For some years now, corporate governance experts have debated the best model of board leadership for public companies.  Studies have compared the historically prevailing U.S. model – in which the chief executive officer also serves as chairman of the board — with different approaches that are more common in other countries, such as the typical approach in many European markets of having an independent board chair.  As U.S. public companies were caught off guard by the depth and severity of the most recent financial crisis, what seemed before to be primarily an academic subject became very real for U.S. public companies.  Some observers suggested that the U.S. board leadership model (and specifically the failure of U.S. regulators to require an independent board chair) contributed to the crisis and to the failure of U.S. public companies to be prepared for the effects of the crisis. Legislators and regulators picked up on this theme, with suggestions that public companies should be required to have an independent board chair.

In the years between Sarbanes-Oxley and the 2008/2009 financial crisis, many boards realized that there were alternatives to having an independent board chair.  For example, many companies continue to have a combined CEO/chairman, but have appointed a “lead” or “presiding” director.  Even where there is no director holding such a title, many boards have called on particular directors (for example, the chair of the audit committee or the chair of the governance committee) to take leadership roles, on behalf of the independent directors.  Moreover, with the tumult in some board rooms and executive suites arising out of the most recent financial crisis, boards in certain instances have chosen, in response to their specific circumstances, to go the route of having an independent board chair, at least until the crisis passes.  Accordingly, as we enter 2010, it is no longer appropriate to say that there is one “prevailing” model of board leadership for U.S. public companies.  Rather, boards increasingly are choosing their leadership models based on their specific circumstances, such as the talent and experience of the chief executive officer, the challenges that the company is facing, and the preferences of their large shareholders.

…continue reading: Drafting Disclosure Relating to Board Leadership and Risk Oversight

Over the course of several forums on governance, director leadership and engaging with shareholders, a number of board advisors have intoned mightily against the notion of having corporate directors involved in a company’s shareholder engagement efforts. The foremost rationale offered for holding directors apart from discussions with investors is that Regulation FD creates insurmountable problems for companies whose directors could potentially be involved in engagement and outreach to shareholders. While there are legitimate concerns about the shareholder engagement process for company officers and directors, fear of Regulation FD need not be among them – if due diligence and care are properly undertaken.

To be clear, Regulation FD requirement can create difficulties for companies in communicating with investors, but engagement with shareholders can be much different than the relationships companies maintain with equity and credit analysts. Whether you need to have your board members involved depends on the answer to four questions: 1) who is the shareholder making the request, 2) what are the circumstances surrounding the engagement request (or need), 3) a determination as to whether director involvement will add value; and 4) which director or directors need to be involved.

…continue reading: Director Engagement With Shareholders Without Fearing Regulation FD

Public company boards have faced unprecedented challenges in recent years, and it appears that they will be subjected to new burdens over the coming months. Just as the failure of Penn Central in 1970 and the collapses of Enron and WorldCom earlier this decade led to fundamental changes in the U.S. corporate governance model, the corporate failures of 2008 are resulting in significant changes in the way that boards, management and shareholders govern U.S. public companies. Moreover, Congress, regulatory agencies and the stock exchanges are currently reviewing the U.S. corporate governance model and considering numerous proposals that would impose new and significant requirements on public company boards. Accordingly, as much as corporate boards have been challenged in recent times, they must be prepared for even more changes going forward.

Corporate boards are reacting to these challenges in a variety of ways. Boards are working harder, they are evaluating and prioritizing the issues that require their attention, and new best practices are beginning to emerge. Many directors and other corporate stakeholders are hopeful that if boards are successful in improving their own practices, they may be able to avoid another substantial re-regulation of public companies, in the style of the Sarbanes-Oxley Act of 2002.

…continue reading: What Boards Should Be Doing Right Now

(Editor’s Note: This post is based on a Gibson, Dunn & Crutcher LLP memorandum by Amy Goodman and Gillian McPhee.)

The current economic and regulatory landscape poses unprecedented challenges for public companies and their boards of directors.  They are facing scrutiny from shareholders, Congress, regulators and the public, and new proposals to address the causes of the financial crisis have been emerging on almost a daily basis for over a year now.

Many of these proposals remain under consideration at a time when calendar-year companies are beginning preparations for the 2010 proxy season, complicating the planning process.  The uncertainty of the current environment means that, with respect to many issues–such as the SEC’s proxy access proposals–companies and their boards find themselves in a “wait and see” mode.  Directors should remain informed during this time as new developments occur, and they should be prepared to respond at an accelerated pace.  To assist boards in addressing the potential changes that lie ahead, this memorandum outlines key issues for directors to consider over the coming months.

