It’s
a wonder that board members don’t resign their positions en
masse. Boards, and the committees that make them up, are facing
unprecedented challenges this year and governance has seldom been
tougher. From a legal perspective, these issues range from
additional TARP-driven certifications, to cross-board limitations, to
executive compensation and stability. Financial concerns include
the needs to sign off on the certainty of key numbers, despite our
uncertain times. Suffice it to say that their plates are more than
full. As if that list wasn’t scary enough, the threat of
litigation pervades all, as similarly-themed litigations have already
been brought.
As background, listing standards for national exchanges require listed
companies to form committees that equate to the “plumbing” for
key functions overseen by the board. By law, they must have three board
committees, audit, compensation and nominating. Companies will
sometimes tack on their own home-grown committees to this list.
Varying by company, these include groups germane to their business,
like executive, governance, independent directors and disclosures
committees. Whatever the set up, these committees are truly
challenged by daunting, new legal and economic circumstances.
The issues facing the audit committees are among the most daunting.
This committee starts off tightly-ruled. Under Sarbanes-Oxley,
all members must be independent and at least one member should be
considered a “financial expert.” Challenge one for this
group is its need to sign off on mark-to-market valuation decisions and
how these valuations were determined, a difficult task considering the
volatility in the market. For banks, they will also have to approve
credit loss reserves, which will be an extremely challenging endeavor.
These decisions are not only difficult but are fraught with risks.
Shareholders have gone so far as to sue audit committees. In 2005,
Nortel Networks Audit Committee was sued for allegedly issuing false
and misleading statements which was later settled as part of a larger
Nortel settlement agreement.
Cross-board membership is also challenged: if individual members serve
on more than three public company audit committees than the reporting
company must explain how this does not impair their ability. Some
companies, such as Cypress Semiconductor and Innospec, have gone a step
further and limited their audit committee member to service on no more
than three public company audit committees.
Vying for the honor of most daunted is the compensation
committee. With TARP and ARRA (the recently signed American
Recovery and Reinvestment Act of 2009, aka the “stimulus
package”) which imposes compensation rules and restrictions, this
should be no surprise. TARP imposes significant restrictions on
executive pay and “golden parachutes,” among other things.
ARRA requires all TARP recipients to have compensation committees made
up entirely of independent members. Compensation committees for TARP
recipients are also required to certify that they have reviewed the
2008 senior executive officer incentive compensation arrangements with
the Senior Risk Officer to confirm that these arrangements do not
encourage unnecessary and excessive risk taking by the senior executive
officers. As one example, Popular Inc., in their recent preliminary
proxy, provided this type of certification.
Beyond the banking industry, other compensation committees are
challenged to balance compensation decisions against the
companies’ performance in nearly unprecedented economic
circumstances. Several committees have already disclosed the decisions
they have taken in light of these circumstances. For instance, the
compensation committee of Synnex Corporation has determined not to
increase the base salaries of its executive officers. Other
company's compensation committees, such as Icagen, have
determined to award no cash bonuses. Like the audit committees,
compensation committees also run the risk of litigation. In October
2008, Fannie Mae’s compensation committee was named as a
defendant along with its benefits plans committee in a purported class
action suit. This suit alleges breach of fiduciary duty for
investing the Fannie Mae ESOP in Fannie Mae stock when it was no longer
prudent. The suit has been consolidated into a larger multi-district
class action litigation.
Finally, even the innocuous-sounding nominating committees is seeing
economic circumstances impact their decisions. Heron Lake
Bioenergy disclosed how their nominees were intended to provide
continuity of leadership and guide it through volatile economic times.
The nominating committee of Synovus Financial determined that current
economic conditions warranted postponement of restricted stock awards
to its non-management directors. Ares Capital’s nominating
committee has gone so far as to justify the continuation of its
classified board to maintain the continuity and quality of leadership
in light of current economic conditions and volatility.
In normal times, these committees have jobs that sound quite mundane.
The audit committee oversees financial reporting, internal controls,
risk management and the appointment of outside auditors. It is also
required to submit a report on the proxy statement that includes their
recommendation to the board about including the audited financial
statements in the annual report. Compensation committees are tasked
with determining benefits and compensation for executives and directors
of the company and report on it; they must also recommend the inclusion
of the compensation discussion and analysis required in the proxy. The
nominating committee evaluates and recommends new candidates for the
board as well as establishes guidelines for shareholder nominees.
However, these are far from normal times. In an era where few
find it possible to justify excessive compensation or toxic asset
valuations, board committees will need to do just that. Perhaps
most importantly, they must do two other things: first and foremost,
provide quality leadership in tumultuous economic circumstances.
Second, whether as a whole or merely as a “disclosure
committee,” the board must ensure proper disclosure of the
company’s activities as it navigates through the tumult.
Published: February 26, 2009
