance of separating the C&E function from the general counsel’s office, suggesting that the risk management responsibility of the general counsel, at times, pulls in a different direction from the compliance role of the CECO— perhaps particularly in dealing with whistleblowers. Another participant offered a different view, however: that compliance responsibility is not necessarily incompatible with the role of general counsel and that the broader challenge for corporations involves managing institutional conflicts of interest around compliance (and whistleblowing) in a nuanced and reasonable way.

There was stronger agreement that the head of the compliance function requires direct access to, and oversight by, the board for the internal reporting and anti-retaliation aspects of the role to be truly empowered and to ensure the independence of the overall compliance program. Discussion also touched on the idea that CECO compensation, hiring and firing ought to involve board-level supervision and involvement to preserve the independence of the CECO role.

One of the other key comments about the CECO role and internal reporting was that the CECO has both practical and cultural importance. On a practical level, the CECO oversees all the mechanics of operating a confidential reporting line, performing investigations, educating employees and executives, and so on. By extension, when the CECO is not sufficiently empowered, experienced, or resourced, the ability of the company to prevent and detect misconduct is likely to be impaired. Meanwhile, on a cultural level, the CECO role demonstrates corporate commitment to the internal reporting process and to genuinely encouraging employees to come forward and report. The practical and cultural aspects of the CECO role are important to building trust and common ethical values in the workplace, and may be very relevant in modulating the risks associated with external whistleblowing under Dodd-Frank.

Protecting Truth and the Whistleblower
Another theme that emerged during the session involved the relationship between reporting and corporate culture and the importance of “getting the culture right” to facilitate reporting efforts. It was observed that the relationship between ethical culture and internal reporting practice is multifaceted and that the success of each depends to some degree on the other. The topic arose initially through an interchange between participants with different views on the likely impact of the Dodd-Frank whistleblower provisions. One person suggested that the prospect of financial awards for direct reporting to the SEC might have an explosive effect on efforts to build a “culture of integrity” within corporations because such awards encourage a mercenary mentality and undermine trust between employees and management. It was further argued that “companies have to clean from within” and that creating an avenue for employees to bypass internal reporting of fraud could have the effect of “detonating” corporate culture.

However, a contrasting viewpoint was also expressed— namely, that the availability of the Dodd-Frank whistleblower channel need not be viewed as antithetical to ethical culture and could instead serve as a rallying point for organizations in seeking to build such a culture. The group discussed the new Dodd-Frank whistleblower rules as presenting incentives for companies to “raise their game” and to evaluate the leadership and resources dedicated to their C&E programs, with the aim of making internal reporting mechanisms the natural choice for employees seeking to report misconduct.

Incentives for Reporting
One of the central topics of discussion during the symposium involved the various uses that might be made of financial and non-financial incentives to try to influence employee-reporting behavior in different ways. Again, several respondents expressed worry about the potential for invidious impact of SEC financial incentives under the Dodd-Frank whistleblower provisions and the resulting possibility that some employees might circumvent internal reporting channels altogether or passively allow instances of misconduct to proliferate. Such fears may be overblown and historical evidence on whistleblowing and qui tam litigation suggests that the vast majority of whistleblowers do try to make use of internal avenues for reporting fraud, prior to going to outside authorities.

One participant argued that Dodd-Frank presents less of a challenge to internal reporting mechanisms than does simple skepticism on the part of employees regarding whether the internal reporting pathway is robust and safe to pursue. Another suggested that, ideally, internal and external reporting avenues could be aligned with each other, even if employees do have the option to go directly to the SEC to report instances of fraud. Still another said that the chief problem faced by all whistleblower mechanisms, internal and external, involves getting people to come forward to report fraud when silence is typically easier and presents far less risk to an employee’s career.

One suggestion offered to help reinforce internal reporting was that corporate compensation schemes could be tweaked to include a set of ethical leadership criteria for management, thereby supporting a culture in which internal whistleblowers are supported and valued.…

Far more controversial was the suggestion that companies might consider offering bounties or bonuses directly to employees for coming forward internally to report allegations of fraud. One participant suggested that management ought to reward good internal whistleblower tips with bonuses, in much the same way that other valuable contributions to the corporate bottom line are rewarded. Another suggested that specific examples of internal reporting can sometimes involve huge contributions to risk management and corporate welfare, adding that employees who contribute in that way should be recognized and celebrated within the company for doing so.

Deep ambivalence toward whistleblower incentive payments (whether made by the SEC or a corporation itself) was expressed in the comments of several symposium participants, who noted that such payments seem “unsavory” or may smack of “paying a rogue to catch a rogue.” It was also noted, however, that the public policy for instituting whistleblower incentives has typically been formulated precisely with the latter aim in mind. The success of past whistleblower efforts in combating fraud is arguably demonstrated by the billions of dollars in settlements and damage payments that have been awarded as a result. By loose analogy, one person suggested that some form of internal corporate incentive payments might also serve as a useful tool for reinforcing the internal compliance function and for rooting out corruption within a company.

Trust Is Imperative
One significant observation shared at the symposium was that employee trust in internal reporting mechanisms, and in the corporate commitment to anti-retaliation, is central to enticing employees to come forward internally with evidence of fraud or misconduct.

As one participant remarked, “People will only come forward to report when they have trust in the system.” Another said, “Providing avenues to protect the confidentiality of people who report” is an important factor in “overcoming employee reticence …and [fears of] retaliation.”

Embedded in these comments was the notion that employee trust in internal reporting may often be hard to come by and that a lack of trust might be part of the explanation for recent survey findings that a substantial fraction of witnessed incidents of workplace misconduct are never disclosed by the witnessing employee to anyone.

In some basic sense, employee trust in internal reporting and antiretaliation efforts is a complement to strong organizational culture. If the latter is perceived by employees as lacking or weak, the former is more likely to be found in short supply. On this point, one participant noted that the corporate commitment to anti-retaliation has sometimes been inconsistent or ambivalent, as reflected in a series of high-profile court cases in which corporations successfully argued that statutory anti-retaliation provisions do not and should not protect employees who make use of internal reporting mechanisms. It was also asserted that these precedents have had the effect of weakening internal reporting channels and simultaneously making corporations look less sincere in their commitment to anti-retaliation. One putative result has been a loss of trust among employees. As another participant put it, whistleblowers “serve a critical purpose” in corporate efforts to self-police against fraud. By extension, protecting confidentiality and fostering trust in internal reporting are key steps for making whistleblowers a corporate asset rather than a threat to the company.

Michael D. Greenberg is the director of the RAND Center for Corporate Ethics and Governance. This article is excerpted from the May 2011 report For Whom the Whistle Blows: Advancing Corporate Integrity and Compliance in the Era of Dodd-Frank. Copies of the full report are available at www.Rand.org.

Participants

Michael D. Greenberg: Symposium Chair, Director, RAND Center for Corporate Ethics and Governance

Donna C. Boehme: Symposium Co-Chair, Principal, Compliance Strategists

Urmi Ashar: President, NACD Three Rivers Chapter

Stephen Cohen: Deputy Chief, Enforcement Division, SEC

Keith T. Darcy: Executive Director, Ethics and Compliance Officer Association

Randy DeFrehn: Executive Director, National Coordinating Committee for Multiemployer Plans

James N. Dertouzos: Director, RAND Institute for Civil Justice

Paula J. Desio: Former Deputy General Counsel, U.S. Sentencing Commission

Charles M. Elson: Edgar S. Woolard Jr. Chair and Director, Weinberg Center for Corporate Governance, University of Delaware

Patrick J. Gnazzo: SVP, General Manager U.S. Public Sector CA Technologies (retired)

John P. (Jack) Hansen: Executive Fellow, Center for Business Ethics, Bentley University; Immediate Past Chair, Compliance and Ethics Committee, Association of Corporate Counsel, Chuck Howard Partner Shipman and Goodwin

Peter E. Jaffe: Chief Ethics and Compliance Officer, AES Corp.

Fred Kipperman: Senior Director of Strategic Relationships, RAND Corp.

Stephen Kohn: Executive Director, National Whistleblowers Center

Alexandra R. Lajoux: Chief Knowledge Officer, NACD

Sean McKessy: Head of Whistleblower Office, SEC

Joseph Murphy: Director of Public Policy, Society for Corporate Compliance and Ethics; Of Counsel, Compliance Systems Legal Group (retired)

Steven Pearlman: Partner, Seyfarth Shaw

James Thomson: President, CEO RAND Corp.

Harold J. Tinkler: Chief Ethics and Compliance Officer, Deloitte LLP and the Deloitte U.S. firms (retired)

But who is the shareholder? Is it Warren Buffett, the notoriously long-term investor who has never sold a share of Berkshire Hathaway? Or the hedge fund trader who holds shares for a nanosecond—a time span so short that a blink of an eye is measured in the hundreds of millions of them? Or is the shareholder a state pension fund keen to influence social policy, or the mutual fund that owns the entire S&P 500? Or maybe it’s the activist investor pushing for a change in strategic direction over the next few months, and then sells after the run-up, presumably to less “strategically focused” shareholders.

In corporate governance, all shareholders compete for directors’ attention. Being an intelligent listener in this noisy environment is what the directors of the Directorship 100 do best. The dispersion of shareholder interests means the board has to weigh priorities and make some unpopular choices. In doing so, it looks to those fellow directors who are best at bringing about desired outcomes. People with an unerring instinct for savvy business decisions are wired differently—part investment guru, part business maven, part organizational psychologist. Other directors will follow their lead, even under trying circumstances. A board will stick with a CEO when the “influential” director says it’s the right thing to do, but will terminate once they hear, “Time’s up.”

There are many names for this rarified group of individuals, but we refer to them simply as the Directorship 100. It is an honor bestowed not so much by NACD Directorship, but by the collective wisdom of the boardroom community.

But how is influence related to good corporate governance? In compiling the Directorship 100, we look for both influence and its requisite companion, a sound ethical compass, and then assess these mercurial qualities against all known public information and survey data. Outstanding expert advisors weigh in, more research is followed by more questions and more debate. The result is our list of finalist candidates for the Directorship 100. If any doubts remain or a story is still unfolding as may happen during a period of crisis, we generally defer the decision.

The NACD Directorship 100:

Directors and Officers

Governance Professionals and Institutions

Corporate Governance Hall of Fame Class of 2011

NACD 2011 Public Company Director of the Year and B. Kenneth West Lifetime Achievement Award Winners

People to Watch

We anticipate a faintly Shakespearean reaction from some readers: “Throw out the bankers.” Our answer to why they are on the list at all is that a bank director who survived the debacle of ’08 ought to be recognized, if not enshrined. Board service is not an easy thing to measure, especially by looking at near-term stock market results or even regulatory trauma in this age of indict now, research later. The Directorship 100 tries to bring some insight into these special situations, and hopefully our approach demonstrates a balanced perspective.

A Fluid Environment
The Directorship 100 list is hard to get on and easy to get off. In any given year, a company might experience a corporate governance crisis, and a director rises to the occasion and is recognized. In quiet years, that same director folds happily into the background.

Selecting the Class of 2011
Our two primary lists measure people and institutions. Directors and Officers are chosen for their individual attributes, not because of the board they serve on—although if you are a chair of a major company, that speaks volumes about how your peers feel about you. For the Governance Professionals and Institutions, if you work for the SEC, it is your role that makes you influential. Leave it and you leave the list.

Research Methodology
The term “research methodology” ranks right next to “economic formulae” in generating passionate reader interest. For the Directorship 100, methodology is more of a recipe than a method, and we choose our honorees based on quantitative results from our online survey of NACD members, search engine rankings, and qualitative measures including peer input from NACD chapters, expert review and major media references. The result is better attuned to the reality of the boardroom than you’ll find elsewhere.

We are careful to avoid the “familiarity fallacy.”

A popularity contest would understate results for a great director albeit one ignored by the media. Whereas a story like Mark Hurd’s departure from Hewlett-Packard or News Corp.’s phone-hacking would raise awareness of those directors, for better or worse. Our failsafe mechanism is an editorial advisory board, which devoted valuable time and expertise to a review of more than 1,000 nominations.

In some cases individuals were elevated that did not rank as well as they should have (“poor test takers,” the SAT’s would call them), whereas in others, the numerical ranking was somewhat self-generated by what might be called a “friends and family” approach. That’s okay for cell phone service plans, but not as useful for the D100.

