Perhaps more than ever, the passion that today’s public boards bring to their roles intersects with shareholder scrutiny and regulatory reform at the increasingly transparent corner of corporate excellence—clearly seen through the prism of ROI, values and ethics.

Bottom line: This only works with the right board;  success continues by keeping the board’s mission aligned with corporate strategy.

“A board is a great gift on behalf of the shareholders,’’ says Theodore L. Dysart, a managing partner with Heidrick & Struggles, where he is a leader in the Global Board of Directors Practice. “These directors really want the best for the company.”

Sometimes, however, what’s best for the company is for a single director, or several, to step away to ensure the highest performing board possible.

Replacing directors is an evolving art laced with essences of traditional organizational skills, robust team building and effective leadership roles grounded in solid management science. The resulting best practice is the evolution of “relationship” boards into “skills and experience” boards.  This evolution also supports thoughtful, meaningful board-succession planning to support future strategic plans.

This requires a variety of new approaches to board composition, such as “recruiting skill sets versus recruiting names,” says Peter R. Gleason, managing director and CFO of the National Association of Corporate Directors (NACD). Other requirements include reducing experiential overlaps and closing professional gaps. “You have to constantly look at what you need and what you have” both in terms of immediate assessments and the changes and challenges forecast for the next two or three years for the corporation, Gleason says.

Since most boards have some latitude regarding their size, they don’t need to wait for a pending term limit to expire or the looming retirement of a current member to recruit the strategic expertise necessary for critical, long-term success. These boards also don’t need to be bound by a multi-month, if not multi-year, recruitment cycle for new board members.

“By staffing up, say from 12 to 15, a board may increase short term to get the skill sets necessary for the future,” explains Gleason. “Let’s say the corporation wants to expand into India next year. The board is going to want someone with multi-national experience. Planning for that ahead of time means going after a strategic expert in global management, knowing that someone else on the board, like a banker, will be retiring in a year or two.”

As executive compensation both in and out of the C-Suite continues to garner regulatory and shareholder interest, recruiting board members with extensive human-resources expertise is another key area of consideration. Directors who have HR experience “with internal performance metrics are critical moving forward,” Gleason says, especially as the Securities and Exchange Commission spotlights pay-for-performance and other executive compensation risks as mandatory reporting metrics.

With the SEC focusing more on disclosure rather than criteria of public board members, diversity is the hot-button issue when openings for directors occur, according to Edward H. Pendergast, president of Pendergast & Co., board chair of PLC Medical Systems, and an NACD faculty member.

“Diversity in the boardroom is looked at differently than diversity in the public,” where it usually refers to race, gender or ethnic backgrounds, says Pendergast, who serves on several public, private and non-profit boards. “In the boardroom, it is beyond that. It is about not having people from the same background. It used to be there would be seven CEOs on the board. No one from HR. No one from Techno-logy. No one from R&D. We need to look at diversity in every way. The ‘thinking’ boards are spending more time to find a director to fit their needs; someone who is honest, ethical and willing to take a contrarian position.”

This “patience vs. balance approach” gives the organization—whether a $2-million or a $2-billion corporation—the correct corporate governance model, bypassing short-term gain in favor of embedded fiduciary and risk oversight tied to individuals who foster an aggressive, value-driven and performance-oriented culture, and are knowledgeable and responsive to market forces.

So, given the “new normal” of the post-recession recovery, if it’s necessary to replace the entire board of a public company over the next three to four years, is it also possible?

Yes, according to Robert M. Galford, managing partner of the Center for Leading Organizations and chair of the compensation committee of Forrester Research. But it does take time to bring new members up to speed. What Galford suggests is that board chairs exercise a bit of creativity to rejuvenate current members while actively recruiting new members for the future.

“Boards get into patterns and into assigned roles,” Galford said. He urges directors to be bold and brave: “Ask the C-Suite what it would like to see from its board.”

Galford also recommends occasionally ditching the C-Suite to allow board members direct contact with middle managers and other high-potential employees in an informal setting. One way of accomplishing this, he says, is to politely disinvite the C-level—except maybe the chief counsel, as lawyers like to say, out of an abundance of caution—from the dinners that are often held the night before a quarterly board meeting. Then invite the “skip-down” crowd to meet with the board.

“Don’t have the ‘highfalutin’ there. Invite two to five employees per board member so the board sees more of the organization. This way, board members get a great deal of value unfiltered,” Galford says.

He also advocates that even experienced directors should participate in continuing education and executive leadership programs for public-board members.

“It’s very invigorating. [These programs] are surprisingly helpful. First, they calibrate your own point of view. Second, it gives you the ability to gain perspective on what’s on the horizon for boards in general. And, third, it is an opportunity to formally and informally hear from others about the issues that they are grappling with,” says Galford, who has more than a dozen years of public-board experience and is a faculty member for NACD’s customized education programs.

Over those 12 years, Galford says, board service has become “harder work, more work, more serious, more consequential. It may take awhile for board members to re-energize [as a result of educational and leadership programs] but once it works, the results are better returns for stakeholders and shareholders. It’s a fairly high return of investment…[a] tremendous return on costs that provide significant improvements. There’s very high ROI in this.”

This emphasis on board leadership demonstrates that boards are pro-actively refreshing and recruiting by considering individual skills and evaluating experience against corporate strategy. The results of these “skills and experience” boards: directors and managers are working together to achieve “constructive interaction” with a focus on activities that help the company maximize shareholder value.

The accounting and audit firm outlines the roles and responsibilities of being a member of a volunteer organization. This handbook, one in a series, includes both advice on recruiting new board members and the role of the board. It covers topics such as liability and accountability, financial stewardship and need-to-know tax information and regulations.

The handbook also offers a step-by-step look at operating procedures for a not-for-profit board on subjects such as information flow, proper meeting prep and board selection. Acting as a unit, each board member fulfills several functions, and demands on the board members of not-for-profit organizations are mounting.

Grant Thornton’s handbook  is designed to help board members understand these demands and the ways to meet them.

Click here to read the not-for-profit board member handbook.

This is an excerpt of Surviving and Thriving in Uncertainty, Creating the Risk Intelligent Enterprise by Frederick Funston and Stephen Wagner (Wiley Books, 2010).

Conventional risk management focused on asset protection, typically in the form of insurance. It was also believed that risks could be identified and managed within silos and that risk aversion would maximize shareholder value. Risk was typically seen as a cost, not an opportunity. Risk management programs took “one size fits all” forms. For these and many other reasons, conventional risk management has failed.

In the turbulent and uncertain 21st century, the buffers of space and time no longer exist. Information has become instantly available. It still confers power, but now everyone has it. Communities of interest can form overnight. Centralized control often fails in the face of turbulence. Fixing pieces no longer solves problems. Many assets are now intangible and cannot be protected in traditional ways. Many risk events are unknown and perhaps unknowable.

Surviving and thriving in uncertainty and turbulence requires unconventional thinking and calculated risk taking. The enterprise must be understood holistically and seen as a living organism. Risks must also be understood as opportunities that can be optimized or exploited, not just as costs. Risks must be viewed as interconnected and difficult to contain. Like wildfires, they cross boundaries and must be managed accordingly. If a risk is relevant and potentially life-threatening, be prepared for it.

Everything has changed but human nature. Judgment will always be difficult. The 21st century enterprise must develop a 21st century view of risk and risk management. Nearly all enterprises have certain characteristics in common. They all operate to a large degree in the same macro-economic environment. The “fatal flaws” and corresponding “risk intelligence skills” described in Part II apply almost universally.

That said, every enterprise is also unique and differs from all others in key ways. Every enterprise operates at a different stage of development. It possesses different skills, understanding, awareness, and culture. Each of these distinct characteristics must be considered carefully by leaders trying to improve risk intelligence, along with the unique benefits the enterprise can realize through that improvement.

The benefits of improved risk intelligence
Demonstrating the value of prevention is often difficult. It should be intuitively obvious that the improved ability to protect existing assets while more effectively managing the risks to future growth ought to improve the enterprise’s chances of survival and success. The enterprise that builds risk intelligence into the core ways of running its business can improve its resilience and agility and should realize the following benefits:

• Challenging basic business assumptions can help identify “Black Swans” provide first-mover advantage
• Defining the corporate risk appetite and risk tolerances can help reduce the risk of ruin
• Improving signal detection can provide advance warning and enable more proactive responses
• Identifying mission-critical interdependencies can help establish an appropriate margin of safety
• Anticipating potential causes of failure can improve chances of survival and success through improved preparedness
• Factoring in momentum and velocity can improve speed of response and recovery
• Verifying your sources and corroborating the reliability of information can improve insights for decision making and thus the quality of decisions
• Taking a longer-term perspective can aid in identifying the potential unintended consequences of short-term decisions
• Improving operational discipline helps sustain success
• Understanding the Total Cost of Risk (TCOR) can help demonstrate the value proposition and reduce the Cost of Failure while improving risk intelligent enterprise management

Making the transformation
Once the enterprise understands its current state of risk intelligence and the best opportunities for improvement, it needs a plan to close the gap and transform the way it comprehends and manages risks to value. It takes time and effort to become a risk intelligent enterprise.

Risk intelligence is not a status or designation that can be attained and then enjoyed ever more. Rather, it is a way of making better decisions amid uncertainty and under turbulent conditions. Thus, risk intelligence is not an end in itself but a way of doing business, not a goal but a developmental journey. By the same token, improving risk intelligence must be a deliberate and sustainable enterprise process, rather than a mere project.