1.  Executive Summary

As discussed in more detail below, as boards prepare for the potential changes that lie ahead, there are a number of key areas to consider.  These include:

a. Director Elections.  Boards and companies should take a holistic approach to the director election process, considering the potential impact that the loss of broker discretionary votes will have on director elections at the upcoming annual meeting, as well as the effect of majority voting, “notice and access” (also known as “e-proxy”), and expected voting recommendations of the major proxy advisory firms.

b. Executive Compensation Practices and Disclosures.  Boards and compensation committees should evaluate their companies’ compensation practices and policies in light of the current environment, including the strong possibility of federal legislation requiring an advisory vote on executive compensation, or “say on pay.”  For the 2010 proxy season, new required disclosures are anticipated relating to the risks created by employee compensation plans and the use of compensation consultants.  In view of these considerations, companies should assess their compensation disclosures, with particular focus on the Compensation Discussion & Analysis.  In addition, boards and compensation committees should be aware of executive compensation practices that institutional investors and proxy advisory firms frown upon (such as tax gross-ups) and those that they advocate, such as “hold-through-retirement” provisions and “clawback” policies.

c. Board Leadership.  Boards and companies should expect a continued spotlight on the issue of board leadership in the coming months.  In anticipation of new required proxy disclosures about board leadership structure, boards should consider why their current leadership structure is appropriate.  At companies that combine the positions of chair and CEO, consideration should be given to what, if any, steps should be taken to enhance the independent leadership of the board.  In addition, the board should consider this issue as part of the succession planning process.

d. Risk Oversight.  Boards and companies should consider whether the board has the appropriate structure and processes in place for overseeing the major risks facing the company.  The board should be comfortable that it understands these risks and how the risks relate to the company’s business and strategy.  Boards, and those who advise them, should think carefully about how the board is spending its time and see that the board has adequate time to address critical issues such as strategy and risk.
e. Shareholder Engagement.  Boards should be attentive to what their companies are doing to engage shareholders and recognize that, more than in the past, directors may need to play a greater role in reaching out to shareholders.  Initiating a dialogue before a major issue arises helps build a relationship so that the company is not approaching a major shareholder for the first time to talk about a critical subject.

f. Shareholder Proposals for the 2010 Proxy Season.  For the 2010 proxy season, we expect that shareholder proposals seeking the appointment of an independent chair and proposals seeking an advisory vote on executive compensation will continue to be popular.  In addition, executive compensation in general is likely to be a frequent subject of shareholder proposals.  Finally, shareholders’ ability to call special meetings and supermajority voting provisions also are likely to be focal points in the next proxy season.

…continue reading: Considerations for Public Company Directors in the Current Environment

(Editor’s Note: This post by Francis H. Byrd first appeared as a Governance & Proxy Review Update.)

With the introduction of Senator Schumer’s Shareholder Bill of Rights there has been a great deal of discussion surrounding the role of the Non-Executive Chairman (NEC) versus that of the CEO. Discussion of this concept in the media would lead one to believe that the role of the NEC is to serve as a supervisor of the Chief Executive. Nothing could be further from the truth. In fact, it appears that this misconception of the role is the rationale behind Senator Schumer’s bill requiring mandatory NECs for all companies. Companies will lose not only the right to make decisions about their leadership structure but would then be forced to subscribe to a flawed notion of the NEC-CEO relationship that could lead to serious problems for the board and company.

U.S. companies, who have separated the positions of chair and CEO, are usually hoping to achieve three specific and important goals: (1) allow the CEO to focus exclusively on managing the enterprise; (2) create a director leadership position with a focus on board administration and communications between the independent directors; and (3) craft a defined director leadership position, codified within the firm’s governance guidelines, possessing the procedural authority to lead the board during an unexpected or forced CEO transition. Many firms utilizing this structure provide for a recombination of the roles when the board deems it appropriate.

In these instances the NEC is likely to be a director of long tenure with experience and understanding of the company. The NEC would be likely to maintain an office at the company, and spend more time with the CEO than other board members. His/her primary function would be to insure robust communications between and amongst board committee chairs and as needed with individual directors. Under this board leadership model, the CEO is relieved of the tasks of managing the intra-board relationship and can focus more attention on the competitive and regulatory and risk challenges facing the company. Leading the full board meetings, the important executive sessions of independent directors, and involvement in board, committee and director evaluations are key elements of the NEC role.