The NACD Board and CBL
Readers should note that the NACD board of directors, chaired by Barbara Hackman Franklin, and the NACD Center for Board Leadership, are recused from the D100 on the grounds that they help select the finalists. We wanted you to know that if not for their role in the selection process, they would rank among the very best in the D100.

One more caveat: Some important names were left off either because they are new to their role, too narrowly focused, or in some cases, just fell out of the spotlight. So we created a new category for them, “People to Watch,” which we think of as our bullpen for future D100 honorees. We would not be surprised if they are brought out to the mound in future years, and that you will be following as we do this grand procession of those who contribute time and effort, as well as ingenuity and thought, to the cause of good governance.

To register for the NACD Directorship 100 gala dinner and forum, please click here.

Boardroom Etiquette
The Berkshire Annual Meeting will be open, provocative and orderly. Unlike other public companies’ AGM, there will be no gadflies or noisy activists. Nor will there be protestors unless you consider those spouses who skipped the chance to buy jewelry directly from Warren Buffett at Borsheim’s. Why aren’t protestors and activist rabble-rousers here? Because Berkshire’s shareholders would rally for the company. Courtesy prevails, aided by the fact that no other company is so focused on ethical behavior and corporate performance, and so not focused on personal enrichment or compensation, yet is so very rich and very well compensated.

No other company is so transparent— even on issues such as executive compensation, scandal and succession. Yet it is notoriously private. Therein lies the irony. For Berkshire shareholders, irony is preferable to the agony that greets so many public company annual meetings.

What makes the Berkshire meeting so riveting is the chance to watch Buffett and Munger spend as many as nine hours answering unrehearsed questions from shareholders that have been selected by three outstanding financial journalists— Carol Loomis of Fortune magazine, Andrew Ross Sorkin of The New York Times and Becky Quick of CNBC. The meeting and its full-day questionand- answer format requires the Berkshire leaders to have unfathomable resources of energy for one purpose: to demonstrate their total commitment to the shareholder. There is a reason why See’s Peanut Brittle shares the dais with their microphones.

What’s in it for these two billionaires? It’s how they learn. The prodding and questioning sharpen them and focus their attention. Nothing is opaque and transparency rules. Finally, Buffett has an unshakable faith that telling the complete truth is the only way to ensure you won’t be testifying against someone else’s version years later.

Opening Lines
“Good morning, I’m Warren, he’s Charlie. I can see, he can hear, that’s why we work together.” And so we have the basic requirements for a visionary and his sounding board.

Who Will Succeed Buffett?

Then Buffett makes a short announcement: “We ask that you not use any devices to record this meeting. Participants in our film [Steve Carell and the cast of The Office] have contributed their time as individuals—without pay, of course— and we want to respect their rights to their work. If you happen to see anyone making a recording, please ask them to stop.”

He is pure Old Testament, relies on the rule of law and respect for ownership. He’s a bit cynical, too. And, like the rest of us, he likes things for free.

Sokol and Other Questions
After his opening remarks, Buffett launches into the Q&A focused on the one thing on everyone’s mind: David Sokol. The media have been circling the wagons and shareholders are wondering: Could this be the iceberg that dents, if not sinks, the Berkshire succession plan?

David Sokol, once thought to be a possible successor to Warren Buffett, talks to a shareholder at the 2010 annual meeting.

Buffett reveals his hand by playing a clip from the Salomon Brothers testimony he gave before Congress in 1991. His words then echo his belief today. In his testimony then, Buffett promised “full cooperation” to the committee and offered a fig leaf as well as a sharp-edged sword to his new employees: “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.” As the clip ends, the shareholder audience cheers. They, like their chairman, want to do the right thing. This is what their company stands for. This is how their CEO thinks and lives. This is their annual meeting.

‘Inexplicable and Inexcusable’
Buffett gets down to the details of the Sokol story—he takes it as his duty to explain how psychology and executive behavior could lead a Berkshire executive to violate the company’s code of ethics, although he admits the matter is still incomprehensible to him. And with that, Buffett moves closer to the microphone and relates the details of the matter to his shareholders, skipping none of the embarrassing facts, and not without some sadness (which he then posts verbatim on the Berkshire website).

“In looking at what happened a few months ago with Dave Sokol’s failure to notify me at all that he’d had any kind of contact with Citigroup, in fact, he directed my attention to the fact that they represented Lubrizol and never said a word about any contact with them, and then the purchase of stock immediately prior to recommending Lubrizol to Berkshire…I don’t think there’s any question about the inexcusable part. The inexplicable part is somewhat—well, it’s inexplicable, but I’d like to talk about it a little bit because I will tell you what goes through my mind.

The GOP leader, first elected to Congress 18 years ago, finally has the gavel in his hand. Re-elected to a 10th consecutive term in November, the 62-year-old lawyer from Vestavia Hills (population: 24,000) says he brings a Main Street, not a Wall Street, perspective to his expanded duties on Capitol Hill.

The son of an engineer on the old Southern Railroad who keeps a collection of model trains on display in his office, Bachus has spent the last four years as the ranking Republican on the Financial Services Committee, the counterpart to chairman Rep. Barney Frank (D-Mass.).

Bachus understands the important and influential role that directors play in their oversight of America’s public companies. He is one of a growing number of legislators to go on the record with the NACD and recently consented to an interview with NACD Directorship’s Jeffrey M. Cunningham.

In the interview, Bachus outlines his legislative priorities: a desire to end spiraling deficit spending will require that he dare touch the dangerous “third rail of politics” and curb entitlement programs.

What was your reaction to becoming the first Alabaman to hold the Financial Services chairmanship since the 1800s?
It is a great honor to have the support of my constituents, Speaker Boehner and my Republican colleagues, so I can serve as chairman of the Financial Services Committee. If I do my job well, hopefully Alabama won’t have to wait another 140 years for another committee chairman!

How did you interpret the 2010 election from a political perspective?
The American people did not like what was going on in Washington and they demanded a change in direction. That’s what the 2010 elections were about. The American people saw a record-breaking spending binge going on in Washington, which resulted in a record-breaking budget deficit and a national debt that has grown to once unthinkable levels. In fact, during the previous four years before the 2010 election, our national debt doubled. The American people want us to reduce government spending because they intrinsically understand the path we’re on right now is unsustainable. Real changes and hard decisions must be made. Republicans have gotten that message and our majority in the House is working to fulfill the people’s mandate. It’s certainly not going to be easy, but we have no choice. President Obama recently started using the slogan “Win the Future” to describe his spending programs. But America is not going to win the future if we force our children and grandchildren to inherit a mountain of debt.

Which economic issues will you and your colleagues be most focused on?
The main objective of House Republicans right now is to get the nation’s fiscal house in order so the private sector can grow and create jobs. Our economy will not be healthy until people who want to work can get a job. Making sure the climate is right for people to get jobs is our job.

Usually when Congress passes a major piece of legislation it is very difficult to revisit it any time soon, unless there is a sunset provision, which is not the case here. So I think most of the debate will be carried on at the regulatory level. In virtually every area, with some broad strokes as guidelines, Dodd-Frank was given over to regulators to administer. — Michael Oxley

How do you plan to make that happen?
Excessive government spending and borrowing play a key role in our economy’s uncertain outlook. It crowds out private sector investment, sows uncertainty for job creators and erodes the confidence that is necessary for job growth.

Yet, under the President’s own budget projections, the federal government would spend $46 trillion over the next 10 years. That would double the national debt by the end of his term and triple it by the end of the decade.

Stanley Bernstein

However, since the Reform Act of 1995, corporate governance has been in an evolving state of turmoil spurred by several well-known business failures. This has led to greater investor angst and the consequence of increased litigation aimed at directors. To get the plaintiffs’ insight into these issues, NACD Managing Director and Senior Advisor Jeffrey M. Cunningham conducted an in-depth interview with Bernstein, one of America’s leading securities and corporate governance plaintiff attorneys. Bernstein offers NACD members his candid assessment of the major issues around liability and litigation today and offered advice on what boards must do to limit their exposure and better perform their role especially in light of the important implications of the Dodd-Frank Act on corporate governance.

How did you get your start in the plaintiffs’ bar?
Ironically. My career started at Weil Gotshal as a securities and commercial litigation associate, representing corporate America as plaintiffs. Fast forward, in the 1980s my wife was named “lead plaintiff” in one of the largest securities frauds involving a company named “Crazy Eddie.”

That’s insane.
Precisely. Now, hanging on my wall is my wife’s stock certificate for 25 shares of Crazy Eddie. We had lost most of the small investment due to the famous fraud. I asked a lawyer to bring a securitiesfraud class action. It ultimately settled for more than $50 million, a very large sum at the time. After it was over, I realized, “Heck, I can do this, too. And probably better.” Our firm, Bernstein Liebhard, has today grown to be one of the powerhouses in securities litigation nationwide, representing large institutional holders and more than 10 states and state public pension funds in securities litigation.

Crazy Eddie stock certificate on Stanley Bernstein's office wall.

How competitive is your end of the business?
Ultra cutthroat. It has become a full-time practice just to court institutional investors. Today, if a public pension fund issues an RFP to establish a panel of securities litigation firms, they are likely to get 30 or 40 law firms responding. The Reform Act has empowered the institutional investors in their selection of counsel and in negotiating fees very aggressively, which has perhaps inured to the benefit of the classes.

What was the impact of Milberg Weiss and Bill Lerach departing the business?
Most of the name partners of Milberg left the practice but the firm is alive. Its California office split off several years ago and is quite active in its own right. The plaintiffs’ bar is quite resilient. You can throw legislative, judicial and legal hurdles in the way, but there’s a way to overcome them all by pleading, lobbying and replacing one talent with the next generation of talent.

So the prospects for profitable litigation are good?
Ben Franklin was wrong: death and taxes are not the only certainties. Fraud is, too. And so will be fraud litigation. But there are certain cases that are not economic to pursue because they’re just so expensive to litigate. That has led to more competition on the remaining cases.

What is it about a particular case that makes it expensive?
The biggest driver right now is electronic discovery, which has transformed all types of litigation and any significant case that survives a motion to dismiss.

Presumably due to volume?
Nobody has come up with a magic bullet of how to examine 10 or 20 million documents quickly. Today, every piece of paper and electronic communication is saved. Ten years ago, documents were shredded, and not necessarily nefariously. Now, people don’t write notes, they send emails, Blackberry messages, instant messages, and there is a record for all of it and it’s ghastly expensive to gather and ghastly expensive to review. But in those silos are the perennial needles in the haystack. I think one of the other sea changes is that because of the recession, many large defense law firms don’t have that much business, so in cases that would have been resolved earlier in the past, there may be an incentive by the defense to stretch out the eventual sit-down to resolve the matter.

How important is it to you to represent the class?
That’s why we live. It is essential to our mission to protect investors.

Now, wasn’t the PSLRA (Private Securities Litigation Reform Act) of 1995 intended to reduce securities litigation?
Yes, and it has invigorated it in ways that only the most prescient could have envisioned. The largest impact is the misguided belief that with the heightened pleading standard and the requirement for a “lead plaintiff,” it would be more difficult, if not impossible, for institutional investors to use securities litigation as a vehicle to accomplish goals and right wrongs. But the unintended consequence is that investors actually saw this as their vehicle to show their beneficiaries that they’re fighting hard to reform corporate America, and with respect to the heightened pleading standards, it forced the plaintiffs’ bar to sharpen its tools, and file better complaints. Candidly, some of those complaints prior to the Reform Act were not up to par. So, we’ve uncovered methods to plead cases that are far superior to anything that existed prior to 1995, through the use of investigators, the internet, whistleblowers, confidential witnesses— and, yes, the requirement to have a lead plaintiff with a significant financial interest in the outcome.

In a wide-ranging interview with NACD Directorship’s Jeff Cunningham, America’s leading corporate jurist, Delaware Chancellor William B. Chandler III, explains his legal philosophy, concerns about liability, where he sees the line drawn between the federal branch and the Delaware Court, the impact of the Disney case on director behavior, the powerful new mediation alternative and more. Loosely translated from Old French, “chandler” refers to “one who lights the way” and he does so here for both the role his Court plays on behalf of directors and investors and how it is enhancing the enviable and unique 200-year-old tradition of Delaware corporate law.

