Doug Oberhelman

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

VERBATIM

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Corporate Governance Highlights

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

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

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

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

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

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

Caterpillar’s Board of Directors

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Caterpillar website

Effective oversight of financial reporting— even in times of growth and relative calm—is no simple matter for an audit committee. Add in a global financial crisis, economic recession and uncertainty, sweeping regulatory reforms and unprecedented expectations by investors and regulators for transparency and accountability, and you have one of the most demanding, challenging—and vital—roles in Corporate America.

It’s not a stretch to say that the financial and economic crisis and ensuing volatility and uncertainty in the United States and global markets have put audit committees, and the financial-reporting systems they oversee, through a gauntlet. To be sure, some were well prepared— likely buoyed by systems and processes put into place following the Sarbanes- Oxley Act of 2002. Others were less prepared— and the crises exposed critical gaps in their financial-reporting systems, oversight processes or both.

Investors’ and regulators’ expectations of audit committees have always been high; but the demands and challenges facing audit committees have perhaps never been greater: complex accounting rules and regulations, innovative financial instruments, the global nature of businesses, product innovation, pressures on companies to meet expectations and stay competitive— there is little that doesn’t impact a company’s financials. And, as one seasoned audit committee chair often reminds us: If it’s complicated and requires a lot of time and detailed focus, it usually lands on the audit committee’s plate.

This paper is not intended to be a comprehensive manual or treatise on the duties and responsibilities of the audit committee (which is readily available from numerous sources today). Rather, drawing on the experiences and insights of our Blue Ribbon Commission members, as well as the thoughtful work and writings of others in the business, audit and governance arenas, including the NACD National Audit Committee Chair Forum, it is intended to offer practical perspectives, suggestions and leading practices on what makes an audit committee effective.

No single approach will work best for every audit committee, but we believe the perspectives and leading practices outlined in this report (including ten guiding principles) will help audit committees and boards—as well as auditors, managers and others—drive the financial-reporting process to provide investors, regulators and the market with a clear and accurate picture of the company’s performance, risks and prospects.

Setting the Agenda: Making the Most of Audit Committee Meetings
Ensuring that the audit committee’s agenda appropriately addresses the issues that require the audit committee’s attention and keeps the committee focused on its primary oversight responsibilities can be a major challenge.

Given the scope of the audit committee’s responsibilities, we recommend that at the beginning of each year, the committee create a formal responsibilities checklist and calendar for the coming year, including a tentative calendar for each audit committee meeting throughout the year. The responsibilities checklist and calendar should be based on the audit committee’s charter. [A model audit-committee charter, with tentative agendas for the year, is included in the Commission’s full report.]

The tentative agenda for each audit committee meeting throughout the year is typically crowded with key oversight topics—such as the company’s financial reports and disclosures, the control environment, risks, audit processes, whistleblower complaints and legal and regulatory compliance—as well as numerous mandatory compliance activities.

In preparation for each audit committee meeting, the challenge for the audit committee chair is to prepare a focused (yet flexible) agenda, which devotes sufficient time to the company’s key financial-reporting risks, as well as other items that require the audit committee’s attention. Audit committees must be proactive in setting their agendas—with input from management and internal and external auditors—and must not simply react to an agenda proposed by management.

To accomplish this, audit committee chairs employ a number of leading practices in developing the agenda for each audit committee meeting, including the following:

• In preparing the agenda, the chair will allocate sufficient agenda time to address what’s important, and then address the required items (not vice versa).

• The initial draft of the agenda will often be prepared by someone in management who serves as the audit committee’s primary support, such as the CFO, controller, CAE, corporate secretary, etc.

• The audit committee chair will take responsibility for finalizing the agenda and, distributing a draft agenda, if there is sufficient time, to members of the audit committee for their input.

It’s important to discuss the agenda with the CFO, the audit engagement partner, the CAE, the general counsel—and perhaps others—to obtain their suggestions on key issues and topics for the agenda, including the time allotted to each item and who should participate in the discussion of each topic. In sequencing the agenda, the most important items should be covered first; however, avoid having the same items at the end of the agenda, as it may be perceived as a lack of interest on the committee’s part.

Of course, audit committee members should be encouraged to suggest agenda and follow-up items for future committee meetings.

