Are consultants the new Barbarians at the Gate?
Martin Lipton appears to think so. Best known as the father of the poison-pill takeover defense, the New York corporate attorney propounded that critical view of outside board consultants earlier this year.
External consultants, declares Lipton, a founding partner at the venerable New York law firm Wachtell, Lipton, Rosen & Katz, are emerging as the handmaidens of public pension funds, hedge funds, and other activist shareholders bent on eroding the vitality of the modern, publicly owned corporation. u00e2u20acu0153Shareholder activism,u00e2u20ac he declared in a blistering February 2007 speech in Miami, u00e2u20acu0153is ripping through the boardrooms of public corporations and threatening the future of American business.u00e2u20ac
In his take-no-prisoners oration (New York Times columnist Gretchen Morgenson labeled Liptonu00e2u20acu2122s hard-edged rhetoric u00e2u20acu0153something of a rantu00e2u20ac), the lawyer cited a number of villains contributing to the u00e2u20acu0153eclipse of the modern corporation.u00e2u20ac High on his list are the u00e2u20acu0153parade of lawyers, accountants, consultants, and auditorsu00e2u20ac working in tandem with shareholder activists and having a u00e2u20acu0153demeaning effectu00e2u20ac on boards of directors.
Thatu00e2u20acu2122s a heady indictment, one that has already excited a fair share of comment in the business press, investment community, and corporate governance circles. Governance observers such as Robert Thompson, an expert in business and securities law at Vanderbilt Law School, agree thereu00e2u20acu2122s been an increase in the use of consultants since Sarbanes-Oxley, leading to the conclusion that Liptonu00e2u20acu2122s incendiary language hasnu00e2u20acu2122t been winning him adherents. Of corporate boardsu00e2u20acu2122 increased use of consultants, Thompson says, u00e2u20acu0153It doesnu00e2u20acu2122t really trouble me. To say that itu00e2u20acu2122s emasculating the board is an overstatement.u00e2u20ac
Paul Regan, president and chairman of the San Francisco forensic accounting firm Hemming Morse, expressed puzzlement at the proposition that outside experts could provoke dissension among directors. Regan, who has been involved in high-profile investigations for the Securities and Exchange Commission, the Justice Department, and attorneys for aggrieved shareholders for nearly 40 years, says: u00e2u20acu0153Boards should seek information from experts. When that information is used properly, it allows [directors] to make better decisions. I donu00e2u20acu2122t see how that has any impact on a boardu00e2u20acu2122s collegiality.u00e2u20ac
Catherine Bromilow, a partner and U.S. leader for corporate governance at PricewaterhouseCoopers LLP in New York, suggests that rather than disrupt boards, an external consultant can help boards function more smoothly. At one consulting assignment, for example, a special committee that had already been created as a vehicle to improve the boardu00e2u20acu2122s effectiveness enlisted her services. Her task, she says, was to conduct u00e2u20acu0153one-on-one, nonattribution interviewsu00e2u20ac and provide the special committee with a performance evaluation.
It was the boardu00e2u20acu2122s decision on whether to adopt her recommendations, Bromilow says. u00e2u20acu0153I just presented my views for them to consider.u00e2u20ac The upshot? The directors decided to drop a pension plan because board members were less willing to stand up to management as long as they were not vested. The board also changed its committee structure u00e2u20acu0153because one board member was connected to a company supplier,u00e2u20ac she explains.
In a survey conducted by Corporate Board Member magazine at its recent Annual Boardroom Summit conference in New York, board members themselves seem more favorably disposed to outside consultants than Lipton or other critics would have us believe (even if they do appear less than enthusiastic about paying sizeable sumsu00e2u20ac”typically hundred of dollars an houru00e2u20ac”for consultantsu00e2u20acu2122 services). Indeed, there appears to be widespread acknowledgement that external experts are increasingly necessary if boards of directors are to meet their obligations and fulfill their duties in setting policy at the modern, complex, publicly owned corporation.
When the question of whether outside consultants were having a positive or negative influence was put to approximately 500 directors and officers at the recent Boardroom Summit, the responses did not reflect Liptonu00e2u20acu2122s outrage. Three-fourths of the CEOs and directors surveyed said they believe boards would be well advised to hire outside expertsu00e2u20ac”especially if the board would be making a key decision in an area where it had little or no expertise. At the same time, however, roughly 20%u00e2u20ac”indicated they shun outside experts.