Directors get sued. Why does the venue matter?
Well, of course no one wants to be sued, but unfortunately those are facts of business life. But if directors find themselves in the Court of Chancery, at least they are assured they will get a judge who specializes in corporate law and who will give a reasoned decision in a timely way, and the director will know exactly the basis for the decision. Parties to litigation in Delaware are assured of totally impartial judges who have no reason to favor one side or the other. Delaware judges are strongly incentivized not to give home field advantage to any party, and instead to assure all litigants not only an expert’s perspective but complete objectivity and impartiality—that should make a director or any litigant feel a little better about going into this environment.

Is this unique among American courts?
The reason Delaware is viewed as the center of the universe for corporate law is that a defendant (or a plaintiff) can be guaranteed—no matter which judge you get—to have a jurist acutely familiar with this body of law; a judge who works with corporate law issues day in and day out, seven days a week. That’s the uniqueness of the Court of Chancery. Of course, litigants also have an automatic right of appeal to an equally expert Supreme Court, with jurists equally versed in our corporate law and equally poised to offer prompt decisions.

Are there practical reasons as well?
Many, but perhaps most importantly, the Delaware Court of Chancery’s culture ensures that we are sensitive to the speed of business in terms of timely judicial procedures designed to assure decisions in real time. My Court is very sensitive to the importance of deciding matters in an expedited manner to assure the business world that litigation will not cause business decisions to become moot due to delay.

Is precedent under Delaware law applicable in other venues?
Yes it is. If you are a Delaware company, no matter where you are sued, whether Texas, California, New York or Virginia, and the case involves an issue that we call the internal affairs of the corporation—the relationship between directors, management and stockholders—the Delaware corporate law will apply. The courts in all American jurisdictions follow and apply what is known as the internal affairs doctrine, which means that the law of the state of incorporation applies to internal corporate governance disputes, no matter the venue.

ADDITIONAL STORIES ABOUT WILLIAM B. CHANDLER III AND THE DELAWARE COURT OF CHANCERY
A Tribute to Chancellor Chandler by Stephen P. Lamb
Why Directors Need Delaware by Charles Elson

For example, I recently spoke by telephone with a judge in Virginia who has a case involving a Delaware corporation and a former chief executive officer of the company who lives in Virginia; and there’s a parallel case here in Delaware involving the same parties. It’s a fight about compensation. In the interest of judicial economy and to save the parties’ costs, we agreed that the judge in Virginia would go forward with the case because his case was more advanced, but also because the Virginia judge is very familiar with Delaware law. Interestingly, he told me that he was familiar with my Disney decision and he will be applying that decision to this case. So, whether you are sued in Delaware or some other venue, the likelihood is that the Delaware corporation law will be applied to the dispute.

What cases will define your legacy as Chancellor?
To me, the most important case I have worked on is the one I’m working on right now. Whether it’s Disney or the dissolution of a failed start-up company—all of my cases are equally important. Some of the smaller disputes involving micro-cap companies frequently generate some of the most important principles and ideas in our jurisprudence. I will have to leave it to others to assess which cases define my legacy.

Delaware Chancery Court is a uniquely American court. How global is your reach?
My colleagues and I travel abroad occasionally to give lectures to law classes and to conferences. The work of my Court is known and admired around the globe. Indeed, many times my colleagues and I are asked to speak to judges in other countries about the procedures and substance of our corporate law. There is keen international interest in the work of my Court and our state’s judicial system in general.

Let’s get into specifics. What makes litigation different in Delaware?
I think some of the important factors include the specialist approach, the specialized court with a limited jurisdiction and the historical tradition of deciding disputes, one at a time, with a judge writing an opinion that explains in detail the rationale for the decision. As a consequence, the judge feels a special responsibility or obligation to apply venerable equitable principles, and especially fiduciary duty concepts, to often-complex factual scenarios in a way that results in a fair and just solution to the problem. In this manner, an equity judge “owns” the decision because he is personally responsible for the result, rather than a jury, for example, which is not accountable and not really personally responsible for the decision in the same way a judge in a court of equity is.

Regardless of your personal viewpoint, proxy access is being hailed as a game changer that significantly enhances shareholder rights and, in particular, is widely believed to give institutional investors unprecedented power in board director elections. Until now, shareholders who wanted to elect their own directors have had to bear the expense of the election costs. The new rules give shareholders access to the company’s proxy statement, putting them on the same level as company-nominated directors. The majority of the director community is still uncertain about the true impact of the new rules, according to the results of a survey conducted by NACD Directorship as part of the first Board Confidence Index (see story page 38).

Said one public company director, “Everyone should take note of the fact that there is going to be more scrutiny of the representation on boards. There is a broad misconception that boards are not representing shareholders well when in fact, I believe, that is not the case. Be that as it may, boards should probably be looking at this issue offensively. Boards that are well governed should rest comfortably, but self assessment is always important and this now provides an extra incentive.”

Editor’s Note: Since this article was published, the SEC stayed the effectiveness of its proxy access rules due to a legal challenge by the U.S. Chamber of Commerce and the Business Roundtable.

The changes in the winds for the boardroom are twofold: the prospect that directors will have to either campaign for election in a popularity contest that could pit boards against management, or fight dissident nominees to maintain their seats. Most of the tens of thousands of public-company directors now serving on America’s public-company boards (estimates vary, but our research suggests the number could be as high as 75,000) have been nominated to boards by an independent nominating and governance committee. Based on disclosures to the SEC mandated since 2003, sources for these nominees vary. In rough order of prevalence, they include recommendations to the nominating committee from non-management directors, senior managers, executive recruiting firms, and shareholders submitting names to the nominating committee. (Half of the 701 respondents to the 2010 Public Company Governance Survey said their boards use an executive recruiting firm for directors). Some governance experts see proxy access as a deal breaker for many director candidates who may not want to face the prospect of having to fight for a board seat and risk harm to their reputations by failing to succeed in a director election.

The concern that proxy access will politicize the director election process—by driving shareholders dissatisfied with company performance to propose their own director candidates—has been fueled in part by the U.S. Chamber of Commerce and the Business Roundtable. Both organizations have criticized proxy access for the potential handicaps it places on the more than 10,000 publicly traded companies whose 2011 proxies have already been made accessible to some shareholders. The rule is seen as federalizing what was originally left up to the discretion of individual company boards.

William Gruver, who serves on the board of TheStreet.com, says he is of mixed mind on the rule. “In an ideal world, having a popular wide-open process where anyone can nominate as many candidates as they’d like is the democratic ideal,” he says, “but we’re not ancient Athens. We live in a much more complex world and what gets lost in that ideal is some of the subtleties that might influence a vote and can be understood by directors who are responsible for nominations and might not be as well understood by the shareholder base.”

Gruver knows something about running for office. After retiring from a 20-year career at Goldman Sachs, he moved full time to his home in the tiny resort town of Eagles Mere, Penn., where he became a three-term mayor. He ultimately decided not to seek re-election because of the rigors of the political campaign process. When asked if he would agree to run on a dissident slate at a company, he said it would depend on the circumstances—a sentiment expressed by other directors.

Tom Wajnert, lead director of RJR, has been opposed in a director election in which he prevailed, and would be willing to run again. He advises boardroom brethren “not to get worked up about” the rule changes. When shareholders nominate directors, it’s important for them to make their perspective and point of view known to the company and its sitting directors. “I don’t see this as personal campaigning. The people who are nominated are usually very qualified and if they’re not, the proxy advisors won’t recommend them,” Wajnert says.

Given his prodigious board experience, Edward A. Kangas, who is non-executive chairman of Tenet Healthcare and serves on boards including United Technologies and Intuit, is among the highly regarded statesmen of corporate governance. He says he is okay with making the director election process “more democratic.” He believes that if a board is doing a good job and CEO compensation is truly aligned with the interests of shareholders there is little to worry about, even with the new rule. On the other hand, if a company is doing a poor job and is being unresponsive to shareholders, and proxy advisors such as Institutional Shareholder Services (ISS) start to recommend withhold votes, there will be some shareholders who will say, “We’re not happy with that” and they’ll want to make a change. “I’m okay with that, too,” Kangas says, “and think sometimes it will improve governance.”

What is not okay, Kangas says, is the director nominee who is not independent because of his or her allegiance to a specific cause or issue. “I believe that directors represent all shareholders. If I were on a board and there was a director or two who were basically representing the interests of one investment fund and were simply worried about that one shareholder, that would be outrageous. Independent directors need to represent all shareholders, not a distinct subset.”

The SEC may have closed the door on easy access by approving a three-percent three-year holding requirement. Robert A.G. Monks, the shareholder activist who co-founded ISS and The Corporate Library, an independent research firm of which he is a principal and member of its board, thinks these caveats establish a high enough threshold to be “dissuasive.”

To that point, some funds are not allowed to hold as much as one percent of any equity in their portfolio, so shareholders would have to get together to amass shares to qualify for access. “It’s not going to be easy, but it’s not going to be completely impossible either. To nominate a director will require a high degree of collaboration and coordination,” says Francis Byrd, senior vice president and risk practice leader in corporate governance at the Laurel Hill Advisory Group.

These kinds of collaborations have been happening long before proxy access. In fact, they have been occurring since the proxy reforms of 1992. Veterans in the field will remember the proxy reforms advocated by United Shareholders Association (USA) founded by T. Boone Pickens and Ralph Whitworth (who reportedly worked for $1 a year to advance the cause of shareholders). When those reforms resulted in easier communications among shareholders, the USA actually closed its doors, announcing that its mission had been accomplished.

More recently, Whitworth’s firm, Relational Investors, teamed up with the California State Teachers’ Retirement System (CalSTRS) to try to resolve a number of governance concerns both shareholders had with Occidental Petroleum. After a year of discussions with various company officials and no results, the investors threatened to nominate as many as four new directors in a classic proxy fight for control that ultimately, forced the retirement of Ray R. Irani as CEO. Shareholders may not use the new proxy-access mechanism for such initiatives, but the point is clear: the most effective way to prevent shareholders from nominating their own slates is to understand and address their concerns before they file for access. Certainly this has been the case when shareholders filed proxy resolutions about governance matters other than access. During the 2010 proxy season, after successfully engaging companies to make corporate governance changes, CalSTRS withdrew 21 of the 28 shareholder proposals it had filed on various governance matters.

“It’s important that the board not over- or under-react…it’s also important for the board to understand what investors are looking for. Take a step back: Investors are interested in maximizing their returns; it would be foolish of them to suggest something that would not be in the best interest of the company,” said one major public company director.  “The framework is now in place for more scrutiny on the selection of board members, but the levers can be adjusted if that becomes necessary,” said this director.

Shareowners have a 30-day window—no later than 120 days prior to the proxy filing, no greater than 150 days—to notify the company and the SEC of director nominees. The company, however, has until 14 days after the close of this window to respond to the nominating shareowner or groups. This allows the board to collectively evaluate the candidates and make a decision regarding the slate to be presented. A public company has the ability to exclude a shareowner nominee if:

• The nominating or shareholder group has not met compliance requirements.
• The nominating shareowner or group or nominee does not meet the eligibility requirements.
• Including the nominee(s) would result in the company exceeding the maximum number of nominees.

If a board chooses to exclude a nominee, it must notify the nominators within 14 days following the window for nomination submissions.  In return, the nominating shareowner or group has 14 days upon receipt of the board’s notification to respond. This is the nominator’s opportunity to fix any defects in the nomination.

Investor groups (including labor unions and pension funds) have largely applauded the new proxy-access measure, which has been described as a “silver bullet” for shareholders. The California Public Employees’ Retirement System (CalPERS), the country’s largest public-pension fund with assets of more than $206 billion, achieved its top governance goal with the new rule and plans to use it with a careful aim.

In advance of passage of proxy access, CalPERS and CalSTRS began building a database of independent directors. The Diverse Director Database, nicknamed “3D,” is a pool of qualified candidates who can be nominated for seats on poorly performing corporate boards in which they hold shares. Anne Sheehan, head of corporate goveranance at CalSTRS, explained to one corporate governance writer the reasons the pension fund wants to expand the director pool. [NACD has  a similar database, Directors Registry.]