In order to devote more meeting time to important issues and risks, some audit committee chairs separately identify agenda items that are appropriate for a “consent agenda”—i.e., items that are routine and do not require discussion—so that the committee can approve the items without discussion, assuming all committee members agree.

Some audit committee chairs also set aside time at each meeting (or at least periodically) for the audit committee to take a “deep dive” into an important accounting judgment or estimate, or a significant accounting development that is affecting the company. Some also make it a point to have operating management discuss selected agenda items, such as key areas of risk.

In finalizing the agenda, the audit committee chair should ensure that the agenda devotes sufficient time to the company’s key financial-reporting risks. At the same time, the chair should ensure that the audit committee does not take on too much beyond its core responsibilities. If mission creep occurs, the chair may need to discuss with the chairman of the board or the chair of the nominating/governance committee the possibility of shifting certain oversight responsibilities to another committee or to a new committee.

Making the Most of Meetings
The frequency of audit committee meetings will vary from company to company, with most committees holding four to six “in person” meetings each year, as well as teleconferences as required. Typically, the audit committee will meet, often by phone, prior to the filing of the company’s 10-Qs and 10-K to discuss the reports.

The productivity and effectiveness of audit committee meetings hinges in large measure on the diligent preparation and participation of each member, as well as on the dynamics between committee members and other participants in the meeting. The audit committee chair is responsible for ensuring the efficient use of meeting time and that each agenda item receives appropriate attention. Again, audit committee chairs employ a number of practices to accomplish this, including:

• Working with appropriate management to ensure the quality of premeeting materials—for example, ensuring that the pre-meeting materials are at a level of detail appropriate for committee members (and not simply materials prepared for management and now passed along to the audit committee).
• Asking that copies of all “presentations” and other materials to be covered during the committee meeting be distributed with other pre-meeting materials well in advance of the meeting. To allow sufficient time for discussion, the chair often instructs management to assume that all audit committee members (and others, as appropriate) have read all presentations and other pre-meeting materials, and to limit their “presentation” to an overview of the most significant issues of interest and relevance to the committee.
• Setting aside time at the beginning of each committee meeting for members to have one last look at the agenda (including the amount of time allocated to each item on the agenda) after members have had an opportunity to review the premeeting materials.
• Concluding—and sometimes beginning— each audit committee meeting with an executive session so that members of the committee have an opportunity to discuss important matters privately.

We note that some audit committees routinely have informal “between meeting updates” on issues and developments, typically by email or conference calls. These updates—in which committee members participate on a “voluntary” or time permitting basis—help streamline committee meetings, as members are more current on the issues.

Executive Sessions
Candor and unvarnished viewpoints are tremendously important to the audit committee in its oversight role, which is why executive sessions are now standard fare for audit committees. As stated in the NYSE corporate governance rules, executive sessions serve as a “check on management” by promoting open discussion among the audit committee members without members of management present, and by providing an opportunity for the audit committee to have private conversations with members of management, and with the CAE and external auditors.

We offer the following suggestions for making the most of audit-committee executive sessions:

• The NYSE corporate governance rules require the audit committee to hold periodic, private sessions with management, external auditors and the CAE, and a portion of the executive session should be devoted to these sessions. Many audit committees have private one-on-one sessions at each audit committee meeting with the CFO, the CAE and the audit engagement partner. They also have periodic (once or twice a year), private one-on-one sessions with others, such as the CEO, general counsel and compliance and risk officers. Some audit committees make it a point also to have periodic private sessions with managers below the CFO level, to assess whether information the committee receives is open and transparent, and not “overly controlled” by senior management.
• When meeting one-on-one with management and external and internal auditors, audit committee members generally pose questions to elicit any concerns about management or auditor competency, resources or candor, as well as general concerns about the financial-reporting and control environment or specific accounting and control issues. At times, the audit committee chair may provide managers and auditors with a question in advance, so they have an opportunity to consider the issue more fully before the session (this should not be a “gotcha” exercise). Of course, audit committee members need to be prepared to ask follow-up questions, “test the answers” and take action to address any issues or concerns.
• Avoid negative inferences about the calling of executive sessions by holding them, as a matter of routine, at all audit committee meetings. These sessions might last several minutes or much longer; the key is to ensure discussions are not rushed or inhibited by artificial time constraints —and committee members should plan their schedules accordingly.
• An “audit committee members only” portion of the executive session provides an opportunity to privately discuss the performance of the financial- management team, including the adequacy of communications from the team, as well as compensation, succession planning, any issues or concerns that may have surfaced during the audit committee meeting and the audit committee’s own effectiveness and efficiency. It also provides an opportunity for audit committee members to deliberate and reach a consensus on difficult issues.
• It’s generally left to the audit committee chair to communicate with management or auditors regarding any issues or concerns that were identified during the executive session that may require their attention and follow-through. In addition, the chair should report to the lead director or board, as appropriate.

