NYSE: Corporate Governance Guide NYSE:

NYSE: Corporate Governance Guide nyse.com/cgguide nyse.com/cgguide 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 NYSE: Corporate Governance Guide

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 nyse.com/cgguide

NYSE: Corporate Governance Guide is published by: White Page Ltd 17 Bolton Street London W1J 8BH United Kingdom Phone: + 44 20 7408 0268 Fax: + 44 20 7408 0168 Email: [email protected] Web: www.whitepage.co.uk

First published: 2014 ISBN: 978-0-9565842-6-7

NYSE: Corporate Governance Guide © 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

he ever evolving challenges facing corporate boards prompt an updated snapshot of what is expected from the board of T 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.

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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

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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

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NYSE: Corporate Governance Guide

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 Chapter 3 NYSE Governance Services 66 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

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Chapter 13 Chapter 24 Recruiting and onboarding directors Best practices in code of conduct Spencer Stuart 102 development Chapter 14 NYSE Governance Services 172 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 NYSE Governance Services 191 Spencer Stuart 118 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 Booz Allen Hamilton 137 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 Booz Allen Hamilton 218 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

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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 governance: key trends and 1 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

t’s the question of the moment: what kind of board does your company need to maintain a competitive edge? Industry and Ileadership 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,

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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

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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-

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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.

NYSE: Corporate Governance Guide 5 Real look at corporate governance

David F. Larcker,2 James Irvin Miller Professor of Accounting, and Brian Tayan, MBA 2003 Stanford Graduate School of Business

esearchers have taken a thorough and critical look at corporate governance from various perspectives. They have studied Rhow 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?

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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

NYSE: Corporate Governance Guide 7 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.

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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.

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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.

NYSE: Corporate Governance Guide 9 Real look at corporate governance Stanford Graduate School of Business

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

10 NYSE: Corporate Governance Guide Stanford Graduate School of Business Real look at corporate governance

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.

NYSE: Corporate Governance Guide 11 Real look at corporate governance Stanford Graduate School of Business

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. Companies are organizational entities and Brian K. Boyd, “CEO Duality and Firm 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. another. In the end, the best hope for a best- For a review of the research literature, see: David 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. directors, taking into account the individual Emphasis added. Myron Steele, “Verbatim: 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).

12 NYSE: Corporate Governance Guide Perspectives from ratings agency, institutional investors, CHAPTER 3:and shareholder services

An institutional investor’s viewpoint on corporate governance 3A Glenn H. Booraem, Principal and Fund Controller Vanguard

nstitutional investors comprise a large, growing, and diverse group of shareowners ranging from, at one end of the spectrum, Iactivist 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.

NYSE: Corporate Governance Guide 13 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

14 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 15 An institutional investor’s viewpoint on corporate governance Vanguard

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.

16 NYSE: Corporate Governance Guide Vanguard An institutional investor’s viewpoint on corporate governance

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

NYSE: Corporate Governance Guide 17 An institutional investor’s viewpoint on corporate governance Vanguard

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—

18 NYSE: Corporate Governance Guide Vanguard An institutional investor’s viewpoint on corporate governance

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

NYSE: Corporate Governance Guide 19 The evolution of active ownership

3BMartha Carter, Head of Global Research, and Patrick McGurn, Executive Director and Special Counsel ISS

nstitutional investors have spent the past three decades developing new ways to monitor and manage their portfolio Irisks 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-

20 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 21 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

22 NYSE: Corporate Governance Guide ISS The evolution of active ownership

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,

NYSE: Corporate Governance Guide 23 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

24 NYSE: Corporate Governance Guide ISS The evolution of active ownership

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.

NYSE: Corporate Governance Guide 25 Corporate governance: perspectives from a credit ratings agency 3CChristian A. Plath, Vice President, Senior Analyst, and Corporate Governance Specialist Moody’s Investors Service

n considering corporate governance in credit analysis, Moody’s is confronting two primary questions. First, what aspects of Icorporate 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

26 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 27 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

28 NYSE: Corporate Governance Guide Moody’s Investors Service Corporate governance: perspectives from a credit ratings agency

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

NYSE: Corporate Governance Guide 29 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

30 NYSE: Corporate Governance Guide Moody’s Investors Service Corporate governance: perspectives from a credit ratings agency

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.

NYSE: Corporate Governance Guide 31 Engaging with investors on corporate governance 4 Kenneth A. Bertsch, Partner, and Robert E. Zivnuska, Principal CamberView Partners

here is no question that US public company executives are engaging institutional investors on governance and related Tmatters 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

32 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 33 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

34 NYSE: Corporate Governance Guide CamberView Partners Engaging with investors on corporate governance

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.