“We are working on establishing a database of independent director candidates and we are doing that for a few important reasons,” Sheehan said. “One reason is that there is now demonstrated economic value from having a diverse board of directors and we believe that makes the composition of boAards a shareholder value issue. Another reason is the necessity to expand the pool of qualified candidates.”
Almost 3,000 of the sitting directors on companies in the Russell 3000 are over age 70, she noted, while many companies have retirement policies that typically go into effect at age 72. This means that many boards will be retiring directors in the next two years, leaving seats open for nomination and election. “Couple that with the adoption of majority voting standards by companies and this looks like a significant long-term shareholder value concern,” Sheehan said. “Add to that the last three decades of market collapses, beginning with the 1987 crash, and we as long-term investors have to take the director pool seriously.”

As to qualifications, the SEC’s recent disclosure rules are “going to be very valuable for shareholders, because we should learn why the sitting directors are on the boards,” Sheehan notes. “Naturally, the qualifications are going to have to match the company’s needs. We will put quality people in the database, many of whom will not have prior public-company board service, and we will do some screening to be sure that the qualifications that people put forth are true, but the final decision will still be made by shareholders when they vote. The nominating committees on these boards are going to be critical to this effort as well. In the final analysis, we are dealing with a human problem and there are no guarantees. There aren’t any in the current environment and the existence of the CalSTRS/CalPERS database is not going to produce any magical guarantees either.”

Passing the Legal Test

Some investors are hugely concerned that proxy access will be stymied by litigation while momentum around the access issue wanes. Dissenters in the 3-2 vote along party lines were Republican Commissioners Kathleen L. Casey and Troy A. Paredes. “I believe the law is so fundamentally flawed that it will have a great difficulty surviving judicial scrutiny,” said Casey, after the SEC announced adoption of the rule.

David Hirschmann, president and CEO of the Chambers’ Center for Capital Markets Competitiveness Group, has said it “will carefully review the rule that was approved…and will continue to fight this flawed approach using every method available.” Opponents of the rule had 60 days from its date of passage on August 25 to file a legal challenge. (Outside counsel for the Chamber, which has successfully challenged other SEC rules, is Eugene Scalia, son of Supreme Court Justice Antonin Scalia.)

Monks said he is concerned legal challenges could slow down implementation but others, including Patrick McGurn, special counsel to ISS, think the SEC did a thorough job “putting its ducks in a row,” noting that the SEC’s initial draft was 250 pages but the final version at 451 pages addressed issues such as the costs and benefits of the rule and its potential impact on competition and capital formation that would likely be the basis for a court challenge.

The bottom line on proxy access? ISS McGurn warns, “If you’re dead wood in the boardroom, you’re in trouble.”

In compiling this year’s Directorship 100, as the famous comedian opined, NACD found that all things financial lead to Washington, D.C.—at least in good old Twenty-ten. It is no surprise then that this year’s version of The Directorship 100, the list of the most influential people in the boardroom, pointed at least indirectly at those who earned their influence in the voting booth or by advising those who did. The investor has spoken, and it seems she has spoken to her Congressman.

No surprise either that Finance Chairmen Chris Dodd and Barney Frank the eponymous authors of the financial legislation that became law, were re-elected to the list again this year. Nor that supremely activist SEC Chairman Mary L. Schapiro’s appearance on our list was, unlike many SEC decisions, unanimous.

Even among our non-Washingtonian’s there lurks a sense of Beltway déjà vu: Paul O’Neill, a newcomer to the Directorship 100, was Treasury Secretary to former President Bush, and joins our list as an advisor to Steve Schwarzman’s Blackstone Group. Similarly, H. Rodgin (Rodge) Cohen, Edward Herlihy and Anton (Tony) Valukas have earned government chops either defending, advising or otherwise playing a central role in the affaires du gouvernement of the credit crisis. So too our CEOs, among them Warren E. Buffett, Rex W. Tillerson and James L. Dimon. All had their say, sometimes more than they bargained for, at hearings, on and off the record. Investors such as Ralph V. Whitworth, Roger W. Ferguson Jr. and David M. Rubenstein, are no strangers to government as employees, testifiers or investors: Whitworth just turned his attention onto Occidental Petroleum at the same time the government is looking closely at the sector. No list is complete without the media and our list is composed of the absolutely quintessential: The New York Times’ Andrew Ross Sorkin, CNBC’s Becky Quick, Fortune’s Carol J. Loomis, Bloomberg’s Norman Pearlstine and Fox’s recent hire, Charles Gasparino, are all closely followed by administration officials.

To order PDFs or extra hard copy issues of The September 2010 issue with the full Directorship 100 cover story, please contact Keith Pew at kpew@NACDonline.org.

The Hill and the West Wing are of course  well represented, starting with the President himself and key members of his administration, including Valerie B. Jarrett, Rahm Emanuel, David Axelrod and Kenneth Feinberg. Not quite czars despite the sobriquet the media likes to place on them, they do exert a profound influence on the shape of the boardroom in these times.
All members of the Directorship 100, regardless of how they arrived here, have power and influence. Some of it is new, some of it is long-standing. Our modest job is to reveal those who exert the kind of influence that will permit the continued, if sometimes shaky, path that our system of capitalism is on, and the importance of corporate governance as a critical guidepost along the route. As the Bard wrote, “Be not afraid of greatness: some are born great, some achieve greatness, and some have greatness thrust upon them.” Whichever is your preferred route, these members of the Directorship 100 are having a profound impact on corporate governance.

Regulators and Rule Makers

The Delaware Courts
Despite the push by the federal government to make corporate governance law, the most important business court in the land, by far, is still the Delaware Court of Chancery, headed by Chancellor William B. Chandler III, and his fellow Chancery judges, Vice Chancellors Leo E. Strine Jr., Donald F. Parsons Jr., John W. Noble, and the court’s newest member, J. Travis Laster. Laster made waves last spring with a surprise ruling on so-called “freeze-out” tender offers. He ruled that in a transaction where the majority shareholder buys minority partners with a tender offer, the controlling shareholders receive “both the affirmative recommendation of a special committee and the approval of a majority of the unaffiliated stockholders.”

Should the ruling be challenged, it would end up in the Delaware Supreme Court, captained by Chief Justice Myron T. Steele. More often than not, Steele has the last word on corporate governance law.

Andrew Cuomo, New York Attorney General
Andrew Cuomo is taking a page right out of the Eliot Spitzer playbook: parlaying a crusade against Wall Street banks like Citigroup, AIG and Goldman Sachs into a run for the governor’s mansion. Let’s hope he doesn’t emulate Spitzer in every way. While many executives complain that Cuomo’s tactics overlap the duties of the SEC, forcing them to walk a delicate line between state and federal securities law, his rebuke of credit ratings agencies was welcome in many corner offices. Like Spitzer, Cuomo was not afraid to make use of the Martin Act, a piece of New York legislation passed in 1921 that gives the attorney general broad powers to pursue financial fraud (certain defense counselors allege it is unconstitutional). And now that the attorney general-to-governor path seems to be well-worn, a host of candidates to replace Cuomo have cropped up, including Nassau County DA Kathleen M. Rice, a Democrat, and Republican Daniel M. Donovan, the DA of Staten Island.

Congress
Fresh from passage of the legislation that bears their name, Congressman Barney Frank and Senator Christopher Dodd will forever be associated with financial reform. Still to be determined is if they will be heralded or pilloried for the act they shepherded, as it could take several years to see if it is a playing field leveler or an overwrought burden on businesses. Either way, the act is a curtain call of sorts for Dodd, who announced he will not be seeking reelection in November. Dodd’s departure could open the door for Sen. Charles E. Schumer (D-NY)to play a more active role in sponsoring business legislation. Schumer deserves much of the credit (or blame, depending on your perspective) for many of the governance reforms that were enacted in the financial reform bill. Likewise, Congressman Henry A. Waxman (D-CA) has been a vocal proponent of changes to corporate compensation practices. As chairman of the House Committee on Energy and Commerce, Waxman is also expected to play a lead role in crafting a sweeping energy bill.

Should the Republicans take over the Senate in the midterm elections, Senator Richard Shelby (R-AL) would likely take over as chairman of the Senate Banking Committee. Shelby has been a vociferous opponent of the financial reform bill and an advocate for small business owners. His counterpart on the House Financial Services Committee is ranking member Rep. Spencer T. Bachus. The nine-term Congressman from Alabama, a devout fiscal conservative, faces re-election this fall.

Apart from the financial reform bill, Congress also appointed the Financial Crisis Inquiry Commission to assess the causes of the crisis. The 10-member commission is chaired by Democrat Philip N. Angelides, the former treasurer and candidate for governor of California. Also called the Angelides Commission, its final report is due to Congress in December.

The SEC
Under Mary L. Schapiro, the Securities and Exchange Commission has undergone drastic changes. With the stigma of being the agency that missed the Bernie Madoff scandal and failed to rein in excesses on Wall Street still lurking, Schapiro has moved aggressively to remake the Commission. Whether it was taking on Goldman Sachs or nearly doubling the number of investigators, there is no doubt that the SEC under Schapiro and her fellow commissioners, Kathleen L. Casey, Elisse B. Walter, Luis A. Aguilar and Troy A. Paredes, has a far more activist agenda than the one under predecessor, Christopher Cox. While the financial reform bill short-circuited the SEC’s efforts on proxy access, Schapiro had an important advisory role on the legislation.

The SEC will no longer provide companies with guidance on dismissing some proxy proposals on substantive grounds. That has led to many more resolutions making their way onto the proxy, including some that many would consider fringe issues. Another seismic change at the SEC was the creation of a Division of Risk, headed by Henry Hu. The division is intended to assess systemic risk in the financial markets. Another new face at the SEC is Richard C. Ferlauto, who was named to the Office of Investor Education and Advocacy. Ferlauto is no stranger to the Directorship 100, however, as he has made the list in past years for his role as head of governance at the American Federation of State County and Municipal Employees. Other recent additions include David M. Becker, who was appointed general counsel last year, and Meredith B. Cross, who was named director of the division of corporate finance. Both Becker and Cross are returning to the Commission. Brian V. Breheny also plays an important role in the SEC’s governance efforts as deputy director for Legal and Regulatory Policy in the Division of Corporation Finance.

Robert H. Herz, Chairman, FASB
Robert H. Herz was appointed chairman of the Financial Accounting Standards Board (FASB) in 2002 and is now in his second term. He has been a long-standing guardian of the nation’s accounting standards and has played an integral role in moving FASB closer to adopting international standards. This year Herz took part in FASB’s joint sessions with the International Accounting Standards Board (IASB) to detail nearly a dozen major accounting changes that will be finalized in 2011. Adopting a timeline set by the Group of Twenty Nations, the boards plan to adopt the new standards by mid-2011. Working at a fast pace, Herz and the FASB are changing standards that are long overdue for improvement. Herz is engaged in balancing convergence with the domestic concerns of U.S. investors and the public: “I am proud to say that so far my fellow board members and our staff, both FASB and IASB, have risen to the occasion.”

Daniel L. Goelzer, Acting Chairman, PCAOB
Daniel L. Goelzer was appointed by the SEC as a founding member of the Public Company Accounting Oversight Board (PCAOB) in 2002 and took over as acting chairman last year after Mark Olson stepped down. The Supreme Court ordered changes to the way PCAOB board members are removed but left the agency, established by the Sarbanes-Oxley Act to oversee the accounting firms that audit public companies, in tact. Prior to joining the PCAOB, Goelzer served as general counsel to the SEC and early in his career worked as an auditor in the Milwaukee office of Deloitte & Touche.

The Exchanges
After a roller-coaster trading day on May 6, 2010 that saw the largest intra-day point drop in the history of the Dow Jones—a so-called “flash crash”—leaders at the major exchanges were on high alert. Duncan L. Niederauer, CEO of NYSE Euronext, quickly reassured investors and concluded that the trading glitch was related to the fragmentation of markets and global trading volumes, not technical problems. In fact, he says that circuit breakers, which halted trading while order was restored, helped prevent trading activity from causing greater volatility. Niederauer has help overseeing the exchange from Deputy Chairman Marshall N. Carter. The NYSE is known as having some of the highest corporate governance standards of any exchange in the world. The job of continuing that tradition is partly charged to Scott R. Cutler who is U.S. listings chief.

Across town at the Nasdaq OMX, Robert Greifeld, president and CEO, is also responsible for upholding high standards of governance at the exchange’s 3,700 listed companies.

Bruce Aust, executive vice president of Nasdaq’s Corporate Client Group and leader of the Corporate Services program, has spearheaded Nasdaq’s expansion into corporate governance support services.

