Archive for the ‘Working Group on Director Accountability’ Category

VC Governance FAQ: (2) Especially now, when transparency is so important, why is limited financial information available from a private company?

images-3This is the second in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: At a time when transparency is so important to institutional investors, how can fiduciaries reconcile that there is limited information available with a private company?

Answer: Actually there is plenty of financial information available from private companies, but that does not mean that it is available to institutional investors as passive investors who are Limited Partners in venture capital or other private equity partnerships.

Putting that point aside, for a moment, what is absent is a quoted liquid market in their equity and debt securities, which means that the determination of the book value of those private companies is necessarily subjective. Institutional, or any other investors, for that matter, who choose to invest in illiquid securities, presumably do so because they expect to obtain superior returns from the illiquid securities at the end of the investment period than they would from liquid securities over the same period—otherwise it’s not worth giving up the liquidity and taking the risk of the longer holding period. To get to the core of your question, providing passive institutional investors with more financial information about illiquid securities isn’t going to make them more liquid.  They key is whether you can rest assured that the general partner who is responsible for managing your investment is honoring the trust that you have placed in that manager.

There has been a multi-year move among auditors, driven by demand for greater transparency in understanding the process behind the book valuation of private, illiquid investments, to bring more of a “mark to market” approach in the way the general partners of private equity partnerships value their portfolios.  Before I discuss this in more detail, I should fully answer your question:  the main reason why general partners, particularly in venture capital, should legitimately limit the amount of information they disclose to their investors about their private investments is (1) competitive considerations, particularly for disruptive emerging technologies where protecting intellectual property and market competition from large companies are defining elements in the company’s potential for success.

Having said that, if a sophisticated institutional investor insists on having the right to inspect the details about specific private investments, see business plans, and otherwise get details about the company, if they are prepared to sign a confidentiality agreement and have a good reason for wanting to see this information, it certainly exists and can be made available.

To address the broader point about accuracy in book valuation, I am concerned that the developing industry standard for venture capital is at risk of going too far while providing no real benefit to investors. I see the auditors forcing excessive quarterly compliance burdens on the general partners, and this trend has been developing since the institution of 409a valuations for common stock.  The reason I feel this burden is unnecessary is because, in my view, the additional information may be very precise without being accurate.

The fact remains that you don’t know the value of a private asset unless you actually intend to sell it.  And in venture capital, the second you become a forced seller of a company, you have given it the equivalent of the kiss of death.  For many emerging companies, the moment that you become a bona fide seller and are perceived to have to sell the asset, the value will be diminished—so you can imagine why the lack of an IPO market is the single greatest source of distress for venture capital in the U.S.  To conclude on this question, I’d like to emphasize that, in my view, for early stage companies with little or no revenue, valuation models driven by public equity or option inspired equity models simply make no sense.

VC Governance FAQ: (1) How much information are limited partners (pensions, endowments, foundations, etc.) entitled to receive from a VC fund?

images-2It’s that time of the year again– time to send out audited financial statements and K-1’s to your limited partners– which means it’s also a great time to address some of the common questions that investors raise about VC partnership governance and disclosure issues.

I recently spent some time answering a series of such questions posed to me by Susan Mangiero, the founder and CEO of Investment Governance, Inc., whose site Fiduciary X, is an emerging “one-stop best practices information portal for investment decision-makers and their service providers.” Fiduciary X, on whose advisory board I serve, combines peer networking, research, productivity tools, proprietary data sets,  and a governance-focused knowledge base with a documents archive to serve fiduciaries and risk managers.

In the interests of sharing this interview with a broad group of interested readers, I am going to be posting one question and my answer each day for ten days, including today.  For access to the full interview, which will be published March 15, please go to the Fiduciary X Ezine registration site.logo

Question:  How much information are limited partners (pensions, endowments, foundations, etc.) entitled to receive from a VC fund?

