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.

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.

“I am shocked that in this time of extreme financial crisis for the bank that you would spend the time and legal expenses to challenge a resolution of this sort when the bank could simply ask the proponent to withdraw in light of the fact that you were now implementing the advisory vote,” wrote Tim Smith of Walden Asset Management in a letter to BofA executives. Walden was behind one of the say-on-pay proxy initiatives. “Is this a sign that bank executives don’t even know how to have a simple conversation with their shareowners to work out a basic agreement?” he scathed.

The BofA case highlights a well-known fact in the relationship between boards and shareholders: what we have here is a failure to communicate. The financial crisis and swooning stock market have heightened investors’ hunger for more information on corporate governance issues. Frustrated shareholders unsatisfied with structures in place for executive compensation, CEO succession planning, board nominations, and other hotly debated governance issues, are calling for a forum to voice their concerns directly to the board. “The collapse of the economic system has everyone talking about corporate governance… boards need to have a rational dialogue with shareholders,” says Stephen Brown, director and associate general counsel of corporate governance at TIAA-CREF.

Currently, the majority of boards do not have an open forum in which both sides are receptive and willing to meet to hear the other side’s concerns. Proxy resolutions, viewed today by some activists as a way to “knock on the door” of boardrooms, could instead become a last resort should changes be made in how investors and directors communicate with one another.

The news is not all bad. According to a recent survey by Spencer Stuart, data collected over the past 10 years from proxy reports filed by S&P 500 companies and surveys of corporate secretaries and general counsels found that 45 percent of respondents reach out to shareholders in some way. However, despite this number, only recently has progress been made toward regular dialogue that seeks to find middle ground between boards and investors. Pfizer was something of a test case in 2007, when it planned a meeting with large shareholders to discuss governance issues. Last summer, UnitedHealthcare Group created an advisory committee to allow shareholders to suggest new directors. PepsiCo signed a broad set of governance guidelines last June known as the Aspen Principle, which includes a promise to facilitate more communication with their shareholders. The boards of Home Depot, Hewlett-Packard, and Northrop Grumman have held dialogues with shareholders on compensation issues or even to discuss board nominees.

The Reg FD Effect

These companies are still the exception rather than the rule. Over the last several years, major changes have occurred that have curtailed the amount of information disclosed to investor groups. Barry Genkin, partner at Blank Rome, who has advised CEOs, boards, and audit and compensation committees in proxy battles, believes a lot of the unrest began when regulation prevented the amount of information companies made public, known as Regulation Fair Disclosure or Reg FD. “Companies used to meet with analysts and those analysts would write up reports,” says Genkin. “After new regulations intended to prevent ‘selective disclosure,’ companies were limited to only information they could place in an 8-K or press release.” Instead of working out other ways to inform investors, companies simply sent out less information, he says.

Edward E. Lawler III, a professor at the University of Southern California Marshall School of Business and founder and director of the University’s Center for Effective Organizations, believes that the SEC’s more recent efforts to push companies for more disclosure has backfired. “In a failed effort by former SEC chairman Christopher Cox, who pushed for more disclosure—what he got was more paper,” argues Lawler. “It backfired. With 30-page proxy statements, I don’t think people became more knowledgeable.”

“Information didn’t dry up,” adds Genkin. “But it wasn’t as robust.” Overall, Genkin agrees that companies have not dealt well with the disclosure requirements to investors. “A constant communication mechanism needs to happen,” says Genkin. “Enlightened companies who are aware of their company’s communication shortcomings need to be very aggressive.”

Some experts think that boards will soon have little choice but to communicate better with large shareholders. “Early on, investors were rebuffed because they were coming from a single direction,” says Patrick McGurn, special counsel at proxy advisory firm RiskMetrics Group’s ISS governance services unit. “Investors were reaching out and directors did not reach back.” McGurn emphasizes that the old way of communication is being absolved. He advises boards to open the door to large investors, and he says progress is being made, with some boards more actively connecting with their largest shareholders and telling them the changes their board is looking to make. “[Directors] want to stop any backlash that might happen when such information is actually disclosed in a proxy statement,” says McGurn. Establishing an open line of communication could help directors and investors avoid lengthy and costly proxy battles later on.

Last year, the National Association of Corporate Directors assembled a blue-ribbon commission on board and shareholder communications. Among its many recommendations was that the governance committee should have oversight of board and shareholder communications and make efforts to ensure that they are open, candid, and productive.

Pfizer’s Breakthrough

The concept of open communications is not new. As far back as 1992, Martin Lipton, a partner at Wachtell, Lipton, Rosen & Katz, and an opponent of “excessive” input by investors, and Harvard Business School professor Jay Lorsch called for the boards of U.S. companies to “meet annually in an informal setting with five to 10 of the larger investors of the company,” according to the paper, Talking Governance: Board-Shareowner Communications on Executive Compensation, co-authored by Stephen Alogna of Deloitte & Touche and Stephen Davis, project director at the Millstein Center at the Yale School of Management and the founding editor of Global Proxy Watch.

“The collapse of the economic system has everyone talking about corporate governance…boards need to have a rational dialogue with shareholders.

- Stephen Brown, TIAA-CREF

“It’s still a very slow and very rare process in the United States for boards to open up dialogue,” says Davis. “The investor relations function tends only to get investors to buy shares when pushing out information, but a two-way dialogue is what is needed.”

An important step toward opening the lines of communication occurred in 2007, when pharmaceutical giant Pfizer’s board decided to plan a meeting with larger shareholders for the sole reason of discussing governance issues. “When it comes to finding channels and pioneering ways of opening dialogue, Pfizer is a good example,” says Davis. Pfizer’s board met with 30 of its largest investors and took questions from them on corporate governance issues. “This is not about strategy, and it’s not about a dog-and-pony show,” Margaret “Peggy” Foran, former senior vice president of corporate governance, associate general counsel, and corporate secretary of Pfizer, said at the time. “[The board] just wants to gather as much information as possible to make the best decisions. I never thought of listening as a dangerous sport.”

Foran, now vice president, general counsel, and corporate secretary of Sara Lee, believes that eventually Sara Lee will follow the example set by Pfizer. She believes informal “listening exercises” involving large investors, lead directors, the CEO, and executives like herself, can lead to an official meeting, such as Pfizer’s. With many issues investors are seeking to address, boards realize that shareholder groups are diverse—and not everyone is going to leave the table happy.

Pfizer director Suzanne Nora Johnson agrees that creating a dialogue can be a positive step in building trust between boards and stakeholders. Yet, she says, the board serves a broad range of sometimes competing stakeholder interests, and it cannot select the ideals of a few at the expense of the many. “There are many different types of stakeholders,” says Nora Johnson. “You have to listen carefully and best evaluate whether the stakeholder has both short-term and long-term interests.” Since the 2007 meeting, the Pfizer board has not met again with shareholders apart from the annual general meeting, scheduled for April. But Nora Johnson says the board found the experience to be beneficial and says it will hold similar meetings again in the future, either annually or biennially.

“I think you will see a lot more informal [meetings between shareholders and directors],” says Foran. “For the past five or six years, boards have gotten more involved, with the help of shareholder proponents like RiskMetrics.” Moreover, Foran says, it’s becoming noticeably routine that all board members are attending annual meetings rather than only a select few.

Yet some directors do not agree that such meetings can be productive. Ashok Shah, a director at Sapient, a technology consultancy, thinks that opening the lines between directors and shareholders could create static. “I believe strongly that the relationship with the shareholder should be with one body in the company,” he says. “Today it’s mostly the CEO and the management team, and having that one relationship with the shareholder is the most productive and healthy method, rather than introducing one more conversation with the board. Otherwise, you have two teams talking with shareholders, which could lead to confusion and contradiction.”

