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What to Watch For in 2016

January 12th, 2016 | By

A Message from NACD’s CEO to Our Members

Each year I find myself declaring that the profession of directorship has become more challenging than it was in the previous year. I believe we’ve now reached the point where we should recognize this escalation as the status quo, not an annual anomaly. The Securities and Exchange Commission’s director qualification disclosure requirements, the advent of proxy access, and the increasingly public role of shareholder activists have contributed to a business environment in which directors’ qualifications and performance are continually scrutinized.

Kenneth Daly NACD CEONACD’s mission is to help directors lead with confidence—and to foster stakeholders’ confidence in their directors’ ability to effectively serve their companies. I’d like to highlight three critical issues that we believe directors—of all company types—should focus on during the year ahead.

1. Director Awareness

The dramatic slowdown in China’s economy, plummeting oil prices, recent terrorist activities, and the rise of the digital economy have put a fine point on the need for directors to be aware of disruptors that may cause a drastic change in sea conditions for their organizations.

No one can be expected to anticipate every potential disruption. (Who could have seen Uber idling around the corner?) But foresight comes down to one deceptively simple practice: asking the right questions. Are board members exploring the possible impacts of a terrorist act on the company’s supply chain, investigating their organization’s vulnerability to a cyber attack, or considering new competitors that can bring products to market faster than ever before and with nominal investment?  Throughout 2016 our NACD Directorship 2020 initiative will continue to focus on disruptive forces, putting a spotlight on the issues that may affect your companies in the years to come.

Suggested NACD Resources:
Environmental and Innovative Disruption: What Directors Need to Know
Leveraging Social and Demographic Trends

2. Shareholder Activism

It goes without saying that activist investors have gotten our attention. A record-setting 355 activist campaigns were announced in 2015, including 33 against Fortune 500 companies. Last year was also a record year in terms of activist campaigns resulting in board seats—127 resulted in at least one board seat for the activist or the activist’s appointee. Our own annual survey of public-company directors found that 20 percent of respondents’ boards were approached by an activist investor in the past year. But nearly half of respondents reported that they are unprepared for an activist challenge.

Activists aren’t practicing black magic; they are performing effective due diligence and smart analytics on their holdings. Boards need to think like activists and anticipate the issues these investors may raise. Do your company’s metrics fall outside industry norms? Does your board composition have any perceived weaknesses? Do you engage with management about the assumptions that undergird your company’s strategy? In 2016, NACD will continue to provide resources that can help your boards to anticipate—and respond to—emerging issues.

Suggested NACD Resources
Identify the Enemies of Effectiveness and Think Like an Activist
Investor Perspectives: Critical Issues for Board Focus in 2016

3. Mergers & Acquisitions

M&A activity reached record levels in 2015. Given this phenomenon, it’s more critical than ever that boards understand their role in M&A. We believe it boils down to readiness and oversight.

At any given time, directors may need to consider either the sale of their own company or the purchase of another company. The board must carefully weigh all opportunities to buy or sell as part of its routine corporate oversight. Be on the lookout for NACD’s new M&A Board Resource Center, which will be available later this quarter. The center will serve as a one-stop shop to help boards participate effectively in the evaluation of proposed M&A transactions.

Suggested NACD Resources
FAQs on the Role of the Board in M&A
Recorded Webinar:  The Extent of the Board’s Role in M&A

NACD Cyber Summit
On a final note, I’d like to call your attention to the 2016 NACD Cyber Summit, which will be held on June 15 in Chicago. With Congress now considering passage of a bill that would require companies to publicly identify the “cybersecurity experts” on their boards, scrutiny of the board’s role in cybersecurity oversight has never been greater. This year’s Cyber Summit will equip directors and management with the tools they need to foster cyber resiliency and confidently oversee cyber-risk management.

If you would like to receive additional resources on the three issues mentioned above or more information about the Cyber Summit, I encourage you to contact your dedicated NACD Concierge. If you have not yet had a chance to meet the concierge assigned to you, give us a call at 202-775-0509, and we’ll connect you.

Thank you for being an NACD member. I wish you a successful year ahead.

Sincerely,

Ken

Ken Daly’s 2015 Letter to NACD Membership

January 23rd, 2015 | By

Dear NACD Members,

As I look ahead to the challenges that boards will face in 2015, I am more confident than ever in NACD’s mission to help directors navigate an increasingly complex environment. Our programs and resources remain focused on helping directors improve their performance as strategic assets for their organizations. We achieve this primarily by providing the foresight to anticipate emerging issues, thereby enhancing stakeholder confidence in the board’s ability to provide effective leadership.

I’d like to briefly share with you the three critical issues that NACD will focus on this year.