Answer: Section 17-305 (b) of the Delaware Revised Uniform Limited Partnership Act, which governs LP information rights according to DE law, specifically allows the GP to withhold from LPs “any information the GP reasonably believes to be in the nature of trade secrets or other information the disclosure of which the GP in good faith believes is not in the best interest of the Fund or could damage the Fund or its business or which the Fund is required by law or by agreement with a third party to keep confidential.”  This would include the GP’s fiduciary duties and confidentiality obligations with respect to not disclosing portfolio company information without the consent of such company.  The Act provides for a specific list of information that LPs are entitled to, and funds historically disclose that same information to their LPs—the top law firms in Silicon Valley model their LP agreement forms to be pretty consistent with Delaware law.

images-1Specifically, Section 17-305 of the Act provides for the following:

(a) Each limited partner has the right, subject to such reasonable standards (including standards governing what information and documents are to be furnished, at what time and location and at whose expense) as may be set forth in the partnership agreement or otherwise established by the general partners, to obtain from the general partners from time to time upon reasonable demand for any purpose reasonably related to the limited partner’s interest as a limited partner:

(1) True and full information regarding the status of the business and financial condition of the limited partnership;

(2) Promptly after becoming available, a copy of the limited partnership’s federal, state and local income tax returns for each year;

(3) A current list of the name and last known business, residence or mailing address of each partner;

(4) A copy of any written partnership agreement and certificate of limited partnership and all amendments thereto, together with executed copies of any written powers of attorney pursuant to which the partnership agreement and any certificate and all amendments thereto have been executed;

(5) True and full information regarding the amount of cash and a description and statement of the agreed value of any other property or services contributed by each partner and which each partner has agreed to contribute in the future and the date on which each became a partner; and

(6) Other information regarding the affairs of the limited partnership as is just and reasonable.

The current state of the art for Agreements of Limited Partnership in venture capital allows the GP to override the information rights LPs have pursuant to the Delaware Revised Uniform Limited Partnership Act (the “Act”) as permitted pursuant to the Act and allows the GP to “adjust” identifying information given to the LPs in order to protect the identity of the Fund’s portfolio companies, which often is an issue in the case of Freedom of Information Act (FOIA) LPs.  In addition, the partnership agreement allows the GP to restrict / withhold information from LPs if “the General Partner reasonably determines [such LP] cannot or will not adequately protect against the [improper] disclosure of confidential information, the disclosure of such information to a non-Partner likely would have a material adverse effect upon the Partnership, a Partner, or a Portfolio Company.”  Other elements of the well drafted agreement do provide the LP’s with disclosure rights to their advisors, equity holders, etc. and provide remedies and protections to the GP with respect to GP withholding rights and improper LP information disclosure.


Getting From Here to There– It’s Time to Engage in Common Sense Approaches to Public Policy

I usually try to keep my blog posts short. Today I have failed in this endeavor but urge you to please read through to the end of this important post. The current issue of Foreign Affairs Magazine features an excerpt from Leslie Gelb's new book, Power Rules: How Common Sense Can Rescue American Foreign Policy.  This essay is exceptionally good, and, in my view, Gelb's thesis should be applied to all forms of statecraft and to promote the resolution of both newly emerging and long stagnating public policy debates.

Gelb accurately diagnoses the "weakening fundamentals of the United States.  First among them is that the country's economy, infrastructure, public schools, and political system have been allowed to deteriorate.  The result has been diminished economic strength, a less vital democracy, and a mediocrity of spirit."

Several paragraphs in this powerful essay deserve highlighting:

"The bases of the United States' international power are the country's economic competitiveness and its political cohesion, and there should be little doubt at this point that both are in decline.  Many acknowledge and lament faltering parts here and there, but they avoid a frontal stare at the deteriorating whole.  It is too depressing to do so, too much for most people to bear. … The United States is now the biggest debtor nation in history, and no nation with a massive debt has ever remained a great power.  Its heavy industry has largely disappeared, having moved to foreign competitors, which has cut deeply into its ability to be independent in times of peril.  Its public-school students trail their peers in other industrialized countries in math and science. They cannot compete in the global economy.  Generations of adult Americans, shockingly, read at a grade-school level and know almost no history, not to mention no geography.  They are simply not being educated to become the guardians of a democracy.

These signals of decline have not inspired politicians to put the national good above partisan interests or problem solving above scoring points.  Republicans act like rabid attack dogs in and out of power and treat facts like trash.  Democrats seem to lack the decisiveness, clarity of vision, and toughness necessary to govern.  This tableau of domestic political stalemate begs for new leadership.  The nation that not so long ago outproduced the rest of the world in arms and consumer goods, the nation lionized and envied for its innovation, can-do spirit, and capacity to accomplish economic miracles, has become overwhelmed by the tasks it once performed competently and with relative ease."

