Preventative Measures
Directors need not, and should not, wait until they are served with a complaint to take steps to mitigate the potential consequences of lawsuits. At a minimum, directors should work with in-house counsel to ensure that corporate matters that are likely to generate litigation, such as mergers and divestitures, or the sale of stock by corporate insiders, are conducted in a way that limits the ability of potential plaintiffs to assert credible claims. By expressing their views – setting the “tone at the top” – directors can make it known that litigation prevention is an important corporate goal that will, in the long run, save the company expense and reputational damage.

ADDITIONAL STORIES IN THE DIRECTOR’S GUIDE TO LIABILITY:
Risks Rising
The Ultimate Insurance Check List
Avoiding the “F” Word: How Your External Auditor Can Help You Avoid Fraud
The D&O Glossary: Litigation Terminology Every Director Should Know

Directors should also be advised of the status of the liability insurance (often referred to as a D&O policy) purchased for their benefit and ensure state-of-the-art coverage for the directors is secured. Directors should, at a minimum, insist that their company purchase insurance that provides them with direct coverage for any losses they incur as a result of litigation.

Directors should also review their company’s charter and corporate bylaws to ensure that the provisions providing for the indemnification and advancement of legal fees are sufficiently robust. In particular, directors should satisfy themselves that the company’s indemnification and advancement provisions are broad and mandatory (to the extent allowed by the law of the state in which their company is incorporated) rather than narrow and permissive:  i.e., that they require the company to cover directors’ litigation expenses in the widest possible range of circumstances and from an early stage of the suit. This will minimize, and in many cases eliminate, the financial burden directors may otherwise need to bear if they are sued personally.

When the Lawsuit is Served
The first step directors should take upon finding out that they have been sued is a basic one:  notify the appropriate parties. Directors should notify senior management at their company, including the company’s General Counsel, so that the company can begin planning its response to the lawsuit and make any public disclosure it is required to make. In order to invoke D&O insurance coverage, the directors should ensure that the insurance carrier is notified promptly. It is also important to know whom not to tell:  directors should refrain from discussing the suit itself or the claims at issue with anyone other than their counsel. Barring exceptional circumstances, any conversations with non-lawyers about the litigation will not be protected by the attorney-client privilege. Venting to friends or colleagues about the underlying facts can potentially create witnesses who may ultimately be called to testify about the conversation.

A few other basic steps are also in order. First, directors should ask for a detailed memo outlining the pertinent provisions of the applicable D&O insurance and indemnification policies – although directors should already be generally familiar with their terms. Second, directors, working with company counsel, should ensure that they and the company preserve all documents (including emails) that relate to issues raised in the lawsuit (including copies of documents that they possess personally). Third, depending on the nature of the lawsuit, directors should consider informing any other companies on whose boards they sit. These companies may also need to disclose the lawsuit publicly.

Obtaining Counsel
The directors’ next task is to obtain appropriate legal representation. In most instances, directors will not need to retain counsel independent of the company. The company’s outside counsel will be able to represent both the directors and the company, so long as this dual representation does not create a conflict of interest. However, when there is such a conflict – such as when the case is brought derivatively on the company’s behalf against the directors – separate counsel may be necessary. If that occurs, the company can assist or even spearhead the directors’ search for their own independent counsel, but directors can and should suggest potential candidates and participate actively in the process, including reviewing the backgrounds of potential candidates and participating in interviews.

It will often be in a director’s best interest to share representation (and therefore conserve corporate resources) with other director (or officer) defendants, but this depends on the role the director played in the events that gave rise to the litigation and whether the director has defenses that are unique or unavailable to co-defendants. For example, the director may not have attended the board meeting at which the challenged conduct took place, or a co-director may be accused of having a unique pecuniary interest in the challenged conduct; in such circumstances, it might be in the director’s interest to distance herself from those directors who were at that meeting or are benefiting from the conduct. Because lawyers cannot pursue a defense strategy on behalf of one client that implicates another client, directors facing such a situation should think seriously about securing independent representation for themselves or for a similarly situated group of defendants.

Assessing the Claims
Directors should also make sure that they thoroughly understand the nature of the claims so that they can respond to them appropriately. The most common form of claim filed against a director is a suit by a shareholder, and such claims fall into one of two broad categories. Either they are “direct” claims, brought by a group of shareholders who allege that director misconduct has injured them uniquely; or they are “derivative” claims, as mentioned above, such as a claim that directors have wasted or misappropriated corporate assets and thus harmed the company itself. Certain kinds of alleged wrongdoing often generate both direct and derivative lawsuits (such as at companies alleged to have improperly back-dated stock options). Shareholders, however, do not determine whether a particular claim is direct or derivative. This question is objective, fact-sensitive, and governed by state law.

A fundamental precept of corporate law is that the decision whether to pursue derivative litigation on behalf of a company is a business judgment belonging to the board. This has created a unique set of legal rules and responsibilities for directors. For example, where the claims at issue are derivative, directors may need to investigate and then decide whether the company should pursue the case, or where certain directors may lack independence, directors may need to create a special committee to make this determination. In this situation, the directors as a whole or the special committee will need independent counsel to guide them through this process.

Stay Involved
Regardless of the type of claim alleged, directors should remain personally involved in the litigation. Directors should not wait passively for infrequent or ad hoc updates on litigation strategy and factual development. Rather, directors should stay abreast of the progress of the litigation and receive regular updates from counsel to ensure that the claims are being dealt with in a way that is measured, minimally disruptive, and most likely to achieve a successful result.

Douglas H. Flaum and David Hennes are litigation partners in Fried, Frank, Harris, Shriver & Jacobson LLP’s New York office. Zachary Hall, a litigation associate, also contributed to this article.

Web hits prove the point. In early 2010, a web search yielded nearly 4 million hits for the word-for-word phrase: “Shareholders are the owners of the company.” By contrast, the wishful notion that “Osama bin Laden is dead” appeared only 410,000 times, and the happier belief that “Elvis is alive” appeared merely 52,200 times. It’s obvious many people believe shareholders own companies. But is that belief correct?

The answer is: No, shareholders do not own the corporation. Rather, they own  (or in some  cases, temporarily hold) a type of security commonly called stock.  Both corporate law and economic reasoning support the limited nature of this ownership, and also undermine the claim that directors should always strive to maximize shareholder value.

The Legal Case
Although it can be difficult for non-lawyers to wrap their heads around the idea, no human being can own a corporation. This is  because corporations are legal persons—independent entities with their own rights, including the right to hold property in the corporate name. In effect, corporations, like human beings, own themselves.
As a legal matter, shareholders who purchase shares of stock in a  corporation own nothing more than that—shares of stock. Similarly, bondholders own only bonds, and executives with employment contracts own their contracts. None of these types of ownership give shareholders, bondholders or executives the right to control the firm. The right to control the firm’s assets and actions rests in the hands of its board of directors, and only when they act as a body and follow proper board procedures.
An important consequence of this governance structure is that shareholders not only have no legal right to control the firm, they also have no legal right to help themselves to the corporation’s assets. In fact, the only time shareholders receive any funds directly from the corporation’s coffers is when they receive a dividend or the corporation repurchases their shares. This only happens when the directors vote to declare a dividend or a corporate repurchase.