1. Cybersecurity. It will surprise no one that cyber-risk oversight has become a top agenda item for boards. NACD’s latest survey found that the majority of directors are dissatisfied with the cybersecurity information they are getting from management. How well does your board understand the company’s cyber risk practices? Does your board have an established response plan in the event of a cyber-breach? These are the issues that NACD will continue to help directors resolve throughout 2015.

Suggested NACD Resources:
– Director’s Handbook on Cyber-Risk Oversight
– NACD Advisory Council on Risk Oversight: Cybersecurity Oversight and Breach Response

2. Board-Shareholder Communications There’s no question that shareholders will continue to influence boardroom agendas in 2015. In our most recent meeting with major institutional investors, we asked the participants to list their priorities for board focus in 2015. The three areas identified were: (1) focusing on “drivers” of effective board leadership, (2) holding directors accountable when investors believe shareholder rights have been undermined, and (3) ensuring communication between boards and investors are about context, not volume. We will continue to meet with both institutional investors and activist shareholders throughout the year and will share their perspectives with you.

Suggested NACD Resources:
– Investor Perspectives: Critical Issues for Board Focus in 2015
– NACD Blue Ribbon Commission Report on Board-Shareholder Communications

3. Strategy. You may be wondering why strategy is on this list. Isn’t oversight of the organization’s strategy an inherent responsibility of the board?  The answer is still yes. However, in an increasingly dynamic climate, boards can no longer afford to take an annual “review and concur” approach to management’s strategy. Our 2014 Blue Ribbon Commission Report strongly recommends continuous board engagement with management in the strategy development, and course correction, process. Our members’ reaction to this new – and potentially radical – approach has been very positive, and we will continue to provide guidance on this topic in 2015.

Suggested NACD Resources:
– NACD Blue Ribbon Commission on Strategy Development
– The Board’s Role in Strategy: Interview with General Mills Director

Two final notes. Our NACD Directorship 2020 initiative, which puts a spotlight on the market disruptors that will impact companies in the years to come, continues to be very popular. We will hold three member-exclusive events again in 2015. Please be sure to register early as the sessions tend to sell out.

We are holding our inaugural NACD Strategy and Risk Forum in San Diego on May 12-13. The forum will include a full day dedicated to cybersecurity, with former Department of Homeland Security Secretary Tom Ridge as a featured speaker. Click here to learn more about this exciting new program.

Thank you for your membership. I wish you a successful year ahead and encourage you to continue to work with your dedicated NACD Concierge to identify the educational programs and topical resources to enhance your board leadership.

Ken Daly
Chief Executive Officer
National Association of Corporate Directors
Advancing Exemplary Board LeadershipTM

Proxy Season Paradoxes

June 19th, 2014 | By

As corporate fiduciaries, directors represent shareholders. But what should boards do when their sense of corporate good conflicts with resolutions advanced by specific owners? It is easy to say that boards need to do more to oversee risk, or to improve strategy, but without real-world testing, these statements become platitudes. Let’s take a look behind the headlines surrounding six recent proxy season conflicts—starting with five Fortune 500 companies (Bank of America, Darden, Staples, Target, and Walmart) and closing with a mid-market real estate investment trust (REIT) family (Ashford). In each case, boards have had to draw the line when confronted by special interests—while still respecting the rights and interests of all shareholders, including activists.

Please click on a company name above to go directly to the case study.

Bank of America: Of Accounts and Accountability

The issue. Is the board responsible for preventing honest administrative errors? On April 28, the Federal Reserve Board announced that it would require Bank of America Corp. to suspend planned increases in capital distributions and resubmit its capital plan. This requirement followed disclosure by Bank of America that the bank made an error in the data used to calculate regulatory capital ratios used in the most recent stress tests conducted by the Federal Reserve. The error was unintentional and, in comparison to the $2 trillion on the balance sheet, small. Nonetheless, the consequences became clear at the annual meeting on May 7, when the California State Teachers’ Retirement System (CalSTRS) pension fund voted against four of five members of Bank of America’s audit committee. “The shortcomings in processes and risk controls underscore the need to make the necessary changes to ensure this sort of issue does not arise again,” opined CalSTRS spokesman Ricardo Duran in an e-mailed statement to the Wall Street Journal. Yet only a minority of investors joined the California giant. Apparently, most investors shared the views of William Smead, chief investment officer of  Smead Capital Management in Seattle, who told the Wall Street Journal that the bank’s CEO Brian Moynihan “is a straight shooter” so his fund would “stay the course.” At the meeting, shareholders elected the full board for another term, approved all the management proposals, and rejected all four shareholder proposals; still, the CalSTRS campaign and commentary fired warning shots heard around the governance world.