This is the most succinct and gut-wrenching summary of our national predicament that I have read.  Gelb puts his finger directly on the jugular vein of America's innovation ecosystem and diagnoses the multiple layers of dysfunction that have launched our country into such a deep crisis.  I share his fear of a new global reality developing along the following lines:

Images-1"The real danger in this universe of primitivism and plenty is not new wars or explosions among major states, or a world war, or even a nuclear war.  It is the specter of nations drowning in a flood of terrorism, tribal and religious hatred, lawlessness, poverty, disease, environmental calamities, and governmental incompetence.  Many nations are going under because they are simply unable to cope, and they will drag others down with them."


Gelb closes this essay with an impassioned plea for action, and most important, he retains a strong sense of hope and pride in our country:

"Every great nation or empire ultimately rots from within.  One can already see the United States, that precious guarantor of liberty and security, beginning to decline in its leadership, institutions, and physical and human infrastructure, heading on the path to becoming just another great power, a nation barely worth fearing or following.  It is time to send up flares signaling that the United States is losing its way and its power, that it is in trouble. But it is even more important to reaffirm the belief that the United States is worth fighting for both across the oceans and at home.  There should be no doubt that the United States, alone among nations, can provide the leadership to solve the problems that will otherwise engulf the world.  And for all the country's faults, there should be no doubt that it remains the last best chance to create equal opportunity, hope, and freedom.  But to restore all that is good and special about the United States, to rescue its power to solve problems, will require something that has not happened in a long time: that pragmatists, realists, and moderates unite and fight for their country."

ImagesI've been sending out flares to other realistic moderate pragmatists on this and other topics that demand a "common sense" approach for years.  Through groups such as the Council on Foreign Relations, the Aspen Institute's Socrates Society, the Working Group on Director Accountability and Board Effectiveness, and, most recently, the Security Innovation Network, I have joined and helped forge communities of interest bound together by empowered individuals who are thoughtful and constructive agents of change.  As Gelb points out, we have a lot of wood to cut, but I remain energized and, most importantly, hopeful that we can make a difference because we have to.  Given where America stands today, fomenting pragmatic and realistic change is not an option, it is a requirement.



The SEC’s Colossal Failure of Oversight– Isn’t This a Violation of the Business Judgment Rule?


The damning New York Times headline, “SEC CONCEDES OVERSIGHT FLAWS FUELED COLLAPSE,” from a September 26th article by Stephen Labaton, will hopefully end up as more than a footnote in the long list of misdeeds by the ‘stewards’ of the American economy that have brought American capitalism to the precipice of systemic financial collapse. According to the article, a report by the inspector general of the SEC asserts that “voluntary regulation does not work” and that the SEC’s oversight program for the investment banks “was fundamentally flawed from the beginning.”

The article goes on to state:

The report found that the S.E.C. division that oversees trading and markets had failed to update the rules of the program and was “not fulfilling its obligations.” It said that nearly one-third of the firms under supervision had failed to file the required documents. And it found that the division had not adequately reviewed many of the filings made by other firms. The division’s “failure to carry out the purpose and goals of the broker-dealer risk assessment program hinders the commission’s ability to foresee or respond to weaknesses in the financial markets,” the report said.

We should not gloss over the importance and the far reaching nature of this indictment of the SEC by the SEC’s inspector general. The most fundamental fiduciary duty in business is the Duty of Oversight. Oversight is a theme which binds together the more commonly referred to fiduciary Duties of Care, Loyalty, Confidentiality, and Disclosure. Violators of the fiduciary duties listed above often seek refuge in the Business Judgment Rule and try to to hide behind ‘squishy’ judgment call concepts like “good faith” and “honest belief”. But the Business Judgment Rule stands on oversight, and the SEC clearly failed in its duty of oversight of the investment banks. In my view, in addition to the bankers, the regulators themselves should also be held responsible for this crime against America.

Below is a definition of the rule, taken from the white paper, “A Simple Guide to the Basic Responsibilities of VC-Backed Company Directors”, written by the Working Group on Director Accountability and Board Effectiveness:

Business Judgment Rule
Creates a presumption that in making a business decision, the directors of a company acted on an informed
basis, in good faith and in the honest belief that the action taken was in the best interests of the company.
The business judgment rule helps protect a director from personal liability for allegedly bad business
decisions by essentially shifting the burden of proof to a plaintiff alleging that the director did not satisfy
its fiduciary duties. This presumption and the protections afforded by the business judgment rule are lost if the directors involved in the decision are not disinterested, do not make appropriate inquiry prior to
making their decisions, or fail to establish adequate oversight mechanisims.

