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As regulators sift through the wreckage left in the wake of Enron Corp. and other business disasters, they are discovering that many of the problems — questionable accounting, ethical lapses and exorbitant payouts to top executives — circle back to one spot: the company board of directors. Critics contend that too many boards have become simply yes-men for management, composed of insiders, paid consultants or golfing buddies of the CEO. Such boards, they say, are much more likely to routinely sign off on management requests instead of protecting the interests of stockholders. “A certain laxity developed” among boards of directors, said Carol Bowie, director of governance research services at the Investor Responsibility Research Center in Washington, D.C. “They left too much room for management to pursue their own interests.” Reform, however, is on the way. And of all unlikely places, it is coming from that champion of the free market system, the New York Stock Exchange. On Aug. 1, the exchange announced its version of a Corporate Declaration of Independence: new corporate governance rules for the 2,800 companies listed on the Big Board. “Our board had 85 million good reasons — each and every individual investor in the United States — as the basis to take strong action today,” said NYSE Chairman and CEO Richard Grasso in presenting the new standards. Many of the provisions focus on creating a board free from the influence of company management. The rules also require shareholder approval of most stock option plans and authorize the exchange to publicly censor and even delist a company for repeated or flagrant violations. Experts said that if enacted, the rules could force the most dramatic changes to corporate governance in decades. “It’s going to change the dynamic between the CEO and the board,” said Jonathan L. Freedman, a partner at Dewey Ballantine. “It’s as big a set of rules as any others that have been passed lately.” The Securities and Exchange Commission must approve the proposed standards for them to go into effect. However, it is widely anticipated that once the required 45-day comment period has elapsed, the agency will quickly ratify them as is. BOARDS MUST BE INDEPENDENT Most of the attention on the new rules has focused on the requirement that a majority of directors be independent, replacing the current standard that calls for only three independent directors, regardless of the board’s size. The directive is aimed at outlawing an Adelphia Communications-type board, which was stacked with insiders, including the cable company’s founder, John Rigas, his three sons, a son-in-law and his banker. The Rigases are charged with raiding the company’s coffers to the tune of $1 billion in loans to buy condos in New York, Colorado and Mexico, make a documentary film, build a golf course and buy a hockey team, all with a rubber-stamp of approval from the board. Three of the Rigases are now facing criminal charges for using the company as their “personal piggy bank.” Yet it may be too late for Adelphia, which was forced into bankruptcy shortly after the Rigases’ looting came to light. The independence mandate should help curb such flagrant abuses. But corporate governance experts said that other aspects of the new rules are even more significant. In particular, they cite the requirements that the nominating, compensation and audit committees all be comprised solely of independent directors. Additionally, non-management directors must meet without management on a regular basis. These provisions are aimed at a more subtle form of domination over a board, in the guise of a CEO who selects, pays and dishes out favors to its putatively independent members. The board may still technically qualify as independent, but if the CEO is very strong-willed and the board is very passive, problems can crop up, said Joel Seligman, dean of Washington University School of Law in St. Louis. The board of Enron Corp., for example, qualified as independent, as do the boards of 75 percent of the companies listed on the exchange. Nonetheless, Enron’s auditing committee signed off on dubious off-balance-sheet partnerships that disguised massive amounts of debt and filled the pockets of chief financial officer Andrew Fastow, according to a Senate panel investigating the matter. “The board’s independence was clearly compromised,” said Charles Elson, director of the Center for Corporate Governance at the University of Delaware. “There was a culture of reliance on management.” With the exchange’s new rules, “those days are over,” Seligman said. The exchange has also tightened the definition of “independent,” restricting its application to those directors who have “no material relationship with the listed company, either directly or as a partner, shareholder or officer of an organization that has a relationship with the company.” Former employees qualify as independent only after a five-year cooling-off period, bumped up from three years. Although defining what constitutes a “material relationship” could be tricky, many companies will go further than the exchange’s dictates, Elson said. “These rules will be a floor, not a ceiling,” he said. But lawyers said the focus on increasing the number of outside directors and on their expanded duties could make it hard to recruit qualified people for the job. “Being an outside director is not meant to be a full-time job,” Dewey Ballantine’s Freedman said. “If I were asked to be an outside board member, first I’d wonder what I did to piss off this person and then I’d run for the hills,” he said. In other important moves designed to take control away from management, the exchange is directing listed companies to give shareholders the opportunity to vote on most stock option plans, and taking away the right of brokers to vote their customers’ shares on such proposals. The new standards are just one of a flurry of regulatory responses to the crisis in investor confidence brought on by Enron and other business scandals. Major open questions still remain, such as how stock options should be accounted for, whether accountants and lawyers should be liable for aiding and abetting a corporate fraud, and whether Congress went too far in an earlier initiative to curb perceived securities class action abuses. So it remains to be seen how the current push for reform will play out. But the reaction from institutional investors to the exchange’s new standards has been “extremely favorable,” said the Research Center’s Bowie. “The rules are not a silver bullet,” she said, “but the board is the key to these abuses.” “If the independent directors are empowered and the board is doing its job then the necessity of all these other reforms will fall away,” she said.

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