Editor: Your background in corporate governance is extensive. In the
post-Enron era, corporate executives and directors have new responsibilities.
For starters, would you summarize the responsibilities in place before the
corporate scandals and Sarbanes-Oxley?
Wardell: Many of the things that have recently become regulatory and
statutory requirements were identified as best practices prior to Sarbanes and
the corporate scandals. For twenty years, for example, there was an expectation
that companies would have an audit committee. Compensation committees were also
a best practices expectation. In neither case was there extensive stipulation as
to such things as membership or a committee charter. Another thing that
exemplified the pre-Sarbanes era was less emphasis on preparing for meetings of
the governing board - the circulation of pre-meeting materials and an
expectation that board members would be familiar with those materials by the
time they got to the meeting - as well as a lack of emphasis on the time the
board was to devote to deliberation. If there was a standard, it was that the
board would do what it needed to do to meet its corporate responsibilities.
Over the last few years, and in light of the corporate scandals, I have been
asked by directors whether they should rely less on the recommendations of
management. My answer is that they should insist that management's
recommendations be well framed and well footed, i.e. solidly grounded. In
addition, the board must deliberate and discuss those recommendations thoroughly
before they are approved, including turning them over to an independent
committee for a more exhaustive review, if necessary. The final result may be
the same, but the process will most likely serve to avoid the breakdowns
that seem to characterize much of the troublesome corporate behavior in the
pre-Sarbanes era.
I think it is fair to say that if the regime in place before Sarbanes
and the scandals looked to best practices, the present regime - Sarbanes-Oxley,
the SEC regulations and the listing requirements of the securities exchanges -
represents a codification of what already existed. Instead of encouraging the
right behavior on the part of senior management and the board, the present
regime mandates it.
Editor: What are the implications of these changes for corporate
counsel? Why is corporate counsel so crucial to the legal compliance system that
is emerging from the corporate scandals?
Wardell: Corporate counsel are expected to have the first line of
access to information. As a result, the first questions are going to be
addressed to them, and they will be expected to have at least the outline of a
response. Their familiarity with this new and rather complex set of requirements
is going to be critical because, in the new scheme of things, senior management
and the governing board are subject to scrutiny that was simply not focused on
them before, and it is corporate counsel that must, in most corporate settings,
interpret the requirements, implement the systems and structures that are
necessary for compliance and see that they are maintained on an ongoing basis,
if the executive officers and directors of an enterprise are to be seen
as meeting their fiduciary responsibilities. Corporate counsel have a very
intense role to play.
Editor: General counsel have always had a responsibility to the
corporation and its shareholders that transcended their responsibilities as
members of the senior management team. This is now in much sharper focus as a
result of the corporate scandals. Is this a step forward?
Wardell: General counsel have always had an ultimate responsibility to
the company's shareholders, but they have always had to work within the
culture of the company. Underscoring the responsibility of general counsel to
the shareholders represents a step forward, to be sure - direct access to the
independent members of the board and to the audit committee, who are the
representatives of the shareholders, are good things - but general counsel need
to function within the corporate management structure of the enterprise to
remain effective. At its best, the position of general counsel now represents a
line of communication, a connection, between the operating culture of a company
and the persons who come to its governance structure from the outside. Of
necessity, there is a certain tension in this role. And, of course, it is now in
the spotlight.
Editor: We are beginning to hear, from both directors and senior
management, that they are so focused on process that they do not have time to
pay attention to the business of the enterprise.
Wardell: No doubt an exaggeration, but, yes, I think that is a
concern. There are so many checks and balances in the Sarbanes-Oxley compliance
architecture that the process can get in the way of the ultimate obligation of
management and the board to provide value to the shareholders and achieve the
corporation's business purpose. A side effect of this development is the
enhanced importance of the audit committee. A good audit committee is an
extremely valuable part of the governance structure, but if too much of the
compliance process is delegated to the committee by the rest of the governing
board - and the other directors are then entitled to say that they have met
their obligations to the company - not only is the committee being
over-utilized, but the board as a whole is being under-utilized. It is going to
take some time for issues like this to be addressed.
An additional critical issue for senior management and the governing board is
risk management. This is not putting an insurance program in place and
then forgetting about the company's risk profile. It involves analyzing and
understanding that profile and its underpinnings and then taking steps to
mitigate the risks. And the directors oversee management in this process.