J. Thomas Presby, a director who serves on multiple boards, including American Eagle Outfitters and Tiffany & Co., isn’t sure if greater communication is the answer. “At this moment, I’m not persuaded. I’ve attended a lot of annual meetings; most are orderly, and there are some but not a lot of questions. No one has stood up and said they need more communication,” he says.

To be sure, shareholders are a varied lot, often equipped with competing agendas and different views on governance. Genkin warns of the shareholder wolves in sheep’s clothes—the investor who is only interested in short-term performance. From his experience, there are shareholders out there looking to pursue their own aims under the guise of everyone’s interest. He notes that boards can hone in on who is legitimately concerned with the company’s long-term well-being and those looking for fast returns. Careful listening is required. “I’ve had activist shareholders approach boards saying ‘we’re your friends,’ while offering views that could be useful to the board,” says Genkin. “Some of the ideas of activist shareholders have become beneficial to the company and it becomes a win-win.”

Good Listeners

Many directors are warming up to the idea of establishing better communications with investor groups. Last fall, Bonnie Hill, a director at Home Depot, told a gathering of directors at an NACD conference: “Directors are accountable to—and should be responsive to—shareholders.” She said it should be the lead director or committee chairs who meets with large shareholders and that the talks should be structured and well planned. “The chairman or CEO should be the first point of contact. Then I think there are directors who might be clearly involved, such as the chair of the compensation committee. But it’s important to identify in the boardroom what kind of communication will take place—and who will do what.”

Some directors say that any outreach should be more of a listening exercise for boards than engaging in a back-and-forth dialogue. “It would certainly benefit the company if there were a more open line of communication between shareholders and directors,” says Charles “Randy” Whitchurch, a director at SPSS and Scan Source. “But this should be more of a one-way conversation, the board ought to be hearing the shareholders. I do not think the board should be the voice of the company speaking to shareholders; that’s the role of management. I think the danger of having a conversation is that it will become more of a two-way debate. Directors aren’t always as tuned into what the company’s message is. You run the risk of directors going off message…having been a CFO of a public company for 17 years, it was very important that we followed clear protocols on who and how we communicated with shareholders.”

Thomas C. Wajnert, lead director at Reynolds American, agrees that the focus should be on gathering feedback from shareholders. “Yes, they should be communicating, but I think it should be in the context of listening,” he says. “I think where the board has to draw the line is engaging in a debate—the board needs to be in listening mode.” Governance Road Show Opening the lines of communication means going beyond a telephone call or email. TIAA-CREF’s Brown suggests a “governance road show,” where a combination of general counsels, corporate secretaries, and lead directors, go out to meet with their investors. The hope is that relations will improve and become more accessible if investors know senior leaders in the company are interested in their concerns. “One firm we work with sends its general counsel to make the rounds with its large investors,” says Brown. “The feeling on our side is: we have access and feel as comfortable picking up the phone as he does.”

“I think the dangers of having a coversation is that it will become more of a debate. Directors aren’t always as tuned into what the company’s message is. You run the risk of directors going off message.”

- Charles “Randy” Whitchurch

Boards are expected to enact a more proactive role in listening to issues concerning shareholders. Experts believe that boards who refuse to adjust their communications strategy risk repercussions during proxy season. “The boards who are worried [about lack of communication with shareholders] are who should be least worried,” says Nell Minow, editor and co-founder of The Corporate Library. “Those who aren’t worried…they’re in trouble.” Minow advises that boards be open to more frequent dialogue, even if that means overhauling the way business is done.

Once the doors to dialogue are opened, rather than a lot of “babbling,” says Foran, it is better to seize the opportunity and narrow the criteria. “Shareholders should use the dialogue constructively— not micromanage,” she warns. “If boards allow shareholders to use the opportunity to talk as a weapon, boards are not using their fiduciary duty in the correct way.” Foran believes that in most cases, investors are trying to learn and understand—not attack. She notes some companies are initiating dialogues before a crisis rather than fending off shareholders made angrier because they feel ignored.

There may be another reason to for boards to seek more open communications with shareholders: majority voting. Some experts think that shareholders may withhold votes for directors who they perceive to be unopen to hearing their concerns. “There is a carrot and stick equation with communicating—with majority voting being the stick,” says McGurn. “If companies don’t dialogue when they’re approached by investors, they’ll see some effort to withhold or vote against.” If that begins to happen, some directors may be putting their largest shareholders on speed dial.

Highlights from the three-day event include:

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

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

In 2008, the financial services industry saw the highest rate of forced succession of any industry with 18 percent of CEOs pushed out, according to the WSJ.

One irony of the economic crisis is that it shows some institutions are beyond the grasp of any one person at the top while some of the most highly experienced executives, their reputations in tatters, can no longer even be considered for top roles.

Moreover, several candidates have reportedly turned down CEO positions in favor of lower positions at firms that didn’t accept Troubled Asset Relief Program (TARP)  funds and are therefore beyond the reach of government pay caps.

Overall, the WSJ report concludes, the pool of candidates for succession at financial services firms is shallow.

Hiring a CEO leaves an indelible mark on any corporation. Choosing the right leader can revolutionize a company and create success for decades to come. But the wrong selection can easily take years to correct. As directors look back at their tenure serving on a corporate board, their proudest and, perhaps, saddest memories usually involve the selection of a new CEO.

How can board members ensure that the CEO selection process becomes a fond memory?

Regrettably, selecting a corporate leader has become a static process, particularly since Sarbanes Oxley has forced interviewers to be overly cautious. What’s more, most CEO candidates are polished enough to present themselves in the most favorable light. Interviewers ask the same predictable questions, and oftentimes fail to expose a candidate’s most important character traits.

In truth, few people are prepared to be a CEO and too many fail the first time. Yet what board of directors can afford to hire a leader on a learning curve? With this in mind, search committees must move beyond the classic interview script when they meet a new candidate, and ask themselves these ten essential leadership questions:

1. Is Your New CEO The Smartest One in the Room?

Intelligence is only the beginning of great leadership. Regardless of their educational pedigree, a leader absolutely must possess “commercial intelligence” – the ability quickly size up a company’s goals, and then deliver a winning strategy in a highly-focused manner. The right candidate will not ask what the company wants to do, but will suggest what the company should do.

Does the executive recognize his or her own weaknesses? Does this leader acknowledge when he or she needs input from others? A CEO must welcome help, especially if it’s not his or her area of expertise.

2. Are They As Good As They Think They Are?

The key here: Does the executive recognize his or her own weaknesses? Does this leader acknowledge when he or she needs input from others? A CEO must welcome help, especially if it’s not his or her area of expertise. The only way to become a great leader is to surround yourself with people who have strengths different from your own.

3. Can They Manage Cross-functionally?

CEOs of major companies must deal with brand building, balance sheet issues, and cross-channel distribution. They must be as comfortable in a budget meeting as in an advertising meeting. Boards can no longer hire a single skill set, but must choose a true leader – someone who runs a business by influence across all functions.

4. Can They Stay Involved Without Micromanaging?

Successful CEOs know how often unforeseen mistakes can undermine a business. Most worry all the time. However, leaders must get past the details to serve as the strategic leader of the business. At the same time, they cannot afford to grow too distant from the day-to-day business. The key is to find someone who knows how to manage the balance.

Great CEOs don’t come into an organization thinking they know more than the collective wisdoms of their new companies. They find their way into the culture, establish themselves and then charter a new course for the business.