1. Eliminate the doctrine of joint-and-several liability, at least for non-economic damages.

2. Congress and the courts need to impose and follow rational guidelines for punitive damage awards, so the greater interests of workers and shareholders can be taken into account. The United States Supreme Court has strengthened and clarified constitutional guidelines on the award of punitive damages. Lower courts should heed those rulings.

3. Congress or the courts should reverse the “opt-out” provision, so that people must affirmatively choose to join a class-action lawsuit.

4. Return to the original understanding of the rule of law. Congress or the courts should rely on the implied power to roll back the ability of a single jury to tax and regulate the entire United States.

5. Congress needs to act on asbestos law reform. Our courts are clogged with lawsuits filed by people who, while they may have been exposed to asbestos, have absolutely no illnesses. These claims prevent those with real illnesses from having their day in court.

6. Restrict government lawsuits, so that regulation through litigation becomes a thing of the past.

7. Enact a Legal Consumer’s Bill of Rights that would give clients the vital element of any functional marketplace—disclosure and honest information.

Steven B. Hantler is the chairman of the Foundation for Fair Civil Justice. For more information, contact the FFCJ at 770.317. 2423 or email todd@dminews.com.

Legal reform advocates in state after state are conducting defensive campaigns, barely holding on to hard-won gains or watching them slip away. Boards of directors are in the bull’s-eye, and would do well to heed the warning that in this war of attrition, the plaintiffs’ bar may succeed in worsening the legal climate for business across the country.

How has this happened?

It’s partly a political shift, partly an anti-business sentiment, and frankly, too many companies sitting on the sidelines or looking the other way. The plaintiffs’ bar knows this and is aggressively pursuing opportunities everywhere, as illustrated in the Foundation for Fair Civil Justice’s Annual State Litigation Guide, produced in conjunction with NACD Directorship.

The selected profiles that follow were chosen to provide an illustration of those states doing well and those like California, that have plummeted to the bottom of the list. Directors can get a quick glimpse of the future by asking their general counsel, “How bad would it be if in 10 years our state’s legal environment becomes just like California’s?”

Liability Map and State Rankings

FLORIDA
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  48th
Modest changes in law improve some aspects of Florida’s liability climate for business, but overall it remains dismal. The plaintiffs’ bar spends millions of dollars to recruit candidates, fund policy initiatives and exercise significant control over the judicial selection and retention process.

In April 2010, Governor Charlie Crist signed two liability reform bills that will help level the litigation field somewhat. The first bill, Fairness in Slip and Fall Lawsuits, shifts the burden of proof to the plaintiff in a slip-and-fall case originating in a business, an important change that streamlines Florida liability law with its neighboring states. Florida Attorney General Bill McCollum and the business community supported the second bill, the Transparency in Private Attorney Contracting. This prohibits the attorney general’s office from hiring outside trial lawyers on a contingency fee basis. In order to hire outside attorneys, the attorney general will have to provide written determination stating that the representation is cost-effective and in the public interest.

In 2009, workers’ compensation reforms were enacted that reinstate strict cap fees on a claimant’s attorneys. Florida’s reform success list includes the elimination of joint-and-several liability in 2006, and asbestos/silica litigation reform in 2005.

In addition to ongoing legislative efforts to protect previous reform gains, reformers will need to counter the plaintiffs’ bar control exercised over judicial appointments, retention elections and coordinated court challenges against reform laws.

ADDITIONAL COVERAGE IN THE ANNUAL STATE LITIGATION GUIDE:
The Seven Myths of Business, According to Highly Effective Plaintiffs’ Lawyers
How to Rein In the Plaintiff Plutocrats
Liability Map and State Rankings

GEORGIA
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  28th
Since the 2005 passage of Georgia’s omnibus tort reform legislation, legislators have remained relatively silent on civil justice reform. In response to the well-organized reform effort that included a strong coalition of medical, business and advocacy organizations, by contrast the plaintiffs’ bar is now actively engaged on multiple fronts to water down, undo legislatively or defeat in court various reform provisions.

The state Supreme Court, which only recently shifted to a rule-of-law majority based on the appointment of former U.S. Attorney David Nahmias by Governor Sonny Perdue, nevertheless in March unanimously struck down the state’s medical-malpractice damages caps as unconstitutional. Two weeks earlier, the high court upheld offer of judgment and emergency- room malpractice protections as constitutional, thus producing a mixed result in the multiple legal challenges against the 2005 reforms.

In 2009, Governor Perdue introduced FDA “preemption” legislation to provide liability protection for pharmaceutical and medical-device manufacturers in the state, as well as a “loser pays” civil litigation bill patterned after Alaska. Neither bill succeeded. The Georgia General Assembly has not enacted any new reforms in 2010.

The organized legal attacks against the 2005 reform provisions will succeed in direct proportion to the temperament of the judges who hear the cases, from the lower courts to the Georgia Supreme Court. This motivates the plaintiffs’ bar to try to elect an anti-reform governor who appoints judges, and a pro-plaintiff attorney general. Because the Courts have been chipping away at the 2005 reforms, Georgia’s liability climate has slipped in recent years.

ILLINOIS
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  47th
The liability climate in Illinois is among the worst, despite successful efforts by the reform community to fend off recent legislative proposals favoring the plaintiffs’ bar. In February, the Illinois Supreme Court struck down limits on jury awards in medical malpractice cases enacted four years earlier by the Illinois legislature amid  “spiking liability costs” for medical providers. The state Supreme Court ruling is likely to trigger significant insurance cost increases, and establishes a dangerous precedent for other states where caps are being challenged in court.

The influence of the plaintiffs’ bar in Illinois permeates not only the state bar but also the state legislature. With anti-reform majorities in both chambers of the Illinois General Assembly, the state’s pro-reform advocates have been forced to fight back a multitude of anti-business initiatives. Legal reform advocates, such as the Illinois Civil Justice League (ICJL), successfully fought 2009 legislation that would have allowed prejudgment interest to accrue from the time the defendant was served.

The plaintiffs’ bar appears to be most interested in the three Illinois Supreme Court retention elections this year. Activist Justice Thomas Kilbride looks to be the most vulnerable of the three and is the recipient of a lion’s share of the plaintiffs’ bar support.

The American Tort Reform Association (ATRA) continues to designate Cook County (Chicago) as a “Judicial Hellhole.” Madison was moved to ATRA’s “Watch List” and St. Clair Counties was cited as a jurisdiction to watch, despite a spike in asbestos and pharmaceutical filings. In lieu of substantive legal reforms, Illinois’ liability climate will continue to discourage growth and job creation.

MICHIGAN
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  43rd
Michigan’s liability climate has dramatically slipped due to aggressive trial bar legislative efforts and state election results favoring anti-reform legislators. Unlike most other states, Michigan’s legislature meets all year, giving plaintiff forces ample time to work the system.

Newly invigorated with 2008 election gains in the state House of Representatives, plaintiffs’ bar allies are maneuvering to: repeal the Food and Drug Administration preemption defense; expand the Consumer Protection Act to allow for more causes of action; dilute or eliminate previously enacted medical liability reform, including expert witness standards, affidavit of merit, statute of limitations; and erode automobile no-fault.

Following the U.S. Supreme Court decision in Wyeth v. Levine, which left the authority to each state to determine which lawsuits challenging FDA decisions would be allowed, the Michigan General Assembly debated several bills sponsored by activist legislators, all of which threaten earlier reform gains.

Attorney General Mike Cox, a strong rule-of-law advocate, is running for the governor’s spot in 2010. Since the 2008 elections when the rule-of-law majority on the state Supreme Court was lost, an additional justice is up for election in 2010.

Although Michigan’s liability climate has been conducive to growth and job creation, it is now a state to be watched because of both the very aggressive plaintiffs’ bar legislative efforts and new control of the state Supreme Court by an activist majority.

MISSISSIPPI
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  21st
Mississippi’s legal climate is improving, mostly because of the Tort Reform Act of 2004 that included reforms relating to product liability, joint-and-several liability, jury service, medical liability and non-  economic damages. Not surprisingly, the plaintiffs’ bar is pushing to undo these reforms.

The plaintiffs’ bar unsuccessfully sought legislation to change the definition of the term “trade secret” so only the “most distinctive” part or parts would qualify. This would have made it more difficult and expensive for companies to protect trade secrets.

A “loser pays” reform measure was defeated; it would have enabled defendants to recover litigation costs from the plaintiff if the defendant won. This would have limited value, as most cases are settled. Another defeated reform was the Lawsuits Reduction Act, which provided that a legislative or regulatory act does not create a private right of action unless specifically stated in the legislation.

Reformers support private attorney retention sunshine legislation that would make public the process by which state contracts with private attorneys is open to public scrutiny. However, political losses by reform  advocates have led to a continuing impasse. The state’s business community is closely watching Double Quick, Inc. vs. Ronnie Lee Lyma, now before the Supreme Court of Mississippi on the question of the constitutionality of caps on non-economic damages.

Mississippi’s overall climate trend is conducive to growth and job creation, but this trend is fragile and depends on the future election successes by pro-reform advocates.

NEW JERSEY
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  50th
New Jersey’s liability climate is consistently among the worst of the 50 states. There have been some recent reform successes, however. Governor Chris Christie is signaling that he understands that liability laws are hurting the state economically. However, significant liability reform proposals have not been announced.

The plaintiffs’ bar and its allies in the state legislature unsuccessfully supported legislation expanding wrongful death actions that would have allowed unlimited damages, as well as legislation that would have expanded strict liability under the state’s consumer fraud law. As a result of the weak state consumer-fraud law, businesses are in jeopardy of becoming lawsuit targets for something as minor as an invoicing error. Of note, more than 93 percent of tort lawsuits in New Jersey originate out of state.

Reformers are supporting legislation that would establish qualification standards for expert witnesses, a measure that would have significant impact in the medical malpractice arena. Additionally, the New Jersey Lawsuit Reform Alliance is working with lawmakers to establish a reasonable appeal bond cap. Currently, New Jersey requires defendants to post the entire amount of a court award as bond for the appeal.

It is unlikely New Jersey’s liability climate will be favorable to economic growth and job creation in the foreseeable future.

OHIO
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  15th
Ohio continues to serve as a business and legal harbinger for the Midwest and a central battleground for legal reform in its legislature and courts. The state has a highly active and motivated plaintiffs’ bar and an equally motivated business community focused on specific tort-reform measures to strengthen the state’s economy and medical community. The 200-member Ohio Alliance for Civil Justice has advocated for comprehensive tort-reform initiatives including medical criteria for asbestos, silica and mixed-dust cases.

A 2010 Ohio Insurance Department report shows that the state has realized significant benefits since state-level medical malpractice reforms in 2003 put a $350,000 cap on non-economic damages. The report details a 21 percent drop in medical liability-related lawsuits between 2005 and 2006. An additional result is the influx of new physicians practicing in the state, a similar development experienced by Texas after enacting its recent reforms.

The outlook for the state Supreme Court is unclear. In a controversial move, Governor Ted Strickland appointed Franklin County Probate Court Judge Eric Brown to fill the remaining months of Chief Justice Thomas J. Moyer, who died unexpectedly in April. Brown will face current Justice Maureen O’Connor, a Republican, on the ballot in November for a full term as chief justice. Governor Strickland could have appointed a caretaker or elevated a lower court judge on a temporary basis: Some worry that Brown’s appointment is an unnecessary politicization of the Supreme Court. This will be one of the nation’s most closely watched court elections.

PENNSYLVANIA
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute): 46th
Pennsylvania’s liability climate remains one of the worst in the country. Lame duck Governor Ed Rendell’s support of several critical pieces of legislation that would expand liabilities, along with the pro-plaintiffs’ bar imbalance in the state House and Senate, point to the 2010 elections as nearly the only hope for meaningful change.

Rendell’s most famous flip-flop was support for, then later veto of, the Fair Share Act reforming joint-and-several liability. The original 2002 Fair Share Act was passed and later struck down by the courts on procedural grounds, not substance, which had been remedied by the newer legislation. Pennsylvania remains one of a small handful of states not to enact this important reform.

Recently introduced legislation would have driven up jury awards by allowing plaintiffs’ lawyers to quantify damages by suggesting lump sum figures to a jury, thereby tainting the discretion of a jury.