NYSE: Corporate Governance Guide 35 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

36 NYSE: Corporate Governance Guide CamberView Partners Engaging with investors on corporate governance

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

NYSE: Corporate Governance Guide 37 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

ver the last several years, US public companies have begun to spend more time both preparing for possible advances from Oactivist 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

38 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 39 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

40 NYSE: Corporate Governance Guide 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,

NYSE: Corporate Governance Guide 41 Fostering a long-term perspective: using strategic simulations to 6 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

ommercial institutions face an unpredictable world with challenges ranging from bottom-line management, to insider Cthreats, 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

42 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 43 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

44 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 45 CHAPTER 7:Selections from Corporate Board Member What directors think: a Corporate Board Member/ 7A Spencer Stuart survey Deborah Scally, Editor and Director of Research, and Kimberly Crowe, Managing Editor NYSE Governance Services

hat kind of board does your company need to maintain a competitive edge? Industry and leadership experience Ware 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

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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

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Figure 1 board to be self-reflective and allow for 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 tenure. Just over half (53 percent) of 16% directors reported that their boards employ IMPORTANT a mandatory retirement age. In addition, 39 percent said their boards require a mandatory resignation submission in the 51% event of a personal reputational event, SOMEWHAT IMPORTANT such as a bankruptcy or arrest, and 28 percent require a mandatory resignation if a director fails to garner a majority vote. 26% However, fully half of those surveyed said NOT VERY IMPORTANT the latter is not required nor needed, which may indicate a preference by directors to 6% 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

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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

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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- Figure 2 looking strategy and vision and manage key risks.”

WHICH ARE Julie Hembrock Daum 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 BOARD EVALUATION and 2012. While there was a 16 percent uptick in the number of new independent directors elected to S&P 500 boards during the 2013 proxy year (339 directors), boards 85% continue to wrestle with the question of AGE CEILING how to promote ongoing board renewal,” Daum says. “In our experience, making board composition and performance an 49% annual topic of board discussion is a good TERM LIMITS approach to ensuring the board has the right expertise and skills as the economic 25% and competitive landscape changes.” In analyzing the methods used by boards to encourage healthy turnover, 85 percent of directors surveyed said board

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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

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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 and effectiveness. While a good relationship 18% must exist between the board and senior NO management to run a successful company, there must also exist a healthy separation for good decision-making at the board level. Kasnet’s company has a separate 82% 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

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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, we asked for opinions about the new SEC 21% disclosure of CEO/median employee NO pay ratios: 70 percent worry that such disclosure will result in a misleading 17% indicator, while nearly half believe it IT WASN’T OUT OF ALIGNMENT will be costly and difficult to accurately compile and report. Only 17 percent of TO BEGIN WITH those surveyed believe it will provide meaningful information to investors. One director echoed the comments of several 62% others, saying, “Regulators (SEC, PCAOB, Dodd-Frank, etc.) are out of control with

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Figure 5 oversee risk across the enterprise. As a 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 be helpful, while 29 percent said more lead time to digest those reports would 44% be appreciated. However, some directors BETTER UNDERSTANDING OF obviously feel overwhelmed and find the HOW TO OVERSEE RISK process burdensome and a distraction. As one director put it, there is “too much ritual risk management and too little emphasis on 39% generating shareholder value.” A SEPARATE RISK COMMITTEE Meanwhile, 33 percent said the ability to delegate risk to a separate committee 33% that could keep closer tabs would be MORE TIME TO DIGEST REPORTS advantageous. Others, however, don’t agree with this approach. “Risk oversight should 29% rest with the full board,” says Bagalay. MORE DETAIL IN REPORTS “Every board member should understand and accept that corporate risk oversight 11% 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

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Figure 6 “Our board has put a strong focus on 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 STRATEGIC PLANNING response, followed by M&A opportunities (61 percent), succession (47 percent), global business strategy (42 percent), and 81% IT strategy (38 percent) (Figure 6). One M&A director who commented on the survey noted, “Boards need more experience from members who have private equity or other 61% 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.” GLOBAL STRATEGY “There is no question in my mind that boards have gotten significantly more 42% effective at performing their duties over the IT STRATEGY last 10 years, even though we still see some 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

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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.

56 NYSE: Corporate Governance Guide Growing goodness, Annie’s way

7B Deborah Scally, Editor and Director of Research NYSE Governance Services

or investors who nabbed the offering of 950,000 shares of common stock at $19 a share in March 2012, Annie’s has Fcertainly 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

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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

58 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 59 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.)

60 NYSE: Corporate Governance Guide How sweet it is! One-on-one with Jim Nevels 7C Deborah Scally, Editor and Director of Research NYSE Governance Services

escribing his role at The Hershey Company as the “first among equals,” Chairman Jim Nevels has a lot to smile Dabout 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,

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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.

