NYSE Corporate Governance Guide PDF

NYSE: Corporate Governance Guide
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NYSE:
Corporate Governance Guide
Published in association with New York Stock Exchange,

an Intercontinental Exchange Company | NYSE Governance Services
Consulting editors: Steven A. Rosenblum, Karessa L. Cain,

and Sabastian V. Niles, Wachtell, Lipton, Rosen & Katz
Published by White Page Ltd

Consulting editors Steven A. Rosenblum, Karessa L. Cain, and Sabastian V. Niles,
Wachtell, Lipton, Rosen & Katz
Publisher Tim Dempsey
Publishing editor Nigel Page
Production editor Matt Rosenquist
Design Graphic World Inc
Printing and binding Transcontinental Printing
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First published: 2014

ISBN: 978-0-9565842-6-7

© December 2014
Copyright in individual chapters rests with the authors. No photocopying: copyright licenses do not apply.
DISCLAIMER
This guide is written as a general guide only. It should not be relied upon as a substitute for specific legal
or financial advice. Professional advice should always be sought before taking any action based on the
information provided. Every effort has been made to ensure that the information in this guide is correct
at the time of publication. The views expressed in this guide are those of the authors. The publishers and
authors stress that this publication does not purport to provide investment advice; nor do they accept
responsibility for any errors or omissions contained herein.
The NYSE: Corporate Governance Guide (the Guide) contains summary information about legal and
regulatory aspects of corporate governance and is current as of the date of its initial publication (December
2014). Although the Guide may be revised and updated at some time in the future, Intercontinental Exchange
| NYSE Governance Services does not have a duty to update the information contained in the Guide, and
will not be liable for any failure to update such information. Intercontinental Exchange | NYSE Governance
Services makes no representation as to the completeness or accuracy of any information contained in the
Guide. It is your responsibility to verify any information contained in the Guide before relying upon it.
Introduction—the
spotlight on boards
Steven A. Rosenblum, Karessa L. Cain, and Sabastian V. Niles Wachtell, Lipton, Rosen & Katz
T
he ever evolving challenges facing corporate boards prompt
an updated snapshot of what is expected from the board of
directors of a major public company—not just the legal rules,
but also the aspirational “best practices” that have come to have
almost as much influence on board and company behavior. The
end goals of boards remain the same: overseeing the successful,
profitable, and sustainable operations of their companies. But the
pressures that confront directors, from activism and short-termism,
to ongoing shifts in governance, to global risks and competition,
are many. The submissions contained in this guide provide
additional perspectives on the current corporate governance
environment and the challenges—and opportunities—faced by
boards of directors.
In the current environment, boards are expected to:
• Establish the appropriate “tone at the top” to actively cultivate

a corporate culture that gives high priority to ethical standards,
principles of fair dealing, professionalism, integrity, full
compliance with legal requirements, and ethically sound strategic
goals.
• Choose the CEO, monitor his or her performance, and have a
succession plan in case the CEO becomes unavailable or fails to
meet performance expectations.
• Maintain a close relationship with the CEO and work with
management to encourage entrepreneurship, appropriate risk
taking, and investment to promote the long-term success of
the company (despite the constant pressures for short-term
performance) and to navigate the dramatic changes in domestic
and worldwide economic, social, and political conditions.
• Approve the company’s annual operating plan and long-
term strategy, monitor performance, and provide advice to
management as a strategic partner.
NYSE: Corporate Governance Guide iii

Introduction—the spotlight on boards Wachtell, Lipton, Rosen & Katz
• Develop an understanding of shareholder of age, length of service, independence,

perspectives on the company and expertise, gender and diversity, and
foster long-term relationships with provide compensation for directors that
shareholders, as well as deal with the fairly reflects the significantly increased
requests of shareholders for meetings time and energy that they must now
to discuss governance and the business spend in serving as board and board
portfolio and operating strategy. committee members.
• Evaluate the escalating demands of • Evaluate the board’s performance, and
corporate governance activists designed the performance of the board committees
to increase shareholder power. and each director.
• Work with management and advisors • Determine the company’s reasonable
to review the company’s business and risk appetite (financial, safety, cyber,
strategy, with a view toward minimizing political, reputation, etc), see to the
vulnerability to attacks by activist hedge implementation by management of state-
funds. of-the-art standards for managing risk,
• Organize the business, and maintain monitor the management of those risks
the collegiality, of the board and its within the parameters of the company’s
committees so that each of the increasingly risk appetite, and oversee that necessary
time-consuming matters that the board steps are taken to foster a culture of risk-
and board committees are expected to aware and risk-adjusted decision making
oversee receives the appropriate attention throughout the organization.
of the directors. • See to the implementation by
• Plan for and deal with crises, especially management of state-of-the-art standards
crises where the tenure of the CEO is in for compliance with legal and regulatory
question, where there has been a major requirements, monitor compliance, and
disaster or a risk management crisis, respond appropriately to “red flags.”
or where hard-earned reputation is • Take center stage whenever there is a
threatened by a product failure or a socio- proposed transaction that creates a
political issue. Many crises are handled seeming conflict between the best
less than optimally because management interests of stockholders and those of
and the board have not been proactive in management, including takeovers and
planning to deal with crises, and because attacks by activist hedge funds.
the board cedes control to outside counsel • Recognize that shareholder litigation
and consultants. against the company and its directors is
• Determine executive compensation to part of modern corporate life and should
achieve the delicate balance of enabling not deter the board from approving a
the company to recruit, retain, and significant acquisition or other material
incentivize the most talented executives, transaction, or rejecting a merger
while also avoiding media and populist proposal or a hostile takeover bid, all of
criticism of “excessive” compensation which is within the business judgment of
and taking into account the implications the board.
of the “say-on-pay” vote. • Set high standards of social responsibility
• Face the challenge of recruiting and for the company, including human rights,
retaining highly qualified directors who and monitor performance and compliance
are willing to shoulder the escalating with those standards.
workload and time commitment required • Oversee relations with government,
for board service, while at the same community, and other constituents.
time facing pressure from shareholders • Review corporate governance guidelines
and governance advocates to embrace and committee charters and tailor them
“board refreshment”, including issues to promote effective board functioning.
iv NYSE: Corporate Governance Guide

Wachtell, Lipton, Rosen & Katz Introduction—the spotlight on boards
To meet these expectations, it will be devote sufficient time to preparing for and
necessary for major public companies (1) to attending board and committee meetings;
have a sufficient number of directors to staff (4) to provide the directors with regular
the requisite standing and special committees tutorials by internal and external experts as
and to meet expectations for diversity; (2) to part of expanded director education; and
have directors who have knowledge of, and (5) to maintain a truly collegial relationship
experience with, the company’s businesses, among and between the company’s senior
even though meeting this requirement may executives and the members of the board.
result in boards with a greater percentage We thank each of the contributors to this
of directors who are not “independent”; guide for their thoughtfulness and hope you
(3) to have directors who are able to find their perspectives of value.
NYSE: Corporate Governance Guide v

Tom Farley, President New York Stock Exchange, an Intercontinental Exchange Company
Foreword
The relationship between companies and their shareholders has
never been more important than it is today. Open communication
as well as trust in both management and the board are critical
to building long-term relationships with investors, which allow
companies to stand out amongst an ever-increasing range of global
investment options.
The New York Stock Exchange has long recognized the role of
good corporate governance in protecting shareholder value and, in
turn, the capital markets. In 1895, the Exchange recommended that
companies issue a full report of their annual operations at least 15
days before the shareholder meeting. In 1899, we began requiring
regular financial statements of all listed companies. We supported
one share, one vote initiatives in 1926 and the establishment of
proxy solicitation regulations in 1927. Furthermore, in recognition of
the critical role the board plays in supporting good governance, we
urged listed companies to have at least two outside directors on the
board starting in 1956. In 1977, we required that listed companies
have independent audit committees comprised of outside directors.
Finally, in 1999, well before Sarbanes-Oxley Act of 2002 (SOX)
regulations, we required domestic listed companies to have audit
committees of at least three independent directors, and set financial
expertise requirements for the committees.
This long history of supporting good corporate governance
is the reason we are pleased to be bringing you NYSE: Corporate
Governance Guide. We are very grateful to our partners on the project,
including our publisher and expert contributors. Our collective
goal is to help you navigate the changing landscape of corporate
governance today. To that end, the guide covers a broad spectrum
of topics from selecting and developing a high quality board and
succession planning to ensuring a board works effectively as a team.
It goes on to explore a range of topics that a board must address if
it is to enable the company to achieve its full potential including
strategy, risk management, communicating with shareholders, and
overseeing an effective ethics and compliance program.
Companies need corporate governance policies that place the
interests of their shareholders first. In today’s world of increasingly
vi NYSE: Corporate Governance Guide

Foreword NYSE: Corporate Governance Guide
complex regulation it is necessary to to position themselves well for meeting

supplement a skillful compliance team with investor expectations down the road. After
an equally strong governance program. all, good governance is about enabling
Effective governance and compliance entrepreneurship and innovation within
programs must be tailored for the unique a framework of accountability, which
and continually evolving circumstances of ultimately increases trust in our capital
each corporation, and a well-functioning markets and allows us to continue to lead
board is at the heart of that challenge. globally.
Even privately held companies would Regards,
benefit from establishing good governance
practices now, as this would allow them
NYSE: Corporate Governance Guide vii

NYSE: Corporate Governance Guide Contents
Contents
PART I: STAKEHOLDER PERSPECTIVES 7A What directors think: a Corporate Board
ON CORPORATE GOVERNANCE 1 Member/Spencer Stuart survey
NYSE Governance Services 46
Chapter 1 7B Growing goodness, Annie’s way
The evolution of corporate governance: key NYSE Governance Services 57
trends and issues facing directors today 7C How sweet it is! One-on-one with Jim
NYSE Governance Services 2 Nevels
Chapter 2 NYSE Governance Services 61
Real look at corporate governance 7D A new frontier: one-on-one with Maggie
Stanford Graduate School of Business 6 Wilderotter
Perspectives from ratings agency, institutional
investors, and shareholder services 13 PART II: THE COMPOSITION AND
3A An institutional investor’s viewpoint on STRUCTURE OF THE BOARD 71
corporate governance
Vanguard 13 Chapter 8
3B The evolution of active ownership Building a balanced board
ISS 20 Spencer Stuart 72
3C Corporate governance: perspectives from Chapter 9
a credit ratings agency Corporate governance update: renewed focus
Moody’s Investors Service 26 on corporate director tenure
Chapter 4 Wachtell, Lipton, Rosen & Katz 78
Engaging with investors on corporate Chapter 10
governance Conducting effective board and director
CamberView Partners 32 evaluations
Chapter 5 Global Governance Consulting LLC 85
The board’s role as strategic advisor Chapter 11
NYSE Governance Services 38 Effectively structuring board committees
Chapter 6 Global Governance Consulting LLC 91
Fostering a long-term perspective: using Chapter 12
strategic simulations to prepare for uncertain Managing information flows among board
futures and management
Booz Allen Hamilton 42 Securities and Corporate Governance
Chapter 7 Practice, Gunster, Yoakley & Stewart, P.A. (Fort
Selections from Corporate Board Member 46 Lauderdale, FL) 97
viii NYSE: Corporate Governance Guide

Contents NYSE: Corporate Governance Guide
Chapter 13 Chapter 24
Recruiting and onboarding directors Best practices in code of conduct
Spencer Stuart 102 development
Should I serve as a member of the board of Chapter 25
directors of a newly public company? How to survive and thrive in a crisis
Fenwick & West LLP 108 Pillsbury Winthrop Shaw Pittman LLP 179
Chapter 26
PART III: KEY CHALLENGES FOR Crisis communications in the age of
BOARDS AND MANAGEMENT 117 permanent engagement
LEVICK 185
Chapter 15
Succession planning: strategies for building Chapter 27
the pipeline The importance of effective board oversight
Spencer Stuart 118 NYSE Governance Services 191
Chapter 16 Chapter 28
Communications strategies FCPA and compliance: a board and senior
management perspective
Joele Frank 124
Wachtell, Lipton, Rosen & Katz 197
Chapter 17
Reputation, analytics, and corporate strategy Chapter 29
Handling regulatory inquiries, investigations,
Booz Allen Hamilton 130
and settlements
Chapter 18 Arnold & Porter LLP 204
Managing technological change
Chapter 30
Sarbanes-Oxley/internal control
Chapter 19 KPMG LLP 212
Capital structure, leverage, and capital
allocation Chapter 31
Cybersecurity oversight
Citi Corporate and Investment Banking 142
Chapter 20
How to win the say-on-pay vote Chapter 32
Cybersecurity law
Pay Governance LLC 148
DLA Piper 225
Chapter 21
Board of director compensation: evolution Chapter 33
and aligning design with shareholders Navigating the opportunities and pitfalls of
social media channels
Pay Governance LLC 155
Sard Verbinnen & Co 230
Chapter 22
Principles for effective enterprise risk PART IV: SHAREHOLDER ACTIVISM 237
management
KPMG LLP 160 Chapter 34
Chapter 23 Key strategies of activist investors
Audit committee priorities Citi Corporate and Investment Banking 238
KPMG’s Audit Committee Institute 166
NYSE: Corporate Governance Guide ix

NYSE: Corporate Governance Guide Contents
Chapter 35 European Union

Advance preparedness—dealing with activist France
hedge funds Bredin Prat 291
Wachtell, Lipton, Rosen & Katz 244 Germany
Chapter 36 P+P Pöllath + Partners 296
Shareholder proposals: recent trends and Italy
developments Chiomenti 300
MacKenzie Partners, Inc. 251 Spain
Uría Menéndez 306
Chapter 37 United Kingdom
Engaging with proxy advisory services
Herbert Smith Freehills LLP 310
CamberView Partners 259
Asia Pacific
Chapter 38 Australia
Tools for knowing your stockholder base King & Wood Mallesons 315
Innisfree M&A Incorporated 265 Hong Kong
Chapter 39 Deacons 319
Understanding/messaging with institutional Japan
investors Anderson Mori & Tomotsune 323
FTI Consulting 270
CONTRIBUTOR PROFILES 329
PART V: INTERNATIONAL
PERSPECTIVES/“HOT BUTTON” ISSUES
AND DEVELOPMENTS 275
North America
Canada
Osler, Hoskin & Harcourt LLP 278
Mexico
Creel Abogados, S.C. 282
Latin America
Brazil
Pinheiro Neto Advogados 286
x NYSE: Corporate Governance Guide

Part I
Stakeholder perspectives on
Corporate governance
Electronic version of
this guide available at:
nyse.com/cgguide
The evolution of corporate
1 governance: key trends and
issues facing directors today
Deborah Scally, Editor and Director of Research, and Erica Salmon Byrne, Executive Vice President,
Compliance and Governance Solutions NYSE Governance Services
I
t’s the question of the moment: what kind of board does your
company need to maintain a competitive edge? Industry and
leadership experience are obviously important factors and most
boards have added a financial expert thanks to the Sarbanes-
Oxley Act, but does your board have information technology
(IT) expertise? Social media savvy? How about an international
perspective? The implementation of Dodd-Frank has also meant
time spent on say-on-pay and executive compensation, putting
an additional spotlight on the compensation committee and your
shareholder communication initiatives.
Given the meteoric rise in IT risk, it is likely your board either
already has a director who is well versed in information technology
and data security or is looking for one to help it better understand
the company’s IT risk profile. The same is true for the fast-growing
realm of social media; its increased use as a competitive strategy in
recent years has brought correspondingly greater risks. And if your
company is contemplating expansion outside of the US, bringing in
a board member with international experience is a must. At the same
time, more attention must be paid to the tricky arena of anticorruption
and compliance with the Foreign Corrupt Practices Act (FCPA), with
its minefield of risk. And yet none of this should become a distraction
from the core mission of a director: to effectively represent shareholder
interest and focus on enhancing shareholder value.
There are five key categories board members should be thinking
about as they think about corporate governance today: board
composition and effectiveness, leadership challenges, executive
compensation, risk management, and strategic planning. While
compensation and succession are long-running themes, there are
new twists on risk oversight that reflect the current corporate
environment, both technologically and globally.
Assessing board composition

For any given company, there must be both management and a
governing body that are up to the task of meeting current challenges.
And while many of the requisite skills are the same year after year,
2 NYSE: Corporate Governance Guide

NYSE Governance Services The evolution of corporate governance: key trends and issues facing directors today
corporate challenges continue to evolve that 39 percent said their boards require a
require new blood and fresh approaches. mandatory resignation submission in the
While the concept of “refreshment” is event of a personal reputational event,
more readily applied to employees and such as a bankruptcy or arrest, and 28
management, there’s a growing trend among percent require a mandatory resignation if
investors and academics to apply it to a director fails to garner a majority vote.
boards as well. Shareholders want to ensure However, fully half of those surveyed said
that the boards of the companies in which the latter is not required nor needed, which
they own stock are capable of handling may indicate a preference by directors to
the leadership and governance demands evaluate each case individually rather than
of the current marketplace and that the under blanket guidelines.
highest standards of independence are being In addition to examining the methods
met. This viewpoint reflects the belief that boards are using to refresh their ranks, an
today’s corporate boards are one step further important function is for boards to undertake
from the days when boards were often a healthy self-evaluation to ensure all sitting
formed under the auspices of long-standing members are contributing something unique
friendships or business favors—and stayed and relevant to the whole. This is often an
that way. important step when there is a vacancy
Today’s board members are well aware on the board. Industry experience is often
they need to stay sharp. Two thirds of viewed as a compelling factor for selecting
directors in NYSE Governance Services’ a board member, especially in terms of
2014 “What Directors Think” (WDT) survey how a candidate could contribute to the
found the need to periodically refresh the competitive growth and strategy of the
board with new blood as either important company. The 2013 Spencer Stuart Board
(51 percent) or critically important (16 Index revealed that 23 percent of new
percent), with another 26 percent saying that directors were retired chief executive officers
refreshing the board is at least somewhat (CEOs), chief operating officers (COOs),
important. chairmen, presidents, and vice chairmen,
And the time has never been more compared with just 16 percent in 2012. And,
appropriate for a jaundiced look at board for the first time, fewer active CEOs than
composition. According to WDT survey retired CEOs joined S&P 500 boards, 77
partner Spencer Stuart, among S&P 500 versus 79.
boards, retirement ages are being pushed One area that is a focus for 2014 within
back, and as a result, board members are this idea of board composition is initiatives
becoming older and more entrenched. Yet, to promote board diversity. Thought by
one irony today is that adding younger many to have benefits above and beyond
board members to the ranks inadvertently a perception of political correctness, board
means these new directors may one day diversity has gained momentum in countries
end up with longer-than-average tenures. that have put their regulatory muscle behind
Along those lines, the WDT survey asked such initiatives. Here in the US, we are now
directors whether it would create a problem seeing institutional investors place increased
for a board member to serve as much as 30 emphasis on this issue as well, with high-
years on one board. Respondents were split profile investor/director collaborations on
on this point, with 53 percent saying yes, 47 the rise.
percent no. Ironically, despite the earlier finding in
Most boards have formal policies the WDT survey noting that two thirds of
regarding ongoing board service and directors believe it’s important to refresh the
tenure. Just over half (53 percent) of board, they rated themselves least effective
directors reported that their boards employ in terms of the nominating/governance
a mandatory retirement age. In addition, committee’s process to effectively encourage
NYSE: Corporate Governance Guide 3

The evolution of corporate governance: key trends and issues facing directors today NYSE Governance Services
board turnover and to create a board reflects a growing understanding that these
that has a balance of needed skills and roles are as important to the continued
diversity. It’s worth noting that two of the success of the organization as the CEO.
bottom four results in this category are Another tough leadership decision boards
related to board composition and turnover have to face is whether to split the chairman/
challenges, indicating many directors are CEO role, an issue that was elevated
attuned to the fact that these important following the financial crisis of 2008. In
areas need more attention in the future. In light of increasing investor pressure, it’s not
analyzing the methods used by boards to surprising that many companies are doing
encourage healthy turnover, 85 percent of so. However, external forces to persuade
directors surveyed said board assessment/ boards to split the roles are often met with
evaluation is an effective tool to encourage just as many compelling internal reasons to
board refreshing. Boards use annual board combine them. In the end, boards need to feel
evaluations to assess the effectiveness of the comfortable they are doing the right thing for
board as a whole as well as the contributions the company—and for the right reasons. The
of individual directors, which can identify separation of the two positions is unwise if
directors who are underperforming or it leads to board micromanagement; many
whose skills no longer represent a good fit also argue that separation is essential in
with the strategic direction of the business. order to establish that the board has the
right and responsibility to be certain that the
Choosing company leaders company’s business strategy is given a tough
Since 2002, succession planning has and challenging review.
continually topped the list of challenges Yet another thorny issue related to board
for boards. This is one of those “get it leadership emerges when a CEO steps down
right” issues that continues to be a struggle and is subsequently offered the chairman’s
for boards. Interestingly, it’s long-term seat. Whether such appointments stem
succession that on average board members from personal board loyalty or a desire
lack confidence in—not short-term. Fully 81 for continuity, the situation is far from
percent of the WDT respondents indicated ideal, governance experts say, because the
that the company’s succession plan would perception of influence from a past CEO is
proceed without a hitch in the event their usually too much to overcome.
CEO was immediately unable to perform The common thread running through
his or her duties. While these findings might these issues involves board independence
seem at odds, they more likely reflect the and effectiveness. While a good relationship
distinction between an emergency plan and must exist between the board and senior
a successful, long-term succession plan. management to run a successful company,
Boards tend to take on this issue with great there must also exist a healthy separation
vigor when they are faced with an imminent for good decision-making at the board level.
CEO change (planned or otherwise).
However, when not faced with that urgency, Setting executive compensation
boards may avoid delving into detail on this Since 2010, every public company has been
issue out of deference to the incumbent. through some level of angst related to
Outside the CEO role, there is a rising trend Dodd-Frank–imposed legislation requiring
to include other key senior management a shareholder advisory vote on executive
roles in the succession planning process. pay. In year one, the fear of the unknown
Many companies these days have a formal created the lion’s share of work and worry,
process to assess internal candidates for but most companies saw smoother roads
roles, including the chief financial officer in subsequent years. In this year’s WDT
(CFO), the general counsel (GC), the head survey, 45 percent of directors surveyed
of internal audit, and so forth. This likely said their board spent more time on say-

NYSE Governance Services The evolution of corporate governance: key trends and issues facing directors today
on-pay in 2013 than the previous year, and Interestingly, nearly 40 percent of those
24 percent acknowledged receiving tougher surveyed agreed they could do a better
scrutiny from shareholders. On a positive job at risk oversight if they had a better
note, fully 70 percent said their efforts to understanding of how to do so. Hot spots
improve shareholder communications crop up all the time, and even traditional
paid off and termed 2013’s proxy season a risk areas are often murky.
smoother experience. For example, 20 percent of respondents
Interestingly, when asked if three years of said they are not confident in directors’
say-on-pay had resulted in making executive understanding of the many facets of IT risk,
pay more aligned with shareholders’ one of the most elusive new risk areas for
interests, only 21 percent of those surveyed companies today.
agreed. Nearly two thirds (62 percent) said
no, because, in their opinion, executive pay Thinking strategically
was not out of alignment in the first place. In addition to overseeing compensation and
This will continue to be an area of focus risk and finding the right company leaders,
for directors, however, because of the new board members must keep profitability
Securities and Exchange Commission (SEC) and increasing shareholder value in their
rule regarding disclosure of CEO/median crosshairs. Without meeting these goals,
employee pay ratios. all the others hold little value. Therefore
the board’s role in shepherding strategic
Managing risk planning for future growth is imperative,
Of paramount importance year after year particularly in an environment where
is the board’s responsibility to oversee risk competitive change happens quickly.
across the enterprise. As a demonstration that Accordingly, 81 percent of directors in the
boards are fulfilling this role appropriately, WDT survey chose strategic planning as a top
87 percent of those surveyed in the WDT agenda item—the most popular response,
survey affirmed that new strategic objectives followed by mergers and acquisitions (M&A)
are reviewed by the full board to ensure opportunities (61 percent), succession
they align with the company’s risk appetite. (47 percent), global business strategy (42
But there is no denying the job is an percent), and IT strategy (38 percent).
overwhelming one. In terms of what would
improve the board’s ability to oversee risk, 44 Looking ahead
percent of directors said getting management In all, directors this year appear to be
reports with more key highlights but laser focused on ways they can help their
fewer details would be helpful, while 29 companies grow and prosper in the year
percent said more lead time to digest those ahead and are working to better understand
reports would be appreciated. However, and come to grips with the battery of risk
some directors obviously feel overwhelmed elements that continue to make the job more
and find the process burdensome and a challenging. In doing so, they are on track
distraction. Meanwhile, 33 percent said to ensure that their boards are operating as
the ability to delegate risk to a separate effectively as possible and have the requisite
committee that could keep closer tabs would skill sets to ask the right questions and stay
be advantageous. ahead of the risk curve.

2 Real look at corporate governance
David F. Larcker, James Irvin Miller Professor of Accounting, and Brian Tayan, MBA 2003 Stanford Graduate School of Business
R
esearchers have taken a thorough and critical look at corporate
governance from various perspectives. They have studied
how legal, social, and market forces influence the control
mechanisms that companies adopt to discourage self-interested
behavior. They have examined the structure and operations
of the board of directors. They have explored processes of the
board, including strategy, risk management, CEO succession
planning, performance measurement, compensation, audit, and
the consideration of mergers and acquisitions to determine the
relation of each to governance quality and performance outcomes.
The result is a vast research literature across multiple disciplines
that chronicles the association between corporate governance
choices and the likelihood of future success or failure.
For the most part, the findings of this research are modest. Many
observed structural features of corporate governance simply have
little or no relation to governance quality. For example, there is
relatively little evidence that the structure of the board materially
influences a company’s operating performance (positively or
negatively) or that it decreases the likelihood of adverse events
such as bankruptcy, earnings restatement, or significant lawsuit.
For other governance decisions—such as whether to pay directors
in cash or stock, or to award executives golden parachute severance
payments—the research results are so mixed as to be effectively
inconclusive. While there is evidence that governance programs are
critical to success—such as proper risk management or a workable
CEO succession plan—it is the quality with which the program
is designed and implemented rather than its mere presence that
determines whether it will be successful.
Simply put, many of the “best practices” recommended by
activists, pundits, proxy advisory firms, and regulators are not
supported (and in some cases contradicted) by rigorous research.
Why? If best practices are indeed best practices, shouldn’t their
value be evident in the research? What does it mean that it is not?
What should directors do to ensure that they have the best system
in place to protect and enhance corporate value for shareholders and
stakeholders?

Stanford Graduate School of Business Real look at corporate governance
Research summary relationship between the independent

There is no shortage of opinion when it status of the chairman and future operating
comes to best practices in corporate performance.5
governance. Take, for example, the issue of The empirical evidence for other best
whether to separate the chairman and CEO practices is similarly inconclusive. There
roles and require an independent chairman. is little systematic evidence that it benefits
According to one shareholder group: a company to have a lead independent
director; maintain fully independent
We believe that the role of the Chief
audit, compensation, and nominating and
Executive Officer and management is to
governance committees; limit the size of the
run the business of the company and
board; declassify the board; restrict board
the role of the board of directors is to
interlocks; or pay directors in stock rather
oversee management. We believe given
than cash (see Table 1 for a summary).6
these different roles and responsibilities,
Given this, there are four implications
leadership of the board should be separated
that directors should bear in mind when
from leadership of management.1
designing a corporate governance system for
Proxy advisory firm Glass, Lewis & Co. their company:
agrees with this position: “We ultimately
believe vesting a single person with both 1. Rely on data.
executive and board leadership concentrates 2. Consider the context.
too much oversight in a single person 3. Focus on functions, not features.
and inhibits the independent oversight 4. Keep an organizational perspective.
intended to be provided by the board on
behalf of shareholders.”2 According to Rely on data
the head of a large pension fund: “This is First, corporate directors should adopt
just a fundamental principle of corporate governance standards only to the extent
governance. Obviously, common sense is that there is empirical justification for
that there should be separation between the doing so, or when the benefit of doing so is
chairman of the board and CEO.”3 established by rigorous data. This sentiment
Unfortunately, there is little empirical was expressed by Myron Steel, former chief
support for this “common sense.” The justice of the Delaware Supreme Court, who
issue of chairman independence has been wrote:
extensively studied by countless academics
Until I personally see empirical data
and rigorously demonstrated to have no
that supports in a particular business
material impact on governance quality
sector, or for a particular corporation,
one way or the other. For example, Baliga,
that separating the chairman and CEO,
Moyer, and Rao (1996) examine companies
majority voting, elimination of staggered
that announce a separation (or combination)
boards, proxy access with limits, holding
of the chairman and CEO roles. They find
periods, and percentage of shares—
no abnormal positive (or negative) stock
until something demonstrates that one
price reaction to these announcements.
or more of these will effectively alter
They also find no material impact on
the quality of corporate governance in
subsequent operating performance.
a given situation, then it’s difficult to
They conclude that although a combined
say that all, much less each, of these
chairman/CEO “may increase potential
proposed changes are truly reform.
for managerial abuse, [it] does not appear
Reform implies to me something better
to lead to tangible manifestations of that
than you have now. Prove it, establish
abuse.”4 Similarly, Boyd (1995) provides a
it, and then it may well be accepted by
meta-analysis of studies on chairman/CEO
all of us.7
duality and finds no statistically significant

Real look at corporate governance Stanford Graduate School of Business
Table 1
Board Attribute Explanation Findings from Research
Independent The chairman of the board No evidence that this matters.
chairman meets NYSE standards for
independence.
Lead independent The board has designated an Modest evidence that this
director independent director as the improves performance.
“lead” person to represent
the independent directors
in conversation with
management, shareholders,
and other stakeholders.
Number of outside Number of directors who Mixed evidence that this can
directors come from outside the improve performance and
company (non-executive). reduce agency costs. Depends
primarily on how difficult it is
for outsiders to acquire expert
knowledge of the company
and its operations.
Number of Number of directors who No evidence that this matters
independent meet NYSE standards for beyond a simple majority.
directors independence.
Independence of Board committees are entirely Positive impact on earnings
committees made up of directors who quality for audit committee
meet NYSE standards for only. No evidence for other
independence. committees.
Continued on next page
This standard should be a precondition of all success of an organization. The fundamental

governance changes, both those mandated challenge for directors is to understand which
by law and those voluntarily adopted by governance practices improve corporate
corporations. Governance changes are outcomes and why.
costly, and failed governance changes even
more so. They are costly to the firm in Consider the context
terms of reduced decision-making quality Second, directors should take into account
and inefficient capital allocation, and they context. Governance systems cannot be
are costly to society in terms of reduced completely standardized because their
economic growth and value destruction for design depends on the setting. Take again the
both shareholders and stakeholders. Careful issue of whether to require an independent
empirical analysis can go a long way toward board chairman. This structure has not been
better understanding what works and does shown in the research literature to uniformly
not work so that changes can be made benefit companies because there are certain
in a cost-effective manner.8 There is no contexts in which it is favorable and others
question that governance is important to the in which it is not.

Table 1 (continued)
Board Attribute Explanation Findings from Research

Bankers Directors with experience in Negative impact on company
commercial or investment performance.
banking.
Financial experts Directors with experience Positive impact for accounting
either as public accountant, professionals only. No impact
auditor, principal financial for other financial experts.
officer, comptroller, or
principle accounting officer.
Politically Directors with previous No evidence that this matters.
connected experience with the federal
directors government or regulatory
agency.
Employees Employee or labor union Mixed evidence on
representatives serve on the performance.
board.
“Busy” boards A “busy” director is one who Negative impact on
serves on multiple outside performance and monitoring.
boards (typically three or
more). A busy board is one
that has a majority of busy
directors.
Interlocked boards An executive from Company A Positive impact on performance,
sits on the board of Company negative impact on
B, while an executive from monitoring.
Company B sits on the board
of Company A.
Board size The total number of directors Positive impact on performance
on the board. to have smaller board
if company is “simple,”
larger board if company is
“complex.”
Diversity The board has directors that Mixed evidence on performance
are diverse in background, and monitoring.
ethnicity, or gender.
Classified (or A board structure in which Mixed evidence on performance
staggered) directors are elected to and monitoring.
boards multiple-year terms, with
only a subset standing for
re-election each year.
Director The mix of cash and stock Mixed evidence on performance
compensation with which directors are and monitoring.
compensated.

An independent chairman can be responsibility of the audit committee or

beneficial when a company promotes a dedicated risk committee?
new CEO, particularly an insider with 2. Do the board and management understand
no previous experience at the CEO level. how various operational and financial
It can also be beneficial when company activities of the firm work together to
performance has declined and significant achieve the corporate strategy? Have they
changes to strategy, operations, or culture determined what events might cause one
are needed that require management’s or more of these activities to fail? Have
complete attention while the board these risks been properly managed or
considers whether a change in leadership mitigated?
or sale of the company is necessary. It might
also be appropriate when the company has
CEO succession
received an unsolicited takeover bid, which
management might not be able to evaluate 1. Does the company have a CEO succession
independently without consideration for plan in place?
their own job status. 2. Is the CEO succession plan operational?
However, having an independent Have qualified internal and external
chairman can also cause several potential candidates been identified? Does
disadvantages. First, it can be an artificial the company engage in the rigorous
separation, especially when the company evaluation of internal talent and manage
already has an effective chairman/CEO in their development to support long-term
place. It can make recruiting a new CEO succession needs?
difficult when that individual currently
holds both titles or expects to be offered
Executive compensation
both titles. It can lead to inefficient decision-
making because leadership is shared. And 1. What is the total compensation paid to
it can create addition costs to decision- the CEO? How does this compare to the
making when specialized information about compensation paid to the CEOs of peer
company operations does not easily transfer institutions?
from the CEO to the chairman (known as 2. How is the compensation package
an “information gap”). Finally, a separation expected to attract, retain, and motivate
between the chairman and CEO can weaken qualified executive talent? Does it provide
leadership during a crisis.9 appropriate incentive to achieve the goals
For these reasons, the correct structure set forth in the business model? What is
will depend on context. This is true not the relationship between large changes in
only for the issue of whether to require an the company stock price and the value of
independent director but also for the vast stock awards held by the CEO? Does this
majority of corporate governance policies. properly encourage short- and long-term
performance without excessive risk?
Focus on functions, not features
Third, directors should place more emphasis In each of these, the first set of questions
on the functions of governance and less asks about a governance feature, the second
on features of governance. To illustrate the about a governance function. A focus on
difference, consider the following sets of the latter will almost certainly yield more
questions: benefit to the organization. One mistake
that experts often make is to assume that the
Risk management
presence of the feature necessarily implies
1. Does the company have a risk management that the function is performed properly.
program? Does the full board of directors That is, if a succession plan is in place, the
oversee risk management, or is this a assumption is that it is a good one; if there

is a risk committee, the company is diligent or cooperation? Do employees self-

about managing risks; if compensation monitor, or are checks and balances
is not excessive, it provides the correct necessary? Is risk-taking encouraged,
incentives. And yet the research evidence tolerated, or discouraged? What level
suggests that this is not always the case. of trust are employees afforded? Is this
In designing governance systems, directors merited?
should move beyond the simple decision
of whether to adopt a governance feature CEO personality
and instead tackle the more difficult—and
substantive—question of how to design a Who is the CEO, and what motivates this
governance system that will add tangible individual? What is his or her leadership
value by encouraging the pursuit of style? What are the individual’s ethical
corporate objectives and discouraging self- standards? What is the “tone from the
interested behavior. top,” and what behaviors does this
encourage? How does this affect the
Keep an organizational perspective choices made by other members of the
Fourth, despite the important role that senior management team?
laws and regulations play in corporate
governance, directors should not lose Board quality
sight of the fact that corporations are
organizational entities and their oversight What are the qualifications of board
requires an organizational perspective. This members? Why and how were they
means that effective governance solutions selected? Do their qualifications match
will take into account the realities that the full set of needs of the organization?
come with managing and monitoring What skills are missing? How will these
groups of individuals, including personal needs evolve in the future? Is there a real
and interpersonal dynamics, models of succession plan for board members?
behavior, leadership, cooperation, and
Directors should pursue this type of analysis
decision-making. At a minimum, the
further and with greater rigor. Doing so
following elements should be considered
will require tools and techniques across
before deciding on the types of controls and
disciplines. It is a mistake to think that
procedures that are required to properly
corporate governance can be adequately
govern the organization:
understood from a strict economic, legal, or
Organizational design behavioral (psychological and sociological)
perspective. All of these views are necessary
What is the structure of the company? to understanding complex organizational
How does the structure encourage or systems.
restrict individual initiative? Does it allow Furthermore, this necessarily implies
for self-interested or unethical behavior? that the optimal system of governance will
Are controls appropriate given this be firm-specific and take into account its
structure? How were they developed? unique culture and attributes. Adopting
Were they intentionally designed, or did “best practices” will likely fail because that
they evolve from historical practice? How approach attempts to reduce a complex
should they be modified? human system into a standardized
framework that does not do justice to the
Organizational culture factors that make it successful in the first
place. This explains why two companies
What is the culture of the organization? can both succeed under very different
Does it encourage individual performance, governance structures.

Conclusion Notes
Context is critical to designing an effective 1. The Walt Disney Company, form DEF-14A (Jan.
corporate governance system. The 18, 2013).
appropriate system for a company to adopt 2. “Proxy Advisers Urge Split of Chair, CEO Roles
will be the one that is best fitted to it, given at Disney,” Reuters (Feb. 26, 2013).
its environment, strategy, and operations 3. Interview with Jack Ehnes, “CALSTRS vs.
and also given its culture, leadership, and Disney’s Iger,” CNBC (Feb. 22, 2013).
the quality of individuals who work there 4. B. Ram Baliga, R. Charles Moyer, and Ramesh S.
every day. As tempting as it might be to
Rao, “CEO Duality and Firm Performance: What’s
select an “off-the-shelf” solution of standard the Fuss?” Strategic Management Journal (1996).
best practices, no effective one exists. 5. Brian K. Boyd, “CEO Duality and Firm
Companies are organizational entities and
Performance: A Contingency Model,” Strategic
a system that is optimal for one company
Management Journal (1995).
is unlikely to produce the same results at
6. For a review of the research literature, see: David
another. In the end, the best hope for a best-
practice solution to corporate governance Larcker and Brian Tayan, Corporate Governance
Matters: A Closer Look at Organizational Choices and
is the careful thought and critical analysis
Their Consequences (New York, NY: FT Press, 2011).
of well-informed and well-intentioned
7. Emphasis added. Myron Steele, “Verbatim:
directors, taking into account the individual
variables that have the greatest bearing on ‘Common Law Should Shape Governance,’”
NACD Directorship, February 15, 2010.
the company’s long-term success or failure.
8. Careful theoretical analysis is a key foundation
of careful empirical research. Best practice white
papers published by “blue ribbon panels” are is
not the same as careful theoretical analysis.
9. For more on this debate, see Millstein Center
for Corporate Governance and Performance,
“Chairing the Board: The Case for Independent
Leadership in Corporate North America, Policy
Briefing No. 4,” Yale School of Management (2009).

Perspectives from ratings
CHAPTER 3: agency, institutional investors,
and shareholder services
3A An institutional investor’s viewpoint

on corporate governance
Glenn H. Booraem, Principal and Fund Controller Vanguard
I
nstitutional investors comprise a large, growing, and diverse
group of shareowners ranging from, at one end of the spectrum,
activist hedge funds that may take concentrated positions in
a relative few companies for a short period of time, to, at the
other end of the spectrum, broadly diversified index mutual
funds that typically have much longer holding periods. As a
large mutual fund manager, with the majority of our clients’
assets invested in our index funds, Vanguard falls squarely in the
latter category. While there may be some consistency among the
views of institutional investors on various issues, these different
investment perspectives may inform divergent views as to ideal
corporate governance arrangements. Given this diversity of
perspectives, it would be impossible to faithfully present in this
chapter the views of all mutual funds, let alone all institutional
investors. As such, a range of views on issues will be discussed
here, and references to “we” and “our” will indicate Vanguard’s
view on a particular matter.
We view corporate governance not as an end unto itself, but
rather as an enabler of long-term value creation and protection. We
believe that value is maximized by creating a system of rights and
responsibilities that (1) ensures the accountability and responsiveness
of the corporation to its shareholders; (2) promotes behaviors and
compensation practices that reinforce a long-term perspective;
and (3) encourages a rich dialogue on matters of importance
between investors and companies. These beliefs translate into three
dimensions—quantitative, qualitative, and collaborative—each of
which is discussed in more detail in this chapter. The quantitative
dimension includes those objective, structural governance features
that we believe are important for the creation and protection of
long-term value. The qualitative dimension encompasses a range
of more subjective considerations, such as board composition and
effectiveness and compensation design, which, though far from
black and white, are critically important to us as investors. And
finally, the collaborative dimension captures the degree to which
companies seek and respond to the views of their shareowners on
critical matters.

An institutional investor’s viewpoint on corporate governance Vanguard
Quantitative dimension percent—of those in the S&P 500 with

An initial survey of a firm’s governance combined chair/CEO roles now designate
typically starts with an assessment of the an independent director as a lead or
objective structural features that define presiding director. From our perspective,
the allocation of rights and responsibilities so long as this lead or presiding director
among shareholders, directors, and has input into board agendas, and most
managers. These include, among other important, is empowered to convene the
things, the mechanisms through which other directors independent of the chair,
directors are identified, nominated, elected, we believe that each board should be able
and removed; the framework within which to determine how it ensures leadership
executives are compensated; and the ways independent of management.
in which shareholders may initiate action With respect to the entire board, we believe
independent of the directors. that the value of the shareholder franchise is
Historically, there has been tremendous maximized when directors are subject to
focus on ensuring a meaningful complement annual elections (ie declassified boards) and
of independent directors on the board, as where a majority of the votes cast is required
well as board committees comprising to elect them. This view is increasingly held
exclusively independent directors. This by a wide spectrum of investors. We believe
focus on independence figures prominently that these standards maximize directors’
in the NYSE’s listing standards and accountability to shareholders by providing
is evaluated closely by investors in their a mechanism for their replacement, either
consideration of corporate boards. Though individually (in response to concerns over
critical, independence is a necessary, but their independence, performance, or fitness
not sufficient, attribute of the majority of a for service) or in extraordinary circumstances
company’s directors. Other, more subjective, en masse (in response to egregious governance
considerations for director effectiveness are or performance failures, or in connection
discussed further in the qualitative section of with a hostile change in control).
this chapter. There has been significant attention paid
That said, one area in which to board declassification in recent years as
independence has been a particular focus many companies—typically at the behest of
is in the leadership of the board. There their shareholders, either through precatory
has been tremendous pressure from many proposals or other engagement—have
investors for a mandatory separation of migrated to annual election of all directors.
the roles of the chief executive officer As of December 2013, nearly 90 percent
(CEO) and chair of the board. Despite of companies in the S&P 500 Index had
this pressure, among US companies, it is declassified boards (or were in the process
still relatively common for one person to of declassifying). This is a stark change from
hold both titles. According to research from only five years prior, when only 65 percent
Farient Advisers, approximately 60 percent of the S&P 500 was declassified. Across
of S&P 500 constituents have combined the broader market—the members of the
chair/CEO roles, while among the broader Russell 3000, excluding the S&P 500—about
market (Russell 3000), only about 45 50 percent of boards are still classified, with
percent of companies vested both roles a gradual shift toward declassification (4
in the same person. The concern of those percent since 2010). (FactSet SharkRepellent)
advocating for mandatory separation is In our discussions with companies about
that a combined chair/CEO is inherently board declassification, they typically raise
conflicted in that he or she is a member of two concerns. First, they argue that annual
the very management team that the board election will interfere with the board’s long-
is tasked with overseeing. Acknowledging term perspective and stability by creating
this concern, the vast majority—nearly 80 more frequent director turnover. Our

Vanguard An institutional investor’s viewpoint on corporate governance
observations across thousands of companies should be short-term in nature and used

indicate that average board tenure is not primarily to respond to transient threats (eg
materially different between companies temporary dislocation in stock price that
with classified boards and those subject enables an opportunistic hostile approach).
to annual election. In fact, according to We view the classified board and long-
data compiled by Glass Lewis LLC, among term shareholder rights plans not approved
S&P 500 directors, there is a mere nine- by shareholders as relatively permanent
month difference in average tenure between solutions to what are typically temporary
members of classified boards (9.65 years) issues. We do not believe that governance
and declassified boards (8.92 years). Across should pose impediments to accountability
the broader market (ie the remainder of the for companies that are the targets of acquirers
Russell 3000), there is virtually no difference, or activists as a consequence of persistent
with the average tenure of classified board underperformance.
directors at 9.37 years and their declassified Inasmuch as we consider annual election
board counterparts at 9.17 years. The second of directors an important manifestation of
objection to declassification that companies the board’s accountability to shareholders,
may present is that it eliminates the board’s we also view as important the requirement
negotiating leverage with a hostile acquirer. that directors receive a majority of the votes
While a hostile acquirer could run a proxy cast in order to be elected. This preference
fight to replace a majority of the sitting applies only to uncontested director
directors with new directors predisposed elections (ie those in which the number of
to a deal, as a practical matter, this does nominees equals the number of open seats).
not happen with any discernible frequency. As a practical matter, a plurality standard
In fact, according to data from FactSet should apply in those instances where there
SharkRepellent, there were only 10 instances are more nominees than available seats to
among Russell 3000 companies between ensure that all seats are filled. We believe
2009 and 2013 in which a controlling faction that a director’s failure to get a majority
of the board was replaced. In every one of of the votes cast in his or her favor is
these situations, the replacement of directors an unequivocal statement by shareholders
by shareholders was motivated primarily that should be generally respected by the
by an egregious corporate governance track board. As a general matter, most directors
record or persistent underperformance, not a are re-elected by an overwhelming majority
typical hostile takeover. of the votes cast; during 2013, directors at US
Our interest as practically permanent companies received, on average, 95 percent
shareholders is not to leave companies support for their re-election. According
defenseless against hostile overtures that to data from the Council of Institutional
undervalue their long-term prospects, or Investors, only 57 directors out of more than
activist interventions that seek short-term 17,000 nominees failed to garner a majority
changes with damaging long-term effects. of the votes. While we have historically been
We also want to guard against structures such comfortable with arrangements in which a
as classified boards that may have the effect board has the authority to either accept or
of entrenching management and insulating reject a director’s resignation, we are troubled
them from appropriate accountability to by instances in which boards appear to have
their shareowners. To this end, we have not disregarded shareholders’ votes by retaining
objected to companies’ use of shareholder a failed director without substantively
rights plans (otherwise known as “poison addressing the reason(s) behind the vote
pills”) to stem the accumulation of “creeping outcome. Of the 57 directors noted above,
control” by potential acquirers and provide only eight ceased to serve after failing to
the board with negotiating leverage. At get a majority of the votes. In the remaining
the same time, we believe that these plans instances, a board’s unwillingness to respect

the objective outcome of an election makes In some respects, these mechanisms serve
us increasingly skeptical of their ability to as substitutes for one another in that they
discharge other elements of their fiduciary both permit shareholders to initiate a course
obligations as shareholder representatives. of action independent of the board (where
While the annual shareholder meeting permitted under the relevant corporate
is typically the venue in which matters are statute and the company’s articles). While
presented for shareholder approval (and the approaches are equivalent from the
appropriately so), there may be extraordinary perspective of initiating action independent
situations in which shareholders should of the board, the special meeting route is
be able to take action independent of the most consistent with the typical framework
board. (The most frequently cited potential for shareholder approval of actions. Because
actions to be taken in these instances are the a party soliciting action by written consent
removal and/or election of directors and the needs only to accumulate the requisite
consideration of a transaction not supported consents (typically within a certain time
by the board.) The typical mechanisms for period), all shareholders may not be
this “shareholder override” are the ability equally informed as to the solicitation (as
for holders of a prescribed percentage of the distinct from the special meeting, which
outstanding shares to either call a special would follow the same notification rules
meeting of shareholders or to take action as the annual meeting). Further, since
by written consent. As a general rule, where action may be taken as soon as the requisite
written consent is permitted, we believe consents are received and presented to the
that a majority of the shares outstanding company, as distinct from votes cast at a
is an appropriate threshold. In fact, we special meeting on a certain date, there is
believe that a majority of shares outstanding inherently less predictability to the process
should be the most stringent requirement for written consent as opposed to the special
for any matter presented for a shareholder meeting. The use of these mechanisms is
vote; accordingly, we are generally opposed extraordinarily rare, and their presence
to provisions requiring a supermajority serves, in large part, as a deterrent to board
(typically ranging from two thirds to intransigence. That said, written consent
80 percent) of the outstanding shares to has been used increasingly in recent years
approve either changes to the company’s to initiate the replacement of directors at
articles or significant transactions. There companies with persistent governance and/
is debate among investors with respect to or performance issues.
the appropriate threshold to call special One other quantitative factor of particular
meetings. Shareholder proposals are often concern is the consistency between economic
submitted seeking the ability of holders ownership and voting power. In short, we
of as few as 10 percent of the outstanding share the position of most other institutional
shares to call a meeting; our view is that investors that voting rights should be
25 percent of the outstanding shares may directly proportional to economic ownership
be a more appropriate level to strike the (ie one share, one vote). Capital structures in
appropriate balance between a level that is which one class of shareholders has voting
low enough to be achievable (remember, this rights that are superior to those of other
is just to call the meeting, not to approve the owners are antithetical to this view. While
action) and high enough to prevent meetings these structures may be more common with
from being called—and the associated costs recently public companies—especially those
being imposed on all investors—by a small with founders who retain a controlling
minority of shareholders whose views are voting interest despite a minority economic
not shared by a sufficient complement of position—we believe that as companies
other investors to suggest that they may mature, these arrangements should be
prevail in a shareholder vote. phased out or eliminated in their entirety.

Qualitative dimension qualifications will necessarily vary based

While the objective, structural indicia of on the company itself (eg its industry, stage
governance are critically important to of development, geographic distribution of
investors, its “softer” manifestations may business), as well as the other directors
be even more so. Paradoxically, investors on the board. Each board must determine
have historically focused a significant the appropriate complement of skills and
proportion of their energies on addressing qualifications needed by the board as a body
the more quantitative attributes of and must then select a group of directors
governance—precisely because they’re that bring these attributes to bear in the
more easily measured or observed—when right proportion. Boards must consider the
it’s these more qualitative considerations appropriate mix of “generalists” (eg those
(board composition and effectiveness, for with executive, financial, and/or academic
example) that are the ultimate determinants credentials) and “specialists” (ie those with
of corporate viability. We’ve observed specific industry or functional experience
innumerable instances in which, despite relevant to the company’s business);
governance structures deemed suboptimal boards should also consider other personal
against many investors’ standards, attributes (eg gender, ethnicity, national
independent directors have made decisions origin) when assembling a board that is
in shareholders’ (not necessarily their own) uniquely positioned to serve their investors’
best interests. Even in the face of “insulating” best interests. While this could be viewed
or “entrenching” governance provisions, as an objective, “check the box” exercise
the reality that we’ve observed is that the to fill out a skills matrix, in reality it is
vast majority of corporate directors are well likely far more art than science. The ongoing
qualified, well intended, and truly engaged opportunity for boards through disclosure
on shareholders’ behalf. Nonetheless, we and engagement (as discussed more later
anticipate that investors will continue in this chapter) is to convey to investors
to advocate for quantitative, structural what skills, experiences, and attributes they
governance provisions in order to protect view as important for their board to possess
their ability to effect change in the future. and how each director contributes to that
We have frequently said that our desire for portfolio of skills.
governance reforms shouldn’t be interpreted There has been growing debate on the
to reflect dissatisfaction or concern with subject of board refreshment and the variety
current management or directors, but rather of “automatic” mechanisms to generate
a desire to ensure that we have the option to board turnover. Among these are term limits
effect change in the future if things go awry. and mandatory retirement ages for directors
Given the board’s central role in overseeing and/or deeming directors non-independent
management (including its responsibility after a certain period of time. Each of these,
for CEO hiring and succession), few things though objectively effective in necessitating
should be more important to investors than the replacement of directors and, thus,
the effectiveness of the board. As noted refreshing the board, also has the potential
earlier, there is wide agreement on the side effect of removing from service directors
necessity of substantial independence on who still have much to contribute and who
the board, both generally, as well as in a are staunchly independent advocates for
leadership role (ie chair or lead/presiding investors’ interests. The benefit of these
director). Though necessary, independence provisions (ie that they are largely immune
is by no means sufficient for high-quality from manipulation) is also their limitation
directors. In addition to independence in (ie that they limit the ability of a well-
form as well as substance, directors must intended, well-functioning board to make
also bring qualifications that are relevant exceptions). Regardless of the existence of
to each particular board assignment. These these formal provisions, where directors

are subject to annual elections, shareholders regard is robust discussion, disclosure of

have the ability to express their preferences their rationale, and the context for their pay
as to directors’ continued service by voting decisions, with particular attention devoted
accordingly. to the relevance of performance metrics and
We have not adopted explicit tenure the rigor of the performance targets that
limits—either at the individual director level drive incentive compensation.
or for the board in aggregate—though it is a
growing discussion topic with companies. Collaborative dimension
More relevant in our view is the rigor and Our discussion of the quantitative and
effectiveness of each board’s self-evaluation qualitative dimensions of governance has
process and its consequent impact on focused almost exclusively on attributes
board membership. In our view, a board’s and behaviors of corporate issuers and
exclusive or primary reliance on automatic their boards. Increasingly, however, both
mechanisms to replace directors may be investors and issuers alike are devoting
indicative of a board whose evaluation more resources and energy to engaging
process lacks substance. Ensuring that the with one another. This engagement takes
board’s aggregate capability continually various forms at various times but is an
represents the best complement of skills increasingly common and effective means
and perspectives to effectively oversee the of bringing about change. Engagement is
corporation’s future (as opposed to its past) likely to be a discussion topic at practically
is second perhaps only to CEO succession every corporate governance and director
planning among the board’s key strategic education conference, and at least two
imperatives. cross-constituency industry groups—the
Finally, while evaluating compensation Shareholder-Director Exchange (SDX) and
may seem like a purely quantitative process, The Conference Board Governance Center—
the variety of approaches and the variability issued reports on corporate/shareholder
of the outcomes make it a largely qualitative engagement in the first quarter of 2014.
exercise. Indeed, the design and execution While discussion of engagement often
of an executive compensation program and jumps right to the one-on-one dialogue
the degree to which it effectively links pay between investors and company executives
and performance provide a window on the or board members, the Conference Board’s
board’s thinking and their stewardship. Guidelines for Investor Engagement (March
While there is a long-running debate on the 2014) makes the point that in many respects
appropriate quantum of CEO compensation engagement, broadly defined, begins
that we will not attempt to resolve here, with companies’ disclosures to investors
our focus from a governance perspective generally, as well as investors’ disclosures
is on ensuring that pay is sufficiently regarding their views on key issues. The
aligned with corporate performance and more context behind their decisions and
value creation, and that it is reasonable actions that issuers can provide in their
in the context of a company’s peers and public disclosures, the better positioned
the market for executive talent. Given the investors are to make informed decisions—
variety of industries in which companies either regarding voting at the company’s
operate and compete, as well as the variety shareholder meeting or further engagement.
of sectors in which a single company may Likewise, the more transparent investors are
have operations, there is generally no with their points of view on key issues, the
universal performance metric or perfect better positioned investee companies are to
peer group against which to evaluate pay be responsive to those concerns.
and performance—hence, the qualitative Nonetheless, there are often instances
nature of the analysis here. As a result, what in which one-to-one engagement—beyond
investors expect from companies in this communicating through disclosure—

between investors and issuers is a productive studies cited earlier—as to the appropriate
exercise. While it is increasingly common for participants from the company in this
companies and their largest investors to dialogue. Investors are increasingly
have routinely scheduled opportunities to interested in discussing certain matters
exchange views (often at a different time of with members of the board, as opposed
year than the company’s annual meeting), to members of management. In particular,
the majority of engagements are still where the decision-making on a particular
reactive—initiated by one party or the other matter is exclusively in the purview of
in response to a particular issue. The bulk of the board (eg compensation of the CEO),
reactive engagement initiated by companies investors are more inclined to expect
tends to be driven by a few factors. Among dialogue with the relevant member(s) of
these are adverse recommendations issued the board (eg the chair of the compensation
by proxy advisory firms on company committee for concerns related to CEO
proposals or votes actually cast against pay). To this end, we believe that boards
company proposals by investors. In these may be well-served by the designation of a
instances, executives or board members reach committee of directors to serve as the focal
out to investors to explain the company’s point for engagement and other interactions
rationale for supporting their proposals with key shareholders.
and seek either to refute proxy advisory
firm recommendations against them or to Summary
convince investors to reconsider their votes. Effective corporate governance structures
Investors typically reach out to companies and practices are of critical importance to
either to clarify information regarding or all manner of institutional investors. Many,
communicate concerns with proposals to like us, view governance as a key enabler
be presented at a shareholder meeting, or of sustainable, long-term value creation
to discuss concerns with some aspect of for all shareholders. Though the objective,
corporate governance (that may or may structural components of the governance
not be the subject of a shareholder vote). framework are the most obviously
For example, some institutional investors quantifiable features of the environment,
will write to or otherwise contact a subset it is ultimately the qualitative aspects (ie
of companies in their portfolio at which do we have the right people serving as
they’re seeking to effect some sort of shareholders’ agents in the boardroom?) that
governance reform (eg adoption of majority have the most lasting impact. Engagement
voting). This outreach is typically the first between investors and the companies they
step in a dialogue between the investor own is critical to ensuring an alignment of
and the company and very often results in long-term interests among all stakeholders.
the adoption of responsive changes by the
company.
There has been ongoing discussion—and
ample coverage in the two engagement

3B The evolution of active ownership
Martha Carter, Head of Global Research, and Patrick McGurn, Executive Director and Special Counsel ISS
I
nstitutional investors have spent the past three decades
developing new ways to monitor and manage their portfolio
risks and to encourage the creation of sustainable value. Over
the course of the past dozen years, in response to two global
market meltdowns, active ownership has emerged as the leading
option for portfolio oversight.
Cobbled together from a variety of tools and tactics, active ownership
uses perpetual portfolio monitoring, in-depth engagement, and the
utility of the proxy vote as communications tools to forge a bond
between shareholders, the directors who represent their interests,
and the executive teams that boards select to run companies’ business
operations. Active ownership has already shown promise as recent
proxy seasons have featured fewer contentious meetings and more
constructive interaction between those three key stakeholders.
This chapter provides a brief description of this emerging active
ownership strategy and unpacks its three component activities—
proxy voting, engagement, and the development of governance
standards.
Informed voting—Prior to the 1980s, poor disclosure, constraints
on shareholders’ ability to communicate with their peers, and
structural impediments to the exercise of voting rights limited the
shareholder franchise. Not surprisingly, the end products of this
dysfunctional process were low voter turnout and high portfolio
turnover. In response to this, Institutional Shareholder Services
(ISS) was founded to aid institutions seeking to exercise their
franchise through its core mission of developing and applying both
“house view” and institution-specific, custom voting policies. Since
the 1980s, the spread of requirements for investors to properly
manage their voting activities, improvements in disclosure rules,
and the development of a more efficient proxy voting system have
lowered the costs connected with voting and raised the benefits to
shareholders of exercising those rights.
Active engagement—Investor/issuer interactions were common
place in recent decades, but the scope of this contact was limited
and its impact on long-term value creation was negligible. In sharp
contrast, today’s investor/issuer engagements seek to promote two-

ISS The evolution of active ownership
way communications and the sharing of ideas Issuers responded to these challenges
about issues ranging from compensation by erecting defenses—poison pills, golden
to business strategy. Such engagement parachute severance programs, and
encourages stability and sustainable growth other “shark repellants”—and adopting
by creating greater trust between the three aggressive entrenchment tactics—including
key constituencies. discriminatory greenmail payments to
Developing governance standards— potential bidders, which in turn drew the ire
Competition for listings between markets of many investors.
and shortsighted economic nationalism long Council of Institutional Investors
undermined the development of strong members, along with other like-minded
governance standards. Two global market institutions (such as TIAA-CREF) and
collapses, however, showed the folly of this individual investors (one raider/activist,
competitive death spiral by graphically T. Boone Pickens, formed the United
demonstrating the interdependent nature of Shareholders Association in 1986 to harness
global capital markets. In the wake of these retail investors into a market force), began
economic shocks, national governments to address their concerns—initially focused
(witness the passage of the Sarbanes-Oxley on “shareholder rights” issues such as calls
and Dodd-Frank laws in the US), as well as for shareholder votes on poison pills and
voluntary investment organizations (such as the adoption of confidential voting—via the
the Council of Institutional Investors [CII] shareholder proposal process and public
in the US and the International Corporate advocacy at the Securities and Exchange
Governance Network [ICGN] globally) Commission (SEC) and other federal
have embraced the concepts of greater agencies. These challenges to managements
transparency, meaningful risk oversight, and via proxy contests, shareholder proposals,
enhanced shareholder rights. and opposition to board-proposed charter
changes and stock option plans exposed
Active ownership and proxy voting significant conflicts of interest in the proxy
Prior to the 1980s, proxy voting was a back- process.
office exercise for most institutional investors, Media reports exposing such abusive
with staff often marking ballots in line with behavior drew a swift response from the US
the board/management recommendations. Department of Labor (DOL), which oversees
Both the New York Stock Exchange (NYSE) the Employee Retirement Income Security
and most voters considered core voting Act (ERISA) and other federal employee
issues such as the election of board members benefits laws. In the late 1980s, the DOL
and approval of equity compensation plans released guidance to pension trustees that
to be “routine” voting items worthy of only clarified their duties to vote shares in line
cursory attention. Activism was rare, and with the best interests of plan beneficiaries.
exiting an investment—doing the so-called The DOL followed its guidance with a series
“Wall Street Walk”—remained the preferred of examinations of industry voting practices,
response of most professional investors to which led to further guidance about record
underperformance. keeping and other compliance practices. (In
In response to a decade of sideways 1994, the DOL codified this guidance in an
market returns, however, a new breed of Interpretive Bulletin.)
activist players, dubbed corporate raiders, Spurred by these new fiduciary
emerged in the late 1970s and early 1980s. requirements with respect to proxy voting,
Fueled by access to cheap credit (“junk” asset managers and owners sought to
bonds), these opportunistic investors were improve the efficiency of their operations.
drawn to the potential to harvest unrealized Investor demand and the seasonal nature
value in public companies via tender offers, of proxy seasons around the globe led to
proxy fights, and other forms of activism. the rise of the proxy advisory industry.

The evolution of active ownership ISS
Starting in 1985, ISS was the first firm to Over the next several years, annual elections
offer both research reports and proxy voting and majority voting would emerge as
recommendations. Prodded by further majority practice—without the need for a
regulatory guidance, many investors also change in listing standards or federal law—
began to explore voting of their international and the NYSE dropped uncontested director
(non-US) holdings. Again, proxy advisers elections and equity compensation plans
stepped in to assist investors by providing from its list of “routine” voting items, thus
procurement and translation services and ending discretionary voting on those items.
proxy analysis for non-US stocks. By the Starting in 2006, in response to rising
mid-1990s, many large investors also looked investor and public policy attention to rising
to off-load the labor-intensive, physical CEO pay levels, some US activists, borrowing
portion—still dominated at the time by paper an idea from the UK market, began to call
documents—of their voting operations to for periodic “advisory” votes on executive
voting agency services created by proxy pay. Using “say-on-pay” as their rallying
advisers. Eventually, the emergence of cry, activists pushed for voluntary adoption
electronic voting led proxy advisory firms of those votes. Some early successes with
and other market intermediaries to create nonbinding shareholder proposals helped
voting and record-keeping platforms. Some convince US lawmakers to require such
investors’ desire to use proxy voting policies votes in the wake of the 2008 financial
which were more closely aligned with their market meltdown.
particular, unique perspectives, led to the Still, the communicative value of the vote
development of “custom” voting agency is limited both by the narrow subject matter
services whereby recommendations are of the ballot items permitted under state
based on clients’ proxy voting guidelines. law and the largely binary—for or against—
(Today, ISS applies more than 400 custom nature of shareholders’ choices. Cognizant
policies reflecting their view of proxy of these shortcomings, active owners have
issues related to both governance and turned to direct engagement to augment
environmental and social matters.) The voting.
SEC’s requirement for vote disclosure by
investment companies led proxy advisers to Active engagement
add services that help investors to file and Engagement—loosely defined as discussions
post their voting records. between investors and the public companies
Over the past two decades, the elections in which they invest—is a common
of directors and advisory votes on pay component to the public discourse on global
have supplanted shareholder resolutions as corporate governance. While it may be touted
proxy voters’ primary focus. In the early as the latest trend, and indeed it is on the
1990s, shareholders began to focus on rise, the subject of shareholder engagement
director elections. Some investors, including with companies has been around quite a
mutual funds, had used “withhold” votes long time.
in uncontested director elections as a Institutional investors, who decades
communicative tool for years, but for most earlier sold their shares as their means of
investors voting “no” remained a last resort protest, now engage through quiet diplomacy
action. Voters’ attitudes sharply shifted and more public forms of communication
in the wake of the Enron and WorldCom to present their positions. Other forms of
scandals. Activists began to push for— activism, from sponsoring nonbinding
and mainstream investors supported— shareholder resolutions to launching full
stronger voting rights in boardroom board proxy contests, now serve as catalysts
elections, including destaggered director for engagement.
terms, requiring majority voting, and the How do investors and companies view
elimination of broker-may-vote discretion. engagement, its goals, and its progress? A

study (The State of Engagement between US Board members are increasingly

Corporations and Shareholders) conducted by participants, if not leaders, in the
ISS for the IRRC Institute (IRRCi) in 2011, engagement process. Traditionally left
found: for company management, the meetings
with shareholders now often include
• The level of engagement is high—87 independent directors. These directors are
percent of issuer respondents and 70 taking up the tasks of discussing strategy,
percent of asset managers engaged. pay practices, risk oversight, shareholder
• The frequency of engagement is proposals, and other governance topics with
increasing—50 percent of issuers and 64 the shareholders that they are elected to
percent of asset managers said they are represent. And the discussion is a two-
engaging more. way street. Increasingly, investors reach out
• The pattern of engagement exhibits a to boards to engage. Boards that listen to
bimodal distribution—most institutions shareholders and respond to their concerns
engage regularly or rarely, if at all. often reap the benefits of their engagement
• The vast majority of engagements are at election time.
never made public—80 percent of issuers Engagement of companies and their
and 62 percent of asset owners said most shareholders across geographical borders
engagements remain private. is also increasing. Shepherded along by
• Investors and issuers do not always stewardship codes and United Nations
agree on the success of engagements. Principles of Responsible Investment
Issuers tend to think that establishment (UNPRI) signatories, including ISS, the
of a dialogue was a success, while most proliferation of engagement and constructive
investors define success as additional dialogue is a permanent fixture across the
disclosure or changes in policies. global governance landscape.
Letter-writing campaigns, face-to-face
Updated in April 2014 (Defining Engagement: meetings, and other forms of engagement
An Update on the Evolving Relationship Between have already eclipsed shareholder
Shareholders, Directors, and Executives), the resolutions as the primary catalysts for
ISS/IRRCi engagement study showed that changes in governance practices. While
engagement has become even more important the numbers for some types of shareholder
than it was just three years earlier in 2011. proposals pushing for governance reforms
While many factors led to an increase in have dropped in recent years, the pace of
engagement between companies and their reform has accelerated.
shareholders, the regulation that mandates Consider the recent jumps in the use of
advisory votes on executive compensation annual board elections and majority voting
propelled the level of engagement to new at US corporations.
heights and raised the stakes. ISS’s QuickScore database shows that the
Most of the trends and observations prevalence of majority voting (with director
from the initial study were reinforced in the resignation requirements) in uncontested
update. Issuers are still more likely to view boardroom elections at large-cap (S&P 500)
engagement as a means to an end (garnering firms jumped by nearly 10 percentage points
favorable proxy votes), while investors over the course of the past three years—from
are more likely to view engagement as an 69 percent in 2012 to 78.8 percent in 2014.
ongoing process. Conversations with those The spread of majority voting at the
interviewed for the updated survey showed broader Russell 3000 universe of firms
that issuers tend to think of the duration has been less profound, but perhaps
of engagement in days or even hours, but more impressive given the relative lack of
investors define the duration of engagement shareholder proposal activity outside of the
in months or years. large-cap universe. (As of late May 2014,

The evolution of active ownership ISS
according to ISS’s Voting Analytics database, Rights Directives, breaking down barriers to
the number of shareholder proposals voting and increasing the available information
pushing for majority voting at Russell 3000 on which to make informed decisions. As
universe companies stands at 27. Seventeen the Directives cascaded throughout Europe,
of these proposals target S&P 500 boards.) additional changes sprung up. The debate
A search of the QuickScore database on board diversity led to quotas for women
calculates a five-percentage point rise—from on boards in several markets, such as
15.9 percent in 2012 to 21 percent in 2014—in Norway and France. The opportunity for
the use of majority voting across the Russell shareholders to vote on executive pay was
3000 index. added to many markets, including Italy,
Asset owner participants in Lucian France, and Switzerland. Recently the UK
Bebchuk’s Shareholder Rights Project at added a forward-looking binding vote on
Harvard Law School and other proponents remuneration policy to its long-standing
continue to use engagement to destagger advisory vote on the pay program.
directors’ terms at a breakneck pace. In Asia the focus on investor stewardship
According to ISS’s QuickScore database, and concerns about the performance of
the use of annual board terms at S&P 500 Japanese companies has led to the Financial
companies jumped by more than five Services Agency’s 2014 release of the investor
percentage points over the past three stewardship code. Taking a lead from the
years—from 67.4 percent in 2012 to 73.6 UK stewardship code, the Japanese code
percent in 2014. Notably, QuickScore data articulates seven overarching principles
also identifies a sizable group (14.7 percent) that emphasize disclosure, monitoring,
of S&P 500 boards that are in the process of engaging, and reporting as activities for
returning to annual elections. investors. ISS was pleased to be part of
As a result, management-proposed the committee that oversaw drafting of
destagger charter changes on ballots to date the code. Changes to corporate regulation
this season now outnumber shareholder include India’s revisions to its Companies
resolutions on the topic by a margin of 71 Act, with new board member evaluations
to 15. Sky-high support—83.1 percent of the and additional compensation disclosure,
votes cast as of late May meetings—may as well as Australia’s ASX Revised
help to convince many boards to propose Corporate Governance Principles and
the change without the embarrassment of a Recommendations, with a new provision
lopsided loss at the ballot box. for boards to provide a framework for risk
management. Both India and Australia also
Developing global standards addressed director tenure, which will be
In the post–financial crisis environment, part of a board’s evaluation of independence
global governance standards are on the of its directors. Investors are likely to see
rise. Over the past five years, market additional stewardship codes, corporate
participants have witnessed the convergence governance changes, and other reforms in
of fundamental best practice tenets, such Asian markets that want to attract global
as independence, pay for performance, capital. As such, regulation has driven
and shareholder rights. As the convergence significant corporate governance changes
of governance trends continues, changes over the past several years.
in regulations, corporate disclosures, and In addition to regulatory developments
shareholder practices will likely align with a acting as a driver for global standards, the
model of global active ownership. proliferation of investors voting, engaging,
One of the most prominent geographical and holding portfolios in global markets has
areas for regulatory change is Europe. The brought the discussion of governance topics
European Union made sweeping changes to to a level of worldwide discourse not seen
empower shareholders in the EU Shareholder 10 or 15 years ago. Particularly interesting is

the movement in portfolios beyond the BRIC Still, as the foregoing developments
markets (Brazil, Russia, India, and China) indicate, active ownership will continue to
and into emerging markets. As measured by evolve, driven by regulation in developing
ISS’s universe of companies that it covers on markets, augmented by engagement
behalf of its institutional clients, increases between companies and their shareholders,
in portfolio holdings are now being seen in and supported by informed proxy voting.
emerging markets in Asia and the Middle Institutional investors will utilize the tools
East. Expect investors to continue to look in of active ownership to mitigate risk in their
all corners of the globe for the best possible portfolios and pursue long-term, sustainable
investments, and the governance standards value creation.
by which the markets operate will play a key Against this backdrop, ISS welcomes
role in their investment decisions. the opportunity to engage constructively
with all governance stakeholders as we
Conclusion seek to further our mission to provide
Active ownership is a work in progress. Since unbiased governance advice to the global
no two investors are alike, their approaches institutional investor community and tools
to managing risk and monitoring their for corporations to mitigate governance risk
portfolios will vary widely. for the benefit of their shareholders.

3C Corporate governance: perspectives
from a credit ratings agency
Christian A. Plath, Vice President, Senior Analyst, and Corporate Governance Specialist Moody’s Investors Service
I
n considering corporate governance in credit analysis, Moody’s
is confronting two primary questions. First, what aspects of
corporate governance are relevant to credit risk? Second, how
should we assess the quality of corporate governance and, how
should that assessment factor into the credit decision?
Fundamental credit analysis incorporates evaluation of franchise
strength, financial statement analysis, and management quality.
Moody’s views corporate governance as an important analytic
element of management quality. To the extent that shareholders as
well as creditors and others have confidence that proper systems
of management accountability and incentives are in place, they can
have greater confidence in the present management of the company.
In theory, they also can be more confident that, should management
fail to meet emerging challenges, managers will be held accountable,
either through early action by the board of directors, or through
pressures, up to and including hostile takeover, in the market for
corporate control.
While there is substantial overlap between creditor and
shareholder interests, there are also important potential conflicts
due to the differing structures and risk profiles of debt and equity
instruments. Unlike equity holders, whose investments have
unlimited upside potential, creditors, including bondholders, face
low upside return but high potential downside risk. Equity investors
and debt investors may also have very different investment horizons
with equity focused more on the short term and debt focused more
on the long term. Because of these differences, debt investors will
have inherently less risk appetite for increased dividends and share
repurchases, increased leverage, investments in risky projects, and
aggressive acquisitions. Creditors may also be concerned with
structures and processes that might promote excessive alignment
with shareholders’ interests, including executive compensation
policies that are aggressively focused on shareholder returns.
In our analysis of corporate governance and management quality,
we consider how competing interests are balanced and examine any
evidence of shifting priorities (eg toward more shareholder-friendly
financial policies). We take our cues from such things as sometimes

Moody’s Investors Service Corporate governance: perspectives from a credit ratings agency
subtle changes in business strategy or governance issues is typically a negative

accounting policy and from our discussions or neutral ratings consideration in North
with corporate management teams. America. Strong corporate governance in
and of itself cannot overcome weakness in
Assessing corporate governance in the ratings a company’s business strategy or financial
process profile, but it can help protect a strong
business. High-quality corporate governance
No “check-the-box” or “one size fits all” can reduce the likelihood of future problems
Moody’s believes that there is not a single and may speed remediation of those problems
clear formula of good governance that is if they occur. Weak corporate governance on
verifiable and adequate. The cookbook the other hand can put downward pressure
approach has severe limitations in our view. on a rating or limit the near-term potential
Context is important, including legal and for upward movement on the rating.
cultural context, industry characteristics,
ownership patterns, company growth Sector considerations are important
stage, and other factors. Therefore, while Moody’s analysts must also consider the
market standards for corporate governance unique features of, and current developments
are significant in considering governance, in, individual sectors and their impacts on
Moody’s does not take a “checkbox” governance and credit quality. For example,
approach. We believe that the potential Moody’s sets a high standard for the
strengths, risks, and mitigating factors of governance and management of financial
each company’s corporate governance must institutions since these companies generally
be assessed on a case-by-case basis. are more exposed to confidence-sensitivity on
While “one size does not fit all,” as many the part of investors, creditors, and customers
observers say, there are strong reasons to expect than nonfinancial corporates, particularly
certain common good governance attributes with respect to funding. Some sectors have
in large publicly held enterprises, including distinct ownership issues, such as dual-
clearly independent oversight of management, class shareholding structures in media
comprehensible structures of management companies. Certain others may have elevated
accountability and succession planning, and levels of shareholder activism, such as the
rational executive incentive structures. This technology sector has seen in recent years
is particularly true for investment grade (see “Shareholder activism” section later in
companies, where we would expect to find this chapter).
robust corporate governance practices.
Moody’s views on key corporate governance
Important factor but rarely a central ratings issue issues
Corporate governance is an important Moody’s analysts give particular focus to the
element in our assessment of a company’s following aspects of corporate governance
creditworthiness. While we expect the and management quality. The exhibit on the
frequency of severe corporate governance following page summarizes our views on
problems to be low, the potential impact for these issues.
creditors can be high. At the extreme, poor
corporate governance, if unchecked, can Board of directors composition and leadership
endanger the viability of the enterprise. In Moody’s view, the board of directors
That said, while we consider corporate is the fulcrum for managing governance
governance to be an important factor in our relationships and the mechanism by which
analysis, it is rarely a central ratings issue as it managers are held accountable. Therefore
is typically one of several elements Moody’s we regard the quality, reliability, and
analysts need to consider in determining a independence of the board as critical to
credit rating. The assessment of corporate effective governance. A board of directors

Corporate governance: perspectives from a credit ratings agency Moody’s Investors Service
Table 1 Moody’s Summary Views on Key Corporate Governance Issues

Issue Area Moody’s View
Board Composition • In our view, both shareholders and creditors benefit from
and Independence robust board oversight of senior management, adequate
independence, and appropriate skills and backgrounds of
board members.
Board Leadership • We take the view that the presence of an independent chair
or independent lead director with substantive responsibilities
improves board effectiveness.
Ownership and • Much depends on context. We tend to have more comfort
Control Issues with widely held firms subject to robust disclosure
requirements. Controlled companies present a unique
analytical challenge. Controlling owners can operate with
a long-term view, in alignment with creditors’ interests.
However, there can be several risks from controlling
ownership, including potential for conflicts of interest and
abusive related-party transactions.
Takeover Defenses • Mixed views, and much depends on context. On one hand,
they may focus corporate management in the long term and
therefore promote alignment with creditors’ interests, but
they can also serve to entrench management.
Management • Depth and experience of senior management and robust
Quality succession-planning processes are areas of particular focus.
Executive • We are primarily concerned with pay structures and
Compensation metrics that focus the company on long-term sustainable
performance and alignment with creditors’ interests.
Shareholders’ and creditors’ interests in this area may differ.
Internal Controls, • A well-functioning and deeply imbedded system of controls
Compliance, and and internal checks and balances as a means of reducing
Risk Management operational risk and the overall risk profile of a company.
Effective risk management is a key credit concern.
Shareholder • The more aggressive variety of activism (ie by activist hedge
Activism funds) is mostly negative for creditors since activists may
agitate for strategic, financial, and policy changes that may
benefit shareholders at creditors’ expense. However, there
have been cases where activism has led to positive outcomes
for creditors.
that effectively promotes and protects strategic planning—poses an additional

long-term interests of shareholders and the inherent risk from a creditor standpoint.
corporate entity will, by and large, mitigate Important considerations include:
risk for creditors, by assuring proper
oversight of management. Conversely, • whether the board has sufficient
a board that fails in basic oversight of independence to act as a counterweight
key areas—such as conflicts of interest, to management and major shareholders
management succession, risk management, • directors that possess appropriate
internal controls, financial reporting, or qualifications considering the

organization’s size, complexity, and particularly family owners, can encourage

development stage long-term decision-making that is in
• appropriate board turnover to allow alignment with the long-term horizon of
for the addition of new skills and fresh the company’s creditors. Creditors may also
perspectives benefit by some insulation from the short-
• appropriate committee structure (eg term pressures of public equity markets.
audit, nominating, and compensation) to However, such companies can present their
support the full board in its duties own risks. This concern can be significant at
• sufficient meeting frequency of the full some North American companies, but tends
board and key board committees. to be a larger issue in many overseas markets,
in which controlling shareholders are much
On the subject of board leadership, more often present. For example, complex
Moody’s takes the view that the presence ownership structures (eg multiple minority
of either an independent chairman or a ownership interests or pyramid structures)
strong independent lead director with can magnify the governance challenges
substantive responsibilities improves board boards face in exerting independent oversight
effectiveness. Separation helps achieve an over controlling shareholders. This lack of
appropriate balance of power and increases accountability may harm creditor interests in
management accountability to the board. some circumstances, as entrenched managers
However, the success of any given structure fail to react appropriately because they lack
is dependent on the individuals who hold objective understanding of the situation of the
the key roles and how they work together. firm, or as the controlling shareholder seeks
It is important that the chairman and CEO special advantage. Related-party transactions
roles are defined and that the responsibilities may give rise to potential conflicts of interest
and limits of each role are respected. that are often difficult to assess from the
outside. “Key man” and leadership transition
Ownership and control issues risks in family-controlled firms can also be a
Ownership characteristics of a firm can have credit concern.
substantial impact on public shareholders For controlled companies, the creditor
and on creditors. We tend to have more impact to a significant degree will depend on
comfort with widely held, publicly traded who the controlling shareholder is and how
companies that are subject to rigorous public that shareholder views fair dealing toward
disclosure requirements. However, these creditor interests. While corporate governance
companies have their own vulnerabilities. In concerns (such as a lack of meaningful board
particular, there is a danger that the managers independence) may be present, the owner’s
of the company will make decisions in their maintaining a conservative and disciplined
own interests or for expedience, rather than strategy and financial profile can help to offset
the interests of the outside shareholders (the some of these concerns. Other mitigating
“agency problem”). At its extreme, such factors include material controlling owner
behavior, if unchecked, can endanger the wealth invested in the business, transparent
viability of the enterprise. ownership structures, absence of multiple-
“Controlled” companies may occasion class shares, and robust independent director
fewer worries about misalignment of review and approval processes for related-
managers and shareholders, exactly because party transactions.
there is less separation of management and
control (at least to the extent that equity Management quality
interest is equal to voting interest). A majority Management quality and operating expertise
holder has power and motivation to monitor is ultimately reflected in the other dimensions
performance that a diversified shareholder of our analysis, particularly the company’s
base lacks. Also, large shareholders, fundamentals, which over time make up

Corporate governance: perspectives from a credit ratings agency Moody’s Investors Service
management’s “track record.” We also • processes and procedures for the board
separately consider aspects of management and audit committee to assure themselves
quality that we believe directly influence that the company has adequate internal
a firm’s strategic priorities and long-term controls and compliance systems
performance. Important considerations • whether compliance, internal audit, and
include: risk functions have a high standing in the
organization
• the breadth and depth of management • audit committee composition, including
experience at senior levels duties, frequency of meetings, and
• “key man” risk-management dominated interaction with key internal and external
by one or two individuals parties
• management entrenchment • whether the company has a history of
• management continuity/turnover regulatory, tax, or legal infraction beyond
• management capacity and capability to an isolated episode or outside industry
plan and carry out business objectives. norms.
In particular, Moody’s views effective CEO The potential financial reputational damage
and management succession planning to companies that fail to properly manage risk
as critical to the sound management and is a major threat; therefore, risk management
oversight of an organization. As such, we is a key credit concern. In Moody’s view,
view it as a critical board responsibility. A risk management should be tailored to the
meaningful board role in the management specific company, but in general an effective
development and succession planning risk management system will (1) adequately
process can provide investors with added identify the material risks that the company
confidence. For example, the board can help faces in a timely manner; (2) implement
ensure that competent professionals are appropriate risk management strategies that
involved in the selection process and that are responsive to the company’s risk profile,
the decision criteria fit with the company’s business strategies, specific material risk
vision, mission, values, and strategic choices. exposures, and risk tolerance thresholds;
The board also can exercise its full powers to (3) integrate consideration of risk and risk
resolve any internal conflicts that might arise management into business decision-making
during the process. Furthermore, the board throughout the company; and (4) adequately
can help ensure there are both long-term and transmit necessary information with respect
emergency succession plans in place and to material risks to senior executives and,
that these plans are approved by the board as appropriate, to the board or relevant
and reviewed on a regular basis. committees (eg risk committees in large
financial institutions).
Internal controls, compliance, and risk management Boards have a critical oversight role in the
We regard a well-functioning and deeply area of risk management, including helping
imbedded system of controls and internal to define the organization’s risk appetite
checks and balances as a means of reducing and ensuring that a proper risk management
operational risk and the overall risk profile framework is in place. The support of
of a company. This is a particular concern for the board is critical to creating an overall
confidence-sensitive and highly regulated culture that promotes decision-making at
companies such as large financial institutions. all levels of the firm that is sensitized to risk
Important considerations include: matters and risk-adjusted performance. The
identification and management of risks are
• the absence of past control issues or generally the responsibility of management.
financial reporting issues, such as The lack of clear responsibilities between
restatements management and the board and the failure

of risk-control measures can be substantial filing shareholder proposals to activist hedge

credit concerns. funds making specific demands for strategic,
financial, and operational changes. Moody’s
Executive compensation is more concerned with the latter type,
Moody’s believes that understanding which has become increasingly prevalent
executive pay is important in corporate in certain nonfinancial corporate sectors,
credit analysis for three reasons. First and including the technology, energy, retail, and
foremost, incentives for the key leaders pharmaceuticals sectors.
help to shape company policies and Activist pressure can lead to significant
performance pressures. Second, effective changes at target firms, which have the
compensation policies are important potential to change the company’s credit
for executive recruitment and retention. profile. In our view, shareholder activism
And third, where disclosure on executive has generally benefited shareholders but
compensation is reasonably good (as in the held mixed results for credit investors. In
US, Canada, and certain other markets), some cases activists have prompted changes
pay practice can provide some visibility that can benefit credit profiles by imposing
into the relationship between the board of greater financial and capital discipline
directors and senior management, and on or by improving a company’s corporate
whether management is in fact accountable governance practices. But it also increases the
to the board. risk of future shareholder-friendly actions,
In Moody’s view, compensation plans including shareholder-focused strategic and
that enhance credit quality show: financial policy changes, new or expanded
share repurchases, and divestitures of cash-
• a long-term orientation in pay structure generating assets with proceeds potentially
and practice passing to shareholders. Activism can also
• a clear connection between pay structure lead to strategic changes that heighten event
and company strategy risk.
• balance in pay structure, particularly in We increasingly expect companies
balance between shorter- and longer-term in sectors most vulnerable to activists to
pay elements move proactively to boost shareholder
• balance in performance metrics, limiting rewards and address other issues to avoid
the extent to which metrics may be becoming actual targets, for instance by
gamed and taking bondholder interests launching share buybacks and paying out
into account special dividends. Such steps can pressure
• risk-mitigating features (such as caps on credit metrics by siphoning off cash and
incentive award payouts) increasing leverage. In addition, we expect
• discipline in pay practice over time. to see more companies continue to opt for
negotiated settlements with activists, rather
It is important to note that shareholders and than waging often long, costly, and bruising
creditors are likely to have different views on public battles, including proxy contests.
optimal pay structure due to their differing Company managements and activists
risk appetites and investment horizons. are increasingly agreeing to seat activist
Moody’s therefore tends to favor plans nominees on the board or to add new
that promote a disciplined attitude about independent directors before a shareholder
leverage and discourage risky, short-term vote on boardroom composition can take
strategies highly focused on share price. place. Several rated firms that have been
targeted by activists now have activist
Shareholder activism nominees serving on their boards, which we
Shareholder activism can take a variety of think will add to the pressure on corporate
forms, ranging from large pension funds managements to boost shareholder rewards.

4 Engaging with investors on
corporate governance
Kenneth A. Bertsch, Partner, and Robert E. Zivnuska, Principal CamberView Partners
T
here is no question that US public company executives are
engaging institutional investors on governance and related
matters much more now than in the past. And in an increasing
number of situations in which companies face particular challenges,
outside directors also are involved in engagement efforts.
These interactions, in person and by telephone, are conducted
both during proxy solicitation periods and in the “off season,”
the latter being of importance as companies attempt to establish
relationships, sound out investors on various issues, and lay the
groundwork for voting success at the annual meeting.
In the US, the requirement for periodic “say-on-pay” votes has
been a particular engine for engagement. But broader trends—
including concentration of institutional holdings; a wider shift
of power to shareholders over the last 30 years; and increased
willingness of “passive” investors to challenge management and
support activists— underlie the movement toward more substantive
dialogue on governance issues.
For the chief executive officer (CEO), chief financial officer (CFO),
and investor relations (IR) staff, dialogue with active managers at
buy-side institutions is nothing new. But governance as a key focus
is relatively new for most companies, and serious engagement
with institutional investors using index and quantitative strategies,
or with the buy-side institution’s internal corporate governance
departments, has intensified.
The roster of participants in governance discussions differs from
that for traditional IR, on both sides (investor and corporate).
Buy-side participants in governance dialogue

On the investor side, a number of leading asset managers and asset
owners (mainly pension funds but also endowments) have increased
staff attention to corporate governance in order to fulfill proxy-
voting responsibilities more diligently and more independently. This
change has been taking place over the last decade or more, and at
times is slow as investors weigh effectiveness in this area with cost
control.
Many of these institutions are invested across major portions of
the public company universe, either through explicit indexing or

CamberView Partners Engaging with investors on corporate governance
through a variety of quantitative approaches organizations have increased integration of

to meet perceived optimal diversification. governance/proxy voting with investment
Many investing organizations at one time staff (as opposed to treating proxy voting
handled proxy voting haphazardly at best. as a strictly compliance/legal function).
Under regulatory pressure to recognize the But even at these institutions, governance
value of the vote beginning in the late 1980s staff members tend to review a portfolio of
and ratcheting up in the early 2000s, some hundreds or thousands of companies, and
institutions shifted at first to heavy reliance their knowledge of the specific company and
on proxy advisory services, most notably ISS. its industry, and key business drivers, may
Over time, there was increased interest in therefore be limited.
making the necessary internal investment to Portfolio managers (PMs) and analysts
build out in-house competencies that could are becoming more attuned to governance
deliver a bespoke approach more closely dynamics and more often have greater
tailored to the portfolio management teams’ awareness now of norms and characteristic
strategy. Research and recommendations governance problems and challenges, in part
from proxy advisory firms continue to play due to increased inclusion of governance in
a major role in voting, but most of the educational programs and Chartered Financial
largest asset managers either make the final Analyst (CFA) testing. The growth of activist
voting decisions themselves or have a proxy investing also has had an impact here.
firm that makes recommendations based As companies engage institutions on
on customized guidelines. Typically in the governance, they can expect to speak with
latter case, some case-by-case matters will a range of portfolio managers, analysts, and
be referred to the investor for decision. And governance staff members, and it is critical
in this model, proxy advisory firm voting to communicate effectively with all these
according to guidelines on more routine groups.
issues can and at times is overruled.
Bottom line: at most but not all of the Company participants in engagement
larger asset managers, and at certain fund Many leading US companies now routinely
owners (mainly public pension funds), reach out to investors, including governance
governance staff plays a key role in the departments, on corporate governance
voting decision, so engagement with these and compensation. They have sought to
individuals can be critical to the outcome of build relationships, and these engagements
the vote. typically involve a mix of IR, secretary/
New Securities and Exchange Commission governance, and human resources (HR)
(SEC) guidance issued June 30, 2014, may staff, with senior executives brought
increase pressure on more investment in regularly. Outside directors also are
managers to take greater direct responsibility increasingly involved in selected situations,
for the vote and to perform due diligence usually because of the nature of a particular
around vote agency services where that duty challenge.
is delegated under a set of voting policies. The Traditional investor relations work
new guidance, called Staff Legal Bulletin No. focuses on making the case for investment
20, is discussed in Chapter 37 of this guide on in the company and with buy-side outreach
proxy advisory firms in a broader discussion dedicated to guidance and information
of the role of these firms. important for understanding current
Governance staff members generally are and near-term performance. Corporate
not involved in picking stocks, and their governance engagement, as the term
knowledge of specific companies is limited, suggests, features more emphasis on
although they typically bring investors structural elements but also tends to involve
better understanding of governance norms more explicit focus on certain longer-term
and issues. Some fundamental investing matters.

Engaging with investors on corporate governance CamberView Partners
Most often, there is a cross-departmental a shareholder to address politely in a CEO-

aspect of this, and it is highly valuable for led discussion, such as concerns about CEO
various functions to work together smoothly. compensation and succession, or where
Those typically involved are the head of there are serious investor criticisms of
investor relations (and sometimes the CFO management performance.
and finance executives more generally), the
general counsel and/or corporate secretary, Recognize the reality of shareholder power but
and senior HR staff where compensation also its limitations
issues are at the forefront. Activist investors willing to express specific
While shareholder interactions would prescriptive views are at the forefront, but
seem to have a natural home in investor even in the absence of an activist holder,
relations, it is difficult for IR staff to engage the reality is that shareholders, including
meaningfully without deep understanding of those classified as “passive,” now can have
company governance, the board of directors significant sway in the boardroom. Investor
in particular, and executive compensation. views are shaping corporate policies through
At times, financial reporting expertise proxy voting and through engagement,
also comes into play. Also, it is important and to maintain good relationships with
for IR to realize differences between shareholders to forestall potential challenges
portfolio manager/analyst perspective from an activist.
and perspective from institutional investor A perception of management/board
governance departments. nonresponsiveness can open the door
Perhaps the most prominent change on the to activists when a company develops
company side of governance engagements performance problems. In a dynamic
is the increasing involvement of outside economy, with companies expected to focus
directors (especially the lead director or on shareholder value, charges of insularity
independent chair) in selective governance and resistance to necessary change are potent
discussions with investors. This may be weapons for activists. Such accusations
common in some markets, but in the US are particularly effective in the ears of a
many directors have been leery of such governance team with personal experience
discussions. Factors have included strong US of frustration when attempting to engage
rules around selective disclosure (including with company representatives.
those in the Security and Exchange Still, insight into the boardroom from
Commission’s Rule Fair Disclosure [FD]), as those on the outside is limited, which
well as fears that the company should speak shareholders widely acknowledge. Fiduciary
with one authoritative voice at the top. But duty as well as practical ability to actually
in recent years, directors at a significant accomplish corporate goals rests with the
number of US companies have met with board and senior executives, who generally
investors notwithstanding these concerns. will be given wide latitude to operate so
As with corporate executives speaking with long as performance is acceptable, conflicts
investors one-on-one, care needs to be taken of interest are perceived as well managed,
to avoid disclosure of potentially market- and the board and management effectively
moving information and to not to speak communicate broad strategy, awareness of the
for the company in a manner that conflicts competitive environment, and willingness to
with agreed policy. Meetings with investors listen, change, and adapt as necessary.
in this context typically involve listening
as much or more than talking in any case, Know your investors and recognize their
even where the company tees up issues for diversity
discussion. It is critical to know who your investors are
A major reason to engage: there are some to the extent possible (there are some limits
subjects that are particularly awkward for on timely information on ownership). As

your investor base shifts over time, you need well as voting approach and relative reliance
to be on top of who is moving into, and out on proxy advisory services.
of, the stock, and their perspectives. This Geographic location and focus is another
obviously applies to well-known activist differentiator. The investment world is
investors, but more generally is critical in increasingly global, and US companies
understanding your potential supporters should anticipate that a number of their
and detractors and affects how votes will major investors will be based overseas and
turn out at annual meetings. informed by governance standards in their
Institutional investors have a range of home markets. Investors recognize that
investment styles, time horizons, interests, certain differences in governance certainly
degrees of focus (ie do the positions in their will arise from differing legal frameworks,
portfolio number in the very low double- and probably from cultural factors as well,
digits or the thousands), and views on but they may also believe that their home
best practices. Their investment strategies market represents best practices that should
will likely inform their view of executive be followed globally. Additionally, there
compensation design and appropriate has been some convergence on expectations
metrics. The wide variation in investment globally. Certain overseas investors have
approach is perhaps most clear in the involved themselves in advocacy in the US
contrasting time horizons of explicit and and other markets, seeking to drive change.
closet indexers who will hold your stock Investors of course share a desire for
essentially forever and traders who are strong returns to shareholders, even if some
quickly in and out of your stock. may be more heavily focused on the short
This diversity leads to sometimes sharply term than others. But this commonality
conflicting views of various holders. Some should not shroud recognition of difference
company executives find this frustrating when seeking to understand investor views
(“tell us clearly what you want us to do, and or to engage with shareholders.
then we can do it”). But investor diversity is One further note: a variety of investors
a reality of the market that cannot be wished may seek active interaction with the company.
away and must be navigated. These of course include shareholder activists
Even among fundamental investors, there who seek fundamental change and who may
are a variety of views of a company’s future. be willing at times to engage in proxy fights.
It is common for the same stock to show up It also includes usually passive investors
in both growth and value portfolios (labels who advocate certain governance and/or
that arguably convey limited information social and environmental policies. Most of
but hint at the breadth of perspective on a these actors wish to engage in dialogue with
given company). companies, and it usually is in the company’s
There are other key sources of diversity best interest to entertain this dialogue, to
among institutional investors. A fundamental understand the viewpoint of potentially
distinction is between asset owners (funds in potent critics, and to communicate the
this context) and asset managers. Pension company’s perspective on complex issues.
funds often retain voting rights, and some
public and union funds are highly active in Understand how your investors reach voting
the governance arena. Views on governance decisions
may differ from asset managers, even those A core IR function is to understand how
who manage investments for the funds. and why buy/sell decisions are made at
And not incidentally, asset managers may particular institutions. With the increased
control significantly fewer votes than raw importance of proxy voting, it has become
ownership information indicates. Proxy vital for companies facing challenging votes
solicitors can help companies understand to understand how voting decisions are
voting power of particular institutions, as made at particular institutions.

