Will Directors Morph Into Corporate Constables?

Two years after a wave of scandals swept Corporate America, many executives complain that they've got their hands full satisfying demands for accountability by increasingly pesky institutional investors and fulfilling the stricter auditing requirements imposed by the Sarbanes-Oxley Act.

But there's no rest for the weary. Execs may soon be getting an additional barrage of questions from their directors. Thanks to new federal sentencing guidelines, boards will be expected to do a far more thorough job of ensuring that no laws are being broken. The new rules, ordered up by Congress under Sarbanes-Oxley and to take effect on Nov. 1, are just now starting to catch the attention of corporate counsels. Essentially, they will boost minimum standards for corporate legal compliance -- and put directors in the position of policing whether a company is doing all it can to meet them. "This is a new obligation for board members that I don't think many people see coming," says Michael W. Peregrine, a Chicago-based partner at law firm McDermott, Will & Emery.

Will the new sentencing guidelines have their intended effect? After all, previous reforms haven't much changed corporate behavior. Since current standards for self-policing are vague, many executives have gotten away with following them in form, not substance. This time, though, the reforms may make a big difference by assigning specific oversight tasks to directors.

Oddly enough, the tougher scrutiny of corporations emanates from the U.S. Sentencing Commission. The federal agency is best known for guiding judges to set consistent prison terms. In May, the USSC posted new guidelines directing judges to impose larger fines on companies found guilty of wrongdoing if directors did not adequately try to detect and prevent crime.

The change is meant to spur directors to take back board powers ceded over the years to managers. Existing USSC guidelines require companies only to have legal compliance plans; it isn't concerned with who oversees them. As a result, some compliance plans were shams. Enron Corp. had a 64-page code of conduct highlighted in company videos by former Chief Executive Jeffrey K. Skilling, while Tyco International Ltd. (TYC ) was a member of the leading ethics officers association. "You really need a big, strong player to deal with senior executives," says Andrew W. Singer, publisher of Mamaroneck (N.Y.)-based compliance journal ethikos. "Who is there but the board?"

The new guidelines require that all directors know exactly what their corporation is doing to stop crimes inside the company. That means they'll have to attend briefings and be expected to ask tough questions. Then they or their audit or compliance committees will have to check annually with the folks who run the compliance programs to see if the systems are working properly. They also will have to keep a wary eye on the changing business and legal climate, in order to spot danger areas that might tempt an unscrupulous exec to step outside the law.

The hope is that by setting the bar higher, directors will have stronger incentives to keep tabs on how well the compliance folks are doing at preventing bad behavior. But skeptics abound. They note that the USSC standards apply only to corporations, not board members. They can't make directors do anything they don't want to do. Directors can be sued by shareholders for failing to abide by the standards, but they never personally pay money in lawsuits. Judgments and settlements are always covered by the companies and insurance. Says Lawrence A. Cunningham, law professor at Boston College: "The guidelines will have no effect."

Not everyone harbors doubts. Gregory J. Wallance, a member of a USSC advisory group and a partner at law firm Kaye Scholer LLP, says that view downplays society's rising expectations of directors. "Notwithstanding director and officer [insurance] policies, directors don't want to be sued" for not taking basic precautions, says Wallance.

So now it's up to directors to decide whether to make perfunctory checks while patrolling their new beats, or act like the smart cops shareholders want.

By David Henry in New York

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