In judicial opinions, directors are usually described as owing fiduciary duties “to the corporation and its shareholders”—implying the two are not the same, and that directors’ duties are broader than just duties to shareholders. Even more important, under the doctrine known as the business judgment rule, a shareholder can’t successfully sue a board for failing to maximize shareholder value. To the contrary, directors enjoy wide legal discretion to sacrifice “shareholder value” in order to protect employees, customers, creditors and the community.

This is why fans of shareholder primacy almost always cite the nearly century old case of Dodge v. Ford as their primary legal support for the idea of shareholder primacy. But Dodge v. Ford was really a shareholder-versus-shareholder dispute in a close corporation. Similarly, the second case typically cited—Revlon v. Mac- Andrews & Forbes Holdings, Inc., is also legally irrelevant. In Revlon, the Delaware Supreme Court held that an end-game situation where the directors of a publicly traded firm had decided to sell the company with a controlling shareholder—in effect, terminating the corporation’s existence as a public firm—the board had a duty to maximize shareholder wealth. But subsequent Delaware cases have made it clear that if the directors of the firm decide not to sell at all, or prefer to do a stock-for-stock exchange with another public company, the infamous Revlon doctrine no longer applies. For example, in Paramount Communications v. Time, the Delaware Supreme Court upheld directors’ right to “just say no” to a hostile offer, even though the offer was at a premium over the market price for the company’s stock.

The Economic Case
Paying attention to the realities of corporate law should also put the kibosh on two other sub-legends surrounding the idea of shareholders as owners. The first is the false notion, favored by economists, that shareholders are the “principals” in public corporations and that directors are shareholders’ “agents.” As we have just seen, this agency metaphor misstates the real legal status of shareholders and directors. At law, a principal has a right to control her agent. But shareholders can’t exercise direct control over corporate directors. Moreover, case law describes corporate directors not as “agents” but as fiduciaries with a wide range of discretion, who owe duties not just to shareholders but also to the firm as a whole.

The second mistaken sub-legend is the claim that shareholders are the sole “residual claimants” in the corporation, entitled to each and every penny of profit the firm earns after it pays its expenses. This  sub-legend ignores the legal reality that in a public company, the board of directors controls not only whether the shareholders receive dividends out of earnings—the board controls whether the firm has earnings at all. This is because the board controls corporate expenses. If a company is  doing extremely well, the directors can pay a dividend, but they can also raise employees’ salaries, improve customer service or work toward a lower debt-equity ratio for creditors.

It is thus wildly misleading to describe shareholders as the sole residual claimants in companies that aren’t actually in bankruptcy.

To the contrary, while shareholders typically share in the wealth when the corporation does well and suffer when the firm does poorly, so do employees, creditors and other “stakeholders.” Many different groups are potential residual claimants and residual risk-bearers in public firms, just as many different groups— not just shareholders—contribute to the firm’s success. Thus, from an economic perspective, it doesn’t make sense to focus only on shareholders. While shareholders are important participants in firms and deserve to be protected, corporations give more value to society when directors look out for the interests of customers, creditors, employees and other stakeholders as well.

This idea is supported by modern options theory. In effect, bondholders own the right to access cash flow but have sold a call to shareholders, while shareholders own the right to access the cash flow but have sold a put to bondholders. Neither shareholders nor bondholders can claim an exclusive right to “own” the company’s cash flow, much less the company.

Why Should Directors Care?
These legal and economic arguments against shareholder primacy have practical importance. Shareholder primacy thinking pressures directors to make business decisions that they know, intuitively, are not in the best interests of their firms. In the mistaken belief that both law and economic efficiency demand they “maximize shareholder value,” directors may fire valuable employees, cut customer support, limit research and development and sell off valuable assets and divisions.

In contrast, once directors understand that shareholders do not in fact own the corporation and that they need not respond to shareholders’ every whim, they can focus instead on getting the best possible corporate performance—on behalf of all stake- holders. In the end, shareholders only stand to benefit.

Lynn A. Stout is professor of law at the University of California Los Angeles School of Law.

Editor’s Note: This is the second in a series of conversations between top executives as they discuss business scenarios that impact the boardroom.

Timothy W. Burns: As you know, I spend a good deal of my time counseling boards of directors and officers on insurance issues. If their company is solvent, and their insurance is strong, directors have historically faced very little risk of personal liability. What keeps me up late at night these days, however, is 1937. Here’s what I mean: Eight years after the 1929 stock market crash, the economy went into a tailspin again. And, I’m concerned that perhaps we haven’t seen the end of 2008.

Lawrence Fine: I guess you’re saying that inevitably, big disasters will have their aftershocks.

Burns: Right. And if it happens again, good insurance becomes of critical importance in protecting the personal assets of directors.

Fine: Directors and officers have been exposed for decades, but earlier in the millennium when the WorldCom and Enron scandals made front pages, plaintiffs seemed to really step up their game in volume and severity. Those actions brought a new level of awareness to the potential exposure to directors and officers. Our litigious society is becoming a danger for everyone.

Burns: With the credit markets tightening in 2007, and then the economy melting down in 2008 and early 2009, it really forced directors and officers to consider how they may be targeted personally. The good news, though, is that except for certain market segments, the D&O market has—at least to date—remained somewhat reasonably priced.

Fine: But there are a number of plaintiffs’ lawyers pushing the envelope with legal theories and increasing settlement demands. That’s partly inspired and supported by a lot of anti-corporate sentiment right now. As a result, plaintiffs, who have always threatened that they would try these cases, have actually been doing that lately, with, unfortunately, mostly positive results from their perspective. It seems that juries are not looking favorably on corporate defendants. So, Tim, let’s take a moment to talk about these new developments and what directors need to be aware of and prepare for.

Burns: A big issue is that institutional investors definitely seem to be competing among themselves to see who gets the biggest settlement. They’re encouraging their lawyers to do the same thing and the bounties that some of these institutional investors are purportedly offering their counsel are designed to confiscate money directly from the personal assets of individual defendants.

Fine: Yes, that poses a difficult and interesting situation. We are now seeing instances in which a particularly competitive institutional plaintiff will seek the money directly from the individual and try to prevent the company or the insurer from reimbursing it. That poses a very difficult circumstance for a board director. This approach can be taken even in the face of a settlement involving the corporate defendant. We’ve had success in diffusing these situations, because a high percentage of the time, the plaintiff counsel is blustering for effect. The job here is to have them convinced by a practical insurer, through an experienced claims analyst, particularly one who is known to the plaintiff counsel, that they should just let it go and move on. From the plaintiff’s perspective, money is money, so how can they turn down the settlement the insurer is offering to pay?  Because we say that there just won’t be any settlement if plaintiff counsel insists on going down the other route, seeking the money from the individual, which, while dramatic from the plaintiff’s point of view, may well be complicated and uncertain to yield results.

Burns: I am concerned that in these changing times, plaintiffs’ lawyers are going to be under increasing pressure from the institutional investors to get more and more. Historically, the dynamics of these cases have favored settlement, but there is a lot of uncertainty out there in this post-crisis environment.

Fine: One reason the plaintiffs are taking more cases to trial is that they are competing for the institutional-investor business. Also, the plaintiff bar has been fragmented and unconsolidated after several of the old-guard plaintiff lawyers were the subject of government investigations, and several of them were sent to prison. The plaintiff lawyers that remain are aggressive litigators, and are much less committed to settling cases, and more interested in making a name for themselves through trying cases. It’s harder to get a reasonable dialogue going in a case.

