Board of directors can't escape blame
Who was minding the company? Others may take lesson from Enron
01/25/2002
By BILL DEENER
The Dallas Morning News
The fallout from Enron Corp.'s collapse has taken a most predictable turn.
Company executives have fired the accountants; the accountants are blaming the executives; and the politicians have launched a fusillade of inquiries.
But the key players aren't limited to management, its auditors and the investigators. Analysts and experts are asking, "Where was the board of directors?"
"It is amazing to me how the most highly qualified people that you can imagine are put on these boards, and then for some reason they become completely dysfunctional," said Nell Minow, editor of The Corporate Library, corporate watchdog group based in Washington, D.C.
Enron's board of directors had nothing to say. A spokesman for the National Association of Corporate Directors predicted that the Enron debacle might prompt boards around the country to take a more active oversight role.
But experts in corporate governance countered that had the Enron board been more active, it might have avoided joining the ranks of directors who also watched helplessly as their companies' stock tanked. Sunbeam Corp., Rite Aid Corp. and Waste Management Inc. are all recent examples.
Contrary to what many shareholders believe, the board of directors – not the chief executive officer and certainly not the auditors – has the ultimate responsibility for the management of the company. And one of the board's chief responsibilities is to hire the chief executives and monitor their performance.
So how do the boards of prominent companies – often populated by business stalwarts, top academicians and legal scholars – fail?
"Regardless of what role, if any, the board played in Enron's collapse, this debacle will be on the minds of boards of directors of companies across the country," said Henry Hu, a corporate law professor at the University of Texas School of Law. "Good times or bad, I hope that more boards will put in the necessary time, effort and diligence, watch out more for the shareholders' interest, and be less concerned about the happiness of inside managers."
Change ahead?
And Peter Gleason, vice president of research and development for the National Association of Corporate Directors, said: "I think now after this Enron case, you will see a more proactive approach by directors," Mr. Gleason said. "I think you are going to see more directors with that duty of courage who stand up and say: Explain this to me. What does this mean?"
Attempts to reach several Enron board members for comment were unsuccessful, and their offices referred all calls to the Enron public affairs office. Eric Thode, a spokesman for Enron, said Wednesday: "Board members choose not to participate in this story."
On Wednesday, however, Enron's chief executive officer Kenneth Lay resigned, saying in a statement: "This was a decision the board and I reached in cooperation with our creditors' committee." Mr. Lay will retain a position on the board.
There's surprising consensus among experts on corporate governance as to the reasons for board members' lapses. At the top of the list is the fact that regardless of performance, boards have not been held financially responsible for the losses suffered by shareholders, Ms. Minow said.
That's because standing between directors and the shareholders who sue them are several layers of legal armament and insurance coverage. Virtually all large companies provide liability coverage for their directors and officers, called D&O insurance.
In addition, several states, including Delaware, have passed laws to limit the liability of officers and directors. And in some cases companies simply indemnify their directors against fines and lawsuits, meaning the company will pay the legal freight.
There are exceptions, but outside of criminal acts, the directors aren't exposed to much threat of liability. At the same time they can take home an annual salary of $70,000 to $100,000, Ms. Minow said.
The average salary for board members at the top 200 companies is $137,000, according to Mr. Gleason. And the average compensation for Enron directors in stock and cash is about $400,000, according to published reports.
"The number of times a corporate director has had to open up his or her own checkbook are extremely rare," Ms. Minow said. "If you are not a crook, you are not going to get into much trouble."
Revoking coverage
Enron's providers of D&O insurance could try to rescind their coverage, arguing that the company misled them about earnings. A spokesman for one of those providers, St. Paul Cos., said his company has about $19 million in D&O exposure.
Asked whether the company might rescind Enron's coverage, company spokesman Mark Hamel said: "I really can't answer that. These are not cookie-cutter policies. I don't know what's in this one."