62 NYSE: Corporate Governance Guide 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.

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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

64 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 65 A new frontier: one-on-one with Maggie Wilderotter 7D Deborah Scally, Editor and Director of Research NYSE Governance Services

aggie Wilderotter, chairman and CEO of Frontier Communications Corp., has a full agenda for 2012. To Mstart, 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

66 NYSE: Corporate Governance Guide 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

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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?

68 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 69 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.)

70 NYSE: Corporate Governance Guide Part II The composition and structure of the board

Electronic version of this guide available at: nyse.com/cgguide Building a balanced board

8 Julie Hembrock Daum, North American Leader, Board Practice Spencer Stuart

key function of a corporate board of directors is to shape and guide its company’s strategy over the long term and A 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.

72 nYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 73 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

74 nYSE: Corporate Governance Guide Spencer Stuart Building a balanced board

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,

NYSE: Corporate Governance Guide 75 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

76 nYSE: Corporate Governance Guide Spencer Stuart Building a balanced board

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.

NYSE: Corporate Governance Guide 77 Corporate governance update: renewed focus on 9 corporate director tenure David A. Katz, Partner, and Laura A. McIntosh, Consulting Attorney Wachtell, Lipton, Rosen & Katz

he issue of director tenure recently has garnered significant attention both in the US and abroad. US public companies Tgenerally 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

78 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 79 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

80 NYSE: Corporate Governance Guide Wachtell, Lipton, Rosen & Katz Corporate governance update: renewed focus on corporate director tenure

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

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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

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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 their business judgment to act in an informed See, eg, Judy Canavan et al., “Board tenure: 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 The views expressed are the authors’ and See Raymond K. Van Ness et al., “Board of 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 Notes Tenure and Firm Performance,” July 2013 Draft, 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 of the Group and shareholders.”), available at 4 See Spencer Stuart Board Index 2013, at 15. One 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. theglobeandmail.com/report-on-business/ 7 See Carol Hymowitz and Jeff Green, “Corporate 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. org.uk/Our-Work/Codes-Standards/Corporate- 9 See, eg, Kimberly Gladman and Michelle Lamb, governance/UK-Corporate-Governance-Code.aspx. “Director Tenure and Gender Diversity in the United

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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- best/ar/pr. 22 HKEx Corporate Governance Code and 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 (updated per HKEx Consultation Conclusions on See Huang, supra note 14. The study examined 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 on Universal Proxy and Board Tenure,” 24 Afep-Medef Code, Corporate Governance 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 A. Katz and Sabastian V. Niles, “ISS QuickScore 28 See Kelly, supra note 25. 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 and David A. Katz et al., “ISS QuickScore 2.0,” 31 See Greg Berberich and Flora Niu, “Director 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 Directors Be Effective Monitors? – Evidence Id. at 37. 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/.

84 NYSE: Corporate Governance Guide Conducting effective board and director evaluations 10 Susan Ellen Wolf, Founder and CEO Global Governance Consulting LLC

igh-performing boards typically conducted periodic self- evaluations as a method of driving continuous improvement Hlong 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

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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?

86 NYSE: Corporate Governance Guide 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

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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.

88 NYSE: Corporate Governance Guide 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

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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.

90 NYSE: Corporate Governance Guide Effectively structuring board committees 11 Susan Ellen Wolf, Founder and CEO Global Governance Consulting LLC

ffectively structuring board committees is an important foundation for building and maintaining a strong board. ECommittees 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

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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.

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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

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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.

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Table 1 Examples of charter requirement descriptions and annotations­—continued Charter When and Comments Requirement How Satisfied 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.

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Table 1 Examples of charter requirement descriptions and annotations­—continued Charter When and Comments Requirement How Satisfied 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

96 NYSE: Corporate Governance Guide Managing information flows among board and management Robert12 B. Lamm, Co-Chair Securities and Corporate Governance Practice, Gunster, Yoakley & Stewart, P.A. (Fort Lauderdale, FL)

nformation is the lifeblood of the board. While non-executive directors should seek out current, complete, and accurate Iinformation 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

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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

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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

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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

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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.

NYSE: Corporate Governance Guide 101 Recruiting and onboarding directors

13 Julie Hembrock Daum, North American Leader, Board Practice Spencer Stuart

he composition of the board is critical to the health and effectiveness of every listed company. The ideal board Tcomprises 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

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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

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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

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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

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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

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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.

NYSE: Corporate Governance Guide 107 Should I serve as a member of the board of directors of 14 a newly public company? Jeff Vetter, Partner, and James Evans, Partner Fenwick and West LLP

n recent years, there has been a significant increase in the number of companies conducting initial public offerings in the IUS, 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?

108 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 109 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.