Many studies and medical associations have in recent years declared the Commonwealth’s healthcare system in extreme crisis based on the number of physicians leaving medical practice or moving from the state, as well as the closing of critical specialty facilities, particularly maternity units. Employee health insurance is among the most expensive in the country.

The 2010 elections will highlight many issues related to the civil justice imbalances that have created quality-of-life and cost hardships for the people of Pennsylvania.

TEXAS
2010 U.S. Tort Liability Index Output Rank (Pacific Research Institute):  18th
Texas maintains a favorable liability climate, even while the plaintiffs’ bar spends millions to put forward hundreds of bills intended to roll back tort reforms enacted in recent years. Two recent bills, both of which passed at least one legislative chamber, would have exempted asbestos-related mesothelioma lawsuits from scientifically sound standards of causation and weakened workers’ compensation law.

Other plaintiffs’ bar bills called for sweeping qui tam expansion for targeting Texas businesses; requirements for employers to reimburse for “phantom” medical expenses allegedly incurred in personal-injury matters; lowered standards of liability protection for emergency-room treatment; eliminated the right to contract for arbitration as an alternative dispute resolution in many kinds of cases; expanded class-action lawsuit provisions to allow the state Attorney General to bring suit on behalf of individuals; and, eliminated certain liability protections for physicians who practice in rural hospitals.

The Texas Trial Lawyers Association is investing heavily in the state’s election cycles. According to The Wall Street Journal, plaintiff lawyers spent $9 million in 2008’s state legislative elections to gain support and it is likely this funding will increase in 2010.

Thanks to continued pressure from the Texas business community and legal reform advocates, the state’s economy has fared better and will rebound sooner because of a legal and regulatory environment encouraging investment and job creation.

Methodology
The U.S. Tort Liability Index: 2010 Report measures which states impose the highest and lowest tort liability costs and risks. Lawrence J. McQuillan, PhD, and Hovannes Abramyan, MA, researchers with the Pacific Research Institute (PRI) co-authored the biannual report, now in its third edition. The rankings (see full map and chart, page 24) are free of subjective bias of the authors and are based solely on the best outside, independent data primarily from A. M. Best Company, VerdictSearch, American Tort Reform Foundation, American Bar Association and National Center for State Courts.

The ranking provides an accurate snapshot of each state’s current tort liability system, a timely and useful tool for business decision makers. It matters greatly whether your state is towards the top or bottom of the tort-climate ranking.

Looking at recent data, job growth was 57 percent greater in the top 10 tort states than in the worst 10; state GDP growth was 25 percent greater, tax revenues grew 24 percent more because of better performing economies; and there was a 232 percent difference in migration rates between the top states (net inflow of people) and bottom states (net outflow of people).

The report uses 13 variables— adjusted to account for differences in the size of each state—to rank states from best to worst in terms of relative monetary tort losses and relative tort litigation risks. The authors selected the variables after consulting with dozens of legal scholars, economists, university professors, insurance experts and lawyers, and after an exhaustive review of the scholarly academic literature.

Nine variables track liability losses for private and commercial automobiles, farm owners, commercial general liability, other general liability, homeowners, medical malpractice, product liability, personal self-insurance and commercial self-insurance. Liability losses measure the expected total cost of new claims incurred in a given year. Four variables track litigation risks regarding outlier jury awards, the presence of plaintiff-skewed “Judicial Hellholes” (as defined by the American Tort Reform Association), number of attorneys and tort caseload.

The authors collected data for each state across the 13 variables. Once all variables were ranked from best to worst across all 50 states, an average ranking was calculated for each state by adding together the ranks it earned on the 13 variables and dividing by 13. The average rankings were used to compile the final, overall ranking, from 1 to 50. The state with the best average ranking across all 13 variables received an overall ranking of 1. The state with the worst average ranking received an overall ranking of 50.

Very small differences in average scores matter greatly because they determine the ordinal, or relative, rank. Economic studies demonstrate that relative differences among states, not absolute differences, primarily determine the inter-state allocation of capital, labor and entrepreneurship—the ingredients of economic growth.

Steven B. Hantler is the chairman of the Foundation for Fair Civil Justice.

NACD Directorship: Has the boardroom of 2010 undergone a sea change?
Noski: Yes and maybe no. I think we have the Sarbanes-Oxley compliance aspect nailed down. We spend a great deal of time with strategy and succession. If a business isn’t in duress, the board’s work is fairly straightforward. But if you pick the wrong CEO, you have just wasted the next five years because it takes a few years to assess and terminate the current CEO and then a few years for a successor to get up to speed. So to me, succession is a key skill and a critical responsibility that is sometimes overlooked in the regulatory frenzy.

ADDITIONAL COVERAGE IN THE BOARDROOM GUIDE FOR NEW DIRECTORS:

A Message to New Directors

The Renaissance in Succession Planning and Board Recruiting

Congratulations, You’re the Audit Committee Chair. Now What?

Performance and Pay Alignment: A Top Priority for Compensation Committees

NACD Directorship: What are some of the challenges for new directors?
Bromilow: I have seen new directors struggle in some areas. It’s important for directors to understand the culture. Different companies operate in very different ways, so understanding how to work within that framework is important. To the extent the company is in a unique industry, it may also be a challenge to understand the business model and the special risks. New directors should also understand how the board approaches its oversight role.

For directors new to the audit committee, there is an additional layer of challenge. Financial reporting is complex and audit committee members should understand how the company deals with it. It includes understanding how financial information rolls up, the key players in the finance function and the applicable regulatory and compliance matters.

NACD Directorship: Pfizer is a leader in corporate governance, how do you orient new directors?
Kenney: Pfizer has a very robust director orientation process with scheduled meetings with each of our division heads and other senior leaders over the course of six to nine months. We give directors a significant amount of information to contact any member of senior management, including the controller and treasurer. We provide not only office contact information but also their home contact information. This is management’s way of saying to our directors, “We have confidence that you can go directly to any of these people with questions.”

NACD Directorship: Norm, suggestions for the new director?
Augustine: When I served on one board, we had a board dinner the night before each meeting. At every dinner we would assign one member to talk about his or her life. It changed the tone of the board and its effectiveness. We all looked at each other quite differently when we knew more about each other. It helped us work together much more effectively.

NACD Directorship: How much time do directors now need to devote to board duty?
Kopelman: The surveys indicate this has increased significantly over the last decade, but recently leveled off. Trying to overlay upwards of 175 hours of annual board service—
including review and preparation, travel, board and committee meetings, plus informal calls and emails on top of a full-time staff or line job is surely a challenge both for the executive and his or her employer. Recently retired, seasoned executives seem to be able to get up to speed quickly and devote the ongoing time.

NACD Directorship: Are there specific skills for new directors?
Levine: Independent judgment. The proxy rules from December 16 now require for the first time that boards explain their selection criteria philosophy. For me, that is key—does that person have the ability to have a challenging discussion without becoming too personal? Directors need to keep their cool but also know when to strike it hot. I would also add that they should have a burning curiosity about the important things. It’s important to understand their individual potential contribution as well as how they will impact on the creation of meaningful board dialogue.

Barry: Boards look for specific skills in new directors that may be currently lacking—which can reflect the sector or the company’s condition at the time. So while the specific skills being sought will differ from company to company, there are skills and attributes that are important for all directors. First, directors should bring  broad business experience and an appreciation for contemporary management techniques and leading practices. Second, directors need to demonstrate leadership. This encompasses strategic thinking and planning, decision making, negotiation and problem solving. They also must have the courage to ask tough questions and to probe management when they are uneasy. Third, it’s important for directors to have insight, judgment, integrity and a sound professional demeanor—to disagree without being disagreeable.

NACD Directorship: Should “on-boarding” be a formal process? What special recommendations would you have?
Noski: What I ended up doing was to design my own onboarding. Once I understood the organization, I would advise the CEO or lead director that these are the people that I want to go and spend time with. My early experience was largely trial and error. Now, I work with the board chair or lead director and we have designed a program for incoming directors. Another novel approach is to have a policy of not assigning new directors to serve on committees in their first year.

Bromilow: Boards don’t turn over that quickly, so companies often have an ad hoc onboarding program. Director candidates should conduct due diligence before accepting any nominations, so they will already have some insight into the company. But that doesn’t preclude the need for proper orientation, which should include, at a minimum: the company’s strategic plan; a discussion about the key risks the company faces, how it mitigates those risks and the board’s role in risk oversight; and an introduction to the management team and an understanding of the succession plan.

From PwC’s perspective, audit committee orientation for new members should start with a discussion of financial reporting, including areas of key judgment. Then it should introduce the key players from finance, internal audit and the external audit team. It should also cover how the audit committee discharges its other core responsibilities over areas like compliance.

Kopelman: We have to make a distinction between folks who have never sat on a public board before and those who have a couple of directorships under their belt. You need to make sure that new directors get a grounding in governance—that they thoroughly understand the board’s role and especially how it differs from management’s, both legally and practically. I have seen an informal buddy system—assigning a sitting director to each newcomer—work well. Also, I’m involved with onboarding directors for companies coming out of Chapter 11: You’re parachuting people in who need to start functioning as a team. It will take time for them to gel and function effectively as a group—just look at the Yankees over the last eight years!

NACD Directorship: Norm, what have you seen that works?
Augustine: The best example I can think of comes from Procter & Gamble. As the board would travel to various parts of the world, P&G would arrange for us to visit people in their homes and sit down with real customers—housewives, children and families. We’d ask them about Tide—why don’t you buy Tide? In one case, the reason was that when the housewife had to buy soap she had to walk a considerable distance home with a huge box—so she wanted small packages even if they were less economical. The result was Tide produced and sold in smaller boxes. You can’t merely have the corporate staff tell you what the business is about you have to get out and see it.

NACD Directorship: Scott and Glenn, do you or the NYSE have a view to share?
Cutler: I agree that relationships with management, service providers and customers are extremely important for directors, as is having an understanding of governance. But more than ever, corporate boards have to focus on the company’s stock, its shareholders and what influences their decision-making. There aren’t enough boards that have an active dialogue with shareholders, and boards ought to think more about that.
Tyranski: What does the investing public think? Investors are really counting on boards to reach out and meet with the right person beforehand and ask the right questions.

NACD Directorship: John, in terms of understanding risk, what extra measures should the audit committee be taking?
Morrow: I can’t overstate the importance for audit committee members to get to know the people in the finance function, including the CFO, controller and other significant players. There is so much that can go wrong within the finance function—so much opportunity for fraud and malfeasance—that audit committee members should get to know the character and integrity of individuals in key finance function roles.

NACD Directorship: What about new directors and that highest profile of subjects, compensation?
Ferracone: The compensation committee is certainly where the accountability resides, and the workload has increased due to added regulation and scrutiny. The board members on the compensation committee really do need some structured training. It is often said that many board directors have skills from their careers that are quite relevant but ironically, few have experience with executive compensation. So at Farient, our orientation begins with the framework that provides the new director with a strong but basic background—looking first at a detailed view of the external landscape. We then also capture the compensation history in the company, its peer group, its pay philosophy, its plan designs, as well as internal issues. We then take new compensation committee members through the alphabet soup of technical items: 162(m), 280G, 409A, SEC disclosure rules and long-term incentive valuation models.

Our overarching goal in this exercise is to train the new director to be on the lookout for program design features and scenarios that develop into outliers. Finally, with respect to performance and pay alignment, we show how to test to what extent their company’s performance and pay are aligned.

NACD Directorship: What are some of the smart compensation practices you have seen?
Augustine: The first question many people outside the corporate world ask is whether the CEO for this or that company is worth 250 times the wage of the lowest paid worker. That may seem like quite a disparity. But take the experience at P&G where A.G. Lafley led an effort that rewarded shareholders with billions of dollars in what was essentially a “turnaround.” What was he and his team worth to a shareholder?

I’m a believer in pay for performance, but that is not always so simple. What if companies perform poorly, not because of CEO performance but because of a poor economy? Should the CEO and management then be penalized? When things are going badly management is not enjoying life; the job is much more arduous—dealing with constituencies that are quite unforgiving. This is the last time one would want to risk losing a good CEO. But if we pay generously when things go up, do we not cut pay when things are in decline? It is also noteworthy that in the military they give medals for bravery in retreats, too.