All corporate directors and persons in positions of accountable oversight responsibility need to commit these rules to memory– and, more importantly, to act on them in the daily course of business.

Missing the Point– WSJ Reports on Splitting the Chairman and CEO Roles in Public Companies

The Wall Street Journal’s January 14th article "When Chairman and CEO Roles Get A Divorce" explores the increasing trend toward separating the Chairman and CEO titles.  Unfortunately, it fails to raise a critically important question– is it advisable for former CEO’s to remain on their own boards as independent directors, much less as chairmen? 

The article points out that "36% of Standard & Poor’s-500 companies have separate chairmen and CEO’s, up from 22% in 2002, according to the Corporate Library, a research group in Portland, Maine."  The article does not note that the S&P 500 lags significantly behind all public corporations in this regard, as 49% of all U.S. public companies have inside chairmen vs. 51% that do not, according to the Corporate Board Member / PricewaterhouseCoopers Survey, What Directors Think 2007.

The Journal writes in the context of James Cayne’s resignation as the CEO of Bear Stearns last week, noting that Cayne remains board chairman.  Reporting from London, the WSJ reporter, Joann S. Lublin, observes the following:

"As at Bear Stearns, splits in the top posts at American businesses are often the result of a leadership transition or financial trouble.  In numerous cases, the chairman is a concern’s retired CEO.  Yet the gradual emergence of non-CEO chairmen in the U.S. raises a sticky question: How do you perform a role that rarely existed until recently?"

While the article goes on to discuss the dynamics of groups that have been formed to provide peer support for independent board chairmen, I would like to pose a different, and perhaps more difficult, question.

Why doesn’t Jimmy Cayne make a clean break from Bear Stearns and become the chairman of another board?

Keeping former CEO’s on the board of your company is generally contra-indicated for several obvious reasons:

*First, most former CEO’s have strongly held continuing views and core beliefs as to how the company should continue to be run;

*Second, it is emotionally very difficult for former CEO’s to let go of such strongly held convictions; and

*Third, people have a natural tendency to second-guess other people.

These emotionally charged issues are only compounded when a CEO moves to the chairman’s role under a cloud of some sort, as Ms. Lublin observes above. 

I wrote an extensive article on this topic in the Spring 1999 issue of Directors & Boards magazine, "The Problem of Emotion in the Board Room", in the context of the challenges faced by public and private companies.  A strong case can be made that former CEO’s should normally not remain on the board of their former company, as chairman or otherwise.  They can be great directors and great chairmen, but they should accept these roles at new companies where they can perform in leadership positions without the emotional baggage they carry in the transition from the incumbent CEO role. 

I concluded the Directors & Boards article with the following:

"Walter Wriston, who retired as CEO and as a director of Citicorp in 1984, observed in a 1993 article in Directors & Boards that ‘In short, there are a myriad of reasons for the retiring CEO to leave the board, and few if any arguments for the other course… the human desire to stay on with a company that has been home for many years is stong and understandable, but the world is so full of so many other interesting things to do that the desire to stay should be resisted doe one’s own sake and for that of the company.’ "

Top Reasons Why Public Company Directors Should be Removed

According to What Directors Think 2007, nearly one-quarter (23%) of the over 1,000 respondents to the sixth annual U.S. public company directors survey feel that a member of their board should be replaced.


*  The director does not have the skill set needed… 36%

*  The director is not engaged…………………………….  31%

*  The director comes to meetings unprepared…….. 18%

*  The director has been on the board too long…….  17%

The first three categories above should resonate equally with private company directors and certainly with venture capitalist directors.  I have maintained for many years in my corporate governance writings that the most common problems faced by boards cut across issues of revenue size and company maturity.

At their core, these are issues that relate to the mutual accountability of individuals who belong to small groups and the need to avoid systemic dysfunction in order to maximize the opportunity for positive corporate outcomes.

In fact, many of these issues are only exacerbated in VC-backed companies because emerging companies are resource-constrained and under severe pressure to execute over a shorter time frame than larger corporations which have greater resources at their disposal.