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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

NYSE: Corporate Governance Guide 111 Should I serve as a member of the board of directors of a newly public company? Fenwick and West LLP

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

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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.

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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

114 NYSE: Corporate Governance Guide Fenwick and West LLP Should I serve as a member of the board of directors of a newly public company?

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.

NYSE: Corporate Governance Guide 115 Should I serve as a member of the board of directors of a newly public company? Fenwick and West LLP

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.

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Electronic version of this guide available at: nyse.com/cgguide Succession planning: strategies for building the pipeline Cathy Anterasian,15 North American Leader, CEO Succession Services, and Dayton Ogden, Global Leader, CEO Succession Services Spencer Stuart

t any company, one of the most important responsibilities of the board and of the CEO is ensuring an uninterrupted Aflow 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.

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• 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

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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

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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

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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:

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• 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.

NYSE: Corporate Governance Guide 123 Communications strategies

16 Matthew Sherman, President and Partner Joele Frank

oards of directors and management teams are now routinely challenged—both privately and publicly—by investors, sell- Bside 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

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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

NYSE: Corporate Governance Guide 125 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:

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• 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.

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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

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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.

NYSE: Corporate Governance Guide 129 Reputation, analytics, and corporate strategy 17 Chris Foster, Vice President, and Jason Kemp, Principal Booz Allen Hamilton

e live in a world of increasing transparency and high- velocity communications. Information not only travels Wfaster, 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

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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

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(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

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132 NYSE: Corporate Governance Guide Booz Allen Hamilton Reputation, analytics, and corporate strategy

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 Data historically-based predictions on Drives 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.

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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

134 NYSE: Corporate Governance Guide Booz Allen Hamilton Reputation, analytics, and corporate strategy

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.

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Managing technological change

18 Jim Newfrock, Vice President, and Samitha Amarasiri, Principal Booz Allen Hamilton

echnology is a powerful force enabling efficient corporate enterprise growth when properly employed. The pace of T“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

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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

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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

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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

140 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 141 Capital structure, leverage, and capital allocation1 19Ajay 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

ffective financial strategy involves taking a comprehensive view of capital structure, funding liquidity, risk management, Ecapital 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).

142 NYSE: Corporate Governance Guide Citi Corporate and Investment Banking Capital structure, leverage, and capital allocation

Figure 1 Dramatic rise in financing costs post-2008 25 A BBB 20 BB B 15

10

5 Spread Over Treasury (%) Treasury Spread Over 0 2003 2004 2005 2006 2007 2008 2009 20102011 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.)

NYSE: Corporate Governance Guide 143 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% 400 12.5% 11.6% 300

7.2% 200 6.3% 4.6% 100 2.8% 2.4% Number of Companies 2.2%

0 00-1 1-2 2-3 3-4 4-5 5-6 6-7 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 20.6% 800 700 600 500 11.4% 400 8.2% 8.6% 8.0% 7.3% 7.4% 300 6.5% 6.3% 200 3.7% 4.1% 2.0% 3.1% 100 0.8% 1.4% 0.3% 0.1% 0 Number of S&P Rated Companies AAA AA+ AA AA- A+ AA- BBB+ BBBBBB- BB+ BB BB-B+B B- CCC+ and Below Source: S&P Ratings Direct (Industrials).

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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

1999 2001 2003 2005 2007 2009 2011 2013 1999 2001 2003 2005 2007 2009 2011 2013 Source: Bloomberg.

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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

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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

NYSE: Corporate Governance Guide 147 How to win the say-on-pay vote

20 Don Kokoskie, Partner, and Christine Oberholzer Skizas, Partner Pay Governance LLC

or most companies, the say-on-pay vote is an annual rite of spring just like baseball’s opening day. Like all competitors, Fcompany 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).

148 NYSE: Corporate Governance Guide 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.

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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%

150 NYSE: Corporate Governance Guide Pay Governance LLC How to win the say-on-pay vote

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

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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

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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

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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.

154 NYSE: Corporate Governance Guide Board of director compensation: evolution and aligning design 21 with shareholders Stephen J. Pakela, Managing Partner, and John R. Sinkular, Partner Pay Governance LLC

ver the past 15 years, the methods of compensating nonemployee directors have changed in tandem with the Orisk 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:

NYSE: Corporate Governance Guide 155 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

156 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 157 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

158 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 159 Principles for effective 22 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

he operating environment at many companies today is in a state of constant flux as a result of new regulations and Tincreased 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.

160 NYSE: Corporate Governance Guide 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 non- management 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

NYSE: Corporate Governance Guide 161 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.

162 NYSE: Corporate Governance Guide KPMG LLP Principles for effective enterprise risk management

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

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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

164 NYSE: Corporate Governance Guide KPMG LLP Principles for effective enterprise risk management

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.

