The Board Challenge of the Dominique Strauss-Kahn Affair

Newspapers and blogs have been  full of reports on the Dominique Strauss-Kahn affair, but there is an important corporate governance aspect that has hardly been voiced. It has a wider application than this one incident or this one news-story; it is the question of what a board should do about reports of a sex-pest who occupies a senior role in their organisation.

DSK is clearly innocent until the result of his trial is known; but this is a general question. Has the board of the IMF done what it should? What, generally should boards do? They are at risk if they do nothing. They risk damage to their reputation but also possibly financial damage if they owe a duty of care to a complainant who can show that they knew or should have known what was going on and failed to act.

The IMF is a special case, where the Managing Director (DSK) is also chair of the board, reporting to a board of governors comprising nominees from shareholding countries – who do not get involved in detailed oversight of management processes. But what would be the situation in a corporate board? These situations may be rare but are not unknown. It is clear that responsibility falls on the chairman to institute an investigation whenever serious matters regarding the conduct of a director come to light. It is clear that any director who becomes aware of an issue should report it to the chairman. If the subject of concern is the chairman then a senior director should institute an investigation after having obtained the consent of the board. UK public companies have a Senior Independent Director who should perform this role. What should not happen is for these matters to be swept under the carpet. Waiting to see if they come before a court is not a good option.

This week’s reports that Fred Goodwin, late of RBS, had an affair with a senior colleague highlights another aspect of the same issue. Whilst it is common for partners to meet through work, an intimate relationship where one party is the chief executive, particularly in a bank, risks conflicts of interest that may affect financial probity. One is reminded of the affair of Paul Wolfowitz, president of the World Bank, who was accused of impropriety in having a relationship with someone who worked, indirectly, for him. One wonders whether this matter would have been pursued if its subject had not been a controversial figure who pursued controversial policies and had been appointed by an unpopular US president. But at the very least, such a relationship should be reported to the board so that they can monitor behaviour in the knowledge of the relationship. But generally I cannot believe that these work relationships are ever actually a secret – I recall working at a bank and stepping into the lift late one evening. The chief executive was also in the lift, going down to the basement car park with a young female lawyer who worked in the organisation. It may have been entirely innocent but I knew instantly that it wasn't. In reality board members pick up what is happening pretty quickly too but too often choose to ignore it. The likely outcome of doing nothing is not good and, in a world of Twitter and Facebook, will become less and less of a good option.

Burson Marstellar contributes to corporate governance thinking

There were newspaper reports last week that Burson Marstellar had been retained by Facebook to get negative stories about Google into the press. 

Paul Cordasco, a spokesman for Burson-Marsteller, told the Guardian on Thursday that the assignment was "not at all standard operating procedure" and was against the company's policies. He added: "The assignment on those terms should have been declined."

Which raises a number of interesting governance questions;

• at what level in the company was this assignment approved?
• what are the company's policies and how are they communicated to staff? 
• how does the company control what staff do?

Subsequently they added about the former journalists, who were trying to interest papers in these stories, that

The pair will receive receive extra "training" and Burson-Marsteller said it intends to redistribute its code of ethics to all employees in the wake of the scandal.

Could BM maybe publish this code of ethics as well as explaining what their systems are for controlling what their staff do? Because I find it very odd that a pr company does not have control systems that vet new assignments for issues such as appropriateness, ethics, conflicts of interest etc. If they don't then that is a huge governance issue because corporate governance is not just about boardroom behaviour but also about how the board communicates its values and controls how its people carry out company policy.

In the past BM has been accused of acting burnish the image of some pretty nasty African dictators and stepped back from such activities. In light of that is the company really saying that they don't have a system in place for new assignments to passed through an approval process?

David Sokol, Berkshire Hathaway and Integrity in Corporate Governance

Much has been written about David Sokol advising the Berkshire Hathaway board to acquire a company, called Lubrizol, in which he had recently bought shares. There has been much debate in public about whether he made sufficiently full disclosure and whether the board asked the appropriate questions. The point that emerges is that rules and procedures can only take you so far. In the end we rely upon personal integrity and a shared understanding of ethics.

The rules and procedures are just a starting point - any investment professional would ideally not invest on their personal account anyway. Sokol's earnings at Berkshire Hathaway are not made public but his role at MidAmerican, an 89% owned subsidiary, are reported to have brought him $24m over 3 years. One would guess that his other roles would have added substantially to this. His profit on Lubrizol was just $3m. I say 'just', that is a lot of money but surely, for someone on such a scale of earnings, it should be possible to abstain from personal investing without feeling poor?

I understand that the sort of executives sought by Berkshire Hathaway are natural dealers but surely...? But ok, suppose he could not resist...then, whatever the BH disclosure rules may be, surely if you advise a purchase of shares in a company where you hold shares you over-disclose: you detail what shares you bought, when you bought them and any surrounding circumstances such as advice to or even conversations with other people concerning the target company. You disclose who told you what that may have led you to buy shares. You cannot be too clean.

I understand that Sokol's lawyers claim he was not asked the right questions. Maybe not. But that ain't the point. My set of personal values says that no questions should have been necessary. Maybe this was just one of many investments and he forgot (actually it wasn't because he claims to make only a handful of trades each year). But if you are an investment adviser then, regardless of whether rules oblige you to do so, you should keep your own detailed register of interests so that nothing can be forgotten and so that all trades are reported to those you advise.

