Building a Better Director

The Law School has been holding a Directors’ College for years, but it is suddenly more relevant than ever. 

Bill Lerach, his signature shock of white hair shorn short, moved through the cocktail party crowd on the second night of Directors’ College. From the bar, Lerach looked around the packed Bechtel Conference Center at Stanford, soaking up the nervous buzz in the air.

In the center of the room, Securities and Exchange Commission Chairman Harvey Pitt huddled with Munger Tolles Olson partner Ronald Olson. Fortune magazine Executive EditorJoseph Nocera leaned into the conversation. In corners and on leather chairs, executives from some of America’s largest companies and investment funds noshed finger food over their Medot or mineral water, talking about issues of keen interest to Bill Lerach. 

Lerach is the lead partner in the plaintiffs’ law firm most feared by corporate directors, Milberg Weiss Bershad Hynes & Lerach, responsible for more than 70 percent of class-action shareholder suits brought in the United States. 

Joked Lerach later: “I’m long Enron.”

QUESTIONING CORPORATE PRACTICES

At Stanford Law School’s eighth annual Directors’ College, a sold-out two-day series of off-the-record seminars on corporate governance, 170 attendees and 60 speakers came from around the country. Organized by Law School Professor Joseph Grundfest ’78 and Munger Tolles partner Simon Lorne, the white-shoe gathering in June drew CEOs, directors, lawyers, investment fund heads, academics, and regulators. 

The timing was auspicious. On Monday, at the close of the college’s first day, the Dow Jones index had dropped 2.2 percent and the Nasdaq 3.3 percent as Tyco International CEO Dennis Kozlowski resigned suddenly in the face of a criminal investigation. Scandal was leaping from company to company, and the lawsuits were mounting. Directors were on the front line. Directors’ College attendees wanted to know how they could arm themselves to raise standards of corporate governance. Eleven panel sessions and six keynote speakers covered a gamut of topics, from executive compensation and board committees to accounting practices and crisis management. The talks underscored three overlapping categories of abuse that might be remedied: audits, independent directors, and bosses’ pay. And this triad of bad corporate practices propped up the public outrage that was spurring regulators and politicians. 

“It’s very difficult to overstate the crisis of confidence among investors today,” said SEC Chairman Pitt.

AUDIT REFORM

While some speakers called for more lawyers, niles, and regulations to assist directors in discharging their duties, few held out hope that the answers to genuine reform would emanate from Washington, D,C., or the Financial Accounting Standards Board. Common sense should take a more prominent seat at the boardroom table, speakers said, and the audit function should move from bright-line rules that can be easily exploited to principle-based reporting that promises shareholders a more transparent picture of a concern’s true financial condition. 

Joseph Berardino, in his first public appearance since resigning as CEO of Arthur Andersen, decried “accounting principles that have gotten to be like the IRS code.” He suggested that accounting firms switch from the current pass-fail audit to a report card-style grading system. That would give auditors more leverage over clients in accounting disputes and also let investors reward companies with high marks and discount those with low. 

“Bad accounting follows bad business decisions,” Berardino said. “Focus on understanding what is going on in the business and on risk management.”

INDEPENDENT DIRECTORS

The need for more independent directors carried through almost every panel discussion and speech. At a minimum, directors needed to be financially qualified to judge a corporate balance sheet, said Roman WeiI, professor of accounting at the University of Chicago Graduate School of Business. 

Weil reviewed results of his annual multiple-choice accounting exam that many attendees had completed in advance. As in previous years, it was humbling. Most failed. “I don’t know if we’ve made much progress on financial literacy,” Weil complained. 

The harshest note was sounded in Walter Hewlett’s opening night address, when the dissident loser of the bruising nine month boardroom proxy battle charged that directors who relied solely on management information to vote on the Compaq and Hewlett-Packard merger were guilty of a “dereliction of duty.” 

“At the very least, boards must be pried from managements’ hands,” Hewlett said in one of his first speeches after leaving the Hewlett-Packard board.

BOSSES’ PAY

Director independence, or lack thereof, lay at the heart of abuses in compensation, speakers said. 

Charles Elson, professor of corporate governance at the University of Delaware, called on companies to require that directors be independent, be subject to term limits, and hold on to their shares until two years after they step down from the board. Truly independent directors would prevent bosses from writing their own compensation plans, and holding shares during their tenure would discourage appearances of insider trading, he claimed.

But after the panel discussion, one director of a publicly traded company countered that he had served on his board longer than a decade and had not taken a vow of poverty. Many in the audience applauded. Forgoing compensation for two years after leaving a board, the director added, would create “a very limited set of circumstances to get a director to serve.”

BULGARIAN STOCK MARKET

Bill Lerach brought directors’ fears to vivid life. In a panel where he represented the plaintiff’s attorney in a mock shareholder lawsuit, he deposed a reluctant director played by Stanford Law Professor Kennetll Scott ’56 before U.S. District Court Judge Susan Illston ’73. Lerach led Scott over one exploding mine after another. 

Lerach conceded he had one goal-settlement. With more than 95 percent of all shareholder suits settled before trial, Lerach said depositions are designed to show directors and executives how embarrassed they would be in a public trial and to make them look ridiculous and evasive. “It was like watching yourself be operated on without anesthetic,” said one audience member afterward. 

In a luncheon keynote speech on the closing day, Lerach said the country was in the “midst of the largest financial fraud since 1929.” Without reforms led by directors themselves, he warned, Wall Street would come to “resemble the Bulgarian stock market.” And, he added, “A whole generation of investors is going to stay away.”