Most Public Company Boards Conduct Full-Board Evaluations and Find Them Effective

What_directors_think PriceWaterhouse Coopers and Corporate Board Member recently released their sixth annual survey of directors of public companies, which aggregates responses from over 1,000 corporate directors on a variety of important issues. 

First, some interesting statistics from What Directors Think 2007:

How many people actually serve on public company boards of directors?  At the end of 2007, directors on U.S. corporate boards totaled 48,950 from 5,772 public companies. 

Of this total,  66% hold only one board seat– a result which certainly surprised me and is unheard of among the multiple-board seat VC  community.

Women occupy 4,544 board seats, or 9.3% of the total.  Out of a total of 5.341 board chairmen, 49% are insider chairmen and 51% are outside chairmen– a ratio that holds across revenue size categories.

The survey also revealed some very useful information on Corporate Governance–

Respondents rated the following Top Five hallmarks of good governance, in order of priority:

(1) The board holds regular executive sessions without the CEO;

(2) The board is composed mostly of independent directors;

(3) The board or a committee conducts regular, formal CEO performance reviews;

(4) The company has a formal management succession process in place;

(5) The board evaluates both whole-board and director performance.

As a VC, I feel strongly that numbers (1), (3), and (5) above are entirely applicable to VC-backed companies and should be high priorities for VC directors.

In 2007, 88% of public boards conducted a full-board performance evaluation on a regular basis, up from 33% in 2002– 78% of respondent companies listed on NASDAQ do so even though this is not a NASDAQ requirement.

Only 57% of directors characteriz their board’s evaluation process  as effective or very effective– leaving 38% saying it is somewhat effective and 5% saying it is ineffective.  The authors conclude that "these results show many boards are not maximizing the usefulness of this process which, among other things, directors have told us can improve board communication, provide focus for board and management recruitment efforts, and identify ways to streamline board processes to make the best use of directors’ time."

Private company directors should follow this increasing trend toward board and director performance evaluation in far greater numbers– for more on how VC companies should apply best practices to approach these issues, go to to review material prepared by the Working Group on Director Accountability and Board Effectiveness.

Are Sentencing Guidelines for White Collar Criminals Too Severe?

Cover The January/February 2008 issue of Corporate Board Member magazine features a picture of Dennis Kozlowski on its cover and asserts in its cover story tag line: "Why giving convicted executives decades in prison makes no sense."

The story itself mentions over a dozen recently convicted executives serving long sentences for fraud, including Bernie Ebbers, former CEO of WorldCom, 66 years old (25 years in Oakdale Federal prison in Louisiana); Walter Forbes, former Chairman of Cendant, 65 years old (12 years in Allenwood federal prison in Pennsylvania); Sanjay Kumar, former chairman and CEO of Computer Associates, 45 years old (12 years in the federal correctional facility at Fairton, New Jersey); John Rigas, 83 years old, former chairman and CEO of Adelphia Communications (15 years at the Butner federal facility in North Carolina; Jeffrey Skilling, former Enron CEO, 54 years old (24 years at the Federal correctional institution in Waseca, Minnesota; and Kozlowski-sidekick Mark Swartz, former CFO of Tyco, 46 years old (up to 25 years in state prison in Rome, New York). Swartz, like Kozlowski, is eligible for parole in 2013, and they are both two years into serving their 25 year sentences.

One of the main points of this interesting article follows:

"The overarching problem with multi-decade sentences for nonviolent crimes like fraud and drug possession is that they seem disproportionate to the goals prison sentences are supposed to achieve: penitence, deterrence, restitution, and retribution.  Does life without parole for a white-collar offender– or 25 years for a single drug offense– really accomplish these things any more effectively than, say, three-to-five-year sentences?  Perhaps in some specific cases, but surely not in all."

As I read the article, written by Rob Norton, I felt that it made many good points but that considering drug offenses and finanical fraud in the same construct detracted from some of the more powerful arguments for reform. 

In my view, the punishment meted out to individuals guilty of massive corporate fraud should be considered in a class of its own.  Where I think that the author falls short in this article is in failing to consider the fact that with great power comes great responsibility.  Corporate CEOs and other senior managers hold the financial futures of many thousands of people in their hands– they are the stewards of the retirement plans for the generations of employees that may have preceded them, as well as of the financial security of the company’s current employees and the investing public.  Many CEOs are responsible for corporations that have higher incomes than the GDP’s of most countries in the world.