5. Can They Fit in Culturally?

Leaders are hired for their skills and fired for their style. A major cause for early leadership failure is not fitting in with the existing culture. In fact, matching the wrong personality to an organization leads to almost certain failure. Experience can be altered, but personalities cannot. Great CEOs don’t come into an organization thinking they know more than the collective wisdoms of their new companies. They find their way into the culture, establish themselves and then charter a new course for the business.

6. Can They Think Young?

E-commerce and similar advances have altered the business world at lightning speed. These technological shifts have also widened the generational gap between 55-year old leaders and their 35-year old direct reports or, in many cases, their peers. Regardless of age, true leaders must possess a gift for bridging this gap.

7. Can They Exploit Trends to Their Advantage?

Years ago, it was okay to commit to a single strategy. A factory could produce –and sell— widgets for fifteen years. However, business leaders today must adapt and discard trends quickly to keep their businesses relevant. For instance, in the 1980s, Banana Republic embodied the “safari trend,” with a jeep in front of every store. In response, Les Wexner of Limited created a popular brand called Outback Red. When the trend died, so did the label. He didn’t have to rebuild 400 stores.

8. Where Have Their Former Employees Gone?

A strong mentor can both choose good people, and mold them into future leaders. Many leaders want soldiers, who simply execute their commands. The more effective leader hires people who create new ideas that propel them toward bigger jobs. Only a true leader can engender the success of his employees. By doing so, they create a stronger organization as a whole.

9. Can They Be Passionate Without Being Emotional?

No one wants to put up with emotional bosses, particularly those who get insulted and grow defensive each time an idea is challenged. It’s impossible to get much work done when executives must constantly manage their CEOs’ psyche. By contrast, passionate leaders care more about their business than their ego. They will listen to those around them.

10. Do They Have A Sense of Humor?

While no search committee wants to hire the class clown, a sense of humor can be an incredibly powerful tool for leaders. Humor disarms people –be it disgruntled employee, dissatisfied shareholder, or unyielding client— and forces them to consider another point of view. Leaders who can find something to smile about amid difficult situations instantly create a positive workplace. A sense of humor is one of the few qualities possessed by most U.S. Presidents –including Abraham Lincoln, George W. Bush, and Barack Obama. If Lincoln could find levity during the Civil War, shouldn’t a CEO do the same during a weak earnings period?

Les Berglass is the founder of Berglass + Associates, an executive search firm focused on consumer goods companies. Berglass+Associates has been responsible for placing the CEO of organizations, such as Bath & Body Works, DSW Inc., St. John’s, and Victoria’s Secret.

Schoenfeld, which manages about $3 billion and owns 1.5 percent of Saks, urged other shareholders on Monday to vote against the way the company currently elects directors.

Under its current election process, only four of Saks’s 12 directors come up for election every year and each serves a three-year term.The company’s staggered board “serves only to protect management and sitting board members, letting them keep their jobs and compensating them very well, irrespective of the company’s performance,” Peter Schoenfeld, the hedge fund’s eponymous founder, said in a letter.

The hedge fund also asked shareholders to withhold votes for there-election of one Saks board member, C. Warren Neel, a professor ofcorporate governance at the University of Tennessee, Knoxville.

“There are real issues with this management team,” Schoenfeldtold DealBook. “The company has never met the goals it has set forthemselves under this management team.”

Saks, known for its flagship store on Fifth Avenue in New York, hassuffered months of weak sales as well-heeled consumers cut spending onluxury items. Shares of the company are down nearly 74 percent over thepast year and have dropped to as low as $1.50 a share earlier thisyear. In January, the company said it would eliminate 1,100 jobs andreduce inventory by 20 percent.

]]> http://www.directorship.com/hedge-fund-targets-saks-board/feed/ 0 http://www.directorship.com/gantler-ruling-stresses-independence-and-process/ http://www.directorship.com/gantler-ruling-stresses-independence-and-process/#comments Wed, 01 Apr 2009 04:00:00 +0000 Stuart H. Gelfond http://www.directorship.com/?p=4527 Gantler v. Stephens reemphasizes that, when considering the merits of a sale of a company, even non-management “outside” directors must be aware of potential conflicts of interest which might be viewed as affecting their independence—especially when one of the options implicates management’s own interests. ]]> The Delaware Supreme Court’s recent decision in Gantler v. Stephens reemphasizes that, when considering the merits of a sale of a company, even non-management “outside” directors must be aware of potential conflicts of interest which might be viewed as affecting their independence—especially when one of the options implicates management’s own interests.

The breach-of-fiduciary suit alleged that ,after starting a process to solicit bids for the sale of the company, management and the board abandoned that process to pursue an alternative that benefited management and the directors at the expense of public shareholders.

Strikingly, the court found that abandoning the sales process—even apart from the subsequent approval of the going-private alternative—could itself constitute a breach of the directors’ duties. While purporting to reaffirm the traditional understanding that commencement of a process to “shop” the company does not give rise to an affirmative duty to sell, a combination of factors led the court to hold that, under the specific (and perhaps unusual) circumstances alleged, litigation over the decision not to sell should proceed to discovery.

The decision also covers a variety of other important issues, including the point that the fiduciary duties of corporate officers are essentially identical to those of directors, but this article will focus only on certain practical lessons which can be drawn from the alleged facts that prevented the outside directors from successfully invoking the protections of business-judgment rule at the very outset.

First, independent directors need to take control of the process when management’s own interests become involved. Here, no structural attempt was made to address the conflicts presented by management’s support for a going-private alternative. A single outside director was designated to chair a special committee, but he died, and the committee was never reconstituted. The conflicts the court found to affect the loyalty of two of the outside directors (that they were principals of vendors that did substantial business with the company, which was potentially at risk following a change of control) were perhaps not that substantial, but the lack of any recognition of other,more obvious, conflicts may have given the court a particularly jaundiced view of the directors’ independence.

Indeed, it was alleged that management had engaged in deliberate sabotage and had driven away a potential bidder, identified by the company’s financial adviser, by repeatedly failing to provide promised due diligence– thus illustrating the risks created by the directors’ failure to supervise or monitor management contacts with potential acquirers in a conflict situation. Even if particular outside directors are deemed independent for the purposes of stock-exchange listing rules, the board should carefully consider their independence in the context of the particular transaction (or alternatives) at hand.

Second, independent directors need to ensure that alternatives are thoughtfully considered and that this consideration is documented. Here, the only firm thirdparty bid that was obtained was allegedly rejected without any substantive discussion. While the bid’s terms were not necessarily so overwhelming (they included only a modest premium to market price) as to make rejection unjustifiable, no reasoned justification for the rejection appeared in the record. Even though the court formally held only that the allegations could establish a breach of the duty of loyalty, and declined to reach the separate issue of the duty of care, the court’s conclusion on the loyalty issue may have been colored by its perception of a sloppy and careless process. Since unacknowledged conflicts of interest provide a motive and explanation for process failures, the failures may themselves serve as indirect evidence suggesting disloyalty.

Third, from a risk management perspective, it is significant that the board in this case did not unanimously support the path taken. The dissenting director, who was also a substantial shareholder, ultimately left the board and joined with other shareholders in filing suit. Thus, the complaint had inside detail on the alleged flaws in process that might have been unavailable to a typical plaintiff. The lack of consensus should have made the majority and its advisers even more focused on ensuring that an appropriate and careful decision process was both followed and documented.

While the extent of process breakdown alleged here might have been unusual, the decision serves to refocus attention on the importance of process, including examination of even seemingly minor potential director conflicts, in anticipation of the next wave of transactional activity.

Stuart H. Gelfond is a corporate partner and David B. Hennes is a litigation partner resident in the New York office of Fried Frank Harris Shriver & Jacobson LLP.

