Boards of Directors Are Driven

¶ … boards of directors are driven by far-reaching regulatory reforms and increased corporate expectations in order to comply with the Sarbanes-Oxley legislation. Consequently, many feel an ever-growing need for orientation, education, and evaluation. Corporate directors are currently trying to gain the hands-on knowledge required to become more valuable professionals in the boardroom, with the help of general counsels, financial executives, HR representatives or corporate secretaries. Ethics is a very important part of their change, since enforcing business morality is the main objective behind the Sarbanes-Oxley act.

Sarbanes-Oxley is a U.S. law passed in 2002 designed to strengthen corporate governance and restore long lost confidence to the investors. The Act was supported mainly by Senator Paul Sarbanes and Congressman Michael Oxley. It was the natural consequence of a number of major corporate and accounting scandals in recent years, which involved influential companies in the United States. Public trust in accounting and reporting practices were collateral victims in these scandals.

The new legislation has changed a lot in the business world and prompted the "back-to-school" momentum among the boards of directors of the present. The most important thing requested from people who make decisions at the top of the major companies was a greater scrutiny and accountability of corporate directors. Having this particular purpose in mind, the authors of the Sarbanes-Oxley Act of 2002 managed to create a new governance environment by giving corporate boards a lot of new responsibilities. For instance, one can find among the changes the fact that board audit committees for each and every publicly listed company were compelled to have at least one financial expert by 2004.

A brief description of this legislation should provide a clearer image of the issue. New or enhanced standards and responsibilities for all U.S. public company boards, management, and public accounting firms are established by the Sarbanes-Oxley Act.

The law contains 11 titles, or sections, ranging from additional Corporate Board responsibilities to criminal penalties. The authority in charge with implementing rulings on requirements to comply with the law is the Security and Exchange Commission (SEC).

The Sarbanes-Oxley Act addresses mainly the following points: it establishes new standards for Corporate Boards and Audit Committees, sets out new accountability standards and criminal penalties for Corporate Management, promotes the objective of new independence standards for External Auditors and establishes a Public Company Accounting Oversight Board (PCAOB) under the Security and Exchange Commission (SEC) which is entrusted with the overseeing of public accounting firms and issuing of accounting standards.

It would have been difficult for the SEC to implement and supervise the application of the new legislation all by itself. Usually, when a law doesn't make sense and is inappropriate for the current economic or social environment, it is simply rejected by the people who should apply it. The proof that the Sarbanes-Oxley act is an example of a good piece of legislation is the fact that, since the act has passed through congress, other organizations have decided to join this movement in order to increase the accountability for board members and make sure that their skills and experiences match the tasks for which they are held responsible.

For instance, the New York Stock Exchange (NYSE) began requiring boards of its listed companies to perform annual self-evaluations, intended to determine whether the boards themselves and their committees are actually functioning properly. There aren't specific guidelines telling boards how should evaluate themselves, nor does the NYSE supply a set of rules regarding the approach to take in order to achieve the desired objectives. However, there is one thing that the NYSE regulation does, and that is to make the boards responsible for regularly judging and improving their performance. These are merely exercises, but there are "Some governance experts [who] expect such exercises to become the norm for any large public company-regardless of where it is traded."

There are also other rules set out by the NYSE: the New York financial institution obligates listed companies to adopt and disclose whatever corporate governance guidelines they choose, including the particular guidelines regarding how directors are orientated and how their continuing education is achieved.

If one should review the last two years, one would be surprised with how many accomplishments the world of corporate governance has known. Still, there are many things still to be done. Every company listed on the a U.S. exchange, no matter which, has already experienced many months of the Sarbanes-Oxley Act and is now able to understand the challenges it poses. The new piece of legislation speaks about "independence," a concept having ramifications and implications that directors and officers have been trying to grasp, while doing their best to ensure compliance with the Act.

The new listing standards from the NASDAQ Stock Market, the New York Stock Exchange, and the American Stock Exchange had to be absorbed in a short interval of time by board members, while directors have also been busy analyzing the SEC proposal on shareholder access to the proxy.

Anyway, it may easily be said that, although present day rules, regulations, and oversight of directors are tighter than always, the essential qualities required for board service have remained the same, i.e. An independent mind, the adherence to duties of loyalty and to the care towards shareholders and stakeholders, integrity and the courage to ask "difficult" questions. A system functions easily if directors possess such qualities. If they don't, no matter how strict rules and regulations are, the system is destined to fail, simply because rules are designed to eliminate "exceptions," i.e. corrupt, unethical people, and not regulate the behavior of the entire community, which should have a moral attitude even in the absence of rules.

