Time For Reflection

Board members at San Francisco-based Wells Fargo & Co. have always relied on annual reviews to help measure the bank’s performance and identify critical deficiencies within the financial institution. So when the New York Stock Exchange (NYSE) introduced self-evaluation guidelines in 2004, the bank’s CEO says board members had no hang-ups about complying with a mandate they considered part of the bank’s corporate governance plan.

“We’ve always done board evaluations at Wells Fargo because it just makes sense,” says Dick Kovacevich, chairman and chief executive officer at the country’s fifth-largest bank.

The premise behind self-evaluationsu00e2u20ac”a checks-and-balances system intended to bolster corporate governance by requiring NYSE-listed companies to perform annual reviews of their directorsu00e2u20ac”is that they give boards the tools they need to determine if they are carrying out their legal and fiduciary responsibilities. Like the Sarbanes-Oxley Act, the new listing standards are a direct consequence of the accounting scandals that rocked several large U.S. firms and shook up corporate America.

The requirement extends down to the auditing, compensation, and corporate governance committees. At its core, an evaluation is supposed to make boards take a long, hard look at themselves: How well does the board or its committees perform in reality compared to how they should be doing? The results of these appraisals should yield enough information to help boards pinpoint areas that are in need of improvement, according to Steven Barth, a partner with Chicago-based Foley & Lardner LLP’s Business Law Department and program chair for the firm’s National Directors Institute.

“The NYSE evaluation guideline is a soft requirement, but if a company fails to describe its board evaluations in its annual proxy statement, it could be subject to delisting. The NYSE is simply saying it believes this is a good idea and that companies should go through this process,” says Barth. “The board should conduct an annual evaluation because if it’s done correctly, the process can make it a better board. It can enhance the company and help each person become better at their job.”

One fundamental shift among boardrooms across the nation has been an increase in diversity. A roster comprised of members from different industries, geographies, and ethnicities has replaced retired CEOs who joined boards largely for bragging rights and golfing buddies who specialized in the wink, nod, and just-smile attitude.

“In the past, you got an invitation to serve on a board. It was a higher calling, an honorary title. For some people, it was about getting on any board simply so they could say they served on a board,” says Pat McGurn, vice president and director for corporate programs at Institutional Shareholders Services (ISS) in Rockville, Maryland.

McGurn’s firm rates more than 5,000 public companies using a corporate governance quotient (CGQ) system that awards points on board independence and CEO succession plans, among other things.

“Today, being on a board is a j-o-b,” says McGurn.

Barth agrees. “If the days of cigar-smoking, golf-centered meetings are not already gone, they are definitely numbered.”

Even the estimated average time spent on board mattersu00e2u20ac”including review, preparation time, meeting attendance, and travelu00e2u20ac”has changed, according to a USC/Mercer Delta Corporate Board Survey updated in March 2005. In 2004, members spent 188 hours serving public boards, up from 180 hours in 2003 and 156 hours in 2001.

While the concept of boards assessing their performance, holding themselves accountable, and adopting the current NYSE standards was almost unheard of 10 years ago, the impact of the guidelines probably wasn’t as hard-hitting for the regulation-heavy banking industry, compared to other business sectors.

That’s partly because the financial services industry has always dealt with strict oversight measures, tight controls, and tough penalties brought on by the Federal Deposit Insurance Corp., Securities and Exchange Commission, and Sarbanes-Oxley requirements, says Barth.

Wells Fargo’s Kovacevich says it shouldn’t matter if it’s outlined in corporate governance guidelines or not, doing board and committee evaluations is a good business practice that every financial services firm should adopt.

“Performance evaluations are a great way to clarify everyone’s goals and responsibilities within the company and identify the board’s strengths and weaknesses,” says Kovacevich. “It also gives everyone an opportunity to make comments and have input in how the board operates.”

Execs at Memphis, Tennessee-based First Horizon National Corp. agree.

“Public companies should be doing these evaluations regardless of it being a requirement or not,” says Harry Johnson, First Horizon’s executive vice president and legal counsel. “These evaluations should help the company enhance the relationships and the processes that are already in place.”

Wells Fargo and First Horizon are not alone. Ninety-seven percent of the directors surveyed in the USC/Mercer Delta study said their firms had written corporate governance guidelines in place when the NYSE regulations went into effect, up from 85% in 2003 and 75% in 2001.

At $36.6 billion First Horizon, the annual board evaluation is coordinated by the bank’s in-house legal counsel. Its most recent evaluation showed it could benefit by adding another director to its roster to help tackle the responsibility of updating the corporate governance committee on all relevant board activities.

“Through the evaluation process, we were able to address key issues, identify ways to improve upon them, and take positive action,” says Johnson. “By adding one more person, we’ll be able to accomplish more tasks and do our job as a board better.”

Yet some governance experts are concerned that the amount of time devoted to monitoring the board translates to less time spent on doing actual business such as CEO succession or strategy development.

“The worry is there and it’s a greater concern today. We have to ask ourselves, if so much time is spent on compliance, are we so overwhelmed by this that we miss the forest for the trees?” says Kovacevich. “I think there is a balance, and, over time, this becomes an effective process that serves us well and ultimately doesn’t take an exorbitant amount of time.”