Burns: Insurers, directors, officers and companies all face a wide array of enemies. It’s not just the plaintiff securities bar anymore. There are derivative lawsuits. There are government investigations galore. The environment is getting continuously more costly and more difficult.

Fine: The competitive nature of litigation means there’s more incentive than ever for institutions to opt out of class actions and seek higher percentage returns. That’s one of the things that the plaintiffs’ lawyers are pitching to them, and that’s just another major complication for any given company in resolving all of the issues they face on numerous battle fronts.

Burns: The government appears to be getting more aggressive as well, and I guess that’s to be expected after the recent financial turmoil. But this certainly has directors and officers that I talk to worried about their liability.

Fine: Yes. Sometimes dealing with the government can be a longer, more difficult process than dealing with civil plaintiffs, because it is not, at the end of the day, necessarily a predictable decision maker, in that its decisions may not be governed by practical, quantifiable measurements such as dollars. Mary Schapiro (chairman of the Securities and Exchange Commission) has made many public statements about increasing enforcement and cooperating with other government entities. Recently, the SEC has been utilizing Section 304 of Sarbanes-Oxley, the clawback section, to recover bonuses from individuals who they are not even alleging personally committed any fraud, which is pushing the envelope of what it would seem that SOX 304 was designed for. That’s after several years of the SEC not pursuing clawback claims, and receiving some criticism for that.

Burns: Congress is looking to legislatively expand liability exposures for directors and officers, isn’t it?

Fine: The tone in Congress is, in many ways, anti-big business, with several bills currently being pushed which could drastically increase exposures to directors and officers. One such bill would lower pleading standards for all civil litigation and turn back the clock a few decades, so that plaintiffs can get by a motion to dismiss in virtually every case, it would seem. The other bill would undo the Supreme Court decision in the Stoneridge case, and affirmatively  create a civil action for aiding and abetting of securities fraud. It’s always been the case that the government can pursue aiding and abetting claims, and the SEC is probably prepared to do that now.

Burns: Some carriers have opined that this aiding and abetting liability, if it comes to pass, might not be covered under D&O insurance policies. I don’t really see the logic in that view. It appears to me that aiding and abetting would fall within the definition of wrongful acts in a D&O insurance policy.

Fine: We would agree, but it depends on the exact phrasing of allegations. Basically, Chartis’ policies are generally supposed to cover directors and officers for things that they’re alleged to have done in that capacity, and we’re not sure how or why a carrier would argue otherwise.

Burns: We also are seeing the potential that more and more companies may not be there to back up their directors and officers when things start to go wrong on all fronts.

Fine: When a company has bad news that leads to litigation, one of the worst-case scenarios is that the company may have to file for bankruptcy, whether it’s a re-organization or liquidation, as in the case of Lehman Brothers. Your concerns seem warranted, in that bankruptcy filings have been way up recently, and they’ve been leading to increased litigation against directors and officers.

Burns: The good news is that the trend over the past few years has been for companies to increasingly purchase Side A coverage that protects directors and officers in the event the company becomes insolvent. It appears to me that a lot more of these Side A policies are going to be triggered than in the past.

Fine: Side A policies generally are starting to see more action, from derivative suits as well as bankruptcies. For example, in the Broadcom case, $40 million of the settlement was paid by Side A carriers. Probably, some carriers who have been writing Side A coverage have enjoyed years of low activity, and felt it might be relatively low risk. But hopefully, those carriers are prepared to start paying more on Side A policies.

Burns: It certainly appears from those numbers that some of the Side A insurance policies are likely to come into play. What I’m interested in, and I’m sure others are as well, is your view of the recent statistics on securities class-action filings. Securities- fraud class actions were down last year. What do you make of this?

Fine: It’s really a moving target. The numbers for 2009 on the Stanford Securities Clearinghouse website keep increasing as additional suits are added to the list belatedly. The count is now up to 178, nine higher than the 169 suits which were discussed in Cornerstone’s 2009 year-end report and press release. Various other commentators such as Advisen and NERA post consistently higher numbers. So there’s definitely more to the story than just one headline.

Burns: Another recent trend that offers some concern is the rash of under-the-wire lawsuits. And, by that I mean lawsuits filed just before the statute of limitations expires. There are an increased number of cases in which the defendants are sued almost two years after the disclosures on which they are being sued were made. It used to be that your stock would decline, and you’d be sued within the first few days of the decline.

Fine: Directors and officers ought to know that when the stock goes down, they are likely to be sued. The statute of limitations was increased by Sarbanes-Oxley from one year to two years and it gives the plaintiffs freedom to plan when they’re going to get the cases filed, and how they’re going to manage their inventory.

Burns: There do appear to be a lot of game-changing developments out there. The one thing that provides me some comfort is that in the past, directors and officers who have had strong and adequate D&O insurance have not had to pay personal assets. Even with these recent developments, hopefully that trend will continue.

Fine: Good lawyers are expensive these days. Discovery can be a black hole if it’s not managed well and efficiently. The cases are just very expensive, and individual insureds should be concerned about who is spending the limits and how fast the money is going.

Burns: That does pose a concern. You could have a case in which a rogue former officer effectively monopolizes the spending on the D&O policies. And, you’re absolutely right that defense costs seem to be getting more expensive. Boards and directors need to pay attention to who is going to have access to these policies. Given the multiple individuals with access, and sometimes the company itself, it’s important to seriously evaluate how much insurance the board needs.

Fine: People often ask how much is enough insurance. What type of advice do you give?

Burns: Frankly, I’d say that you want to look at what’s been enough in the past, and increase it considerably. Defense costs are rising, potential liability that’s covered under these policies is rising, and at the same time, you’re looking at increasing D&O insurance limits. You should be careful in deciding from whom to purchase D&O insurance.

Fine: There are other more specialized policies for outside directors that probably bear looking at. But we think that directors are best off to make job one focusing on getting the best possible foundation for their insurance program with the best primary policy. Not every gap can be filled by the primary policy, however, because of potential bankruptcy issues and whether the debtor has rights in a traditional ABC D&O policy.

Burns: The economics of the purchase of D&O insurance makes Side A, B and C policies a fact for most companies. The company and the board want to protect the directors, officers and the company from liability from securities claims and other liabilities that are covered under these policies. Because of this fact, it is important to make sure that you’re purchasing the best ABC Side coverage that you can get.

Fine: Have you been seeing carriers in excess positions being asked to pay more money, and has that been going smoothly or not?

Burns: There are a lot of cases in which the settlements are in the multimillion-dollar range. Excess insurance policies are coming more and more into play. That is an unusual development for most excess D&O insurance companies. Many of them are not in the habit of paying claims day to day, in my experience, and you have to do a lot more work to collect from some excess D&O insurers. You may have to file litigation at times with respect to some excess D&O insurers who just were not expecting to have the number of claims and the size of settlements that we’re seeing now.

Fine: We’re seeing that when we go to mediations, which increasingly have a lot of different layers of carriers, one never knows at which level there’s going to be a hard stop or what the reasons given will be.

Burns: That’s a dangerous situation. These cases, in order to be resolved successfully, require that all the parties obligated to participate actually participate in resolving the case.

