Boards & Governance

Launching a New Business Requires Something Special

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Innovation has long been critical to a company’s sustained success. Yet many companies fail to innovate meaningfully and consistently—and compensation programs may be partly to blame for many firms’ failures.

Seymour Burchman

In our experience, the compensation programs within larger corporations are typically not structured to appropriately reward entrepreneurial teams that are starting innovative ventures.  For example, metrics are often wrong, measurement periods are frequently too short, and the size of the rewards are rarely commensurate with the incremental value they create. We know of three executives who were instrumental in launching $100 million-plus businesses. Despite the huge incremental value all three created for their corporations, their compensation plans failed to adequately reward them for creating such explosive growth. Although they received large bonuses and public recognition, they and their teams received only a tiny fraction of the value that they created. Sadly, all three of these executives left their companies to work in smaller, more entrepreneurial firms.

Barry Sullivan

Well-considered special incentives can be helpful—even mission-critical—in launching new businesses. These incentives can be tailored to fit the specific facts, circumstances, and expectations for a new business much more naturally than the regular, ongoing incentive programs of the parent company.

These special incentive plans—designed to help launch new businesses—are generally guided by five key principles:

  1. Provide appropriate motivation and reward for a successful launch.
  2. Ensure a fair allocation of the value created between the new business team and the company.
  3. Reflect the “real” economics of the business. For example, business financials should include:
    • All costs of the new incentive plans;
    • Parent company overhead costs attributable to the new business, where feasible; and
    • All capital requirements of the new business.
  4. Deliver an appropriate risk and reward tradeoff for participants to provide upside opportunity beyond traditional caps (perhaps even allowing uncapped rewards), balanced with no incentive payout if the new business fails.
  5. Ensure an adequate time horizon to gauge business success or failure.

Such incentives have three key benefits:

  1. Greater ability to attract outside talent to new startups, which can carry significant career risk
  2. Improved likelihood of retaining key talent after a successful launch
  3. More incentive to advance the ideas for startups in the first place

One such approach is illustrated by the design of a new business compensation plan for a startup within an established direct marketing company. The plan was requested by the company’s board in response to a proposal by a group of managers who wanted to launch a new line of business. Importantly, the board wanted a compensation plan that provided significant upside to the entrepreneurial manager group, and, at the same time, protected the broader business. The final design had the following features:

  • To recognize the increased risk and to give the plan an entrepreneurial character, a risk premium was added to the compensation package that was also provided to company executives of a similar pay grade, and the long-term incentive opportunity was left uncapped. However, on the downside, if the launch was not successful, payouts were essentially limited to salary and a small short-term bonus.
  • Part of the compensation was paid along the way through a short-term bonus with payments based on the achievement of key financial and nonfinancial milestones that were critical to a successful launch. Given the difficulty in predicting the exact timing of things, incentive payments were milestone-based, rather than tied to finite time periods. But, all milestones had to be achieved within a three-year period – a negotiated test period, balancing expectations for the new business and the board’s risk tolerance. Additionally, milestone bonuses were back-end loaded, with no more than 50% of the total opportunity paid within the three-year launch window.
  • The bulk of the compensation was delivered through a long-term incentive that was specific to the business unit and was tied to the value created by the business unit over a seven-year period, less all costs incurred by the parent company including capital invested, corporate overhead attributable to business, and all compensation costs. Importantly, this approach ensured the incentive program was self-funded —an important protection for the board. Value was determined using a multiple of earnings derived from the parent’s historical financials.The upshot: the business had a promising start, but it faltered against latter-stage milestones and was shuttered in its first three years. The payout to the entrepreneurs was limited to salary and a single milestone-based bonus payment. Although there was a big upside opportunity, the company’s ultimate compensation exposure was very limited. Importantly, failure was not rewarded, as had been the case with prior plans.

 

Seymour Burchman  is a retired managing director at Semler Brossy. Burchman, who has been an executive compensation consultant for over 30 years, has consulted on executive pay and leadership performance for over 40 S&P 500 companies. He may be contacted at sburchman@semlerbrossy.com.

Barry Sullivan is a managing director at Semler Brossy.  Sullivan supports boards and management teams on issues of executive pay and company performance. He may be contacted at bsullivan@semlerbrossy.com. 

How to Win Over the Customer of the Future

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NACD and Marsh & McLennan Companies will host a Board Committee Forum on Strategy and Risk at the upcoming 2017 Global Board Leaders’ Summit. This forum will explore converging risk and strategy issues facing boards as companies respond to digitization and artificial intelligence.