There are three types of board evaluations: a collective assessment of the board by all the directors, self-assessments by each director, and peer-to-peer evaluations.

Although the NYSE clearly outlines U.S. public company’s obligations to perform an annual performance evaluation and confirm the activity on its annual proxy statement, the stock exchange has left it up to individual companies to determine how to conduct the review. A recent study by the National Directors Institute on board evaluations suggested that directors ask the following questions for both board and committee evaluations:

– What are the board’s strengths?

– What are the areas in which the board needs to improve?

– What improvements to the agenda should be discussed?

– What is the appropriate number of board meetings and how long should they go?

– What is the appropriate board size and composition?

– What should be the board’s principal goals and objectives for the following year?

– Has the committee complied with its charter and completed actions outlined by its work plan?

– Does the committee hold a sufficient number of meetings during the year?

– Does the committee meet for an adequate amount of time to fulfill its responsibilities?

– Does the committee have the right mix of members, skills, and experience to be effective?

– Does the committee receive adequate information in a timely manner from the company?

– What actionsu00e2u20ac”if anyu00e2u20ac”should the committee undertake?

Once a year, every committee member and director at Wells Fargo completes an extensive questionnaire prior to the review meeting. On a scale of one to fouru00e2u20ac”one is weak, four is excellentu00e2u20ac”respondents rate everything from management performance to committee contributions. The informal survey is a thought-provoking exercise designed to help prepare board members to discuss issues that concern the company as well as their individual obligations.

What management issues bother them the most? Are they getting everything they needu00e2u20ac”and wantu00e2u20ac”to do their job effectively and efficiently? What areas in the bank’s corporate structure could use the most improvement? These are just a sampling of the questions that serve as the company’s scorecard.

Kovacevich says his bank’s sessions actually provide a platform for candidu00e2u20ac”and safeu00e2u20ac”dialogue among board members. The bank takes the whole process a step further by allowing board and individual committee members to have a say in how the questionnaires are developed.

“For a long time, we’ve been talking about issues in our evaluations that are now coming up for other company boards,” says Kovacevich. Indeed, he recalls the bank’s talks of CEO succession plans back in the early 1990s, when it barely registered on corporate radars.

“We have always done board evaluations, even before they were required by the New York Stock Exchange,” says Kovacevich. “And we’ve always structured it so that our staff has a part in developing the process because they’re the ones that come up with new areas to focus on. They know firsthand what issues affect them and what they want to address.”

So how does a large company like Wells Fargo with multiple board committees address sensitive issues while keeping simmering animosities from boiling over? Personalities are bound to clash and misunderstandings are inevitable. After all, it can’t be easy for anyoneu00e2u20ac”let alone successful business leadersu00e2u20ac”to undergo scrutiny by fellow board members.

“We don’t do individual or peer-to-peer evaluations,” says Kovacevich. “Our board and committee evaluations are extensive enough to give us the information we need to measure our performance.”

Individual and peer evaluations pose the most challenges and have a greater risk for conflict, according to Barth, who currently works with more than 20 public company boards around the country.

“I sat on a board where a personal evaluation came in on a director and fingers were pointed and people were named,” says Barth. “It really turned into a dysfunctional situation where the two directors came to every meeting afterward with an ax to grind. The tension is so bad now that the board has canceled this year’s evaluation out of fear.”

“I think you have to be a close group of people with a lot of trust and comfort to do personal evaluations,” he adds. “It’s hard, and not a lot of boards can do it.”

Indeed, for some directors, board evaluations are a dreaded exercise that can leave a nasty taste behind, says Roger Raber, president and CEO of the National Association of Corporate Directors in Washington, D.C. “This is not something board or committee members should be afraid of.”

Nor should it be used as a device to oust an unpopular member, says Raber. “The evaluations are intended to give board members insight into how to make the board more efficient,” he says. “This is not a time to deliberately look for someone to put blame on and cast out.”

Although bankers claim they’re familiar with the evaluation processu00e2u20ac”and say that good business has dictated the procedure for years, even decadesu00e2u20ac”a new host of legal issues has popped up.

“The most important thing a board can do is to decide up front how it will handle the evaluation and its results,” says Barth. If problems arise, information gathered during an evaluation procedure is likely to be discoverable in litigation, he adds.

“If there is ever a problem within a company, the plaintiff’s lawyers are likely to identify and use the material that was part of the evaluation process. They could argue a problem was brought up in that evaluation process and then never dealt with,” he says. “It can really create a road map for director liability issues.”

Both Barth and Raber suggest that boards discussu00e2u20ac”and decide up front how to conduct evaluations and what to do with the results. “You can shred all the documents related to the evaluation,” says Raber. “People get the shakes when they hear that because it reminds them of Enron. But that’s not what we’re talking about here.”

In fact, say compliance experts, it’s completely legal to toss out the informal questionnaires used during the evaluation process. “But you don’t want to be tossing these questionnaires out for years and years and suddenly someone wants to keep one on record because they got high marks for something,” says Barth. “That would raise red flags, too. You have to be consistent. You either keep everything or nothing at all.”