NYSE: Corporate Governance Guide 165 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

he challenges faced by companies have never been greater, from the rapid pace of change in technology to the impact of Tglobalization 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.

166 NYSE: Corporate Governance Guide 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

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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/

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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.

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• 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

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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

NYSE: Corporate Governance Guide 171 Best practices in code of 24 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 n effective ethics and compliance program must establish standards of ethical conduct, as well as procedures to Aprevent 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

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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.

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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

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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

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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,

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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,

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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.

178 NYSE: Corporate Governance Guide 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

n April 24, 2013, Rana Plaza, an eight-story garment factory in Dhaka, Bangladesh, collapsed. Thousands were killed Oor 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

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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

180 NYSE: Corporate Governance Guide 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.

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 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

182 NYSE: Corporate Governance Guide 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 Feedback Loop Narrative The master narrative and subnarratives 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.

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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.

184 NYSE: Corporate Governance Guide Crisis communications in the age of permanent engagement 26 Richard S. Levick, Chairman and CEO LEVICK

he diverse crises that continue to confront just about every industry sector of the global economy did not begin with Tthe 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

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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.

186 NYSE: Corporate Governance Guide 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.

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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

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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.

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• 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

190 NYSE: Corporate Governance Guide The importance of effective 27 board oversight Erica Salmon Byrne, Executive Vice President, Compliance & Governance Solutions, and Eric Morehead, Senior Compliance Counsel NYSE Governance Services

uring the last two decades, the role that directors play with respect to oversight of an organization’s ethics and compliance Dprogram 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.

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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 Delaware corporate law to liability. 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

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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

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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

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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

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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

196 NYSE: Corporate Governance Guide FCPA and compliance: a board and senior management perspective 28 Ralph M. Levene, Partner, and David Gruenstein, Partner Wachtell, Lipton, Rosen & Katz

n today’s post–financial crisis enforcement environment, companies devote greater effort and resources than in the past Ito 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,

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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

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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

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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).

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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

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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 governmental touch points discussed above. 188 A.2d at 130. Due diligence should specifically focus on 3 698 A.2d 959 (Del. Ch. 1996).

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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 United States v. Kay corruption compliance program would take into Eg, , 513 F.3d 432, 447-48 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. 27 13 Id. §§ 78dd-1(a); 78dd-2(a). Compare eg, Press Release, SEC, SEC Announces Non-Prosecution Agreement with 14 Id. §§ 78dd-1(a)(1)(B)-(a)(2)(B); 78dd-2(a)(1)(B)- 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/ opa/pr/2010/November/10-crm-1251.html. 21 Id. §§ 78dd-1(c)(1); 78dd-2(c)(1); 78dd-3(c)(1). See, eg, United States v. Kozeny, 582 F. Supp. 2d 535

NYSE: Corporate Governance Guide 203 Handling regulatory inquiries, investigations, and settlements 29 Michael Trager, Senior Partner; John Freedman, Partner; and Joshua Martin, Partner Arnold & Porter LLP

e live in an era of heightened regulatory scrutiny of public companies. As Mary Jo White, the chair of the US WSecurities 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

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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

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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:

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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 Practice Pointer Information Act (FOIA). See, for example, 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.

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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)

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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 Taking appropriate proactive steps at testimony. 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).

NYSE: Corporate Governance Guide 209 Handling regulatory inquiries, investigations, and settlements Arnold & Porter LLP

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 Practice Pointer consequences, and does not require court 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

210 NYSE: Corporate Governance Guide Arnold & Porter LLP Handling regulatory inquiries, investigations, and settlements

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 Practice Pointer to penalties paid as part of the settlement. 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).

NYSE: Corporate Governance Guide 211 Sarbanes-Oxley/internal control

30 Neal Bradsher, Partner; Aaron Sage, Director; and Alicia Seaton, Director KPMG LLP

he Public Company Accounting Reform and Investor Protection Act of 2002 (also known as the Sarbanes-Oxley Act, or SOX) Twas 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.

212 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 213 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.

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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.

NYSE: Corporate Governance Guide 215 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-

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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.

NYSE: Corporate Governance Guide 217 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

xecutive leadership has a fiduciary responsibility to ensure the organization builds and maintains a cybersecurity Eprogram 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.

218 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 219 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

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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

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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,

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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.

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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.

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32 Ed Batts, Partner DLA Piper

ybersecurity has engulfed many risk managers lately because of the ubiquitous and transformative nature of the threat. CEvery 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

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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

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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.

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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

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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?

NYSE: Corporate Governance Guide 229 Navigating the opportunities and pitfalls of social media channels 33 Kayla Hamberg, Senior Associate Sard Verbinnen & Co

uccessful public companies cannot afford to ignore social media’s outsized influence in today’s world. With 73 percent Sof 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

230 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 231 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.