John Marshall

Business and society at large are in the midst of a remarkable change not seen since the Industrial Revolution. Boards and the C-Suite must understand the fundamental scope and impact of the changes to guide their organization through the next ten years.

There are two ways companies can view this change. From one perspective, it’s time to play defense. Automation is expected to rapidly erode job security for entire categories of workers. Increasing transparency will melt away the ties that bind together vertically integrated businesses. Scale-driven manufacturers will see 3D printing create decentralized and fragmented production, making many traditional factories obsolete. Virtually no conventional business will be spared by this exponentially accelerating change.

But there’s another perspective—and a wholly optimistic one. Just as there has never been this degree of change, there has never been this degree of possibility for innovation. But what will it take to win customers in this new world of extreme connectivity and automation?

To answer this question, Lippincott has worked extensively across industries to predict the changes ahead. The six fundamental shifts below offer a picture of the customer of the future and the world for which companies need to prepare.

1. A life flow. New models of work, platforms for sharing information, and constant connectivity that technology provideswill upend the traditional concepts of one job, one house, and singular ownership of things. Optionality will be what provides stability in a world that prioritizes access over ownership and experiences over possessions.

Companies that are able to move with their customers in a de-centralized, independent fashion will undoubtedly do well in the future. Convenience and flexibility will become crucial selling points. The acts of hailing a cab, visiting the grocery store, or stopping at the bank have already been streamlined to a swipe of a finger. Even the most minor interruptions will stand out.

2. A transparent existence. The amount of data created by these technologies will explode, as everything and everyone increasingly becomes tracked and scored. Tracking each facet of life presents companies with enormous opportunities—but also accountability to customers who will demand transparency around how their data is being managed. This heightened visibility will lead to a rise of ratings, and every brand we consider will have a score. Companies will need to be more transparent than ever, opening up their customer experience for full accountability. Those hiding anything will quickly be exposed.

3. The rise of the omnipotent individual. Products offered on digital platforms will be modular, customized, and democratized. As a result, customers will wield god-like power over each component of their lives, from their homes to their genes. In response, the production of products will become flexible and dispersed, customized to the unique wants of these empowered consumers.

Companies will need to give their customers the power to unbundle, customize, make, modulate and mix. They’ll need to go beyond a “one size fits all” approach and grant customers the power to control their own unique experiences. Those that master this will be rewarded handsomely for it.

4. An on-demand world. Technology makes the world more immediate. On-demand access and automated task completion will serve appetites for instantaneous results, and customers will reward the fastest solutions with their dollars and data. While customers will have less to do, they will have more to manage. For companies, it’s incredibly important to keep up with customers’ ever-increasing expectations for immediacy and efficiency throughout every aspect of the customer experience.

5. Exponential intelligence. Consumers will have more access to information than ever before, shifting who and how they trust. As a result, their decision-making processes will change from being a personal deliberation to a collaborative and connected feedback loop. Lippincott’s research shows that 62 percent of consumers would rather make decisions based on intelligent apps and crowdsourced information than on the advice of family and friends. Companies should strive to provide their customers with as much knowledge about their business and its products as possible.

6. Synthetic reality. Virtual reality and the real world will overlap, expanding consumer perspectives and opening up new possibilities in information access, communication, how people shape their personal identity, and the monetization and gamification of products and commodities. The companies that help their customers navigate between the two worlds with ease will open up new channels to connect, creating a business differentiator in the process.

As these six shifts unfold, they’ll yield a bounty of new innovations and value propositions. Companies and their boards need to think deeply and strategically about what these changes portend for the fundamental underpinnings of their business designs and value add to the customer of the future. And for those that do, something great is just beginning.

To read Lippincott’s full report on these six shifts, click here.

John Marshall is the chief strategy and innovation officer at Lippincott.

To learn more about strategy and risk, attend the 2017 Global Board Leaders’ Summit where you will have the opportunity to explore emerging risk issues with peers. A detailed agenda of NACD and Marsh & McLennan’s Board Committee Forum on strategy and risk, can be found here.  