Fine: The purpose of insurance is to reduce uncertainty and provide reliable protection. You have to be an educated consumer and achieve as much certainty as you can, so saving some money on a premium, but being less sure that the claims will be paid, means that you’ve really got nothing. So in these times, despite occasional overly reassuring remarks from a pundit, anything can happen, and I think that it’s the job of directors and officers insurance to be a reassuring backstop against that world of uncertainty.

Atlantic Coast Federal named Jay S. Sidhu to its board of directors. Sidhu is currently chairman and CEO of New Century Bank. Atlantic Coast Federal is the holding company for Atlantic Coast Bank.

Maura Markus was appointed president and COO at Bank of the West. Markus most recently served as head of Citigroup’s International Retail Bank.

PHC elected Douglas J. Smith to its board of directors. Smith is the former assistant vice president of labor relations for Union Pacific Railroad.

Integrated Electrical Services named Terry L. Freeman senior vice president and CFO. Freeman most recently served as senior vice president and CFO of Metals USA.

Brian J. Scott, general manager of Microsoft’s Health & Life Sciences, was elected to the board of directors at Nexxus Lighting.

Pamela Packard

Despite the recent attention, many directors view tax-risk management and tax governance as tedious topics best left to accountants and attorneys or delegated to the audit committee. No doubt there are other directors who view the IRS’s campaign to promote tax risk management as integral to good corporate governance as a faintly veiled attempt to increase tax revenue. Here is another view.

Good tax-risk management and governance requires the board be able to discuss, debate and influence the corporation’s overall tax risk posture within the realm of its oversight role. “One size does not fit all” is popular in corporate governance circles today and certainly applies here. Valid business reasons may exist for a company to choose to have a conservative, moderate, or even an aggressive, albeit complaint, overall tax-risk posture. Importantly, boards must understand the consequences of each approach. A company could choose to take conservative tax positions in hopes of reducing compliance costs associated with tax examinations. This could also serve as a counterbalance for companies with significant risks inherent in their core business strategies. At the other end of the spectrum, companies that choose to take aggressive tax positions must expect resources will be spent defending the positions taken and expect that the potential for creation of increased long-term shareholder value outweighs the risks. Best practices in tax governance ultimately may evolve into willingness for transparency but will not require agreement with the IRS on all matters.

IRS Commissioner Doug Shulman’s statement, “…the general public has little tolerance for overly aggressive tax planning that can be viewed as corporations playing tax games,” is undoubtedly an accurate reflection of current sentiment. Contrast that statement with a well- known quote attributed to Judge Learned Hand, “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”  Does one expect sufficient alignment could ever exist among the competing views of the myriad stakeholders and various public policy considerations to allow a company’s tax-risk posture to be decided purely from a single public policy point of view?

The impact of adverse publicity regarding tax matters varies with the circumstances and is certainly different when a corporation lobbies for company or industry favorable legislation, litigates and loses a well thought out tax position, or violates tax-compliance rules. Risk to reputation over tax matters could be critical for corporations holding themselves out as leaders in good corporate governance practices and certainly is critical for those providing tax, governance or government related services.

As publicity increases around this issue, shareholders are unlikely to be silent. One might expect activist shareholder action for failing to enhance shareholder value if the tax risk posture of a company is significantly more conservative than is typical for its peer group, particularly if the company follows the IRS’s position on issues that other taxpayers fight and win. Alternatively, would shareholder actions arise if a company undertakes costly tax litigation, which ultimately is unsuccessful?  How will rating agencies and proxy advisory firms view these issues?

The IRS has indicated it will measure a company’s overall appetite for risk as a possible predictor of the company’s tax-risk appetite (and allocate its audit resources accordingly.)  While risk appetite may be consistent across an organization, it is as probable that it is not. For example, significant willingness to take risks for strategic initiatives and revenue enhancement opportunities may coexist with zero willingness for risk in regulatory and reputational matters.  Where in this spectrum would tax risk be?

Certainly management will make its recommendation. Will the board review and either accept or reject the recommendation, or will the board consider and debate the alternatives – as evolving best practices might suggest?  The practicality of this depends in part on whether tax risk in a particular corporation is viewed as a business management risk, an enterprise risk, a governance risk or a “top ten” risk.

Given the breath and potential magnitude of these issues, an ancillary governance question arises: “Does the board possess sufficient knowledge of tax to appreciate the inherent risks and make informed decisions in this area?”

One looks at the evolution of skills in the boardroom and remembers: boards used to rely on the auditors with respect to the financial statements, now audit committees are required to have a designated financial expert; boards used to rely on the compensation consultants engaged by management, now many boards hire independent compensation consultants and choose board members with compensation expertise. The list of examples goes on.

Will boards hire independent tax firms to advise them directly? This was among the suggestions made by Shulman. While not specifically addressing tax risks, the recent NACD report on Risk Governance acknowledges the potential value consultants may bring and yet suggests “…the use of independent consultants should not be a tool of first resort. Boards should seek to possess expertise that matches the company’s needs. When the required skills are absent, boards should look to their own composition and make adjustments to meet company demands.” Another governance question arises: “Will tax be added to the skills matrix used by nominating committees to identify and recruit new directors?”

Clearly, the IRS’s goal is to improve corporate tax compliance and increase tax revenues. Shulman has chosen the route of appealing to best practices in corporate governance and risk management to obtain allies in the boardroom. In the current political and business environment, one wonders whether his suggestions foretell a future regulatory mandate if the vast majority of boards fail to embrace this initiative. At a minimum, a warning bell has rung – tax risk governance is yet another area where boards’ oversight will be subject to scrutiny.

Pamela Packard is a corporate director and a former vice chairman and National Business Line Leader of Tax at the public accounting and consulting firm, BDO Seidman, LLP.

The views expressed in this article are those of the author and do not represent the views of any organization with which she is or has been associated.

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

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

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

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

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

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

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

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

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

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

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

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

In the coming weeks and months, Toyota will face intense public and legal scrutiny in the form of class-action lawsuits and congressional hearings. And that’s just in the United States.

By examining how Toyota has managed its massive recall, we can all learn several important lessons.

Work with regulators and lawmakers. Companies are responsible for monitoring adverse event reports and alerting regulatory agencies of any potential safety concerns. Failing to communicate promptly with regulators about these issues will undermine the agency’s trust in your company and raise doubts about your ability to make responsible decisions and execute a recall that protects consumers. Likewise, if the regulators are forced to come to you first, you can expect increased scrutiny and skepticism of your recall management across the board.

Quick and effective recalls are critical to consumer safety and brand protection. When regulators are involved from the outset, they can become allies in your effort to guarantee consumer safety. Proper communication is essential to putting your company in a position to mitigate the legal and economic risks of a recall.

Be in the consumer safety business. Now more than ever, Toyota is in the business of keeping customers safe, calming fears, and quickly coordinating repairs. Toyota must protect the goodwill and loyalty it built with consumers through years of excellent service and a history of safety awards for cars across its fleet.

During a recall, your company is no longer in the business of making products. It is in the business of protecting the public. When everything you stand for is at risk, your business model changes. Just as your company is in crisis during a recall, your customers are facing their own personal crises, particularly when they believe their own safety has been compromised. Everything you do during a recall must demonstrate genuine concern for the well-being of your existing and future consumer base.