Get to Know Finance, Internal Audit Teams
Audit committee meetings provide an opportunity for audit committee members to get to know (and understand the potential of) members of the internal audit team and the entire finance team—whether the treasurer, tax director, chief accounting officer, controller, et al.—as well as managers a level or two below these C-level executives. At the same time, however, it is important to recognize that it is difficult to give the audit committee exposure to these key individuals without having committee meetings become unnecessarily large.

To this end, the audit committee chair should work with financial management to develop a systematic approach to providing key members of the finance and internal audit teams with appropriate, periodic exposure to the audit committee, while at the same time ensuring that there is a clear purpose for their presence at the committee meeting.

Reports to the Board, Meeting Minutes
The NYSE corporate governance rules require the audit committee to report regularly to the board of directors, and the commentary states that: “The audit committee should review with the full board any issues that arise with respect to the quality and integrity of the company’s financial statements, the company’s compliance with legal or regulatory requirements, the performance and independence of the company’s independent auditors and the performance of the internal audit function.”

For many boards, the audit committee’s report to the full board is the primary method of informing the board of the audit committee’s activities and ensuring proper coordination of the audit committee’s activities with other committees of the board.

Typically, the audit committee chair has 15 to 20 minutes on the board agenda to present the committee’s report, including time for director discussion and questions. The challenge is to update directors on the audit committee’s work, including significant issues and recommendations, and enable directors to focus on key items, engage in discussion and ask questions—in short, to keep all board members informed about the committee’s work.

While minutes of committee meetings are critical to document the processes the committee followed in carrying out its oversight responsibilities, there is an ongoing debate as to how much detail should be included in the minutes. It is critical that audit committees obtain the advice of counsel regarding the content and level of detail that is appropriate. Minutes of audit committee meetings should be distributed to the full board on a timely basis.

Ten principles to help guide audit committees—and the management and audit professionals supporting them—in their oversight of the financial-reporting process:

1. Be proactive in focusing the agenda on what’s important—financial-reporting risk— and make the most of audit committee meetings.
2. Insist on transparency, both external and internal—among the audit committee, management and internal and external auditors.
3. Focus closely on external financial communications—beyond the 10-K and 10-Q.
4. Question the continuing validity of key assumptions that underlie critical accounting judgments and estimates and be up-to-speed on key financial-reporting issues and developments affecting the company.
5. Assess the audit committee’s role in the oversight of risk management—with an eye to clarifying the scope.
6. Set and manage clear expectations for external and internal auditors.
7. Make sure the chief financial officer (CFO) and the entire finance organization, as well as internal audit, have what they need to succeed, and be sensitive to the strains on these organizations.
8. Assess the tone at the top and throughout the organization, including the effectiveness of compliance and anti-fraud programs.
9. Help link change and risk management— and monitor critical alignments (controls, risks, etc.)
10. Take a hard look at the audit committee’s effectiveness—including its composition and leadership—and find ways to continuously improve.

Commission Members (directorships in italics)

Co-Chairs
Dennis R. Beresford* – University of Georgia; Fannie Mae; Kimberly Clark; Legg Mason, Inc.

Michele Hooper* – The Directors Council; AstraZeneca; PPG Industries; UnitedHealth Group; Warner Music Group

Commissioners
James T. Brady – Ballantrae International, Ltd.; Constellation Energy; McCormick & Co.; T. Rowe Price Group

Richard Chambers – Institute of Internal Auditors

J. Michael Cook – Comcast; International Flavors & Fragrances

Cynthia Fornelli – Center for Audit Quality

The Honorable Barbara Franklin* – Barbara Franklin Enterprises; Aetna; American Funds; Dow Chemical

Patrick Lee – KPMG Audit Committee Institute

James P. Liddy – KPMG LLP

Kenneth Daly – NACD

Peter Gleason – NACD

(*NACD Board Member)

Copies of the complete 2010 Report of the Blue Ribbon Commission on the Audit Committee may be purchased at NACDonline.org. NACD members receive a substantial discount.