Another critical issue involves corporate compliance programs as outlined in
the proposed Sentencing Guidelines for Organizations recently sent to Congress
by the United States Sentencing Commission. I see these as becoming increasingly
important because they envisage compliance programs that will serve to permit
the directors and the non-financial members of the senior executive group to
reach a certain comfort level with respect to the entire operation of the
enterprise, and not merely those reflected in the financial reports. A breakdown
in financial reporting may have been at the center of the scandals, but the
fallout from the scandals has reached much further. Consequently, the
responsibilities of directors and senior management, including corporate
counsel, are much greater today than they were in the past.
Editor: There was a time when senior management in many corporations
looked upon corporate counsel as less important than the departments and
divisions that produced the enterprise's revenues. Do you see this attitude
changing?
Wardell: Yes. There is more recognition today of the real advantages
of having in-house counsel participate at the board level. Governing boards are
looking to corporate counsel to provide them with information about what is
going on within the company. Needless to say, that might represent something of
a threat to other members of senior management. The participation of general
counsel in board deliberations does give the directors quick and direct access
to information that, given their responsibilities under Sarbanes and the regime
that derives from it, is essential to the fulfillment of their governance
duties. Among other things, it enables the board to function as a kind of
counterweight to management. I think this is a very healthy development,
particularly in light of the almost automatic board approval of management
initiatives that was common in the pre-Sarbanes era. Without necessarily leading
to confrontation, it permits the board to critique management proposals in an
informed and intelligent way.
Editor: Please give us an overview of the Sarbanes-Oxley §404
implementation process. What is the role of the corporate legal department in
this process? And the role of the CFO? Is there a kind of built-in friction
here?
Wardell: It's too early to predict the impact of the §
404 implementation process. Most CFOs and general counsel agree that the process
will entail an additional layer of costs. This is reflected in the increased
staffing that has taken place at the auditing firms. The ambiguities derive from
the regulations themselves. As initially proposed, § 404 would
have imposed the entire framework to establish and evaluate internal controls
proposed by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO), which is very complex. There was serious concern expressed about this,
and the final regulations applied COSO only to financial controls. The SEC's
consideration of postponing some of the other implementation features
constitutes a recognition of just how very extensive even these requirements
are. It may take several audit cycles for the dust to settle.
The risk as I see it is that § 404 will become the ultimate
road map, which will mean setting up elaborate systems and cross checks, the
implications of which must be understood by management at each step of the
process and desperation will convert this to a rote process. I am participating
in a task force that is struggling with these issues and attempting to develop a
set of useful tools for compliance officers. It is not an easy task. The role of
corporate counsel in this context has not been defined with any particularity as
yet, but even at this early stage I can detect a certain tension between
corporate counsel and the financial and other groups responsible for different
aspects of internal controls.
At this point I see the best solution in the implementation of a Six Sigma
process, the measurement-based methodology that focuses on process improvement
and variation reduction. This process is both complicated and expensive.
However, those organizations which have installed it, in my experience, are the
ones which are least disturbed by § 404 and COSO and the best
equipped to design response mechanisms.
Editor: In light of the increased responsibilities that corporate
counsel now must assume, there would appear to be a need for more attentiveness
- meaning more staffing - to the issues of legal compliance. Do you see any
movement in corporate America acknowledging this need? Any increase in hiring by
corporate law departments?
Wardell: I think there is a need that is now being met by an increase
in hiring by corporate legal departments. Companies are also creating a
compliance group, headed by a chief compliance officer who, more often than not,
is a lawyer.
Editor: And if general counsel believes that the legal department is
understaffed and that, as a consequence, he or she is unable to meet his or her
obligations to the corporation?
Wardell: The options are limited. General counsel might reach out to
outside counsel to frame a response. If neither the management group nor the
board is responsive because of costs, outside counsel may be in a position to
make a proposal - utilizing outside resources - that will be palatable to
management and the board and, at the same time, enable general counsel to meet
his or her obligations. I have been in this position, and I have made such
proposals. Of course, there are situations where the only solution entails the
hiring of additional legal staff. If that is not forthcoming, general counsel
may have to conclude that the only choice is to move on. Recognizing this is
important. For general counsel to be rebuffed in this situation, and then stay
on, can mean that he or she is part of the
problem.
Published September 1, 2004.