The lesson. Boards cannot prevent error, but they can ensure quality of both processes and people. Clearly, this bank (like every institution) can continue to improve its controls. On the other hand, when management is willing to admit mistakes and act quickly, and the board has supported this progressive direction, it’s hardly time to change leadership.

Darden Restaurants (and Pfizer): The Right to Sell (or Buy)

The issue. Should cut-or-keep strategy be decided by boards and management or by shareholders? On May 16, Darden Restaurants Inc. announced a definitive agreement to sell its Red Lobster chain restaurant business and related assets, and assumed liabilities to Golden Gate Capital for $2.1 billion in cash. Red Lobster was failing and the board opted to sell it rather than turn it around. The deal will net Darden about $1.6 billion, of which approximately $1 billion will be used to retire outstanding debt. The deal is expected to close in early 2015 after necessary regulatory approvals. A week later, on May 22, Starboard Value, protesting the sale, put forward a full slate of candidates for Darden’s board of directors to be voted on at the company’s June 22 annual meeting. (Similar questions arose on the buy side at the Pfizer annual meeting on April 24 during the recently ended Pfizer bid for Astra-Zeneca.)

The lesson. Boards have a right to exercise judgment on whether a struggling company should turn around or sell off part of the business—or, conversely, whether a market leader should grow via merger. Analyst John Maxfield, writing about Red Lobster for the popular investment site Motley Fool, observed that turnarounds rarely succeed. He cited wise words from Warren Buffet, who wrote the following back in 1980: “When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.” The Darden board apparently believed that the fundamental economics of Red Lobster were unfavorable so they sold it. (On the buy side, the Pfizer board made a similarly justified strategic decision—not to let go of a division, but instead to chase, and subsequently let go of, a dream.)

Staples: A Matter of Discretion

The issue: Can the board justly exercise discretion in pay in order to retain executives during a turnaround? The Staples board believed so, and proceeded in good faith to pay accordingly, but shareholders disagreed. On March 3, the Staples board rewarded executives for their added workload in turning the retailer around by approving a “2013 Reinvention Cash Award.” The board also approved an extra reward cycle to retain executives and staff who had not received a bonus in two years due to dragging financials caused by the poor economy for consumer discretionaries. Institutional Shareholder Services (ISS), a proxy advisory firm, urged investors to reject the plan in their advisory “say-on-pay” vote at the annual meeting on June 2. ISS carries considerable influence in the proxy policy-setting and voting processes, and in this case apparently they did, as a majority of shareholders (53.64%) voted against the Staples plan. At that same meeting, 50.66 percent of shareholders cast advisory votes to split the chair and CEO roles at the retailer.

The lessonWhile directors should make every effort to comply with their policies when awarding pay, they should reserve and defend the right to exercise discretion; similarly, directors are the ones who should determine the independent leadership structure for their boards. When boards exercise compensation discretion, for example by making an award that did not appear in a plan, they need to clearly communicate early on their reasons for doing so. This is a key finding of the NACD Blue Ribbon Commission (BRC) on Executive Compensation, convened in 2014, as well as previous BRCs on the topic. Communication, not compensation, may be the core issue here. (Then again, communication of any point requires two parties—the speaker and the listener. In some cases, however, it simply may be that shareholders are unwilling to hear management’s reasons for a nonroutine pay decision.)

Target: Expecting the Impossible?

The issue. If a board knows that a particular risk exists and takes action to defend against it, are directors to blame if the defense does not function well enough to prevent harm? In mid-2013, anticipating hacker problems, Target began installing a $1.6 million malware detection tool made by the computer security firm FireEye; yet due to a break in the chain of alerts during the most recent holiday season, the defense did not work and Target suffered an attack at the height of the holiday shopping season. Subsequently—despite swift response to the problem (replacing the chief information officer and strengthening security)—ISS recommended that shareholders vote against 7 of the company’s 10 directors at the company’s June 11 annual meeting, urging rejection of the members of the audit and corporate responsibility committees. The day before the meeting, Luis Aguilar, a commissioner at the Securities and Exchange Commission, mentioned the Target incident in a speech at the NYSE, and observed that “effective board oversight of management’s efforts to address these issues is critical to preventing and effectively responding to successful cyber-attacks.” Shareholders did vote by a majority on June 11 to keep the full board, but concerns linger. More than 90 lawsuits have been filed against Target by customers and banks for alleged “negligence,” and they are seeking compensatory damages as well.

The lessonThe line between the board and management is still distinct, but it is no longer bright; it will vary by company, so it is up to each board to find it. IT risk oversight is not easy. NACD’s Director’s Handbook Series on Cyber-Risk Oversight recommends that boards approach cybersecurity as an enterprise-wide risk management issue, and encourages directors to understand the legal implications of cyber risk as they apply to their company’s specific circumstances. Boards can encourage them to build that arsenal. Meanwhile, boards can and should vigorously defend themselves against voting campaigns that would disrupt board continuity at the expense of various stakeholders, including not only shareholders but also employees and their communities.

