MCI Corporate Governance final 8/26/03 3:48 PM Page 1 RESTORING TRUST Re p ort to The Hon. Jed S. Ra ko f f The United States District Court for the Southern District of New Yor k On Co r p orate Gover n a n c e for the Future of MCI Richard C.Br e e d e n Corporate Monitor August 2003 MCI Corporate Governance final 8/26/03 3:48 PM Page a Table of Contents Executive Summary 1 Introduction 8 SEC Proceedings and the U.S. District Court 9 Good Progress to Date 10 More to Be Done 13 Understanding the Problem 13 Failures of Governance 16 Abusive Compensation Practices 17 A Board That Followed Governance “Best Practices”? 20 How Could This Happen in One of America’s Largest Companies? 22 The Role of Regulation 24 Looking Forward 27 Part 1: The Board of Directors 30 Recommendation 1.01: Number of Members of the Board 32 Recommendation 1.02: Independence Requirements 33 Recommendation 1.03: Meetings and Commitment 34 Recommendation 1.04: Separate Independent Sessions 35 Recommendation 1.05: Special Board Meetings 36 Recommendation 1.06: Director Training and Retraining 36 Recommendation 1.07: Mandatory New Directors 37 Recommendation 1.08: Removal of Directors 38 Recommendation 1.09: Skill Base of Board of Directors 40 Recommendation 1.10: Standards of Independence 42 Recommendation 1.11: Change of Status 43 Recommendation 1.12: Limits on Board Memberships 44 Recommendation 1.13: Nominations of Directors 44 Part 2: Board Leadership and the Chairman of the Board 49 Recommendation 2.01: Non-Executive Chairman 51 Recommendation 2.02: Responsibilities of the Non-Executive Chairman 51 Recommendation 2.03: Term Limits and Performance Review 52 Recommendation 2.04: Resources 53 Recommendation 2.05: Qualifications 53 Recommendation 2.06: Nominations for Non-Executive Chairman 54 Recommendation 2.07: Compensation of Non-Executive Chairman 54 RESTORING TRUST MCI Corporate Governance final 8/26/03 3:48 PM Page b Table of Contents Part 3: Board Compensation 56 Recommendation 3.01: Board Retainer 56 Recommendation 3.02: Mandatory Stock Investment 57 Recommendation 3.03: Long-Term Stock Retention 57 Recommendation 3.04: Equity Grants 58 Recommendation 3.05: Advance Disclosure of Stock Transactions 58 Part 4: Ex e c u t i v e Compensation 60 Recommendation 4.01: Greater Reliance on Cash Compensation 63 Recommendation 4.02: Bar Against Retention Payments 64 Recommendation 4.03: Severance Programs 64 Recommendation 4.04: Shareholder Approval of Mega Awards 67 Recommendation 4.05: Limitation of Stock Options 69 Recommendation 4.06: Long-Term Equity Retention 69 Recommendation 4.07: Retention of Compensation Consultants 70 Recommendation 4.08: Mandatory Expensing of Options 71 Recommendation 4.09: Evergreen Contracts Prohibited 71 Part 5: The Audit Committee 74 Recommendation 5.01: Committee Membership 74 Recommendation 5.02: Experience Standards 74 Recommendation 5.03: Meeting Requirements 74 Recommendation 5.04: Leadership Rotation 75 Recommendation 5.05: Audit Committee Compensation 76 Recommendation 5.06: Limits/Independence 76 Recommendation 5.07: Use of Corporate Aircraft and Other Corporate Assets 77 Recommendation 5.08: Review of Related Party Transactions 77 Recommendation 5.09: Annual Review of CFO 78 Recommendation 5.10: Required Resources for Audit Committee 79 Recommendation 5.11: Training for Audit Committee Members 79 Recommendation 5.12: External Audit Oversight 80 Recommendation 5.13: Internal Audit 80 Recommendation 5.14: Disclosure Review 81 Recommendation 5.15: Mandatory Auditor Rotation 82 Part 6: The Governance Committee 84 Recommendation 6.01: Committee Membership 84 Recommendation 6.02: Charter/Duties 84 RESTORING TRUST MCI Corporate Governance final 8/26/03 3:48 PM Page c Table of Contents Recommendation 6.03: Number of Meetings 85 Recommendation 6.04: Shareholder Resolution Process 85 Recommendation 6.05: Disclosure Committee Oversight 86 Recommendation 6.06: Remuneration 86 Part 7: The Compensation Committee 88 Recommendation 7.01: Committee Membership 88 Recommendation 7.02: Meeting Requirements 88 Recommendation 7.03: Leadership Rotation 88 Recommendation 7.04: Compensation Committee Fees 89 Recommendation 7.05: Review of Related Party Transactions 89 Recommendation 7.06: Annual Review of Director of Human Resources 90 Recommendation 7.07: Required Resources for Compensation Committee 90 Recommendation 7.08: Training for Compensation Committee Members 91 Recommendation 7.09: External Compensation Oversight 91 Part 8: The Risk Management Committee 93 Recommendation 8.01: Risk Management Committee 93 Recommendation 8.02: Committee Membership 93 Recommendation 8.03: Charter/Duties 93 Recommendation 8.04: Number of Meetings 94 Recommendation 8.05: Remuneration 94 Part 9: General Corporate Issues 96 Recommendation 9.01: Cash Flow Reporting 97 Recommendation 9.02: Dividend Policies 97 Recommendation 9.03: Transparency Policies 99 Recommendation 9.04: Finance Department Staffing 100 Recommendation 9.05: Change in Control Issues 102 Part 10: Legal and Ethics Programs. 