Voice of experience
“To be successful, risk management has to be a core process of managing the enterprise, not merely a project. A lot of directors seem to think that because they devise a ‘strategy’ to deal with known risk, they’ve got a good handle on risk. My perception is that they don’t. Too often, all they want to do is identify the top 10 risks based on what people know. It’s a project approach—and that’s not what’s really needed. A systematized approach of understanding the most basic business assumptions has more long-lasting potential.”

—Larry Rittenberg, Professor and Chairman Emeritus, Committee of Sponsoring Organizations of the Treadway Commission (COSO)

Developing and applying the necessary supporting processes, systems, and tools enterprisewide requires a “fractal” approach, in which any part of the whole embodies the properties of the whole. That implies that skills, processes, systems, and tools are common at every organizational level.

To be effective, these processes, systems, and tools must be deployed throughout the enterprise and applied with discipline. Although they will be applied differently at different levels, if the skills, processes, systems, and tools work for senior executives and the board, then directors and executives should have confidence that they will work elsewhere. Also, as with any skills, the more you practice, the better you become—provided you practice properly and maintain discipline.

At its best, risk intelligence informs every area of the business at every level such that the practices become part of every function, strategy, initiative, decision, activity, and job. This entails making risk intelligence an organizational value on the order of practicing true customer focus or achieving high quality through zero defects.

Such values do not come about by themselves or by executive decree or through a one-shot training initiative, a short-term project, or a “check the box” approach. They come about because the board and management view them as worthwhile, practice them publicly, recognize them in compensation programs, and embed them in core processes and systems.

The transformation challenge
In many organizations, despite the number and severity of risk management failures, executives still remain unconvinced of the business case for improved risk intelligence and thus risk management. Given this, there are several possible explanations as to why transformation efforts may fail.

For starters, even though the greatest value of risk management is prevention and preparation, demonstrating its value in advance often proves daunting. People may say, “That can’t happen here,” or “It can’t happen again,” or “We’re too smart to let that happen to us.”

Voice of Experience
“People don’t see the need for prevention until it’s too late. Obviously when a crisis occurs, everyone recognizes the need; it’s self-evident. It ought to be obvious that prevention is less expensive and more effective than response and recovery. I’ve tried to create recognition of the need for prevention in stages by starting with a risk scan. Let’s make sure we understand the risks that we have in the organization and the need to take some actions to mitigate the risk, understand it more, and be more involved in what this looks like.”

–Suzanne Hopgood, director

Prevention, therefore, is much less likely to receive priority, especially when resources are scarce. A clear statement of the TCOR may be required to demonstrate the value of improved prevention and preparation. Even when executives are convinced of the value, those who try to implement a systematic approach may experience flawed or prolonged execution.

Generally, it is best to aim for rapid implementation by building more systematic consideration of risk to value directly into core business processes. Early wins are important to demonstrate value. Nothing succeeds like success, and word of mouth can aid implementation.

Lack of program management such as specific milestones and metrics as well as a failure to recognize the level of effort required can contribute to failed implementation. The implementation may also fail if the implementation team lacks dedicated, credible, and capable resources; if the vision and expectations are poorly communicated; and if the enterprise lacks a common language of risk. Difficulties in reconciling the different perspectives of various specialist silos also can result in a lack of cross-functional alignment and coordination.

Conclusion
The first part of this book addresses the reality that conventional risk management has failed. The 21st century enterprise requires an unconventional approach to the understanding and management of risk to value in times of uncertainty and turbulence. Because turbulence cannot be predicted or modeled, the enterprise needs to improve its vigilance and preparedness.

The second part of the book describes 10 risk intelligence skills that ought to be common to directors, officers, and employees even if the challenges and decisions they must make will be different. The development of these ten skills is, of course, no absolute guarantee of success. However, their absence is likely a harbinger of fatal flaws that could lead to the demise of the enterprise.

The third part of the book describes the characteristics of the risk intelligent enterprise and the responsibilities of directors, officers, and employees. It outlined steps that can be taken to improve risk intelligence. It also discussed some missteps that ought to be avoided.

While all these parts when taken together may seem to be onerous and costly, the reality is that decisions that affect the enterprise’s survival and success are made every day at every level of the enterprise. This is enterprise management.

Physicians Formula elected Thomas Lynch to its board of directors. Lynch is the founder and senior managing director of Mill Road Capital.

Errol Gillespie was appointed to the board at Estate Coffee Holdings. Gillespie, an expert in farm management and the coffee industry, is a former agronomy extension officer with the Coffee Industry Board in Jamaica.

William C. Mills joined Interleukin Genetics’ board. Mills is currently an independent venture capitalist.

Monster Worldwide named two new directors, Cynthia McCague and Jeffrey Rayport, to its board. McCague has more than 35 years of experience as a human resources professional. Rayport is currently a Partner at Castanea Partners.

Primerica named P. George Benson to its board. Benson has been president of the College of Charleston since February 2007.

Joseph P. Sullivan, former chairman and CEO of Protocare, joined CIGNA’s board. Sullivan currently serves as a director of Amylin Pharmaceuticals. He is also chairman of the board of advisors of RAND Health.

Diana R. Wetmore has been appointed vice president of business development and alliances at Emerald BioStructures. She previously served as vice president of alliance management at Cystic Fibrosis Foundation Therapeutics.

Henry Ruhnke Jr. joined the 1st Capital Bank board of directors. Ruhnke is a registered architect and a principal of Wald, Ruhnke & Dost Architects.

Landen Capital has named James C. Gervais to its board of directors. Gervais retired from the Canadian Forces as a Lieutenant General, the second highest rank in the Canadian military.

AcademixDirect has appointed Karen C. Francis as chairman and CEO. Francis was formerly chairman and CEO of Publicis & Hal Riney.

David H. B. Smith was elected to the board at Northern Trust. Smith is executive vice president of policy and legal affairs and general counsel at the Mutual Fund Directors Forum.

Vermillion named Sandra A. Gardiner vice president and CFO. Gardiner served as CFO of Bend Research.

Adriana Pozzani Lynch, founder of Pozzani & Associates, joined Arbonne International as senior vice president and chief marketing officer.

Urastar Energy has appointed Charles W. Reed to its board. Reed is a registered professional geologist with more than 40 years of work experience in the mining industry.

Now, since I last spoke here two years ago, our country has been through a terrible trial. More than 8 million people have lost their jobs. Countless small businesses have had to shut their doors. Trillions of dollars in savings have been lost — forcing seniors to put off retirement, young people to postpone college, entrepreneurs to give up on the dream of starting a company. And as a nation we were forced to take unprecedented steps to rescue the financial system and the broader economy.

Complete text of President Obama’s speech on Wall Street reform yesterday at Cooper Union College.

And as a result of the decisions we made — some of which, let’s face it, were very unpopular — we are seeing hopeful signs. A little more than one year ago we were losing an average of 750,000 jobs each month. Today, America is adding jobs again. One year ago the economy was shrinking rapidly. Today the economy is growing. In fact, we’ve seen the fastest turnaround in growth in nearly three decades.

But you’re here and I’m here because we’ve got more work to do. Until this progress is felt not just on Wall Street but on Main Street we cannot be satisfied. Until the millions of our neighbors who are looking for work can find a job, and wages are growing at a meaningful pace, we may be able to claim a technical recovery — but we will not have truly recovered. And even as we seek to revive this economy, it’s also incumbent on us to rebuild it stronger than before. We don’t want an economy that has the same weaknesses that led to this crisis. And that means addressing some of the underlying problems that led to this turmoil and devastation in the first place.

Now, one of the most significant contributors to this recession was a financial crisis as dire as any we’ve known in generations — at least since the ’30s. And that crisis was born of a failure of responsibility — from Wall Street all the way to Washington — that brought down many of the world’s largest financial firms and nearly dragged our economy into a second Great Depression.

It was that failure of responsibility that I spoke about when I came to New York more than two years ago — before the worst of the crisis had unfolded. It was back in 2007. And I take no satisfaction in noting that my comments then have largely been borne out by the events that followed. But I repeat what I said then because it is essential that we learn the lessons from this crisis so we don’t doom ourselves to repeat it. And make no mistake, that is exactly what will happen if we allow this moment to pass — and that’s an outcome that is unacceptable to me and it’s unacceptable to you, the American people.

As I said on this stage two years ago, I believe in the power of the free market. I believe in a strong financial sector that helps people to raise capital and get loans and invest their savings. That’s part of what has made America what it is. But a free market was never meant to be a free license to take whatever you can get, however you can get it. That’s what happened too often in the years leading up to this crisis. Some — and let me be clear, not all — but some on Wall Street forgot that behind every dollar traded or leveraged there’s family looking to buy a house, or pay for an education, open a business, save for retirement. What happens on Wall Street has real consequences across the country, across our economy.

I’ve spoken before about the need to build a new foundation for economic growth in the 21st century. And given the importance of the financial sector, Wall Street reform is an absolutely essential part of that foundation. Without it, our house will continue to sit on shifting sands, and our families, businesses, and the global economy will be vulnerable to future crises. That’s why I feel so strongly that we need to enact a set of updated, commonsense rules to ensure accountability on Wall Street and to protect consumers in our financial system.