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

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

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

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

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

Regulators and Rule Makers

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

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

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

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

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

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

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

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

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

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

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

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

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

Over-regulation, globalization, changing liquidity profiles, financial complexity—these were just a few of the topics discussed at this year’s Audit Committee Issues Conference. “Against the backdrop of a rapidly changing business environment and a still fragile economy, there are a host of challenges and opportunities confronting business leaders,” said Henry Keizer, KPMG’s Global Head of Audit, during opening remarks. “The key will be to understand your changing business fundamentals and to focus on the areas of greatest impact in the months ahead.” Roundtable participants included Fortune 500 public company directors who serve on the boards of such prestigious companies as AIG, AXA Financial, Comcast, ExxonMobil, JPMorgan Chase, Microsoft, Oracle, PetSmart and UnitedHealth. NACD Directorship’s chairman and editorial director, Jeffrey M. Cunningham, moderated the wide ranging and provocative discussion between these veteran directors and governance gurus.

ADDITIONAL COVERAGE FROM THE ISSUES CONFERENCE:

• Survey results: The Top 10 Concerns of Today’s Audit Committees
• Arthur Levitt: “The Real Governance Problem”
• Donna E. Shalala: Prescient remarks about healthcare reform
• Harvey L. Pitt: “Ten (or so) Golden Rules” for boards

A New Normal in the Boardroom?
The baseline for discussion was set against the question of whether board directors see a return to business as usual or what was referred to as the “new normal.”

“From my experience, I think we’ve learned to imagine the unimaginable,” said Charles H. Noski. “Just consider that several institutions that were around for a century or more don’t exist any longer. In boardrooms today, the talk is routinely about the new normal, which simply means we are still in an economic recession that has occurred globally and broadly, so yes, there is a new normal.”

Another theme repeatedly echoed was the nature of changing business models and not only for financial services, where impending legislation could still rewrite the rules for large banks, insurance companies and private equity. Michele J. Hooper said that while the economic crisis accelerated restructurings at some businesses, others face different but equally daunting challenges. “For pharma companies, there is the constant of pricing pressures, the challenge to develop patents, the time and cost to develop new drugs, changes to sales and marketing models…[these] are global issues for the industry,” Hooper said. “As healthcare budgets are challenged around the world, the pressure on exactly who is going to pay for new drug therapy development is a critical question. The new normal is that change is a constant.”

Even as the worst of the economic storm seems to be receding, populist fervor against big business, the financial sector and Wall Street continues unabated. Directors find that amid competing and sometimes conflicting legislative and regulatory proposals, it’s difficult to even guess which regulatory approach will prevail. Charles Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware, noted, “There are two problems. First on a macro governmental level, I think we’ve seen an extraordinary shift in the way in which the government interacts with the private economy. On a secondary level for directors, I think we’re seeing a real change in how boards work. But there’s a danger that the regulatory restrictions and demands are forcing boards to make decisions that are not their own.” Added Christopher S. Lynch, “In this politically charged and economically uncertain environment, the challenge for boards of the GSEs (government-sponsored enterprise) is to provide management some contextual perspective on how the business model might evolve.”

Even so, there appears to be new or renewed commitment to growth, which was quite refreshing to hear and led to a discussion of how CEOs are preparing a new set of objectives and a related set of investments to achieve them. For the CEO, that means priorities may have changed. “After finding sufficient liquidity to pay our dividends, I think now the question is, ‘How do we get back on the path to growth?’” said Alex J. Mandl. “Cost-cutting can only take you so far. What kinds of acquisitions, what kinds of investments need to be made—whether it’s in people or systems. Those are the critical questions facing companies today.”

Specter of Overregulation
In addition to complying with new rules and regulations, several audit committee members sounded the alarm on what they fear may be extreme regulation.

“Frankly, I’m very concerned about the role of government, the risk of overregulation and the possibility of being overly burdened by public policy,” said Reatha Clark King. “I don’t hear enough debate about it among directors and I’m very concerned about more government involvement and its impact on the competitiveness of our companies.”

Directors echoed King’s concerns, noting that while boards have gotten beyond the initial onslaught of new compliance activity as the result of the SOX, “the government has an infinite capacity to create new programs, so you have to constantly step it up. The issue for directors today is, ‘What is our business model and what are we going to do to compete?’” said Richard K. Lochridge.

