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Jun 26, 2014

The Importance of Board Evaluations
 

This is the second of our two-post series on the increasing importance of board evaluations for corporate compliance by governing boards. The first post of this series stressed the need for board evaluations and this second post will cover how to proceed with performing board evaluations.

Our first post explained that the state law duty of care is viewed as requiring the board of directors of any organization to attract and retain sufficient prudence or expertise as directors, and to provide direction and oversee matters critical to the health of the organization into the foreseeable future (discussed in our May 12, 2014, post).


The Objective of the Evaluation

The first step in the process is to determine the objective or objectives of the evaluation (as discussed in our May 12, 2014, post).  Generally there are at least these three:

  1. Practices Evaluation. The practices of the board and its committees for purposes of improving board governance to meet the future needs of the company;
  2. Skills Evaluation. The background, skills and experience of each individual member of the company’s board for purposes of determining competence of the board for the future of the organization; and
  3. Compliance Evaluation. The organization’s compliance with legal requirements and ethical aspirations, including compliance with any regulatory order, including any corporate integrity agreement.

The most common evaluation is the practices evaluation. Most practices evaluations are simply each board member evaluating the organization’s, the board’s, and their committee’s practices. However, a more helpful evaluation would be to identify and use some best-practice benchmarks against which the organization’s, the board’s, and their committee’s practices will be compared.

The skills evaluation is typically used as part of a strategic planning process where the board determines the collective background, skills and experience believed to be required for the future of the organization, compares that with the collective background, skills and experience of the current board, and then determines how to fill any gaps. However, a good question to include in any evaluation, especially a practices valuation, is an open-ended question to the effect of “Do you have any background, experience or skills that may be helpful to the organization and the board that are not being fully utilized?”

Consideration should be given to conducting any compliance evaluation either under the direction of general counsel to the organization or special counsel to the board, in order to add protection of the attorney-client privilege and for advice on legal issues such as probative value of evidence and materiality.

The Subject of the Evaluation

The next step in the process is typically the subject of the evaluation, which can be (with respect to the objectives identified in the first step):

  • Full board and its committee where each individual director evaluates the full board and its committees; or
  • Individual director self-evaluations where each individual director evaluates himself or herself; or
  • Individual director peer evaluations where each individual director evaluates each other director.


Full Board Evaluation

A full board evaluation typically addresses:

  • Understanding of responsibilities
  • Independence
  • Composition and structure of the board
  • Composition and structure of the committees of the board
  • Strategic planning
  • Policy development
  • Board succession
  • Company executive succession
  • Oversight function
  • Financial acumen
  • Business development
  • Conflicts of interests
  • Meetings
  • Communication
  • Understanding of oversight of risks
  • Decision making
  • Board/management relationship
  • Information dissemination
  • Appropriateness of questioning
  • Level of participation
  • System of checks and balances for management decisions

The most important board evaluation question is open-ended to the effect of:  “The effectiveness of our board could be improved by ______________”.


Individual Director Self-evaluations


Each individual director evaluates himself or herself as to matter such as:

  • Understanding role and responsibilities
  • Levels of knowledge (both company and industry)
  • Participation
  • Attendance
  • Willingness to question
  • Independence of thought of action
  • Conflicts
  • Business development
  • Continuing education

The two most important director self-evaluation questions are “The organization, other directors, and management could improve my effectiveness by ______________,” and “Do you have any background, experience or skills that may be helpful to the organization and the board that are not being fully utilized?”


Individual Director Peer Evaluations

Each director evaluates himself or herself and then separately evaluates each other director on the matters described above under “Individual director self-evaluations.  However, we recommend that this be conducted through a third-party evaluator with whom the board has confidence.  The report to each director shows the director’s self-evaluation and the average of the evaluations of that director by the other directors.  Each of these reports must be confidential.  The peer evaluation can be expanded to a 360-degree evaluation where, in addition to other directors evaluating each other director, management, other stakeholders, such as shareholder in a closely-held corporation, and strategic partners, such as outside legal counsel and audit firms also evaluate each director.