Pension fund trustees certainly have little to cheer about. What can they do now?
We currently advise 11 large funds that own shares in many companies around the world, including many financial-services firms. We’re engaging with these banks on their risk management, strategies, and the ways in which they pay themselves. If these questions had been asked earlier by more people, we would not be where we are today. We often behave as though banks were operating independently, as if they didn’t have owners. It is in pension funds’ longterm interests to have a dialogue with the companies they invest in. This process of engagement involves direct board-level contact and is most effective when it is collaborative. We do have robust conversations, but most companies appreciate and benefit from a dialogue with their long-term shareholders. This seems rather obvious, but companies that are well managed and do the right thing tend to do better in the long run.

How do we end this downward spiral?
Part of it is lack of confidence and trust, and the problem that no one (including the banks) seems to know how much the banks are worth. Globally, there’s a real opportunity for big pension funds and insurance companies and the banks they invest in to work together. There is also an opportunity for more collaborative and longer-term thinking. Everyone’s retrenched and lending on a very short-term basis, but it’s in their rational self interest to begin working with one another.

But somebody’s got to go first?
Absolutely. The large funds should get together and demonstrate some leadership themselves and start the dialogue. Part of the reason I’m here [in the United States] is to talk to prospective pension-fund clients. We offer a service through Hermes EOS to empower pension funds and enable them to work together to be better owners of companies.

Are you optimistic about corporate governance changes as a result of this environment?
It’s essential and long overdue. The United States has possibly the worst governance environment. Shareholders’ rights are stronger in the U.K. and pretty much every other country. The United States is lagging and that has contributed to the current problems. Shareholders lack key rights and the large pension-fund owners of U.S. companies could do a better, more responsible job with majority directors elections, access to the proxy, and say on pay. Our experience in the U.K. is that such rights improve the quality of the dialogue between companies and their shareholders to mutual benefit. Funds will also need some encouragement to exercise their rights. I expect this will happen with the [Obama] administration.

Do you think CEO compensation problems are restricted to a few widely publicized, egregious cases, or are the excesses widespread?
This is a consequence of lack of oversight, a lack of shareholder rights, and a lack of transparency. CEO pay must be aligned with the interest of shareholders and customers. Are there models? The only model for Hermes EOS is what is in our clients’ best interests—better managed, more valuable companies to invest in. We are not pushing any particular compensation model. The right model is that which encourages long-term, sustainable financial and business success.

Should there be a cap on executive pay?
I would hope that wouldn’t be necessary if the large, long-term shareholders were acting in their own rational self-interest. This should occur naturally. We don’t want government and regulators to intervene, so we should get our own houses in order and create a more efficient market that reflects the interests of participants. We should also look to local best practices. We were talking to several banks over the past two years and challenged them about the ways they were paying traders. They claimed that there was a market for executive talent that required a certain level of pay. We strongly encouraged banks to work together to produce a best-practice model for their industry and their market.

In your view, has U.S.-style litigation had any effect outside of the United States?
I don’t think it’s spreading. Such litigation seems unique to the United States because of corporate law and the relatively poor level of shareholder rights. Although we should expect shareholders to take action when they have been defrauded, many securities class actions are opportunistic and distracting to corporate management. Also, as a long-term shareholder, it is rather like suing yourself. You take money out of one pocket, give some to the lawyers, and put the remainder back in another pocket.

Is there a particular shareholder bill of rights to which you subscribe?
We support local best practice. There’s no one ideal set of rights, although the best governance systems facilitate good corporate management and accountability to the owner. The problem with “corporate governance” as it is too often interpreted and practiced is that it has become an exercise in compliance, rather than good corporate management and ownership. Companies need responsible and interested owners, rather than box-ticking traders of their shares.

How have corporate frauds, such as the one the former CEO of Satyam admitted to, affected how Hermes looks at governance in countries such as India?
India is a really interesting example because quarterly reporting has brought such a short-term focus and pressure to companies, perhaps even more so than in the United States. Small adjustments, or a small lie, become magnified over time as the adjustments continue. Weak corporate management may try to maintain growth in earnings to meet the expectations of asset managers with a short-term focus. This is very different than the challenge we provide to companies through Hermes EOS. The conversation that CEOs and CFOs frequently have with the City of London or on Wall Street is very short term and generally not about the substance of the businesses they are running.

Short selling has also been blamed for creating a short-term focus. Has it become a big problem?
Short selling is not in itself bad, but it needs to be properly controlled and there should be more transparency. Also, those people who are facilitating short selling by lending their stock should do so in a managed way, monitoring the lending volumes and corporate actions. This sort of rational, self-interested control by pension funds and other long-term end owners of companies is esssential if we are to avoid heavy-handed regulation in this area. The best regulation will provide additional transparency and create open and transparent markets, which are necessary for restoring trust in our financial system. It is then for the market participants to behave responsibly and at the very least, avoid doing damage to the financial system on which we all depend.

Should we do away with quarterly reporting?
I don’t see the benefit of it. What’s more important is that the end investors should take control of the situation and demand better terms from management for their money. As we look ahead, I hope that pension funds and other institutions will rise to the challenges presented by the credit crisis and help build a more stable and sustainable platform for growth.

In the face of the current financial crisis, Millstein has been at the forefront, calling for boards to take greater responsibility and improve oversight of risk management. He recently delivered the keynote address at the KPMG Audit Committee Issues Conference, presented in association with the National Association of Corporate Directors and Weil Gotshal. His message was clear: Directors need to restore trust and reset their goals. What follows is an excerpt from Millstein’s speech. The full text can be found at www.directorship.com/millstein.

I’ve had the good luck to have lived through the Great Depression and every recession since, and I’m still here, which is the good news. However, the depression of the 1930s had a lasting impact on my attitude toward life and times. I don’t suppose any of us who lived through it ever fully recovered enough not to worry about money, jobs, and all the rest, no matter how we otherwise made out in life.

This particular crisis bears a resemblance—but only a resemblance— to the 1930s. Really, in my opinion it’s nothing like it and won’t be. Furthermore, I am confident that the lasting effect this time will be positive, not negative. Watching my grandchildren and their attitudes, I see them fully capable of resetting their goals in a very positive way. I think they will see the world as one in which real values are more important than the values we created in the 1980s and 1990s. So, I’m confident about the future, despite what follows in this speech.

The first thing we must do is restore trust in the system. This requires a new approach to proposed government regulation once the need for emergency responses subsides. Future regulation should be based on an analysis of its costs and benefits in terms of economic impact. In addition to regulatory reform, we need to take a hard look at how the private sector governs itself. To earn trust, both analysis and reform demand total transparency to convince the public at large that regulation and governance are designed to benefit the “real economy,” not Washington or the executive suite.

The second theme is “resetting” the goal of these public and private efforts. The goal cannot be to get back to where we were in 2007! The public at large won’t accept that—the financial “anything goes” attitude of 2007 led us to where we are now. Rather, as President Obama has stated, the goal has to be to provide jobs and put people to work. This is our immediate goal; it can evolve and shift later, but this is our guiding principle now. We should focus pragmatically, not ideologically, on what actions will best allocate capital for the creation of real jobs. This is a far better objective than ideologically, and perhaps almost mindlessly, bolstering financial institutions by relying on economic models that are no longer applicable.

Most importantly, I heard in Obama’s acceptance speech what [columnist] David Brooks labeled the “politics of cohesion”: a new personal and mutual responsibility and unity, supporting pragmatism. This will indeed accomplish our goal over time if, and only if, across the entire private sector institutions and individuals alike reset goals and values. For the private sector, specifically the corporates, it means fulfilling their responsibilities to society at large, as well as to their shareholders and stakeholders.