Mentor to the CEO, not manager of the Chief Executive

A common misconception that I fear is firing the call for change, is the belief that the NEC will or should serve as a supervisor of the CEO. That the NEC, who under this faulty scenario possesses industry knowledge equal to or greater than the CEO, is the Admiral to the Chief Executive’s captain, prepared at any moment to order a change of course or trim of sail. A relationship designed to these parameters would create serious disruptions for the board and confusion in the senior management ranks as to who is in charge.

In actuality, the split roles need to be handled with care. Done right, the NEC serves as a mentor and sounding board for the CEO on issues to be presented to the board, on feedback from the executive sessions of the independent directors, and on issues facing the enterprise. The CEO looks to the NEC for feedback and counsel on the board’s concerns, whether strategic planning or risk mitigation. The relationship is more Mentor to CEO than supervisor to manager – it can’t work any other way. If a company faces an unexpected CEO transition (due to death or resignation), a board with an NEC (or strong, active Lead Director) might be better positioned to act swiftly and deftly.

Given the sensitive nature of the NEC role, the selection, ability and willingness of the director who undertakes the position and the CEO who must work within this leadership structure are all of prime importance–which is why boards need to be free to choose the leadership structu re that works best for them, and not have it mandated by Washington.

One way to sum up the “big picture” of corporate governance in the U.S. today is as follows:

We are in the midst of a true revolution in our private enterprise economic system, much of which is being driven in the name of “corporate governance” by multiple parties with an ever-expanding agenda.

This may sound like one of those deliberately extreme statements sometimes designed to stimulate debate—but I offer it simply as a description of where things are. In fact:

• The roster of participants in the U.S. corporate governance arena today is extraordinarily large and diverse, the collective agenda of these participants is very broad, and the level of dedication of these various participants to achieving their agendas is quite high.

• The common purpose or effect of their efforts is to redesign in significant ways the publicly traded business corporation, a central instrument of U.S. capitalism.

• This redesign involves sources of capital, the role of risk-taking, the fundamental purpose of business corporations and the role of directors.

The bottom line reality is that today’s corporate governance reform movement is reshaping materially our private enterprise economic system. Moreover, inadequate attention is being paid to assessing the scope and magnitude of the changes — and the risks they present to our economy. This inattention needs to be corrected promptly, before the law of unintended consequences produces considerable harm to our economic system in the name of “corporate governance.”

Participants in the Corporate Governance Universe Today

There is no question that the ranks of the participants in the corporate governance dialogue have been steadily expanding over the past decade, and as a result of the recent financial crisis and global recession, this has significantly accelerated in the past year or so. These participants now include: (1) the SEC; (2) the NYSE and Nasdaq; (3) shareholder governance activists; (4) hedge funds/other shareholders with shortterm or special economic interests; (5) public pension funds and other institutional investors; (6) corporate governance rating services; (7) proxy advisory firms; (8) academics in various disciplines; (9) labor unions; (10) the President/White House; (11) Congress; (12) the Treasury Department; (13) the Federal Reserve System; (14) the Federal Deposit Insurance Corporation; (15) the Department of Justice; (16) state Attorneys General; (17) the media; and (18) state corporate law (legislatures and courts).

Each of these parties or groups has become an active voice of corporate governance “reform.” The growth of this universe is a clear testament to the dramatically increased visibility and importance ascribed to “corporate governance” in today’s world.

…continue reading: U.S. Corporate Governance Today: A Reshaping of Capitalism

It is a pleasure to be here with all of you at the 2009 Independent Directors Conference Workshop to share my views on the regulatory reform issues currently being discussed. I do have to mention that all the views I express today are my own and do not necessarily reflect those of the Commission, the individual Commissioners, or the staff.

I welcome the opportunity to talk with you today. As a practitioner in the securities industry for thirty years who often advised boards of directors, including mutual fund boards, I am familiar with your work and know its importance. I have the utmost admiration for independent directors. You more than anyone have to exemplify the principle that — laws tell you what you can do but values inspire what you should do. As fiduciaries, you play a critical role in setting the appropriate tone at the top and overseeing some of the most important aspects of the fund’s business from keeping fees in line to negotiating important contracts.

Your efforts are crucial to safeguarding the retirement savings and investments of hard working men and women. At the end of 2008, mutual funds, including money market funds, were collectively responsible for approximately $9 trillion of investors’ monies invested in countless corporations, municipalities and myriad investment opportunities. These assets represented the savings of over 92 million individuals.

I have had the distinction of serving on the Commission during “transformational” times, to say the least. I took office at the end of July 2008 and literally my first two months were filled with unprecedented Commission action — running the gamut from being involved with some of the SEC’s largest settlements ever in cases involving Auction Rate Securities to an unprecedented amount of emergency rulemaking and Commission orders.

