Companies, Directors Facing Crisis in the Boardroom

SPECIAL REPORT – Banking & Finance: Boards Under Fire What Do They Know?

By ANTHONY PALAZZO

Staff Reporter

In corporate boardrooms across the country, everybody has an idea about changing the system.

They come from institutional investors, from corporate governance types, from politicians and from shareholders pushing ballot proposals.

Place more truly independent directors on the board. Appoint a lead outside director. Have outside directors meet separately for a portion of each meeting. Season your auditing committee with a financial pro. Kick insiders off the nominating committee, so that the chief executive can’t handpick friends for the board. Rein in compensation.

Good suggestions all. Easier made than put into place.

“We’re all in a process of groping. Us, the press, Congress, the courts. How do we tighten these rules without destroying the ability of directors to oversee the running of these companies. It’s a real tension,” said Richard Koppes, a corporate governance expert at Jones Day Reavis & Pogue in Sacramento.

Already, fallout from the Enron Corp. bankruptcy and others have led to crises of investor confidence at companies ranging from National Golf Properties Inc. to General Electric Co. Corporate boards, desperate to restore credibility, are taking action to improve governance and to cover their backsides.

“We’ve seen a hesitancy of CEOs to take on more board roles themselves,” said Stephen Fowler, chief executive of Board Seat, a San Francisco search firm that focuses on board placements. “We’ve been seeing pressure from investors that CEOs should not be taking so many outside board seats.”

At one private company in Northern California, venture investors recently blocked the CEO’s appointment to an outside board, Fowler said. “The venture investors felt he was too busy. He needed to focus on his own company.”

At Walt Disney Co., long a poster child for boardroom cronyism (one of its directors heads a school that Eisner’s children attended), Chairman and Chief Executive Michael Eisner recently hired prominent corporate governance expert Ira Millstein to assess the directors’ roles. As perhaps a sign of things to come, Disney already has cut business ties with two of its directors.

“If anybody can educate them on these issues it would be Ira,” said Nell Minow, editor of the Corporate Library and one of Disney’s most vocal critics.

Some are raising questions about whether directors will meet the heightened demands being placed on them.

According to a report by Korn/Ferry International, outside directors spent an average of 173 hours on board duties in 2000, up from 157 in 1999. Even then, sitting CEOs were cutting their commitments, and board searches were beginning to expand to retirees, foreigners and younger candidates.

The report was published in mid-2001, before Enron’s meltdown. Some believe that disaster has only added to the burden.

“It’s going to be more difficult to attract good directors. Nothing that’s happened would make it less time consuming or less risky to be a director,” said William Ouchi, a professor at the Anderson School of Management at UCLA.

Others said it’s not likely that people will stop wanting to serve on boards. “We’re scaring off the people who shouldn’t be on boards,” said Minow. “The people who thought that being on a corporate board would be a good schmoozing opportunity with lots of freebies, it’s about time they left.”

Past crises indicate that the allure of a prestigious board seat is enough to overcome any hesitancy on the part of recruits.

“There’s endless crying wolf on these things,” said Ralph Ward, publisher of Boardroom Insider, a newsletter. In the mid-1980s, the first of a number of court decisions found directors to be “asleep at the switch,” Ward said. Premiums shot up. “There were a lot of people who said this is the end of the world for boards, and it didn’t turn out that way.”

Indeed, corporate governance has improved by many measures over the past two decades, recent debacles notwithstanding.

“I think directors do a better job today than they did 15 or 20 years ago,” said Joe Carcello, a corporate governance expert and associate professor at the University of Tennessee. “They’re less likely to be rubber stamps, and more likely to challenge management.”

In the late 1990s, the SEC and the stock exchanges implemented corporate governance rules that many large companies adopted. Then-SEC chairman Arthur Levitt gave an influential speech at New York University called “The Numbers Game,” in which he assailed the quality of financial reporting. After that came a blue-ribbon panel headed by Millstein that made several recommendations to strengthen audit-committee composition and practices. Most of the recommendations were adopted by the appropriate regulatory bodies.

As a result there’s been a heightened demand for sitting chief financial officers and for retired auditors from Big 5 accounting firms to sit on boards.

Carcello believes it’s no accident that the recent Enron-type revelations come less than a year after the last of these requirements were put in place. “The best disinfectant is sunshine. That has a powerful way of focusing your attention,” he said.

Remaking the board

The focus on the audit committee has broadened to the nomination and compensation committees. As these are reconstituted, the board itself is being remade.