Decreased Enforcement Expected From SEC Regarding Conflict Minerals Regulations – For Now

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Joan Meyer

In April 2017, the U.S. Securities and Exchange Commission’s (SEC’s) Division of Corporate Finance announced it will not recommend enforcement action for companies that disclose, but do not further investigate usage of conflict minerals which may be from the Democratic Republic of Congo (DRC). Any company manufacturing or contracting to manufacture products using such minerals had previously been required to conduct extensive due diligence on its supply chain and make this diligence publicly known with a note that its products contained minerals which “have not been found to be ‘DRC conflict free.’” However, following a series of partial losses in court, the SEC appears to be backing off the rule—for now.

The Conflict Minerals Rule and Disclosure Requirements

Reagan Demas

A provision in the Dodd-Frank Act aims to cut off funding sources for armed rebel groups in the DRC and surrounding countries in central Africa. It requires companies manufacturing products containing certain minerals to conduct supply chain audits and disclose if those minerals were known to have originated in the DRC or adjoining countries. The SEC, as the enforcer of this provision, issued a rule requiring issuers of securities who filed reports with the SEC under Sections 13(a) or 15(d) of the Securities Exchange Act of 1934 and who manufactured or contracted to manufacture a product in which the defined conflict minerals were a necessary part, to file a separate special disclosure form, Form SD.  Although these obligations were placed on manufacturing issuers, in practice, the diligence requirement was imposed on others in the supply chain because many manufacturers required their supply chain partners to certify origin of minerals and compliance with the rule.

Maria McMahon

When Form SD was first issued, items 101(a) and (b) required companies using conflict minerals to attempt to identify the country of origin of those minerals. If after conducting a “reasonable country of origin inquiry” the company determined that the country of origin was neither the DRC nor an adjacent country, it had to disclose this finding (and a description of the country of origin inquiry conducted) on its website as well as to the SEC. Per item 101(c) of Form SD, if a company’s minerals may have originated in either the DRC or its neighboring countries, the company was required to conduct additional, more extensive due diligence, and then file and publish a conflict minerals report. This report had to include a description of the company’s due diligence efforts, certified results of an independent private audit, and a list of planned changes as a result of the audit. In the report and on its website, companies also had to describe which products had “not been found to be ‘DRC conflict free,’” although for the first two years of enforcement they could use the label “DRC conflict undeterminable.”

Legal Challenges

The National Association for Manufacturers challenged these regulations on both procedural and constitutional grounds. After the district court granted the SEC summary judgment, the Association appealed to the DC Circuit of Appeals. Ultimately, the appeals court found that forcing companies to note whether or not their products are DRC conflict free was unconstitutional under the First Amendment. The case was remanded to the U.S. District Court for the District of Columbia, which issued its final judgment in April 2017 and set aside the part of the rule that requires companies to add language that their products are “DRC conflict free” or “have not been found to be ‘DRC conflict free.’” Citing both the court decision and the unclear efficacy of the rule,  SEC Chair Michael Piwowar reopened comments and the SEC stayed the compliance portions of the rule pending the conclusion of litigation. The SEC announced it would not pursue enforcement actions against companies who only complete Form SD items 101(a) and (b) and do not pursue more extensive diligence on sourcing or secure an independent audit. The SEC has taken the view that the purpose of item 101(c) of Form SD and the related conflict minerals reports was to determine the status of conflict minerals by requiring the “conflict free” or “not conflict free” labels, and that these measures and the requirements for more detailed due diligence are in need of re-evaluation and clarification given recent court rulings on this matter.

Implications

Although companies are not currently expected to conduct the extensive due diligence envisioned by item 101(c) of Form SD, they are still expected to conduct in good faith a reasonable country of origin inquiry and disclose this information to the SEC and the public. Companies and boards still need to ensure there are effective diligence programs in place that allow reasonable inquiry into supply chain partners and components, particularly if conflict minerals are necessary to any product the company manufactures. By statute, the SEC is required to issue a rule relating to due diligence for conflict minerals. Although the “conflict free” labeling requirement has been eliminated, the question remains whether conflict minerals reports, in their current form, are otherwise valid. The SEC is currently developing its future enforcement recommendations with respect to the rule.

In the interim, companies should continue to ensure effective supply chain diligence mechanisms are in place that allow them to confirm where components, particularly conflict minerals, are sourced. To the extent that auditing or diligence measures had already been put into place prior to the final judgment and SEC announcement, companies may want to continue to implement these measures given the lingering uncertainty about future application of the rule. Companies also have the ability to submit comments on the rule to the SEC and should make their views known to influence future enforcement on this issue.

