Corporate Scandals Put Directors in the Hot Seat

Hours after former Tyco International Ltd. executives were charged last week with stealing $170 million from the company, Tyco announced it was shaking up its board of directors--an apparent acknowledgment that confidence was waning in the group that the indictment described as dupes.

Of Tyco’s 11 directors, only Chief Executive Edward Breen and former DuPont Co. Chairman Jack Krol will be nominated for reelection. The move allows Breen to work with a new board and sent a signal to corporate America that directors can be held accountable for failing to keep an eye on a company’s managers.

Although pressure is most intense on directors of companies accused of fraud and corruption, experts say that even boardrooms untouched by scandal can no longer afford to be cozy corporate clubs. In hastily called meetings and conference calls with lawyers and advisors, board members are struggling to understand and discharge their responsibilities under the new corporate reform law, and some of them are questioning whether they are up to the task.

Boardroom turnover is accelerating as directors with pristine reputations call it quits, fearful of the taint of a lurking scandal, and those who lack the business acumen necessary to dig through the books are being pushed aside. Half of the Fortune 500 boards are looking for new members who have no ties to the company or its officers, according to one headhunting firm. That’s up from 20% a year ago.

Boards are steering away from management chums, corporate gurus and former politicians with marquee value. Even efforts to achieve racial and gender diversity are taking a back seat these days to the pursuit of independence and expertise, according to recruiters and corporate governance experts.

To many, this unprecedented tumult at the top is a defining moment for corporate boards--a period in which the management-friendly fraternities of the past will yield to an independent corps of well-trained, well-paid experts.

“It’s been a long time coming,” said Peter Gleason, chief operating officer of the National Assn. of Corporate Directors, which supports the movement toward board independence and expertise. “These are things that have been espoused by institutional investors and corporate governance experts for years, and now we’re in a period where crisis has hit and somehow we have to restore confidence in corporate America.”

Others view the new era more darkly, as a period in which corporate boards may lose veteran members with a wealth of experience and talent. One lawyer who advises and defends directors said one of his clients is rethinking his membership on three Fortune 500 boards.

“He’s had a stellar career and he said to me, ‘Hey, should I be sitting on these boards?’ ” said J. Michael Nolan, a New Jersey lawyer. “ ‘Is it worth my reputation being tarnished?’ ”

Many boards are engineering their own transformations. Directors are taking the lead in identifying and recruiting nominees, a process that had been dominated by CEOs, and their priorities have changed.

“Search committees are no longer saying, ‘We need a woman,’ ” said Steve Mader, president of Christian & Timbers, a Cleveland-based executive recruiting firm. “They are saying, ‘We need the best person we can find with deep experience in a functional area.’ ”

One-third of 5,000 publicly traded companies surveyed by the corporate directors association in 2001 had boards dominated by insiders--members of management and people with personal and business relationships with the firms. Many of them have begun recruiting outsiders in anticipation of the Securities and Exchange Commission’s adoption of a rule proposed by the New York Stock Exchange that would require boards of publicly traded companies to be dominated by independent directors within two years.

Pending rules aside, boards also are motivated by a desire to send investors a positive message that effective management oversight is a priority, corporate governance experts said.

Shareholders are pushing for board accountability and a bigger say in directors’ selection. Institutional investors and shareholder advocates are papering companies with proposals for governance reforms for consideration at annual meetings next spring. By itself, the AFL-CIO, which wields the clout of $400 billion in pension funds invested in a wide array of companies, is launching shareholder proposals at 300 of them.

“We’re going to see far more intensity than we’ve ever seen before, given the performance of the market and collapses, ranging from Enron to WorldCom,” said Bill Patterson, director of the labor federation’s office of investment. “Shareholders have seen the damage that having a go-along board can have.”

Members of reconstituted boards and directors who have left scandal-plagued companies but remain on other boards are expected to face scrutiny.

“Shareholders are starting to see the board as individuals, not just as a faceless lump,” Patterson said. “Shareholders will be looking to individual board members to account for what they’ve been doing.”

At the same time, minority groups are keeping the pressure on corporate boards to fill vacancies with individuals who reflect the demographics of the nation’s shareholders, employees and consumers. Of 12,000 Fortune 1,000 board members, for instance, 120 are “American Latinos,” according to the New American Alliance.

“It’s been a chummy club until now,” said Moctesuma Esparza, a Hollywood producer who chairs the nonprofit advocacy organization. “The board culture was extremely insular. People got selected on the basis of personal and business relationships and the friends of the CEO. The American public is really not represented on boards of directors.”

Also under attack is the practice of directors hopscotching among boards. Directors spend an average of 200 hours a year per board preparing for and attending meetings, according to the directors association. As new oversight duties increase the amount of time they must commit to each board, it is widely believed it will become more difficult for them to serve so many.

“A lot of directors ... sit on five, six boards and make quite a bit of money doing that,” said Judy Fischer, managing director of Executive Compensation Advisory Services of Alexandria, Va. “However, the question is, are they providing adequate professional advice that is protecting shareholder value?”

If directors serve on fewer boards, more individuals will be needed. Fischer and others said they expect that to put pressure on firms to boost their pay.

Gleason, of the directors association, agreed, saying one way to increase pay would be to shift compensation packages away from the current model, in which retainers of $10,000 to $50,000 dwarf meeting fees. Increasing meeting fees, he said, would improve the pay of the directors who work the most, such as members of audit and other busy committees.

But, he said, until the current popular backlash against corporations subsides, directors would do well to refrain from passing out any raises.

Times staff writer Ralph Frammolino contributed to this report.