There is some precedent for revoking coverage. A division of New York-based American International Group dropped its coverage for Sunbeam's directors after the company restated its earnings in 1998. Sunbeam later sued in federal court, and AIG agreed to pay $10 million, although it did not have to reinstate the policy.
Tom Ajamie, a Houston attorney who often represents shareholders, said he's hopeful that one legacy of the Enron case will be that Congress and the regulators stiffen the penalties for deliberate misdeeds by board members.
"It would really help, if board members had to pay fines out of their own pockets," said Mr. Ajamie, who is not involved in the Enron case. "Right now, the way the laws are written, they don't suffer much."
While stiffer fines and penalties would probably improve the board behavior, no one believes these would completely solve the problem. That's because much of the financial harm inflicted on shareholders is not deliberate and certainly not criminal.
Many times the breach of the shareholders' trust is rooted in simple inattention. Directors at the top 500 U.S. companies or so often serve on at least three other boards.
"I have known directors who sit on 15 boards," said Jackie Cook, research associate for Boardroom Analysis and expert on corporate governance. "With most boards meeting six to eight times a year, that is more than 100 meetings a year they are obliged to attend. Some directors are spread too thinly."
Peer pressure
Another issue in board competency involves something that every parent of a teenager understands well – peer pressure, or the courage to stand up to it. And no amount of regulation is going to instill courage in timid board members, said Curtis Verschoor, a research professor at the DePaul University school of accountancy.
"It takes a certain amount of courage when you belong to this club called the board of directors to stand up and disagree with the chairman of the board and the CEO," Mr. Verschoor said.
Ms. Minow offered this scenario: Imagine, sitting at the table with the 15 members of the Enron board, many of whom are old friends of Mr. Lay. There's a dean of a prestigious law school; a president of an world-class cancer center; and CEOs of Fortune 500 companies.
Mr. Lay then proceeds with a sparkling presentation about the growth prospects for the world's largest energy trading company and, by the way, the stock price has soared from $20 a share to $80. In that environment, it would have taken a courageous board member to ask tough questions, Ms. Minow said.
"Very often these meetings are run like pep rallies," she said. "They put some numbers up on a screen with some fancy special effects and wonderful PowerPoint presentation. At the end, everybody applauds, and then they go have lunch."
Further, she said, much of Enron's collapse was related to complex partnerships where the company booked millions of dollars in debt. Some have argued that the Enron auditors didn't even understand the complexity the company, which has 3,500 subsidiaries and affiliates.
"Some board members might have thought they would look foolish by asking a question about one of these partnerships in front of the CEO," Ms. Minow said. "That's why the single most important thing I recommend to boards is that they meet before and after the formal board meeting without management present."
Mr. Gleason, of the National Association of Corporate Directors, perhaps put it best when he said board members have a "duty of courage to stand up and ask the tough questions."
Finding expertise
No one is suggesting that directors micromanage the company, but they need to have a basic understanding of how the firm operates, its financing and its structure.
Also, he said, effective boards need to constantly evaluate whether its skills are aligned with those of the company. For example, if a company plans to expand overseas, it may need to consider a board member with some international business experience.
But even the harshest critics concede the system works better now than it did 20 years ago.
"If you think boards are too weak relative to inside management today, it was much worse two or three decades ago," said Mr. Hu of the University of Texas School of Law. "Now boards are much more willing to fire underperforming CEOs than in the old days."
The rise of institutional investors, such as pensions and mutual funds, also have forced boards to be more engaged, Mr. Hu said.
"When you own $500 million of a company's stock, you have a real economic stake, have the sophistication and resources to see what is going on – and you are going to get your phone calls returned," Mr. Hu said.
But he added even small investors and shareholder advocacy groups can have a positive impact on a board of directors by simply attending the annual meetings.
"I would encourage shareholders to go to the annual meetings and start asking tough questions of members of management," Mr. Hu said. "If they can't or won't answer ask them why not." |
