Boardrooms: The Ties That Blind?Linda Himelstein
It has been more than a year since Weirton Steel Corp. employees began their uphill battle to oust Harvey L. Sperry from Weirton's 13-member board. But in a dramatic showdown on Apr. 13, the employees, who own 77% of the company's stock, finally got their way. Sperry withdrew his renomination bid to avoid a threatened war over a vote on a vital stock offering at the May 26 annual meeting.
Why all the fuss over Sperry, a well-respected 64-year-old attorney who has served the steelmaker since 1984, both as lawyer and director? Conflict of interest, employees charge. It was bad enough that Sperry's law firm, Willkie Farr & Gallagher, was collecting more than $1 million a year to handle Weirton-related matters. But at the same time, the firm represented about 20 foreign steelmakers--sometimes in trade disputes against Weirton. "It's hypocritical to represent both sides," says Frank Slanchik, president of the Employee Shareholders' Assn. "If we're going to have an independent director, we want one who's really independent."
CEO Herbert Elish, reversing months of unwavering support for his longtime confidant, seems to agree. "If they're getting substantial fees from management, they can't be independent," he says. Weirton will now abide by a policy that bars anyone with financial ties to Weirton from serving on its board. "The objective was to put the company into a position where the parties could join together to seek approval of issuing common stock," says Sperry, noting that "conflicts arise all the time" when firms as large as his represent so many different clients.
What happened at Weirton is a sign of the times--a likely preview of what's to come for many companies that routinely name their trusted lawyers, bankers, or business advisers to directorships. For years, companies have been under fire to get corporate insiders off their boards. But as the 1994 proxy season swings into high gear, the heat is on from shareholder groups, courts, regulators, and insurers to do the same for so-called affiliated directors who do business with the companies they serve.
Already, companies such as Time Warner Inc. and Salomon Brothers Inc., under intense pressure from disgruntled outsiders, have unraveled the close-knit circles they once cultivated. Should that movement gain momentum, the impact could be immense: A review of 1993 proxy statements by the Investor Responsibility Research Center, a group that follows shareholder issues, shows that more than half of the companies in the Standard & Poor's 500-stock index, including Motorola, Occidental Petroleum, and Coca-Cola, have directors whom they also tap for professional services. "This is where the law is going," says Harvey L. Pitt, a lawyer who advises boards. "The burden on directors and professionals is going up."
One compelling reason: lawsuits. Roughly 300 U.S. companies last year were hit with 713 claims against directors and officers--23% more than just five years ago, according to a study released in February by Wyatt Co., a Washington consulting firm. Companies with more than $1 billion in assets experienced the greatest jump, with claims up 53% since 1987. The survey's author, Phillip Norton, predicts that one in four companies will face board-related litigation this year, much of which will include conflict-of-interest issues.
HILLARY'S HAUL. At the heart of these and other actions is the belief that some directors are simply too cozy with management, either because of personal loyalties or their reliance on company-related business, to be independent. Exacerbating the problem, critics say, is that the public is often in the dark about how much directors or their firms are paid for professional services, since companies aren't legally required to disclose fees unless they exceed 5% of a director's firm's gross revenues.
When they do, it can raise red flags. Hillary Rodham Clinton, for example, has been criticized for using her board seat at TCBY Enterprises Inc. to steer $1.2 million of business to the Rose Law Firm in 1991-92. "If you have a self-interest then, by necessity, you can't be looking after shareholder interests with the proper degree of objectivity," says Melvyn I. Weiss, a lawyer who represents shareholders.
Many executives don't see it that way. They argue that affiliated directors pose little risk of conflicts and instead offer valuable insights into the running of the companies they serve. Besides, taken to its extreme, the notion of directorial independence would all but eliminate some of the most qualified candidates. Says Curtis H. Barnette, CEO of Bethlehem Steel Corp., which employs the law firms of two of its directors: "It would be regrettable indeed to preclude people from rendering important service because of a personal relationship with the company."
Regrettable, maybe. But the courts are beginning to suggest otherwise. In the tussle for control of Paramount Communications between Viacom and QVC Network, the Delaware Chancery Court blasted Paramount's 14 directors last November for virtually rubber-stamping the wishes of Chairman Martin S. Davis, who backed Viacom, without adequately assessing QVC's competing bid. "The board simply followed management's lead in rejecting the unwelcome offer," the court wrote. A possible explanation for directors' alleged passivity is their ties to Davis or the company. One director was a partner at Lazard Frres & Co., Paramount's investment advisers; two were Davis' longtime friends; and three were Paramount employees. The ruling ultimately cost Viacom almost $2 billion more for the deal.
Regulators and institutional investors are also getting into the act. The Internal Revenue Service, under a tax law enacted this year, states that any director receiving compensation from a company above minimally-set amounts, are not independent, thus precluding companies from claiming certain tax deductions. The New York Stock Exchange doesn't consider directors independent if they simultaneously act as advisers, consultants, or lawyers for a company on an on-going basis. And the Teachers Insurance & Annuity Assn.'s College Retirement Equities Fund (TIAA-CREF) recommends that not only should boards consist of a majority of independent directors but that key committees have only unaffiliated outsiders.
