Boards increasingly pushed to establish CEO oversight procedures.
Even wildly-gifted CEOs need supervision.
That appears to be the takeaway from recent regulatory cases where companies have been taken behind the woodshed for not monitoring their star chief executives.
The most recent example involved swift action by the U.S. Securities and Exchange Commission (SEC) against Tesla Inc., as well as its talented CEO, Elon Musk. The SEC sued both Musk and Tesla after Musk tweeted a series of “false and misleading” statements about a transaction to take Tesla private.
Part of the settlement included corporate government changes: Musk had to relinquish the chairman job, the addition of two new independent directors, the creation of a new committee of independent directors, and additional controls and procedures to oversee Musk’s communications.
Radical measures for a radical CEO?
“Boards are always responsible for CEO oversight, but the Tesla situation seems to be a case study of an extreme example: You have a headstrong CEO who, for all we know, has perpetually rejected every board attempt to rationalize his conduct,” says Joseph A. Grundfest, a professor of law and business at Stanford Law School.
CEO Oversight Tips
• Put procedures and policies in place that create an information pipeline between management and the board, says Michael Blankenship, a partner at Locke Lord. “You need to find a way to have an open and honest dialogue.”
• Make sure the CEO is on the phone with several directors monthly, he adds. “Keep the information up to date.” Big risk areas, such as cybersecurity, data privacy and sexual harassment, should be discussed regularly.
• Strive for a culture of transparency. CEOs must feel they can bring the bad news, as well as the good news, to the board, says Mary Beth Vitale, former director of CoBiz Financial Inc.
• Directors should make sure the information flow is not asymmetrical. “If the information is just coming from management, you’re not doing your job,” Vitale says. She suggests attending industry conferences, staying on top of competitor’s earnings calls and keeping abreast of what institutional investors and employees are saying about your company.
• Bring a dispassionate approach to the job of director, even if the CEO is a larger-than-life and transformative leader, says Philip Bezanson, managing partner of the Seattle office with Bracewell law and government relations firm.
• Consider it a warning sign if the CEO takes offense at being challenged by directors. “If a CEO is getting prickly because you’re asking questions, you’ve got the wrong CEO,” Vitale says.
• Take it as a red flag if the CEO says, “Trust me. We’ve got this under control. Don’t worry about it,” Bezanson says. “Directors should stick to their guns when they see something they don’t like.”
• The board’s expectations of management should be set on a yearly basis, Blankenship counsels. If a CEO exhibits signs of unpredictable behavior factor that into the executive’s performance review, writes Sarah Fortt, senior associate with Vinson & Elkins in a piece on director oversight.
The board might well have fired a less valuable CEO, Grundfest adds, “but Tesla’s future seems so tied to Musk’s leadership that the board could well have no rational alternative but to work with Musk, warts and all.”
Unfortunately, the warts led to a $20 million fine against Musk and another $20 million against Tesla, not to mention a hit to the stock price. And in early November, a group of investors including California, Connecticut, Oregon, and New York pension funds holding about $775 billion in assets, called for a board overhaul because of a “lack of responsiveness to fundamental governance concerns.”
Examples like this create an oversight conundrum for boards that have to balance company performance and a successful yet flawed CEO. A director’s duty is to serve the interests of shareholders, not the CEO, however dazzling. Fulfilling that obligation includes having processes and controls to oversee and hold accountable senior managers.
“I think this is just a reminder that relationships shouldn’t trump oversight,” says Sarah Fortt, a senior associate at Vinson & Elkins who focuses on corporate governance and board representation. “It’s a reminder to the board of directors to ask the tough questions.”
There’s definitely room for improvement among companies. Only 56% of boards formally evaluate the CEOs leadership in assessing the corporate culture, according to the “2017-2018 Public Company Governance Survey” by the National Association of Corporate Directors. Just 19% reported they discussed with institutional investors the setting of goals and performance metrics for the CEO.
When it comes to keeping tabs on the CEO, regulators are watching. The Tesla remedies, for example, are “specifically designed to address the misconduct at issue by strengthening Tesla’s corporate governance and oversight in order to protect investors,” Stephanie Avakian, co-director of the SEC’s enforcement division, said in a statement. What’s more, “holding individuals accountable is important and an effective means of deterrence,” said SEC Chairman Jay Clayton in a related statement.
Federal Reserve Chairman Jerome Powell has also minced no words about the Fed’s expectations of directors. In a speech last year at the agency’s Large-Bank Directors Conference, he called the oversight of management and holding management accountable “core board responsibilities.”
“Across a range of responsibilities, we simply expect much more of boards of directors than ever before. There is no reason to expect that to change,” Powell said.
Besides regulators, institutional shareholders and activist investors also want directors to be active leaders.
“There’s a tremendous pressure on boards to be extremely knowledgeable about any risk, particularly areas of current intense investor focus, like cybersecurity, climate change, #MeToo,” Fortt says.
The challenge for many boards is to oversee without overstepping. “It’s a tricky time out there,” says Nada Usina, a member of Russell Reynolds Associates’ board and CEO advisory group. “I think what we’re seeing is a different level of scrutiny.”
Walking a delicate line
Unlike in the past, CEOs today expect an active and engaged board, says Mary Beth Vitale, who was on the board of CoBiz Financial Inc. until it was acquired by BOK Financial Corp. in October. “They know we’re not going to be just a rubber stamp. The C-suite comes with their ‘A game’ when they come to the board because we make the decisions,” she says.
Yet, it can be a delicate balancing act. Oversight should not mean stepping into the shoes of management. U.S. directors were 8% less likely than the global average to cross the line from oversight into operations, according to a global board culture study by Russell Reynolds.
“Nothing good comes from micromanagement,” says Michael Montelongo, an independent director of Herbalife Ltd. “If you’re constantly micromanaging, you remove any power and responsibility the management team has to make decisions and move the company forward. Why do you need them if you do that?”
For Montelongo, the principle of NIFO should apply — “Noses in. Fingers out.”
“The board is there to coach, support management, set the strategic direction, provide management the resources to achieve that strategic direction, monitor the performance of the company and ensure compliance. Directors direct; management manages,” says Montelongo, who joined the Herbalife board toward the end of an epic Wall Street battle over the company involving two investors.
The relationship between the board and CEO should be built on mutual trust, accountability and understanding of each other’s history and limitations, Montelongo explains.
“Then when the unexpected or extraordinary happens, both directors and management is organized, trained, and equipped to handle it together,” he says.
Maureen Milford is a Delaware writer focused on corporation law and governance matters.