Now even though the financial crisis continues, the rapid response phase of the crisis is giving rise to discussions of reform resulting from that crisis. In fact, the issues being discussed could very well lead to the largest wholesale regulatory restructuring this country has seen since the great depression. For example, we at the SEC currently find ourselves enmeshed in parallel discussions about the structure of the financial regulatory system, the SEC’s role in such a system, and the regulation of entities under our jurisdiction.

Like me, you too have the opportunity and challenge of representing investors in a time of “transformation.” The global financial crisis has brought us to a point where transformation of existing financial regulation is a given.

The opportunity to take a fresh look involves all of us here today, we at the SEC, and you as fiduciaries, overseeing trillions of dollars that represent a substantial portion of our Nation’s wealth.

…continue reading: Making Investors a Priority in Regulatory Reform

The just deposed GM leadership team has been in control for nearly a decade. During this period, market share, profitability and stock price have declined precipitously, while debt has risen dramatically. One of the fundamental issues raised by the economic crisis, primarily in the financial sector but also in failing industries like automobile industry, is: Where was the board of directors to set meaningful performance goals (not simply stock price) and hold business leaders accountable? This question, in turn, has raised even more fundamental issues about whether, despite endless governance writing, conferences and academic centers, corporations are capable of governing themselves when hard decisions need to be made.

One important perspective on the Obama administration’s decision about transforming the GM leadership and Board is a demand for accountability. While the failures of the past decade form the critical backdrop, the administration’s “Determination of Viability Summary” holds GM accountable for the failures of the “Restructuring Plan Report” submitted on February 17, 2009, pursuant to the US-GM loan agreement signed at the end of last year. Simply stated, that government summary finds the GM report unrealistic in assumptions about market share, price, brands, dealers, Europe, product mix and legacy costs—and far too slow in its actions. That Ford’s new management team is not seeking bail-out funds is the strongest argument that the time for accountability has arrived. This is not change for
change’s sake.

Of course, from a different perspective, this is all about negotiations (or, when the government is involved, politics). It is a negotiation with the GM stakeholders (especially the unions, bondholders and dealers) to make faster, bigger voluntary moves in 30 days to avoid the more unpredictable and potentially Draconian rigors of formal bankruptcy (even if on an expedited basis). It is a negotiation with the a broad spectrum in Congress to show reluctance to throw more good money after bad and to base the future on realistic plans, while holding out hope that GM can rise again (and get more durable financial assistance from the taxpayers).

It is, ultimately, a negotiation with the American people to see if combining hard actions now with the prospect of more support under specific conditions later can, in the midst of the economic maelstrom and now too-numerous-to-count government anti-recession programs, create political support down the road for longer-term federal involvement in GM. (On the subject of negotiation: it would be enjoyable to be in Fiat’s position when Chrysler comes to negotiate a joint venture with the alternative that the government will cut off support if no deal is done.)

In his announcement, President Obama gave the expected disclaimers: “The United States government has no interest in running GM. We have no intention of running GM.” His auto and financial analysts have found GM’s restructuring plan wanting. So a new plan will be developed. But they also found GM’s execution too slow. The unanswered question today, with removal GM’s leader, is who will take the GM helm, and join the GM Board, actually to “operate” the new GM for the longer term—and under what kind of “super-board” operational oversight from Uncle in Washington. A new age of GM accountability is dawning, but how will it work is in execution, not just in planning.

Recent events in the financial markets and the ensuing economic turmoil has shattered the trust of investors, regulators and Main Street in financial institutions and the capital markets on a global scale. The crisis has heightened focus on the importance of risk management at all corporations and has encouraged a fresh look at the role of the board in risk oversight. Although the manner in which a board fulfills its risk oversight responsibilities is a matter of business judgment, directors should bear in mind that conduct will be judged by investors, regulators, the media and others with the benefit of 20-20 hindsight. There is benefit to be had in going beyond the standards of care set by Caremark and its progeny, which require board oversight of an effective compliance and reporting system. Remembering that “best practices” provide a zone of comfort with respect to avoiding director liability, we set forth below ten areas for the board to enhance its focus in 2009 in light of the current environment. They are all related in some respect to enhancing the board’s ability to oversee management’s efforts to identify and avoid, mitigate or manage risk, with the caveat that specific actions to be taken will vary for each company.

