Corporate Governance

The Myth of an Independent System for Nominating Directors (and Another Reason Why Shareholder Access Is Necessary) (Part 3)

By J Robert Brown Jr.

What the rules of the exchange do not do, however, is ensure that management has reduced influence on the nomination process.  While the committee is the one that actually nominates the candidates, the sources can come from anywhere, including the CEO. 

This was made clear by the process used by HP to nominate additional directors to the board.  According to the WSJ, "four of the most outspoken board members during those deliberations wouldn't stand for re-election" and instead "five new directors to take their places."  The process for selecting the five additional directors raised concerns that were flagged in a report issued by ISS. 

Of the seven new directors nominated for the board, five of them were, apparently, nominated by an ad hoc committee that included the CEO.  As the report noted:

• The nominating committee is responsible for leading the process for board appointments and making recommendations to the board. In this case, only two of the seven director nominees were identified by the company's Nominating & Governance Committee, with the assistance of a professional search firm. The remaining five nominees were identified by an ad hoc committee including the company's new CEO.

The report noted other commentary suggesting that the nominees in fact had connections to the CEO.

• According to a Bloomberg article published on Jan. 26, 2011, at least four of the five director nominees have connections with Apotheker. Senequier sits on the board of Schneider Electric with Apotheker, and at least three of the director nominees have been customers of SAP AG, where Apotheker was the CEO and worked from 1988 to 2010.

The CEO's participation in the selection of the directors "raises red flags."  As the report stated:

• Given the problematic board issues that have arisen at the company in the past (including the forced resignation of a former independent chair in 2006), shareholders would have expected the company to adhere to the highest standards of board governance. The board is responsible for representing shareholders and overseeing management, in particular the CEO. Permitting the CEO to directly influence the identification and appointment of outside directors runs contrary to best practices. A CEO's participation in the appointment of directors, especially if the director has significant relationships with the CEO, can make it difficult for such directors to be objective.

The issue was, apparently, raised with HP.  The Company, according to the ISS Report, "characterized the role of the 'ad hoc committee' as akin to that of a search firm, and stressed that the candidates identified by this committee were vetted by the Nominating & Governance Committee and approved by the full board."  ISS was not mollified.

• the fact remains that the new CEO was involved from the earliest stages of the process. According to HP's Nominating and Governance Committee Charter, the purpose of the Committee is "to identify individuals qualified to serve as directors and recommend to the board candidates to be nominated for election as directors by shareholders at HP's annual meeting…" Furthermore, the charter notes that "each director on the Committee must be independent within the meaning of applicable laws or listing standards…" The CEO's formal participation in the ad hoc committee established to identify potential director candidates runs contrary to the Nominating and Governance Committee's Charter which specifically calls for the process to be conducted by independent directors only.

So what difference does it really make?  The Report issued by ISS also noted some of the likely interaction that the newly nominated directors would have with the CEO.

• Importantly, shareholders should have concerns in light of the new CEO's participation in the selection process for new directors who will have oversight of his future compensation, especially considering the company's history of abrupt CEO exits that have proved costly to investors. Mr. Apotheker's arrangement includes substantial up-front signing awards of cash and stock, and severance provisions that would result in sizeable payouts – including automatic vesting of all his time-based equity – upon his termination without cause. Many aspects of the company's incentive programs are subject to board discretion as well, and depend on the board exercising its authority objectively – e.g., the granting of discretionary bonuses and approval of higher-than-median pay benchmarking. As cited earlier in this report, this is a key reason that directors should be selected and appointed without undue management influence.

HP and Marty Lipton saw things very differently as the next posts will show.

Full post as published by The Race to the Bottom on March 16, 2011 (boomark / email).