At Baker & McKenzie, Joan Meyer is a partner and chairs the North America Compliance, Investigations & Government Enforcement Practice Group. Reagan Demas is a partner and Maria McMahon is a professional support lawyer in the North America Compliance, Investigations & Government Enforcement Practice Group in Washington, DC.

To learn more about strategy and risk, attend the 2017 Global Board Leaders’ Summit where you will have the opportunity to explore emerging risk issues with peers. A detailed agenda of NACD and Marsh & McLennan’s Board Committee Forum on strategy and risk, can be found here.  

How Are Trends in Executive Compensation and Governance Playing Out in the 2017 Proxy Season?

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Investors now see corporate governance as a hallmark of the board’s effectiveness and one of the best sources of insight into the way companies operate. In response to this trend, Farient Advisors LLC, in partnership with the Global Governance and Executive Compensation Network, produced the report 2017—Global Trends in Corporate Governance, an analysis of corporate governance practices in the areas of executive compensation, board structure and composition, and shareholder rights throughout 17 countries.

NACD, Farient Advisors LLC, and Katten Muchin Rosenman LLP cohosted a meeting of the NACD Compensation Committee Chair Advisory Council on April 4, 2017, during which Fortune 500 compensation committee chairs discussed the report’s findings in the context of the current proxy season. The discussion was held using a modified version of the Chatham House Rule, under which participants’ quotes (italicized below) are not attributed to those individuals or their organizations, with the exception of cohosts. A list of attendees’ names are available here.

Global Governance Trends

2017—Global Trends in Corporate Governance finds that governance standards around the world have strengthened in response to financial crises and breakdowns in corporate ethics and compliance. Those crises and breakdowns have led to greater pressure from governments and investors, who are demanding economic stability and safe capital markets. In regard to executive compensation, the report notes a number of global governance trends:

Source: Farient Advisors, 2017—Global Trends in Corporate Governance, p. 18.

  • Most of the 17 countries surveyed (94%) require executive compensation disclosure, although the disclosures made and the quality of these disclosures varies from country to country. Surveyed countries that had the least developed disclosures are South Africa, China, Brazil, and Mexico.
  • Say-on-pay voting is mandatory in most developed countries, although there is variance on whether the votes are binding or not. For developed countries where the vote is voluntary (e.g., Canada, Belgium, Germany, and Ireland), it still remains a leading practice.
  • Common leading practices are to use competitive benchmarks, such as peer groups to establish rationales for pay, and to provide investors with information on components of pay packages and performance goals.

2017 Proxy Season Developments

Meeting participants shared a number of observations and practices from the current proxy season:

  • Continuous improvement on disclosures Council participants indicated they are sharing more information with shareholders, in a more consumable way. “We want to be in the front ranks as far as providing information to shareholders,” said one director. “Instead of asking ‘why should we share that?’ we’re starting to ask ‘why not?’” Another director added, “Over the last few years we’ve moved from a very dense legalistic document to something that’s much more readable. Our board set up a process to do a deep-dive review every two years; this fall is our next review. It’s a way to ensure our disclosures keep pace with current practices and also reflect where we are as a company and board.

Council members also discussed the status of Dodd-Frank rulemaking, given the new presidential administration and SEC commission. S. Ward Atterbury, partner at Katten Muchin Rosenmann LLP, said, “While it’s unclear exactly what the SEC will do with Dodd-Frank requirements in the future, investors have spoken on some of the issues, especially on things like say on pay and pay for performance. There may be less formal regulation, but the expectations on companies and boards are still there [to provide pay-for-performance disclosure].”

  • Growing interest in board processes According to one director, “We’re hearing more interest about CEO succession as it relates to strategy. Investors are asking us to describe our process—they understand we can’t discuss specifics.”
  • Director Pay Dayna Harris, partner at Farient Advisors LLC, discussed the increased focus on director pay: “Given the recent law suits regarding excessive director compensation and an increase in director pay proposals in 2016, Institutional Shareholder Services (ISS) created a new framework for shareholder ratification of director pay programs and equity plans.” ISS’ framework evaluates director pay programs based on stock ownership guidelines and holding requirements, equity vesting, mix of cash and equity, meaningful limits on director pay, and quality of director pay disclosure. ISS’ updated factors for evaluating director equity plans include relative pay magnitude and meaningful pay limits.
  • Environmental, social, and governance (ESG) issues Meeting participants agreed that social issues, such as ESG and gender pay equity, are increasing in popularity among investors. In particular, nonbinding shareholder proposals on climate change received majority support this year at Exxon Mobil Corp., Occidental Petroleum Corp., and PPL Corp.
  • Refining approaches to outreach and engagement with investors Meeting participants discussed leading practices for engaging shareholders. Some directors indicated that investors have turned down their offers to speak on a regular basis because of time constraints. One delegate emphasized that just making the offer to meet with shareholders is appreciated, even if that offer is turned down. One director said, “We invited one of our major long-term shareholders to speak at one of our off-site [meetings] as part of a board-education session. It was a different type of engagement and very valuable.