Resetting the Goal
When we begin the process of careful regulation and governance reform, we have a reset goal: facilitate the flow of capital in a way that creates jobs in those industries which together will productively and efficiently employ the most Americans. The goal can be met by a variety of initiatives, but each initiative will need to be examined with that goal in mind.

Furthermore, in assessing the economic impact of proposed regulations and private initiatives, we must make strategic choices for the economy as a whole, between innovative and lightly regulated financial markets and the stable and heavily regulated market of the post-depression period. The right balance is one that creates the most jobs and stimulates economic growth in the long term. Directors and management are in a position to play an important role in reining in over-zealous attempts to constrain the financial industry and in assessing how much is too much.

Our situation is undoubtedly precarious and will continue to be for an indeterminate time. The banking sector is apparently imploding as we speak. Indeed, some wise heads see nationalization looming. What will that do to our market model?

Where and when does it stabilize? Not clear. So we are faced with the need to legislate, regulate, and modify behavior in an imploded capital market. The almost knee-jerk past response was to “fix” the capital market, using outmoded models, and without careful concern for the negative consequences: In good faith perhaps, but too much, and exclusively, government-think. And the negative consequences have landed on President Obama’s desk.

We didn’t have reliable economics or financial engineering on which to base our actions. Lehman and the Troubled Assets Relief Program, for example, may have been good-faith efforts to impact capital-market institutions and market behavior based on theories (and models) which then demonstrably didn’t work—and indeed, backfired. As a noted modeler recently pointed out, “…many of the predictive models taught in the classroom—models that fueled the financial industry’s boom and eventual bust—simply no longer work…They are all broken.”

So we go to work on all of this in a period of “pedagogical improvisation.” As FDR once did, we may have to use buckshot, since we have no reliable silver bullet to fix all this. And we need to be ever mindful that our task is not just U.S.-centric—the world is watching and doing its own thing.

This, then, is the context in which we all go to work in the future to regulate and self improve: uncharted territory, a broken compass, and only a North Star—people and jobs—to go by.

Where Do We Go From Here?
How exactly do we accomplish the reset goal? What are the new models now that it seems existing financial-capital market models are broken? In early January, hundreds of economists attended the annual meeting of the American Economic Association and, as a group, agreed that a profound shift has occurred. Why the shift in thinking? Because economic models are built on the assumption that people act rationally. However, irrational behavior appears to have played a significant part in the financial crisis. Maybe we start at the beginning with Adam Smith—not with The Wealth of Nations, but with The Theory of Moral Sentiments. Even Adam Smith’s world of competition and maximizing self-interest may not suffice, because the market does not exist in a world made up of people of prudence, of self-control, and beneficence.

So as academics, economists, theorists, and philosophers go back to their “pedagogical improvisation” and attempt to construct viable models, I suggest that, for now, we use President Obama’s pragmatic goal and mutually responsible approach as the guiding principle: What can the government and the private sector do to allocate capital away from the self-enrichment of special sectors and toward the production of goods and services for the creation of jobs? We should insist that such a test be applied. It may turn out not to be simple in application, but it’s a place to start each analysis.

The guideline, then, for future legislation and regulation: Does it serve the national interest in making capital transparently and fairly available to enterprises that create jobs in America?

We can no longer allow financial engineering, as important to the functioning of the market as it certainly is, to continue to be the tail wagging the dog of the real world of producing the goods and services which provide the jobs and economic growth vital to the whole world’s well-being.

Dysfunctional capital markets, which had a life of their own and became an end in themselves—rather than an instrument of solid economic development and job creation—are at the heart of this crisis. It is therefore critical that any and all responses to this crisis revert to the recognition that capital markets should be treated as an instrument, but only an instrument, to restore trust and promote real economic growth.

Cost/Benefit Analysis
It is too soon to tell the exact shape that the forthcoming regulatory overhaul will take. A crisis of this magnitude would not have been possible without a combination of multiple flaws in the regulation and deregulation of our financial system—and it will take some time to design effective remedies. Such remedies necessitate a set of strategic choices regarding where along the spectrum— between innovative, lightly regulated financial markets susceptible to crisis, and more stable, heavily regulated financial markets—is the optimum?

There will be many people pushing for a stripped-down sort of financial sector not given the freedom to create the next paper economy or shadow-banking industry that may prove inefficient in the long term. Indeed, some groups seem to suggest a return to old-fashioned commercial banking—taking deposits and lending to business, industry, and homeowners, on a closely regulated basis. However, there is another view—that innovation and risk-taking are a source of wealth and should not be stifled. But with such innovation and risk, and consequent potential instability, you need trust, trust that financial activities will support social productivity and the creation of jobs. How do we go about balancing and designing the right kinds of regulation that restore trust? How can we know that any governmental proposal satisfies its requirements? The customary message of our recent past—“because I’m telling you so” or “because disaster will otherwise ensue”—will not do for long-term solutions.

There is an old-fashioned way. Any future proposal for regulatory reform or governmental assistance should undergo a rigorous cost-benefit analysis in terms of economic impact, one that carefully weighs the expected benefits to the goal of growth and job creation against expected costs, potential risks, and negative market impact—all factors in assessing the economic impact— before it is adopted. Moreover, the main considerations involved in this  analysis should not be the exclusive province of government bureaucrats; transparency to the private sector and the public at large is essential. With participation by the private sector, only proposals which pass this stringent and transparent economic impact analysis should be allowed to go forward.

This is hardly a revolutionary suggestion. As long ago as 1979, an American Bar Association Commission published a scholarly report titled, “Federal Regulation—Road to Reform.” Its theme, just as applicable today, is that regulation should not be undertaken without adequate analysis and evaluation of its impact—an analysis that must have participation by impacted parties. Corporate leadership must step into the gap left by failing or teetering institutions and speak up to ensure that we don’t over-regulate and that our public and private reform efforts are supporting the production of goods and services and the creation of jobs.

What Regulation Makes a Difference?
As Obama and his economic team go about crafting legislation and designing specific regulations, it seems their efforts are being guided by what is known as the “Group of 30 Report,” which provides suggested guidelines for regulating the financial industry (including those industries, like private equity and hedge funds, that have historically, at least in part, been unregulated). The Group of 30 is a not-for-profit body of senior representatives from government and the private sector. Larry Summers, the head of the White House’s National Economic Council, is said to be preparing a blueprint of proposed regulatory changes to the financial industry, which will in large part be based on the Group of 30 Report.

Now, let’s turn to a few specific proposals and apply a simple test: let’s ask ourselves whether proposed regulation encourages the allocation of capital in a way that creates jobs. What follows are off-the-top- of-my-head examples—for which others may have different reactions. But that’s where analysis comes in.

REGULATORY REORGANIZATION: Greater coordination or some form of financial oversight reorganization by and among the Commodity Futures Trading Commission (CFTC), the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA), the Federal Reserve, and other federal agencies.

• It looks efficient , but will it result in a more appropriate allocation of capital? Perhaps one hand at the tiller is too much central control and not enough room for competing ideas.

• Will some form of bank nationalization change the whole equation? How?

EXECUTIVE PAY: President Obama has called Wall Street bonuses “shameful” after a report found that financial executives received an estimated $18.4 billion in bonuses in 2008.

• Limits on executive pay in the financial industry will encourage a flow of highly skilled labor out of that sector and into those sectors that produce jobs, or into regulatory or enforcement positions that will help regulation and oversight keep pace with the inevitable innovation that always finds the gaps in regulation.

CREDIT RATING AGENCY REFORM: High on SEC Chairman Mary Schapiro’s list?