In the minority view, the routine employment of outside consultants is especially dangerous when it becomes what some consider an expensive crutch. The trouble, some feel, is that too many directors are increasingly fearful of being held liable for negligence. Consequently, this view holds, board members are tempted into relying too heavily on outsiders and, in effect, outsourcing their duty to make key decisions.
u00e2u20acu0153The danger comes when consultants are not used for information but for protection from liability,u00e2u20ac says Charles Elson, a law professor and director of the Weinberg Center for Corporate Governance at the University of Delaware. u00e2u20acu0153The board has to make sure that the consultants it hires are independent and competent,u00e2u20ac he adds, u00e2u20acu0153and that [directors] not substituting the outsidersu00e2u20acu2122 judgment for their own.u00e2u20ac
There is also the danger that, in hiring outside consultants, the board may be encroaching on managementu00e2u20acu2122s role in operating the company, rather than setting policy. u00e2u20acu0153If a board hires a consultant to do things that, in the normal course of business, senior management should handle, I think theyu00e2u20acu2122re on a dangerous path,u00e2u20ac says Charles Wendel, president of Financial Institutions Consulting, a Ridgefield, Connecticut firm that specializes in advising independent and community banks.
Outside consultants come in all flavors. They are available to dispense advice on a myriad of areas including, among other things, information technology, accounting rules, executive compensation, mergers and acquisitions, market research, and corporate governance. And the majority of the time, they provide a valuable resource for the board. u00e2u20acu0153Most boards can pick and choose the expertise they need without giving up their own judgment,u00e2u20ac says Thompson, the Vanderbilt law professor.
In some cases, consultants are hard to avoid. When a publicly owned banking company gets involved in a merger or acquisition, for instance, hiring an outside consultant is not only advisable but de rigueur. u00e2u20acu0153Whether youu00e2u20acu2122re the buyer or the seller, itu00e2u20acu2122s customary to engage legal counsel and financial advisers,u00e2u20ac says James Rockett, a partner in the San Francisco office of Bingham McCutchen and cohead of the law firmu00e2u20acu2122s financial institutions and regulatory practice.
u00e2u20acu0153Their role is to assist the board in analyzing the transaction and assist in determining that the transaction is fair to shareholders. In every single merger I work on,u00e2u20ac he adds, u00e2u20acu0153we go through a carefully documented process to make sure that the board understands the contractual provisions and that the terms are consistent with the norm.u00e2u20ac
However, before making a final decision on buying or selling a company and settling on the terms, Rockett asserts, the board must go beyond the advice of attorneys and the investment bankeru00e2u20acu2122s fairness opinion. Directors, he says, must also evaluate the strategic elements of the merger, acquisition, or buyout, along with the companyu00e2u20acu2122s social and cultural considerations u00e2u20acu0153to make sure that, in the final analysis, they are comfortable with the transaction beyond what their advisers tell them.u00e2u20ac
To Joseph Ford, a partner in DLA Piperu00e2u20acu2122s Austin, Texas law office and cochair of the firmu00e2u20acu2122s financial services group, it seems almost preposterous that board members would eschew hiring outside advisers in a change-of-control situation at a corporation. He asks rhetorically: u00e2u20acu0153Why wouldnu00e2u20acu2122t you take all necessary precautions to prevent something from blowing up in your face?u00e2u20ac
Having said that, not all consultantsu00e2u20ac”or the need for themu00e2u20ac”are created equal. Consultants who are hired in a merger or acquisition situation, for example, are sometimes regarded as more necessary than, say, corporate governance consultants who might be advising a companyu00e2u20acu2122s board on achieving greater independence.
Meanwhile, the SEC, the New York Stock Exchange, the Internal Revenue Service, and various other rule-setting agencies continue to expand the scope of a directoru00e2u20acu2122s duties. According to the 2007 What Directors Think survey of 1,300 directors coproduced by Corporate Board Member magazine and PricewaterhouseCoopers, directors rated their service on the audit committee as the most difficult task, followed by membership on the compensation committee. The task rated as least demanding was u00e2u20acu0153understanding the companyu00e2u20acu2122s marketplace.u00e2u20ac
Regan, the forensic accountant, likens his role in advising an audit committee to a physician providing a second opinion. u00e2u20acu0153For years, audit committees figured that all they had to do was hire a decent outside auditor, and [in doing so] they had fulfilled their responsibility. But now they canu00e2u20acu2122t delegate that responsibility. Theyu00e2u20acu2122ve got to actively and vigilantly monitor the quality of financial statements.u00e2u20ac
Listing requirements on the stock exchanges now require that the corporate charters of member companies provide board members with opportunities to garner the requisite expertise, notes PwCu00e2u20acu2122s Bromilow. u00e2u20acu0153With all the focus on executive compensation now,u00e2u20ac she says, u00e2u20acu0153there is a push to have committees hire their own consultants. People really want to see advisers who are not being used by management. So thereu00e2u20acu2122s been a significant increase in boards engaging consultants.u00e2u20ac
Jan Koors, a managing director at Pearl Meyer & Partners in New York, where she is an executive compensation expert, is working overtime these days to keep boards abreast of the latest round of proxy disclosure rules. The SEC has promulgated the disclosure rules in three tranchesu00e2u20ac”August and December of 2006, followed by subsequent amendments in spring, 2007u00e2u20ac”and they add up to several hundred pages in length, or about the size of the Manhattan telephone book. Another area that almost certainly necessitates outside assistance surrounds the most recent rules adopted in connection with Section 409A of the Internal Revenue Code, which govern the tax treatment of deferred compensation in the event of bankruptcy.