Regulation needs to be properly balanced between the call for greater transparency and measures that would appear to add little value economically. “Business remains uncertain as to the intent of the increased governmental regulation,” said Kathleen Connell. “Is it transparency and accountability for investors, improved risk management to prevent future systemic failures or simply political optics and burdensome reporting? Properly conceived systemic risk-management policies and increased transparency and accountability practices add value to the corporate community, increasing their competitiveness by restoring consumer confidence and assuring investors that businesses are well managed.”

Financial Communications
Earnings guidance would alone be a subject for a lively and divergent discussion. If the company on whose board you serve didn’t stop or change the way it issued earnings guidance, you were in a minority. One exception may apply to technology-oriented companies, however, because the market’s expectations are different. “In the tech world, where there’s still an expectation of growth by investors, there’s a stronger inclination to give some sort of guidance,” said Ray Bingham. “The metrics used have changed over time and certainly, the tolerances accepted around any particular set of numbers have gotten much, much wider as the perception of risk has grown.”

The assembled directors also agreed that their audit committees are more deeply scrutinizing all of the company’s financial communications. In the view of one director, the earnings press release is the most important communication to investors, but there was also discussion about how to manage the volume and complexity of financial and other information that boards receive.

“We’ve set up a series of informal audit committee calls throughout the quarter in which directors can participate with management and our outside advisors to learn more about emerging issues, key assumptions, accounting and financial-reporting alternatives and potential outcomes,” Lynch said. “We’ve requested that management spend more time with our directors to ensure we better understand the complexity of the issues they are dealing with and how those transactions will be presented in our public filings.”

Mary R. “Nina” Henderson suggests receiving financials and the MD&A separately, one in advance of the other. “This permits a deeper dive and fuller review,” she said. “Also, any matter with continuous impact, based on numerous estimates and assumptions, is reviewed frequently, not only at Q and K review meetings.”

The Securities and Exchange Commission has emphasized disclosures and the MD&A in its new rule-making. “This focus on disclosures is likely to continue and will probably increase—particularly with the SEC’s new disclosure rules regarding compensation, risk and governance,” said Teresa E. Iannaconi. “The SEC is very focused on the protection of investors, but they may miss the forest for the trees,” said Holly J. Gregory. “There seems to be little concern about the impact of their regulatory efforts on how boards function. The perspective I’ve heard expressed by SEC staff in discussions about proxy access is ‘Our role isn’t to think about what the impact might be on the boardroom and the corporation. We are here to protect investors.’ But I think it’s reasonable to ask, to what end?”

Added Gregory, “Investors need corporations capable of succeeding over the long term and this requires regulations that are thoughtfully balanced.”

The Business of Risk
The NACD’s Kenneth Daly said what most audit committee members know all too well: the time commitment to public company board service is “nothing short of unbelievable.” But it’s not the amount of time spent on board work that’s the issue, noted J. Michael Cook, it’s how directors are being asked to use their time. “I know lots of folks who will spend the time—have another meeting, stay longer—if they feel they are adding value and doing something important. What’s frustrating to many people is the amount of time we spend doing things that aren’t very productive…And then, after we do all this great work on risk and risk management, identifying and dealing with the critical risks affecting the business, perhaps the greatest risk—the financial viability of our economy and the financial future of our country—is outside of our control and is being decided for us by people who often are not fiscally responsible in the costs and risks they impose on us.”

Cook raised a point central to any current assessment of the audit committee. With the tremendous focus on risk, there was general agreement that the full board should oversee the strategic risks facing the company. “We see the audit committee’s responsibility for risk often narrowing to risks within the audit committee’s core areas of oversight—clearly financial reporting risks, but also compliance risks, perhaps IT risk, sometimes financial risks,” Mary Pat McCarthy said. “If the board doesn’t have a finance committee, the audit committee may take on that issue as well.”

Cook, who described himself as a “fairly strict constructionist,” said he doesn’t believe committees should be doing work that belongs on the agenda of the full board: “The audit committee exists to oversee one very specific enterprise wide risk and that is the risk of erroneous or fraudulent financial reporting.”

Viewed from a different angle, Bingham suggested that strategy should not be formulated for the avoidance of risk. “In my view it should not be so much the avoidance of risk but rather the requirement that the board understand what kind of risk the company is exposed to and whether there will be an appropriate payback for the risk that’s being tolerated,” he said.