Now, here’s the good news: A comprehensive plan to achieve these reforms has already passed the House of Representatives.  A Senate version is currently being debated, drawing on ideas from Democrats and Republicans. Both bills represent significant improvement on the flawed rules that we have in place today, despite the furious effort of industry lobbyists to shape this legislation to their special interests.

And for those of you in the financial sector I’m sure that some of these lobbyists work for you and they’re doing what they are being paid to do. But I’m here today specifically — when I speak to the titans of industry here — because I want to urge you to join us, instead of fighting us in this effort.  I’m here because I believe that these reforms are, in the end, not only in the best interest of our country, but in the best interest of the financial sector. And I’m here to explain what reform will look like, and why it matters.

Now, first, the bill being considered in the Senate would create what we did not have before, and that is a way to protect the financial system and the broader economy and American taxpayers in the event that a large financial firm begins to fail. If there’s a Lehmans or an AIG, how can we respond in a way that doesn’t force taxpayers to pick up the tab or, alternatively, could bring down the whole system.

In an ordinary local bank when it approaches insolvency, we’ve got a process, an orderly process through the FDIC, that ensures that depositors are protected, maintains confidence in the banking system, and it works. Customers and taxpayers are protected and owners and management lose their equity. But we don’t have that kind of process designed to contain the failure of a Lehman Brothers or any of the largest and most interconnected financial firms in our country.

That’s why, when this crisis began, crucial decisions about what would happen to some of the world’s biggest companies — companies employing tens of thousands of people and holding hundreds of billions of dollars in assets — had to take place in hurried discussions in the middle of the night. And that’s why, to save the entire economy from an even worse catastrophe, we had to deploy taxpayer dollars. Now, much of that money has now been paid back and my administration has proposed a fee to be paid by large financial firms to recover all the money, every dime, because the American people should never have been put in that position in the first place.

But this is why we need a system to shut these firms down with the least amount of collateral damage to innocent people and innocent businesses. And from the start, I’ve insisted that the financial industry, not taxpayers, shoulder the costs in the event that a large financial company should falter. The goal is to make certain that taxpayers are never again on the hook because a firm is deemed “too big to fail.”

Now, there’s a legitimate debate taking place about how best to ensure taxpayers are held harmless in this process. And that’s a legitimate debate, and I encourage that debate. But what’s not legitimate is to suggest that somehow the legislation being proposed is going to encourage future taxpayer bailouts, as some have claimed. That makes for a good sound bite, but it’s not factually accurate. It is not true. (Applause.) In fact, the system as it stands — the system as it stands is what led to a series of massive, costly taxpayer bailouts. And it’s only with reform that we can avoid a similar outcome in the future. In other words, a vote for reform is a vote to put a stop to taxpayer-funded bailouts. That’s the truth. End of story. And nobody should be fooled in this debate.

By the way, these changes have the added benefit of creating incentives within the industry to ensure that no one company can ever threaten to bring down the whole economy.

To that end, the bill would also enact what’s known as the Volcker Rule — and there’s a tall guy sitting in the front row here, Paul Volcker  — who we named it after. And it does something very simple: It places some limits on the size of banks and the kinds of risks that banking institutions can take. This will not only safeguard our system against crises, this will also make our system stronger and more competitive by instilling confidence here at home and across the globe. Markets depend on that confidence. Part of what led to the turmoil of the past two years was that in the absence of clear rules and sound practices, people didn’t trust that our system was one in which it was safe to invest or lend. As we’ve seen, that harms all of us.

So by enacting these reforms, we’ll help ensure that our financial system — and our economy — continues to be the envy of the world. That’s the first thing, making sure that we can wind down one firm if it gets into trouble without bringing the whole system down or forcing taxpayers to fund a bailout.

Number two, reform would bring new transparency to many financial markets. As you know, part of what led to this crisis was firms like AIG and others who were making huge and risky bets, using derivatives and other complicated financial instruments, in ways that defied accountability, or even common sense. In fact, many practices were so opaque, so confusing, so complex that the people inside the firms didn’t understand them, much less those who were charged with overseeing them. They weren’t fully aware of the massive bets that were being placed. That’s what led Warren Buffett to describe derivatives that were bought and sold with little oversight as “financial weapons of mass destruction.” That’s what he called them. And that’s why reform will rein in excess and help ensure that these kinds of transactions take place in the light of day.

Now, there’s been a great deal of concern about these changes. So I want to reiterate: There is a legitimate role for these financial instruments in our economy. They can help allay risk and spur investment. And there are a lot of companies that use these instruments to that legitimate end — they are managing exposure to fluctuating prices or currencies, fluctuating markets. For example, a business might hedge against rising oil prices by buying a financial product to secure stable fuel costs, so an airlines might have an interest in locking in a decent price. That’s how markets are supposed to work. The problem is these markets operated in the shadows of our economy, invisible to regulators, invisible to the public. So reckless practices were rampant. Risks accrued until they threatened our entire financial system.
And that’s why these reforms are designed to respect legitimate activities but prevent reckless risk taking. That’s why we want to ensure that financial products like standardized derivatives are traded out in the open, in the full view of businesses, investors, and those charged with oversight.

And I was encouraged to see a Republican senator join with Democrats this week in moving forward on this issue. That’s a good sign. That’s a good sign. For without action, we’ll continue to see what amounts to highly-leveraged, loosely monitored gambling in our financial system, putting taxpayers and the economy in jeopardy. And the only people who ought to fear the kind of oversight and transparency that we’re proposing are those whose conduct will fail this scrutiny.

Third, this plan would enact the strongest consumer financial protections ever. And that’s absolutely necessary because this financial crisis wasn’t just the result of decisions made in the executive suites on Wall Street; it was also the result of decisions made around kitchen tables across America, by folks who took on mortgages and credit cards and auto loans. And while it’s true that many Americans took on financial obligations that they knew or should have known they could not have afforded, millions of others were, frankly, duped. They were misled by deceptive terms and conditions, buried deep in the fine print.

And while a few companies made out like bandits by exploiting their customers, our entire economy was made more vulnerable. Millions of people have now lost their homes. Tens of millions more have lost value in their homes. Just about every sector of our economy has felt the pain, whether you’re paving driveways in Arizona, or selling houses in Ohio, or you’re doing home repairs in California, or you’re using your home equity to start a small business in Florida.

That’s why we need to give consumers more protection and more power in our financial system. This is not about stifling competition, stifling innovation; it’s just the opposite. With a dedicated agency setting ground rules and looking out for ordinary people in our financial system, we will empower consumers with clear and concise information when they’re making financial decisions. So instead of competing to offer confusing products, companies will compete the old-fashioned way, by offering better products. And that will mean more choices for consumers, more opportunities for businesses, and more stability in our financial system. And unless your business model depends on bilking people, there is little to fear from these new rules.

Number four, the last key component of reform. These Wall Street reforms will give shareholders new power in the financial system. They will get what we call a say on pay, a voice with respect to the salaries and bonuses awarded to top executives. And the SEC will have the authority to give shareholders more say in corporate elections, so that investors and pension holders have a stronger role in determining who manages the company in which they’ve placed their savings.

Now, Americans don’t begrudge anybody for success when that success is earned. But when we read in the past, and sometimes in the present, about enormous executive bonuses at firms — even as they’re relying on assistance from taxpayers or they’re taking huge risks that threaten the system as a whole or their company is doing badly — it offends our fundamental values.

Not only that, some of the salaries and bonuses that we’ve seen creates perverse incentives to take reckless risks that contributed to the crisis. It’s what helped lead to a relentless focus on a company’s next quarter, to the detriment of its next year or its next decade. And it led to a situation in which folks with the most to lose — stock and pension holders — had the least to say in the process. And that has to change.

Let me close by saying this. I have laid out a set of Wall Street reforms. These are reforms that would put an end to taxpayer bailouts; that would bring complex financial dealings out of the shadows; that would protect consumers; and that would give shareholders more power in the financial system. But let’s face it, we also need reform in Washington.  And the debate — the debate over these changes is a perfect example.

I mean, we have seen battalions of financial industry lobbyists descending on Capitol Hill, firms spending millions to influence the outcome of this debate. We’ve seen misleading arguments and attacks that are designed not to improve the bill but to weaken or to kill it. We’ve seen a bipartisan process buckle under the weight of these withering forces, even as we’ve produced a proposal that by all accounts is a commonsense, reasonable, non-ideological approach to target the root problems that led to the turmoil in our financial sector and ultimately in our entire economy.

So we’ve seen business as usual in Washington, but I believe we can and must put this kind of cynical politics aside. We’ve got to put an end to it. That’s why I’m here today. That’s why I’m here today.

And to those of you who are in the financial sector, let me say this, we will not always see eye to eye. We will not always agree. But that doesn’t mean that we’ve got to choose between two extremes. We do not have to choose between markets that are unfettered by even modest protections against crisis, or markets that are stymied by onerous rules that suppress enterprise and innovation. That is a false choice. And we need no more proof than the crisis that we’ve just been through.

You see, there has always been a tension between the desire to allow markets to function without interference and the absolute necessity of rules to prevent markets from falling out of kilter. But managing that tension, one that we’ve debated since the founding of this nation, is what has allowed our country to keep up with a changing world. For in taking up this debate, in figuring out how to apply well-worn principles with each new age, we ensure that we don’t tip too far one way or the other — that our democracy remains as dynamic and our economy remains as dynamic as it has in the past. So, yes, this debate can be contentious. It can be heated. But in the end it serves only to make our country stronger. It has allowed us to adapt and to thrive.