Engaging with investors on corporate governance CamberView Partners
As suggested above, practices vary. Most of the particular circumstances. The

larger asset managers either have governance communication of the reasoning behind
departments, significant PM/analyst a compensation program, or any strategic
involvement in key vote decisions, or both. business decision, should be as direct and
They generally do not vote automatically streamlined as is practical and not delivered
with a proxy advisory service. In fact, a in a manner that inadvertently communicates
number of the largest US asset managers condescension to the outside investor.
subscribe to both ISS and Glass Lewis, which
use differing (if similar) methodologies and Tell a story using plain English and selective,
whose recommendations routinely differ. simple visuals in the proxy statement and
Most but not all of the larger institutions supplemental filings
usually are open to engagement by the With a push from the SEC, the movement
company to discuss governance generally to bring plain English to certain securities
and specific important proxy votes. However, filings made some headway more than a
there are important exceptions to this even decade ago. However, most proxy statements
among large institutions. Midsize investors continue to be mired in legalistic language.
often do not engage in dialogue and can be The proxy statement is a compliance
more dependent on proxy advisory firms. document to be sure (that is, it must
provide certain disclosures), but it is not
To communicate effectively begins with just a compliance document any more. For
knowing what only you know US companies, the proxy statement is the
Companies face an inherent challenge in central tool for communicating with investors
communicating what goes on “inside” generally on corporate governance. It should
the company—and especially inside the be comprehensible to the nonsecurities lawyer
boardroom—to those on the outside. And and make use of effective plain English
insiders cannot communicate effectively summaries. Most institutional investors
without an acute understanding of what view the document in electronic form, which
they know that will not be visible, or easily means that companies can make good use
understandable, to outsiders. of internal hyperlinks to provide a user with
The public corporation is a complex easy ability to drill down in the document.
ecosystem, and insiders often underestimate This is a tool that most companies are not
this challenge. It is easy to forget that you using in any sophisticated way at this time.
are an expert with specialized knowledge Proxy statements are evolving, and the
of your company, field, and industry when changes are generally improvements, but
you spent most of your professional life companies also must be concerned with
working with people in the same field. In consistency year to year. That is, changes
this context, it is important to remember should not be overly self-serving or
that governance/proxy voting staff dealing repeatedly radical or erratic. This is true
with hundreds or thousands of companies not just from the standpoint of dealing
will have a steeper learning curve than with potential SEC scrutiny but also in
portfolio managers and analysts who have establishing credibility with investors over
more focused responsibilities. time.
This problem may be most evident in Some companies have managed the
the area of executive compensation, which difficult challenge of establishing a tone of
tends to be complex. An effective executive candor in proxy statements, which can be
compensation approach may be highly useful in building credibility with investors
keyed to the particular circumstances over time. This means recognizing where
of the company, but if you are to secure problems have occurred, without being
shareholder support, you must be able to defensive. Understandably, companies (and
guide outside shareholders to understanding corporate legal departments) have a concern

that admitting to a misstep will contribute to practices; interactions through engagement;

litigation vulnerability. However, excessively and other indications of how boards respond
glowing proxy statement commentary about to shareholders.
company performance year after year, while It is difficult to convey the substance
returns to shareholders are limited, exposes of board work in written documents, but
the company to some risk of appearing blind companies are finding ways to give some
to reality. understanding of the strengths of their
Since the advent of say-on-pay, some board and individual directors, including
public companies have begun making better through effective communication of how
use of graphs in their proxy materials and the board thinks about board balance and
in supplemental filings. A good picture can board succession. Leading companies also
be worth a thousand words, as the saying have considered how best to communicate
goes (or at least a few hundred words). the quality of their boards through director
But, particularly in the proxy statement biographies and description of qualifications.
summary or compensation discussion and Highlighting that your board is independent
analysis summary, try to actually substitute is fine, but realize that nearly all US public
the graph for the words (that is, do not company boards (at least those without
always do both). And remember that this dual class share structures or a dominant
can be overdone if too many graphs are used shareholder) have highly independent
or they are overly complex, such that they boards, so that is not going to distinguish
take significant work to decode. Remember, your board from others.
the point is to tell the story effectively to an One final comment: in the last several
impatient reader. years, increasing numbers of companies
Finally, keep in mind that some key have filed supplemental proxy materials,
investors who read proxy statements are sometimes in response to critical proxy
moving beyond check-the-box governance, advisory service reports. Such materials can
seeking to understand how the board be useful in focusing on main messages
actually performs, with investors believing even if they do not state anything outside
that relatively clear windows into that the four corners of the proxy statement. The
are provided by: company performance, availability of this tool should not take away
particularly as measured by objective from efforts to make the proxy statement
financial metrics and especially the external an effective communications document that
measure of total return to shareholders (share anticipates investor concerns.
price change plus dividends); executive pay

5 The board’s role as strategic advisor
Erica Salmon Byrne, Executive Vice President, Compliance & Governance Solutions, and Deborah Scally,
Editor and Director of Research NYSE Governance Services
O
ver the last several years, US public companies have begun to
spend more time both preparing for possible advances from
activist investors and communicating with their shareholder
bases. Significant increases in the amount of total assets under
management by activist hedge funds mean that it is much more
common today for companies to regularly update their directors
on developments in the area of activist investing and to regularly
meet with their largest institutional shareholders along with
members of their board.
In light of the broad scope of companies and issues that activist
investors are targeting, companies should be proactive in preparing
for engagement with an activist investor and examine their business,
strategic plan, and governance practices with a view to identifying
issues that activist investors may raise. These companies should be
cognizant of the increasing media exposure that activist investors
and their investments are receiving and be prepared for some level
of media and investor scrutiny of the company, directors, and senior
management in the event that the company becomes the subject of
activist investor interest. A key part of that review process must be
leveraging the role the board plays as a strategic advisor.
We all know that the chief executive officer (CEO) and
management team are appropriately in charge of developing the
company’s strategic plan. The plan is then presented to the board
of directors for approval during a special planning meeting. Most
boards and governance experts say boards should be meaningfully
involved in shaping and ultimately approving the strategic plan and
major decisions—but if they try to develop plans, they’re bordering
on management. To play their strategic role to the fullest, directors
must know when to participate and when to pull back. As the
Institute of Corporate Directors advocates, board members should
be “nose in, fingers out.”
The tricky part is distinguishing meaningful involvement from
development.
One positive outcome of the governance debate over the past
several years has been that the board of directors is no longer satisfied

NYSE Governance Services The board’s role as strategic advisor
with simply approving management’s meeting. In addition, each of the board

strategic plan once every three to five years. members now has a business unit he’s
Indeed, sound governance practices, coupled mentoring, so that we become more
with an unstable business environment, have involved in that particular business and
led board members to play a more active role can summarize for the board what is
in developing and regularly following up on happening in each of our major segments.
strategy. We’ve gotten away from the old once-
Involving the board of directors in the a-year dog-and-pony show where you
strategic planning process achieves several just get mind-numbing slides that don’t
objectives: give you enough time to interact with the
people. I feel pretty comfortable with our
• adds diverse viewpoints to reinforce the involvement in strategy planning now.
quality of the strategic plan and related
Another director noted:
decisions
• improves the board’s understanding of the We all recognize as a board that it’s very
organization’s business environment and difficult to predict both the economy and
its sense of ownership and accountability the pace at which changes occur. We’re
• ensures that the executive team and board probably 50% more involved than we
members work in a collaborative rather were; we’ve done this by putting together
than confrontational setting special committees that look at strategic
• encourages identification of additional issues, and this didn’t exist a year ago. Of
critical issues, such as evolving course, you need to keep your nose in and
cyberthreats, social media developments, fingers out. I’ve been on eight different
or other external forces that must be taken public-company boards, and the best
into consideration when developing a ones realize that the job is governance,
strategic plan not management. You should be a great
• ensures that the strategic plan is resource to the management team, but
considered in light of other key issues the you can’t cross the line and start to
board is responsible for, including CEO manage.
and senior leadership succession.
In the end it is the role of management to
devise a strategy that makes sense for long-
There is therefore a trend toward boards
term shareholder benefit, but the board can
doing more than simply approving the final
play an important role in evaluating the
version of the strategic plan. This has led to
risk-reward ratio as well as provide a foil for
greater board participation in the strategic
constructive debate.
planning process; whether it be determining
In order for the board to play that role,
and updating the organization’s vision,
however, the makeup of the board must be
values, and objectives, or contributing
appropriate. The qualities of a good director
to improving market intelligence. As
are, without a doubt, good listening skills,
one director told Corporate Board Member
sound judgment, and a talent for asking the
magazine:
right questions rather than the tendency to
We’re much more involved than a few think and act alone. In fact, 88 percent of
years ago. In the past we’d talk about directors in the NYSE Governance Services/
strategy, but it always seemed that by RHR International Survey pointed to the
the end of the meeting we were out of quality of boardroom dialogue and debate—
time and it didn’t get enough attention. followed by the ability to ask tough questions
So we decided to put it at the beginning of management and diversity of thought and
of the meeting, or to start talking about experience among members—as most critical
it at dinner the evening before the board to boardroom success. Conversely, a lack of

The board’s role as strategic advisor NYSE Governance Services
candor in the boardroom (77 percent) and scenario. Oftentimes, the outside chairman
a lack of mutual respect and collaborative or lead director is designated for the role;
culture (68 percent) were the lead answers sometimes it’s the chief operating or financial
given when directors were asked to name officer. These are not long-term solutions,
the factors most likely to undermine board merely stopgaps to allow a board time to find
effectiveness. the right, long-term solution. For example,
As noted above, diversity of thought and in June 2008, the board of Wachovia Corp.,
experience among members was one of the the big Charlotte, North Carolina, banking
top three responses given when naming company, ousted CEO Ken Thompson after
important attributes to board effectiveness. the company reported massive losses on
More than 60 percent of the directors we bad real estate loans. The search to replace
surveyed say diversity is a key factor, and him led a month later to Robert Steel, the
86 percent agree that a proactive approach to former US Treasury undersecretary. In the
board diversity is a necessary building block interim, directors went with one of their
to a great board. In summing up crucial board own, Chairman Lanty Smith, an investor
components, several directors reflected on the with a diverse business background, to run
need for diverse backgrounds. One director the show. “Having a short-term successor
pointed to the importance of “diversity of for an emergency gave us time,” the board
experience by directors who are actively noted. As it turned out, it was time enough
engaged within the proper role of the board to determine Wachovia’s next strategic turn,
to provide oversight and perspective.” as later that year, the board sold Wachovia to
When asked to choose from a list of possible Wells Fargo & Co.
actions that could be instrumental in making a “The good news is more and more
great board, 81 percent of director respondents directors are appreciating the importance
chose a “regular, ongoing evaluation program of both CEO evaluations and succession,”
for CEO/leadership succession” as the most said T. K. Kerstetter, Chairman of NYSE
significant contributor. Many of the directors Governance Services, Corporate Board
we surveyed believe their board does a Member. He notes that an effective CEO
credible job in this area. Sixty-seven percent evaluation program requires leadership on
indicated their board does a very good job the board’s part and is being embraced more
managing and evaluating the performance than ever before. Therefore, he says, it is
of the CEO; 30 percent said they do this important to establish a regular process for
job at least somewhat well. (Interestingly, evaluating the CEO and discussing both the
when asked about US boards overall, these board’s and the CEO’s plans for the future.
percentages were basically reversed: 33 “Recruiting, compensating, cultivating,
percent said boards do this job very well, retaining, and planning for the succession
and 59 percent said they do it somewhat of the CEO has always been one of the core
well.) Further, when asked to rate their responsibilities of the board, and boards
board’s effectiveness at aligning the CEO’s that handle it well typically have a good
performance with board expectations, two foundation that allows them to be effective
thirds (68 percent) pronounced themselves overall.”
effective, and 28 percent said they were at As to factors that could limit board
least somewhat effective at doing so. Directors effectiveness, a majority (53 percent)
also increasingly understand the difference worry about a lack of independence from
between long-term CEO succession planning management, and 43 percent say ill-prepared
and short-term or “disaster” succession directors could undermine success. With
planning, and the role that differentiation regard to the latter, a solid majority (59
plays in their strategic thinking. percent) say US boards overall fail to do a
Of course, there’s no “right” person to good job of replacing directors who are not
temporarily take the helm in a disaster contributing value; 27 percent say this is a

NYSE Governance Services The board’s role as strategic advisor
problem on their board. The effectiveness which of course plays a critical factor in the
with which a board renews itself and board’s ability to serve as a key strategic
manages its own succession is a key factor to advisor to the management team.
ensure a healthy and self-sustaining board,

Fostering a long-term perspective:
6 using strategic simulations to
prepare for uncertain futures
Nicole Monteforte, Senior Associate Booz Allen Hamilton
One thing a person cannot do, no matter how rigorous his analysis or heroic
his imagination, is to draw up a list of things that would never occur to
him.
Thomas Schelling,
University of Maryland economist, winner of the 2005 Nobel Memorial Prize
in Economic Sciences for demonstrating how game theory applies to the
interactions of people and nations
C
ommercial institutions face an unpredictable world with
challenges ranging from bottom-line management, to insider
threats, to cyberattacks. Continuous change and volatility are
the primary constants of business, and one false move or moment
of inaction can spell the difference between being “in” or “out”
in the broader marketplace. For a company to survive—let alone
lead—in this dynamic global space, it must do three things well:
1. Understand the forces at work in the marketplace, how they

could affect the business, and what they mean for the future.
2. Provide top managers with experience competitors lack, which
includes growing a cadre of top managers who can think and act
strategically.
3. Grow the buy-in to act on this understanding and experience at
an enterprise level.
Such understanding and experience must come from looking

forward and responding to potential discontinuities and surprises
with decisive action. This willingness to act, in turn comes from
confidence in the assumptions and potential outcomes surrounding
the situation the company faces and from buy-in from the full team
of executives across the enterprise. Such understanding, experience,
confidence, and enterprise-wide buy-in can only come from having
lived through the crisis before it strikes. In his seminal work, The
Strategy of Conflict, Thomas Schilling demonstrated how these
dynamic variables can actually be used to predict future action—
using game theory to predict the unpredictable. Since 2001, Booz
Allen Hamilton has been leading industry in the application of
world-class strategic simulations in the financial services sector and

Booz Allen Hamilton Fostering a long-term perspective: using strategic simulations to prepare for uncertain futures
the broader commercial sector writ large. Your indeterminable future must consider
Adapted from our decades-long experience how competitors will react to your moves
providing wargame and exercise support to and each other’s moves, and how the market
US government clients, Booz Allen strategic will react to all of these moves. In turn, your
simulations in the commercial sector offer strategy itself is likely to be multifaceted.
our clients this ability to live the crisis before With this uncertainty, how do we come
it strikes. to closure on a strategic direction? What
unforeseen pitfalls lie in wait?
Case study (reputational risk at large, global Faced with similarly complex and
financial institutions) uncertain situations, many businesses have
Understanding the past is vital to good used “strategic simulations”—business
judgment about the future. But straight- wargames—to test and refine strategies.
lining a successful past into a scenario of Every business in a complex environment
how the future may unfold, even with faces the same dilemmas: It is difficult to
experts postulating events, has been the plan for a future you cannot predict. You
rocks and shoals on which many companies cannot really understand your competitors
have run aground. Prior to 2008’s financial or your marketplace unless you can see the
crisis, many large financial institutions situation as they see it. You cannot succeed
might have been forgiven for struggling unless everyone on the team is working to
to contemplate realities where issues like the same goals and viewing the situation
reputational or liquidity risk could cause similarly. Strategic simulations create a
entire businesses to fail. Yet in 2006 one such dynamic “low-risk” environment, where
institution had the temerity to contemplate your key leaders can come together, analyze
just that. What if reputational risk were a alternatives under “pressure,” and gain the
reality? And what would it take for our benefit of this alternative perspective prior
business to fail? Working with analysts from to facing those real decisions in the real
Booz Allen Hamilton’s simulation team, this world. Moreover, strategic simulations offer
institution designed a Senior Management businesses the added benefit of creating a
Exercise focused on operations in disrupted defined environment for a shared learning
environments, with the goal of uncovering experience. It is an experience where
those unknown variables that could participants come through on the other side
otherwise unhinge a firm’s reputation in not only knowing things about themselves
the marketplace if mishandled. While this and their colleagues they did not previously
particular simulation was not focused on but also with the shared understanding and
mortgage-backed securities and some of enterprise-wide buy-in on the next step—
the other variables that led to 2008’s global be it an acquisition, updated go-to-market
decline, the experience nonetheless prepared strategy, or a more nuanced understanding of
this organization well to deal with issues the threats that are ahead (think: cyberattack,
like strategic communications, refined and hostile takeover, market corrections).
battle-tested business continuity plans, and Strategic simulations bring the best minds
enterprise-wide consideration for line-of- in the company together to develop and
business–specific decisions—lessons that no test strategies in no-holds-barred interaction
doubt served their enterprise well during with “competitors” and in the face of
the tumultuous months of 2008–2009. “external forces” over which you have no
control. It offers the following benefits:
Immediate benefits
Indeed, strategic simulations offer our • Team building and bonding as well as
clients a window into the future, with many ownership of strategic lessons and the
potential benefits devoid of more traditional strategies developed over the course of
forms of analysis and strategic planning. the simulation.

Fostering a long-term perspective: using strategic simulations to prepare for uncertain futures Booz Allen Hamilton
• Direct acknowledgment and the potential the simulation, the manufacturer in question
to address those difficult-to-model but not only had a validated set of assumptions
nonetheless critical variables in a fully around how their current strategies would
interactive, rather than deterministic be received but also a list of action items to
fashion. carry forward, including diversification of
• A methodology to challenge conventional markets beyond the core North American
wisdom and the freedom to break from focus and a reduction in their product
“known truths” and other limiting development cycle timeline, insights and
paradigms. actions that positioned them with the tools
• A forum to provide key training to necessary to take market share and drive
managers around the dynamic aspects of growth for the decade to come.
strategic planning.
• “No-risk” exploration of strategies, prior How it works
to implementation—with the added For years, many businesses used scenario
benefit of providing an opportunity planning to deal with future complexity,
to internalize lessons learned and but taken alone, scenario planning is just
anticipated “speed bumps” among your “best guessing” at the future. To really
core leadership before living them out in understand what might happen, a scenario
the real world. or a strategy must be played against realistic
• An articulated view of the full range and conditions before it is actually implemented.
nature of potential outcomes (competitor This can best be accomplished through a
capabilities and strategies, market “competitive simulation” of the future.
dynamics, financial impacts). Competitive simulations allow strategies to
be exposed to marketplace and adversary
Case study (preparing for the “next big thing” reactions, potential execution issues, and
in the US automotive industry) reactive modifications—in short, all the
The automotive industry has been and variables that would happen in real life.
remains a highly competitive market A competitive simulation is a dynamic,
space in which every competitive edge time-compressed process, uniquely tailored
gained, be it in clean technologies, luxury to each of our client’s problem sets to design
products, or safety, can be a differentiator a process to actually “live” through the
in the competition for consumers. In the future. The results are decided by human
late 1990s and early 2000s big industry interactions and expert judgment, with
witnessed the rise of several newcomers financial implications of decisions often
driving innovation and capturing share that tracked by a model of the industry. Players
may have previously been taken for granted. live in the real world with the capabilities
The question became: How can we best and constraints of the company they are
strategize to prepare for the next decade? So playing. That world develops and changes
in the early 2000s, teaming with Booz Allen as a result of decisions players make.
Hamilton simulation experts, we were able Using our time-tested multiphased
to uniquely tailor a simulation designed process, the Booz Allen simulation team
to test competition in the US marketplace designs each effort to match a particular
for passenger vehicles from 2005 to 2014. client’s unique problem sets. From concept
Analysis of relevant industry trends and development, to design and testing, to
competitor “profiles” were generated to be execution and analysis, each phase of the
paired with a dynamic scenario pushing Booz Allen design process is structured
simulation participants many years out into to ensure organizational inputs, test and
the future to explore how market forces validate key assumptions, and produce
would both be shaped by and react to the most effective strategic simulation
adopted company strategies. At the end of possible. These processes can be designed

Booz Allen Hamilton Fostering a long-term perspective: using strategic simulations to prepare for uncertain futures
across a fully customizable time frame— processes. The simulation highlighted the
understanding that shorter time frames real risk the company was facing from global
often dictate certain elements—however, our competitors but also provided the CEO with
decades of experience have taught us that a punch list of items that were then used
an 8–16 week engagement often offers our to reinvent their investment strategy and
clients the most rewarding experience. internal processes, steps that have allowed
them to grow into a global food company
Case study (managing integration and market with broader market share and a more
share in the food processing industry) integrated portfolio.
Companies may choose to grow through
many different ways, but those that choose Conclusion
to grow through acquisition often find a The challenges facing today’s financial
unique set of challenges when integrating institutions and the markets they operate are
capabilities, processes, and personnel. In real, dynamic, and unprecedented in their
the food processing industry, Booz Allen scale and potential to disrupt. Moreover,
Hamilton simulation designers encountered yesterday’s “ground truths” are being
a client in need of game-changing analysis disproved as too shortsighted or worse
to prepare for the future. The company yet, naïve, on almost a daily basis. In such
in question had grown through aggressive environments, organizations require tools that
acquisition strategies that had cobbled can adapt with them and, more important, can
together a portfolio of more than 100 help them peer around the corner to see what
independent operating companies—though is coming next. The difference in this market
they were certain of the strength of products between action and inaction, preparedness
and capabilities they had to deliver to and flat-footedness, will determine which
the market, the positive impacts of these organizations thrive and which lag behind.
acquisitions had yet to be realized. Working Strategic simulations offer our clients
with the company, the Booz Allen simulation access to an alternative analytic framework
team designed an engagement that allowed to face these challenges head on, to prepare
the company to test the market, develop for their unknown futures, and to be
potential strategies, and reinvent internal positioned on the other side for success.

CHAPTER 7: Selections from Corporate Board Member
What directors think: a

7A Corporate Board Member/
Spencer Stuart survey
Deborah Scally, Editor and Director of Research, and Kimberly Crowe, Managing Editor NYSE Governance Services
W
hat kind of board does your company need to maintain
a competitive edge? Industry and leadership experience
are obviously important factors and most boards have
added a financial expert thanks to Sarbanes-Oxley, but does
your board have IT expertise? Social media savvy? How about
an international perspective?
Given the meteoric rise in IT risk, it is likely your board either
already has a director who is well versed in information technology
and data security or is looking for one to help it better understand
the company’s IT risk profile. The same is true for the fast-growing
realm of social media; its increased use as a competitive strategy
in recent years has brought correspondingly greater risks. And if
your company is contemplating expansion outside of the United
States, bringing in a board member with international experience is
a must. At the same time, more attention must be paid to the tricky
arena of anticorruption and FCPA compliance, with its minefield
of risk.
The results of the 2014 Corporate Board Member/Spencer Stuart
What Directors Think survey, a long-running annual study based
on the input of public company directors nationwide, reveal
directors’ views on rejuvenating the board, risk oversight, say-on-
pay, and more. In many areas, this year’s findings align with more
than a decade of What Directors Think results and demonstrate
that CEO succession and the desire for more time for strategic
planning continue to be chief challenges for US public company
boards.
In addition to the core areas of study, this year we posed
a number of questions around board structure, turnover, and
guidelines to better understand the methods and processes boards
are employing to maintain their vibrancy and effectiveness.
Interestingly, quite a few directors wrote in to comment that these
latter issues, while topical, should never become a distraction from
their primary responsibility of improving the bottom line.
For example, one director noted that while surveys typically ask
about say-on-pay and regulatory issues, the board’s focus should

NYSE Governance Services What directors think: a Corporate Board Member/Spencer Stuart survey
be squarely on enhancing shareholder demands of the current marketplace and

value: “Shareholders want us to make that the highest standards of independence
money for them. . . . We work for those are being met. This viewpoint reflects the
who invest in our companies to make a belief that today’s corporate boards are one
profit.” Another offered a similar comment, step further from the days when boards
saying, “A board’s obligation is to further were often formed under the auspices
and enhance a company’s revenue growth, of long-standing friendships or business
profit potential, and shareholder benefit” favors—and stayed that way.
rather than to be overly concerned with Today’s board members are well aware
political correctness. This year’s results they need to stay sharp. As John Bagalay,
support the fact that directors’ commitment one of our respondents and an executive
to shareholder interests remains paramount, in residence at EuroUS Ventures, notes,
but Stephen G. Kasnet, a survey respondent “Failure to establish an orderly method of
and chairman of Rubicon Ltd., maintains changing board composition creates two
boards can find common ground with some problems: one diplomatic and the other
of the so-called softer issues and those that leadership refreshment.” Two thirds of
have a direct line to profitability: “A well- directors we surveyed agree, finding the
informed board can and does establish goals need to periodically refresh the board with
and structures that meet the shareholders’ new blood as either important (51 percent)
and business’s needs.” or critically important (16 percent), with
To provide context to the issues that another 26 percent saying that refreshing
surround corporate governance at the start the board is at least somewhat important
of 2014, we have organized survey data (Figure 1). Bagalay adds, “All companies
into five categories: board composition need board members who come on without
and effectiveness, leadership challenges, a predisposition to accept the way things
executive compensation, risk management, are.”
and strategic planning. While compensation And the time has never been more
and succession are long-running themes, appropriate for a jaundiced look at board
the results show there are new twists on composition. According to What Directors
risk oversight that undoubtedly reflect Think survey partner Spencer Stuart,
the current corporate environment, both among S&P 500 boards, retirement ages
technologically and globally. are being pushed back, and as a result,
board members are becoming older and
Assessing board composition more entrenched. “While it sometimes
For any given company, there must be makes sense for boards to ask experienced
both management and a governing body directors to remain on the board longer, they
that are up to the task of meeting current must also ensure they have the diversity
challenges. And while many of the requisite of skill sets that are important in today’s
skills are the same year after year, corporate business world to define a forward-looking
challenges continue to evolve that require strategy and vision and manage key risks,”
new blood and fresh approaches. says Julie Hembrock Daum, who leads
While the concept of “refreshment” is the Spencer Stuart North American Board
more readily applied to employees and Practice.
management, there’s a growing trend Yet, one irony today is that adding
among investors and academics to apply younger board members to the ranks
it to boards as well. Shareholders want to inadvertently means these new directors
ensure that the boards of the companies may one day end up with longer-than-
in which they own stock are capable of average tenures. Along those lines, we asked
handling the leadership and governance directors whether it would create a problem

What directors think: a Corporate Board Member/Spencer Stuart survey NYSE Governance Services
board to be self-reflective and allow for

Figure 1 change as needed.” And in his mind, this
type of well-executed evaluation negates
the need for external regulatory pressure to
HOW IMPORTANT manage board performance. “The fact that
IS IT TO REFRESH a great many boards are up for reelection
THE BOARD annually allows for shareholders to give
due consideration to board performance,”
PERIODICALLY? he states, and thus evaluations can be
handled without regulatory intervention.
Most boards have formal policies
CRITICALLY IMPORTANT regarding ongoing board service and
16% tenure. Just over half (53 percent) of
directors reported that their boards employ
IMPORTANT a mandatory retirement age. In addition,
51%
39 percent said their boards require a
mandatory resignation submission in the
event of a personal reputational event,
such as a bankruptcy or arrest, and 28
SOMEWHAT IMPORTANT percent require a mandatory resignation if
26% a director fails to garner a majority vote.
However, fully half of those surveyed said
NOT VERY IMPORTANT the latter is not required nor needed, which
6% may indicate a preference by directors to

evaluate each case individually rather than
under blanket guidelines.
In addition to examining the methods
boards are using to refresh their ranks,
another important function is for boards
for a board member to serve as much as to undertake a healthy self-evaluation to
30 years on one board. Respondents were ensure all sitting members are contributing
split on this point, with 53 percent saying something unique and relevant to the
yes; 47 percent no. As one director noted, whole. This is often an important step
“I generally favor age limits, but [Warren] when there is a vacancy on the board.
Buffett is causing me to rethink the issue. Dovetailing with this idea, the survey asked
Who wouldn’t want Buffett at 80-plus?” directors which attributes would be most
Another pointed out that proponents for age important in selecting their board’s next
limits “seem to focus on the negative side of new member. Not surprisingly, financial
longevity but give little or no credence to and industry expertise were the top two
the wisdom gained only through years of choices, followed by CEO experience,
experience.” knowledge of information technology,
Jim Hunt, a survey respondent and and global expertise. Close behind was
retired Walt Disney World executive who the relatively new demand for directors
sits on several boards including Brown & with marketing and digital/social media
Brown Insurance, says, “A robust, specific experience.
board evaluation . . . of each board member, Industry experience is often viewed
coupled with individual discussions as a compelling factor for selecting
with each member by the chairman/lead a board member, especially in terms of
director, should provide for a company’s how a candidate could contribute to the

competitive growth and strategy of the And, for the first time, fewer active CEOs
company. Tim Gentz, a survey respondent than retired CEOs joined S&P 500 boards,
and chairman of Speed Commerce Inc., says 77 versus 79, “suggesting that more boards
to make his board stronger, “We need to are comfortable that retired CEOs can make
enhance our industry knowledge both via a similar contribution as sitting CEOs—
education and by recruiting candidate(s) who are more reticent these days to sit on
with industry experience, as we have incremental outside boards,” she notes.
recently changed our strategic direction.” One area that Corporate Board Member has
With regard to leadership experience, been actively tracking for the past several
the survey found a difference of opinion years involves initiatives to promote board
about the upside of having active CEOs diversity. Thought by many to have benefits
serving on boards. One director said there above and beyond a perception of political
is a need for more CEOs or COOs who are correctness, board diversity has gained
willing to sit on boards, explaining, “We momentum in countries that have put their
now have too many professional board regulatory muscle behind such initiatives.
members who are getting education boxes Such regulations, however, have not gained
checked through the NACD, etc., who don’t a foothold in the United States, nor do most
have the experience of actually running directors expect them to. Nearly 60 percent
an organization. They tend to be good believe there will be no formal actions in
on process and weak on leadership.” But the US in the next three years related to
another director complained that “board board diversity, though 38 percent believe
members who are also CEOs and sit on we will see increased pressure on this front
multiple boards are cheating everyone— by investor activists.
[they don’t have] enough time to do any of As one director noted, progress toward
it right.” more diverse boardrooms is likely to occur,
“Active CEOs bring a wealth of relevant but it will come about by more organic
current business experience to the board,” means. “Diversity cannot be achieved by
says Daum, “which is why they are mandatory selection of less experienced
frequently sought by boards looking to members; it has to come about naturally
recruit a new director. They also tend to through societal changes. As more and
relate well to the company CEO and are more diversity enters the job markets, the
well-equipped to build a strong working pool of directors will allow for diversity.”
relationship with him/her,” she adds. These views are telling in that directors
“But boards will want to be cognizant of themselves are a key component in how
the tradeoffs in adding a sitting CEO to their future boards are shaped. Nearly two
their boardroom, among those, potentially thirds (63 percent) of those surveyed, for
less time to devote to company business example, said individual board member
in between meetings or when extra time recommendations are the most successful
is required—in a crisis, for example. source of new board members, followed by
Boards also will want to have a candid the use of search firms (22 percent).
discussion about whether they are looking For a closer look at the functions of the
for a marquee name or someone who will board and its members, the survey set out
actively contribute to the dialogue and to ascertain how effective the board and its
deliver value,” she explains. committees are in several key oversight areas.
Daum says the 2013 Spencer Stuart Directors are most confident in the audit
Board Index revealed that 23 percent of committee’s ability to accurately monitor
new directors were retired CEOs, COOs, financial reporting, followed by their ability
chairmen, presidents, and vice chairmen, to challenge management when appropriate,
compared with just 16 percent in 2012. and the compensation committee’s ability

to properly align CEO compensation and Ironically, despite the earlier finding
performance. Rounding out the top six are noting that two thirds of directors believe
the audit committee’s ability to investigate it’s important to refresh the board, they
internal fraud, the board’s ability to develop rated themselves least effective in terms of
and deliver the CEO’s performance review, the nominating/governance committee’s
and the compensation committee’s ability to process to effectively encourage board
properly set industry benchmarks for CEO turnover and to create a board that has
compensation. a balance of needed skills and diversity.
“For the 10-plus years we’ve been Other relative weaknesses noted by
doing this survey, directors have been respondents include the full board’s ability
unwavering about their ability to monitor to complete a management succession plan
financial reporting. I truly believe that audit and to monitor the organizational risk
committees take great personal pride in management plan to mitigate exposure. It’s
their ability to perform this important task,” worth noting that two of the bottom four
says TK Kerstetter, chairman of Corporate results in this category are related to board
Board Member. “What is equally interesting composition and turnover challenges,
over those 11 years is how little has changed indicating many directors are attuned to the
regarding the order of the duties they feel fact that these important areas need more
they oversee effectively.” attention in the future.
“Boards must have the diversity of skill

sets that are important to define a forward-
looking strategy and vision and manage key
Figure 2 risks.”
Julie Hembrock Daum

WHICH ARE
EFFECTIVE TOOLS Spencer Stuart North American
TO ENCOURAGE Board Practice
BOARD
“Spencer Stuart’s research shows the
REFRESHING? number of new board appointees fell by
23 percent in the period between 2008
and 2012. While there was a 16 percent
BOARD EVALUATION uptick in the number of new independent
85%
AGE CEILING
directors elected to S&P 500 boards during
the 2013 proxy year (339 directors), boards
continue to wrestle with the question of
how to promote ongoing board renewal,”
49%
Daum says. “In our experience, making
board composition and performance an
annual topic of board discussion is a good
TERM LIMITS approach to ensuring the board has the
25% right expertise and skills as the economic

and competitive landscape changes.”
In analyzing the methods used by
boards to encourage healthy turnover, 85
percent of directors surveyed said board

assessment/evaluation is an effective tool and a successful, long-term succession

to encourage board refreshing. Boards use plan. As Rubicon’s Kasnet explains, “As a
annual board evaluations to assess the young company, we foresee little need for a
effectiveness of the board as a whole as directional change but are prepared for the
well as the contributions of individual potential of an abrupt change.”
directors, which can identify directors Speed Commerce’s Gentz agrees. “I
who are underperforming or whose skills believe boards take this issue on with
no longer represent a good fit with the great vigor when they are faced with
strategic direction of the business. Forty- an imminent CEO change (planned or
nine percent cited the use of an age ceiling, otherwise). However, when not faced with
and 24 percent chose term limits as a means that urgency,” he explains, “boards tend to
to bring on new members (Figure 2). ‘theoretically’ deal with the issue, knowing
“Whatever the tool, boards should it is important but not wanting to delve
ensure they are having a regular dialogue into it in detail until necessary. Oftentimes
about whether the expertise and diversity this is to avoid creating concern for the
of perspective around the table reflects the incumbent.”
strategic vision for the organization,” says The survey also sought to find out more
Daum. about boards’ ongoing processes to plan for
Finally, in the area of board performance succession within the ranks of rising senior
and effectiveness, we surveyed directors’ management. Almost 60 percent indicated
views on director education. Nearly three their board has some type of formal process
fourths of those surveyed (73 percent) said to assess internal candidates, leaving nearly
they receive reimbursement for attending 4 in 10 that do not. In another finding, 68
an educational program they anticipate will percent indicated their company’s method
make them a more effective director. for benchmarking candidates against best-
in-class talent is at least somewhat effective,
Choosing company leaders nearly 20 percent admitted their efforts
Since this study’s inception in 2002, are not at all effective, and another 14
succession planning has continually percent were unsure. On an encouraging
topped the list of challenges for boards, note, nearly four fifths of those surveyed
and this year was no exception: 10 percent said their board reviews the company’s
of respondents said they were “poor” at CEO succession plan at least once a year,
this responsibility and another 26 percent and another 14 percent said they do so
said they were “adequate”—much lower whenever the need arises.
than other dimensions measured. Why, “By definition, internal candidates are not
year after year, is this so, we wondered? proven CEOs. To gain insights into whether
According to director Jim Hunt, boards a candidate is capable of moving into the
continue to grapple with CEO succession role, boards need to embrace an assessment
planning because they sincerely want to process that is fact based, rigorous, and
“get it right.” forward looking. It’s also important to
Interestingly, it’s long-term succession not lose sight of how an organization’s
that they lack confidence in—not short- internal talent compares to the best-in-
term. Fully 81 percent indicated that the class talent externally,” Daum explains.
company’s succession plan would proceed “Taking a look at external talent—through
without a hitch in the event their CEO research, informal or formal introductions,
was immediately unable to perform his or a search—can provide important insight
or her duties. While these findings might when assessing the readiness of potential
seem at odds, they more likely reflect the successors,” she adds. “This process is
distinction between an emergency plan critical to give the board a good sense of the

relative strength of the internal candidates, However, external forces to persuade

as measured against the outside talent pool boards to split the roles are often met with
that would likely be considered for the just as many compelling internal reasons
role.” to combine them. In the end, boards need
Another tough leadership decision to feel comfortable they are doing the right
boards have to face is whether to split thing for the company—and for the right
the chairman/CEO role, an issue that reasons. Director John Bagalay, the EuroUS
was elevated following the financial crisis Ventures executive, says that in past CEO
of 2008. In light of increasing investor searches in which he has been engaged,
pressure, it’s not surprising that 69 percent many CEO candidates have told him they
agree or strongly agree that splitting these would not take the job unless they were
roles results in more favorable proxy also made chairman. “I have never acceded
advisory recommendations; likewise, 64 to that request. The insistence on having
percent agree or strongly agree that doing both positions is a clear indication that the
so offers more independence of thought candidate doesn’t want an ‘intrusive’ board.
within board discussions, and 60 percent The separation of the two positions is unwise
affirm that it establishes more effective CEO only if it leads to board micromanagement.”
evaluations. Bagalay believes that separation is essential
in order to establish that the board has the
right and responsibility to be certain that
the company’s business strategy is given a
tough and challenging review.
Yet another thorny issue related to board
Figure 3 leadership emerges when a CEO steps down
and is subsequently offered the chairman’s
seat. Whether such appointments stem
IF YOU WERE AN from personal board loyalty or a desire
for continuity, the situation is far from
INCOMING CEO, ideal, governance experts say, because the
WOULD YOU WANT perception of influence from a past CEO
THE PAST CEO is usually too much to overcome. When
we asked respondents if, as a hypothetical
SERVING AS incoming CEO they would want the past
CHAIRMAN? CEO serving as chairman of the board, 82
percent resoundingly said no (Figure 3).
The common thread running through
YES these issues involves board independence
18% and effectiveness. While a good relationship

must exist between the board and senior
management to run a successful company,
NO there must also exist a healthy separation
82% for good decision-making at the board

level. Kasnet’s company has a separate
board chair and CEO, along with a lead
director who has fairly broad powers, and
he says the system works, but he also says
he would be against keeping a past CEO
on the board if it became a disincentive for
an incoming CEO. Hunt adds that while he

has observed situations where a new CEO after the 2013 proxy season, especially
could and would benefit from the departing in comparison to prior years. Forty-five
CEO either remaining in or stepping into percent of directors surveyed said their
the chairman role, he believes such matters board spent more time on say-on-pay in
are situational and require each board to 2013 than the previous year, and 24 percent
undergo a considered review to deliver the acknowledged receiving tougher scrutiny
best outcome for shareholders. from shareholders. On a positive note, fully
70 percent said their efforts to improve
Setting executive compensation shareholder communications paid off and
Since 2010, every public company has been termed 2013’s proxy season a smoother
through some level of angst related to experience.
Dodd-Frank–imposed legislation requiring Interestingly, when we asked if three
a shareholder advisory vote on executive years of say-on-pay had resulted in
pay. In year one, the fear of the unknown making executive pay more aligned with
created the lion’s share of work and worry, shareholders’ interests, only 21 percent
but most companies saw smoother roads of those surveyed agreed. Nearly two
in subsequent years. In this year’s survey, thirds (62 percent) said no, because, in
we wanted to see how companies fared their opinion, executive pay was not out of
alignment in the first place (Figure 4).
As a follow-up, we offered several
scenarios and asked which situation
would warrant a board making changes
to its executive compensation plan prior
Figure 4 to the company’s next say-on-pay vote.
Not surprisingly, we found that relative
company performance is the key. Fully 80
HAS SAY-ON-PAY percent of those surveyed said if executive
compensation were higher than peer level
RESULTED IN and the company was underperforming,
BETTER that would be reason to make changes; 52
ALIGNMENT WITH percent agreed even if compensation were
in line with peers. A much smaller group
SHAREHOLDERS’ (15 percent) said changes would be in order
INTERESTS? if compensation levels were higher than
those of peers even if the company was
hitting performance targets.
YES Wrapping up the compensation arena,
21% we asked for opinions about the new SEC

disclosure of CEO/median employee
pay ratios: 70 percent worry that such
NO
disclosure will result in a misleading
17% indicator, while nearly half believe it
will be costly and difficult to accurately
IT WASN’T OUT OF ALIGNMENT compile and report. Only 17 percent of
TO BEGIN WITH those surveyed believe it will provide
62%
meaningful information to investors. One
director echoed the comments of several
others, saying, “Regulators (SEC, PCAOB,
Dodd-Frank, etc.) are out of control with

oversee risk across the enterprise. As a

Figure 5 demonstration that boards are fulfilling
this role appropriately, 87 percent of those
surveyed affirmed that new strategic
WHAT WOULD objectives are reviewed by the full board
IMPROVE YOUR to ensure they align with the company’s
BOARD’S ABILITY risk appetite. But there is no denying the
job is an overwhelming one. In terms of
TO OVERSEE RISK? what would improve the board’s ability
to oversee risk, 44 percent of directors
MORE HIGHLIGHTS/FEWER said getting management reports with more
DETAILS IN REPORTS key highlights but fewer details would
44%
be helpful, while 29 percent said more
lead time to digest those reports would
be appreciated. However, some directors
BETTER UNDERSTANDING OF obviously feel overwhelmed and find the
HOW TO OVERSEE RISK process burdensome and a distraction. As
39%
one director put it, there is “too much ritual
risk management and too little emphasis on
generating shareholder value.”
A SEPARATE RISK COMMITTEE Meanwhile, 33 percent said the ability
33% to delegate risk to a separate committee

that could keep closer tabs would be
MORE TIME TO DIGEST REPORTS advantageous. Others, however, don’t agree
29% with this approach. “Risk oversight should

rest with the full board,” says Bagalay.
MORE DETAIL IN REPORTS “Every board member should understand
11% and accept that corporate risk oversight

is his or her special responsibility—that
REPLACING ONE OR MORE requires every board member to know and
BOARD MEMBERS understand company strategy and the risks
that go with it.” Kasnet says that while his
7% company established a risk management
committee early on and its function has
grown substantially, still “the subject is
discussed in great detail regularly in board
meetings.”
Interestingly, nearly 40 percent of those
new policies that are very costly and often surveyed agreed they could do a better
do not improve governance.” Another job at risk oversight if they had a better
added, “Governance changes have become understanding of how to do so (Figure
more publicized, but the end results have 5). Hot spots crop up all the time, and
not dramatically changed overall operating even traditional risk areas are often murky.
results [which are] a function of operating For example, 20 percent of respondents
efficiencies as well as good governance.” said they are not confident in directors’
understanding of the many facets of IT risk,
Managing risk one of the most elusive new risk areas for
Of paramount importance year after companies today.
year is the board’s responsibility to

“Our board has put a strong focus on

Figure 6 discussing our strategic plan with more
regularity. We have a number of board
members aging out over the next five years,
TOP FIVE TOPICS which will create a nice opportunity to
MOST RELEVANT bring in fresh blood and some different
TO YOUR NEXT skill sets.”
Accordingly, 81 percent of directors
BOARD MEETING we surveyed chose strategic planning
as a top agenda item—the most popular
response, followed by M&A opportunities
STRATEGIC PLANNING (61 percent), succession (47 percent),
81%
M&A
global business strategy (42 percent), and
IT strategy (38 percent) (Figure 6). One
director who commented on the survey
noted, “Boards need more experience from
61% members who have private equity or other

similar experience to assist the board in
CEO SUCCESSION matters of M&A and activism. I believe
this is a missing component of board
47% composition.”
“There is no question in my mind that
GLOBAL STRATEGY
boards have gotten significantly more
42% effective at performing their duties over the
last 10 years, even though we still see some
IT STRATEGY
repetitive negative trends associated with
38% risk and CEO succession duties,” Kerstetter
of Corporate Board Member notes. “More
and more, boards are understanding and
embracing the need for effective board
leadership, which should result in more
confidence in boards’ abilities to perform
effectively in all areas of governance.” In
Thinking strategically the end, he continues, overseeing risk and
In addition to overseeing compensation and selecting/retaining the right CEO are two
risk and finding the right company leaders, of the most fundamental duties a board
board members must keep profitability and of directors must administer. “My hope is
increasing shareholder value in their cross- that we will see that confidence reflected in
hairs. Without meeting these goals, all the future director opinion surveys.”
others hold little value. Therefore the board’s
role in shepherding strategic planning for Looking ahead
future growth is imperative, particularly in In all, directors this year appear to be
an environment where competitive change laser-focused on ways they can help their
happens quickly. Bagalay noted that this companies grow and prosper in the year
is another good reason for refreshing the ahead and are working to better understand
board: “The danger of strategic direction and come to grips with the battery of risk
stagnation dictates the need for orderly and elements that continue to make the job
predictable change in board composition.” more challenging. In doing so, they are
Another survey respondent agreed, saying, on track to ensure that their boards are

operating as effectively as possible and as well as to thank the nearly 600 directors
have the requisite skill sets to ask the right who took the time to respond to our
questions and stay ahead of the risk curve. survey and to those who offered additional
Corporate Board Member would like to comments and perspectives to this year’s
thank Spencer Stuart for supporting and findings. For a full copy of the results, visit
sponsoring this important annual research www.boardmember.com/WDT2014.

7B Growing goodness, Annie’s way
Deborah Scally, Editor and Director of Research NYSE Governance Services
F
or investors who nabbed the offering of 950,000 shares of
common stock at $19 a share in March 2012, Annie’s has
certainly made good on its tagline “Growing Goodness.”
In the 18 months since its IPO, the Berkeley, California-based
company, trading as BNNY on the NYSE big board, has performed
extraordinarily well. In fact, it jumped 89 percent on its first day
of trading, making it the best first-day IPO performance since
LinkedIn the year before. Moreover, since its initial catapult, the
stock has chugged steadily upward, closing at around $49 at the
current time.
Annie’s is one of the new breed of company whose mission
reaches beyond its P&L, thus creating tremendous brand loyalty
and positive messaging. Despite an unabashedly cute persona—
its ubiquitous bunny logo can’t help but draw a smile—Annie’s
performance is anything but lightweight. Boasting substantial
investment and managerial talent behind the scenes for more than
a decade, Annie’s has successfully transformed itself from a quiet,
niche organic and natural food company to a big league player.
Working hand-in-glove, CEO John M. Foraker and board chair
Molly Ashby are largely responsible for this evolution. Bringing
the gravitas of 16 years as JP Morgan Capital’s chief investment
strategist where, among other things, Ashby was a key member
of the team that organized the $5.1 billion leveraged buyout
of HCA Holdings, this mother of two has been instrumental
in Annie’s growth and progress since 2002. Ashby’s interest
in developing and funding companies she sees as worthwhile
stems from the founding philosophy of her own investment
management company, Solera Capital, which she launched in
1999 and serves as CEO. Simply stated, Solera’s philosophy is to
identify and invest in modern companies that bolster the values
Ashby and her colleagues stand for: sustainability, diversity, and
responsibility. Thus, two key ingredients—Solera’s capital injection
plus the untapped growth potential of the organic and natural food
market—have created the perfect recipe for Annie’s success. Over
the course of its 10 years of ownership, Solera invested $81 million
in Annie’s, an investment that multiplied roughly six-fold at the

Growing goodness, Annie’s way NYSE Governance Services
time of the IPO in 2012. Today, Annie’s growth we saw in the organic and natural
enjoys a market capitalization of more than space. It was intriguing to us that there
$830 million. were few companies of size and scale in
Since 2002, the Annie’s team has worked that space. We also believed that, while the
to push its products out of the dusty growth itself was strong, there would be
organic and natural food shelf to take their an acceleration of growth coming from the
rightful place in the mainstream market. distribution of natural and organic [foods]
To make this a reality, management and in mainstream channels. What was also
the board realized wider backing would be very important to us, as it is in all of our
necessary, so for the last two years, Ashby companies, was a very strong alignment
has overseen a calm and ordered private- with the founder and the leadership team as
to-public transformation, facing head-on well as with the values and the mission of
the opportunities as well as challenges the company. At Solera, we’re really hands
that come with running a publicly-traded on, we’re operations focused, and we take
company. Shortly after the announcement long views on sectors, but we are centered
of its positive Q1 2014 financial results, as on a mission and a core set of values that
well as an announcement the company was are really important to us. We just found
expanding its presence with family entrees, outstanding alignment with Annie’s on all
Corporate Board Member interviewed Ashby those fronts.
about her experiences and her perspective
in the rearview mirror to offer proverbial So you first came aboard Annie’s as a director
food for thought to others who may be in 2002 and then took over the chairmanship
considering a similar path. in 2004. Turning to the relationship you have
with the leadership and company today,
Molly, we’d like to talk about your experience you and CEO John Foraker have both been
navigating Annie’s through its post-IPO first there for more than a decade, yet the rest of
year, but it might help set the stage for you to the board members are relatively new by
tell us about your principal company, Solera comparison. Was there a concerted effort
Capital, and how it came to take a major stake to recraft the board to meet the challenges
in Annie’s more than a decade ago. ahead as you looked at going public?
Certainly. Solera is a growth investor, and its Yes. The long-term advanced planning for
focus and mission is to identify and to work this kind of undertaking is really important,
closely with companies in sectors we believe so as part of that process you determine
have really strong growth prospects— what an optimal board of directors would
those that are well positioned for the long look like—the experience, expertise, skill,
term. We bring a lot of capital, focus, and etc. needed, because the requirements of a
operating expertise into the building of our public company are different than those of
companies. So, by way of background, we a private company. We began a good, strong
have Annie’s in the organic and natural dialogue with several prospective board
sector, we also have a company, Latina, members with that in mind and began that
in the Latin space, an affordable luxury process significantly ahead of the IPO.
company called Calypso—all of which are
in sectors we believe have exceptional, long- How did you approach that task? That’s a big
term prospects. We also built a consumer undertaking, even outside of all the details
health-care company called The Little Clinic related to the IPO mechanics, financing,
from two to more than 100 clinics before regulations, and so forth.
selling it to our partner The Kroger Co. in Specifically, we looked at potential directors
2010. who had served on large, public companies
Specifically, we made our acquisition because we knew Annie’s was growing
of Annie’s in 2002 because we loved the rapidly, and that experience would be

NYSE Governance Services Growing goodness, Annie’s way
tremendously valuable. We also looked for accounting firms, prospective underwriters,

experience in specific functional areas, such and the organization, at a deep level, were
as finance, audit, consumer products, and IT. all aligned on the requirements of being
We looked specifically at how the members public and were starting to think through
would complement each other from a skill and create a really thoughtful timeline. You
set standpoint, as well as generally. It was could perhaps do it quicker than a year,
important that our directors had expertise depending on the company, but for us it was
that our management team would be able more than a year. And during that period we
to draw on in important functional areas. continued to evaluate going public versus
So we were really building a matrix as we other strategies.
went along. And then, for us at Annie’s,
an extremely important overlay was strong So as you stepped back and made those
alignment with our values, our mission, and assessments, how did you really know when
our approach, which is what we look for in the time was right? What turned that light
all our companies. green?
We considered the readiness of governance,
That’s a lot of things to put in that matrix. legal, the management team, and the
It is. And we are continually building depth of reporting capabilities within the
and growing and developing our board, company.
because we want the board to gel—to
work well together, to have the right set What good advice did you get that helped
of complementary skills, to be aligned on you and the Annie’s team move through the
mission and values, and provide exceptional transition from private to public?
oversight and assistance to management. One piece of excellent advice was to start
behaving as if we were a public company
I can appreciate the amount of effort that’s before we were actually out in the public
gone into that thus far. How have you arena. This helped us refine the way we
evaluated the board since the IPO? did things and made judgments about our
A good public board is like a living, breathing degree of readiness.
organism. And so it’s important to look at
the evolving needs of the company and So it sounds like you had a good process
whether the board is positioned to address for gauging your readiness and laid your
those needs. You need to be asking these groundwork well in advance of the initial
questions: How are we doing? Do we have public offering. Were there any surprises
all the skills we need? Are we the right size? this past year? Things that were perhaps
Have we got all the committee alignments either easier than you expected or more
right? There’s an ongoing process of self- challenging?
evaluation. I would say that you get a lot of good
advice, but still the IPO experience is eye
So in terms of laying the groundwork for the opening. Amassing the resources needed to
IPO, how early did you start? be public—human resources, adviser teams,
It was more than a year. We knew if we in-house teams, and systems and processes
wanted to seriously entertain going public, to communicate and engage thoroughly and
we needed to do a great deal of planning and thoughtfully with shareholders—is a big
have access to good advice. We gave ourselves issue. We think of our shareholders as our
lead time to make sure the company was public investment partners, so the resources,
ready and we had the right team in place—at time, and focus we put into our relationships
both the board and management levels— with our investors is huge. This is perhaps
and had all our processes lined up. John the single greatest distinction moving from
and I needed to ensure that our lawyers, the private to the public arena.

Growing goodness, Annie’s way NYSE Governance Services
Indeed, and the tide can change quickly, and hard in preparation, and because John and
sometimes in reaction to external things that I and the board all had confidence in the
are not in your control. business and in the team’s readiness. In
Yes, management and the board need to addition, we felt very strongly that it was
work together to make sure enough thought, important for this kind of company to go
support, people, and resources are being public and to show that Annie’s mission and
applied in this area. values were truly enabling to the business.
It was very important and powerful and
So touching on this important aspect of energizing for us to think that if you could
investor relations and shareholder activism, take this company public, you could really
we’ve seen a groundswell of investor demonstrate that you can be true to your
interest in recent years in corporate social values and produce results that translate
responsibility, which is something that is into long-term shareholder value.
ingrained in the fabric of Annie’s and has
been for years. Have you felt any tension It must be tremendously gratifying to feel
thus far in trying to balance a philosophy of that all those things are firing in sync.
social responsibility and the pressure to meet Yes, and while we are proud that the IPO
investor performance expectations? has been a success, John and I and the
No, and I know [Annie’s CEO] John Foraker entire Annie’s board hope and believe that
and I share the same perspective here. We our success shows that public shareholders
saw the public offering as a wonderful way appreciate how values can truly be enabling
to enable others to share in the growth of a from a financial standpoint.
business we felt really strongly about. We (From Corporate Board Member, 2013 4Q:
were able to do it because we had worked 20–25.)

7C How sweet it is! One-on-one
with Jim Nevels
D
escribing his role at The Hershey Company as the “first
among equals,” Chairman Jim Nevels has a lot to smile
about as he leads the board of one of the world’s most
respected confectionery empires. Nevels has a sweet job—
literally. As chairman of The Hershey Company, Nevels oversees
the governance of one of the best-known and beloved brands
in the country. It’s practically impossible to think of Hershey’s
mouthwatering chocolate and not grin. But that brand speaks to
more than simply good taste. Hershey’s long-standing tradition
of philanthropy is in its genes—a side of the company Nevels has
long been associated with through his day job at The Swarthmore
Group, an institutional investment advisory firm, as well as
his tenure on the board of directors of The Hershey Company.
Corporate Board Member recently interviewed Nevels about what
makes Hershey’s culture, approach to business, and outlook so
successful and unique.
Can you begin by sharing some background on The Hershey Company?

It is certainly a unique corporate model in terms of its history and
ownership structure.
The greatest confectionery company in the world, The Hershey
Company was founded by a visionary and an extraordinary man
named Milton Hershey more than a century ago in 1894. During
the course of this incredible history, Mr. Hershey persevered and
became a successful entrepreneur and a philanthropist who, with
his wife in 1910, established a cost-free, private school for orphaned
children, The Hershey Industrial School, now known as the Milton
Hershey School. He left Milton Hershey Trust an established legacy
that included a controlling interest in The Hershey Company. The
Milton Hershey Trust has a 30 percent financial interest in the
company, but by virtue of dual-class stock, voting control is held by
Hershey Trust Company. The Hershey Company has had 13 CEOs,
and the relationship with Hershey Trust Company has been very
good. There is no divergence whatsoever between Hershey Trust
Company, as the controlling shareholder, and all other shareholders,

How sweet it is! One-on-one with Jim Nevels NYSE Governance Services
because Hershey Trust Company acts for the along with his global leadership team, and
benefit of all shareholders. the roughly 13,000 employees that comprise
our Hershey family. So in his tenure, we’ve
How and when did you become involved seen dramatic growth, enhanced capacity,
with The Hershey Company? and capability.
My background as a lawyer and as an At The Hershey Company we have the
institutional asset manager of The most advanced confectionery manufacturing
Swarthmore Group, which I founded 21 facilities in the world, one of which produces
years ago, were experiences that contributed 72 million Hershey Kisses 24/7! It’s an
to my invitation to join the board of directors incredible facility, and there is no doubt that
of Hershey Trust Company in 2007. Then in Mr. Hershey would be extremely proud.
2008, I had the singular honor and humbling So we are continuing to execute on the
opportunity to be elected to the board of fundamentals, and we are doing so around
directors of The Hershey Company; and an expansiveness of these three corporate
a year later, I was elected by the board to objectives for which management and the
be its chairman, and I continue to serve as board have reached a consensus.
chairman today.
Talk to us a little bit about the board culture
What have been the major business objectives at Hershey and the directors’ working
during your chairmanship? relationship with management.
Since 2009, management of The Hershey Our CEO is a member of management who
Company and the board of directors have also serves on the company’s board. The
focused on three corporate objectives, the remaining nine directors are all independent
first of which is to strengthen and fortify directors.
North American operations. Historically, The The board dynamics are consensual.
Hershey Company has been a predominantly In terms of board leadership, I have a
North American–centric company, and the fundamental belief that consensus is
goal is to focus on the core business, which ultimately desired, and 99 percent of the time,
is geographically North America. So that is that’s the way this board operates. I’m also a
the first outcome. firm believer in allowing committees to do
Second, in 2009 there was consensus their work. We have a governance committee,
between management and the board that an audit committee, a compensation and
a second matter of importance should be executive organization committee, and a
succession planning. Not just in respect finance and risk management committee.
to the C-suite, but succession planning We also have a fundamental belief that
stem to stern. There are employees in the every board member shares responsibility
manufacturing facilities who have long for good governance and corporate social
tenures with the company, and literally, responsibility. We don’t have a separate
when they leave the confines of a particular committee to address corporate social
manufacturing facility, a tremendous issues; however, the company has made
amount of resources and assets are leaving great contributions and accomplished some
the company as well. So how do you go amazing things with respect to corporate
about imbuing the culture of a company social responsibilities, for which the board
by means of succession planning? This is of directors and senior management are very
something that we’ve been working on very proud.
studiously. Another key ingredient is the recognition
The third matter is enhancing the of a line of equilibrium between governance
company’s international footprint. We have and management. Let’s assume we’re
seen the market recognize the abilities of our standing at a chalkboard, and you draw a
extraordinarily capable CEO, J.P. Bilbrey, line across the middle of the chalkboard.

NYSE Governance Services How sweet it is! One-on-one with Jim Nevels
Above the line is governance; below roughly $180 million in dividends flow to
the line is management. There are times the Milton Hershey School. So we have
when that horizontal line moves up and a very interesting juxtaposition in which
down and results in a situation where, in the company takes care of children here in
fact, management may be in the role of Hershey, but we never want to do so at the
governance, and there are times when that expense of children elsewhere. And, so that
line moves the other way, and the talents of is one of those paradoxes of which we’re very
the board are such that they can serve as able aware and which we take very seriously—it
consiglieri or able advisers to management. is in the fiber of this great company.
But management has the final call and must Remember, corporate social responsibility
execute the objectives and maintain good was practiced some 100 years ago when
governance standards. So that is the perfect Milton Hershey started his philanthropy,
example of the collaboration above the line so it’s in our DNA. Our employees adopt a
and below the line. group home at the school, for example, and
contribute in many other wonderful ways.
You once referred to the chairman’s job as So back to the issues we have confronted,
being a “first among equals.” Can you tell us during the company’s recent annual meeting
what you mean by that? of stockholders, the board was very placid,
Certainly. What I mean by that is the but also very dynamic in that there was
chairman leads through serving and the tremendous focus on the progress of the
chair is the prism through which the will company, its financial success, and also on
of the board is reflected. This requires what the company is doing with respect
the chairman to be very studious about to corporate social responsibility. We were
collaboration and consulting with the board selected to be represented on the prestigious
on an ongoing, consistent basis. The chair is Dow Jones Sustainability Index in 2012.
the living, breathing symbol of the board. We were also ranked among America’s
“First among equals” means exactly that— 100 Best Corporate Citizens by Corporate
that by virtue of the consent that is earned Responsibility Magazine in 2013. In the 2012
from the body politic called the board, and Newsweek Green Rankings, we moved up
those constituent members, they consent to 172 spots overall, and to No. 7 in the food
the position and the conduct of the chair. and beverage peer set, up from No. 20 in
And if you take that point of view, the chair 2011.
must reflect the body called the board. The In addition, there’s the Bloomberg Civic 50,
chair doesn’t have a super vote and cannot where we were ranked No. 29 for the “most
do things by fiat, but rather by persuasion. community-minded companies” in America.
That’s philosophically the way in which I Hershey was the only confectionery
believe the chair should interact with and company and the second-highest ranking
lead the board. CPG (consumer-packed goods) company
on this year’s list. Then there’s the Carbon
What are some of the more interesting Disclosure Report, where we improved our
shareholder issues that the Hershey board carbon disclosure score from 67 in 2011 to
has had to deal with? 80 in 2012. With regard to our corporate
Well, a few years ago I had the honor of social responsibility reporting, the latest full
taking a trip to Ghana, one of the cocoa- CSR report [issued in 2012] is available, and
growing regions, the very genesis of the we’ve been lauded for the transparency level
supply chain for the confectionery delight of that report. So the social issues are front of
called “chocolate.” It was very enlightening mind for Hershey, along with the maxim of
and interesting because we heard a lot about “doing well by doing good,” which was the
the issues of child labor and sustainability. mantra of our great founder that is instilled
Remember, this is a company in which in all of us.

How sweet it is! One-on-one with Jim Nevels NYSE Governance Services
That is a lot of positive recognition in You bet, and therein lies the other element.
recent years. Did something internally at The board [made a good decision to establish]
Hershey propel increased attention to social a finance and risk management committee in
responsibility and sustainability issues? 2009, in which finance and risk management
I think these issues have fully evolved into functions were separated from functions
front-of-mind issues with management and of the audit committee (given the bone-
also within the priority of strengthening crushing workload that the audit committee
and fortifying North American operations. bears). [This was especially prudent] given
So they fall within that purview. Likewise the liability, as well as the opportunity
they fall within the purview of increasing it provides to enhance the internal audit
our international footprint. We must function as we expand abroad. When you
“do well by doing good” in all of our look at all the work that audit has to do,
geographies. enterprise risk is a very serious business and
being attentive to those issues will keep a
Turning to the international priority you group of very talented people on the board
mentioned, what have been some of the rather occupied.
challenges for Hershey, a company that
has had a very rich, domestic history in One of the hot topics from investors lately
Pennsylvania for so many years? is the push toward having a separate CEO
and chairman, which Hershey already has
It is quite difficult, but we’re doing it
in place. Do you believe that is the proper
prudently and deliberately. Our CEO, J.P.
structure as a standard of governance?
Bilbrey, says it best: “We will do it at a
measured pace.” And that is precisely what The Hershey Company has utilized both
we’re doing. We’ve had the good fortune structures from time to time, and certain
to acquire a company in Canada called situations can dictate a separation of these
Brookside Foods, and to date, the integration positions. I frankly believe there is little
of this company has been successful. Our difference between the role of the lead
footprint in Mexico and into South America director and the non-executive chair. As to
puts us in a wonderful position to be the my personal opinion in respect to that, I have
candy company of the Americas from the to answer: It depends. I think there are times
Hudson Bay to the Straits of Magellan. that absolutely warrant the two (positions)
As you may know, this has been a very being one person, and then I think there are
interesting period recently for us in that other times when it does not, and in that
we introduced our first global brand, regard, it will depend on the collective facts
Lancaster (named after Mr. Hershey’s and circumstances. I will say this: When the
hometown), which will be sold outside the CEO and chair roles are separate, it is the role
United States, in China. The board made and function to manage the board and to be
a historic trip last October and held a the prism through which the board’s views
board meeting in Shanghai. In addition, are reflected and to be a wise counselor to
we opened an international research and the CEO. That’s essentially my role.
development center in Shanghai. This has
You mentioned that there have been 13 CEOs
been an incredible statement to both the
in Hershey’s history. How does the board
enterprise and, quite frankly, the world, that
approach succession planning?
the company is very serious about creating
an international footprint. Succession planning is one of the corporate
focus points that the board believes is very
I am sure these new global initiatives also important. J.P. Bilbrey has been charged
introduce new risks as well. Has overseeing to move forward with this focus and has
FCPA risk and compliance become a critical cultivated a number of potential successors
issue for the board? internally. He is giving the board full view

NYSE Governance Services How sweet it is! One-on-one with Jim Nevels
of how those people conduct themselves, Yes, and one of the things that is so unique
though, of course, his successor may not about this company as a brand is this: As
be within the company today. He has been a student of business and as a lawyer, I
very studious about giving the board the oftentimes wondered when I looked at a
opportunity to see the fulsome talent at this balance sheet: “What does the term goodwill
great company. mean?” After serving on The Hershey
Company board of directors, I now have a
So you have put the responsibility to cultivate better understanding. It is that look on an
talent on him? individual’s face when I say, “Hershey”—
Yes, and the board’s charge falls with its because invariably, they smile! Now that’s
compensation and executive organization goodwill.
committee. And that’s where the review
of the organization falls. The very capable Indeed! I’m smiling right now.
chairman of this committee, Robert Right. This is really illustrative of what
Cavanaugh, has the longest tenure on the goodwill is, and it’s also illustrative of our
board, and he’s also a graduate of the Milton company’s values, which encompasses
Hershey School. goodwill to children, families, and (the
public’s) happiness. And we’re all here—the
Jim, it sounds like you have an enlightened board, J.P., the global leadership team, and
board and a relationship with management the 13,000 dedicated employees—that’s the
that is based on mutual respect. Add that to reason we come to work.
being in the business of making something (From Corporate Board Member, 2013 3Q:
that people love, and it must make this job an 34–42.)
enjoyable endeavor.

7D A new frontier: one-on-one
with Maggie Wilderotter
M
aggie Wilderotter, chairman and CEO of Frontier
Communications Corp., has a full agenda for 2012. To
start, she must oversee the telecom as it digests its 14-state
acquisition of Verizon and do so amid headwinds that aren’t
likely to abate in the near future. But Wilderotter’s moxie and
endurance are firmly ingrained, and she has no intention of
swaying off course. Corporate Board Member caught up with
Wilderotter, also a director on the Procter & Gamble and Xerox
boards, just moments before a Frontier board meeting and asked
about the company’s boardroom dynamic, her leadership style,
succession planning, and what’s in store in the months ahead.
To begin, let’s talk about the relationship you have with the board at
Frontier. How would you describe the boardroom dynamic? As both
the chairman and CEO, what keys have you found to maintaining good
communications with your lead director and the rest of the board?
It’s a great question. I would say, first, when I think about the
Frontier board and I think about the dynamic, it’s a very healthy
environment. The board is active. [Directors are] participatory. They
are passionate about the business. They are diverse in who they
are and their experience. So they bring a lot to the table. And we
have structured our board meetings where it’s about discussion
and decision-making, not about download. So we don’t spend a lot
of time on PowerPoint presentations. If there’s a thought-starter,
it might be one or two slides, but that’s it. So we take topics and
we go deep in a discussion and debate environment from a board
perspective to really help the company make better decisions. So I
would say the dynamic is very healthy.
As for my communication style, I’m a very proactive communicator
with our board in between meetings. I send out e-mails probably three
or four times a month on different activities that are taking place
within the company that are informative for the board to keep them
abreast of what’s happening, as well as any key critical updates on
the business. I also usually reach out by phone once a quarter to
each board member. And if I have a specific topic that we’re going to
discuss at the board meeting that I want them thinking about ahead

NYSE Governance Services A new frontier: one-on-one with Maggie Wilderotter
of time, I’ll do a personal phone call to each the [matched] board member gets together
of them to sort of give them a framework of three to four times a year with that senior
what I’m thinking about, so when we get executive, off cycle of a board meeting. It’s
together, there’s good discussion and it’s not usually for a meal, so it’s more of a casual
cold for them. setting. It allows them to get to know each
other, [for the director] to understand the
It’s interesting that you call each of them senior leader’s perspective and thoughts
individually. Do you feel like that allows about the company, as well as what [the
them to express a reaction or a view to you executive is] personally working on and
that perhaps they’d be less than willing to what his or her career aspirations are. It lets
talk about in the full group? the board member provide insights as to
Well, that could be, but that’s not the reason what’s important to the board and where
for it. I just think that every board member the company is headed strategically. Then
processes information differently. I do it out when I do a succession plan review of our
of respect to give them all the opportunity, top people once a year with the board,
maybe not just for first reaction, but also each mentor on the board partners with me
to ask me questions that would give them on each of those senior leaders to discuss
better insight to have them think about the opportunities for that leader and the
it. That’s really the whole genesis of that succession opportunities in the company.
approach. And I don’t just call two or three.
I call all of them. That sounds like a very productive board
development program.
I assume that part of this approach is because It is. And I’m not involved in any of those
you can put yourself in that position, since [prior] discussions, so it’s really between my
you are also a director sitting on the other senior leadership and the board members.
side of that conversation on other public And it’s also nice because since we’ve had
company boards? it in place for several years, we’ve actually
Correct. Because I do sit on the Procter rotated senior leaders through a couple
& Gamble and Xerox boards as well, I different board members. So my goal over a
understand the role of the CEO versus the five- to 10-year window is to get each board
role of a board member. And as a CEO member to know, pretty intimately, three or
[sitting as a director on another board], you four members of the senior leadership team.
don’t want to jump in and try to help the I think the board members enjoy it a lot, as
other CEO be the CEO. You want to make do the senior leaders. It’s a win-win all the
sure you maintain the right role based upon way around.
the position you’re in.
Succession planning is always one of the
I know when you appeared on Corporate most challenging aspects we hear about from
Board Member’s [Oct. 20] webcast “This board members. Does Frontier have any other
Week in the Boardroom,” you mentioned initiatives in place with regard to succession
Frontier’s board mentoring program. Can planning and development?
you explain a little about how that works and Yes, I do a three- to four-hour session every
why you think it’s valuable? year with my board strictly on succession
We’ve had the program since 2005, so it’s planning where I take them through the top
been in place a fairly long period of time. I 20 people in the company. We call it “Two
look at it as part of succession planning for Great Candidates,” in which I take them
the company. I take the top 10 to 12 company through the two successor candidates for
officers and match them with different each of those jobs in the company. So they
board members for a two-year rotation get exposure throughout the rest of the year
program. During that two-year window, to the potential candidates for those jobs in

A new frontier: one-on-one with Maggie Wilderotter NYSE Governance Services
addition to understanding the capabilities of kids, raising money for different charities.
the folks who are in those positions and their That gave us a good balance, I think, for
next steps as well. being successful later in life in the C-suite
and the boardroom.
We also wanted to talk a bit about the topic of
boardroom diversity. It must feel good when On a broader scale, in your opinion, what else
you and your sister [Denise Morrison, CEO should corporate America be doing to further
of Campbell Soup Co.] are characterized as move the needle toward a more diverse
role models who embody the best qualities executive suite and boardroom?
of successful women today. How did your With regard to what companies can do to
upbringing affect the business success you move diversity forward, I think it starts with
and your sister have enjoyed? the tone at the top. The CEO of the company
From an upbringing perspective, I think has to make this a priority and not just talk
one of the great things our parents taught about it, but put actions in place in those
my sister and me was that if you get a great companies by putting women in senior roles
education and work hard for what you want, and by taking risks and chances on up-and-
you can do anything you want to do. They coming women in the organization for high-
built a lot of confidence for us at an early age, profile positions. I also think the CEO has
and I do think that is a big issue with a lot to make sure the pipeline is strong from the
of women, because they don’t come across hiring of entry-level women and moving
self-confident. They often come across more them up through mid-management and into
deferential in how they portray themselves senior-level roles, so you have a constant
in the business world. And as we all know, pipeline of diversity. And, I think CEOs also
our male counterparts don’t know anything have to look at the makeup of their boards to
but confidence. So I think that is a big gift make sure their boards are reflective of the
my folks gave Denise and me early on in customers they serve.
our lives. In addition, my father brought the
business world into the dining room every Right, and that makes perfect sense, but
night, so we talked about what he was doing it does not yet reflect the vast majority of
in business. He shared the different activities boardrooms across corporate America.
he did. He even took us to work with him in I sit on three public company boards, and
the 1970s before it was cool to do that. all of them have four or more women. So
they are very diverse boards. My board,
What was his profession? in particular, is quite diverse, and I think
He worked for the telephone company—for when you get what I call a mass of two to
AT&T and Cincinnati Bell. three women on a board, it does change the
dynamics in the boardroom for the better,
Oh, how interesting for you, now that you are because I do think that critical mass really
heading up a telecom yourself. helps bring more of a balanced approach to
Yes, exactly! So he sort of opened up the the decision-making.
business world to us so it wasn’t a big
mystery. And my mom was one of the top Speaking of tough decision-making, I know
real estate agents in New Jersey. She worked you’ve been reporting quite a bit lately about
part-time, but was very accomplished at Frontier’s 2010 acquisition of Verizon’s local
what she did. So I think [we were motivated wireline operations in 14 states in 2010. You’ve
by the] combination of education, a focus been saying that in general, the progress
on delivering results (we had to do business reports are very good, the integration is going
plans if we wanted to buy anything), and very well, and your cost-saving synergies are
giving back to the community. We did a lot right on track or even ahead of schedule. Is
of community service work when we were all of that still the case?

NYSE Governance Services A new frontier: one-on-one with Maggie Wilderotter
I think you’ve got to consider that we tripled more on some quick hits on the revenue side
the size of the company 15 months ago, so we earlier, versus just building for the long-term
are still swallowing the whale, as they say. foundation for revenue. Hindsight is always
We are making great progress. Every month, 20/20, but I think you have to recognize the
we improve the metrics of the company. dynamic of the market you’re in, in addition
Integration and cost synergies are ahead of to the dynamic of the company. Our board
plan. And we have said since the beginning is very supportive of what we’re doing. This
that fourth quarter 2011 and into 2012 is when was a big, courageous step for the board
the revenue line would start to turn. As you to take 15 months ago, because we had the
implement different programs and you get option to sell the company at the time. So we
broadband builds, what follows, usually at a chose the longer journey that would deliver
six-month lag, is the building of the revenue more shareholder value. We still feel that
side. I still feel very strongly that’s the case— way. There’s been no change in our thinking
that we will see it turn, and it will continue from that perspective. But it’s a journey. We
to improve on a trend-line basis through said it would take through 2013 to get all of
2012. And I think that’s one of the big things the integration done and to really get the
the Street is still waiting to see. I think they company humming on all cylinders, and
feel very good that we’ve done a good job we are still, with our heads down, following
on integration, on synergies, but we haven’t that path.
really proven the case on the revenue line yet.
The ironic thing is, when you’re in a market But it’s a difficult thing, isn’t it, to take that
where there’s a lot of volatility, like we are courageous step and then tell your story,
today, it’s, in many ways, a fear-based market. emphasizing that the benefits will show up
So you don’t get the same runway that you in the long term?
would get when the economy is good. Correct. And you want to build sustainable
businesses. This is not short term. This
Undergoing something like this is a huge is long term. We’re a hundred-year-old
undertaking from the board’s perspective to company, so transforming every 25 years is
ensure that an acquisition of this magnitude not unusual for our industry. But as a CEO
meets, or exceeds, shareholders’ expectations. and as a board, you have to have thick skin.
What steps have you and the board taken You’re going to have to deal with noise in the
to keep shareholders informed of the deal’s system as you get there. And you talk about
progress and its performance, and can you that esoterically, about the noise that you’re
share any challenges or lessons learned along going to get hit with, but it’s not until you
the way for other boards that are considering get the noise that you really realize what the
an acquisition strategy in the year ahead? noise is.
My CFO and I are very proactive with
our shareholders. Just in the last couple Well, from all indications, things appear to
of weeks, I’ve spoken to all 20 of our top be moving ahead, and we wish you the best
holders to keep them informed on how we’re on that front. So in closing, what thoughts do
doing, and we attend a lot of conferences. you have about the upcoming proxy season
We do a lot of outreach with our analysts as for Frontier? Are there any particular issues
well as our investors. But I also think, and you feel will “create noise” for your company
we remind them all the time of this, we’re this year? What is the Frontier board doing
staying the course; we haven’t changed the to prepare for its upcoming annual meeting?
story. But there’s an impatience, and there’s I would say it’s pretty much staying the
a worry about whether the story will have course on a number of the governance issues
the happy ending that everybody thinks that have already been on the table over the
it should have. In looking at this again, I last year or so. I think the say-on-pay issue
think we probably should have focused will continue to evolve.

A new frontier: one-on-one with Maggie Wilderotter NYSE Governance Services
I do think there is a lot more emphasis With regard to the chairman and CEO role
on the rigor the board goes through on separation issue, it appears to have worked
executive compensation, and we will see well in your situation. I’m assuming
more companies moving into performance- Frontier’s board has been very supportive of
based comp. I think that’s a trend we will the current structure.
continue to see, and it’s one we’re spending Yes, it has. We’ve been candid, and we’ve
a lot of time on with our board, making talked about it. And if there’s a decision at
sure you have not just base salary and some point to separate those roles, we will
annual bonus, but also long-term incentive do it for the right reason, for shareholder
compensation. That is becoming more the value. I’m very active with our board,
majority in terms of how executives get paid though it’s not me who dictates the agenda;
versus just short term. So I think that’s a big it’s a collective agenda. I think the directors
issue. feel they have the right access and input
I also think you’ll continue to hear noise to set the agenda and don’t really need
in the system about separating chairman to change out the chairman leadership to
and CEO roles, and the pros and cons of change that dynamic. We also have a very
that. I don’t think there’s a consensus on active lead director who’s proactive with me,
whether you do it one way or the other. I and I am with him, so I think that makes a
think it’s situational based on the company difference on the governance side. And I’ll
and the board. So, I’m not sure how much also say with both Procter & Gamble and
change we’ll see this year, but there could Xerox, the CEO is also the chairman of those
be some changes with different companies companies as well, and I don’t foresee that
on that subject as well. Other than that, being changed in either of those companies
we’re not really hearing a lot in terms of at this point.
shareholder proposals or upcoming issues (From Corporate Board Member, 2012 1Q:
that are happening on the governance front. 28–34.)

Part II
The composition and structure
of the board
nyse.com/cgguide
8 Building a balanced board
Julie Hembrock Daum, North American Leader, Board Practice Spencer Stuart
A
key function of a corporate board of directors is to shape
and guide its company’s strategy over the long term and
encourage company management to take a similarly long
view when thinking about market challenges and opportunities on
the horizon. In our experience, the best boards regularly evaluate
their company’s strategy, in light of new market developments
and competitive threats. But what about boards themselves?
Board composition lies at the heart of board effectiveness.
Progressive boards should continually consider whether they have
the optimum composition that reflects the strategic priorities of
the business and the diversity of stakeholders. The need for careful
planning of board succession is greater today in light of aging boards,
pressure from rating agencies, governance watchdogs and regulators,
and the demand for a broader set of skills to support changes in
company strategies in a fast-changing world. All boards, from major
corporations to nonprofit organizations, need to demonstrate their
willingness to evolve if they are to remain relevant.
The composition of the board should be viewed as a strategic
asset. Boards should regularly review their makeup in light of the
company’s strategic direction, identify the competencies that would
be valuable to find in future directors and regularly infuse the board
with fresh perspectives relevant to the organization’s future.
Increased focus on director tenure

A growing board composition issue is director tenure. On one
hand, independent director representation on S&P 500 boards
continues to grow. In 2014, the Spencer Stuart Board Index found
that 84 percent of S&P 500 directors were independent, compared
with 80 percent a decade ago. On 58 percent of boards in 2014, the
CEO was the only non-independent director, compared with just 39
percent of boards in 2004. While board independence appears to be
increasing, some investors have become more vocal in questioning
how director independence is defined and whether independence is
compromised after many years on the board. In 2014, 16 percent of
boards had an average director tenure of 11 or more years, and the
average tenure of S&P 500 boards was 8.4 years.

Spencer Stuart Building a balanced board
Proxy advisory firms have begun to Seventy-three percent of S&P 500 boards
ask how long is too long when it comes have established a mandatory retirement
to director tenure, and some governance age for directors, compared with 79 percent
activists are contemplating whether length in 2004. But the average retirement age has
of service should be factored into definitions crept up in recent years, as boards have
of independence. Institutional Shareholder raised their mandatory retirement ages to
Services (ISS) announced in early 2014 that allow experienced directors to serve longer;
it will begin to take into consideration in its 92 percent of boards that have established a
QuickScore rating whether a company has mandatory retirement age set it at 72 or older,
“excessive” director tenure of more than versus 49 percent in 2004. At the same time,
nine years. According to an ISS 2013–2014 boards are recruiting more retired executives
policy survey, 74 percent of investors who than in the past. In 2014, more than half of
responded indicated that long director the newly elected directors were retired. As
tenure is problematic, including 15 percent a result, boards are getting older and longer
who agreed that lengthy director tenure tenured. In a world that is increasingly
can diminish a director’s ability to serve as global, rapidly changing, and more reliant
an independent steward, 11 percent who on new and innovative technology, directors
agreed that lengthy director tenure can may not be as current.
limit a board’s opportunities to refresh its
membership, and 48 percent who indicated Diversity considerations
that they share both of these concerns. Boards are increasingly recognizing that
Critics of the ISS decision cite the boards with a good mix of age, experience,
benefits of having long-tenured directors and backgrounds tend to foster better debate
on the board. Long-tenured directors can and decision-making and less groupthink.
bring to board deliberations valuable In recent years, female representation
experience, institutional knowledge, and an on boards in particular has been a growing
understanding of the company’s strategy, area of focus. In addition to shareholder and
operations, and culture. In many situations, government attention to the issue, recent
directors with long ties to a company can research continues to highlight the benefits of
be more confident and better prepared to gender diversity on boards. For example, the
challenge management because of their 2012 Credit Suisse Research Institute report
historical knowledge than a director with Gender Diversity and Corporate Performance
less history with the company. found that, during the six-year period
Currently, there are no specific regulations ending in 2011, companies with at least some
or listing standards in the US that speak to female representation had better share price
director independence based on tenure. And, performance, higher return on equity, and
in fact, most US public companies do not better average growth than companies with
have governance rules limiting tenure; only no women on their boards.
three percent of S&P 500 boards specified While women serve on US corporate
a term limit for directors in 2014. Several boards in greater numbers than in the past,
other countries have adopted regulations female representation on S&P 500 boards
linking board tenure to independence, some has fallen behind countries such as Norway,
requiring boards to explain why a director Finland, Sweden, and France as European
should be considered independent after governments have made diversification
a certain tenure and others setting tenure a priority. Women now account for 19
limits after which a director can no longer be percent of independent directors of S&P 500
considered independent. companies, according to the 2014 Spencer
In the absence of tenure or term limits, Stuart Board Index, up from 16 percent in
many US boards rely on mandatory 2009 and 16 percent in 2004. Two thirds
retirement ages to promote turnover. of S&P 500 companies have two or more

Building a balanced board Spencer Stuart
women on the board, compared with 45 for just 8.1 percent of directors on the top
percent in 2004. Yet still 5 percent have no 200 S&P 500 companies. Forty-five percent
women. of those 200 companies do not have an
One of the most significant barriers to international director.
increasing female representation on boards is It is important to point out that boards
a perception that the pool of qualified female do not have to sacrifice critical skills or
director candidates is limited. Our experience expertise to increase diversity, but they may
recruiting women to boards demonstrates have to broaden their approach to director
that qualified women are available for board recruitment and their perceptions about the
roles. Between 2007 and 2012, one third of ideal director. Boards often define the ideal
the women we recruited for board roles board member as a current or former CEO
were top corporate executives, including or CFO, and women and minorities are
CEOs, chief operating officers, presidents, still underrepresented in these ranks. In
or chairwomen. Divisional business leaders addition, some boards still look for director
and general managers represent another candidates within their own personal and
significant source of female director talent, professional networks, and these networks
as do finance leaders, bankers, and auditors. may include few women, minorities, or
As companies seek greater integration of leaders from outside the US.
digital, social media, and e-commerce into
their business models, women are proving Succession planning for the board
to be an important source of director talent. In the past, boards had a tendency to replace
Other sources include government leaders, a retiring director with an individual “who
academics, senior consulting partners, and looks like the person who left” or allowed
functional leaders. the chief executive officer to take the lead in
Increasing ethnic and racial diversity is filling board seats. Today, of course, boards
another priority for many boards. In a 2014 no longer cede responsibility for director
survey of corporate secretaries as part of recruitment and succession planning to
the Spencer Stuart Board Index, minorities, the CEO, yet they often address director
women, and sitting CEOs topped the list succession only on an as-needed basis—
of the most desired profiles for director when facing an impending vacancy.
recruitment; 64 percent of respondents This approach, however, may put
indicated that recruiting minority directors boards at a disadvantage in this time when
was a priority. However, recruitment of growth and innovation are top priorities
minority directors has not kept pace with for most organizations. Facing new global
demand. Among all directors for the top and competitive challenges, companies
200 companies of the S&P 500, 9 percent are are transforming themselves through
African-American, 5 percent are Hispanic/ new product strategies, different product
Latino, 2 percent are Asian, and 8 percent are mixes, and expansion into new markets
from outside the US. and geographies. In an ideal world, outside
Another consideration is whether to add directors with relevant experience can
an international business perspective to the serve as valuable advisers to the board and
board. For example, it can be valuable to management about the company’s market,
have one or more directors from strategic geographic, and product directions, as well as
markets or with working experience in those providing a sounding board for management
markets if the company is expanding its on the critical issues the company is likely to
global footprint, building manufacturing or encounter. Wise boards will want to foresee
distribution capabilities overseas, or moving where the company is headed in the future
into a complex or particularly competitive and have individuals on the board with the
market. International directors remain a expertise to help the company move in that
small minority on US boards, accounting direction as efficiently as possible. Boards

can accomplish this by vigorously managing as a whole includes the expertise and
director succession. skills that it will need to help the company
External forces, too, encourage a more deliver on its strategic vision. If skills gaps
proactive stance on board succession are identified, they can be used to help
planning. Investors have become a potent shape the search for new directors when
voice in board governance, holding directors vacancies occur or signal a need to expand
accountable for company performance the board. Increasingly, boards are sharing
and even challenging the nominations of their thinking about board composition and
directors. Institutional investors, on the how the qualifications, skills, and attributes
whole, are looking for board directors of individual directors satisfy the defined set
who are independent from management of skills for the board by including a skills
and possess the relevant business and matrix in the annual report.
financial experience. Furthermore, boards The skills matrix should take into
that plan for director departures will be account regulatory and listing requirements,
better positioned to recruit directors with the committee needs, the strategic direction of
desired experience. the business, and the appropriate diversity
Director departures or retirements create of perspectives.
openings that enable the board to expand or
strengthen its skills in certain areas. Boards Strategic considerations
should take advantage of natural attrition Some boards are prioritizing new areas
to recruit directors who can add valuable of expertise when recruiting and tapping
perspectives about the company’s strategic nontraditional candidates, especially
direction, bringing on, for instance, directors younger, active executives, to bolster their
with experience in a particular market, knowledge in disciplines such as digital or
industry, or business model. social media, certain areas of finance and
emerging markets, or global business. We
Developing a skills matrix continue to see an increase in the number of
As a starting point, the board should stay new directors who are serving on an outside
up to date on the timing of anticipated public board for the first time—39 percent
vacancies, including those due to directors’ of new directors were “first-time” directors
plans for retirement, term or age limits, in 2014, compared with 30 percent in 2012,
and the needs of individual committees for as boards bring on younger executives with
specific expertise. In most cases, director these capabilities.
departures are known well in advance,
giving the board the opportunity to plan Director independence requirements
for specific board openings. Boards also According to NYSE Euronext guidelines, at
should proactively review their composition least three quarters of the board members
periodically to ensure that they continue to must be independent, and all members of the
have the right mix of expertise in light of the audit, human resources and compensation,
company’s strategic direction. and nominating and governance committees
When working with clients on this must be independent. Boards must
exercise, Spencer Stuart often uses a board affirmatively determine that directors who
profile matrix to examine the demographics are classified as independent have no material
and professional backgrounds of current relationship with the company, either directly
board members and identify gaps or voids or as a partner, shareholder, or officer of an
in the board’s composition. As the board organization that has a relationship with the
reviews topics such as the businesses in company. The nominating and governance
which the company competes, strategies to committee is responsible for reviewing the
grow profitably, and competitive threats, qualifications and independence of directors
it is natural to consider whether the board and board committees on a periodic basis,

Building a balanced board Spencer Stuart
as well as the composition of the board as the desired expertise and qualifications
a whole. This assessment should include for new directors, identifying potential
members’ qualifications as independent, as director candidates, and reaching out to
well as consideration of diversity, age, skills, candidates well in advance to let them
and experience in the context of the needs of know the board’s interest. It may be helpful
the board. to tap external resources at the point when
specific vacancies are nearing. For example,
Committee needs through their work with boards and top
The matrix should also include consideration executives, search consultants often know
of the board’s committee requirements. on a confidential basis the plans of many
Knowledgeable, independent directors are senior leaders. Particularly in the case of
needed to lead and serve as members of CEOs, who are often inundated with board
the audit, compensation and nomination, invitations, it is valuable to understand
and governance committees. The chair, their restrictions and preferences for outside
especially, must be current on the relevant board service, as well as their retirement
governance issues and trends. Retired CEOs, plans. A search firm often has the ability to
chief operating officers, and chairs are a discreetly test executives’ interest in a new
growing source of audit committee chairs, board role and his or her future availability,
as are active and retired finance executives. and also to look globally at new, younger
Retired and active CEOs and COOs are candidate pools such as executives with
often tapped to chair the compensation digital experience.
committee.
Role of director evaluation and director
Diversity development in building a balanced board
One important category in the matrix is A board can position itself to refresh and
diversity. Rather than being considered recruit directors with the desired experience
an end in itself, diversity is increasingly by regularly reviewing its composition. The
considered an underlying criterion when
potential directors are sought for skills
or experience. More and more, boards
recognize that having diverse perspectives Table 1 Developing a skills matrix
on the board—in the areas of age, gender,
• Think holistically about director
race and ethnicity, and, in some cases,
recruitment as opposed to one-off
geographic knowledge—expands their
recruitments.
views on issues, options, and solutions.
• Develop a matrix of the overall skills
The ideal board mix will vary depending
and experience required for the
on the needs of the company and could
board based on an analysis of the
include directors with significant public
skills and experience necessary to
company board experience, directors with
support strategy.
relevant sector and geographic experience,
• Inventory the skills, contributions,
and directors with international business
and diversity of current board
experience.
members to identify any gaps to be
Today, most boards start planning for
filled.
vacancies at least 12 months in advance and,
• Use a skills matrix to ensure the
in cases when several retirements are on
bases are covered when recruiting.
the horizon, boards think holistically about
• Outline specific requirements for key
a multi-year process. The process begins
committee chairs.
with the board reviewing and confirming

annual board evaluation is a natural platform • Cast a wide net for director candidates
for the full board to review its composition with the goal of identifying the best
and discuss the expertise that it will need candidate—not just the ones known to
in the future. Through the evaluation, board members.
individual directors and the board as a whole • Have a good reason why each director
can identify the areas of knowledge the board belongs in the room. Be clear about the
should possess in the coming years based on perspective or expertise the individual
the company’s strategic direction and the contributes.
competitive landscape. From there, the board • Keep an open mind about what a director
can evaluate whether it currently includes should look like and the different ways
individuals with the relevant backgrounds directors can contribute. Boards can
and, if not, what skills or experience widen their net by looking at retired
would be valuable to seek in new directors executives or senior business unit or
when vacancies occur. A growing number functional leaders, who may not have
of boards conduct individual director the breadth of experience of a CEO but
assessments to understand the performance can bring valuable knowledge in specific
and contributions of each director to help areas.
improve individual performance and to • Establish a strong new director orientation
encourage appropriate turnover. program. All first-time directors benefit
from an orientation and ongoing training
Conclusion that helps them quickly get up to speed on
Forward-looking boards elevate the task the business and the company’s approach
of planning for director succession. They to governance.
engage in an ongoing review of the board’s • Understand your board’s culture and
skill-sets relative to the company’s strategy assess candidates for their fit.
and direction and find opportunities • Continuously review the board’s skill-
to acquire the necessary capabilities and sets and performance relative to the
experience. As they become more proactive company’s strategy and direction to
in this area, boards will ensure the board as ensure that the board as a whole has the
a whole, and directors individually, have the knowledge, experience, and skills to guide
energy, expertise, and experience to guide the the management team as it addresses new
organization as it addresses new challenges challenges and market opportunities.
and market opportunities. In our experience, In addition, this will ensure that every
the most effective boards do the following: director is contributing. The annual board
evaluation is a natural platform for the
• Carefully define the expertise that is full board to review its composition and
important for the board—for example, discuss the expertise that it will need in
industry or functional knowledge or the future.
international business experience.

Corporate governance
9 update: renewed focus on
corporate director tenure
David A. Katz, Partner, and Laura A. McIntosh, Consulting Attorney Wachtell, Lipton, Rosen & Katz
T
he issue of director tenure recently has garnered significant
attention both in the US and abroad. US public companies
generally do not have specific term limits on director service,
though some indicate in their by-laws a “mandatory” retirement
age for directors—typically between 72 and 75—which can
generally be waived by the board of directors. Importantly, there
are no regulations or laws in the US under which a long tenure
would, by itself, prevent a director from qualifying as independent.
Institutional Shareholder Services (ISS) and other shareholder
activist groups, as well as some large institutional investors,
are beginning to include director tenure in their checklists as an
element of director independence and board composition. Yet
even these groups acknowledge that there is no ideal term limit
applicable to all directors, given the highly fact-specific context in
which an individual director’s tenure must be evaluated. In our
view, director tenure is an issue that is best left to boards to address
individually, both as to board policy, if any, and as to specific
directors, should the need arise. Boards should and do engage in
annual director evaluations and self-assessment, and shareholders
are best served when they do not attempt to artificially constrain
the board’s ability to exercise its judgment and discretion in the
best interests of the company. In addition, in much the same way
boards consider chief executive officer (CEO) succession issues,
boards are beginning to address director succession issues as well.
Director tenure in the US

According to executive recruiting firm Spencer Stuart, the average
tenure of directors at S&P 500 companies in 2013 and 2012 was 8.6
years.1 The average tenure of CEOs was close, at 7.2 years, in both
2013 and 2012.2 ISS reports that the average tenure of S&P 1500
directors was 10.8 years in 2013, an increase from 10.3 years in 2012.3
Very few US companies—only three percent of the S&P 500—have
term limits for directors, none of which is less than 10 years.4
There appears to be a recent trend toward raising retirement ages
and extending board service as valuable directors grow older. In
the S&P 500, over the last 10 years, the percentage of boards with
a mandatory retirement age of 70 has decreased from 51 percent to

Wachtell, Lipton, Rosen & Katz Corporate governance update: renewed focus on corporate director tenure
11 percent, while the percentage of boards corporate strategic decision-making. These

with a mandatory retirement age of 75 or resources are particularly valuable to a
greater has increased from three percent to company whose business is highly complex
24 percent.5 Meanwhile, the average age or whose significant projects have unusually
of independent directors in this group has long-term horizons for completion.15
increased from 60 to 63.6 Board turnover In recent years activists’ attempts to
was reported last year to be at a 10-year micromanage the boardroom have begun
low; one source reports that 291 board seats to complicate the traditional view. Boards
turned over at S&P 500 companies in 2012, with many long-serving directors are now
as compared to 401 in 2002.7 described as “entrenched” and deaf to
Despite these trends, boards are steadily shareholder concerns.16 Critics posit that
becoming more diverse.8 Long tenure is older directors—who are typically the longer-
often cited as an obstacle to achieving board tenured directors—can no longer keep current
diversity,9 yet current patterns of tenure and with respect to industrial or technological
retirement have not prevented increases in developments and are unable to offer new
gender and racial diversity on US boards. The insights into corporate issues; they fear that
number of women directors continues to rise; these directors may hold fossilized positions
at S&P 500 companies, the percentage with that are no longer relevant in the changing
at least one woman director has grown in economic and business environment.17
the last decade from 85 percent to 93 percent, Some argue that extended board service
and the total percentage of women directors can create a culture of undue deference to
has increased from 13 percent to 18 percent.10 management, particularly in cases where
Minority representation has also increased the chief executive also has held the position
in this time frame, as has the percentage of for many years. While these may be valid
independent directors of non-US origin.11 concerns in isolated situations, it is often
In the US and Canada, regulators have the case that older directors are among the
wisely refrained from adopting guidelines savviest and most skilled board members,
regarding director tenure. Long tenure on and that long-tenured directors may be
a corporate board historically has been in the best position to manage a powerful
understood—and demonstrated—to be an chief executive by virtue of their shared
asset to board effectiveness and a feature history and many years of building trust and
that goes hand-in-hand with solid corporate collegiality together. Whether the advantages
performance and good management. Having outweigh the disadvantages of long tenure
a core group of long-term directors has for any given director on any particular
been seen as beneficial to board dynamics board ultimately can be evaluated only by
as well as to the relationship between considering the specific circumstances. As
the board and management.12 According with many other important elements of
to some estimates, new directors require corporate governance, in matters of director
between three and five years to acquire tenure, one size does not fit all.
sufficient company-specific knowledge,13
with more time required for directors of Director tenure abroad
companies with complex operations and A growing number of countries have adopted
more intangible assets.14 Long-serving tenure-related guidelines or restrictions for
outside directors thus are highly valued for independent directors.18 With very few
their experience and organizational memory. exceptions, the “comply-or-explain” model
Often, they have made important and useful prevails, and the recommended maximum
industry connections over the course of tenure for a corporate director is between
their careers. Such directors frequently have nine and 12 years. The European Commission
gained a deep understanding of the relevant recommends that independent directors serve
industry, and in board discussions they can a maximum of three terms or 12 years.19 In
offer historical context for consideration in the UK, the UK Corporate Governance Code

Corporate governance update: renewed focus on corporate director tenure Wachtell, Lipton, Rosen & Katz
(formerly known as the Combined Code) might be the case for any director who has
provides that a board should explain, in its served in that position for more than ten
annual disclosures, its reasons for determining years.”27 According to one source, 21 percent
that a director who has served more than nine of non-executive directors at the top 50
years qualifies as independent.20 The average listed companies in Australia have directors
tenure of a UK director is less than five years.21 who had served at least nine years.28 The
In Hong Kong, an independent director is Australian episode demonstrates that strong
limited to a three-term, nine-year maximum opposition to director tenure limits still
tenure unless shareholders separately vote exists outside the US despite the increasing
on a resolution permitting re-appointment, international popularity of such policies.
which should include the board’s justification
for determining his or her independence.22 Academic studies
Singapore recommends “rigorous review” Academic researchers have examined the
of the independence of a director who has question of whether there is an optimal
served more than nine years, and the board length of tenure for outside directors, with
is expected to explain any determination varying results. Studies from the 1980s
of independence in such case.23 In France, through the 2000s have shown, for example,
the only country with a mandatory regime, that longer tenure tends to increase director
directors may not be deemed independent independence because it fosters camaraderie
after the end of a term in which they reach 12 and improves the ability of directors to
years of service on the board.24 The French evaluate management without risking social
rule creates an effective term limit, as longer- isolation.29 A 2010 study confirmed that
serving directors are not eligible for audit companies with high average board tenure
committee membership or other board roles (roughly eight or more years) performed
left to independent directors. better than those companies with lower
In Australia, a recent move toward a average board tenure, and that companies
recommended term limit was quashed by with diverse board tenure performed better
significant opposition. The Australia Stock than those with homogeneity in tenure.30 A
Exchange (ASX) Governance Council, an 2011 study, by contrast, examined a sample of
advisory committee that includes business, S&P 1500 boards and found that long-serving
shareholder, and industry groups, last directors (roughly six or more years)—as well
year proposed a “comply-or-explain” as directors who served on many boards,
guideline that ASX-listed companies’ older directors, and outside directors—were
independent directors be limited to nine more likely to be associated with corporate
years of service. Reportedly, pressure from governance problems at the companies
several of the country’s largest companies they served.31 One 2012 study found that
resulted in the Council’s dropping the boards with a higher proportion of long-
tenure restriction in its final guidelines.25 serving outside directors were more effective
The final report incorporates references in fulfilling their monitoring and advising
to tenure limits, recommending that one responsibilities,32 while another 2012 study
factor to be considered in assessing director found that having inside directors increased
independence is whether the individual “has a board’s effectiveness in monitoring real
been a director of the entity for such a period earnings management and financial reporting
that his or her independence may have behavior, presumably due to their superior
been compromised.”26 The commentary firm-specific knowledge and operational
expands on this point: “The mere fact that sophistication.33 On the related topic of board
a director has served on a board for a turnover, a recent study of S&P 500 companies
substantial period does not mean that he or from 2003 to 2013 found that companies that
she has become too close to management to replaced three or four directors over the
be considered independent. However, the three-year period outperformed their peers.34
board should regularly assess whether that The study found further that two thirds of

companies did not experience this optimal equiring all directors to step down after a
turnover and that the worst-performing certain number of years could rob the board
companies had either no director changes at of critical expertise.”43
all or five or more changes during the three- Similarly, some large institutional
year period.35 investors have enhanced their focus
A 2013 study on director tenure by a on director tenure. State Street Global
professor from the INSEAD Business School Advisors (SSgA), for example, announced
has received significant attention. The study a new policy in 2014 that sets forth specific
hypothesizes that there is a trade-off between guidance regarding factors that might lead
independence and expertise for outside SSgA to vote against certain directors at
directors—a prejudgment that is widely the companies in which it invests.44 SSgA
disputed36—and examines the effect of tenure will consider “longer-than-average” director
on the monitoring and advising capacities of tenure, benchmarked against the applicable
the board.37 After review of more than 2,000 market, as well as whether any long-tenured
companies, the author finds that the optimal directors serve on key committees, and
average tenure for an outside director is whether the board in question is classified.
between seven and 11 years, though industry- SSgA sensibly has indicated that it will,
and company-specific factors create substantial at least initially, proactively and directly
variability.38 He concludes that nine years is engage with board members on the issue
generally the optimal point at which a director of director tensure and board diversity
has accumulated the benefits of firm-specific before taking action to vote against director
knowledge but has not yet accumulated the nominees.
costs of entrenchment.39 As a policy matter, Beginning in the 2013 proxy season,
however, he suggests that in light of the ISS offered a product called QuickScore,
significant variations across industries and which uses specific governance factors
company characteristics, regulating director and technical specifications to rate public
tenure with a single mandatory term limit company governance.45 In 2014, company
would not be appropriate.40 ratings (based on data that companies
Taken together, the academic studies may review and correct) were released in
show that conclusions about optimal director February, and the scores were included in
tenure are elusive. Common sense indicates proxy research reports issued to institutional
that a board should use tenure benchmarks shareholders. ISS has stated that it will
not as limits but as opportunities to evaluate use corporate public disclosures to update
the current mix of board composition, ratings on a continual basis throughout the
diversity, and experience. year. Director tenure will now factor into
a company’s rating: ISS views tenure of
Activists and term limits more than nine years as “excessive” by
Shareholder groups have begun to highlight virtue of “potentially compromis[ing] a
the issue of director tenure. The Council director’s independence.”46 Having long-
of Institutional Investors (CII) last year tenured directors thus may negatively affect
announced a new policy calling for boards a company’s score.
to evaluate director tenure when assessing While the factors ISS uses to produce a
director independence.41 The statement company’s rating are public, the specific
accompanying the policy change suggested calculation methodology is not. There is no
that long tenure can affect a director’s reason to believe that a rating generated by
“unbiased judgment” and asserted that this new product will bear any relation to
“[e]xtended tenure can lead an outside the actual quality of governance or financial
director to start to think more like an performance of a particular company. The
insider.”42 Nonetheless, CII stopped short very name of the QuickScore metric alludes to
of endorsing a tenure limit, noting that “[r] the superficiality of its mechanically derived

results, generated without regard to the fact- new perspectives are being added to the
specific circumstances of a board of directors board.”48
and the real-world needs of the company it
ISS endorses—rightly, in our view—a
supervises.
robust director-evaluation process,
ISS’s QuickScore is an outlier with respect
conducted annually by the corporate
to director tenure—not in terms of the
governance or nominating committee of the
nine-year limit, which may well have been
board.
determined by reference to the policies of
some foreign countries and perhaps even
Board judgment
to the 2013 study mentioned above, but
It is unfortunate that the tenure of outside
in considering any longer service to be
directors may become yet another point
automatically detrimental. We are not aware
of controversy in shareholder activists’
of any country whose governance guidelines
ongoing efforts to dictate ever more elaborate
create a mandatory maximum of nine years
standards for director independence and
for a corporate director. While various
board composition. There is no reason to
countries use the three-term, nine-year time
believe that extended director service
frame as a benchmark, they recognize that
does, in and of itself, compromise director
boards may indeed have excellent reasons
independence. Indeed, as the studies
to extend a director’s term well beyond that
mentioned above suggest, factors ranging
limit. Hence the flexibility of the “comply-
from industry-wide characteristics all the
or-explain” model, which requires a board to
way to company-, board-, and candidate-
consider director tenure and communicate
specific elements can be meaningful in
with its shareholders, yet still preserves the
assessing appropriate director tenure. Term
board’s ability to make informed decisions
limits, like any bright-line rule, may offer
for the company using its business judgment.
superficial appeal, but the potential downside
Outside of the QuickScore product, ISS
is that valuable directors may be forced off
itself recognizes the wisdom of a more
the board in circumstances that would be
reasonable approach. The ISS 2014 Proxy
detrimental to the board, the company, and
Voting Manual discusses the pros and cons
the shareholders.49 Moreover, term limits can
of limiting director tenure and contains the
interfere with the development of effective
following, eminently reasonable, language
collaboration among board members, a
on director retirement age and term limits:
crucial element of a successful board and
Rather than impose a narrow rule on director
one that can be built only over a period of
tenure, shareholders gain much more by
time. “In the end, creating a stellar Board of
retaining the ability to evaluate and cast
Directors is part science, part art.”50
their vote on all director nominees once
Many arguments both for and against
a year and by encouraging companies to
long tenure are valid. The debate can best
perform periodic director evaluations.47
be resolved in individual cases by reference
Accordingly, ISS offers the following proxy
to the facts on the ground, and no arbiter is
voting policy for US companies in 2014:
better positioned to determine the appropriate
“Vote against management and length of service of a director than the board
shareholder proposals to limit the tenure as a whole. Companies and their shareholders
of outside directors through mandatory should resist any pressure to establish term
retirement ages. Vote against management limits, a mandatory retirement age, or another
proposals to limit the tenure of outside mechanism that would constrain board
directors through term limits. However, discretion in evaluating the effectiveness and
scrutinize boards where the average performance of individual directors. With
tenure of all directors exceeds fifteen annual evaluations and self-assessments,
years for independence from management most boards monitor and manage their
and for sufficient turnover to ensure that own performance quite effectively, and

they should continue to have the latitude States: A Scenario Analysis,” GMI Ratings, June
to determine the tenure of their directors 2013, available at http://www.gmiratings.com.
in light of their conclusions regarding the 10 See Spencer Stuart Board Index 2013, at 6.
needs of the company. As a general matter, 11 See id. at 19-20.
the US is well served by directors’ using
12 See, eg, Judy Canavan et al., “Board tenure:
their business judgment to act in an informed
manner in furtherance of the best interests of How long is too long?” Directors & Boards, Board
Guidelines 2004, at 39, available at http://www.
the company and its shareholders, and the
highbeam.com/doc/1G1-114244181.html.
area of director tenure is no exception.
13 See Raymond K. Van Ness et al., “Board of
The views expressed are the authors’ and
do not necessarily represent the views of Director Composition and Financial Performance
in a Sarbanes-Oxley World,” Academy of Business
the partners of Wachtell, Lipton, Rosen &
& Economics Journal 10 (5), 56-74 (2010), at 8,
Katz or the firm as a whole. A version of this available at http://www.albany.edu/faculty/
article originally appeared in the New York vanness/AA/ARTICLES/DirectorSOX.pdf.
Law Journal on May 22, 2014. 14 See Sterling Huang, “Zombie Boards: Board
Tenure and Firm Performance,” July 2013 Draft,
Notes at 30, available at http://papers.ssrn.com/sol3/
1 Spencer Stuart Board Index 2013, at 17.
papers.cfm?abstract_id=2302917.
2 See id. 15 See, eg, BHP Billiton, Submission to the ASX
3 ISS 2014 U.S. Proxy Voting Manual, at 37. See also Corporate Governance Council, Nov. 15, 2013 (“[W]
Vipal Monga, “Board Directors Are Extending Their e believe that particularly in a long-cycle business
Tenures,” CFO Journal, WSJonline, Apr. 1, 2014. An such as ours, governance is enhanced by having a
investigation by the Wall Street Journal found that balance of longer serving Directors. . . . Formulaic
28 outside directors in the Russell 3000 had served considerations of tenure should not override the
on a single board for at least 40 years. See Joanne other considerations of independence and the
S. Lublin, “The 40-Year Club: America’s Longest- proven ability of Directors to be able to exercise
Serving Directors,” Wall St. J., July 16, 2013. independent judgement and act in the best interests
4 See Spencer Stuart Board Index 2013, at 15. One of the Group and shareholders.”), available at
http://www.asx.com.au/documents/public-
oft-cited example of a US company with term limits
consultations/bhp_submission.pdf.
is Target Corporation, which recently raised its
directors’ term limit from 15 to 20 years. See Target 16 See, eg, Hymowitz & Green, supra note 7.
Corporate Governance Guidelines, § 24, November 17 See, eg, Canavan et al., supra note 12.
2013, available at http://www.target.com.
18 See, eg, Janet McFarland, “Countries Set out
5 See Spencer Stuart Board Index 2013, at 6.
Rules on Directors’ Tenure,” theglobeandmail.
6 See id. com, Nov. 24, 2013, available at http://www.
7 See Carol Hymowitz and Jeff Green, “Corporate theglobeandmail.com/report-on-business/
careers/management/board-games-2013/
Directors Get Older, Hold Their Seats Longer,”
countries-set-out-rules-on-directors-tenure/
Bloomberg Businessweek, May 23, 2013.
article15574442/.
8 As we have previously discussed, while diversity
19 See Official Journal of the European Union,
on US boards of directors has improved in recent
Commission Recommendation of 15 February 2005,
years, significant additional improvement is both
Annex II, “Profile of Independent Non-Executive
desirable and necessary. See David A. Katz and
or Supervisory Directors,” Section 1(h), available at
Laura A. McIntosh, “Developments Regarding
http://eur-lex.europa.eu/LexUriServ/LexUriServ.
Gender Diversity on Public Boards,” N.Y.L.J.,
do?uri=OJ:L:2005:052:0051:0063:EN:PDF.
Oct. 31, 2013, available at http://www.wlrk.
com/webdocs/wlrknew/WLRKMemos/WLRK/ 20 The UK Corporate Governance Code B.1.1
WLRK.22908.13.pdf. (September 2012), available at http://www.frc.
9 See, eg, Kimberly Gladman and Michelle Lamb, org.uk/Our-Work/Codes-Standards/Corporate-
governance/UK-Corporate-Governance-Code.aspx.
“Director Tenure and Gender Diversity in the United

21 “Investors Focus More Attention on Director 34 See George M. Anderson and David Chun,
Tenure,” Society of Corp. Secretaries & “How Much Board Turnover Is Best?” Harvard
Governance Professionals, July 30, 2013 (citing a Business Review, April 2014, available at http://
Grant Thornton survey of 2012 data). hbr.org/2014/04/how-much-board-turnover-is-
22 HKEx Corporate Governance Code and best/ar/pr.
Corporate Governance Report A.4.3, available 35 See id.
at http://www.hkex.com.hk/eng/rulesreg/ 36 See, eg, Van Ness et al., supra note 13.
listrules/mbrules/documents/appendix_14.pdf
37 See Huang, supra note 14. The study examined
(updated per HKEx Consultation Conclusions on
Review of the Corporate Governance Code and 2009 data.
Associated Listing Rules, Oct. 28, 2011). 38 See id. at 30-32.
23 Singapore Code of Corporate Governance 39 See id. at 4-5.
2.4 (May 2, 2012), available at http://www. 40 See id. at 7.
ecgi.org/codes/documents/cg_code_
singapore_2may2012_en.pdf. 41 See Amy Borus, “More on CII’s New Policies
24 Afep-Medef Code, Corporate Governance on Universal Proxy and Board Tenure,”
Council of Institutional Investors, Oct. 1, 2013,
Code of Listed Corporations Section 9.4 (June
available at http://www.cii.org/article_content.
2013), available at http://www.ecgi.org/codes/
asp?article=208.
documents/afep_medef_code_revision_jun2013_
en.pdf. 42 Id.
25 See Ross Kelly, “Australia Backs Away from 43 Id.
Proposed Director-Tenure Cap,” Asian Business 44 See Rakhi Kumar, “Addressing the Need for
News, Mar. 25, 2014. Board Refreshment and Director Succession
26 ASX Governance Council, Corporate Governance in Investee Companies,” State Street Global
Principles and Recommendations (Third Edition), Advisors, IQ Insights, 2014, available at http://
Mar. 27, 2014, at 16, available at http://www. ssga.co.nz/library/povw/733339 Addressing the
asx.com.au/documents/asx-compliance/cgc- Need for Board Refreshment. . . . in Investee_
principles-and-recommendations-3rd-edn.pdf. Companies_1_CCRI1399281503.pdf.
27 Id. at 17. 45 For more information on QuickScore, see David
28 See Kelly, supra note 25. A. Katz and Sabastian V. Niles, “ISS QuickScore
3.0,” Harvard Law School Forum on Corporate
29 See Van Ness et al., supra note 13, at 8-9 (citing
Governance and Financial Regulation, Oct. 27,
various studies). 2014. Available at www.wlrk.com/webdocs/
30 See id. at 18. wlrknew/AttorneyPubs/WLRK.23595.14.pdf
31 See Greg Berberich and Flora Niu, “Director and David A. Katz et al., “ISS QuickScore 2.0,”
Wachtell, Lipton, & Katz Client Memorandum,
Busyness, Director Tenure and the Likelihood of Jan. 28, 2014, available at http://www.wlrk.com/
Encountering Corporate Governance Problems,” CorporateGovernance; see also ISS’s website at
January 2011, at 5, available at http://papers.ssrn. http://www.issgovernance.com/governance-
com/sol3/papers.cfm?abstract_id=1742483. solutions/investment-tools-data/quickscore/
32 See ISS Benchmark Policy Consultation, 46 See ISS’s website at http://www.issgovernance.
“Director Tenure (US and Canada),” 2014, com/governance-solutions/investment-tools-
available at http://www.issgovernance.com/ data/quickscore.
file/files/Directortenure-USandCanada.pdf.
47 ISS 2014 U.S. Proxy Voting Manual at 39.
33 See Jeff Zeyun Chen et al., “Can Inside
48 Id. at 37.
Directors Be Effective Monitors? – Evidence
from Real Activities Manipulation,” Aug. 24, 49 See, eg, Carnavan et al., supra at 41.
2012 Draft, available at http://business.gwu. 50 Amy Errett, “The Dream Team: What It Takes
edu/accountancy/workshops/files/katherine
to Build an Effective Board of Directors,” Maveron
percent20gunny.pdf.
Features (2011), available at http://www.maveron.
com/blog/2011/10/the-dream-team-what-it-
takes-to-build-an-effective-board-of-directors/.