For Further Reading

Seven Tactics for Minimizing Director Litigation Headaches

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Craig Zieminski

Law firms that specialize in suing directors will scrutinize nearly every major transaction, public offering, stock drop, restatement, and press release filed by public companies. For instance, according to Cornerstone Research, stockholders file lawsuits challenging the majority of public company transactions valued at more than $100 million, with an average of three lawsuits per transaction. An effective defense of these almost-inevitable lawsuits can begin long before they are filed. With a few simple steps, directors can reduce the burden of these lawsuits and protect themselves from the most common tactics utilized by stockholders’ attorneys.

1. Vet conflicts early and often. Perhaps the easiest way to avoid fiduciary duty liability is to avoid situations where you have conflicting interests in a transaction or other board decision. Due to various protections under Delaware law, directors are rarely held liable for poor or ill-informed decisions if the directors are not self-interested (unless they are grossly negligent), and articles of incorporation almost universally protect directors from monetary damages for such decisions. By contrast, Delaware fiduciary duty law imposes exacting standards for directors who participate in board decisions when they have a material self-interest in that decision. Thus, any major board initiative should begin with a full analysis of each director’s potential self-interests, and this analysis should be updated throughout the initiative. Of course, this analysis requires you to stay organized with your outside business interests (e.g., your employer’s customers, suppliers, and competitors) and personal financial situation (e.g., ownership interests). Recusing yourself can be the stitch in time that saves nine.

Andrew Jackson

2. Treat all board communications formally. The documents that often cause the most trouble in litigation are informal e-mails between two directors. Even if e-mails contain nothing objectively negative regarding the board decision at issue, such e-mails can raise questions about the board’s deliberative process, especially if the issue raised in an e-mail was not discussed with the full board. A skilled plaintiff’s counsel can often interpret a casually written message in an unintended manner. In most instances, if a director raises any concern outside of a board meeting, the full board should resolve that concern and memorialize the process in a contemporaneous document (e.g., the minutes). If you have said anything in an e-mail that is inconsistent with your ultimate vote on an issue—even if you were just playing “devil’s advocate”—you should be prepared to square your communications with your vote. In other words, make sure your concerns are resolved through the deliberative process before making your decision.

3. Maximize efficiency in pressing circumstances. Perhaps underestimating how quickly and diligently directors and their advisors can work in exigent circumstances, plaintiffs’ attorneys often allege that board decisions were too rushed. For instance, in one of the more infamous Delaware fiduciary duty decisions, a financial advisor did not send any valuation materials to a board of directors until 9:42 p.m. on the night that the directors met to vote on a merger. The board met at 11 p.m. and approved the merger that night. Tight deadlines are often unavoidable, but directors can take steps to maximize the efficiency of the process. For instance, request early drafts of meeting materials, make your advisors work around-the-clock when necessary, and don’t wait until the board meeting to ask questions. At the end of the day, you need to be able to honestly state that you had enough time to fully consider any issues or concerns and come to a reasoned decision. Use your resources efficiently to get to that point.

4. Make your advisors an asset, not a liability. The quality and independence of a board’s advisors is a direct reflection on the quality and independence of the board’s process. This scrutiny begins when a board (or committee) selects its outside advisors. Stockholders may cry foul if directors simply accept management’s recommended advisor, especially if any member of management may have a self-interest in the relevant transaction.

To avoid these common allegations, interview multiple advisory firms, thoroughly inspect their potential conflicts, and negotiate for a fee structure that aligns the advisor’s incentivizes with the best interests of the stockholders. Stockholders also regularly allege that advisors are “deal cheerleaders” who bend their analysis to support the board’s wishes. To rebut these allegations, insist that your advisors objectively analyze the relevant issues, and ask them to obtain the board’s approval for any significant assumptions, methodology decisions, and other subjective portions of their analyses. To the extent possible, you should also resist your advisors’ efforts to load their work-product with disclaimers. Above all, carefully analyze your advisors’ work-product, ask questions, and do not rely on their opinions until you understand and approve of the efforts and reasoning underlying those opinions.