The fact is that too many CEOs have approached their responsibilities in a cavalier manner and ignored their roles as stewards of the public trust.  Should this be treated any differently than the commission of a violent crime against an individual? Yes.  But the magnitude of corporate fraud may impact thousands of families and ripple through many lives in ways that never come to light during trial.

Dennis Kozlowski states in this article: "I’m serving a worse sentence than many murderers, rapists, and child molesters.  Another thing, I was convicted of stealing my bonus.  Well, I never got it.  It’s still in Tyco as deferred compensation I never collected.  It’s like finding somebody guilty of bank robbery when the money is still in the bank."

I believe that Dennis Kozlowski’s deferred comp may have recently left Tyco headquarters as part of the $3 billion class action lawsuit settlement agreed to be paid by the company last month.  I also doubt that he plans to try collecting it in 2013 if he makes parole.  More importantly, most rapists and murderers aren’t sufficiently achievement oriented or psychologically stable enough to be afforded the kind of power and public trust that Dennis Kozlowski received in the first place.

I do agree with the underlying premises of the article– that there is plenty wrong with our prison system, that it is overpopulated, and that rigid sentencing guidelines should be revised to give judges greater latitude in individual cases.  But I also feel strongly that senior corporate officers must be given powerful reasons to think long and hard before making the choice to cross the line into white collar crime.  Perhaps the headline-grabbing examples of these recent harsh sentences will help future CEOs and other senior executives consider the privilege of their positions and their stewardship obligations as corporate titans more seriously before they choose to pursue misguided visions of entitlement to the excess riches that attend powerful executive positions.



Fred Amoroso and Carol Bartz on Director Accountability and the Value of Annual Board Assessment

SpencerStuart recently published the 2007 Silicon Valley Board Index, which updates useful statistics on Silicon Valley public boards, ranging from average annual board retainers for directors ($35,600 in 2007 up from $25,000 in 2003) to the continuing lagging percentage of female directors serving on Silicon Valley public boards (48% in 2007, up from 44% in 2003 but well below 91% for the S&P 500).

This year’s report also includes a Roundtable Discussion featuring Carol Bartz, Executive Chairman of the board of Autodesk (formerly also President and CEO) and a Cisco director; and Fred Amoroso, President and Chief Executive Officer of Macrovision and Chairman of the board of Foundry Networks.

Co-authors Nayla Rizk and John Ware of SpencerStuart pose the following question, which is of particular relevance to VC-backed private company boards:

"Clearly, the way boards see their role has changed.  One way more boards are using to continually define their role and hold themselves accountable is the annual board assessment.  How do your boards handle evaluations?  Do you conduct individual evaluations?"

AMOROSOWe’ve actually spoken a lot about whether we should do formal evaluations and, to be honest, it’s a sensitive topic.  Not everyone likes to go through that level of scrutiny.  We’ve offered a kind of self- awareness approach.  A few of our board members have actually gone out and participated in director training in different areas, so they are more aware of some of these things. . . . Board training is going to be one of the things we’ll see more of over time.

BARTZ: We do have board evaluations. . . . We’ve actually found it quite useful to collect information from each member and then tally it.  Then we can talk about it– such as, "We’ve all given ourselves a low score here, what do we want to do about it?" . . . It’s very important to be self-aware.  Even though we don’t evaluate directors person by person, the board evaluation process makes everyone self-aware.  We include questions such as "Does everybody participate?"  "Is everyone adequately prepared?"  And if you are sitting around the room and we collectively got a low score on "Is eveyone prepared?", then you have to do a little self-evaluation.  You know, "Gee, maybe they are talking about me."  I think it is very effective.

As I read through these answers, I was struck by the fact that these observations are equally true for private companies.  As we have written in "A Simple Guide to the Basic Responsibilities of VC-Backed Company Directors", avoiding scrutiny of their own actions is a natural inclination for company directors because the CEO reports to the board. 

But shouldn’t the board be held accountable to an absolute minimum standard of acceptable performance? Yes!  It is a critical legal requirement, through the exercise of the director’s duty of oversight, to scrutinize company management.  At the same time, directors cannot be exempt from scrutiny themselves–  lest we forget what has occurred at the Adelphia’s, Tyco’s, and Enrons of the world…

As Bartz, points out, generating self-awareness is the key– to the extent that asking questions about elements of the board’s collective performance generates a "Gee, maybe I…" moment, that is a positive accomplishment.  These are basic best practices for large and small companies, whether they are public or private. 