Offer consumers an easy remedy. When a product fails to meet expectations or, in Toyota’s case, endangers consumers, it is impossible to avoid buyer’s remorse and negative attention to your brand. But offering an effective remedy and supplementing the solution with unfailing customer support will speak to the level of commitment Toyota has for its customer base and reassure the public that it is capable of correcting this and any future issue with its product line.

A critical part of the recall process is the remedy. The mistake that led to the recall is in the past. Providing a timely and effective remedy is your company’s opportunity to redeem itself. Appearing slow or incapable of responding will only increase public doubt and regulator concern. It is critical that you provide the right solution quickly and ensure that everyone involved – be they grocery stores, sales agents, or car dealerships – understands who will be delivering the remedy and providing the resources and answers the public requires.

Communicate, communicate, communicate. Without constant communication, there are only questions. Consumers ask whether they are safe in Toyota cars. Dealers wonder how they will handle repairs and soothe consumer fears. Before long, regulators will be asking questions about recall management.

During a recall there are many parties of interest – from regulatory agencies to consumers, dealers to employees, and investors to boards of directors. Regardless of the audience, it is critical that they receive the latest information as soon as it is available.

Be sure to plan for all possibilities and prepare to answer every possible question. Allow no surprises. It is how your company handles these challenges that will determine if the road ahead will be rough or smoothe. If you don’t control how the final chapter of this story is written, others surely will.

During a recall, your destiny is in your own hands. In the case of Toyota, how the company manages the massive recalls now underway will determine whether those recalls play out as a speed bump or a deep pothole that knocks the wheels off a once highly respected brand.

Mike Rozembajgier is director of recalls for ExpertRECALL and also blogs at www.ExpertRECALL.com/blog

To learn more about how to manage recalls, attend The Directorship Forum in June.

Val John Christensen was elected CEO at EnergySolutions. The appointment follows the resignation of former CEO Steve Creamer. Christensen has been president of the company since 2008.

3PAR a utility storage company, appointed Stephen M. Smith to its board of directors. Smith is the president and CEO of Equinix.

Steven Cakebread joined the board of directors at TheLadders.com. Cakebread is the former president and CFO of Salesforce.com. TheLadders.com is an online marketplace for 100+K jobs and 100+K job seekers.

C4 Waterman elected Bruce Raymond to its board of directors. Raymond spent 20 years as CEO of Quicksilver Garments.

Former president and CEO of Equity Inns, Howard A. Silver, was named to the board of directors at Education Realty Trust. He will serve on the Compensation and Nominating and Corporate Governance committees.

Peter Roddy joined the board of  directors at Vermillion, a medical test maker. He will serve as chairman of the audit committee.

Former chairman and CEO of The Interpublic Group, David Bell, was elected to Resonate‘s board of directors. Resonate is an online advertising technology company.

Hugh Sloan was appointed to the board of directors at Spartan Motors and will serve as chairman of the board. He has been an independent member of the board since 2007.

Eaglecrest named Carl B. Hansen to its board of directors. Hansen is currently president and CEO of Atacama Pacific Gold Corporation.

James Brandi was elected to the board of directors at OGE Energy. Brandi is currently a partner of Hill Street Capital.

The annual shareholders’ letter stands in contrast to newer channels of communication that Loomis and Quick both acknowledged have changed how they find information and locate sources, although both said they don’t use Twitter or Facebook.

Levick advised that directors at least ascertain whether management  is aware of the “high-authority bloggers”covering their industry or company, noting that some members of Congress are now doing this.
Both of the media panelists said that they spend little time speaking directly to public company board directors. “In most cases,” Loomis noted, “we can’t get board members to talk to us about issues such as compensation. We read the proxy statements and the arguments in the CD&A.” Quick concurred, asking the audience, “Would you like my phone number?”

Boards can significantly improve their effectiveness in CEO succession by forming a succession planning committee and optimizing its performance. The key elements to this operation include the formation of the committee, its composition, its process, and its interaction with the board. It is the execution of these details–and not ad hoc approaches–that make the real difference in a successful succession and selection process.

Choosing the right directors for the job
Many succession committees are composed of board members who volunteer and have the most time available. While enthusiasm and time are certainly required, these are truly the bare minimum; membership on the succession committee based solely on those criteria can lead to a sub-optimal outcome.

Then there is the issue of skill sets–who has been through or even led companies through CEO successions? Many boards take great care to make sure that the people who serve on the audit and risk committees are deeply qualified. Yet when staffing what is arguably the board’s most important committee, they often appoint people primarily on the basis of availability, rather than on skills, experiences, and qualifications.

Increased scrutiny from shareholders and the Securities and Exchange Commission has made this a dangerous path to pursue. While the days of board directors taking a hands-off, more collegial than rigorous interest in company matters have been largely abandoned, populating the succession committee with those who have the most time on their hands has been an all too common practice. But by taking firm ownership of the committee formation process, the lead director or chairman can avoid this mistake.

Ideally, this director would first see to it that the committee is led by someone who has been through an extensive succession planning process and has a highly sophisticated understanding of it. Such experience could come from having served in a similar capacity on a board, or from having led a personal succession planning as a CEO, or having led a complex human resources organization with effective succession planning practices. Being led by someone who has been deeply involved in succession planning increases the chances of success right from the beginning. It also enhances the overall planning process– such a leader understands it and is better able to guide the board through a task that is fraught with risk.

After the committee chair is selected, the board’s lead director or chairman should nominate the most capable and qualified members of the board to fill out the committee. Those members should know how the process works and how to effectively interview and assess CEO-level executives.

Grasping the nuances
Committee members need to understand the difference between recruiting and hiring. Prospective CEOs from outside the company are typically well positioned and aren’t actively looking for another position. Assessing, courting, and engaging them requires a nuanced approach. Committee members must be able to articulate in a compelling manner the company’s current situation and the opportunities for the company’s future. The committee members’ understanding of the situation and passion for the company can enhance the process for prospective candidates, who are, after all, interviewing with their future bosses.

Candidates can also be impressed or turned off, depending on how they are treated. The logistics of meeting with them and accommodating their schedules can either send the signal that you value their time and care about them–or you do not.  Committee members should therefore make themselves available for interviews and, if necessary,  travel to meet candidates.  Bringing the very best candidates to the table requires that each committee member invest in the process and powerfully engage with the candidates. And they shouldn’t forget about a candidate’s spouse. It is critical at the appropriate time to engage the spouse in the process to ensure that he or she is on board and comfortable, and to treat the spouse with the same high level of consideration and respect that is accorded the candidate.

Over the long term, it is wise for the board to take a regular inventory to make sure that it has among its members the recruiting and succession experience it will need. If not, it should actively seek members who can complement the board with these strengths.

The “interim” CEO
Even assuming an ongoing succession process that is part of the cadence of the board, an emergency succession may become necessary. An incumbent CEO may leave unexpectedly through an illness or accident, or be recruited to another company, or even lose the confidence of the board. In these situations, a board member–typically the chair, lead director or someone else who is qualified–will step in as the interim CEO. This buys time for the board to run a thorough succession and selection process, as when Ed Whitacre stepped into the CEO role at General Motors from his position as chairman of the board of directors.

Usually, it is clear that the interim person, whether from the board or the company, will not be a candidate for the permanent role. But, on occasional, a board will naively put an internal candidate into the interim role and then add that person to the list of candidates for the next CEO. If the candidate doesn’t win the position, the results can be disastrous: the candidate will likely leave the organization and the company will lose a valued colleague. A skilled chair of the succession committee, however, could have managed the risk.  By selecting a true “interim” candidate, the chair can allow for a proper succession and selection process and allow the board to select the best person, whether from inside or outside, to run the company.