“There’s a lot of concern that stocks have gotten out of hand, that senior management is raking in, in some cases, obscene amounts of money, in some cases at the expense of shareholders and employees,” Carcello said.

Even politicians have gotten into the act, with measures pending in Congress and the Attorney General of New York going after the securities industry for giving bad advice. “For those of us in the corporate governance business, the joke is, “Thank you Enron.’ The good part about Enron is we’re probably going to get some major changes in laws and regulations, and plus it gets people’s attention,” Koppes said.

A key question is whether directors are being given enough resources to play a more active role.

“Boards have hit some sort of crisis point. It’s sort of like having a volunteer fire department in a small town, and that town grows up to be a metropolis,” Ward said. “You’ve still got a handful of volunteers trying to attend to everything, but it’s wholly inadequate.”

At National Golf, where outside directors have taken over management of the company as it sorts out a financial crisis, the annual director fee was increased to $84,000 from $12,000. The company’s interim chief executive, Charles (Skip) Paul one of three previously independent directors was granted a $360,000 a year salary.

“I started working here daily full-time in mid-December,” Paul said in an earlier interview.

That was after National Golf entered its crisis. Shareholder activists are striving to find directors who will act before a crisis hits.

“It may be that we were paying them too much for what they did but not enough for what we’d like them to do,” Minow said.

A Lack of Independence

The smoke is rising.

In L.A. and elsewhere, directors find themselves mopping up after fires set by former managers managers the board was supposed to be supervising.

In the post-Enron era, directors won’t be let off the hook as easily as they might have in the past for the mistakes made by their hired help.

“The companies that have had problems have had directors that have been too cozy with management. In general it’s been a lack of vigorous monitoring and oversight by truly independent directors,” said Richard Koppes, of counsel at Jones Day Reavis & Pogue in Sacramento.

Now boards are scrambling to improve their corporate governance practices. “There’s a lot of directors that don’t want to be Enron directors,” Koppes said.

From 1986 to 1996, Koppes was chief counsel at Calpers, the California Public Employees Retirement System. There, he used the fund’s mighty clout to shame and cajole corporations into improving their governance policies.

There was improvement, but it wasn’t enough.

“In a legal sense, directors have a fiduciary duty to look out for shareholders. In practice, the reality is in many cases, it’s the management’s board, it’s not the shareholder’s board,” Koppes said.

In Los Angeles, there have been a number of well-publicized implosions.

At Homestore.com Inc., insiders, including directors, sold hundreds of millions of dollars worth of stock. Later, the company revealed that it inflated its revenues and the stock price collapsed.

“They falsified their financial statements or their announcements. And they engaged in accounting irregularities. That pretty much distills it,” said Sherry Reser, a spokeswoman for the California State Teachers Retirement System. CalSTRS is lead plaintiff in a shareholder lawsuit that targets former Homestore.com Chairman and Chief Executive Stuart Wolff, along with other former executives. She declined to discuss CalSTRS’ view on the culpability of the rest of the board.

At Global Crossing Ltd., the board approved a lucrative pay package for Robert Annunziata, Chairman Gary Winnick’s hand-picked choice for chief executive. The package included a $10 million signing bonus and options priced below market. He lasted one year.

“If the CEO candidate asks you for below-market options, that’s when you hit the button on your desk that says eject,” said Nell Minow, editor of the Corporate Library, a watchdog Web site on corporate governance and CEO pay. Minow began criticizing Global Crossing’s board two years before the telecommunications firm declared Chapter 11 bankruptcy.

Because of Global Crossing’s bankruptcy, lawyers have targeted individual directors and executives, including Winnick, in shareholder lawsuits. But it isn’t likely that they’ll be successful, unless it can be shown that laws were broken and the directors knew about it. “The fact is, nobody’s ever had to pay a dollar out of his pocket unless there was fraud,” Minow said.

Which leads to corporate governance’s dirty little secret: Many directors know they probably wouldn’t have acted any differently in place of the discredited Enron board.

“The directors I’ve been talking with are increasingly concerned about what happened with Enron,” said Ralph Ward, publisher of Boardroom Insider, a corporate governance newsletter. ” They think, ‘There but for the grace of God go I.'”

Although they’re ultimately responsible for a company’s survival, directors are ill-equipped to second-guess the chief executive. The CEO has access to much more detailed information than part-time board members who may show up to a meeting once every couple of months.

“(Outside directors) know that if you have professional managers who live and eat and breathe the company and are highly motivated, if those people are actively trying to hide something from you, there’s no way you’re going to find it,” Ward said. “It’s just a mismatch.”

Anthony Palazzo