It is generally accepted that the full board has overall responsibility for risk oversight, mirroring the board’s responsibility for overseeing strategy. In deciding how to organize itself to oversee risk and risk management, the question arises as to whether the board should establish a separate risk committee. This article explores that question and provides examples to clarify the role and responsibility of a separate risk committee in situations where the board decides to establish one.

Through the risk oversight process, the board of directors obtains an understanding of the critical risks inherent in the corporate strategy, accesses useful information from internal and external sources about the critical assumptions underlying that strategy, remains alert to organizational dysfunctional behavior that can lead to excessive risk taking, and provides input to executive management regarding critical risk issues on a timely basis. How the board views risk oversight as a process should dictate how it chooses to organize itself for purposes of executing that process. The risk oversight process enables the board and management to develop a mutual understanding regarding the risks the company faces over time as it executes its business model for creating enterprise value. In organizing itself for risk oversight, what are some of the factors for boards to consider and when should boards establish a separate risk committee?

…continue reading: Should Your Board Have a Separate Risk Committee?

The past year has been one of change and challenge for public companies and their boards, as companies have moved to implement “say-on-pay” and other provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). With the 2012 proxy season on the horizon, public companies and their directors will continue to feel the impact of Dodd-Frank as the Securities and Exchange Commission (“SEC”) proceeds with its ongoing efforts to implement the law. At the same time, public companies and their boards are operating in an environment where the balance of power between boards and shareholders continues to shift. The traditional, board-centric model of corporate governance continues to gravitate toward a paradigm that includes an increased role for shareholders. Activist shareholders are seeking greater participation in companies’ governance and operations, and they are exerting increased pressure on companies to adopt so-called corporate governance “best practices.”

…continue reading: Considerations for Public Company Directors in the 2012 Proxy Season

Companies looking ahead to the 2012 proxy season should be aware of the recently updated corporate governance policies of Institutional Shareholder Services (ISS). [1] While maintaining its formal policy of issuing “case-by-case” evaluations in many areas, ISS has issued numerous revisions of prior policies as well as new policies on certain types of shareholder proposals that had not been previously addressed. The key areas of interest for companies preparing for 2012 are likely to be proxy access, say-on-pay, pay-for-performance, and risk oversight.

Proxy Access

Shareholder proposals on proxy access are likely to be a topic of importance next year due to the Securities and Exchange Commission’s (SEC) amendment to Rule 14a-8, effective September 20, 2011. The rule now provides that companies may not exclude proposals for proxy access procedures from their proxy statements on the basis that they relate to the nomination or election of directors. Proponents must meet the current eligibility requirements of Rule 14a-8, which require that the shareholder have owned at least the lesser of $2,000 in market value, or 1 percent, of company shares for at least one year. (Companies may, of course, ask for noaction relief from the SEC to exclude such proposals on other grounds. [2])

…continue reading: The ISS 2012 Policy Updates: Another View of the Cathedral

I. Introduction

Overview

Corporate risk taking and the monitoring of risks have remained front and center in the minds of boards of directors, legislators and the media, fueled by the powerful mix of continuing worldwide financial instability; ever-increasing regulation; anger and resentment at the alleged power of business and financial executives and boards, including particularly as to compensation during a time of economic uncertainty, retrenchment, contraction, and changing dynamics between U.S., European and emerging market economies; and consistent media attention to corporations and economies in crisis. The reputational damage to boards of companies that fail to properly manage risk is a major threat, and Institutional Shareholder Services now includes specific reference to risk oversight as part of its criteria for choosing when to recommend withhold votes in uncontested director elections. This focus on the board’s role in risk management has also led to increased public and governmental scrutiny of compensation arrangements and their relationship to excessive risk taking and has brought added emphasis to the relationship between executive compensation and effective risk management. For the past few years, we have provided an annual overview of risk management and the board of directors. This overview highlights a number of issues that have remained critical over the years and provides an update to reflect emerging and recent developments.