Walmart: What Price Integrity?

The issue. Does the board have a right to invest heavily in building an ethical culture or should shareholders get more of that money? Sometimes it seems that boards are damned if they do and damned if they don’t. On June 6, Walmart shareholders voted to reelect the entire Walmart board, and to reject a proposal that would mandate a separate chair and CEO, among other votes. This vote occurred despite campaigns against the directors in March; both the CtW Investment Group (on March 19) and ISS (on March 25) issued reports critical of Walmart, recommending that shareholders vote against two existing directors, as well as the company’s executive compensation proposals. They claimed that the company failed to disclose information to shareholders regarding sums spent on investigations into alleged company violations of the Foreign Corrupt Practices Act. In fact, Walmart did publish a global compliance report with details on its programs, so the main reason for the critique seems to be the amount of money spent on compliance. Randy Hargrove, a Walmart spokesperson, has assured the public that “[t]he board has authorized whatever resources are necessary to get to the bottom of the matter.”

The lesson. Boards have the right and, one might argue, the obligation to invest resources to ensure ongoing efforts to improve compliance and integrity. Global companies have many employees and agents to oversee. Policies can go only so far. Perhaps the best guidance here comes directly from the classic Delaware Chancery Court decision in the Caremark case (1996) in which Chancellor William Allen, finding in favor of a defendant board in an insurance kickback case, held that a board as part of its duty of care has an obligation to “exercise a good faith judgment that the corporation’s information and reporting system is in concept and design adequate to assure that appropriate information will come to its attention in a timely manner as a matter of ordinary operations.” If a board fulfills that requirement, its oversight should be praised rather than condemned.

Ashford: A Tale of Two REITs

The issue. Who gets to determine governance—the board or shareholders? The recent history of the Ashford REIT complex provides a real-world laboratory for the issue. It all started in February when the Ashford Hospitality Trust (AHT) board amended AHT bylaws to require board approval of any future bylaw amendments. (Previously, AHT bylaws could be amended by shareholders without board approval.) One reason for this amendment is that the AHT board wants the company to remain under the protection of the Maryland Unsolicited Takeover Act (MUTA). The AHT board also voted to increase the number of shares required to call a special meeting of shareholders. In response, ISS called on shareholders to withhold votes for all but one director at the annual meeting on May 13. At that meeting, all directors were voted in by a majority of votes cast, despite a high amount of negative votes for the targeted directors. Earlier, shareholders of an AHT spin-off, called Ashford Hospitality Prime (AHP), which is advised by AHT, approved two proxy proposals submitted by Unite Here, a union representing workers in the garment and hospitality industries. AHP shareholders voted by a majority of 68 percent to have the company opt out of MUTA—a result that the AHT board hopes to avoid. So far the board of AHT is holding firm in favor of takeover protections and remaining under MUTA protection, unlike its AHP spin-off.

The lesson. Within the bounds of legal compliance, governance is a responsibility of the board, not the shareholders. So when it comes to preserving corporate independence, boards need not give up their corporate shields just because activists accuse them of being too defensive. This may well be a case of rhetoric versus reality. When the MUTA was passed 15 years ago (in 1999), the Baltimore Business Journal hailed it as good for investors: “Corporate takeover bill protects stockholders,” read the news item. In an editorial detailing the law’s provisions to a painstaking degree, the Baltimore Business Journal concluded: Some public commentary on the takeover bill has mistakenly suggested that it takes away all obligations directors have to stockholders. To the contrary, unlike Pennsylvania’s corporate law, which is highly pro-management and provides no relief to investors or stockholders in Pennsylvania corporations, Maryland law now provides some increased procedural advantage to and greater flexibility for directors, while preserving the primacy of stockholder value and providing an escape valve from the most troubling provisions for future investors in Maryland corporations. It seems that with the passage of time, and inattention to statutory language, the anti-MUTA myth has risen again. We will watch this case for further developments.

Conclusion

These developments have involved different issues—financial planning, mergers and acquisitions, compensation, cybersecurity, internal controls, and takeover protection. Nevertheless, these developments point to the need for ongoing director education on risk oversight in all of these areas, not just in a classroom, but also on the job, and with more active monitoring. These stories also show the value of understanding the evolving expectations of governance itself. As directors face increasing pressures to continually know more and do more, they can strive to improve, yet at the same time recognize the intrinsic limitations of the board’s role. Directors should also seek to provide investors with information on the context and rationale behind the board’s decisions, as part of the company’s overall shareholder engagement and communication program. This close look at current struggles has yielded important lessons—and guidance for an ever-challenging future.