2008 Directors Forum

On June 25, 2008, Faegre & Benson llp and the University of Minnesota Law School sponsored the 2008 Directors Forum, a one-day conference for directors and general counsel held at the Minneapolis Club in downtown Minneapolis. The forum focused on business and legal issues facing boards of public companies and on corporate governance best practices. Eligible attendees received 3.75 hours of continuing legal education credit and 5.0 hours of Institutional Shareholder Services director education credit. This article summarizes the remarks of the keynote speaker and the findings of the panel discussions.—Ed.

"Corporate America is in great difficulty. It is being skewed away from funding investment in the future to focus on short-term gain."

This was no critic of capitalism speaking. It was Martin Lipton, a founding partner of the New York-based law firm Wachtell, Lipton, Rosen & Katz and one of the most prominent corporate lawyers in the United States. Lipton, the keynote speaker at the 2008 Directors Forum, is also an unabashed fan of the American corporation. "It was the public corporation that created the industrial base of America, the businesses we have today," he said. And the corporate board of directors—a collection of advisors with extensive business knowledge and experience who helped guide the corporation—played the central role. Both are under threat, Lipton warned.

"The Eclipse of the Public Corporation"

Lipton titled his address "Shareholder Activism and the ‘Eclipse of the Public Corporation': Is the Current Wave of Activism Causing Another Tectonic Shift in the American Corporate World?" He borrowed the phrase in quotes from a 1989 article in the Harvard Business Review that, in Lipton's words, "postulated the end of the public corporation as we know it." At the time, he noted, Harvard Business School Professor Michael Jensen suggested that public corporations would respond to a series of huge takeovers by moving to private ownership because that was the only way they could plan for and build long-term equity and profitability.

Now different forces are at work, Lipton said. He cited a series of corporate crises—and responses to crises: Enron, the collapse of the Internet bubble, Congressional hearings, Sarbanes-Oxley. Most recently, "the sub-prime financial crisis has significantly altered the corporate landscape," he said.

Lipton identified two forces in particular as causing the tectonic shift to which he alluded in his title:

• Institutional investors wield enormous influence over corporations, pushing governance measures such as shareholders having a "say on pay" of top executives and majority voting for corporate directors. Yet academic research cited by Lipton has concluded there is no consistent relationship between ratings that evaluate governance practices and corporate performance.
• A relative handful of activist hedge funds wield a disproportionate amount of power, essentially holding corporations hostage and pressuring them to make decisions that yield short-term profits for investors but damage or even destroy the company. "The power of these activist hedge funds is enormous," Lipton said. They are, in large measure, "able to dictate business strategies to corporations."

These and other forces—including the regulatory requirements of Sarbanes-Oxley—have had a dramatic impact on corporate boards, and on corporations themselves, according to Lipton. On a structural level, there has been a shift to "procedural" boards, which are concerned first and foremost with making sure public companies follow rules. "What we've done is skew the basic function of the board of directors from providing advice and shaping strategy to compliance," Lipton said. "We've transferred too much influence to stockholders."

"The pressures exerted by new and stronger governance and compliance duties," Lipton said in a written version expanding upon his remarks, "have been pervasively eroding the centrality of the board and transforming its role in the governance structure of public companies, with the end game being a new conception of the corporate organization…In short, the crux of the issue today is whether the institution of the corporate board, the members of which exercise their business judgment in the management of the corporation, can cope with shareholder activism and survive as the vital governing organ of the public corporation."

These effects are not benign, Lipton warned. "The realization of a short-term profit in the stock market doesn't necessarily benefit shareholders over the long term," he said. "…Boards are increasingly vulnerable to pressures to realize short-term share price gains and other agendas at the expense of long-term value creation."

Lipton had recently visited China, he told the meeting, where state-owned companies "are not plagued by activist shareholders." They don't have to focus on short-term stock prices to appease investors. "Our companies are not going to be able to compete if they are not able to think about the long term," he warned.

The Panel Discussions

With Lipton's provocative address as a starting point, 21 panelists pondered and sometimes debated the themes he had touched upon—and much more. While there was little disagreement with his basic assessment—that American corporations are facing enormous challenges—no one was ready to surrender.

The panelists had confronted those challenges personally. They had led mature companies and started new ones, founded companies and taken them public, helped buy and sell others—in one case, SuperValu's mammoth $11 billion purchase of Albertsons. They had advised companies under pressure from hedge funds, struggled to handle a CEO's indictment, and wrestled with lawsuits involving executive compensation.

The panelists spoke of a "post-SOX" world. The subprime mortgage crisis was omnipresent.

But so was the belief that there is still a need for strong, effective—and ethical—leadership at the top of American corporations: While the board of directors as an institution may be under threat, it is no less essential. "The tone at the top may be the most important element [in a company's success]," one panelist said. "It establishes the culture of the entire company."

And that leadership must focus on the long term: "The real representative boards spend their time looking out at the five-, ten-year horizon," one speaker said.

Said an executive: "We talk about strategy all the time. We're always talking about strategy for the company."

Communications and Decision-Making in the Board Room

Participants: James T. Hale, retired Executive Vice President, General Counsel and Corporate Secretary of Target Corporation; Lee R. Mitau, Executive Vice President and General Counsel of U.S. Bancorp; William T. Monahan,
Retired Chairman, President and Chief Executive Officer of Imation Corp. The discussion was moderated by
W. Morgan Burns, a partner in
Faegre & Benson's corporate group.

