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SEC wants to encourage investments. There is a great deal of discrimination against our securities industry in foreign countries where the mutuality of business opportunity does exist. We are sharing a Governmental committee in the State Department and Treasury Department to try to articulate those areas of discrimination and begin a foreign task force to pull it away. Foreign access to the New York Stock Exchange is a serious problem for them, and they are anxious that we help them clear it away for American industry abroad. There are a great number of fraud cases involving foreign countries, and indeed there are a great many Americans perpetrating frauds on people abroad. All these things will be the subject of this new office.

Q. COLEMAN. Mr. Hills, would you comment on the propriety of an attorney serving on the Board of a company he represents.

A. HILLS. I've always thought it was categorically wrong if he's representing them in the areas of securities work. It's a potential, and very serious conflict of interest in a publicly held company.

Q. HARMAN. Mr. Hills, the SEC has done a great job in investigating bribery, but apart from ordering disclosures, do you have the power to ban bribery itself? A. HILLS. No, and I suspect there will always be some bribery. Our job is to make sure that material bribery is displayed to the stockholders and to let the stockholders decide whether they want a management that does that.

CEO-BOARD RELATIONSHIPS

(William Taylor French, Chairman, First National Stores, Inc.)

In earlier years, the literature and the seminars on CEOs and their Boards seemed to assume that if Boards recognized the duties and responsibilities they had under the law and their corporations' by-laws-if they organized themselves properly, carefully selected a Chief Executive, clearly spelled out his delegated authority, wrote both the CEO's and their own job descriptions, and took a number of other specific steps everything would work out fine. It now seems clear that this approach virtually ignores the relationship, the personalities, and the mutual trust of the parties involved. It is a bit like a correspondence course in sex-it ignores personal relationships.

Before addressing the seminar, I selected 13 Chief Executives whom I know on a close personal basis and could count on for full and honest opinions. I wrote them, posing a series of questions concerning the CEO-Board relationships. The companies of these men are in a variety of businesses-business and computing machines, basic metal mining and production textiles, department stores, petroleum, financial services and consumer goods marketing to name a few. In sales volume, they range in size from over 13 billion dollars to 416 million.

While the input from these 13 CEOs and my own experience are weighted to larger corporations, the following comments are applicable to any publicly held company, regardless of size. My observations are, however, limited to the CEO and the outside members of his Board.

The first question was:

"Is the relationship between a CEO and his Board different today than it was five years ago? If so, in what way? If not, should it be?"

The head of a large publishing company responded. "Yes, it is susbtantially different, and it continues to change with the Board getting stronger and stronger as its members get more scared. The CEOs seldom dominate the Board any more. This has to be a healthy trend."

Another CEO responded, "Yes. Outside directors have much more involvement with the business and, as a result, have more input than in past years."

A third reported: "The relationship between the Chief Executive Officer and his Board is different today. Management is becoming more professional every year. Members of Boards feel greater responsibility and participate more actively in their overview of management's performance. I think this is entirely appropriate."

A somewhat different question probed the CEO-Board relationship from another angle.

"It has been said that a company has either a strong CEO and a "subservient" Board or vice versa. Is this true? If so, can you envision a constructive working relationship where both the CEO and the Board have strong, important roles?" The panel was unanimous. While most acknowledged that the proposition was frequently true, they all felt strongly that there need be no incompatibility be

tween a strong CEO and a strong, participating Board of Directors. One response

was:

"While the proposition is probably true in many companies, I see no reason why there cannot be a constructive working relationship in which both CEO and Board are strong. If a strong CEO has a real understanding of the legal relationship between himself and the Board and is not thin skinned, the Board should be able to face up to him strongly on his major decisions."

⚫ The panelists are saying that this relationship is not based on structural form but rather on a developing sense of responsibility and responsive interaction grounded largely in mutual respect and confidence. Without mutual respect and confidence, no meaningful relationship exists.

Let us consider a significant complication in this relationship. I have stated the de jure fact that a corporation cannot legally function without a Board of Directors. In the real world, the de facto situation is much more important. A successful corporation cannot run without a strong CEO. Despite the trend to "Office of the Chairman," or "Office of the President," or "The Executive Office," there must be a strong leader-in effect a Chief Executive Officer-in charge. This fact of life is the essence of the CEO-Board relationship.