Improving Governance
While criticism of corporate boards has never been more acute, more than half of the audit committee members attending the Issues Conference said the public’s criticism was justified. What measures should be taken to improve board performance? Prepping directors for new roles within the boardroom, evaluating their performance, managing information and ensuring commitment and engagement of individual directors spurred the most comment.

Clearly, there’s no one single rule that applies to all companies; there are various ways to approach both the orientation of new directors and their ongoing contributions as effective board members.

“I know of no highly effective business organizations that don’t evaluate individual performance,” Lynch said. The most effective evaluations, according to Mandl, are led by the independent chairman or lead director or “someone who has the capacity to talk to individuals and as a whole to take the lead.”

Bingham serves on a European board that retains an “expert” to support the board and each committee. The job of these experts is to review management’s reports analytically and assist the board and committees with their work. They are hired externally and supervised by the board.

Greatest Concerns
At the conclusion of each Roundtable—one was held in Miami, the other in Phoenix—directors were asked to rank their concerns. Interestingly, the growing threat of reputation risk, including risk related to enforcement under the Foreign Corrupt Practices Act, generated reaction at both sessions and led to some agreement that “tone at the top” is—or should be—a major area of focus for directors. Bruce Piller of KPMG concurred. “To me, tone at the top is a risk that carries over to a number of areas on the audit committee’s plate—from financial-reporting risk, to the control environment, to fraud risk and compliance.” Reputation risk, said Laban P. Jackson, “is what we worry about all the time. And the thing that I worry about is that our people know that the board cares about how they perform ethically. It is incredibly important to me to get out and meet the people out there and let them know that I care about the work they’re doing.”

The challenge is to communicate tone at the top “deep, deep into worldwide organizations,” said Ellen Odoner. “One key source of support and vigilance can be the legal department. In the United States, reinforced by SOX, inside lawyers recognize that they are expected to play an active compliance as well as business role. It is vital to build the same understanding among the lawyers in far-flung business units.”

Keizer offered a final thought on what should top the agenda of boards and audit committees going forward, echoing the sentiments of directors: “The one key challenge is tone at the top and culture within the organization. Who are we and what do we want to be known for? What’s being measured? What is management being rewarded for? When it comes to culture and tone at the top, we need to make sure that we have learned from the crisis and that we reward the right behavior. That, to me, is the overarching issue.”

Conference Speakers, Panelists and Thought Leaders
Ray Bingham – Director, Dice Holdings, Flextronics International, Oracle, STMicroelectronics
Kathleen Connell - Chair, Corporate Governance Center, Berkeley Haas Graduate School of Business
J. Michael Cook – Director, Comcast, International Flavors and Fragrances
Jeffrey M. Cunningham - Chairman, CEO, Editorial Director, Directorship
Kenneth Daly – President and CEO NACD
Charles M. Elson – Weinberg Center for Corporate Governance, Director, HealthSouth
Holly J. Gregory – Partner, Corporate Governance, Weil, Gotshal & Manges LLP
Mary R. (Nina) Henderson – Director, AXA Financial, Del Monte Foods, Pactiv
Michele J. Hooper – Director, AstraZeneca, PPG Industries, UnitedHealth Group, Warner Music
Teresa E. Iannaconi - Partner, National Office, KPMG LLP
Laban P. Jackson – Director, JPMorgan Chase
Henry R. Keizer – Global Head of Audit, KPMG International Cooperative, and U.S. Vice Chair – Audit, KPMG LLP
Reatha Clark King – Director, ExxonMobil
Richard K. Lochridge – Director, Dover Corp., Lowe’s, PetSmart
Christopher S. Lynch – Director, AIG, Freddie Mac
Alex J. Mandl – Director, Dell, Hewitt Associates, Horizon Lines, Visteon; chairman of the board, Gemalto
Mary Pat McCarthy - U.S. Vice Chair, KPMG LLP, and Executive Director, KPMG’s Audit Committee Institute
Charles H. Noski – Director, ADP, Air Products & Chemicals, Microsoft, Morgan Stanley
Ellen J. Odoner – Head of Public Company Advisory Group, Weil, Gotshal & Manges LLP
Bruce J. Piller – Western Regional Managing Partner, KPMG LLP