This article first appeared in the August 2004 issue of The Technology Times, a publication of The Eastern Technology Council. It is reprinted here with permission.
The high profile failures of Enron, WorldCom, Tyco and other “blue chip” companies have resulted in intense scrutiny of corporate directors and the process of selecting them. While the scope of the fraud in these cases is shocking, at the heart of each situation is a failure of the board to provide oversight of and checks on company management. These failures led to the adoption of the Sarbanes-Oxley Act of 2002 (“SOX”) and new corporate governance standards for companies whose securities are listed on the New York Stock Exchange, NASDAQ and AMEX. SOX and the corporate governance requirements of the securities exchanges focus substantially on creating board independence and establishing board committees that have significant authority. Following these standards alone, though, will not necessarily insure that a board is best suited to protect and advance the interests of shareholders.
New standards adopted
SOX, among other things, mandated that national securities exchanges adopt listing standards that require audit committees to be composed entirely of independent directors; that companies must disclose whether their audit committee contains a “financial expert” and that the audit committee have broad powers to appoint and manage the company’s independent auditors and other experts as well as establish accounting controls, whistle blower and other policies. Both NASDAQ’s and NYSE’s adopted standards include a requirement that the board have a majority of independent directors; that non-management directors meet at regularly scheduled executive sessions without management present; that companies have a nominating committee composed of independent directors (or in the case of NASDAQ listed companies that directors are selected by a majority of independent directors) and audit committees are composed of at least three independent directors all of whom, in the case of NYSE listed companies, and at least one of whom for NASDAQ listed companies, is “financially literate.”
In light of the focus on board member independence and the necessity of “financial literacy” it’s a challenge for shareholders, existing boards and management to select board members who meet these requirements and also are the best available candidates.
Boards need diverse skills
All potential director candidates should be analyzed with the particular characteristics of the company in mind. Factors such as the age, size and business of a company and a particular need for specific skill sets such as financial, regulatory or public relations expertise may make one candidate an excellent fit for one board and a bad fit for another. Typically smaller companies desire smaller boards with all directors taking an active role. Larger companies have larger boards that are comprised of committees with specific responsibilities. All boards (and the newly empowered committees) should have members with diverse experiences and skills.
While the rules on what constitutes independence are too complicated for this article, in selecting board members you should be careful about selecting people who are too independent or have no personal or business ties to other board members, especially in situations where there is a very strong CEO. There is great value in creating a board where the members know and trust each other as this often promotes a closeness that encourages open and honest dialogue. Consider strongly appointing former CEOs or other former senior executives of the company – they often make the best directors because of their intimate knowledge of the business.
Questions to ask yourself
In selecting a potential member you should perform complete and careful diligence on the candidate. The candidate should meet with the CEO, other Board members and key shareholders to determine whether there is a good fit and common goals. Ask yourself these questions in the evaluation process:
What skills and experience does this person have and are they different and complementary to existing board members?
Do they meet the independence, “financial literacy” or other requirements of SOX or any applicable securities exchange?
What is this person’s personal style and how will it fit with the personalities of the board and management?
Does this person have the time available to focus on the director job?
What are the reasons this person wants to serve: Is he or she interested in just collecting fees or does this person have a curiosity about the business?