…continue reading: Risk Management and the Board of Directors – An Update for 2012

The Federal Reserve has released proposed rules to implement the enhanced supervisory and prudential requirements in Sections 165 and 166 of the Dodd-Frank Act. These proposed rules represent the Federal Reserve’s primary effort, one and a half years after the enactment of Dodd-Frank, to put in place prudential standards that will govern the largest bank holding companies in the United States and any nonbank financial firm designated in the future as systemically important and subject to Federal Reserve oversight. Our memorandum, Federal Reserve Proposes Enhanced Prudential Standards and Early Remediation Requirements For Large BHCs and Nonbank SIFIs, describes the Federal Reserve’s proposal.

Of particular interest, the Federal Reserve is proposing, for the first time, to formally limit the consolidated exposures that a large BHC or nonbank SIFI, together with its subsidiaries, may have to any other counterparty at 25% of its capital and surplus, and to limit such exposures between the very largest institutions to 10% of capital and surplus. In addition, the Federal Reserve is proposing, for the first time, to require large BHCs and nonbank SIFIs to comply with a formal regulatory liquidity standard. While these proposed rules are consistent with Dodd-Frank’s requirements, and in some cases tie in with international regulatory efforts, they represent a new chapter in the regulation of large banks and non-bank financial institutions and efforts to reduce systemic risk. The proposed rules, however, defer rulemaking on several important topics to a future release. For example, despite press reports, the proposed rules do not contain the Basel Committee’s G-SIB surcharge but instead state that the Federal Reserve will implement the surcharge by 2014, with it taking effect between 2016 and 2019.

The full memorandum is available here.

Brian Tayan and I recently co-authored a book, titled Corporate Governance Matters, which takes an organizational perspective, rather than a legal perspective, on the important topic of modern corporate governance. Our purpose is to examine the choices that organizations can make in designing governance systems and the impact those choices have on executive decision-making and the organization’s performance. The book relies on an extensive body of professional and scholarly research, and aims to correct misconceptions and cut through the considerable rhetoric surrounding corporate governance. We hope the book provides a framework that enables practitioners to make sound decisions that are well supported by careful research.

Our book covers a wide range of topics regarding corporate governance. These include a discussion of the environment in which the organization competes to understand how various forces influence the mechanisms it adopts to discourage self-interested behavior by management. In addition, we spend considerable time examining the board of directors, including the structure, processes, and operations of the board, along with the board’s functional responsibilities, such as oversight and risk management, succession planning, compensation, accounting and audits, and the consideration of mergers and acquisitions. We also examine the role of the institutional investor to understand how diverse shareholder groups and third-party proxy advisory firms influence governance choices. The book also includes an assessment of commercial and academic governance ratings systems.

Many of the conclusions of the book are phrased in the negative. While the lack of positive correlations may disappoint some, this has important implications for the current debate on governance and your evaluation of the types of governance systems that organizations might require. Some of the central lessons we draw in the book including the following:

…continue reading: Corporate Governance Matters: Lessons for Practitioners

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 regulatory oversight framework is broken. The SEC failed to regulate credit default swaps, loosened broker-dealer leverage restrictions at just the wrong time and failed to regulate dark-debt driven hedge fund activities. The Federal Reserve failed to impose reserve requirements on syndicators of collateralized loan or credit obligations. All that will change now.

Importantly, in its entire seventy-five year history, there has never been a visiting committee appointed to review the SEC. We need a committee of non-bureaucrats, non-industry groups, non-politicians, analogous to the visiting committees that accredit and review university excellence.

Meanwhile, there is going to be greater skepticism and scrutiny of board of director oversight than ever before, as a ripple effect of failed companies, regulatory tightening and the push for reform. In some ways, that is not a bad thing, because lax practices still exist, such as the increasing trend of front-loading board meetings with management presentations so detailed and so numerous as to numb the outside directors’ ability to assess strategy and examine any one problem with requisite focus. The ratio of minutes of director discussion to minutes of slide presentations has greatly diminished, as companies’ ability to mine and marshal presentation data has risen parabolically.

That process within the boardroom—that dynamic—needs to be managed by the board itself.

What’s Going On?