5. Ensure that the meeting minutes fully reflect the process. We cannot overstate the importance of minutes in litigation against directors. First, judges and juries typically place more weight on contemporaneous records of a board decision than after-the-fact testimony. Second, depositions often happen several months (if not years) after a challenged board decision, and minutes are an important tool for refreshing directors’ memories. Ask the board secretary to draft minutes promptly after a board meeting so that you can review them while the meeting is still fresh on your mind. When reviewing minutes, make sure that they accurately reflect a summary of the issues discussed, the specifics of any decisions reached, and a list of all attendees (plus mid-meeting arrivals and departures). Not every single statement made during a meeting can or should be part of the minutes, but it is important for the minutes to reflect every topic discussed at the meeting. Ask yourself: “If I’m questioned about this meeting at a deposition next year, will these minutes help me answer questions and show the court that we fulfilled our duties?”

6. Know the boundaries of the attorney-client privilege. The attorney-client privilege is not a guarantee that all correspondences with counsel are shielded from discovery. For instance, contrary to many directors’ (and attorneys’) beliefs, the attorney-client privilege does not protect every e-mail on which an attorney is copied. Rather, an e-mail is generally privileged only if the correspondence is sent in furtherance of requesting or providing legal advice. Parties in litigation are often required to redact the “legal advice” portion of e-mails and produce the remaining portions. Thus, an e-mail (or a portion of an e-mail) concerning purely business issues might not be shielded from production. Additionally, communications with certain persons that would ordinarily be privileged, including in-house and outside counsel, may not be privileged under certain circumstances. Further, even if a document is undisputedly privileged, litigants sometimes waive the attorney-client privilege for strategic reasons, such as when the board asserts that it made a challenged decision in reliance on advice from counsel. While it is vital to have open and honest communications with your counsel, it is also important to remember that those communications may be shown to an opposing party. If there is something you would not write down in a non-privileged e-mail, then consider calling your attorney instead of sending an e-mail.

7. Use a board-specific e-mail address. By exclusively using a non-personal e-mail address for board-related correspondences, you can significantly reduce the odds of personal e-mails (or e-mails concerning your other business endeavors) becoming subject to discovery. Too often, we see directors using their “day job” e-mail addresses for their directorial correspondences; this can lead to situations where your employer’s confidential information must be copied, reviewed by your outside counsel, or (worse yet) produced to the opposing party in litigation. The same holds true for personal e-mail addresses, which some directors use for their family’s bank statements and board-related e-mails. The best way to potentially avoid this situation is to proactively segregate board-related e-mails to a different e-mail account. Some companies create e-mail addresses for their directors. If yours does not, consider creating an e-mail account and conducting board-related business solely from that address.

Craig Zieminski and Andrew Jackson are litigation attorneys at Vinson & Elkins LLP. They specialize in representing companies and their directors in lawsuits alleging breaches of fiduciary duties, partnership agreement duties, merger agreements, and federal securities laws.

The Strategic-Asset General Counsel

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Kimberly Simpson

In June, NACD convened general counsels (GCs) from across the country for a one-day meeting in New York City on the role of the GC in supporting boards of directors. Program panels consisted of directors, GCs, and subject-matter experts on legal issues affecting board decision making.

The Evolving Role of the GC

According to Richard D. Buchband, senior vice president, GC, and secretary for ManpowerGroup, the GC must clear the way for the board to focus on strategic matters. Though each company is different, long past are the days when the GC’s role was to take minutes in the corner of the boardroom.

A clue to how a general counsel will be perceived in any given company may be found in the interview process, when a candidate should take note of whether board members participate. Also, in assessing how the board will utilize the GC, a candidate or sitting GC should be aware of whether board members hail from countries in which the GC traditionally takes a smaller role, reporting not to the CEO but to the CFO, according to Yvonne E. Schlaeppi, director for Stallergenes Greer and former GC for several companies, including Johnson Controls Europe.

Once connected to the board, the general counsel can be of value for many facets of the enterprise, leveraging his or her unique position in the organization to assimilate information and data from across the business. Several suggested that the general counsel should always offer a recommendation when providing input to the board. In fact, judgment is a critical part of what a GC offers the board. “The crux of a GC being a strategic advisor to the board is having your good judgment on the complex mix of puzzles which general counsels deal with all the time—including commercial, legal, and people challenges—recognized and valued,” said Schlaeppi.