ActiveIdentity named Brad Boston to its board of directors. Boston is the senior vice president of Cisco’ Global Government Solutions Group and Corporate Security Programs.

Philip Kempisty has been elected to Poly-Pacific International’s board of directors. They have proposed share consolidation with Kempisty. Kempisty is the managing partner of Kempisty & Company Certified Public Accountants.

Marsh & McLennan named H. Edward Hanway to its board of directors. Hanway was chairman and CEO of Cigna for almost 10 years through 2009. Marsh & McLennan is an insurance broker and consulting firm.

Sandeep Vij has been appointed CEO of MIPS Technologies, a provider of processor architectures and cores for home entertainment and multimedia. Vij will serve as president, chief executive officer and director. He succeeds interim CEO Anthony B. Holbrook.

Atheros Communications named Charles E. Harris to its board of directors. Harris is currently providing services to Atheros during its integration of Intellon, where Harris serves as chief executive officer.

Richard Magee has been named to GFI’s board of directors. Magee is a former wholesale broker and former chairman of Tullett & Tokyo Forex International. GFI provides wholesale brokerage, electronic execution and trading support product for global financial markets.

President of Clear Financial Solutions, Steven Plumb, has been elected to the board of directors for American International Industries. Plumb will serve as the chairman of the audit committee.

Cardinal Health announced that Dr. James Mongan has been appointed to the board of directors and will be part of the audit committee. Mongan served as President and CEO of Partners HealthCare System for 6 years until December 2009.

John Malone joined the board of directors at Ascent Media Corporation, the owner of Ascent Media Group. Ascent Media Corporation services the digital media supply chain. Malone is currently the chairman of Liberty Media, Liberty Global and DIRECTV. He is also serving on the board of directors for CATO Institute, Expedia, Discovery Communications, SIRIUS XM and InterActive. In addition, Malone is the chairman emeritus of the Board for Cable Television Laboratories.

Timberline added Robert Martinez to its board of directors. Martinez has had 35 years of experience in the mining business and has served on the board of directors for Metallica Resources.

Twin River announced the appointment of three new board of directors, barring state approval. If approved by Rhode Island state legislators, Glenn Carlin, John McLaughlin and John E. Taylor would oversee the Lincoln, RI slots parlor when it emerges from bankruptcy. Glenn Carlin is the senior managing director of Americas Investment Banking for CBRE Capital Advisors, Inc. John McLaughlin is an independent gaming consultant. John E. Taylor is currently President and CEO of GameLogic.

Let’s begin with Washington: what are you telling your boards to be on the lookout for?

Mostly there is trepidation around what is unknown. Washington is focused on health care right now, but boardrooms, obviously, need to be aware of what’s happening. At Nasdaq OMX and on behalf of our issues, we want companies to be public companies. It’s good for our capital market. It’s good for job creation and it’s good for innovation. There is certainly an awareness that Washington is going to play a key role as we come out of the recession on issues such as tax, cap and trade, immigration and jobs.

And there any non-corporate governance challenges that concern you?

There’s a common belief that health care is going to be expensive and we will need resources to pay for it. Where are those resources going to come from? It’s still an unknown and is making a lot of people very uneasy.

Is the recession over? What are some of the important challenges that remain in your opinion?

There are positive signs. We’ve had resurgence in the IPO market. The second half was strong with some private equity and a few venture capital deals…There is general awareness that we need to create more jobs and more opportunity.

What should we to come out of the great compensation debate?

We just completed a corporate governance survey going into 2010. Proxy access, compensation and board elections are all up in the air. We do believe that there will be changes driven by the SEC and the exchange will follow suit. The U.K. financial services sector has been interesting in particular but I don’t think here you will see changes that lead to other industries. Instead, I do think there’s a greater move toward more disclosure around executive pay and I would expect that to continue.

What’s new on the activist shareholder front and what is NASDAQ OMX doing to help directors navigate this landscape?

Activism has been increasing from even before the economic downturn. We have tools to help you understand your shareholder better, to identify when shareholders are in acquiring positions, and to get messages out to your shareholders. Activists were here before the downturn and it’s likely we will see an increase as more investors turn to stock. We may see an increase–see more investors for stocks

As you look ahead to the New Year, what are the main governance themes you see for 2010?

This will be the first year that brokers will not be allowed to vote shares, which will create new costs, as you make sure you’re getting your shareholder vote. Given that this is the first year, companies will have to spend a lot more time making sure that every vote is counted. The other question that every board member is going to want to know is what is the risk element and it could be as minor as is our cash protected to what’s the dollar doing. I think the government will put into place greater transparency around securities and risk. Nobody liked the stock price but at least you knew what the stock price was. I think you will see over-the-counter derivatives traded on more exchange-type platforms as well to give investors a better sense of their value.

Green initiatives took a back seat during the recent global climate, but do you see things changing coming out of the Copenhagen  summit? ?

Carbon trading is going to be looked at in 2010, 2011, 2012–it’s a matter of priorities. We just saw that coming out of Copenhagen. I do believe that companies must be prepared and understand that we will have carbon trading. To that point, Nasdaq acquired Nord, an energy and carbon-trading platform in Norway where there is more trading. Directors need to keep a close watch. Europe has a lot of trading.

What’s are your professional priorities for the New Year?

To continue to execute on our strategy. As part of our deal with OMX, we now operate 70 exchanges around the globe. Nasdaq itself was always known and now with the Philadelphia options market we are much more diversified for equity. In the last year, 24 companies have switched to Nasdaq including large cap brands such as Mattel, DreamWorks, and most recently, Micron.

Specifically, the changes will require disclosure concerning:

• The relationship of a company’s compensation policies and practices to risk management, when those compensation policies and practices create risks that are reasonably likely to have a material adverse effect on the company;
• The grant date fair value of equity awards in the Summary Compensation Table, replacing the prior approach of requiring disclosure of the amounts of compensation expense recognized for financial reporting purposes;
• The potential conflicts of interest that compensation consultants may have when performing services for the company, focusing on disclosure of fees paid (subject to a $120,000 threshold) for executive compensation services and for additional services;
• The background and qualifications of directors and nominees for director, describing the experience and skills that led the company to choose the director or nominee for the board;
• Other public company directorships held by each director or nominee over the past five years;
• Legal proceedings involving a company’s executive officers, directors, and nominees for director, including disclosure covering the past ten years and covering a significantly expanded list of relevant proceedings;
• The board of directors’ consideration of diversity in the process by which directors are considered for nomination to the board;
• The leadership structure of the board, including whether the company has combined or separated the roles of chairman and principal executive officer, and why the company believes that its leadership structure is appropriate for the company, as well as a discussion, in some circumstances, of whether and why, a company has a lead independent director;
• The extent of the board’s role in the oversight of risk; and
• Voting results, which are to be provided on a significantly accelerated basis under cover of Form 8-K.
  ]]> http://www.directorship.com/mofo-sec-ex-comp/feed/ 0 http://www.directorship.com/some-common-sense-advice-for-new-directors-2/ http://www.directorship.com/some-common-sense-advice-for-new-directors-2/#comments Thu, 15 Oct 2009 14:00:41 +0000 Herbert S. Winokur http://www.directorship.com/some-common-sense-advice-for-new-directors-2/ The task of finding outstanding and committed new directors is not an easy one, and it is likely to get even harder. More directors will be needed as creditors increase their influence, whether through government investment in financial institutions or through debt restructuring at over-leveraged companies. Yet the availability of top candidates is shrinking due to factors that make board service less attractive, such as the increasing time commitment required, need for more industry expertise, regulations governing pay and accounting, and litigation risk.