NACD Directorship: Norm, it is nuanced as you say, but we have to deal with it. Any suggestions?
Augustine: Many of the issues around compensation can be resolved through a few smarter practices. “Holding periods” are an example. I strongly believe management should hold the stock resulting from the exercise of options, after selling the necessary amount to pay taxes, for at least three years. I also favor certain clawback provisions, which can be an excellent reminder of the need for long-term performance. Whatever the case, judgment is crucial; don’t trap yourself with formulas alone.

Gershkowitz: The most important issue we are helping clients to address is how to truly ensure that pay is aligned with performance. Virtually every company makes this claim but we now know that it is much harder to achieve than one thinks. Farient has developed a visual representation of alignment that is underpinned by a quantitative model that we use with compensation committees to take a snapshot of their current degree of alignment relative to the broad market, their industry and even a specific peer group.

We also work with committees to run different scenarios to see how it might be possible to improve alignment by introducing new programs or redesigning some features of current programs. For example, using a fixed-share approach to stock option awards will have a different impact on alignment going forward than a value-based approach.

Similarly, a performance-share plan will have a different impact on alignment than a stock option or restricted stock plan. In the current environment, the ability to determine where a company stands in terms of pay and performance alignment and model out future scenarios before approving new plans, plan changes or plan exceptions can be a powerful decision-making and governance tool for compensation committees.

The Boardroom Guide for the New Director Advisory Council

Norman R. Augustine, former chairman and CEO, Lockheed Martin
John J. Barry, partner and leader of the corporate governance group, PricewaterhouseCoopers
Catherine L. Bromilow, partner, corporate governance group, PricewaterhouseCoopers
Christopher Y. Clark, president and publisher, Directorship
Jeffrey M. Cunningham, chairman, CEO and editorial director, Directorship
Scott R. Cutler, EVP/co-head of U.S. Listings and Cash Executions, NYSE Euronext
Robin A. Ferracone, executive chair, Farient Advisors
Todd M. Gershkowitz, senior vice president, Farient Advisors
Steve Kalan, associate publisher, Directorship
Rosemary Kenney, director, corporate governance, Pfizer
Kenneth P. Kopelman, partner, Kramer Levin Naftalis & Frankel; director, Liz Clairborne; president, New York chapter of the NACD
Gregg A. Krowitz, VP/listings strategy and analytics, NYSE Euronext
Stuart R. Levine, chairman and CEO, Stuart Levine & Associates; director, J. D’Addario & Co., Broadridge Financial Solutions
John F. Morrow, director, corporate governance group, PricewaterhouseCoopers
Charles H. Noski, director, ADP, Air Products and Chemicals, Microsoft, Morgan Stanley
Glenn W. Tyranski, SVP, financial compliance, NYSE Euronext
Judy Warner, chief content officer, Directorship

The result is a profile of the federal agency most visibly aligned with markets and risk—a story both inspiring and impressive but daunting in its implications for boards of directors and their companies. As Schapiro embarks on her second year in office, the SEC’s 29th chairman commands a laundry list of initiatives that include crucial legislative proposals, with proxy access prominent among them. Her challenge will be to convince Congress that the agency’s shift to a self-funding—and therefore independent platform—will help restore public confidence in its ability to be an effective market overseer. And, of course, in the process, to rebuild its battered reputation.

To make that happen, Schapiro, the four commissioners and the SEC’s staff of 3,700 will need to reorganize themselves to mend the weaknesses in infrastructure exposed by the financial crisis and the criminal wrongdoing of investment scammers such as Bernard Madoff. The agency started the new year off with a bang on “Super Wednesday,” January 13, 2010. During an open meeting that morning, the Commission voted 5-0 on two high-profile matters:

• Proposed a rule to prohibit broker-dealers from providing customers with unfiltered, or naked, access to an exchange or alternative trading system as well as other measures to reduce market access risks. It also approved a new Nasdaq rule that requires broker-dealers offering sponsored access to Nasdaq to establish certain controls over financial and regulatory risks.

• Published a concept release inviting comment on the current market structure for trading U.S.-listed equities, a move that sparked both commissioners and staff to be most vocal during the meeting in urging, encouraging and even courting public remarks.

Then, in an afternoon press conference that same day, the Commission:

• Unveiled what the SEC called the most sweeping reorganization in the Division of Enforcement since 1972, including the establishment of a new Office of Market Intelligence to analyze tips according to internally developed risk criteria to identify potential securities fraud.

• Announced a series of enhanced “whistle-blowing” measures, including three levels of cooperative agreements, to encourage individuals and companies to be more proactive in the agency’s investigations and enforcement actions.

The ramifications for public company boards of the reawakened and newly charged SEC are numerous, particularly in the areas of risk management, compensation, shareholder communications and director qualifications, among others. Yet, even though Bernie Madoff is in jail and the recession is officially over, there is still a great deal of angst, as U.S. public companies and their boards eye ever-changing global economic and market risks. As they witness the prospects of additional regula-tory burdens targeting boardrooms and C-suites, the reaction is not enthusiastic across the board. Depending with whom you speak, you might hear bravos and encomiums, or lukewarm acceptance mixed with outright consternation.

“We’re going in the wrong direction,” says James A. Unruh, founding partner of Alerion Capital Group, former chairman and CEO of Unisys and currently an outside director of CSG, Prudential Financial, Qwest Communications and Tenet Healthcare. “Let’s face it. As public companies, we have dropped the ball in terms of some risk management. This means boards have to be more diligent in their oversight and management of risk.” But, he says, this should not not occur at the demand of the government. Unruh cites  “say on pay” and chairman/CEO splits as examples of where regulatory reforms are singling out issues that might be best left to directors.

“Shareholders are not well-informed enough, despite the spate of recent Congressional and SEC proposals and rulings enhancing shareholder communications,” he said, echoing what others have said: “If the shareholders are unhappy, they should vote against directors or sell their stocks. We need boards that are more transparent, but the solution is not to allow shareholders to make all the decisions.”

While a global systemic breakdown has been declared the culprit by most leading economists, including Federal Reserve Chairman Ben Bernanke, popular opinion and the media have focused on the failure of risk-management processes at our leading banking institutions, and the cascade effect that had on all companies. Thus, the scrutiny and criticism towards management and board directors has been more pointed than in previous declines. While directors are moving swiftly to restore confidence in their institutions’ corporate governance, there is an equally urgent need to set the record straight with regard to how most boards performed versus the few in the spotlight, as well as the significant contributions now being made towards recovery.

To embark on such a mission, directors need to know what people are thinking and saying, and why. To obtain these important insights, Directorship and Deloitte collaborated to study the matter in detail, and in conjunction with Korn/Ferry International, set out to determine how the broader community—defined as “Main Street”—views the boardroom. In the course of our research, the opinions of teachers, laborers, policy makers, doctors, students, academics, and community leaders were sought (see Methodology, opposite). To gauge and compare those data with inside-the-boardroom views, we also asked the opinion of the C-suite, which includes board directors, chairmen, CEOs, and members of management.

The objective of “What Society Thinks? (about boards and business)” was principally to establish a baseline that, reviewed over time, would record changes in perceptions and point to where education and reform are needed, in terms of public opinion. Independent directors, says Henry Ristuccia, Deloitte & Touche LLP partner and U.S. leader of Governance & Risk Management, need to step back and determine the motivating factors for this perception and to the extent that there is genuine longer-term reputational risk. “The reason we contributed to this study is because we sensed a shift in perception, but wanted to be able to point to the exact causes. How dramatic has the change been? That will be answered by the research and subsequent studies every six months. What matters most are the lessons we can learn. It’s the same old issue that, if you don’t address the problem, then the regulators and legislators will do it for you.”

While many studies have focused on the more obvious question of “what the boardroom thinks,” there was a growing sense on the part of Directorship’s editors that a new measurement could be used to inform boards of directors what others think about them. As the data was analyzed, it was clear the results were instructional and constructive for its implications to directors and the C-suite at large. “There are always lessons to be drawn from challenging times, and today is no exception,” says Ray Lewis, managing partner, Deloitte LLP’s Center for Corporate Governance. “There are areas that proactive boards will focus on improving, whether they are about processes, sensitivities, or simply risk vs. reward metrics. In reviewing the data, we cannot predict whether societal attitudes will change quickly upon recovery or whether this is a longer-term shift. But providing directors and CEOs with a deeper understanding of the environment in which we are working is an important step.”

The institutions and organizations that share a commitment to good corporate governance are well aware of a shift in the public’s perception about boards and business, and have already taken action to address the issue proactively. In the fall of 2008, for example, the National Association of Corporate Directors (co-publisher of NACD Directorship) released Key Agreed Principles to Strengthen Corporate Governance for U.S. Publicly Traded Companies to show that boards are “leading the way” in restoring public and investor confidence in American boardrooms and C-suites. The initiative has led to a series of white papers, peer-to-peer meetings and, most recently, a Blue Ribbon Commission on Risk Governance.

Directors should also be willing to engage in a role that helps shape public opinion, says Steve Mader, vice chairman and managing director, of Korn/Ferry, if for no other reason than it is good for business. “We spend all our time on shipwrecks. Few would dispute that based on results, a small number of boards did not perform for their shareholders and their companies,” Mader says. “But my point is everyone, and especially directors, should join in the fight to shape public opinion rather than allowing it to be shaped for them. In the capital markets, value goes up and down by trillions of dollars driven by simple sentiment. That’s a trillion-dollar capital-formation challenge every morning.”

Seeking Answers
The specific objective of “What Society Thinks?” was to distinguish the views of   select groups on a variety of board-specific topics now the subject of intense debate, study, media attention, and regulation: for example, public opinion on issues ranging from accountability and transparency to environmental and social responsibility. Also examined was how well society understands the board’s role in dealing with issues such as corporate governance, compensation, labor, ethics, risk management, and the environment. How does society perceive the board’s role vs. the CEO? And how do the board and management see themselves in these contexts? These are the questions that the research set out to explore. “The intensity of negative publicity around American business, particularly in the automotive and financial-services sectors, has created a ripple effect at the corporate-governance level,” says Nels Olson, managing director of Korn/Ferry’s Eastern region and senior client partner in the CEO and Board Services practice. “On an annual basis, Korn/Ferry advises hundreds of boards on their composition and the selection of new directors. At the end of the day, consumers are the shareholders and we need to understand their perceptions, so we can properly guide our clients.”

The Directorship/Deloitte survey was organized into five broad categories: board duties and compensation, board responsibilities, opinion of board directors and CEOs, the economic crisis, and director and CEO compensation. In all, 39 questions were asked, including:

• How would you assess the credibility of board directors and CEOs today and how effective have they been during the economic crisis?

• Did CEOs and directors adhere to good corporate governance standards?

• How many hours do directors work and how much should they work?

• Is what directors and CEOs get paid fair?

• Should CEO compensation be capped and tied to company performance?

• How familiar are different constituencies with the responsibilities of a public-company board director?

• Should the role of the chairman and CEO be separated?

• What motivates CEO performance?

• Was criticism in the media of board directors during the economic crisis fair?

• Was criticism in the media of CEOs fair?

• Who was most responsible for the economic crisis?
  ]]> http://www.directorship.com/main-street-meets-c-suite/feed/ 1 http://www.directorship.com/2009-directorship-100/ http://www.directorship.com/2009-directorship-100/#comments Wed, 14 Oct 2009 19:50:09 +0000 Directorship Editors http://www.directorship.com/?p=11149 Welcome to the third edition of the Directorship 100, the who’s who of the corporate governance community, or, more accurately defined, the most influential people in the boardroom. When we set out three years ago to identify those 100 individuals who exert the most profound influence on the boardroom agenda, it seemed like a daunting task: so many stakeholders in business, government, and the shareholder community, but too few places on the roster by order of magnitude.

  What we also discovered in putting the list together was that in some instances, it became impossible to separate the captain from the team. This year’s D100 is a case in point: Our editors and board of advisors were nearly unanimous in our selection of President Barack Obama as this year’s most powerful corporate governance influence. And yet, to do justice to the seismic shift his policies have brought about in the boardroom, we also had to recognize the many other  “New Voices” in the Administration who are now leading the greatest financial reform of American business since the 1930s.

  So, we ask that in the pages ahead you pay more attention to who counts, and less to how we count, in arriving at our final selection of individuals and institutions that have met the requirement to be “most influential.” We think you’ll agree it’s an intricate and impressive mosaic where the whole equals much more than the sum of its parts, which may or may not be greater than 100.

