January 12, 2007

Directors: The Retirement Age Dilemma

Poor Home Depot. After its botched annual meeting last year and lavish executive pay – not to mention poor stock performance – it looks like it’s now easy game for the mass media on lesser issues. On Wednesday, the NY Times ran this article skewering the company’s board for waiving age limits for three of its directors. Given the apparent roles of these three directors in setting former CEO Nardelli’s lavish pay, there appears to be a basis for the attack.

But generally, I don’t believe in age limits for directors in all cases – some of the most productive directors can be those with the most age (and experience). In our “Board Composition” Practice Area, I have had a number of FAQs on age limits posted for some time including this one:

Should boards have age limits for their directors?

Most experts believe yes – unless the company truly believes it has a sound director evaluation process. If a board develops an effective process for evaluating individual directors, it may not need mandatory retirement guidelines – but if a board does not have a sound evaluation process, a mandatory retirement age should be considered.

Retirement ages vary between 70 and 75. Some companies allow the board to waive the retirement age for certain directors. Although a waiver may allow a company to keep a director who is quite valuable (and even become more valuable as more experience is garnered), this might be difficult to administer as some directors might wonder why they were not granted a waiver. Or even worse, a board may become divided over whether to grant a waiver to a particular director.

A possible solution is to grant limited waivers so that directors serve for just one more year. But this still could cause the problems noted above, without providing much in the way of a real benefit if the affected director is a true asset.

Proponents of mandatory retirement ages and term limits argue that they serve to bring fresh outlooks and perspectives to boards by periodically forcing a board to replace directors. Proponents also contend that directors who serve on a board for many years may be less independent from management and, as a result, less of an advocate for shareholders. In addition, retirement ages for directors can provide boards with a way of getting non-performing directors off the board without having to ask for a director’s resignation.

The bottom line is that most experts believe a bright line test can save boards from serious interpersonal issues that inevitably will cost a lot of invaluable time and energy and could cause permanent divisiveness on the board.

ISS generally recommends that investors oppose management and shareholder proposals to impose mandatory age limits or term limits on directors. ISS notes in its U.S. Voting Manual: “[A] mandatory retirement age sends the message that older directors cannot contribute to the oversight of the company. Although establishing a retirement age or limiting the number of times a director may be elected to the board provides a mechanical or ‘bloodless’ means for addressing a real or potential performance issue with a director, it does not take into consideration the fact that a board member’s effectiveness does not necessarily correlate with the length of his board service or his age. Time served is not a substitute for a thoughtful and rigorous board and director evaluation process, which is a better determinant of a director’s fitness for service.”

Carl’s Corner: Back in Business!

Finally got my act together and have started adding more wisdom from Carl Schenider of Wolf Block in “Carl’s Corner”. In this month’s installment, Carl tackles preferred stock features.

SEC’s Chief Accountant Backs Shielding Auditors From Lawsuits

Vineeta Anand of Bloomberg continues to do some great investigative reporting, including this story based on an interview with SEC Chief Accountant Conrad Hewitt:

“The U.S. Securities and Exchange Commission’s top accountant said he supports a proposal to shield public-company auditors from liability if they fail to detect fraud because shareholders won’t be protected should lawsuits force more accounting firms out of business. ‘We would like to see the remaining `Big Four’ firms remain as auditors for companies,” SEC Chief Accountant Conrad Hewitt said in an interview. ‘It helps investors. We would also like to see the second-tier and third-tier firms remain financially solvent.”

Most of the largest U.S. companies are audited by either PricewaterhouseCoopers LLP, Deloitte & Touche LLP, Ernst & Young LLP or KPMG International. Arthur Andersen LLP, formerly the world’s fifth-biggest accounting firm, shut down in 2002 after being convicted of obstruction of justice in the federal government’s investigation of fraud at Enron Corp.

Glenn Hubbard, a former White House economic adviser who’s dean of Columbia University’s business school, and former Goldman Sachs Group Inc. President John Thornton in November called for limits on auditor liability as part of a campaign to make U.S. financial markets more competitive. The group they lead, the Committee on Capital Markets Regulation, wants to ease provisions in the 2002 Sarbanes-Oxley Act that put more of an onus on auditors to detect accounting mistakes and fraud, making them more vulnerable to shareholder lawsuits in future Enron-like scandals. ‘We certainly don’t want to have another Arthur Andersen failure,” Hewitt said.

Mark Olson, chairman of the Public Company Accounting Oversight Board, said in a separate interview that Congress should set policy on protections for auditing firms. ‘Liability exposure is a significant management issue for firms,” he said. The six biggest accounting firms, which also include Grant Thornton LLP and BDO International, said in a Nov. 7 report that regulators should penalize individuals, rather than entire organizations, for faulty audits or misconduct.

SEC Deputy Chief Accountant Zoe-Vonna Palmrose, before joining the agency, wrote in a 2005 academic paper that lawsuits by public-company shareholders “undermine the stability of even the largest audit firms.” She suggested establishing a new government office to review whether accountants should be culpable for securities violations.

Hubbard and Thornton’s committee, which is backed by U.S. Treasury Secretary Henry Paulson, said Nov. 30 that Congress can prevent ‘damage awards against audit firms and their employees at a level that could destroy a firm.’ The SEC in December proposed changing the provisions for business-practice audits under Sarbanes-Oxley to reduce costs for public companies.”