  If the job of finding great new directors is difficult, so is the job of sitting on a board, especially for the first time. Here is some common-sense advice for new directors. First, and most importantly, remember that directors direct and managements manage.

  Why Serve?
  Understand why you choose to serve and embrace it. In earlier times, directors often served for prestige, compensation, and fellowship, and their performance rarely was challenged. Those halcyon days are gone. You now must consider reputational risk, substantially expanded (and often last-minute) time commitments—perhaps at little per diem pay—and a more formal environment (which can impinge on candid strategic focus). Do due diligence on the company and its industry, as you will be judged in the court of public opinion—and perhaps even in the courthouse. You’ll need courage, good business instincts, and the rare ability to judge others accurately.

  Directors must exercise due care in decision making and need, as much as possible, to ensure that the information they receive is accurate, complete, timely, and verifiable.

  Reliance on Outside Advisors
  As a matter of corporate law, directors are generally entitled to rely on advice from outside advisors, including compensation consultants. Directors should exercise care in selecting experts and shouldn’t hesitate to question those experts as much as necessary.

  We recommend that the following be adopted as standard best practice for directors:

  1. Audit Committees should meet regularly with supervisory partners of their firm’s auditors, not just the audit partner, and should require that the auditors disclose conflicts and disagreements about accounting matters and the consequences thereof. Auditors already disclose conflicts with management and “opinion-shopping”, but directors need to understand the “close calls” that accountants are making.

  2. Compensation Committees should focus more on actual performance and on compensation expected under different scenarios, and less on consultants’ standard pitches on comparables.  Rewards for performance must be based on realistic goals, taking into account the environment and the factors management controls. In general, paying annual bonuses for performance only relative to an earnings budget should be avoided (because management controls the budget) and relative to peers’ stock performance equally (because management doesn’t control either its own or peers’ stock prices). Further, mark-to-market accounting of financial investments, determination of pension liabilities, and other key P&L components can be manipulated to affect reported profits and compensation. True operating cash flow, and performance relative to competitors, while also not perfect, are worth considering as performance measures. Proper use of deferred payouts tied to actual realizations will go a long way towards realigning managements’ and stockholders’ interests.

  3. Boards should receive regular presentations from outside counsel about important trends and cases in corporate law, especially those affecting their duties and their liability. In addition, directors should be assured on a regular basis that each of their primary law firms has brought forward any legal or ethical concerns.

  Board Oversight
  It goes without saying that boards should focus on economic and financial scenarios covering the full gamut of assumptions. In the current environment, liquidity is a key concern. At other times, expansion or strategic transactions may play a larger role.

  Management will always control the flow of information, and even deeply engaged boards will be on the losing end of an asymmetry of knowledge. But directors must exercise due care in decision making and need, as much as possible, to ensure that the information they receive is accurate, complete, timely, and verifiable.

  We offer the following suggestions to mitigate, at least partially, the inherent disadvantage directors face due to this asymmetry.

  First, ensure that management provides access to, and explanations about, competitors’ performance. Detailed understanding of relative competitive assessment of revenue growth, operating margin, employee turnover, customer satisfaction, and pricing policies will be far more useful than reiteration of historical financials or unsupported projections. Rating agencies face conflicts and their work cannot always be relied on (in any case, ratings often lag reality), and securities research can be superficial and dominated by management or employers. Spend time finding out how the firm is really doing.

  Second, create and exploit opportunities to engage informally with employees at all levels of the organization. Plant managers, sales staff, and human resource middle managers, for example, will have a less edited view of how the business is going than you will hear at board meetings.

  Third, make sure senior management regularly reinforces the responsibility, under a code of conduct or ethics policy, for every employee to notify an outside board member, anonymously or not, of any planned or known misconduct, whether financial fraud, Foreign Corrupt Practices Act payments, improper behavior, or other improper actions. The purpose of this “honor code” is to give directors more eyes and ears.

  Fourth, make sure board meetings include enough time for the independent directors to reflect in executive session on the reports they have received and to raise questions for later follow-up.

  It is important for directors to have a good working relationship with management, and, at the same time, one that permits directors to exercise their responsibilities. This relationship best can be described as one with “healthy tension.” Directors and management need to understand that asking probing questions is not done out of suspicion: Sometimes judgments of senior management are just wrong, and directors must press their questions, no matter how uncomfortable this becomes.

  Knowing Good from Bad
  There is no perfect system for identifying a CEO who lacks honesty, integrity, or capacity. Just as a board needs to know the physical health of top officers, however, it also should (subject to reasonable limits on privacy) understand their financial health, and, as much as possible, their values. Financial circumstances, especially excess leverage, sometimes force desperate people to take improper steps.

  One tip after years of experience: In addition to probing executives’ financial health, if a CEO regularly requests less compensation than his/her compensation committee would have awarded, that CEO is less likely to get the company into trouble via excessive risk taking or fraud.

  Good luck to all new board members, and, remember, selecting a good CEO and helping him or her achieve the goals set by the board is one of your most important jobs.

  Herbert S. Winokur is managing general partner of Capricorn Holdings and has been a director of numerous public companies.

  ]]> http://www.directorship.com/some-common-sense-advice-for-new-directors-2/feed/ 0 http://www.directorship.com/directors-board-return-to-campus/ http://www.directorship.com/directors-board-return-to-campus/#comments Mon, 12 Oct 2009 14:18:26 +0000 Django Gold http://www.directorship.com/?p=11148 “Education is a lifelong journey.” “A mind once stretched by a new idea never regains its original dimensions.” Such clichés have been a staple of the greeting card and bookmark industries for decades, but there is more than a grain of truth to each. Indeed, no corporate director would say “no” to a little extra knowledge, especially in this economic environment, which is why director education programs continue to be a fundamental component of executive enhancement.

  Today’s corporate education programs have attained a level of diversity and comprehensiveness unimagined by previous generations of executives. The modern global business climate has opened up vast sections of fertile territory for new exploration and interaction. The complexities of modern markets have necessitated a new approach to mastering the ever-expanding requirements of finance, risk, and strategy. Technological innovation presents numerous opportunities for growth and expansion as well as challenges. In short, the business world has changed and continues to change at an impressive rate, and the continual accumulation of new knowledge is and will always be an absolute necessity.

  The most important reason to look towards executive education programs, however, may not be entirely based on enhancing the skill set of executives and directors, but rather on the all-important goal of appeasing their bosses: the shareholders.

  A significant lasting effect of the financial crisis has been that shareholders have become increasingly concerned about the qualifications and personal character of those board members and executives in whom the well-being of their portfolios is entrusted. Now directors and C-suite executives are being called upon, either directly or indirectly, to prove their worth as leaders, and executive education programs can be a valuable tool in demonstrating to shareholders the development of new and relevant skills necessary in a changing economic landscape.