Further, the career of Robert Bostrom, senior vice president, GC, and corporate secretary for Abercrombie & Fitch Co., illustrates how the general counsel can be the glue for an organization in turmoil. During a prior role as general counsel at Freddie Mac, he saw several CEOs and CFOs come and go around the time of the 2008 financial crisis and when the government appointed a conservator. Today, Bostrom co-chairs Abercrombie’s enterprise risk management group and leads the organization’s crisis management team, taking point on risks affecting the company’s reputation.

Moving the Board Forward

Of course, given that the GC is often the most knowledgeable person about issues of corporate governance, the GC brings tremendous value by providing advice and counseling on governance matters. Gillian A. Hobson, partner, capital markets and mergers & acquisitions at Vinson & Elkins, pointed out that such governance matters include issues such as independence, diversity, proxy access and others outlined in Commonsense Corporate Governance Principles, published in 2016 by a group of leading executives and investors. In addition, in order to move a board forward, the general counsel has a number of specific tools at his or her disposal. The general counsel can:

  • Suggest formats for a board evaluation and skills matrix;
  • Bring outside information (such as NACD’s Blue Ribbon Commission Reports) and outside perspectives (such as those from ISS, BlackRock and others) to the board; or
  • Develop relationships with board members, including board leadership and more progressive board members.

William E. McCracken, director for MDU Resources Group and for NACD, suggested that when boards get “stuck,” the GC is in a “unique position to lift the board’s vision up to see what else is happening out there.” Steven Epstein, corporate partner and co-head of mergers and acquisitions at Fried Frank, agreed. “The GC will be up to speed on the general M&A landscape and the latest thinking of the courts and will be well-positioned to combine that knowledge with the business objectives of the company, which is extremely valuable to the board.”

No Surprises and Keep It Short

Several times throughout the day, panelists espoused the best practice of imparting “no surprises” to the CEO or the board. For example, if the GC sets up lunch with a board member, Buchband suggests a check in with the CEO after the meeting is set but before the lunch takes place. “I ask the CEO if there are any issues he would like me to raise or discuss,” said Buchband. Keeping the board informed on matters affecting governance is equally important.

Also, all panelists reiterated how important it is for the GC to keep materials short and topline for the board. “We can be victims of our own desire to be thorough,” noted Buchband.

Enterprise Risk Management and Compliance Make the GC’s Job Easier

The role of risk assessment is not to avoid all risk, but rather to identify and manage risk, said George J. Terwilliger III, partner at McGuire Woods. In fact, Bostrom noted that enterprise risk management at Abercrombie helps him and the company prioritize risks. If a risk rises to the top, then a cross-functional, high-level team has agreed that it should be there, and he doesn’t have to champion the cause as a lone voice.

Daniel Trujillo, senior vice president and chief ethics and compliance officer for Wal-Mart International, stressed that a culture of compliance must start at the top. A program must then be implemented that is effective, consistent, data driven, efficient and sustainable. Terwilliger echoed that compliance has to be part of the fabric of the company, with the compliance council acting as a convener rather than as “internal police.” Today, predictive analytics help his team spot trouble early at Walmart, at the country or even the store level.

Consider Cross-Border Complexities

Just as Wal-Mart operates globally, so too do companies like Abercrombie. David H. Kistenbroker, global co-head of white collar and securities litigation at Dechert, reminded the audience to consider cross-border complexities when advising the board. Long-arm statutes in the United States and United Kingdom can impact deals all over the world. Due to such complexities, the GC is in a unique position to be a strategic asset to companies operating globally, especially where board members are all based in in the United States.

NACD would like to thank the panelists for sharing their experiences with attendees, and for these generous sponsors for their support of the event: Dechert, Fried Frank, KPMG, and Vinson & Elkins.

Kimberly Simpson is an NACD regional director, providing strategic support to NACD chapters in the Capital Area, Atlanta, Florida, the Carolinas, North Texas and the Research Triangle. Simpson, a former general counsel, was a U.S. Marshall Memorial Fellow to Europe in 2005.