1. Apply judgment in tailoring governance structures and processes to the current needs of the company. Remember that adopting a one-size-fits-all check-list approach to corporate governance is fundamentally inconsistent with effective governance. Care should be taken to avoid bowing to pressures to adopt practices that may not be in the company’s interest, while at the same time actively considering the viewpoints of key shareholders on appropriate matters. Boards should tailor their governance practices and structures to the company’s unique needs. The Key Agreed Principles to Strengthen Corporate Governance of U.S. Public Companies published in October 2008 by the National Association of Corporate Directors with support and input from The Business Roundtable and the International Corporate Governance Network (available here and briefly outlined in the Appendix to this document) reflect an effort to distill and articulate fundamental principles-based aspects of governance on which there is broad consensus. The Key Agreed Principles capture the current baseline consensus among boards, managements and shareholders about a range of effective governance practices. Their articulation may help improve the quality of discussion and debate about those governance issues that have not yet gained consensus, and also serve as a touchstone for boards in tailoring governance and avoiding a rote approach. We urge boards to gain familiarity with the Principles and consider them in tailoring their own governance structures and practices to meet the needs of their respective companies.

2. Take a fresh look at board composition and director competency. While a board is more than the sum of its parts, it requires key skill sets and experiences to be positioned to provide and oversight of risk and compliance. The nominating/corporate governance committee should review with rigor the composition of the board and determine whether the board is comprised of people with the optimal mix of experience given the business, circumstances and nature of the risks facing the company. The right mix of competencies will change over time as the company evolves and care needs to be taken to avoid a mindset of “permanent tenure” for directors. The board should use the evaluation process (as well as term/age limits where appropriate) to refresh itself periodically. It is not enough to pull together a distinguished group of men and women if those directors do not have the expertise necessary to understand the fundamentals of the company’s business as the business changes over time and the attendant risks. Given the emphasis on independent directors, boards need to take special care to ensure that persons on the board have industry specific expertise and distinct sources of information about the intricacies of the business and related risks. The board should consider ways to ensure that it is not simply dependent on management for its understanding of the business and the industry. The nominating/corporate governance committee should ensure that company-specific director education and orientation programs are presented to the full board periodically, especially programs that address risk oversight and risk management generally, providing directors with the opportunity to learn about specific risks affecting the company and changes in business conditions and legal standards that may impact on risk.

3. Consider implementing some form of independent board leadership. The ability to exercise effective oversight may be compromised where the board lacks any defined leadership for the independent and non-management directors. Management has natural conflicts and blind spots — in monitoring CEO performance, providing risk oversight and evaluating the strategic plan. The long-range trend is toward a separation of the chair and CEO positions, with an independent director filling the chair role, and that trend is likely to accelerate as shareholders seek assurances that the board is strongly positioned to provide objective judgment in its review of management decisions in key areas. The board — and in particular the independent directors assisted by the nominating/corporate governance committee — should evaluate whether to appoint a separate independent chairman or a strong lead director to assist the board in fulfilling its oversight responsibilities, and should explain its choice to shareholders. For companies that combine the roles of CEO and chairman, expect increased pressure from shareholders to separate the positions or at a minimum create a strong lead director position with an appropriate range of responsibilities. Indications are that independent board leadership will be a “hot button” issue for shareholders during the 2009 proxy season.

…continue reading: Areas for Enhanced Board Focus

Corporate strategy is a difficult undertaking for directors, even in the best of times. While management draws on significant resources to develop and refine corporate strategy, directors have fewer opportunities to contribute to the endeavor. It is not surprising then that while CEOs suggest that participating in corporate strategy is the second most important activity that their boards undertake, they give their boards only the 11th highest grade for their performance in this realm. “What’s the board’s role in strategy development?: Engaging the board in corporate strategy”, David A. Nadler, Strategy & Leadership, Vol. 32 No. 5, 2004. The difficulty of developing corporate strategy, as well as the stakes involved, increase significantly in times of economic crisis such as we are facing today.

Against this background and facing the current economic crisis, the Lead Director Network, a group of lead directors, presiding directors and non-executive chairmen from many of America’s leading companies created by King & Spalding and Tapestry Networks, met on November 3, 2008 to discuss the role of the board in corporate strategy. Following this meeting, King & Spalding and Tapestry Networks have published the ViewPoints report, to present highlights of the discussion that occurred at the meeting and to stimulate further consideration of this important subject. The following provides highlights from the meeting, as described in this ViewPoints report.

Greater Involvement of Boards in Corporate Strategy. Members of the Lead Director Network observed that boards have become significantly more involved in corporate strategy in recent years. This increased involvement might be attributable to boards being more proactive, generally, since the corporate scandals in the early part of this decade, the rise of activist investors, and directors’ own efforts to become more engaged in corporate strategy, particularly when their companies are undergoing rapid changes or facing turbulent events.

…continue reading: The Board’s Role in Corporate Strategy