106 Recommendation 10.01: Ethics Office 109 Recommendation 10.02: Ethics Pledge 109 Recommendation 10.03: Legal Department 110 Recommendation 10.04: Ethics Programs 110 Recommendation 10.05: Diversity Issues 111 An n e x 113 RESTORING TRUST MCI Corporate Governance final 8/26/03 3:48 PM Page d EXECUTIVE SUMMARY RESTORING TRUST MCI Corporate Governance final 8/26/03 3:48 PM Page 1 Executive Summary “Power tends to corrupt, and absolute power corrupts absolutely.” Lord Acton, 1887 Restoring Trust is not just a study of corporate governance. It is also intended as a blueprint for action. The 78 recommendations in Restoring Trust were developed pur- suant to the terms of the Permanent Injunction (the “Permanent Injunction”) issued in November 2002 by the Hon. Jed S. Rakoff of the United States District Court for the Southern District of New York (the “Court”) in connection with the enforcement proceed- ing brought against WorldCom, Inc. (the “Company” or “WorldCom”) by the United States Securities and Exchange Commission (the “SEC”). The Permanent Injunction and subse- quent Orders of the Court required the development of recommendations intended to prevent any reoccurrence of the governance abuses that were instrumental in the collapse of WorldCom. In addition, the Company is required to implement all recommendations of the governance report unless it obtains leave of the Court not to implement a specific recom- mendation. Thus, Restoring Trust is a study, but it is also a plan of action for changes that will be put into place. The various investigations of WorldCom that have been published to date have examined how personnel at the Company committed what appears to be the largest accounting fraud in history. Those investigations also outline the governance practices that were followed during the tenure of former WorldCom CEO Bernard J. Ebbers (“Ebbers”). Among other things, the board of directors of the Company consistently ceded power over the direction of the Company to Ebbers. As CEO, Ebbers was allowed nearly imperial reign over the affairs of the Company, without the board of directors exercising any apparent restraint on his actions, even though he did not appear to possess the experience or training to be remote- ly qualified for his position. One cannot say that the checks and balances against excessive power within the old WorldCom didn’t work adequately. Rather, the sad fact is that there were no checks and balances. As with some other U.S. companies, the compensation practices of WorldCom allowed lav- ish compensation, far beyond any rational calculation of value added by senior executives such as Ebbers, the CFO Scott Sullivan (“Sullivan”), or the COO Ron Beaumont (“Beaumont”). Compensation abuse at WorldCom is most vividly symbolized by more than $400 million in “loans” from shareholders to Ebbers that were put in place initially by two 1 RESTORING TRUST MCI Corporate Governance final 8/26/03 3:48 PM Page 2 Executive Summary directors who were longtime associates of Ebbers. The loans, which are unlikely ever to be repaid (other than the value of some collateral seized and sold by the Company), represent- ed a nearly incredible action by a board that supposedly existed to represent shareholders, but in fact spent much of its time devising ways to enrich Ebbers. Other compensation practices were also an abuse of shareholder interests. Massive volumes of stock options were granted to Ebbers, Sullivan, Beaumont and other executives, repre- senting hundreds of millions of dollars in value at the time. The board also allowed Ebbers to pay $238 million in “retention” grants to favored executives and employees in 2000, without standards or supervision. Ebbers allocated these grants to whomever he wished, in whatever amounts. The retention program was in effect a giant compensation slush fund. When Ebbers was finally fired by the board (which did not yet know about the fraud that had been committed, but that did know the Company had massive levels of debt), the board awarded an ad hoc severance program that would possibly have given Ebbers and his wife cash payments during their lives of more than $50 million in cash. The package also gave Ebbers interest subsidies on his shareholder loans that appear to have been worth $30-40 million per year. Recommendations for Change Restoring Trust contains 78 individual recommendations. These cover the selection of directors, qualification, conflicts and independence standards for board members, the functioning of the board and its committees, establishment of the position of non-executive chairman, specific limits on compensation practices, equity compensation programs, accounting and disclosure issues, ethics and legal compliance programs and other areas. The individual recommendations reflect several broad themes. These include: 1. Establishment of a Governance Constitution for the Company. Under the recommendations of Restoring Trust the Articles of Incorporation are to be used as a Governance Constitution for the Company. Most of the governance standards of the Company are to be placed in the Articles, where they can only be changed with prior shareholder consent.