  Regulators & Rulemakers

  Team Obama
  It is often written that reasonable people may disagree, and with Americans and their Presidents, it is practically a way of life. But even an unreasonable person could only conclude that this President and his Administration are having a profound and lasting influence over the boardroom. President Barack Obama has demonstrated an enormous capacity for calm in uncertain times. His relative youth leads to frequent comparisons to John F. Kennedy and his communications skills to those of Ronald Reagan. But it is his aggressive response to the unparalleled economic challenges that greeted him at the dawn of his young presidency that harkens back to an earlier figure of towering influence,  Franklin D. Roosevelt.

  FDR’s massive social and financial reform programs—the creation of Social Security as part of the New Deal, the establishment of the Securities and Exchange Commission (SEC) and the Federal Deposit Insurance Company (FDIC)—helped restore confidence in the nation’s banking system coming out of the Great Depression. One could plausibly take major portions of FDR’s New Deal and substitute his name with President Obama’s.  The implementation of the $787-billion American Economic Recovery Act one month after Obama took office, coupled with his handling of the Troubled Asset Relief Program (TARP), which sought to strengthen the financial sector by buying up the assets and equity from troubled banks, has clearly helped the nation avoid further financial disaster and put the economy on the path to recovery.

  And finally, turning again to the FDR playbook, Obama assembled a team of wise men and women, formidable economic and business minds, whose decisions are having a lasting effect on the role of the corporate director. Preeminent among them was the choice of Rahm Emanuel as chief of staff. Described as a veritable “influence machine,” within the Administration and Congress, the former Congressman from Obama’s home state of Illinois is known as a hard-charging, brutally candid, sometimes combative, acutely intelligent man who can get things done and knows the ways of the Capitol and the boardroom.

  The Enforcers
  Perhaps second only to Obama in terms of her influence on boards and corporate governance, career regulator Mary Schapiro heads up the 75-year-old SEC. Before the crisis, the agency’s very existence was in question: “Obsolete,” “out of touch,” and “behind the times” were just some of the many terms uttered by detractors. The Commission, under former chairman Christopher Cox, was pilloried for missing the Madoff scandal.

  As former SEC chairman and Directorship 100 Hall of Famer, Arthur Levitt described her: “She has the skills, the intellect, and the character to be a superb SEC chair.” But Schapiro will face a new kind of challenge in the role, not just that of proving her own qualifications, but also instituting a significant remodeling of the SEC itself, as she works to bring it into the new regulatory era.

  Moving swiftly to address regulatory concerns in the wake of the financial crisis, the SEC has rolled out a series of proposals that could embody the biggest change to the rules of the game for directors in some time. Schapiro, who is no stranger to the boardroom, having served on the boards of Duke Energy and Kraft Foods, has overseen proposed rule changes on proxy access, broker voting, say on pay, and new requirements for disclosure on executive compensation and director qualifications. It’s now up to her and fellow commissioners Kathleen Casey, Elisse Walter, Luis Aguilar, and Troy Paredes to determine the final regulations that emerge from the proposals.

  Other key players Schapiro has brought into the SEC include Senior Advisor Kayla Gillan, Chief Accountant James Kroeker, and Director of Enforcement Robert Khuzami. Gillan was a founding board member of the Public Company Accounting Oversight Board (PCAOB) and former general counsel to CalPERS. Kroeker joined the SEC as deputy chief accountant in 2007 from Deloitte and Touche where he had been a partner in the firm’s national accounting services group. Kroeker recently said that the proposed road map for the convergence of International Financial Reporting Standards,pushed to the back burner amid the larger issues of market reform, would be restored as another top priority. Khuzami is a former federal prosecutor, has pledged to improve the SEC’s enforcement performance by creating specialized units to provide “structure and resources for staff to ‘get smart’ about certain products, markets, regulatory regimes, practices and transactions.”

  TARP Overseers
  Another example of Obama’s preference for brains over politics was his reappointment of Sheila Bair to chair the FDIC. Another fiscally conservative Republican, on Bair’s watch alone this year, 94 banks have failed, creating a new challenge:  how to replenish the fund. Bair has also been an integral part of the team overseeing TARP. Neil Barofsky is a former New York assistant attorney general confirmed by the Senate in December as special inspector general. Dubbed the “TARP Cop,” his job is to figure out how and where the $700-billion TARP funds are spent, reporting directly to the President and providing updates to the Congressional Oversight Panel chaired by bankruptcy expert and Harvard Law School professor, Elizabeth Warren. COP’s first report, released in February, casti-  gated then-Treasury Secretary Henry Paulson for his performance and lack of transparency, reporting that the Treasury Department  had overpaid by $78 billion for the assets it bought from banks.

  Interestingly, while Obama sponsored and was a strong proponent of  “say on pay” legislation while a senator, since appointing Kenneth Feinberg special master of compensation, he has appeared unwilling to make the issue a top priority. Feinberg, who has immersed himself in some of the country’s most troublesome and high-profile cases, is considered a superb choice, both in terms of skill and temperament, by Capitol Hill insiders. His most noteworthy case was the 33 months of pro-bono work he did following the 2001 terrorist attacks to determine how much each victim would receive from the federal government’s September 11th Victim Compensation Fund.

  Feinberg may in fact be perfectly suited for a job that most compensation specialists see as thankless, and possibly as a “no win” situation. As the Obama Administration’s comp expert, Feinberg was called on to monitor the compensation of executives in what were once some of America’s most prestigious corporations, now TARP recipients, including American International Group (AIG), Bank of America, Citibank, Chrysler, GMAC, and General Motors.

  Fed to the Rescue
  To prevent American capitalism from spiraling deeper into the abyss, nine months after President Obama made his first Cabinet announcement, he re-nominated Ben Bernanke as Federal Reserve chairman. The former Princeton economics professor was selected by Bush in 2005 to succeed Alan Greenspan. In 2008 after the market crashed, Bernanke invoked emergency powers, slashed interest rates, and spent trillions of dollars to right the financial system. Just last month, he declared the recession “likely over.” Though he seldom gives interviews, Bernanke is never far from the public eye and has been a stalwart in the transition between presidential administrations and in the effort to stem the economic slide.

  When then President-elect Obama named his economics team, it included players who, like Bernanke, were already steeped in the crisis details, demonstrated a studied understanding of Depression-era economics, or some combination of both. Enter Treasury Secretary Timothy Geithner and Chief White House Economic Advisor Lawrence H. Summers. Geithner, who is currently pushing legislation to provide more systematic regulation of financial institutions, including new limits on executive compensation, recently told one interviewer that he is optimistic major reforms will be passed.

  Prior to his appointment replacing Henry Paulson, Geithner was president of the Federal Reserve Bank of New York and part of the team central to the critical negotiations that resulted in Bear Stearns being tucked into JPMorgan Chase, Merrill Lynch going to Bank of America, Lehman Bros. disappearing, and Citigroup and other struggling banks getting a lifeline.

  Summers, the former Harvard University economist who became its president following his tenure as Treasury Secretary to President Clinton, is director of the Cabinet’s National Economic Council. The group was established in 1993 to coordinate and ensure that the President’s economic policy agenda is carried out.

  Rounding out the team, Paul Volcker, the former Fed chief under Clinton, was selected to chair the president’s economic recovery advisory board. And Christina Romer, a former UC Berkeley economist, who administration sources suggest is well- regarded by both parties, chairs the Council of Economic Advisers. Her appointment was seen as a further triumph of brain over politics in Obama’s approach to talent recruitment.

  ]]> http://www.directorship.com/2009-directorship-100/feed/ 7 http://www.directorship.com/dynamic-duos/ http://www.directorship.com/dynamic-duos/#comments Fri, 04 Sep 2009 19:36:56 +0000 Django Gold http://www.directorship.com/?p=8952 >>]]> Sherlock Holmes had Dr. Watson and Michael Jordan had Scottie Pippen. The rest was history, of course. And while many mammoth corporate success stories are often the vision of a single captain of industry—a Henry Ford, a J.P.Morgan, or a Larry Ellison—in a few instances they are the work of a tagteam of individuals who complement each other’s strengths and may, just as importantly, sharpen each other’s instincts for distinguishing opportunities.

  Such is the case with the iconic business duos presented here. These eight famous pairings—one of them infamous for its failure in the final act—present a spectrum of the unique qualities and dynamic teamwork necessary for the effective management of extremely innovative, complex organizations. A variety of top-tier combinations reveal several variations on the theme that two heads are better than one: some, like Richard Sears and Julius Rosenwald, were marriages of necessity; others, such as Sanjay Jha and Greg Brown, co-CEOs of Motorola, were partnered in hopes of salvaging an ailing organization; still others, like Warren Buffett and Charlie Munger, seemed fated to cohabitate in the same corporate host.

  The delicate balance required for a successful top-level tandem power structure is no easy achievement, as evidenced by a string of dissolutions; keeping two big personalities in harmony requires a set of unique personality traits on both sides. “It all depends on how they behave and if they can keep their egos in check,” says Harvard Business School Professor Joseph Bower, author of The CEO Within. “It works remarkably well if you also have strong board members who are able to make it work.” The challenge, as Bower sees it, is living up to the age-old adage of “diversity in counsel, unity in command”: however many leaders a company has, it has to move forward decisively. But while having a single visionary at the helm is often just what a company requires, the breadth of experience and wisdom offered by a pair of equally guided leaders can also have its advantages. “As long as there is cooperation, a pair will bring greater assets than can come from one person’s intellect,” adds Bower.

  “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”  – Warren Buffett, chairman and CEO, Berkshire Hathaway

  Today’s activist shareholders urge boards and CEOs to seek a second opinion or appoint a devil’s advocate that can result in what some believe is a bifurcated structure, as evidenced by the recent push for splitting the roles of CEO and chairman. One of the common arguments for not splitting the roles is that it creates confusion about exactly who is in charge. Another is that it hinders the company’s leadership to communicate with one, clear voice. Yet another is that the two get in each other’s way, one reining in the other, forcing a compromised and dulled strategy. However, great business duos learn to sidestep these traps and work together for the greater good of the organization. They improve each other’s ideas without watering them down. They move in concert without stepping on each other’s toes.

  The question of what is the optimal executive leadership structure is one the board must answer and be answerable for (though many of the following examples took place before the boardroom had the significance it has today); a director could not find a better starting place from which to view the issue than by looking at the following examples of tandem business success.

  “Communication is the cornerstone,” says Belmont University Prof. Jeff Cornwall, who studies business organizational structure. “Successful partners are able to feel comfortable tackling difficult issues without being afraid of hurting each other’s feelings.” Certainly, when addressing high-impact challenges on a day-to-day basis, the best pairings have had a tendency to avoid sugarcoating the issues at hand, and a no-nonsense approach is also required. Says Cornwall, “Partners must have a similar work ethic, and they should have similar values, but not necessarily similar personalities.” Such advice, along with the examples offered below, affirms John Rockefeller’s maxim that friendship founded on business is preferable to business based on friendship. With such an appropriately sober attitude in mind—and with the implicit advice offered by history’s great duos—one should move confidently in building a capable leadership team.

  Warren Buffett and Charlie Munger: Berkshire Hathaway
  The partnership between Warren Buffett and Charlie Munger has been well documented throughout the pair’s 50-year professional relationship, but for traders, investors, and general profit-seekers at large, their formula for success remains elusive. In their leading roles at Berkshire Hathaway, the two have led investors (and themselves) to steady returns virtually unparalleled in the investment community. Their methods, as the two attest, are deceptively simple, yet their successes have been without peer.

  Buffett and Munger are unified in their ability to generate profit for investors in their funds, and the two men share similar investing values that revolve around the simple tactic of targeting undervalued assets and obtaining them. As Chairman and CEO Buffett put it in last year’s letter to shareholders, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” However, the individuals behind Berkshire’s success have demonstrated their unique characters, even as they have waged a common investment crusade. Buffett, with his tireless, common-sense approach to investing, his emphasis on wise governance, and his seemingly infinite humor and wisdom, is the prototype for would-be fund kings. His annual shareholder letters offer up world-class insight into the methods by which steady returns are generated, all tinged with the folksy warmth that is no small part of the man’s appeal.

  ]]> http://www.directorship.com/dynamic-duos/feed/ 4