Despite greater intensity of director effort, the core challenge for directors trying to fulfill their roles in providing vision and vigilance for public companies remains the same: they passionately desire and dutifully need to know “what is going on” in the important areas of company strategy and management execution in order to do their director jobs well.

…continue reading: Shenanigan’s Wake

This note was prompted by our review of the recent decision of the Delaware Court of Chancery in In Re Citigroup Inc. Shareholder Derivative Litigation, C.A. No. 3338-CC. In the context of dismissing, on the basis of a failure adequately to plead demand futility, allegations in a complaint of breaches by directors of their duty of oversight, the Court emphasizes the continuing vitality and primacy of the business judgment rule presumption as a key protector of our system of private capital investment. For corporate lawyers, the analysis and outcome of the case is not particularly surprising. However, in this meltdown environment, the outcome could easily be misunderstood as a reflection of a supposed era of state corporate law being too kind and gentle to directors.

So we’ve written this note to include some context and elaboration, rather than just reporting some specific key findings and an overall assessment — such as “It is a heartening decision for directors who oversee their companies in good faith, even though business decisions made on their watch result in ‘staggering’ losses” — which would likely only contribute to the misunderstanding.

Our objective is to illuminate both the serious and thoughtful approach to decisionmaking reflected in the Citigroup decision — an approach that is characteristic of Delaware judicial decisions generally — as well as the important underlying economic policy on which it is grounded. In addition, in a particularly difficult time, when change seems to be the order of the day, we hope that by providing some context and elaboration we may in some small way help counteract a tendency to discard or diminish certain core legal concepts which have stood the test of time and for good reason.

* * * * *

That famous curse — may you live in interesting times — is upon us! For directors of business corporations nothing could be more true. For almost a year now, the global financial markets have been in turmoil, and the global economy has followed suit. In more ebullient times, risks were undertaken in businesses across many industries and around the world that, on a hindsight basis, the directors and management of numerous companies wish had never occurred. As events have unfolded, operating results have plummeted, balance sheets have deteriorated, stock market values have declined dramatically and personal wealth has imploded. All in all an ugly environment and one uniquely positioned for victims to assign blame and seek recompense.

…continue reading: Directors’ Duty of Oversight in a Meltdown

The slow demise of the U.S. car industry over decades and the spectacular collapse of the U.S. financial system have a lot in common. Both implosions are the result of poor management: shortsighted incompetence in the car industry and reckless risk-taking in the financial sector. Where was the oversight? And what could be a better indictment of the incentives in our system than the fact that even the executives who made the most egregious calamitous decisions are all walking away as rich men, while many of their shareholders have been wiped out?

(The Corporate Library reports that Richard Fuld, the person primarily responsible for the destruction of Lehman Brothers (and clearly among the most incompetent CEOs of all time), was the 13th highest CEO in 2007, with $71.92 million in compensation in 2007, including more than $40 million in value from realized stock options. The third highest-paid executive on the list was Angelo Mozilo, former CEO of Countrywide Financial Corp., which collapsed on its subprime loans. His total actual compensation for 2007 was $124.69 million. Bank of America had to pay him another hundred million dollars to make him disappear. It took government intervention to stop the CEOs of Fannie and Freddie from receiving $25 million in parachutes. The list of scandalous pay and no board supervision goes on and on.)

The fact is that our US corporate governance system is dysfunctional. The most important feature of a governance system is its ability to limit the power of those CEOs—the black sheep if you will—who are inclined to break it. Therefore, the only effective mechanisms are those that are external to the firm — those that cannot be dismantled by bad CEOs: management’s fiduciary duty, the requirement to hold an annual meeting, the possibility of an external takeover (at least before Delaware gave management the poison pill and staggered boards to prevent them), the negative publicity surrounding excessive salaries. In contrast, internal governance mechanisms, such as the power of the Chairman’s board to fire the CEO, are seldom effective. Any bad CEO worth his salt will have worked hard to make this extremely difficult.

It is imperative to our global competitiveness that we improve our corporate governance system. If we do not, we may fix all our present economic calamities only to have new ones erupt elsewhere before long.

…continue reading: How to Fix One Root Cause of Our Economic Crises