10 Conducting effective board
and director evaluations
Susan Ellen Wolf, Founder and CEO Global Governance Consulting LLC
H
igh-performing boards typically conducted periodic self-
evaluations as a method of driving continuous improvement
long before evaluations were required. Since 2003, the
NYSE has required all listed committees and their audit,
compensation, and nominating committees to perform self-
evaluations. The requirements are found in Listed Company
Manual Section 303A.09 (board), 303A.07 (audit committee),
303A.05 (compensation committee), and 303A.04 (nominating
committee).
After a decade of experience, boards are rejecting processes that
take up hours of valuable time but are nothing more than “check-
the-box” compliance exercises. Current trends in self-evaluation
reflect three goals: (1) the boards want to identify ways to work more
effectively to drive value creation; (2) they want to avoid litigation
risk (usually without the need for cumbersome processes trying to
gain attorney-client privilege); and (3) they want to complete the
process quickly.
These trends mesh well with the needs of companies transitioning
to publicly-traded status. Newly-public companies often are quickly
evolving businesses where the board’s focus on sustainable long-
term value creation is critical. These companies are also deluged
with new required processes, so they prefer a self-evaluation model
that saves time and avoids administrative burden.
This chapter takes the reader through the major steps in planning
and executing an effective board self-evaluation: evaluating key
considerations, deciding upon design, selecting areas of focus,
gathering data, interpreting data, reporting data, and following
through. At the end of this chapter, there is an example, based on
the model self-evaluation design that is the starting point at Global
Governance Consulting for our newly-public clients.
Key considerations
No one self-evaluation method is right for every board. Further, a
method that is right one year might be a bad choice the next year.
Those executives and attorneys who provide governance support to
the board will want to recommend one or two methods that would

Conducting effective board and director evaluations Global Governance Consulting LLC
be best given the current circumstances. The often a recruiting firm or governance expert is
following key considerations may influence the best fit to lead the self-evaluation. These
the recommendation: experts, or an investment banker, may be the
best choice if there is external pressure for a
Board culture and personalities change in board composition or leadership.
Some considerations here include whether
directors work with one another in a formal Staffing and support
or informal manner and whether directors If the board or management that supports
are comfortable discussing sensitive board the board, rather than an outside party,
dynamics with outsiders (such as a board- will facilitate the self-evaluation process,
recruiting firm, outside counsel, or an outside it is useful to consider the administrative
governance expert) or with staff (such as the burden of the process (for example, it takes
corporate secretary or the human resources more time to sift through written comments
executive). than to gather data through oral interviews).
It is also important to clarify with outside
Current industry environment facilitators whether their own team will
It is helpful to understand how the board schedule appointments and handle other
experience stacks up against the boards of tasks or will expect help from company
key competitors. Sometimes this information personnel. This information allows advance
is already readily available, for example, planning to ensure that the optimal level of
from a recent board-recruiting project; at administrative support is in place.
times when this evaluation has not been
done for several years, it is useful to include Design decisions
it in the self-evaluation process. Effective Once the key considerations have been
leaders for such an exercise include board- evaluated, the next step is to design the
recruiting firms and investment bankers. process. Design decisions include:
Current company status 1. Will directors provide oral input? If yes,

In calm times, when a company is reporting will they do this individually or in a
solid earnings in a stable industry, the board group?
may prefer to handle the self-evaluation on 2. Will directors provide electronic or
its own or with the corporate secretary. written input?
At times when the company is undergoing 3. Will members of management who
transformation, such as a period of rapid interact with the board provide input?
growth or moving to publicly-traded status, 4. What topics will be covered, and in how
often a governance expert or motivational much detail?
leader is the right facilitator for the self- 5. Will there be questions about the
evaluation. performance of individual directors in
And in those dark times when a company addition to questions about the collective
is beset with litigation while its industry is performance of the board?
under heavy regulatory or societal pressure, 6. Who will facilitate—board leadership, the
the board may be most comfortable with corporate secretary, or other member of
outside counsel leading the self-evaluation management who supports the board;
and using an oral rather than a written outside motivational leader; board
process. recruiter; governance expert; other?
7. Will anyone beyond the facilitator (such
Current board status as board leadership or members of
If the board is facing change (for example, management) have access to the raw data
going public, facing upcoming retirements, obtained or participate in analyzing the
or restructuring in connection with a merger), data?

Global Governance Consulting LLC Conducting effective board and director evaluations
8. Are comments anonymous? Gathering the data

9. Will results be reported in summary or will Key items for gathering the data are: (1)
directors see the granular data for each being sure directors understand the process
question? Will there be a written report? in advance; (2) honoring promises (for
10. Who will participate when the board example, about the time asked of directors);
reviews the report and considers whether and (3) being sure the input from directors
any actions are advisable based on the is clearly understood. We believe oral
results? For example, will the facilitator interviews are the superior method to get the
meet with the board or will any members input with minimum administrative burden,
of management who are not also directors and we find that the general counsel and
participate? outside counsel are often most comfortable
11. Who is responsible for follow-up to with these interviews.
make sure any improvements identified
in the self-evaluation are implemented? Analyzing the data
Sometimes the nominating committee This step cannot be rushed. It is a mistake
chair is responsible for follow-up and to look only at numerical scores, without
implementation. A more effective practice also considering how the results fit with
is to assign responsibility for the follow- the company’s current circumstance, the
up based upon the content. For example, external environment, and, if available, the
the audit committee might be asked to results from the prior year. It is important
take the lead if an outcome of the self- to consider the results in the context of the
evaluation was to increase focus on risk company’s short- and long-term strategic
oversight, or the CFO might be asked goals. This careful approach best informs the
to take the lead if an outcome of the board about how they might increase their
self-evaluation was to provide director effectiveness at driving value creation over
education on drivers of the stock price in the long term.
the industry.
12. Will the same process be used for each Reporting the data and determining focus
committee as for the board? Sometimes areas
a different process for one or more Oral or written reports can be equally
committees is advisable given current effective. A concise reporting of overarching
circumstances. For example, if a committee strengths and weaknesses, followed by
is newly formed, questions about meeting board deliberations to choose one or two
dynamics and information flow will be areas of focus, allows a board to hone in on
inapplicable. Unique questions for the continually improving their effectiveness at
committee can provide useful feedback driving value creation.
for the committee chair and management
in agenda planning. Follow-up
13. Would a change of process be helpful, or This is a step that is often skipped. The
would the continuity derived from using easiest way to ensure that the agreed-upon
the same process as in prior years be focus areas are implemented is to assign
useful? someone to be responsible and to specify a
14. What records will be retained when the time for completion, all at the same meeting
process is completed? It is important that where the focus areas are identified.
the general counsel is comfortable with Sometimes the party is a board leader.
the retention plan. Further, everyone who For example, the responsible party for a
may create records of the self-evaluation focus area about better aligning the incentive
should know in advance whether the pay opportunities to creation of shareholder
records might be subject to discovery or value might be the compensation committee
litigation holds. chair. A reasonable timeframe in that example

might be to bring a recommendation to the The addition of individual evaluations

board before the next award of incentive pay includes the risk of an unintended
opportunities. consequence. Most directors are highly
In other circumstances, the responsible accomplished individuals used to delivering
party might be a member of management. high performance. It is human nature to want
For example, the corporate secretary might to perform well if one is being personally
be the responsible party for better organizing graded. When individual evaluations are
the advance materials so that each director included, directors sometimes dilute their
could easily find the information that he attention from their work as part of the
or she needs to prepare for a meeting. In board to focus instead on how they are being
that example, it would be reasonable to ask perceived as individuals.
that this be implemented prior to the next
meeting. Example of a model self-evaluation process for
In still other cases, an outside party might the newly-public company
be included in the action plan for a focus This example follows a board through the
area. For example, one board determined entire self-evaluation process.
that it was likely that the company and its The governance committee selected an
shareholders would receive takeover offers outside facilitator to lead the process. The
as soon as the initial public offering was facilitator was a governance professional
concluded. The focus area was to be well with experience in the industry and in
prepared to respond should there be one newly-public companies.
or more offers. The board asked the CFO The facilitator first gathered background.
and the general counsel to set up a special He learned about the company’s governance
meeting with the investment bankers and structure by reading the governance
outside counsel, where the likely scenarios guidelines, committee charters, and director
could be discussed well in advance of the biographies. He learned about the company
board facing an actual offer. In this case, by reading SEC filings about the company,
the timeframe would be integrated into the press releases, and analyst reports.
schedule for the initial public offering. The facilitator next gathered the
information to help him determine which
A note about the evaluation of individuals issues should be covered by the self-
Several years ago, evaluating individual evaluation. He had a short conversation
directors as well as the full board was in with the general counsel, who is also the
vogue. For some boards, this can be an company secretary, about current board
effective tool in encouraging directors to issues. He had a 20-minute conference call
contribute to their full potential. For other with the board chair and the nominating
boards, this helps encourage the exit of those committee chair, who provided information
directors who are not adding value. about recent changes in board composition,
Unless there are special circumstances strategic direction, and highlights of board
present, we believe the better process strengths and challenges. He had a 15-minute
evaluates the work of the board as a group but conversation with the CEO, who is also a
does not include evaluations of individual director. He asked the CEO for her view on
directors. Boards work as a group rather strategic direction. He also asked the CEO
than as individual performers. All critical to discuss the skills and experience the CEO
decisions are determined by a vote of the needed from the board that were being well
group. Further, when the right questions are met by the current board, as well as any that
asked, the results will still include feedback might be added to fill in expertise that would
about any individual director who may be help the CEO in achieving the long-term
getting in the way of the board’s work. strategic plan.

Global Governance Consulting LLC Conducting effective board and director evaluations
Table 1 Topics for a public company’s self-assessment

Audit Compensation Nominating
Board
Committee Committee Committee
Skills/expertise Skills/expertise Skills/expertise Skills/expertise
Meeting dynamics Meeting dynamics Meeting dynamics Meeting dynamics
Information flow Information flow Information flow Information flow
Oversight of Selection and Executive Director recruiting
strategic interaction with compensation and orientation
matters independent and stock
auditor ownership
guidelines
Oversight/ Oversight of Process for Board
encourage internal audit succession development,
innovation matters planning education,
and CEO new director
performance orientation
evaluation
Oversight of Oversight of Executive stock Oversight of
HR matters internal ownership shareholder
(including CEO controls and requirements engagement
performance, other financial
succession reporting
planning) matters
Oversight of Oversight of risk Process for board/
operational and matters and committee self-
quality matters compliance evaluation
systems
Oversight of Determining
financial committee
matters leadership and
membership
Preparedness for Director
crisis response compensation
and stock
ownership
requirements
Next, the facilitator recommended on which the director serves. During the
topics to be covered and anchored this interview, the director provided a numerical
recommendation with the client. Table 1 score for each question. The scores were:
shows the topics initially recommended; the 5 = excellent
shaded topics were those actually covered 4 = good
by the self-assessment. 3 = adequate
The facilitator interviewed each director 2 = could be better
about each of the topics to be covered for 1 = substantial improvement needed now
the board, as well as for the committees

The directors were welcome, but not The facilitator next drafted reports for the
required, to provide comments to support board and for each committee, showing the
the numerical score. Based on a particular overarching strengths and opportunities, as
director’s input, the facilitator asked follow- well as the granular feedback. He sent the
up questions as needed. For example, one drafts to the general counsel and the chair of
director provided many scores of two, the nominating committee for review. They
but added few comments about why. The had no feedback or questions, so the reports
facilitator asked: “You gave relatively low became final. The facilitator then sent the
scores across all the questions; can you help reports to the board chair and the CEO for
me understand what could be better?” The review. He also sent each committee’s report
director’s response was enlightening. He to that committee’s chair.
said: “As I think it through, our board flies At the request of the board chair, the
through many, many issues. Some issues corporate secretary provided the report in
are important and other issues are not. We the advance materials for the next meeting.
do not take the time to get down deep into At the board meeting, the facilitator
the most important issues because we are so discussed the overarching strengths and
busy covering all the topics on the agenda. opportunities. He answered questions
When I have suggested that some of these from directors. The nominating committee
issues could be moved to routine reports or a chair then led the board in discussing the
consent agenda, the general counsel cuts me feedback and deciding upon two key areas
off, stating, ‘now that the company is public, for enhancing the board’s work.
the board is required to cover the topic.’ I The first focus area was keeping strategic
have not pushed back on that advice, in part focus. The board decided to exercise tight
because no one else has spoken up about oversight of the strategic progress over the
it. However, I do not think it is true. I have next 24 months, when the proceeds of the
been on three other public company boards, initial public offering would be used to grow
and there we did not spend so much time on the business. To implement, the board asked
these procedural issues. In each case where I the CEO to put recent developments into the
gave a low score, much of the problem comes context of the annual and five-year strategic
from the board just skimming the issue rather goals during his operational report at each
than having a robust deep discussion.” regular board meeting.
After the interviews of each director were The second focus area was making sure
completed, the facilitator analyzed the results. the new public company requirements were
The analysis of course included tabulating met, but without taking too much time
the granular results for each question. But from the board’s consideration of pressing
his analysis went further. He also created strategic and business issues. They directed
a list of overarching strengths identified in the corporate secretary to benchmark the use
self-evaluation. This is an important part of of consent agendas and other techniques to
the process that is sometimes overlooked. implement this focus item.
If strengths are not identified, the strengths
sometimes are inadvertently diluted in a Conclusion
scramble to complete a checklist of other, The boards of listed companies are required to
less important items that might be improved. perform annual self-evaluations. Designing
During the analysis, the facilitator also the right process can assist your board in
created a list of overarching opportunities increasing the effectiveness of its work to
where changes might make the board’s drive value creation, without creating undue
future work more effective. This is also administrative burden.
important, as opposed to just listing those
issues with a lower score, which can mix
minor concerns with critical issues.

11 Effectively structuring
board committees
Susan Ellen Wolf, Founder and CEO Global Governance Consulting LLC
E
ffectively structuring board committees is an important
foundation for building and maintaining a strong board.
Committees provide expertise to the board’s work on critical
topics. Committee meetings provide the time to take a deep dive
on these critical topics. The committees also ensure that the work
of the full board is well informed, by providing timely reports of
their work.
At the newly public company, effectively structuring board
committees is even more critical than at established companies. The
newly public company is at a pivotal juncture as it invests the initial
public offering (IPO) proceeds to grow the business. The company
and the board are also grappling with many new listing requirements.
If the committees handle these requirements expeditiously, it can
save important time at full board meetings for oversight of business
matters that are key to creating long-term value.
This chapter takes you through the main steps in effectively
structuring board committees—identifying the committees and their
function, naming excellent committee leadership, adding the optimal
mix of committee members, carefully constructing the committee
charter, and advance planning for agenda and calendar. Finally, it is
important to periodically review and follow up, so that committees
evolve as the company and external circumstances change.
What committees does the company need?

Listed companies are required to have three board committees:
audit, compensation, and nominating/governance. I advise most
clients to start with the recommended three committees and in 12
to 24 months revisit to establish whether other committees would
be helpful.
In some industries, other committees may be required. For
example, at certain types of banks or insurance companies there
may be risks such as derivatives exposure and industry regulations
that require a risk and/or investment committee. In other industries,
additional committees may be practical. One example is the energy
industry, where the products are necessities. There also are many
safety and environmental concerns. As a result, it is often practical

Effectively structuring board committees Global Governance Consulting LLC
to add environmental and safety committees so that board skills match long-range needs,
or a corporate responsibility committee. given the company’s strategic direction.
Another example is the pharmaceutical It is often the case that there is a comfort
industry, in which two types of additional level with existing board members.
committees are often helpful: science Management knows them. Major investors
committees (which oversee issues such as (particularly private equity investors who
drug pipeline productivity, pipeline value, may exit the stock gradually) know them.
and product safety) and business oversight The comfort level can make it easy to keep
committees (which oversee compliance with existing committee chairs or, if existing chairs
complex regulations about manufacturing will not meet the independence requirement,
and marketing processes). to draw from other existing board members
It is important to be practical if adding for the chair. But at least for the three key
committees beyond the required three. committees—audit, compensation, and
Many times, companies rush to have extra nominating—it is also important to make
committees related to current trends, such as sure the committee chairs have served on the
risk or cybersecurity. Every committee takes same committees at other public companies,
extra director and management time. Every preferably as committee chairs. This
committee also uses up more full board experience is the foundation for delivering
time, on committee reporting, considering all that the company and the board will need
committee membership assignments, etc. As from the committee.
a result, when the matters are not critical to One perceptive private equity firm I know
the company’s business, it is better initially starts recruiting new board members about a
to pass on additional committees and cover year before the planned IPO. They seek new
the topics in a way that does not take so members who meet many criteria:
many board resources as an extra standing
committee would. • They are independent under SEC
regulations and listing standards.
Excellent committee leadership is crucial • They have experience on at least one of
Chairing board committees is an important the three key committees at other public
role. The chair must control the agenda and company boards.
the meeting so that all necessary business is • They have experience leading, as directors
completed. or management, companies in the post-
High-performing chairs go a step IPO transformation.
beyond. They drive the committee’s work • They have industry knowledge.
in a manner that assists management in
building long-term value. This works As you might imagine, nominees meeting
out differently in each committee. For an such tough requirements are difficult to
audit committee, that might mean making identify. The private equity firm uses a
sure the way financial metrics are tracked top recruiting firm, known for expertise in
allows management to measure return on the industry, to be sure to identify the best
investment for the IPO proceeds that will candidates. The new directors have some
be plowed into growing the business. For a time between their election and the IPO to
compensation committee, that might mean get to know the company, the management
pushing for a compensation program that team, and the other directors. Often, one or
allows recruiting/retaining the leaders more of these new directors ends up as a
needed to steer the company through the committee chair from the IPO forward.
transformation, in addition to employing I believe that newly public companies with
shareholder-friendly performance metrics. the strongest boards have the best chance at
For a nominating committee, that might succeeding. And strong committee chairs are
mean driving a change in board composition a lynchpin to building strong boards.

Global Governance Consulting LLC Effectively structuring board committees
Ideal committee membership review, or items required to be disclosed, or

In addition to a strong committee chair, it is items on a best practices checklist (ranging
important to revisit committee membership from organizations giving governance
as a company prepares for the IPO. To begin ratings, such as the Institutional Shareholder
with, counsel must review the independence Services, to the National Association of
requirements in SEC regulations and Corporate Directors). These other items
listing standards. However, there are other might be things the newly public committee
considerations beyond these requirements should aspire to do. However, there are so
that merit attention. many required items that I think it is most
First, management should think about prudent to get a year or two of experience
what it will need from the committees to handling the requirements before building
accomplish its vision for success. The CEO’s additional items into the charter. There is no
thoughts are important. So are the thoughts of prohibition from the committee undertaking
other leaders who will rely on the committees these other items. However, leaving them
for their areas of responsibility. For example, out of the charter allows the committee to
the CFO and treasurer might want an audit choose how to spend its time. Particularly, it
or finance committee member with recent gives the committee breathing space to make
capital markets experience if they anticipate sure there is time to focus on keeping the
needing to issue debt to create the best capital business strong as the company grows by
structure. Or the internal audit executive investing the IPO proceeds in its business.
might want an audit committee member who
is familiar with the Sarbanes-Oxley Section Creating committee calendars and agenda
404 internal controls provisions, as well It is important to do advance work beyond
as with how other companies in the same the committee charters before the IPO, or as
industry handle those provisions. soon thereafter as possible.
Next, board leadership, including the The advance work will provide two benefits.
chair or presiding director, the governance First, it will ensure that as things become busy,
committee chair, and the chair of the the charter requirements and other tasks the
applicable committee, should think about committee has designated as important will
what the board needs from the committee. not be overlooked. Second, it promotes the
Those considerations provide an outline for committee’s focus on the bigger picture of all it
strengths needed on the committee. If existing will accomplish over time. The committee will
committee members cover all of them, there avoid the trap of considering discrete tasks
is no further work. If not, then committee without putting them into perspective.
re-assignments, or recruiting one or more The advance work includes creating a
new directors who can be assigned to the 12–18 month calendar and rolling agenda
committee, may be needed to create the right for each committee. This makes it easy for
mix of skills and experience on a committee. the staff to help ensure that all requirements
are met. It also makes it easy for committee
Tips for committee charters members to understand how and when
It is important not to over-reach on required requirements will be met. This document
functions for a committee in its charter. should be included in the advance materials
I strongly recommend having the charter for every committee meeting and posted on
cover only what is required by SEC rules, the board portal, so that everyone can easily
listing standards and state corporation law access it from time to time.
for the committee in question. The advance work also includes
Typically, the starting point for the charter benchmarking the use of consent agendas and
comes from the law firm assisting with other techniques to be sure the committees
the IPO. Some law firms also add items are not bogged down in the many public
the SEC staff wants a board committee to company requirements. It is important that the

committee understands the requirements and the committee’s charter—do you oversee the
oversees the work to meet the requirements. auditors, do you oversee financial reporting,
However, many committees report that do you oversee internal controls? While it is
hindsight shows they spent too much time on important to ensure that the committee’s key
technical details presented by eager outside functions are covered, these routine matters
vendors and subject matter experts. The can be taken care of without too much time
advance work allows much of the technical from committee members. Instead, the
detail to be covered in advance material committee can use the self-evaluation to
rather than during meetings. Sometimes focus on ways to drive long-term value
opinions of counsel and accounting experts creation and to make the committee work
upon whom the committee may rely are more effective (see Chapter 10 for more
helpful in this regard. The key here is to find details on effective self-evaluation processes).
a reasonable balance—the committee must An effective first step is to ask the
feel comfortable that the requirements will corporate secretary to annotate the charter
be adequately addressed but still leave time to show meeting dates where each charter
to oversee business matters that are key to requirement was covered with a brief
creating long-term value. description. Table 1 illustrates examples of
such annotations for a charter requirement
Review and follow-up of the three key committees.
Often the annual self-evaluation is merely a
mind-numbing checklist of the functions from
Table 1 Examples of charter requirement descriptions and annotations

Charter When and
Comments
Requirement How Satisfied
Audit Committee
At least annually, obtain Sept. 2013 regular meeting— The committee asked for
and review a report advance materials benchmarking data about
by the independent included an overview of how other companies’
auditor describing: the the independent audit audit committees handle
firm’s internal quality- firm’s quality processes, this task in advance of the
control procedures; any results of its own quality 2015 quality review.
material issues raised control review, a report
by the most recent of a peer review, and
internal quality-control commentary from the
review, or peer review, PCAOB’s review of the
of the firm, or by any firm’s work; also the
inquiry or investigation results from a company
by governmental survey of the finance,
or professional accounting, and tax
authorities, within the teams’ perception of the
preceding five years, independent audit firm’s
respecting one or more quality processes; at the
independent audits meeting the committee
carried out by the firm, discussed these matters
and any steps taken with the engagement
to deal with any such partner and a partner from
issues. the firm’s national office.

Global Governance Consulting LLC Effectively structuring board committees
Table 1 Examples of charter requirement descriptions and annotations—continued

Charter When and
Comments
Compensation Committee
Make recommendations Sept. 2013 regular The committee instructed
to the board regarding meeting—review that when future equity
equity-based information from plans are presented
compensation plans the committee’s for consideration, the
that are subject to independent anticipated reaction of
board approval. compensation each investor holding
consultant, more than 5% of the
management, and outstanding shares be
the company’s included with other
compensation evaluative data.
consultant regarding
a proposed new
stock option plan and
recommend that the
board approve the plan.
Nominating Committee
Oversee evaluation of the Sept 2013 regular meeting— Board and committee
board and management. selected method of board liked the process and
self-evaluation based facilitator. Plan to use
on alternatives together again next year, and
with benchmarking to ask the facilitator to
data provided by the present the results at
corporate secretary. meetings of both the
Selected method of committee and the board.
management evaluation Next year, will ask
based on alternatives executive recruiter who
together with works with the board
benchmarking data on succession planning
provided by the senior to assist with the
HR executive. process for management
October 2013 special evaluations.
telephone meeting—
selected outside
governance expert to
facilitate the board self-
evaluation and approved
topics to be covered.
December 2013 regular
meeting—received
results of the board self-
evaluation at committee
meeting and presented
those results to the board.

Table 1 Examples of charter requirement descriptions and annotations—continued

Charter When and
Comments
Nominating Committee—continued
January 2014—joint
meeting with the
compensation committee,
received CEO’s self-
evaluation and his initial
evaluation of the other
executive leadership
team members; discussed
those results and
determined next steps
February 2014—telephone
meeting with the
compensation committee,
completed evaluation of
management.
Annotations like those in Table 1 allow a strong board is important to building

the committee a quick way to verify that all long-term value. Strong committees are the
requirements were met and to refresh itself foundation for a strong board. It is worth
about enhancements suggested during the the time to plan ahead, so that the right
year. leadership and membership can be recruited.
For newly public company committees, It is also important to focus upon committee
a self-evaluation process customized to take structure and function. This will help avoid
into account the company’s opportunities overcommitting with too many committees
and challenges will best position the or too many nonrequired functions that can
committee to evolve and add value. overwhelm a board. And most important,
this will allow the committee to keep its
Conclusion focus on helping the board and management
As a company goes public and reinvests create long-term value.
the IPO proceeds into the business, having

12 Managing information flows
among board and management
Robert B. Lamm, Co-Chair Securities and Corporate Governance Practice, Gunster, Yoakley & Stewart, P.A. (Fort Lauderdale, FL)
I
nformation is the lifeblood of the board. While non-executive
directors should seek out current, complete, and accurate
information about the companies on whose boards they serve—
and many, in fact, do so—their knowledge of those companies is
necessarily dependent upon information provided by management.
Similarly, management cannot properly follow the mandates and
views of the board of directors if those mandates and views
are not communicated in an effective and timely manner. Thus,
information flows among the board and management are critical
to the proper functioning of both, as well as to the execution of a
company’s strategic plan and many other critical processes.
This chapter considers the factors and processes to be kept in
mind in managing these information flows.
Information flows to the board

Let’s start with the basics, noting that while the following discussion
concentrates on materials for board and committee meetings, the
same considerations apply to less formal information flows, which
are discussed below.
The Goldilocks principle—moderation in all things

We all remember the story of Goldilocks, particularly that she always
searched for an ideal midpoint. She disliked the bowls of porridge
that were too hot or too cold, the beds that were too hard or too soft,
and so on; instead, she sought out the bowl, bed, and so forth that
was “just right.” Managing information flows among management
and the board should utilize the same principle: Determine what’s
“just right,” based upon the specific facts and circumstances.
Quality of Information: Before addressing other aspects of information
flow, it’s critical to focus on the most important “just right”—namely,
that the board and its committees receive full and fair information,
including bad news as well as good news. Bearing in mind the earlier
statement that boards are largely dependent upon the information
provided by management, it’s unconscionable—and dangerous—
to sugar-coat information given to the board. We have all read
(often in articles about scandals) of boards that were not informed

Managing information flows among board and management Securities and Corporate Governance Practice
about adverse developments. A very good Plaintiff’s Counsel: In giving that

if tragic example is the scandal that rocked projection, did anyone indicate that it
Penn State a few years ago; according to was premised on 10% growth in GDP
published reports, management consistently during that same first year? Or that the
opted not to tell the board of the allegations synergies resulting from the acquisition
of sexual abuse and even of inquiries by the would be fully implemented within six
authorities. Examples in the corporate context months after closing?
abound as well.
Of course, the Goldilocks principle applies Director Jones: Well, er, I don’t remember
here as well—everything in moderation. anyone saying that, and I also don’t
But at a minimum, management needs remember anything about those
to avoid even a soupçon of the “no bad assumptions in the materials.
news” approach. In fact, the first questions
management (including the corporate Plaintiff’s Counsel: How about the fact that
secretary) should ask when something Red is involved in a lawsuit challenging
bad—or good—happens are, “do we need the patent protection on its principal
to tell the board, when do we tell them, and product?
what do we tell them?”
Some examples: Director Jones: Well, I know that the
materials said that the lawsuit was
• When preparing materials on acquisitions entirely without merit. I guess that turned
and similar corporate transactions, it’s out to be wrong . . .
important to candidly discuss the risks
Amount of Information: Let’s proceed to
of proceeding—and not proceeding—
discuss the amount of information provided
with the deal. Giving only the upside is
to the board. It may be tempting to give the
simply not good policy. And if the upside
board massive amounts of information to
(or downside) is based upon certain
avoid omitting something that may be of
assumptions, be straightforward about
significance. The thinking goes that you are
the assumptions and how realistic they
protecting the directors against liability by
are. The same goes for timing, antitrust
making sure that they have every piece of
implications, and other aspects of the
potentially relevant information. However,
transaction.
think of Goldilocks: There is such a thing
• When informing the board about litigation
as too much information, and giving your
brought by (and against) the company,
directors everything that may possibly be
it’s important to be realistic about likely
of interest falls into this category. First,
outcomes.
there is no assurance that the directors
will find the important needles in massive
Just think about how not being realistic may
haystacks of information. In fact, by giving
play out in court:
them too much information, you may be
Plaintiff’s Counsel: Director Jones, when forcing them to choose between reading it
the board considered the $50 billion too quickly and thereby not absorbing it, and
merger with Red, Inc., what was said not reading any or all of what you’ve given
about the statement in the board materials them. In either case, you may be causing
that the acquisition would be accretive problems—not the least of which may be
within the first year? that your directors will not be prepared
for discussions at board meetings (and the
Director Jones: Well, that was pretty worst of which may be that your directors
impressive; it’s not often the case. So the are found liable for not considering the
fact was noted during our discussion. appropriate information). Consider how

Securities and Corporate Governance Practice Managing information flows among board and management
furnishing masses of information might play risk that they will forget some of it by the
out when a matter considered by the board time the meeting rolls around. Also, giving
is litigated: information too soon may result in the failure
to update the information as more details
Plaintiff’s Counsel: Director Jones, we
become available or in the directors missing
note that the board received a 50-page
that critical new factoid. The risks associated
memorandum, copies of the merger
with giving your directors information too
agreement and a number of ancillary
late seem obvious; they may not be able
documents, and a 60-page banker’s “blue
to review it on time, or they may read
book” in connection with its review of
it too hurriedly, possibly overlooking key
the $50 billion merger with Red, Inc.
details. And think about how late delivery
Did you notice a footnote on page 42
of materials might play out when a matter
of the memorandum pointing out that
considered by the board is litigated:
the assumptions underlying some of
the anticipated synergies between your Plaintiff’s Counsel: Director Jones, we
company and Red, Inc. had not been note that the board received a 20-page
tested? How about the statement on page memorandum and other materials in
25 of the banker’s blue book that Red, Inc. connection with its review of the $50
had been sued based on allegations that billion merger with Red, Inc. Frankly,
its principal product was defective? it looks like these materials were very
carefully prepared; they are neither too
Director Jones: Well, I read the materials, long nor too short—in fact, they look
but I don’t remember those two items. just right. However, when did the board
I’m sure I read them, but I just don’t receive these materials?
remember.
Director Jones: I believe we received them a
Plaintiff’s Counsel: Did any other members couple of hours before the board meeting
of the board ask about either of those two got underway.
items when the merger was discussed
and approved at the board meeting? Plaintiff’s Counsel: You mean two hours
before the board meeting at which the
Director Jones: I don’t recall. board was asked to approve, and in fact
did approve, the merger with Red, Inc.?
Instead, it is (or should be) management’s
task—often executed by the corporate
Director Jones: Umm . . . yes.
secretary—to make sure that the information
provided to the board is reasonable in
Plaintiff’s Counsel: Were you able to
amount and can be read and digested prior
read the materials, much less carefully
to the meeting (and it’s acceptable to let the
consider them?
directors know that they are expected to do
so). Even if the company’s culture calls for
Director Jones: Well, it was tight. I’m glad I
the use of lengthy, highly detailed materials,
took that speed-reading course last year. . .
that approach is unlikely to work for non-
executive directors. Good governance does not involve a one-size-
Timing of Delivery: Again, the Goldilocks fits-all approach, but delivery of materials
principle applies—avoid giving your five to seven days prior to a meeting is
directors information too early or too late. It generally regarded as appropriate.
may seem desirable to get them information
as soon as it is ready, to assure that they will Provide good road signs for your directors
have “all the time in the world” to review Have you ever noticed that road signs seem
and consider it. However, this runs the to be made by people who already know

Managing information flows among board and management Securities and Corporate Governance Practice
how to get there? You see a road sign that some of your directors serve on other
says “I-95 Ahead,” so you stay on the road boards where the same acronym means
on the assumption that there will be an something entirely different. Therefore,
entrance ramp or another sign that tells you include acronyms in your glossary or
how to get on I-95—but it never happens. explain them in some other manner—and
Don’t you wish that road signs could follow not on the last page, either.
a consistent format and actually do what • Readability—It should go without saying
they’re supposed to do? that anything going to the board should
The same concerns apply to the be carefully proofread. However, write
information you provide to your board. If in plain English rather than legalese
every document your board receives follows and make the materials easier to follow
its own unique approach, you are making through use of shorter paragraphs,
your directors’ jobs harder—without any bullet points, and other tools to focus the
commensurate benefit. Why not make directors on what is important.
it easier for them, as illustrated by the
following? Informal communications to the board
The Goldilocks principle and the other
• Format—Materials furnished to the board approaches to board agendas and other
should follow the same format; that way, formal communications discussed above
directors will know where to find what should be considered in dealing with
it is they’re looking for or what you periodic, less formal communications as
want them to see. If directors know that well.
the request for authorization—that is, Of course, the first decision is when to
the specifics of what the board is being engage in informal communications with
asked to approve—appears in the same the board and/or a committee. As suggested
place in every memo or slide presentation above, this decision should be guided by the
(preferably in a prominent place on the following questions:
first page), it will guide their reading.
The same goes for any glossary or list of • Do we need to tell the board?
acronyms (see details below). If tables • When do we tell the board?
continue on several pages, make sure • What do we tell the board?
that the header row appears at the top of
each page, and try to avoid having rows In considering whether and when to engage
split across two pages. These are small in informal communications with the board,
tips that can make a director’s job much remember that sending something to the
less arduous, increasing the likelihood board on a too-frequent basis may be a
that he or she will read—and absorb— bit like the boy who cried wolf; if you’re
the document in question. And if your constantly sending materials to the board,
board members are reading materials on it may be hard for directors to distinguish
a tablet or computer, you should consider between routine matters that might better
avoiding double-column formats; while be collected for distribution on a regular
there are studies indicating that double- basis (for instance, on a weekly or biweekly
column formatting is easier to read, that’s basis) and materials that truly require their
not necessarily true when you’re reading attention. There’s no sure way of knowing
something on a screen. this, but it can be very helpful to ask directors
• Technical Terms—Where technical for their candid views as to how often they
terms must be used, provide a glossary. want to receive routine updates on various
Don’t assume that your directors know matters.
common acronyms in your industry or Once a decision is made to communicate
your company; in fact, it’s likely that with the board, the Goldilocks principle

Securities and Corporate Governance Practice Managing information flows among board and management
continues to apply. Specifically, as is the case review the communication before it is sent,
with formal board and committee materials, in case the drafter is unaware of how the
it’s important that distributions between communication will come across to the
board meetings need to be moderate in management team.
length and tenor and that format and similar Second, while clarity of substance
factors can make informal materials useful should be a given in all communications,
and informative. it is particularly important when the
The same can be said for content— board is giving directions to management.
different directors and boards may want to Management may be timid about questioning
see different things. Some boards may want the board’s directions, so rather than ask for
to receive analyst reports on the company clarification, management may implement
as they are published; others are content to what it perceives to be the board’s direction
wait for a weekly or biweekly summary. The only to find out that the board meant
best way to gauge what your directors may something else entirely.
want to see is to ask them. Third—and this surely applies to all
communications in both directions—the
Information flows to management board and individual directors may want
Because of the very nature of board– to think twice before putting anything in
management relations, communications writing. If the board is not represented
from the board to management are far more by its own counsel, it should consider
likely to be informal than formal. However, consulting with the company’s general
the same rules apply as those outlined above, counsel or outside counsel to determine
with a few extra wrinkles. whether a particular communication may
First, clarity of tone is very important. be discoverable; too often, boards assume
Management can be sensitive to board that their communications are confidential
criticism, and if a communication comes without realizing that confidential
across as harsh or insulting rather than communications will generally be available
constructive, relations between the to plaintiffs and others unless some type
two groups can be seriously impacted. of legal privilege can be claimed—and that
Depending upon the circumstances, it it is very difficult to sustain a claim of
may be desirable to have a second director privilege.

13 Recruiting and onboarding directors
Julie Hembrock Daum, North American Leader, Board Practice Spencer Stuart
T
he composition of the board is critical to the health and
effectiveness of every listed company. The ideal board
comprises a diverse group of directors from widely varying
backgrounds offering complementary skills and who work well
as a team. The makeup of the board sends out important signals
to the market about the direction in which the company is
heading. More so than ever, each new director appointment
carries significant weight and is closely scrutinized by everyone
from shareholders and analysts to employees and the media.
The ability to recruit the right directors and integrate them
successfully is one of the clearest indicators of a high-functioning,
effective board. The task of selecting and appointing new director
candidates falls to the governance committee, which in many
instances will engage the services of an executive search firm
to assist with the identification, assessment, and referencing of
candidates. After appointment, the corporate secretary will assume
responsibility for devising and implementing a tailored onboarding
program to bring the new director up to speed on key topics, ranging
from the board’s structure, governance, and responsibilities to the
company’s strategic objectives, financial reporting, and relationships
with investors and management.
Linking board composition to business strategy

We suggest that boards begin assessing the need for any specialized
skill or experience by considering the company’s strategy for the
next several years and then taking stock of the skills currently on
the board (including directors who will be cycling off the board in
the near future). Does the board as currently constituted give the
company its best shot at success in supporting the strategy? Would
additional, and perhaps different, skills significantly enhance the
board’s ability to do its job?
Boards need to anticipate their own needs by adhering to a rigorous
process of regularly evaluating the collective skills and experience
on the board against what is required by the company’s strategy.
It is easy to fall into the trap of “fighting the last war” rather than
focusing on the vision for the company several years out. The result

Spencer Stuart Recruiting and onboarding directors
of this careful evaluation may be a decision consideration and conducting due diligence,
to add experience in areas such as finance, the top candidates will be approached.
risk, technology, or digital/social media or
bringing in someone with knowledge and Recruiting directors with complementary skill
expertise in a specific geography. In any sets
case, it is useful to think holistically about Every board should be greater than the sum
director recruitment rather than making one- of its parts. There is a distinction between
off appointments in a vacuum. individual expertise and collective capability,
and a key part of the recruiting process is
The recruitment process and the role of the assessing how well candidates will be able
search firm to work alongside existing directors. The
Having the right expertise in the boardroom is importance of board culture and dynamics
paramount. The natural turnover of directors cannot be underestimated. Wherever
provides opportunities to refresh the board possible, board members should have the
with new and needed skills as the economic opportunity to meet finalist candidates
and competitive landscape changes—and to before they are appointed.
increase the diversity of perspectives. When No board needs one individual with
approached thoughtfully, ongoing board experience in all aspects of the business, but
renewal can improve board effectiveness. directors as a group need to be able to deal
Many boards use annual board with any and all aspects of the business. A
evaluations to assess the effectiveness of the well-balanced board will comprise directors
board overall as well as the contributions who bring specific experiences, skills, and
of individual directors, which can identify perspectives, and yet who are capable of
directors who are underperforming or contributing to board decisions on topics that
whose skills no longer represent a good fit may fall outside their sphere of expertise. In
with the strategic direction of the business. other words, they need to have sufficient
These evaluations can yield opportunities to financial and business acumen that they will
refresh the board. not be left behind in any aspect of board
The vast majority of board departures debate.
are known about well in advance, giving The governance committee must
the CEO and governance committee enough consciously construct a board that is strong
time to consider carefully what kind of and has the right mix of perspectives.
profile the successor should have and what One effective strategy is to think in terms
kind of expertise will enhance the board and of a skills matrix. Each square of the
further align it with the strategic vision of matrix reflects a “must-have” or “nice-to-
the business. have” skill or experience, such as prior
If the committee decides to engage an board experience, audit or compensation
executive search firm, both parties will discuss committee experience, or specialized
the selection criteria and produce a statement expertise in a particular industry or in areas
of director specifications summarizing key such as international business, marketing,
client requirements and preferences. The technology, digital/social media, or finance.
search firm will then conduct a broad-based The matrix will of course vary depending on
identification of candidates who meet the the nature of the business, its strategy, and
criteria, assessing their suitability, screening its current situation.
them for any potential conflicts of interest
or existing board schedule conflicts, and Adding diversity to the board
submitting a report to the nominating Diversity takes many forms, and the
committee. The committee will narrow the relevant mix of perspectives sought by a
list of potential candidates to a short list board will vary depending on factors such
of priority candidates and, after further as the scale of the business and demographic

Recruiting and onboarding directors Spencer Stuart
considerations (eg customer base and There are a number of dimensions to

geographic footprint). While not an end in consider when thinking about adding
itself, boards are increasingly recognizing that international representation to the
including diverse perspectives on the board board. Differing time zones, languages,
is important. This is borne out by results of a customs, and cultural nuances can present
corporate governance survey published in the seemingly insurmountable hurdles, but
Spencer Stuart Board Index. We asked about the boards that are truly motivated to add
profiles that are most desired by boards when an international dimension find ways to
recruiting new directors. Minorities, women, overcome these obstacles. For example, a
and active CEOs/COOs topped the list in board that demonstrates a commitment to
2014, cited by 64 percent, 71 percent, and 60 being global—by having board meetings
percent of respondents, respectively, which and director site visits outside the US, for
is consistent with our own director searches. example—will be more likely to attract an
Other profiles that are in high demand international director.
are executives with financial expertise (45 Having an international director who
percent), international experience (55 percent), works and lives abroad is not the only
and specific industry expertise (51 percent) way to add a more global dimension to the
and retired CEOs/COOs (40 percent)—or board. Some boards expand the search for an
some combination of these backgrounds. international director to include executives
Adding international directors to the who were raised, were educated, or have
board can be a sensible step if the company worked abroad but now live in the US.
has made a strategic decision to extend its Sometimes, it can be helpful if the diversity
global footprint, build manufacturing and of perspective sought by a board extends to
distribution capabilities overseas, or move having board directors who may be viewed
into a particularly competitive or complex as counter to the company’s prevailing
market. But this is easier said than done. culture, particularly when it comes to risk.
Despite the increasing importance of global Boards may also specifically seek a candidate
markets to US businesses, international who can serve as a countervoice to the rest of
directors remain a small minority on the the board and who has the courage to swim
boards of leading companies. Indeed, against the tide when there’s momentum
45 percent of US boards do not have an for something, whether it’s a new product
international director. or innovation or a merger or acquisition
We regard the inclusion of international opportunity.
directors on boards as important for two
reasons: Recruiting directors to serve on committees
A key aspect of developing the right mix of
• Providing market intelligence and entrée: skills on the board is populating committees
Directors with knowledge of business with appropriate technical expertise. The
culture, business dynamics, regulations, audit committee needs financial expertise
and key influencers can pave the way for and a solid understanding of risk; the
operating in critical countries or regions. compensation committee needs strong
• Expanding the board’s perspective: directors who can develop a performance-
International directors may add based CEO compensation scheme acceptable
something to the board that is harder to shareholders and create effective
to quantify than specific market know- communication around it; the nomination
how but potentially is of even greater committee may need experience in handling
value—creating a more open and diverse CEO succession issues; the risk committee
mind-set on the board and enhancing the requires a knowledge of the stress tests and
board’s deliberation and problem-solving other measurement tools that can provide a
skills. fair picture of the company’s major risks, and

usually needs directors with a background views. The chair or lead director plays
in the company’s industry. an important role in creating this
environment and getting contributions
Attracting the best candidates from everyone around the board table.
Recruiting new independent directors today • Make board service a rewarding
can be difficult and time-consuming. The experience for directors. Tap into the
desire for specialized expertise and diversity expertise and brain power of directors by
in the boardroom has increased competition structuring board meetings in a way that
for some candidates. At the same time, gives directors the opportunity to engage
many directors are accepting fewer board with one another, rather than having
assignments than they did in the past, and a series of presentations. CEOs gain
more companies have restrictions on how additional benefit when they develop
many additional outside board roles a one-on-one relationships with individual
director may accept. As a result, directors directors.
frequently are more discriminating about
which boards to join. Where boards are finding new directors
Experienced directors want to serve on In recent years, it has become harder to recruit
well-managed boards that make a difference active CEOs, the most desired candidate
to the performance of the company. They pool for corporate boards because of their
want to work with smart, engaged directors broad-based leadership, management, and
and be comfortable with the CEO’s leadership governance experience and current business
capabilities and character. Finally, they want knowledge. As the time demands of the
to serve on boards that allow them to learn CEO’s role and board service have increased,
and build new skills. When they find board many CEOs (54 percent of S&P 500 CEOs in
opportunities that offer these professional 2014) are electing not to serve on any outside
and personal rewards, they are willing to boards. As CEOs have reduced their outside
accept a new director role—despite the time board commitments, boards increasingly
pressures and demands. are tapping retired CEOs and other senior
Boards can improve their chances of leaders and, for audit committee roles, CFOs
attracting directors with the most relevant and other finance executives. In 2004, just
experience by understanding the motivations 13 percent of audit chairs were financial
and concerns of director candidates and executives—CFOs, treasurers, and public
the company’s perceived strengths and accounting executives—compared with 37
weaknesses. Here are a few lessons from the percent a decade later.
front line of director recruiting: Many current directors are scaling back
on their commitments, focusing on only
• Assume that there will be good one or two boards instead of several. In
competitors for a candidate’s time, response, boards have increased their
whether it is another board opportunity director retirement age to allow experienced
or another interest. directors to stay on longer. The average
• Understand your board’s “value retirement age for S&P 500 company boards
proposition,” based on where the is now 72, and 30 percent of boards have a
company is strategically, the kinds retirement age of 75 or older. On the whole,
of issues that come to the board, the independent directors are older than they
composition of the board, and the strength were a decade ago. The average age of all
of the management team. directors is now nearly 63, versus 60 in
• Define the board dynamic and chemistry 2003, and just over half of the 2014 cohort of
and promote an environment that newly elected directors are retired.
encourages active participation by every While the representation of retired
director and is respectful of differing executives on boards has increased, we

Recruiting and onboarding directors Spencer Stuart
are seeing a countervailing trend as well. complexity in an unfamiliar environment are

Some boards are prioritizing new areas the ones most likely to learn and adapt to the
of expertise, recruiting nontraditional challenges faced in the boardroom.
candidates, especially younger, active One of the most common difficulties
executives, who can bolster the collective for first-time directors, especially senior
knowledge of areas such as digital or social executives, is adjusting to a more detached,
media, since most sitting directors are of supervisory role, focusing on the strategic
a generation that did not grow up with rather than the operational agenda, and
these technologies. In addition, management understanding the distinction between
teams desire directors who understand the governance and management. There are new
current business environment. conventions and protocols to learn, and some
first-time directors take longer than others to
Recruiting a first-time director make the mental switch between executive
When openings exist, boards still tend to and non-executive ways of thinking and
prioritize prior governance experience when behaving. Chairs need to be sensitive to the
recruiting new directors. Nevertheless, challenges in making this transition and
executives or other professionals with no provide advice to the new director on the
prior public company board experience are nuances involved.
a growing source of new directors for boards
needing to add specific skills or knowledge. Director onboarding
S&P 500 boards appointed 145 first-time Chairs and boards have a responsibility to
directors in the 2014 proxy year, representing ensure that all directors, not just those joining
39 percent of all new directors. a board for the first time, are given proper
First-time directors tend to be senior support so that they can get up to speed
executives who have already had some as quickly as possible. Whereas historically
exposure to the board, such as CEOs, CFOs, some boards may have tolerated new
or executive committee members who directors taking a back seat and observing
have run large divisions of multinational proceedings for a year or so before making
companies. First-time directors will usually an active contribution, few directors have
be familiar with the industry the company that luxury today. A thorough yet tailored
operates in, although people with strong program is therefore critically important.
finance experience may be tapped to join a Ideally, a new director without previous
board in a sector that is new to them. board experience will participate in a
Board candidates from outside the general director training program, which
business world are often at a disadvantage can offer the opportunity to become more
because they may not have managed a profit familiar with the role of the board and
center or developed a sufficient level of individual directors, important governance
expertise that will enable them to contribute regulations and listing requirements, and the
to board decision-making over complex governance issues affecting the boardroom
financial matters. Having a good grasp of today.
financials is one selection criterion on which Director induction programs are usually
few boards will compromise. run by corporate secretaries, sometimes
First-time directors should be able to with input from the chief human resources
demonstrate good judgment and intellectual officer. If the new board member has had
agility and be comfortable dealing with some prior general training in the role of
complexity. They need to be able to bring a director, the induction can focus on the
analysis and logical reasoning to bear company, its products, services, and key
on a new, ambiguous, or fast-changing players, the wider business context, and the
situation in order to reach a sound decision. culture of the board and how it operates. The
Prospective directors who can work with best examples typically take several days

and involve presentations by the heads of In addition to the initial induction

all the company’s functions and divisions, program, many boards offer “top-up”
such that new board members feel fully training or attendance at seminars run by law
immersed in the business and know where or accountancy firms. Corporate secretaries
to go for additional information. generally provide important information on
Unfortunately, the quality of board changes to legislation, accounting rules, and
induction programs is variable, and some governance codes in board packs.
companies do not even provide them. It
is not enough for the CFO and general Conclusion
counsel simply to run through the core Multiple forces have converged to make
finance and governance issues; the new board service more complex and challenging
director should ideally spend some time today. Directors are taking on fewer board
at company headquarters with senior positions than in the past, conducting more
executives from each of the main functions thorough due diligence into each opportunity,
(eg investor relations, human resources, aware that they will have to grapple with a
audit, information technology). New board range of pressures—from new regulatory
directors should be encouraged to make requirements and shareholder activism
site visits to see as much of the company’s to intense scrutiny and a growing board
operations on the ground as they reasonably agenda. With fewer CEOs willing to serve on
can. Boards also may contemplate having an outside boards, nominating committees are
informal mentor program that pairs a new casting their nets wider. Recruiting directors
director with a more experienced director from the broadest possible talent pool
who can provide perspective on boardroom will pay dividends, providing the board
activities and dynamics or help with meeting has a clear vision for creating a diverse,
preparation, explain aspects of board papers, coherent, and well-balanced entity in which
and debrief and act as a sounding board each individual appointment supports the
between meetings. company in achieving its strategic objectives.

Should I serve as a member
14 of the board of directors of
a newly public company?
Jeff Vetter, Partner, and James Evans, Partner Fenwick and West LLP
I
n recent years, there has been a significant increase in the
number of companies conducting initial public offerings in the
US, particularly in the technology and life sciences industries.
Although most of these companies have boards of directors that
are composed of members with some experiences serving on the
board of directors of a public company, many of these companies
have at least a few members of the board of directors that have
little or no such experience.
Serving as a member of the board of directors of a public
company can be rewarding for a variety of reasons, including the
ability to maintain existing or develop new professional skills and
networks. In addition, serving on the board of directors of a newly
public company provides opportunities to participate in the overall
strategic planning and oversight of an enterprise, oftentimes with
companies that are at the forefront of new technologies or industries.
Serving on a board of directors, however, also comes with a litany of
responsibilities and risks, including a substantial time commitment,
fiduciary duties to stockholders, a wide variety of other legal
obligations, and potential liability exposure.
Before joining a board of directors, a potential director should first
seek to determine if the company represents the right opportunity to
achieve his or her goals without representing disproportionate risk.
In addition, the prospective member should consider whether he or
she meets the various requirements for membership, particularly as
an independent member of the board of directors, under both stock
exchange and Securities and Exchange Commission (SEC) rules.
The prospective member should then consider the substantial time
commitment, legal obligations, restrictions, and potential liabilities
that come with serving on the board of directors of a public company.
Questions to consider before joining
• How is the company’s business performing, what are its prospects,

and what do investors think of its prospects?
• Does the company have a history of regulatory or legal disputes?
Does the company have a history of disputes with investors?

Fenwick and West LLP Should I serve as a member of the board of directors of a newly public company?
• What is the “tone at the top”? Does the received, during any twelve-month
company appear to have a substantial period within the last three years, more
commitment to compliance, good than $120,000 in direct compensation
governance, and ethical behavior? • (1) the director is a current partner or
• Does the existing board of directors employee of the company’s internal or
currently work well together? external auditor; (2) the director has
• Is the board of directors dominated by an immediate family member who is
a few members, or are the views and a current partner of such a firm; (3)
opinions of others welcomed? the director has an immediate family
• How committed is the company to member who is a current employee of
supporting good information flow to the such a firm and personally works on the
board of directors? listed company’s audit; or (4) the director
• What is the scope of insurance coverage or an immediate family member was
and indemnification available? within the last three years a partner or
• How well do I understand the company’s employee of such a firm and personally
business and industry? worked on the listed company’s audit
within that time
Are you qualified to join? • the director or an immediate family
Public companies typically must have a member is, or has been with the last
board of directors composed of at least a three years, employed as an executive
majority of independent members. These officer of another company where any of
independence standards are required by the listed company’s present executive
the rules of stock exchanges as well as by officers at the same time serves or
the US securities laws. In addition, investor served on that company’s compensation
advisory firms and many institutional committee
investors focus on additional attributes • the director is a current employee, or an
when making determinations about whether immediate family member is a current
to support a company’s proposed board executive officer, of a company that has
of directors composition at stockholder made payments to, or received payments
meetings. from, the listed company for property
or services in an amount which, in any
Stock exchange rules of the last three fiscal years, exceeds the
A majority of the members of the board greater of $1 million or two percent of
of directors of a public company must be such other company’s consolidated gross
“independent” under applicable stock revenues.
exchange rules. The NYSE requires the
board of directors to make an affirmative In the technology and life sciences industries,
determination of independence, citing a the last requirement of the list above can be
range of considerations such as commercial, an unexpected potential pitfall, as it is often
industrial, banking, consulting, legal, the case that directors with the desired
accounting, charitable, and familial industry knowledge may also serve as
relationships. However a member cannot be executive officers with which the company
considered independent if: does business.
For persons serving on the compensation
• the director is, or has been within the last committee of a board of directors, the board
three years, an employee, or an immediate of directors must also consider additional
family member is, or has been within the independence factors, including the source
last three years, an executive officer of any fees paid to the director and whether
• the director has received, or has an the director is otherwise affiliated with the
immediate family member who has company or any subsidiary or affiliate.

Should I serve as a member of the board of directors of a newly public company? Fenwick and West LLP
Additional requirements for audit committee member, and therefore qualifying as an

members audit committee financial expert would be
The NYSE requires that audit committee an attractive attribute in a proposed board
members be financially literate. The SEC also member.
has additional, more stringent requirements
for members of an audit committee, No loans
including that audit committee members Public companies are prohibited from
may not receive additional compensation extending or maintaining (or arranging
from the issuer, or be “affiliated” with for the extending or maintaining) loans to
the issuer (holding less than 10 percent directors. While most companies are mindful
of an issuer’s securities, individually or of this restriction, to the extent there is any
through an affiliated fund, is a safe harbor pre-existing arrangement in place, such as
to this definition). Issuers are also required outstanding debt for stock purchases or
to disclose whether they have an “audit other forms of debt, it must be eliminated
committee financial expert” serving on the prior to a potential candidate joining the
audit committee. board of directors.
An audit committee financial expert is a
person who has the following attributes: Are you able to commit the requisite time?
Board membership involves a very
• an understanding of generally accepted significant time commitment. In addition
accounting principles and financial to the substantial time a director must
statements spend learning about and understanding
• the ability to assess the general application a company’s business and its industry,
of such principles in connection with the there are a number of additional factors to
accounting for estimates, accruals, and consider in making a realistic assessment of
reserves the time commitment that will be required.
• experience preparing, auditing,
analyzing, or evaluating financial Frequency of regular meetings
statements that present a breadth and While many private companies have regular
level of complexity of accounting issues meetings of the board of directors, public
that are generally comparable to the companies will typically have more frequent
breadth and complexity of issues that and longer meetings, as well as regular
can reasonably be expected to be raised meetings of committees of the board of
by the registrant’s financial statements, directors. These include the stock exchange
or experience actively supervising one or requirement that nonmanagement directors
more persons engaged in such activities must meet separately on a regular basis
• an understanding of internal controls and without management. Additionally, the
procedures for financial reporting board of directors and its committees will
• an understanding of audit committee often meet on an ad hoc basis with relatively
functions. short notice.
Each year, a public company must
This experience must generally have been disclose the number of board and committee
gained through education and experience meetings held and identify the members
as a financial officer, controller, or auditor, who did not attend at least 75 percent of
actively supervising, overseeing, or assessing those meetings. While poor attendance
such persons. impacts the ability of a member to fully
While it is not required that a public perform his or her duties, it may also attract
company have an “audit committee financial recommendations to withhold a vote for
expert” serving on its audit committee, most re-election from investor advisory services
issuers prefer to have at least one such such as ISS.

Additional workload for committee members such as ISS will recommend votes against a
For many newly public companies, recently member who serves on more than six public
added members of the board of directors company boards.
are often asked to serve on at least one if
not more of the committees of the board Fiduciary duties
of directors in order to ensure they are Members of a board of directors have
composed of independent members. fiduciary duties to the company’s
Because of its unique role in overseeing stockholders, in the form of a duty of care
all aspects of a company’s financial systems and a duty of loyalty. In most circumstances,
and reporting and risk management, the directors will have the benefit of a legal
audit committee is typically a very time- standard that is referred to as “the business
intensive committee, with a larger number judgment rule,” and this means that courts
of meetings and more information to will not interfere with managerial decisions
review in preparation for meetings. of the directors and a court will presume that
Compensation committee membership also the board acted with appropriate diligence,
increasingly requires a more substantial time in good faith, and in the honest belief that
commitment, as a result of the increased they are acting in the best interests of the
public and regulatory focus on executive stockholders.
compensation.
Duty of care
Other committee duties Directors have a duty to act on an informed
Over time, companies may face unusual basis, after due consideration of relevant
events or emergencies that would require information and appropriate deliberation.
frequent meetings of existing committees or To meet their duty of care, directors should
the formation of special committees. These regularly attend meetings and prepare in
events might include internal investigations advance of meetings by reading materials,
related to accounting irregularities or asking questions of management, requesting
whistle-blower complaints, proxy contests, additional information as needed, consulting
acquisitions, or other unusual transactions. with advisers, and requesting expert advice
These occurrences will often involve as needed.
numerous and lengthy meetings over a
potentially indeterminate period of time. Duty of loyalty
Directors have a duty to act in good faith
Travel in the best interests of the company and
Prospective members of the board not their personal interest. Transactions
of directors should also factor in travel in which the director might have a
required to attend meetings. While many personal interest are not prohibited, but
companies in the high technology and they require consideration and approval
life sciences industries are geographically by disinterested members of the board
concentrated, this is not always the case, of directors after full disclosure of the
with companies also holding meetings at a transaction. The classic example that brings
variety of locations. into question the duty of loyalty is when
a director either appears on both sides
Conflicts with other board memberships of a transaction or receives a personal
If an audit committee member serves on the benefit not shared by all stockholders.
audit committees of more than three public Without the approval of disinterested
companies, the board must determine that members of the board of directors, the
such simultaneous service would not impair transaction could be voidable under state
the ability of such member to effectively corporate law, or may require the director
serve. In addition, investment advisory firms to prove that the transaction was fair to the

company. Most public companies have a for any purchases and sales (at a profit)
“related party transaction” policy or other within a six-month period.
similar approval process for these types of Section 16(a) requires all directors to file
transactions. However, the director should reports (Forms 3, 4, and 5) with the SEC
not assume that the company is aware of a disclosing any direct or indirect economic
director’s interest in a transaction. interests in the securities and any transactions
in those securities. These reports, which are
Disclosure of personal information available to the public, enable the SEC and
As a director, a variety of information will the public, including plaintiffs’ attorneys,
become publicly available. The reporting to examine trading by company insiders,
company will be required to provide such as directors and officers and large
detailed biographical information about stockholders.
each director, including work experience A public company must also disclose the
over the past five years, other board name and the number of late and omitted
memberships, age, and involvement in filings in its annual proxy statement or Form
bankruptcies and other legal or government 10-K. The SEC may take action and seek to
proceedings. Many companies also disclose impose substantial fines for each failure to
educational background of members of the make the necessary filings. This penalty is
board of directors as well. A relatively new separate from the potential loss of profits
disclosure requirement is that companies from the stock transactions. If a person is a
must discuss the “specific experience, habitual violator, the SEC can temporarily
qualifications, attributes or skills that led or permanently prevent him or her from
to the conclusion that the person should serving as an officer or director of a public
serve as a director . . . in light of the company.
registrant’s business and structure.” The Section 16(b) requires disgorgements of
reporting company will also be required profits on sales of these securities if the
to provide detailed disclosure of directors’ director has made a purchase within six
stock ownership and compensation. months before or makes such a purchase
This information is usually obtained by within six months after the sale. A “purchase”
the company having the director complete or a “sale” would not be deemed to occur
a lengthy and detailed questionnaire in most transactions with an issuer such
(commonly referred to as a “D&O as option grants or exercises. Rather, open
Questionnaire”). As a further matter of market purchases and sales in the market
diligence, many companies will also conduct will typically be the source of matching
background checks of potential members of transactions for Section 16. However, it does
the board of directors, with any significant not matter if the sale follows the purchase
discrepancies being cause to withdraw the or the purchase follows the sale. These
invitation to join the board. profits, which are often referred to as “short-
swing profits,” are computed by matching
Significant restrictions on how directors may purchases and sales (whether or not they
transact in company securities and discuss involved the same shares or certificates) so
information regarding the company as to maximize liability. Thus, short-swing
profits may exceed actual gains in certain
Section 16 circumstances. There is no reimbursement or
Section 16 of the Securities Exchange Act of indemnification for these disgorged funds.
l934 requires directors of public companies
to file reports concerning their holdings Rule 144
and transactions in a reporting company’s Under Rule 144 of the Securities Act,
registered equity securities. Section 16 also directors and other affiliates cannot publicly
imposes penalties for “short-swing” trading resell securities on the open market that

have not been held for at least six months. information concerning the company, and it
Once an affiliate has held the securities for can also be illegal to tip or disclose material
at least six months, Rule 144 permits sale of nonpublic information to outsiders. Persons
the securities if the affiliate complies with all violating insider trading or tipping rules
of the following requirements. may be required to disgorge the profit made
or the loss avoided by trading, pay the loss
• Adequate public information. “Adequate suffered by the persons who purchased
public information” about a company securities from or sold securities to the
must have been available for a period of insider tipper, pay civil penalties of up to
time prior to the sale. This requirement three times the profit made or loss avoided,
is generally not met until 90 days after pay a criminal penalty of up to $1 million,
the company completes its initial public and serve a jail term of up to 10 years.
offering. This requirement is satisfied Information is “material” if it would be
so long as a company has filed all of expected to affect the investment decisions
the required SEC reports during the of a reasonable stockholder or investor. Both
preceding 12 months. positive and negative information may be
• Manner of sale. Securities can be sold under material. While it is not possible to identify
Rule 144 by an affiliate only in a normal all information that would be deemed
broker’s transaction in which the buyer is “material,” the following information would
not solicited, in transactions directly with ordinarily be considered material:
a “market maker,” or in so-called “riskless
principal transactions.” To ensure that • financial performance, such as quarterly
the broker is experienced in dealing with and year-end earnings
Rule 144 sales and properly executes • operational metrics, such as customer
the transaction, the use of a full-service counts and associated retention or
broker is usually recommended. attrition rates
• Volume limitations. An affiliate’s sales • potential mergers, acquisitions, or
under Rule 144 during any three-month dispositions
period are limited to a volume of shares • developments regarding customers,
not exceeding the greater of (1) one suppliers, or partners, such as the
percent of the outstanding shares of acquisition or loss of a significant contract
the class being sold, or (2) the average • stock splits, public or private securities,
weekly reported trading volume in such and/or debt offerings
securities during the four calendar weeks • significant management changes
before filing of the Rule 144 notice of sale. • introduction of key new products and
• Filing of notice. If a stockholder uses Rule services.
144 to sell more than 5,000 shares or to
sell shares having an aggregate sales price Many companies have implemented insider
of more than $50,000 during any three- trading policies that only permit directors
month period, the stockholder must, at to sell during specific “trading windows.”
the time of the sale, file three copies of a These windows are often closed for a period
Form 144 notice with the SEC (and one of time prior to the end of a fiscal quarter
copy with any stock exchange on which and then re-open after the announcement of
the stock is listed). The selling broker earnings. However, for newly public, high-
will generally help you complete and file growth companies, these trading windows
Form 144. may be closed at other times, such as for
potential acquisitions or other significant
Insider trading transactions. As a result, directors may find it
It is illegal to trade in company securities difficult to sell any securities of the company
while in the possession of material nonpublic at the desired times.

Regulation Fair Disclosure (FD) of reasonable care could not have known,
Regulation FD prohibits directors (among about the misstatement or omission.
other company personnel) from disclosing In addition to potential liability in
any material nonpublic information about connection with offerings of securities,
a company privately to certain persons directors potentially could face claims as
(typically stock market professionals, such a result of a company’s statements in its
as analysts, or stockholders likely to trade periodic reports it files with the SEC, such
on such information). The SEC has taken as current reports on Form 8-K, quarterly
enforcement action against companies reports on Form 10-Q, or annual reports on
and individuals for violations of this Form 10-K.
prohibition. In addition, directors could face liability
Directors will need to be mindful as to under Section 10(b), which prohibits conduct
what information they discuss with brokers, deemed to be a “scheme to defraud”
research analysts, investment fund managers, investors. Liability under Section 10(b) of the
or other securities industry participants. Even Securities Exchange Act typically takes the
statements such as “things look good” or form of class action lawsuits following drops
“the company is doing well” could be seen as in stock price. Typically, only the company
conveying material information. In addition, and its senior officers are held accountable
many companies have strict communications under Section 10(b). In rare instances outside
policies that prohibit public disclosure of directors may also be liable, for example, by
information regarding the company outside signing off on misleading press releases, or if
of controlled processes. there were sales of stock by such directors in
advance of a stock price drop.
Other sources of liability under securities laws
Under US securities laws, directors (and Additional pitfalls
certain other company personnel) potentially
face liability in connection with public Proxy contests/activist stockholders
offerings of securities and in connection If a company has been underperforming,
with a company’s ongoing public reporting. whether through a depressed stock price or
Directors will sign the company’s annual lack of growth, activist investors, such as
reports on Form 10-K, and if the company hedge funds or other similar entities, will
registers additional securities for public sale, often launch a campaign for a company to
directors will also sign those registration pursue ways to increase stockholder value.
statements. Often these campaigns take the form of
Sections 11 and 12 of the Securities Act proxy contests, where an activist stockholder
impose liability for the making of materially would propose an alternate slate of directors
false or misleading statements (or material for election at a board meeting. As part of
omissions) in registration statements and these concepts, there will often be a lengthy
prospectuses. These are the documents that and very public campaign by the activist,
are used to make public offerings of securities alleging that the board was not effective, was
(as opposed to the periodic reports filed by not properly performing its duties, and was
companies on a quarterly and annual basis, no longer appropriate to be overseeing the
for example). Plaintiffs do not have to prove company. These contests are time consuming
intent or reliance, just that they purchased and can damage members of the board of
securities pursuant to a materially false directors’ reputations among investors, even
or misleading registration statement or if they were otherwise acting appropriately.
prospectus. Sections 11 and 12 allow for an
affirmative defense for directors, placing the Majority voting/withhold campaigns
burden of proof on the defendant to show In recent years, investor advisory firms such
he or she did not know, and in the exercise as ISS and Glass-Lewis have recommended

that stockholders withhold votes for insurance on behalf of directors, officers, and
re-election of members of the board of employees, whether or not the corporation
directors for a number of reasons, including would have the power to indemnify such
if companies maintain corporate governance person. The primary types of coverage are
practices that they find undesirable, or known as Side A, Side B, and Side C, with
if the company’s compensation practices Side A and Side B being most relevant to the
exceeded their guidelines or for otherwise director.
having policies or taken actions outside Under the so-called “Coverage A,” “Side
of their recommended standards. When A,” or “Natural Person Insured” clause,
coupled with a structure that requires that individual directors are covered for a “loss”
members of the board of directors receive a arising from a “claim” against the director
majority of votes cast for re-election (known or officer for any alleged “wrongful act”
as “majority voting”), a board member during the policy period, except when and
that did not receive the requisite votes to the extent the company has indemnified
(even though they were legally sufficient the officer or director. Insureds are typically
for re-election) could be forced to resign the entitled to advancement of defense costs
position. These “withhold” campaigns can while a claim is pending.
similarly be time consuming and damaging Under the so-called “Coverage B,” “Side
to members of the board of directors’ B,” or “Corporate Reimbursement” clause,
reputations. the policy pays the “loss” of the company
arising from “claim” made against a director
How you can mitigate liability for any alleged or actual “wrongful act”
during the policy period, to the extent the
10b5-1 trading plans company has indemnified the director or
The SEC enacted Rule 10b5-1 to provide an officer for the loss.
affirmative defense to a charge that stock Side B coverage typically requires the
sale was based on insider information. As a company to make indemnification payments
result, many directors may choose to enter up to the retention (or deductible) amount
into what is known as a “10b5-1” trading before the carrier is obligated to pay. Typically,
plan, which is often a written plan with when a director or officer must defend against
a broker for the broker to sell a certain a claim, he or she requests indemnification
number of shares at a set price (or based on based on an indemnification contract and/
a formula) on specified dates over several or the company’s charter documents. The
months or quarters. The director would not company agrees to advance defense costs
retain any ability to influence the timing of upon execution of an undertaking by the
sales or the amount of shares to be transacted. officer or director to repay those costs if the
Furthermore, the director may not enter director is subsequently found not to be
into a trading plan when in possession of entitled to indemnification.
material nonpublic information. Side A may be triggered, rather than
While such a plan can provide a defense Side B, when the company is insolvent and
to insider trading allegations, it does reduce cannot pay indemnification. Another trigger
flexibility, since the director effectively puts is payment to settle a derivative action.
the number of shares to be sold into the These policies typically contain numerous
hands of a third party. Additionally, if a plan exclusions, such as if the insured had
is in place, trades outside of the plan are knowledge of a fact or circumstance likely to
often discouraged. give rise to a claim but failed to disclose it in
the insurance application, criminal fines, and
D&O insurance penalties, among many others. Therefore, a
Many states’ corporate laws allow director should review with outside experts
corporations to purchase and maintain the terms of the policy.

Charter provisions and indemnification agreements numerous pitfalls and potential liabilities
Most newly public companies will have for doing so. However, by following some
included provisions in their certificate of relatively simple guidelines, these may
incorporation and/or by-laws providing hopefully be avoided:
for indemnification of officers to the fullest
extent permitted by law. They will also often • be active, engaged, questioning, and
have indemnification agreements and may informed
make indemnification and advancement • require that corporate governance and
of fees mandatory. Many states’ corporate compliance procedures are in place,
laws will permit a corporation to indemnify reviewed periodically, and scrupulously
any person who was or is a party or is adhered to
threatened to be made a party to any • take prompt steps to address any
threatened, pending, or completed action, regulatory or reporting issues
suit, or proceeding, whether civil, criminal, • monitor potential conflicts of interest
or investigative (other than an action by or involving directors or officers
in the right of the corporation) by reason of • require that information presented to the
the fact that the person is or was a director, board is accurate, thorough, and timely
officer, employee, or agent of the corporation. • increase time commitments for board
This indemnification will often cover business, for example by scheduling
all expenses, including attorneys’ fees, committee meetings for the day preceding
judgments, fines, and amounts paid in board meetings instead of the same day;
settlement. In many instances, a corporation review board packages in advance of
may also be permitted to pay expenses meetings
(including attorneys’ fees) in advance of • use independent advisers such as
the final disposition of the action, suit, or experienced outside counsel and
proceeding, so long as the director agrees to compensation specialists
repay amounts advanced if it is ultimately • scrutinize indemnification and insurance
determined that the person is not entitled to provisions
be indemnified. • be aware of your obligations under
As is the case with directors and officers securities laws
liability insurance policies, indemnification • attend director education programs on a
provisions contained in a company’s regular basis
certificate of incorporation and by-laws and • when the company is offering securities
the terms of indemnification agreements can to the public, carefully read the disclosure
be complex, and the director should consult documents, ask questions, and request
with an expert in this area before joining a briefings from management and auditors
board of directors. and seek advice of outside counsel with
experience in these transactions
Conclusion • consider a trading plan for transacting in
For a board member new to serving on public the company’s securities
company boards, the time commitment and • inquire of management as to how the
scrutiny of board process has increased company is performing and request
substantially in recent years. There are regular business updates.

Part III
Key Challenges for boards
and management
nyse.com/cgguide
15 Succession planning: strategies
for building the pipeline
Cathy Anterasian, North American Leader, CEO Succession Services, and Dayton Ogden, Global Leader, CEO Succession Services Spencer Stuart
A
t any company, one of the most important responsibilities
of the board and of the CEO is ensuring an uninterrupted
flow of capable management. Boards and CEOs that do
not make succession planning a priority can put at risk their
company’s ability to carry out its strategy or to respond to new
competitive threats, potentially shaking the confidence of both
the organization itself and the financial markets. The risks of
complacency or poor planning are steep when it comes to talent
development and succession, especially as succession has become
a growing concern for investors.
Successors and succession plans rarely just emerge. They are
a product of the board’s commitment to thoughtful, diligent
planning and a willingness to hold the CEO accountable for the
process. Boards that embrace this process work with the CEO to
ensure that senior executives receive the appropriate developmental
opportunities, including exposure to the board and potentially to
outside board experiences, and push to meet a broad range of top
executives.
A rigorous succession planning process

The NYSE Corporate Governance Guidelines state that listed
companies must adopt and disclose corporate governance guidelines
around management succession: “Succession planning should
include policies and principles for CEO selection and performance
review, as well as policies regarding succession in the event of an
emergency or the retirement of the CEO.” In practice, boards must
balance the need to provide appropriate information about the CEO
succession process to fulfill their fiduciary and legal obligations with
the need to protect sensitive internal information about potential
candidates from being made public.
In our experience, a credible and sustainable CEO succession
planning process involves the following:
• Preparing over time for an orderly, well-executed handover that

proceeds from a robust management development process.

Spencer Stuart Succession planning: strategies for building the pipeline
• Developing contingency plans to deal planning process may find that there is not
with other succession scenarios, for enough time to address the developmental
example, a death, health crisis, or other needs of candidates with high potential.
personal reason, that force a sudden Starting early also allows directors to have
CEO transition, or performance problems more interactions with potential candidates
requiring an accelerated succession. over time, so they can observe patterns
• Driving agreement about the long-term of performance and behavior and gain
strategic direction of the company and deeper insights into candidates’ succession
developing CEO selection criteria based readiness. Finally, when C-suite succession
on the future needs of the business. A very is an established process—rather than a
precise and thoughtful profile should be response to an imminent transition—it can
the compass that guides the board in minimize the emotion and drama from the
making tough decisions throughout the process because it is business as usual.
process.
• Defining the respective roles of the Tie the profile of the future CEO to the strategic
board, the committee, the CEO, and the direction of the business
management team in succession planning, The foundation for CEO succession planning
and establishing the mechanisms to make is the strategic direction of the business, from
succession planning an ongoing and real- which the profile and selection criteria for
time process. the future CEO can be developed. Getting
• Assessing potential internal candidates this right is critical because the CEO criteria
based on the defined selection criteria, provide a road map for internal candidate
understanding their strengths and development plans and a framework for
development needs, and then creating selecting from among finalist candidates.
development plans to close any gaps. It A potential pitfall for the succession
is important that internal candidates feel planning process is basing criteria for the
good about this process. next CEO on a strategy that is too rooted
• Gaining an understanding of the talent in the present or relies on status quo
marketplace and how internal candidates assumptions, rather than a view of where
compare to external talent benchmarks. the company needs to be in five to 10 years.
• Ensuring the CEO and chief human When this happens, the criteria for the next
resources officer are overseeing an active CEO may not be tied to the specific strategic,
and effective C-suite succession program organizational, and operational levers that
so that all senior executives accumulate the next CEO will need to employ, potentially
the experience and skill sets they need to impeding the development of internal
be effective. candidates with these capabilities. Very
• Regularly reviewing the succession plan simply, if you don’t know where you want
and adjusting when necessary. to take the company, it’s hard to evaluate
who is the right person for the company’s
The value of starting early next phase—some executives are skilled at
When should succession planning begin? growing a company; some are experienced
While somewhat counterintuitive, ideally, in turnarounds; some are perfect for
the process should start early in a CEO’s maintaining the company’s current course.
tenure. Starting early and creating a normal Wise boards agree on strategic issues up
cadence around executive development front, since these decisions will influence
and long-term C-suite succession planning the kind of future leader or leaders the
increases the chances that strong internal company will need, and push themselves
candidates will be identified, assessed, and to go beyond generalities. They identify
ready when a transition is near. Boards the very specific effect the next CEO needs
that wait too long to begin the succession to have on the business and define the

Succession planning: strategies for building the pipeline Spencer Stuart
skills that it will take to accomplish that. should understand candidates’ track records
These could include invigorating the delivering against the same strategic and
innovation pipeline, applying disciplined operational levers that the next CEO will
cost management, pursuing specific growth be required to pull, drilling down into the
targets in emerging markets, or building specific contributions individuals have
new organizational capabilities to drive made in the businesses they have run. In
organic growth. addition, boards should strive to gain an
In addition, boards should consider the understanding of an executive’s potential to
question of cultural fit. If the organization’s stretch into the CEO role.
culture is viewed as a valuable asset, then— Executives’ analytical capabilities, social
all things being equal—the board should intelligence, and self-awareness are all skills
favor a profile that fits into the culture. In that speak to their ability to succeed in more
other cases, the culture of the company complex and demanding contexts. CEOs
can be an impediment to its success. A must operate amid greater ambiguity and
culture that is too invested in its own ways complexity than in their previous roles, so
of doing business and not learning and understanding whether executives have the
changing in a dynamic market may require skills to navigate these challenges is critical.
transformational change. In these cases, Assessing candidates’ business judgment
the board will give more weight to the and self-awareness also can shed light on
capabilities needed to transform the culture. which executives will be best able to learn,
Agreeing on a future-looking strategy develop, and adapt as CEO. This is no small
that informs the criteria for the next CEO is consideration in an environment in which
a critical step that helps make the process go the one thing boards can be sure of is that the
smoothly. It also helps boards avoid the trap collection of issues and challenges facing the
of choosing an executive who mimics the business when the new CEO is named will
incumbent’s strengths. be different six months later.
A careful review of individuals’
Adopt best-in-class assessment approaches competencies, including the observations of
By definition, potential internal candidates others who can validate their performance
for the CEO role are not proven CEOs, in current and past roles, can reveal whether
so how can boards gain better insights candidates have the relevant experience and
into their ability to succeed in a role that identify potential gaps. Gaps may include
is dramatically different in scope and a lack of specific knowledge or experience,
complexity? Unless boards are diligent, traditional “hard skills,” such as experience
evaluations of succession candidates tend with regulators or financiers, or a deficiency
to be relative to the roles executives are in in certain “soft skills”—behavioral skills
today rather than mapped to the future. To such as the ability to navigate complex
gain the insights they need to understand the interactions or to influence, motivate, and
capabilities of their company’s executives create followers, among others. Boards also
and make the discerning judgments about will want to consider whether the culture
their readiness for the top role, boards need of the company needs to evolve, and how
to embrace an assessment process that is aligned individual candidate profiles are
fact-based, rigorous, and forward-looking. with the desired company culture.
A board’s ability to choose a CEO An additional component of candidate
successor requires a frank view of executives’ assessment is benchmarking internal
readiness, including an understanding executives against executives outside the
of their development needs based on the organization. Companies that are strong
future direction of the company and the producers of executive talent sometimes
likelihood of their being able to close any lose a sense of how their leaders compare
gaps in a reasonable amount of time. Boards to the best-in-class talent externally or

overlook how the world has shifted around or of the committee responsible should know
them. Taking a look at external talent— the potential candidates who are willing to
through research, informal or formal take on management responsibility in an
introductions or an executive search—can emergency or which board member may be
provide additional insight when assessing able to step in.
the readiness of potential successors.
Ideally, benchmarking should happen in Creating a succession committee
tandem with internal assessment, so that Succession planning is arguably one of
the results of the internal assessments and the more interesting responsibilities of
external benchmarking can be compared the board—and a task that many board
simultaneously. This process is critical members are eager to be a part of. It also
to giving the board a good sense of the can be one of the most intensive board
relative strength of the internal candidates, responsibilities, depending on where the
as measured against outside talent who board is in the process, requiring significant
have proven themselves as skilled in the work between meetings. While the entire
operational areas that will be critical for board should be involved at critical touch
the company’s future success and have points throughout the succession planning
demonstrated the values and behaviors that process, a smaller succession planning,
align with the ideal company culture. nominating, or personnel committee—that
includes only directors who are the most
Planning for other succession scenarios qualified and who have the necessary time—
History has proven that unplanned can steer the process for the board and
leadership vacancies occur, so preparing handle the granular work associated with
for the succession of the CEO over the long assessment and benchmarking.
term is not sufficient. The unexpected can In our experience, the ideal size of this
happen: Illness, death, unanticipated family group is three or four directors. The lead
demands, or poor performance can end a director or non-executive chair is often
CEO’s tenure. A CEO may decide, due to included in this group, and it can be helpful
illness or for other personal reasons, to leave to include two board members who have
earlier than planned, or be recruited away the expertise of being former CEOs, but
for a new career opportunity. It’s critical, who are not active CEOs, given the time
then, that boards stay vigilant in reviewing commitment. It is even better when at
the company’s succession readiness. least one of these former CEOs also chairs
As part of ongoing succession planning, another committee such as the nominating,
boards should plan for an emergency governance, or compensation committee.
situation requiring a sudden change in However, boards may want to avoid
leadership. This plan could involve internal assigning the audit committee chair to this
executives who are far enough along in their task because of the time commitment for that
CEO readiness, a current board director, role. The succession planning group often
or a retired CEO as potential candidates to may include the company’s current CEO
immediately step in as acting CEO on an acting in an “of counsel” capacity.
interim basis. Boards also should discuss As this committee takes ownership of
accelerated succession scenarios, which can many of the details of succession planning,
be implemented if the board begins to have it should keep the rest of the board up
concerns about the performance of the CEO to date and ensure its continued buy-in
or its own relationship with the CEO. throughout the process. This should
The board and the CEO should establish happen at the beginning to ensure that the
together a strategy in advance and define board understands the process; upon the
the procedures that will take effect if an development of the key selection criteria for
emergency occurs. The chairman of the board the position; at the review of the assessment

Succession planning: strategies for building the pipeline Spencer Stuart
summary of internal candidates; and upon in the company, making sure development
the review of the benchmarking information plans are in place for these executives, that
on external executives. they are given challenging assignments or
new roles, and that they gain exposure to
The CEO’s role in succession planning the non-executive directors, for example, by
At the most basic level, the CEO’s role presenting during strategy meetings.
is straightforward: driving management At a broader level, boards want to
succession at senior levels, including the be confident in the succession pipeline,
early identification of any inside CEO ensuring that the CEO is focused on
contenders, ensuring that the organization developing a succession-ready team and
is developing succession-ready executives, that directors have the insights about
and serving in an of counsel role to the potential CEO contenders they will need
board. The CEO is in the best position to to provide the necessary developmental
make sure directors have the insight they assignments and, ultimately, to choose a
need by working closely with the chief successor. This ideally is a broad-based
human resources officer (CHRO) to ensure effort that incorporates up-to-date profiles
the company has a robust, forward-looking for all the senior team positions, regular
approach to executive talent development. assessments and benchmarking, and
The CEO should make sure that the CHRO thoughtful developmental assignments.
is thinking about development plans for This does not mean that directors
potential internal candidates with a forward- must become talent managers. It does
looking lens, assessing individuals based on require boards to take responsibility for
the future requirements of the business, and ensuring that the right processes for talent
translating those requirements into specific management are in place and that they
developmental opportunities. The CEO and have the appropriate knowledge of potential
board can benefit from bringing in outside leadership. Directors should get to know
assessment expertise when evaluating the senior leadership through presentations
how the internal team stacks up against in the boardroom and regular meetings
the requirements and external benchmarks, outside of it. Boards should plan on a deep-
particularly when the business may require dive talent review at least once annually,
a change in strategic direction. which includes having the CEO and top HR
As the time for a transition nears and the executive lead a discussion about forward-
process turns toward the board’s selection of looking leadership requirements against
finalist candidates and potentially a search, which talent can be evaluated. By being
the CEO’s participation diminishes. involved on an ongoing basis, the board
can observe patterns of performance and
Developing a robust pipeline: the board’s role develop a more nuanced point of view on
in broader C-suite succession executives’ strengths and weaknesses.
While the board should be deeply involved
in succession planning for the CEO role, less Conclusion
agreement exists among experienced directors Succession planning works best when
about how involved the board should be in it is viewed as a critical, ongoing board
influencing talent decisions further down responsibility closely tied to management
in the executive team. At a minimum, the development. Among companies that do
board should be confident that the CEO has a it best, succession planning is not focused
strong team and that the organization has an solely on selecting the next CEO but instead
effective succession planning process in place involves a top-down and bottom-up
for other key executive roles. approach to developing management talent
Many boards monitor the succession for all key positions. These companies tend
planning for the top 10 or 12 positions to share several common characteristics:

• They have strong boards that stay deeply • They minimize the human drama in the
involved in the succession planning succession process by creating conditions
process with the CEO on a continual for a predictable outcome.
basis. • They periodically calibrate likely internal
• They continually expose their top candidates for CEO against comparable
management team to the board. outside leaders.
• They encourage “next-generation” • They develop a “succession culture” in
CEOs to gain exposure to the media, the which all levels of the organization plan
investment community, and, sometimes, for the inevitability of change by ensuring
outside board service opportunities. that top executives and high-potential
• They view succession planning as an leaders throughout the organization are
ongoing process that is linked to the given the proper tools, exposure, and
strategic planning process to ensure a fit training to develop into contenders for
between where the business is going and advancement.
the skills of likely successors.

16 Communications strategies
Matthew Sherman, President and Partner Joele Frank
B
oards of directors and management teams are now routinely
challenged—both privately and publicly—by investors, sell-
side analysts, industry experts, regulators, and others. They
are finding that their decisions are increasingly being scrutinized—
from executive compensation, corporate governance practices,
and capital allocation to the ability to develop and implement
strategic plans. Boards and management teams that are perceived
to be lax or indifferent in addressing these issues often face public
opposition and proxy challenges by activist investors. Notably,
traditional institutional investors are no longer sitting on the
sidelines: they are increasingly supporting activist activity—and
in some cases, instigating it.
The best defense is often a good offense. This begins with
execution and shareholder returns. Ensuring that the investment
community understands and supports a company’s strategy
is also an important element. Board engagement and strategic
investor communications can help foster this understanding. While
engagement and advance preparation will not prevent shareholder
activism, it can significantly influence the outcome when a proxy
contest occurs.
Communications in peacetime
The traditional role of a board of directors has been to set strategy
and to hold management accountable for executing that strategy. But
the role of the board has evolved.
The expectation for regular dialogue between the executive
management team and shareholders, which has long been “best
practice” in investor relations, today has been extended to directors
as well. Investors expect directors to be knowledgeable about the
business, engaged in the strategy, and accessible to answer questions
and share points of view on the company, its peers, and the industry
landscape.
Externally, the board has an unmatched degree of authority and
credibility. It can reinforce and support the management team,
while at the same time holding them accountable for performance.
Accordingly, when speaking with investors, they must strike a

Joele Frank Communications strategies
balance so as to not undermine management. While establishing a relationship in advance

Ensuring that management remains the may not be determinative in a vote, it can
primary spokespersons with shareholders, help create a climate of greater receptivity
particularly outside of a proxy contest, and trust.
will help achieve this balance. Director/ Before any meeting with investors—
investor communications should largely activist or otherwise—board members
occur around normal course events where should be informed and prepared.
management is present, such as investor Directors must be armed with details about
days, or in select investor roadshow meetings management’s prior engagement with the
when a director’s presence can help support shareholder, the shareholder’s investment
the company’s investment rationale or an focus and history with the company, as well
investor relationship. Director accessibility as any public or private statements that the
and outreach should also be considered shareholder has made about the company.
when shareholders are questioning board- Directors are encouraged to run through
level matters, such as company leadership, mock Q&As and other role-playing exercises
executive compensation or governance to prepare for investor meetings and ensure
policies outside of management’s purview. that directors know how far they can go on
At smaller companies with fewer key topics.
resources, directors may take on a more
active communications posture to augment The current landscape
the executive management team. At Shareholder activism has become a prolific,
organizations where the chair and CEO roles well-organized force. Once the domain of
are combined, a strong independent lead a few celebrity-like names and gadflies,
director can be an influential counterweight. activism today is mainstream, dominating
Directors can be important ambassadors headlines and dedicated columns in
to the investment community. Providing financial media such as The Wall Street
shareholders with access to a director Journal and the Financial Times, and even
reinforces that a company (1) has an active mainstream news and pop culture outlets,
and engaged board, (2) is committed to sound such as Time and Vanity Fair. The level of
governance policies and practices, and (3) media interest in activism has grown with
takes seriously the views of its shareholders. the dollars invested. Activism has become
Such director/shareholder relationships can its own asset class. Assets held by activist
also be important in establishing trust and hedge funds totaled more than $100 billion
a strong base of supportive shareholders. in 2013 compared with $66 billion at the
Indeed, if a company first undertakes serious end of 2012. And in the first quarter of this
outreach to the investment community when year, activist strategies saw $3.5 billion in
a proxy contest is underway or imminent, new capital inflows according to data from
it is likely to be too late to establish the Hedge Fund Research.
relationships and credibility needed to At the same time activists have become
mount a formidable defense. more sophisticated and nuanced in their
When identifying targets for investor/ approach. They are establishing teams of
director meetings, it is important to consider advisers that mirror those established by
not just an institution’s portfolio managers companies, including legal counsel, financial
with whom management regularly interacts adviser, investor relations/public relations
but also that institution’s governance/proxy adviser, proxy solicitor, and operations
advisory boards. Often in a proxy contest, consultants. Slates of directors put forth by
these governance bodies, sometimes in shareholder activists no longer comprise
conjunction with and sometimes instead of representatives of that fund and their
the portfolio managers, are the ones who “friends and family.” Activist slates now
control the voting of an institution’s shares. include reputable current and former senior

Communications strategies Joele Frank
public company executives with relevant before. For example, T. Rowe Price, an
industry experience and credible track institutional investor with $614 billion in
records at other publicly traded companies. assets under management, supported Carl
While a handful of activists continue to Icahn’s opposition to the buyout of Dell last
seek headlines over substance, a number of year. California State Teachers’ Retirement
activists today prepare and publish extensive System, which manages $176 billion, joined
white papers with specific suggestions for Relational Investors in its 2013 campaign
a company’s strategy. Although activists’ to split the Timken Company into separate
assumptions are sometimes flawed, their businesses. Earlier, Ontario Teachers
conclusions unrealistic, and their proposals Pension Plan, with over $140 billion under
not always in the best interests of the management, joined with JANA Partners
company and all shareholders, the extent to advocate a break-up of McGraw Hill.
of analysis and data activists put forward Some traditional long institutional investors
in these white papers demonstrates that are even working with activists behind the
they are taking these matters seriously and scenes, asking them to get involved. The
devoting considerable time, energy, and New York Times reported that “institutional
resources to their efforts. investors even have an informal term for
As shareholder activists have refined this: R.F.A., or request for activist.”1
their approach, the balance of power has Activists also typically receive support
shifted in their favor. Between 2009 and from proxy advisory firms, such as ISS and
2012, of the proxy fights that advanced to a Glass Lewis. ISS can influence between 20
vote, activists won 37 percent of the time. In percent and 30 percent of a vote; Glass Lewis,
2013, that percentage rose to 60 percent and while somewhat less influential, still makes
has already increased to 68 percent in 2014 headlines with its voting recommendations.
with numerous meetings yet to be held.
Even when a situation does not Communications in the face of a challenge
advance to a shareholder vote, activists are The pace and urgency of communications
increasingly gaining concessions, such as increases markedly when an activist
board representation, corporate governance challenge emerges. The rhetoric tends to
changes, capital return, and other measures, heat up and events unfold under rapid fire
through settlements. Of the 90 proxy because a proxy fight, much like a political
campaigns launched in 2013, only 30 went to campaign, is a battle for votes and support.
shareholder vote. The majority of campaigns In any contested situation, the management
were either settled (36) or withdrawn (24). team and board of directors will be subject to
Notably, a company’s size and greater scrutiny by investors and the media.
performance are no longer a defense. Mega- Directors should be prepared to be
cap companies such as Apple, Microsoft, publicly challenged and criticized. In such an
and Procter & Gamble have all been targeted environment it is difficult to resist the urge
by activist investors and have implemented to set the record straight when confronted
changes as a result. with falsehoods and slights. But discipline
What created the pendulum swing? and coordination are vital when everything
Why do shareholders believe they need potentially can be used against the company
a “watchdog” on their boards? Why are by the activist.
companies settling? While some may debate There is no “one-size-fits-all” approach to
the triggers behind the lack of shareholders’ conducting and winning a proxy fight. All
confidence in companies and their boards actions and words must be developed and
of directors, a few contributors to this shift tailored to the specific circumstances, often
are incontrovertible. Institutional investors, in real time. That said, a few communications
such as mutual funds and pension funds, principles will serve a company well in
are more supportive of activists than ever almost any circumstances:

• Do not be defensive. Actions and the directors and management as well as

communications should present the objective metrics about the company’s
company and its directors as open- performance. Are the directors and executives
minded and receptive to the view of its confident or evasive? What is their reaction
shareholders. to provocative statements and how willing
• Take the high road. Avoid personal attacks. do they appear to consider differing ideas
Shareholders do not like to see the on capital returns, mergers/acquisitions,
company or its directors or management strategic alternatives, and so forth? Are
team attack other shareholders. there divisions among the management and
• Stay aligned. In a proxy fight, directors board? Does the leadership have command
and senior management play critical roles of the facts of company performance, an
in communications efforts. Both should understanding of macro industry trends,
be seen as aligned and supportive of the and a strategic vision?
overall corporate strategy and direction.
Collective judgment should determine What to do before a proxy contest
when and how to deal directly with Advance preparation can significantly
challenges. increase the chances of a favorable outcome
• Harmonize messages and spokespeople. in a proxy contest. We recommend several
Spokespeople should be limited and steps that all companies should take:
messages consistent. Responses, even by
board members, should be coordinated 1. Establish core team: Identify a team that can
with the company and its advisers. manage rapid responses in a campaign
• Be timely. As much as possible, the scenario. Core team should include key
company should respond in a swift members of senior management, legal
manner to ensure its messages are counsel, financial advisers, investor
communicated to key constituencies— relations/public relations adviser, and a
including the investment and analyst proxy solicitor. Assign roles and decision
community, employees, customers, and rights ahead of a campaign and conduct
partners—during the same news cycle. regular update calls so the team is primed
While the media inherently favors the for action.
activist, responding in the same news 2. Assess/address vulnerabilities: Be candid
cycle will help balance the story. Some about the company’s strategic and
boards choose to establish subcommittees operational weaknesses. Review
for communications to help ensure operational and financial results, stock
an efficient approval process for price performance, and other key issues
communications during a proxy fight. including leadership, capital allocation,
and broader market and industry
While disciplined and aligned messages are developments. Review and consider
important, so too is the forum in which they enhancing the company’s governance
are delivered. structure and policies as well as any
Large group, public meetings should structural defenses. Work with legal,
be avoided. These kinds of meetings can financial, and communications advisers to
be usurped by an activist in an effort to develop a “defense white paper,” which
disseminate its own messages and embarrass can often identify key vulnerabilities that
the company. Instead, we emphasize targeted, can be addressed before they are raised
one-on-one or small group meetings with publicly by an activist. This “opposition
investors and sell-side analysts, which offer research”—similar to the approach used
the greatest amount of control. in political campaigns—can be invaluable
In these meetings, investors will be in mounting an effective and credible
assessing subjective characteristics of defense.

