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 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.
- 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.
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.