• Having SEC examiners at credit rating agencies, or lifting the near-monopoly created by the SEC’s Nationally Recognized Statistical Rating Organization (NRSRO) designation, or creating something akin to the Public Company Accounting Oversight Board (PCAOB) to oversee the credit-rating agencies.

• Will this help allocate capital more efficiently? Maybe by ridding the credit rating business from perceived conflicts, there possibly will be more candid assessments of risk, and capital would flow to the most efficient uses. But are the “solutions” simply theoretical and not practical? Are there downsides? HEDGE FUND REGULATION: Another item on Schapiro’s to-do list.

• Insisting on hedge fund registration would provide great transparency around hedge funds and the size and nature of their investments. This may help the allocation of capital to its most productive uses, but what risks does it present to the system in general?

• Other proposals include regulation of short selling (including more aggressive enforcement of rules against naked short selling, public disclosure of short positions, reinstatement of the “uptick rule,” and prohibitions on short selling). Are these just facial cleanups and how do they impact capital flows to enterprises that create real jobs?

RISK-BASED CAPITAL REQUIREMENTS: Yes, probably. Capital requirements encourage creditors to do business with financial institutions, by giving them protection, which, in turn, gives financial institutions additional capital to invest in productive ways. What are the downsides to job creation?

THE GLASS-STEAGALL ACT: Should this and other barriers between commercial banks and other investment-banking services be reinstated?

• By removing incentives to act in the interest of themselves and the generation of business and bonuses, banks might allocate capital to its most productive use. Perhaps this is already underway, but has it been thought through on an economic-impact analysis? Again, does some form of bank nationalization change this equation?

FINANCIAL REPORTING: In an article titled, “How to Restore Trust in Wall Street,” former SEC chairman Arthur Levitt and former SEC accountant Lynn Turner described the need for improving the quality, accuracy, and relevance of financial reporting in the effort to restore trust. In defending fair-value accounting as making the risk profile of an institution more transparent, the authors argued, “[W]e should be pointing fingers at those at Lehman Brothers, AIG, Fannie Mae, Freddie Mac, and other institutions who made poor investment and strategic decisions and took on dangerous risks. Blame should not be placed on the

process by which the market learned about them.” Are they right?

INTERNATIONAL FINANCIAL REPORTING STANDARDS: Shift global regulators, including the SEC, to a single set of accounting standards. A uniform set of accounting rules seems to promote the efficient flow of capital internationally and further enhance financial- market coordination. But which standard encourages appropriate capital allocations, and which might cloak it?

These are just a few of the proposals on the table. It’s my goal to seek a formal and rigorous economic-impact analysis as to whether each regulatory reform seeks to reset the capital markets to facilitate the flow of capital to the real economy, to well-performing enterprises that create jobs and economic growth; abjures a self-enriching financial system; and does not have serious adverse consequences.

We have a long way to go to financial recovery, but we know economic growth depends on trust in the functioning of the capital market and in the people responsible for running financial institutions and our productive corporations. We know the government and private sector have important roles to play in our economic recovery.

The private sector, along with public regulators and lawmakers, must insist that government action is aimed at resetting the capital markets to their original purpose—to facilitate the flow of capital to corporations that create economic value in the long-term and provide jobs. Every rule, new and old, must be examined and tested to ensure that it serves the national interest in making capital transparently and fairly available to enterprises that create jobs in America.

Moreover, the private sector is uniquely positioned to restore trust in the capital markets. It is at the very place regulation ends that individuals are asked to make discretionary decisions about the use of capital in the interest of their beneficiaries. It’s here in the gray areas that self-regulation and prudent corporate-governance practices are absolutely necessary. It’s in the boardroom that independent oversight is necessary, especially in the area of risk management, to instill market confidence.

The Recurrent Crisis Recurs

Boards and shareholders have ducked on compensation
Our individual savings generate the entire capital market, either through direct investment in public corporations, or indirectly through intermediaries such as pension funds, IRAs, mutual funds, savings banks, investment banks, insurance companies, and the like. Indeed, the government itself is an intermediary as it redistributes our taxes as the source of the recovery program. All intermediaries are dealing as fiduciaries for other people’s money, ultimately—ours. No matter how long the ownership chain, we are still the principals.

Together “we,” the whole investment chain, are the owners of corporate America and we should act like it. “We” have ducked our responsibility to halt compensation excesses in the financial sector and, to a certain extent, sections of the rest of corporate America. Now that compensation has come front and center in the wake of a crisis which has not only exposed its flaws, but did so on national network television, activation is essential. Not just because compensation at excessive levels is unacceptable to most of the beneficiaries—us—(which is reason enough), but because compensation is a politically attractive ground for regulation.

We should act now to re-establish the public trust in business and our enterprises. If we do not, we will face a regulatory response that can never accommodate all the unique individual circumstances of every company and industry. I believe any regulation will be so “swiss cheesed” in content, or by innovative interpretation, as to be ultimately ephemeral and ineffective.

But unless we act swiftly, history teaches that regulation seems inevitable given the public anger at excessive compensation. This is not just because it is a part of the economic downturn, but because it is the part the public understands best.

There seems to be a natural recurrent cycle for corporate governance crises: crisis, regulation; another crisis, more regulation; yet another crisis, and still more regulation. Today’s crisis involves the one issue the public is in total agreement about—excessive executive compensation. Naturally, regulation is hovering.

The regulation which has followed each crisis could have been avoided: Boards of directors would have needed to be attuned to, or at least just aware of, the temper of the times and perhaps, simply, a common sense of right and wrong.

Examples abound, but I will mention just two. The Foreign Corrupt Practices Act of 1977 was enacted following an SEC investigation and subsequent public disclosures of bribery. Was a statute carrying criminal penalties needed to convince boards that bribing was not an acceptable method of doing business? More recently, the regulatory response to crisis included passage of the Sarbanes-Oxley Act in 2002, an event which is particularly painful to me. Just a few years before Enron, John Whitehead and I chaired a Blue Ribbon Committee on “Improving the Effectiveness of Corporate Audit Committees.” The Committee unanimously recommended improvements in audit committee practices to reform the growing bookkeeping gyrations that were in use at the time. The recommendations were not generally adopted. Then came Enron and the congressional hearings that ensued. What began as our suggested voluntary practices quickly became legislated “musts” for board audit committees.

And here we are again. Who didn’t know that compensation practices had grown out of hand? Certainly the public did and complained, to no avail, as did a number of major shareholders often derided as “activist” troublemakers who were essentially ignored. Meanwhile, all forms of compensation in and beyond the financial sector continued to grow, as did the distance in compensation between executive management and the factory floor.

Why did so many boards fail to respond? Principally because, I believe, they chose to be tone deaf and paid little attention to the too-quiet voice of shareholders. Instead, they were complicit, relying on the easy “everyone else is doing it” excuse during the high-flying era, which has just collapsed.

Now the new crisis, and the bonus practices of some top-drawer bankers have brought in a troubled President ready to act on our behalf. The President, quite understandably, set forth new regulation containing direct-compensation caps and related restrictions for bailed-out corporations.

Moving forward, it would be useful for us to remember that the end of the ownership chain is the board of directors, the ultimate fiduciary for shareholders of every stripe. Compensation has always been the board’s responsibility. If they cease to be tone deaf, boards across the corporate spectrum will pick up the challenge and voluntarily bring compensation back to earth, before Congress, which isn’t tone deaf on this issue, moves in with broader “reforms.”

What will it take to develop a spine in the boardroom on the compensation issue? First and foremost, pressure from the institutions that represent all of us as their beneficiaries. Those institutions, individually and as a group, generally own enough stock, directly or indirectly, to be “heard” by their investees. And we, the provider of savings to the institutions, have the voice and legs to encourage them to be heard.