And I read a report recently that I think fairly illustrates this point. It’s from Time magazine. I’m going to quote: “Through the great banking houses of Manhattan last week ran wild-eyed alarm. Big bankers stared at one another in anger and astonishment. A bill just passed… would rivet upon their institutions what they considered a monstrous system… such a system, they felt, would not only rob them of their pride of profession but would reduce all U.S. banking to its lowest level.” That appeared in Time magazine in June of 1933.  The system that caused so much consternation, so much concern was the Federal Deposit Insurance Corporation, also known as the FDIC, an institution that has successfully secured the deposits of generations of Americans.

In the end, our system only works — our markets are only free — when there are basic safeguards that prevent abuse, that check excesses, that ensure that it is more profitable to play by the rules than to game the system. And that is what the reforms we’ve been proposing are designed to achieve — no more, no less. And because that is how we will ensure that our economy works for consumers, that it works for investors, and that it works for financial institutions — in other words, that it works for all of us — that’s why we’re working so hard to get this stuff passed.

This is the central lesson not only of this crisis but of our history. It’s what I said when I spoke here two years ago. Because ultimately, there is no dividing line between Main Street and Wall Street. We will rise or we will fall together as one nation.  And that is why I urge all of you to join me. I urge all of you to join me, to join those who are seeking to pass these commonsense reforms. And for those of you in the financial industry, I urge you to join me not only because it is in the interest of your industry, but also because it’s in the interest of your country.

Craig Mataczynski has joined Vulcan Power as CEO. Mataczynski is the former CEO of Renewable Energy Systems Americas.

Constellation Brands elected Jerry Fowden to its board . Fowden is CEO of Cott.

Intelligent Communication Enterprise has appointed Nelson Wu to its board as a non-executive director. Wu is the general manager of business development at Hin Leong Trading in Singapore.

Michael J. Somers was elected to the board of directors at Willis. Somers was formerly CEO of the Irish National Treasury Management Agency.

Central Garden & Pet named John Ranelli to its board of directors. Ranelli previously served as CEO and president of Mikasa.

Highlights of the SEC Guidance
The SEC guidance highlights four ways in which climate change may trigger disclosure obligations:

1. Impact of international climate change accords; Indirect consequences of climate change regulation or resulting business trends, such as (a) decreased demand for carbon-intensive goods and services related to carbon-based energy sources and a corresponding increased demand for goods and services with a low carbon footprint, (b) increased competition to develop innovative products, and (c) increased demand for alternative energy sources;
2. Physical impacts of climate change, such as (a) property damage and disruption to operations on coastlines as a result of rising sea levels or severe weather, (b) indirect financial and operational impacts from disruptions to operations of major customers or suppliers from severe weather, (c) decreased agricultural production in areas affected by weather-related changes, and (d) increased insurance claims, premiums and deductibles for public companies with facilities in areas subject to severe weather.

If material to a registrant’s business, disclosure of the foregoing potential impacts of climate change may be required under Regulation S-K, specifically Item 101 (description of business), Item 103 (legal proceedings), Item 303 (management discussion and analysis) or Item 503(c) (risk factors).

Implications of the SEC Guidance
Public companies should keep the following issues in mind in preparing their annual reports to shareholders, Form 10-Ks and other public filings.

• Consider both the risks and opportunities of climate change: Companies should not focus solely upon the risks of climate change, but also on the opportunities of climate change (such as sales of allowances in a cap and trade system or increased demand for products with a low carbon footprint).
• Consider both indirect and direct risks and opportunities of climate change: The SEC Guidance provides examples of direct climate change risks (such as potential physical impacts or costs to improve facilities) as well as indirect risks and opportunities (such as changing demand for certain goods and services or reputational harm).
• Resolve doubts concerning the materiality of climate change in favor of disclosure: Although the SEC Guidance does not alter the traditional standard of “materiality” — which requires disclosure if a reasonable investor would view the information as important in making an investment decision — doubts whether information is material should be resolved in favor of disclosure.
• Ensure that adequate disclosure controls and procedures are in place to evaluate the materiality of climate change issues: The SEC Guidance does not require public companies to disclose their carbon footprint, but management needs sufficient information concerning greenhouse gas emissions and related operational matters to evaluate the likelihood of a material effect. Therefore, companies must have adequate controls and procedures to process information potentially subject to disclosure. Such controls and procedures should already be in place for management to make required certifications under Sarbanes-Oxley, but disclosure committees should now add an assessment of the materiality of climate change issues to the company’s business.
• Reconcile voluntary and mandatory disclosure of climate change issues: Many public companies voluntarily disclose information regarding their greenhouse gas emissions and climate change risk in corporate sustainability reports and various greenhouse gas reporting programs, such as the Climate Registry, the Carbon Disclosure Project and the Global Reporting Initiative. Companies should ensure that any mandatory SEC disclosure is consistent with prior voluntary disclosure or be prepared to explain any differences.

Richard M. Schwartz is a litigation partner and head of the environmental practice group in the New York office of Fried, Frank, Harris, Shriver & Jacobson LLP. Donna Mussio is a senior associate in the environmental practice group. Coleman Kennedy, an associate in the environmental practice group, also contributed to the preparation of this article.

Ultralife has named Brigadier General, U.S. Army (Retired) Steven M. Anderson to its board. Anderson has more than 31 years of experience in U.S. Department of Defense operations.

Peter Frank has been named to the board at Viasystems. Frank is currently the president of GSC.

EDA Consortium elected six people to its board. Edmund Cheng, Dane Collins, Aart de Geus, John Kibarian, Alex Shubat and Ravi Subramanian all joined the board.

Weikang Bio-Technology has appointed Yvonne Zhang, Yilun Jin, Allen Zhang and Yan Huang to its board.

Generac elected David Ramon to its board. Ramon, formerly president and CEO of USA.NET, will serve on the audit committee.

ARIAD Pharmaceuticals named Robert Whelan Jr. to its board of directors. Whelan was a Fellow at the Harvard University Advanced Leadership Initiative from 2008-2009.

Julie England, former vice president and general manager of RFID at Texas Instruments, joined the board of directors at Intelleflex.

RailAmerica appointed Ray M. Robinson and John E. Giles to its board. Robinson is a former AT&T executive and Giles is RailAmerica’s president and CEO.

Sheli Z. Rosenberg was recently named to General Growth Properties’ board of directors. Rosenberg is the former president, CEO and vice chair of Equity Group Investments.

Conseco elected David K. Zwiener to its board of directors. Most recently,  Zwiener was CFO at Wachovia.

The sophistication of the perpetrators behind these and similar incidents has propelled the data security issue beyond the IT realm into the boardroom. Directors and officers must now make it their business to understand what information their com-pany holds, where it is located and how it is protected. Boards need to analyze the potential impact a breach could have on the organization, be part of the effort to design and implement a far-reaching program to prevent breaches and prepare the organization to respond properly if one occurs.

Navigating the Regulatory Environment
Responding to regulatory changes can be among the most complex pieces of the puzzle. Numerous federal and state regulations pertaining to data privacy and security have been enacted and more are in the pipeline. For companies that don’t keep pace with the fast-moving regulatory environment, it’s a minefield of rules that could erupt in fines, penalties—and substantial liability for your organization and its management. A sampling of recent regulatory standards follows:

• The Health Information Technology for Economic and Clinical Health Act
  A provision to the economic stimulus bill, the HITECH Act expands the privacy and security regulations of the Health Insurance Portability and Accountability Act (HIPAA) beyond the healthcare industry and health insurers to any business performing activities involving Protected Healthcare Information

• Payment Card Industry Data Security Standard
  Created by credit card associations to combat fraud, PCI-DSS requires all those in a card transaction stream, including merchants, processors, and acquiring banks, to implement controls to protect credit card data.

• The Federal Trade Commission (FTC) Red Flags Rule
  This rule requires creditors to implement a program that identifies and detects warning signs of identity theft before extending credit to customers.

• Massachusetts 201 CMR 17
  Some 45 states currently require companies to notify those affected by a data breach as soon as practicable. Massachusetts enacted the most sweeping state mandate to date, requiring any businesses handling personal information of state residents to proactively develop, execute and maintain a program to protect this information.

More than a Policy
Since traditional insurance typically does not respond to data security and privacy events, boards need to be proactive in ensuring that a comprehensive approach to mitigating breach exposures includes insurance.

Privacy and security liability insurance should expressly address both first-party and third-party costs associated with a breach incident. It should be underwritten by a carrier with relevant experience in the line and in-house IT specialists who speak the language of your company’s own data security team. Other important facets to look for in coverage include:

• A broad definition of “covered information,” including not only the personal and private information of individuals but confidential corporate data;

• Coverage for legal liability damages and defense costs, as well as regulatory actions, fines and penalties (as permissible by law); and

• Coverage for the myriad costs a company will incur to manage an incident. Also ask about coverage to notify victims in those few states that do not currently have breach notification laws; while not required, the gesture can create goodwill and keep incidents from escalating.

Once a proper plan and insurance are in place, sound corporate governance requires that you stay closely attuned to data security risk. If the data security issue is not handled properly, the stakes can be high, including directors, officers and corporate liability, exorbitant fines and penalties and damage to your company’s reputation. With policies and procedures to prevent and respond to incidents, broad-based insurance and ongoing monitoring of the risk and regulatory environment, your board can be confident that this governance duty is prudently addressed.