The general corporation laws of the several states provide that the management of a corporation is the responsibility of the Board of Directors. If this mythical responsibility to "manage" a company were ever truly exercised by a corporation's Board-at least for any appreciable period of time-it would be a disaster. . Therefore, there is universal agreement that a principal function of the Board of Directors is to select the Chief Executive Officer and to delegate most management and administrative functions of the company to that officer. In fact, the directors rarely select the Chief Executive except under crisis conditions. The replies from some of the panel indicate, however, that this may be changing, or at least that the trend of thinking on CEO selection may be changing. The President of a very large department store chain summed up the traditional view this way:

"The directors do not usually select the CEO, and they should not. I believe they merely should accept the recommendations of management, and they usually do."

*Three panelists took what may be the developing point of view. Two said that their companies' Boards truly select the CEO and that they indeed had been so selected. The third response said the directors "usually truly selected the CEO. Certainly more than in prior times."

The question of the Board's role in selecting the CEO goes to the heart of the relationship between the CEO and the Board. The fact is that Board members most often are selected by the CEO rather than the reverse. This contradiction puts a director in an anomalous position in his CEO relationships.

This is perhaps why so much of what has been written is confined to the impersonal aspects of a Board's duties and functions. This is where one reads that the Board of Directors determines overall policies for the corporatoin, sets realistic and attainable objectives and goals, monitors or audits performance, and so forth. In fact, a Board's relationship with management also depends on mutual respect and confidence. The degree to which mutual respect and confidence are present depends in no small measure on the strength and style of the CEO. Usually, the CEO sets the pattern of his relationship with the Board.

How does a good working relationship develop between the Chief Executive Officer and his Board members? Before going on a company's Board, an understanding must be reached of what is expected and what the relationship will be. The ideal way is for the potential director to probe the related questions at the time when a potential relationship is discussed.

The best approach for a potential Board member is to sit down informally with the CEO and discuss his concerns and his desire to participate more actively as a Board member. He does, of course, run the risk of solving the problem by suggesting his own resignation. More than likely, however, the CEO will welcome having this question broached and will have already had some concerns of his own. It might be suggested to him that he draft his concept of the general role of his directors, circulate that draft to his outside directors for comment, and then discuss and adopt such a statement at a future Board meeting. This was done a little over a year ago at a company where I am a director. The resulting statement reads as follows:

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"GENERAL ROLE OF THE BOARD

The Board should be the primary force pressing the management to the realization of its opportunities and fulfillment of its obligations. This requires meaningful involvement in company affairs both in Board meetings and outside.

The principal concerns of the Board are the broad policies of the Corporation, its general direction, pace and priorities. Its members should be fully informed in advance of all major proposals, and should have an opportunity to make a meaningful and deliberate contribution to the decision-making process. The Board should not become involved in the details of day-to-day business operations. The Board should appraise performance on an ongoing basis, and take appropriate action to stimulate or advise to change top management. It should also review and provide guidance on basic operational aspects of the Corporation, including its sales and profits, the adequacy of its personnel and personnel policies, and its financial, accounting and audit standards and resources consistent with first-class corporate citizenship.

Outside directors will be expected to become familiar with the condition and operations of the Corporation through Board and committee meetings and by personal observation and inquiry."

The relationship spelled out in that statement really works; in fact, it has worked magnificently because just developing the formal state created an understanding of how each of us felt. Principally it works, however, because the Chief Executive is secure enough in his own authority and ability so that he is not threatened by a strong Board. He is open to ideas other than his own and receptive to guidance from his directors.

The kind of strength this CEO has does not result from domination. In such a relationship the CEO should promote open discussion and even introduce topics which he might consider potentially uncomfortable should he feel that they require the Board's consideration. The CEO must be able to stimulate participative involvement by his directors without losing control to them. He and his directors must never forget that the final decisions are up to the CEO.

I am not describing an idealistic situation. It is how things are working today in many companies, large and small. Running a company today is so demanding that the CEO should be seeking all the help he can get from his directors. This approach also is stimulating to his Board and, in turn, creates an environment that helps attract high quality candidates to serve on the Board.