Communication with boards is available to the institutions informally and through more formal means such as proxy resolutions. Majority voting is available to shareholders of many corporations to remove compensation committee members. Public bullhorns are effective. A nudge from government may come in legislated rights for shareholders to have a “say on pay” which I believe is useful, but not critical, for those institutions that seriously want to communicate with a board. Those institutions need not await legislated “access” to place their own directors on a board, if they are serious about protecting us, their beneficiaries, rather than the boards and managements of their investees.

We know that all shareholders and taxpayers have the voice to act on compensation now.

Do they have the will?

Ira M. Millstein is the senior associate dean for corporate governance at the Yale School of Management, and senior partner, Weil, Gotshal & Manges. He is a member of the board of the National Association of Corporate Directors and has lectured and written extensively on corporate governance.

Why did the Sarbanes-Oxley Act—passed in the aftermath of accounting scandals to restore credibility, accountability, and transparency—fail to curb the current abuses that led to this wretched financial crisis?

Certainly, the broadening of the crisis from the financial sector to the wider market can be blamed on a lack of investor confidence. But wasn’t SOX enacted to restore this confidence? Wasn’t it supposed to ensure that the proper controls were in place and the incentives to gild the lily were deflated? Then why, as Yogi Berra might say, does this feel like deja vu all over again?

Truth be told, I realized that Corporate America had reached an epic low point when an old friend, an astute investor and longtime bank director, declared shortly after the fall of the House of Lehman: “They’re all liars…I wouldn’t invest a thing.”

These harsh words go to the very heart of our responsibility as directors to shareholders and to the corporations on whose boards we choose to serve. They also underscore how completely the public statements made by company executives in the days leading up to the collapse of their once venerable companies have eroded investor confidence. Losses to shareholders and employees just from Lehman, once the fourth largest investment bank, are staggering. The list of those holding the bag includes the 158-year-old firm’s 25,000 employees (a group that as a whole owned 30 percent of the firm’s stock) and more than 400,000 shareholders. The plunge in Lehman’s shares this year wiped out $15 billion of their net worth.

No question what is needed now is a restoration of trust. But is new regulation the answer? SOX was well intended, but as we’ve just witnessed, it failed to prevent this horrific outcome.

More specifically, Section 404 of SOX was a form of risk analysis that provided, on paper at least, for an evaluation of a company’s internal controls. Section 404 also mandated that annual reports detail the scope and adequacy of internal-control structures and the procedures for financial reporting, while requiring accounting firms to assess and report on the effectiveness of those structures and procedures.

The idea was that, in addition to fraud, the internal controls mandated by 404 would expose unnecessary risk. A massive amount of money was spent to implement 404 with the good intention of creating a less risky corporation and alerting investors and boards of the potential for risk. Small businesses fought back against the high costs of SOX and 404 implementation. But big business—including companies in the most highly regulated industries such as financial services and insurance— duly went about developing bureaucratic apparatus to analyze risk.

The objective seemed, unfortunately, to design a process that passed legal muster. But an activity that is purposely designed to meet a regulatory requirement as its goal often produces problematic results, as we have now discovered. Assuring that the controls apparatus is in place and well-documented is not the same as assuring that it works well.

So, what do we do now?

The answer clearly lies in risk assessment. But how do we make it both effective and confidence-building to the investing public? It must be designed and carried out in an inspired way, not because the government requires it, but because it is the directors’ duty to shareholders. Such an approach ultimately will create a better process and, in the end, a better result.

The Corporate Library’s survey also found:

• the median increase in total board compensation was just under 11 percent;

• the median increase in compensation for individual directors was almost 12 percent;

• this is the third year of double-digit increases for directors and boards, though the rate of increase appears to have slowed;

• median total board compensation for the S&P 500 is more than $2 million;

• median total compensation for individual directors of S&P 500 companies is less than $200,000.

The principles, labeled “Key Agreed Principles to Strengthen Corporate Governance for U.S. Publicly Traded Companies,” were released on October 16 and consist of ten maxims that boards should follow for continued success. These include obligations to board responsibility, transparency, and accountability, for example the sixth principle that asserts “Assessment of management performance and integrity are at the heart of effective governance, and should factor into all board decisions.”

In lauding the NACD’s efforts, PGI president and COO Michael J. Ryan, Jr., claimed that the principles encourage boards to think outside the box, and were developed “to help shareholders and boards avoid rote approaches to corporate governance.” In lending his firm’s endorsement, Ryan called on investors and other governance institutions to “implement the Principles, and to treat them as the first step in ongoing corporate governance reform.”

The National Association of Corporate Directors is a non-profit organization built to assist and advise the decision-making of corporate boards and their individual directors. The Association, founded in 1977, has 10,000 members.

Among the executives whose credentials fell under question: Dennis Workman, chief technical officer at Trimble Navigation, a maker of global-positioning-system devices; and James DeHoniesto, who, until Wednesday, served as chief information officer at Cabot Microelectronics, a supplier of chemicals and pads used to polish microchips.

Over the past few years, corporate officials or directors have lost their jobs due to resume inaccuracies, including executives at RadioShack, Herbalife, and Usana Health Sciences. Barry Minkow, a sometimes short seller, uncovered the erroneous credentials at the latter two companie and the WSJ story suggested that his research could cause investors to question vetting policies for management and board members. “You have to ask yourself, as any good investigator would say, what else might be there?” says Minkow, who heads the San Diego-based Fraud Discovery Institute.

Minkow also told the WSJ he has cross-checked companies’ top officials’ biographies—typically included with the Securities and Exchange Commission—against a database of college degrees open to private investigators. The search confirmed each case of inaccurate degree claim with the university involved.

The SEC filing found that Workman, Trimble’s CTO, inaccurately stated that he holds a master’s degree in electrical engineering from the Massachusetts Institute of Technology. M.I.T. says Workman attended the school and studied physics for two semesters but did not earn a degree.

LeaAnn McNabb, a spokesperson for Trimble, believed he had received a master’s degree when he left M.I.T.’s doctoral program in the late 1960s.

“I don’t remember receiving the degree,” says Workman to WSJ. “It’s my position that I earned it, that’s for sure. I’m unequivocal about that.” Workman also said he had planned to earn a Ph.D., but had to leave school because of the Vietnam War.

A corporate biography claimed DeHoniesto, Cabot Microelectronic’s CTO, had a bachelor’s degree in computer science from the University of Pittsburgh. While he did attend the school in the 1980s, he never earned a degree. DeHoniesto resigned from the company on Wednesday.

Sam Box, who until recently served as president of Tetra Tech, appeared repeatedly in the company’s SEC filings as a holder of a bachelor’s degree in civil engineering from the University of California. However, upon further questioning, the environmental-engineering company said that Box had admitted that he does not have a college degree and that they would demote him to vice president.

When searching beyond the executive suite, inflated credentials are also prevalent further down the corporate ladder. Jenifer DeLoach, who supervises background checks for corporate clients at Kroll, the investigative arm of Marsh & McLennan, says inflated credentials are common.

Kroll issues an annual report of its “hit ratio” that says about 20 percent of job seekers and rank-and-file employees undergoing background checks by their company are found to have inaccurate and inflated credentials on their resume.

Robert Lazarowitz, who sits on the board of Knight Capital group, said he earned a bachelor’s degree in accounting from the University of South Florida. However the school confirmed that he only attended USF for two years—in 1975 and 1976—and never earned a degree, according to WSJ.