Reviewing these rules would be a Herculean task for most boards, but Koors is familiar with their nuances from A to Z. Experts at other leading compensation consulting firms, such as Minneapolis-based Clark Consulting, which has a dedicated financial institutions practice, are equally reliable and play a key role in helping boards navigate such waters.
The tempo for additional regulations has definitely increased in recent years, experts say. u00e2u20acu0153These new tax rules were adopted as a result of executivesu00e2u20acu2122 bad behavior. Every time thereu00e2u20acu2122s some new perceived abuse or scandal, a regulator decides there needs to be a new rule. They just keep multiplying.u00e2u20ac
And advisers in the area of compensation fill an important niche. They can help the board detail the key components of a compensation package: base salary, the annual bonus (and whether that bonus should be tied to growth in annual sales revenues, company stock price, market share, or some other applicable benchmark), equity, and, often, long-term compensation.
Moreover, as Koors notes, the elements that go into the design of an executive compensation plan also entail, among other things, a detailed understanding of tax and accounting rules, legal implications, and disclosure requirements. Koors describes the level of complexity as u00e2u20acu0153labyrinthine.u00e2u20ac
In addition to simply understanding these regulations, directorsu00e2u20acu2122 decisions regarding executive compensation matters are now under the magnifying glass in a variety of ways. Not only are Congress, federal regulators, and shareholders more keenly aware of the process, butu00e2u20ac”as executive salaries have hit the stratosphereu00e2u20ac”the news media and the public are expressing greater interest as well. All of which prompts Koors to volunteer cheerfully, u00e2u20acu0153Thereu00e2u20acu2122s no question that this is why I have a job.u00e2u20ac
Ronald Janis, a law partner at Day Pitney in New York, cites executive compensation as an issue that is all but impossible for boards to confront without experts lending a hand. u00e2u20acu0153On compensation issues,u00e2u20ac he says, u00e2u20acu0153you always need a consultant to provide support and help organize directorsu00e2u20acu2122 thought processes, because itu00e2u20acu2122s not something they do all the time.u00e2u20ac
The aforementioned What Directors Think survey corroborates the observation that corporate boards typically need outside expertise for many areas today. Only 40% of boards in the survey, for example, reported having a formal budget for educating directors, and by all accounts, most directors remain dependent on management for information. The question of whether boards ought to have more staff and bigger budgets is percolating in corporate governance circles, several sources say.
Yet, PwCu00e2u20acu2122s Bromilow says receiving too much information in what she calls a data dump can sometimes be as thorny a problem as not having enough. u00e2u20acu0153I was called in by one bank board after it had faced some regulatory difficulties,u00e2u20ac she says, u00e2u20acu0153and regulators were requiring that more details of transactions go to the board level. But it was more information than a single person could carry. So we looked at what was truly necessary and designed the way information should flow.u00e2u20ac
There seems little argument that when outside experts are doing their job and providing boards with sage advice, they are also helping keep directors in the good graces of government regulatorsu00e2u20ac”and out of the courts and the newspapers. Yet many experts themselves acknowledge that thereu00e2u20acu2122s a downside if boards become profligate in their use of experts.
u00e2u20acu0153Obviously the use of so-called experts can drive up the cost to the bank and, in some cases, their use was really unnecessary,u00e2u20ac says Rockett, the San Francisco attorney. u00e2u20acu0153A board needs to have different points of view, but sometimes consultants can get in the way.u00e2u20ac
Ford, the DLA Piper lawyer, agrees, saying itu00e2u20acu2122s possible for boards to overuse consultants in an effort to avoid legal liability. Consider the following scenario: By spending money unnecessarily on outside counsel, a company could invite criticism from shareholders and possibly even a derivative lawsuit charging waste of corporate assets. Yet, if such a company kept earnings high, Ford adds, u00e2u20acu0153it would be highly unlikely.u00e2u20ac
And if some are heavily reliant on consultants, there remain others like Christopher Murphy who say his bank board manages to keep the use of outside consultants to a bare minimum. Murphy, who is president, chief executive officer, and board chairman at South Bend Indiana-based 1st Source Bank, believes having a strong board obviates the use of outsiders.
u00e2u20acu0153We bring people onto the board because of their expertiseu00e2u20ac”engineering, legal, financial management, retail business experienceu00e2u20ac”as well as their variety of different educational backgrounds, which adds value,u00e2u20ac Murphy says. u00e2u20acu0153We think using consulting firms would abdicate our responsibility.u00e2u20ac
At the same time, he thinks the growing supply of corporate governance consultants reflects a trend that focuses on simply obeying rules, rather than abiding by ethics and principles. u00e2u20acu0153A consultant isnu00e2u20acu2122t going to solve the problem of whether youu00e2u20acu2122ve been moral or not,u00e2u20ac Murphy says. u00e2u20acu0153Too often, rules just become a game. And people never ask the question, u00e2u20acu02dcIs that right?u00e2u20acu2122 u00e2u20ac