"THE ROLE OF THE PROFESSIONAL DIRECTOR"

(Joseph W. Barr, Former Secretary of the Treasury)

At a business seminar at Loyola College in Baltimore, I concluded that the sheer constraints of time make it difficult for the average outside director of a publicly held corporation to live up to the expectations of the governmentespecially the Securities and Exchange Commission-plus investors and lenders. I then suggested that these time constraints could be overcome and a middle ground carved out by utilizing the services of a "professional director" who spends all his time as a director of various publicly held corporations.

To test the concept, I sent copies of my speech out to roughly 200 men in industry, finance and government. The replies raised serious and thoughtful questions, objections, or areas of concern.

They reflected a deep and pervasive concern over the way our great public corporations will be managed, and a certain anxiety and perplexity as to how public companies can live up to ever higher expectations from the government, investors, and the public. They nearly all reflect an uneasy feeling that the old ground rules are shifting and that no one quite knows how the new game will be played. If corporate affairs are being pushed toward total exposure, it is only proper that I reexamine publicly my statement on the role of the professional director in light of the comments I received.

First of all, there were objections to the term "professional director." I believe they were justified. The term carries a certain implication that perhaps management cannot cope with the business and needs a "professional director." More important, clinging to the term "professional" leads into the trap that the SEC narrowly avoided last year. You will remember that in 1974 the SEC publicly stated that it had under consideration a set of guidelines for the conduct and selection of directors of public corporations . . . very definitely a move in the

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direction of professionalism. They abandoned this effort in December 1974 after determining that they could not develop a working consensus on their guidelines. Also, it would be troublesome defining the standards of ethics, the technical training, and the practical experience and background that are implicit in the term "professional." To eliminate these difficulties, I will abandon the term "professional director" and replace it with "extra time director."

The second area of concern was that the public recognize that the contributions made to Board deliberations by the CEOs of other large publicly held corporations were invaluable despite their time constraints. However, it should be noted that there is a deep skepticism in the Congress and in the regulatory agencies as to the effectiveness of these relations between companies... even when no conflict of interest is involved. There is a rather pervasive disbelief that the CEO of one industrial giant facing problems around the world can help direct the affairs of another multinational behemoth.

The third area of concern to emerge that a professional director could not keep his hands off day-to-day operations which are properly the concern of management-also is valid. An "extra time director" must be constantly vigilant in staying away from operating or personnel decisions. This is a legitimate problem area that should be faced squarely and understood clearly by management and the "extra time director."

The fourth area raised was the worry that a professional director would want his own staff. This is an explosive area with a great potential for creating confusion and discord within the company.

The fifth source of concern related the independence of the professional director to his additional compensation. Here again, some difficulty exists, but somehow it seems to fade a bit if the term "extra time director" is used. The compensation is for "extra time," not to subvert a professional.

Finally, there seemed to be an undercurrent of opinion that it would be best to have no outside directors. This is perfectly understandable. In many companies it is difficult for management to realize that the awesome public prestige that usually surrounds the founder of a great industrial empire just does not pass on down to his successors. As a result, the way in which investment decisions are made change radically. There is no doubt that in earlier years men like Walter Chrysler, Alfred Sloan, William McKnight, and Eli Lilly attracted investors who were going along for a ride on the personal ability of the man. In essence, these men and many others were heading great public corporations, but their own personal prestige was so great that the companies had certain attributes of a private operation. As these men left the scene and were replaced by managements not nearly so well known by the public, the private character of the companies disappeared, and they emerged as truly public corporations with outside directors who were expected to direct. Thus, it is only natural that many managements today look back with a certain nostalgia to the days of the founder and the inside Board.

Of the six areas of concern, one, the objection to the term "professional" is I believe unanswerable. I have cheerfully dropped that adjective and substituted the expression "extra time director" which is more accurate. Of the other five, two were valid warnings of possible troubles. The issues of compensation and interference with day-to-day management should be addressed clearly and precisely. The last three issues I would class as understandable.