Communications strategies Joele Frank
3. Review and refine investment rationale and 7. Identify third parties: In addition to
governance messages: Activist investors current investors, companies should
launch multipronged attacks that typically identify potential supportive third
include criticism of a company’s strategy, parties such as sell-side and industry
performance (actual and as compared analysts, academics, customers, and
to peers), capital allocation, shareholder business partners. Politicians, regulators,
returns, and corporate governance. and business and trade organizations
Corporate messages should be reviewed are also potential sources of support.
to ensure that they accurately reflect the Traditional shareholder advocates and
company’s track record and goals in these corporate governance “gurus” can wield
areas. significant influence in a contentious
4. Identify appropriate board member(s) for proxy campaign. Ideally, these potential
investor engagement and train as needed: advocates should be cultivated long
As noted above, in addition to a regular before their support is needed.
dialogue between management and 8. Review/correct ISS evaluations: ISS issues
investors, companies are increasingly voting recommendations, which consider
identifying independent director(s) to ISS issued governance scores and
meet with select shareholders prior to an related reports, for approximately 39,000
activist attack. As appropriate, conduct companies in 115 countries each year.
training with selected directors to ensure It is not uncommon to find mistakes or
they are comfortable discussing the details outdated information reflected in these
of the company’s operations as well as scores and reports. Although ISS has
have familiarity with “best practice” a separate team focused on reviewing
guidelines for talking to shareholders, and opining on proxy contests and other
including an activist. matters, ISS governance scores are often
5. Review/expand director bios: In a proxy cited by activists in their attacks and relied
campaign, individual directors may upon by other shareholders in forming a
become targets of attacks. The tenure, view on a company’s record. Working
experience, independence, and stock with the company’s proxy solicitor,
ownership of a company’s board are companies should review governance
scrutinized—by the activists themselves reports to ensure accuracy and, if needed,
as well as by other shareholders and that appropriate corrections are made and
proxy advisory firms. With this in mind, scores updated.
review the bios of current directors
and identify opportunities to enhance Conclusion: don’t wait to engage
the listed credentials to make clear the Shareholder activism is here to stay. Whether
relevant skills and expertise that these a company is facing good times or bad, it
directors provide. In a contest, new would be a mistake for any company to
perspectives and diversity of experience begin preparing for a fight only after one
can be as important as experience within is threatened or, worse yet, has already
a company’s industry. To the extent new begun. As a matter of course, directors
directors are contemplated, consider and management should engage with their
expertise that is both diverse and relevant shareholders regularly to ensure that the
to the company’s strategies and goals, not company understands the expectations of
just its industry. the investment community and that the
6. Renew/refresh investor relationships: As investment community understands the
discussed, establishing a relationship in company’s businesses, vision, and plan for
advance may not be determinative in a value creation.
vote but it can help create a climate of At the end of the day, the management team
greater receptivity and trust. is in charge of the company’s operations and

responsible for implementing and executing For companies today, strategic

the corporate strategy. That said, strategically communications and selective director
utilizing a board member in a company’s engagement are important tools that should
investor relations program can help build be deployed pre-emptively to deter or defeat
a track record of open and transparent the rising tide of shareholder activism.
communications with shareholders. This, in
turn, can provide a board and management Notes
team with critical insights into its investor 1 de la Merced, Michael and Gelles, David. “New
base, bolster that company’s credibility, and Alliances in Battle for Corporate Control.” The
in certain instances, head off any interest or New York Times Mar. 18, 2014.
approach from an activist investor.

17 Reputation, analytics, and
corporate strategy
Chris Foster, Vice President, and Jason Kemp, Principal Booz Allen Hamilton
W
e live in a world of increasing transparency and high-
velocity communications. Information not only travels
faster, it travels everywhere. The rapid convergences
of cloud, social, and mobile technologies have created a new
generation of empowered information consumers.
In today’s interconnected consumer economy, the notion that a
company’s reputation can be “managed” as a simple commodity
or unidimensional artifact is dangerously outdated. In a fully
networked global culture, every morsel of information—no matter
how trivial or seemingly innocuous—has the potential to go viral in
a heartbeat. Reputations that took decades to build can be destroyed
in mere moments.
Reputation strategy is the solution to reputation volatility

Reputation is a complex set of perceptions, beliefs, and expectations
held by all of an organization’s stakeholders. It is the sum of their
opinions, based largely on what they see, read, hear, and experience.
Reputation is an outcome of organizational behavior, values,
decisions, and actions. Unlike traditional tangible assets, it is both
multidimensional and fluid. Although invisible, reputation can be
integrated into business planning and operationally embedded into
organizational approaches across business units and geographies
to positively affect a company’s valuation, sales, employee morale,
performance, partnerships, and a host of other critical areas.
Reputation can be leveraged for strategic advantage through
insights gained from the scientific application of real-time big-data
analytics and multidisciplinary approaches that we have developed,
tested, and implemented over years of working with government

Booz Allen Hamilton Reputation, analytics, and corporate strategy
defense, intelligence, and cybersecurity with a company’s products or services. A

agencies. Our portfolio of analytics and company’s reputation, however, is formed
processes enables us to understand attitudes, by a collective belief system about quality or
opinions, and behaviors and to create character. These beliefs are typically formed
predictive models that anticipate behavior, from hearing or reading the opinions of
actions, and response to content. other people—friends, experts, and even
Building reputation is not an entirely total strangers—which today are relayed
new idea. But the application of scientific across an ever-widening array of media
methods incorporating advanced analytics platforms and channels.
brings new capabilities for prediction and Indeed, the difference between brand
optimization that reveal new opportunities and reputation is huge and not yet fully
and genuine advantages. appreciated. Before the era of 24/7 media,
More than just a technique for managing reputational damage could be managed and
reputation, reputation strategy is derived mitigated by skillful public relations teams
from a carefully orchestrated set of scientific or corporate communications executives.
processes that create and sustain competitive In the rapidly evolving global information
advantage in a turbulent world. landscape, however, stakeholders have
Reputation is not monolithic; it is greater access to information and can easily
assembled from thousands of data points uncover actions, behaviors, decisions,
across stakeholder groups and markets. or values that are incongruous with
Thus, reputation is complex and cannot communications of the organization. Today,
be simplified to a single score or index. news travels faster and farther than ever
A forward-thinking organization will take before, and communications professionals
deliberate steps to monitor and analyze need the support of additional capabilities
data that might impact its reputation. More and tools to be effective.
important, it will take proactive steps to Until fairly recently, the downside risk
build its reputation on a solid foundation, of confusing brand and reputation, or not
one brick at a time. understanding how the mechanics of brand
management and reputation strategy differ,
Brand does not equal reputation was relatively minor. However, the Internet,
Great companies discern the critical the Web, broadband networks, and handheld
difference between brand and reputation. mobile devices have changed all of that.
Let’s take a moment to examine this Now, the risks are higher, and the downsides
difference, because it is vitally important. are considerably steeper.
As consumers, our impression of a brand
is usually formed by our direct experiences Reputation exists in a complex ecosystem
Reputation cannot be judged, described, or
distinguished at a glance. Multiple streams
Table 1 A good reputation of data from multiple sources must be
• creates trust in an organization’s collected, integrated, analyzed, evaluated,
products or services and harvested for insight that can be used to
• provides access to policy and decision develop meaningful responses to changes or
makers shifts in reputation. Since reputation is built
• attracts and retains the best from an aggregate of components, different
employees approaches are required for different
• drives credibility with outside companies and different markets.
partners Reputation strategy is composed of
• serves as a critical success factor for multiple action steps and processes based
investors. on environmental factors, as well as factors
within an organization’s sphere of influence

Reputation, analytics, and corporate strategy Booz Allen Hamilton
(Figure 1). Through the application of In a recent engagement with a global firm,
reputation strategy, scalable, repeatable, we integrated multiple types of data into a
reliable, and predictable actions can be taken. single model, making it possible for our client
Every organization has a unique set of to recognize how each issue contributed to
attributes that can be classified into those reputation and what impacted reputation
that could affect existing value or those across stakeholders.
that could generate new value. This allows Based on our analysis, we identified
organizations to address risks and issues, activities that should be created, sustained,
as well as proactively identify and address or eliminated in order to support reputation
opportunities. goals. With a comprehensive understanding
For example, reputation can be leveraged of the factors or “drivers” underlying the
to create business advantages in supply chain company’s reputation, we helped them
relationships, executive talent recruiting, devise a workable strategy for influencing it.
sales, sourcing, finance, and other functional
areas of the modern enterprise.
Figure 1 Reputation ecosystem

Value Chain
and Operations Leadership
phere of
ional S Infl
izat
Financial
Product/Service
n ue
Experience ga nc Performance
Or e
Corporate
Workplace
Citizenship
holder P
ke
tions Sta
er
ceptions
Social/
Industry
Culture
ta
an
d Expec
Legal/
Regulatory Environmental
Env rs
ironm o
e n t a l Fa c t
Political Technological
Economic

Figure 2 Reputation analytics engine

System Inputs Analytical Engine
Custom
Stakeholder Optimization
Research Using a real-time modeling tool, Value
compare alternative scenarios
and their predicted impact on
Digital profit, strategy, reputation, etc Short/Medium/Long
Listening Term Decision-Making
Predictive
Internal Generate real-time and Reactive/Proactive
Informed historically-based predictions on Drives
Data Planning
by impact of company initiatives
on stakeholders and reputation
External Long-Term
Data Strategy
Descriptive
Generate picture of the
company’s dynamic
Desk reputational environment
Research
Prediction is key to better outcomes in what markets would be impacted by

Big-data and real-time analytics create specific aspects of their reputation.
essential capabilities for modeling, • We customized and delivered our Global
comparing, and predicting outcomes of Reputation and Business Intelligence
reputational issues. Recently our experts Model to:
generated real-time predictive indicators of  integrate the wide range of data streams
reputational impact for a client and tested we identified and integrated so our
multiple scenarios for how to address the client could understand stakeholder
situation based on our Reputation Analytics relationships and their causes.
Engine (Figure 2). We also created a reporting  align program initiatives with corporate
framework that helped our client understand strategic objectives to indicate impact
their reputation globally and develop and assist with strategic planning and
strategies for protecting and enhancing their efficacy analysis.
reputation over time. The engagement reinforced and solidified
Over the course of the engagement, our belief that successful implementation of
we performed research, data integration, data analytics involves various departments
data/driver analysis (predictive and and functional areas of the modern
descriptive), strategy development, and enterprise working in close collaboration.
change management analysis. The results of It includes departments like information
our work provided visibility into resource technology, communications, operations,
allocation and critical insights that informed and human resources and functions
future situations. like data science, business strategy, and
We took the following action steps: subject matter experts. The key word is
“collaboration.” Experience shows that the
• We developed an early warning system total is always more than the sum of its
to let our client know which stakeholders parts.

Reputation, analytics, and corporate strategy Booz Allen Hamilton
Addressing reputational challenges tactics worked fine in an age when there were
successfully requires: only three major television networks and
essentially one national telephone company.
• building a system to enable reputation Events happen much more quickly
to be used as a strategic advantage with now; news travels much faster. As a result,
consumers, governments, and employees opinions are formed more quickly, and
• monitoring, evaluating, analyzing, and reputations can be damaged or destroyed
responding appropriately in real time within days or hours.
• predicting where and how Given the dynamics of today’s
communications have an effect on interconnected global culture, reputation
reputation (eg crisis life cycle, regressive strategy requires a blend of business
analysis) intelligence, big-data analytics, predictive
• learning how to allocate resources modeling, and forecasting capabilities.
appropriately to gain maximum reputation Traditional reputation management tools
strategic advantage. and approaches are often inadequate for
dealing with modern-day challenges.
While it is possible to outsource certain Reputation strategy is a combination of
components of reputation strategy, companies business acumen and scientific expertise. It
should also consider developing their own should be used as an ongoing strategy to
internal expertise and experience. In addition propel and protect business objectives, but
to helping firms create and implement it cannot be conjured up or jerry-built at the
successful reputation strategies, we also train last moment or in the face of a crisis. It must
in-house staff to handle reputational issues as be staffed and fully functioning before the
they arise and to address ongoing programs crisis. Waiting until the emergency arises
for protecting and enhancing reputation at virtually guarantees a bad outcome.
the highest possible levels.
It is also crucial that the processes and Reputation is not a momentary phenomenon
techniques of reputation strategy be practiced Reputation building is a long-term strategic
and repeated over time. Truly effective endeavor. It is an integrated set of ongoing
reputation strategy requires multiple iterative processes, not an individual program or
processes and cycles. campaign or one-shot initiative.
Moreover, reputation is not a singular
New tools for extracting value event or state. Reputation has multiple states
from streams of data and forms. It changes over time—sometimes
The rise of big data and data science has given slowly, sometimes with breathtaking speed.
us new tools and techniques for extracting Building a reputation that is strong, resilient,
value from information, revealing hidden and anti-fragile requires top-down leadership,
patterns, and uncovering fresh insights. executive sponsorship, and buy-in at all
New database technologies and advanced levels of the enterprise. It requires written
analytics solutions enable us to blend policies, training, incentives, and discipline.
knowledge and expertise from multiple The concept of reputation as a strategy must be
industries, improving business outcomes woven into the culture of the organization.
and driving faster cycles of innovation in In great progressive companies,
hypercompetitive markets. reputation is an integral part of the cultural
In today’s communications environment, DNA. It isn’t an afterthought; it’s top of
big data acts like an accelerant. Issues that mind.
took years or months to unfold now spin
wildly out of control in hours or minutes. Don’t try this at home
Clipping newspaper articles, holding focus Reputation strategy isn’t a “do-it-yourself”
groups, taking surveys—those kinds of or “back-of-the-envelope” affair. In modern

markets, reputation strategy is a genuine Reputation strategy is a set of scientific

competitive advantage. Smart organizations multidisciplinary processes aligned to
will set aside the time and devote the generate insight, guide better business
resources necessary for creating and decisions, and create measurable value for
sustaining practical reputation strategies. the modern enterprise. It must be integrated
They will invest in the people, processes, into business planning and operationally
and technologies required for bringing those embedded into organizational approaches
strategies up to speed and making them across business units and geographies, with
work, effectively and reliably. the proper executive sponsorship to promote
We take an integrated approach to the strategy. Ultimately, accountability sits
understanding and operationalizing at the highest level of the organization such
reputation strategy—we use research and as the CEO and board to increase awareness
real-time data to help our clients obtain an of the strategy and keep employees at all
understanding of their reputation and to levels engaged.
inform the development of strategies for
protecting and enhancing their reputation—
and business—over time.
Net takeaway
Reputation is a key strategic asset that provides tangible value to organizations through:
• creating trust in the organization’s products and services
• providing access to policy and decision makers
• attracting and retaining the best employees
• driving credibility with outside partners
• serving as a critical success factors for investors.
Reputation must be protected and enhanced through authentic organizational values, deci-
sions, behaviors, and actions, which requires a clear and evidence-based reputation strategy.
Our portfolio of analytics and processes enables us to understand attitudes, opinions, and
behaviors and to create predictive models that anticipate behavior, actions, and response to
content.

18 Managing technological change
Jim Newfrock, Vice President, and Samitha Amarasiri, Principal Booz Allen Hamilton
T
echnology is a powerful force enabling efficient corporate
enterprise growth when properly employed. The pace of
“new” continues to accelerate, posing both new opportunity
and possibly massive disruption within our established
systems and data. As in the case with other change elements—
environmental, political, legislative—savvy corporate boards
will have the pulse on emerging technology and a view as to
when is the ideal timing to drive adoption for maximum benefit
without wasting limited capital. Following are seven questions
proactive directors should consider when “talking tech” with
their management teams.
How old is your daily use technology?

No kidding, what’s the oldest system we have in production?
What’s the average life of the tech environment across all sources (eg
hardware, software, apps, storage)? How old are the most mission
critical? A strategy based on “sweating the asset” can be attractive
because extending the useful life of existing investment can help to
meet quarterly numbers or fund necessary resources to deal with
new compliance issues and regulations. This, however, is a limited
life strategy—the longer one puts off refactoring of information
technology (IT) systems to current standards, the harder it is to
make the change without breaking the “as is.” Fragility and outages
become more common as new systems built around the edge of the
existing core simply don’t integrate.
To do’s:
• Build a true baseline. This goes beyond the fixed asset registry—
software build components are some of the most compromising
features of legacy and can be masked in financial reporting.
Ongoing feature additions may be capitalized, but that is not
the same as refactoring. Painting over the wood doesn’t undo
underlying decay.
• Consider appropriate allocation to staying current, neither too
fast nor too slow—maximize the value of investments but

Managing technological change Booz Allen Hamilton
avoid overaging that puts the company how it will scale from targeted to full
at risk and creates a future bubble cost of enterprise use case. Ensure that your
replacements. enterprise is thinking about and making
use of the new data management tools,
Are you mired in “yesteryear’s” data but resist funding large platforms devoid
management strategies? of a specific set of measurable business
Historically, information technology needs.
systems were grown in purpose built • Ask to be briefed on the chief information
silos. Enterprise Resource Planning (ERP) officer (CIO) or chief technology officer
management systems made inroads on (CTO)’s portfolio of projects and the
integration but never encompassed the segmentation into Exchange Transfer
entire suite of applications. For those Load (ETL) traditional database treatment
systems and industries not encompassed and those which might benefit from the
in the ERP, data continued to grow and NoSQL/Hadoop approach.
proliferate in a much more ad hoc manner.
Organizations have responded with data Is your security architecture in
warehouse initiatives to further aggregate the medieval age?
data, but not all yield the expected payoffs. Most boards are aware of both the potential
The limitation of relational databases such exposure in allowing external access to their
as Oracle and Sybase require forethought in enterprises and the business friction created
determining the exact type of analysis to be by trying to maintain a “closed shop.” It
performed in order to organize and design is rare to find a corporation today with
the informational store. This becomes an no Web presence and some semblance of
expensive task in iterative build and design e-services and communications channels.
as the business continues to evolve the type Simple firewalls and demilitarized zones
and variety of questions to be answered. are inadequate to protect against more
When the individual business lines reach sophisticated attacks—the old model of castle
the limitation point of an existing relational walls and a moat with select access to the
database, frequently they spin up brand new “courtyard only” offers minimal protection
operational data stores for point analysis in today’s operating environment. The
and further complicate information flows layered protection approach employed to
in the attempt to access all the information. protect traditional data structures—known
Better methods and technologies exist, but, as a “defense in depth” strategy—can be
for many, there’s significant inertia in the quite successful. However, with data being
entrenched “as is” in part simply because it ubiquitous, a new set of techniques must be
is what they know and understand. added. This might include the establishment
of multiple security zones—”inner walls”—
To do’s: and greater attention to the underlying
building blocks in your infrastructure
• Ask about initiatives to incorporate and applications. Possibly of even more
new techniques, like NoSQL, Hadoop, importance is the emerging concept of
metadata tagging. If you’re not hearing Attribute Based Access Control (ABAC),
about these, your teams are probably not which could replace the present proliferation
evolving your infrastructure. of Role Based Access Control (RBAC). RBAC
• If initiatives like the above exist, inquire security is largely “manual” and results in
about plans to use them to accelerate independent role definitions per application.
the rollout of new solutions and reduce Fluid organizational changes and new
overall cost. product alignments can cause role hierarchy
• On the development front, ask whether models to rapidly become obsolete. In
the approach is iterative in nature and contrast, ABAC models derive access based

Booz Allen Hamilton Managing technological change
on both rules and accurately tagged data initiatives in this space result in glitzy
and thus provide fine-grained entitlements experiments or point use of what could
ad hoc for authorized access and actions. be truly transformational change. Boards
ABAC rules use contextual information to should be aware of spend and posture in
make decisions without the overhead of this area. Cloud and mobile should both be
traditional RBAC systems. Improvements done at a scale that can move the needle on
in access to and use of the underlying data performance. Be wary of mobile initiatives
move beyond external/internal definition, that are restricted only to the use of very
and exploding role definitions, and become small customer sets or only external users.
more adaptable and self-maintaining. For Similarly, cloud initiatives for very select
analytic application of the new data tools, use cases are going to deliver only a fraction
security can be extended into the data itself of the potential. While experimentation is
through cell level security (eg Hadoop, valuable in the short run, the bigger payoff
Accumulo). Ultimately, emphasis needs may be in truly changing how internal staff
to evolve including protecting the “king/ work and external customers access your
queen behind a castle moat” and securing enterprise. Boards should expect a more
the data wherever it travels. encompassing road map for mobile and
cloud and steer clear of “me too” strategies
To do’s: that seek to use technology for a sense of
“in vogue.” Notional application will yield
• Well-advised boards should ensure notional results.
first and foremost that there is an
accountable officer responsible for the To do’s:
corporation’s security. Good information
security doesn’t “just happen”—it takes • As with new data technologies, ask when
leadership, focus, and consistency. and where the organization is applying
• Make sure the organization does not mobile and cloud strategies. Don’t let
ignore today’s more sophisticated risks. antiquated security concerns stall broader
As in the case with other risk and change, application. The issues are solvable.
a realistic picture needs to be drawn • Recognize that not all clouds are equal.
of the current situation, what’s at risk, A reputable, well-secured provider is
the honest probability of an issue, and fundamentally different from a “free”
finally, a quantified risk adjusted return cloud storage offering.
in moving to next-generation security • If the strategy presented is niche, consider
architecture. it a starting point. Encourage business
• Encourage a holistic security architecture and technology teams to show the
beyond inside/outside, authorized/ longer-term road map and think beyond
not authorized; zones, attributes, and simple inclusion of a new technology.
cellular security are all examples of new Thoughtfully applied, cloud and mobile
approaches that further secure the data. can be transformational.
Are your mobile and cloud initiatives a part of Have you established a “Magna Carta” of data
the business or floating untethered? governance?
The power of mobile devices to transform With the explosion of data, new techniques,
businesses, to extend reach, and to allow and data management strategies, there is
“real-time” updates are profound. In tandem enormous value in the data embedded within
with cloud or virtualized data storage, truly the organization and accessible beyond the
the ability to have information access to organization. As data availability increases,
products and services is nearly limitless. there will be a huge push for new insights,
Unfortunately, too many technology new growth ideas, and options to reduce cost

Managing technological change Booz Allen Hamilton
and improve compliance, even while issues we’ve discussed thus far may all emerge
around consent, access, and ethical use will as point discussions or presentations.
become more pronounced. For regulated Beyond discussing specific application of
entities, the concept of a chief data officer new technology, boards should also look to
is catching hold and typically focuses on understand how they fit into an overall plan.
maintaining the integrity and compliance Do you get a sense for the top-down view
rules around the data. The convergence of the of technology needs and path forward when
organization around data needs a strategy reviewing the strategy? A balanced strategy
and organizational governance approach to will have projects both tactical and strategic
match its culture and needs. For example, considering both risk reduction and growth.
while the appropriate consents for use Many IT strategies assume and are based on
might be in place, has your team considered evolutionary progression of technology. In
customer perception and are you comfortable today’s environment, organizations need to
with both the process and the decision? Data make provision for the power of disruptive
use will continue to evolve, and like research technologies. Left to meander, an IT strategy
integrity in academia and drug development, can damp out disruptive technology, and this
appropriate oversight and governance of the may not be in the best interest of the company.
methods, results, and publication must be
carefully managed. Above and beyond this, To do’s:
increased access to data and use of canned
tools opens up the risk of data error and • Ensure an IT strategy that is linked to
mismanagement. While there’s much to be the business initiatives, leverages new
gained through broader use of analytics, the ideas, and is aligned with the pace of the
potential for poor context or inappropriate business. Strategy needs to stay fresh and
computation increases. show progress. If the initiatives presented
are aging without measurable progress,
To do’s: you may need to encourage more frequent
metrics.
• Establish a data use governance/ • Major milestones should demonstrate
oversight committee. Don’t assume that the impact of new technology and
private information collected for one the business benefit and not merely
purpose can be freely applied to a new highlight functional releases or increased
purpose. deployment
• Test and monitor the access, use, and • Objective vetting of a strategy can be
approach to research. As your data impactful. Consider how to appropriately
becomes more accessible through the test against external views, to ensure
use of a new data management strategy, reliability and that leading-edge,
the potential for amateur statisticians to paradigm-shifting ideas are incorporated.
miscalculate increases. Where analytics
are high stakes, appropriate method is Is your staff ready for all this change?
necessary. Increase integrity by ensuring While we watch our children jump into
that the mathematicians and the new technology and figure it out quickly,
programmers are working collaboratively. applying technology in the workplace takes
Understand the “who” behind new more than just providing a slick consumer-
analytics. like application and design interface.
Training, process integration, planning for
Has your organization produced an IT strategy adoption, and the inevitable cultural change
or are you just being served appetizers? that comes with process and role change
Too often technology information comes to all impact the staff, their morale, and their
the board in bite-size chunks. The themes support for adoption. Organizations need

Booz Allen Hamilton Managing technological change
to actively manage technology adoption. As access to data. Business accountability in

boards consider large potential change— managing transition to new application
technology and other—it is important to access paradigms—from RBAC to ABAC,
evaluate the human factor. for example—also require thoughtful
participation from departmental and
To do’s: functional managers.
• Board awareness, endorsement, and
• Ensure that the impact of new technology communication can play a key role in
is carefully assessed and that process, change readiness. The impact of staff
training, and communication are knowing the importance the board places
planned for within project budgets in on technology or other encompassing
major new technology adoption. This change can have significant impact
will be particularly necessary for broad- in their attitude and support for any
reaching use of mobile or increased transformational initiative.

19 Capital structure, leverage,
and capital allocation1
Ajay Khorana, Managing Director and Global Co-Head, Financial Strategy and Solutions Group; Anil Shivdasani, Wells Fargo
Distinguished Professor, University of North Carolina at Chapel Hill and Senior Advisor, Financial Strategy and Solutions Group;
and Cecil Wang, Associate, Financial Strategy and Solutions Group Citi Corporate and Investment Banking
E
ffective financial strategy involves taking a comprehensive
view of capital structure, funding liquidity, risk management,
capital allocation, and distribution policy. Each of these
elements of financial policy has important linkages to one
another, and the optimal strategy involves taking an integrated
view to develop a financial plan that maximizes the company’s
valuation. While the optimal solution for any company will be
uniquely influenced by the company’s long-term strategic and
financial goals, each of these facets of corporate financial policy
involves some common considerations that should be addressed
in the context of the company’s competitive opportunity and
growth prospects within its industry.
Designing an optimal capital structure

The starting point for capital structure analysis often begins with
an assessment of the optimal debt-equity mix on the company’s
balance sheet. Relative to equity, debt is a cheaper and more tax-
efficient form of capital. However, high leverage ratios increase the
probability of financial distress. An optimal capital structure entails
choosing a leverage ratio that balances the cost advantages of debt
financing against the risk of incurring financial distress and the
costs associated with a weak credit profile. Financial distress costs
can vary substantially across industries as well as over the economic
cycle. In the aftermath of the financial crisis of 2007–2008, financing
costs rose by three times relative to the historical average over the
past decade (see Figure 1).

Citi Corporate and Investment Banking Capital structure, leverage, and capital allocation
Figure 1 Dramatic rise in financing costs post-2008

25
A
Spread Over Treasury (%)
BBB
20
BB
B
15
10
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Source: Citi.
Beyond these cost-benefit trade-offs, an companies may refrain from pursuing

optimal capital structure also incorporates an acquisition if it endangers their credit
several other considerations. Among rating, implying that this flexibility option
these, the flexibility afforded by the capital is not frequently exercised. However, this
structure to pursue strategic investments behavior could sometimes be suboptimal.
either in the form of capital expenditures, Even in the context of a ratings downgrade,
research and development, or acquisitions strategically important transactions can be
tends to be an important factor that leads value additive if the buyer ensures adequate
many companies to limit the amount of access to liquidity and an appropriate path
leverage on the balance sheet. For example, to deleveraging.2 In these situations, the
a buyer may find it more advantageous to ultimate outcome depends on the buyer’s
finance an acquisition with cash from new ability to manage rating agency concerns
debt issuance rather than a stock-financed about management’s willingness to take
transaction since it could enhance their risk and view of financial policy going
competitive position as a bidder. As a result, forward.
it is not uncommon for companies that Access to capital markets through cycles is
anticipate substantial growth through future another important factor in capital structure
acquisitions to be more conservative in their choice. Despite substantial current market
leverage choices so that they retain available liquidity, the availability and access to debt
“dry powder” for acquisition financing capital can vary over time as interest rates,
needs. Companies anticipating substantial investor risk aversion, and market dynamics
acquisition driven growth often appear affect the amount of issuance capacity at
to target a capital structure that is more various ratings. This is particularly relevant
conservative than what strictly quantitative for lower rated, speculative grade issuers
models would suggest. that face more constrained market access
Though flexibility to pursue an acquisition in periods of limited market liquidity.
strategy is often a paramount consideration, Thus, companies requiring regular and
evaluating how much flexibility to retain uninterrupted access to debt markets tend
is a complex task, leading some companies to find leverage ratios supportive of a credit
to be potentially overconservative in rating at or near investment grade to be
their capital structure choices. Some more desirable. (See Figure 2.)

Capital structure, leverage, and capital allocation Citi Corporate and Investment Banking
Figure 2 Leverage ratios across NYSE, AMEX, and NASDAQ

500 17.8%
16.3% 16.4%
Number of Companies
400
12.5%
11.6%
300
7.2%
200 6.3%
4.6%
100 2.8% 2.4% 2.2%
0
0 0-1
3-4 1-2
4-5 5-6 6-7
2-3 7-8 8-9 9+
Debt-to-EBITDA (x)
Source: Compustat. Note: Debt-to-EBITDA has been adjusted for operating leases and pensions. Sample
includes all nonfinancial US common stocks traded on the NYSE, AMEX, and NASDAQ as of August 1,
2014.
For these reasons, it is common for size tends to have a substantial impact
companies to frame their capital structure on ratings. Issuers with a larger asset or
decision in terms of a target credit profile revenue base that is well diversified across
rather than a target leverage ratio. While geographies, customers, and business
credit ratings are closely correlated with segments tend to have higher and more
leverage ratios, they also tend to be resilient ratings than their smaller peers.
correlated with other important company Consequently, two companies in the same
attributes such as the size and scale of industry can have very different rating
operations, the stability and visibility outcomes even though their leverage ratios
of earnings, the nature and cyclicality may appear similar. The wide dispersion
of the sector, as well as management’s in credit ratings across companies is not
commitment to a conservative or aggressive simply driven by differences in leverage
financial policy. In particular, company alone. (See Figure 3.)
Figure 3 Wide dispersion in credit ratings

900
Number of S&P Rated Companies
20.6%
800
700
600
500 11.4%
400
8.6% 8.0% 8.2%
7.3% 7.4%
300 6.5% 6.3%
200 3.7% 4.1%
3.1%
100 1.4% 2.0%
0.3% 0.1% 0.8%
0
AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+
and
Below
Source: S&P Ratings Direct (Industrials).

From a ratings perspective, an important under various economic scenarios is

consideration is whether a company should emerging as a tool to assess the appropriate
target an investment grade or a speculative rating buffer for companies that need to
grade rating. An investment grade rating manage this cyclicality.
affords greater access to broader capital Credit ratings also play a prominent role
markets and provides additional flexibility in counterparty risk assessment as customers
in selecting among financing alternatives. and suppliers are increasingly engaged
Unlike investment grade debt, speculative in enterprise risk management. In a 2010
grade issuance generally involves greater survey, about 70 percent of respondents said
use of protective covenants. Only in recent that they use credit ratings along with credit
years have covenant-lite loans emerged as a default swap spreads to assess counterparty
more flexible funding alternative for issuers risk.4 In sectors such as financial institutions,
pursuing leveraged transactions. payments, and processing, counterparty risk
The cyclicality of a company’s cash flows is an important consideration in seeking
can also materially impact the choice of an new business opportunities. Maintaining a
optimal credit rating. Though credit rating low counterparty risk profile can also be an
agencies often take a “through the cycle” important capital structure consideration in
view of a company’s capital structure, cash sectors involving long-dated contracts and
flows in some industries are highly cyclical. licensing agreements, such as in defense,
In such situations, particularly if a company health care, and information technology.
is close to the speculative grade threshold, Therefore, a strong credit rating can
it may be desirable to target a rating that materially contribute to the firm’s overall
is higher than the theoretical optimum to business competitiveness.
build a sufficient cushion for the rating in In addition to the choice of the optimal
the event of an economic downturn. Such leverage ratio or credit rating, several other
downturns carry a disproportionately larger aspects of capital structure design warrant
effect for companies with sensitive cash careful consideration.
flows and weaker credit profiles. Speculative Liquidity management: Liquidity
grade issuances exhibit significantly more management has become a central aspect
volatility over the course of an economic of capital structure design in light of the
cycle than the market for investment grade recent financial crisis. Companies with high
debt.3 Stress-testing the capital structure leverage ratios can mitigate financial risk
Figure 4 Greater fluctuation in issuance volume for speculative grade issuers

Investment Grade Issuance ($Bn) Speculative Grade Issuance ($Bn)
1200 400
350
1000
300
800 250
600 200
150
400
100
200
50
0 0
9
01
03
05
07
09
11
13
9
9
19
20
20
20
20
20
20
20
19
20
20
20
20
20
20
20
Source: Bloomberg.

Capital structure, leverage, and capital allocation Citi Corporate and Investment Banking
by ensuring adequate access to external target strong investment grade ratings. At the
sources of liquidity to meet planned and lower end of the credit spectrum, proactively
unexpected needs for investment and addressing upcoming maturities and
capital structure refinancing. Maintaining avoiding large maturity towers is essential
sufficient cash holdings along with access to managing refinancing risk. Interest rate
to bank loan facilities is therefore important and exchange rate risks pose additional
for all companies, and access to adequate challenges. However, an appropriate mix
liquidity has now become part of the credit of fixed and floating rate debt can optimize
rating evaluation process. For firms that borrowing costs as well as manage risks
have limited access to the bank market, associated with changes in interest rates and
synthetic solutions employing capital the term structure. Overseas denominated
market alternatives have emerged as tools debt can similarly serve both as a hedge
to enhance liquidity. Treasury and working against exchange rate movements and as a
capital management solutions are also platform for the issuer to establish a more
gaining popularity as efficient methods to globally diversified investor base.
centralize cash management and free up Business and financial risk management: A
operational liquidity needs that can be used comprehensive risk management program
to support overall corporate liquidity. can be a vital component of capital structure
Funding base diversification: The global design since corporate cash flows are
banking sector has seen significant changes exposed to a multitude of risks stemming
in recent years as banks adapt to the new from foreign exchange, commodity prices,
regulatory environment including Basel III and market risk factors. In some sectors
capital standards, Dodd-Frank regulation, such as consumer and natural resources,
and the introduction of new liquidity for example, commodity price volatility
requirements. These changes have forced can have a substantial impact on cash
banks to carefully evaluate the trade-off flows, thereby affecting leverage ratios and
between balance sheet growth, underlying potentially impairing credit ratings. The
capital requirements, and return dynamics ability to hedge such risks can make cash
across the credit spectrum. Evaluating flows more stable, mitigating some of the
the use of bank credit and diversification risks associated with a high leverage ratio.
of funding sources has thus become an Therefore, the choice of a target leverage
increasingly important aspect of optimal and credit rating should be considered in
capital structure design. The advantages conjunction with the company’s financial
of funding diversification are particularly exposures arising from these operational
important for speculative grade issuers in considerations and its ability to manage
light of Basel III requirements that impose these risks.
higher risk weightings on their offerings, Managing contingent and off-balance
resulting in reduced credit availability and sheet liabilities: Managing off-balance sheet
higher pricing. Companies can also diversify exposures such as liabilities from defined
their external funding base through the benefit pension plans has become an
issuance of convertible and hybrid securities, increasingly important element of capital
which can bring a broader base of investors structure assessment for firms with legacy
to support the capital structure beyond healthcare and retirement programs. Over the
traditional fixed income investors. past decade, many firms sponsoring defined
Liability management: Optimizing the benefit pension plans have experienced
structure of liabilities is a critical element of significant levels of plan underfunding and
capital structure. Short tenor debt is typically rising contributions stemming from the
cheaper but entails greater refinancing low interest rate environment. As pension
risk. Companies requiring access to the underfunding has increased, pension-
commercial paper market typically need to adjusted debt ratios have risen, pressuring

credit ratings and limiting financial flexibility. repurchases has become an integral part of
The size of pension liabilities has thus become the capital allocation process. While equity
an important consideration in designing the markets tend to prefer a stable or rising
optimal capital structure. Risks to the capital pattern of dividend payouts, share buybacks
structure stemming from pension plans can have also become a regular component of
be managed in a variety of ways. These tools shareholder distributions for many firms. Since
include liability-driven investment strategies, distribution preferences vary across investors,
de-risking strategies, as well as risk transfer firms need to pay careful attention to their
strategies such as pension buyouts, buy-ins, shareholder composition and appropriately
and longevity swaps. balance the decision to reinvest capital in new
Capital structure design should also growth projects versus returning capital in
consider the extent of contingent liabilities the form of dividends and share repurchases.
that arise in the context of potential litigation A balance sheet that accommodates these
due to unforeseen legal risks, environmental funding considerations from shareholder
exposures, and a changing regulatory distributions is another fundamental
environment. The often unpredictable nature step in optimizing capital structure and
of these risks can create exposures to financing maximizing shareholder value. Companies
and operating plans that can be partially that successfully integrate investment and
mitigated through a robust capital structure distribution decisions alongside the long-
and access to adequate liquidity. term strategic and financial objectives of the
firm are best positioned to deliver value
Implications for capital allocation through capital structure management.
Capital structure choices have important
ramifications for capital allocation decisions. Notes
An appropriately designed capital structure 1 We thank Dan Pakenham for helpful feedback
can help lower financing costs and affect and discussions.
the hurdle rates used to evaluate various 2 For a detailed discussion and analysis of
investment alternatives. Not surprisingly, transformative acquisitions, please see our Citi
appropriate capital allocation in conjunction Financial Strategy and Solutions Group (FSG)
with a well-designed capital structure report, Time to Transform, Ajay Khorana, Elinor
directly influences firm value. Across most Hoover, Anil Shivdasani, and Nikolina Kalkanova,
sectors, equity valuation multiples are 2014.
closely linked to both the firm’s cost of 3 The annual change of aggregate speculative
capital as well as the incremental return from grade issuances is four times more volatile than
investments over the cost of capital.5 Hence, investment grade issuances from 2000 to 2013.
corporate executives should holistically 4 For a detailed discussion of counterparty risk,
evaluate capital structure decisions with please see our Citi FSG report, 2010 Corporate
an emphasis on allocating capital toward Finance Priorities, Carsten Stendevad, Anil
businesses that are likely to generate the Shivdasani, Shams Butt, Ajay Khorana, Dan
highest risk-adjusted returns for the firm. Pakenham, Gabriel Kimyagarov, and Michael
Under this portfolio approach, in some Simonetti, 2010.
cases it may even be rational to invest in 5 For a detailed discussion of corporate valuations
businesses generating a low current return and the cost of capital, please see our Citi FSG
if these projects carry a valuable embedded report, Hedging Cost of Capital, Elinor Hoover,
growth option and/or complement other Ajay Khorana, Anil Shivdasani, Jeffrey Colpitts,
and Lorenzo Beacco, 2013.
business units within the firm.
Along with new investments, distribution
of capital in the form of dividends and share

20 How to win the say-on-pay vote
Don Kokoskie, Partner, and Christine Oberholzer Skizas, Partner Pay Governance LLC
F
or most companies, the say-on-pay vote is an annual rite of
spring just like baseball’s opening day. Like all competitors,
company directors and executives are interested in one
outcome—winning.
And, for the first three years of say-on-pay voting, companies
have been doing so in overwhelming numbers as companies have
done a good job of aligning pay and performance, differentiating
pay based on actual results, eliminating poor pay practices, and
communicating these efforts to shareholders. But each year, the
playing field changes and the bar is raised, requiring companies to
consider doing things differently (eg realizable pay, relative pay-
performance analyses, proxy advisory firms’ voting simulations,
shareholder outreach) in order to continue their successes or
overcome setbacks.
With the right planning and preparation, including practices,
companies can maintain or improve their chances of winning their
say-on-pay vote more than the participants in those other springtime
contests.
What is say-on-pay?
Born out of Dodd-Frank and formally enacted in 2011, say-on-pay
is a nonbinding vote by shareholders as to whether they support or
do not support the pay program in place for the company’s named
executive officers (NEOs), as described in its proxy for the prior year
(ie the vote in 2014 is in consideration of the pay reported for 2013).
The board of directors is not bound to make any changes as a result
of the vote. According to the Securities and Exchange Commission
(SEC) rules, companies must conduct a say-on-pay vote once every
three years and provide shareholders the opportunity to vote on the
frequency of their company’s say-on-pay vote once every six years.
Most companies (81 percent) adopted annual say-on-pay voting
frequency in 2011, with others conducting votes every three years
(18 percent) or every two years (1 percent).

Pay Governance LLC How to win the say-on-pay vote
What is a winning vote? Directors also vary in their view of

What constitutes a say-on-pay “win” what constitutes support. The survey
varies depending on one’s perspective. Pay Governance conducted with NYSE
Most companies’ by-laws define a “win” Governance Services and Corporate Board
as a simple majority. However, institutional Member asked directors about these issues.
investors typically expect more than We asked what level of say-on-pay support
a simple majority, though views vary. should require a strategic review of executive
Finally, ISS and Glass Lewis have greater pay programs. Seventy-four percent of
expectations: respondents suggest that support below 70
percent indicates a need for strategic review.
1. ISS considers a vote with less than 70 Only 18 percent indicated 50 percent support
percent support to be indicative of to be the threshold for detailed review. We
“significant opposition” to a company’s also asked what level of say-on-pay support
executive compensation program. should mandate changes to executive pay
Interestingly, our research indicates programs. Forty-two percent indicated 50
this level of support corresponds to the percent to be the threshold for pay changes,
historical level of support companies while 22 percent consider 70 percent to be
receive on average (65–70 percent) when the threshold. In our experience, directors
they do NOT receive ISS’s support. also consider year-over-year changes in say-
2. Glass Lewis considers a vote with less on-pay support. A vote that remains high
than 75 percent support to be indicative (eg 90 percent) but down slightly from the
of “a significant level of shareholder prior year probably is no cause for concern.
disapproval.” However, a vote that slips to 75 percent or 80
percent from over 90 percent may precipitate
As one might expect, both ISS and Glass some discussions among directors about the
Lewis expect companies to respond to a program’s practices, pay levels, linkages to
perceived lack of support by addressing performance, and shareholder expectations.
problems with their pay program and Since the initial say-on-pay votes in 2011,
disclosing the details of how this was done in the average level of support for all companies
the following year’s proxy. This expectation is remarkably high and consistent year over
weighs heavily in ISS’s and Glass Lewis’s year (Table 1).
future voting recommendations and does Three years of vote results indicate
not consider the level of shareholder support shareholders overwhelmingly support the
garnered or the nonbinding nature of the executive compensation models in place.
vote. Despite all of the media attention on
Table 1 Average level of support for say-on-pay vote

2011 2012 2013 Total/Aggregate
Companies 98.6% 97.5% 97.7% 97.9%
“Winning”
Companies 1.4% 2.5% 2.3% 2.1%
“Losing”
No. of Companies 37 56 53 146
“Losing”*
Average Level of 91.6% 90.8% 91.3% 91.3%
Support for “All”
Companies
* Includes nine companies that have failed twice and three companies that have failed all three years.

How to win the say-on-pay vote Pay Governance LLC
and, in some cases, outcry over executive and the paper value of all unvested or
compensation, shareholders believe the pay outstanding equity awards at the end of the
model works. period). Realizable pay is quite different from
the pay disclosed in the proxy’s summary
Why have companies won? compensation table (SCT), which is actual
Pay Governance’s research and analysis salaries, cash incentives earned, and the grant
have proven executive pay and company date or accounting value of equity awards.
performance are aligned over the long The accounting value of equity awards can
term. Pay Governance researched CEO vary significantly from the realizable value,
pay opportunities from 2003 to 2012 for a which takes into account changes in the
constant sample of long-service CEOs at 45 number of shares earned and the stock price
Fortune 500 companies. This long-service, based on changes to a company’s financial
constant CEO sample was selected to prevent results. In our view, realizable pay is a
bias due to changes in incumbents, company better basis than SCT pay for evaluating the
mergers, or significant acquisitions. alignment between pay and performance.
For this group, we assessed pay and Our research helps explain why
performance for the 10-year performance shareholders have been overwhelmingly
period ending in the first quarter of 2013. supportive in their say-on-pay votes:
Performance was based on the company’s
total shareholders’ return (TSR). Pay for 1. Realizable pay has a much higher
the period equaled the CEO’s realizable correlation with TSR performance than pay
pay (actual salaries, cash incentives earned, disclosed in the SCT of proxies (Table 2).
vesting date value of stock awards earned for 2. Companies with high performance have
continued service or meeting performance meaningfully higher realizable pay than
goals, realized gains on exercised options, low performers (Table 3).
Table 2 Correlation to TSR

Compensation Definition 5-Year 10-Year
SCT/Proxy-Reported Pay 3% –6%
Realizable Pay 41% 38%
Table 3 10-Year Analysis

Segment Median TSR Total Realizable Pay as a % of Low-
Performing Group Realizable Pay
Median Average
High TSR 640% 217% 209%
Performers
Medium TSR 313% 128% 164%
Performers
Low TSR 91% 100% 100%
Performers
S&P 500 85%

In addition to strong pay and performance a clear business rationale or support the
alignment, most companies have done a company’s strategic direction
good job addressing executive pay practices • validate and communicate the business
that are typically viewed negatively, case for those practices that remain
including: reducing or eliminating executive • conduct realizable pay and performance
perquisites, eliminating tax gross-ups analyses relative to peers to identify
associated with perks and other benefits, any potential issues between pay and
reining in of lucrative retirement benefits, performance alignment
transitioning from individual employment  Analyses could be based on TSR as
contracts to executive severance polices, well as other key financial metrics.
eliminating single trigger change-in-control  Analyses can also be done separately
(CIC) equity awards, as well as reducing of annual cash compensation (salary
CIC-related benefits. plus actual bonus earned) to determine
Our experience suggests companies if issues reside with the company’s
historically have won their say-on-pay vote annual or long-term incentive plans.
by: • assess annual and long-term incentive
payout levels versus the company’s
• having strong TSR results historical financial results or past
• basing cash and stock incentives on performance as well as relative to
performance metrics that generally competitors or peers
appear to be highly correlated with their • analyze the correlations between metrics
investors’ returns used for annual and long-term incentives
• setting goals for incentives that are and stock price valuation, stock price
appropriately demanding from both growth, and TSR
the perspectives of shareholders and • examine the degree of difficulty associated
executives with incentive goals from multiple
• aligning pay opportunities and resulting perspectives: company’s historical results,
pay levels well versus those performance peers’ historical results, probability of
expectations achievement, cost of capital, analysts’
• avoiding “toxic” pay practices that could estimates of the company, as well as peers
potentially offset any of the benefits from and discounted cash flow modeling.
the above practices.
Furthermore, companies should examine
How can companies continue this success? and understand if ISS and Glass Lewis
Now that we are in year four of say-on-pay, will support their say-on-pay proposal in
some might argue there is little more to advance. Say what you might about ISS, their
be done to enhance the alignment of pay quantitative pay-for-performance tests are
and performance and most companies have fully disclosed and pretty well understood,
addressed poor pay practices. However, ISS making it relatively easy for companies to
and Glass Lewis continue to modify their simulate them and understand any potential
voting guidelines and with volatile TSR and exposure. While less transparent than ISS,
an unpredictable economy, companies are Glass Lewis’s pay-for-performance tests
always at risk. Diligence will remain the can also be tested. Conducting these tests
watchword. well in advance of a company’s annual
In order to continue the say-on-pay shareholders’ meetings helps companies
winning streak, companies should: understand their implications, determine the
need for additional actions, appropriately
• eliminate any “problematic” pay structure their Compensation Discussion
practices that still exist that do not have and Analysis (CD&A) and conduct any

necessary outreach to ISS or institutional 2. ISS analyst subjectivity and unique

investors. company factors may play an important
If necessary, companies may need to role in final vote recommendations.
go beyond the quantitative tests of ISS
and Glass Lewis. While proxy advisory However, failure to gain ISS or Glass Lewis
firms’ quantitative analyses have become support is not a death knell. Eighty-four
clearer, their qualitative assessments of percent of companies NOT receiving ISS’s
companies’ pay programs have become support still pass every year, though the
more subjective and murky at best. While it average level of support (72 percent) is 23
is well known that “HIGH” concerns from percent lower than those receiving a “For”
ISS regarding a company’s quantitative pay- recommendation.
for-performance alignment will lead to a
qualitative assessment of the company’s pay How do companies stay ahead?
practices, we have observed inconsistencies Acknowledging the changing ISS and Glass
in how these qualitative assessments are Lewis tides, shareholder outreach is essential
applied. Numbers aside, it has normally in this fluid say-on-pay environment.
been difficult for companies to understand Companies need to understand constituents’
what issues they should focus on to secure perspectives. No politician goes into an
support. election without understanding the issues
Pay Governance researched how various near and dear to their voters’ hearts;
qualitative factors affected ISS’s voting companies should do the same. Companies
recommendation in 2013 for those companies need to know their shareholder base,
receiving a “HIGH” concern on the ISS’s including the percent of the overall vote
quantitative pay-for-performance tests. We each investor controls, the role ISS and
focused on ISS as access to their reports is Glass Lewis play in determining their voting
more readily available than those for Glass recommendations, and any internal voting
Lewis. This research led to a proprietary policies those institutions may have.
methodology (“Qualitative Factors Score”) Good communication of programs’ pay
to understand how ISS’s qualitative reviews and performance alignment is essential.
are related to its vote recommendations. Unfortunately, this is an area where most
The core of this methodology is a database companies aren’t as effective as they could
of 118 companies, including all S&P 1500 be. CD&As are getting longer but not
companies receiving “HIGH” levels of necessarily better. Considerable time is spent
concern on their quantitative tests for 2013. describing the pay program and the process
These companies normally are subjected but not enough is spent on how pay and
to ISS’s qualitative review. We split the performance are aligned. In our view, more
sample into companies receiving “FOR” companies need to focus on hard facts in the
and “AGAINST” vote recommendations CD&A:
from ISS and analyzed the influence of their
Qualitative Factors Score on the ISS vote • Demonstrate the stretch in the
recommendation. We found: performance goals, which could be done
by comparing current year targets to prior
1. The balance between ISS “praises” year’s targets and current year actual
and “concerns” appears to have been results to prior year’s actual results.
influential in ISS’s final 2013 vote • Discuss the (real or perceived) degree
recommendations. In other words, of difficulty associated with goals based
companies should have more pay on past results, those versus peers or
practices that are viewed positively by ISS probability of achievement.
than those that may be viewed negatively • Illustrate current year’s payout levels
by ISS. versus prior years’ payout levels and

the related volatility in payout levels to which is probably the most common
communicate the truly “at-risk” nature of reason.
compensation. • What is the proxy solicitor’s role: Proxy
• Include realizable pay analysis, which few solicitors may have some insights into
companies disclose (even if they conduct portfolio managers that may be able
the analysis) and may take companies to influence the vote, whether they are
more time getting comfortable with the influenced by proxy advisory firms’
results of such analyses. For example, high recommendations or have their own
relative realizable pay for high relative guidelines about what are the most critical
TSR results is just as appropriate of an issues (inaccuracies in proxy advisory
outcome as low (or median) realizable firms’ reports, peers for benchmarking,
pay for low (median) relative TSR. Back- incentive plan design, goal difficulty, CIC
testing realizable pay analyses for pay- benefits, etc).
for-performance alignment may help in • Who should represent the company: Most
this regard. investors do not want to hear from
• Communication can no longer be a one- the CEO, as their pay could be at the
way “CD&A Avenue.” Companies need heart of the issue. The Compensation
to actively engage with shareholders, Committee Chair is an obvious choice
even if preliminary results appear to as they are responsible for administering
be positive. Developing and cultivating and managing the company’s pay
relationships with investors will enable program from the board’s perspective.
companies to gather context, potentially However, companies should consider
pay dividends in the future, and should the issues being discussed with investors
become an integral part of the annual and whether they warrant the chair’s
compensation process just like the say-on- participation. Finally, whoever is
pay vote, proxy and CD&A preparation, involved from management should be
goal setting, and so forth. close enough to the issues to have a
meaningful conversation.
In approaching shareholders, companies • When to engage: Waiting two days before
typically go beyond trying to influence or the annual meeting will not cut it. Even
change the voting recommendations of ISS trying to schedule something during the
and Glass Lewis. Specifically, in conducting height of the proxy season (say, January to
shareholder outreach companies should May) may be difficult. Our experience is
consider the following: that firms like ISS, Glass Lewis, and other
institutional investors have ample time
• What influences institutional investors’ outside the proxy season crunch.
voting: The company’s pay policies and • Who to engage: While portfolio managers
analyses (including those analyzing may not be doing the actual voting
pay and performance alignment), its at investment firms, they may have
proxy statement, and direct engagement some influence on the voting process,
with the investor group are viewed particularly at mid-size firms as opposed
as more effective in influencing to small firms (which may rely more on
institutional investors than proxy advisor ISS and Glass Lewis recommendations)
recommendations or third-party research. or large ones (that have their own
• What’s the reason for engagement: This governance groups).
could range from communicating the pay • What to say: Companies need to be careful
plan to improve understanding, seeking here so as not to violate Regulation Fair
shareholder input about current practices, Disclosure requirements. Investors want
discussing potential program changes, or to understand how the pay program
responding to low shareholder support, supports the company’s goals of creating

value as well as the rationale behind • Communication—enhanced shareholder

the program’s decisions. More important, outreach, proxy advisor outreach, more
shareholders (and advisors) want transparent CD&As, enhanced disclosure
assurance that their views are being heard of performance goals, and goal setting
and the company will consider and/or rigor.
commit to changes, as appropriate. • Pay levels—some companies reduced
pay levels and disclosed that they were
Obviously, each company’s approach “sharing the pain” felt by shareholders.
will vary depending on the facts and • Design—two thirds of companies made
circumstances. However, an ongoing changes to their long-term incentive
dialogue with shareholders can help build programs, with almost all of them
support for the company’s pay program, adding a performance-based program
provide insight into potential problems (eg performance-restricted stock,
outside the areas of concern for proxy performance shares) going forward.
advisory firms, and may provide companies • Stock ownership guidelines—fifty percent
benefits when they are most needed—at implemented or enhanced executive
a time when their programs are being ownership guidelines for their CEO and
challenged by shareholders. NEOs.
What if you fail? There’s always next year—winners and

Nobody’s perfect—what happens if you losers both are looking ahead to next year’s
stumble and lose say-on-pay (or the support say-on-pay vote and wondering what
is a slim majority)? In 2012, 26 of the 37 changes may come to this game: legislation,
companies that had failed say-on-pay the voting policies, and sentiment may change.
prior year gained majority support. We Companies need to bring their A Game,
think say-on-pay winners and losers should which requires continued thoughtful
examine the factors behind the tremendous program design and continued testing and
turnaround in support from the 26 companies rationalization of that design and resulting
that lost their vote in 2011 but won it in 2012. pay levels, as well as savvy communication.
In other words, these companies were first-
time losers, second-time winners. The most
“To win. Nothing else matters,
common actions by these companies were:
and nothing else will do.”
– Sandy Koufax.

Board of director compensation:
21 evolution and aligning design
with shareholders
Stephen J. Pakela, Managing Partner, and John R. Sinkular, Partner Pay Governance LLC
O
ver the past 15 years, the methods of compensating
nonemployee directors have changed in tandem with the
risk and workload of being a director. The catalyst for change
over this time period includes a variety of regulatory changes, such
as Sarbanes-Oxley and Dodd-Frank, revamped proxy disclosure
rules, which have enhanced transparency, and an overall increase
in shareholder activism. For example, audit committees meet
more frequently and must have a qualified financial expert as
one of their members; compensation committees have greater
workloads as a result of a combination of the enhanced proxy
disclosure rules and the impact of the say-on-pay shareholder
advisory vote; and governance committees must now wrestle
with governance practices and policies and shareholder rights
issues.
In simple terms, today’s corporate director needs to dedicate
more time to the job, assume greater risk, and meet a higher
qualification standard. Arguably, these issues and newer issues
such as director tenure limits have reduced the pool of available
individuals who are willing or qualify to serve as a director. As with
all things impacted by supply and demand, the total compensation
provided to directors has risen. Over the past decade, total director
remuneration has increased annually by approximately five percent
on average. Despite this level of increase surpassing the typical
increase in employee pay, it lags behind the increase in CEO
compensation over the same time frame.
The methods and design of director compensation programs
have changed over time as well. The basic construct of director
compensation arrangement continues to be a mix of cash
compensation and an equity award. However, the means of
delivering those two elements has changed rather dramatically over
the past decade.
Design principles
In designing and administering director compensation packages, a
common framework followed by companies includes the following:

Board of director compensation: evolution and aligning design with shareholders Pay Governance LLC
1. Pay philosophy—Total pay is targeted to be the annual service provided to shareholders.

competitive with the market median with We expect this shift to continue among
an emphasis on equity compensation and smaller and mid-size companies where the
an ongoing stock ownership or holding elimination of meeting fees is not yet a
requirement. majority practice.
2. Peer group—Comparisons are made to the Growth in the value of director cash
company’s pay peer group (companies compensation has varied and is best analyzed
used for CEO and senior executive pay before, during, and after the Great Recession
benchmarking) and, as appropriate, a (2008–2009). Prior to the Great Recession,
large data set of comparably-sized general fees were increasing at a high single-digit
industry companies. percentage rate as boards transitioned to the
3. Pay benchmarking—Companies conduct new regulatory requirements that demanded
detailed pay benchmarking annually or, a greater workload and increased the level of
at least, every two years. risk and responsibility for directors. During
4. Pay adjustment timing—The bias is to not the Great Recession, board fees and retainers
make changes every year (even though were largely frozen or in some cases reduced
pay benchmarking may be conducted to align with the generally modest reductions
more frequently) and to consider increases in executive salaries at some companies.
following a “lead-lag” approach. More recently, director cash compensation
has generally increased at a rate of three
In the following sections, we review each percent to five percent as a more normal
element of compensation. economic climate has settled in.
Cash compensation Equity and cash compensation mix

The traditional directors’ compensation Over time, as director compensation has
program included both an annual retainer increased, the trend has been to provide
and a separate fee provided for attending greater focus on equity compensation, which
board and committee meetings. The presence provides direct economic alignment to the
of a meeting fee encourages meeting shareholders whom directors represent.
attendance and automatically adjusts for Currently, it is common to have equity
workload as measured by the number represent a slight majority of regular
of board and committee meetings. Some annual compensation—such as a pay mix
companies even provide a lower meeting of equity compensation 55 percent and cash
fee for telephonic meeting participation. compensation 45 percent. In analyzing broad
Meeting attendance is less of an issue today market practices, we typically find directors’
as companies disclose whether their directors total compensation allocated 40 percent to 50
attend at least 75 percent of meetings and percent to cash compensation and 50 percent
proxy advisors scrutinize those directors to 60 percent to equity compensation. The
who fail to meet the threshold. More recently, emphasis on equity compensation is also
most large companies and more mid-size directionally consistent with the typical pay
and small companies have simplified their mix for senior executives.
approach to delivering cash compensation
by eliminating the meeting fee element Equity grant design
and instead providing a larger single cash In the early 2000s, stock options delivered
retainer. The rationale for this change is to most or all of director equity compensation,
ease the administrative burden associated similar to the approach for compensating
with paying a director a fee for each meeting executives. The strong trend since then has
attended and to communicate that meeting been to use full-value shares to deliver all (or
attendance is expected with less emphasis at least most) of equity compensation. This
on actual time spent and more emphasis on shift in approach was driven by the change

Pay Governance LLC Board of director compensation: evolution and aligning design with shareholders
in accounting standards, negative views of calling for a separation in the board chairman
stock options as a compensation vehicle for and the CEO roles. While this debate is
directors (and executives), and other factors. ongoing, a governance model has emerged
During this time the perception of using stock where independent directors are either led
options for directors changed dramatically, by a non-executive chairman (at companies
particularly from high-profile scandals in the that have separated the leadership role) or a
first half of the 2000s (Enron and WorldCom, lead director (for companies that maintain
among others) and the reassessment of the a combined chairman and CEO role or an
alignment of the incentive characteristics of executive chairman). At companies that have
stock options relative to directors’ duties and separated the board chairman and CEO roles,
fiduciary responsibilities. As a result, today, an independent non-executive chairman is
the most common market practice is to appointed to lead the independent directors.
deliver equity compensation solely through The responsibilities of this position vary
full-value shares; a minority of companies by company as does the compensation of
(typically 25 percent or less, depending on the position. Typically the non-executive
the set of companies analyzed) continue to chairman receives an additional chairman’s
grant stock options. retainer delivered in cash, equity, or a
Companies vary in the delivery of the combination thereof that is in addition to
full-value shares with the most common the typical director compensation. At the
approaches including: low end of the spectrum, the non-executive
chairman’s extra retainer is typically
1. restricted shares (restricted stock or positioned modestly above the extra retainer
restricted stock units), which have a provided to the audit committee chairman
restriction period that may range from (or the lead director, as discussed below),
six months to three years (with one year or at the high end of the spectrum, the
generally the most common) additional retainer can be significantly
2. deferred stock units, in which actual higher, such as an additional $200,000 or
shares are not delivered or sold until more.
departing the board At a minority of companies, the executive
3. outright grants, which are immediately chairman is typically a founder or outgoing
vested at grant. CEO. This position is typically limited in
duration, ranging from three months to two
The use of performance-based awards years, and generally receives the executive’s
for directors is nearly nonexistent due to previous salary and bonus opportunity with
the desire to avoid any misperceptions no or a modest equity award. Executive
between compensation and their duties and chairmen typically assist the transition of the
fiduciary responsibilities (which include new CEO and continuation of an ongoing
setting performance goals, then assessing corporate strategy.
and certifying performance results for For those companies that have decided
executive incentive compensation plans). to continue with a single combined role,
Those companies that desire to give some an independent director serving in the
level of performance-based compensation role of lead director (or presiding director)
typically do so through a modest grant of has emerged as a best practice to lead
stock options in combination with a grant of an executive session of the independent
full-value shares. directors. When this role emerged in the years
between 2000 and 2005, the lead director
Board leadership compensation often received no additional compensation
Following the scandals mentioned above, and frequently rotated among independent
the debate over board leadership intensified committee chairmen or was represented
with many outside governance experts by the governance committee chairman.

Board of director compensation: evolution and aligning design with shareholders Pay Governance LLC
More recently, for companies to maintain executives. In order to align directors’

the combined role of chairman and CEO, economic interests with the shareholders they
lead directors have become more prominent represent, companies typically provide full-
and are now typically appointed by the value equity awards and require minimum
independent directors and are compensated stock ownership specified as a multiple of
with an additional retainer, which in many the annual retainer or equity award value.
cases is above that provided to the audit At larger companies, the minimum stock
committee chairman. ownership guideline is typically three to five
Board committee chairmen are typically times the annual retainer or equity award
provided an extra retainer to compensate value, with the expectation that this will
for the additional work with management be achieved within five years of joining the
and outside advisors in preparing to board.
lead committee meetings. Following the Some companies also have stock
introduction of Sarbanes-Oxley, the extra holding requirements, which may be
retainer provided to the chairman of the used in addition to stock ownership
audit committee increased at a higher rate guidelines. For example, companies may
than other committee chairs in recognition of require directors to retain net (after tax)
the additional workload in terms of number shares upon lapse of restrictions until the
of meetings and required preparation, minimum stock ownership guideline is
heightened risk, and the financial expertise achieved. Other companies may solely use
required of the position. Following the stock holding requirements (such as grant
introduction of the enhanced proxy disclosure equity compensation as deferred stock
rules in 2006 and the say-on-pay advisory units) to ensure directors accumulate and
vote in 2010, extra retainers provided to the retain meaningful levels of stock ownership
chairman of the compensation committee through their tenure as a director.
were increased to be positioned closer to Due to their duties and fiduciary
(or just below) that of the audit committee responsibilities, shareholder optics, and
chairman. other factors, many directors decide to retain
all of the equity compensation provided
Benefits and perquisites during their board service. In addition, some
Few companies provide retirement benefits directors may decide to make outright stock
and perquisites to directors, which results in purchases to accelerate their accumulation of
“total compensation” typically equaling the company stock.
sum of cash meeting fees and retainers, and
annual equity grants. Those companies that Contemporary best practices
previously had director retirement plans Over time, director compensation levels and
transitioned away from such programs, program design have evolved to address
due to the increased focus on equity the changing regulatory environment and
compensation, the broader trend to close changing role of the typical director, as
defined benefit plans for employees, and described above. Director compensation
other factors. Some companies continue to arrangements have settled to a general
provide directors (and executives) with a design adopted by most companies:
matching charitable gift contribution to the
charity of the director’s choice. • annual cash retainer representing
approximately 40 percent to 45 percent of
Stock ownership guidelines and requirements the total program value
There is near universal use of stock ownership  some continued use of meeting
guidelines or holding requirements for fees (with smaller annual retainer),
directors, which is consistent with the particularly at smaller to mid-size
prevalence of requirements for senior companies

Pay Governance LLC Board of director compensation: evolution and aligning design with shareholders
• annual equity award most often delivered pay higher include director term limits and
through full-value shares that vest limitations on how many boards a director
after a specified time and representing can serve. However, future shareholder
approximately 55 percent to 60 percent of proposals regarding “director say-on-
the total program value pay” and similar examples of shareholder
 some continued use of stock options in activism or proxy advisor policy regarding
combination with full-value shares director compensation could serve to limit
• extra retainers for leadership positions (ie future increases in director pay levels. With
non-executive chairman, lead directors, these issues in mind, we anticipate that pay
and committee chairmen) and in some levels will increase nominally (generally
instances members of committees who three percent to five percent per year) and
are impacted by significantly different that program designs will generally be stable
workloads (ie audit committee members) (with some companies continuing the trend
when compared to other committees of eliminating per-meeting fees in favor of
• stock ownership guidelines representing higher annual cash retainers). In reviewing
three to five times the annual retainer. market practices, we note that there are
some variances by industry and company
Going forward, a number of issues could size and that each company should consider
potentially impact the level of compensation its objectives and other circumstances in
provided to directors both positively and reviewing its directors’ pay and determining
negatively. Issues that could limit the supply whether any changes should be made going
of available directors and potentially drive forward.

22 Principles for effective
enterprise risk management
Deon J. Minnaar, Americas Leader ERM and GRC; Angela J. Hoon, Principal; Dorothy Guo, Director;
Nicole S. Homme, Director; Vishal Mehta, Director; and Eric J. Parker, Director KPMG LLP
T
he operating environment at many companies today is in
a state of constant flux as a result of new regulations and
increased regulatory scrutiny as well as disruptive business
models and a myriad of emerging risks. These conditions have
placed enterprise risk management (ERM) at the forefront of
company initiatives to anticipate and manage volatility and
continuing economic uncertainty. We find organizations either
establishing ERM programs or enhancing the maturity of their
existing programs to manage the dynamic landscape, understand
their most critical risks, make well-informed decisions, and
respond with increased confidence to heightened financial
scrutiny and the related expectations of their boards of directors,
shareholders, and regulatory and rating agencies.
ERM is an organization-wide means of identifying, assessing,
communicating, and managing risk. Using a systematic approach,
ERM aims to:
• strengthen risk management capabilities as an integrated part of

strategic and business planning
• foster a culture for communicating and sharing information to
support robust decision-making throughout an organization
• provide an expanded understanding of risks and their
interrelationships to help drive performance and value.
As organizations re-engineer their processes or adapt newer operating

models to address their evolving risks and challenges over time, they
need to adjust their ERM practices in alignment with these changes.
This chapter elucidates four time-tested, foundational principles
for effective enterprise risk management: (1) executive sponsorship
and risk culture; (2) effective governance and infrastructure; (3) risk
management enablers and accelerators; and (4) effective communication
and change management. These principles serve as the backbone for
an effective ERM program throughout an organization and at all
maturity levels, from implementation to advanced programs.

KPMG LLP Principles for effective enterprise risk management
Principle 1: executive sponsorship and risk people, and reward achievements, an

culture effective risk culture requires commitment
A sustainable and effective enterprise risk of all levels of the organization. In a strong
management program begins with and risk culture, all members of the workforce
requires strong executive sponsorship understand that managing risk is part of
and an organization-wide respect for risk. their daily responsibilities.
Commitment to ERM requires dedication and In addition, transforming risk culture
a willingness to get involved; leadership’s requires effective communication—
commitment, in turn, denotes its stand for including regular, consistent messaging to
effective risk management and a strong employees—to help ensure that everyone
risk culture. This commitment is reflected across the organizations understands his or
through three core activities: her daily responsibilities for managing risk.
Leaders must send a strong message that they
1. Lead by example: An organization can affect use ERM as a strategic tool to manage the
behaviors by demonstrating a strong risk business, and, therefore, risk management is
culture with integrity and commitment by valued and critical to organizational success
all leaders. By walking the talk, executive and survival. Structured communication
leadership naturally sets an example for and ongoing training can demonstrate
the rest of the organization to follow. unambiguously that risk culture is on the
2. Encourage good behaviors: Organizations leadership agenda. These efforts can also
can effectively promote a positive risk cultivate an organization-wide understanding
culture by directly and explicating for risk management protocols and the roles
rewarding people for culturally congruent and responsibilities for helping drive risk
behaviors and sanctioning them for nonmanagement decisions.
compliant behaviors. Such actions send a ERM fosters collaboration and
clear signal about what executive leaders integration; it involves everyone working
truly value. together and making a concerted effort to
3. Champion risk culture: “Tone at the top” manage risks in a cohesive and cost-effective
is unequivocally the most important manner. Each “line” plays a vital role in the
driver of organizational risk management organization’s risk management. As primary
culture. While the phrase may be stakeholders, executive leadership is best
overused, there is simple truth in the idea positioned to truly transform a traditional
that when leadership sets the example, risk management function into an integrated
others will follow. one that provides enterprise-wide capability
to drive performance and value.
Risk culture
Risk culture determines how an organization Principle 2: effective governance and
identifies, understands, and acts on the risks infrastructure
it faces. Culture can significantly affect an Effective governance and a supportive risk
organization’s ability to make strategic risk infrastructure are critical to the success of
decisions and deliver business performance. ERM. The governance framework should
It can be extraordinarily fragile without establish clear accountability and rigorous,
executive leadership’s endorsement and yet practical oversight for risk management
commitment. throughout the organization. The “three
Risk culture cannot be influenced by lines of defense” risk management model
the risk management function alone; it is illustrates the distinct roles organization-
driven by a combination of the “C-level’s” wide and manifests that everyone plays
commitment to risk management and the a role in its execution. (See Figure 1.) The
tone at the bottom. While executive leaders first line (business unit) involves those
are able to authorize resources, empower employees whose everyday responsibility

Principles for effective enterprise risk management KPMG LLP
is to help identify and manage risks. The evaluating strategic risks, and providing a
second line (management oversight) includes check and balance on management decisions.
management personnel in business, risk, The full board is accountable for both risk
compliance, and other oversight functions content and risk process and defining effective
who establish risk management policies, set risk oversight objectives, while multiple board
standards for managing risks, and enforce committees may be established to provide
and monitor specific risk and controls. The oversight on specific risk areas, depending
third line (independent assurance) includes on their expertise. The management team is
internal audit, which provides assurance responsible for embedding risk management
over business activities. into the operations of the business, overseeing
Within these three lines of defense, certain control design and implementation, and
fundamental governance components reporting risk information to the board. First-
are required for an effective and efficient line (business unit) personnel are responsible
program: clear accountability, a common for identifying risk, implementing and
ERM framework and methodology, data operating controls, and risk reporting.
definition and governance, and technology. Management is responsible for
communicating risk information to the
Clear accountability and rigorous oversight board. In many companies, establishing a
A governance structure supports oversight management risk committee or council can
of risk management policies and processes, help:
rationalizes and systematizes risk assessment
and governance reporting, and provides • facilitate oversight and encourage
assurance that processes are adequate and discussion of risks across the organization
appropriate. Within this structure are defined • create buy-in, as well as a shared vision
roles and responsibilities for the board, of the desired target state and the
executive management, and the three lines understanding that achieving it is an
of defense—business unit, management, and evolutionary process
independent assurance functions. • drive follow-up activities on mitigation
Boards should validate that strategy and plans to close gaps.
risk are aligned—by setting risk appetite,
Typically, organizations develop standard
tools for board risk reporting, such as
Figure 1 Three lines of defense ERM program dashboards and templates.
risk management model In general, reports should enumerate and
prioritize risk exposures, indicating category,
Executive Leadership description, risk mitigation assessment, and
audit review findings, as well as corrective
action plans and current status. Such
reporting provides high-level visibility
into both risk exposures and business
1st Line 2nd Line 3rd Line opportunities and fulfills heightened
expectations that corporate leaders will be
Business Management Independent
Unit Function Assurance actively engaged in the risk management
(identify and (oversight) (review process.
manage risks) process)
Common ERM framework and methodology
An ERM framework promotes a common
Integrate and embed risk management view and understanding of risk across an
into business operations organization and is essential for effective
program implementation and execution.

For organizations with developmental Data definition and governance

programs, a framework outlines the program’s While adopting common risk taxonomy is
necessary, primary elements; companies with critical to the success of an integrated ERM
mature ERM programs consistently leverage program, equally important is providing
a common framework and methodology the ability and flexibility to make changes
throughout the organization. Use of a to the data definitions and structure to
common framework facilitates a repeatable continue to meet the evolving needs of the
process that allows companies to identify organization. However, this change must
both current and emerging risks, as well be subject to appropriate management and
as assess and improve the adequacy of the oversight to help provide business users
risk management process. Such a process with high-quality risk data that is easily
involves reviewing risks that have seriously accessible in a consistent manner. Risk data
affected the company in the past, both to governance calls for specifying an authority
understand their causes and consequences and accountability framework to encourage
and to evaluate the effectiveness of corrective desirable behavior in the creation, storage,
actions. Looking forward, the framework use, archival, and deletion of risk-related data
establishes a means for timely identification of and information. It involves consultation
emerging trends and processes for developing with key stakeholders regarding potential
response strategies, gaining consensus, and changes to established risk taxonomies and
implementing action plans. data definitions. Formal approval should be
Utilizing a common risk language and granted before any changes are made that
tools throughout the risk management will impact the organization’s shared risk
program—from risk assessment to risk language. A key principle of effective ERM
reporting—will help drive standardization is to maintain agreed-upon data definitions
in both process and output. The framework and formats, identify data quality issues,
and supporting methodology should and ensure that business users adhere to
include standard risk taxonomies, risk rating specified standards.
scales, and risk assessment templates. Once
the framework is developed, users should Technology and organizational infrastructure
be trained on its requirements to facilitate Convergence of risk management through
consistent application. enabling technology provides the means for
Operating models vary by organization; organizations to develop a shared repository
thus, developing and implementing an ERM for risk data that supports a common
program framework within an organization view of risk and sharing of compliance
also involves an analysis of how its risk information across the enterprise. Similarly,
management practices align with other transparent risk reporting ensures the
management activities and strategic appropriate connections and linkages are
objectives. Risk management enablers that made. A centralized risk management
are extremely important to this alignment platform may also be used to achieve a
include clearly articulating a company’s consistent set of information on key risks,
risk appetite, risk tolerance metrics, and issues, and mitigating actions that allows
risk thresholds for decision-making, along for organizational impact to be analyzed
with delegation of authority and associated and reported in a timely and consistent
limits. Additional discussion of select manner. This platform is very useful for
risk management enablers is provided in establishing a baseline communication and
Principle 3: introduce risk management reporting mechanisms among management
enablers and accelerators. and the board. Many risk management

Principles for effective enterprise risk management KPMG LLP
technologies are available, including some activities. Many factors contribute to striking
that support enhanced risk monitoring and a good balance:
analysis and automated work flows for
reporting, assessments, and remediation • First, organizations should acknowledge the
management. commonalities and potential overlaps in the
risk appetite statement and strategic plan
Principle 3: introduce risk management and ensure cross-functional collaboration
enablers and accelerators when developing the two documents.
A successful ERM program requires that • Next, the organization should establish
multiple business units and functional boundaries or protocols by which each
areas of different sizes and uneven levels of document is expected to pursue common
maturity collaborate on risk management. objectives.
Often, the result is a large gap between • Finally, firms should establish a formal
inception, adoption, and implementation of mechanism by which to resolve conflicts
program activities. and harmonize the risk appetite statement
Consequently, most organizations seek to and the strategic plan.
introduce specific enablers and accelerators
to drive their ERM programs and reduce Data and analytics
these gaps. Foundational elements such as The benefits of embedding data and analytics
common risk taxonomy and risk policy, an in ERM are immense. For instance, a data-
integrated technology solution, risk strategy driven organization will have at its disposal
and appetite, and change management numerous scenarios and hypotheses that can
(people) practices as well as increased use help the organization effectively respond
of insights and analytics are among leading to unanticipated macroeconomic shifts or
practice enablers that position ERM to sudden operational challenges and leverage
promote value throughout the organization. those insights to identify potential business
Below, we focus on two enablers—the risk opportunities (the upside of risk) in a more
appetite statement and data and analytics— uncertain and competitive environment.
that are rapidly gaining importance as Perhaps there has been no greater
organizations ascend the risk management impact of advanced data and analytics
maturity continuum. techniques than on enabling the prolific use
of unstructured data for risk management.
Risk appetite statement Traditionally, internal auditors and ERM
Regulatory and industry practices strongly practitioners have used limited-functionality
suggest that companies develop a risk tools to manage large volumes of structured
appetite program to guide risk governance. or numerical data for risk management
Such a program includes a risk appetite purposes. However, the latest technology
statement that identifies major risks and defines solutions can also process and analyze non-
acceptable levels for major areas of risk. numerical, unstructured data—including
An effective risk appetite statement should e-mails, social media chats, or proprietary
be easy to communicate and encourage early customer relationship management (CRM)
adoption from all stakeholders. In addition, and point of sale (POS) data—to provide
it should include the following “best in a wealth of insights that supplement
class” attributes. empirical information. The key difference
While both the risk appetite statement is that these tools supply real-time data
and the strategic plan share a common that provide a view into the thoughts
objective of promoting sustainable and and actions (“sentiments”) of a variety of
controlled business growth, often the external stakeholders and other influencers,
combined message can be contradictory and including customers and consumers. Mature
result in unapproved or stalled business ERM programs are taking these qualitative

inputs and supplementing their quantitative circumstances that present to the different
risk assessments to effectively identify levels of risk management—executive,
risks—particularly those related to corporate assurance, management, and operational
conduct, reputation, or fraud—and even (business units). Adopting a consultative
identify unexploited opportunities. approach to communication helps create
the openness required to encourage
Principle 4: effective communication and brainstorming and supports the parties in
change management challenging each other and considering
Similar to the premise that ERM is everyone’s different perspectives when making
responsibility, these foundational principles decisions. For example, when a risk like
for effective ERM complement each other disruptive technologies impacts various
and are more valuable when practiced in areas within a business, it will require
concert than by themselves. The executive collaborations to truly appreciate the impact
sponsorship and cultivation of risk culture and implications of such a risk event.
discussed in Principle 1 encourage active As risk is discussed in different forums
involvement of all members of the workforce, there should be a mechanism to share
thereby building the trusted relationships information, ideas, and decisions across the
necessary to share information and ideas lines of defense. In addition to fostering
that shape results and improve decision- a well-informed risk culture, the ongoing
making by collectively aligning with communication will promote consistency in
strategies and objectives. This risk-informed risk management and change management
and aware culture is supported by a target- practices.
operating model that provides governance
mechanisms and processes highlighted Change management
in Principle 2. The structure furnishes the Just as creating an ERM program with a clear
necessary support and establishes consistent and practical vision is critical, pragmatic
practices, standards, and behaviors that change management is essential for
solidify a strong, repeatable program and sustainability. Proper change management
lead to a risk culture that exemplifies effective through the right communication,
communication and consistent messaging management buy-in, and stakeholder
(albeit at different levels of granularity, as involvement solidifies the risk culture
necessary) throughout the three lines of established at the onset and ensures that the
defense. ERM program remains viable.
To remain efficient and functional, change
Program sustainability, consistent communication, management needs to be woven into the
and consultative approach ERM program infrastructure at all levels.
Effective communication means continual This is the process by which new risks
improvement in how the risk function and the and opportunities are realized, challenges
business lines work together to consistently are noted, and processes and practices are
share risk information across the business. enhanced and updated before they become
From the onset, employees need to understand ineffective or obsolete. ERM is a constantly
stakeholder expectations, the potential impact evolving science; mechanisms must be built
and importance of the ERM program, and in to allow the program to change in tandem
how it ties to strategy and goals. with emerging risks, business challenges,
An effective risk management model and new opportunities that shape the
needs to consider the unique challenges and organizational landscape.

23 Audit committee priorities
Dennis T. Whalen, Partner in Charge & Executive Director; and
Susan M. Angele, Senior Advisor, Thought Leadership KPMG’s Audit Committee Institute
T
he challenges faced by companies have never been greater,
from the rapid pace of change in technology to the impact of
globalization and geopolitical disruption, to an exponential
increase in the level of regulation and enforcement. Companies
must be prepared to navigate through these challenges in a
manner that not only mitigates the risks but enables the company
to seize opportunities in the short term and build sustainable
growth in the long term. If this weren’t complex enough, this
must be managed in a climate that demands an unprecedented
level of transparency and accountability.
As business has become more complex, the role of the audit
committee has also evolved. Importantly, high-performing audit
committees no longer simply sit back and listen passively to
management presentations. They are actively engaged—setting the
proper tone to ensure that the organization creates and maintains
a culture of honesty and high ethical standards, providing strong
oversight in the area of legal compliance as well as with respect to
other risk areas within its purview, taking control by defining the
information they want to see and seeking out diverse and unfiltered
perspectives.
The breadth of the audit committee’s responsibility has evolved
also, and it varies by company—in some companies the committee’s
mandate is identical to the requirements placed upon it by law,
regulation, and New York Stock Exchange (NYSE) listing standards,
while in other companies the audit committee may have a purview
that is so broad it can encompass any and all potential regulatory,
operational, or strategic risks. Whatever the committee’s scope, a
top-performing audit committee will need to prioritize in order to
successfully guide its company through the challenges. This chapter
is not intended to be a comprehensive survey of the laws and
regulations impacting the audit committee. Rather, it is intended to
offer a guide to help focus audit committee time and attention on
what matters most.

KPMG’s Audit Committee Institute Audit committee priorities
Scope of the audit committee’s responsibilities expect the company’s management of risk
The role and responsibilities of the audit to be broad and robust, including strong
committee should be clearly laid out in its oversight at the board level. Depending
charter. This includes those responsibilities on the overall board-level workload and
that are specified by law and NYSE listing the expertise of the directors assigned to
standards. Broadly stated, the audit the various committees, this oversight
committee is required to provide oversight can take place in various places: the full
of the company’s financial reporting and board, the audit committee, a separate risk
internal control over financial reporting; committee, or a different committee. As a
oversee the internal audit function and best practice, many companies map their
the external auditors; discuss policies major strategic, operational, and compliance
with respect to risk assessment and risk risks to ensure that each and every one has
management; establish procedures with been allocated an appropriate amount of
respect to whistle-blower complaints; and time on the agenda of the board or one of
engage in self-assessment of its performance. its committees. In doing so, care should
In addition to the responsibilities that are be taken to prioritize responsibilities and
required, many boards assign to the audit balance the overall workload among the
committee broader responsibilities in areas board and its committees.
relating to the full array of risk. KPMG’s
Audit Committee Institute conducted a Committee composition
global survey that included approximately In light of the critical role of the audit
500 audit committee members of US committee, it is imperative that committee
companies. The responses below indicate members have the knowledge, time, and
the percentage of US-based respondents level of commitment needed to provide
who indicated that the referenced category strong oversight and insightful counsel.
of risk resides with their audit committee. The NYSE listing standards require that
an audit committee include a minimum of
• Financial risks (cash flow, access to capital, three directors. Given the range in the scope
compliance with debt covenants, etc.): 58 of audit committee responsibilities and the
percent specific needs and challenges of different
• Anti-bribery and corruption: 45 percent companies, not surprisingly there is some
• IT/cybersecurity risk: 45 percent variation in the size of audit committees and
• Legal/regulatory compliance: 42 percent the skill sets of the committee members.
• Risk management process: 34 percent Audit committees of NYSE-listed
• Operational/supply chain risks: 12 companies typically contain three to five
percent members. First and foremost, all directors
who serve on the audit committee must
A small number of audit committee members be “financially literate” and “independent.”
even indicated that their committee has In addition, the NYSE requires that at
primary responsibility for risks relating to least one member of the committee have
business model disruption and/or strategy. accounting or related financial management
As these responses suggest, there is no expertise, and the Securities and Exchange
“one size fits all” when it comes to the scope Commission (SEC) rules require a company
of the audit committee’s responsibilities. On to disclose whether any member of its
the one hand, it is important to ensure that audit committee qualifies as an “audit
the audit committee is not overburdened and committee financial expert.” Beyond these
has the time to carry out the responsibilities requirements, it is helpful if the audit
that are required by law. On the other hand, committee collectively has the knowledge to
particularly for large, mature companies, identify the unspoken issues and concerns,
regulators, investors, and the public at large challenge the assumptions, ask the hard

Audit committee priorities KPMG’s Audit Committee Institute
questions, and assess the quality of the ICOFR). As part of the annual audit, the
responses. Therefore, consider whether the external auditors will audit ICOFR and
audit committee should include members advise the committee if they have identified
who have direct experience in the company’s any significant deficiencies or material
industry as well as general experience weaknesses in ICOFR.
in key areas, such as emerging markets,
supply chain, information technology (IT), Relationship with the company’s external
and so forth, as relevant and appropriate. auditors
Companies that need a key expertise that Pure and simple, the company’s external
is not available among the members of the auditors work for the audit committee. Section
committee sometimes retain outside experts, 301(2) of the Sarbanes-Oxley Act of 2002
for example in the area of IT risk, such as (Sarbanes-Oxley) requires audit committees
cybersecurity. of listed companies to appoint, compensate,
retain, and oversee the external auditor,
Oversight of financial reporting and internal including resolution of disagreements
control over financial reporting with management on financial reporting
Before the company’s annual and quarterly matters. When engaging a new audit firm,
financial statements are filed or distributed, management will typically participate in
and before the company communicates vetting firms and making recommendations,
its annual and quarterly results through but the final decision must be up to the
press releases and analyst calls, the audit audit committee. The audit committee
committee discusses these materials with reviews the external audit plan annually,
the chief financial officer (CFO), the internal and as matters arise, to ensure that the
auditor, and the external auditor. Given the audit plan appropriately takes into account
importance of this oversight responsibility, new concerns, emerging risks, or changes to
sufficient time must be allocated on the the company’s business operations. Under
agenda. The committee members can, Sarbanes-Oxley, the audit committee has the
and should, ask probing questions and responsibility and authority to compensate
continue to ask questions and request the external auditor and so must ensure
information until they are satisfied that that any negotiated fee will provide for an
the communications and disclosures are appropriate audit while making efficient
appropriate. For example, the committee use of the company’s resources. Also, any
members should be informed about how nonaudit services to be provided to the
the company applied accounting policies company by the external audit firm must
and judgments, including any changes be approved by the committee in advance,
in application of policies, assumptions in since with certain de minimis exceptions
critical areas that could impact estimates the external auditor will not continue to
such as reserves or valuations, any changes be considered independent if it performs
or adjustments since the prior disclosure of a nonaudit services for the company without
matter, any issues with respect to which there such prior approval. Finally, the audit
was a disagreement or even a significant committee evaluates the performance of the
discussion between management and the external auditors.
auditors, any unusual transactions, and any
other information or issue that significantly Relationship with the company’s internal audit
impacts the financial statements. group
Separately from the substance of the According to the Institute of Internal
financial statements, and equally important, Auditors, the value proposition provided by
the audit committee also monitors the the internal audit function is “assurance,”
company’s internal control over financial “insight,” and “objectivity.” (Source:
reporting (commonly abbreviated as https://na.theiia.org/about-us/about-ia/

Pages/Value-Proposition.aspx.) The audit and appropriately. Strong audit committee

committee should leverage internal audit oversight of the process and the resolution
as a barometer, helping the committee of complaints can help instill the right level
understand the critical risks to the business of attention.
and plans in place to address those risks— Audit committees can also provide an
including key operational and technology important safeguard by actively modeling
risks and related controls, as well as risks in integrity and closely monitoring the tone
the critical areas of compliance and financial in the organization, at the C-suite level
reporting. Leading practices with respect and below. The committee may also have
to audit committee oversight of internal responsibility for overseeing the code of
audit include review of the department’s ethical business conduct and the company’s
structure and succession plans; approval of programs and controls designed to prevent,
the annual internal audit plan—including deter, and detect fraud, corruption, and
confirmation that internal audit has been other illegal conduct.
granted resources and access to people and
information as needed to appropriately Taking control of the committee meeting
implement the audit plan; review of the agendas
selection, retention, performance, and Given the broad responsibilities and heavy
compensation of the head of the internal workload of the audit committee, it can be
audit function (chief audit executive, or challenging to find the time to get it all done
CAE); and open lines of communication in a quality manner. Some of the practices
among the CAE, the external auditors, and used by leading companies are:
the audit committee chair.
• Develop a rolling agenda that calendars
Oversight of ethics and compliance—related all of the committee’s responsibilities for
matters the year. This way the committee can
In accordance with Section 301 of Sarbanes- look at its overall workload and rebalance
Oxley, audit committees are required to agenda items as needed.
establish procedures for the receipt, • Craft individual meeting agendas so that
retention, and treatment of complaints the important issues are addressed first,
received by a company regarding accounting, and allow flexibility in the time allotted
internal controls or auditing matters, and to each item, to ensure there is sufficient
confidential, anonymous submission by time for robust discussion.
company employees of concerns about • Be selective in the quality and quantity of
questionable accounting or auditing matters. information provided to the committee.
Section 922 of the Dodd-Frank Wall Street Audit committee members should insist
Reform and Consumer Protection Act of on receiving the information that they
2010 (Dodd-Frank) and its implementing find most helpful as they perform their
regulations provide for financial rewards roles, and on receiving it sufficiently in
to individuals who provide information to advance of the meeting. The amount of
the SEC with respect to securities violations information should be appropriate—one
and protect them against retaliation. While of the unfortunate side effects of the
there is no specific procedure mandated move by many companies from printed
for a company’s handling of complaints, materials to electronic board portals is
it is in a company’s interest to encourage that there is no longer a natural temper,
employees to raise issues or questions early such as binder size or postage cost, on
and ensure that they feel comfortable and the volume. Care should be taken to
protected in doing so, to elevate issues and ensure that the materials provided to
concerns to the appropriate level within the the committee are high in quality and
organization, and to address them quickly manageable in quantity.

Audit committee priorities KPMG’s Audit Committee Institute
• Use the meeting time for discussion and as whether the committee is devoting
questions. Materials should be provided sufficient time to the most important issues,
to committee members at least a few days whether it requests and receives the right
before the meeting, and they should read type and depth of information, whether the
and think about them in advance, so that committee members are prepared, engaged,
the meeting can be geared more toward and add value to the discussions, whether
focused discussion than on listening to they exhibit the right level of independence
management read PowerPoint slides. from and healthy skepticism of management,
• Make the most of the executive and whether the chair provides effective
sessions. Audit committees of NYSE- leadership. To truly add value, the committee
listed companies are required to meet evaluation should be more than just a “check-
separately with the external and internal the-box” exercise and should serve instead
auditors. These sessions can be used to as the touchstone for a robust discussion that
gain valuable insight into the company’s enables continuous improvement. Given
financial reporting and internal controls the ever-present potential for litigation, the
as well as the culture and tone of the company’s legal counsel should be consulted
organization. before any documents, including notes, are
created.
Evaluating committee performance
Annual evaluation of the committee’s Conclusion
performance is required for NYSE-listed Clearly, the audit committee plays a critical
companies. The listing standard does role in protecting the long-term interests
not specify any particular process, and of the company and its investors. To do so
the process may vary from company to effectively, the committee must use its time
company. In determining what is right wisely and focus on the right priorities. A
for any particular company, consider the company that has a top-tier audit committee
following variables: will be able to answer “yes” to all of the
Should the evaluation be performed following questions: (1) Is the committee
solely by the committee members or with operating in accordance with all applicable
the help of a third party? Particularly if there requirements (law, regulation, listing
are issues, a third party may hear about and standards, committee charter)? (2) Does the
be able to communicate concerns that would scope of the committee’s work strike the right
otherwise remain unspoken. balance between its required responsibilities
Who should provide input? At minimum, and broader risk issues in light of the critical
each committee member should be heard. In need to provide strong oversight of matters
addition, input from the chair/lead director bearing on financial reporting, the totality
and the board members who do not sit on of other issues and challenges facing the
the committee can be a good way to calibrate company, the workload of the full board
the helpfulness of the committee’s work to and its other committees, investor and
the board at large. Some companies engage regulatory expectations regarding the level
in 360-degree assessments, including input of oversight, and the company’s maturity
from management and the external auditors. cycle? (3) Does the committee collectively
The number of participants involved in have the appropriate set of skills, experience,
this type of assessment varies by company, and judgment to identify risks, challenge
and companies that engage in a 360-degree assumptions, and provide valuable
assessment typically do not do so every year. perspective with respect to the matters on
On what should the evaluation focus? In its agenda? (4) Are new members effectively
addition to confirming that the committee “onboarded”? (5) Are the committee
has satisfied the requirements of its charter, members actively engaged, asking probing
evaluations should include questions such questions, contributing valuable insight, and

devoting sufficient time inside and outside respect to integrity, transparency, and open
the boardroom to truly understand the dialogue? (8) Does the committee hold itself,
“rhythm” of the organization? (6) Are the management, and the external auditor to
agendas constructed to ensure that there is high standards and insist on continuous
sufficient time for meaningful discussion of improvement?
important issues? (7) Does the committee
set and enforce clear expectations with

24 Best practices in code of
conduct development
Erica Salmon Byrne, Executive Vice President, Compliance & Governance Solutions, and
Beth Van Derslice, Compliance Counsel NYSE Governance Services
A company Code of Conduct is often the foundation of upon which

an effective compliance program is built.
Resource Guide to the U.S. Foreign Corrupt Practices Guide, Chapter 5
A
n effective ethics and compliance program must establish
standards of ethical conduct, as well as procedures to
prevent and detect criminal conduct. Those standards
should be clearly drafted and appropriate both for the size of the
organization and the industry in which the organization operates.
Indeed, a properly assembled and distributed code of conduct
is the single most effective and impactful part of any compliance
and ethics program. Such a code is a written record of not only an
organization’s expectations but also its ethical culture. This fulfills
the first hallmark set forth by the Federal Sentencing Guidelines
(FSG), which recommends “the promotion of an organizational
culture that encourages ethical conduct and a commitment to
compliance with the law [through the establishment of] standards
and procedures to prevent and detect criminal conduct.”
A code of conduct is called the cornerstone of an effective
compliance program because it “knowledge-sets” the “floor” across
the organization. The document’s goal is to provide the tools to allow
every employee, regardless of job description, to spot the key red
flags for the company’s most important risk areas. It is not intended
to include all of the information they may need to understand each
substantive risk area in full, as much of that information only applies
to those whose job responsibilities require them to act in that area.
However, the code addresses the key topics and makes clear the
behavioral expectations and company values—with the best codes
focusing on affirmative conduct rather than prohibitions. The more
detailed information is delivered through policies, which should be
cross-referenced in the applicable section of the code.
However, organizations often view the code of conduct as a
necessary evil, mandated by various regulatory and governmental
agencies, rather than an opportunity to educate employees about

NYSE Governance Services Best practices in code of conduct development
the behavioral expectation to which they and engaging manner, allocate proper
are held.1 Codes that focus on rules rather resources to layout and graphic design.
than values tend to be overly formal and When engaging in the code-creation or
difficult to read, having clearly been written code-revision process, be sure to account for
by a team of lawyers. Organizations that the many ways in which the code will be used.
take this approach miss a prime opportunity For example, factors such as proliferation,
to pronounce their values, standards, and certification, and training should all be
expectations to both internal and external considered. Properly distributing the
constituents. Studies show that companies code, tracking its acknowledgment, and
exhibiting a pronounced emphasis on conducting training on its subject matter
ethics and trust have higher employee sends strong signals to regulatory and legal
retention rates and attract more prospective entities that your organization is making a
employees. Therefore, taking time to relate good faith effort to implement an effective
your company’s values, reputation, and compliance program.
success with compliance in a meaningful The code-creation or code-revision
way not only helps your organization fulfill process is a daunting task and can quickly
the FSG, but is also a shrewd business become overwhelming without proper
decision. planning and knowledge of the issues at
The code serves as the primary means hand. NYSE Governance Services, with its
for your organization to communicate its team of attorneys, analysts, subject matter
commitment to ethical and legal conduct experts, writers, and editors, has provided
to both internal and external stakeholders. this article as a useful reference guide for
While a single document cannot anticipate those embarking on or considering the code
every possible situation that an employee of conduct revision or development process.
might face, your code should provide proper
and effective guideposts for behavior. To Developing the code
achieve this, tie the code’s guidelines to your Once the team responsible for code revision or
company’s values and ethical commitments. creation has completed the planning process
Do so in a manner that facilitates employees’ and established a basic time line, there is one
grasp of the critical nature of compliance more step to complete before drafting may
and ethical decision-making, consistent with commence: the collection and synthesis of
the code. In addition, the code should enable pertinent supporting and related materials.
employees to quickly recognize when to Supporting materials include the employee
seek guidance, encourage them to report handbook, internal policies or processes, and
concerns, and provide various avenues to a lesser extent the corporate responsibility
through which they can do both. report or philanthropy report. Related
When revising or creating the code, materials are more general and tend to come
consider the audience to which the code is in the form of marketing materials, sections
directed. Ensure that the language is at such of the company website that cover company
a level that your largest employee base will history or values and generally speak to
fully comprehend the content. Take into the internal culture at the organization. It is
account the locations where your employees also important to look to samples of internal
conduct business and ensure that all code communication coming from the C-suite or
content is applicable to all of the audiences the management level. These documents
receiving it. Scrub this content to ensure are crucial in helping to ensure a consistent
that it will resonate with employees in voice not only in the code itself but also as
foreign jurisdictions, and be sure to provide compared to other materials produced by the
translated versions of the code in these organization. More on how to utilize these
locations, as appropriate. Furthermore, in materials effectively is covered in the “Risk
order to reach your employees in an effective topic coverage” section later in this chapter.