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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

NYSE: Corporate Governance Guide 233 Navigating the opportunities and pitfalls of social media channels Sard Verbinnen & Co

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

234 NYSE: Corporate Governance Guide Sard Verbinnen & Co Navigating the opportunities and pitfalls of social media channels

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

NYSE: Corporate Governance Guide 235 Navigating the opportunities and pitfalls of social media channels Sard Verbinnen & Co

Figure 1 Volume of mentions 800,000 700,000 600,000 500,000 400,000

Mentions 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.

236 NYSE: Corporate Governance Guide Part IV Shareholder activism

Electronic version of this guide available at: nyse.com/cgguide Key strategies of activist investors

Ajay Khorana,34 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

hareholder activism has morphed from an occasional threat facing corporate management and boards to a sweeping Strend 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

238 NYSE: Corporate Governance Guide Citi Corporate and Investment Banking Key strategies of activist investors

Figure 1 Trends in global Traditional institutional investors are also 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 259 in the US and UK, these investors have also begun to vote more frequently against 35 204 204 management. This has allowed activist investors to pursue firms where it would 28 30 161 169 otherwise be difficult for a single activist 22 30 investor to gain influence without the 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 for targeting, we conducted an analysis of Spain United Kingdom 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 10% 2013. The findings and methodologies are 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.

NYSE: Corporate Governance Guide 239 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

Maximize Value Change Executive OperationalChanges Management Shareholder Board Related DistributionAlternativesInfluence M&A Amend Bylaws Sale of CompanyIncrease CapitalReview Strategic Monetize Assets Compensation 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

10

Frequency (%) Frequency 5

0

0 to 10 -10 to 0 10 to 20 20 to 30 30 to 40 40 to 50 -50 to -40 -40 to -30 -30 to -20 -20 to -10 Excess Return Six Months Prior to Campaign Announcement (%) Source: SharkRepellent and FactSet.

240 NYSE: Corporate Governance Guide Citi Corporate and Investment Banking Key strategies of activist investors

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.

NYSE: Corporate Governance Guide 241 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 Source: SharkRepellent, ISS, and FactSet.

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.)

242 NYSE: Corporate Governance Guide Citi Corporate and Investment Banking Key strategies of activist investors

Figure 6 Activists are also targeting multi-segment firms Fraction (%) of Global Campaigns Where Target has Multiple Business Segments

52.0 50.0

36.9 37.2 34.6 35.5 31.7 34.8

2006 2007 2008 2009 2010 2011 2012 2013 Source: SharkRepellent, ISS, and FactSet.

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 assertive shareholder base. Continuously 2 “Hedge Fund Activism in Europe,” European engaging with investors, carefully Corporate Governance Institute, Marco Becht, Julian Franks, and Jeremy Grant, 2010.

NYSE: Corporate Governance Guide 243 Advance preparedness—dealing with activist hedge funds 35Martin Lipton, Partner, and Sabastian V. Niles, Activism Governance and M&A Counsel Wachtell, Lipton, Rosen & Katz

his year has seen a continuance of the high and increasing level of activist campaigns experienced during the last T14 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

244 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 245 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.

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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

NYSE: Corporate Governance Guide 247 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.

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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

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Shareholder proposals: recent trends and developments 36 Paul Schulman, Executive Vice President MacKenzie Partners, Inc.

ecurities and Exchange Commission (SEC) Rule 14a-8 (the Rule) governs the procedures for a shareholder to submit Sa 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

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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.

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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

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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.

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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

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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

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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

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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.

258 NYSE: Corporate Governance Guide Engaging with proxy advisory services 37 Kenneth A. Bertsch, Partner CamberView Partners

n 2015, Institutional Shareholder Services (ISS) celebrates its 30th anniversary. Since the founding of ISS, proxy advisory Ifirms (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

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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.

260 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 261 Engaging with proxy advisory services CamberView Partners

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

262 NYSE: Corporate Governance Guide 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.

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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/

264 NYSE: Corporate Governance Guide Tools for knowing your stockholder base 38 Arthur B. Crozier, Chairman Innisfree M&A Incorporated

n recent years it has become increasingly important for publicly- traded companies to have detailed, current information about Iwho 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.

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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

266 NYSE: Corporate Governance Guide 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

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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

268 NYSE: Corporate Governance Guide 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.

NYSE: Corporate Governance Guide 269 Understanding/messaging with institutional investors 39 Leigh Parrish, Senior Managing Director, and Steven Balet, Managing Director FTI Consulting

ngagement with the investment community has transformed remarkably over the past several years. A significant Ereason 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.