Like I said...rules are a starting point and then corporate governance is about personal integrity and a shared understanding of ethics.

Conflict of duties between nominee directors and company law

City AM reported on 20 April on a call to shareholders by Pensions Industry Research Consultancy (PIRC) to vote against the re-election of directors of Anglo-Swiss miner, Xstrata plc who are nominees of (soon to be floated) Glencore. They argue that these directors are not independent enough. This simply exemplifies a long-standing incongruity in company law and governance. The Companies Act 2006 makes clear that a director's duty is to the company they serve - so how can the nominee of another company and likely shareholder possibly be carrying out their duty? They are nominated in order to represent that other company, otherwise why would they be nominated? But this is blatantly incompatible with the legal position.

Appointment of Non-Executive Directors - how little has changed

Non-executive directors are in the front-line of corporate governance. A critical part of their role is to probe and challenge the executive directors - to hold them to account and to apply common sense and specialist expertise to test the appropriateness of their strategies.

The Higgs Report into the role and effectiveness of non-executive directors and the Tyson Report on their recruitment and development, both published in 2003, addressed issues of board composition. The latter, in particular, talked about the importance of board diversity to better decision making. In this it echoed the views of others, such as Tomorrow's Company. It talked about things such as defining skills or perspectives that are lacking in the board and going out and recruiting against that brief, It talked about being prepared to recruit from people who possess the right skills and qualities but who may have worked below board-level in their careers or have worked as consultants or advisers to businesses.

So have things changed with the passage of eight years and in light of the increased focus on corporate governance? Not a bit of it. British boards still have very few women but they also have very few of anything other than British, white, middle class, heterosexual men who share a very limited background and have all pursued very similar career paths. I know someone who is exploring the possibility of taking on one or more NED positions and she has been told by headhunters that, in reality, very few appointments result from search assignments. Companies don't want to pay. Just as Tyson reported in 2003, over half of appointments result from a tap on the shoulder by someone you know. Another person I know, who is looking for an NED role finds that his lack of previous main board experience is a huge impediment; this despite having served as a divisional MD for a large quoted company.

If non-executive directors really are important - and I believe they are - then this lack of diversity and lack of change is a real problem. I don't have a solution. I don't think legislation or regulation is appropriate but cannot think how we combat this damaging rigidity in our economic and social fabric. Tyson suggested measuring and reporting board background and composition on the basis that people manage what is measured. I am not sure that would work either but it is surely worth a go - however nothing has happened in this respect in eight years. Any ideas?

Shareholder rebels over executive pay

I would link this post to the headline in the Sunday Times, but it is hidden behind a paywall. The article about Standard Life, the biggest sharteholder in Rio Tinto, criticising "the mining giant for handing bosses generous rewards for hitting 'unchallenging' targets. It follows 41% of votes going against last year's remuneration report. The issue raises some interesting questions;

• Should shareholder votes on the remuneration committee's report be binding instead of just advisory?
• Should public companies treat these expressions of shareholder dismay rather more seriously?
• Does the lack of board responsiveness itself point to serious governance issues? For example are the non-executive directors actually doing their job or are they merely cheerleaders for the board?

As time passes and we see more of this, I suspect there will be a growing consensus for reform. The big problem is that shareholders will rarely vote against the reappointment of directors. By the time a company is performing badly enough to warrant that, the shareholders simply sell and leave a takeover to institute reform. However that discipline does not help when a company is performing reasonably well, yet shareholders are unhappy about outrageous remuneration packages. What is needed is a mechanism that produces more active non-executive directors who are not all part of the club who vote each other outrageous remuneration. It is not even always that directors sit on each other's boards or are personal friends. They just have similar backgrounds and similar interests and believe that high remuneration for pedestrian performance is ok because that is the deal they have themselves received in their day jobs.

This is an argument for boardroom diversity

Financial Advisers in the Corporate Governance Process

The role of financial advisers in the corporate governance of listed companies ought to be a pivotal one. I am not so old but still remember a time when investment banks (or merchant banks, as they were known then) were often paragons of rectitude and the more reputable ones would not deal with a company if they felt it was acting improperly: not illegally, just improperly. Really, it is true. Of course, there were some that sailed close to the wind even then. I remember the time when I was involved in negotiating to buy Hard Rock Cafe and, at the very end of the deal - when everything was agreed - the advisers acting for the vendor raised the issue of their fees. Apparently they were not being paid by the vendor, having set up the deal speculatively, and wanted to land us with the extra cost. We were shocked. There was nothing illegal in this, just not quite cricket to leave it so late to tell us. Still, it was Drexel Burnham and Lambert and when you dealt with them you knew you were in the wild west.

Since then everyone has become inured to revelations about financial advisory firms. A recent Harvard Law blog examines the recent court case arising from Barclays behaviour in the del Monte takeover - where they advised and also misled the del Monte board. I would not have imagined that of Barclays in the past. And of course there is the opprobrium heaped on Goldman Sachs for selling investments to clients at the same time as other parts of their organisation described the securities in unflattering terms. Still, a City connection recently offered the opinion that people prefer not to deal with advisers they don't trust; and that over the next few years one may see the deal flow to some of these major institutions dwindling in quality and quantity as boards of directors go back to seeking advisers they can trust.

An interesting thought.