Talk notes: NACD Director Professionalism: The Nominating and Governance Committee: New Challenges and Opportunities in Board Composition

Director Professionalism Course
National Association Of Corporate Directors
Philadelphia, PA
June 8-9, 2010

The Nominating and Governance Committee: New Challenges and Opportunities in Board Composition

Suzanne Hopgood, Managing Director, Board Advisory Services, NACD; Director, Acadia Reality
Bob Hallagan, Director ResCare, Inc., and Beskshire Life Insurance Company; vice chairman and managing director, board leadership services for Korn/Ferry International; former CEO of Heidrick & Struggles

Suzanne specializes in companies in trouble, including company whose CEO is on $400M bail. Was on board of Worldcom.

This was a surprisingly interesting topic, all about board composition and the urgent issue of how boards get rid of deadwood. New SEC requirements require explanations of why every director is on the board, challenging the sense of entitlement that many directors have that "I join a board when I'm 50, and I'm on the gravy train until I'm 70."

This sounded like a potentially boring topic, but they suggest that the board Nominating/Governance Committee should lead the effort to "get the right people on the bus, and get the wrong people off."

• "This is an extraordinarily important. Years past, it was audit. Then compensation. Now it's board composition, which means Nominating and Governance committees."
• Bob shows chart of "Alan's hypothetical performance, leading up to and after the IPO"
  • Going public?  Lawyer says that after you go public, "You need a board. Right now, it's your mom. You can get a group of people who have solved the problems you're trying to solve."
• Four types of boards
  • Has negative impact on performance
  • No impact on performance
  • Good fiduciary checkmark board (i.e., ensures you stay compliant) -- affects performance a little, minuscule bit
  • Has positive impact on performance
• "Announcement that you're looking for a great board can scare the crap out of competitors. Imagine the list of board members that would scare your competitors."
• Focused objective of governance committee, the charter should read, "our company takes on all the characteristics of a high-performing board"
  • "Our biggest risk is our fellow board members. There are people I'm on boards with that I'd never serve again with, regardless of how much money I get. We can't overlook that today."
  • "Do you want to be on the board of Massey Energy (coal company with the worst safety record in the U.S., had recent coal mine disaster, etc.)? Are these people you want to be on the boat with? If not, then it's the responsibility of the nominating/governance committee to take action."
• Questions to ask
  • are we taking advantage of new disclosure requirements?
    • "if you can't answer the unique value you provide, then get off the board."
  • have we identified and secure necessary skill sets for the board?
  • do we maximize communication?
• New SEC regulations impact Nom/Gov committees
  • Elimination of broker discretionary voting (NYSE Rule 452)
  • Proxy Disclosure Enhancements Release No 33-9089
    • Rules focus on enhancing disclosure in following areas:
      • compensation
      • director qualifications
      • diversity (not defined? skill set? racial? sex?)
      • board leadership (incl. CEO/chairman roles: explain why it works for your company)
      • risk
    • Some write a paragraph; Suzanne's board wrote lots of pages.
  • Expectation from directors is that it's lifetime employment: not a three year term, but a sense of entitlement: "I get a board position at 50, and I'll be there until, say, 70 years old."
    • When prompted, 80% of room believed that this is the expectation AND that this is reality.
    • When prompted, 0% thought that this is NOT the way it should be
    • (Interesting. What are the barriers for getting the board rotation people want? Someone suggested term limits.)
    • (Interesting article on board compensation here. Stunning how highly paid many directors are:
      • "The article goes on to note that data from executive recruiter Spencer Stuart's study of 491 large and important companies reveals that average director pay for non-employee directors was $213,000 in 2008.  Moreover, proxy statements companies in the surveywhose average salary, in Fortune's words, "exceeded the nosebleed level of $400,000," revealed director compensation packages ranging from $713,500 to roughly $1.5 million.  Does this kind of compensation gut the idea of director independence?"
    • Question: what is average age of average board member age?
      • north of 65 for many; many have board members with age over 80
    • Institute of Institutional Investors: new SEC rules for proxy will be incredibly disruptive: the fact that boards can't explain why board members are there, activist boards will use this as a wedge to get their people on the board.
      • Another thing going on: was interviewed by The Atlantic about Coca Cola board: board age was so old, many had problems finding rooms; advanced age doesn't mean diminished competence. Boards rely on age rules because they don't have balls to kick ineffective directors off boards.
      • The demands from boards are so high, people with full time jobs can't be on boards. CEOs average on 1.2 boards. CEOs don't have time to be on boards.
