Former Securities & Exchange Commission chairman Richard Breeden has outlined a series of proposals for corporate governance changes at MCI—the former WorldCom—in an attempt to restore trust in the company, which was a high-profile player in the financial scandals of the late 90s. The changes include new rules on the selection of directors, increased power for shareholders in governance decisions, and greater transparency, and are expected to serve as a blueprint for other companies that want to be seen as governance leaders.
Breeden presented a report that includes 78 recommendations that the new management at MCI must enforce, unless the company persuades the court to strike a specific change. The U.S. District Court in New York had ordered the plan to be crafted to prevent a recurrence of the accounting scandal that led to WorldCom’s bankruptcy filing and the destruction of more than $180 billion in shareholder value.
MCI chairman and chief executive Michael Capellas said the company supports the report’s recommendations on corporate governance, including the separation of the chairman and CEO roles, but other governance experts voiced concern that the recommendations would shift too much power from management and the board and into the hands of shareholders.
The report goes well beyond the post-Enron governance reforms codified in the Sarbanes-Oxley Act, and in stricter listing standard proposed by the New York Stock Exchange and Nasdaq Stock Market.
The result of the report “will be a set of policies and procedures that go beyond what any major public company has in place today,” says Breeden. “The result will be a stronger, more capable and more independent board of directors, limits on problematic compensation practices, and a much greater emphasis on transparency and integrity in the company’s internal operations. Shareholders will in the future have a much stronger voice in setting limits of behavior.”
The recommendations are a response to the failure of governance practices at WorldCom and other major corporations in the late 90s.
“The various investigations of WorldCom that have been published to date have examined how personnel at the company committed what appears to be the largest accounting fraud in history,” says Breeden. “Among other things, the board of directors of the company consistently ceded power over the direction of the company to [former chief executive Bernie] Ebbers.
“As CEO, Ebbers was allowed nearly imperial reign over the affairs of the company, without the board of directors exercising any apparent restraint on his actions, even though he did not appear to possess the experience or training to be remotely qualified for his position. One cannot say that the checks and balances against excessive power within the old WorldCom didn’t work adequately. Rather, the sad fact is that there were no checks and balances.”
Restoring Trust contains 78 recommendations for change, covering such areas as the selection of directors; conflict and independence standards for board members; the functioning of the board and its committees; establishment of the position of non-executive chairman; specific limits on compensation, equity compensation programs; accounting and disclosure issues; ethics and legal compliance programs and other areas.
Under the recommendations of the Breeden report, the articles of incorporation are to be used as a “governance constitution” for the company. Most of the governance standards are to be placed in the articles, where they can only be changed with prior shareholder consent. Says Breeden, “This represents an important shift of power from the board to the shareholders. The board’s discretion in matters of business oversight remains extensive, but as to the governance rules themselves, shareholder consent will be required in advance for changes to be made.”
To empower shareholders, the report makes specific recommendations to improve communication. “The board of directors is required to establish an electronic ‘town hall’ where shareholders will be free to communicate with the board and to propose resolutions for consideration in this electronic facility,” says Breeden. “Resolutions that are adopted through the “town hall” process must be included in the proxy the following year.”
The report also requires “a completely new approach” for nominating directors, requiring at least one new director to be elected each year. “For the first time, a group of shareholders will have the power, if it does not agree with proposed candidates to fill board vacancies, to nominate their own candidates for inclusion in the management proxy statement. This will mean that unless a mutually acceptable compromise is reached, there will be a contested election for filling the vacancies in that year. In that event shareholders will have a genuine choice of whom to select.”
In an attempt to prevent “the cronyism that existed in WorldCom’s past,” the report established “very high standards for independence of directors, and for director qualifications.” With the exception of the CEO, 100 percent of the members of the board must be fully independent, and the company’s CEO will not be allowed to sit on other corporate boards. No compensation, consulting agreements, or payments of any kind to directors will be permitted, except board and committee retainers. Directors will be limited to a maximum term of ten years in office.
Finally, under the recommendations, the company will also intensify efforts to develop disclosure practices that will result in transparency of financial information beyond SEC requirements. The company will work to develop enhanced reports of cash flows, and to publish a target dividend policy.
Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, singled out the requirement that directors be independent and buy MCI stock with one-fourth of their pay for particular praise. But he also warned that separating the chairman and chief executive positions could backfire by making other directors less diligent. The positions were separate at WorldCom during the time that the scandal occurred.
James Owers, a governance expert at Georgia State University, called the plan a “dramatic improvement” for WorldCom, but warned that having the CEO as the only executive on the board could reduce perspectives from inside the company.
On the corporate side, however, the report was criticized as “corporate governance on steroids.”
“Many of the recommendations will not unduly restrict the ability of MCI’s management to operate MCI’s business,” says Mike O’Sullivan, author of the Corporate Law Blog. “However, the Breeden Report does diminish the role and status of MCI’s CEO, making me wonder whether MCI’s Governance Constitution will diminish MCI’s ability to attract and retain the best officers.
“At the same time, the Breeden Report’s shift of responsibility to the board may make it more difficult for MCI to attract and retain the best directors. MCI’s Governance Constitution will effectively disqualify any CEO of another company from serving on MCI’s board—who’d have the time?—and discourage any retired person who wants to retain a semblance of retirement in his or her life.
“While I am sure many will view MCI’s Governance Constitution as a blueprint for other companies, very few companies have the resources to implement it.”
Others clearly feel the recommendations will give too much power to shareholders.
According to Martin Lipton of the law firm Wachtell Lipton Rosen & Katz, the recommendations “would straight-jacket and enfeeble boards of directors and undermine their ability to effectively guide their corporations…. These proposals would impose severe and unnecessary administrative burdens, threaten to divert the attention of the board and management away from the business of the corporation and suggest an environment of governance by ‘checklists’ rather than true good governance.” Additionally, the recommendations “would interfere with the board’s ability to make the key policy and strategy decisions that the board is legally empowered and required to make.”
Breeden dismissed the criticisms from Lipton, who 20 years ago invented the “poison pill” anti-takeover defense, as “an eloquent argument for the status quo.”