Mark Camillo is vice president of professional liability at Chartis. The views and opinions expressed herein are those of the author and do not necessarily reflect those of Chartis Inc. or its subsidiaries, business units or affiliates.

What has changed, dramatically, is the steady spotlight on compensation. In the current environment, companies are subjected to intense scrutiny:  by regulators, by the press and of course, by shareholder groups, who will increasingly have input on issues once the business of the board only. Nonetheless, companies must still vie for the best CEOs.

Everyone—candidates for CEO jobs included—realizes that the game has changed significantly when it comes to attracting top talent in a cost-constrained, highly sensitive environment. And no one, on the giving or the receiving end, wants to be in the position of defending a pay package that attracts the wrong kind of    attention. That does not mean, however, that companies will have to recruit less-than-ideal executives for the crucial top spot, nor does it mean the executives who are tapped for these ever-demanding positions will have to settle for less than they deserve. Both sides must recognize that the ground rules have changed and adjust accordingly.

Job one is finding the best possible CEO candidate through a rigorous and systematic search process. This is no time to lower expectations or requirements. As always, the board should start with the strategy of the company and determine the skills, experience and specific competencies required in the next CEO to ensure the success of the strategy.

When closing in on the best candidate for the position, it is advisable to candidly address compensation package-related issues with the individual. A number of features that were previously fixtures in CEO packages, including perks such as chauffeurs, bodyguards, club memberships and personal travel in corporate jets, are no longer acceptable. This will be no surprise even for candidates who may be leaving positions where these features are still in effect.

The board doing the hiring and the CEO being recruited will most likely agree to leave some traditional, commonly accepted practices behind, including many severance provisions which, while not forbidden outright, are now far more difficult to get compensation committees to approve. They represent a “red flag” and may make the company vulnerable to damaging criticism.

Clearly, there is a delicate balance to maintain when constructing a compensation package for a new CEO: one that is generous enough to attract the best candidate, yet is in tune with currently accepted practices and does not raise objections among influential and vocal groups. Given the fact that the board or compensation committee must be able to justify all elements of compensation packages, one increasingly acceptable way to structure compensation is with a strong pay-for-performance orientation. Particularly in the case of a new CEO, this approach is perceived as fair to all sides. Assuming the CEO delivers above-market performance for above-market compensation, there is more likely to be broad understanding and acceptance.

Boards simply cannot afford to be myopic when assembling compensation packages to attract CEOs. Boards have to be acutely aware of how compensation will be viewed from a distance, recognizing what is off the table and what is now considered acceptable. With thought and proper planning, boards will still be able to attract the best CEOs, even in a cost-constrained environment.

Nels Olson is managing director, Eastern Region, for Korn/Ferry International and senior client partner with the Board & CEO Services practice.

Given the pressures on management, internal controls, and financial-reporting systems in this environment, the audit committee’s role—and its effectiveness—will be pivotal. We recently spent two days talking with 120 audit committee members from around the United States—across industries, large- and mid-cap—about their top concerns and priorities, and what they see as keys to audit committee effectiveness going forward.

Not surprisingly, the three areas cited by conference attendees as the “top concerns” for 2010 are the uncertainties of the economic/legislative environments, risk management/oversight and financial communications.

Risk, uncertainty and the audit committee’s role. The search for top-line growth is a critical priority for companies today, and boards are mobilizing management to rethink the company’s strategy, stress-test the business model and address—head-on—the challenges of a low-growth environment. Audit committees are helping to “ignite” the conversation about where the risks are in this environment—whether it’s Foreign Corrupt Practices Act risk associated with the search for growth in emerging markets, or focusing internal audit on the risks associated with the company’s new strategic initiatives.

Audit committees are also rethinking their risk oversight role. While more and more boards are assuming oversight responsibility for strategic risks, some boards still see an expansive role for the audit committee, encompassing oversight of the company’s risk-management processes as well as key substantive areas of risk.

Others take a much more restrictive view, as one panelist noted: “The audit committee exists to deal with one very significant enterprise-wide risk, and that’s the risk of either fraudulent or erroneous financial reporting. That’s plenty.”

Deeper involvement in all financial communications. Audit committees are intensifying their focus on all financial communications—from earnings guidance and earnings press releases to the MD&A and other disclosures. Some companies have taken the financial crisis as an opportunity to either discontinue earnings guidance, or reconsider the types and frequency of guidance they provide.

Our discussions also pointed to the earnings press release as perhaps the most important communication to investors today: “It’s where the action is,” said one director. But earnings releases often pose more issues than 10-Qs, as they contain important business information that often does not come from the financial reporting system, is not audited, and is not subject to internal controls.

The dialogue also highlighted key disclosure areas the Securities and Exchange Commission will be focusing on in 2010, including new disclosures companies must make about how they address risk, compensation, leadership and other aspects of corporate governance.

And, of course, audit committees will need to stay focused on a number of key financial reporting issues that became particularly acute during the financial crisis, including fair value, goodwill and intangible impairments, pension assets and obligations, and tax valuation allowances.

Gauging the audit committee’s effectiveness. Given the challenges ahead, conference attendees emphasized the need for audit committees to take a close look at their effectiveness, to ensure the committee is focused on the right issues and is in a position to help lead the business forward. To this end, panelists highlighted a number of questions for audit committees to consider as they monitor their performance:

• Do we have the right people on the committee—directors who understand the business and are willing and able to ask the right questions?
• Is each member of the committee capable of understanding the financial reporting issues and complexities arising from the company’s business activities?
• Do we take an active role in determining the committee’s agenda and defining its information requirements?
• Do we insist on transparency—both internal transparency (between management and the audit committee) and external transparency?
• Do we speak our mind? Do we listen? Do we build consensus?
• Do we take a hard look at our committee’s performance, and assess the performance of individual committee members?

Mary Pat McCarthy is U.S. vice chair, KPMG, and executive director of KPMG’s Audit Committee Institute.

So, now it’s time to suit up and show up, right?

Not quite. There’s more. Gone are the days when the annual meeting was a “circus” for grandstanding on pet causes. Today’s shareholders are more sophisticated than ever, and their queries can be illuminating.

If you chair the board or a committee, you need to be ready to answer some challenging questions. Here are some concerns that are likely to surface.

Board chairs (and CEOs): Get ready for questions about anything under the sun ranging from the changing environment to the specifics of governance policies.

Audit committee chairs: Be ready to explain what you do to keep risk on the board’s discussion agenda. NACD’s recent Blue Ribbon Commission report on risk governance can help.

Compensation committee chairs: Be prepared to talk about pay for performance, as well as say on pay, and risk elements in compensation structures, per the SEC’s new disclosure requirements.

Governance committee chairs: Your focus must be on building a strong board. Be sure to get familiar with all the new disclosure enhancements now required—including how you consider “diversity” as you nominate directors. NACD’s reports and surveys support inclusion of diverse personal characteristics (traits such as race and gender) as well as professional background and competencies in building a strong board.

Effective board-shareholder communications is a governance cornerstone. It’s one of our 10 Key Agreed Principles, and the topic of a past Blue Ribbon Commission report. [Visit www.nacdonline.org.] It’s also the subject of an upcoming NACD tool focused on the new proxy disclosure enhancement rules.

Communication begins with you. Your engaged presence at an annual meeting—even if only as an intelligent listener—is a picture worth a thousand words. Suiting up and showing up is an important beginning. The rest is up to you.

Kenneth Daly is president and CEO of the National Association of Corporate Directors.

NACD’s Leading the Way initiative gives voice to the good work boards are doing to strengthen and restore confidence in corporate America. Participating boards agree to review their practices using the NACD Key Agreed Principles and are recognized for their leadership.

Learn more: Download the Principles at www.nacdonline.org/LeadingtheWay.

About NACD
The National Association of Corporate Directors, a nonprofit organization founded in 1977, is the country’s only membership organization devoted exclusively to improving corporate board performance. NACD conducts educational programs and standard-setting research, and provides information and guidance on a variety of board governance issues and practices. Membership comprises board members from U.S. and overseas companies, ranging from large publicly held corporations to small, private, and closely held businesses. With chapters in many major cities, NACD provides education and peer networking forums for members at both a national and local level. NACD offers the Certificate of Director Education, a voluntary development program for directors, and conducts the annual NACD Corporate Governance Conference convening and honoring exemplary directors.

Myth 1:
Widespread coverage about bonuses reflects grave concerns about corporate governance.

Truth:
Widespread coverage about bonuses is driven by resentment over certain people making much more than you or me.

Resentment has been focused on the big banks perceived to be responsible for the financial crisis, but has spread far beyond bankers to every highly paid executive. The root of this resentment is a populist sentiment that nobody can be worth millions of dollars.

Legitimate governance concerns exist regarding executive compensation, such as pay that is divorced from performance, or pay that encourages bad behavior. And taxpayers are certainly entitled to raise a fuss about high pay to individuals whose companies survived by the grace of government assistance. But none of these items, nor all of them together,  explains the number of headlines about executive pay. The outrage about bonuses is not the product of lofty governance concerns; it is the visceral reaction of an angry mob, encouraged by mass media trafficking in voyeurism and fanning envy in the guise of condemning greed. Those “obscene” payouts going to CEOs or bankers are the next best thing to putting pornography on the business pages.

Myth 2:
CEOs are overpaid because they are greedy

Truth:
CEOs are paid what they are because of what they can negotiate.