270 NYSE: Corporate Governance Guide 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

NYSE: Corporate Governance Guide 271 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

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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

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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.

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Electronic version of this guide available at: nyse.com/cgguide

NORTH AMERICA CanadaAndrew J. MacDougall, Partner; Elizabeth Walker, Partner; and Robert Yalden, Partner Osler, Hoskin & Harcourt LLP

orporate governance in Canada is founded on a system of legal rules that involve a single-tier board model similar to, Cand 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

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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.

NYSE: Corporate Governance Guide 279 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

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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.

NYSE: Corporate Governance Guide 281 Mexico Carlos Creel, Senior Partner, and Javier Soní, Senior Associate Creel Abogados, S.C.

exico’s legal framework underwent a substantial revision in the last couple of years. Amendments to the Mexican MConstitution 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

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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

NYSE: Corporate Governance Guide 283 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

284 NYSE: Corporate Governance Guide LATIN AMERICA Brazil Henrique Lang, Partner Pinheiro Neto Advogados

orporate governance standards and practices have improved in Brazil over the last decade, along with the initial public Coffering 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

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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

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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.

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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.

NYSE: Corporate Governance Guide 289 EUROPEAN UNION France Didier Martin, Senior Partner Bredin Prat

rance has a relatively non-interventionist stance in respect of corporate governance, which allows listed companies to take Fa 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

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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

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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’

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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.

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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.

NYSE: Corporate Governance Guide 295 Germany Wolfgang Grobecker, Partner, and Bernd Graßl, Partner P+P Pöllath + Partners

n Germany, listed stock corporations (Aktiengesellschaften) traditionally have a two-tier board system, consisting of the Imanagement 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,

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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

NYSE: Corporate Governance Guide 297 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

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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

NYSE: Corporate Governance Guide 299 Italy Carlo Croff, Partner, and Enrico Giordano, Partner Chiomenti

he key corporate governance provisions for Italian listed Tcompanies 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).

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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.

NYSE: Corporate Governance Guide 301 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

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• 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.

NYSE: Corporate Governance Guide 303 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.

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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.

NYSE: Corporate Governance Guide 305 Spain Carlos Paredes, Partner Uría Menéndez

orporate governance of listed companies in Spain is primarily regulated by corporate legislation, which is mainly composed Cof 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

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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

NYSE: Corporate Governance Guide 307 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,

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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.

NYSE: Corporate Governance Guide 309 United KingdomGareth Roberts, Partner Herbert Smith Freehills LLP

n the United Kingdom, in common with many other developed markets, there has, since the events of 2008, been a heavy focus Ion 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

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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

NYSE: Corporate Governance Guide 311 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

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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.

NYSE: Corporate Governance Guide 313 ASIA PACIFIC AustraliaDavid Friedlander, Partner; Medard Fischer, Senior Associate; and Anna Chen, Solicitor King & Wood Mallesons

s in other jurisdictions, a combination of challenging business conditions and heightened scrutiny, by both regulators and Ashareholders, 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.

NYSE: Corporate Governance Guide 315 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

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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

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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.

318 NYSE: Corporate Governance Guide Hong Kong Alexander Que, Partner, and Yuki Wong, Professional Support Lawyer Deacons

orporate governance in Hong Kong is regulated by a well- established legal and regulatory framework comprising Ccommon 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.

NYSE: Corporate Governance Guide 319 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

320 NYSE: Corporate Governance Guide 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,

NYSE: Corporate Governance Guide 321 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.

322 NYSE: Corporate Governance Guide Japan Hiroki Kodate, Partner, and Keita Tokura, Partner Anderson Mori & Tomotsune

he amended Companies Act, which was enacted on June 27, 2014 and is expected to come into effect in April or May T2015, 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.

NYSE: Corporate Governance Guide 323 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

324 NYSE: Corporate Governance Guide 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-

NYSE: Corporate Governance Guide 325 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

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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.

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Contributor profiles

Electronic version of this guide available at: nyse.com/cgguide

NYSE: Corporate Governance Guide Contributor Profiles

NYSE: Corporate Governance Guide

Contributor profiles

NYSE Governance Services Erica Salmon Byrne 2355 E. Camelback Road Executive Vice President, Compliance & Suite 700 Governance Solutions Phoenix, Arizona 85016 Email [email protected] 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 [email protected] 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 [email protected] 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

NYSE: Corporate Governance Guide 331 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 [email protected] for the Mortgage Bankers Association of Mr. Tokura is a partner at Anderson Mori America in Washington, D.C. & Tomotsune with extensive experience Beth Van Derslice in corporate governance, mergers and acquisitions (public, private, domestic, Compliance Counsel and cross-border), and related financial Email [email protected] 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 John Freedman related intellectual property issues. Partner, Washington, D.C. Email [email protected] 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 [email protected] 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 [email protected] 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

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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 [email protected] Email [email protected] 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

NYSE: Corporate Governance Guide 333 Contributor Profiles NYSE: Corporate Governance Guide

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 [email protected] 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 [email protected] 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 [email protected] 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

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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 [email protected] 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 [email protected] 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 [email protected] 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

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security organizations ASIS, ISACA, and ISSA. Bredin Prat In addition, Mr. Newfrock participated as 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 [email protected] 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 [email protected] 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.