Dennis Kozlowski, Mark Swartz, and “the Niceties of Corporate Governance”

Dennis_before Koz  Swartz

Floyd Norris posted a story in his blog in today’s New York Times, "Unhappy Birthday, Dennis", citing the New York State appellate court’s unanimous ruling upholding the criminal convictions of Dennis Kozlowski and Mark Swartz for "grand larceny in the first degree (12 counts), conspiracy in the fourth degree, violation of General Business Law § 352-c(5) and falsifying business records in the first degree (8 counts)", otherwise known as stealing millions of dollars from Tyco and Tyco’s shareholders.

In his blog post, Norris walks down memory lane and notes how he wrote a column in 1999 questioning the integrity of the Tyco juggernaut, whose astronomical growth throughout the 1990’s was often compared to that of General Electric under the stewardship of Jack Welch.  Bringing us forward to the present day, Norris reflects:

"An investor who bought when I wrote back in 1999 could have gotten out with a nice profit a few months later. But if he held on, he would have since lost a third of his investment.  In that 1999 column, I quoted Mr. Kozlowski as saying there was “no risk that investors will wake up one day and find out there’s something wrong.” Perhaps the operative part of that forecast was “wake up.”

Based on my own direct experience with Kozlowski and Swartz in the context of Tyco’s AMP acquistion in 1998-1999, in 2002 I wrote an extensive expose of the Tyco fiasco in Directors & Boards Magazine titled "Tyco’s Betrayal of Corporate Governance".  This story followed my Spring 1999 story, also featured in Directors & Boards, titled "The Problem of Emotion in the Boardroom", which dissected the topic of emotional dysfunction in both the public and prviate boardroom, using the example of the board dynamics at AMP, which was Tyco’s last major acquisition ($11 billion).  In this case, in October 1998 Tyco interceded as a "white knight" to Allied Signal’s hostile takeover bid for AMP in August 1998.

In reading the appellate court’s decision (click here for the full text of the decision), I found it particularly galling that Mark Swartz and Dennis Kozlowski have persisted in claiming that they were legitimately entitled to the egregious compensation that they awarded to themselves.  Happily, the appellate court blasts this claim:

" More significantly, though, the entitlement claim was flatly refuted by Mark Foley, the Tyco executive who was responsible for the calculation of the year-end figures on which the annual bonuses were based. In fact, Foley’s testimony unequivocally established that defendants received everything they were entitled to under the end-of-the-year formula. Thus, defendants’ claims only succeeded in pitting their credibility against that of the committee members and Foley and various other members of their own staff. Defendants even contradicted each other on a number of points. The jury’s resolution of this factual issue is amply supported by the weight of the evidence since defendants’ self-serving testimony was illogical, internally inconsistent, refuted by Tyco’s records and shown to be false by all other witnesses."

But I find the implications of Swartz and Kozlowski’s assertions that corporate governance process is irrelevant even more disturbing:

"Most notably, Tyco’s annual proxy statements, prepared under defendants’ supervision, failed to indicate even the most oblique reference to their multimillion-dollar midyear bonuses. This documentary void revealed more than a few isolated "procedural irregularities," as Swartz maintains, or a "fail[ure] to adhere meticulously to all of the niceties of corporate governance," as Kozlowski would have it. Rather this consistent pattern of documentary omission over a period of years constituted powerful evidence of defendants’ intentional hiding of these payments from the directors and led inexorably to the jury’s conclusion that defendants took these bonuses without permission or authority. The absence of any reference to these transactions in the chain of documentation available to the committee clearly demonstrates defendants’ coverup of their thievery."

Happily, the court soundly rejects these notions, yet I am deeply troubled that anyone, even a desperate person such as Kozlowski, would consider the approach that portraying corporate governance requirements as a "nicety" might carry weight with a panel of judges.

The requirements of corporate governance are not niceties.  They represent necessary processes with a fundamental purpose– to protect investors and to safeguard the duties of responsible stewardship and oversight that define core director responsibilities.

Kozlowski and Swartz amply deserve to serve their full jail time, and it is cold comfort for investors who lost billions of dollars to see this small measure of justice strongly reaffirmed by the appellate court of the State of New York.

I wonder if Dennis was able to stick a small birthday candle in one of his delicious jailhouse vending machine Payday candy bars today to celebrate his 61st birthday?