Owen Kratz, CEO of Texas-based Helix Energy Solutions Group, said he earned a bachelor’s degree in biology and chemistry from the State University of New York at Stony Brook. Another falsehood, as Stony Brook confirmed that Kratz does have a biology degree from the College at Brockport, a less-prestigious SUNY campus where Kratz transferred in 1974.

Kenneth Keiser, the president and COO of PepsiAmericas, one of the country’s largest Pepsi bottlers, says he has a bachelor of the arts degree from Michigan State University. The university confirmed that he never graduated.

A PepsiAmericas spokesperson, Mary Viola, says the company was aware that Keiser stopped attending college “10 or 20 hours short of a degree.” She said that his bachelor’s degree was mistakenly imputed in its past several proxy months.

“I’m sure Keiser does read their proxy, but he doesn’t read his own bio,” says Viola.

C.H. Robinson, the company responsible for the error had “mistakenly assumed that he earned a degree.” However, Angie Freeman, a spokesperson for C.H. Robinson, said Keisner signed off on his own mistaken biography. “The company did periodically provide the materials for him to review,” she says, in the process of preparing its 2006, 2007, and 2008 proxy statements—all of which included the false degree.

This is a national survey designed to solicit direct knowledge from those currently serving on corporate boards. Our intention is to gather useful and meaningful data around several key issues, including (but not limited to) board dynamics, compensation, process and structure.

If you are currently a corporate director we would appreciate your insight and ask that you complete the survey. Your responses will be kept strictly confidential.

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Other notable speakers include U.S. Congressman Barney Frank; former SEC Commissioners Harvey Pitt and William Donaldson; world-renowned economist David Hale; institutional investor and Vanguard founder John Bogle; former Congressman Michael Oxley; Chief Justice Myron Steele; Justice Leo Strine, Jr.; Martin Lipton of Wachtell Lipton; Lucian Bebchuk of the Harvard Law School; Jeffrey Garten, former Undersecretary of Commerce; Charles Elson of the University of Delaware; and Patrick McGurn of RiskMetrics.

For more information and to register, click here or email events@directorship.com. Board Connection readers can use this code VIPHS500 to save 40 percent off regular rates.

There is a significant decline in executive turnover for CEOs, CFOs, and overall C-level management as compared to the same time periods in 2007 and 2006. CEO turnover declined 13 percent, CFO turnover declined 21 percent, and overall C-level turnover, including boards to vice presidents, declined by 23 percent.

When comparing turnover numbers in September 2008 and September 2007, numbers declined similarly (see below charts). CEO turnover for September 2008 decreased by two percent compared to 2007. CFO turnover declined by 23 percent and C-level turnover declined by 20 percent from 2008 to 2007.

Executive turnover has declined as unemployment numbers continue to rise. Despite the rising unemployment numbers, executive turnover numbers continue to deflect this trend as such a scenario would usually accompany an increase in executive turnover.

Liberum expects to see a growth in executive turnover numbers moving into the fall and early winter. Despite the decline in September’s figures in executive turnover, there continue to be a number of high-level executive changes that are of note.

While the numbers have been surprising, Richard Jacovitz, senior vice president of Liberum Research, believes that companies have been focusing on cutting expenses and maintaining top management to help execute cuts. “I do expect as the financial crisis begins to bite and ultimately turn into a real recession, that we will see executive turnover jump precipitously,” he adds.

John Thompson, vice chairman of executive search firm Heidrick & Struggles, says he has observed at least two of what he calls “soft factors” that strangle a board’s effectiveness— allowing a board to be ruled by emotion rather than logic and not proactively managing conflict. “In some instances, where you have a long-standing or founding CEO or if the CEO is a significant shareholder, I see boards asking the CEO what he wants: Do you want to step up to chair? Do you want to exit the board? Too often, I see the board following the CEO, and the CEO is making a decision on an emotional rather than a logical basis, and shareholders are not being served.”

Leading a recent Directorship Roundtable at the Nasdaq OMX Market Site in New York on “Building Better Boards,” Thompson said the litmus test for effective boards is how they manage conflict; ineffective ones fail to do so, while effective boards work to manage agreement. In fact, “it’s something that seems counterintuitive,” Thompson said. “Boards often may not know whether they are in agreement on a topic because some directors refuse to speak up,” he said. “In many boardrooms, there is a lack of direct communication or straight talk. I’m not talking about being abrasive or disruptive, but often when there is a very dominant lead director or CEO, people don’t want to tangle with what the boss wants.”

“On a personal basis, it is surprising how many times I hear directors say, ‘Gee, I can’t believe that we are thinking about doing this,’” said Thompson. “And it strikes me: Why haven’t they spoken up about it? Some directors hold back. Even on issues that are extraordinarily serious such as succession, or hiring a new CEO or board member. Look at some of the issues around stock-options backdating. Sometimes board members just don’t have the time, or fear that raising a question will result in endless debate. Newer board members may think they don’t know enough historical data to speak out. And that’s too bad, because they can often bring a framework or a point of view that might propel the board to work more effectively, ” said Thompson.

“Having been a new board member, I do think we have to speak up. There are no stupid questions,” said Pamela G. Sheiffer, a director for New York & Co. “I do think that at times we are rushing off to catch planes, or there is a board member who perhaps sits on too many boards and doesn’t have the time to commit, so that person thinks ‘I’m not going to bring this up because it’s getting towards the end of the meeting and I don’t want to hold everyone up.’ ”

The introduction of a new director can be the perfect time to conduct a full board review. “When you have a new board member, that is a great time to review,” said Thomas J. Clarke Jr., chairman and CEO of TheStreet.com, who was recently appointed to a board where an issue cropped up that resulted in a management change. “I think it was because I wasn’t afraid to ask the questions that needed to be asked,” he said.

Dissonance and Dissidence

Roundtable participants John A. Ward III, chairman of MAP Alternative Asset Management, and Raymond S. Troubh, a director who serves on such boards as Gentiva Health Services and Triarc Companies, have at different points in their board service careers been brought into companies in need of drastic change. Success can sometimes breed complacency, Ward noted, and the ability to be a new voice asking critical questions can become a necessary learning experience for the entire board.

Both dissonance and dissidence can be constructive, Troubh suggested. “As you get older and stronger, you can speak out more as a brand new director. CEOs shouldn’t always have their way. And directors should have a large, personal stake in the company, so when they talk about shareholders, they’re talking about themselves,” he said. “With respect to succession planning, the chairman can’t pick his own successor. It’s the board that will continue under the new leader who should make that determination. This permeates my view of the independence of the nominating committees as one of the great new developments and will assure that tougher, smarter, more able, objective people will serve on boards.”

Management of ego is also a key factor in building a constructive board. “The leadership sets the tone for all, whether it’s in the boardroom, a surgical room, or on a sports field,” Thompson said. “I think in the boardroom you must manage egos. It’s not consensus you’re aiming for, but leading a group of people in an intelligent discussion to arrive at the right decision.”

One tactic that Thompson has seen work to diffuse a dissident board member who may be controlling the tenor of a meeting, is to have the courage to say, “I hear that people are passionate about position A, but I’m still having trouble with this. Can anyone help me?” or “I’m having some difficulty following the logic of this assumption. Can you help me better understand it?” This simple, direct approach is effective particularly for lead directors or independent committee chairs, Thompson said, “because it totally dismantles the emotion and brings it back to the group.”

Holding regularly scheduled board teleconferences, perhaps weekly, also provides “a consistency and momentum without the chief executive being part of the conversation,” said Allan Grafman, president of All Media Ventures, who serves on a number of boards. “Week after week, you begin to ferret out the issues and by the time you come to the quarterly board meeting, much of the thinking and discussion has already taken place.”