But what are the principles that should define the life of corporate professionals? Although exhibiting certain personal characteristics is an important aspect for all directors, there is also an important thing to be said about the proper understanding of their responsibilities. Understanding and reviewing their responsibilities during the time they pertain to board service is a very useful thing for both young directors and for seasoned individuals.

Reviewing company performance is probably the most important responsibility of every director. Consequently, in order to perform this specific task, directors have the obligation to review annual reports, press releases, and analyst reports, with the purpose of gathering information regarding the status of the company, the way it is marketed to, and perceived by, the public. Since this is a very complex process, directors have to understand fully the way the company functions, with a particular accent on its financial performance. This is a job that has to be constantly kept in mind by the board. Reviewing and revising the company's strategy, while also taking interest in outside performance indicators supplied by independent, external bodies is something the board of directors should do constantly.

Another function of the board of directors concerns risk management and oversight. There are no excuses for directors who fail to detect when the SEC or other regulatory agencies are considering an investigation or litigation, or have even initiated the required procedures. This is where it is probably the most important for directors to make sure that there is a climate of disclosure and transparency, although such a climate should exist just about everywhere in the company.

Crises are events when the ability of directors is put to some real testing. Members of the board should be familiar with the company's crisis-management program, while also having a clear notion on whether the board actually has the authority to intervene during a crisis and solve it accordingly. Accurate and legal financial statistics are extremely important, so there must be a constant supervision of the reporting systems that produce these statistics. Such results are achieved by ensuring the existence of internal controls and reliable communication with the auditors.

There have been many cases when governance authorities have stated that CEO selection and evaluation is the most important function of the board. Therefore, "in this regard, directors should produce qualitative and quantitative, short- and long-term performance goals for the CEO. Stock price, while one quantitative measure of company performance, cannot be viewed in isolation. Additional metrics, such as new income, cash flow, product quality, customer satisfaction, and market share, also provide important measures of the CEO s leadership."

There is also a special attention that needs to be paid to ethical problems. One author states that "in addition, directors must ensure that the CEO sets the right "tone-at-the-top" for accountability and integrity. Annual evaluations of the CEO and other senior management should become part of the boards regular practice, and can be enhanced by regular executive sessions of the board without the CEO present."

There is another thing to be considered, and which is one of the most spectacular in the business world: the CEO succession process. Such events exist in order to solve problems relating to leadership changes resulting from retirement, severance, or incapacitation of the CEO. CEO succession has become lately a significant issue for companies listed on the American exchanges, as the National Association for Corporate Directors 2003-2004 Public Company Governance Survey points out.

One other new thing brought to the attention of companies by the Sarbanes-Oxley Act is the fact that, under this law, every public company is supposed to prove strong internal systems designed to catch an employee intending to commit fraud or flag accounting errors before a company has the opportunity to make its profits official. An addendum to this rule is the obligation of a company knowing about problems with its control systems to disclose what it has uncovered. This obligation generated what an author called the "current flood of mea culpas."

As mentioned above, many companies have faced serious difficulties during the last few years. Companies conducting their activity in Silicon Valley, for instance, such as Versant, Portal Software and Sipex, have acknowledged that they have encountered problems such as not having experienced accounting staff, lacking checks and balances in the case of employees handling corporate cash and the inability to demonstrate that their financial computer systems are tamper-proof or accessible only by authorized users.

In other cases, such Monolithic Systems, Asyst and Rita Medical Systems, other system weaknesses have been confessed, such as the impossibility to reliably balance the corporate books at a certain point in the recent past.

The example of the Sipex Company, based in Milpitas could be considered relevant According to its own description, published on the company's website, "Sipex Corporation is a semiconductor company that designs, manufactures and markets high performance, value-added analog integrated circuits (ICs). Sipex serves the broad analog signal processing market with interface, power management and optical storage ICs for use in automotive, portable products, computing, communications, and networking infrastructure markets. The company is headquartered in Milpitas, CA with additional offices in Belgium, Canada, China, Germany, Japan, Taiwan and the UK. Sipex sells products direct and through its distribution channels."

The company announced in March 2004 that its auditors have found problems that included errors in figuring out costs that were related to deferred sales, while also discovering an undesirable reliance on manual accounting work. As a consequence, the SEC has begun investigation relating to the company's past revenue recognition practices, considering especially the fact that the company's chief executive officer has resigned last year, following a series of disagreements with the board of directors, a fact which draws attention once again to the board.

The fact that Sipex is not the best example one could give regarding the correct application of the Sarbanes-Oxley Act became clear on April 6, 2005, when the company announced that it received a Nasdaq Staff Notification stating the Company is not in compliance with Nasdaq's Marketplace Rules. Sipex had the right to appeal, otherwise facing the serious sanction of delisting.