It’s easy to call someone else’s pursuit of self-interest greed (of course, we are never greedy pursuing our own interests), but that doesn’t provide a useful distinction in the context of compensation. Every one of us gets what we think we can when we are selling something important, whether it is our house, our car or our labor. CEOs happen to have a rare and valuable talent, and companies are bidding for it.

In negotiating their pay, CEOs are not just exercising their own greed; they are playing on the greed of the owners (or shareholders) to use them to get the highest returns possible. As in any other market transaction, greed is tempered by the fear that the deal might not get done, or might go badly.

Myth 3:
These are not market transactions. CEOs are taking advantage of pliant boards.

Truth:
Pliant boards cannot logically be responsible for high CEO pay.

The explosive growth in CEO pay over the last 20 years coincides with a huge shift of power from management to boards—a shift that is acknowledged by even the most vocal critics of CEO pay. Yet, the background assumption in virtually every report about executive compensation is that managerial power is to blame for CEO pay and steps must be taken to reduce or counteract that power.

Managerial power is real enough. Powerful CEOs are able to extract all manner of perks and privileges from their companies. But the fact that managerial power exists does not save it as the reason for high CEO pay. Quite the opposite; the trend in the shift of power towards directors is impossible to reconcile with the upward trend in executive pay. Any theory that assumes directors are systematically lazy, stupid or corrupt is impossible to reconcile with the experience of those of us who work with boards. In fact, directors are quite conscientious about their work. If anything, they are wary about overpaying the boss, and generally—though not always—able to impose whatever judgments they think necessary to keep that from happening.

Myth 4:
CEOs are overpaid.

Truth:
Some CEOs are overpaid, but most are underpaid relative to their contributions to their firms.

If the job is worth billions or tens of billions a year to the owner of the business, and the person they hire can do it just a little better than the next best person, then the owner can easily justify paying the best what would look like a fortune to the rest of us. Such a judgment can only be made by directors with the information and experience to do the job. That doesn’t guarantee that they will do it right, of course, but it is certain that nobody with less experience or information will do it better. Boards don’t have the luxury of their critics’ 20/20 hindsight.

Of course, some people don’t buy that anyone can be worth millions per year. Our society had to get over a similar hang-up about entrepreneurial wealth during the Carnegie and Rockefeller era before we came to accept the fortunes of Warren Buffett and Bill Gates. We got over Michael Jordan and Brad Pitt earning millions for their performances. We will get over it with top management,  too. For now, boards must cut through public cynicism to make difficult judgments about how much their top managers are worth to the company, just as a high-end property broker must judge the value of a prime location, or a master jeweler must appraise a rare gem.

Myth 5:
Perverse incentives in firms are a serious problem that brought our financial system to the verge of collapse.

Truth:
Perverse incentives primarily existed between firms, not within firms.

In 2008, the world discovered the “trader’s option,” i.e., traders make a fortune if they take big risks and win, or leave the shareholders (and, perhaps, taxpayers) holding the bag if they lose. Finance executives have known about the trader’s option for decades and had evolved ways to manage and contain it. What they couldn’t manage or contain, or clearly see, was the degree to which the incentives between firms had been thoroughly distorted by a policy of easy money, politically degraded lending standards and that black hole for questionable securitizations known as Fannie Mae and Freddie Mac. Bankers reacted to these incentives with their usual profit-seeking  behavior, including innovations that then enabled smart people to arbitrage these  politically created opportunities.

Lehman’s Dick Fuld and Bear Stearns’ Jimmy Cayne had no reason to encourage the behaviors that blew up their firms. A careful study of firm-level incentives was conducted by a pair of well-regarded academics from Switzerland and the United States. They compared the variable pay structure (bonus plans, long-term plans, etc.) of firms that got into trouble during the financial crisis with those that didn’t, and found exactly zero evidence that firm-level incentives were to blame.

Myth 6:
Bonus plans should pay out only if the company performs well.

Truth:
Not if “bonuses” are actually commissions, or rewards for managers saving their firms in a dismal market.

Where pay is intended to be largely variable, as it is in many trading, asset management or investment-banking jobs, then “bonus” is kind of a misnomer. Like a salesman who falls far short of his quota, he still deserves to be paid for the little revenue he brought in. His “bonus” could very well represent lower compensation than he could have made being entirely salaried versus commissioned. And how is it fair to deny a bonus to the person whose portfolio did not blow up in a catastrophic year, or to the investment banker who brought in clients under dismal economic conditions, possibly saving their institution from going under altogether?

If a company’s management team strongly outperforms its hapless peers in a down industry, should they get a bonus?  If a mediocre management team in a booming industry sees their profit and stock price jump, do they deserve a bonus?  Reasonable people could argue yes or no to either of these examples, but boards must decide these things all the time. An unforgiving critic can always claim that they got it wrong, even if there is no definitively correct answer.

Myth 7:
Boards should offer bonuses solely to align pay with performance, not as a way to simply get more money into management’s pocket.

Truth:
Boards could use bonuses, in part, as a cost-control measure rather than for pure alignment purposes.
Directors must always balance retention, alignment and cost control. For instance, Code 162(m) excludes pay above $1 million from being deducted from taxes.

“Performance-based pay” is exempted from that limit, with bonuses being the non-dilutive version of such pay. So, let’s say a manager can command a $3 million paycheck. The board could pay this executive $3 million in salary and have the shareholders eat about $700,000 in extra taxes, or they can try to save that tax by offering a $1 million salary and a $2 million bonus. Since this bonus is nominally “performance-based pay” one might reasonably ask, “How demanding is the performance to earn it?”

In the past, it might not have been truly at risk because the board was disguising fixed pay as a “bonus” to save on taxes. If they wished to place the bonus amount truly at risk, they would have to offer a higher target bonus, such as $3 million; investors would not accept additional risk without additional potential reward, and their managers are no different.

Boards will have to give up that ploy. They will either have to explicitly guarantee all $3 million and have shareholders eat the taxes, or they will have to pay a total target compensation of $4 million. Either way, the cost to shareholders will go up because directors, unlike their critics, must deal in trade-offs, and the nature of trade-offs is that you can’t get more of everything—retention, alignment, and lower costs—at the same time.

Don’t Yield, Explain
These myths originate in understandable antipathy toward people appearing to make big bucks, sometimes despite poor performance, especially when so many are experiencing difficult economic times. But corporate boards must use their best judgment to deal with compensation on a more economic and granular level. Of course,  directors can’t ignore what the media is reporting or what the critics are saying. But they should respond by engaging with the truth, instead of bending their pay programs to conform to a distortion of reality merely to throw off  the right “optics.”  Boards  that best balance these competing demands will likely oversee the strongest performing firms.

Marc Hodak is the managing director of Hodak Value Advisors and teaches corporate governance at New York University’s Leonard N. Stern School of Business.

Today, this notion of shareholder primacy is under attack from two directions.

The Legislative Attack
First is the legislative attack. The present economic crisis has precipitated a federal governmental response that may be harmful to this philosophy and ultimately  results in a scarcity of capital necessary to the success of our system. Regulators have been weakening the alignment of executive pay to stock price performance—a critical component in shareholder primacy. The economic stimulus bill signed into law by President Obama last year included a curb on performance-based pay for the most highly paid executives in firms receiving funds from the Troubled Assets Relief Program (TARP). Such pay cannot be more than one-third of the executive’s total compensation. To be sure, there are exemptions, including one for long-term restricted stock. Still, the law erodes shareholder primacy by weakening the link between executive pay and stock price performance. In doing so, a primary tenet of modern compensation philosophy has been upended—to relate executive pay to corporate performance to effectively align management and shareholder interests to result in ultimate corporate profitability and greater shareholder return. Limiting compensation in this manner suggests that the corporate goal is no longer greater shareholder value and return to the investor, but the preservation of the corporate status quo, ultimately harmful to investor interests.

The Academic Attack
Second is the intellectual attack. There has been some prominent academic support for the notion that corporate directors serve multiple stakeholders to an equivalent degree, rather than shareholders first and foremost. This school of thought says that directors serve the corporation, not its owners, and as such, directors serve multiple constituencies, including employees, customers and communities.

The legislators and scholars who are challenging shareholder primacy offer some intrinsically appealing ideas. One might be tempted to cheer for the legislators’ TARP restrictions, for who would not want to put an end to outrageously excessive compensation during a time of economic depression? And one might be easily drawn to give a sympathetic ear to scholars’ arguments for the stakeholder model of governance. After all, who does not want to honor those who toil for companies or who buy company goods? Who would cavalierly overlook the interests of one’s own hometown?

Why Preserve Primacy?
These attacks may be well armed with attractive arguments, but they are all the more dangerous.  In my view as a director and as a shareholder, it is urgently important to preserve the notion of shareholder primacy for five reasons.

1. Shareholder primacy is key to our entire capital system. Simply put, companies have three sources of capital: earnings, debt and equity. Weakening equity as a source of capital will force companies to rely increasingly on earnings or debt. Reliance on earnings has its limits, particularly for long-term investment, as earnings can be volatile and have a natural size limit. As for debt, it has its place, but the effects of overleverage can be disastrous. Equity is the answer for many corporations at various points in their life cycles.

2. Unless shareholders are protected, they will not invest and the economy will stagnate, contract, and ultimately grind to a halt. If we didn’t put shareholders’ interests first, investors simply would not invest and we would lose the capital vital to U.S. economic success.

