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Column

Gary Sutton
‘Sutton’s Laws’ Columnist
Directors & Boards

Indicators of Trouble
Here are a few of mine as I seek to ascertain the tone at the top.

By Gary Sutton

Google the phrase “backdated options” and try, just try, to find an article written before 2005.

Tough, eh?

As a director back then, you didn’t list “backdated options” among your top 10 worries, or even in the top 100. Neither did your auditors. There were all these other things, like SOX and recognizing revenues and capitalizing expenses that created way too many known opportunities for humiliation. Besides, backdating options simply was not and is not illegal, as long as they are disclosed and properly expensed as compensation.

You cannot hope to anticipate every abusive tactic that an ethically challenged CEO may conceive. Sorry. He’s full-time and you’re part-time. He, hopefully, understands the details way better than you anyway. So the odds favor him.

You can, however, sense ethical lapses in the way many other things get handled. Then you quietly resign from the board. But let the other directors and this CEO know why you’re quitting.

It’s All about Tone?
It’s the “tone at the top” that leads to most problems. That’s more important than an impossibly obtrusive effort to scrutinize every past detail or guess the next fraud.

Remember the uproar over “friends and family” IPO shares?

That one’s still a mystery to me. Bill Ford was chastised for getting Goldman Sachs IPO shares, and had to return them. I got Goldman Sachs IPO shares and, being way less visible, flipped them.

Was that a crime? I thought not and think not. If the IPO shares were issued too cheap, then Goldman was abusing itself. Didn’t it have that right? I had a personal account with Goldman but controlled no corporate business that was big enough to get its attention.

Bernie Ebbers was derided for getting Rhythms Netconnections IPO shares. But I got some myself (cannot remember which banker passed them on to me), flipped them, and made some modest money. Was that wrong?

If subpoenaed, and if I brought along documents for the half-dozen other IPO shares I got (which all lost money), perhaps the judge or jury might see these events as what they were -- about as significant as arguing over the luncheon check. But had I been entangled in some public stock meltdown, those IPO gifts and flips that worked would get a darker shading by the media. The rules keep evolving.

Your Best Defense
Tone at the top is your best defense.

What are some indicators of trouble?

• A CEO salary that’s in the top quartile for your industry while results are in the bottom half. Slam-dunk.

• Expense accounts that pay for more wine than food and more first-class tickets than coach. Bad for shareholders.

• Annual employee turnover above 30% or below 15%. Some is healthy; too little or too much is sick.

• CFO presentations at meetings that explain intricate financing deals that enhance reported earnings without boosting cash, or offshore tax deals that reduce, significantly, your burdens, or changing amortization schedules, or shifting time zones to keep the month open a bit longer or difficulty closing the quarters. Slick or vague answers. Bail out!

• Severance that’s inconsistent. Something’s wrong.

• A CEO who’s in his third decade of being in charge. He truly believes it’s his money now.

• Excessive alcohol, sex, or weight among officers. Management takes discipline.

• Management that never has quiet, one-on-one moments with a board member. Something’s hidden.

Develop your own set and follow them as much as you do the checklist stuff for governance. You’ll be less frequently embarrassed and rarely sued.

Gary Sutton has been a CEO and director of a number of private and public companies in his career as a specialist in startups and turnarounds. He writes the “Sutton’s Laws” column for Directors & Boards. His book, Corporate Canaries: Avoid Business Disasters with a Coalminer’s Secrets, was published by Nelson Business in 2005. He can be contacted at garysutton@san.rr.com, or visit his blog at http://blog.coughingcanaries.com.