Having said this, it still appears that the presence of at least one “extra time director" on the Boards of publicly held corporations can be of significant benefit to shareholders, to management, and to the other directors. There is just no way to improve on the priceless assets of time and the absence of operating responsibility possessed by the "extra time director."

In addition to the six areas of concern, there was no additional area of almost unanimous approval. Nearly every respondent agreed that the audit committee furnished the best recognized and most widely accepted vehicle for the work of the "extra time director."

Over the past few years the audit committee has come into its own. The usefulness of a committee of outside directors working with the inside controllers and auditors and the independent auditors to produce responsible and meaningful financial statements is now almost universally accepted. Many Government agencies like the concept because they feel that an audit committee of outside directors in a publicly owned company will be more interested in representing shareholders than management . . . at least if the audit committee pays any

attention to the Securities laws. Management seems to have learned to live with and to use the services of an audit committee. Accounting firms now have a forum of outside directors to talk to in cases where fraud, illegal conduct, or sheer basic differences of opinion arise with management. And last, investors, lenders, and analysts seem to cheer on the audit committee as another check on the reliability of a company's figures. So the audit committee is widely acclaimed.

But with all this acclaim, there seems to be an increasing unease on some audit committees. They are fairly well convinced that in the event of troubles the Government plus investors, lenders, analysts, and reporters will be charging straight at the audit committees. As a result, service on audit committees involves some fairly awesome responsibilities. The chairman of the committee, especially, seems to be on the point of exposure.

"Extra time" becomes probably the best and only defense to directors serving on audit committees, especially the chairmen. Spending two to four hours a year in cut and dried sessions with a perfunctory look at the figures and the situations raised by the management letter does not seem to be either a defense or the proper discharge of the responsibilities to shareholders associated with service on an audit committee.

The audit committee should address at least the following areas. First and most important is knowing the people with responsibility for the numbers. . . the staffs of the controller, treasurer, auditor, and the tax counsel. Numbers can be a very dull business, but they come to life with these staff people and take on a meaning which seldom is developed from just examining the documents. In addition the opportunity to know the outside directors who are members of the audit committee gives staffers a place to go if they think that fraud or illegal acts are being practiced by management.

Secondly, the committee should be familiar with any current or potential problems in the company that may involve material shifts in the numbers. These may involve problems in inventory, tax liabilities, litigation, transaction or translation gains or losses, or unexpected swings in the fortunes of subsidiaries. Audit committee responsibility in these areas is not a vehicle for solving or correcting problems, but a monitoring operation to make certain that the financial statements disclose fairly the company's position.

And last, audit committees have only recently been charged with oversight in the areas of domestic political contributions and illegal or perhaps just unusual overseas transactions.

The "watchdog" aspect of the audit committee should not be over-emphasized but unfortunately it is there. With it is the time requirement . . . especially for the chairman. So the "extra time director" can be a valuable addition to any audit committee. He cannot relieve other directors of their own liability, but by his extra efforts he can make the functioning of the audit committee more meaningful. If the audit committee is performing effectively, then the entire Board can move closer to public expectations.

THE CHANGING ROLE OF DIRECTORS IN THE 1970's

(Arthur D. Lewis, Chairman, U.S. Railway Association)

The basic legal concept of what Boards are supposed to do has not changed over time. Boards have always had a fiduciary responsibility to represent the best interests of the stockholders, preserve the basic integrity of the assets, and maintain the financial position of the company. Similarly, they have always had responsibility, however neglected, to see that the corporation meets its responsibilities to the public. The Board has had the specific duty of selecting the Chief Executive and his successor and acting as an advisor to him. It has worked with him to set corporate objectives and strategies and act as a review board in determining his performance and the performance of his staff.

It has of course delegated to management the responsibility and authority to run the company. But it cannot delegate to management that ultimate responsibility and accountability to the stockholder and the public.

Thus, the fundamental underlying role of the Board is not changing. What is changing is the degree to which Boards are being held accountable for their actions. Because accountability has become a demanding fact today, there is an obvious need to reemphasize the need for adequate Board performance.

Almost invariably, writers on the subject are critical of Board performance. Rightly or wrongly, the corporation has been, in the view of the critics, largely

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