Gretchen Morgenson

Fair Game: Members of the Board Rarely Walk the Plank

You might think that board members overseeing businesses that cratered in the credit crisis would be disqualified from serving as directors at other public companies.

You would, however, be wrong.

Directors who were supposedly minding the store as disaster struck at companies like Countrywide Financial, Washington Mutual or Fannie Mae have not all been banished from other boardrooms. In many cases, directors just seem to skate away from company woes that occurred on their watch.

To some investors, this is an example of the refusal of those involved in the debacle to accept responsibility for it. Whether you are talking about top executives loading up on leverage, regulators who slept while companies took on titanic risks or mortgage lenders that made thousands of dubious loans, few in this crowd have acknowledged culpability. Taxpayers and shareholders, meanwhile, who had nothing to do with the problems, are left holding the bag.

“None of these directors have stood up and said, ‘We made a mistake here by not calling management to account,’ ” said Paul Hodgson, senior research associate at the Corporate Library, a corporate governance research company. “They have certainly avoided the limelight as far as blame is concerned.”

Moreover, they continue to get work as directors at other companies.

This is not to say that these directors are not performing their duties. Indeed, some would argue that directors who have witnessed at close range the collapse of a company may learn a great deal from that experience and bring to their boardroom activities an increased sense of responsibility. But it is hard to blame shareholders for wondering whose side directors are on, given the broad failures by many board members to recognize and rein in risk-taking at so many companies.

As fiduciaries for the owners of the companies on whose boards they serve, directors have a duty to act in shareholders’ interests. After all, they are the shareholders’ representatives, and they are charged with ensuring that their companies are operated soundly and with long-term profitability in mind. Yet it doesn’t always seem to work out that way.

Frederick E. Rowe, president of Investors for Director Accountability, a nonprofit shareholder advocacy group, said, “Here’s a conversation you’ll never hear: ‘Yes, I get paid $475,000 a year. I play golf with the CEO; he’s a personal friend. I go to interesting places for board meetings, I am around interesting people, and I would never say one word that would jeopardize my position on the board.’”

The main reason for director dysfunction is that board members have little fear of being fired for incompetence or sleepwalking through meetings. Because of the way director elections are structured, board members can win their seats if they receive just one vote of support. And even if a majority of shareholders withholds support from directors at annual elections, the directors who are singled out are often allowed to stay.

Shareholders interested in ousting a director or two must mount an expensive proxy fight to do so.

There is movement afoot to change this arrangement. The US Securities and Exchange Commission has proposed new rules that would give large shareholders a way to replace incompetent directors with their own nominees. Two weeks ago, the SEC reopened its comment period for these rule changes.

But the proposal has too many limitations, shareholder advocates say. For example, only those who have owned a stock for one year and who hold a stake of at least 1 percent in a big company may have their director nominees included in a company’s proxy materials and submitted to a shareholder vote.

“It’s a step forward, but a pretty embarrassingly baby step,” said John Gillespie, a former investment banker who, with David Zweig, is joint author of “Money for Nothing,” a forthcoming book on board failures. “The bigger problem is the culture of boards, which doesn’t allow directors to do an effective job even if they wanted to.”

Solutions to the culture problem, he said, would include instituting term limits for directors, in order to keep fresh blood circulating on a board, and separating the roles of board chairman and chief executive.

Most important, Gillespie said, US shareholder groups holding 10 percent stakes in companies should have the right, as they do in Britain and other countries, to call special meetings. Then and there, they could jettison directors who are seen as not doing their jobs.

“The reality of our human nature is to pay more attention to people who can fire you than to those who can’t,” Rowe said.

Even though the stock market has performed well this year, Hodgson of the Corporate Library says he thinks that many directors will face significant opposition, albeit still toothless, from shareholders at annual elections in 2010.

“I think we are going to see some of the highest levels of either ‘no’ votes where companies have a democratic process or withhold votes,” he said. “People were at fault there, and saying that nobody could have predicted it is not an excuse. If you are on the board, you have the responsibility to find those things out and not just believe what management is telling you.”

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