Under TIAA-CREF's standard, a company such as Occidental Petroleum Corp. wouldn't pass muster. Of its 13 directors, 8 are either directly employed by the company or receive fees for professional services. Director Louis Nizer's law firm collected $12.5 million in the last two years. Arthur Groman's law firm received $4.7 million. As for Occidental's compensation and nomination panels, Groman chairs them both. Occidental did not return calls.
Such corporate behavior raises concerns about independence. "You need to have people who ask the critical questions," says Richard H. Koppes, general counsel of the California Public Employees' Retirement System, the powerful institutional investor. After complaints from CalPERS and others about an overall lack of accountability, Time Warner has gone from having a majority of insiders and affiliated directors on its 15-member board to just two corporate insiders and no affiliated directors.
Now, institutional investors are proposing resolutions to force Advanced Micro Devices Inc. to appoint more outsiders to its six-member board and only outsiders to key committees. The plan would eliminate CEO W.J. Sanders III from the four-person nominating committee and possibly Joe L. Roby, a managing director of Donaldson, Lufkin & Jenrette Securities Corp., and R. Gene Brown, a managing director at the economic consulting firm of Putnam Hayes & Bartlett Inc. (Both firms have worked for AMD.) The company opposes that proposal, and the one for more outsiders on the board, arguing that the definitions of what constitutes an outsider are too restrictive. Besides, AMD is planning to expand its board by two members, which it says would give outsiders a five-to-three majority.
Most companies echo AMD's position. Michael D. Eisner, chairman and CEO of Walt Disney Co., maintains that any conflict arising from Director Robert A.M. Stern, a prominent architect who has been on the board since 1992 and has earned $2.3 million from the company in the past three years, could be easily handled within Disney. Stern has worked on several multimillion-dollar Disney projects, including a Wild West hotel at EuroDisney. "He's an extremely talented man, and it would be foolish not to use his talents for the benefit of this company," says Eisner, noting, however, that Stern is unlikely to get new Disney contracts while on the board.
MUCH ADO? AMR Corp., with three affiliated directors on its 13-member board, says it has no intention of booting anyone just because critics don't like the way it looks. "You could create a situation where no one but retired people and people from nonprofits could sit on your compensation committee," says AMR's Al Becker.
Like the companies, many directors believe the current furor is overblown. Lester Pollack, a Paramount director and a partner at Lazard Frres, the adviser on the Viacom deal, says conflicts are easilynies, many directors believe the current furor is overblown. Lester Pollack, a Paramount director and a partner at Lazard Frres, the adviser on the Viacom deal, says conflicts are easily avoided. "When it becomes an issue of conflict, one abstains from the potential conflict," says Pollack, adding that his link with Lazard never impeded his ability to be independent on merger-related matters.
Such self-policing generally goes unchecked--so long as companies remain profitable. But when trouble begins brewing, perceived conflicts can pose serious liability problems. "When I see a board not doing its job, these are the first things I look for," says shareholder activist Nell Minow, a principal with LENS Inc., an investment firm in
LENS is now on the warpath against Stone & Webster Inc., a New York-based engineering and construction firm that LENS believes is underperforming in part because it relies too heavily on insiders to govern the company. Among the 12 directors are three insiders and at least two affiliated directors, including Fred D. Thompson, who earned $134,000 in legal fees in 1993, and Kent F. Hansen, a Massachusetts Institute of Technology professor who made $61,000 in 1993 for consulting. "It's a question of where you stand and where you sit," says Minow. "And we want these people to sit a little farther apart."
William F. Allen Jr., Stone & Webster's chairman, concedes that his company isn't performing as well as it should. But he says the cause is unrelated to the board's makeup. "We disagree that some magical change of the corporate board will make the company profitable," says Allen. Moreover, Allen and President Bruce C. Coles have confidence in the autonomy of these directors--a belief that has led them to reject LENS' requests for alternate candidates for directorships.
While Stone & Webster battles it out with LENS, some companies, insurers, and trade groups are moving to address the conflict-of-interest dilemma. Insurance carriers have begun discouraging professionals from serving as directors for client companies by excluding certain coverage from liability policies. Home Insurance Co., for instance, denies professional liability coverage to attorneys for work they do for companies on whose boards they sit.
ACTION WITHIN. Even directors are taking action. The National Association of Corporate Directors, a 17-year-old trade group in based Washington, discourages members from serving on the boards of companies that are their clients. "A company should never put its investment banker, commercial banker, or attorney on its board," says John M. Nash, president of the group.
General Motors Corp. in March published a series of 28 nonbinding guidelines aimed at giving its outside directors more control, including in such matters as choosing new directors and reviewing senior executives' performance. GM's board was publicly harangued in the late 1980s for its lack of independence under former CEO Roger B. Smith.
These efforts are important defensive measures in a world of greater public scrutiny. But are they enough? For the most part, when companies disclose in their proxy statements the various business relationships they have with individuals on their boards, the statements often don't reveal how much money is being received by the firms of the affiliated directors. Until companies are forced to be more forthcoming about their ties to their directors, shareholders and others will be hard-pressed to tell how beneficial--or detrimental--these relationships can be.