If you have questions on this post, please feel free to contact Kevin Kinross at 614.227.8824 or kkinross@incomplianceconsulting.com.


The next post will focus on how to engage the board in strategic planning, which is one of the board’s most important responsibilities.


 

Posted by J. Beavers in  Board Evaluations   |  Permalink

 

Jun 12, 2014

The Importance of Board Evaluations
 

Now that we’ve completed our five-post series on corporate compliance for governing boards, we shift our focus to the increasing importance of board evaluations in this two-part series. This first post stresses the need for board evaluations and the second post will cover how to proceed with performing board evaluations.



Most institutional investors, regulators (such as the SEC and National Association of Insurance Companies), and governance commentators are taking the position that the state law duty of care requires board directors of any organization to attract and retain sufficient prudence or expertise as directors to provide direction and oversee matters critical to the health of the organization into the foreseeable future (discussed in our March 27, 2014 post). For this reason, board evaluations are often conducted in conjunction with consideration of a strategic plan to determine the organization’s future direction.

Institutional investors (such as the Council for Institutional Investors) and organizations that rate the corporate governance of public companies (such as Institutional Shareholder Services) were among the first to expect public companies to evaluate at least:

  • The background, skills and experience of each individual member of the company’s board for purposes of determining competence of the board for the future of the company, and
  • The practices of the board and its committees for purposes of improving board governance to meet the future needs of the company.

In addition, federal sentencing guidelines (discussed in our May 12, 2014 post) generally require, as part of a corporate integrity agreement taken into account in sentencing an organization, that the organization’s board evaluate:

  • The organization’s compliance with the corporate integrity agreement;
  • The practices of the board and its committees for improving board governance to meet the future needs of the organization; and
  • The background, skills and experience of new members added to replace prior members of the board, which is typically required as part of the agreement.
The SEC began requiring public companies to disclose (in proxy statements at least annually and in prospectuses at each public offering of their securities) a description of  the business experience during the past five years of each director, executive officer, person nominated or chosen to become a director or executive officer and other highly compensated persons of influence. This description includes each person's principal occupations and employment during the past five years; the name and principal business of any corporation or other organization in which such occupations and employment were carried on; and whether such corporation or organization is a parent, subsidiary or other affiliate of the registrant.  In addition, for each director or person nominated or chosen to become a director, briefly discuss the specific experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director for the registrant at the time the disclosure is made, in light of the registrant's business and structure.  If material, this disclosure should cover more than the past five years, including information about the person's particular areas of expertise or other relevant qualifications.  When an executive officer or highly compensated person of influence has been employed by the company or a subsidiary for less than five years, a brief explanation shall be included as to the nature of the responsibility undertaken by the individual in prior positions to provide adequate disclosure of his or her prior business experience. What is required is information relating to the level of his or her professional competence, which may include, depending upon the circumstances, such specific information as the size of the operation supervised.

Regulators of non-public companies, such as state regulators of mutual insurance companies, are proposing new rules to describe:
  • The processes in place for the board to evaluate its performance and the performance of its committees;
  • Any board or committee training programs;
  • Processes for identifying, nominating and electing members to the board and its committees, including enough detail to allow each state’s insurance commissioner to determine (i) whether a nominating committee is in place to identify and select individuals for consideration as directors; (ii) whether directors’ terms have limits; (iii) how the election and re-election processes function; and (iv) whether a board diversity policy or skills matrix is in place and how it functions; and
  • The expertise and background of its board members and significant committee members, and how that expertise and background of the collective members are anticipated to meet the future operational needs of the company.

Finally, best practices (discussed in our May 29, 2014) require boards to strive not to just follow the rules, but strive for a commitment to excellence in governance. Undertaking a board evaluation with a goal of continuous improvement and creating an “expertise” board evidences that commitment.


The next post in this series will cover how to proceed with board evaluations.


 

Posted by J. Beavers in  Board Evaluations   |  Permalink

 

 

 

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