Seven Ways to Stronger Oversight of Supply Chain Risk

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Jim DeLoach

One important source of operational risk relates to the organizations, people, processes, and resources comprising a company’s supply chain. In many sectors, companies increasingly depend on the external elements of the supply chain (e.g., suppliers, outsource partners, third-party logistics) in an effort to cut costs while increasing capabilities and global reach. Because every business depends on a well-functioning, cost-effective supply chain, every board should consider its oversight of supply chain risks. The following are seven suggestions for better board-level oversight of supply chain issues.

1. Strike the right balance when selecting a supplier. Time, cost, quality, and risk are four factors a company needs to consider when identifying potential suppliers, negotiating contracts, and evaluating supplier risk and performance throughout the lifespan of the contract. Boards should be leery when management emphasizes one or two factors over the others as this can result in unintended consequences. For example, seeking to reduce procurement costs when negotiating supply contracts should not lead to the unintended consequence of taking delivery of components that fail to meet critical quality specifications or timing requirements.

2. Make procurement decisions with an enterprisewide perspective. Striving for functional excellence is a laudable goal, but it has its limits. Companies can incur huge losses making procurement decisions in isolation, ignoring initiatives undertaken by the research and development, engineering and finance functions.

3. Ensure the supplier agreement spells everything out. When a contract clearly defines scope, business objectives, deliverables and performance specifications, it lays the foundation for ongoing monitoring of contract compliance and supplier performance and reduces the risk of costly disputes and misunderstandings. For example, the contract should clarify product and packaging specifications and quality control and inspection protocols so that performance can be monitored over time. It also should ensure that intellectual property and critical assets (e.g., proprietary molds and tools the company gives to the supplier) are adequately protected. Due to the complexity of managing suppliers operating in other countries, boards should ensure that the procurement process is supported by legal advisers knowledgeable of the applicable court jurisdictions, particularly in countries where laws, customs, and business ethics may vary.

4. Hold suppliers to the same level of accountability. The rigor of company processes for identifying, sourcing, measuring, monitoring, and reducing third-party relationship risks should be proportionate to the level of risk and complexity of those relationships. With respect to legislative and regulatory developments regarding disclosure of the actions a company has voluntarily undertaken to remove labor abuses from its supply chains, companies should seek the advice of counsel as to the status of these developments and the jurisdictions and circumstances in which they apply. Given this environment, a case can be made for adopting and enforcing a supply chain code of conduct—especially for vendors authorized to act as agents on behalf of the organization. Coupled with a code of ethics that details the principles and values by which the company operates, a code of conduct might address topics such as human rights, health and safety standards, environmental sustainability standards, ethical and responsible business behavior, and cybersecurity standards.

5. Conduct periodic third-party audits. A supply chain code of conduct is only as good as the vendors who sign it. That’s why a cost-effective third-party audit process is Such audits may be integral to the due diligence associated with vendor selection and onboarding. Conducted on a periodic basis, third-party audits may focus on: selected internal controls, such as cybersecurity; vendor performance against contract specifications; and compliance with laws and regulations. The audits may also be conducted before contract renewals.

6. Monitor supplier risk and performance over the life of the contract. The risk environment is not static over the life of the contract. All suppliers should be segmented based on factors such as risk, the level of spend, criticality, and alternatives in the market. The segmentation should drive the level of preselection due diligence, the contracting strategy, and the level and frequency of monitoring through contract duration. Ideally all facets of contract and supplier risk are addressed through performance reporting, including early warning alerts before it’s too late to act on a timely basis.

7. Pay attention to business continuity risk. There are many instances where a single-source supply strategy is the right business decision. In these cases, however, quality, time, and cost considerations often win out over business continuity risk considerations despite the risk of supply chain disruptions. Thus, risk assessments should consider what could happen to the organization’s business model if any key component of the supply chain were taken away, even though a cause may be somewhat elusive at the time of the assessment.

An assessment should also consider the implications of plausible and extreme scenarios stemming from the loss of strategic sources of supplies for an extended period, including exposure to data security risks and physical access to sensitive information, the financial impact, expected recovery time, and adequacy of current recovery and contingency plans. To illustrate, directors should inquire whether management has considered the following questions:

  • What would happen if we were to lose, for any reason, one or more of the suppliers that we depend on for essential raw materials and components?
  • How long would we be able to operate?
  • What if there were significant disruptions in transportation?
  • What contingency plans do we have?
  • Have our key suppliers performed their own risk assessments with respect to key “Tier Two” or “Tier Three” suppliers? How do we know?

The board should be informed of the results of these assessments.

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