  Making the Grade
  In fact, executive education’s new justification may be one that the architects of such programs themselves are just beginning to come to grips with: regulators may require these programs. As shareholders watched resentfully, and sometimes vocally, as their portfolios diminished, the first scapegoats often have been directors and executives. Clearly, directors and executives have to prove themselves in different and more convincing ways than pre-Lehman collapse.

  The backlash stemming from the financial crisis is that shareholders and regulators are pushing for increased disclosure of the background and qualifications needed for service in the top ranks of a public company. The Securities and Exchange Commission’s proposed Proxy Disclosure and Solicitation Enhancements would require directors to provide more information on their backgrounds and qualifications on proxy forms. With this in mind, the kind of development offered by executive education programs may be just what directors need to prove their mettle to the company’s owners.

  “No one school can teach all that’s required to be a director…If you have a board, and you want to make it work more effectively, we can do that.” —Harvard Professor Jay Lorsch

  “The issues facing director accountability are very broad, but [executive education] may be persuasive to some shareholders in establishing a director’s value,” says Stanford University Professor Joseph Grundfest. Though directors may face skepticism from shareholders who doubt a company’s management capabilities, enhancements offered by executive education programs can go a long way in convincing shareholders about the commitment and training of their directors.

  Harvard’s Jay Lorsch is more skeptical: “No one school can teach all that’s required to be a director.” Lorsch says that while his school’s programs are invaluable in sharpening the skills needed to serve on a board, there is no replacement for years of on-the-job experience; in fact, he says, shareholders may not take such programs into consideration when evaluating directors. “If you’re on the board of a bank, and you don’t know anything about banking, we can’t fix that,” says Lorsch. “If you have a board and you want to make it work more effectively, we can do that.”

  One significant, tangible perk of executive education is that many agencies actually will endorse certain programs by granting higher rankings to boards whose directors have participated in such educational opportunities. In fact, ISS Corporate Governance Services, which administers proxy ratings for RiskMetrics, bases its proxy ratings in part on a board’s completion of approved educational programs. (ISS credits can also be earned by attending programs provided by the National Association of Corporate Directors and by Directorship.)

  Peer Exchange
  For executives with years of experience in a high-pressure daily working environment, time spent on the job is certainly more valuable than hours spent in a classroom setting. There is no substitute for experience, but the vast possibilities offered by new and innovative means of learning can add a new dimension to experience. One significant advantage to executive education, for example, is the opportunity to connect with new people and ideas. “The peer element is crucial,” says Gordon Armstrong, director of marketing at Duke Corporate Education. “Just engaging these smart people in conversation and giving them new ways of thinking about what they already know is very valuable.” Stanford’s Grundfest agrees: “Directors learn a great deal from talking with other directors, and these interactions are a very important element of the work.” It may simply be a matter of new ways of viewing things, says Assistant Dean Whitney Hischier at the UC Berkeley Center for Executive Education: “Oftentimes, if people have been in a particular industry or company for a while, they may have not been exposed to differing points of view. There is a humbling aspect to realizing we don’t all know everything.”

  In addition to the engaging minds found among classroom peers, the range of professors in today’s executive education programs is broad—and doesn’t necessarily follow the traditional mold of yore. Though most schools do rely on a core faculty, more often they are bringing in specialists from a variety of fields. “Our professors come from real-world arenas, including international politics, securities studies, environmental politics, and international law,” says Dean Deborah Nutter of the Fletcher School at Tufts University. “And they all bring with them a vital international perspective.”

  Engaging the Globe
  The curriculum offered by today’s executive education programs reflects the diverse challenges facing today’s executives, directors, and middle managers in a complex and interwoven business environment. The issues of risk management, regulatory compliance, teamwork, problem solving, audit, crisis management, succession planning, asset allocation, and executive compensation that confront today’s business leaders are those which an educational faculty can help tackle. “The world is changing very rapidly,” says Nutter, “and we’re always staying on top of changes in the world to help shape our curriculum.”

  Besides the unique educational and networking opportunities afforded by the collaboration of savvy business minds, today’s director education programs focus intently on the new global business frontier. A majority of these programs display an international character, with faculty and curriculum directed towards the possibilities offered by the worldwide market. “We once led a program for Ericsson,” explains Armstrong, “where the executives were faced with a new market in South Africa that they were not at all familiar with. We had them meet with leaders of South African NGOs (non-governmental organizations) and really gain a new cultural understanding they otherwise wouldn’t have had access to.”

  “It’s absolutely valuable to do a little exploring of the unknown,” says Hischier. She describes one program in which executives from a Norwegian petroleum company were taken to Brazil, one of their countries of operation. While there, the executives were taken into the field to meet with local oil suppliers, officials with the energy ministry, and community organizations to better understand the day-to-day life of a country that before had been merely a source of product. The field experience, far removed from the confines of the classroom, allowed company executives to see first-hand the reality of a country that until then had been an abstraction.

  “If the world were stable, then our programs wouldn’t do much,” says Grundfest. “But the business world now changes so rapidly that even the most experienced directors have more of a reason to spend time educating themselves about these new developments.” Grundfest likens the new opportunities for directors to those available to an experienced surgeon: new techniques, instruments, and drugs that are constantly being developed make continual education a necessity.

  Looking Ahead
  While traditional educational pathways focus on the lessons to be learned from the past, executive education programs are very much designed towards the future and its possibilities. With the world in flux thanks to a generation-defining recession, directors, executives, and managers at all rungs on the corporate ladder must acclimate themselves to the unique challenges posed by a global marketplace and a regulatory environment far less forgiving than that which nourished the downturn. “There is a broader scope of content to cover now,” attests Hischier. “Our programs are becoming more multidisciplinary in response to a changing world.”

  “The job of a director is dynamic and the obligations are changing rapidly, especially in terms of legal exposures,” says Grundfest. “As a result, our programs are changing. We reinvent them every year in response to what’s changing in the world.” While most program directors are still determining how their curriculum will be updated in response to the changes in the market, the most obvious impact is a greater emphasis on risk and its related disciplines. As director and executive education programs change, tomorrow’s leaders would be wise to consider such programs to stay abreast of new and valuable methods of adaptation, innovation, and success.

  ]]> http://www.directorship.com/directors-board-return-to-campus/feed/ 1 http://www.directorship.com/heidrick-gwin/ http://www.directorship.com/heidrick-gwin/#comments Fri, 02 Oct 2009 13:37:49 +0000 News Editor http://www.directorship.com/heidrick-struggles-announces-new-board-practice-leader/ Executive search firm Heidrick & Struggles has named partner Bonnie W. Gwin as head of its North American Board Practice unit. Gwin, who has worked with the firm for more than 11 years, has held a number of posts at Heidrick, including president of the Americas division. “The corporate governance landscape is going to change rapidly and dramatically in the next 18 months,” says Gwin, “with legislation and regulation that will significantly affect the composition of boards.” Gwin, whose position at Heidrick had seen her leading the charge in expanding board diversity to include a wide array of global talent, is heralded by her peers as an innovator. Says Gwin herself of the challenges ahead, “I find board searches are the most interesting work that we do. Apart from the CEO, directors have the most impact on the direction of corporate America and our economy as a whole. And today, there is a real premium on bringing in the most outstanding board members who uphold the highest standards of corporate governance and serve their companies and shareholders well.”
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