Board Practices Like Night And Day Since SOX

OIt's like night and day," says Bill Ide, a partner at McKenna Long & Aldridge, comparing current board committee procedures with his earlier experience as general counsel and corporate secretary of Monsanto.

"We're in an era of process- and rules-based operation," notes Ide, who also chairs the governance and nominating committee of restaurant operator AFC Enterprises, and sits on its audit committee. "Congress and the SEC are trying to change the culture."

That's the consensus from directors and experts who spoke with Compliance Week about the changes being made to practices and procedures by boards and committees. The Sarbanes-Oxley Act has added a huge workload to the audit committee, while updated stock exchange corporate governance codes expanded the burden on both compensation and nominating/governance committees.

What's In The Binders?

Harris

"Sarbanes-Oxley ties everything together within the company, all the way up to the top," says James Harris, president and CEO of financial advisers Seneca Financial Group. According to Harris, who is also chairman of the nominating and governance committee at El Paso Electric and an audit committee member at software maker Peregrine Systems, the result is greater diligence on the part of directors. "It's forcing internal management and directors to pay attention to what's in the binders," he notes.

That increased diligence means that committee members are no longer accepting management presentations at face value. "You have to delve deeper in yourself," Ide says. "When internal audit comes in, we can't just accept it, we have to look at it and contrast that with what the outside auditor says."

But according to Ide, that greater attention to detail is not creating a "check the boxes" approach that many governance experts feared would result from SOX's prescriptive rules. "By forcing people to go through this, things are changing," he notes. "A lot of us would say the old culture was too CEO-centric."

Silver

Michael Silver, a partner at Hogan & Hartson, agrees that directors are not simply going through the motions. "Every audit committee I deal with has a renewed sense of purpose and focus, far beyond asking, 'What do we need to do to comply?'" he says.

That means corporate executives need to be on their game, ready to discuss and explain any information presented to the board or its committees.

"Some Lawyers Think I'm A Fool ..."

A downside for committee members, of course, is workload. According to a survey conducted by the Financial Times last year, audit committees were meeting more frequently than in previous years as directors work to implement new regulatory requirements and fulfill investor expectations.

In addition, the flurry of new regulations and standards—from shareholder approval of equity compensation plans to MD&A disclosure of off-balance sheet arrangements—has created more documents to review, understand, and sign off on.

In many cases, committee members are having trouble simply digesting all the new requirements. "You wear your committee members out because it takes so much time," says John Olson, a partner at Gibson, Dunn & Crutcher who also chairs a corporate governance section at the American Bar Association. And that emphasis on the minutiae can come at the expense of strategic leadership. "They spend so much time worrying about process they lose sight of the big picture," notes Olson.

For example, says Olson, audit committees used to meet once a quarter, but now it's six to eight meetings a year—a number that's in sync with the FT survey. Even reviews of quarterly releases can take an hour or two.

The increased burden has caused some directors to scale back. "One woman was on five audit committees," he says, "She's cut that back to three and is thinking of cutting it to two. That's a shame, because she's highly qualified."

Liability concerns could prompt other directors to resign. A Korn/Ferry International study published in November 2003 noted that 23 percent of directors at Fortune 1,000 companies turned down additional board roles last year due to increased personal liability risk. "The first case that finds audit committee members liable for failing to fulfill their duties will cause a lot of hand-wringing," says Silver at Hogan & Hartson.

"Some lawyers think I'm a fool to sit on the audit committee," says Seneca's James Harris. "Others say as long as you follow the procedures diligently you'll be OK." As a result, Harris does not tolerate sweeping things under the rug. "If you see something you don’t like, you have to say something right then and there," he says.

The Current Focus

Without a doubt, audit committees are increasingly preoccupied with Section 404 of the Sarbanes-Oxley Act, which requires companies to strengthen internal controls and have their auditors check the procedures. "By the end of the third quarter, calendar-year companies need to have tested and repaired the internal controls," says Harris. "You don't want to turn everything over to the outside auditors and have them find a problem. You'd have to report that."

Enterprise risk management is also a priority, as described in last month's entry by Compliance Week columnist Harvey Pitt. Under revised stock exchange governance rules, audit committees must evaluate business risks. Ide says in the past, risk management focused on insurance, not risks that might derail the business plan. "Risk management has never been handled well," he says, "Most corporations don't have a good process." Ide thinks risk management will take up more audit committee time later this year. "You have to put the procedures in place first before you worry about the risks," he says.

Director recruitment and evaluation is another priority at many companies, especially smaller ones that never had nominating and governance committees before. "Many are recruiting," says Gibson Dunn's John Olson. "They have to decide how to go about it, what criteria and what procedures they should use."

Governance committees are starting to evaluate directors' performance, a process that may strain established relationships. "We've designed a form and sent it out," says Grace Holmes, corporate compliance officer and assistant secretary at $1.6 billion oil and gas firm Cooper Cameron. "Many directors have known and respected each other a long time. It will be interesting to see what comes out of that."

Advisers & Minutes

As the pressure mounts on boards, many committees are hiring independent advisers to assist their deliberations. According to Institutional Shareholder Services, 81.4 percent of boards tracked by the firm in June have expressed authority to hire their own advisors, up from 75.1 percent in May.

"Compensation [committee] uses consultants, likely different from the ones management uses," says Hogan & Hartson's Silver. "In addition to traditional compensation consultants, they're using consultants who advise on ISS requirements. Third-party validation has become important since Sarbanes-Oxley." Institutional Shareholder Services recommends a vote for or against stock option plans based on published guidelines.

Ide sees audit and compensation committees using independent advisers, as well. "Some are advocating that independent directors should have their own lawyer, but I don't think that's common practice yet," he says, "The directors do need an outside lawyer when they're dealing with D&O insurance."

While there seems to be concensus on the hiring of advisors, most committee and board members differ on how they should handle minutes. Board minutes have become important post-SOX, as they constitute important legal documents that could be that could be used by a plaintiff's lawyers against corporate defendants.

Holmes says Cooper Cameron's minutes have become longer post-SOX, but the style has not changed. The audit committee used to meet twice a year; today, it meets three times in person and has quarterly telephone calls to review the news release and 10-Q. "There are now minutes of those quarterly sessions," she says, "We used to just record the fact that they had approved the release."

Some committee members are pressing to include more detail in minutes, according to GD&C's Olson. "The theory, driven by litigation risk, was to keep minutes simple," he says, "Who was there, what subjects were discussed, what actions were taken and that's it. Now, members want a record that shows they've been diligent."

Ide believes the minutes should be comprehensive. "I insist the lawyers write something that wouldn't matter if it appeared in the New York Times the next day, or two years from now. You don't want anything left out," he says.