Best practices in code of conduct development NYSE Governance Services
Once these materials have been gathered risk geographic locations, or US government
and factored into the overall organization contracts may need to maintain slightly
(or outline) of the code document, the team longer codes. However, creative use of space
is ready to start drafting. Following, you will on the page, effective bullet points, and call-
find points of consideration when drafting out boxes can keep information concise, yet
your code of conduct. thorough, meaning that even longer or more
detailed codes can be quite readable.
Tone from the top While organizations are becoming
One of the most effective tools a company can increasingly adept at crafting effective
utilize to communicate confidence in a code, executive introductions, far fewer are able to
and the ethics and compliance program as a maintain a consistently warm tone beyond
whole, is a clear and pronounced endorsement the preamble. Too often, the remainder of
of the document by the executive leadership the code is handed off to internal counsel
team. A common format for demonstrating for drafting, leaving this majority of the
a convincing tone from the top is an document a legalistic, incomprehensible
introductory message from a member of this encyclopedia of “thou shalt not” rhetoric.
team. This most commonly takes the form Simply put, a code’s success is defined
of an introductory letter from the company’s by its ability to energize employees and
CEO, president, and/or chairperson, though motivate them to ethical behavior—in order
it could also come from the chief compliance to achieve such success, the language and
officer or could even be signed by the entire tone used must be well received by the
executive team. It is critical that this letter employee base.
employ a tone and vocabulary that employees To achieve an engaging and inviting
will recognize as coming from the executive tone, it is important that you pay ample
author to whom the letter is attributed. attention to voice during the drafting phase.
Since the code is often one of the first Generally speaking, avoid the third person
documents new hires read when they join a (eg “All employees must”), as this can create
company, this introduction by a high-level a tone that appears condescending at worst,
executive should also serve as a welcoming or distant and impersonal at best. Instead,
smile and handshake. We encourage use a warm, first-person voice (we, us).
including a photograph and signature of the An inclusive voice allows employees to
executive(s) in question to provide a visual feel a sense of ownership of the code and
connection between the executive team and implicitly reminds readers that the code
the code. applies to everyone at the organization.
Focus on expected behaviors rather than
Readability and tone prohibitions. To avoid alienating employees
As with any professional document, codes with what sounds like a list of state lottery
must strike the right balance between detail rules, begin each risk area with a positive
and brevity. Codes that are too brief often do explanation of the guidelines they must
not adequately cover the necessary risk areas, follow rather than a list of prohibitions. If
prompting many questions and providing the topic in question is based on clear, right-
too few answers. Conversely, verbose codes versus-wrong reasoning, focus your efforts
run the risk of losing readers’ interest and on explaining the preferred behaviors rather
may begin to resemble a policy manual or than those that are forbidden. For example,
employee handbook. As a rule of thumb, when discussing guidelines for giving and
effective codes fall somewhere between receiving gifts, set forth the criteria that a gift
8,000 and 10,000 words in length. However, must meet in order to comply with company
companies with complex international policy. For those risk topics that require a
operations, a bevy of unrelated business units, degree of interpretation, provide examples
operations in highly regulated fields or high- of positive or recommended behavior along

with the internal or external resources it looks like and how employees react to it,
available for seeking guidance. is a complex and serious issue, and fear of
Tailor the complexity of the material to your retaliation is a leading cause of employees
target audience. While codes are frequently failing to report misconduct. All employees
written by lawyers, they do not have to sound are expected to abide by and endorse a firm
as though they were. Remember, the purpose culture of nonretaliation. Managers have the
of a code is to present behavioral guidelines additional responsibility to encourage their
and explain ethical decision-making to your direct reports to communicate unethical
average employee, not necessarily to the most conduct and ensure that any “good faith”
educated individual in your organization. report is not met with acts of retaliation.
When drafting your code, target the level Emphasize that by reporting concerns,
of complexity to your broadest employee employees are doing the right thing and helping
base. Modern word-processing software the company halt and/or prevent misconduct.
contains the necessary tools to determine the It is important to create a link between
approximate grade level of the document as ethical conduct and reporting, rather than to
you draft it. Be sure to employ the services of simply emphasize that reporting violations
a professional editor to vet the complexity of is expected or that failing to do so violates
your code’s language. company policy. While the latter can have its
intended effect, emphasizing the importance
Nonretaliation and reporting of speaking up to the organization’s culture
Clearly communicate resources for asking is more likely to inspire employees to
questions or making reports. It is pivotal that overall ethical behavior and is therefore
whatever resources your company provides more effective. Elucidate the ways in which
to employees to ask questions or report reporting concerns allows your company
misconduct are clear and outlined within to halt or prevent misconduct and thus
the code. Commonly, code documents will contributes to the ethical culture at your
include a dedicated reporting section that sets company.
forth the avenues by which employees should Given the whistle-blower provisions of
seek guidance and report ethical or legal the Dodd-Frank Wall Street Reform and
misconduct. Such a section should be placed Consumer Protection Act (12 USC § 5301
near the beginning of the code to educate [2010]) that provide lucrative incentives
employees about the necessity of reporting for those who report wrongdoing
known or suspected misconduct, as well as to the government in furtherance of its
the process by which they are expected to do investigations, it is more important than ever
so. This section does not necessarily need to to encourage employees to report internally
be an exhaustive list of reporting channels rather than report to a government agency
and contact information but should include first—or worse, not speak up at all.
the most important contacts and state where Ensure compliance with international reporting
a comprehensive list is available. laws. While US law allows companies to
Make a firm statement of the nonretaliation mandate that employees report ethics and
policy. It is important that a code not only legal violations, this is not true in all countries.
shows employees how to report misconduct Many nations permit language indicating that
but also takes steps to ensure that they employees “should” report, but failure to
fully understand and act in accordance with report is not necessarily considered sufficiently
the clearly stated culture of nonretaliation egregious to justify termination, depending on
within the organization. More and more, the seriousness of the unreported incident. In
best practices codes are explaining the certain jurisdictions, such as France, you may
various ways retaliation can occur, so that only go so far as to encourage employees to
employees are clear about what behavior is report. The French Data Protection Authority’s
unacceptable. Retaliation, including what (CNIL) 2005 guidelines state that “reporting

should always be discretionary and by no your organization faces, looking to those risks
means mandatory.” (Source: “Anonymous that are both systemic to your organization
Reporting Procedures and Codes of and unique to your industry. Benchmarking
Ethical Conduct in the European Union,” at against your peers and leveraging recently
http://www.gibsondunn.com/Publications/ completed internal audits and/or compliance
Pages/AnonymousReportingProceduresand risk-assessment results will provide focus as
CodesofEthicalConductintheEuropean to which topic areas to cover. Culture and
Union.aspx.) Thus, it is important to ensure knowledge surveys are also excellent ways
that global code language is consistent with to gauge the temperature of compliance and
such guidelines; you should also stress face- general understanding of compliance across
to-face interaction. the organization. If no such risk assessment,
It is also important to note that some audit information, or survey process or
jurisdictions require not only that the tools exist, give serious consideration to the
company protect “good faith” reports, but deployment of resources to further identify,
also that it expressly inform employees that prioritize, and mitigate your company’s
making reports not in good faith is a behavior ethics and compliance risks. Referencing
that is not protected from retaliation and will the codes of peer companies will provide
result in disciplinary action. additional insight into applicable risk areas.
Finally, if you have European Union Reference corresponding company policies.
subsidiaries, it is generally recommended Faced with the difficulty of communicating
that you check for possible conflicts with a wide range of topics to a broad audience,
local labor legislation. For example, in operationally diverse and globally-reaching
Germany if the subsidiary has established organizations often struggle to maintain
a works council, you need to obtain prior codes of reasonable depth. Failing to
approval from this body before adopting appropriately limit guidance can result
the code. In France, you will likely need to in a lengthy document, posing legitimate
request the nonbinding opinion of the works readability concerns. To provide employees
council before proliferating any reporting adequate detail on topics while maintaining
requirements to local employees by means reasonable document length, codes should
of the code or other document. While aim to illustrate expected behaviors for
challenging, satisfying the requirements of important risk areas rather than to duplicate
these and other laws is feasible without the company’s collection of stand-alone
necessitating country-specific codes of policies. Providing the name and/or location
conduct. of the corresponding policy (or policies)
provides quick access for those who require
Risk topic coverage additional information.
Give thought to risk topics in accordance
with your organization’s size, structure, and Learning aids
industry. While regulatory mandates require Supplement the code content with learning aids.
organizations to implement a code of Keep in mind that, while codes aim to break
conduct, very little guidance is provided down policy material into a more digestible
regarding what that code should contain. and direct format, some readers are less
Instead, SOX, the FSG, and various stock comfortable than others with the written
market regulations focus on what should be word. While the code’s text should explain
the intended purpose of the code—generally, difficult-to-understand concepts and terms,
to deter wrongdoing and promote honest, you can further ensure comprehension of
ethical conduct and compliance with laws. these by including learning aids, which
Determining the substance of the code supplement the main code text by bringing
is the most important step in the code abstract concepts into the realm of practical
development process. Consider the risks advice. Learning aids can take many forms,

including question-and-answer segments document that will engage your reader,

and real-life scenarios and vignettes that so long as your design team pays proper
demonstrate the implications for certain attention to format and use of white space.
courses of action.
Ensure that the learning aids are relevant. Communicating the code
It is important that you ensure that the
learning aids depict realistic scenarios for Translations
your organization and the business you According to section 8B2.1 of the FSG,
conduct. This requires that you utilize companies must show they have made a
relevant job titles, geographic locations, good faith effort to educate their employees
work environments, and scenarios. The best on the standards and laws to which they will
scenarios tend to be drawn from actual be held. Therefore, companies with a global
situations that have occurred in the past, reach will often provide publicly available
common questions and complaints, and copies of their code in various local languages.
hotline reports. If the learning aids are Generally, if your company maintains more
written in the form of vignettes, be sure than 50 employees in a given jurisdiction,
to use names that represent all geographic you will want to translate the code into
locations in which you operate. the local language of that jurisdiction. This
remains true even when you are fairly certain
Presentation, style, and organization your employees speak English as a second
Ensure the code is visually appealing and language, as their reading comprehension
consistent with design cues found in other is likely to be higher in their first language.
company documents. While we are taught not Additionally, if you are operating in a high-
to judge a book by its cover, the converse risk area from a compliance perspective (such
is often true when it comes to codes of as doing business with the government in the
conduct. When a code looks like just another People’s Republic of China), you should
policy, it will likely be disregarded as such. consider translating the material regardless
Oftentimes, organizations choose to enlist of the number employees you maintain
their marketing and communications teams in this location. When determining such
to create a look and feel for the code of high-risk areas, utilize the results of your
conduct. Having a colorful and vibrant code most recent compliance risk-assessment
can vastly increase the likelihood that the or external tools such as Transparency
code will be read from cover to cover. International’s Corruption Perception Index
When designing the look and feel of (source: Transparency International’s 2013
your organization’s code, adopt a visual Corruption Perception Index, http://www.
style that fits with existing internal and transparency.org/cpi2013/), which ranks the
external company communications. For risk of corruption by country.
example, employ the same design resources
responsible for your company’s annual Maintaining the code
report. Keeping a design aesthetic consistent
with existing company branding will convey Update the code on a regular basis
that this code is unique to your organization. Remember, your organization will need to
A code that is branded in this manner can re-examine and revise the code to keep it
serve not only as an internal marketing tool fresh as a teaching document. In the event of
for ethics and compliance but also as an significant corporate compositional changes
external marketing tool. (such as mergers, acquisitions, or overseas
While lavish page layouts are certainly expansion) or regulatory changes affecting
engaging to readers, keep in mind that your operations, you will most likely need
they are not necessarily imperative. It is to update the guidelines set forth in the code
quite possible to create a relatively low-tech at the time these changes occur. Otherwise,

consider updating the content of the code HARM FROM CRIMINAL CONDUCT, AND
every two years. Keep in mind that a regular EFFECTIVE COMPLIANCE AND ETHICS
schedule of review and revision of the code PROGRAM, §8B2.1. Effective Compliance and
is consistent with the FSG, which require Ethics Program; Sarbanes-Oxley Act of 2002,
organizations to evaluate periodically the Section 406, 15 USC Section 7264, Code of ethics
for senior financial officers; Dodd-Frank Wall
effectiveness of their programs.
Street Reform and Consumer Protection Act,
Refreshing the code does not necessarily Section 922; Federal Acquisition Regulation
require changing the precepts of the code (FAR), Section 52.203-13, Contractor Code
and can be as simple as updating the of Business Ethics and Conduct; UK Bribery
presentation to ensure that readers remain Act 2010, Section 7, Failure of Commercial
engaged. Better yet, add new examples, Organisations to Prevent Bribery; Brazil’s “Clean
comprehension aids, and other attention- Company Law,” Law n.12.846/2013; Securities
getters, or add interactive elements. A static and Exchange Commission; 17 CFR 229.406, PART
code will quickly lead to perfunctory review 229_STANDARD INSTRUCTIONS FOR FILING
on the part of employees, and such review FORMS UNDER SECURITIES ACT OF 1933,
SECURITIES EXCHANGE ACT OF 1934 AND
undercuts the purposes of the code and the
ENERGY POLICY AND CONSERVATION ACT
annual certification process. OF 1975_REGULATION S-K, Sec. 229.406 (Item
406) Code of ethics; New York Stock Exchange,
Notes Listed Company Manual Section 303A.10, 303A.00
1 A few key laws and regulations that highlight Corporate Governance Standards, 303A.10 Code
the need for a Code, include: Federal Sentencing of Business Conduct and Ethics; NASDAQ Market
Guidelines, Chapter 8 - PART B - REMEDYING Rule 4350(n) Code of Conduct.

25 How to survive and thrive in a crisis
Thomas A. Campbell, Partner; Fusae Nara, Partner; Stella D. Pulman, Senior Associate;
and Nicholas M. Krohn, Associate Pillsbury Winthrop Shaw Pittman LLP
O
n April 24, 2013, Rana Plaza, an eight-story garment factory
in Dhaka, Bangladesh, collapsed. Thousands were killed
or injured. By any definition, it was a tragedy of the
highest order. Less than 24 hours after the collapse, fashion
giant Benetton—headquartered 4,500 miles away in Treviso,
Italy—denied that any of its clothes were supplied by Rana
Plaza. But, as the incident and Benetton’s ties to the factory were
investigated, it quickly and publicly became clear that Benetton
had been supplied by Rana Plaza. Benetton had to retract its
earlier statement and admit to manufacturing clothes at the
factory. At this point, the Rana Plaza tragedy became a crisis for
Benetton. The reputation and trademark that Benetton had so
carefully nurtured were placed in jeopardy.
The Rana Plaza incident and the trap that Benetton fell into are
not unique—they are the “new normal.” We live in a world that is
flattening and shrinking. Companies have become interconnected in
complex ways that they may not be able to fully understand. When
disaster strikes, these complex connections become transparent to
all as information travels around the globe with blinding speed. The
Internet, 24-hour news cycle, and social media give instant exposure
before there is time to consider a matter and respond.
Many companies have exploited these new market conditions
and, as a result, have been richly rewarded. But, at the same time,
they must prepare for the inevitable volatility that also comes from
this flat, complex, interconnected, and transparent world.
This “new normal” precipitates a crisis where, in the past,
Benetton’s connection to this tragedy might have passed without
note. Twenty years ago, Benetton’s operations would have been
simpler, and it would have better understood its own supply chain.
Benetton’s connection to Rana Plaza would probably not have been
discovered. If discovered, Benetton would have had days to prepare
its response. Instead, it felt compelled to make a statement less than
24 hours after the incident that proved to be false. There was no
deceit here, the company simply did not know the truth. The new
normal cannot be controlled. Companies can only control how to

How to survive and thrive in a crisis Pillsbury Winthrop Shaw Pittman LLP
respond to crises. To quote Andrew Zolli: extraordinary decision to do just that. What
“if we cannot control the volatile tides of had been a crisis for all parties involved
change, we can learn to build better boats.” became much more serious for nonoperators
Indeed, companies need sophisticated crisis who had not anticipated such exposure.
management plans to weather the type of Such an unexpected consequence requires
storm that hit Benetton. improvisation, not strict implementation
of a set plan. The nonoperators needed
What is a crisis? professionals who could recognize that the
A crisis is an event that has the potential rules could change. In a crisis, companies
to result in a catastrophic financial and/or also need assistance from crisis management
reputational loss that requires a sophisticated, professionals who can understand how the
multidisciplinary response within a collapsed rules can and will change in the circumstances
time frame. Let’s unpack that statement. that are unique to their industry. A company
needs to be ready for a sophisticated
• An event that has the potential to result response commensurate with the uncertainty,
in a catastrophic financial or reputational magnitude, and complexity of a crisis. Many
loss law firms advertise “crisis management,” but
they are simply repackaging their traditional
Not every disaster is a crisis. A crisis is major litigation practice. Do not be fooled,
typically unpredictable and extraordinary effective crisis management requires a
and can occur to the best-managed multidisciplinary team that includes but is
companies in the world. A true crisis not dominated by litigators. You do not
jeopardizes the future of a company. These want to win your litigation and lose your
crisis events are often rare occurrences that company. The team that supports you should
are hard, if not impossible, to predict. They include lobbyists who are familiar with both
are not usually found on the list of major the legislative and executive branches of
incidents, for which most companies have government. It should also include lawyer
defined emergency response plans. They are and nonlawyer subject matter specialists.
unexpected “Black Swan” events such as the Furthermore, the person coordinating the
Exxon Valdez oil spill or the racist remarks response needs to understand what can and
of a National Basketball Association team cannot be done effectively by outside crisis
owner. While the spill or remark may cause a communicators. All of these elements must
crisis, and a preplanned response may begin be carefully orchestrated and protected to the
to limit a company’s exposure; in a crisis, greatest extent possible within the attorney-
liability management is needed to stem the client and work product privileges.
tide of cascading events triggered by it.
• Within a collapsed time frame
• Requires a sophisticated, multidisciplinary
response A crisis demands immediate action.
However, trajectory is more important than
During a crisis, the rules of the game can velocity. In other words, the direction you are
change. Things behave differently. To give heading is more important than your speed.
an example: Before the Deepwater Horizon In a crisis it is easy to find yourself moving
oil spill in the Gulf of Mexico, the US had rapidly in the wrong direction because the
almost never prosecuted a nonoperating actions taken at the outset of a crisis can have
investor in an oil well under the Clean a disproportionate effect on the ultimate
Water Act. (The US had only prosecuted one outcome. Fact gathering and analysis are
nonoperator before and under very different critical to setting your company’s trajectory
circumstances.) Faced with the largest oil out of a crisis. Then, once your trajectory
spill in US history, the government made the is set, concerted effort over time will produce

Pillsbury Winthrop Shaw Pittman LLP How to survive and thrive in a crisis
extraordinary results. But all this requires Emergency response best practices
that the facts are gathered and analyzed by In the immediate aftermath of a crisis, certain
competent experts and then internalized predictable response issues will arise that
into corporate goals that are achievable. a company should be prepared to manage.
This takes time, and unless you are working
with experts who are familiar with crisis • Evidence preservation. Rule number one,
management, that time is often wasted by two, and three: Never destroy evidence.
distractions caused by mistakes made early Ever. A company’s document retention
in a response. policy should be clearly and verifiably
There are two main components to crisis communicated to all employees as a
management: (1) emergency response and (2) matter of routine training and reiterated
liability management. Emergency response in the early stages of an emergency.
typically involves operational personnel who A legal hold memorandum for record
implement a company’s incident response retention should be circulated at the
plan in the field. At the outset of a major earliest possible time, and procedures for
incident, this is the most important task. collecting physical evidence should be in
But as first responders get an emergency place, as well as procedures for gathering
under control—for example, containment electronic data and securing critical hard-
of an oil spill—a separate group of liability copy documents.
managers needs to focus on liability • Interaction with investigating agencies.
management. Liability management is less Should a government agency with
formalistic and is implemented at the senior investigatory powers respond to the
executive level. It involves the fact gathering incident, a company must take great care
and analysis, strategic planning, goal setting, in how it communicates with the agency
narrative framing, and communication that, and how it assists with the investigation.
if properly executed, will significantly reduce Control and access to the incident site
a company’s total exposure (Figure 1). will be a critical issue. Throughout the
investigation, a company should exercise
The crisis hypothesis firm but reasonable controls. It should not
In our experience, most crises follow be afraid to say “no” to investigators, but
recognizable patterns. While it is almost it should do so for good reason and it must
impossible to predict most crises, best recognize the potential consequences.
practices can be identified that will help Consent to an agency’s demands—or
management prepare, organize, and lead lack thereof—should be memorialized.
during a crisis. If an agency requests a site preservation
agreement, it should exclude unrelated
property. Also, it should be clear that the
Figure 1 The crisis management agreement does not represent consent to
progression an agency’s jurisdiction.
• Document collection and preservation. A
Liability company should anticipate document
Management
requests from an investigating agency, as
well as discovery in subsequent litigation.
CRISIS MANAGEMENT Here are a few ground rules:
 All document requests should be clear
Emergency and in writing.
Response  The company should be aware of its
rights to object to certain document
! requests and withhold certain types of
Crisis Event Resolution information.

 Clear internal procedures for document managing our clients’ crisis liabilities, we
collection, review, and production have created the following template for
should be developed. how to intake, process, and act on rapidly
• Employee interviews. Before an employee evolving, difficult circumstances. We refer
is interviewed by an investigating agency, to it as the Pillsbury Crisis Management
the employee should be informed of Process, as shown in Figure 2.
his or her rights during the interview Once a company is notified of the
(eg to take notes, to have someone else crisis, emergency response is initiated and
present), and the employer’s expectation the company’s incident response plan is
that the employee tell the truth and not implemented. At the same time, management
guess or speculate. It is imperative that must prepare for an initial response and
no one intimidate employees or improperly assess the situation. An important initial step
influence their testimony. The company is to prepare a holding statement. This is also
should also be sure employees know the the first misstep that many companies make.
company’s counsel does not represent To avoid errant or unworkable statements,
them individually. the holding statement must not speculate or
make assertions of fact that could be untrue.
Liability management best practices Nor should it admit liability. But it should
While you may not be able to plan for express an appropriate level of empathy for
“Black Swan” events, you can implement those injured. Here is an example:
systems and procedures for dealing with
Our thoughts and prayers go out to those
them when they arise. Through years of
affected by this tragic accident. As the
cause is under investigation, drawing
any conclusions at this stage would be
Figure 2 The Pillsbury crisis premature. We are fully cooperating
management process with governmental authorities and will
provide updates on the investigation as
soon as possible.
Develop Strategies and Tactics
While the statement is being framed, the
Narrative
Framing company should assemble the full crisis
Liability management team it will need to manage
Management Communicate its exposure. There should be a core team
Goal Feedback Loop Narrative
Setting
consisting of senior management, the general
counsel, in-house communications, and an
internal and/or external crisis manager.
Fact Gathering Implement This group should be small and take full
and Analysis Strategies and Tactics advantage of the attorney-client and work
product privileges. As areas of expertise
Initial Control are identified, a second, multidisciplinary
Meeting team should be created and expanded. This
Initial Response could include, for example, an external
and crisis communications firm, insurance
Assessment coverage experts, litigators, and lobbyists.
Members of the teams will need to work
Initiation Of
Notification
Emergency Response together, seamlessly. Trust is key. Build
trust relationships by conducting training
drills with members of the teams before a
Incident/Event crisis. These drills should be more about
building trust and learning the strengths and

Pillsbury Winthrop Shaw Pittman LLP How to survive and thrive in a crisis
weaknesses of a team, rather than the proper other time zones to pass projects back and
response to a particular set of facts. forth in order to work around the clock. Not
Once the team members are identified, only can this keep the company a step ahead
there should be an initial control meeting at but it will allow the teams to rest, and rested
which the scope, structure, and terms of an people make better and quicker decisions.
internal investigation are authorized. This Fact gathering begins what we call the
is the beginning of the “race to the truth.” Liability Management Feedback Loop.
Legal counsel should direct the investigation Figure 3 illustrates the iterative process that
so it is privileged and confidential. It is we have developed to manage this crisis.
imperative to establish and reinforce controls Once the facts are known, the company
during an investigation. There should be must engage in the critical task of goal
guidelines for document preparation and setting. As a result of a crisis, a company is
retention. There should also be limitations inevitably changed. It is critical to determine
on collecting documents outside the formal what the new company will look like and
investigation process. set ambitious but achievable master goals.
Regardless of the protections and Again, trajectory is more important than
privileges that are felt to be in place, the velocity. The goals should be “big picture”
investigation team should act as if everything and long-term, yet specific enough to guide
that is written is discoverable. Remember, in decisions. Such goals might be to preserve
a crisis the rules can change. Traditional brand integrity or to resume operations as
barriers can break down and the opposition quickly as possible. The absence of long-
could bring resources to bear that result term planning will result in being trapped in
in unprecedented discovery. Also, at some the “thick of thin things.”
point, documents or communications could Once the company’s master goals are set,
be inadvertently disclosed or a company they should be communicated to the entire
could waive privilege. team in most cases. This will allow the team
Fact gathering and analysis is time to weigh its decisions against achievement
intensive and may require significant of the master goals. In some instances,
manpower. In the race to stay ahead of however, certain goals, strategies, and tactics
government agencies, media, or other must be withheld.
outside parties, implementing a 24-hour With clear master goals, the company
work loop can allow critical tasks to get must distill the facts it has gathered
done faster. We have had success with the and develop pointed messages to various
systematic utilization of team members in stakeholders that complement and
further its goals. This is called narrative
framing. It starts with the development
Figure 3 The liability management of a master narrative that addresses all
feedback loop of the facts on hand. From the master
narrative, subnarratives are developed
for the various stakeholders. This is an
Develop Strategies and Tactics important exercise as not every stakeholder
Narrative needs or wants to hear the same thing. The
Framing subnarratives should be carefully tailored
Liability to each audience, but must be dynamic.
Management Communicate
Goal Narrative The master narrative and subnarratives
Feedback Loop
Setting should be reframed and rewritten as new
facts emerge or circumstances change. But,
to the extent possible, key messages should
Fact Gathering Implement
and Analysis Strategies and Tactics remain consistent and the narrative should
always further the master goals.

Once the company has identified its information is critical and the involvement
narrative, it can develop a strategic and of counsel can make the difference. Also, as
tactical plan to communicate the narrative liability management displaces emergency
and achieve its goals. The company could, response concerns, strategic legal issues
for example, identify governmental actors it will become more important. Specific
may want to contact. It could also develop demands and requirements, such as victims’
a communications strategy that identifies assistance and insurance reports, will all
media outlets with whom the company need to be closely coordinated with the
can work to convey key public messages. company’s legal strategy. This, again, puts
However, before external communications the general counsel at the center of the
are made, it is important that all potential company’s crisis management efforts. It is
spokespersons receive media training or most effective when this role is written into
refreshment training. a company’s response plan, which helps
Communication of the narrative should eliminate confusion when a crisis arises.
closely follow the strategies and tactics
the company develops. It should reach A note for publicly-traded companies
stakeholders quickly and efficiently in a Directors and officers of a company should
way that allows the company to convey always be as accurate as possible in any
its message and, in turn, to manage public filings with the Securities and Exchange
perception. Key groups include the media, Commission (SEC) and in communicating
industry, and the public. The company should with investors and the public. This is
not forget to communicate the narrative to critically important and especially difficult
employees and customers, too. In the face in the immediate aftermath of a crisis
of a crisis, morale may be low and customer incident, when the facts and the causes of
loyalty could be questioned. If the company an incident are unclear. False statements
is to maintain its core business, these critical or omission of material facts can create
relationships must be preserved. additional exposure. The company should
As the narrative is communicated and not say too much or the wrong thing at the
the company implements its strategies risk of misstating the facts. But, at the same
and tactics, the cycle of gathering facts, time, it cannot say too little and run the risk
setting goals, and narrative framing should of omitting critical facts. The company must
continue. Circumstances are sure to change, carefully evaluate its disclosures, especially
and the company’s management of the disclosures to the SEC and public statements
circumstances must change too. by upper management.
As a result of the “new normal” of
The role of the general counsel greater interconnectivity, complexity, and
The general counsel should be at the center transparency, companies will face volatility
of your crisis management effort. It is critical and crises on a more frequent basis. For that
that the attorney-client and work product reason, companies have to be prepared to
privileges are preserved, to the extent implement a sophisticated crisis management
possible. Constant, disciplined involvement plan that will not only protect their core
by counsel is needed to achieve this goal. business but will allow them to change
With these privileges intact, the company for the good in the aftermath of a crisis. If
can have candid internal discussions employed proactively, the strategies and
and will at least have some control over tactics described above will help companies
the timing of its disclosures. Control of survive and even thrive when facing a crisis.

26 Crisis communications in the age
of permanent engagement
Richard S. Levick, Chairman and CEO LEVICK
T
he diverse crises that continue to confront just about every
industry sector of the global economy did not begin with
the economic meltdown of 2008. Nor will they end with
legislative and enforcement solutions even if we were tempted to
believe that such solutions are obtainable in the practical world.
On the financial and investment side, the challenges are especially
formidable. In this sector, crisis is by definition an intrinsic part of
business under both ordinary and extraordinary circumstances, in
a way that is not absolutely the case elsewhere. Who knows, new
technologies might, for example, someday minimize the threat of
data security breaches.
But contention, accusation, and imperilment are inevitable
wherever and whenever money changes hands.
Crisis is permanent and ubiquitous

The elephant is in every room. In M&A, there are those who think too
much is being paid and others who think they’re being shortchanged.
During public offerings, reputation must be guarded and promoted
against any number of present or foreseeable contingencies. Executive
compensation remains a festering issue that can roil shareholder
relations. Good governance is a persistently elusive goal as earnings
statements are held to withering scrutiny and directors struggle to
define and meet their increasingly burdensome obligations.
The overarching impact of the financial crisis was to exacerbate
the situation to a historic extent. Thanks to the meltdown, and the
endless inquiries and punitive actions that resulted, public distrust
has become pandemic. The focus is no longer limited to specific
targets, an Enron or a WorldCom, but extends instead to practically
every financial institution and public company. In response to that
distrust, regulatory activity has accelerated to a feverish pace and
won’t likely abate in the near future irrespective of who holds
political power.
In this chapter, we’re going to talk about best practices for
businesses trying to survive and grow in this culture of permanent
crisis, in terms of both strategy and tactics. Significantly, many

Crisis communications in the age of permanent engagement LEVICK
governance experts and market analysts relevant here. As SEC chairman Mary Jo
resolutely advocate a one-size-fits-all White told the Commission’s 10th Annual
strategy with their every breath—a simple Transatlantic Corporate Governance
enough yet compelling strategy predicated Dialogue in December 2013, “It was not so
on transparency and accountability. long ago that the ‘activist’ moniker had a
Tactically, the agendas are naturally distinctly negative connotation. It was a term
variegated as different problems call for equated with the generally frowned upon
different solutions—especially in a digital practice of taking an ownership position to
marketplace where exigent communications influence a company for short-term gain. But
proliferate in the blogosphere and the social that view of shareholder activists, which has
media, in ways that often seem beyond the its roots in the raiders of the 1980s takeover
control of affected parties. battles, is not necessarily the current view
It is our intent that this discussion will and it is certainly not the only view.”
prove broadly relevant to public companies What is the message here for management?
facing any type of crisis. That said, we have In any crisis situation, an entity under attack
chosen to focus on one specific area—the must have a narrative, a controlling story to
challenge brought by activist investors—for tell that will provide a persuasive context
three reasons. in which the confidence and loyalty of key
First, it is the most convenient spectrum stakeholders can be reaffirmed. Traditionally,
through which to view all the issues that that narrative has involved good guys and
spell crisis in the financial sector. An activist bad guys: for example, “management is
uprising may involve governance as well under siege because XYZ seeks a short-term
as performance; say-on-pay challenges to gain that is clearly not in the interest of
executive comp no less than loud opposition long-term investors. You shareholders are
to planned mergers and acquisitions. And, the prospective victims and, as officers and
the best practices appropriate during such directors, we are the vindicators who will fend
shareholder crises apply equally when any off this pre-emptive attack, stay the course,
challenges beset management, whether and recommit to providing long-term value.”
activists are in the picture or not. It is a long-patented narrative but,
Second, the activist phenomenon usefully significantly, observers as different as Charles
broadens the discussion inasmuch as it Elson and Nell Minow are not surprised
potentially affects all public companies— by White’s implicit challenge to it. “The
from PepsiCo to Sotheby’s—and not just the dominant view in the current environment
financial institutions whose practices and is that activism has its benefits,” says Elson,
decisions have been the particular target of Professor of Finance at the University
public disapprobation since the meltdown. of Delaware and Director of the John L.
Third, the activist challenge particularly Weinberg Center for Corporate Governance.
underscores the need to respond to changing “Activism has many friends.”
circumstances. If crisis communication is all “The SEC is traditionally a captive of
about the management of risk and perception, managers, so I guess it’s a good sign that
those risks and perceptions are subject to [White] would make such a statement,”
historic trends and remain in constant flux. says Minow, a founder of GMI Ratings,
Management must be nimble, be quick to who as early as 2003 was dubbed “the
respond, and modify their approach as the queen of good corporate governance” by
attitudes of one decade are transformed in BusinessWeek Online. In any event, the
toto in a matter of just a few years. potentially salutary impact of activism is
now widely recognized—which means
Crisis strategy: the old narrative doesn’t work that if management wants to successfully
While such megachange is generally relevant confront the activist challenge, it will need a
to any crisis situation, it is transparently new narrative, a new strategy.

LEVICK Crisis communications in the age of permanent engagement
This need for a new strategy goes beyond bid, and his Trian Fund Management LP
the simple question of who wears the white continued to meet with major investors,
hat and who wears the black. Events ongoing marshalling purported evidence of bloated
in 2014 confirm that it’s no longer enough revenue and volume share loss suffered on
to simply persuade stakeholders that the Nooyi’s watch. But “that’s the beauty of the
company is performing well and producing free market system,” says Minow. “Like any
value, or that its governance practices are investor, Peltz thinks he knows something
sound. that no one else knows. It’s up to both sides
Among recent cases in point, activist to make their case to the shareholders.”
Nelson Peltz, having forced the spin-off of From management’s standpoint, it’s a
Kraft’s North American business to form glass-half-empty or glass-half-full scenario.
Mondelez, then pressured PepsiCo to buy The half-empty perspective: “We’ve
Mondelez and split into two companies, done everything right. Now we have to
beverages and snacks. The split “would defend a proven record against someone
create two leaner and more entrepreneurial else’s unproven proposition.” According to
companies,” according to Peltz. Minow, “the burden of proof is always on
It’s significant that, during this fracas, third management because it’s management that
parties characterized PepsiCo (among other goes to market every day.”
activist targets) as a corporate governance The half-full perspective: Management is
gold standard and one of the world’s best- in the catbird’s seat because the challenger is
managed enterprises. That perspective seems the one who must prove that he or she has
to return us to the old crisis narrative: that is, a better approach than the present course of
an opportunistic attempt to plunder a great action, which is yielding substantial benefits
company for short-term purposes. to stakeholders. “Absent performance and
To its credit, PepsiCo did not fall back governance issues, it is much tougher to
on this storyline to counter Peltz. It chose make that case,” says Elson. “The implicit
a different kind of strategy altogether, as response is, who are you to dictate policy
PepsiCo apparently understood that its changes to a high-performer like us?”
corporate performance and governance Understood in the narrower context
didn’t matter—not when Peltz was essentially of crisis communications, the same best
claiming that however well PepsiCo was practice—what we refer to above as the
doing, he could do better. “one-size-fits-all strategy”—drives the
approach in either case: namely, complete
The high road candor and transparency. And, what works
Shrewdly, PepsiCo’s message, effectively in the context of an activist insurrection is
delivered by chief executive Indra Nooyi, likewise imperative during any sort of crisis,
was all about the positive. Just the facts, especially when metrics and performance
ma’am: PepsiCo has enjoyed six consecutive indices cannot be jiggered or suppressed.
quarters of organic revenue growth as core “No word games or sophistries,” advises
earnings per share grew 17 percent and gross Elson, whether the crisis at hand is a
margins expanded. The company’s snacks, shareholder revolt, an SEC inquiry, or an
beverages, and healthy foods portfolio earnings restatement.
has high co-purchase and co-consumption Implicit in this fundamental strategy is
levels, generating $1 billion per year. Cash a willingness to sit down and negotiate
flow from traditional beverages supports in good faith with a Carl Icahn no less
investments and emerging markets growth. than the Department of Justice. Attacks and
Stock was up 25 percent over the preceding denigration are self-defeating. Never make it
two years, 14 percent better than Coca-Cola. personal. Being dismissive of the other guy’s
Peltz balked at what he called PepsiCo’s position as “noise” was a dubious strategy in
“dismissive tone” in rejecting the split-up 1985; in 2014 it is not a strategy at all.

Always be willing to bargain; it is never a institutional practice is usually to not take the
sign of weakness, no more than a settlement bait, to stay on the high road, and to continue
agreement with a regulator necessarily to refrain from personalizing the response.
constitutes an admission of enterprise-wide But the question also arises, who speaks
culpability. Do not fall back on the self- for management?
deceiving position that the other side is It’s all about timing. In a crisis situation
negotiating in bad faith. “Who are you to say of any sort, credibility depends on the
whether they’re negotiating in good faith or appearance of disinterestedness. In
not?” warns Minow. responding to activists, it may therefore be
A commitment to bargain also serves the too late for management to spearhead the
entity’s self-interest if only because corporate crisis communications campaign once the
spokespersons must apprehend and co-opt challengers reveal their presence.
the other side’s message. They’ll likely hear “The very appearance of the activist
that message at the negotiating table and, confirms that management has messed up
as a result, gain a road map as to what their the communications. If he’s after you, you’ve
own countermessages will be. already failed,” says Minow. “The advisable
course is to openly acknowledge that you’ve
Who speaks for management? messed up, and to pick a credible third
The essence of crisis management is party to represent the company’s position.
communications and, in any communications That third party is inevitably the outside
campaign, specific actions—the choice of directors. That’s their job.”
who is to speak, how the message is worded, The board may only be theoretically
and where it is to be delivered—can be as disinterested, but it’s the officers, not the
decisive as what the entity says. directors, who are now under direct fire.
To be sure, language and style matter. “The directors need to go on a protracted
When Peltz uses a word like “dismissive” to listening tour, equaling or surpassing the
characterize PepsiCo’s response to his split- dialogue that the activists are certainly
up proposal, he was sending shareholders having with major shareholders. In fact, I
a message, or trying to, that the company wouldn’t even call the board a third party
was unwilling to entertain new ideas; that it at that point. It is now the company’s own
was uninterested in the kind of dialogue and voice,” adds Minow.
negotiation that counselors like Elson and Nor should outside directors wait until
Minow quite appropriately deem essential. there’s a crisis (any kind of crisis) to act in
Even more pointedly, when activist lieu of management. “Make friends before
Daniel Loeb campaigned to seize a board you need them,” advises Minow. “Keep the
position at Sotheby’s, he called the auction directors out there; make sure they meet
house “an old master painting in desperate with major investors at least a couple of
need of renovation.” Executives, he averred, times a year. Find out what those investors
devour “organic delicacies” and rare are looking for.”
wines while shareholders foot the bill. No It’s a particularly pointed lesson for
less than in a court of law, language can companies that, like PepsiCo, have no visible
engender major rule change as, in this case, wounds or conspicuous vulnerabilities.
Loeb also targeted a two-tier shareholder No matter who you are, effective crisis
system that limits activists’ holdings to 10 communications always begin before there’s
percent compared to 20 percent for passive a crisis.
shareholders.
Like aggressive plaintiffs’ lawyers, such Crisis tactics: all media are “social”
activists have a freer range in their choice of Anecdotal evidence, and the observations
language and are typically more apt to shoot of sundry consultants, suggests that more
from the hip. In all crisis engagement, the best outside directors are now committed to

LEVICK Crisis communications in the age of permanent engagement
just the kind of intensified activity that Such grassroots coalition-building

Minow advocates. “Boards are preempting via the social media catalyzes multiple
what activists could do by taking the same communications initiatives. For instance,
action themselves,” according to Leigh USPX has disseminated guidelines for
Ann Schultz, managing director of Riveron say-on-pay voting decisions, reminding
Consulting. investors that “if we mindlessly vote in
Among those actions, boards and the favor of executive pay packages we will be
companies they serve are no longer content . . . providing ‘insulation’ for compensation
with “protracted listening tours.” Some (but committees and CEOs.”
certainly not all) have realized that, whatever There are numerous examples of
the crisis, a more robust engagement is companies that have, in response, effectively
necessary before crises, during crises, and— engaged social media for other purposes
in order to regroup, resolve lingering issues, than promoting goods and services. eBay
and rebuild the brand—post-crises. The tweeted updates on earnings calls and
inevitable place for such engagement is, of analyst meetings. By 2009, Amgen was
course, the social media. using the Web to survey shareholders
Most corporate adversaries, from plaintiffs’ about executive pay. A year later Intel set
lawyers to nongovernmental organizations, up interactive online Q&As and allowed
got to those media first. It was in 2007 that shareholders to vote online during its annual
activist shareholders really saw proof of what meeting. Alcoa’s Facebook page drew many
was possible in the digital age. Shareholder thousands of followers; its Twitter account
Eric Jackson posted videos on YouTube and linked to the earnings release, earnings call
created what became a high-authority blog webcast, and the investor presentation.
to air grievances about Yahoo’s business Such companies are at least sending a
performance. Small investors, representing message that they’re as much a part of the
around 2.6 million shares, responded twenty-first century as their adversaries.
warmly. Six days after a contentious board Many other companies have more recently
meeting, chief executive Terry Semel stepped joined the fray, yet here too the adversaries
down. The online initiative clearly played a have an advantage. We noted above that
role in the shake-up. corporations must be more restrained in their
Since Yahoo, shrewd activist use of the language than activists, plaintiffs’ lawyers,
social media has grown apace, especially and the like. Similarly, corporations face risks
as the Goliaths have taken their cues from in their online practices that shareholder
the Davids. In late 2013, for example, activists don’t. Corporate missteps are brand-
Carl Icahn used Twitter to announce his damaging if not actionable. Every Tweet can
stake in Talisman Energy. By Christmas have global impact.
he’d won two board seats without a proxy The solution involves a delicate balancing
fight. Icahn continues to use his own Web act, as scrupulously orchestrated as it is
platform, Shareholders’ Square Table, to aggressively implemented. As entities
“discuss what can be done to change our match the adversary tweet for tweet—
current, dysfunctional system of corporate with again, unstinted transparency—
governance.” specific best practices for most digital crisis
A powerful name like Icahn leveraged by communications include:
viral communications spells constant crisis
for management. But activists have gone • Engage in a way that keeps opinions open.
even further to instantly roil markets. They The goal isn’t to pre-empt discussion; it’s
created online forums like us.proxyexchange. to respectfully lead it.
org (USPX) to build voting blocs, allowing • Act quickly. Companies can’t hope to
users to transfer their proxy-voting rights to “own” the conversation by responding to
other like-minded investors. two-day-old criticisms or questions.

• Respond to adversaries on the same of crisis management is not about avoiding

channels they’re using—tweets for tweets, risk; it is about identifying the benefits
Like for Like. The implicit message to that may or may not justify running the
shareholders: “We’re listening.” anticipated risk. It is also about identifying
• Enlist a social media team. Someone needs the risks that must be run.
to monitor what’s happening online. The digital challenge is one salient
Someone needs to set and maintain the example of how the crisis communications
tone with which management responds. burden falls heavily on directors who are
Someone needs to ensure that the now obliged to confirm the crisis readiness
company has an online personality that of the companies they serve, including their
matches its brand and that the company levels of social media engagement. It is all
actually takes action by day’s end. the more reason to start planning ahead of
need, not just by communicating regularly
The worst thing a company can do as it with major investors but by fostering open
ponders the social media landscape is to dialogue internally as well, to assure a
simply say, “This is all too risky. We won’t united front once war is declared.
do it.” Risk management as a component

27 The importance of effective
board oversight
Erica Salmon Byrne, Executive Vice President, Compliance & Governance Solutions,
and Eric Morehead, Senior Compliance Counsel NYSE Governance Services
D
uring the last two decades, the role that directors play with
respect to oversight of an organization’s ethics and compliance
program has expanded due to the enactment of the US Federal
Sentencing Guidelines for Organizations (the Organizational
Guidelines), guidance from the Department of Justice (DOJ) for
prosecuting organizations, several key court decisions, and the
growing expectations of employees, partners, shareholders, and the
public. All of these changes mean that directors must now exercise
greater oversight and control of compliance.
Despite these fundamental changes, organizations often fail to
adequately support directors with the vital resources and expertise
they need to exercise effective oversight of an ethics and compliance
program. Failure to educate directors about the content of the
program and support their oversight of the program will render
the program “ineffective” in the eyes of regulators. This chapter
examines the history of events leading to board oversight of ethics
and compliance programs and examines those actions that constitute
appropriate oversight in light thereof.
Background
The development of director responsibility for organizational ethics
and compliance has been a steady progression of key events,
including court decisions, federal sentencing policy, and guidance
from the DOJ.
The responsible corporate officer doctrine

The “responsible corporate officer doctrine” first arose out of two US
Supreme Court case decisions rendered more than 30 years apart. In
essence, the doctrine established that corporate officers and directors
could be held criminally liable for corporate legal violations when
they are in a position of responsibility and authority, have the power
to prevent the violation, and fail to do so. This liability can attach
even in situations where the officer or director did not specifically
participate in or authorize the act in question, as happened in the
two cases described in this chapter.

The importance of effective board oversight NYSE Governance Services
Over time, federal and state prosecutors that, as part of their duty of good faith,
have successfully applied this doctrine directors have an obligation to ensure that
to executives and directors for violations a corporate information and reporting
arising in cases as varied as antitrust, system exists and is adequate. The following
environmental controls, and fraud. The standard for assessing liability in situations
Department of Justice has been very clear where directors are unaware of employee
that it will continue to hold directors misconduct that results in corporate liability
and officers responsible for corporate was announced by the Court:
wrongdoing. The decision to pursue a
Generally where a claim of directorial
particular director may hinge upon
liability for corporate loss is predicated
factors such as the committee upon which
upon ignorance of liability creating
the director served, his or her meeting
activities within the corporation . . .
attendance, or the director’s role in the
only a sustained or systematic failure of
organization in general. As a result of
the board to exercise oversight—such
these tightening standards and regulator
as an utter failure to attempt to assure
expectations, serving as a director has
a reasonable information and reporting
become a more dangerous proposition
system exists—will establish the lack of
requiring the exercise of greater care.
good faith that is a necessary condition
to liability.
Delaware corporate law
It is worthwhile to consider the tightening This standard created a keener awareness
standards that have evolved in Delaware, of the importance of board oversight of a
always at the forefront of corporate law company’s ethics and compliance program
due to its central role as the most-used and had a substantial impact on related best
incorporation jurisdiction. Delaware law practices.
for some time has allowed the imposition Ten years after the Caremark decision,
of criminal liability upon directors in the Delaware Supreme Court clarified the
combination with potential civil liability for Caremark language in the case of Stone
violating a director’s duty of loyalty. v. Ritter, a derivative action brought by
In 1996, Delaware’s Court of Chancery shareholders on behalf of AmSouth
made waves in the compliance and Bancorporation against 15 present and
corporate law communities with its opinion former directors. The plaintiffs alleged that
in In re Caremark by defining a strict role for the bank’s directors had failed to ensure the
careful director oversight of organizational existence of a reasonable compliance and
compliance. reporting system that resulted in violations
Several federal and state agency of the law and eventual fines and penalties
investigations resulted in federal indictments of $50 million.
of Caremark and two of its officers based The Stone court reiterated much of what
on allegations of unlawful kickbacks. The the Chancery Court had said in Caremark,
company pled guilty to a single felony and stated again that directors have a duty
count of mail fraud and agreed to pay of good faith separate from their duties of
approximately $250 million in civil fines and loyalty and care. The Stone court explained
criminal reimbursements. This led to several that the duty of good faith at issue in Caremark
shareholder derivative suits that alleged and Stone—the alleged failure to establish or
Caremark’s board of directors breached oversee compliance systems—is a subset
their fiduciary duty of care by failing of the duty of loyalty. This is particularly
adequately to “supervise the conduct of important because, unlike situations where
Caremark employees, or institute corrective directors have violated their duty of care,
measures, thereby exposing Caremark to corporations cannot limit or eliminate
fines and liability.” The court determined directors’ liability for violating their duty

NYSE Governance Services The importance of effective board oversight
of loyalty. The court stated that directors organizations where the “culpability” of an
may be held liable if they completely fail organization was calculated to determine
to implement a reporting or information fine range, adjusted by aggravating and
system or controls, or having implemented mitigating factors, these guidelines included
such a system, consciously fail to monitor probationary terms for organizations so that
or oversee its operations, thus disabling effective compliance programs could be
themselves from being informed of risks or developed while they were under supervision.
problems requiring their attention. When the Commission promulgated the first
The Stone decision has had a significant sentencing guidelines for organizations in
impact on the field of ethics and compliance. 1991, the preamble stated in part that “steps
It builds upon the standard announced in taken by the organization prior to the offense
Caremark regarding potential liability of to prevent and detect criminal conduct,
directors, by determining that directors the level and extent of involvement in or
are liable for the damages resulting from tolerance of the offense by certain personnel,
legal violations committed by employees and the organization’s actions after an
of a corporation when the directors do not offense has been committed” would be the
exercise due care. Under this holding, if standards that determined the organization’s
directors fail to implement a reporting or penalty. Additionally, the Commission noted,
information system or controls, or fail to “probation is an appropriate sentence for an
monitor such systems, they may be liable. organizational defendant when needed to
Furthermore, the Stone case looked to factors ensure that another sanction will be fully
similar to those found in the US Sentencing implemented, or to ensure that steps will be
Commission’s Organizational Guidelines taken within the organization to reduce the
(discussed below) in determining whether likelihood of future criminal conduct.”
board oversight of a company’s ethics Additionally, the first version of the
and compliance program is adequate. The Organizational Guidelines clearly stated
court focused primarily on the structure that companies that had directors who
of oversight of the compliance systems “participated in, condoned, or [were]
at the bank—for example, the position willfully ignorant of the offense,” or did
of compliance officer and the role of the not train all employees with regard to the
oversight committee of the board—and also compliance program, could face enhanced
discussed the staff designated to implement penalties. However, beyond the broad
the program, including training, policies, mandates for all employees, including
and monitoring systems. directors, to be aware of the organization’s
program and avoid direct involvement in
The Organizational Guidelines misconduct, the original Organizational
When Congress passed the Sentencing Guidelines offered no specific guidance as to
Reform Act in 1984, it created an entirely the unique responsibilities of directors with
new system of sentencing for federal crimes regard to the oversight of organizational
based around binding sentencing guidelines compliance.
and created an independent expert body, the That all changed in 2004. As part of
US Sentencing Commission, to produce the the Sarbanes-Oxley Act of 2002 (SOX),
guidelines. The first sentencing guidelines the Commission received a Congressional
for individuals were introduced in 1987. directive to ensure that the Organizational
The Commission tabled consideration of Guidelines and their associated Commentary
guidelines for organizations at that time, but were sufficient to “deter and punish
continued to study the topic by compiling a organizational criminal misconduct.”
comprehensive database of organizational A broad range of experts were drafted
cases. When the Commission finally onto an Advisory Group and spent 18
settled on a hybrid sentencing scheme for months examining the effectiveness of the

compliance criteria of the Organizational Organizational Guidelines, a compliance

Guidelines. When the Group concluded officer should report to the board or its
their efforts, they recommended that the designated subcommittee no less than
Commission promulgate a stand-alone annually about the implementation and
guideline to address effective ethics and effectiveness of the program. Although
compliance program hallmarks. One of such limited reporting now falls short of
the primary recommendations that the what are considered best practices, the
Advisory Group made to the Commission 2004 amendments to the Organizational
was to “specify the responsibilities of an Guidelines certainly caused organizations to
organization’s governing authority . . . for pause when evaluating the board oversight
compliance.” aspect of their program.
An effective ethics and compliance In 2010, the most recent amendments
program is defined in the Organizational to the Organizational Guidelines further
Guidelines as one through which an clarified the role the board should have
organization exercises “due diligence to with the compliance officer. Under the
prevent and detect criminal conduct” and Organizational Guidelines, an organization
otherwise promotes “an organizational is deemed to have an effective ethics and
culture that encourages ethical conduct and compliance program, even if high-level
a commitment to compliance with the law.” personnel are involved in a criminal offense,
As previously noted, one of the factors so long as the individual with operational
accounted for in an effective program responsibility for the program has “direct
is whether the “governing authority” is reporting obligations” to the board of
knowledgeable about the content and directors or its designated committee.
operation of the ethics and compliance This change reflects the increased
program and exercises reasonable oversight importance of providing timely information
of that program. This requirement caused to the board regarding misconduct,
considerable concern, given the multiple potential misconduct, and the operation
responsibilities many directors already of the organization’s program in general.
have. As a result of public comment, the While the Commission did not designate
Commission’s 2004 amendments allow the that organizations must change existing
board to delegate oversight responsibility to reporting relationships between the board
a subcommittee, such as the audit committee, and the executive level of the organization,
as appropriate. If the board does delegate the new amendment suggests that the
oversight, however, it must ensure that it is organization should have a formalized
still receiving sufficient information to fulfill procedure for the individual with day-
its oversight obligations. to-day operational responsibility for the
While the 2004 amended Organizational program to communicate with the board.
Guidelines did not provide great detail on In practice, organizations should consider
how board oversight must be exercised, whether they are receiving regular reporting
board training was clearly addressed. on the operation of the ethics and compliance
The amended Organizational Guidelines’ program from operational staff and whether
training requirement applies to directors and those individuals have the “expressed
high-level personnel, in addition to all other authority” to communicate with the board
employees. Regardless, some companies should they need to.
still fail to train their board members on
their codes of conduct, high-level risk areas, Department of Justice guidance
or other ethics and compliance program Board oversight of ethics and compliance
components. programs is further detailed in the DOJ’s
Additionally, to have an effective McNulty Memorandum, which gives
ethics and compliance program under the guidance to prosecutors on the factors they

NYSE Governance Services The importance of effective board oversight
should consider in determining whether 1. the structure and resourcing of the ethics
to indict a corporation. These factors were and compliance program, and whether
permanently memorialized in the DOJ’s the compliance officer has sufficient
U.S. Attorneys’ Manual in 2008. The DOJ authority to implement the program
considers, among other factors, the existence 2. the structure of the company’s reporting
and adequacy of a corporation’s ethics and system and the company’s policies
compliance program when determining regarding responding to suspected
whether to charge a corporation. The DOJ misconduct
also takes into account whether directors 3. the types of compliance training that
exercise independent review over proposed employees and others, particularly
corporate actions and whether they received managers, are required to complete,
information sufficient to do so. In addition, and any modifications to those training
the DOJ considers whether directors have requirements
made efforts to ensure the organization has 4. the company’s risk-assessment process
established an information and reporting and results, and the methods developed
system reasonably designed to provide by the company to prioritize and address
management and the board of directors with the risks identified therein
timely and accurate information regarding the 5. the way in which the company audits
corporation’s compliance with the law. When for implementation of the ethics and
the DOJ is determining how to dispose of a compliance program and for substantive
case, the role of the organization’s board in violations, especially in high-risk areas
implementing and overseeing the ethics and 6. the perception of employees regarding
compliance program is heavily scrutinized. the culture of ethics and compliance at the
corporation, including fear of retaliation
Lessons learned for reporting suspected misconduct,
and whether employees believe that
What constitutes appropriate board oversight? management is committed to compliance.
Since the implementation of SOX, most
corporations have kept their audit committees This information, at a minimum, should
apprised when the corporation receives be provided to the board on a regular,
allegations of suspected misconduct and of periodic, and timely basis. Best practices
the company’s responses to those allegations. suggest that reports to the board (or
A majority of companies are also requiring appropriate subgroup) regarding the
board approval of the company’s code of program—including the direction in which
conduct and any related major policies. the program is heading and other high-level
Communication of this type of information information—should be made quarterly. The
continues to be very important, but falls minimum standard for reporting under the
far short of the information required for the Organizational Guidelines is annually.
board to exercise appropriate oversight. In Active oversight also requires training for
order to exercise oversight, boards should the board of directors. Directors may feel that
receive expanded information regarding a they receive overlapping training by virtue
company’s ethics and compliance activities of sitting on more than one organization’s
in order to adhere to the requirements of the board; however, mandatory training on each
Organizational Guidelines, DOJ guidance, organization’s code of conduct, as well as
and applicable law. on industry-specific risk topics of particular
For example, beyond acquiring basic significance, is critical for directors to
information such as misconduct reports and complete. It allows directors to be sufficiently
approving major written standards, boards familiar with said policies, procedures, and
should also periodically receive information training initiatives to exercise reasonable
about: oversight of those programs. Not only

does such training protect the organization level of scrutiny of a board’s monitoring—or
in the event of corporate malfeasance, it failure to monitor—a corporation’s ethics
also protects the individual directors and compliance activities has increased
from civil and/or criminal liability. It is dramatically. The challenge for boards,
very difficult for a director to ensure the executive officers, and ethics and compliance
“consistent” application and enforcement officers is to view the increased scrutiny and
of the organization’s ethics and compliance enhanced standards not merely as a host of
program that the Organizational Guidelines new legal requirements but as an opportunity
require without periodic, applicable training to review and enhance their corporate
on risk topics, the code of conduct, and a governance and ethics and compliance
director’s role in oversight. practices and set a true “tone from the top.”
Conclusion
Corporate governance and compliance
practices have undergone enormous change
in a relatively short period of time and best
practices are continually developing. The

28 FCPA and compliance: a board and
senior management perspective
Ralph M. Levene, Partner, and David Gruenstein, Partner Wachtell, Lipton, Rosen & Katz
I
n today’s post–financial crisis enforcement environment,
companies devote greater effort and resources than in the past
to overseeing the implementation and operation of an effective
compliance program. Regulation has become more extensive
and complex; the US government has grown more aggressive
and demanding in its compliance expectations and enforcement
efforts; and foreign governments have similarly increased their
enforcement activities. The price of compliance has gone up, as
has the cost of non-compliance.
This chapter addresses the oversight roles played by the board
and senior managers of a US-listed public company with regard
to compliance with the Foreign Corrupt Practices Act (FCPA).
This area of compliance is critically important to listed companies
with multinational operations. More generally, this discussion of
compliance in the context of the FCPA illustrates issues that cut
across different areas of compliance, including the appropriate
roles of senior management and the board and key elements of an
effective compliance program.
The legal obligations of boards and senior managers in regard to

compliance
The Delaware Supreme Court’s 1963 decision in Graham v. Allis-
Chalmers Mfg. Co.1 illustrates that, just as the board is not responsible
for managing the day-to-day business affairs of a company, so too,
it is not responsible for day-to-day compliance. The directors in
that case were sued on the theory that they should have known
that company employees engaged in behavior leading to corporate
antitrust liability and that they should have brought the company
into compliance, thereby preventing the loss. The Delaware Supreme
Court stated in emphatic terms that “absent cause for suspicion
there is no duty upon the directors to install and operate a corporate
system of espionage to ferret out wrongdoing which they have no
reason to suspect exists.”2
Chancellor Allen’s decision in In re Caremark International Inc.
Derivative Litigation3 interpreted Allis-Chalmers for the modern
era. Consistent with the board’s oversight responsibilities generally,

FCPA and compliance: a board and senior management perspective Wachtell, Lipton, Rosen & Katz
Caremark recognized a limited role for boards different functions at different levels of the
to help assure that senior managers adopt corporate enterprise. Senior management
and implement an effective compliance of large multinational companies with
program. As recognized by the Delaware geographically diverse operations may
Supreme Court in Stone v. Ritter, liability not know of the day-to-day activities of
under Caremark may arise from “a sustained employees or agents in remote locations.
or systematic failure of the board to exercise Senior management should thus enact
oversight,” which might be found if “(a) the systems providing for monitoring, internal
directors utterly failed to implement any reporting, and periodic reviews, and then
reporting or information system or controls; should be able to rely on such systems,
or (b) having implemented such a system lower levels of management, and “control”
or controls, consciously failed to monitor functions until an issue comes to their
or oversee its operations thus disabling attention requiring senior-level involvement.
themselves from being informed of risks or When such an issue does come to senior
problems requiring their attention.”4 management’s attention, however, it is
Caremark liability requires a showing of important to respond in a timely manner
bad faith and has been called “possibly to gather facts and to implement remedial
the most difficult theory in corporation steps as needed and appropriate. This does
law upon which a plaintiff might hope to not mean that a full-blown independent
win a judgment.”5 However, the bad faith internal investigation is always required.
requirement also means that violations of Rather, the nature as well as the scope
Caremark duties are generally not subject to of the inquiry should be appropriately
exculpation or indemnification.6 While the tailored to the circumstances. There are
standard for finding Caremark liability is many circumstances where a focused effort
high, the boards of companies that announce by in-house counsel and others within the
compliance problems nonetheless have been company to gather the necessary facts will
subject to such claims almost reflexively. suffice and be most expeditious and efficient.
Numerous,7 but not all,8 cases have been Regardless of the nature of the fact-
dismissed. The lesson from multiple gathering process, in certain circumstances
perspectives—prevention, good governance, evidence of problems in the past may signal
and defending a potential Caremark claim— a risk of future misconduct. Senior managers
is that the board should assure itself through who were not aware of questionable conduct
its oversight that an adequate compliance in the past when it occurred, and thus
program (inclusive of adequate information may not be criticized on that basis, may be
systems and controls) has been implemented criticized for letting new violations happen
and is continuing to function effectively. “on their watch.” To protect the company
The board’s oversight role should be and all concerned, prompt consideration
precisely that: to receive periodic reports, should be given where necessary to taking
and otherwise when circumstances require, preventive measures on an interim basis
to see that management is focused on these pending further inquiry or other remedial
issues and has taken what appear to be steps that may be appropriate.
proper and timely steps to identify and
address compliance risks in its business. Summary of the FCPA
Exercising that oversight sends the message The FCPA was enacted in 1977 in the wake
that the board itself regards compliance of revelations of widespread bribery of
as important and that management should foreign governmental officials by American
thus do so too. companies seeking to do business overseas.
While senior management should enact an The FCPA, as amended, consists of anti-
effective compliance program, distinctions bribery provisions and also so-called
should be made between managers with accounting provisions (which in fact impose

Wachtell, Lipton, Rosen & Katz FCPA and compliance: a board and senior management perspective
broad record-keeping and internal control Given the prevalence of state-owned or

requirements on issuers).9 controlled entities engaged in commercial
The anti-bribery provisions apply activities, for example in China, it should
to: (1) “issuers,” ie, companies with US be highlighted that foreign officials may
registered securities or that are otherwise include officers or employees of such
required to file periodic reports with the “agenc[ies]” or “instrumentalit[ies]” of a
SEC, including foreign issuers with ADRs foreign government.16
trading on a US exchange;10 (2) “domestic The FCPA by its terms applies to the
concerns,” which include US individuals activities of agents or intermediaries who
(ie citizens, nationals, and residents) and would pay a bribe, and the issuers or others
US corporations, partnerships, and certain who would employ them to do so. The
other US entities;11 (3) foreign nationals or FCPA specifically prohibits payments or
entities that act to further a corrupt payment offers to a third party (such as an agent)
while in the US;12 and (4) officers, directors, while “knowing” that all or a portion of such
employees, agents, and stockholders of payment to the third party will be passed
issuers or domestic concerns.13 on or offered to a foreign official.17 It is not
The anti-bribery provisions generally necessary that the identity of the foreign
prohibit covered persons and entities official be known. The FCPA contains a
from corruptly making, authorizing, definition of “knowing” that relaxes the
promising, or offering payments (“anything traditional meaning of that word in certain
of value”) to foreign officials (any officer, respects—for example, it presumes the
employee, or representative of a foreign “knowing” condition to be satisfied where
government, agency, department, or the allegedly knowing party is aware of
instrumentality thereof, such as a state- a high probability of the existence of the
owned enterprise), foreign political parties relevant circumstance.18
or their representatives, candidates for The FCPA applies to other “indirect”
foreign political office, and employees or benefits as well. For example, the FCPA may
representatives of a public international be implicated in certain circumstances by
organization (eg International Monetary making charitable donations or underwriting
Fund [IMF], World Trade Organization sponsorships at the behest of a foreign official
[WTO], World Bank) with the purpose or to organizations associated with a foreign
of assisting in “obtaining or retaining official.19 Similarly, hiring or otherwise
business.”14 That so-called “business benefiting members of the family of a
purpose test” does not require that the foreign official may present FCPA issues. The
bribe’s purpose specifically be to facilitate government remains focused on these and
obtaining or keeping a government contract. other alleged means of “evading” the FCPA.
US enforcement authorities interpret the There are two affirmative defenses to the
business purpose test broadly, treating anti-bribery prohibitions of the FCPA for
bribes for the purpose of obtaining a which a defendant would bear the burden
business advantage as meeting this statutory of proof. One affirmative defense is for
requirement.15 expenses directly related to the bona fide
The FCPA requires that the payment be “promotion, demonstration, or explanation”
made or offered “corruptly,” essentially of a company’s products or performance
with an intent to wrongfully influence the of a contract, but not a trip for personal
recipient to misuse his official position. entertainment.20 The other affirmative
Thus, while the FCPA does not specify a defense is for payments that are lawful under
minimum value of what is offered or paid, the written local law of the foreign country;
a gift of company promotional items of however, absence of law prohibiting a
nominal value normally would not reflect payment or conduct, or the fact that corrupt
corrupt intent. payments may not be prosecuted or are

otherwise part of the generally accepted civil litigation, management distraction, and
custom and practice in a foreign jurisdiction, stock drops. While the DOJ and SEC have
do not fall within this defense.21 There is consistently stated that they will reward
also an exception for payments to facilitate cooperation, including self-reporting (“if we
or expedite “routine government action” [the government] find the violations on our
involving “nondiscretionary acts,” although own, the consequences will surely be worse
US enforcement authorities have taken a than if you had self-reported the conduct”26),
narrow view of this exception.”22 a “pass” may not be available,27 and there
The accounting provisions of the FCPA continue to be substantial costs in any event.
require issuers to make and keep books and This includes the cost of the company’s internal
records that, in reasonable detail, accurately investigation itself. Without compromising
and fairly reflect an issuer’s transactions and the integrity of the investigation, it must be
dispositions of an issuer’s assets, and further carefully managed to ensure efficiency and
require issuers to devise and maintain a proportionality. The DOJ and SEC have also
system of internal accounting controls signaled their intent to pursue FCPA charges
sufficient to assure management’s control, against individuals more aggressively.
authority, and responsibility over the firm’s
assets.23 The FCPA’s accounting provisions An effective FCPA compliance program
are not limited to the subject matter of The following discussion is intended to
foreign bribery. Individuals and businesses highlight certain important elements of
may not knowingly falsify the company’s an effective FCPA compliance program.
books and records, or circumvent or fail to Familiarity with these elements, and more
implement a system of controls. generally with the issues raised by corporate
The US Department of Justice (DOJ) and compliance programs, should enable
the Securities and Exchange Commission nonexperts to ask better questions and to
(SEC) share responsibility to enforce the improve compliance efforts.
FCPA. The DOJ has sole authority to bring
criminal cases, including for violations of the Tone at the top and at ground level—An
accounting provisions.24 For an individual effective compliance program requires
defendant to be criminally prosecuted, he that management set the correct “tone at
or she must have acted “wilfully,” which the top”—that is, that compliance with
requires that the defendant acted voluntarily, applicable laws and regulations, including
purposefully, and with “knowledge that [the the FCPA, is “the” priority, that management
defendant] was doing a ‘bad’ act under the expects employees to make compliance part
general rules of law,” without, according of the day-to-day business culture of the
to the US government and certain cases, company and that non-compliance should
requiring that the defendant “have known of not be “balanced” against business or
the specific terms of the [FCPA] or even the other considerations, however compelling.
existence of the statute.”25 Thus, the message should be conveyed
Regardless of such legal standards, most specifically that it is not a justification for
cases, including criminal cases, against “looking the other way” that it is impossible
corporations settle. They often involve (in the to do business in a jurisdiction without
case of an anti-bribery violation) a guilty plea, paying a bribe. That tone at the top can be
criminal and/or civil fines, disgorgement set by management actions (eg rewarding
of profits from the wrongful conduct, and good compliance and punishing bad) and
ancillary “remedies” such as the imposition words (eg sending periodic reminders
of a compliance monitor. There can be emphasizing the importance of compliance
collateral consequences from an announced such as after another firm has been charged
FCPA violation as well, including possible with an FCPA violation or announced an
debarment from government contracting, investigation).

Equally important, managers at the kinds and levels of risk, as do different

local, operational, or “ground” level doing companies operating within those industries
business overseas should reinforce the and different business practices. The different
message that compliance with the FCPA countries in which a company may operate
is an important part of doing day-to-day also will present greatly varying levels of
business. An effective compliance program risk. Improving visibility into local practices
will focus on both levels: providing for in foreign countries is an important element
standard-setting and overall monitoring at in shaping an effective compliance program.
the top, implementation and controls at In-house and, in certain cases, outside
ground level, and effective communication counsel can play a critical role in identifying
up and down the organization. FCPA risks so that a set of procedures can
be tailored accordingly. Identifying such
Tailored procedures that enforce policies—An risks requires an assessment of government-
effective compliance program requires, in related “touch points” in the particular
addition to strong written FCPA policies, business, both “direct” ones (such as doing
procedures—that is, corporate controls and business with a governmental department/
processes—designed to ensure that the agency or state-owned enterprise as
company’s FCPA policies are being followed counterparty) and “indirect” ones (such as
as business is conducted. For example, governmental licenses/permits/approvals,
companies retaining third-party agents tax, labor/employment or environmental
in foreign jurisdictions should implement rulings, audits and inspections, and
specific procedures to vet, document, train, import/export duties). Being able to
and monitor the agents’ activities on their gather information on a privileged basis
behalf. Another example is that companies can be essential in certain circumstances to
that do business with foreign governmental improving compliance prospectively while
counterparties should implement specific avoiding pitfalls. An FCPA risk assessment
procedures to approve and monitor also requires an understanding of where
promotional and other activities involving “value” may be created in the business from
transfers of value, such as travel and which an improper payment may be made
entertainment, gift giving, and charitable (eg unusual discounts, rebates, or margin in
and political donations, to ensure that they sales or distribution transactions). Finally,
not mask improper payments. it is also important that companies reassess
It is almost always possible for the these touch points and risks inherent in their
government, in retrospect, to criticize a business periodically and when entering
company for not having a procedure that new businesses or new foreign markets (or
would have helped prevent the particular implementing new business approaches) to
problem that occurred. Nonetheless, ensure that FCPA risks are identified and
it is important that a company design a addressed proactively.
“reasonable” (or in the parlance of the
UK Bribery Act, “proportionate”28) set of Training—An effective compliance program
procedures tailored to the particular risks must operate at “ground” level, and this
inherent in its business activities. Industry includes training. While Internet-based
“best practices” may be considered along training is typically an efficient way of
with other factors in determining what conducting basic training for large groups
procedures will pass muster as “reasonable.” of employees, tailored training of employees
A prerequisite to developing an who perform critical roles overseas on
appropriate set of “reasonable” FCPA the front lines of FCPA compliance may
procedures is that management perform improve the tone on the ground and the
an assessment of, and thereby attempt to overall effectiveness of the program. Thus,
understand, the particular risks inherent in its for example, training of country managers
business. Different industries have different and local/regional controllers and similar

personnel may be best conducted at group assessing the adequacy of the target’s existing
meetings for other management purposes, compliance program, and identifying past or
where senior management can convey the ongoing FCPA issues. Representations and
importance of compliance and performance warranties and other deal terms may be
expectations. The law may be complex, but used to allocate or otherwise manage FCPA
the best training is often simple—that is, risk in the transaction. In any event, FCPA
geared to what will educate and persuade compliance at the newly acquired company
particular audiences to spot as early as should be integrated in a timely manner in
possible the issues that arise in their business coordination with other integration efforts.
so that they may, where necessary, bring the
matter to the attention of others who are best Agents—It is important that a company assess
positioned to deal with the complexity and its dealings with “agents” or other third parties
to safeguard corporate interests beyond local whose actions on behalf of the company could
business needs. create FCPA liability. This has historically
been a major problem area for companies, as
Detection—An effective compliance program a very high percentage of FCPA enforcement
should also include adequate systems to actions involve misconduct by agents or
detect possible instances of wrongdoing. other third-party intermediaries.29 There are
Line managers are often in the best position a variety of different compliance measures
to detect possible wrongdoing, and there that address this risk, including performing
are a variety of techniques designed to due diligence concerning the agent, carefully
ensure that line managers are looking for, documenting the agent’s retention, training
and timely reporting, issues. For example, the agent, obtaining representations and
bottom-up certifications may serve to warranties, monitoring the agent’s activities,
detect questionable conduct in addition to and promptly responding to “red flags.”
supplying a basis on which the company
and its senior management may rely. Conclusion
Ground-level finance, compliance, and other It is important that directors and senior
“control” personnel also may play a key managers fulfill their respective roles with
role in preventing and detecting possible respect to compliance with the FCPA, as well
wrongdoing. On a centralized level, periodic as other laws and regulations generally. While
internal audits focused on anti-corruption questions exist as to whether the government
issues may detect risks and potentially adequately “rewards” effective compliance
wrongful activities. And in-house counsel, when problems do arise, an effective
alone or operating with the assistance of compliance program is critically important
outside counsel, may conduct inquiries to to giving the company the chance to: (1)
evaluate specific issues (including possible prevent wrongful conduct before it occurs; (2)
instances of wrongdoing) on a privileged detect potential wrongful conduct earlier; (3)
basis. The availability of internal whistle- remediate wrongful conduct in a more timely
blower systems, and the ease of use of such and effective manner; (4) achieve a “better”
systems, is also important to detection. outcome in the event of an enforcement
investigation; and (5) best protect the company,
Mergers & acquisitions—Companies that devote and its board, senior management, and other
considerable effort to their own FCPA constituents, from potential civil liability and
compliance may nonetheless “inherit” the other collateral consequences.
FCPA risk of the companies they combine
with or acquire. FCPA due diligence Notes
should be tailored to the risk profile of 1 188 A.2d 125 (Del. 1963).
the target, including the direct and indirect
2 188 A.2d at 130.
governmental touch points discussed above.
Due diligence should specifically focus on 3 698 A.2d 959 (Del. Ch. 1996).

4 911 A.2d 362, 369-70 (Del. 2006). (S.D.N.Y. 2008) (rejecting local law defense where
5 In re Caremark, 698 A.2d at 967. written Azeri law did not legalize the improper
payment at issue; local law relief from criminal
6 See DEL. CODE ANN. tit. 8, §§102(b)(7), 145(a)
liability for bribe payer who made voluntary
(West 2011). disclosure to local authorities was insufficient).
7 Wood v. Baum, 953 A.2d 136 (Del. 2008); In re 22 Id. §§ 78dd-1(b); 78dd-2(b); 78dd-3(b). FCPA
Intel Corp. Deriv. Litig., 621 F. Supp. 2d 165 (D. Resource Guide at 25. It should also be noted that
Del. 2009); Desimone v. Barrows, 924 A.2d 908 (Del. the UK Bribery Act does not contain an exception
Ch. 2007). for facilitation payments and so care must be
8 American International Group v. Greenberg, et al., exercised to ensure applicability of the exception to
965 A.2d 763 (Del. Ch. 2009); In re Countrywide Corp. a company’s activities.
Deriv. Litig., 554 F. Supp. 2d 1044 (C.D. Cal. 2008). 23 Id. § 78m(2)(A)-(B).
9 Other jurisdictions have their own anti-bribery 24 FCPA Resource Guide at 4.
laws, eg, the UK Bribery Act. An effective anti- 25 Eg, United States v. Kay, 513 F.3d 432, 447-48
corruption compliance program would take into
account all potentially applicable foreign and (5th Cir. 2007).
local laws. 26 Andrew Ceresney, Keynote Address at the
10 15 U.S.C. § 78dd-1 et seq. International Conference on the Foreign
Corrupt Practices Act (Nov. 19, 2013), available
11 Id. § 78dd-2.
at http://www.sec.gov/News/Speech/Detail/
12 Id. § 78dd-3. Speech/1370540392284.
13 Id. §§ 78dd-1(a); 78dd-2(a). 27 Compare eg, Press Release, SEC, SEC
14 Id. §§ 78dd-1(a)(1)(B)-(a)(2)(B); 78dd-2(a)(1)(B)- Announces Non-Prosecution Agreement with
Ralph Lauren Corporation Involving FCPA
(a)(2)(B); 78dd-3(a)(1)(B)-(a)(2)(B).
Misconduct (Apr. 22, 2013), available at http://
15 See, eg, United States v. Kay, 359 F.3d 738, 755 www.sec.gov/News/PressRelease/Detail/
(5th Cir. 2004) (“Congress intended for the FCPA PressRelease/1365171514780 with Press Release,
to apply broadly to payments intended to assist DOJ, Former Morgan Stanley Managing Director
the payor, either directly or indirectly, in obtaining Pleads Guilty for Role in Evading Internal Controls
or retaining business for some person, and that Required by FCPA (Apr. 25, 2012), available at
bribes paid to foreign tax officials to secure illegally http://www.justice.gov/opa/pr/2012/April/12-
reduced customs and tax liability constitute a crm-534.html. See also DOJ, “A Resource Guide to
type of payment that can fall within this broad the U.S. Foreign Corrupt Practices Act,” at 21-23
coverage.”). See US Department of Justice, Criminal (discussing bribes paid by foreign agents).
Division & Securities and Exchange Commission, 28 See Ministry of Justice, The Bribery Act 2010:
Enforcement Division, A Resource Guide to the US
Guidance, at 21, available at http://www.justice.
Foreign Corrupt Practices Act (Nov. 2012) at 12-13.
gov.uk/downloads/legislation/bribery-act-2010-
(“FCPA Resource Guide”).
guidance.pdf (“Adequate bribery prevention
16 15 U.S.C. §§ 78dd-1(f)(1)(A); 78dd-2(h)(2)(A); procedures ought to be proportionate to the risks
78dd-3(f)(2)(A). that the organisation faces.”).
17 Id. §§ 78dd-1(a)(3); 78dd-2(a)(3); 78dd-3(a)(3). 29 See, eg, Press Release, DOJ, Marubeni
18 Id. §§ 78dd-1(f)(2)(A)(i)-(ii); 78dd-2(h)(3)(A) Corporation Resolves Foreign Corrupt Practices
(i)-(ii); 78dd-3(f)(3)(A)(i)-(ii). Act Investigation and Agrees to Pay a $54.6 Million
Criminal Penalty (Jan. 17, 2012), available at http://
19 SEC v. Schering-Plough Corp., No. 04-cv-945
www.justice.gov/opa/pr/2012/January/12-
(D.D.C. June 9, 2004) (Compliant) and In re crm-060.html; Press Release, DOJ, Oil Services
Schering-Pough Corp., Exchange Act Release No. Companies and a Freight Forwarding Company
(June 9, 2004). Agree to Resolve Foreign Bribery Investigations and
20 Id. §§ 78dd-1(c)(2)(A); 78dd-2(c)(2)(A); 78dd-3 to Pay More than $156 Million in Criminal Penalties
(c)(2)(A). FCPA Resource Guide at 24. (Nov. 4, 2010), available at http://www.justice.gov/
21 Id. §§ 78dd-1(c)(1); 78dd-2(c)(1); 78dd-3(c)(1). opa/pr/2010/November/10-crm-1251.html.
See, eg, United States v. Kozeny, 582 F. Supp. 2d 535

29 Handling regulatory inquiries,
investigations, and settlements
Michael Trager, Senior Partner; John Freedman, Partner; and Joshua Martin, Partner Arnold & Porter LLP
W
e live in an era of heightened regulatory scrutiny of
public companies. As Mary Jo White, the chair of the US
Securities and Exchange Commission (SEC), promised at
her confirmation hearing, the SEC is pursuing an enforcement
strategy that is “bold and unrelenting.” In today’s regulatory
climate, companies increasingly are being judged by the way
they respond to investigations, and any perceived failure to
respond appropriately can have severe consequences. As a result,
companies must react swiftly and effectively when confronted with
an inquiry. This chapter summarizes key practical considerations
in responding to an investigation.
Who are the regulators and what do they investigate?

The SEC is the primary regulator of public companies and is a law
enforcement agency. SEC investigations are conducted by the staff of
the Division of Enforcement (Staff). These investigations involve the full
range of issues under the federal securities laws, including improper
financial reporting, misleading disclosures, incorrect accounting, false
filings and offerings, inadequate internal controls, inaccurate books
and records, insider trading, stock manipulation, misappropriation
of assets, and anticorruption violations. Each year, the SEC brings
hundreds of civil and administrative enforcement actions.
While this chapter focuses on SEC investigations, many of the
practical considerations also apply to inquiries conducted by other
law enforcers, including the US Department of Justice (DOJ), state
securities departments and attorneys general, and regulators such
as the Commodity Futures Trading Commission, Financial Industry
Regulatory Authority, and Public Company Accounting Oversight
Board. High-profile investigations often can lead to a media blitz,
shareholder litigation, delisting, and reputational harm, as well as
capture the attention of Congress.
The commencement of an investigation

SEC investigations, like most others, can begin in a variety of ways—
from the informal (such as a call from an investigator or a voluntary

Arnold & Porter LLP Handling regulatory inquiries, investigations, and settlements
letter request) to the formal (such as a subpoena public companies disclose investigations.
for documents or testimony). The Staff is Instead, companies must determine whether
authorized to conduct informal inquiries, the facts and circumstances require line-item
called Matters Under Inquiry (MUIs), or disclosure (for example, under Item 103 of
formal investigations upon the issuance of a Regulation S-K) or if disclosure is required
Formal Order of Investigation (Formal Order). because the investigation is quantitatively or
Formal Orders designate members of the qualitatively material. In doing so, companies
Staff to act as officers of the SEC for purposes should assess the probability and magnitude
of conducting the investigation, including of the outcome of the investigation, including
issuing subpoenas to compel the production whether any potential losses are probable
of documents and testimony. and reasonably estimable. In addition, issues
or events that arise during or as a result of
the investigation may themselves require
Practice Pointer disclosure (for example, if significant errors
Any person who is compelled or requested in previously issued financial statements are
to furnish documents or testimony has uncovered).
the right to request and be shown the If required, disclosure should be prompt
Formal Order. To receive and retain a and complete. If not required, companies
copy, however, such persons must follow should consider whether to make a
certain procedures in sending a written voluntary disclosure, including assessing
request, and approval of the request is factors such as the ability to place the
at the discretion of the Staff (although issues in context and the likelihood of
such requests typically are granted). See the investigation becoming known without
Rule 7(a) of the SEC’s Rules Relating to disclosure. The timing of disclosure is
Investigations, 17 C.F.R. § 203.7(a); see also critical. It can be premature if the details
SEC Enforcement Manual, Section 2.3.4.2. and depth of the potential problems are
While Formal Orders are generic in nature, unknown and end up understated, or too
they do provide some information with late if it is perceived that a company did
respect to the potential violations being not react in a timely fashion. Company
investigated. securities counsel should be consulted on
all disclosure issues.
Regardless of how investigations start,

Practice Pointer
companies should take them seriously and
Companies should consider
avoid compounding problems by failing to
implementing crisis communications
stop ongoing violations, destroying or failing
plans to deal with the marketplace, as
to preserve documents, making inaccurate or
well as employees, customers, vendors,
false statements, or doing anything else that
and the like. These plans can be developed
results in losing credibility. Throughout the
generally in advance of any problem and
course of an investigation, companies should
tailored to specific situations as they arise,
remember that credibility and cooperation are
and they can be helpful at all stages of
key. The SEC and DOJ, among others, have
an investigation (from initial disclosure
issued frameworks for obtaining cooperation
through resolution). In developing
credit during an investigation. See, for
communications plans, companies
example, SEC Enforcement Manual, Section
should assess whether a public relations
6; United States Attorneys’ Manual, Title 9-28.
firm should be engaged. If feasible, the
engagement should be made through
Disclosing the investigation counsel to preserve the attorney-client
There is no line-item requirement under
privilege and to protect work product.
the federal securities laws requiring that

Handling regulatory inquiries, investigations, and settlements Arnold & Porter LLP
Preserving relevant evidence archived, consider retaining relevant

Upon receiving notice of an investigation, backup tapes and ceasing recycling of
companies should take immediate action such tapes. Take a “snapshot” of the email
to preserve potentially relevant documents, system and other servers and databases as
including considering the following steps: appropriate.
4.
If the authority conducting the
1. Identify a list of individuals who might investigation issues a preservation notice,
have information and documents relevant the specific terms must be followed—
to the investigation and, if necessary, clarification or modification can be sought
expand the list as more information is as necessary.
learned.
2. Send written notices to these individuals Collecting, reviewing, and producing
instructing them to preserve hard-copy documents
and electronic documents. Provide There are different options for collecting
examples of the types of documents to documents, ranging from self-collection by
be preserved (including documents that asking individuals to provide documents for
might not be readily apparent, such as review and production, to guided collection
instant and text messages and voicemails), by interviewing individuals to identify
as well as the potential locations of such responsive documents, to more centralized
documents. Instruct personnel to err collection by imaging individuals’ hard
on the side of being overinclusive in drives and conducting “office sweeps.”
their preservation efforts and to preserve Companies also should collect noncustodial
all originals, drafts, and duplicates. If responsive documents, such as centrally
practical, obtain representations or stored hard-copy or electronic documents,
certifications from personnel stating that and use a system to track the source of
they are complying with the preservation documents and compliance with collection
memoranda. requests. Failure to collect and produce
all responsive documents and properly
comply with a subpoena can create negative
Practice Pointer inferences and even lead to self-standing
For certain personnel, the circumstances proceedings to enforce the subpoena—
also might warrant taking control of hard- something the SEC has trumpeted in recent
copy documents, hard drives, laptops, and pronouncements and acted on by marching
personal devices. In this regard, companies into federal court.
should not rely on certain individuals to
preserve documents, particularly if it is
possible they were involved in potential Practice Pointer
wrongdoing. Companies should take Companies should determine if responsive
immediate control of all files of suspected documents from former employees have
wrongdoers. been maintained. Similarly, companies
should consider collecting from individuals
who depart the company during the
3. Work with company technology personnel investigation (for example, retaining their
to preserve electronic documents, and hard drives).
consider using an outside document
vendor retained through counsel. Ensure
that all relevant documents are preserved Much of the early part of the investigation
even if they are scheduled for routine will be spent reviewing and producing
disposal as part of a pre-existing policy. If documents. In doing so, companies should
electronic documents are not automatically consider the following steps:

1. Use a database provided by a qualified

vendor to store, review, and produce Practice Pointer
collected documents. Whether confidential treatment can
2. For larger requests, consider using search be requested will depend on the
terms to identify potentially responsive authority conducting the investigation.
documents. For example, the SEC has specific
requirements for making confidential
treatment requests under the Freedom of
Information Act (FOIA). See, for example,
Practice Pointer
17 C.F.R. § 200.83. Conversely, certain
Discussing search terms and related
other regulators do not permit requests
issues with the authority conducting the
for confidential treatment.
investigation can help ensure that the
company is responding appropriately.
Depending on the circumstances,
agreements to narrow certain aspects of a
Inquiring into the facts
request or subpoena can be reached.
Companies should begin inquiring into the
facts as soon as possible. In certain instances,
this might warrant an independent internal
3. Review and code all documents for investigation—but, in others, it might
responsiveness and privilege. This process involve a less formal review. In either case,
also can be used to identify key documents the ultimate goal is to uncover and assess all
that will be useful as the investigation of the facts (the good, bad, and ugly).
proceeds.
Practice Pointer Practice Pointer

The review process will depend on the Factors to consider when deciding
nature of the documents. In addition to whether to conduct an internal
a privilege review, companies should investigation include the egregiousness of
consider whether documents might the potential problem, the likelihood that
contain information that is personal, financial statements or disclosures will be
proprietary, or covered by statutory affected, whether the problem is systemic
privileges or protections. If documents in nature, and how many individuals
reside outside of the US, companies should are involved and their seniority levels.
be cognizant that foreign jurisdictions Related questions include who should
often have data-protection laws and other oversee the investigation (for example,
legal restrictions. management, the board, the audit
committee, or a special board committee)
and who should conduct it (for example,
internal audit, in-house counsel, outside
4. Comply with the instructions in the
defense counsel, or independent outside
request or subpoena when determining
counsel with no prior relationship with
the mechanics and format of productions
the company). To answer these questions,
and be transparent about production
companies also should consider (1) the
protocols (for example, identifying the
credibility of the investigation with the
reasons for redactions).
regulators, (2) efficiencies from using
5. Where permissible, request confidential
investigators familiar with the company,
treatment of the documents, including
and (3) conducting the review under the
notification of requests made by third
attorney-client privilege.
parties to access the documents.

Identifying key documents and conducting (4) the company can elect to waive the
interviews are important parts of the fact- privilege and disclose the discussion to
gathering process (whether or not a formal third parties, including regulators, without
internal investigation is undertaken). As for obtaining the interviewees’ consent,
interviews, companies should consider the and (5) the interviewees must keep the
following steps: discussion in confidence and may not
discuss the substance of the interview with
1. Generate a list of interviewees. Be aware anyone but counsel.
that multiple interviews of the same
individual may be necessary as further
information is uncovered. Practice Pointer
2. Determine whether cooperation of Interview notes or memoranda should
personnel can be required (through board reflect the fact that Upjohn warnings were
resolution or otherwise) and what actions provided, and companies should consider
can be taken if an individual refuses to whether written acknowledgments
submit to an interview. should be obtained from interviewees.
Practice Pointer 6. Determine how to document interviews.

Under the Dodd-Frank Wall Street Reform Keep in mind that this documentation,
and Consumer Protection Act, there are including notes or formal interview
antiretaliation provisions prohibiting memoranda, could be susceptible
employers from taking adverse to production to the regulators (and
employment actions against whistle- possibly in civil litigation). Avoid
blowers. Companies should consider verbatim recitations and use appropriate
these provisions (along with other legends that identify the documentation
relevant restrictions under employment as being covered by the attorney-client
law or otherwise) before requiring privilege and attorney work product
employees to submit to interviews under doctrine.
threat of termination for noncooperation.
Preparing for and defending testimony
If testimony is required, companies
3. Determine the subject areas of inquiry. In should determine whether and to what
addition to substantive issues, cover the extent witnesses should be represented
interviewees’ document collection efforts by separate counsel. (In some instances,
and the identity of other individuals who individual representation already may have
might have relevant information. been secured—for example, in advance
4. Have two interviewers present at of internal interviews.) Depending on the
each interview to assure proper circumstances, company counsel might
documentation of what was said and to represent certain individuals, or individual
avoid misunderstandings. counsel might represent multiple witnesses,
5. Provide Upjohn warnings at the outset, but potential conflicts of interest need to be
notifying interviewees that (1) counsel considered. Company counsel also should
represents the company and not the assess the feasibility and advisability of
interviewees, (2) the interview is being entering into oral or written joint defense or
conducted to gather facts in order to common interest agreements with counsel
provide legal advice to the company, (3) for others. In addition, companies should
the discussion during the interview is determine whether it is mandatory or
privileged, but the privilege belongs solely permissive to provide advancement of legal
to the company, not the interviewees, expenses (and, ultimately, indemnification)

to individual directors, officers, or other This needs to be done effectively and for the
employees, as well as the prerequisites for purpose of creating a clear record.
doing so—for example, undertakings to
repay advanced funds.
Practice Pointer
Experienced securities enforcement prac-
Practice Pointer titioners typically do not “object” during
SEC rules provide for witness sequestration SEC testimony. This notwithstanding,
and prohibit witnesses or their counsel counsel should interject appropriately if
from being present during the testimony an examiner goes out of bounds in terms
of other witnesses (unless permitted in of questions that call for privileged infor-
the discretion of the officer conducting the mation, irrelevant questions, inaccurate
investigation). See Rule 7(b) of the SEC’s statements of fact, poor treatment of the
Rules Relating to Investigations, 17 C.F.R. witness, or the like.
§ 203.7(b). Counsel, however, is permitted At the end of SEC testimony, counsel
to represent and defend the testimony should request confidential treatment of
of more than one witness. See SEC the testimony under FOIA and follow
Enforcement Manual, Sections 3.3.5.2.2 up with a written request. Counsel may
and 4.1.1.1. During testimony, the Staff also request a copy of the testimony tran-
will typically ask counsel to confirm that script, but sometimes it is advisable not
they represent the witness. Accordingly, to do so—for example, if there is ongoing
if company counsel intends to appear at civil litigation, counsel may decide not
testimony and is not already representing to request a transcript (but, even then, it
the witness, they should consider could be subject to discovery).
discussing this in advance with the Staff
or entering into a limited representation
for the purpose of defending the witness
at testimony.
Taking appropriate proactive steps
Based on an assessment of the facts,
companies should consider taking
appropriate proactive steps, including
Preparation is crucial for any testimony, deciding whether to self-report improper
and sufficient time should be reserved to conduct in advance of a regulatory
cover all potential areas of inquiry. Company investigation (taking into account a range
counsel should already have an extensive of pros and cons) or to impose remedial
understanding of the facts and issues, and measures. Companies can use remedial
the goal of preparation should be to help measures both as a sword (by gaining
ensure that truthful, complete, and credible cooperation credit) and a shield (by making
testimony is provided. Witnesses who do not recurrence of the underlying misconduct
recall much of anything, particularly if the less likely).
facts at issue are recent or of a memorable Remedial measures to consider include
nature, are not received well—and they can (1) developing new or enhanced policies,
be perceived as noncooperative or even procedures, and controls, (2) providing
obstructionistic. training, (3) restructuring lines of reporting
SEC and other regulatory testimony and hiring consultants or additional personnel,
is not governed by evidentiary or civil (4) reassigning, suspending, or terminating
procedure rules, but counsel should avoid employees, (5) implementing heightened
the appearance of impeding the inquiry supervision, (6) withholding bonus payments
or coaching the witness during testimony. and making additional revisions to equity-
Counsel, however, can ask for clarification, as based or other compensation, and (7) providing
well as ask the witness substantive questions. restitution (if possible and appropriate).

Responding to a preliminary charging The conclusion of the investigation, including

determination settlement and other considerations
At the end of SEC investigations, if the Regulatory investigations can conclude in a
Staff makes a preliminary determination number of different ways, ranging from no
to recommend an enforcement action, they charges to the filing of a contested action. As
typically will issue a “Wells notice.” These for SEC investigations, if a decision is made
notices communicate the Staff’s preliminary not to pursue charges, Staff policy provides
determination, identify the potential securities that a closing letter should be issued (although
law violations, and advise of the opportunity this has not always happened consistently).
to make a “Wells submission” responding Other potential outcomes include a (1)
to the charges. The Staff may also provide deferred prosecution or nonprosecution
counsel with an oral briefing of their concerns. agreement (see SEC Enforcement Manual,
The primary purpose of making a Wells Sections 6.2.3 and 6.2.4), (2) settlement with
submission is to dissuade the Staff initially, an agreed-upon action, or (3) contested
or the SEC Commissioners ultimately, action filed by the SEC.
from proceeding with an action or, if this is If an SEC settlement is contemplated,
unsuccessful, to mitigate the charges. These companies should consider a number of
submissions provide an opportunity to lay issues, including:
out the facts in the best light (including
correcting any misconceptions on the 1. Can the company accept the charges
part of the Staff), show why an action is being sought by the Staff? Is the Staff
unwarranted and would be unsuccessful willing to reduce harsher charges (for
if brought, and identify policy and other example, scienter-based violations of the
considerations militating against an action. antifraud provisions) to lesser charges
When drafting a submission, counsel should (for example, process-oriented violations
be cognizant that the audience is the Staff such as nonscienter antifraud, books and
(including senior enforcement officials, as records, or internal control violations)?
well as the trial attorneys who would litigate 2. Is the Staff willing to proceed in a forum
the case) and the Commissioners (who will acceptable to the company, whether
consider the submission if the Staff decides as an administrative cease-and-desist
to proceed with a recommendation). proceeding (which includes findings
of fact, but generally is considered less
severe, has relatively fewer collateral
consequences, and does not require court
Practice Pointer approval) or a civil injunctive action
Wells submissions are not mandatory and,
in federal court (which includes only
in certain circumstances, are not advisable.
allegations rather than factual findings)?
For example, if discussions have made it
3. Are the proposed monetary and
clear that the Staff will not change their
nonmonetary sanctions acceptable? (The
mind and there is no possibility of an
potential sanctions in an SEC action are
acceptable settlement, a company may
discussed below.)
decide to forego a submission. Doing
4. Will the Staff permit the company to
so will avoid revealing the company’s
settle without admitting or denying
positions in advance of contested litigation
the violations, or will admissions be
and protect against potential admissions.
required? (The Staff recently has started
In this regard, the Staff takes the position
to require admissions in certain cases
that Wells submissions are admissible as
involving egregious conduct.)
evidence. Significantly, false statements in
5. Can the company accept the collateral
a Wells submission could be charged as a
consequences of the action, such as
separate criminal offense.
reputational harm, potential consequences

in civil litigation, or disqualifications

from certain issuer exemptions under the Practice Pointer
federal securities regulations (assuming The SEC requires settling parties to agree
the Staff does not agree to waive such not to seek or accept any indemnification
provisions)? or reimbursement (including from
insurers) and not to claim, assert, or
apply for any tax deduction with respect
to penalties paid as part of the settlement.
Practice Pointer
These restrictions typically apply only
Companies operating in particular
to penalties, and not to disgorgement or
industries also might face further
prejudgment interest.
consequences. For example, aspects of
a settlement might trigger debarment
provisions relevant to government
contractors. Companies should assess the foregoing
factors when deciding whether to resolve
an investigation by settlement or to move
The SEC can impose a wide range of sanctions to litigation. Decisions made during the
in connection with a settled or contested course of the investigation can position the
action. The nature of the sanctions will company and help determine the outcome,
depend on the underlying conduct, as well including whether the inquiry will conclude
as the company’s response to such conduct without any action being taken, an acceptable
(including self-reporting, cooperation, and settlement will be possible, or litigation will
remediation). Potential sanctions include be the only option.
(1) an injunction or cease-and-desist order,
(2) disgorgement of “ill-gotten gains” and
related prejudgment interest, (3) penalties
ranging up to millions of dollars per incident,
(4) barring individuals from serving as
officers or directors of public companies,
(5) barring accountants or attorneys from
appearing or practicing before the SEC,
and (6) requiring companies to agree to
undertakings (such as the appointment of an
independent consultant or monitor).

30 Sarbanes-Oxley/internal control
Neal Bradsher, Partner; Aaron Sage, Director; and Alicia Seaton, Director KPMG LLP
T
he Public Company Accounting Reform and Investor Protection
Act of 2002 (also known as the Sarbanes-Oxley Act, or SOX)
was enacted as a response to the crisis of confidence in the
financial integrity of public companies. While SOX is composed of
11 titles, ranging from corporate tax return approvals to securities
analyst independence, three titles (III, IV, and IX) specifically cover
corporate governance and internal controls applicable to public
companies.
Though all public companies must comply with applicable
SOX requirements, pre-initial public offering (IPO) and newly
public companies will face the greatest challenges in designing
and implementing a robust system of internal controls to meet the
requirements outlined in titles III, IV, and IX. Specifically, SOX Section
404(a), which requires management to assess the effectiveness of
internal controls over financial reporting (ICOFR) annually, and
Section 404(b), which requires the independent auditor to provide
an independent assessment, can involve significant effort. Certain
phase-in exemptions, however, are afforded newly public companies
to allow time for implementation of these ICOFR requirements. With
a well-planned and well-executed ICOFR implementation strategy
that takes advantage of applicable exemptions, private companies
can smoothly transition to public entities in full compliance with
SOX. Management’s assessment under Section 404(a) must be based
on a suitable control framework. Though not required, most US
registrants utilize Committee of Sponsoring Organizations of the
Treadway Commission (COSO), discussed further below, as their
internal control framework.
COSO internal control—integrated framework

In 1992, the COSO published the Internal Control–Integrated Framework
(the original framework), an integrated framework establishing a
common definition of internal control:
Internal control is a process, effected by an entity’s board of directors,
management, and other personnel, designed to provide reasonable
assurance regarding the achievement of objectives relating to operations,
reporting, and compliance.

KPMG LLP Sarbanes-Oxley/internal control
In 2013, COSO released an update to the and up to 20 years in prison. This includes
framework. The changes made to update compliance with the requirements of Section
the 1992 framework are evolutionary, not 13(a) or 15(d) of the Securities Exchange Act
revolutionary. The 2013 framework takes of 1934 covering management’s reporting of
into account changes in the business ICOFR. Such stringent penalties are designed
environment and operations over the last to serve as a deterrent to executives who
20 years. The 2013 framework retains the would otherwise be inclined to mislead the
definition of internal control and the COSO public or falsify financials for personal gain.
cube, illustrating the five components of The Sections 302 and 906 certifications
internal control: control environment, risk are required with a public company’s
assessment, control activities, information first periodic Securities and Exchange
and communication, and monitoring Commission (SEC) filing (eg 10-Q, 10-K, 20-F)
activities. and all such filings thereafter. As a result,
The principles-based COSO framework newly public companies will generally be
defines the elements of internal control required to certify under Sections 302 and
that are expected to be present and 906 prior to having fully implemented an
functioning in an integrated manner, ICOFR assessment program under Section
including ICOFR. Ultimately, ICOFR should 404. Due to this difference in timing of
provide reasonable assurance regarding the implementation, certifying officers will need
reliability of an entity’s financial reporting to ensure they have a sufficient basis on
and the preparation of financial statements. which to provide their required 302 and 906
certifications. Fortunately, one transitional
SOX Sections 302 and 906 period modification to the certification
SOX imposes greater accountability on senior language is allowed for newly public
management for the company’s financial companies, who may omit the paragraph on
reporting results. Section 302, in particular, the 302 certification related to effectiveness of
requires the principal executive and ICOFR, including responsibility for designing,
financial officers to certify they have read the establishing, and maintaining ICOFR, until
financial statements and, to the best of their their second annual filing (eg 10-K, 20-F).
knowledge, the financial and nonfinancial
information is accurate, complete, and fairly Disclosure controls and procedures
presented. Additionally, they must certify To assist management in fulfilling their
that the following items, if applicable, have responsibilities under SOX Sections 302
been appropriately disclosed: any material and 906, companies will need to establish
changes to the company’s internal controls, disclosure controls and procedures. Effective
any significant deficiencies or material disclosure controls and procedures (DCP)
weaknesses in the design or operation of include thorough financial statement review
the company’s internal controls, and any and mid-level management ownership of
evidence of fraud involving management controls to provide comfort to the chief
or employees having a significant role in executive officer (CEO) and chief financial
ICOFR. officer (CFO) that disclosures are complete
SOX Section 906 holds the chief executive and accurate. Some common elements of
and financial officers legally liable for DCP can include the following:
verifying that the report fairly presents, in
all material respects, the financial condition •
Disclosure policy—articulates the
and results of operations of the issuer. corporate disclosure objectives, and
Under Section 906, upper management who specifies the following: who is authorized
knowingly certify misleading or fraudulent to speak on behalf of the company,
financial statements are subject to criminal responsibility for disclosure processes
penalties including fines of up to $5 million throughout the organization, policies

Sarbanes-Oxley/internal control KPMG LLP
for maintaining disclosure records, • Scope evaluation/risk assessment—The

and procedures for managing all implementation process begins with an
disclosure channels such as electronic evaluation of the company’s locations,
communications, corporate websites, segments, and processes. Per both SEC and
and corporate and public presentations Public Company Accounting Oversight
to parties other than the investment Board (PCAOB) guidance, companies are
community. recommended to utilize a top-down, risk-
• Disclosure committee—assists senior based evaluation of financial reporting
officers in implementing proper DCPs risks and related controls by performing
and overseeing the accuracy and both a quantitative analysis of account
timeliness of disclosures (eg review of balances and a qualitative analysis of a
periodic financial statements prior to variety of risk factors (eg susceptibility
public disclosure and filing with the SEC). to errors, volume of activity, degree of
• Subcertification process—promotes judgment or estimate). Upon evaluating
and expands accountability of financial the qualitative and quantitative factors,
disclosure by requiring key company management finalizes the locations
personnel to certify similar assertions and processes to include in its SOX 404
as those included on the 302 and scope. Next, material financial statement
906 certifications. Note: Ultimate line items are mapped to the in-scope
responsibility under Sections 302 and processes. Finally, process-level risks are
906 rests with the chief executive and identified for relevant financial statement
financial officers and cannot be delegated assertions.
through a subcertification process. • Document controls—Once the risk
• Control owner certification process— assessment is completed, key controls
requires control/information technology should be identified and documented,
(IT) application owners to periodically including those addressing assertions
certify to the adequacy and operating related to all significant accounts and
effectiveness of internal controls. disclosures. Major categories of controls
Control owner certifications may include include the following:
notification to management of any  Entity-level controls (ELCs)—
material changes in controls. centralized monitoring controls that
may reduce the reliance on lower-level
Section 404: assessment of internal control process/transactional controls. ELCs
Implementing an effective system of can be further classified as direct or
ICOFR, as required by SOX Section 404, indirect based on whether or not they
involves significant cost and planning address a relevant financial statement
and coordination of multiple stakeholders assertion.
including management, employees, and  General information technology
the company’s independent auditor. The controls (GITCs)—controls governing
ongoing maintenance of the ICOFR program, the environment, effective operation of,
however, is less burdensome as the focus access to, and program development
shifts from identifying and adequately and program changes related to the
addressing (ie documenting and testing) all in-scope IT applications.
financial reporting risks and controls to only  Process-level controls—controls, both
those items that have changed. manual and automated, within the
in-scope processes that mitigate the
SOX 404 implementation phases identified risks to the relevant financial
ICOFR implementations generally consist statement assertions to an appropriate
of the following components (see Figure 1): level.

Documentation such as process flow-  Significant deficiency—a deficiency,

charts, narratives, and risk and controls or a combination of deficiencies, in
matrices can facilitate management in internal control over financial reporting
understanding of the flow of financial re- that is less severe than a material
porting–related transactions and identify- weakness, yet important enough to
ing the related risks and control points. merit attention by those responsible for
oversight of the registrant’s financial
• Test controls—Upon identifying and reporting.
documenting controls over financial  Material weakness—a deficiency, or a
reporting, management performs combination of deficiencies, in internal
testing of controls to help ensure they control over financial reporting such
are adequately designed—providing that there is a reasonable possibility
reasonable assurance regarding the that a material misstatement of the
reliability of financial reporting—and registrant’s annual or interim financial
operating effectively. Testing strategies statements will not be prevented or
should be determined based on the detected on a timely basis by the
nature of the account or disclosure (eg company’s internal controls.
accounts with an inherently higher level • Report on controls—The results of
of risk), and the volume, complexity, and controls testing are formally documented
homogeneity of individual transactions. by management in a report on the design
Changes from a prior period are also and effectiveness of internal controls.
considered when planning and executing The independent auditor reviews
tests of controls. management’s report and test work, as
• Correct deficiencies—Identified control well as the results of their own testing,
deficiencies related to design or operating and issues an internal controls opinion
effectiveness are documented and as part of its overall audit report. If a
assessed individually and in aggregate material weakness exists, management
to determine severity related to the cannot conclude they have maintained
potential magnitude and likelihood effective ICOFR. Significant deficiencies
of misstatement in the financials. For and material weaknesses must be reported
purposes of SEC reporting, ratings of to the company’s audit committee of
“deficiency,” “significant deficiency,” and the board of directors. For material
“material weakness” are assigned. Per the weaknesses, management must state
SEC, significant deficiency and material in its annual report filed with the SEC
weakness are defined as follows: that its internal controls are ineffective.
Figure 1 ICOFR implementation phases

Scope Document Test Correct Report on
Evaluation Controls Controls Deficiencies Controls
• Determine • Document • Test control • Identify and • Prepare written

significant design of design correct control assertion of the
controls controls over and operating deficiencies. effectiveness of
and business relevant effectiveness. ICOFR.
units. assertions
related to all • Document
significant results.
accounts and
disclosures.