3. The stakeholder system has numerous problems. As a famous corporate commentator used to say, “Even a broken watch gets the time right twice a day.” If boards of directors are responsible to multiple constituencies, directors will make decisions that will always benefit someone, but at the expense of the health of the corporation.
Furthermore, while the other stakeholders can protect themselves contractually, shareholders cannot—that is why we have a board that is elected by the shareholders. Shareholders are indeed the last “residual claimants” and in this lies their primacy from both a legal and economic perspective. Finally, obligations to multiple constituencies lessens managerial accountability, as even a bad decision may please someone— leading to inadequate management and corporate disaster.

4.  The argument and conflict between the shareholder primacy and stakeholder theories is more apparent than real. To maximize shareholder value, all of the stakeholders need to be content with corporate direction.

5. We have met the enemy and it is us. The investment class in this country is broad. In today’s world, most taxpayers are investors and every investor is a taxpayer. Most stakeholders are in fact shareholders. The largest owners of many companies are the employees, through their retirement plans.

Significance of Equity Pay
Perhaps the greatest proof of the importance of shareholder primacy comes from the realm of director compensation. Numerous studies have shown a correlation between good corporate performance and the receipt of director pay in stock. This was true two decades ago when I wrote about it in the Boston College Law Review, and it remains true today, as Sanjai Bhagat of the University of Colorado has confirmed with his extensive current studies—notably his December 2008 Columbia Law Review article (with co-authors) on “The Promise and Peril of Corporate Governance Indices.” Professor Bhagat and team ran every commonly measured governance variable and found only one that correlated to financial performance—and that was paying directors in stock. They wrote: “In sum, of all the measures of governance quality evaluated…only the outside directors’ stock ownership measure was related to multiple measures of performance, firms’ future accounting profitability and disciplinary management turnover upon poor performance.”

The image of battle may seem extreme, but much is at stake.  Looking back to eras before our own, we see investor protection as a motivating force in much of modern economic history, dating back at least as far as the era of joint stock-trading companies 400 years ago. Without exaggeration, one could say that the new world of America itself was founded on the principles that make equity capital possible. Do we want to cast this vital legacy aside for political expediency or correctness, however well meaning?

Independent, equity-holding boards, accountable first and foremost to investors in free elections, are the ultimate solution to the compensation controversy and the key to effective investor protection. As independent directors elected by shareholders and serving their collective interests, we are both the proof and the prize of shareholder primacy. We must  defend and serve this concept vigorously for the good of free enterprise and the future vibrancy of the American economy.

Charles M. Elson is the Edgar S. Woolard Jr. chair in corporate governance and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. He is a director of HealthSouth Corp.

There is a good likelihood that the PCAOB will replicate its prior behavior and adopt (or approve something similar to) the new audit standards, making them applicable to public company audits.  Further, major thrusts of the new audit standards are (i) to highlight the role and responsibility of management in the preparation of an entity’s financial statement and (ii) to encourage communication between the auditors of an entity and those charged with corporate governance.  It is inevitable that there will be extended, and more meaningful, discussions on a myriad of topics that are closely related to the entity’s financial statements.  Given this inevitability, it behooves directors to familiarize themselves with the more-interactive environment they are likely to encounter in the near-term future, since it will interwoven with the question of whether the directors have successfully discharged their fiduciary responsibilities.

The Genesis of Current Accounting Standards
The primary responsibility for generating auditing standards has fallen upon the American Institute of Certified Public Accountants (AICPA), since its predecessor American Institute of Accountants was appointed to that task by the Federal Reserve Board in 1917.  Since 1978, that task has been the province of the Auditing Standards Board (ASB), which is the senior technical committee of the AICPA. Over the years, the ASB and its predecessors have generated 120 Statements on Auditing Standards, which are included in the Codification of Statements on Auditing Standards and have come to be known as Generally Accepted Auditing Standards (GAAS).

By virtue of the Sarbanes-Oxley Act of 2002, the PCAOB assumed the responsibility for promulgating auditing standards relating to the financial statements of public companies.  With some exceptions, the PCAOB has adopted the pre-existing GAAS as its own.

The Need to Change Auditing Standards
An event that caused the ASB to decide to overhaul its auditing standards was globalization.  As entities become more multi-national, their various components became subject to the accounting and auditing rules of different jurisdictions.  In an attempt to address this hodge-podge, the International Auditing and Assurance Standards Board (IAASB) began to develop standards that it hoped would be applicable worldwide.  The AICPA, however, did not think it appropriate to blindly adopt auditing standards promulgated by an entity that lacked the background to fully understand the development of American audit standards.  Thus, the ASB was asked to converge U.S. GAAS with the international standards being developed to the extent possible so the two standards would be more consistent while allowing for divergence where appropriate.

Since a rewrite was necessary, the ASB decided that the rewrite should also include the concept of clarity.  As 120 standards had been developed over the years by different sets of people, it was felt that an overhaul, including the use of simpler language, would provide a more unified structure that was easier for an auditor to understand.

Also bearing directly on the clarity aspect of the project was the fact that the language used in the standards sometimes obscured the difference between mandatory requirements and applicable guidance.  Thus, the new standards were written in such a way as to clearly distinguish between the two.

By way of example, a comparison of the related parties standard is instructive.  The current standard, promulgated is 1983, is twelve paragraphs in length and it is accompanied by several auditing interpretations generated since.  The PCAOB standards are a virtually verbatim adoption.  By contrast, the proposed new standard is twenty-seven paragraphs in length, accompanied by 52 more paragraphs of applicable guidance.  As one might imagine, it is both more comprehensive and more specific.

The Roles of Those Charged With Governance
It has always been the auditor’s mantra that an entity’s financial statements are the primary responsibility of corporate management.  This makes perfect sense since the management chooses the accounting, develops applicable policies, hires the personnel to implement those policies, establishes and maintains internal controls and then supervises compliance.  While management responsibility is the basic premise on which an audit is conducted, mention was only sporadically made in GAAS since the focus was primarily on the auditor.  This has now changed.

The 10 bedrock auditing standards, which have been in existence over half-a-century, and which made no mention of management responsibility, will soon be extinct.  They are replaced by a Preface to the new Codification which in its second-numbered paragraph has a detailed explanation of why management responsibility is a basic audit premise.  Previously, the auditor was encouraged to discuss management responsibility before taking on an audit; now, the management’s acknowledgment of its responsibilities is a mandatory part of an engagement without which an audit cannot be undertaken.  The standard auditor’s report, which formerly made a generalized reference to management responsibility, will soon have a detailed explanation for the benefit of recipients.

In addition to this intensification of focus on management responsibilities, the new standards are rife with provisions encouraging a dialog (and sometimes providing a script) between the auditors and those charged with corporate governance, whenever certain issues arise.  Again illustrative is the proposed related party standard.  The basic premise is weaved into one of the application paragraphs, with an explanation as to why the premise is particularly important in the related party context.

How Changes Will Affect Outside Directors
The outside director will approve an audit engagement that acknowledges the role of management in the preparation of financial statements, and will receive an audit report that describes that role at length.  It will be impossible for that director to say, with any degree of plausibility, that he/she has no understanding of what that role might be.

Instead, that director would be best served by asking both management and auditor their respective understandings of that role, what policies, procedures, and internal controls are designed to assist in that role, and how well management is meeting those responsibilities.  Any unsatisfactory or inconsistent answer should be followed up, and a concise record should be made of the inquiries and responses to minimize future questions as to whether the directors had fulfilled their fiduciary responsibilities.

Similarly, the increased emphasis on communication between the auditors and those charged with corporate governance will undoubtedly result in more such communications.  As the ultimate stewards of the business entity, the directors can only discharge their fiduciary responsibilities by paying close attention to these discussions, resolving any issues that arise, and keeping a careful record of what has transpired.

Of course, one might say that a careful director would do all these things under the present standards, and one would be right.  The difference under the new standards is that these circumstances will arise more often.  The director should anticipate this development and decide what types of issues should be addressed, after consulting with counsel and consultants as appropriate.  The minefield of compliance with fiduciary responsibilities will be tricky and it is best to negotiate it with experienced assistance.

And properly addressing the issues that will be raised is important.  Obviously, it is important from a litigation possibility perspective and from the perspective of discharging fiduciary obligations; but it is also important from the perspective of fostering better management performance and more reliable financial statements.

Anthony Costantini, a New York-based partner of the law firm of Duane Morris LLP, recently completed a three-year term as a public member of the Auditing Standards Board.

A good compensation committee education process will to some extent include new as well as current members. New members can learn not only about the substance of the compensation system, but also the context for past compensation committee decisions. Current members will have an opportunity to take an inventory of the company’s executive compensation plans and decisions. Further, they will be forced to articulate answers to probing questions. Within this context, we suggest that the education process include the five components shown below, which we refer to as the ABCs of educating new compensation committee members

Explain the roles of the board, the committee, management and the compensation consultant.
Some aspects of this education could take place as part of the committee’s normal ongoing annual planning processes, while other aspects are better handled up front as a new committee member comes on board. Regardless of the timing of these components, we have outlined the specifics of each component, based on our experience with clients:

Articulate the company’s business strategy and performance and their link to executive pay.
Our view is that executive compensation should be a derivative of corporate strategy and should help drive value for shareholders. How a company creates economic value should have a direct impact on its executive compensation plans and policies including the pay mix, the selection of performance metrics and goal setting. The linkage between the company’s business strategy, performance and its executive compensation programs should be something that any compensation committee member, current or new, can readily explain to fellow board members, shareholders and executives.