The essence of this discussion was captured by one panelist, who recommended a "Goldilocks" strategy of providing information to a company's board of directors: "not too little…and not too much"; the amount "has to be just right." With the right amount and kind of information, others said, a board can keep its eyes on the prize: Devote its time and energy to discussing strategy and fundamental issues facing the company.

What are the characteristics of an effective board chair? A good chair, one panelist noted, must know how to solicit input from others—without allowing the discussion to become a free-for-all. A good chair must be in sync with the company's CEO. The advice, in a nutshell: "Lead with a velvet glove."

The Role of Directors in Strategic Planning

Participants: James P. Dolan, Chairman, President and Chief Executive Officer of Dolan Media Company;
Joseph T. Dunsmore, President,
Chief Executive Officer and Chairman of Digi International Inc.;
Pamela K. Knous, Executive Vice President and Chief Financial Officer of SuperValu Inc.; John H. Matheson, Melvin C. Steen and Corporate Donors Professor of Law, University of Minnesota Law School. The moderator was Steven C. Kennedy, a partner in Faegre & Benson's corporate group.

The law does not clearly distinguish between the role of a public company's management and its board of directors. In practice, however, the panelists agreed, an effective board is a policymaking group with strategic responsibility for the company. As such, it must be involved in key decisions, such as acquisitions and assessing and guarding against risk. With fierce competition for executive talent, and with public attention heavily focused on executive pay, one of a board's most important duties is to determine how much to pay top executives, one panelist noted.

The board's responsibility is broad. "As a board member, you better know what's going on," suggested one panelist. "Because ultimately, if things go wrong, the buck stops at your door."

"They push us," said one executive, praising his board. "A quiet [board] meeting is not a good meeting."

Another key comment: "We talk about listening as being in the DNA of the company. You must be willing to be changed. Listening is key."

Developments for Board Committees

Participants: Janet M. Dolan, President of Act 3 Enterprises and the retired President and Chief Executive Officer of Tennant Company; Michele J. Hooper, Managing Partner and Founder of the Directors' Council; Thomas L. Strickland, Executive Vice President and Chief Legal Officer of UnitedHealth Group. Amy C. Seidel, a partner in Faegre & Benson's corporate group, moderated.

With the changes wrought by Sarbanes-Oxley and other new regulations has come a greater emphasis on board committees. That change, Martin Lipton noted, is not always benign, as it can lead to "balkanization" and have "a corrosive impact on collegiality."

Compensation committees are at the epicenter of change. "Executive compensation is probably the hot topic in the area of corporate governance," commented one panelist. Said another: CEO pay is "a lightning rod issue."

For audit committees, the assessment of risk is "the number one issue." And yet, the assessment of risk can itself be risky—a potential road map for litigation. But that comment prompted a spirited response: "We either have to do a good job, and be ready to defend ourselves, or don't [serve on the board]."

Still, there was more consensus than disagreement. With an increased emphasis on committees, communication is more essential than ever, both among committees and with management. And some tasks are too important for any one committee. "We are engaged in talent development [of top managers]," one panelist said. Noted another: "At almost every turn, we have discussions of where we stand with CEO succession."

Handling Crises Involving the CEO

Participants: John L. Sullivan, Senior Vice President, General Counsel and Corporate Secretary of Imation Corp.; John P. Whaley, Managing Administrative Partner of Norwest Equity Partners. Moderator Douglas P. Long is a partner in Faegre & Benson's corporate group.

Members of this panel had first-hand experience with the sort of crises that truly challenge corporate directors—in one case, fraud by a CEO and other executives; in another, a CEO's sudden illness and death. Such "shocks to the system" highlight the role of emotion in business. "So much of what a board does depends on the strength of personal relationships," one person said. A crisis tears at the fabric of relationships.

To some degree, structural safeguards can help protect a company. Directors must have opportunities for frank, informal conversation with senior managers. Good independent directors play a watchdog role.

But no safeguard is 100 percent effective. "The lesson for me," said one speaker, "is that if the top people in a company want to commit fraud, they most likely will be able to commit fraud—for a period of time."

When a CEO becomes terminally ill, the challenge is radically different. How much should the board disclose? When? How? And empathy, rather than anger, is the dominant emotion. "There is no class in law school that teaches you how to [respond to this kind of challenge]," one participant said.

Responding to Activist Shareholders

Participants: Charles M. Osborne, Executive Vice President, Chief Financial Officer of Fair Isaac Corporation; Steven A. Rosenblum, Partner, Wachtell, Lipton, Rosen & Katz; Judith Wilkinson, Partner, Joele Frank, Wilkinson Brimmer Katcher. The moderator was Philip S. Garon, a partner in Faegre & Benson's corporate group.

Had this forum been held only five years ago, Garon noted in his introductory remarks, activist hedge funds would not even be on the agenda. Their rise, with their focus on short- and mid-term profits from stock price increases, dividends and stock repurchases, represents a major change for public corporations.

Often, the voting power of activist hedge funds exceeds their economic stake in a company or their economic stake actually exceeds their stock ownership through the use of derivatives. These disparities between share ownership (and consequently voting power) and economic risk were not envisioned under our existing legal framework, according to one panelist.

Activist hedge funds and corporate governance activists use some of the same strategies. Characteristics of companies that frequently attract activist hedge funds include significant cash holdings; depressed stock prices; and the operation of multiple businesses, one or more of which could be sold. One panelist noted, however, that some activist funds also hold substantial equity positions in successful public companies with few of these characteristics.

When an activist hedge fund invests in a company, management and directors must make crucial decisions about whether, when and how to meet with fund representatives. One panelist observed that activist hedge funds may be among a corporation's largest shareholders, which must be taken into consideration.