Sarbanes-Oxley/internal control KPMG LLP
Additionally, the SEC recommends focus of many companies to create new

companies consider disclosing additional or place more reliance on existing process
details regarding material weakness, flowcharts. Consideration of this should
including the nature, impact, and be given by companies anticipating an
planned/executed remediation activities. IPO, as well as newly public companies,
as they evaluate and determine the format
Management considerations for their control documentation.
While there are several required components • Degree of centralization—For companies
of a SOX program (eg testing of controls), with decentralized operations and control
management can exercise judgment over environments or multiple locations/
various aspects related to the program business units, consideration should be
design and execution. Such items include, given as to whether a consistent, global set
but are not limited to, the following: of controls will be established for the entire
organization or if each location is granted
• Alignment between management’s and the a degree of autonomy in the identification
external auditor’s evaluation approaches— of controls. There are advantages and
Management and the external auditor disadvantages to either approach (eg
must individually express an opinion uniformity versus flexibility; corporate
on the effectiveness of ICOFR. Provided versus entrepreneurial); consequently,
certain criteria are met (eg competence management should evaluate its unique
and objectivity of management resources circumstances to determine the most
executing the SOX program, minimum effective approach.
control testing sample sizes), guidance • Multi-use documentation—Management
allows the auditor to utilize the work of may choose to leverage its SOX control
other parties as part of their assessment. In documentation for purposes beyond
other words, the external audit may place satisfying its Section 404 ICOFR
reliance on a portion of the procedures requirements. Examples include
performed by management as part of adding additional process steps, risks,
management’s assessment. However, and controls related to regulatory or
this will generally require the evaluation operational aspects.
approach utilized by management to be
aligned with the external audit evaluation Obstacles to implementation
approach, which may not be the most SOX compliance takes considerable
effective or cost beneficial for management planning and coordination across all levels
purposes. Thus, the potential cost and of management to implement and maintain.
benefits of maximizing auditor reliance Pre-IPO companies should evaluate obstacles
should be evaluated early in the process to prior to beginning SOX implementation.
help ensure the desired level of reliance is Potential obstacles may include limited
achieved. resources with the appropriate business
• Documentation format—There is no knowledge, competing priorities on
required format of control design management’s time, and complex IT systems
documentation. Companies may elect that must be aligned to SOX controls.
to utilize flowcharts, narratives, policy Companies also face continual changes
and procedure manuals, risk and control within business processes and ongoing costs
matrices, or a combination to document of compliance efforts.
their design of ICOFR. However, there has Considerable effort is required to identify
been recent emphasis from the PCAOB on and remediate control design deficiencies,
auditors of public companies to clearly instances where controls are either missing
identify the flow of transactions utilizing or inappropriately designed to achieve
a flowchart format. This is shifting the their specified objective. Even for well-

controlled companies, challenges remain Section 406: code of conduct and ethics
related to producing sufficient evidence Section 406(c) requires all US-listed
supporting effective operation of controls. companies to maintain a code of conduct
In many instances this includes education applicable to all directors, executives, and
and cultural changes for areas outside of employees with the definition of “code of
accounting and finance that may not be as ethics” as stated in this section. The NYSE
accustomed to formalized documentation Corporate Governance Rules (Provision
retention requirements (eg IT, operations), 10) also require a company to adopt
understanding the importance of and disclose its Corporate Governance
documenting, and formalizing their controls. Guidelines and Code of Business Conduct
and Ethics. The code of conduct must be
Section 404 transitional timing for newly public publicly available and must define conflicts
companies and other exemptions of interest, illegal and improper payments,
Due to the extensive burden placed on anti-competitive guidelines, and Foreign
companies in implementing effective ICOFR, Corrupt Practices Act (FCPA) compliance, as
the SEC provided phased-in timing of well as acceptable dealings with employees,
compliance for newly public companies. In suppliers, customers, investors, creditors,
addition to the previously discussed Section insurers, competitors, auditors, and so forth.
404 certification and auditor attestation
exemptions, reliefs are afforded by some Section 303 and SEC Rule 10A-3(b)(3): anti-fraud
recent legislation. In addition to the legal liability that
Under Title IX of the Dodd-Frank Wall executive management has for the fairness
Street Reform and Consumer Protection Act of the financial statement presentation, SOX
of 2010 (the Dodd-Frank Act), nonaccelerated Section 303 forbids any officer or director
filers (companies having less than $75 million from taking action to fraudulently influence,
in market capitalization) receive permanent coerce, manipulate, or mislead independent
exemption from the auditor attestation public or certified accountants engaged
requirements under Section 404(b). in auditing the financial statements with
The Jumpstart Our Business Startups the intention of rendering the financial
Act (JOBS Act), ratified on April 5, 2012, statements materially misleading. However,
created, among other things, a new category unlike Section 906, Section 303 does not
of public equity issuers called emerging outline specific penalties for those found
growth companies (EGCs) that can elect guilty of fraud.
to be exempt from some SEC reporting Audit committees must also establish
requirements for up to five years, including whistle-blower procedures and an ethics
the auditor attestation requirement under “hotline” for receiving, retaining, and
Section 404(b). An EGC can elect exemption processing complaints regarding accounting,
from the 404(b) requirement for the shorter internal control, or auditing matters
of the period it continues to qualify as (SEC Rule 10A-3(b)(3)). The policy must
an EGC or five years. This election does be communicated to all employees, and
not impact the Section 404(a) management complaints must be treated confidentially
assessment requirement. and anonymously to foster an environment in
which individuals are comfortable reporting
Additional SOX requirements potential fraud and other violations.
In addition to SOX Sections 302, 906, and Management is required to monitor any
404, several other sections relate to internal reported violations to determine if items
controls and corporate governance. require resolution and reporting to the audit
committee or board of directors.

31 Cybersecurity oversight
William Stewart, Financial Services Practice Leader; Jeff Lunglhofer, Cyber Financial Services Practice Leader;
Sudhir Anantharaman, Principal, Cyber Financial Services Practice Booz Allen Hamilton
E
xecutive leadership has a fiduciary responsibility to ensure
the organization builds and maintains a cybersecurity
program that securely enables business operations and
services. This program must align cybersecurity and regulatory
requirements with the overall business strategy while managing
risk, optimizing information security investments, and ensuring
regulatory compliance via performance measurement and
continuous monitoring. The upsurge in reported cyberattacks
on banks and businesses, high-profile data breaches, and other
damaging incidents underscore the urgency of the task, but
corporate leaders, especially those without extensive cyber
experience or expertise, may wonder how to execute this duty
effectively. How can boardroom executives help the organization
select, implement, and manage robust cybersecurity controls? In
particular, what questions should they ask the chief information
security officer (CISO) and cybersecurity staff to guide the
adoption of the right policies, processes, organizational culture,
technologies, and, most important, cyber team? Executives can
provide the necessary high-level oversight by focusing their
attention on five mutually reinforcing areas of cybersecurity:
• Executive governance—Build effective cyber oversight and

accountability aimed at protecting your most valuable assets.
• Cyber leadership—Connect cybersecurity directly with your
business objectives by elevating the CISO’s role within the
organization.
• Human capital planning—Design policies that attract, develop, and
retain your cyber talent.
• Cybersecurity controls—Implement technologies and processes for
proactive security that anticipates, prevents, protects against, and
remediates cyberthreats.
• Cyber-enabled innovation—Make security a partner with your
business and technology organizations to develop solutions that
support business innovation and growth.

Booz Allen Hamilton Cybersecurity oversight
By asking the right questions to highlight The governance model should also
and strengthen these five areas, corporate establish a well-defined risk appetite
leaders can help their organizations nurture that can incorporate both centralized and
a cybersecurity program that enables the federated approaches. Not every product
business. and business line within an organization
will have the same risk appetite for their
Executive governance operations or functions. For example, in
An effective governance model will have one business line, an always-available help
several important features. First and desk may be an absolute necessity, while
foremost, it will clearly define who has another business group might tolerate
responsibility—who is accountable— more down time with little impact on its
for the cybersecurity activities of the business. The organization’s cybersecurity
organization. Typically, accountability policies and standards should have the
falls upon the CISO, who reports to the flexibility to accommodate these different
chief information officer (CIO), who in requirements.
turn reports to the chief operations officer. By focusing cyber activities on their most
Responsibilities can often become blurred, valuable assets, organizations can align
especially in large organizations, so it is their cybersecurity activities more closely
important that the CISO and cybersecurity with their business objectives; this, in turn,
staff understand both their duties and will enable them to allocate their cyber
expected outcomes. resources in the most efficient way to reduce
Performance measures are essential overall corporate risk. The performance
for holding people accountable. Most measures will not only increase security
organizations understand this, but too in the targeted areas, but they also will
often they try to measure all aspects create return-on-investment metrics that
of cybersecurity equally, creating a can guide future investments and decision-
lot of “noise” that reduces rather than making.
enhances understanding of risks and
vulnerabilities. Consequently, in devising Cyber leadership
performance metrics, organizations should Organizations need cyber leaders who
identify their most valuable assets, such can speak the language of business and
as high-impact information systems that help executives understand the connection
are critical to the organization’s day-to- between cybersecurity and the business.
day operation and data repositories that This represents a more demanding, elevated
store intellectual property, source code, role for CISOs. CISOs traditionally have
customer information, or other sensitive focused on the technical requirements
corporate data. Important assets might of cybersecurity—the protection of data,
also include customer-focused networks networks, and systems—often without
that support business-critical operations, fully understanding their organization’s
physical infrastructure, and even high- core business functions or the business
profile corporate executives. Not every impacts of their cyber activities. At the same
asset is equally valuable, so organizations time, the organization’s business leaders
should prioritize their cybersecurity have not fully understood the challenges
investments and activities to protect the and intricacies of implementing a smart
assets that are most critical to sustaining cybersecurity program. This can lead to
the business. Performance metrics will inefficient cybersecurity investments and
hold the cybersecurity staff accountable a cybersecurity program that exposes the
by measuring how well the organization’s organization to greater business risk than
critical assets are being protected. corporate leaders realize.

Cybersecurity oversight Booz Allen Hamilton
To support CISOs in their expanded role, knowledge and other skills that can inform
boardroom executives should ask whether their cybersecurity activities. This also means
organizational processes facilitate dialogue organizations should create career paths for
between CISOs and business leaders. cybersecurity staff that do not pigeonhole
Similarly, they should ask whether CISOs them strictly as technologists. Instead, an
have the business training and experience ideal career path will allow them to expand
to understand the organization’s business their business and management talents,
operations and priorities. These capabilities along with their technical capabilities, so
will enable CISOs to report cyber risks in they have more opportunities for corporate
business terms; and with this information, advancement. For many organizations, this
corporate executives can provide guidance may require revising or even creating new
based on business risk and risk appetite. labor categories for cyber employees—in
Some risks will be deemed more acceptable terms of both compensation and career
than others. The CISO should provide trajectory—to reflect their vital role as
executives with regular updates regarding: business enablers. Such changes will create
a solid foundation to help attract, develop,
• existing cyber risks to the enterprise and retain cyber staff.
• programs and progress for addressing/ In addition, organizations may also
remediating risks want to consider creating research and
• status of risks previously deemed development opportunities within their
acceptable cybersecurity groups. This will improve both
• changes in the threat environment that the hiring and retention of skilled workers
may impact business risk. who want to participate in developing new
technologies and products, keeping them
By bringing the CISO into boardroom more engaged and energized versus working
conversations, organizations can make the in a purely operational environment. Their
security function a potent force for business enthusiasm and innovative solutions will
improvement. Rather than representing strengthen the organization’s cybersecurity
an obstacle to innovation, as CISOs have posture and, perhaps, lead to new product
often been viewed in the past, they become offerings as well.
partners with business executives and
technical staffs in innovation, problem Cybersecurity controls
solving, and change. An organization’s cybersecurity controls
represent the front line in the battle to
Human capital planning anticipate, prevent, protect against, and
Attracting, developing, and retaining remediate cyberthreats. Overseeing this
cybersecurity talent has become increasingly vast set of cyber processes and technologies
difficult, due largely to a shortage of qualified can be overwhelming, and so it is helpful
professionals. Many organizations are for corporate executives to focus on three
caught up in an endless cycle of luring cyber general categories:
employees from partners and competitors, an
escalating battle that results in few winners. • Baseline controls. These are the foundational
How can your organization become a place controls that are required for nearly any
where cyber talent wants to work? cybersecurity program. They include:
One of the keys to strengthening  Asset management to identify and
human capital planning is to understand track your most valuable assets—that
that cybersecurity is more than a technical is, your business’s “crown jewels.”
challenge, so finding the right people This can be a significant challenge,
means identifying people with either the particularly in a large enterprise
knowledge or potential to develop business environment. Consequently, a

foundational control required deploy a critical security fix? Is there a

for any cybersecurity program well-defined process to test/evaluate
is to understand your assets, such a fix before putting it into production?
as where your most sensitive data Such questions will apply to all of your
resides and how it is transported and assets.
processed. This knowledge will guide  Policy and standards to formalize and
the creation of controls standards capture the vision and direction of an
and requirements that offer the right organization’s leadership, while also
level of security for your business. helping create a more robust and fault-
Some important questions executives tolerant program. An ad hoc approach
may want to ask are: What data is to operating a security organization
considered sensitive? How do we may work well for a while, but can
classify our sensitive corporate data cause an organization to struggle
and assets? Where are they located? when faced with the departure of key
Do we have an accurate inventory staff members and experts. Capturing
of all our assets? Have we defined cybersecurity policies, standards, as
controls standards that address the well as the procedures and processes,
cyber needs of those assets? is essential to creating a sustainable
 Identity and access management program.
(IDAM) to control who has access to  Security monitoring to provide security
specific data, systems, and networks. staff with real-time visibility into
Organizations must be able to answer the health and activity of networks,
fundamental questions about who has systems, and data. Understanding
the right to access sensitive data and how your assets behave—including
how those access rights are granted, your people—is essential to rapidly
monitored, and eventually revoked detecting and stopping data leakage
as needed. Executives might consider before it can cause damage to your
asking: Who is able to access our organization. Data-protection
company’s sensitive data, such as strategies start with being able to
corporate email and data repositories, understand how your data is moving
as well as information on laptops, and your assets are behaving in near
tablets, smartphones, and other real-time across your enterprise. For
devices? Who is able to change or example, would your organization
bypass security controls? Who is able know if corporate data was removed
to access our networks and systems from a server via a USB device or
remotely? Who tracks the number of exfiltrated using a Web-based data
employees, contractors, and others transfer service, email, or other
who have access to sensitive data? means?
 Configuration management to ensure  Incident response to identify and respond
that your infrastructure and assets are quickly to attacks and breaches,
configured—and the configuration is including the ability to remediate and
maintained—to provide the level of restore normal functions. Even the best
security required by your organization. cybersecurity controls cannot prevent
This is a more complex challenge all incidents. Consequently, your
than many realize. As an example, organization should have the ability
maintaining a corporately managed or to respond rapidly once an incident
outsourced web server requires your is detected. Would your organization
organization to know: How was the know how to identify a single asset
server configured when it was built? on your enterprise network that
How quickly could the organization appeared to be leaking data? How

long would it take to detect the to share data with strategic business
breached asset? At what point would partners, and they enable you to take
corporate executives be notified of a advantage of more efficient ways to
potential cyberbreach? When would process and store data, such as private
you involve external legal counsel and and public cloud environments and an
law enforcement? How often are your increasingly mobile workforce.
incident response plans tested? Will  Predictive threat intelligence to enable
your incident response and forensics your organization to predict, rather
procedures hold up in court? than just respond to attacks, by focusing
In addition to asking the high-level on monitoring the threat actors directly
questions suggested for each control area, versus waiting for indications that
executives should ask the CISO whether an attack against your organization
the organization has sufficient resources, is already underway. This can be
training, and discipline to achieve its accomplished by leveraging third-
cybersecurity goals. party threat intelligence providers,
• Emerging controls. Your organization building your own internal program,
should also be positioning itself to or a combination of the two. Your
adopt the next-generation of controls for decision should be based upon your
increasing security and reducing cyber need to predict and prevent attacks
risk. Making sure that your cybersecurity and your available resources. Building
program is exploring the features and a threat intelligence capability requires
capabilities of these emerging controls dedicated staff with the right levels
can also strengthen your human capital of expertise, technology platforms to
strategy to keep your cyber talent happy monitor the “dark web” where threat
by giving them opportunities to explore actors operate, and the ability to collate,
cutting-edge technologies and strategies analyze, and generate actionable threat
on behalf of your business. Among the intelligence reports.
still-maturing technologies that your Again, executives should ask their CISOs
cybersecurity team should be paying what they are doing to track, develop, or
attention to are: incorporate these emerging controls into
 Cyber data analytics that analyze the vast their organization’s cybersecurity program.
amount of data generated by your users • Security control framework. Given
and systems to uncover anomalous the complexity and myriad of
activity and identify potential threats, possible cybersecurity controls (this
thus helping anticipate attacks and discussion covers only a select few),
prevent intrusions by even the most your organization should consider an
sophisticated threats. established security control framework
 Insider threat program to detect, to organize and align your security
prevent, and manage rogue behavior controls and guide investments in new
by employees through a variety of controls. An organization can create its
mechanisms, such as employee own framework of standards and best
education, white listing, and behavior practices or it can adopt/modify one of
monitoring. several established standards, such as:
 Next-generation data protection that uses  ISO 27000 series of security standards.
cutting-edge technology—such as These provide international standards
“tokenization” and/or digital rights for baseline corporate security practices
management (DRM)—to provide in numerous areas, including infosec
protection at the data level. These controls, infosec governance, infosec
technologies hold the promise of more metrics, infosec risk management,
securely allowing your organization cybersecurity, network security,

information and communications products, services, and technologies, they

technology (ICT) business continuity, need a security perspective—one that
and incident management, as understands the cybersecurity implications
well as sector-specific guidance for of planned changes—to help guide strategy.
telecommunications, financial services, Consequently, corporate executives will
and health care. want to ensure that their organizations
 The National Institute of Standards promote collaboration among the CISO,
and Technology (NIST) cybersecurity CIO, CTO, and other business leaders
framework. The NIST framework charged with developing new products and
incorporates standards, best practices, technologies. In addition, the CISO should
and creative ideas developed by NIST be empowered to stay ahead of emerging
in collaboration with industry and technologies and formulate future-looking
government cybersecurity experts. It design patterns, requirements, and
provides a foundation upon which standards, so that the business can securely
each organization can build a robust tap into those next-generation technologies.
framework that reflects its individual Whether they are moving to virtualization
culture, processes, and requirements. or the cloud, developing mobile strategies
 International frameworks such as for customers and employees, developing
Control Objectives for Information new products, expanding online services,
and Related Technology (COBIT) and or adopting other innovative solutions,
Information Technology Infrastructure organizations will achieve greater success
Library (ITIL) practices, as well by making the CISO an integral part of
as a variety of regulatory control business strategy and planning.
frameworks developed by industry-
specific organizations. Conclusion
Cybersecurity oversight poses a complex
By creating a cybersecurity framework, challenge for boardroom executives. Those
an organization will also create the tasked with this responsibility often make
documentation required by regulators to the mistake of immediately focusing on
ensure the proper security processes and their organization’s cybersecurity controls.
controls are in place. In addition, a robust In fact, the starting points for a discussion
framework can provide an organization’s of cybersecurity should be governance,
partners with assurance that it has leadership, and human capital planning.
implemented effective security controls. Organizations need a cyber governance
Overall, the framework should be oriented model that (1) links cybersecurity with
to help the organization connect cyber risk business operations and services; (2) defines
with business risk. who is accountable; and (3) incorporates
performance measures to ensure
Cyber-enabled innovation accountability and a focus on protecting
As a business enabler, an effective the organization’s most valuable assets. At
cybersecurity program not only supports the same time, the CISO and security staff
current business, it also facilitates the should have both the technical skills and
integration of innovative next-generation the business knowledge to help leaders
technologies, products, and services. In understand how cyber risks may impact the
an organization that recognizes this key business. Close collaboration between the
connection between security and business, CISO and business leaders will enable the
the CIO, chief technology officer (CTO), and organization to identify and deploy the most
CISO will work closely together on their cost-effective cybersecurity controls—all in
respective agendas. As CIOs, CTOs, and alignment with the organization’s specific
business leaders explore new approaches, business requirements and risk appetite.

Ultimately, this collaboration will spur to make cybersecurity not just a defender
greater innovation as the CISO assumes an of networks and data, but an enabler of
elevated role in the organization’s leadership business.

32 Cybersecurity law
Ed Batts, Partner DLA Piper
C
ybersecurity has engulfed many risk managers lately because
of the ubiquitous and transformative nature of the threat.
Every business uses computers, the vast majority of which
are hooked up to the Internet, whether in an explicit fashion, such
as e-commerce websites, or in more subtle ways, such as plant
equipment seeking software updates. Further, because an overall
security program is only as good as the weakest link in the system,
companies must also be wary of third parties—whether suppliers
or customers—who have access to company networks. And
once a clever criminal has gained access to a company’s system,
whether through a metaphorical front or back computer door, that
criminal can seek to enter through more sensitive electronic doors
within company computer systems to compromise personal data,
steal trade secrets, or wreak retribution for perceived slights.
Cybercrime is difficult to understand. It is not a single strategy
but a host of rapidly evolving and adapting approaches. It can
come from close within, such as an insider with network access
credentials using a thumb drive, or from borders far away. And it is
a completely silent crime that by its very nature is hard to monitor.
Yet, conversely, once cybercrime has been discovered, modern
regulators force public disclosure and accompanying scrutiny.
Securities and Exchange Commission (SEC) regulations require
the public disclosure of material cyberbreaches. Other regulations
impose duties to notify individuals when their personally
identifiable information has been compromised. These disclosures
are embarrassing, undermine the credibility and brand of a company,
and threaten the withdrawal of future business.
Within this difficult construct, what is the legal role of a
member of a board of directors with respect to cybersecurity? The
overwhelming majority of US public companies are incorporated
under Delaware law—and state jurisdictions elsewhere often mimic
Delaware analyses. Delaware recognizes roughly four fiduciary
standards; however, only one applies in the ordinary day-to-
day business of a company when a change-of-control, through a

Cybersecurity law DLA Piper
merger or acquisition or similar transaction, Two emerging paradigms are to have:

is not on the horizon. That uniform standard
is the “Business Judgment Rule,” and it • a chief information security officer (CISO)
focuses on three duties: acting in good faith, who reports potentially to the CFO, or
with due care and loyalty. Accordingly, this chief operating or administrative officer,
rule mandates that a director be free of or in smaller organizations the CEO,
personal conflicts of interest and, perhaps but with a dotted line to a delegated
more broadly applicable, be reasonably well committee of the board; or
informed (as an “ordinarily prudent person” • some companies have adopted a chief
should be in a like position) about the state security officer (CSO), which encompasses
of affairs of the corporation. both physical security and cybersecurity,
As a result, boards have an obligation, and a CISO may be a direct report to a
at the risk of lawsuits from stockholders, CSO.
to be reasonably well informed about a
company’s business. Conversely, most Irrespective, boards should question
members of boards of directors were organizational charts where the CISO (or
nominated for their position because of their equivalent) reports to the CIO, thereby
business experience, which generally means creating a potential for undermining the
they often are older than management and autonomy of the CISO function. A board
not necessarily technologically savvy. must also think about the role of a chief
As directors prepare to fulfill their duty privacy officer and the degree to which
of care in an informed way, what are the a chief privacy officer and CISO interact
issues that matter today? The following and have potentially overlapping, but still
list of questions and issues was created critically separate, duties.
to help outside directors understand the
cybersecurity issues that matter to boards What is the role of board oversight in
today based on information from panel cybersecurity?
discussions and individual directors. Not Does the board of directors receive regular
every topic needs to be visited quarterly, briefings on cybersecurity or only on an
but a board member should have some “as-needed” or exception basis? Has the
general understanding of how the company board delegated cybersecurity monitoring
is approaching each area. to a board committee, often either the audit
committee or a risk management committee?
Who is in charge of your cybersecurity plan, As a general rule, the amount of
and which parts of your company are involved? information that a board receives should
The Roman philosopher Cicero once be commensurate to a particular subject’s
famously asked, “Who guards the guards?” relative importance to the overall business.
Companies in the past have often swept Cybersecurity has the potential to instantly
cybersecurity underneath the responsibility cripple business systems while wrecking a
of the chief information officer (CIO). company’s public image. Accordingly, under
However, the CIO is precisely the individual the duty-of-care principle, a board should
with responsibility for architecting regularly receive updates on cybersecurity.
information technology (IT) systems. Having Such briefings should cover many of the
a cybersecurity function, particularly one topics addressed in this chapter from a
with “red team” functions reporting to the recurring programmatic perspective, as
CIO thus would be the functional equivalent well as any episodic events, such as known
of having an internal audit function report breaches or breach attempts.
directly and only to a chief financial officer Boards should be careful to avoid
(CFO). delegating cybersecurity in full to a

DLA Piper Cybersecurity law
committee. While as with any committee Obviously not all company information
topic a committee may be best positioned to needs to be protected at the same level of
delve into details and tease out clarity at a security. Certain systems may be too old
level that is not feasible for an entire board, the or too big and full of marginally important
relevant committee should spend sufficient information to place expensive security
time to understand its implications—and measures on—however, it is crucial that
thus cybersecurity should not be a “check- such systems have strict gates between those
the-box” perfunctory agenda item for the systems and other more sensitive parts of a
audit committee—and either the relevant company’s overall network.
committee chair should regularly report to Accordingly, a board needs to ask: What are
the full board or, more optimally, ask the the most important information components
appropriate company manager, such as the of the company and where and how are these
CISO, to do so. components stored and protected? What has
In addition, board composition is an management done to assess the risk map of
increasingly important component in this the company’s information crown jewels? Is
area. Just as boards now routinely as a matter the company in a particular industry, such
of regulation have a financial expert, boards as defense, technology, or finance, where
need to consider whether one or more of attacks have occurred with greater regularity
their members is sufficiently educated and among its peers?
savvy on cyber issues to represent the board
as a whole when reviewing detailed issues. If Do you have an incident response plan? Have
the board lacks this competency, they should you done a tabletop exercise?
consider including this skill-set when next Many companies long ago drafted disaster
considering director nominations. response business interruption mitigation
plans for earthquakes, hurricanes, or other
Who are your likely adversaries (state- natural disasters. Having a similar plan,
sponsored, competitive, criminal, etc.), and even if only at a relatively high level, for a
what crown jewels do you most need to protect cyberbreach is a fundamental first step in the
from them? response process. Designate a team ahead of
The idea of state-sponsored cyberthreats may time, including technical, public relations,
seem far-fetched to many boards. However, and legal advisers. Have draft press releases
many industries, such as the financial for the most likely scenarios vetted and on
industry in particular, have been the target of the shelf for possible short-notice release.
state-sponsored threats. Still other industries Understand the internal working group
have come under propaganda attacks, or and levels of authority for responses,
worse, from foreign governments. Some particularly if one or more individuals
governments also blur the line between state- are not contactable because of vacation
sponsored computer espionage and linking it or travel. While boards and management
to their domestic industries. alike often are subsumed by the day-to-day
Companies that have crucial competitive operations of making quarterly numbers,
informational advantages in the form of trade a small amount of advance planning can
secrets, including manufacturing know-how avoid massive confusion and the public
and processes, must also be wary of direct appearance of disorganization if and when
competitors overseas. Finally, any company an incident occurs.
that has personally identifiable information,
including human resources (HR) information What does you network map look like (physical
such as social security numbers of its assets, cloud resources, physical and digital
employees and the financial information of security tools and protocols, etc.)?
its customers, must understand its security Part of the risk-mapping process is to
posturing in protecting this information. understand where and how data is stored.

Cybersecurity law DLA Piper
In a world increasingly reliant on cloud there should be a two-person rule, which may
computing storage, it may surprise board increase cost to complete a certain task but
members where and how vital trade secret also helps ensure redundancy and integrity
data is stored. A board should at least of the process. Finally, to what extent does the
understand at a high level the security company have the ability to archive access
protocols and whether certain data should attempts and/or network activity in order to
reside within more security confines, be able to retrospectively forensically recreate
whether digitally, physically, or both. To what a user’s actions after the fact?
degree does the company outsource its IT
functions, and where geographically do those What are your physical and digital security
functions reside? Are the IT function and the protocols following employee termination?
cybersecurity function outsourced to the same Although many companies believe they
third-party contractor? Can certain functions are well-oiled machines, when it comes
be retained by US or Western personnel to to HR transitions, including termination,
administer certain sensitive networks/areas? oftentimes small details can erode post-
Furthermore, companies historically termination security while, conversely,
have bifurcated cybersecurity from physical terminated employees may be the most prone
security. A more collaborative, integrated to threaten a company’s information assets.
approach is required to efficiently mitigate Although network logins may be turned
the cyberthreat. Physical security managers off, what about physical card readers and
should understand first and foremost their applications on personally owned devices,
own security systems and potential cyber particularly in “bring your own device”
vulnerabilities therein. Physical security and environments? Also, how about third-
cybersecurity managers need then consider party systems (such as HR or enterprise
the interlocking nature of protection—a software systems that may have web login
company may well choose to place certain functionality)? Consider having HR briefly
information on physically secure computers, present to the board on what protocol exists,
potentially in redundant locations, which and then have the CISO briefly summarize
are not in any fashion networked linked and any “red team” efforts to undermine that
thus can be used for business reconstitution protocol and whether it is effective or not.
or absolute protection from network
intrusion/compromise. Physical security is How do you interconnect with and share data
a key component of such an alternative. with your supply chain and other business
partners, and does your company have a
Who has access to sensitive data, and what is vendor risk management program?
the risk of an insider event? A board should understand the overall risk
Does the company have an active program picture of third parties. What are the types
that is regularly monitored and updated, of data that are routinely transmitted back
on which employees have access to certain and forth and what measures are in place
data? All too often, particularly in companies to assure their integrity? Has the company
in nontech industries, individuals may engaged third-party consultants to audit
have access to wide swaths of a network. both the company’s and third parties’
Or an IT department may implement a systems? Does the company require that
compartmentalization protocol but fail to third parties indemnify the company for
update it as employees join the enterprise, harms that may come to pass?
making it a single-point-in-time exercise,
rather than one that is continuously Does your company receive and share
refreshed. And, infamously of late, what is information about cybersecurity threats?
the IT department’s own protocols for its What organizations does your company
individuals? For certain functions or access, belong to? Has it shared information with

DLA Piper Cybersecurity law
state or federal government authorities, and does not risk inadvertent public disclosure
what is the degree of cooperation involved? of confidential public information?
Sharing proprietary data creates perception
challenges in an era when populations, What kind of insurance do you have to deal
particularly outside the US, are wary of with potential security incidents?
potential monitoring of private behavior. As with any complex contract, the devil is
Does your company have a confidential in the details of insurance policies and their
or publicly available policy on the extent riders. At the very least, the board should
of its cooperation, beyond that which is understand at a high level what is and is not
legally required through subpoenas and included in the company’s business insurance
similar actions? Does the company rely profile to avoid unnecessary surprises based
on third-party contractors for additional on inaccurate assumptions once the harm
cyber-resources and has the company has come to pass. Also, does the insurance
vetted these providers to ensure they are include third-party indemnification claims
working cooperatively or, conversely, have in cases where a cyberthreat may not only
safeguards in place to ensure that any shared cause harm to the company directly but also
information is carefully disseminated and to customers or suppliers?

33 Navigating the opportunities and
pitfalls of social media channels
Kayla Hamberg, Senior Associate Sard Verbinnen & Co
S
uccessful public companies cannot afford to ignore social
media’s outsized influence in today’s world. With 73 percent
of Internet users active on social media, organizations
recognize the tremendous opportunities social media presents to
interact directly with customers, employees, investors, and the
public at large. Not all, however, have prepared sufficiently for the
potential pitfalls that social media creates. It is the responsibility
of boards of directors and management teams to understand both
the opportunities and risks inherent in social media, whether or
not their companies are active participants.
Examples of corporate social media blunders are abundant. Legal,
regulatory, and compliance violations are among the most pressing
fears that boards and managements share about their companies’
participation on social media, and rightly so. In July 2012, Netflix’s
CEO, Reed Hastings, came under scrutiny as a result of a single,
seemingly innocuous Facebook post. In the post, Hastings told his
Facebook “friends” that the company had exceeded one billion
hours of viewing time. While Hastings saw the post as a harmless
remark to his followers, the Securities and Exchange Commission
(SEC) investigated the incident as a possible violation of Regulation
Fair Disclosure laws. While the SEC decided not to proceed with any
enforcement action, it provided a stern warning to public companies
about selective disclosure via social media.
Since then, the SEC has issued clarifying guidance for public
companies’ use of social media. In short, investors need to be informed
in advance where they can access material financial information via
social media (a notification and link to social media channels used for
disclosure should be posted prominently on the company’s corporate
and/or investor website). More recently, the SEC has provided
guidance on the use of social media to communicate with investors
as a result of its increasing use by activist investors in proxy contests.
On sites where the number of words or characters is limited, for
example, Twitter, companies must include a link to a full proxy legend
in every post, and the content of any posts must follow all traditional

Sard Verbinnen & Co Navigating the opportunities and pitfalls of social media channels
proxy rules. The important thing to note here monitor opinion and communicate during a
is that SEC guidance with respect to social crisis. With clear goals and a well-designed
media continues to evolve, and repeating program, social media can be a highly effective
behavior that was acceptable in the past may communications channel.
not ensure current compliance. No one wants At the board level, public company
their company to be the “test case” for new directors should ensure that management
SEC law. teams have a comprehensive social media
It can also be tempting for executives plan in place, including policies to govern
to use the informal nature of social media social media conduct and contingencies for
to promote their companies, but again, dealing with social media–related mishaps.
boundaries must be observed. In one well- The rest of this chapter outlines the key
publicized case, Whole Foods CEO John elements of any such plan.
Mackey used an alias while posting on
Yahoo! Finance message boards to champion Be proactive
Whole Foods’ successes and make negative In developing a social media plan, crisis
comments about its rival, Wild Oats Markets. preparedness is essential. Pre-crisis,
An SEC investigation followed. Although organizations should take the time to
Mackey was cleared of legal wrongdoing, he develop the following components: a general
caused himself and the company significant use policy, an inventory of the company’s
embarrassment and reputational damage. existing presence, and proactive messaging
Social media also opens the door for guidelines.
influential customer feedback—not all of
which may be welcome. Recently, General Social media policy: avoiding employee-related
Mills tried to change its online legal policy mishaps
so that customers’ online interaction with In coordination with management, legal
the company would disqualify them from counsel should write a general use social
being able to litigate. Following widespread media policy that clearly delineates between
criticism of these changes on social and professional and personal use. The line
mainstream media, General Mills reversed between personal and professional can be
its policy and apologized. Social media is by hard to distinguish, with platforms that are
its nature a public forum, and any attempt used for both, making this a particularly
to restrict users’ ability to comment freely difficult area to police. Clear policies are a
will invariably be met with a sharp public must.
rebuke. Companies engaged in social media In just one of many examples of the line
should understand this dynamic before being blurred, New York Mets pitcher Matt
inviting any two-way dialogue. Harvey recently made headlines when he
Despite these and many other examples, tweeted a photograph of himself giving
the motivation for companies to participate the middle finger to the camera using his
on social media is well-established. Seventy- personal Twitter handle, causing significant
seven percent of the Fortune 500 maintains an unpleasantness for his employer. Following
active presence on Twitter, and 70 percent a the uproar, the tweet was deleted—as was his
corporate Facebook page. The primary drivers entire personal Twitter account—no doubt at
center around enhancements to marketing and the strong urging of the Mets organization.
recruitment efforts, ranging from attracting The delineation between personal and
new employees, launching or testing new professional use of social media is often a
products, to establishing or reinforcing distinction without a difference, meaning
a leadership position within a company’s companies must be more vigilant than
industry. Companies are also increasingly ever and be prepared to act quickly when
using social media to engage with investors individual employees are not reflecting
and have found it to be a powerful tool to corporate values.

Navigating the opportunities and pitfalls of social media channels Sard Verbinnen & Co
One way to make that distinction clearer is speech. Just because a person has a right to
to provide transparency, and many publicly- speak freely does not mean that he or she
traded companies showcase their social media has a right to release confidential company
policies online. For example, Best Buy has a information, copyrighted information, trade
particularly concise and up-to-date, policy— secrets, nonpublic financial information, and
promoting common sense without using legal so on. Once completed and distributed, the
jargon. It is available for public review on its usage policy should be supplemented with
corporate website. When drafting a policy, regular training and informational update
companies should be thorough and clear to sessions.
prevent misunderstanding and misuse. Best An inadequate or poorly communicated
practices include providing specific language social media policy can increase the risk of
that employees can use if they would like internal issues spreading quickly from social
to discuss their jobs on social media. For to mainstream media. Previously limited to
example: “References to [the company] should a small audience of co-workers and friends,
be limited to a brief company description, as activities such as “I Quit” videos, when posted
provided below: [...].” The policy can go so far on social media and therefore in the public
as to provide standard boilerplate language, domain, can cause broad reputational damage
so that employees know exactly what they to an organization. Recently, a 25-year-
are allowed to use. A simple list of “dos and old employee quit her job at a technology
don’ts” is also a very effective tool. Refer to company by posting a video on YouTube.
Table 1 to review an abridged version of the Almost immediately, it went viral on social
“dos and don’ts” list that appears in Best media, leading to unflattering coverage of the
Buy’s policy. company’s culture and work environment on
Companies should also clearly specify ABC News and The Today Show.
consequences for violations, including Remember that a sound social media policy
termination, in the policy. When doing so, is just a subset of a company’s guidelines
organizations should be sensitive to First governing employee behavior. It does not
Amendment rights, and companies with replace or supersede other policies, such as
union employees should be mindful of any those dealing with discrimination, workplace
restrictions on limiting employees’ right conduct, confidentiality, or securities trading.
to organize. Differentiating public versus After distributing the social media policy,
private usage in a social media policy is companies should create a monitoring
especially important as it applies to free protocol with a designated group watching
Table 1 Abridged version of Best Buy’s “Dos and Don’ts” list as it appears in its Social
Media Policy, as of May 2014
What You Should Do: What You Should Never Disclose:
• Disclose your affiliation. • The numbers: Non-public financial or
• State that it’s YOUR opinion. operational information.
• Protect yourself; be careful about what • Personal information about our
personal information you share. customers.
• Act responsibly and ethically; do not • Legal information.
misrepresent yourself. • Anything that belongs to someone else.
• Honor our differences; live the values. • Confidential information.
Best Buy will not tolerate discrimination.

to ensure employees are complying. This not have a presence on major social
will help mitigate the risk of violations going media platforms. When an issue arises,
unnoticed until they become “viral.” For it is difficult to establish an account in
example, human resources representatives real-time and begin responding credibly.
should check professional social media sites During Hurricane Sandy, many relied on
like LinkedIn to verify that the company is Consolidated Edison’s Twitter account to
referred to appropriately and consistently receive service updates after power outages
by employees posting on the site and create began. At the time, ConEd’s activity on
alerts so that every time the company name social media was minimal, comprising
is mentioned online, designated point people only a five-month-old Twitter account
are notified. Early detection of violations that with minimal tweets and few followers.
lead to swift action can significantly reduce That changed quickly during and after the
the risk of a major crisis. hurricane, when customers took to Twitter
en masse to find and share information,
What currently exists? and ConEd was frequently criticized for
While sometimes overlooked, another its lack of sophistication on social media.
important aspect of preparing a social media Inexperience showed, through an absence of
plan is evaluating what already exists. real-time responses and unfamiliarity with
Are there one or more Facebook pages, the medium, adding to the reputational
Twitter handles, YouTube channels, or damage the company suffered. ConEd now
company LinkedIn pages already utilized? maintains active monitoring on its Twitter
Is the branding and message consistent? account during normal business hours but
Are subsidiaries using these channels should have established its credentials in
without guidance and oversight from the social media before the crisis hit. That said,
parent company? Are individual employees not all companies will be prepared, and the
creating corporate sites? Do competitors following should be kept in mind for those
or third parties control company brands? making their first real foray into social media
A thorough audit of an organization’s during an active crisis situation:
social media presence should be done and
reviewed on an ongoing basis. • The discussion and corporate responses
After cataloging the “official” company will be associated forever with that social
platforms, a running list including login/ media account.
access information and company sponsors • Regard all communications via social
should be maintained by the social media media as permanently “on the record.”
team, and any unofficial or community Generally, it is bad form to delete Tweets.
platforms flagged. In a crisis situation, They cannot be fully deleted and (like
these pages, official and unofficial, will anything posted to the Internet) are
need to be diligently monitored. A recent always available through archiving tools.
search for General Motors’ Facebook pages • Similarly, although a company can delete a
pulled more than 50 different GM pages, social media account, screenshots are still
not including its subsidiary companies’ obtainable on the Web. More important,
pages. During a crisis situation like GM’s if an account is deleted after a crisis dies
ignition switch recall, managing customer down, then what will happen in the next
complaints on all of these pages can be crisis situation? Creating a new account
difficult if a central, coordinated team does exclusively to discuss a specific crisis is
not have access or authority to manage the not a sustainable or advisable strategy.
sites and the ability to respond quickly to
inquiries and complaints as they arise. Prepare to engage
The social media team should also In a crisis situation, proactive communication
ascertain whether the company does may offer the company its best chance to

influence the conversation, or at a minimum Companies should anticipate and

avoid a secondary crisis from arising within prepare in advance to react quickly on social
social media. For example, Target disclosed media, using the same channel in which an
its 2014 data breach early and transparently unsolicited inquiry or comment was made.
by creating a dedicated section on its website Formats appropriate for one social media
and postings on its social media pages. channel (Facebook, which allows for long
Target was commended for its forthcoming postings or Q&A style documents) may not
communications, as are others who have be appropriate for another (Twitter, with its
handled contentious issues in an up-front 140 character limit). Care should be taken
and proactive manner. While the underlying to avoid “canned” responses that make the
issues at Target and its response to the company appear ignorant of the style of a
breach had significant repercussions, the particular channel. Responses that are too
company’s deft handling of social media did similar or phony can aggravate social media
not further inflame the issue. users. Customizing responses with personal
Companies should be aware that they can details, like mentioning a user’s first name
appear evasive if they do not communicate in a response, can be vital to credibility.
consistently on social media during a crisis. If John Smith posts a public complaint on
If left dormant or used irregularly, a lack of a company Facebook page, a prepared
information via social media can exacerbate statement should begin with “Hi John, we’re
an issue. Carnival Cruise Lines (an affiliate of sorry to hear that . . .” This demonstrates an
Costa Concordia, the ship that was wrecked understanding of the informal nature of the
in Italy in 2012, killing 32 people), decided medium and makes any further interaction
to stop posting on its social media channels more authentic.
after the accident out of respect for those who In April 2014, Stonyfield Farms issued a
were affected by the incident. Carnival then voluntary recall on a select group of YoBaby
generated resentment when it began posting yogurts. After posting a proactive statement
again less than a week later—implying that to its Facebook page with a link to more
the crisis was over and causing a secondary information on its website, the Stonyfield team
social media–driven crisis. responded to individual complaints on its
Developing clear guidelines for proactive Facebook page. Responses were personalized.
messaging, and incorporating them into an They used each individual’s name and clearly
overall social media strategy, is imperative demonstrated that the Stonyfield team heard
to allow management the option to get in the complaints. In sensitive situations like
front of an impending crisis. Guidelines this one (a safety issue), the company must
should contain template social media posts show that it recognizes the seriousness of the
that can be ready for use. These posts should issue, cares about its customers, and provides
anticipate possible company vulnerabilities solutions (redirect to more information), not
and be layered into the scenario planning explanations.
components of a company’s larger crisis In general, substantive complaints should
communications strategy. be handled by taking the conversations
offline whenever possible. Short responses
Be ready to react should be prepared in advance to facilitate
Reactive engagement is another important this. If a customer complains via Twitter, the
component of any sound social media plan. company should Tweet back, “We’re sorry
An actual crisis requires a combination of @JohnSmith, please send us a direct message
both proactive and reactive responses. In so we may try to assist. Thank you!” (Note
many circumstances, customers, media, or that Twitter will not allow a company to
investors will dictate social media discussion contact a user directly if the user does not
topics, all of which may require a reactive “follow” the company—meaning the initial
response. exchange likely will occur in full public

view.) Remember that virtually all social backbone of any social media strategy. In
media posts are public and live forever in a crisis situation, monitoring the current
archived databases, even if the accounts are state of play will determine the appropriate
later deleted, making it desirable to take course of action.
specific customer interactions offline. Monitoring protocols should produce
Critically, the avenue to which the activity reports that offer clear summaries
company points unhappy users must be able and analysis, and provide management with
to handle and respond to a rapidly escalating an understanding not only of what is being
volume of complaints. If a customer service said but also whether it is significant. This
team is traditionally prepared to handle is easier said than done. Comprehensive
issues by phone, then social media users social media monitoring reports should
can be directed to that means of taking weigh the more authoritative users and
their communication offline, for example, reflect their significance versus lesser users.
“Please call (800) xxx-xxxx so we may try Reports should compare current volume of
to assist you.” Realize that any information chatter to that of previous days, weeks, or
posted is being distributed broadly. In an appropriate time frame to put activity
many cases, companies or individuals may in context. It is also important to compare
impulsively share a phone number via social volume of mentions with competitors or
media on their own, and if the company is peers who have experienced a similar issue.
unequipped to handle the volume, chaos Essentially, quantitative data is only helpful
ensues. During a heated rant on Twitter, if framed within a qualitative context.
former Miami Dolphins offensive lineman During a crisis, include in a social media
Richie Incognito directed his 90,000 Twitter monitoring report:
followers to call his lawyer if they had an
issue with him and provided his attorney’s 1. Summary of the mentions captured
direct phone line. The Tweet was deleted 2. General sentiment and tone of the
a few hours later, after what must have mentions
been a stressful afternoon for his attorney’s 3. Volume of the mentions, framed within a
receptionist. In a prank that aired on NBC’s designated time period (see Figure 1 on
The Voice in April 2014, country singer Blake next page for an example chart)
Shelton tweeted pop singer Adam Levine’s 4. Identity of key commentators
personal cell phone number—to over six
million people. That number is no longer Insight gleaned from monitoring helps
in service. Needless to say, organizations determine an appropriate and proportionate
should be cautious when sharing phone social media response. In March 2014,
numbers via social media. a WestJet Airlines passenger left a very
Alternatively, companies can direct social offensive, sexist note for the female pilot.
media users to the portion of a company When the pilot posted a picture of the
website that can handle complaints. For note on her personal Facebook page,
example, the American Airlines “About” the issue went viral. The pilot received
section on Twitter includes a link to its overwhelming support on social media,
customer relations webpage. (“Please click and WestJet quickly broadcast its support
here if you require a formal response to of the pilot through social media and
a complaint.”) By clicking the link, users traditional media channels. WestJet’s robust
leave social media, and the conversation is response undoubtedly was informed by
directed offline. the knowledge that the issue had spread
widely through social media, allowing the
Don’t be afraid to eavesdrop company to engage in real-time.
Although it occurs behind the scenes,
monitoring social media chatter is the

Figure 1 Volume of mentions

800,000
700,000
600,000
500,000
Mentions
400,000
300,000
200,000
100,000
0
Feb 21 Mar 05 Mar 17 Mar 29 Apr 10 Apr 22 May 04
Time
Conclusion able to identify and respond to crises via social

Social media can be extremely difficult media. Organizations should monitor social
to control. Executives are appropriately media chatter actively to create real-time
concerned about a range of risks that could awareness of issues and be prepared to act
affect their companies. By developing both proactively and reactively to manage
a comprehensive social media strategy, a crisis. With a game plan in place, boards
companies can mitigate the risk of a crisis and management can feel confident that if
escalating in social media. Management an issue arises, an appropriate social media
should make sure that their companies are plan exists to handle it.

Part IV
Shareholder activism
nyse.com/cgguide
34 Key strategies of activist investors
Ajay Khorana, Managing Director and Global Co-Head, Financial Strategy and Solutions Group; Elinor Hoover, Managing Director and
Global Co-Head, Financial Strategy and Solutions Group and Vice Chairman, Capital Markets Origination; Anil Shivdasani, Wells Fargo
Distinguished Professor, University of North Carolina at Chapel Hill and Senior Advisor, Financial Strategy and Solutions Group;
and Gustav Sigurdsson, Vice President, Financial Strategy and Solutions Group Citi Corporate and Investment Banking
S
hareholder activism has morphed from an occasional threat
facing corporate management and boards to a sweeping
trend that has spread to companies in all sectors and of
all sizes and, increasingly, across geographic regions. Globally,
the pace of public campaign activity has steadily risen over
the past five years from 161 campaigns in 2009 to 259 in 2013.1
Although most campaign activity occurs in the US, shareholder
activism has a foothold in the UK and is gaining traction in other
regions. (See Figure 1.) Activist investors have also engaged with
target companies behind closed doors, particularly in Europe
where nearly 45 percent of all campaign activity may be private
according to a study by Becht, Franks, and Grant (2010).2
A driving force behind the rise in shareholder activism is the
outperformance of activist hedge funds, which, as an asset class,
have generated a nearly 20 percent annual return since 2009, relative
to 7.7 percent for hedge funds as a whole. This outperformance has
spurred large capital flows into new and existing activist funds, and
assets under management in such funds have grown by nearly 40
percent in the past twelve months alone. The outperformance of
“pure-play” activist funds has also led many traditional investment
managers to adopt a more active stance with respect to their
investments. As a result, the number of “occasional activists” has
risen sharply, and the activist shareholder playbook is gradually
becoming a standard part of the asset manager’s tool kit.
This transformation of the activist investor landscape has
overturned a key belief about shareholder activism—that only
smaller firms are vulnerable to activist campaigns. Between 2011 and
2013, the number of targeted companies with a market capitalization
greater than $1 billion nearly doubled from 56 to 104 globally. Several
factors have led to the rising frequency of campaigns against large-
cap firms. Many smaller and underperforming firms have already
been targeted, particularly in the US. Larger funds have given
activist investors the financial capacity to take meaningful equity

Citi Corporate and Investment Banking Key strategies of activist investors
Traditional institutional investors are also

Figure 1 Trends in global increasingly receptive to activists’ agendas
shareholder activism and are engaging with and occasionally
Number of Global Public Activist Campaigns publicly supporting them in pushing for
change at their portfolio companies. With
North America the advent of annual “say-on-pay” votes
Rest of the World
in the US and UK, these investors have
259
also begun to vote more frequently against
35 management. This has allowed activist
204 204
investors to pursue firms where it would
169 28 30
161 otherwise be difficult for a single activist
22 investor to gain influence without the
30
224
leverage provided by institutional investors
176 174 who are sympathetic to the activist’s
131 147 agenda.
Based on an analysis of campaigns
between 2011 and 2013 targeting companies
2009 2010 2011 2012 2013 with a market capitalization greater than
$1 billion, maximization of shareholder
value is cited as the most frequent campaign
objective, with board-related objectives also
Campaigns Outside North America becoming increasingly common. (See Figure
(2006–2013) 2.) Activists have become vocal about both
acquisitions and financial policy issues
and frequently campaign for increased
Other Asia shareholder distributions as well.
Europe ex-Japan
16% 16% Targeting strategies of activist funds
To shed light on the strategies used by
Japan
11% activist investors to identify companies
United Kingdom for targeting, we conducted an analysis of
Spain
2% 28% over 1,600 shareholder activism campaigns
that sought to maximize shareholder value
Italy or gain board representation in S&P 1500
5%
France companies between 2006 and August 31,
Switzerland 2013. The findings and methodologies are
10%
6%
described in more detail in Khorana, Hoover,
Germany
6%
Shivdasani, Sigurdsson, and Zhang (2013).
Source: SharkRepellent and ISS.
Influence of share price performance
Historically, firms subject to shareholder
activism tend to have stock returns and
stakes in larger firms. Activist investors have valuation multiples that lag those of their
also exploited with increasing sophistication peers—targeted firms displayed stock price
the intense media scrutiny that large-cap underperformance of eight percent in the six
companies are subject to, writing open months prior to being targeted and had firm
letters to boards and management, releasing value-to-EBITDA (Earnings Before Interest,
detailed presentations in support of their Taxes, Depreciation and Amortization)
agenda, and even using social media to multiples that were two times below their
publicly pressure their target companies. industry peers.

Key strategies of activist investors Citi Corporate and Investment Banking
Figure 2 Most frequent campaign objectives

Campaign Objectives in $1B+ Situations Globally, 2011–2013;
Many Campaigns Have Multiple Objectives
118
76
63
41
34 27
20 17 15 8 6
Va lde e
vie uti ital
&A
Am an ent
ge al
ny
ts
ws
ive c
at ive
o iz
at gi
te
an ion
Bo lue r
se
eh im
pa
en ge
s
Al S n
la
Re strib ap
ns ut
rn te
M
la
Ch em
io
w o
As
ar ax
By
Ch rat
pe ec
te tra
Re
ce
ag
Co
Sh M
m x
pe
ize
Di se
d
en
E
d
an
ar
O
ea
of
et
flu
on
cr
le
In
Co
In
Sa
M
Source: SharkRepellent and ISS.
However, there is wide dispersion in against S&P 1500 companies in 2013 involved
performance—more than a third of the companies that had outperforming share
targeted firms actually experienced stock prices.
price outperformance prior to being targeted. This pattern is also evident in valuation
Therefore, share price outperformance does multiples. US activist campaigns in 2010
not insulate a company from activism. The and 2011 involved companies that traded
trend of activists targeting well-performing at median firm value-to-EBITDA multiples
companies is intensifying, particularly in the that were 0.9 times lower than their industry
US, where 56.7 percent of activist campaigns peers. By 2012, this gap had narrowed to
Figure 3 Pre-campaign stock returns for targets of shareholder activists

(2006–2013)
35% of targets exhibit positive excess returns
20
15
Frequency (%)
10
0
0
10
20
30
40
50
-4
-3
-2
-1
to
to
to
to
to
to
to
to
to
to
0
-1
10
20
30
40
0
0
-5
-4
-3
-2
Excess Return Six Months Prior to Campaign Announcement (%)

Source: SharkRepellent and FactSet.

0.7 times and disappeared entirely in 2013. three percent prior to the activist efforts—a
It appears that the low-hanging fruit of sharply lower rate than their industry peers,
underperforming firms was largely picked who averaged revenue growth of over seven
in the first wave of shareholder activism, percent. The difference in growth is even
and we are now seeing a second wave of sharper for non-US targets, which grew
activism unfold where activist investors are at 1.6 percent annually while their peers
setting their sights on well-performing firms. grew at 5.5 percent—a more than threefold
Not all industries or geographies are at difference in revenue growth. A similar
the same point in these activism waves. picture emerges based on activist targets’
For example, in Consumer and Information investment in growth, as measured by capital
Technology, the two sectors most frequently expenditures. While their industry peers
targeted since 2006, targets are now more invested an average of 3.7 percent of sales
likely to be well-performing firms than in their business, firms that were targeted
in other sectors, where campaign activity only invested 2.8 percent. (See Figure 4.) This
has been relatively muted to date. Hence, suggests that firms are more susceptible to
the sectors that experienced the most activist overtures when they are investing
campaign activity are entering a new phase little in future growth prospects and
in which the activist shareholder’s agenda highlights the need for companies wishing
has transitioned from turning around to avoid activist pressure to develop credible
underperforming companies to driving growth plans when organic opportunities
change at well-performing companies. This for growth may be lacking.
shift partially reflects a departure from
concerns over valuation, performance, and Conservative financial strategy
simpler balance sheet issues to more complex While conservative financial strategies
issues of corporate strategy such as whether provide management the flexibility to
to spin off entire operating segments. pursue future expansion plans and a buffer
for unexpected events, they increase the
Lack of top-line growth risk of shareholder activism. Within the US,
Weak top-line growth is a significant driver firms targeted by shareholder activists had
of shareholder activism in both the US and lower leverage ratios, lower payout ratios,
globally. US firms that were targets of activist and higher cash balances than their industry
campaigns had grown revenues by about peers. Companies with low top-line growth
Figure 4 Muted revenue growth and low investment for activist targets
Median Revenue Growth (%) Median Capital Expenditures (% of Sales)
4.7
7.3 Targets 3.9

3.7
Non-targets
5.5
2.8
3.1
1.6
North America Rest of the World North America Rest of the World
Source: SharkRepellent, ISS, and FactSet.

Key strategies of activist investors Citi Corporate and Investment Banking
Figure 5 Activists target financial conservatism, particularly in North America

Median Difference Between Target and Non-target Peers
Debt/Capital (%) Net Debt/EBITDA (x) Payout Ratio (%)

3.4
-1.4
-6.7
0.8
-0.3
-13.8 -0.4 -15.5

Cash/Capital (%)
North America
Rest of the World
and substantial but undeployed financial leverage, payout ratios, and cash holdings
capacity are particularly prone to activist vis-à-vis their peers is wider than at firms
intervention. (See Figure 5.) that were targeted at a time when their
Capital structure considerations tend to growth prospects were limited. Therefore,
be less strongly associated with activism robust growth does not insulate a company
outside North America, with non-US from activism if its financial policies may
targets holding only slightly more cash than be viewed by shareholder activists as being
peers and with payout ratios that are only overly conservative. The same is true of stock
modestly lower than their peers. Part of returns—a conservative financial strategy
this difference is attributable to the fact may precipitate an activist campaign even
that, in the US, activists proactively target if the target’s stock has outperformed peers,
companies rather than seize upon corporate especially in the favorable debt environment
events. Shareholder activism outside North of recent years, which has encouraged
America is more often “event-driven” in the activists to seek large shareholder
sense of being precipitated by an upcoming distributions from mature companies that
shareholder vote. In fact, nearly a third follow a conservative financial strategy.
of shareholder campaigns outside North
America were preceded by triggering events Conglomerate business model
such as mergers, equity issuances, asset sales, Firms with diversified business models and
management shuffles, or other operational multiple operating segments are increasingly
or strategic decisions. By contrast, though exposed to shareholder activists, particularly
US firms also face event-driven activism if they trade at a conglomerate discount
risk, the incidence of activism in North and if certain segments may be viewed
America tends to be driven more by activists’ as being noncore. Since 2006, firms with
perception of firm performance and financial conglomerate business models have become
policy. more frequent targets of activism than those
Financial conservatism has been with pure-play business models. In fact, a
a more important driver of activism for majority of activist targets in 2012 and 2013
fast-growing firms—the gap between their were multi-segment firms. (See Figure 6.)

Figure 6 Activists are also targeting multi-segment firms

Fraction (%) of Global Campaigns Where Target has Multiple Business Segments
52.0
50.0
34.6 36.9 37.2

35.5
31.7
34.8
2006 2007 2008 2009 2010 2011 2012 2013

Activists’ focus on diversified firms considering their outsider’s perspective,

reflects in part a general reluctance of some and clearly articulating the firm’s strategy
management teams to divest businesses are all key steps to being “white paper
even though there may be recognition that ready” and to being prepared to address an
these do not represent core businesses. In activist agenda that is not consistent with the
light of these trends, management teams of firm’s strategy. Most important, developing
multi-segment firms should be particularly and executing on a credible strategy to
proactive in assessing the value creation optimize a company’s growth trajectory and
potential from corporate restructuring actions its operating and financial performance are
and developing strategies to minimize the of paramount importance to avoid being
extent to which their valuations suffer from second-guessed by activist investors.
a potential conglomerate discount.
Notes
Conclusion 1 For a detailed discussion and analysis of
Shareholder activism has spread to firms of shareholder activism, please see our Citi Financial
all sizes in all regions and is here to stay. In Strategy and Solutions Group (FSG) report,
this environment, we believe it is of utmost Rising Tide of Global Shareholder Activism, Ajay
importance for boards and executives to stay Khorana, Elinor Hoover, Anil Shivdasani, Gustav
Sigurdsson, and Mike Zhang, 2013.
abreast of the demands of their increasingly
2 “Hedge Fund Activism in Europe,” European
assertive shareholder base. Continuously
engaging with investors, carefully Corporate Governance Institute, Marco Becht,
Julian Franks, and Jeremy Grant, 2010.

35 Advance preparedness—dealing
with activist hedge funds
Martin Lipton, Partner, and Sabastian V. Niles, Activism Governance and M&A Counsel Wachtell, Lipton, Rosen & Katz
T
his year has seen a continuance of the high and increasing
level of activist campaigns experienced during the last
14 years, from 27 in 2000 to over 250 in 2014, in addition
to numerous undisclosed behind-the-scenes situations. Today,
regardless of industry, no company can consider itself immune
from potential activism. Indeed, no company is too large, too
popular, or too successful, and even companies that are respected
industry leaders and have outperformed peers can come under
fire. Among the major companies that have been targeted are
Amgen, Apple, Microsoft, Sony, Hess, P&G, eBay, Transocean,
ITW, DuPont, and PepsiCo. There are more than 100 hedge
funds that have engaged in activism. Activist hedge funds
have approximately $200 billion of assets under management.
They have become an “asset class” that continues to attract
investment. The additional capital and new partnerships between
activists and institutional investors have encouraged increasingly
aggressive activist attacks.
The major activist hedge funds are very experienced and
sophisticated, with professional analysts, traders, bankers, and senior
partners that rival the leading investment banks. They produce
detailed analyses (“white papers”) of a target’s management,
operations, capital structure, and strategy designed to show that the
changes they propose would quickly boost shareholder value. These
white papers may also contain aggressive critiques of past decisions
made by the target. Some activist attacks are designed to facilitate a
takeover or to force a sale of the target, such as the failed Icahn attack
on Clorox. Prominent institutional investors and strategic acquirers
have been working with activists both behind the scenes and by
partnering in sponsoring an activist attack, such as CalSTRS with
Relational in attacking Timken; Ontario Teachers’ Pension Fund with
Pershing Square in attacking Canadian Pacific; and Valeant partnering
with Pershing Square to force a takeover of Allergan.
Many major activist attacks involve a network of activist investors
(“wolf pack”) who support the lead activist hedge fund, but
attempt to avoid the disclosure and other laws and regulations that
would hinder or prevent the attack if they were, or were deemed

Wachtell, Lipton, Rosen & Katz Advance preparedness—dealing with activist hedge funds
to be, a group that is acting in concert. (h) using sophisticated public relations, social
Not infrequently, at the fringe of the wolf media, and traditional media campaigns
pack are some of the leading institutional to advance the activist’s arguments,
investors, not actively joining in the attack including procuring “on the record”
but letting the leader of the pack know support from third parties;
that it can count on them in a proxy fight. (i) hiring private investigators to establish
Major investment banks, law firms, proxy dossiers on directors, management, and
solicitors, and public relations advisers are key employees and otherwise conducting
now representing activist hedge funds and aggressive “diligence”;
are eagerly soliciting their business. (j) litigating to obtain board records and
Among the attack devices used by materials and to block transactions.
activists are:
Current Securities and Exchange
(a) aggressively criticizing a company’s Commission (SEC) rules do not prevent
announced initiatives and strategic an activist from secretly accumulating a
actions and presenting the activist’s own more than five percent position before being
recommendations and business plan; required to make public disclosure and
(b) proposing a precatory proxy resolution for do not prevent activists and institutional
specific actions prescribed by the activist investors from privately communicating and
or the creation of a special committee cooperating.
of independent directors to undertake Prevention of, or response to, an activist
a strategic review for the purpose of attack is an art, not a science. There is no
“maximizing shareholder value”; substitute for preparation. In addition to
(c) conducting a proxy fight to get board a program of advance engagement with
representation at an annual or special investors as discussed below, it is essential
meeting or through action by written to be able to mount a defense quickly and to
consent (note that solicitation for a short be flexible in responding to changing tactics.
slate is very often supported by ISS and, To forestall an attack, a company should
if supported, is often successful, in whole continually review its business portfolio and
or in part, and ISS is also increasingly strategy and its governance and executive
showing support for “control” slates); compensation issues sensibly and in light
(d) orchestrating a “withhold the vote” of its particular needs and circumstances.
campaign; Companies must regularly adjust strategies
(e) seeking to force a sale by leaking or and defenses to meet changing market
initiating rumors of an unsolicited conditions, business dynamics, and legal
approach, publicly calling for a sale, developments.
acting as an (unauthorized) intermediary This outline provides a checklist of
with strategic acquirers and private matters to be considered in putting a company
equity funds, making their own “stalking in the best possible position to prevent or
horse” bid, or partnering with a hostile respond to hedge fund activism.
acquirer to build secret, substantial stock
positions in the target to facilitate a Advance preparation
takeover;
(f) rallying institutional investors and sell- Create team to deal with hedge fund activism
side research analysts to support the
activist; • A small group (2–5) of key officers
(g) using stock loans, options, derivatives, plus lawyer, investment banker, proxy
and other devices to increase voting soliciting firm, and public relations firm
power beyond the activist’s economic • Continuing contact and periodic meetings
equity investment; of the team are important

Advance preparedness—dealing with activist hedge funds Wachtell, Lipton, Rosen & Katz
• A periodic fire drill with the team is • Monitor changes in hedge fund and
the best way to maintain a state of institutional shareholder holdings on a
preparedness; the team should be familiar regular basis; understand the shareholder
with the hedge funds that have made base, including, to the extent practical,
activist approaches generally and be relationships among holders, paying close
particularly focused on those that have attention to activist funds that commonly
approached other companies in the same act together or with an institutional
industry and the tactics each fund has investor.
used • Maintain regular, close contact with major
• Periodic updates of the company’s board institutional investors; CEO, CFO, and
of directors independent director participation is
very important; regularly engage with
Shareholder relations portfolio managers as well as proxy-
voting departments.
• The investor relations officer is critical in • Monitor ISS, GL, CII, and TIAA-CREF
assessing exposure to an activist attack corporate governance policies; activists
and in a proxy solicitation. The regard try to “piggyback” on process issues to
in which the investor relations officer is bolster the argument for management or
held by the institutional shareholders has business changes.
been determinative in a number of proxy • Monitor third-party governance ratings
solicitations. Candid investor relations and reports for inaccuracies and/or
assessment of shareholder sentiment flawed characterization.
should be appropriately communicated • Major institutional investors, including
to senior management, with periodic BlackRock, Fidelity, State Street, and
briefings provided to the board. Vanguard, have established significant
• Review capital return policy (dividends proxy departments that make decisions
and buybacks), broader capital allocation independent of ISS and GL and warrant
framework, analyst and investor careful attention. It is important for a
presentations, and other financial public company to know the voting policies
relations matters (including disclosed and guidelines of its major investors,
metrics and guidance). who the key decision makers and point
• Monitor peer group, sell-side analysts, persons are, and how best to reach
proxy advisers like ISS, activist them. It is possible to mount a strong
institutions like CalSTRS and TIAA- defense against an activist attack that
CREF, Internet commentary, and media is supported by ISS and GL and gain
reports for opinions or facts that will the support of the major institutional
attract the attention of attackers. shareholders.
• Be consistent with the company’s basic • Maintain up-to-date plans for contacts
strategic message. with media, regulatory agencies, and
• Objectively assess input from political bodies and refresh relationships.
shareholders—is the company receiving • Monitor conference call participants,
candid and direct feedback? one-on-one requests, and transcript
• Proactively address reasons for downloads.
any shortfall versus peer company • Continue regular temperature-taking calls
benchmarks; anticipate key questions and pre- and post-earnings and conferences,
challenges from analysts and activists, and exercise caution and oversight
and be prepared with answers; build with respect to large format or “group”
credibility with shareholders and analysts investor meetings.
before activists surface and attempt to
“educate” the sell-side.

Prepare the board of directors to deal with the Monitor trading, volume, and other indicia of activity
activist situation
• Employ a stock watch service and monitor
• Maintaining a unified board consensus on Schedule 13F filings
key strategic issues is essential to success; • Monitor Schedule 13D and Schedule 13G
in large measure an attack by an activist and Hart-Scott-Rodino Act filings
hedge fund is an attempt to drive a wedge • Monitor parallel trading and group
between the board and management activity (the activist “wolf pack”)
by raising doubts about strategy and • Monitor activity in options and
management performance and to create derivatives, as well as corporate debt and
divisions on the board by advocating that other nonequity securities
a special committee be formed.
• Keep the board informed of options and The activist white paper
alternatives analyzed by management, The activist may approach a company
and review with the board basic strategy, with an extensive high-quality analysis of
capital allocation, and the portfolio of the company’s business that supports the
businesses in light of possible arguments activist’s recommendations (demands) for:
for spin-offs, share buybacks, increased
leverage, special dividends, sale of the • return of capital to shareholders through
company, or other structural changes. share repurchase or a special dividend
• Schedule periodic presentations by the • sale or the spin-off of a division
lawyer and the investment banker to • change in business strategy
familiarize directors with the current • improve management performance
activist environment. (replace CEO)
• Directors must guard against subversion • change in executive compensation
of the responsibilities of the full board by • change in cost structures
the activists or related parties and should • merger or sale of the company
refer all approaches to the CEO. • change in governance: add new directors
• Boardroom debates over business designated by the activist, separate the
strategy, direction, and other matters positions of CEO and Chair, declassify the
should be open and vigorous but kept board, remove poison pill and other shark
within the boardroom. repellants, and permit shareholders to call
• Avoid being put in play; recognize that a special meeting (or lower thresholds for
psychological and perception factors same) and act by written consent in lieu of
may be more important than legal and a meeting.
financial factors in avoiding being singled
out as a target. The white paper is used by the activist in
• A company should not wait until it is private meetings with shareholders, sell-side
involved in a contested proxy solicitation analysts, and the media and is ultimately
to have its institutional shareholders meet designed for public consumption
its independent directors. A disciplined,
thoughtful program for periodic meetings Responding to an activist approach
is advisable.
• Scrutiny of board composition is Response to nonpublic communication
increasing, and boards should self-
assess regularly. In a contested proxy • Assemble team and determine initial
solicitation, institutional investors may strategy. Response is an art, not a science.
particularly question the “independence” • No duty to discuss or negotiate (no outright
of directors who are older than 75 or who rejection, try to learn as much as possible by
have served for more than 10 to 15 years. listening, and keep in mind that it may be

Advance preparedness—dealing with activist hedge funds Wachtell, Lipton, Rosen & Katz
desirable at some point to negotiate with the • Remain focused on the business; activist
activist and that developing a framework approaches can be all consuming, but
for private communication and nonpublic continued strong performance of the
engagement may avoid escalation). business, though not an absolute defense,
• No duty to disclose unless leak comes is one of the best defenses. When business
from within. challenges inevitably arise, acting
• Response to any particular approach in a manner that preserves and builds
must be specially structured; team should credibility with shareholders and with
confer to decide proper response. the rest of investment community is of
• Keep board advised (in some cases it may paramount importance. Maintain the
be advisable to arrange for the activist to confidence and morale of employees,
present its white paper to the board or a business partners, and key constituencies.
committee or subset of the directors). • The 2012 defeat by AOL of an activist short-
• No duty to respond, but failure to respond slate proxy solicitation supported by ISS
may have negative consequences. shows that investors can be persuaded to
• Be prepared for public disclosure by not blindly follow the recommendation of
activist. ISS. When presented with a well-articulated
• Be prepared for the activist to try to engage and compelling plan for the long-term
directly with shareholders, sell-side success of a company, they are able to cut
analysts, business partners, employees, through the cacophony of shortsighted
and key corporate constituencies. gains promised by activists touting short-
term strategies. The AOL fight showed
Response to public communication that when a company’s management and
directors work together to clearly present
• Initially, no public response other than a compelling long-term strategy for value
“the board will consider and welcomes creation, investors will listen.
input from its shareholders.” • The recent amendments, and then full
• Assemble team; inform directors. withdrawal, by Carl Icahn of his attempt
• Call special board meeting to meet with to force Apple into leveraging its balance
the team and consider the communication. sheet and paying out $150 billion to its
• Determine board’s response and whether shareholders, showed that investors can
to meet with the activist. Failure to meet be convinced not to support an activist
may be viewed negatively by institutional attack that is not in the long-term best
investors. Meeting may result in activist interests of the company’s shareholders
using the meeting to mischaracterize the (Icahn later restated his support for
company’s position. continued buybacks). In this connection,
• Avoid mixed messages and preserve the it is noteworthy that on March 21, 2014,
credibility of the board and management. Larry Fink, Chairman and CEO of
• Gauge whether the best outcome is to BlackRock, wrote to the CEOs of the S&P
agree upon board representation and/ 500:
or strategic business or other change in
order to avoid a proxy fight.
Many commentators lament the short-
• Be prepared and willing to defend
term demands of the capital markets.
vigorously.
We share those concerns, and believe
• Appreciate that the public dialogue is
it is part of our collective role as
often asymmetrical; while activists
actors in the global capital markets to
can, often without consequence, make
challenge that trend. Corporate leaders
personal attacks and use aggressive
can play their part by persuasively
language, the company cannot respond
communicating their company’s long-
in this manner.

term strategy for growth. They must performance while simultaneously

set the stage to attract the patient making those investments—in
capital they seek: explaining to innovation and product enhancements,
investors what drives real value, how capital and plant equipment, employee
and when far-sighted investments development, and internal controls
will deliver returns, and, perhaps and technology—that will sustain
most importantly, what metrics growth.
shareholders should use to assess their
BlackRock’s mission is to earn the trust
management team’s success over time.
of our clients by helping them meet
It concerns us that, in the wake of their long-term investment goals. We
the financial crisis, many companies see this mission as indistinguishable
have shied away from investing in from also aiming to be a trusted,
the future growth of their companies. responsible shareholder with a longer
Too many companies have cut capital term horizon. Much progress has
expenditure and even increased been made on company-shareholder
debt to boost dividends and increase engagement and we will continue to
share buybacks. We certainly believe play our part as a provider of patient
that returning cash to shareholders capital in ensuring robust dialogue.
should be part of a balanced capital We ask that you help us, and other
strategy; however, when done for the shareholders, to understand the
wrong reasons and at the expense of investments you are making to deliver
capital investment, it can jeopardize the sustainable, long-term returns on
a company’s ability to generate which our clients depend and in which
sustainable long-term returns. we seek to support you.
We do recognize the balance that
must be achieved to drive near-term

36 Shareholder proposals: recent
trends and developments
Paul Schulman, Executive Vice President MacKenzie Partners, Inc.
S
ecurities and Exchange Commission (SEC) Rule 14a-8 (the
Rule) governs the procedures for a shareholder to submit
a proposal to be included in a company’s proxy statement
at an annual or special meeting of shareholders. This chapter
first summarizes the basic regulatory concerns that arise under
Rule 14a-8, then looks at the significant recent trends and
developments in the shareholder proposal arena, and finally
provides some observations on the process.
It is worth noting that the Rule does not apply to shareholders
who solicit their own proxies, rather than having the proposal on
the company’s proxy card. Such shareholders bear the cost of the
preparation and filing of their own materials, the printing and
mailing to shareholders, and the solicitation of proxies. By and
large, these insurgents are seeking shareholder support for board
representation, rather than the corporate governance, environmental,
and social issues most commonly the subject of Rule 14a-8 proposals.
While proposals may be drafted to implement binding changes to a
company’s by-laws depending on relevant state law, virtually all
proposals are precatory (nonbinding or advisory), and there is no
requirement that the company adopt any change should a proposal
receive the required shareholder support. However, failing to do
so violates the proxy voting guidelines of many major institutional
shareholders, as well as those of the two major independent proxy
advisory services, ISS and Glass Lewis. The consequence of this
inaction is generally a vote against (or withheld on) some (depending
on committee membership) or all of the director nominees up for
election at the following shareholder meeting. Depending on a
company’s shareholder profile and the nature of the proposal, this
could have real consequences for companies with a majority vote
standard for the election of directors.
Precatory shareholder proposals typically require a majority
of votes cast, excluding abstentions and broker nonvotes in
order to pass. However, some companies include abstentions in
the calculation, providing a higher bar for a proposal to pass.
Shareholder proponents are calling on companies to take a uniform
approach in which all matters presented to shareholders be decided

Shareholder proposals: recent trends and developments MacKenzie Partners, Inc.
by a simple majority of the shares voted shareholder who wants to bring their own
“for” and “against” and not treat abstentions matter or director candidate to a vote from
as effective votes against a proposal. the floor or in an opposition proxy statement
The Rule allows companies to include may also be stipulated in the company’s
a statement explaining why and how by-laws—the so-called “advance notice
they recommend shareholders vote on by-law provisions.” Typically, deadlines for
the proposal. Companies should seek the these are closer to the meeting, such as 60
benefit of advisors to assist in the drafting of to 90 days prior to the anniversary date
this statement, which needs to be carefully of the meeting as opposed to the mailing
researched and written as it can have a date for Rule 14a-8 proposals. Furthermore,
material effect on the voting outcomes of unless so restricted, these deadlines are
some shareholder proposals. governed by state statutes. These deadlines
generally will be clearly referenced in the
Who is eligible to submit a proposal under Rule prior year’s proxy statement. It is strongly
14a-8? suggested that these by-law provisions be
The eligibility criteria for a shareholder reviewed on an ongoing basis to ensure that
to be eligible to submit a proposal under there are no possible ambiguities, that they
Rule 14a-8 are very modest—the holder provide sufficient notice for a company to
must have continuously held at least $2,000 react, that they are not overly restrictive
in market value, or one percent of the to a shareholder’s ability to provide the
company’s securities entitled to be voted required notice, and that they also account
on the proposal at the shareholder meeting, for the possibility that the annual meeting
for at least one year as of the date the date may change significantly in any
shareholder submits the proposal. particular year.
Valid proof of such ownership can be
easily evidenced by shareholders of record Resubmitting a proposal
(ie shareholders listed directly on the The Rule also provides guidelines allowing
register maintained by the issuer’s transfer companies to exclude proposals that are
agent). However, for beneficial owners (ie identical or substantially the same as ones
street name holders) such proof requires a that have been included in the company’s
written statement from the record holder, proxy materials within the past five years,
such as the shareholder’s bank or broker, based on the previous levels of shareholder
verifying that the shareholder owned support the proposal received.
such shares at the time of the proposal In order to have the proposal excluded at
submission. It is very rare that a company any meeting within three years of the last time
is able to exclude a proposal based on a the proposal was in the company’s proxy, the
shareholder’s lack of evidence that it meets proposal must have failed to receive the
the requirements. following levels of shareholder support:
A shareholder may submit no more than
one proposal for a particular shareholder • three percent of the vote if proposed
meeting, but it is not uncommon for major once within the preceding five calendar
companies to receive two or three or even years;
more proposals from different owners. • six percent of the vote on its last
submission to shareholders if proposed
Deadlines twice previously within the preceding
Under the Rule, the deadline for a five calendar years; or
shareholder to submit a proposal for a • less than 10 percent of the vote on its last
company’s annual meeting is 120 days submission to shareholders if proposed
prior to the anniversary of the previous three times or more within the preceding
year’s proxy mailing. The deadline for a five calendar years.

MacKenzie Partners, Inc. Shareholder proposals: recent trends and developments
These levels allow for the repeated 5. the proposal is related to director elections
resubmission of proposals receiving minimal and would either:
shareholder support. (i) disqualify a nominee who is standing
for election;
Getting a shareholder proposal excluded (ii) remove a director from office before
If a shareholder fails to meet the procedural his or her term expired;
or eligibility requirements summarized (iii) question the competence, business
above, the company may exclude the judgment, or character of one or more
proposal from its proxy, provided that the nominees or directors;
shareholder is notified of any defect in his (iv) seek to include a specific individual
or her submission and given time (14 days) in the company’s proxy materials for
to cure such deficiency. The company may election to the board of directors; or
also apply to the SEC for “no action relief” (v) otherwise could affect the outcome of
to exclude the proposal on the basis of a the upcoming election of directors.
number of criteria laid out in the SEC statute. 6. the matter of the proposal conflicts with a
Some of the most common exclusions used company-sponsored proposal or duplicates
are as follows (see SEC Rule 14a-8 for more another proposal previously submitted by
complete list of exclusions): another shareholder
7. the proposal contains substantially the
1. the proposal violates state, federal, or same subject matter that was previously
foreign laws or SEC proxy rules submitted and did not receive a specified
2. the proposal relates to a personal percentage of the vote.
grievance or special interest Most of the letters filed by companies are
3. the company would lack the power or based on the contention that the proposal
authority to implement the proposal in question relates to ordinary business
4. the proposal deals with a matter relating matters.
to the company’s ordinary business
operations
Table 1 Most frequent proponents under the Rule in 2014

Proponent Number of proposals
John Chevedden 104
New York State Common Retirement Fund 54
Ken Steiner 39
AFL-CIO 26
Jim McRitchie 26
New York City Pension Funds 26
United Brotherhood of Carpenters 25
Trillium Asset Management 23
New York City Funds 22
Calvert Asset Management Co. 21

Frequent filers These proposals are discussed in more

Shareholder proposals are predominantly detail in the following sections.
submitted by holders falling into one of
three categories: (1) public pension funds; Political spending proposals
(2) the so-called “corporate gadflies,” that These proposals generally ask the company
is, individuals who hold relatively small to disclose all of its political spending,
share amounts in numerous companies and including payments to trade associations
routinely file a large number of proposals and other tax-exempt organizations used
each year, generally focused on one or two for political purposes, claiming shareholders
issues; and (3) socially- and environmentally- need comprehensive disclosure to be able to
conscious funds. Table 1 shows the most fully evaluate the political use of corporate
frequent proponents in 2014. assets. Some election-related proposals seek
a direct prohibition of political donations or
Most common proposals seek policies linking corporate giving and
According to ISS, there have been a total company values.
of 926 shareholder proposals filed so far in While these proposals are relatively new,
2014, up from 912 for the entire 2013 calendar compared to most of the other issues on
year. Shareholder proposals in any given the list, they have clearly become the most
year are concentrated on a limited number common over the past two years. While none
of issues. In Table 2, the most common 2014 of them have yet passed, support has been
proposals—most of which were the most as high as 47 percent. The proxy advisors
popular in 2013 as well (see Table 3)—are and institutions do not commonly support
compared. proposals that seek to limit a company’s
Table 2 Most common shareholder proposals under the Rule in 2014

Top shareholder proposals Number of Number of
voted in 2014 proposals proposals
in 2014* in 2013
Political and lobbying activities 84 85
Independent board chair 62 61
Majority vote for the election of directors 28 31
Act by written consent 27 26
Stock retention/holding period 27 37
Pro rata vesting of equity awards 20 31
Greenhouse gas emissions 19 6
Declassify the board of directors 15 32
Proxy access 13 13
Shareholder ability to call special meetings 13 11
Report on sustainability 13 14
Source: Institutional Shareholder Services Inc.

*Number of proposals includes pending, voted, withdrawn, omitted, and not presented proposals as of
July 9, 2014.

Table 3 Most common shareholder proposals under the Rule in 2013

Top shareholder proposals Number of Average
voted in 2013 proposals support
Report on political contributions/lobbying 75 28.3%
Independent board chairman 61 32.0%
Stock retention/holding period 37 23.8%
Declassify the board of directors 32 78.7%
Majority vote for the election of directors 31 59.0%
Pro rata vesting of equity awards 31 33.0%
Act by written consent 26 40.9%
Reduce supermajority vote requirement 21 70.5%
Report on sustainability 14 33.1%
Proxy access 13 32.5%
Source: Institutional Shareholder Services Inc.
activities, but they are generally in favor probably in compliance with the exchange
of proposals seeking greater disclosure, where the company is listed, is not always
particularly at issuers where there has been consistent with that used by the proxy
a controversy. advisors and some institutions.
Shareholder proposals seeking to force
Independent board chairman the appointment of an independent chair are
While there is a degree of acceptance among perennially among the most prevalent, but
many institutions that a combined CEO/ generally do not pass.
chairman role may be warranted and
beneficial to shareholders in some situations, Majority vote
shareholders generally want independent Shareholder proposals seeking to change
lead directors to provide independent board the vote standard required for the election
leadership. of a director to a majority, rather than
The proxy voting guidelines of ISS plurality, continued to receive high levels
and Glass Lewis dictate a vote against a of support from shareholders. The principle
nonindependent chair in the absence of a behind majority voting is almost universally
separate, independent lead director who supported by institutions and the proxy
has a prescribed set of responsibilities. advisors.
An activist may also target the lack of Most large-cap companies, who were
an independent chair during periods of the original targets of these shareholder
sustained and significant underperformance proposals, have adopted some form of
or some negative event involving risk majority voting. Many of these companies
oversight, accounting scandal, or other implemented the change when faced with
negative newsworthy event. An important the submission of a shareholder proposal
point to note here is that the definition that was likely to pass. The majority of
of independence that the company uses, smaller companies still retain plurality

voting as the governance-focused activists many of the major institutions, will vote
have not yet targeted these companies to the against a written consent proposal if the
same extent on this issue yet. company has a special meeting provision
with a reasonable ownership threshold
Shareholder ability to act by written consent and required to call the meeting.
shareholder ability to call special meetings
Although there are practical differences Stock retention/holding for executives or directors
between the written consent and special Shareholder proposals seeking to adopt a
meeting provisions, they are both a vehicle policy requiring that senior executives retain
for shareholders to propose business, usually a significant percentage of shares acquired
the replacement of directors, at any time of through equity compensation programs
the year, not just at the annual meeting. We until reaching normal retirement age or
have combined the discussion of these two terminating employment with the company
issues, particularly as voting policies and have not been successful to date, with all
patterns on each of these proposals suggest being defeated.
that institutions look at them through the Proponents argue retention requirements
lens of whether a company already has one that link executive compensation with
or the other in place. long-term performance by requiring senior
There are two principal advantages to executives to hold a significant percentage of
companies to giving shareholders the right shares obtained through equity compensation
to call a special meeting versus the ability to plans until they reach retirement age will
act by written consent: better align the interests of executives with
the interests of shareholders and the company.
1. An ownership threshold—To prevent abuse
and waste of corporate resources by small Declassification/destagger proposals
shareholders, companies typically set an Shareholder proposals seeking to eliminate
ownership floor in the range of 10 percent staggered board structures have received
to 25 percent to call a special meeting. overwhelming support from all types of
While ISS policy dictates a 10 percent investors. Currently 12.11 percent of the
ownership threshold, most institutions Fortune 500 and 41.99 percent of the Russell
with independent voting policies will 3000 have staggered boards.
generally allow a much higher level Proponents argue that a classified board
and will only view anything above 25 makes it more difficult to change control of
percent as excessive and entrenchment. a company through a proxy contest. Because
Glass Lewis is a little more lenient than only a minority of the directors is elected
ISS on the ownership criteria, preferring each year, a dissident will be unable to win
the limit to be between 10 percent and control of the board in a single election and
15 percent, depending on company size. would need two years to gain control of the
There is no such requirement for a written company unless there are vacancies in the
consent. other classes. They often cite studies and
2. Greater control of the time line— statistics claiming companies with staggered
Shareholders can file and mail written boards have lower valuations, attract lower
consent solicitation materials at any time, premiums as acquisition targets, and are less
while the company can set the time line likely to attract proposals. The major push on
for a special meeting. this topic has come from an advocacy group,
the Shareholder Rights Project, run by a
ISS and Glass Lewis both generally support Harvard professor and backed primarily by
shareholder proposals allowing written some public pension funds.
consent and shareholder ability to call a Management often argues that classifying
special meeting. These firms, along with the board will assure continuity among

directors and stability of the board. A two years being able to submit nominees
classified board encourages directors to look comprising up to 20 percent of the board.
to the long-term best interest of the company A smaller number of proposals submitted
and its stockholders by strengthening the called for a three percent holding for three
independence of nonemployee directors years.
against the often short-term focus of certain As Table 3 illustrates, the majority of
investors and special interests. In addition, proxy access proposals in 2013 were not
a classified board allows for a stable and approved. A closer look though reveals a
continuous board, providing institutional strong correlation between the ownership
perspective both to management and threshold and the level of support. Most
other directors. A classified board reduces institutions and the proxy advisors have
vulnerability to potentially abusive takeover not supported the one percent proposals,
tactics by encouraging persons seeking believing that it opens up the process to
control of the company to negotiate with too many shareholders that may have
the board and thereby better positioning self-interested agendas. Support for
the board to negotiate effectively on behalf these proposals has generally been very
of all stockholders. These arguments do not low, mostly in the single digits. The three
resonate with most shareholders. percent/three-year proposals however, have
gained far greater acceptance and have hit
Proxy access support rates above 50 percent, as high as
“Proxy access” refers to the right of a 64.5 percent.
shareholder to include his or her own
nominee(s) on the company’s proxy card and Supermajority vote requirements
avoid the costs associated with conducting Shareholder proposals seeking to eliminate
his or her own proxy solicitation, which can any voting requirements in the company’s
be significant. charter and by-laws that call for a greater
First, the by-laws need to be amended, than simple majority vote, and replace these
either through shareholder support of a with a simple majority of the votes cast, are
binding Rule 14a-8 proposal or by voluntary strongly supported by the proxy advisory
board action. Once the by-laws have been firms and governance professionals. While
changed, a shareholder who meets the these proposals generally receive high levels
criteria outlined in the by-laws can submit of support, voting outcomes are mixed.
his or her nominees to the company to be Proponents argue super-majority
included in the next proxy statement. voting requirements have been found to
Shareholder proposals to get a company be a blocking and entrenching mechanism
to amend the by-laws to allow proxy access that does not serve the best interest of
are still relatively infrequent, only appearing shareholders.
in meaningful numbers starting in 2012 as Management frequently argues
a result of an amendment to the SEC rules supermajority voting requirements on
that went into effect in 2011. Each Rule fundamental corporate matters help to
14a-8 proposal to effect the first step needs protect shareholders against self-interested
to outline the criteria for a holder to be able and potentially abusive transactions
to submit nominees under proxy access at proposed by certain shareholders who
that company and specify the number of may seek to advance their interests
nominees that may be submitted by such over the interests of the majority of the
qualifying holder. company’s shareholders. Supermajority
The proposals that have been submitted voting requirements encourage interested
have been essentially bifurcated, with the shareholders to negotiate transaction terms
majority calling for a holder or group having that take into account the interests of all of
held one percent of the shares for one or the company’s shareholders and that do

not sacrifice the long-term success of the shares and that the required holding period
company for short-term benefits. be lengthened. He also suggests that
so-called “proposal by proxy”—where a
Updating the Rule 14a-8 proposal process person with no shares acts on behalf of
In March 2014, SEC Commissioner Daniel another holder—should either be banned
Gallagher opined on the shortcomings of or be subject to an even greater ownership
the Rule 14a-8 process and offered some requirement. Commissioner Gallagher also
interesting suggestions to the areas where he suggests that the subject matter of proposals
was most critical that we believe are worth be more carefully policed and limited, and
sharing. that higher voting thresholds be required for
He first commented on the low ownership proposals to be resubmitted.
threshold required to submit a proposal that
allows corporate gadflies and shareholders Recommendations
with minimal holdings and a special interest The costs and distraction associated with
to “hijack the shareholder proposal system.” fighting these proposals can be significant. It
Companies have to incur significant costs, is highly advisable that issuers faced with a
often well into the $100,000s and more shareholder proposal that the board deems
on advice from lawyers, bankers, and to not be in the best interest of the company,
governance experts to analyze and respond consult with an attorney experienced in the
to the proposal. He also noted that only one arena and a thorough process is undertaken
percent of the shareholder proposals filed to first attempt to exclude the proposal
last year were filed by “ordinary institutional and then to craft a message and strategy
investors.” To remedy the deficiencies in the to defeat it. Other advisors, such as proxy
current shareholder proposal regime, to the solicitation firms, can be invaluable with
extent that shareholder proposals are here to providing data on the voting tendencies of
stay, Commissioner Gallagher suggests that specific shareholders, policies of the proxy
the ownership requirement be increased to advisors, and leading the campaign to win
a specified percentage of the outstanding shareholder votes.

37 Engaging with proxy
advisory services
Kenneth A. Bertsch, Partner CamberView Partners
I
n 2015, Institutional Shareholder Services (ISS) celebrates its
30th anniversary. Since the founding of ISS, proxy advisory
firms (PAFs) have created an important institutional investor
service. In so doing, they have become significant actors in
shaping corporate governance, often to the consternation of
corporate executives and board members.
ISS and Glass Lewis (the latter founded in 2003) are the dominant
proxy advisory firms in the US and globally. They provide
standardized “proxy reports” to hundreds of clients on thousands
of companies globally, including vote recommendations. They
also implement customized policies for clients and provide proxy
voting management systems and services to institutional investors,
including separate governance risk ratings by ISS (called the ISS
Governance QuickScore).
Among other services are those provided by ISS Corporate
Services, an ISS subsidiary that ISS says is walled off from its
core institutional investor research/recommendation team. ISS
Corporate Services provides data and analysis, helping companies
navigate ISS. Glass Lewis does not offer a similar service, but the
firm does partner with Equilar, which offers Glass Lewis research to
issuers as well as extensive executive and director pay analytics and
other research.
It is critical for public companies with dispersed ownership,
listed on US exchanges, to be familiar with both of these firms,
and engagement with the firms can be helpful. In almost all
cases ISS and Glass Lewis affect a significant share of voting at
public company annual and special meetings. Some governance
and investor relations executives think of ISS as effectively their
companies’ largest shareholder when it comes to proxy votes.
At the same time, it is a mistake to overestimate the importance
of ISS and Glass Lewis. Many of the largest investors subscribe
to both services (whose recommendations often conflict) and/or
have been growing their internal capacity. Firms should seek to
talk directly to their largest holders on complex or difficult voting
issues and not overstate the PAF role as intermediary. For most
large US companies, ISS and Glass Lewis are highly significant

Engaging with proxy advisory services CamberView Partners
but not determinative of vote outcomes. stable. While the organization’s policies have
Moreover, the proxy services themselves evolved as governance and institutional
look for evidence that companies are shareholder views have evolved, there
engaging shareholders, especially on tough has been substantial continuity in the ISS
issues. approach.
The market for proxy advisory services Glass Lewis ownership changed hands
is competitive. While there is little question twice in 2007. Its founders sold it to Xinhua
that ISS and Glass Lewis in practice help Finance (part of China’s state-run news
shape certain governance practices in the agency), which shortly thereafter sold the
US and elsewhere, to a significant degree firm to the Ontario Teachers Pension Plan
the firms follow their clients, seeking to be (OTPP), and ownership is now shared
in tune with prevailing views on corporate between OTPP and Alberta Investment
governance (to the extent possible in a highly Management Corp.
diverse client base), if leaning in toward the
leading edge. Controversy on the PAF role
Other US-based proxy recommendation Proxy voting recommendations by
services include Proxy Mosaic, a newer ISS and Glass Lewis have long placed
firm that offers client-driven proxy voting the firms in the crosshairs for criticism,
research as well as proxy voting policy particularly from companies. Debate has
development; Egan-Jones Proxy Services, intensified as the importance of proxy
owned by Egan-Jones Ratings Co., which voting in firm governance has increased,
also provides credit ratings; and the Marco although a countervailing factor has been
Consulting Group, which provides Taft- somewhat decreased reliance on PAF
Hartley funds a range of services. recommendations at investment managers
Overseas PAFs that cover US companies and pension funds that have enhanced their
include Pensions & Investment Research in-house capacities.
Consultants Ltd. (PIRC) and Manifest Some level of controversy is inherent
(UK-based firms that will cover S&P 500 in the proxy advisory firm role, at least
companies for their clients) and IVOX, a for firms that make vote recommendations
firm based in Germany. Finally, companies and/or implement broad proxy voting
should be aware that other providers of policies and therefore are decision-makers.
corporate governance and sustainability Clients expect critical analysis (as well
information may produce research that as research and data) from PAFs, and
affects proxy voting decisions, including institutions have expressed a preference
MSCI products GovernanceMetrics and for proxy research firms that make voting
Intangible Value Assessment. recommendations. Certain matters (most
notably in proxy fights) can be enormously
Ownership of ISS and Glass Lewis contentious.
In April 2014, Vestar Capital Partners, a ISS in particular has been a lightning rod,
private equity firm, acquired ISS from MSCI, in significant part due to its larger influence
Inc. MSCI had acquired RiskMetrics Group, but also because of the ISS Corporate
which included ISS, in 2010. RiskMetrics Services business, which critics have said
acquired ISS in 2007 from a group that poses conflicts of interest. ISS says ISS
included Warburg Pincus, which itself Corporate Services operates independently
bought ISS from Thomson Corp. (now of ISS and that it has managed the conflicts
Thomson Reuters). ISS was founded by of interest effectively. ISS stresses that advice
Robert A. G. Monks and Nell Minow. to corporate clients does not influence
Despite frequent changes in ownership recommendation outcomes and that ISS
over the last 14 years, the research/analytic Corporate Services is walled off from the ISS
leadership within ISS has been relatively research and recommendation service.

CamberView Partners Engaging with proxy advisory services
More generally, critics complain that the the capacity and competency to adequately
proxy advisory firms are not shareholders, analyze proxy issues.” Elements of this
owe no fiduciary duty to shareholders, and analysis could include evaluation of the
gain their business to a significant degree on adequacy and quality of the PAF staff
compliance considerations of asset managers and the robustness of its policies and
and asset owners. procedures, including as to whether
recommendations are based on current and
US regulation affecting PAFs accurate information.
The debate includes the question of how Since the advent of say-on-pay votes in
proxy advisory services and/or their clients, 2011, more companies have filed with the
particularly investment advisers, should be SEC supplemental materials prepared for
regulated with regard to proxy voting. The investors specifically disputing ISS (and
Securities and Exchange Commission (SEC) sometimes Glass Lewis) recommendations,
and the Department of Labor (the latter including the factual basis for the
with regard to Employment Retirement recommendations. The SEC guidance may
Income Security Act [ERISA] funds) regard further encourage this trend, as it suggests
the proxy vote as an asset of the fund. The an investment adviser responsibility to
SEC requires an investment adviser that investigate instances of known factual
exercises voting authority over client proxies inaccuracies to probe whether the PAF has
to ensure there are policies and procedures the “capacity and competency” described
in place that are reasonably designed to above. A company effort to flag a material
ensure voting in the best interest of the factual error by a PAF may be helpful if
client.1 In two 2004 no-action letters, the SEC the company does identify a clear factual
indicated that investment advisers may rely error. However, often companies really
on proxy advisory firms if certain conditions are attacking the analytical framework or
are met.2 rigor rather than clear factual inaccuracies.
New SEC staff guidance published in The effectiveness of focusing on this in
June 2014 clarifies aspects of the earlier communications with investors is open to
documents.3 The new guidance provides question. Larger investors in some cases
additional description of due diligence have tired of attacks on ISS and Glass
expected of investment advisers in oversight Lewis, regarding some of the attacks as
on third-party proxy voting providers where weak and tendentious, and would like
the PAF has some discretion in vote decisions, to focus on the particular investor’s core
even if the PAF decision can be changed by concerns on the underlying matters at
the adviser. The guidance also discusses issue.
treatment of conflicts of interest, clarifying
requirements for the PAF to disclose conflicts PAF best practice approaches in Europe and
to its clients. It is not clear that the new Canada
guidance will significantly change proxy In 2013, the European Securities and Markets
voting dynamics, but it may add to pressure Authority (ESMA) considered the need for
on certain investment managers to exercise regulation of proxy advisory firms. ESMA
greater authority in this area, deferring less concluded that regulatory intervention was
to PAFs. not required, but it recommended that the
The new guidance says investment “proxy advising industry” develop a code of
advisers should demonstrate compliance conduct focused on identifying, disclosing,
with the Proxy Voting Rule by, for example, and managing conflicts of interest, and for
sampling votes (perhaps focusing on more fostering transparency to ensure accuracy
complex matters) to determine that the and reliability of advice. As a result, leading
proxy advisory firm (to the extent voting PAFs have been working together on
discretion is delegated to the firm) “has development of such a code, applicable in

Europe but with implications for global Engaging on normal-course company-specific

operations of ISS and Glass Lewis, both of governance matters
which are participating in the effort. Normal-course engagement takes the form
The Canadian Securities Administrators of:
in April 2014 published for comment a
proposed “Guidance for Proxy Advisory • “off-season” meetings and other
Firms.” The guidance is also not binding exchanges
but recommends best practice to promote • “in-season” meetings and other exchanges
transparency and understanding of all market • review of data and/or reports.
participants and covers conflicts of interest,
promotion of transparency and accuracy of Company/PAF engagement can be initiated
proxy voting recommendations, disclosure by the company or by the PAF. Both ISS and
of processes for development of proxy voting Glass Lewis reach out to companies at times,
guidelines, and communications including although ISS has been more active in this
with clients and market participants more regard. ISS encourages companies to provide
generally. it with specific company contact information
to assist when ISS wants to reach out.
Engaging with proxy advisory firms A number of companies seek to meet with
Companies in general engage with proxy ISS and/or Glass Lewis in the “off-season”
advisory firms in three types of situations: (ie outside the proxy solicitation period).
ISS says it will do so when it believes
• normal course governance issues that will a meeting will assist it in producing high-
affect voting at noncontested meetings quality research. In practice, ISS usually has
(for example, on election of directors, say- been open to meetings outside proxy season
on-pay, compensation plans including (which ISS considers to run from February
equity compensation plans, nonbinding 15 to June 30 in the US), although at times
shareholder proposals) ISS prefers to meet by telephone rather than
• proxy fights and contested transactions in person, and ISS reserves the right to turn
• PAF policy development efforts. down meetings, based in part on its own
scheduling pressures. ISS warns that during
Both ISS and Glass Lewis as a general matter the proxy season, analysts generally engage
now express willingness to engage with with issuers only where initiated by ISS or
companies on specific company governance on contentious issues. As time limitations
matters, although Glass Lewis will not do dictate this approach, the greater difficulty
so during a solicitation period (once your engaging during the core US proxy season
proxy statement has been published) except affects companies no matter what their fiscal
(1) if their analyst chooses to reach out to year/annual meeting cycle.
a company to clarify a factual matter; (2) Glass Lewis says it would be happy
in a forum broadly open to Glass Lewis to have a conference call or meeting with
institutional subscribers, principally a Glass any public company to discuss general
Lewis “Proxy Talk”; or (3) where a company corporate governance issues outside of a
reports a data discrepancy in a published proxy solicitation period (although Glass
report. Lewis also references its own “proxy season
Both ISS and Glass Lewis have appointed blackout period” in which time constraints
an internal liaison to facilitate engagement. may preclude a meeting). The Glass Lewis
ISS has published FAQs on engagement.4 “Primer for Issuers” web page (mentioned
Glass Lewis has published a “Primer for above) includes a link to request a meeting,
Issuers.”5 Both these key web resources along with specific instructions.
include links to other pages expanding on Both ISS and Glass Lewis say the issuer
key aspects of interest to issuers. should clearly set forth the agenda for any

CamberView Partners Engaging with proxy advisory services
such meeting. Companies should carefully ISS also invites all companies to verify
evaluate who will participate in a meeting, data in its separate QuickScore product.6
recognizing that in certain circumstances QuickScore seeks to rate companies on
an independent board member (such as governance risk in various dimensions,
the lead director) may be appropriate and and it is presented in summary form
effective, although in many situations the in proxy research reports as well as in
right executive participants may be the right more robust form in a separate product.
team for PAF engagement. (Summary scores are also available on
Both services also have formalized Yahoo! Finance.)
processes around engagement on reports
and data, and both services do revise Engagement on mergers and acquisitions and
proxy reports at times based on corrections proxy contests
of factual data. ISS says no company is Glass Lewis does not engage with either
“entitled” to review its reports before side during the solicitation period in a proxy
publication, but as a courtesy it generally contest except as described above.
provides companies in the S&P 500 index ISS typically seeks to meet with both
with the opportunity to review draft reports, sides in a proxy contest. Both ISS and
with a short time line for response. ISS seeks Glass Lewis have separate mergers
factual corrections, adding: “this is not an and acquisitions (M&A) teams, and
opportunity for the issuer to lobby for a engagement with ISS on a proxy contest
particular voting recommendation, but to (or any M&A transaction) is likely to
check the facts that are being included in our involve the members of this team, who
report.” ISS provides S&P 500 companies may have less focus on governance and
specific instructions on how to respond to more on underlying business dynamics.
the draft report. As such, companies may need to gear the
ISS “does not normally allow pre- engagement differently than is the case for
publication reviews of any analysis relating governance discussions in a noncontested
to any special meeting or any meeting situation.
where the agenda includes a merger or
acquisition proposal, proxy fight, or any PAF policy processes
item that ISS, in its sole discretion, considers ISS has highly formalized processes around
to be of a contentious or controversial its proxy voting policies and its QuickScore
nature.” ISS requests issuers that do not product and invites input from corporations
get an opportunity to review reports before as well as institutional investors. In recent
publication, and that spot an error, to years, the ISS global proxy policy formulation
contact ISS immediately, and ISS does at process7 has invited participation in a
times revise its reports and on occasion a survey, and the firm also has held a series
recommendation, postpublication. of roundtables and conference calls. When
Glass Lewis does not provide any issuers ISS proposes new policies, it opens a 30-day
with prepublication draft reports. It does comment period. Typically, ISS initiates the
have a form for notifying Glass Lewis of a process in July with the survey, which closes
data discrepancy in a published report on its in August. ISS releases survey results, as
“Primer for Issuers” web page (mentioned well as proposed policy changes, seeking
above), and it has a process for revising comment on the latter in late September and
reports based on corrections and also early October. ISS seeks to finalize policy
sometimes revises voting recommendations. updates in November.
Glass Lewis is working with some company Glass Lewis invites issuer engagement on
representatives on a potential approach on policies on an informal basis, but does not
prepublication data review, although it is not have the same formalized role for corporate
clear when a new process may be in place. participation in policy development.