Bring in current information on the external executive compensation environment.
The only thing constant in the world of executive compensation is change. For example, in December 2009 the SEC issued new disclosure rules, and RiskMetrics issued new proxy voting guidelines, both of which address the relationship between executive compensation and excessive risk taking behavior. It is critical that new compensation committee members be brought up to speed fast on what they need to know about the world around them. Farient suggests that compensation committees receive an environmental update as part of their annual compensation planning cycle, or more frequently if warranted by the pace of change. New committee members should be afforded this environmental update as early on in their service period as possible.

Catalog the company’s executive compensation strategy and programs.
Compensation committee members can’t be expected to remember every aspect of the company’s executive compensation programs. Therefore, we recommend that the salient aspects of the compensation strategy, programs and policies be summarized on a single sheet of paper. Farient has developed a tool for this purpose called the Executive Top Sheet. Our clients have found it to be a highly effective resource for current committee members, let alone new members, to refresh their knowledge of the company’s plans.

In addition we develop glossaries for our clients as a reference tool to ensure that there is a consistently high level of technical knowledge across all committee members. The need for a glossary has intensified due to the increase in the number of laws, regulations and accounting rules that are applicable to executive compensation and the proliferation of unique acronyms and language every company develops to describe its executive compensation objectives, philosophies, programs and policies. These glossaries typically cover:

• Definitions embedded in plan descriptions
• Tax provisions (162(m), 409A, 280G)
• Accounting provisions
• Disclosure requirements
• Long-term incentive valuation parameters

Discuss the degree to which the company’s performance and pay are aligned. “Aligned pay” occurs when total compensation, after performance has been factored in, is sensitive to company performance over time and reasonable relative to the market for executive talent given the performance delivered. Achieving alignment requires that compensation committees not only design performance-sensitive compensation plans, but also manage and administer them consistently over time. A pay system that is “designed to align” can still be misaligned if the committee makes exceptions to the plans or frequently changes the plans themselves. In the extreme, the company runs the risk of creating “runaway pay,” which could make it a target for shareholders, the public and possibly the government. New committee members always will inherit plans that were implemented and decisions that were taken prior to their joining the committee. New members deserve to know “what they’re getting into.”

To provide insight to new and current committee members alike, Farient has developed a simple visual called the Alignment Report. This report shows the degree to which performance, as indicated by three-year rolling Total Shareholder Return (TSR), drives reasonable Performance-Adjusted Compensation (PAC), and the extent to which the current pay system likely will achieve alignment going forward. Further, the Alignment Report can facilitate a robust discussion between current and new committee members as to potential changes in plan design or decision-making processes that can strengthen alignment going forward.

Explain the roles of the board, the committee, management and the compensation consultant. To ensure that committee members can adequately plan and prepare for meetings, we routinely help establish an annual planning calendar, as well as a roles matrix that clearly outlines the roles of the board, the committee, management and the compensation consultant. Together, the calendar and roles matrix guide committee processes and ensure that committee members have timely information such that they can make the highest quality decisions. If a planning calendar and roles matrix has already been established, they should be reviewed with new committee members and refreshed with their input—as appropriate.

In the current environment, there can be no higher priority for compensation committees than strengthening performance and pay alignment. The appointment of a new committee member provides an ideal opportunity to ensure that all committee members are equally prepared and equipped to carry out their responsibilities in the most effective way possible.

Robin A. Ferracone is executive chair and Todd M. Gershkowitz is a senior vice president of Farient Advisors, LLC, an independent executive compensation consulting firm.

ADDITIONAL COVERAGE IN THE BOARDROOM GUIDE FOR THE NEW DIRECTOR::

• An Orientation for New Directors
• A Message to New Directors
• A Renaissance in Succession Planning and Board Recruiting
• Congratulations, You’re the Audit Committee Chair. Now What?

The Basic Blocking and Tackling
Understand how the financial reporting works. This includes meeting key individuals in the finance department, understanding critical accounting policies and ensuring that you get an appreciation for the areas requiring the most judgment. Review the company’s key annual and quarterly filings with the SEC. Review recent press releases and listen to a sample of archived analyst calls to get a better sense of what information the company is focusing on when it reports results, and how market observers are viewing the company. Also understand the status of any open issues:  comment letters from the SEC that the company is addressing, the status of any major new accounting standards the company is implementing, and reporting considerations for significant transactions being undertaken. The CFO, controller, chief accounting officer and external audit partner will all play roles in helping you get a deeper appreciation of the financial reports your committee is responsible for overseeing.

Meet with the external audit partner. The external audit partner can be a great resource to you as you transition into your chair role. Get an appreciation for his or her experience, not only with the company, but also within the industry and in dealing with the types of issues the company faces. The audit partner can also provide useful insight into how the company functions, where the reporting risks are and the bench strength of both the finance department and the internal audit function. Additionally, he or she may have perspectives on how the audit committee could be more effective. Understand how the partner ensures that the right team is available to serve the client—particularly important if you have geographically diverse operations.

Use your staff support. Who from the company (corporate secretary, internal audit director, controller or other individual) is assigned to help you with agendas, meeting materials, and general scheduling? Whom can you call with questions? When and where are the meetings, what topics do they typically cover and how long do they usually run? Are there any constraints (such as schedules for other committee meetings) on how long your meetings can run?

Differentiators for Effectiveness
Focus on critical aspects of risk management. This may be the most significant challenge:  How can your audit committee play a central role in risk management without being tagged to oversee all areas of risk within the company? One way is to think of your role as an air traffic controller: knowing what the key risks are and allocating each of them to be overseen by the appropriate committee or the full board. Then you can focus your agendas over the year on overseeing the key risks assigned to the audit committee. Obviously, the audit committee takes the lead in areas such as risk relating to financial reporting. Your committee is also likely to find itself assigned oversight of compliance risks, and perhaps IT and privacy risks, too.

On a related note, you’ll want to think about the best ways for your committee to interact with the compensation committee, as focus grows on the link between risk and compensation. The better the audit committee understands the performance metrics the compensation committee tags to incentive pay, the better the audit committee can monitor the integrity of those metrics—in particular, by focusing on whether the ability to achieve performance targets significantly affects management’s financial reporting judgments. This sharing of information between the two committees is especially critical if there is no cross-committee membership.

Forge strong ties with your internal auditors. Internal audit can be the eyes and ears of the audit committee—giving you an objective view of issues facing the company. But it can do that only if you have the right leadership in the internal audit function and if the audit committee supports internal audit’s effectiveness. Get a sense of how company executives and your external auditors view internal audit.

Also get to know the internal audit director and form your own opinion on his or her effectiveness. Understand how internal audit uses its resources and what additional assurance it could provide if it had more resources. Set aside time for periodic, informal contact with internal audit. Be clear that you are open to hearing about any serious issues, including sensitive ones. Many chairs aim for regular between-meeting contact—a call or coffee—to keep the communication lines open.

Tackle the tough stuff. It’s human nature to focus time and attention on the items we already understand and can grasp easily. It takes discipline to ensure the more challenging issues are included in your agenda.

Identify what these issues are—they may, for example, relate to IT security, derivative transactions, complex technical accounting issues or treasury operations. Ask for more in-depth information on these areas. If they represent major risks, consider relevant training sessions for the entire committee. Insist on getting the information in plain English.

Summing It Up
Don’t go it alone. It’s likely you’re in the chair role because you qualify as an audit committee financial expert. That doesn’t mean you need to have all the answers or that you should ask all the questions. Ensure that all your committee members have a voice. Consider involving them in some of your between-meeting discussions—particularly if there is a reporting issue you’re monitoring. And watch for the dynamics in the meetings themselves, recognizing that it can be difficult to build a cohesive committee when you’re only together five or six times a year in a fairly scripted setting. It might mean privately soliciting views from each director after the meeting, especially if a member has been largely silent during the meeting. It definitely means insisting on time for executive sessions of just the committee members, so that committee members have an alternative venue for sharing what they’re thinking. Consider occasionally visiting one-on-one with committee members between meetings to better understand what issues they are concerned about.

As you work with your committee over time, you’ll develop a better appreciation for the additional information you and your committee members need. You can determine if additional training sessions would be appropriate. You also may identify additional skill sets or experience that would be useful, and that ultimately may dictate a shift in committee composition.

At the end of the day, the committee’s effectiveness is largely up to you. Ensure that you have the relationships, information and members you need to effectively fulfill all the committee’s responsibilities.

The Transition to Chair
If you’re fortunate enough to have been a member of the audit committee before assuming the chair role, your task is easier. You already understand the financial reporting process and the players. And you’ll already have a view on how the meetings should run and whether the materials could be improved. You may also have a perspective on the committee membership.

But you might not have realized just how much the chair did between meetings. You’ll want to schedule time to meet separately with the internal and external auditors and with key members of the finance team, to solidify those relationships. You’ll want to identify areas to dig deeper, and start tailoring the committee’s agenda to reflect your vision.

Catherine L. Bromilow is a partner in the corporate governance group at PricewaterhouseCoopers LLP.

ADDITIONAL COVERAGE IN THE BOARDROOM GUIDE FOR THE NEW DIRECTOR:

• An Orientation for New Directors
• A Message to New Directors
• Performance and Pay Alignment: A Top Priority for Compensation Committees
• A Renaissance in Succession Planning and Board Recruiting