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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, Kenneth A. Bertsch clients, and regulators; and supporting global corporate governance efforts. Rob Partner also engaged in an extensive outreach effort Email [email protected] 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 [email protected] Robert E. Zivnuska Carlo Croff joined Chiomenti in 1984 and became a partner in 1989. He has been a Principal senior partner since 2009. He previously Email [email protected] 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

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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 [email protected] 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 [email protected] 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 [email protected] of Atlanta.

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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 [email protected] 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 Anil Shivdasani team within Citi’s Corporate and Investment 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 [email protected] 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 [email protected] 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.

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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 [email protected] 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 [email protected] 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 [email protected] 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

340 NYSE: Corporate Governance Guide NYSE: Corporate Governance Guide Contributor Profiles

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 [email protected] 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 [email protected] 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 [email protected] 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 [email protected] 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

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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 [email protected] Jeff Vetter Steven Balet is a managing director in the Partner FTI Consulting Strategic Communications Email [email protected] 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

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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 [email protected] 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 [email protected] 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

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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 [email protected] 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 [email protected] 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

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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 [email protected] 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 [email protected] 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

NYSE: Corporate Governance Guide 345 Contributor Profiles NYSE: Corporate Governance Guide

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 [email protected] Email [email protected] 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 [email protected] 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 [email protected] 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

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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 [email protected] 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 [email protected] 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 Susan M. Angele Risk Consulting, Governance Risk, and Compliance (GRC), Enterprise Risk Senior Advisor, Thought Leadership, Management (ERM), Business Process Review, KPMG’s Audit Committee Institute Internal Audit Services, and Regulatory Email [email protected] 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 [email protected] 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

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of ERM methodologies at KPMG. She has Eric J. Parker delivered ERM services to more than 20 Director, Chicago companies across various industries. Email [email protected] Angela J. Hoon Mr. Parker is a director in KPMG’s Chicago office. He has more than 14 years of ERM, Principal, Philadelphia GRC, IT advisory, and audit experience. Email [email protected] 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 [email protected] Vishal Mehta Mr. Sage is a Director in KPMG’s Internal Director, New York Audit, Risk, & Compliance Services (IARCS) Email [email protected] 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 [email protected] Deon J. Minnaar Ms. Seaton is an Internal Audit Risk and Compliance Services director in the firm’s Americas Leader ERM and GRC Dallas office where she has extensive Email [email protected] 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).

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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 [email protected] 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 [email protected] 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 [email protected] 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 [email protected] 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

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rating committees across Moody’s various Elizabeth Walker sector teams, training Moody’s analysts on Partner, Ottawa corporate governance issues, and external Email [email protected] 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 [email protected] 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 Andrew J. MacDougall management in connection with a wide range of corporate governance and M&A Partner, Toronto mandates. He was part of the Osler team that Email [email protected] 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.

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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 [email protected] Attorney-at-Law, Partner Mr. Kokoskie is a partner in the Cleveland Email [email protected] 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 [email protected] 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 [email protected] 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 [email protected] 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

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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 Thomas A. Campbell accounting. Partner John R. Sinkular Email [email protected] Partner, Detroit Tom Campbell is the leader of Pillsbury Email [email protected] 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.

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Nicholas M. Krohn delicate relationship with their respective Associate government authorities. Ms. Nara also Email [email protected] 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 [email protected] 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 [email protected] 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

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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 [email protected] Henrique Lang Since 2010, Ms. Hamberg has worked for Partner Sard Verbinnen & Co as a junior associate, Email [email protected] 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.

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A recognized expert on governance topics, Ms. Daum helped found and develop the Spencer Stuart Wharton School’s Corporate Governance: 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 [email protected] Global Leader, CEO Succession Services Ms. Anterasian leads CEO Succession Email [email protected] 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 [email protected] 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.

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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 [email protected] 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 [email protected] 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 [email protected] 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 [email protected] 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/

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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 [email protected] 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 [email protected] 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 [email protected] 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 [email protected] 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

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(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 [email protected] 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 Laura A. McIntosh advises worldwide and across industries, including technology, financial institutions, Consulting Attorney media, energy and natural resources, health Email [email protected] 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 [email protected] 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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