Notes
1 SEC, Proxy Voting by Investment Advisers,
Release No. IA-2106, January 31, 2003, the “Proxy
Voting Rule.”
2 Egan-Jones Proxy Services, SEC Staff Letter (May
27, 2004), and Institutional Shareholder Services, Inc.,
SEC Staff Letter (Sept. 15, 2004).
3 SEC Staff Legal Bulletin No. 20 (IM/CF), June
30, 2014.
4 http://www.issgovernance.com/contact/faqs-
engagement-on-proxy-research/
5 http://www.glasslewis.com/issuer/
6 http://www.issgovernance.com/governance-
solutions/investment-tools-data/quickscore/
7 http://www.issgovernance.com/policy-
gateway/policy-outreach/

38 Tools for knowing your
stockholder base
Arthur B. Crozier, Chairman Innisfree M&A Incorporated
I
n recent years it has become increasingly important for publicly-
traded companies to have detailed, current information about
who their stockholders are. In particular, the rise of activist
investors and the escalating pressure to engage directly with
institutional investors has made such information a critical
priority for managements and boards of directors. While
information regarding an issuer’s stockholders is available
through various public filings, such information is inadequate—
dated and incomplete at best—in this time of high-volume, high-
speed trading.
While firms offering stock monitoring services have been in
existence since the 1980s, when their services were known as “shark
watch” in response to the sharp increase in hostile mergers and
acquisitions (M&A) activity in that period, they have become much
more sophisticated and accurate.
This chapter describes the reasons why professional stock
monitoring services are necessary in the US, why publicly available
information is inadequate, an overview of the stock monitoring
process, and, finally, the benefits of a stock monitoring program.
Why professional stock monitoring services are necessary

The need for such services arises from the way in which securities
are held in the US. Professional investors, and most individuals,
do not hold their shares in their own names on a company’s stock
ledger. Instead, they use custodian banks and brokers that hold
the shares in their own names through the central share certificate
depository, The Depository Trust Company (DTC). Since the law
of a company’s state of incorporation requires that all issued and
outstanding shares must appear on the company’s stock ledger, DTC
uses a nominee, Cede & Co., to hold bare legal title to the shares held
by its bank and broker custodial participants on each company’s
stock ledger. Consequently, the company’s stock ledger, standing
alone, provides little assistance in determining who actually owns
its shares since generally at least 90 percent of the outstanding shares
appear there as being owned by Cede & Co.

Tools for knowing your stockholder base Innisfree M&A Incorporated
DTC, for a fee, however, does make funds. It is important to note, moreover,
available to the issuer on a daily or weekly that such synthetic positions do not count in
basis a listing of the number of shares held calculating the value of the investment for
by each of its bank or broker custodial determining whether the investor needs to
participants. This Securities Position Report, file under the Hart-Scott-Rodino Act (HSR),
as discussed below, is the bedrock of another potential tip off to an issuer that a
stock monitoring, enabling the tracking of nonpassive investor is acquiring shares.
movements among custodians and thereby Perhaps most important in light of the
ideally identifying buyers and sellers as well rise in shareholder activism, institutional
as other activity regarding the stock, such as investment managers can request to file 13Fs
the likely level of stock lending. confidentially regarding certain holdings
Unlike in other jurisdictions, such as the if they can show to the SEC that such
UK, US issuers do not have the ability to information is “confidential, commercial or
compel disclosure of the actual beneficial financial information.” Such confidential
owners of shares behind custodians. treatment cannot extend for longer than a
As previously mentioned, publicly year, at which point the manager must file
available information is inadequate, and an amended 13F for each calendar quarter
so an issuer that needs to know what is in which it held the security. Usually, by that
happening in its stock needs to hire an time the manager has already made known
experienced professional who can interpret its plans to the issuer and the world or it is
the movements among the custodians as too late for the issuer to respond effectively.
revealed in successive Security Position Notwithstanding the filing requirements
Reports and other available information. of Form 13F, if an investor acquires five
percent or more of a class of a US publicly-
Publicly available information is inadequate traded company, it must file a Schedule 13D
Various regulations require certain investors containing, among other things, the number
to publicly file their investments. The most of shares held and by whom, in the case of
common such filing, Form 13F, must be a group filing, the dates on which shares
filed within 45 days of the end of each were bought or sold, and, most important,
calendar quarter by institutional investment the purpose behind the investment and any
managers that exercise investment discretion “contracts, arrangements, understandings or
over more than $100 million in US exchange– relationships” with respect to the investment.
traded stocks. With respect to each such While this information is of extreme
stock, the institutional investment manager importance to an issuer, this filing also has
must disclose, among other things, the a fatal flaw for the issuer—the filing due
number of shares as to which it has sole or date is 10 days after the investor crosses the
shared investment authority, as well as sole five percent threshold. During that 10-day
or shared voting authority, as of the last day window, the investor can acquire as many
of each calendar quarter. shares as possible. Many issuers have been
The obvious limitation to relying on Form taken by shocking surprise to discover upon
13F to understand the shifting dynamics of the filing that there is now an investor with
a company’s stockholder base is the dated hostile designs owning far more than five
nature of the information. Further, not all percent. There has been extensive debate over
investors a company needs to be concerned the past several years whether to significantly
about are institutional investment managers reduce the 10-day trading window, but there
required to file a 13F. In addition, investors are no indications that the issue will be
do not need to disclose in their 13F filings resolved in the near term.
synthetic positions, such as total return Certain investors who acquire more than
swaps or over-the-counter call options, five percent of a class of securities of a US
both of which are frequently used by hedge exchange–listed company in the ordinary

Innisfree M&A Incorporated Tools for knowing your stockholder base
course of business without the purpose or information regarding the custodians used
effect of changing or influencing the control by professional investors. While many
of the issuer may file a Schedule 13G in professional investors use more than one
lieu of a Schedule 13D. The 13G disclosure custodian, in most cases there is a pattern to
requirements are less stringent, and the filing their holdings that can be identified. Pattern
due date is even more disadvantageous recognition is a particularly important skill
to an issuer seeking to track ownership of for a good stock monitoring analyst.
its shares. A qualified institutional investor It is customary when starting a stock
must file within 45 days of the end of the monitoring program to order Security Position
calendar year in which it owns more than Reports as of the most recent 13F filing date
five percent or within 10 days of the end of and the dates of any other recent public
the calendar month in which it crossed 10 filings. The stock monitoring analyst will
percent ownership. Investors required to then true up the custodians on that date to
file 13Fs must still disclose their ownership the various institutions’ reported filings. This
on that form on a timely basis. Certain step enables the analyst to establish a baseline
other investors with a passive investment with confirmed information and reduce the
objective, but who are not qualified uncertainty caused by the fact that multiple
institutional investors, acquiring more than investors may hold at a single custodian.
five percent of a US exchange–traded equity That uncertainty is particularly an issue
security can also use Schedule 13G, but the with hedge funds since as a group they
applicable filing deadlines are also of little tend to hold at a very limited number of
benefit to the issuer. prime brokers. Accordingly, a good stock
While these public filings, standing monitoring analyst will look at other
alone, are inadequate for a company seeking available sources of information, such
detailed, informed information about its as inbound calls to IR departments and
stockholders, they can be extremely helpful participants at sell-side conferences, in order
to a stock monitoring program, as described to narrow down the possible investors at
in the next section. particular custodians.
Experience is a critical factor in delivering
Overview of the stock monitoring process accurate stock ownership information. While
As noted above, the bedrock of the stock the stock monitoring firms have developed
monitoring process is the Security Position much more sophisticated analytical tools
Reports issued by DTC. By examining the than they had in “shark watch” times, there
increases and decreases among the various is still a significant element of art, along with
custodial holders, an experienced stock science. After years of watching movements
monitoring analyst can often identify who by particular investors or extensive training
are the buyers and sellers on a particular day by someone who has that experience, an
because many institutional investors utilize analyst can interpret far more than a simple
only one custodian. Further, hedge funds examination of increases and decreases at
generally use fewer than three custodians. custodians would reveal.
It is rare for mutual funds, pension funds, Stock monitoring is not a do-it-yourself
and hedge funds to change custodians on a project. As shown above, it requires a
regular basis. Investor-custodial relationships comprehensive database of custodial
are generally long-standing since custody holdings, strong analytical skills, a
services are one of many other services sophisticated understanding of trading
provided by the custodian to the investor, mechanics, and experience.
thereby inhibiting frequent changes.
From years of observation and information The benefits of a stock monitoring program
gleaned from various public filings, stock More than ever before managements and
monitoring firms have databases containing boards need to be concerned about and

Tools for knowing your stockholder base Innisfree M&A Incorporated
understand shifts in their shareholder base custodial account; rather they settle into
and to have such information quickly, the open market buyer’s custodial account
far sooner than through a 13F filing. For after exiting the lender’s custodial account.
example, if an investor began to accumulate Consequently, a stock monitoring program
a position on the first day of a calendar cannot identify the short seller.
quarter, a company relying only on 13Fs Given the recent trends in activist
would not know about that accumulation for investing, where it seems as if no company
four and a half months. is safe, stock monitoring can be an
The most obvious benefit is to help effective early-warning system providing
understand market sentiment regarding the management and the board invaluable time
company and thereby calibrate the investor in which to prepare an effective strategy
relations program. Are new investors to deal with an activist investor. As noted
buying the stock because they know and above, an activist investor can hide its
understand the company’s story? Are existing accumulations by filing confidential 13Fs,
shareholders selling because they no longer using synthetics to mask its accumulations
believe the company’s story or because they and buying aggressively in the 10 days after
are value investors and believe the stock crossing the five percent ownership level
has reached their internal target price? The before disclosing its ownership position and
answers to those types of questions will then intentions in a 13D filing.
drive the IR strategy. For example, if investors Given the complexities involved in
are selling because they do not understand the monitoring accumulations by activist hedge
story, the company should undertake a more funds, especially the limited number of
fulsome and active communications strategy prime brokers used by activists and their
to ensure that remaining investors continue frequent use of synthetic positions, it
to be comfortable with their investment. In is important for a company that feels it
such circumstances, it could also lead to a is vulnerable to use a stock monitoring
more informed targeting program designed to firm that has a strong expertise in this
attract investors who do understand the story area. Given the ramifications, an incorrect
and are willing to pay fair value as a result. identification of an activist hedge fund in
If the company does undertake a targeting the stock has far more severe consequences
program, stock monitoring will provide than a misidentification of a fundamental
confirmation whether or not the program is institutional investor.
effective. If an activist investor is accumulating a
Stock monitoring can also provide more position, the stock monitoring program also
timely insight into the level of open short provides a valuable service by providing
positions, another sign of market sentiment, a comprehensive analysis of the entire
rather than relying on the semimonthly shareholder base. That analysis, by breaking
announcements by the stock exchanges. By the shareholder base down into relevant
comparing total shares settled in custodians categories, such as institutions that subscribe
on a particular day to the corresponding to the leading proxy voting advisory firms,
trading volume, a stock monitor analyst those that do not use an advisory service,
can determine the approximate amount of retail investors, insiders, and so forth, enables
shares lent out on the day (the necessary the company to assess its vulnerabilities and
predicate for a short sale), if there was higher strengths. That assessment then leads the
aggregate settlement volume than would development of an appropriate response
be normal in light of the trading volume. strategy, including the level of engagement
Because a short seller in the ordinary course with the activist and other shareholders and
borrows shares and then immediately sells the communications program.
them on the open market, the borrowed A very effective tool arising out of the
shares never settle in the short seller’s shareholder composition analysis is a vote

Innisfree M&A Incorporated Tools for knowing your stockholder base
projection showing the likely outcome of actual number of shares sold and bought
a proxy fight, usually over the election and how much represents churn, the buying
of directors, an activist’s ultimate threat. and selling of the same share of stock among
By providing a candid, well-informed numerous short-term traders during the day.
assessment of the directors’ likelihood of On very high-volume trading days, it is not
being re-elected or the likely outcome of uncommon for actual buy-sell activity to
votes on other proposals on the agenda, the represent only 20 percent of trading volume.
board can make a well-considered judgment Stock monitoring can also enable senior
on how to proceed, particularly whether to management to direct its shareholder
settle with the activist and, if so, on what engagement activities efficiently. It is
terms. not unknown for an investor to greatly
While a stock monitoring program can exaggerate the size of its position in a
alert a company to serious threats, it can company to secure a meeting with senior
also demonstrate that perceived threats management. A good stock monitoring
arising from unusual trading activity are program enables the company to identify
not well founded. It is not uncommon for such investors and treat them appropriately.
companies to see elevated trading volumes
driven by market rumors, announcements of Conclusion
corporate events, or no readily ascertainable A stock monitoring program is an essential
reasons. Given the prevalence of program tool for publicly-traded companies seeking
and other high-speed trading strategies, to understand the shifting dynamics of
however, trading volume does not their shareholder base and to effectively
necessarily translate into real buying and and efficiently engage with shareholders,
selling activity. Under those circumstances, particularly in light of the increased level of
stock monitoring, by looking into actual shareholder activism. Given the complexities
settlement of shares out of selling custodians involved, companies cannot undertake such
and into buying custodians, will reveal how programs internally, but need to retain an
much of the trading volume represents the experienced provider.

39 Understanding/messaging
with institutional investors
Leigh Parrish, Senior Managing Director, and Steven Balet, Managing Director FTI Consulting
E
ngagement with the investment community has transformed
remarkably over the past several years. A significant
reason for this has been the change in how institutional
investors are viewing corporate governance and what it means
to their investment thesis. In the past, many institutions either
“voted with their feet,” voted exclusively with management’s
recommendations, or allowed proxy advisory firms to hold
sway over shareholder votes during proxy season. Today many
institutions have created corporate governance teams that may
engage with a company on a host of issues and engage with
activists or proposal proponents in contested situations. To be
clear, institutions continue to often vote along proxy advisor
lines, particularly regarding votes on compensation, but more
and more, investors are taking a broader view of the initiatives to
be voted upon and are being proactive in their evaluation of the
issues at hand.
As a result of this change, management teams should view
investment community engagement as a deeper relationship-
building process that can improve the odds of a successful proxy
voting outcome. To help stave off potential proxy issues, the proxy
off-season creates an underappreciated opportunity to inform and
educate institutions on a company’s unique corporate governance
principles and overall capital allocation philosophy and to explain
outliers that may not fit proxy advisors’ specific guidelines.
The heightened investment community engagement can also
have the benefit of preventing potential shareholder activism
by: (1) understanding any concerns of the shareholder base and
addressing those before an activist forces a company to defend its
strategy and policies; and (2) developing credibility as an engaged
board and management team with the corporate governance staff at
institutions.
What a company should know before it engages

Preparing for engagement with the investment community is as
critical as the interaction itself. The first step in the engagement
process is to know with whom a company should be engaging.

FTI Consulting Understanding/messaging with institutional investors
When it comes to corporate governance and on a specific issue at other companies, as

activism issues, institutions are increasingly well as understanding how that institution
separating the investment duties of portfolio may have voted on the company’s own
managers from the corporate governance ballot in prior years.
group or proxy committee that may make
the voting decision. It is vitally important How to engage
that a company understand who ultimately Once the background information on the
makes the voting decision at each institution institution has been ascertained, a company
with which they engage. In most cases, this is now in position to begin engagement. It
information will be readily supplied by the is important to remember that this process
institution or can be supplied by a third must be ongoing in order to be effective;
party advisor. as corporate governance views continue
The second step in the engagement to evolve, a company that has not faced
process is to understand the thought scrutiny for several years may suddenly find
process the particular institution has itself subject to shareholder proposals or a
concerning corporate governance issues. negative vote on directors simply due to a
Most institutions publish their proxy voting sudden change in performance or change in
guidelines online. Some are more detailed views by the governance advocates.
than others and most have a series of issues Further, the engagement process is
where the guidelines may state that the about interacting with shareholders, not
voting determination is made on a “case-by- necessarily winning an argument. Even if
case” basis. This “case-by-case” basis is also a company’s views on a subject differ from
prevalently used in the voting guidelines of an investor’s, the process of engagement
the proxy advisory firms’ voting guidelines. is meant to demonstrate that a company
Although many large institutions publish has participated in a thoughtful process
their proxy voting guidelines, these may when coming to its view. This shows the
be somewhat opaque concerning certain investor that the company has an involved
situations (the “case-by-case”) or may not board of directors and management
address certain situations at all if they team. Establishing this credibility with an
are relatively new. Since 2004, registered investor can pay special dividends should
management investment companies, other the company encounter a difficult vote on
than a small business investment company a proposal or if it becomes subject to an
registered on Form N-5, are required to file activist campaign.
reports with the Securities and Exchange In order to establish this credibility,
Commission (SEC), not later than August 31 when engaging with an institution on
of each year, containing the registrant’s proxy governance matters it is advisable to
voting record for the most recent twelve- include an independent board member on
month period ended June 30, pursuant to the engagement team, particularly with
Section 30 of the Investment Company Act large passive institutions. By giving these
of 1940 and Rule 30b1-4 thereunder (17 CFR institutions access to an independent board
270.30b1-4). member, it allows them to hear what the
This allows companies to access the thought process and philosophy concerning
specific voting history of many of their governance is at the board level.
institutional holders before engaging with The messaging during these meetings
them on a specific governance matter. Many should concentrate on the process the board
companies use third-party services (investor uses to consider governance issues. If a
or public relations advisors or proxy company has a classified board, plurality
solicitors) to help them search for this data voting, or non-independent chair, they
so that they can have a better understanding should be prepared to discuss the reasons
of how an institution is thinking and voting why in a positive manner. Although many

Understanding/messaging with institutional investors FTI Consulting
institutions have expressed displeasure with Their investment power is making them
these practices, it is important during the increasingly influential with companies,
conversations with shareholders to show shareholders, and the media. These economic
that the board regularly considers these activist shareholders, which traditionally
structures and has a rationale for why targeted smaller underperforming
they believe that they enhance shareholder companies, have targeted much larger
value over the long run. Messaging during companies in the past two years, as well
these engagements should always reinforce as companies that have performed well but
that the board’s philosophy consistently where an activist sees an opportunity for
considers maximizing shareholder value. increased yield through a share buyback,
The timing of these meetings is also dividend, or sale.
important. Proxy season typically runs The largest and perhaps most daunting
from March through June, and during these development in the activism space is the
months the corporate governance groups increasing support institutional shareholders
at various institutions are extremely busy. are now giving activists. According to
Although they will almost always take time FactSet, in contests for board seats that
for a call, it is more likely that they will be went to a vote in 2013, 17 were won by
able to focus on the engagement if it is held activists, 12 by management, and 1 was
during the proxy off-season, as during the split. This was only the second year activists
season they may have to spend time on had won more contests than they had lost
companies with current issues. since tracking began in 2001. Through July
Finally, although not an investor, it is 2014, companies and activists had won
also advisable to reach out to Institutional seven contests each, but the number of
Shareholder Services (ISS) during the proxy settlements, 37, already surpassed all of
off-season. Although the influence of ISS has 2013. Many of these settlements occurred
been lessened as more institutions take a more because companies did not feel they had the
thoughtful approach to voting, their influence institutional support to win a vote.
is still considerable, particularly on “say-on- In addition to economic activists, there
pay” votes. In that area it is estimated that a has also been an increase in corporate
negative ISS recommendation can impact an governance activism. By July of 2014, there
average of 30 percent of the votes, although were 901 shareholder proposals brought
this percentage will differ depending upon by these activists at companies, surpassing
the makeup of a company’s shareholder base. the total of 840 proposals brought in all of
ISS will engage with companies, and this 2013. Although many of these proposals
engagement should be conducted in the same do not pass, they often serve as a red flag
manner as engagement with an institution. to economic activists, who may judge poor
votes as symptomatic of displeasure among
Increased engagement in the era of activism the shareholder base and an opportunity for
Activist funds are fast becoming a mainstay on them to promote their agenda.
Wall Street. These firms have outperformed Many economic activist investors
all other hedge funds by strategy in 2012 target companies where they have both an
and 2013, and the investment community investment thesis and where they believe,
has rewarded them with more assets under based on their own intelligence on the
management than ever before. According company’s investors, that they have a path
to Hedge Fund Research, assets managed to victory. Establishing a relationship with
by activist funds have almost tripled over the institutional investor community and
the past five years to approximately $93 establishing confidence in the board by
billion in the first quarter of 2014, increasing engaging with the voting decision-makers
approximately $28 billion dollars in 2013 and corporate governance groups at these
alone. institutions is invaluable in helping to

FTI Consulting Understanding/messaging with institutional investors
prevent an activist from believing that they media platforms versus on a company’s own
have that path to victory. website. But if companies don’t engage, their
voices won’t be heard.
Engagement in the face of activism—getting Increasingly, journalists at mainstream
your story out: the three Cs publications are turning to social media
Companies must understand that the to find leads and sources. If a company
traditional means of shareholder outreach is not participating on social platforms,
to portfolio managers through investment it is creating an out-of-sight, out-of-mind
conferences and on earnings calls is no risk and is increasing the chance that its
longer enough to keep activists at bay. As a viewpoint will not be reflected in the
result, companies need to re-think the way journalists’ articles.
they approach the engagement process and Collaboration begins once the corporate
must develop a more cohesive and fulsome message is defined and disseminated to as
communications narrative that incorporates many influencers as possible. The company
certain elements of corporate governance in can begin developing influencers of its own
advance of activism overtures. by building relationships and support with
When dealing with investor activism, third parties.
it is critical that a company proactively Bloggers, who sometimes have greater
engage with all members of the investment sector expertise than traditional journalists,
community to ensure that investors are the oldest part of the social media
understand, accept, and, most important, spectrum and, therefore, are the most easily
believe in the company narrative. There forgotten—until needed in a crisis. However,
are three elements to communicating a it is a best practice to engage with bloggers
company’s story: content, conversation, and before they are needed.
collaboration. Engaging with bloggers does not mean
Content begins with the investor relations sending them press releases. If a company
officer and chief communications officer can cultivate an influential blogger by
making sure the corporate website says offering that person exclusive information
what the company wants it to say—it is or access to executives, and by so doing
where shareholders, journalists, allies, raise the blogger’s profile, the company
and adversaries first go to learn about a can create a powerful ally in a contest with
company. According to a recent Thomson activists. And a blog can not only inform
Reuters survey, 84 percent of institutional and influence mainstream articles but, as
investors use the investor relations website more institutional voting decision-makers
as a source of research information. Further, rely on key trade and industry blogs for
if a company wants the message it posts information, they that can influence votes.
to be broadly shared, studies indicate that Today, stakeholders are living online.
adding images and video make the website Therefore, companies should have their
far more likely to be viewed. online strategies baked into the broader
Conversation can begin after the website is communications strategy.
optimized. Companies should examine their
social media policies and strategies to make Engaging with activists
sure everyone knows what can and cannot If the event arises, companies should always
be communicated, what’s public, and what’s be open to engaging with known activist
privileged. Then the company can begin to investors just as they would engage with
engage. any shareholder. The specific engagement
Many executives are leery of social process will depend on a number of factors,
media. They are right to be cautious. Social including (1) whether the initial approach
platforms are not without risk. Companies by the activist is private or public; (2) the
can’t control the conversation on social activist’s history; and (3) those involved

Understanding/messaging with institutional investors FTI Consulting
with engaging the activist—management, Engaging with an activist does not

board, or a combination. necessarily mean that the company should
If an activist investor makes his or her feel forced to agree with them. If a company
position public through a filing, letter, or feels confident in its position, based on
some other forum, it is imperative that the conversations with its shareholder base, it is
board and management respond swiftly and OK to say so. If the activist engagement goes
with deference. While the tendency is often public, it is important to show other investors
for companies under attack to either retreat that the board and management are always
or not reply at all, this passive approach open to the views of shareholders, while at
will only exacerbate the situation. The the same time making an argument against
first engagement with an activist investor the activist’s position.
often sets the tone for how productive the
follow-on interactions will be and whether A look ahead on engagement
the situations will develop into a contest, Engagement with investors has changed
settlement, or simply a disengagement by the a great deal over the last several years
activist. and that trend will continue. Companies
Early contact with activist funds fosters should always keep up with the latest trends
a sense of collaboration and ensures both in corporate governance as well as what
sides understand the other’s position. The changes to the rules are pending at the SEC.
company can use this as an opportunity In the future, it is expected that the CEO Pay
to evaluate the argument and assess the Ratio rule, prescribed by Dodd-Frank and
validity of the claim, it will also afford expected to be implemented in 2015 or 2106,
the company an opportunity to reach out may cause a wave of shareholder proposals.
to its investor base, even if the activism The recent rules prescribed by the SEC
is currently private, to understand if the relating to proxy advisory firms may also
argument the activist is making will have have an effect on how institutions vote in
support. It is important not to be dismissive; the future. Although the rules may continue
if the situation results in a proxy contest, the to change, there is little doubt that the
background section of the proxy statement trend toward increased and more effective
will highlight all interactions between the engagement with investors will continue.
activist and the company. A company does
not want the perception that they were
dismissive of a large shareholder.

Part V
International perspectives/
“Hot Button” issues and developments
nyse.com/cgguide
NORTH AMERICA
Canada Andrew J. MacDougall, Partner; Elizabeth Walker, Partner; and Robert Yalden, Partner Osler, Hoskin & Harcourt LLP
C
orporate governance in Canada is founded on a system of
legal rules that involve a single-tier board model similar to,
and influenced by, the systems seen in the United Kingdom
and the United States. Overlaying this is an extensive array of
best practices that are promoted by securities regulators, stock
exchanges, institutional shareholder groups, the media, and
professional bodies. These practices have been influenced by
the high proportion of public corporations in Canada that have
a dominant or controlling shareholder, either through equity
ownership or the ownership of multiple voting rights, and
the economic clout and organization of Canadian institutional
investors, including the Canadian Coalition for Good Governance
(CCGG), a national institutional investor organization that has
pursued an organized program of advocating its views on best
practices without resorting to proxy battles. Legal rules are
less prescriptive than in the United States, generally taking a
comply-or-explain approach reflective of practice in the United
Kingdom and other jurisdictions. While the Supreme Court of
Canada recently affirmed that a board of directors in Canada
owes its fiduciary duties to the corporation rather than any single
constituency, pressure from the media, investor rights advocates,
and other groups has led to voluntary adoption of many practices
by companies that are not addressed by legal rules and that reflect
the desire on the part of particular stakeholders to have a more
direct say on matters of importance to the corporation.
Many of the topical issues in corporate governance in Canada
today reflect a particular effort on the part of shareholders, both
institutional and activist, to exercise more influence. Institutional
investors have lobbied for greater voting influence through the
adoption of majority voting for directors and say-on-pay and
other voting initiatives. These efforts and the impact of increased
shareholder activism in Canada in recent years has prompted a
re-examination of Canadian proxy rules and the impact of proxy
advisory organizations by regulators, and the adoption of advance
notice provisions for nomination of directors by companies. In

Osler, Hoskin & Harcourt LLP Canada
addition, the Ontario Securities Commission to receive majority approval have been
(OSC) is proposing to introduce new very rare but are increasing. There are also
disclosure rules respecting the representation concerns about the impact it may have on
of women on boards and director tenure. the ability of smaller companies to recruit
talented directors and the possibility of
Majority voting and individual voting for “failed elections”—where no directors are
directors elected or an insufficient number of directors
Effective June 30, 2014, all companies are elected with the attributes necessary
listed on the Toronto Stock Exchange (TSX) to meet statutory director residency
are required to have majority voting for requirements or requirements to have an
directors, whether through adoption of a audit committee made up of at least three
policy or under their constating documents independent directors.
or governing statute, although there is an
exemption for majority-controlled companies Say-on-pay
(where a single person or company owns 50 Canadian companies are not subject
percent or more of the voting securities). to an obligation to hold a nonbinding,
Since December 31, 2012, TSX companies advisory shareholder vote on executive
have been required to provide for individual compensation (say-on-pay). Although
voting for directors rather than slate voting many other jurisdictions have passed
and to disclose whether or not they had legislation mandating say-on-pay votes,
adopted a majority voting policy and, in some cases on a binding basis, and
if not, explain why. TSX companies are although a consultation paper issued by the
also required to issue a press release of OSC in January 2011 and the recent CBCA
director election results promptly following Consultation have sought views on whether
the shareholder meeting. Majority voting to require advisory say-on-pay votes, there
means that in a director election that is not are no proposals to adopt similar legislation
contested, where more votes are withheld in Canada.
from voting on the election of a director There are many reasons why say-on-pay
than are voted in favor, the director must is not required in Canada, although none
promptly tender a resignation and the board are determinative. Executive compensation
must announce within 90 days whether or levels have, in general, been lower than
not the resignation is accepted. By the fall of in other jurisdictions. Canadian companies
2011, when the TSX conducted a survey of have a long history of engagement with their
200 of its listed companies, approximately shareholders on matters of interest, including
76 percent of those surveyed had voluntarily executive compensation practices. Executive
adopted a majority voting policy. compensation disclosure practices have
The question whether to extend majority improved. Institutional shareholder support
voting requirements and individual voting for say-on-pay has not been unanimous, as
for directors more broadly has been one large pension fund, the Ontario Teachers’
studied by the OSC and is currently being Pension Plan, has stated that it does not favor
considered as part of a public consultation say-on-pay voting. Canadian companies
on a request for comments on the Canada generally were less adversely affected by
Business Corporations Act published by the most recent economic downturn than
Industry Canada on December 11, 2013 companies in other countries. The widespread
(the CBCA Consultation). While individual use of individual voting for directors means
voting for directors has widespread support that shareholders can express dissatisfaction
and is the common practice in Canada, it is with compensation practices by withholding
unclear to what extent majority voting will votes for the election of members of the
be extended beyond TSX listed companies. compensation committee without needing a
Circumstances where directors have failed separate say-on-pay vote.

Canada Osler, Hoskin & Harcourt LLP
Despite the absence of any legislative is also examining facilitation of board and
requirement, the number of companies that shareholder communications, including
have voluntarily adopted say-on-pay has increased transparency of share ownership.
gradually increased every year. Adopters have Any changes to the Canadian proxy
been almost exclusively larger companies rules are unlikely to change certain features
listed on the TSX. Although the number that distinguish it from other jurisdictions,
of say-on-pay adopters has increased each including:
year, average approval levels have gradually
declined, and the number of companies with 1 the ability of a company to send materials
either failed say-on-pay votes or approval directly to beneficial owners who do not
levels below 70 percent has increased. Such object to disclosure of their identity and
trends, as well as media reports following the holdings
few instances where say-on-pay voting has 2 the ability of a company to set a deadline
highlighted excessive pay concerns at a few for the deposit of proxies up to two
companies, have slowed the rate of voluntary business days before the date of the
adoption by Canadian companies. shareholder meeting
3 the practice of companies and dissidents
Canadian proxy rules not having joint access to beneficial owner
The increased emphasis on voting by voting responses prior to the meeting.
shareholders on dilutive transactions,
individual voting for directors, voluntary Proxy advisory firms
adoption of say-on-pay, and shareholder In response to complaints respecting the
activism has placed increasing pressure on activities and influence of proxy advisory
the Canadian proxy voting system. Gaps in firms, the CSA published a consultation
the system were highlighted in 2012 when paper in June 2012. The paper focused on
TELUS Corporation’s proposal to eliminate concerns respecting potential conflicts of
its dual-class share structure was opposed interest, a perceived lack of transparency,
by a US hedge fund that used an empty potential inaccuracies and limitations
voting strategy to oppose TELUS’s initial on the ability of companies to engage
proposal. with proxy advisory firms, corporate
The Canadian Securities Administrators governance implications, and the extent
(CSA) issued a consultation paper in August of reliance by institutional investors on
2013 regarding the proxy voting system in the recommendations provided by proxy
Canada. The paper sought feedback on the advisory firms.
system for determining voting entitlements Comments were divided. Issuers and
for securities held through intermediaries their advisers agreed with the concerns
on behalf of beneficial owners, including identified, while institutional investors and
consideration of the impact of share proxy advisory firms noted the useful and
lending, documentation errors, and the cost-effective services they provide. Proxy
nature and extent of over-reporting and advisory firms also indicated that they have
over-voting. It also sought information on appropriate policies and procedures in place
the possibility of implementing an end- to address the concerns identified.
to-end vote confirmation system so that In light of the feedback received, the CSA
beneficial owners could receive assurance decided to adopt a policy-based approach
that their votes were received and recorded of providing guidance on recommended
as cast. A roundtable discussion on the practices and disclosure for proxy advisory
issues with representatives from the issuer, firms. The guidance addresses the need
institutional investor, brokerage, and proxy for proxy advisory firms to identify,
advisory communities was held in January manage, and mitigate conflicts of interest,
2014. Separately, the CBCA Consultation implement appropriate practices to

Osler, Hoskin & Harcourt LLP Canada
promote transparency and accuracy of vote the other provinces and territories in Canada
recommendations, and communicate with republished the proposed rule changes for
their clients regarding their practices. comment. The final version of the disclosure
rule was issued in October 2014 by securities
Advance notice provisions regulators in all jurisdictions in Canada
Canada has experienced increased other than Alberta, British Columbia, Prince
shareholder activism as large well-financed Edward Island, and Nunavut.
activist funds have pursued shareholder Under the new disclosure rule, a
activist campaigns as a business. This company subject to continuous disclosure
increase in activity has prompted Canadian requirements in one or more of the
companies to examine their defensive participating jurisdictions, other than
strategies. Many have recently adopted a a company listed on the TSX Venture
long-standing US practice of including a Exchange or investment fund, is required
company by-laws provision requiring to disclose annually the number and
advance notice to the company of any percentage of women directors and women
intent to propose nominees for director. who are executive officers, together with any
Only a handful of Canadian companies had targets the company has adopted regarding
adopted such requirement prior to 2012. the number or percentage of women in
However, many Canadian companies have such positions and the progress made in
done so since. achieving those targets. The company is also
Although modeled on US provisions, required to disclose whether it has a written
Canadian advance notice provisions require policy for the identification and nomination
a person to provide notice of director of women candidates for director or explain
nominees not more than 65 and not less why it does not. If such a policy has been
than 30 days prior to the meeting date, adopted, the company must provide a
compared to a minimum of 60 to 90 days summary of the policy and its objectives,
or 90 to 120 days prior notice under US implementation measures, the annual and
provisions. While such provisions have cumulative progress made on achieving the
largely been supported by institutional objectives, and whether, and if so how, the
shareholders and proxy advisers, increasing board or nominating committee measures
concern that certain aspects of such policies the policy’s effectiveness. The company
may be unduly restrictive are prompting must disclose whether it considers the level
institutional investors to re-examine their of representation of women on the board in
views. identifying and nominating candidates for
director and the level of representation of
Women on boards women in executive officer positions when
Effective December 31, 2014, many public making executive officer appointments, or
companies in Canada will be required to explain why it does not. Companies are
comply with new disclosure requirements also required to disclose whether or not the
which seek to encourage them to increase company has adopted term limits for board
the number of women on boards and in service or other board renewal mechanisms
senior management. and, if not, why not.
The springboard for this new rule was
a consultation paper issued by the OSC Conclusion
in July 2013. In January 2014, following While Canadian corporate governance
receipt of over 92 written submissions and rules take a comply-or-explain approach
a public roundtable discussion, all of which instead of adopting prescriptive rules, most
generally supported the initiative, the OSC companies not only choose to comply with
issued proposed rule changes. In July 2014, such standards but also voluntarily adopt
securities regulatory authorities in many of best practices that go well beyond them.

Mexico Carlos Creel, Senior Partner, and Javier Soní, Senior Associate Creel Abogados, S.C.
M
exico’s legal framework underwent a substantial revision
in the last couple of years. Amendments to the Mexican
Constitution and several laws and regulations were passed
in connection with fundamental areas such as education, labor,
and tax, as well as in sectors critical to the Mexican economy,
including banking, telecommunications, and energy. Although
the benefits of these reforms in Mexico’s business and corporate
environments are not expected to materialize in the short term, a
few examples of their impact to corporate governance are already
in place and may give a hint of what is to come in the future.
Mexican stock corporations: overcoming paternalism

On June 13, 2014, amendments to the General Law on Commercial
Companies (Ley General de Sociedades Mercantiles, or LGSM) were
enacted, which, despite not being revolutionary or innovative per se,
are significant due to the role such amendments play in the policy
underlying commercial legislation in general and more concretely in
the structuring of adequate governance provisions.
In the 80th year since its enactment, the LGSM is often criticized
for being overly protective of minorities and unreasonably intruding
into business aspects pertaining to Mexican stock corporations
(sociedad anónima, or SA), but most of all, for perpetuating an
outdated regulation of commercial entities that is inconsistent
with the developments achieved in the business world during
the last decades. It was not until the enactment in 2006 of the
Law on the Securities Market (Ley del Mercado de Valores, or LMV)
that “investment promoting stock corporations” (sociedad anónima
promotora de inversión, or SAPI) were introduced as a modality of
the traditional SA, aimed to foster the private equity market with
a corporate vehicle that was not only less restrictive than the SAs
but also more compatible with structures used by investors in other
jurisdictions.
The latest amendments to the LGSM substantially replicate
the legal framework applicable to SAPIs and make it available
to SAs, which effort may be construed as one of the first steps
taken by Mexican legislators in a long path leading to a legal

Creel Abogados, S.C. Mexico
framework similar to those applicable in (2) any amendments to the compensation

jurisdictions where the parties to contracts paid to the manager of the Fibra or to the
(and ultimately the market) determine the members of its technical committee (the
terms of commercial relationships. Among manager and parties related to the settlor,
other matters, SAs now enable investors to: the manager, the trust’s subsidiaries, and
(1) freely determine the voting and economic any holders of CBFIs that have a conflict
rights of shares; (2) freely restrict the transfer of interests are expressly forbidden from
of shares; and (3) enter into shareholders’ casting their vote in connection with these
agreements and implement deadlock, drag- matters and those specified in the previous
along, tag-along, registration, and similar item); (3) the removal of the manager of the
rights. Furthermore, these amendments also trust; (4) the issuance of new CBFIs; and (5)
lower the minority thresholds required to: policies pursuant to which the Fibra may
(1) initiate civil actions against directors; (2) enter into or assume indebtedness and any
postpone the voting of matters on which amendments thereto (also subject to certain
shareholders consider themselves not fully statutory restrictions further discussed
informed; and (3) oppose shareholders’ below).
resolutions. Additionally, the LGSM now Additionally, the amendments to
requires directors to maintain confidentiality the Issuers Regulations provide that the
on all nonpublic matters and information technical committee of Fibras must approve:
obtained during their tenure and for one (1) any transaction representing five percent
additional year thereafter. or more of the relevant Fibra’s trust estate;
(2) operating policies in connection with
Mexican REITs: raising an industry standard parties related to the settlor, the manager of
The amendments to the regulations the trust, and the trust’s subsidiaries; and
applicable to securities issuers (Disposiciones (3) individual related party transactions or
de carácter general aplicables a las emisoras transactions that imply a conflict of interests
de valores y a otros participantes del mercado (which must be entered into on an arm’s-
de valores, or Issuers Regulations) enacted length basis and require the affirmative vote
on June 17, 2014, represent a limited but of the majority of the independent members
welcome effort to raise the corporate of the technical committee).
governance standards applicable to Mexican As to financial responsibility, the
real estate investment trusts (fideicomisos de amendments to the Issuers Regulations (1)
inversión en bienes raíces, or Fibras). Said forbid Fibras from incurring in liabilities
amendments introduce minority rights in excess of 50 percent of the book value
applicable to Fibras, forbid related parties of the relevant Fibra’s assets and impose
or parties that have a conflict of interests the obligation to maintain at least a 1.0
from voting in certain matters, and establish debt service coverage ratio (during the
certain restrictions in connection with the following six quarters), and (2) require
leverage and debt service coverage ratios of Fibras to have a committee composed in its
Fibras. majority by independent members of the
Among others, the amendments to the technical committee in order to oversee that
Issuers Regulations set forth that the vote mechanisms and controls are established
of the general meeting of the holders of the to verify that the indebtedness incurred or
certificates issued by a Fibra (certificados assumed by the relevant Fibra conforms to
bursátiles fiduciarios inmobiliarios, or CBFIs) is applicable law.
required in order to approve: (1) related party
transactions or those that may otherwise Directors, officers, and bankruptcy: Vitro’s Wake
imply a conflict of interests, in case the Important amendments to the Mexican
relevant transaction represents 10 percent Bankruptcy Law (Ley de Concursos
or more of the relevant Fibra’s trust estate; Mercantiles, or LCM) were enacted on

Mexico Creel Abogados, S.C.
January 10, 2014. Besides introducing and an economic benefit is obtained for
several substantive and procedural themselves or third parties (including related
innovations for the benefit of creditors (eg parties); and (9) in general, acting willfully or
subordination and a longer look-back period in bad faith, or carrying out illegal actions.
applicable to intercompany and related Additionally, the amendments to the LCM
party liabilities, stricter requirements to introduce a penalty of imprisonment for 3 to
cram down legitimate third-party liabilities, 12 years that may be imposed on members
consolidated insolvency procedures for of the board of directors, sole administrator,
corporate groups, clear-cut rules for debtor- CEO, and officers of an entity that has been
in-possession financing, strict limitations to declared insolvent, if (1) through the altering
the length of the conciliatory stage of the of accounts or the terms of agreements
procedure), said amendments introduced they knowingly cause the registration of
important fiduciary duties and penalties inexistent transactions or expenses, or (2)
applicable to directors and officers of they willfully carry out any illegal action
insolvent entities. or transaction, if a damage to the entity’s
Pursuant to the amendments to the LCM, property is caused and an economic benefit
directors and officers may be liable for is obtained for themselves or third parties
damages and lost profits caused to an entity (including related parties).
in case the latter is insolvent and when any of Moreover, mimicking the “business
the following hypotheses is verified by their judgment rule” applicable in other
conduct: (1) adopting decisions involving jurisdictions, the amendments to the LCM
the entity’s property, despite having a exclude directors’ and officers’ liabilities,
conflict of interest; (2) knowingly favoring when acting in good faith, they (1) comply
a shareholder or group of shareholders in with the requirements set forth in applicable
prejudice of the rest of the shareholders; law or the entity’s by-laws for the approval
(3) in absence of a legitimate cause and by of matters on which the board of directors
virtue of their position, obtaining economic is competent to decide; (2) adopt decisions
benefits for themselves or on behalf of based on information provided by officers,
third parties, including any shareholder external auditors, or independent experts,
or group of shareholders; (4) preparing or when their capacity and credibility “offer no
disclosing information having knowledge of motive for reasonable doubt”; (3) select the
its falseness; (5) causing the omission from most adequate alternative to the best of their
registration of transactions performed by the knowledge, or the possible damage to the
entity, or altering or ordering the alteration entity could not have been foreseen, in either
of records with the purpose of concealing the case, based on the information available at
true nature of the transactions performed, the time they made their decision; and (4)
affecting the entity’s financial statements; comply with the resolutions adopted by the
(6) ordering or accepting the recording of shareholders, provided said resolutions are
false data in the accounting records of the not illegal.
entity; (7) destroying or amending systems, Entities are forbidden from including in
accounting records, or supporting documents their by-laws any benefits, considerations, or
of accounting records of the entity with the liability waivers that limit, release, substitute,
purpose to conceal the relevant records or or offset the aforementioned liabilities of
evidence; (8) altering accounts or the terms of directors and officers; however, they may
agreements, recording inexistent transactions retain insurance policies or guaranties
or expenses, exaggerating the real ones, covering damages and lost profits, except in
or willfully carrying out any illegal action case of actions carried out willfully or in bad
or transaction, if an indebtedness, loss, or faith or that are otherwise illegal.
damage to the entity’s property is caused

LATIN AMERICA
Brazil Henrique Lang, Partner Pinheiro Neto Advogados
C
orporate governance standards and practices have improved
in Brazil over the last decade, along with the initial public
offering market rebound since 2004.
General framework
The Corporation Law (Law 6404/1976), as amended, set forth the
rights, duties, and responsibilities of shareholders, directors, and
officers.
The Securities Market Law (Law 6385/1976), as amended, created
the Brazilian Securities Commission (CVM) and established its rule-
making, surveillance, and enforcement powers.
BM&FBOVESPA, the São Paulo Stock Exchange, has established
the Novo Mercado and other separate listing segments to enhance
corporate governance practice beyond corporate law and is also a
self-regulating entity with surveillance powers.
Brazilian companies are also governed by their by-laws, which
stipulate their management and shareholder rights.
Novo Mercado and other BM&FBOVESPA listing segments

In addition to the traditional listing segment and Bovespa Mais
(organized over-the-counter [OTC] market), BM&FBOVESPA has
established three special corporate governance segments. Level 1
permits the issuance of preferred nonvoting shares; Level 2 requires
preferred shares to hold restricted voting rights; and the Novo
Mercado prohibits the existence of preferred shares. Under the
listing agreements of these segments, companies undertake to adopt
the following main practices:
Level 1: chairman and CEO separation; improved disclosure (eg
quarterly cash flow statements); wide distribution of shares in public
offerings; minimum 25 percent of share capital free float; adoption
of securities trading policy and code of conduct; annual corporate
events schedule.
Level 2: restricted voting rights to preferred shares in certain key
decisions or in any matters that may involve conflicts of interest;
board of directors of at least five members, unified maximum two-
year term, and minimum of 20 percent of independent directors (as

Pinheiro Neto Advogados Brazil
defined in the listing rule); tag-along rights The fiscal council can be set up on a
for noncontrolling shareholders at the same permanent basis or at the request of
price paid to the controlling shareholders; shareholders representing 10 percent of the
mandatory tender offer at economic value voting shares or 5 percent of any class
in case of delisting from the segment; board of nonvoting shares. Unlike a US audit
opinion on tender offers; prohibition against committee, the fiscal council is a corporate
limiting voting rights below 5 percent in body independent from management and
the by-laws; resolution of disputes between external auditors. Its primary responsibility
the company and shareholders through is to review and opine on the financial
arbitration; and the same undertakings of statements and on certain matters such as
Level 1. proposals for capital increases and corporate
Novo Mercado: common voting shares restructurings.
only (no preferred shares) plus the same Except in case of large financial
undertakings of Level 1 and Level 2. institutions, which are subject to a special
requirement by the Central Bank of Brazil,
Governance structure neither the corporate legislation nor the
Brazilian companies operate under a two- BM&FBOVESPA listing rules require
tier board system. The board of directors is Brazilian companies to set up an audit
elected by the shareholders and is responsible committee. Nevertheless, several companies
for setting out the general guidelines and have set up audit committees to improve
business policies, electing and supervising corporate governance, extend the mandatory
executive officers, and choosing and rotation of independent accountants to ten
removing independent accountants, among from five years as permitted for companies
other responsibilities. The board of executive with statutory audit committees meeting
officers is responsible for the day-to-day the CVM guidelines, or to comply with the
management of the company and is vested US Sarbanes-Oxley Act (SOX) (companies
with exclusive power to act on behalf of the with dual listing in Brazil and the United
company. One third of the directors may States). As the US Securities and Exchange
also serve as executive officers, but there Commission (SEC) has permitted Brazilian
is no corporate law requirement to elect companies listed in the United States
independent directors. to adapt the fiscal council to satisfy the
Directors are elected at the shareholders SOX audit committee requirements, some
meeting. Each voting share has one vote. CVM companies make use of this alternative.
established that shareholders representing at While there is no legal requirement,
least 5 percent of the voting share capital of an increasing number of companies have
companies with share capital higher than voluntarily created board committees to
R$100 million may request the adoption improve corporate governance standards.
of cumulative voting. Noncontrolling
shareholders holding shares for a period Management compensation
of at least three months are entitled to The aggregate or individual compensation
elect one board member by separate ballot (including fringe benefits) must be approved
based on preferred nonvoting or restricted at the annual shareholders’ meeting.
voting shares representing 10 percent of the Companies generally approve the maximum
total share capital, or on 15 percent of the aggregate compensation and authorize the
voting shares (for companies with preferred board of directors to allocate it individually
shares) or 10 percent of the total share capital among its members and to the executive
(for companies with common shares only). officers.
If neither of these thresholds is reached, The CVM requires detailed analysis
the noncontrolling shareholders may group and disclosure of the compensation paid
their shares so as to elect one member jointly. to directors and officers (including the

Brazil Pinheiro Neto Advogados
stock-based compensation) in the last three • quarterly financial information on form

years and for the current fiscal year in ITR, accompanied by a limited review
the Formulário de Referência (reference form, report from the independent accountants,
similar to an annual report on Form 10-K within 45 days of the end of each of the
adopted by the SEC). first, second, and third quarters.
Any stock-based compensation plan must
be approved by the shareholders. Stock-based The quality of financial information has
plans establish the legal structure and key significantly improved since 2010, when the
terms and conditions (including maximum International Financial Reporting Standards
corporate dilution, waiver of preemptive (IFRS) issued by the International Accounting
rights, and/or permission to use treasury Standards Board were first adopted, followed
shares), and normally delegate authority to by creation of the Brazilian Accounting
the board of directors for approval of annual Standards Board (CPC). CPC standards
grants and review of the plan itself. While introduced changes in Brazilian accounting
there is no rule or guidance from the CVM on practices (Brazilian GAAP), in furtherance of
the matter, plans usually require shareholder the convergence of Brazilian GAAP with IFRS.
vote for material revisions. Concurrently, the adoption of the
Detailed information on the management Formulário de Referência in 2010 reshaped
proposal on management compensation and and enhanced disclosure on key issues
stock-based plans must be submitted to the such as risk factors, market risks, financial
shareholders on the same day of the call performance, off-balance sheet items,
notice for the shareholders meeting. internal controls, governance, management
compensation, ownership structure, and
Financial information and periodic reports related party transactions. Inspired by the
Brazilian companies must file electronically “shelf registration system” of the International
with the CVM the following main financial Organization of Securities Commissions
information and periodic reporting (IOSCO), the Formulário de Referência can be
information: incorporated by reference in the offering note
for any public offering of securities.
• annual audited financial statements, Companies that disclose financial
accompanied by the management statements or information abroad must also
report, the report from the independent file them with the CVM.
accountants, the report from the fiscal
council (if operating), the capital budget Share trades by directors and officers
(if any), the summary report from the Brazilian rules impose restrictions and
audit committee (if any), and statements disclosure obligations on the trades with
from the executive officers that they have company’s shares by directors and officers.
reviewed, discussed, and agreed to the Directors, officers, and other insiders bound
financial statements and the independent by the company’s mandatory material
accountant’s opinion. Disclosure must information disclosure policy generally
occur no later than three months after the cannot trade their company’s stocks:
end of each fiscal year.
• standard financial statements on form • while in possession of material nonpublic
DFP, within the same time frame information
• annual report on Formulário de Referência, • during a “blackout” period of 15 days
up to five months after the end of the fiscal before disclosure of the quarterly (form
year. The Formulário de Referência must be ITR) and annual (form DFP) financial
updated upon filing of any request for information by the company
registration of a securities offering or • whenever the company is trading its own
up to seven business days as from the shares.
occurrence of certain significant events.

Pinheiro Neto Advogados Brazil
Insider trading is a criminal offense, Adherence to the code is voluntary and

punishable by imprisonment for one to five allows the use of the stamp of the “ABRASCA
years and a fine of up to three times the Seal of Good Practices.” Although the code
unlawful advantage obtained. In addition, is fairly recent, it was supported by the
the CVM may also impose administrative adherence of a group of leading Brazilian
sanctions, which may include a similar fine. companies, including BM&FBOVESPA,
All shared trades in the company’s Bradesco, BRF, CEMIG, Cetip, Gerdau, Itaú,
securities or derivatives by directors, Klabin, Localiza, Santander Brasil, Souza
officers, and members of the fiscal council Cruz, and Weg.
and other statutory bodies and their
connected persons must be notified to the Brazilian takeover panel
company within five days. Up to the tenth Inspired by the UK Takeover Panel, in
day of the subsequent month, the company 2013 key market institutions led by
must file with the CVM two forms, one BM&FBOVESPA sponsored the formation
reporting individual trades and positions of the Takeover Panel Sponsors Association
and another reporting the consolidated (ACAF) to organize, maintain, and
trades and positions, aggregated by each administer the Brazilian Takeover Panel
corporate body. The consolidated form is (CAF). Based on a voluntary self-regulation
publicly available. model, adhering companies must insert in
their by-laws a commitment to submit to
ABRASCA code of self-regulation the Brazilian Takeover Panel tender offers
Since 2011, the Brazilian Association of or corporate restructuring transactions.
Publicly Held Companies (ABRASCA) has Companies may also submit specific
established the ABRASCA Code of Good transactions on a case-by-case basis. The
Corporate Governance and Practices for CVM and CAF entered into a cooperation
Publicly Held Companies. The code is a self- agreement establishing that corporate
regulation initiative based on the “apply-or- restructuring transactions with related
explain” approach, and contains principles, parties will be presumed regular by the
rules, and recommendations of corporate CVM, if deemed in compliance with the
governance in matters involving the board principles and rules of CAF.
of directors, board of executive officers,
compensation, internal controls and risk Bankruptcy and anti-corruption laws
management, code of conduct, control and The Bankruptcy and Company
disclosure of material information, relations Reorganization Law (Law 11110/2005)
with the capital markets, and corporate was approved in 2005 to maximize asset
restructuring transactions. value, protect creditor’s rights, and provide
Compliance with the ABRASCA code’s effective mechanisms for reorganizing
principles, which offer the essence of distressed companies, all of which are in line
regulations without getting into the rules’ with international practices.
details, is mandatory. Companies are allowed An Anti-Corruption Law (Law
to refrain from applying one or more rules 12845/2013) entered into force in 2014. The
so long as they explain the reasons in the new legislation imposes strict liability on
Formulário de Referência. Each company must companies and individuals who participate
disclose in the Formulário de Referência the in acts of bribery. Penalties comprise
date of adherence to the code and declare administrative and judicial sanctions, and
compliance with its principles and other may include a fine of up to 20 percent of the
rules. ABRASCA created a technical team in company’s gross earnings in the last fiscal
charge of monitoring and investigations, as year. Companies are expected to maintain
well as a self-regulation board responsible compliance programs to prevent or reduce
for enforcement. sanctions.

EUROPEAN UNION
France Didier Martin, Senior Partner Bredin Prat
F
rance has a relatively non-interventionist stance in respect of
corporate governance, which allows listed companies to take
a comparatively flexible approach. With legislative provisions
in force only in relation to distinct areas or specific sectors, soft
law, with the “comply or explain” principle at its heart, prevails.
Framework
Legislation
The European Commission has until now avoided introducing
corporate governance legislation (save for in the financial services
sector), preferring to issue nonbinding Recommendations instead.
This has led to member states adopting divergent approaches.
However, firmer action remains a possibility, and the European
Commission has shown particular interest in two areas: reinforcing
the “comply or explain” principle and directors’ remuneration.
Notably, the Council and the European Parliament have just
adopted a Directive on disclosure of diversity on boards of directors
information by large companies and groups.
National corporate governance legislation is principally found
in the Commercial Code with provisions focusing primarily on
the structure and composition of boards and to a lesser extent,
diverse elements relating to directors’ remuneration. In May 2013,
the French government announced it would not introduce further
corporate governance legislation, favoring rigorous self-regulation
instead. It did, however, reserve the right to legislate in this area in
the future.
Soft law
There is no legal obligation to adopt a specific corporate governance
code, even though according to national legislation, listed companies
which do not adopt such a code must explain their rationale. It is
universal practice among French listed companies to follow the
principal code (the AFEP-MEDEF Corporate Governance Code of
Listed Corporations [AFEP-MEDEF code]) produced by two business
associations. The AFEP-MEDEF code was updated in June 2013 to

France Bredin Prat
include a strict interpretation of “comply or board members are non-executive directors.

explain” and a shareholder vote on executive In 2013, 80 percent of CAC 40 companies
remuneration. The MIDDLENEXT code is (the capitalization-weighted ranking of the
generally followed by smaller enterprises. 40 largest listed companies in France) had
The Commercial Code states that when a a unilateral structure. The board may have
company refers to a corporate governance several committees, including an audit
code of a business organization, the chair’s committee (mandatory), a remuneration
report must explain which provisions of that committee, and a nomination committee
code have not been followed and the reasons (both optional except for financial
for non-compliance. institutions).
A High Committee is in charge of
monitoring implementation of the AFEP- Number of directors
MEDEF code. The Financial Markets Directors may be natural or legal persons,
Authority publishes both best practice save for the members of a management board
recommendations and an annual report that and the chair of a supervisory board. There are
names companies that are not in compliance between three and 18 directors on a unitary or
with the “comply or explain” principle supervisory board, and a maximum of seven
or whose explanations are insufficient. members on a management board of a listed
Reputational damage remains the principal company. The average number of directors on
risk for non-compliance with the AFEP- France’s CAC 40 boards is 14.
MEDEF code.
Evaluation procedures
Corporate rules Boards are encouraged to undertake annual
The by-laws and the internal board rules self-reviews and a formal evaluation once
of a company may also contain corporate every three years.
governance provisions.
Characteristics of directors
Corporate and board structures
Status
Corporate structures As a general rule, directors are not employees
The main legal entity for listed companies is of the company.
the SA (société anonyme). There is, however, a
growing number of high-profile companies Term
across Europe converting to societas europea, The Commercial Code prescribes a
such as Airbus, Allianz, and LVMH. The maximum term of six years for directors,
flexibility in board structure accorded to a but this is limited to four years by the AFEP-
societas europea is similar to that accorded to MEDEF code. Terms should be staggered to
French listed companies. ensure the smooth replacement of directors.
Board structures Number of directorships

A listed company may choose between one The Commercial Code provides that no
of two board structures. The first, aligned natural person may be a member of the
to the Anglo-American model is a unitary board of directors or supervisory board
board of directors (conseil d’administration); of more than five French companies.
the second, similar to the German model, is The AFEP-MEDEF code takes a stricter
a two-tier structure with a supervisory board view, recommending that the number of
(conseil de surveillance) and a management directorships for executive directors is
board (directoire). In a two-tier structure, limited to three listed companies or five
the management board members are in the case of non-executive directors;
executive directors and the supervisory including foreign companies but excluding

Bredin Prat France
any companies forming part of the same appointments/nominations committee and

group. The board should also approve any is kept under regular review.
new directorships of its members. The AFEP-MEDEF code sets out a number
of criteria for independence, including that
Chair/CEO the director:
In a two-tier structure, the chair of the
management board is the CEO. Where there • has not been an employee or executive
is a unilateral structure, the company may director of the company, its parent, or
either combine or separate the offices of chair related companies in the previous five
and CEO. The AFEP-MEDEF code prescribes years
that where the positions are combined, • has not been an executive director of an
an explanation of the measures taken to entity of which the company is a director
preserve the balance of powers should be in the previous five years
provided to shareholders. Listed companies • has not been an auditor of the company in
overwhelmingly choose to combine the two the previous five years
functions (87.5 percent of CAC 40 companies • is not a major customer, supplier, or
in 2013). In recent years, a trend has banker of the company or group
developed toward reunifying the functions • does not have any close family ties to
in those companies that had previously split executive directors.
them. According to the Financial Markets
Authority, one way of explaining this trend Finally, a criterion that is often disregarded
is that during the financial crisis, listed by companies assessing the independence
companies wanted to have reactive and of directors is that the director has been
efficient strategic management. a director of the company for not more
than 12 years. Some companies justify the
Independent directors decision not to consider length of service as
France has the concept of a lead independent an obstacle to a director’s independence on
director that is particularly advantageous in the basis that the experience of the director
the situation where the functions of chair takes precedence.
and CEO are combined. Despite this, fifteen
in forty CAC 40 companies choose to have Key corporate governance issues
such a director. Typical responsibilities
of the lead independent director include 1. Remuneration
identifying and managing conflicts of This is an area in which the legislator has
interest and organizing meetings without intervened following a series of scandals.
the presence of the chair. There are laws on termination payments
France is experiencing a growing trend that apply to all companies and laws relating
toward more independent directors on the to directors’ compensation, which only
boards of listed companies. The AFEP- apply to listed companies. There is also
MEDEF code provides that the number specific legislation for the financial services
of independent directors should equal sector and in respect of pension schemes. In
half of the board (excluding directors addition, the AFEP-MEDEF code contains
representing certain stakeholders) in widely- provisions on remuneration.
held corporations with no controlling
shareholders or at least a third in other Executive remuneration Executive remuneration
cases. The independence of non-executive may take the form of fixed and variable
directors representing major shareholders compensation, stock options, and/or
holding more than 10 percent of the share performance shares. The remuneration
capital of the company is determined by the committee proposes individuals’

France Bredin Prat
remuneration, which is then approved by company and the group. The AFEP-MEDEF
the board of directors or supervisory board. code advocates the use of standardized tables
The compensation must be appropriate, to present this information.
balanced, and fair. Fixed remuneration is
generally reviewed at long intervals. Variable Say-on-pay The 2013 version of the AFEP-
remuneration is based on criteria relating MEDEF code introduces “say-on-pay”:
to short-term corporate and individual the board must present the compensation
performance and is recommended to be awarded to executive directors during the
awarded up to a maximum percentage of previous financial year at the Annual General
the fixed remuneration. Certain executive Meeting (AGM) of Shareholders, following
directors are required to hold a certain which an advisory vote of the shareholders
number of shares in the company, as is taken. One resolution is presented for the
determined by the board or supervisory CEO or the chair of the management board
board, until the end of their term of office. and one resolution for the deputy CEOs or
An executive director may be awarded for the other members of the management
stock options or performance shares upon board. In the event that the resolution is voted
meeting targets, provided that an employee down, the board, acting on the advice of the
corporate performance scheme exists. The remuneration committee, must discuss this
director must hold the option or shares for matter at another meeting and immediately
a minimum period, and the exercise of all publish a notice on the company’s website
of the stock options and the acquisition of detailing how it intends to deal with the
shares is restricted. opinion of the shareholders expressed at the
general meeting. It remains to be seen how
Non-executive remuneration Shareholders must this will operate in practice and if we will see
approve a global amount of attendance fees shareholder activism in action.
for non-executive directors, which is then
distributed among the directors relative to 2. Diversity
their various duties and responsibilities. Female representation France has recently
No other remuneration is permitted, and, made significant progress in gender equality,
in particular, non-executive directors may introducing legislation that requires 20
not receive shares or share options free of percent of the board of a listed company to
charge. be female by the date of the company’s 2014
AGM and rising to a 40 percent requirement
Additional remuneration Golden hellos must be in 2017. On December 31, 2013, on average,
disclosed, and there are specific restrictions 28 percent of directors of CAC 40 companies
on golden parachutes. Severance payments were female. A further requirement will
must be conditional upon a set of demanding come into force in 2017: where the board of
performance requirements. Noncompetition directors has eight members or fewer, the
agreements and payments must be approved difference between the number of directors
by the board and are subject to certain of each gender should be no higher than
disclosure requirements. two.
Disclosure All of the executive directors’ Internationalization Recent years have seen
compensation should be disclosed the internationalization of French boards.
immediately after the meeting of the board The trend applies to both genders, but there
that approves it. The annual report must also has been a particularly marked increase in
contain detailed disclosure of remuneration, the number of non-French women joining
including the aggregate compensation and boards. Currently, around a quarter of
benefits paid during the previous financial directors of listed companies are not French
year to each executive director by the nationals.

Bredin Prat France
3. Stakeholder representation Outlook

The Commercial Code provides that where Executive remuneration remains the
employees hold at least three percent of the primary hot issue, particularly with future
capital of a listed company, one or more intervention by the European Commission
directors should be appointed to represent on the agenda. Further national legislation
the employee shareholders. Where a French relating to corporate governance is not
domiciled company employs at least 5,000 expected in the immediate future, although
people in France (or 10,000 worldwide), the it remains to be seen whether the new
number of directors representing employees provisions in the AFEP-MEDEF code (in
must be at least two if there are more than 12 particular, say-on-pay) will be embraced by
directors or one otherwise. By-laws may also listed companies.
contain requirements for shareholder and Another hot issue has recently emerged.
employee representation. The AFEP-MEDEF A working group has been established
code provides that directors representing by the Financial Market Authority in the
employees and employee shareholders have summer 2013 to discuss a possible regulation
the same rights and responsibilities as other regarding the sale of significant assets by
directors. listed companies.

Germany Wolfgang Grobecker, Partner, and Bernd Graßl, Partner P+P Pöllath + Partners
I
n Germany, listed stock corporations (Aktiengesellschaften)
traditionally have a two-tier board system, consisting of the
management board and the supervisory board. According to
Section 161 para. 1 sentence 1 of the German Stock Corporation
Act (Aktiengesetz), the management board and the supervisory
board shall declare annually, in their so-called “declaration of
conformity,” that the recommendations contained in the German
Corporate Governance Code have been and are complied with,
or which recommendations have not been or are not applied
and why (“comply or explain”). The declaration of conformity
must be made accessible on the website of the company on a
permanent basis.
The German Corporate Governance Code presents essential
statutory regulations for the management and supervision of
German listed companies and contains internationally and nationally
recognized standards for good and responsible governance. The
Code aims to make the German corporate governance system
transparent and understandable. Its purpose is to promote the trust
of international and national investors, customers, employees, and
the general public in the management and supervision of listed
German stock corporations.
As a rule, the Code is reviewed annually against the background
of national and international developments and is adjusted, if
necessary. A current “hot button” issue in this context is—and has
been frequently over the last few years—the rules on management
board compensation.
German mandatory statutory rules on management board compensation

and the recommendations of the German Corporate Governance Code
According to German statutory law, the supervisory board is
exclusively responsible to negotiate for the company the terms and
conditions of the service contracts of the members of the management
board. It is regularly the chairperson of the supervisory board who
is empowered to sign the service contract with the respective
management board member. However, the terms and conditions of
the service contract, in particular the entire remuneration package,

P+P Pöllath + Partners Germany
must be approved by the full supervisory benefits, do not exceed the value of two
board with at least a majority vote. years’ compensation and compensate for
As a general rule, when determining no more than the remaining term of the
the total remuneration for each individual employment contract. If the employment
member of the management board (salary, contract is terminated for a serious cause
participation in profits, reimbursement of for which the management board member
expenses, insurance premiums, commission, is responsible, no payments may be made
incentive-based promises of compensation to the management board member. The
such as share subscription rights, and side severance payment cap shall be calculated
benefits of any kind), the supervisory board on the basis of the total compensation for the
must ensure that the total remuneration past full financial year and, if appropriate,
is reasonable in relation to the duties the expected total compensation for the
and performance of the member of the current financial year. Payments promised
management board, as well as in relation to in the event of premature termination of a
the situation of the company, and that it does management board member’s contract due
not exceed the usual compensation without to a change of control shall not exceed 150
special reason. Also, the compensation percent of the severance payment cap.
structure of listed companies shall be Based on statutory rules, the total
aligned toward a sustainable corporate compensation of each of the management
development. Variable compensation board members is to be disclosed by name,
components shall therefore have a multiyear divided into fixed and variable compensation
basis for assessment; the supervisory board components. The same applies to promises
shall arrange for a possibility of limitation in of benefits that are granted to a management
case of extraordinary developments. All of board member in case of premature or
the above shall further apply accordingly to statutory termination of the function of a
pensions, payments to surviving dependants management board member or those that
of the deceased, and similar payments. have been changed during the financial
Further to these mandatory statutory year. Disclosure is dispensed with if the
rules, according to the German Corporate shareholders’ meeting has passed a resolution
Governance Code, monetary compensation to this effect by three-quarters majority.
elements shall comprise fixed and variable According to the Code, disclosure shall
elements. Both positive and negative be made in the notes or in the management
developments shall be taken into account report. A compensation report as part of
when determining variable compensation the management report outlines the
components. All compensation components compensation system for management
must be appropriate, individually board members. The outline shall be
and in total, and in particular must not presented in a generally understandable
encourage unreasonable risks. The variable way. The compensation report shall also
compensation components shall be related include information on the nature of the
to demanding, relevant comparison fringe benefits provided by the company.
parameters. Changing such performance
targets or the comparison parameters with Recent amendments to the rules regarding
retroactive effect shall be excluded. management board compensation
In addition, the Code recommends In its annual review of 2013, the German
severance pay caps. Therefore, in concluding Government Commission on the
management board service contracts, the German Corporate Governance Code has
supervisory board shall take care to ensure implemented some remarkable amendments
that payments made to a management to the recommendations regarding the
board member on premature termination composition and remuneration of the
of his or her contract, including fringe management board. Specifically, the

Germany P+P Pöllath + Partners
Government Commission now recommends including the maximum and minimum

that German listed stock corporations place achievable compensation for variable
a cap on individual management board compensation components
remuneration, both in terms of its total • the allocation of fixed compensation,
amount as well as in terms of its variable short-term variable compensation, and
components. The system-inherent and long-term variable compensation in/for
individual caps should, however, continue the year under review, broken down into
to be defined individually for each company the relevant reference years
by the supervisory board. • for pension provisions and other benefits,
In order to enhance the transparency and the service cost in/for the year under
traceability of the decisions made by the review.
supervisory board, the criteria regarding
management board remuneration, which The Commission initially put this forward
have to be taken into account, have been as a mere proposal to German listed
supplemented. For example, the Government stock corporations and upgraded it to a
Commission now recommends that, recommendation during the consultancy
when defining a remuneration structure, process. The reason is that, according to
the supervisory board shall consider the the Commission, the data to be included in
relationship between the compensation the proposed tables are already available
of the management board and that of in companies and are already published
senior management and the staff overall, in one form or another to a large extent.
particularly in terms of its development Consolidating and standardizing the way
over time, whereby the supervisory board in which the data is presented would
shall determine how senior managers and provide, according to the Commission, a
the relevant staff are to be differentiated. better overview and improve comparability.
Within this context, there is now a new In view of the potential organizational
recommendation that, for pension schemes, expense involved in the conversion, the
the supervisory board shall establish the recommendation regarding information in
level of provision aimed for in each case— the remuneration report and the suggestion
also considering the length of time for which on the use of tables in companies should
the individual has been a management only be implemented beginning 2014.
board member—and take into account the
resulting annual and long-term expense for Shareholder involvement within management
the company. board compensation
In order to improve comparability over As set out above, it is the supervisory
time and with other companies, both for board of a German stock corporation that
the supervisory board and the general is exclusively responsible for determining
public, the Government Commission the compensation of the members of the
recommends that important facts and management board. So far, the shareholders’
figures on management board remuneration meeting of a listed company can only
be prepared in a standardized fashion and give a nonbinding say-on-pay vote in the
by making use of model tables, which are annual general meeting (Section 120 para. 4
henceforth provided for in the appendix sentence 1 of the German Stock Corporation
of the Code. Namely, for financial years Act). The resolution of the shareholders’
starting after December 31, 2013, and for meeting does not give rise to either rights
each member of the management board, the or duties; in particular, the obligation of the
compensation report shall present: supervisory board to exclusively determine
the entire compensation package of the
• the benefits granted for the year under members of the management board remains
review including the fringe benefits, and unaffected. The resolution cannot be

P+P Pöllath + Partners Germany
contested in court. As a consequence, such management board compensation are

vote does not have any influence on the contained in both German mandatory
management compensation package and is statutory rules as well as—in the form of
not challengeable in court. recommendations—the German Corporate
Legislative plans to introduce a mandatory Governance Code. In 2013, some remarkable
say-on-pay of the shareholders’ meeting adjustments to the remuneration rules
following the Swiss debate on excessive of the German Corporate Governance
management salaries have been postponed Code were made, with the aim to further
in Germany. professionalize and strengthen the work
Under the nonbinding say-on-pay carried out by the supervisory board by
environment in Germany, there is usually no increasing transparency and to improve the
proxy fight regarding the shareholders’ vote basis for decision-making. In addition, the
on this particular agenda item. However, the recent amendments to the Code are equally
management board often tries to obtain good aimed at making the relevant remuneration
voting results for all agenda items proposed proposals clearer and more comprehensible
by the boards and tries to ensure this by for all stakeholders, therefore making it
having direct contact with shareholders or easier to assess the governance of companies.
proxy advisers before the annual general So far, shareholder involvement
meeting takes place. in Germany regarding management
compensation is rather limited. The
Summary shareholders’ meeting of a listed company
The supervisory board of a German stock can only resolve on a nonbinding say-on-pay
corporation is exclusively responsible vote in the annual general meeting. Recent
to negotiate the terms and conditions legislative plans to introduce a mandatory
of the service contracts of the members say-on-pay of the shareholders’ meeting
of the management board, in particular have been postponed in Germany.
the remuneration package. Rules on

Italy Carlo Croff, Partner, and Enrico Giordano, Partner Chiomenti
T
he key corporate governance provisions for Italian listed
companies are found in:
• the Italian Civil Code

• the Consolidated Financial Act (Legislative Decree No. 58/1998)
• Regulations No. 16191/2007 and No. 11971/1999 adopted by
Consob, the Italian supervisory authority for listed companies
• the Corporate Governance Code adopted in 1999 by the Committee
for Corporate Governance of Borsa Italiana S.p.A.—the company
that is responsible for the organization and management of
the Italian stock exchange and that is part of the London Stock
Exchange Group—as last amended in 2011.
The Corporate Governance Code sets out high corporate governance

standards in line with international best practices.
The Consolidated Financial Act sets out the “comply or explain”
principle requiring listed companies to disclose information about
their compliance with the Corporate Governance Code in an annual
formal report on corporate governance.
The report must include, among other things: (1) some specific
information about the ownership structure of the issuer; (2) rules for
the appointment and replacement of directors; (3) the key features
of the internal control and risk management system; (4) how
shareholders’ general meetings are regulated; and (5) the structure
and functioning of the management and control bodies and internal
committees.
In 2013, 223 (93 percent) of the 239 Italian listed companies
confirmed their compliance with the Code in their corporate
governance reports (source: Committee for Corporate Governance,
Annual Report 2013).
The foregoing provisions implement the rules and
recommendations provided at the European level (Directive
2007/36/EC on shareholders’ rights in listed companies; Directive
2006/43/EC on the audit of annual accounts and consolidated
accounts; Commission Recommendations 2004/913/EC, 2005/162/
EC, and 2009/385/CE on director remuneration).

Chiomenti Italy
The Italian Civil Code provides for three cannot be delegated, such as the drafting of
different management and control systems: the financial statements.
Moreover, the Corporate Governance
• the “traditional system,” in which the Code recommends that the entire board be
shareholders’ meeting appoints a board entrusted with the primary responsibility
of directors and a board of statutory for determining and pursuing the strategic
auditors targets of the company as well as the (1)
• the “two-tier system,” in which the examination and approval of the strategic,
shareholders’ meeting appoints the operational, and financial plans of the
supervisory body, which in turn appoints company; (2) evaluation of the general
the corporate body vested with the performance of the company; (3) resolutions
management of the company upon material transactions; and (4) periodical
• the “one-tier system,” in which the evaluation of the performance of the board
shareholders’ meeting appoints a board and its committees.
of directors which in turn appoints, from In light of the above, directors are
its members, the supervisory body. designated as either: (1) executive, that is,
those vested with management powers, or
The following description covers only the (2) non-executive, whose role is to enhance
traditional system, since the vast majority the board’s discussion and to provide
(over 95 percent) of Italian listed companies an independent, unbiased judgment on
adopt it. the proposed resolutions, particularly
those where the respective interests of
The shareholders’ general meeting executive directors and shareholders may
The shareholders’ general meeting is made not be aligned, such as executive director
up of the holders of the company’s ordinary remuneration and the internal control and
shares. risk management systems.
Competences of an ordinary general Although independence of judgment
meeting include the appointment of is required of all directors, some board
directors and statutory auditors and members must meet specific independence
resolutions regarding their liability, and the requirements set out in the applicable laws
appointment of the external auditors. An and regulations and recommended by the
extraordinary general meeting (for which Corporate Governance Code. In particular:
higher majorities are required) is mandatory
for amendments to the by-laws, including 1. The Consolidated Financial Act requires
extraordinary transactions (eg share capital that, in order to qualify as independent, a
increases, mergers, and demergers). director shall not be:
(a) under any legal disability, bankrupt,
Board of directors disqualified from public office, or
The board of directors is responsible for the incapable of exercising managerial
ordinary and extraordinary management of functions
the company. (b) associated with the company, any of
It must make decisions with full its subsidiaries, any parent company,
knowledge of the facts and autonomously or any companies under common
with the aim of pursuing and creating value control, or with the directors of
for the shareholders over the medium-long any such entities through personal
term. relations (eg marriage and kinship),
The board can delegate certain functions a self-employment or employment
to one or more directors (the chief executive relationship, or any other relationship
officer/s) and/or to an executive committee of an economic or professional nature
of some of its members. By law, some matters that might compromise independence.

Italy Chiomenti
2. The Corporate Governance Code requires (f) is an executive director in another

that, in order to qualify as independent, company in which an executive
a director must not have or have had director of the listed company is also
any current or recent direct or indirect a director
business relationship with the company (g) is a partner or a director of a legal
or persons linked to the company, entity in the same network as the
whether for themselves or on behalf of company’s external auditors
a third party, which might affect their (h) is a close relative of anyone falling
independent judgment. The board must within the above paragraphs.
evaluate annually the independence of An important role is also attributed to the
directors on a factual basis rather than chairman of the board of directors, who
legalistically, and the results of the must ensure that the documentation relating
evaluation must be disclosed in the to the board agenda is made available to
annual report on corporate governance. directors and statutory auditors in a timely
Factors indicating lack of necessary manner prior to the board meeting.
independence include if the director: The Corporate Governance Code
(a) controls the company, directly recommends the division of key management
or indirectly, or is able to exercise competences, particularly of the chair and
dominant influence over it, CEO roles. Where these two offices are held
including through provisions of any by the same person, the code recommends the
shareholders’ agreement appointment of a “lead independent director”
(b) is or has been in the preceding three to be the representative of non-executive and
fiscal years a significant representative independent directors within the board.
of the company, of a strategically
important subsidiary, or of a company Composition and election
under common control, or of a The number of directors and their term of
company or entity controlling or able office are established by the by-laws or by
to exercise considerable influence over the general meeting.
the company The general meeting appoints the board
(c) has or had in the preceding fiscal year, through a slate election system. At least
directly or indirectly, a significant one director must be appointed from the
commercial, financial, or professional minority slate that obtained the largest
relationship: number of votes, and the relevant director
 with the company, one of its must be free of any direct or indirect link
subsidiaries, or any of its significant with the shareholders who filed or voted in
representatives favor of the slate that obtained the majority
 with an entity or individual that of votes.
controls the company or with any Gender balance must be on a ratio of at
significant representatives of such least 1:3 (either way).
entity Furthermore, the applicable laws and
 or is, or has been in the preceding regulations and the Corporate Governance
three fiscal years, an employee of Code require that there be a minimum
any of the foregoing number of independent directors on the
(d) receives or has received in the preceding board. In particular:
three fiscal years, from the company, a
subsidiary, or the parent company, any • the Consolidated Financial Act requires
significant remuneration beyond fixed that at least one director (or two, if
compensation as a director the board consists of more than seven
(e) was a director of the company for more members) must meet the independence
than 9 years in the last 12 years requirements in that act

Chiomenti Italy
• the Corporate Governance Code requires bodies and corporate functions involved in
that an adequate number of non-executive such system.
directors (usually 3 or 4) must meet the The board of directors must define
Code’s own independence requirements the guidelines of the control system and
• Consob Regulation No. 16191/2007 periodically evaluate its adequacy.
requires that a majority of the directors
of a company which is subject to • A “remuneration committee”: this
management and coordination activity submits proposals or opinions to the
(attività di direzione e coordinamento) by board concerning the remuneration
another listed company must meet the of executive directors and for the
independence requirements under the periodic assessment of the adequacy,
Corporate Governance Code. the overall consistency and the actual
implementation of the remuneration
Committees policy for directors and key managers
In addition to the executive committee, the of the company. A director cannot
board of directors can establish committees participate in meetings of the
with initiative and advisory functions. remuneration committee in which
The Corporate Governance Code requires proposals are formulated to the board
the establishment of: of directors relating to his/her own
remuneration.
• A “control and risk committee”: this
supports the analysis and decisions of In line with the recommendations of the
the board relating to internal control and European legislative bodies, the Corporate
risk management and the approval of Governance Code recommends that
periodical financial reports. Under the the remuneration of directors and key
Consob Regulation No. 16191/2007, this management personnel be established with a
committee is mandatory for companies view to attracting, retaining, and motivating
that are subject to management and people with the professional skills necessary
coordination activity by another company. to successfully manage the company. The
remuneration of executive directors and
This committee is part of the internal control key management personnel is to be defined
and risk management system recommended in such a way as to align their interests
by the Corporate Governance Code in with pursuing the primary objective of the
order to provide consistency between the creation of value for the shareholders over
effective management of the company the medium-long term.
and the objectives defined by the board of With specific regard to banks and
directors, promoting an informed decision- banking groups, Banca d’Italia, the Italian
making process. In particular, the system central bank, has recently launched a public
is to focus on ensuring the safeguarding consultation on proposed amendments
of corporate assets, the efficiency and to the existing Regulation of March 30,
effectiveness of management procedures, 2011, on remuneration policies, aimed at
the reliability of financial information, and implementing Directive 2013/36/EU (Capital
the compliance of management with laws Requirements Directive IV). Although the
and regulations, including the by-laws and consultation closed in January 2014, the new
internal procedures. rules have not yet been published. The new
The internal control and risk management rules are aimed at providing—in the interest
system must be focused on two key of all stakeholders—remuneration systems
aspects: (1) identification, evaluation, that are linked to the bank’s results and
and monitoring of business risks, and (2) structured taking into account the capital and
integration and coordination among the liquidity requirements of such companies.

Italy Chiomenti
•
A “nomination committee”: In 2013, 183 (77 percent) of the 239 listed
this formulates opinions and companies confirmed that they had carried
recommendations to the board regarding out such self-evaluation (source: Committee
the board’s size, composition, and for Corporate Governance, Annual Report
professional skills, and submits specific 2013).
proposals if the company approves
the adoption of an executive director Board of statutory auditors/auditing
succession plan. The board of statutory auditors is the body
entrusted with supervisory duties over the
The remuneration and the nomination company and, in particular, over:
committees are frequently combined in
a single committee entrusted with both • the compliance of the management of the
functions. company with the general law and the
Each committee usually comprises at least by-laws
three directors. The Corporate Governance • the observance of principles of good
Code requires committees to be composed management
of non-executive directors, the majority of • the adequacy of the company’s
which (including the chair) must meet the organizational structure, as well as the
independence requirements. Committees of adequacy and effectiveness of the internal
listed companies subject to management and control and risk management system
coordination activity by another company • the actual implementation of corporate
must comprise only independent directors. governance rules as provided by the
Oversight of related party transactions is, Corporate Governance Code.
under Consob’s Regulation no. 17221/2010,
entrusted to a committee of independent The audit of annual and consolidated
directors (which can be either an ad hoc accounts is carried out by independent
committee or one of the other internal external auditors appointed by the
committees). The committee must opine on shareholders’ meeting. The external
the benefit to the company of the relevant auditors must be appointed for nine years,
transaction as well as on the appropriateness and the key audit partners responsible for
and fairness of its terms. carrying out the audit must rotate from
The proposal for a directive approved the audit engagement within a maximum
by the European Commission on April 9, period of seven years from the date of
2014, aimed at strengthening the voice of appointment. In this context, the board of
shareholders, requires the approval of the statutory auditors:
shareholders’ meeting for related party
transactions of particular significance. • submits proposals to the general meeting
regarding the external auditors to be
Board evaluation appointed
In order to strengthen the functioning of the • supervises the financial reporting process
board of directors, in 2011, the European and the adequacy of the company’s
Commission published a Green Paper accounting system, the audit of annual
underlining that the board should annually and consolidated accounts and the
evaluate its work, taking into account its independence of the external auditors.
composition, organization, and functioning.
In Italy, such recommendation is also Statutory auditors have the right at any time,
contained in the Corporate Governance jointly or severally, to carry out inspections
Code, which requires the directors to carry and investigations, and to ask directors
out, at least annually, an assessment on the for information on specific transactions or
functioning, size, and composition of the business.
board and of the internal committees.

Chiomenti Italy
The board of auditors is composed of The following apply to statutory auditors:

three or five statutory auditors, appointed
by means of a slate voting system. The 1 professionalism requirements, such as
chairman of the board must be a member enrollment in the register of chartered
elected from the slate filed by the minority accountants and/or specific expertise in
shareholders and must be free of any direct the management or auditing of companies
or indirect link with the shareholders who 2 independence as provided by the
filed or voted in favor of the slate that Consolidated Financial Act and the
obtained the majority of the votes. Again, Corporate Governance Code
gender balance must be on a ratio of at least 3 integrity requirements, that is, the
1:3 (either way). absence of convictions for crimes against
economic, financial, and public interests.

Spain Carlos Paredes, Partner Uría Menéndez
C
orporate governance of listed companies in Spain is primarily
regulated by corporate legislation, which is mainly composed
of the Companies Law, approved by Royal Legislative
Decree 1/2010 of 2 July (the Companies Law), which sets out the
rules for all limited liability companies, including a section with
specific rules for listed companies. In addition, Law 24/1988 of
28 July, on the securities markets (the Securities Market Law)
and related regulation provide additional rules relating to listed
companies and specific information requirements relating to
corporate governance practices.
Furthermore, listed companies are subject to a corporate
governance code (the Unified Code), which contains
recommendations that are not compulsory but can be followed
voluntarily. The Unified Code was drafted in 2006 by an ad
hoc committee appointed by the Spanish government among
public officials, businesspeople, and other experts in corporate
governance and finally approved by the National Securities Market
Commission (CNMV). The Unified Code is a harmonization,
review, and update of the recommendations and principles
previously stated by consultative committees in 1998 and 2003.
Although its recommendations are voluntary, the concepts and
definitions of the Unified Code are compulsory (some of them, like
those relating to the definitions of the different types of directors,
have even been enacted into law), and each listed company must
explain its level of compliance with its provisions on a yearly
basis. The recommendations range from those relating to general
shareholders’ meetings to those referring to the board or its
directors, including board composition and functions, selection,
appointment and removal of directors, remuneration, and internal
committees of the board (executive committee, audit committee,
and remuneration and appointments committees).
Both the statutory rules on corporate governance and the
Unified Code are currently under review. In 2013, an ad hoc
experts committee was appointed by the government with a
mandate to propose measures to improve effectiveness and increase
responsibility and, ultimately, encourage the highest standard

Uría Menéndez Spain
of compliance with the international good by many companies that entrust the board
governance criteria and principles. The of directors (and not the shareholders) with
committee’s first report, issued in October the power to decide on the remuneration
2013, contains a proposal for an in-depth of executive directors on the basis that the
review of the Companies Law, which managerial duties of these directors exceed
will have a substantial impact on matters the ones vested on the board as a whole. This
including: (1) rights, obligations, and liability dichotomy, which has sometimes caused the
of directors; (2) directors’ remuneration; courts to rule on the nullity of contractual
(3) composition and functioning of the arrangements with executives since they
board and its committees; (4) shareholders’ were lacking shareholder (and thus by-laws)
rights; and (5) shareholders’ meetings. In support, is the core of the discussions about
May 2014, the government produced a the remuneration of executives and the
draft law that was subsequently submitted powers of the shareholders to decide on
to Parliament. The expert committee will these matters. Although say-on-pay rules
further advise the CNMV on updating the are applicable on a consultative basis in
Unified Code. Both the statutory reform and Spain since 2011, the trend toward a growing
the update of the Unified Code are expected implication of shareholders in the decisions
to be completed in 2014. Also, in the field about remuneration policies for directors
of financial institutions, the transposition (and, especially, executives) is gaining some
of Directive 2013/36/EU of 26 June, on ground. In this regard, the government
access to the activity of credit institutions drafted a law in May 2014 as a result of the
and the prudential supervision of credit ad hoc experts committee’s first report of
institutions and investment firms, and the October 2013. The draft law provides that
enactment of Regulation (EU)575/2013 of 26 the general shareholders’ meeting of listed
June, on prudential requirements for credit companies must approve the remuneration
institutions and investment firms (known as policies for directors every three years and
the CRD IV package to implement Basel III on a decisive basis. It also states that during
standards on banking capital), will certainly said period, any changes to said policies
influence corporate governance in banks and must be voted by the shareholders again
other credit institutions. These initiatives are and that any remuneration of the directors
perhaps the highlight issues of corporate (including executive directors and all kinds
governance regulation in Spain in the near of compensation) must be consistent with
future, since they allow us to anticipate said remuneration policies, or otherwise
substantial changes in the matters referred approved by the general shareholders’
to above. meeting. At the same time, while the annual
say-on-pay on the directors’ remuneration
Expected changes in executive pay regulations report is expected to remain of a consultative
In particular, it is worth referring to the nature, the failure to obtain such consultative
remuneration of executive directors, which approval from the shareholders will also
in the past was the subject of discrepancies cause that the remuneration policies for
between the prevailing case law and the directors for the next year be submitted
practice of Spanish companies. According again to the decisive vote of shareholders,
to prevailing case law, remuneration of even if the three-year validity term for the
executive directors should be provided remuneration policies already approved by
for in the by-laws of the company (either the shareholders has not finished. Therefore,
through the establishment of a maximum although the draft law also states that the
amount by the shareholders’ meeting approval of the contractual arrangements
or through the granting to directors of a with executive directors is a competence of
share in the profits of the company). This the board, it certainly increases the powers
contrasts with the standard approach taken of shareholders for the remuneration to

Spain Uría Menéndez
be paid to said executives. Concurrently, vote, should any other conflict arise, the
the legislation which implements the relevant shareholder would be allowed to
CRD IV package in Spain also strengthens vote, but if said vote cast turns out to be
requirements for executive directors’ and decisive for the resolution to be passed, then
top managers’ pay by increasing the powers in case of a future challenge of said resolution
of shareholders. the burden of proof will be reversed and it
will be the relevant shareholder who will
Conflicts of interest need to demonstrate that the resolution
Another area of expected future reform will conforms to the corporate interest. This
be the extension to shareholders attending would not apply to resolutions where the
a general shareholders’ meeting of the conflict is determined by the position of the
prohibition to vote in cases of conflicts of shareholder in the company (ie resolutions
interest. Until now, the prohibition to relating to the appointment or dismissal of
vote in cases of conflicts of interest was directors, among others).
limited for S.A. or sociedades anónimas (all
listed companies are S.A.) to directors Separation of chair and CEO
in the board meetings or to directors or The split between the roles of chair and
proxy holders representing others in the CEO remains among the hottest topics in the
general shareholders’ meeting, in the corporate governance area, mainly through
absence of precise instructions from the the influence of proxy advisory firms.
proxy grantor. Although it is common to The Unified Code has left the decision to
recommend companies deciding in a general companies on how to determine the specific
shareholders’ meeting about transactions powers of the chair and makes no specific
where a controlling shareholder is conflicted recommendation on the separation of the
to also obtain a majority vote among the chair and CEO positions. When the same
shareholders attending the meeting and not person assumes the roles of chair and CEO,
conflicted, the fact is that any such conflicted it is recommended to counterbalance such
shareholder is not formally prevented to vote. a concentration of powers by appointing a
Now, the proposed reform contemplates senior or a lead independent director who
certain types of resolutions where the would be responsible for requesting the
relevant shareholder of an S.A. should be holding of board meetings; including new
prevented from voting, namely: (1) the points on the board agenda; coordinating
authorization to transfer shares not freely the relationships with external directors;
transferable to the extent the prohibition and supervising the evaluation of the chair
is provided in the by-laws; (2) the decision by the board. A majority of the Spanish
to expel a shareholder from a company, to listed companies combine the roles of chair
the extent it is provided in the by-laws (not and CEO. While we anticipate that this
generally available for a listed company, will probably change during the coming
since it requires a unanimous decision of all years and that we will see more companies
the shareholders); (3) discharge a shareholder splitting the roles of chair and CEO, we
from an obligation or granting a right in believe that no standard rules can be
his or her favor; (4) provide any kind of formulated in this area. It is a matter that
financial assistance, including the granting depends largely on the culture and needs
of guarantees in his or her favor; and (5) of the relevant company. While we believe
discharge a shareholder-director from the that there cannot be any standard rule for
duty not to compete with the company or companies on whether to combine the roles
engage directly or indirectly in activities that of chair and CEO, a decision to split the
may compete with those of the company. In two roles must be made after a careful
addition to these cases in which the relevant analysis of the situation and of the needs of
shareholder would have a prohibition to the relevant company, and, in that regard,

Uría Menéndez Spain
it seems more reasonable to agree on such the pressure of activist shareholders, and
matters at the time of the succession of the there are very few examples of activist
CEO or at any other time in which change shareholders engaging in public fights
is really required. However, as indicated, relating to Spanish companies. Proxy fights
new legislation has been recently enacted are normally seen in the context of two
which implements the CRD IV package groups of significant shareholders trying to
in Spain that specifically provides that the take control of a company rather than driven
chair of the board of a credit institution by activist shareholders trying to persuade
cannot act as CEO unless the institution management to take one or another course
justifies the combination of both roles and of action. This does not mean, however, that
said combination is expressly authorized by activism and shareholder engagement is
the supervisor—that is, the Bank of Spain. out of the scope of Spanish firms. There is
As to the reform of the Companies Law, a growing presence of foreign institutional
the bill submitted to Parliament provides investors in Spanish listed companies,
that the chair of a listed company may be and this, together with the influence of
an executive director, in which case his or proxy advisory firms, has noticeably
her appointment as chair will require a changed the way in which companies
two-thirds majority vote within the board approach their corporate governance and
and the appointment of a lead independent remuneration practices and the preparation
director. of shareholders’ meetings. While in
some cases this policy has facilitated a
Shareholder activism convergence of the interests of management
As to other trends in the field of corporate and shareholders, including, specifically,
governance, one that should improve in institutional ones, thus reducing the
the coming years, is that of the presence likelihood of action by corporate raiders,
of shareholder activism, which has not we anticipate that this growing institutional
blossomed in Spain yet. Contrary to other ownership of Spanish companies will
European countries, Spanish companies allow for an increased frequency of activist
have not been as affected in the past by shareholders engagement.

United Kingdom Gareth Roberts, Partner Herbert Smith Freehills LLP
I
n the United Kingdom, in common with many other developed
markets, there has, since the events of 2008, been a heavy focus
on the governance of corporations both as a tool to regulate
corporate behavior and as a means of giving confidence that some
of the previous mistakes will not easily be repeated. Whether that
confidence is well founded is a matter for debate, but investors,
politicians, regulators, and media observers have ensured that
issues that were once thought dry and technical now sit firmly
in the spotlight. Led by the fiery topic of executive remuneration,
matters of corporate control, disclosure, and reward are the
subject of public debate and scrutiny.
Governance requirements in the United Kingdom are a mixture
of the law, of market expectation, and of the non-statutory UK
Corporate Governance Code. Perhaps unusually, this Code is one
against which listed companies are expected either to comply or
to explain non-compliance, but it has no statutory force. The most
likely consequences of inadequate compliance or explanation are
the withdrawal of institutional support for business at the annual
general meeting and public criticism of the board. But it is also
around the Code and its scope that much of the debate has been
focused, with the Financial Reporting Council, which oversees it,
conducting extensive consultation exercises with companies and
their investors to seek to reflect changing best practice and areas of
corporate risk. There have also been high-profile changes in the law,
particularly on remuneration.
The spread of hot topics is quite a broad one. Let me draw out
some of the main themes.
The issues
Remuneration
Remuneration of senior executives has taken the brunt of attention
over the past year or two. It is of course in many ways an easy target,
being portrayed in some circles as the embodiment of corporate
excess, displaying a lack of alignment of the individual with the
performance of the company and with equity value (the “reward

Herbert Smith Freehills LLP United Kingdom
for failure” argument), and as evidence of have an additional lever and that corporate
disproportionality of treatment between the engagement will need to take this into
board and the body of employees as a whole. account.
Vince Cable, the business secretary in the UK
government, has recently written publicly Shareholder action The reporting season for
to chairs of the remuneration committees of the 2012 financial year brought the so-called
the major listed companies urging restraint “Shareholder Spring” during which there
on bonus awards and telling companies were a number of high-profile instances of
that there is an opportunity “for companies shareholder discontent at large companies
to make peace with the public,” a matter and a small number of high-profile board
that has attracted front page headlines. changes. These were largely, though not ex-
Alongside this, there has been substantive clusively, focused on remuneration and the
change. In particular: advisory vote on the report. Though none
of these major votes was lost, the opposi-
Regulation For more than a decade, UK listed tion affected the likes of Aviva, AstraZeneca,
companies have had to put a remuneration Barclays, BP, Credit Suisse, HSBC, and WPP.
report to shareholders annually for a vote. Generally, the responses in the following
That report has been on the remuneration year were more muted, and it seems that this
paid to directors, and the vote has been ad- reflected lessons learned in both the struc-
visory only. ture of remuneration packages, particularly
In response to the large amount of on bonus arrangements, but also more ex-
publicity over pay levels, and the perceived tensive consultation between companies and
lack of linkage of pay to performance, there investors.
has been a change to the law taking effect So far, the signs on the new policy reports
for financial years from September 30, 2013. have been mixed. While votes against have
The most significant change was that for the not been significant, it is clear that some
first time shareholders of listed companies of the institutional investor bodies have
have a direct say on directors’ pay. As well been expressing views in private on the
as the report on remuneration paid, which structure of those reports and in particular
remains the subject of an advisory vote, on the extent of the discretion retained by
listed companies must put a separate report remuneration committees on some of the
to shareholders, which specifies the policies variable elements. That has resulted at the
determining remuneration and which is date of writing in almost 20 companies
subject to a binding vote. putting clarificatory statements on their
This represents a shift in the balance of websites. The statements address a range of
power between shareholders and directors, different issues, from compensation payable
although it is too early to say how significant to new recruits, to the extent of incentive
that will be in practice. Unusually to some awards to general discretion, but each seeks
audiences, shareholders in UK companies to clarify the extent to which discretion will
have always had the right by simple majority be used or the normal range of variability.
to remove directors from office, and directors In addition, at least one investor—Fidelity—
of listed companies have had to submit has stated that it will vote against pay
themselves to shareholders for re-election. policies that allow vesting and realization
That has not meant that directors are voted of share incentive awards after three rather
off boards, except very rarely. The cases than five years.
are not directly comparable, since ousted What this demonstrates overall is that
directors would still have contractual rights shareholders remain concerned about
to compensation, but the point demonstrates the alignment of executive compensation
that shareholders are not quick to pull the and corporate performance, and indeed
trigger. What is clear, though, is that they about the level of compensation itself. The

United Kingdom Herbert Smith Freehills LLP
combination of this, of the political attention on the benefits to a corporation of having

(see above), and of the potential use of the a diverse board, on the need to address
binding policy vote as a new tool all mean obstacles further down the chain to enable
that this will continue to be a sensitive issue a greater level of diversity at the middle
that corporates will ignore at their peril. and senior levels that will feed through to
the top, and on the need for more attention
Diversity to longer-term succession planning, the
Diversity, both at board and senior executive area will remain one where thoughtful and
level, is a topic that has again attracted innovative companies will be able to derive
significant attention in the United Kingdom. benefit.
While the subject is an extremely broad-
ranging one, the principal focus in the Audit and audit tendering
compliance field has been on gender diversity Audit and audit tendering is a collective
and on the inadequate representation of theme deriving from at least two sources.
women on boards and in senior positions. First, the attention given to risk—both its
The UK government commissioned a report identification and management. Risk, after
on the issue in 2011 from Lord Davies. all, is the one thing that can be said to
He fell short of looking to impose quotas, underpin corporate governance. The taking
for which there was little general support, of equity implies a certain level of risk, and
but recommended that FTSE 100 companies a disclosure regime seeks to ensure that
(the group of the largest listed companies) investors understand the level of risk being
should aim for a minimum of 25 percent taken with their money. Failure to identify
female representation on their boards by and manage risk, or failure having done so
2015. Legislation now requires disclosure to explain it clearly, will ensure a mismatch
by listed companies of the proportion of between reasonable investor expectation and
women on their boards, in senior executive what is delivered. Equally, a regime must not
positions, and in the whole workforce. The seek to eliminate risk—investors who seek
Corporate Governance Code (see above) no risk should not be operating in the equity
requires companies to describe their policy markets. Second, the role of the auditor
toward diversity, including gender diversity, in performing the role of independent
with any measurable objectives and progress scrutineer of the financial accounts that are
against them. It does not require such a used as the basis of reporting.
policy to exist. And it is possible that Europe As to the first, auditors are now required
will require further change, including to issue an expanded report on the audited
possible targets of 40 percent women non- accounts. This must set out the scope of
executive directors by 2020. the audit; show how this addressed risk
At the board level, in the FTSE 100 the and materiality, and, for example, describe
proportion of women has increased from the risks that had the greatest effect on the
12.5 percent in 2011 to 20.7 percent at the overall audit strategy; and how materiality
date of writing. The 25 percent target is was applied in planning and performing the
not therefore out of sight, but this is not audit. Alongside that, the company’s audit
the complete picture. Among executive committee must report on the significant
directors, the figure is just under 7 percent, issues that it considered, how it assessed the
with just over 25 percent of non-executives effectiveness of the external audit process,
being women, and within this sample there what approach it is taking to reappoint the
will be many women with more than one auditor, and, where non-audit services are
directorship. This is not of itself surprising, provided, how it is satisfied that auditor
given the rapid progress made and the independence is preserved.
need to address the executive pipeline as a These requirements are intended both to
longer-term issue. But with increased focus provide transparency and information. It is

Herbert Smith Freehills LLP United Kingdom
still too early to judge how far these intentions public tender process) and will severely
are met, but there has been generally positive restrict the ability of audit firms to carry out
reaction to the first rounds of reports under non-audit work. Positive confirmations of
the new regime, and it does not seem to be the independence will be required, along with
case that a kitchen sink approach to disclosure further audit report disclosure.
has been taken. The visibility provided at one
level of greater detail should be helpful to Conclusion
investors, and it will be of interest to see how There is not scope to do justice to the entire
reports for future periods deal with changing UK governance world in this short piece.
risk issues, and indeed how companies in What this section seeks to do is to look
similar industries or markets assess their at some of the principal themes and put
individual risk profiles. them into a certain context. Underpinning
On the second, the Corporate Governance it all is the thought that better governance
Code now requires the top 350 listed can operate to improve performance and
companies to put their audit work out to also to enhance transparency for investors.
tender at least once every 10 years. There is However one weighs the various factors
no obligation to change auditors as a result, contributing to the financial crisis of 2008,
but there have been several high-profile the ability to identify and manage risk, and
changes made as a result of recent tenders, the culture within the significant entities
including HSBC, Vodafone, and Unilever. (usually financial institutions) that are
In addition, a recent European directive central to the operation of the system, must
will make further significant change in the be critical ones. If there is a risk that the
future (more than two years’ time). This pendulum swings too far in the direction of
will include the need for listed companies regulation and disclosure for its own sake,
to have mandatory rotation of auditors after that is perhaps an inevitable reaction at this
a maximum of 20 years (10 if there is no stage of the cycle.