      • Consequently, people are on boards, merely because they have time to do it.
      • Average retail vote: less than 8%.  (Don't know what this means.)  Apparently, when it's this low, boards are ceding all the power to activist investors. "They will take this power away from companies. You don't want Washington, D.C. to have this kind of power."  (Interesting. TODO: study this more later.)
• Nom/Gov committee as focal point
  • governance issues
  • corporate strategy
  • director composition
  • director and management evaluation
    • "according to your peers, you were rated a 2 out of 10."
  • shareholder communication
  • risk processes
  • committee roles and responsibilities
    • "we change board charter every year, even a couple of words, so there's no question that we're reviewing it."
• Risk responsibilities of the nom/gov committee
  • ensure that the right people are on board
    • skills, experience, etc.
  • evaluate management and directors
  • handle risks associate with:
    • board structure
    • director selection
    • CEO selection
    • coordination between committees
    • communication with shareholders
  • "I was the CEO of a company where I was the fourth CEO in four years, and CEO of another company where I was the fifth in five years. Just based on that, you know that the company performance was terrible. Imagine standing in front of a group of employees who are thinking, 'I've survived the last four fools. I can survive you." (haha)
• High performance board framework (source: NACD Blue Ribbon Commissions on Board Evaluations)
• Listing Exchange requirements
  • NYSE
    • Nom/Gov must be established by charter and be completely independent
    • Key committees must be evaluated annually
  • NASDAQ
    • director nominations must be made by an independent nominating committee OR by a majority of the independent directors on the board
    • One non-independent member of the nominating committee may be permitted to serve, for a limited time, under certain disclosed circumstances
• Governance issue
  • Independence: Listing Exchange, SEC
    • no significant economic ties to the company
    • not an advisor to the company
    • no significant familial relationships
    • not part of management within the last three years (NYSE)
    • audit committee standards are even higher
  • to be meaningful, independence must go beyond structural considerations
• Board evaluations
  • Question: "say more about the disclosability of those board evaluations"
    • "we only do it on paper. we destroy after 30 days. we don't trust electronic forms of this sensitive document."
    • "in board meeting minutes, note that reviews were delivered, but don't go into detail."
    • (golly. very sensitive! apparently the rationale, people get sloppy about what they write down, and without the context, it can be taken out of context.)
• Annual disclosure report
  • disclose all relationships that constitute conflict of interest.
    • "Important. This is the first form that SEC pulls when there's a question of conflict of interest."
  • If uncertain about conflict of interest, the director must disclose all conflicts.
    • "If CEO is holding all their stock in a margin account, is that important to  know?"
  • "D&O insurance is really O-insurance. All funds get used to defend officers. All money is gone by the time you get the directors. Get D-insurance, so officers can't tap out the defense fund."
• Board composition
• Example: Point Blank Solutions 2008 proxy disclosure (wow. this is terrific. shows compensation [up to $25K per year], and brief bio of each person. look at bios on Page 8)
  • "in 2008 proxy, we disclosed strategic plan to shareholders, the nine skillets needed, and disclosed how the skillsets matched the strategic plan. we wrote 5 pages. suddenly, we realized how ridiculous the 5-line legally required bio is."
  • after proxy battle, every one of top 18 shareholders expressed appreciation for the detail explaining the board composition
• Board search process
  • Engage search firm or NACD Directors Registry: the process
    • consultative process
    • interview process
    • background check
    • candidate selection
    • the presentation of an invitation to join the board
• New skillset needs
  
  • Understanding global markets
  • social media (again, the quote that Facebook would be the 4th largest country: it's the 2nd time I've heard this quote at a conference in 4 weeks. First time was the WebVisions 2010)
  • "you want board members that will maximize the group dynamics."
• Background checks and interviewing
  • "You are bringing on someone who is likely to be your partner for a long period of time. Think of how superficial the interview process is. You need to validate the success record of candidates, in the areas that you need time. Really drill down on background and their success, and be sure they have history of making good decisions. What is point of having people on board that don't have history of making good decisions. Then we do extensive 360 degree reference checking. Think that board member may be with company for 10-25 years."
• "Tone at the top doesn't with the CEO, it starts at the board"
  • "Everyone in accounting will know how much money a board member spends. Spending $800/day on hotel in NYC when company is doing layoffs is indefensible."