ASIA PACIFIC
Australia
David Friedlander, Partner; Medard Fischer, Senior Associate; and Anna Chen, Solicitor King & Wood Mallesons
A
s in other jurisdictions, a combination of challenging business
conditions and heightened scrutiny, by both regulators and
shareholders, of board decision-making in recent years has
sharpened market focus on corporate governance in Australia. Of
particular interest to boards of listed companies in Australia are
recent regulatory and market developments relating to disclosure
of corporate governance compliance, executive remuneration,
disclosure of confidential acquisition proposals, and shareholder
activism.
Changes to disclosure under ASX’s “comply or explain” regime

Unlike the mandatory governance rules applicable to companies
listed on the New York Stock Exchange (NYSE), Australian listed
companies are subject to a “comply or explain” regime of governance
recommendations (the Recommendations) coordinated and
published by the Australian Securities Exchange (ASX). Deviations
are generally permitted, but the company’s basis for non-compliance
should be explained in the company’s filings or on its website. A
newly published third restatement of the Recommendations will
take effect for a listed entity’s first full financial year commencing on
or after July 1, 2014. The rewrite is fairly predictable in light of global
governance trends and includes general recommendations regarding
board composition and independence, internal risk management,
effective disclosure, and board and executive remuneration.
Motivated by concern that disclosure of non-compliance is
often overly standardized and difficult for investors to locate in a
company’s disclosure record, ASX has recently introduced a new
Appendix 4G, in the form of a checklist for verifying the location of
corporate governance disclosure, to be filed with a company’s annual
report. ASX has cautioned companies to avoid pro forma governance
disclosure—so we expect to see greater detail in responses.
One area in which Australia is an outlier is tenure-based
independence criteria. Prior to introduction of the third restatement,
proposals were in place to classify board members as non-
independent once they had spent nine years on a board. That
proposal was dropped during consultation.

Australia King & Wood Mallesons
Executive remuneration and the “two-strikes” Disclosure of acquisition proposals and “truth
rule in takeovers”
A uniquely Australian invention, Similar to NYSE requirements regarding
the so-called “two-strikes” rule, was timely disclosure of material new
controversially implemented in 2011 as one developments, a company listed on ASX
of a number of measures introduced to generally must make immediate disclosure
further regulate executive remuneration of any information concerning the company
in Australian listed companies. The rule that a reasonable person would expect to
piggybacks on an existing “say-on-pay” have a “material effect” on the price or
type provision in Australian corporate law value of the company’s securities. Australian
requiring a listed company to put adoption corporate law empowers the Australian
of an executive remuneration report to a Securities and Investments Commission
nonbinding shareholder vote at each annual (ASIC), Australia’s principal corporate and
general meeting of shareholders. The rule securities regulator, to enforce this rule by
applies where at least 25 percent of the votes means of both criminal proceedings and
cast on the resolution are against adoption of civil penalties, including the issuance of
the report at each of two consecutive annual infringement notices or acceptance of
meetings. In that instance, the “two-strikes” enforceable undertakings.
rule requires the company immediately Relevant in the context of takeover
to submit a so-called spill resolution to proposals, the ASX rules provide an exception
shareholders which, if approved, forces the from the general continuous disclosure
company to hold a meeting within 90 days at obligation for information concerning an
which all of the company’s directors (other “incomplete proposal or negotiation,” so
than the managing director) who were long as the information remains confidential
serving at the time of the second “strike” and a reasonable person would not expect
vote must stand for re-election. the information to be disclosed. Despite
Since inception, critics have worried that the availability of the exception, however,
the “two-strikes” rule’s low threshold gives Australian market practice regarding
minority shareholders (and specifically disclosure of acquisition proposals has been
shareholder activists) disproportionate inconsistent, and it has occasionally been
powers to hijack annual meetings and that difficult in practice for target boards to
the elevated threat of a board spill distracts determine when a confidential proposal is
directors from corporate performance. ripe for disclosure. To assist listed entities
Unlike US “say-on-pay” votes, the with compliance, ASX adopted a revised
remuneration report resolution must in all guidance note in 2013 (ASX Guidance Note
cases be submitted to shareholders at each 8) on continuous disclosure obligations. The
annual meeting, meaning that minority guidance note specifically provides that
shareholders could potentially utilize the negotiations between a listed entity and a
“two-strikes” mechanism to threaten an third party will be deemed complete only
incumbent board within a time frame of when the parties enter into an agreement to
approximately 15 months. implement or give effect to the transaction,
Despite these concerns, the rule appears thereby adopting an approach similar to US
to have had only limited practical effect to market practice.
date. While a total of 42 second strikes were Further complicating the issue of when
returned by shareholders across the 2012 and how to disclose acquisition proposals is
and 2013 seasons, only six of the resulting ASIC’s policy of “truth in takeovers,” under
spill votes actually led to a spill meeting, and which ASIC or another interested party may
in each of those cases all or most of the board seek to hold a market participant to definitive
were re-elected. public statements made in connection with

King & Wood Mallesons Australia
an acquisition transaction. Where disclosure companies in 2014 and a recent and highly
relating to a proposal is not sufficiently public attempt by Perpetual Limited, a major
qualified as preliminary and nonbinding Australian fund manager and an activist
(even if the insufficiently qualified statement hedge fund, to unravel a long-standing
takes the form of a misquote or inaccurate cross-shareholding between prominent
reporting not promptly corrected), a party Australian companies Washington H.
may be subject to regulatory action. For Soul Pattinson and Company Limited and
example, action may be taken by ASIC for Brickworks Limited, signalling that US-style
misleading or deceptive conduct, or an shareholder activism is gaining acceptance
application by ASIC or another interested in the market. Activists are assisted by the
party to the Australian Takeovers Panel Australian corporate law regime—one of the
(the Panel) for a declaration of unacceptable most favorable to shareholders among major
circumstances and associated relief. commercial jurisdictions.
In a 2012 decision, the Panel required In addition to the “two-strikes” rule
a bidder that failed to correct inaccurate described above, activists in Australia have
reporting of its intentions in the context a number of legal tools and advantages that
of a competitive public tender offer to are generally not applicable in attacks on
pay compensation to target shareholders Delaware corporations:
who could establish to the satisfaction of
an arbitrator that they were aware of the • Ability to requisition or call a shareholders’
inaccurate press report and, at least in part, meeting: Directors of Australian companies
relied on it when selling target shares in must call a shareholders’ meeting on the
the market. This and other recent Panel request of shareholders representing five
decisions exemplify the seriousness with percent of the votes to be cast at the
which Australian regulators take violations meeting (currently, 100 shareholders can
of the “truth in takeovers” policy. Both also do this, but proposals to change this
bidders and targets in Australia must be are well advanced). The requisitioned
particularly disciplined when making public meeting must be held within two months
announcements regarding their intentions of the company’s receipt of the request.
in an acquisition context to ensure that their Alternatively, those shareholders can call
statements are sufficiently qualified and their own meeting and solicit proxies
need to be vigilant in monitoring the press directly.
to correct inaccurate reporting promptly. • Ability to submit “spill” resolutions/
The issue becomes a key governance matter staggered boards ineffective: Although
from the outset of any public mergers-and- Australian companies are permitted to
acquisitions transaction, as boards must put set specified terms of directors of up to
in place checks and balances and ensure that three years and are permitted to classify
directors stay “on message” in discussion their boards specifically, shareholders
with the media. representing five percent of the votes to
be cast at the shareholders’ meeting (or
Shareholder activism on the rise 100 shareholders currently) may propose
While Australian activism has traditionally a “spill” resolution to replace the board
been undertaken by wealthy individual and appoint the shareholders’ preferred
shareholders (as opposed to activist funds), nominees at any time.
and has often been conducted behind closed • Tactical poison pills constrained: Although
doors, the players and attitudes are clearly shareholder rights plans are not per se
changing. The number of public activist impermissible in Australia, an Australian
campaigns is on the rise, with a record company’s ability to implement a tactical
number of contested director elections poison pill in the face of an unsolicited
commenced with respect to Australian approach or activist accumulation is

Australia King & Wood Mallesons
constrained by an ASX requirement to Given the rise of well-funded activist

obtain shareholder approval for any non– hedge funds, this leaves Australian
pro rata issuance of rights exercisable for boards fundamentally exposed.
more than 15 percent of the company’s
issued capital and by likely Takeovers The emergence of shareholder activism in
Panel challenges in the face of defensive Australia means it is becoming increasingly
measures. important for Australian boards and
• Directors’ use of corporate funds restricted: management to be prepared and to
Directors of Australian companies are understand how to deal with activist investors
severely restricted from using corporate appropriately. As in the US, the initial response
funds and resources to campaign against to an activist campaign is often pivotal to how
removal or appointment of a hostile slate. things will eventually unfold.

Hong Kong Alexander Que, Partner, and Yuki Wong,
Professional Support Lawyer Deacons
C
orporate governance in Hong Kong is regulated by a well-
established legal and regulatory framework comprising
common law, statutory laws, nonstatutory rules, and codes
of practices.
For nonlisted companies incorporated in Hong Kong, the major
sources of corporate governance rules are the Companies Ordinance
(Chapter 622 of the Laws of Hong Kong) (the Companies Ordinance),
the Companies (Winding Up and Miscellaneous Provisions)
Ordinance (Chapter 32 of the Laws of Hong Kong), and precedent
cases under the common law system.
For listed companies in Hong Kong, a much wider range of laws
and regulations governing corporate governance issues applies.
They include:
• The Securities and Futures Ordinance (Chapter 571 of the Laws

of Hong Kong), which regulates, among other things, disclosure
of inside information by listed corporations, insider dealings
in relation to listed companies, and disclosure by directors
and substantial shareholders of their interests in shares in or
debentures of listed companies
• The Rules (the Listing Rules) Governing the Listing of Securities on
the Stock Exchange of Hong Kong Limited (the Stock Exchange),
which cover various corporate governance issues, including
protection of shareholders’ rights, directors, and board practices
as well as corporate reporting and disclosure. The Listing Rules
also contain the Corporate Governance Code setting out the
principles and recommendations of good corporate governance
on various aspects of board practices that listed companies are
required to comply with or explain in a corporate governance
report to be contained in their annual reports.
• The Code on Takeovers and Mergers and the Code on Share
Buy-backs, which provides a nonstatutory framework regulating
takeovers, mergers, and share repurchases with a view to
achieving fair treatment for shareholders who are affected by
such activities. These codes also apply to nonlisted public
companies.

Hong Kong Deacons
Other than laws and regulations mentioned pending a separate review by the Securities
above, various professional bodies such as and Futures Commission.
the Hong Kong Institute of Directors, the Some of the key changes brought about
Hong Kong Institute of Certified Public by the Companies Ordinance for enhancing
Accountants, and the Hong Kong Monetary corporate governance are outlined below:
Authority publish guidance materials to
promote good corporate governance. • restricting the appointment of corporate
directors by requiring every private
Recent development—commencement of the company to have at least one natural
new Companies Ordinance in March 2014 person to act as director, to enhance
One of the most important recent transparency and accountability
developments of corporate governance • clarifying that a director of a company
in Hong Kong affecting companies must exercise the level of care, skill, and
incorporated in Hong Kong is the diligence that would be exercised by a
commencement of the new Companies reasonably diligent person having (1) the
Ordinance on March 3, 2014. general knowledge, skill, and experience
The Companies Ordinance provides the that may reasonably be expected of a
legal framework in relation to formation person carrying out the functions carried
and operation of companies. It contains out by the director (the objective test),
extensive provisions for safeguarding the and (2) the general knowledge, skill,
interests of parties dealing with companies, and experience that the director has (the
including shareholders and creditors. subjective test)
The current Companies Ordinance is the • reducing the threshold requirement
product of a comprehensive exercise started for members to demand a poll from 10
in mid-2006 by the Hong Kong government percent to 5 percent of the total voting
to rewrite the old Companies Ordinance rights
(Chapter 32 of the Laws of Hong Kong) • requiring public companies and the
(the Old Ordinance). Effective from March larger private companies to prepare a
3, 2014, the core provisions of the Old more comprehensive directors’ report
Ordinance have been repealed and replaced that includes an analytical and forward-
by the current Companies Ordinance, while looking business review, while allowing
the remaining provisions that primarily private companies to opt out by special
cover corporate insolvency, winding up, resolution
disqualification of directors, receivers, • widening the ambit of disclosure of
managers, and prospectuses remain intact material interests of directors in contracts
in Chapter 32 (which has been renamed the of significance with the company to
Companies [Winding Up and Miscellaneous cover transactions and arrangements and
Provisions] Ordinance) for the time being to expand the coverage to include the
subject to further reforms in the near future. material interests of entities connected
The Hong Kong government published in with a director in the case of public
May 2014 the conclusions of the public companies
consultation on the corporate insolvency • introducing more effective rules to deal
law improvement exercise and the detailed with directors’ conflicts of interest,
proposals for introducing a statutory including: (1) expanding the requirement
corporate rescue procedure and insolvent for seeking shareholders’ approval to
trading provisions, and an amendment cover directors’ employment contracts
bill is expected to be introduced into the that exceed three years; (2) requiring
Legislative Council in 2015. The provisions disinterested shareholders’ approval
on prospectuses are expected to be moved in cases where shareholders’ approval
to the Securities and Futures Ordinance, is required for transactions of public

Deacons Hong Kong
companies and their subsidiaries; and among other things, has refined the key
(3) requiring the conduct of directors to shareholder protection standards to ease the
be ratified by disinterested shareholders’ burden for overseas applicants. The changes
approval include removing those standards where
• replacing the “headcount test” (ie the the relevant protection is already covered
agreement by a majority in number of under the Listing Rules and broadening
shareholders) with a not more than 10 some standards to accommodate practices
percent disinterested voting requirement in other jurisdictions, for example, allowing
for privatizations and specified schemes certain matters to be approved by a “super-
of arrangement majority” vote of a two-thirds majority
• extending the scope of the unfair rather than applying Hong Kong’s exact
prejudice remedy to cover “proposed acts threshold requirements.
and omissions” so that a member may In December 2013, the Stock Exchange
bring an action for unfair prejudice even published 20 country guides for each
if the act or omission that would be acceptable overseas jurisdiction providing
prejudicial to the interests of members is comprehensive and user-friendly guidance
not yet effected. on how companies incorporated in these
jurisdictions can meet the requirements for
In addition to enhancing corporate equivalent shareholder protection standards
governance, the rewrite exercise also under the Listing Rules.
resulted in substantive amendments with the
major objectives to ensure better regulation, Hot-button issue—controversy over Alibaba’s
facilitate business, and modernize the law. proposed “partnership structure”
The Companies Ordinance is one One of the hottest topics in the Hong Kong
of the longest and most complex pieces capital market since 2013 is no doubt the
of legislation in Hong Kong. Companies listing plan of the China-based e-commerce
incorporated under the Old Ordinance (or giant, Alibaba Group Holding Limited
its predecessors) and persons who plan to (Alibaba).
set up new companies in Hong Kong should Throughout 2013, the media reported that
seek timely professional advice to assist them Alibaba had been in talks with the Hong
in understanding the implications of the Kong regulators on its proposed partnership
provisions under the Companies Ordinance. structure in connection with a proposed
listing in Hong Kong, which according to
Recent development—revised joint policy Alibaba was naturally its first choice because
statement regarding the listing of overseas of the proximity between Hong Kong and
companies in Hong Kong China.
For overseas companies seeking a listing One of the fundamental corporate
on the Stock Exchange, the Listing Rules governance principles in the Hong Kong
provide that the Stock Exchange may refuse capital market, as set out in the Listing
a listing of an overseas applicant if it is Rules, is to ensure that all shareholders are
not satisfied that the overseas applicant is treated fairly and equally. Based on this
established in a jurisdiction where the guiding principle, all shares should carry the
standards of shareholder protection are at same voting rights. Specifically, the current
least equivalent to those provided in Hong Listing Rules do not allow the listing of any
Kong. shares of which the proposed voting power
The Stock Exchange and the Securities does not bear a reasonable relationship to
and Futures Commission of Hong Kong the equity interest of such shares.
published in September 2013 the revised A dual-class structure that contemplates
joint policy statement regarding the listing of one class of shares conferring different voting
overseas companies in Hong Kong, which, rights from another class of shares therefore,

Hong Kong Deacons
by definition, contradicts the “one-share-one- Kong capital market. Unlike the United
vote” principle. Back in 2011, Manchester States, which is in essence a disclosure-
United PLC, the English soccer giant, gave based regime that can thus accommodate
up its original first choice of listing venue, innovative shareholding structures, Hong
because the Hong Kong regulators refused Kong regulators traditionally adopt a more
to grant waiver to accommodate its dual- parental approach. This is founded against
class structure. The structure purportedly a background that in the 1980s almost
proposed by Alibaba seems to be one that is all listed companies were family-owned
somewhere in the middle: It proposed that businesses, and even today, there is still a
Alibaba’s partners, being the key people high concentration of ownership of listed
who manage its businesses, would retain companies in Hong Kong as compared to
control to nominate a majority of its board other stock markets around the world. The
of directors despite that their aggregate Hong Kong market also has the feature
shareholdings in Alibaba were less than of a relatively larger population of retail
15 percent. Joe Tsai, a co-founder and investors in the public, who, compared with
executive vice chairman of Alibaba, thought experienced institutional investments, may
that this partnership structure would “offer be less ready to fully appreciate the risks
an alternative view of good corporate of any possible abuses by the controlling
governance” because this would “set the shareholders and/or the management even
company’s strategic course without being if such risks are fully disclosed in the listing
influenced by the fluctuating attitudes of the documents. Coupled with the lack of a
capital markets so as to protect the long-term litigious culture among retail investors, the
interests of our customers, company and all Hong Kong regulators may therefore see the
shareholders.” Since the special right given need to continue the extensively proactive
to the partners does not bear a reasonable retail investor culture.
relationship to their shareholdings in the Alibaba has finally settled down in
company, the proposed partnership structure pursuing a listing in the United States. Yet,
may be regarded as in violation of the “one- there are continued voices, including the
share-one-vote” principle, albeit to a lesser chief executive of the Stock Exchange and the
extent than the usual dual-class structure Hong Kong Financial Services Development
that confers a superior voting power to one Council, urging more thorough discussion
class of shares generally. on whether we should always stand firm
There have been diverse views in the on the “one-share-one-vote” principle
Hong Kong market as to whether Hong Kong or give room for some companies with
regulators should stand firm in defending weighted voting right structures (namely,
the long-established core value of the governance structures that give certain
“one-share-one-vote” principle or whether persons voting power or other related rights
they should relax the rules for Alibaba or disproportionate to their shareholding)
other technology companies in view of the where there are sound commercial or legal
substantial commercial gains their listings reasons. Finally, in August 2014, the Stock
would likely bring to the market players Exchange published a concept paper to kick
in Hong Kong, or even change the rules off a public consultation process seeking
generally so as to follow the trend of the views on the acceptability of the concept of
other stock exchanges, for example, the New weighted voting right structures. Depending
York Stock Exchange, to allow dual-class on the views garnered by end of November
structures. 2014, the Stock Exchange may then proceed
It would be relevant to briefly explain to launch a second stage formal consultation
the overall regulatory approach in the Hong on the details of the necessary rule changes.

Japan Hiroki Kodate, Partner, and Keita Tokura, Partner Anderson Mori & Tomotsune
T
he amended Companies Act, which was enacted on June
27, 2014 and is expected to come into effect in April or May
2015, is the most important and current development in
Japanese corporate governance. Concerns about the transparency
and effectiveness of the governance of Japanese listed companies
have been increasing, particularly following recent “governance
failure” incidents such as the Olympus Corporation and Daio
Paper Corporation cases. One of the purposes of the Companies
Act amendments is to facilitate the reform of Japanese companies’
corporate governance structures in order to overcome these
concerns.
The two major topics of these reforms are: (1) the introduction of
a new governance structure called the “Audit Committee System”;
and (2) enhanced disclosure obligations for outside directors.
The Audit Committee System
Background
There are two governance structures currently available to listed
companies in Japan: the Statutory Auditor System and the Full
Committee System. The Statutory Auditor System is the traditional,
two-tier board system, while the Full Committee System is a
relatively new structure introduced in 2003 as an alternative.
According to the Tokyo Stock Exchange (TSE), 97.8 percent of all
companies listed on the TSE use the Statutory Auditor System, while
only 2.2 percent use the Full Committee System (source: TSE-Listed
Companies White Paper on Corporate Governance 2013).
The frameworks of the Statutory Auditor System and Full
Committee System as discussed in this white paper relate only to
the “statutory minimum” provided by the Companies Act. Many
listed companies in Japan voluntarily adopt their own governance
structures; for example, utilizing voluntary-based bodies such as
management advisory boards.
Statutory Auditor System

The structure of the Statutory Auditor System is shown in Figure 1.

Japan Anderson Mori & Tomotsune
Figure 1 Structure of the Statutory Auditor System

Appointment/removal General Meeting of Appointment/removal
Shareholders
Appointment/removal
(Board of) Statutory
Accounting Auditor
Auditors
Audit
Board of Directors
Audit Accounting Audit

Supervision/oversight Appointment/removal
Representative
Director(s)/Managers
Statutory auditors are distinct from an Most listed companies in Japan with the
accounting auditor. An accounting auditor is Statutory Auditor System are required to
an independent certified public accountant have a board of statutory auditors, which
(CPA) or auditing firm (as a body corporate) is a supervisory body consisting of the
appointed by the company to conduct company’s statutory auditors. The minimum
external accounting audits on the company. number of statutory auditors for such listed
In contrast, statutory auditors, who are also companies (ie those with a board of statutory
board members of the company, monitor auditors) is three, at least half of which must
the directors and managers of the company be “outside” statutory auditors.
from both an accounting and operational To qualify as an “outside” statutory auditor,
standpoint. Statutory auditors must be a person must not be, and must have never
natural persons and, therefore, cannot be a been, a director, executive officer, or employee
corporate entity, such as an auditing firm. of the company or its subsidiaries (note that
Although statutory auditors are not with the Companies Act amendments, the
directors of the company, they are appointed definition of “outside” has been changed to
and may be removed via a resolution of the require more independence; for instance, an
general meeting of shareholders in the same employee of the parent company of the listed
manner as a director. In order to fulfill their company would disqualify as an “outside”
monitoring responsibility, statutory auditors statutory auditor).
are obliged to attend all meetings of the In contrast, under the Statutory Auditor
board of directors and express their opinion System a company is not obligated by law to
to the board when necessary. However, have any “outside” directors.
statutory auditors do not have a right to
appoint or remove directors or managers of Full Committee System
the company and have no voting rights in The Full Committee System has some
relation to any matters to be resolved by the similarities to a US-style governance
board of directors. structure. Under this system, no statutory

Anderson Mori & Tomotsune Japan
Figure 2 Structure of the Full Committee System

General Meeting of Appointment/removal
Determination of Shareholders
proposal concerning
appointment/removal Appointment/
of directors removal
Board of Directors Accounting Auditor
Appointment/removal
Determination
Committees of remuneration
Supervision/oversight Nomination Audit Remuneration
Appointment/removal
Accounting
Determination of audit
Audit
remuneration
Executive Officers
auditors are appointed. Rather, a company New governance system—Audit Committee System
has three committees: the nomination The Audit Committee System is an alternative
committee, the remuneration committee, governance structure newly introduced by
and the audit committee, as shown in the amendments to the Companies Act. This
Figure 2. structure is a hybrid of the Statutory Auditor
Each committee is composed of at least System and the Full Committee System, as
three directors and a majority of members shown in Figure 3.
in each committee must be outside directors. Under the Audit Committee System,
Therefore, unlike the Statutory Auditor the audit committee is expected to monitor
System, appointment of outside directors directors and other managers. No statutory
is mandatory. For a director to qualify as auditors may be appointed. A majority of
an “outside” director they must not be and members of the audit committee must be
must never have been an executive director, outside directors. Unlike the Full Committee
executive officer, or an employee of the System, the Audit Committee System
company or its subsidiaries (see the change of does not require the establishment of a
the “outside” definition as discussed above). nomination committee or a remuneration
The supervision/oversight and business committee. Instead, members of the audit
execution functions are divided between committee are entitled to give their opinion
directors and executive officers. Under the regarding the nomination and remuneration
Full Committee System, the directors, whose of non-audit-committee-member directors at
term of office is one year, are primarily shareholders’ meetings.
responsible for the oversight of executive The appointment, removal, and
officers. Executive officers, who are remuneration of audit-committee-
appointed by the directors, conduct business member directors will be determined at
executions within the scope of the authority the shareholders’ meeting, separately from
delegated to them by the directors. other directors. The term of office for audit-

Japan Anderson Mori & Tomotsune
Figure 3 Hybrid structure of the Statutory Auditor System

and Full Committee System
General Meeting of Appointment/removal

Appointment/removal Shareholders
and remuneration
determined separately
Appointment/
from other directors
removal
Accounting Auditor
Board of Directors
Opinion on
nomination and
remuneration of
other directors
Supervision/oversight Audit Committee
Appointment/removal
Accounting
Audit audit
Representative
Director(s)/Managers
committee-member directors is two years, the board for the first time. This trend is
while the term of office for other directors thought to be at least partially in response
is one year. to the ever-increasing demand of investors
The Audit Committee System will for transparent and effective corporate
be introduced on an “opt-in” basis; the governance in Japanese listed companies.
same method used to introduce the Full This is evidenced by some proxy adviser firms
Committee System in 2003. This means opposing the renewal of chief executives’
that a company wanting to adopt the new terms at companies with no independent
system may choose to do so by changing its directors. However, as discussed above, an
articles. For listed companies that currently overwhelming majority of listed companies,
use the Statutory Auditor System, the Audit which adopt the Statutory Auditor System,
Committee System may be a more viable are not currently required by law to have
alternative than the Full Committee System any outside directors on the board.
as it would require less drastic changes to
the company structure. New “comply or explain” approach
Over the years there has been contentious
Enhanced disclosure obligations for outside discussion among business communities,
directors academics, investors, regulators, and other
market participants in Japan regarding
Background whether a listed company should be required
In recent years, an increasing number of by law to have a certain number of outside
Japanese public companies have voluntarily directors. However, these discussions did
appointed outside directors. In 2014, for not ultimately lead to the inclusion of such
instance, it was reported that Canon Inc. an obligation in the amendments. Instead,
and Nippon Steel & Sumitomo Metal the amended Companies Act contains a
Corporation welcomed outside directors on new “comply or explain” rule, under which

Anderson Mori & Tomotsune Japan
reporting issuers (notably, listed companies) statutory auditor. Consequently, even under
that do not have any outside directors on the the TSE regulations, listed companies are not
board must disclose in their annual business required to have any “outside” directors on
reports “why the company believes that their board.
having outside directors is not appropriate.” However, on February 10, 2014, the
This rule may, in effect, encourage or even TSE amended its regulations to oblige
force listed companies to appoint outside companies to “make efforts” to have at least
directors. one “independent” director (not statutory
The new “comply or explain” approach, auditor) on the board. This amendment has
together with a newly-introduced restriction further encouraged more listed companies
on the definition of “outside” director, are to appoint more “independent” (hence,
indicative of the fact that the amendments “outside”) directors at annual general
aim to utilize outside directors to bring meetings of shareholders in 2014. According
enhanced transparency to the corporate to the TSE’s announcement on June 17, 2014,
governance of Japanese public companies. 74.2 percent of companies with shares listed
in the first section of the TSE now have at
“Independent” requirement under the stock least one “outside” director and 61.0 percent
exchange rules of companies in the same category have at
The stock exchange rules also regulate least one “independent” director.
the corporate governance of listed
companies. Since 2009, the TSE has required Supplemental note: On June 27, 2014, the Prime
listed companies to appoint at least one Minister, Shinzo Abe, announced the revised
“independent” director or “independent” “Japan Revitalization Strategy - 10 Key Re-
statutory auditor and notify the TSE of this forms”. One of the key reforms is to enhance
appointment. An “independent” director corporate governance. It was also announced
or statutory auditor is defined under the that the government will assist the TSE in
TSE regulations as an “outside” director or drafting the corporate governance code,
statutory auditor who is unlikely to have which outlines the principles of corporate
conflicts of interest with general shareholders governance for listed companies. The details
of the company. Accordingly, not every of the draft code have not yet been disclosed,
“outside” director or statutory auditor can but it is likely to further progress governance
qualify as an “independent” director or reforms in Japan.

Contributor profiles
nyse.com/cgguide
NYSE: Corporate Governance Guide Contributor Profiles
Contributor profiles
NYSE Governance Services

Erica Salmon Byrne
2355 E. Camelback Road
Executive Vice President, Compliance &
Suite 700
Governance Solutions
Phoenix, Arizona 85016
Email esalmonbyrne@corpedia.com
Tel +1 602 712 9919
Web www.nyse.com/corporate-services/ Erica Salmon Byrne is a member of the
nysegs NYSE Governance Services Executive team,
has responsibility for product strategy, and
Eric Morehead also oversees the Advisory Services and
Senior Compliance Counsel Product Marketing teams. She works closely
Email Eric.Morehead@NYSE.com with clients to address their compliance
Eric Morehead is Senior Compliance needs, including evaluating their programs;
Counsel, working with NYSE Governance consulting on best practices in the
Service’s varied clients to build and enhance development, monitoring, and measurement
their compliance programs. Prior to joining of the programs; and assessing their key
NYSE, Mr. Morehead was an Assistant risk areas and specific training needs.
General Counsel of the United States Ms. Salmon Byrne currently hosts NYSE
Sentencing Commission in Washington, Governance Services’ on-demand web video
D.C. In this position he was responsible series, Inside Compliance, and shares the host
for assisting members of the Commission chair of another on-demand web series from
by researching, developing, and drafting NYSE Governance Services, This Week in the
amendments of the US Federal Sentencing Boardroom. Prior to joining the organization,
Guidelines, with a particular focus on the Ms. Salmon Byrne practiced with DLA Piper
Organizational Sentencing Guidelines. He in Washington, D.C., where she specialized in
chaired the policy team that revised the internal investigations, enforcement actions,
Organizational Sentencing Guidelines and government audits, and international law.
strengthened organizational ethics and
Deborah Scally
compliance best practices in 2010. Previous to
Editor and Director of Research
his role with the US Sentencing Commission,
Email deborah.scally@nyse.com
Mr. Morehead was a litigation associate at
Hinton, Sussman, Bailey & Davidson in Deborah Scally is editor of Corporate Board
Houston, Texas, focusing on white-collar Member magazine for NYSE Governance
and regulatory cases where he represented Services, a post she has held since 2010,
clients at trial and before various agencies where she is responsible for all editorial
including SEC, OSHA, and CFTC. content for the publication. Ms. Scally also
leads governance and editorial research
efforts for NYSE Governance Services. Prior

Contributor Profiles NYSE: Corporate Governance Guide
to that, Ms. Scally was editor of Bank Director Keita Tokura

magazine for 17 years, and earlier, she was Partner, Tokyo
deputy editor of Mortgage Banking magazine Email keita.tokura@amt-law.com
for the Mortgage Bankers Association of Mr. Tokura is a partner at Anderson Mori
America in Washington, D.C. & Tomotsune with extensive experience
in corporate governance, mergers and
Beth Van Derslice
acquisitions (public, private, domestic,
Compliance Counsel
and cross-border), and related financial
Email Beth.VanDerslice@NYSE.com
transactions, as well as dispute resolutions
Beth Van Derslice is Compliance Counsel, relating to the M&A.
specializing in developing and implementing
corporate compliance solutions for NYSE
Governance Services’ various clients. Prior
to joining NYSE Governance Services,
Ms. Van Derslice worked as an editor at Arnold & Porter LLP
American Lawyer Media. Previously, she 555 Twelfth Street NW
was a legal fellow at the Associated Press Washington, D.C. 20004
where she researched and drafted papers on Tel +1 202 942 5000
potential media rights to access information, Web www.arnoldporter.com
newsgathering, sports law, and a variety of
related intellectual property issues. John Freedman
Partner, Washington, D.C.
Email john.freedman@aporter.com
Mr. Freedman is a partner in Arnold &
Anderson Mori & Tomotsune Porter ’s Securities Enforcement and
Akasaka K-Tower Litigation Group, with nearly 20 years of
2-7, Motoakasaka 1-Chome experience. His practice focuses on US
Minato-ku, Tokyo 107-0051 Securities and Exchange Commission and
Japan other investigations, complex commercial
Tel +81 3 6888 1000 litigation, white-collar criminal matters,
Web www.amt-law.com/en/ and parallel proceedings involving
simultaneous government investigations
Hiroki Kodate and civil litigation. Mr. Freedman represents
Partner, Tokyo corporations, accounting firms and
Email hiroki.kodate@amt-law.com accountants, broker-dealers, investment
Mr. Kodate is a partner at Anderson Mori advisors, and corporate officers and
& Tomotsune and engaged principally in directors in enforcement investigations and
the fields of corporate governance, mergers securities fraud litigation, represents clients
and acquisitions (M&A), and other general in shareholder derivative and other fiduciary
corporate matters, and regularly advises duty litigation, defends corporations in
both Japanese and non-Japanese clients in antitrust class actions and merger litigation,
this regard. Mr. Kodate worked for the Civil and handles other commercial litigation.
Affairs Bureau of the Ministry of Justice,
where he was in charge of the legislative Joshua Martin
project to modernize Japanese corporate Partner, Washington, D.C.
laws (2002–2005). Email joshua.martin@aporter.com
Mr. Martin, a partner in Arnold & Porter’s
Securities Enforcement and Litigation
Group, has more than 15 years of experience
in the area of securities enforcement and

litigation. His practice consists primarily of Section. He also served on ABA and DC Bar
defending securities-related investigations Task Forces to review the SEC’s selective
conducted by the US Securities and disclosure and insider trading rules.
Exchange Commission, the US Department
of Justice, the Financial Industry Regulatory
Authority, the Public Company Accounting
Oversight Board, Congress, and other
governmental and regulatory entities. He
also represents clients in connection with Booz Allen Hamilton
internal investigations, defends securities 1095 Avenue of the Americas
litigation, provides corporate governance New York, New York 10036
and securities-related counseling, and Tel +1 917 305 8037
handles broker-dealer regulatory and Web www.boozallen.com
compliance issues.
Samitha Amarasiri
Michael Trager Principal
Senior Partner, Washington, D.C. Email Amarasiri_samitha@bah.com
Email michael.trager@aporter.com
Booz Allen Hamilton Principal, Samitha
Mr. Trager co-chairs Arnold & Porter’s Amarasiri, based in the firm’s New York
Securities Enforcement and Litigation Group, office, is a senior member of the Firm’s
leads the firm’s securities enforcement Financial Services Practice and its firm-
practice, and is part of the firm’s leadership. wide 500 person Data Science Practice.
He is an industry veteran with 30 years of He is the Lead Technical Architect for
experience and is recognized widely as a Financial Services clients, focused on
leading securities enforcement attorney. rapid development of next generation
Mr. Trager defends public companies, technologies.
financial services and investment institutions, Recent client work includes helping a
accounting firms, senior executives, directors, Financial Services client tap into the power
and others in investigations conducted by of information within their own data by
the US Securities and Exchange Commission rapidly aggregating and analyzing data
(SEC), the US Department of Justice, across multiple sources. This work led to
Congress, the Financial Industry Regulatory new product offerings in support of revenue
Authority, the Public Company Accounting growth. In addition, he and his team
Oversight Board, and other regulators. helped a client define and roll out a cyber
He also conducts and defends internal security policy and architecture strategy,
investigations and independent reviews, leveraging both internal and external
defends securities litigation, and counsels clouds as a platform for Data Sciences and
on corporate and regulatory compliance, Analytics. Samitha draws upon the deep
corporate governance, crisis management, software development, data management,
disclosure, and securities and market mathematical analysis, and cyber-security
matters. skills within Booz Allen Hamilton to bring
Prior to entering private practice, value to his clients.
Mr. Trager served in the SEC’s Division Prior to joining Booz Allen Hamilton,
of Enforcement in Washington, D.C., Mr. Amarasiri served in senior IT senior
where he was responsible for conducting management roles in top-tier Financial
investigations and involved in representing Services organizations. Many of his
the government in litigation. He serves on engagements resulted in key new business
the Board of Advisors of the SEC Historical insights that enabled organizations to increase
Society and the Executive Council of the top-line revenue, reduce bottom-line costs,
Federal Bar Association Securities Law and effectively manage risks. Mr. Amarasiri

has served Information Security, Technology global public relations agencies, in trade
Risk Management, Merchant Banking, associations, and for national political
Investment Banking, and Fixed Income campaigns.
businesses during his career. He is a delivery- Mr. Foster has led numerous national
focused information technology executive and global public awareness and
with over 20 years of technical leadership at communications campaigns for companies
Financial Services organizations—including including Pfizer, AstraZeneca, Amgen, and
Goldman Sachs, Morgan Stanley, JP Morgan Intel. Prior to joining Booz Allen, Mr. Foster
Chase, and Credit Suisse. was chair of the US health-care practice for
Mr. Amarasiri earned both Masters of Burson-Marsteller, where he led efforts to
Science and Bachelors of Science degrees expand into key sectors, including health
in electrical and computer engineering at information technology, pharmacy benefit
Kansas State University. management, and clinical diagnostics. He
has been a lecturer at Columbia University,
Sudhir Anantharaman Western Kentucky University, University of
Principal, Cyber Financial Services Practice Maryland, and Howard University on topics
Email anantharaman_sudhir@bah.com ranging from strategic communications to
Mr. Anantharaman is a leader in Booz Allen’s health policy. He has a BA in philosophy
private-sector practice with areas of expertise from the University of Virginia and an MS
in strategy, finance, and cybersecurity. He degree in applied behavior science from
interfaces with the board of directors/C- John Hopkins University.
suite on their strategic agenda and managing
a prudent risk-adjusted investment Jason Kemp
portfolio for cybersecurity. Currently, Mr. Principal
Anantharaman supports the CIO/CISO Email kemp_jason@bah.com
of a global macro hedge fund and two Mr. Kemp works with leading global
US megabanks on cybersecurity program organizations across the private sector,
maturity, control suite enhancements and public sector, and civil society located
investments, briefings to the board of in or operating throughout Europe,
directors, and a three-year cybersecurity Eurasia, the Middle East, Latin America,
strategy road map. He previously supported and North Africa to develop cross-sector
two premier Silicon Valley venture capital engagement strategies focused on building
firms on early-stage technology investing. multistakeholder coalitions to support critical
Mr. Anantharaman earned an MBA in business initiatives. He is a leader in Booz
finance from the Booth School of Business at Allen’s commercial, international affairs, and
the University of Chicago and an MSE from international economic development teams,
the University of Michigan. where he supports clients with reputation
intelligence, international supply chain
Chris Foster advisory services, change management,
Vice President international stakeholder engagement, and
Email foster_chris@bah.com corporate affairs strategies focused on the
Mr. Foster serves as a vice president of intersection of economic and social value.
Booz Allen Hamilton focusing on Currently, Mr. Kemp is a senior leader
reputation, corporate strategy, and business within Booz Allen’s corporate strategy
intelligence across multiple lines of and business insights consulting practice
business. His experience includes strategic in the commercial market. He leads the
communications reputation strategy, brand firm’s thought leadership on the topics of
communications, policy implementation, reputation, public-private partnerships, and
alliance development, and social and economic diplomacy, including through
digital communications. He has worked in partnerships with leading academic

institutions like Columbia University and strategic issues that should be explored
Georgetown University. through simulations and wargaming. For
Mr. Kemp is a graduate of Georgia the financial services community, she has
Southern University and received his led the design and execution of more than
Masters degree from George Washington 50 simulations focusing on such issues
University. He is also a graduate of the as: strategic risk management, cyber
Change Management Advanced Practitioner security, large bank failure, resilience of
(CMAP) program at the Georgetown global financial networks, and protective
University McDonough School of Business. response. Ms. Monteforte currently leads a
team of 40 analysts delivering simulations
Jeff Lunglhofer and wargames across government and
Cyber Financial Services Practice Leader industry, to include current engagements
Email lunglhofer_jeff@bah.com with globally systemically important
Mr. Lunglhofer leads Booz Allen’s cyber financial institutions. Ms. Monteforte earned
financial services practice, bringing 18 years a Masters of International Affairs from the
of technical and strategic cyber experience American University.
to the role. His experience ranges from cyber
program diagnostics and design to attack Jim Newfrock
and penetration services. Most recently, Mr. Vice President
Lunglhofer provided crisis management Email Newfrock_Jim@bah.com
and incident response services to a major Mr. Newfrock, currently leads the
financial services client—with support development of service delivery platforms
ranging from real-time threat intelligence in Analytics/Data Sciences in Financial
gathering and report production, to fielding Services.
a large team of host-based forensics experts, Mr. Newfrock has 25 years of experience
network analysts, advanced persistent threat in developing and implementing cost-
(APT) hunters, and evidence handlers. Mr. effective solutions to help clients around
Lunglhofer brings his clients a unique the world assess, reduce, and monitor
blend of deeply technical experience and their risk exposures and improve their
knowledge, along with executive-level Risk and Compliance programs. His work
thinking to help clarify and support risk- has involved leadership of major change
based decision-making at the most senior management initiatives in technology, risk,
level. He earned his undergraduate degree and compliance, including work in complex,
from the University of Virginia and has held global organizations spanning the board of
a wide range of technical cybercertifications directors, the CEO, and management teams
over his career. in business operating and functional units.
Prior to joining Booz Allen Hamilton, Mr.
Nicole Monteforte Newfrock worked for PNC Financial and
Senior Associate First Union Bank in various asset liability,
Email monteforte_nicole@bah.com trading, and cash management roles,
Nicole Monteforte, a Senior Associate including four years in Hong Kong.
with Booz Allen Hamilton, specializes in Mr. Newfrock has produced and
strategy, analysis, and wargaming for the published numerous articles, including:
financial services, defense, and intelligence “Redefining the Governance Agenda,” in
communities. Ms. Monteforte has led the association with pre-eminent law firm, Weil
design and execution of more than 200 Gotshal & Manges; “Managing Risk in the
tabletops, exercises, wargames and Networked Economy,” Corporate Boardroom
simulations since 2001. Ms. Monteforte and CIO; and a study of “Convergence of IT
interacts directly with board of directors/ and Physical Security” on behalf of global
C-suite-level executives to understand

security organizations ASIS, ISACA, and

ISSA.
In addition, Mr. Newfrock participated as
Bredin Prat
130 rue du Faubourg Saint-Honoré
a panel member at the annual meeting of the
75008 PARIS
National Association of Corporate Directors,
FRANCE
a governance conference sponsored by the
Tel +33 1 4435 3535
New York Stock Exchange/Board Summit
Web www.bredinprat.com
Magazine and was also the keynote speaker
on ERM best practices for the National Didier Martin
Association of Corporate Treasurers. Senior Partner
Mr. Newfrock earned a BS degree in Email didiermartin@bredinprat.com
business administration from the University
Mr. Martin is Bredin Prat’s senior partner
of Delaware and an MBA degree from
and one of the leading specialists on
Fairleigh Dickinson University.
French securities law, privatizations, and
William Stewart public tender offers. He regularly advises
Cyber Financial Services Practice Leader major French and international companies
Email Stewart_William@bah.com on corporate law matters and devotes a
significant part of his time to litigation
Mr. Stewart leads Booz Allen cyber
in various areas, such as securities law/
commercial practice and brings more than
takeovers and white-collar crime.
25 years of experience building consulting
Prior to joining Bredin Prat in 1992, Mr.
and systems integration businesses. He
Martin was a partner at Gide, Loyrette &
supports clients in developing C-level
Nouel and had previously worked at Arnold
cyberstrategies and provides a wide
& Porter in Washington, D.C.
range of consulting and implementation
Mr. Martin is a member of several
services addressing today’s most complex
committees and associations, including
cybersecurity challenges. He has grown
the financial transactions committees of
large consulting and systems integration
the Mouvement des entreprises de France
businesses for both public- and private-
(MEDEF) and Association nationale
sector clients, including the US Department
des sociétés par actions (ANSA). He is
of Defense, civil agencies, Intelligence
co-president of the Commission Europe and
Community (IC), and commercial
a founding member of the Observatoire de la
financial services. He consults with senior
Communication Financière.
government executives, as well as with
Mr. Martin was responsible for the drafting
CEOs, CTOs, CIOs, and CISOs. Before
and publication of the commentaries on the
joining Booz Allen, Mr. Stewart worked
French 2012 Monetary and Financial Code
for a major electronics firm, where he
and has written numerous publications on
developed communications security and
corporate law subjects.
key management devices. He also served
as a signal officer, battalion commander,
Brigade/Battalion S-3, and company
commander in the US Army. He has a
BS degree in engineering from Widener
University and an MS degree in electrical
engineering from Drexel University.

team at BlackRock, one of the world’s

largest asset managers. In that role, Rob
managed all aspects of the corporate
CamberView Partners governance function for BlackRock’s equity
Two Embarcadero Center investments in more than 5,000 companies
Suite 2150 based in North and South America. Rob and
San Francisco, California 94111 his team were responsible for developing
Tel +1 415 906 6500 corporate governance policy; representing
Web www.camberview.com BlackRock in discussions with issuers,
clients, and regulators; and supporting
Kenneth A. Bertsch
global corporate governance efforts. Rob
Partner
also engaged in an extensive outreach effort
Email ken.bertsch@camberview.com
as a public speaker at events in the US
Ken Bertsch joined CamberView in January and Latin America. Earlier in his career,
2014 with more than three decades of Rob was an attorney with Skadden, Arps,
leadership roles in corporate governance. Slate, Meagher and Flom LLP focusing
Previously, Mr. Bertsch served as CEO on mergers, acquisitions, and general
and President of the Society of Corporate corporate matters. Rob holds a JD from
Secretaries and Governance Professionals. Georgetown University Law Center and
Previously, he led corporate governance a BA, with honors, from the University of
teams at Morgan Stanley Investment California, Davis. He is a member of the
Management and Moody’s Investors State Bar of California.
Service, and served as Director of Corporate
Governance at TIAA-CREF. Early in his
career, he served for 14 years in various
capacities at the Investor Responsibility
Research Center (a predecessor company Chiomenti
of ISS), including as Director of IRRC’s Via Verdi 2
Corporate Governance Service and Director 20121 MILAN
of its Social Issues Service. ITALY
Mr. Bertsch currently serves as a director Tel +39 02 7215 7660
on the board of the Investor Responsibility Web www.chiomenti.net
Research Center Institute, and has been
named one of the 100 most influential leaders Carlo Croff
in corporate governance by the National Partner, Milan
Association of Corporate Directors. Email carlo.croff@chiomenti.net
Carlo Croff joined Chiomenti in 1984 and
Robert E. Zivnuska
became a partner in 1989. He has been a
Principal
senior partner since 2009. He previously
Email rob.zivnuska@camberview.com
worked at Crowell & Moring in Washington,
Rob Zivnuska is a Principal at CamberView D.C., in 1982, and at Debevoise & Plimpton
Partners, where he helps boards and in New York from 1982 to 1984, where he
management teams understand how to was a senior managing partner. Mr. Croff is
partner effectively with their institutional a business lawyer specializing in providing
investors in addressing shareholder assistance to Italian and foreign clients in
activism, contested situations, compensation corporate mergers and acquisitions, banks,
matters, and shareholder proposals. Before insurance and other regulated entities, and
joining CamberView in 2013, Mr. Zivnuska real estate. Mr. Croff graduated in law
served as Head of the Americas Corporate from the University of Padua in 1979. He
Governance and Responsible Investment received his LLB in international law from

Cambridge University (UK) in 1980 and Elinor Hoover advises corporations globally
his LLM in international law from Harvard on a broad range of corporate finance issues
University, Cambridge, Massachusetts in including capital structure, valuation, capital
1981. He is a member of the Belluno Bar deployment, and risk management. She is
(Italy, 1982) and was admitted to New York also responsible for originating the full range
State Bar (1985). of capital markets-based solutions to include
equity and debt financings, derivatives, and
Enrico Giordano other structured risk solutions.
Partner, Rome Elinor began her career in Finance in
Email enrico.giordano@chiomenti.net 1989 at CS First Boston’s Investment Bank
Enrico Giordano joined Chiomenti in in New York and then joined The Blackstone
1992 and became a partner in 2003. He Group in Tokyo where she specialized in
represents Italian and international issuers cross-border mergers and acquisitions. She
and investment banks in a wide variety joined Morgan Stanley in 1994 in the Fixed
of public and private finance transactions. Income Division to build their derivatives
He has worked on major Italian and business in the US, Latin America, and the
foreign privatization transactions and Asia Pacific region. She was promoted to
has significant experience in the areas of Vice Chairman of Global Capital Markets in
initial public offerings and other public and 2009, joining Citigroup in 2011.
private equity and equity-hybrid securities Elinor graduated from Yale University
offerings, as well as debt offerings. He with a BA in music and a minor in molecular
also advises Italian and international clients biophysics and biochemistry. She received a
with respect to corporate and securities Masters of Business Administration from the
law matters, as well as debt, tender offers, Harvard Business School.
exchange offers, and other restructuring
transactions involving listed companies. Ajay Khorana
Mr. Giordano graduated in law, from the Managing Director; Global Co-Head,
University of Rome in 1989 and received Financial Strategy and Solutions Group,
a PhD in private comparative law from Corporate and Investment Banking, New
University of Macerata in 1991. He is a York
member of the Rome Bar (Italy, 1992). Email ajay.khorana@citi.com
Ajay Khorana works extensively with clients
in a multitude of sectors, advising clients on
a wide range of issues encompassing capital
structure, distribution policy, valuation,
credit ratings, risk management, M&A/
divestitures, optimal liquidity management,
Citigroup Corporate and Investment financing alternatives, and cost of capital
Banking optimization, among others. In additional,
388 Greenwich Street he has authored numerous corporate finance
New York, New York 10013 reports.
Tel +1 212 816 3350 Prior to joining Citi, Ajay was the
Web www.citigroup.com Wachovia Professor of Finance at Georgia
Elinor L. Hoover Institute of Technology and has taught
Managing Director; Global Co-Head, at other well-known business schools in
Financial Strategy and Solutions Group, the US and abroad. He has also worked
Corporate and Investment Banking; extensively with economic consulting firms
and Vice Chairman, Capital Markets on a wide range of finance issues and as a
Origination, New York Visiting Scholar at the Federal Reserve Bank
Email elinor.hoover@citi.com of Atlanta.

His research has been widely published Gustav Sigurdsson

in major academic finance journals and has Vice President, Financial Strategy and
been cited numerous times in major media Solutions Group, Corporate and Investment
outlets including the Wall Street Journal and Banking, New York
Financial Times. Email gustav.sigurdsson@citi.com
Ajay received his PhD in finance from the Gustav Sigurdsson is a Vice President in the
University of North Carolina Chapel Hill Financial Strategy and Solutions Group, the
and is a CFA charter holder. corporate finance advisory and analytical
team within Citi’s Corporate and Investment
Anil Shivdasani
Banking division. In his current role, Gustav
Wells Fargo Distinguished Professor
develops and delivers to Citi’s corporate
of Finance, Director of the Wells Fargo
clients evidence-based advice on capital
Center for Corporate Finance, and Sarah
structure, shareholder distributions, credit
Graham Kenan Distinguished Scholar at the
ratings, risk management, valuation, and
University of North Carolina at Chapel Hill
liquidity.
Email anil.shivdasani@unc.edu
Prior to joining Citi, Gustav was an
Anil Shivdasari teaches courses on mergers Assistant Professor of Finance at the Wharton
and acquisitions and corporate financial School of the University of Pennsylvania,
strategy in the MBA program at the University where his teaching and research activities
of North Carolina and is recognized as one covered all areas of corporate finance, in
of the nation’s outstanding professors in addition to bankruptcy law, auction design,
Businessweek’s Guide to the Best Business behavioral economics, and household
Schools. He was previously Chairman of finance.
the Finance Department at UNC’s Kenan- Gustav received a PhD in economics from
Flagler Business School. Princeton University and a BS in economics
Anil is a Senior Advisor in the Financial from the University of Iceland.
Strategy and Solutions Group where he
was formerly a Managing Director. He has Cecil Wang
advised companies on strategic financial Associate, Financial Strategy and Solutions
issues including valuation, mergers Group, Corporate and Investment Banking,
and acquisitions, capital raising, capital New York
structure, credit ratings, financial policy, Email cecil.wang@citi.com
liquidity management, acquisition financing, Cecil Wang is an associate in the Financial
pensions, and corporate governance. In Strategy and Solutions Group, the corporate
addition, Anil has authored over 50 reports finance advisory and analytical team
on various corporate finance issues. within Citi’s Corporate and Investment
Anil’s research has been published in Bank. His role includes advising clients
leading journals including the Harvard and developing research on a wide range
Business Review, Journal of Finance, and of issues including valuation, acquisitions,
Journal of Financial Economics. His work has capital structure, and distribution policy,
been featured in the media including the as well as credit, risk, and liquidity
Economist, New York Times, Financial Times, management. He has worked extensively
and Businessweek, among others. with clients in the healthcare, technology,
He holds a BA in economics with honors and financial services sectors.
from Delhi University and a PhD in finance Cecil graduated summa cum laude from
in 1991 from Ohio State University. NYU with majors in finance and accounting
and received his PhD in financial economics
from Yale University with a focus on
investments and behavioral finance.

Mr. Lamm is a member of the Florida Bar,

the New York State Bar, and the American
Bar Association (including its Business
The Conference Board Governance Center Law Section and Committees on Corporate
845 Third Avenue Governance and Federal Regulation of
New York, New York 10022-6600 Securities). He frequently speaks and writes
Tel +1 212 759 0900 on securities law, corporate governance, and
Web www.conference-board.org related topics. He currently serves on the
board of editors of The Corporate Counselor,
Robert B. Lamm and he is also a member of the Advisory
Principal Board of iiWisdom, a company that facilitates
Email rlamm@gunster.com company/shareholder engagement.
Mr. Lamm is an Of Counsel to Gunster, Mr. Lamm received a Bachelor of Arts
Yoakley & Stewart, P.A., Florida’s Law Firm from Brandeis University and a Juris Doctor
for Business, and serves as co-chair of the from the University of Pennsylvania School
firm’s Securities and Corporate Governance of Law.
practice. He rejoined Gunster in 2014, having
been a shareholder from 2000 to 2002.
In addition to his role at Gunster, Mr.
Lamm acts as a senior advisor to Deloitte’s
governance services practice and as an Creel Abogados, S.C.
advisory director of Argyle, which advises Paseo de los Tamarindos 400 B Piso 29
corporations on the effective communication Bosques de las Lomas
of corporate governance. 05120 MEXICO, D.F.
From 2008 to 2013, Mr. Lamm was MEXICO
assistant general counsel and assistant Tel +52 55 1167 3000
secretary of Pfizer Inc. His previous Web www.creelabogados.com/en
experience includes service as vice president
and secretary of W. R. Grace & Co., senior Carlos Creel
vice president—corporate governance Senior Partner, Mexico City
and secretary of CA, Inc., and managing Email carlos.creel@creelabogados.com
director, secretary, and associate general Carlos Creel is a senior partner of Creel
counsel of FGIC Corporation/Financial Abogados. Mr. Creel’s practice focuses on
Guaranty Insurance Company. He also has mergers and acquisitions (M&A), private
extensive experience with small- and mid- equity, and corporate governance, as
cap companies as well as non-profit entities. well as banking and finance. Mr. Creel’s
Mr. Lamm is an active, long-term member practice includes advising public and
of the Society of Corporate Secretaries and private companies on corporate governance
Governance Professionals. He was chair of matters, and cross-border joint ventures and
the Society’s Securities Law Committee from strategic alliances, as well as private equity
2011 to 2014 and has served on the Society’s firms in transactional matters. Mr. Creel has
Corporate Practices, Finance, and National substantial experience in corporate finance
Conference Committees, as a member of its and securities regulations.
board of directors, and as chair of its 2004
National Conference Committee; and he is Javier Soní
a recipient of the Society’s Bracebridge H. Senior Associate, Mexico City
Young Distinguished Service Award. He Email javier.soni@creelabogados.com
is also a Senior Fellow of The Conference Javier Soní is a senior associate of Creel
Board Governance Center. Abogados. Mr. Soní specializes in M&A
and financial transactions, having actively

represented domestic and foreign companies

in a wide variety of sophisticated cross-
border deals.
DLA Piper
2000 University Ave
Suite 100
Deacons East Palo Alto, California 94303
5th Floor, Alexandra House Tel +1 650 833 2000
18 Chater Road Web www.dlapiper.com
CENTRAL
Ed Batts
HONG KONG
Partner
PEOPLE’S REPUBLIC OF CHINA
Email ed.batts@dlapiper.com
Tel +852 2825 9211
Web www.deacons.com.hk Ed Batts is a partner with DLA Piper and
co-chair of DLA Piper’s corporate practice in
Alexander Que Silicon Valley, San Francisco, and Sacramento.
Partner, Hong Kong DLA Piper has approximately 4,400
Email alexander.que@deacons.com.hk attorneys globally and routinely represents
Alexander Que is a partner of Deacons’ large enterprises in complex corporate,
Corporate Finance Practice Group and is litigation, and compliance matters. Mr.
based in Hong Kong. He has more than 17 Batts counsels publicly-traded companies
years’ experience in the corporate finance in complex mergers and acquisitions,
field. His practice involves corporate finance corporate governance, and public offerings.
and securities and compliance work, as He also advises on board matters and public
well as private and public mergers and reporting obligations, including activist
acquisitions and private equity transactions. investor situations, stockholder proposals,
He also advises blue chip companies, banks, and accounting-related issues. You can find
and other major clients on Hong Kong his blog on corporate governance matters at
listing rules and securities law compliance www.accruedknowledge.com. Mr. Batts has
matters, as well as on dealing with complex a BA, summa cum laude, from UCLA and a
requirements of disclosure of interest issues JD from Stanford Law School.
under the Securities and Futures Ordinance.
Yuki Wong
Professional Support Lawyer
Email yuki.wong@deacons.com.hk Fenwick and West LLP
Yuki Wong is a professional support lawyer 801 California Street
of Deacons’ Corporate Finance Practice Mountain View, California 94041
Group and is based in Hong Kong. She Tel +1 650 988 8500
has more than 10 years’ experience in the Web www.fenwick.com
corporate finance field.
James Evans
Partner
Email jevans@fenwick.com
James Evans focuses his practice on corporate
and securities law, representing technology
and life sciences companies of international
prominence in a wide range of corporate
matters. He has extensive experience in

capital markets transactions and has of SuccessFactors on the NYSE, NYSE

represented issuers, underwriters, and other Euronext, and Frankfurt Stock Exchange,
parties in a variety of public and private corporate governance matters and joint
offerings of both equity and debt securities, ventures. Jeff was named one of the top 100
including the recent IPOs of Trupanion, lawyers in California by the Daily Journal in
King Digital Entertainment, Veeva Systems, 2013. He was also named a 2012 Attorney
and Good Technology (in registration) and of the Year by The Recorder and is listed in
the recent follow-on offerings of Veeva Chambers USA for capital markets: debt
Systems, Tableau Software, Rocket Fuel, and & equity, U.S. News–Best Lawyers® for
Facebook. In the past three years, Jamie has securities and capital markets law and is
led or co-led more than 15 public offerings repeatedly selected as a Northern California
that have raised over $23 billion of aggregate Super Lawyer by Super Lawyers, a Thomson
proceeds. In addition, Jamie regularly Reuters publication.
advises on mergers and acquisitions and
related securities law issues and provides
ongoing advice to both public and private
companies on general corporate compliance,
SEC reporting, and governance issues. Jamie FTI Consulting
is active in the Seattle and Silicon Valley 1101 K Street NW
business communities, regularly speaking Suite B100
on corporate finance topics, including initial Washington, D.C. 20005
public offerings, other corporate finance and Tel +1 202 312 9100
capital formation issues, and SEC regulation. Web www.fticonsulting.com
In 2014, Jamie was named among the top
attorneys in the United States under the age Steven Balet
of 40 by Law360. Super Lawyers magazine Managing Director, Strategic
named him a “Rising Star” in 2012. Communications
Email Steven.Balet@fticonsulting.com
Jeff Vetter Steven Balet is a managing director in the
Partner FTI Consulting Strategic Communications
Email jvetter@fenwick.com practice and is based in New York.
Jeffrey Vetter’s practice concentrates on public For the past 19 years Mr. Balet has advised
and private offerings of securities, mergers public companies and hedge funds of all
and acquisitions, counseling public and late- sizes on mergers & acquisitions, contested
stage private companies, and other securities proxy campaigns, and corporate governance
law matters. Jeff has worked on more than 50 issues. Mr. Balet’s experience includes
IPOs during his career. His recent issuer-side providing strategic advice in cross-border
initial public offerings include King Digital and global proxy solicitations, corporate
Entertainment, Workday, Facebook, Nimble proxy defense strategy, dissident investor
Storage, Proofpoint, Marin Software, and campaigns, proxy fights, and mergers and
Responsys, as well as additional confidential acquisitions transactions.
offerings. Jeff also represents underwriters of Mr. Balet has extensive experience
numerous initial public offerings, including working with issuers to develop the most
the initial public offerings of Mobile Iron (in effective message for delivering the vote.
registration), Rocket Fuel, Veeva Systems, He routinely counsels issuers on how to
Tableau Software, Jive Software, Fusion-io, engage third party advisory groups such
Salesforce.com, and Omniture. He has as Institutional Shareholder Services as
experience with other public and private well as providing background information
offerings of debt and equity securities and on various activist stockholders and the
stock exchange listings, including the listing techniques they employ. Mr. Balet has spoken

on numerous panels discussing shareholder retail, consumer, education, real estate,

activism as it relates to both mergers and media, and financial services while now
proxy fights. largely focusing her time on capital markets
Mr. Balet has been involved in some communication programs for retail and
of the largest contested situations in the consumer companies. She has led ongoing
past decade, including representing Sanofi- programs for a variety of retailers such
Synthelabo in their acquisition of Aventis, as Office Depot/Max, Aeropostale, Lumber
Rio Tinto in its defense of BHP Billiton’s Liquidators, Guitar Center, Talbots, Dollar
hostile tender, and Oracle in its hostile General, and consumer companies such
acquisition of Peoplesoft. as International Flavors & Fragrances,
Mr. Balet joined FTI Consulting in April Hanesbrands, Movado Group, and Jarden.
2013. Prior to joining the company, Mr. Her recent IPOs include Taylor Morrison,
Balet’s experience included 15 years at Restoration Hardware, and Dollar General
MacKenzie Partners, including three years and crisis and issues management work has
as head of their London Office. included clients such as Orchard Supply
Mr. Balet holds a BA from the State Hardware, American Suzuki Corporation,
University of New York at Albany and a Fairfield Residential, Phillips Foods, Circuit
JD from the State University of New York City, The Children’s Place, and Kid Brands.
Buffalo School of Law. Ms. Parrish began her career at Robertson,
Stephens and managed investor relations at
Leigh Parrish Ivanhoe Mines Inc. prior to joining Morgen-
Senior Managing Director, Strategic Walke Associates, which later merged with
Communications Financial Dynamics/FTI.
Email Leigh.Parrish@fticonsulting.com Ms. Parrish graduated with a BA in
Leigh Parrish is a Senior Managing Director history from San Diego State University.
and the Retail & Consumer Sector Leader
in the Strategic Communications practice of
FTI Consulting and is based in New York.
As a senior communications consultant
Global Governance Consulting LLC
with more than 15 years of experience, she
4526 Westhall Drive NW
has a proven track record in directing critical
Washington, D.C. 20007
communications campaigns and devising
Tel +1 202 808 8545
multi-stakeholder strategic communications
programs. Susan Ellen Wolf
Ms. Parrish’s client engagements have Founder and CEO
ranged from innovative, award-winning Email susan.ellen.wolf@verizon.net
capital markets and business media
Ms. Wolf is the founder and CEO of Global
relations programs to advising clients on
Governance Consulting. She advises boards
communications issues including corporate
and management on using governance to
positioning, key message development,
drive strong performance. She has more
management transitions and terminations,
than 25 years of corporate governance
and employee communications. She has
experience, including serving as chief
extensive experience in event-driven, crisis
governance officer and corporate secretary
and financial situations that includes initial
of Schering-Plough before it merged with
public offerings, mergers and acquisitions,
Merck and securities law/governance
bankruptcy or restructuring, regulatory
positions at the Coca-Cola Company, Delta
probes, litigation, product recalls, and other
Air Lines, and predecessors of Verizon
reputational issues.
and Exelon. Ms. Wolf earned a JD from
Ms. Parrish’s client experience is varied
the George Washington University Law
having worked across industries spanning

School and a BA in sociology from Emory

University.
Ms. Wolf’s frequent projects include
board and committee self-assessments, crisis Innisfree M&A Incorporated
management, audit committee processes 501 Madison Avenue
for overseeing risk issues, compensation New York, New York 10022
committee processes for succession planning Tel +1 212 750 5833
and talent management, nominating Web www.innisfreema.com
committee processes for director recruitment,
Arthur B. Crozier
and shareholder engagement on strategic,
Chairman
compensation, and governance issues.
Email acrozier@innisfreema.com
Arthur B. Crozier is Chairman of Innisfree
M&A Incorporated of New York and of Lake
Isle M&A Incorporated, Innisfree’s wholly-
owned UK subsidiary.
Herbert Smith Freehills LLP Mr. Crozier’s practice includes the
Exchange House representation of US and international
Primrose Street clients in a wide variety of transactions
LONDON and proxy contests, as well as annual and
EC2A 2EG special meetings. In addition, he counsels an
UNITED KINGDOM international roster of clients on corporate
Tel +44 20 7466 2322 governance and executive compensation
Web www.herbertsmithfreehills.com/ issues.
Recent activist/takeover situations he has
Gareth Roberts worked on include: the successful defense at
Partner, Corporate
Clorox against Carl Icahn’s unsolicited offer
Email gareth.roberts@hsf.com
and threatened proxy contest; the successful
Gareth Roberts leads the firm’s dedicated defense at Oshkosh Corporation against a
corporate governance advisory practice and proxy contest and unsolicited tender offer
is recognized as a leader in mergers and by Carl Icahn; the successful defense at
acquisitions (M&A) by Chambers and Legal Agrium against JANA Partners’ proxy
Business and as a leader in the International contest; the successful proxy contest waged
Who’s Who of Corporate Governance 2013. Mr. by P. Schoenfeld Asset Management at
Roberts advises clients on matters ranging MetroPCS to improve the terms of its merger
from very large public M&A deals, to private with T-Mobile; the successful acquisition of
company transactions and board-level Dell Inc. by Michael Dell and Silver Lake
governance advice. He regularly writes for Management, despite opposition by Carl
legal publications on topics such as corporate Icahn and Southeastern Asset Management;
governance, corporate restructuring, and the defense at Transocean against the
directors’ duties. proxy contest conducted by Carl Icahn;
the successful defense at Aspen Insurance
against the unsolicited tender offer and
accompanying solicitation of calls for special
meetings by Endurance Specialty Holdings;
the successful defense at Time Warner Inc.
against the unsolicited acquisition proposal
by 21st Century Fox; and the defense at
Allergan against the unsolicited offer by

Valeant Pharmaceuticals and Pershing people in the boardroom community

Square Capital Management. (2008–2012), Ms. Carter has been quoted in
Mr. Crozier has written numerous articles media around the world and is a frequent
and spoken extensively on the subjects of speaker for corporate governance events
corporate governance, proxy contests, hedge globally. Ms. Carter holds a PhD in finance
fund activism, executive compensation, and from George Washington University and an
international voting practices. MBA in finance from the Wharton School,
He received his BA degree from the University of Pennsylvania.
College of the Holy Cross and his JD from
Boston College Law School. Patrick McGurn
He is a member of the National Investor Executive Director and Special Counsel
Relations Institute, the International Bar Email patrick.mcgurn@issgovernance.com
Association, the Society of Corporate Mr. McGurn is executive director and special
Secretaries & Governance Professionals, counsel at ISS. Considered by industry
the Advisory Council for the Corporate constituents to be one of the leading experts
Governance Forum at Harvard Law School, on corporate governance issues, he is active
and is a Director of the Boy Scouts of on the US speaking circuit and plays an
America, Greater New York Councils and integral role in ISS’s policy development.
a Trustee of The Commonwealth Charitable Prior to joining ISS in 1996, Mr. McGurn was
Fund, Inc. director of the Corporate Governance Service
at the Investor Responsibility Research
Center, a not-for-profit firm that provided
governance research to investors. He also
served as a private attorney, a congressional
staff member, and a department head at
Institutional Shareholder Services (ISS) the Republican National Committee. He
702 King Farm Boulevard is a graduate of Duke University and the
Suite 400 Georgetown University Law Center. He
Rockville, Maryland 20850 is a member of the bar in California, the
Tel +1 212 981 7500 District of Columbia, Maryland, and the US
Web www.issgovernance.com Virgin Islands. Mr. McGurn serves on the
Advisory Board of the National Association
Martha Carter of Corporate Directors. He was named to
Head of Global Research the 2011 National Association of Corporate
Email martha.carter@issgovernance.com Directors’ Directorship 100 list.
Ms. Carter is the head of global research for
ISS. In this role, she directs proxy voting
research for the firm, leading a research
team that analyzes companies in more than
110 markets around the world, provides
institutional investors with customized
research, and produces studies and white
papers on issues and topics in corporate
governance. In addition, Ms. Carter serves
as the head of the ISS Global Policy Board,
which develops the ISS Global Proxy Voting
Policies. Named for five years in a row to the
National Association of Corporate Directors’
Directorship 100 list of the most influential

King & Wood Mallesons

Joele Frank Level 61, Governor Phillip Tower
622 Third Avenue
1 Farrer Place
36th Floor
SYDNEY, NEW SOUTH WALES 2000
New York, New York 10017
AUSTRALIA
Tel +1 212 355 4449
Tel +61 2 9296 2000
Web www.joelefrank.com
Web www.kwm.com
Matthew Sherman
Anna Chen
President and Partner
Solicitor, Sydney
Email msherman@joelefrank.com
Email anna.chen@au.kwm.com
Mr. Sherman is president, a partner, and
Ms. Chen is a corporate lawyer in the Sydney
a founding member of Joele Frank, one
office of King & Wood Mallesons. She has
of the country’s leading investor relations
worked on a range of capital raisings and
and financial communications firms.
public and private mergers and acquisitions
He has more than 17 years of experience
transactions and has assisted in providing
providing strategic corporate, financial, and
general corporate and governance advisory
crisis communications counsel to boards of
services to major Australian Securities
directors and executive leadership teams of
Exchange (ASX)-listed companies.
public companies and private equity firms
involved in mergers and acquisitions, hostile Medard Fischer
takeovers, proxy contests, shareholder Senior Associate, Sydney
activism defense, spin-offs, reorganizations, Email medard.fischer@au.kwm.com
financial restructurings, management
Mr. Fischer is a mergers and acquisitions and
changes, litigation, regulatory actions, and a
equity capital markets lawyer in the Sydney
wide range of corporate crises. Mr. Sherman
office of King & Wood Mallesons, where he
was named president of Joele Frank in
specializes in public and private mergers
August 2013.
and acquisitions and equity capital markets
In 2012 Mr. Sherman received the M&A
transactions. He has experience representing
Advisor’s “40 Under 40” Recognition Award,
public and private clients across a broad
and in 2007 he was named to PR Week’s
range of industry sectors, including financial
inaugural “40 Under 40” list. Mr. Sherman
services and resources.
received an MBA from Columbia Business
Prior to joining King & Wood Mallesons,
School and a BA in international relations
Mr. Fischer practiced corporate law at
and a BA in communications from the
leading law firms in New York and Toronto
University of Pennsylvania.
and is admitted to practice in New York and
Ontario, Canada.
David Friedlander
Partner, Sydney
Email david.friedlander@au.kwm.com
Mr. Friedlander is a securities and mergers
and acquisitions lawyer in the Sydney office
of King & Wood Mallesons who regularly
advises boards and management of listed
companies on corporate governance and

other regulatory issues, with a recent focus Neal Bradsher

on shareholder activism. He has also been Partner, Advisory Services
involved in many high-profile capital raisings Email nbradsher@kpmg.com
and domestic and international mergers Mr. Bradsher is a Partner in KPMG’s
and acquisitions (M&A) transactions, with Risk Consulting practice and based in
particular interest in the US and Asian Minneapolis. He has more than 24 years of
markets. financial and internal audit experience in
Mr. Friedlander is a member of the professional services, consumer markets,
Australian Takeovers Panel and several other diversified industrials, and financial
key corporate law bodies. He is consistently services industries. He has served as
ranked as one of Australia’s top M&A and KPMG’s National IPO Readiness Leader
equity capital markets lawyers and has been for Risk Consulting since 2009, leading
named Best Lawyers’ 2014 Sydney M&A multidisciplinary teams with a focus in
“Lawyer of the Year.” corporate governance, systems, and
processes, including the establishment of
Sarbanes-Oxley (SOX) compliance programs
and internal audit functions.
KPMG LLP Dorothy Guo

345 Park Avenue Director, New York
New York, New York 10154 Email dorothyguo@kpmg.com
Tel +1 877 576 4224 Ms. Guo is a director in the firm’s New
Web www.kpmg.com/aci York office where she practices Regulatory
Risk Consulting, Governance Risk, and
Susan M. Angele
Compliance (GRC), Enterprise Risk
Senior Advisor, Thought Leadership,
Management (ERM), Business Process Review,
KPMG’s Audit Committee Institute
Internal Audit Services, and Regulatory
Email sangele@kpmg.com
Change Technology Implementation. She
In her role as Senior Advisor, Thought has substantial experience in the capital
Leadership of KPMG’s Audit Committee markets area within the financial services
Institute (ACI), Susan Angele works to industry in financial risk consulting,
champion outstanding corporate governance governance risk and compliance, financial
to drive long-term corporate value and business operation assessments, compliance
enhance investor confidence. Focusing on the review, SOX review, and audit services. Her
audit committee and the director community current and past clients include leading
more broadly, ACI engages with directors to financial institutions such as investment
help articulate their challenges and promote banks and broker dealers, multinational
continuous improvement, delivering high- banks, federal bank, investment companies,
quality and actionable thought leadership financial market services providers, and
and building communities to foster shared insurance companies.
learning. Ms. Angele, who previously served
as Global Deputy General Counsel to a Nicole S. Homme
Fortune 500 company and has served on the Director, New York
boards of numerous nonprofit organizations, Email nhomme@kpmg.com
is a frequent writer and speaker on audit Ms. Homme has experience working
committee and board governance issues. with companies for more than 10 years
developing and implementing Enterprise
Risk Management programs. She has also
assisted in the development and innovation

of ERM methodologies at KPMG. She has Eric J. Parker

delivered ERM services to more than 20 Director, Chicago
companies across various industries. Email ericparker@kpmg.com
Mr. Parker is a director in KPMG’s Chicago
Angela J. Hoon
office. He has more than 14 years of ERM,
Principal, Philadelphia
GRC, IT advisory, and audit experience.
Email ahoon@kpmg.com
He has a strong background in providing
Ms. Hoon is a principal in KPMG’s Risk project management, advisory, audit, and
Consulting practice focused on Enterprise attestation services focusing on client
Risk Management/Governance, Risk, and business process and IT controls related
Compliance (ERM/GRC) with more than to financial reporting. Eric’s current and
20 years of ERM/GRC and internal audit past clients include some of the leading
experience in a variety of industries. She is entities in the financial services, industrial
one of KPMG’s National Partners for ERM manufacturing, and energy industries.
and GRC Services and has worked with
senior management and audit committees Aaron Sage
to develop and manage risk-based projects. Director, Advisory Services
Email aaronsage@kpmg.com
Vishal Mehta
Mr. Sage is a Director in KPMG’s Internal
Director, New York
Audit, Risk, & Compliance Services (IARCS)
Email vmehta@kpmg.com
practice in Des Moines. He has more than
Mr. Mehta is a Director in the Risk Consulting 10 years of financial and internal audit
practice specializing in Enterprise Risk experience within the financial services
Management (ERM) and Governance, industry. Mr. Sage serves on KPMG’s
Risk, and Compliance (GRC). He has R&C IPO Readiness team assisting clients
nearly 25 years of experience providing through evaluation of going public and the
internal audit, professional audit, and risk ongoing demands of being public, with
management services across industries with a primary focus on Sarbanes-Oxley (SOX)
a specialization in core manufacturing and and corporate governance requirements.
life sciences. He is an IIA-accredited Quality Additionally, he provides outsource and
Assessor as well as Certified in Financial co-source SOX and internal audit services to
Forensics with significant experience clients in a variety of industries.
conducting corporate/board-requested
investigations. He has extensive experience Alicia Seaton
in conducting trainings for client and firm Advisory Director
personnel. Email aseaton@kpmg.com
Ms. Seaton is an Internal Audit Risk and
Deon J. Minnaar
Compliance Services director in the firm’s
Americas Leader ERM and GRC
Dallas office where she has extensive
Email deonminnaar@kpmg.com
experience with both domestic and
Mr. Minnaar has more than 20 years of international Enterprise Risk Management,
experience in enterprise risk management, Internal Audit services, and Sarbanes-Oxley
risk assessment, and internal audit in a implementation and sustainability services.
variety of industries. He leads the Enterprise She has over 12 years of experience and
Risk Management/Governance, Risk, and has worked across numerous clients and
Compliance (ERM/GRC) practice for the industries to assist companies in creating
Americas. He is on the Americas Steering and maintaining programs for compliance
Committee for GRC and Continuous with the Sarbanes-Oxley Act.
Auditing/Continuous Monitoring Services
(CA/CM).

Dennis T. Whalen of Crisis, and is a regular commentator on

Partner in Charge & Executive Director, television and in print.
KPMG’s Audit Committee Institute
Email dtwhalen@kpmg.com
Dennis Whalen is the Partner in Charge
& Executive Director of KPMG’s Audit
Committee Institute (ACI). In this role, MacKenzie Partners, Inc.
Dennis leads ACI’s initiatives, championing 105 Madison Avenue
outstanding corporate governance to drive New York, New York 10016
long-term corporate value and enhance Tel +1 212 929 5364
investor confidence. Focusing on the audit Web www.mackenziepartners.com
committee and the director community
Paul Schulman
more broadly, ACI engages with directors to
Executive Vice President
help articulate their challenges and promote
Email pschulman@mackenziepartners.com
continuous improvement, delivering high-
quality and actionable thought leadership Paul Schulman joined MacKenzie Partners
and building communities to foster shared in October 2010 and has over 20 years of
learning. Mr. Whalen is a frequent speaker experience in the proxy solicitation industry.
on audit committee and board governance He is primarily responsible for representing
issues and has served as a member of clients in friendly and contested mergers
KPMG’s National Audit Leadership team and acquisitions, going-private transactions,
and the firm’s US and Americas boards of proxy contests for board seats, and a broad
directors, including serving as chair of the range of shareholder approval issues. He
audit, finance, and operations committee. also counsels clients on governance and
compensation issues and advises companies
on responses to shareholder proposals.
Mr. Schulman has extensive experience as
the lead on over 100 contested solicitation
LEVICK assignments, representing corporate issuers,
1900 M Street NW shareholder groups, activist institutions,
Washington, D.C. 20036 and hedge funds.
Tel +1 202 400 3638
Web levick.com
Richard S. Levick, Esq.

Chairman and CEO Moody’s Investors Service
Email RLevick@levick.com 7 World Trade Center
Mr. Levick is chairman and CEO of LEVICK, 250 Greenwich St.
which provides strategic communications New York, New York 10007
counsel on the highest-profile public affairs Tel +1 212 321 6549
and business matters globally—including Web www.moodys.com
the Wall Street crisis, the Gulf oil spill,
Christian A. Plath
Guantanamo Bay, and the Catholic Church.
Vice President, Senior Analyst, and
Mr. Levick was honored four times on the
Corporate Governance Specialist
prestigious list of “The 100 Most Influential
Email christian.plath@moodys.com
People in the Boardroom” and has been
named to multiple professional halls of fame Mr. Plath joined Moody’s Investors Service in
for lifetime achievement. August 2005. He is responsible for publishing
He is the coauthor of four books, including corporate governance commentary in
The Communicators: Leadership in the Age Moody’s credit research, participating in

rating committees across Moody’s various Elizabeth Walker

sector teams, training Moody’s analysts on Partner, Ottawa
corporate governance issues, and external Email ewalker@osler.com
outreach. Ms. Walker is a partner in Osler’s Ottawa
Before joining Moody’s in 2005, Mr. office and practices corporate and securities
Plath was associate director of the Global law with an emphasis on private and
Corporate Governance Research Center at the public corporate finance matters, mergers
Conference Board, an independent business and acquisitions (M&A), and corporate
membership and research organization, for governance. Her practice focuses on the
three years. In this capacity, he produced areas of high-tech and biotech, Crown
research on US and non-US corporate corporations, and other government bodies.
governance “best practices” and helped She advises a wide range of businesses
design education programs on governance and other entities, from start-up companies
for corporate directors and senior executives. to public companies and public sector
Prior to this position, Mr. Plath worked for bodies, on corporate and securities matters,
the Investor Responsibility Research Center including a wide range of private and
(IRRC) for six years, including serving as public M&A transactions, public and private
director of global corporate governance financings, and corporate governance.
research.
Robert Yalden
Partner, Montreal
Email ryalden@osler.com
Mr. Yalden is a partner in Osler’s Montreal
Osler, Hoskin & Harcourt LLP office. He was co-chair of the firm’s mergers
100 King Street West and acquisitions group for 10 years prior to
1 First Canadian Place becoming a member of the firm’s executive
Suite 4600, PO Box 50 committee. His career with Osler spans 20
TORONTO, ONTARIO M5X 1B8 years, during which he has been involved
CANADA with some of Canada’s most innovative and
Tel +1 416 362 2111 groundbreaking transactions. Mr. Yalden
Web www.osler.com has advised boards of directors and senior
management in connection with a wide
Andrew J. MacDougall
range of corporate governance and M&A
Partner, Toronto
mandates. He was part of the Osler team that
Email amacdougall@osler.com
implemented the first poison pill in Canada.
Mr. MacDougall is a partner in Osler’s He led the Osler legal teams involved in
Toronto office and practices corporate and Canada’s largest-ever completed leveraged
securities law, with a particular focus on buyout, as well as the largest-ever buyout in
corporate governance and mergers and the oil field services sector. He has recently
acquisitions. In his corporate governance been involved with a significant proxy
practice, he advises boards and management fight that has seen the problems of “empty
on a broad spectrum of corporate governance voting” on the part of hedge funds receive
issues, including directors’ duties, executive considerable public scrutiny in Canada. He
compensation, shareholder engagement, is the coauthor of Business Organizations,
and shareholder meeting matters, and he Policies and Practices (2008) and teaches a
has written and spoken extensively on course in comparative corporate governance
these topics. He has also advised Canadian at McGill University’s faculty of law.
securities regulators and various professional
bodies in Canada that are active in the
governance area.

Pay Governance LLC

Two Logan Square
P+P Pöllath + Partners 100 N 19th Street, Suite 821
Hofstatt 1 Philadelphia, Pennsylvania 19103
80331 Munich Tel +1 215 569 8500
GERMANY Web www.paygovernance.com
Tel +49 89 24 240 280
Web www.pplaw.com/en Don Kokoskie
Partner, Cleveland
Bernd Graßl, LLM Email don.kokoskie@paygovernance.com
Attorney-at-Law, Partner
Mr. Kokoskie is a partner in the Cleveland
Email bernd.grassl@pplaw.com
office of Pay Governance, with more than 25
Dr. Graßl advises on all areas of corporate years of executive compensation consulting
law and capital market law, with a focus on experience with a wide variety of public and
stock corporation law, securities trading law, private companies on executive and director
stock exchange law, capital market rules, compensation programs, the last 15 years
and takeover law. Mr. Graßl studied law working directly with the boards of directors
in Passau, Augsburg, and at the Victoria of those organizations.
University of Wellington, New Zealand.
He served in a bank apprenticeship, was Christine Oberholzer Skizas
admitted to the bar in 2006, and joined P+P Partner, Chicago
in 2006. Email christine.skizas@paygovernance.com
Ms. Skizas has been consulting with clients
Wolfgang Grobecker, LLM across industries to strategize and develop
Attorney-at-Law, Partner
executive compensation philosophies for
Email wolfgang.grobecker@pplaw.com
senior executives for more than 13 years.
Dr. Grobecker has advised on the full range Her areas of expertise include compensation
of corporate law and capital market law strategy, short- and long-term incentive
for many years, including industrial group design, including traditional and alternative
company law and stock exchange law, as delivery vehicles, and transaction-related
well as securities trading and takeover law. engagements.
He also focuses on corporate litigation. Mr.
Grobecker studied law in Trier, Geneva, Stephen J. Pakela
Switzerland, Regensburg, and Cambridge, Managing Partner, Pittsburgh
England. He was admitted to the bar in 1999 Email steve.pakela@paygovernance.com
and joined P+P as a partner in 2010. He was Mr. Pakela is a managing partner at Pay
a partner in a major German law firm from Governance. He advises clients in areas
2004 to 2009. such as compensation strategy development,
incentive plan design (both short- and long-
term), executive severance, and all forms
of competitive compensation review. He
also advises on director compensation and
corporate governance issues. Mr. Pakela
has extensive experience functioning
as an advisor to client compensation
committees. He works with a broad range
of companies that represent industries such

as manufacturing, mining, financial services,

consumer products, technology, higher
education, and health care.
Mr. Pakela is a certified public accountant
and a member of both the American and Pillsbury Winthrop Shaw Pittman LLP
Pennsylvania Institute of Certified Public 1540 Broadway
Accountants. He has spoken frequently for New York, New York 10036-4039
various organizations on topics pertaining Tel +1 866 716 0445
to executive compensation. Mr. Pakela is a Web www.pillsburylaw.com/crisis-
graduate of Westminster College with a BA management
in business administration, concentrating in
accounting.
Thomas A. Campbell
Partner
John R. Sinkular Email tom.campbell@pillsburylaw.com
Partner, Detroit Tom Campbell is the leader of Pillsbury
Email john.sinkular@paygovernance.com Winthrop Shaw Pittman’s Crisis
Mr. Sinkular is a partner in the Michigan Management team. Mr. Campbell counsels
office of Pay Governance, specializing in US and multinational corporations facing
the analysis, design, and implementation of financial and reputational loss associated
executive compensation programs that drive with a crisis. Typically, these matters require
shareholder value. Mr. Sinkular consults a multidisciplinary response involving
with publicly-traded, privately-owned, and public relations, government relations, and
pre-IPO companies in various industries litigation.
regarding executive and nonemployee Mr. Campbell’s significant representation
director pay programs. He has experience in includes acting as team leader for the
helping companies handle significant changes, crisis management group that advised a
including asset sales, bankruptcy, initial public 10 percent leaseholder of the Macondo well
offerings, mergers, and acquisitions. He has on a billion dollar settlement related to the
worked with numerous Fortune 500 and other 2010 Deepwater Horizon accident and oil spill
prominent companies and has a particular in the Gulf of Mexico. Mr. Campbell also
focus on people-intensive businesses. He recently oversaw a foreign conglomerate’s
works with companies in various industries, internal investigation and integrated
including auto suppliers, branded consumer response to sensitive military, legal, and
products, insurance, manufacturing, and not- political issues that jeopardized a multi-
for-profit organizations. billion dollar financing.
Mr. Sinkular holds the distinction of Mr. Campbell’s global perspective
Certified Compensation Practitioner, and emphasis on strategic planning and
awarded by the American Compensation policy are reflective of his experience in
Association. He earned his BS in business Washington, D.C. as the former General
administration from the University of Counsel of the National Oceanic and
Nebraska—Omaha and a MA in economics Atmospheric Administration (NOAA). At
from Wayne State University. NOAA he led the federal assessment of the
natural resource damage claim for the Exxon
Valdez oil spill and played a pivotal role in
the associated $1 billion natural resource
damage settlement.

Nicholas M. Krohn delicate relationship with their respective

Associate government authorities. Ms. Nara also
Email nicholas.krohn@pillsburylaw.com represents clients in a wide variety of issues
Nicholas Krohn is a member of Pillsbury associated with importation of goods into
Winthrop Shaw Pittman’s Crisis the US by providing most cost-effective
Management team. His practice focuses on solutions. Her clients appreciate her talent,
crisis liability management and emergency experience, and passion in resolving difficult
response. problems and express how much they enjoy
Mr. Krohn works closely with Tom working with her.
Campbell and has made significant
Stella D. Pulman
contributions to the representative matters
Senior Associate
described above. He is familiar with all facets
Email stella.pulman@pillsburylaw.com
of a multidisciplinary response—including,
public relations, government relations, Stella Pulman is a senior associate in Pillsbury
litigation, and internal investigations. This Winthrop Shaw Pittman’s Environment,
experience allows him to act as a “crisis Land Use, & Natural Resources practice and
coordinator,” the attorney responsible for is a member of the Crisis Management team.
coordinating a multidisciplinary crisis Her practice is focused on environmental
management team. He also regularly compliance, emergency response and
counsels the large companies who are crisis management, internal investigations,
looking to proactively strengthen their crisis EHS management systems reviews, and
management capabilities. management of complex environmental
Prior to his legal career, Mr. Krohn liabilities. She regularly advises clients on
proudly served as a light infantry soldier in matters involving crisis events, including
the US Army’s 101st Airborne Division (Air refinery and pipeline explosions, oil spills,
Assault). and other major industrial accidents. In
addition, she frequently works with clients
Fusae Nara to address environmental remediation
Partner issues, natural resource damage liabilities
Email fusae.nara@pillsburylaw.com and restoration, hazardous waste
Fusae Nara is a partner in the law firm’s management, and regulatory compliance
Litigation practice and a lead in the Crisis under state and federal environmental
Management focus team. She has significant laws. Ms. Pulman also regularly provides
experience in complex commercial clients with comprehensive reviews of
litigations, including class actions, with a their environmental, health, and safety
strong record of securing favorable out-of- management programs and systems,
court settlements on behalf of her clients. including evaluation of compliance
Ms. Nara has extensive experience in both assurance, performance, process safety, and
court-sponsored and private mediations. management oversight of EHS.
Her extensive litigation experience is an
asset to the Crisis Management team as crises
typically require this type of knowledge.
Ms. Nara brings an understanding of the
business ramifications of legal disputes to
each matter and works with her clients to
develop common sense business solutions.
Her previous work in the legal department
of a major Japanese corporation provided
her with an understanding of the dynamics
of multinational corporations and the

Sard Verbinnen & Co

Pinheiro Neto Advogados 630 Third Avenue
Rua Hungria 1100 New York, New York 10017
São Paulo-SP Tel +1 212 687 8080
01455-906 Web www.sardverb.com
BRAZIL
Tel +55 11 3247 8400 Kayla Hamberg
Web www.pinheironeto.com.br Senior Associate
Email khamberg@sardverb.com
Henrique Lang Since 2010, Ms. Hamberg has worked for
Partner Sard Verbinnen & Co as a junior associate,
Email hlang@pn.com.br an associate, and currently, a senior
Henrique Lang is a partner in the firm’s associate in the Digital Communications
São Paulo office, where he practices capital Group. Ms. Hamberg develops the digital
markets, securities regulation, merger and strategy behind communications initiatives
acquisitions, and corporate governance, with for high-profile projects and corporate
a particular focus on securities offerings, announcements. She produces, manages,
tender offers, and corporate restructuring and evaluates transaction and corporate
transactions involving publicly-held websites, drafts online communications
companies. He has over 25 years of initiatives, and manages other digital
experience representing leading Brazilian reputation-related and social media–related
and international companies and investment projects. She also advises on a wide range
banks in high-profile transactions, some of of social media topics, including the latest
them awarded as deals of the year in Brazil Securities and Exchange Commission
and Latin America by Latin Lawyer, American regulations on issuance of corporate
Lawyer and other publications. Chambers, securities in social media.
IFLR, The International Who’s Who of Lawyers, Ms. Hamberg writes, edits, and publishes
Practical Law, and other publications have The SVC Digital Scoop, a monthly newsletter
repeatedly recognized him as a leading about hot topics in social media. She speaks
capital markets and/or corporate governance regularly on social media issues before
lawyer in Brazil. He has an LLB from São internal forums.
Paulo Catholic University School of Law Prior to joining Sard Verbinnen, Ms.
(1991) and worked as foreign associate at Hamberg interned at Cohn & Wolfe, a
Davis Polk & Wardwell, New York (1996). public relations firm (2010). Ms. Hamberg
Mr. Lang became a partner in 2000 and has published articles about social media
heads the capital markets group of the firm. issues in Directors and Boards (March 2013)
He was a member of the Novo Mercado and O’Dwyer’s (April 2012). She holds a BFA
Advisory Board (2010) and oversaw the degree from Cornell University (2010).
drafting of the ABRASCA Code of Good
Corporate Governance Practices for Publicly
Held Companies (2011). He is a member of
the Brazilian Bar Associations in São Paulo,
Rio de Janeiro and Brasília.

A recognized expert on governance topics,

Ms. Daum helped found and develop the
Wharton School’s Corporate Governance:
Spencer Stuart Fresh Insights and Best Practices for Directors
353 N Clark, Suite 2500
program and is regularly quoted in The New
Chicago, Illinois 60654
York Times, Financial Times, Businessweek, Time
Tel +1 312 822 0088
magazine, and The Wall Street Journal. She is
Web www.spencerstuart.com
also the coauthor of the recent business book
Cathy Anterasian You Need a Leader—Now What? How to Choose
North American Leader, CEO Succession the Best Person for Your Organization.
Services
Dayton Ogden
Email canterasian@spencerstuart.com
Global Leader, CEO Succession Services
Ms. Anterasian leads CEO Succession Email dogden@spencerstuart.com
Services for Spencer Stuart in North America.
Mr. Ogden is the global leader of Spencer
She is an active member of the North
Stuart’s CEO Succession advisory services
American Board, CEO, Technology, Media
and a member of the Board and Industrial
& Telecommunications, and Consumer
practices. His search-consulting work focuses
practices. Previously she launched and
on senior executive and board recruiting for
co-led Spencer Stuart’s global Executive
international clients. He is commentator on
Assessment Services practice.
key trends and issues affecting CEOs and
Ms. Anterasian has more than 25 years
boards, both in the US and internationally.
of experience in succession planning,
In 2000, Oxford University Press published
assessment, executive search, and strategy
CEO Succession, which he coauthored.
consulting. She advises boards and chief
Mr. Ogden draws from direct board
executive officers on the capabilities and
experience for client work, currently serving
potential of their teams, as well as on
on the board of the American Business
the development of strategies and plans
Conference, an organization that includes
to prepare executives for CEO succession
the CEOs of emerging growth companies.
and other C-suite roles. Ms. Anterasian
He is also secretary and a director of Project
has partnered with numerous boards and
HOPE, a leading health-care foundation
CEOs of Fortune 500, mid-cap, and privately
based in Washington, D.C.
held companies to ensure that successful
Mr. Ogden was elected chief executive of
leadership development, selection, and
the firm in 1987 and in 1993 became the first
transition occur. She has engaged with
CEO in the firm’s history to be re-elected to a
clients globally across financial services, life
third term. He served as chairman from 1999
sciences, industrial, technology, retail, and
through 2006.
consumer sectors.
Julie Hembrock Daum

North American Leader, Board Practice
Email jdaum@spencerstuart.com
Ms. Daum leads the North American Board
Practice and serves on the board of directors
of Spencer Stuart. She consults with
corporate boards, working with companies
of all sizes from the Fortune 10 to pre-IPO
companies, and has conducted more than
1,000 board director assignments.

Uría Menéndez
Plaza de Rodrigo Uría
Príncipe de Vergara, 187
28002 MADRID
SPAIN
Tel +34 915 860 400
Stanford Graduate School of Business Web www.uria.com
655 Knight Way
Stanford, California 94305 Carlos Paredes
Tel +1 650 725 6159 Partner, Madrid
Web www.gsb.stanford.edu Email carlos.paredes@uria.com
Mr. Paredes focuses on commercial and
David F. Larcker company law, mergers and acquisitions,
James Irvin Miller Professor of Accounting corporate governance, banking and securities
Email dlarcker@stanford.edu law, corporate restructuring transactions,
Professor Larcker is director of the Corporate and issues of equity and debt. He regularly
Governance Research Initiative at the advises private and listed companies,
Stanford Graduate School of Business and financial entities, and venture capital firms.
senior faculty at the Arthur and Toni Rembe Mr. Paredes is a lecturer on business and
Rock Center for Corporate Governance. His corporate law at several Spanish universities
research focuses on executive compensation and institutions and has published several
and corporate governance. Professor Larcker articles on different topics within his practice
presently serves on the board of trustees areas.
for Wells Fargo Advantage Funds. He is
coauthor of the books A Real Look at Real
World Corporate Governance and Corporate
Governance Matters: A Closer Look at
Organizational Choices and Their Consequences. Vanguard
P.O. Box 2600
Brian Tayan Valley Forge, Pennsylvania 19482
MBA 2003 Tel +1 610 669 1000
Email btayan@stanford.edu Web www.vanguard.com
Mr. Tayan is a member of the Corporate
Governance Research Initiative and has Glenn H. Booraem
written broadly on the subject of corporate Principal and Fund Controller
governance. Tayan is coauthor with David Email glenn_booraem@vanguard.com
Larcker of the books A Real Look at Real Mr. Booraem is a Principal of the Vanguard
World Corporate Governance and Corporate Group, Inc. and the controller of each of
Governance Matters. the Vanguard Funds. He has worked for
Vanguard since 1989, where he currently
oversees the firm’s corporate governance
program covering nearly $2 trillion in equity
market value. He is a periodic speaker on
governance to industry groups and has
served on the New York Stock Exchange’s
Proxy Working Group and Commission on
Corporate Governance. Most recently, he
served on the Advisory Board on Corporate/

Investor Engagement for the Conference of Management at Vanderbilt University.

Board Governance Center and the Working Mr. Katz is a corporate attorney focusing
Group for the SDX (Shareholder/Director on the areas of mergers and acquisitions,
Exchange) Protocol. He has been recognized shareholder activism, and complex securities
for the past three years (2011–2013) on the transactions, has been involved in many
NACD’s Directorship 100 list of the “most major domestic and international corporate
influential people in corporate governance.” merger, acquisition and buyout transactions,
In addition to his governance-related duties, strategic defense assignments, and proxy
Glenn is responsible for fund accounting contests, and has been involved in a number
operations, security valuation, and fund of complex public and private offerings and
compliance monitoring for the Vanguard corporate restructurings. He also counsels
funds. Glenn earned a BBA from Temple boards of directors and board committees
University, and he is a graduate of the on corporate governance matters and crisis
Advanced Management Program at Harvard management.
Business School.
Ralph M. Levene
Partner
Email RMLevene@wlrk.com
Wachtell, Lipton, Rosen & Katz Ralph M. Levene has been a partner since
51 West 52nd Street 1994 in the Litigation group of Wachtell,
New York, New York 10019 Lipton, Rosen & Katz in New York. His
Tel +1 212 403 1000 practice focuses on the representation of
Web www.wlrk.com major US and foreign financial institutions
and other companies in connection with
David Gruenstein the handling of white-collar criminal and
Partner regulatory investigations and enforcement
Email DGruenstein@wlrk.com matters and related class action and
David Gruenstein has been a partner since derivative civil litigation including involving
1988 in the Litigation group of Wachtell, the FCPA. Mr. Levene also advises clients on
Lipton, Rosen & Katz. His practice focuses the development and implementation of
on handling regulatory and white-collar compliance programs and the conduct of
criminal investigations and enforcement internal investigations.
matters, principally in the securities area,
and a wide variety of complex civil litigation. Martin Lipton
Mr. Gruenstein also regularly provides Partner
compliance advice and counsel to leading Email MLipton@wlrk.com
financial institutions. Martin Lipton, a founding partner of
Wachtell, Lipton, Rosen & Katz, specializes
David A. Katz in advising major corporations on mergers
Partner and acquisitions and matters affecting
Email DAKatz@wlrk.com corporate policy and strategy. Lipton
David A. Katz is a partner at Wachtell, is Chairman of the Board of Trustees of
Lipton, Rosen & Katz in New York City, an New York University, a Trustee of the New
adjunct professor at New York University York University School of Law (Chairman
School of Law, a senior professional fellow 1988-1998), an emeritus member of the
at New York University Center for Law Council of the American Law Institute,
and Business, and an adjunct professor and a director of the Institute of Judicial
at Vanderbilt University Law School. Administration. Lipton is a member of the
Previously, he was an adjunct professor of Executive Committee of the Partnership for
management at the Owen Graduate School New York City and served as its Co-Chair

(2004-2006). Lipton has a BS in economics Sabastian V. Niles

from the Wharton School of the University Activism, Governance, and M&A Counsel
of Pennsylvania and an LLB from the New Email SVNiles@wlrk.com
York University School of Law. He is a Sabastian V. Niles is counsel in Wachtell
member of the American Academy of Arts Lipton’s Corporate Department where he
& Sciences, a member of the International focuses on rapid response shareholder
Advisory Council of Guanghua School of activism, takeover defense, and corporate
Management of Peking University, and governance; US and cross-border mergers,
a Chevalier de la Légion d’Honneur. Mr. acquisitions, buyouts, investments,
Lipton is an Emeritus Chairman of Prep for divestitures, and strategic partnerships;
Prep, having served as Chairman from 1990 and other corporate and securities law
to 2002. matters and special situations. Sabastian
advises worldwide and across industries,
Laura A. McIntosh
including technology, financial institutions,
Consulting Attorney
media, energy and natural resources, health
Email LAMcIntosh@consultant.wlrk.com
care and pharmaceuticals, construction
Laura A. McIntosh is consulting attorney and manufacturing, real estate/REITs, and
for Wachtell, Lipton, Rosen & Katz. She has consumer goods and retail. A graduate of
advised corporate and nonprofit boards of Harvard Law School, he publishes and
directors and has worked on a wide range speaks frequently on matters relating to
of merger and acquisition transactions, corporate policy and strategy.
including public company mergers, tender
offers, divestitures, and joint ventures. Steven A. Rosenblum
Ms. McIntosh graduated summa cum laude Partner
from Yale University and earned a master’s Email SARosenblum@wlrk.com
degree in English Literature from Stanford Steven A. Rosenblum has been a partner at
University. She received her JD from Yale Wachtell, Lipton, Rosen & Katz since 1989,
Law School, where she was the editor-in- and serves as co-chair of the firm’s Corporate
chief of the Yale Law Journal. Ms. McIntosh Department. He focuses on mergers and
has published articles on a variety of legal acquisitions, buyouts, takeover defense,
topics, including corporate governance, shareholder and hedge fund activism, proxy
director and executive compensation, fights, joint ventures, corporate governance,
takeover defense, shareholder activism, and securities law. Mr. Rosenblum has
cross-border transactions, audit committee extensive experience representing major
practices, federal securities law, and companies in each of these areas. He has
corporate case law. been recognized by Chambers Global as one
of the world’s leading transactional lawyers.

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NYSE: Corporate Governance Guide

NYSE: Corporate Governance Guide nyse.com/cgguide

Published in association with New York Stock Exchange,

Consulting editors: Steven A. Rosenblum, Karessa L. Cain,

Published by White Page Ltd

Publisher Tim Dempsey

Publishing editor Nigel Page

Production editor Matt Rosenquist

Design Graphic World Inc

Printing and binding Transcontinental Printing