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the normal high standards of conduct by the Northrop Corporation. The Board, after the lawsuit was filed several weeks following the guilty pleas, vigorously resisted all attempts of plaintiff's counsel to investigate thoroughly the facts underlying the contributions. It was only after the judge turned aside their attempts to block discovery that we had access to some rather startling information. We discovered the fact that these illegal contributions were not an abnormal departure but part of a pattern and practice that had gone on for over a ten-year period involving hundreds of thousands of dollars. In addition to these slush funds generated through foreign transactions and returned to this country for use in political campaigns, we also discovered the fact that millions of dollars of company money was paid to shadowy foreign consultants under the sole authorization of Mr. Jones.

Upon closely analyzing the decision-making process that put in motion these illegal acts, it became clear to us that this Board of Directors was not functioning as an effective Board at all. It was, in fact, totally dominated by Mr. Jones. As long as the corporation was making a healthy profit, the members of the Board of Directors played a most passive and inactive role. The Board was essentially a rubber stamp for Mr. Jones.

Our first demand upon which all other factors were contingent was that there be a full and completely independent investigation and disclosure of the facts and circumstances surrounding these revelations. To that end, we proposed an arrangement which required that an investigation be conducted by a newly constituted Executive Committee of the Board of Directors, four out of five of whom would be new directors brought onto the Board by a joint selection process between both the company and shareholder representatives with court approval. Special legal counsel assisted the Executive Committee in its investigation and preparation of a comprehensive report and submitted it along with recommendations to the full Board for its consideration. That report was completed within six months. In addition to sharply critizing the performance of Mr. Jones as Chief Executive Officer, it offered an insight into the failure of the style of management fostered by Mr. Jones that is not atypical of many major corporations. The Committee concluded that:

"Mr. Jones as Chief Executive Officer must bear a heavy share of the responsibility for the irregularities and improprieties noted in this report, for the atmosphere within Northrop which contributed to those shortcomings, and for the failure to concern himself with the functional weaknesses and pressures within management which have brought the company to its present circumstances. ... More generally, the Committee believes that Mr. Jones created within the company by his example and style of management, an atmosphere which discouraged informed discussion of the wisdom and practicality of various arrangements and practices that carried substantial business risks, as well as significant adverse legal consequences, for the company. Northrop and its shareholders are now confronted with the consequences of his actions." 1

The committee recommended that Mr. Jones step down as Chairman, which he did.

It is instructive to consider how the Board of Directors got into the position of allowing its Chairman to engage unchecked in such improper conduct. Mr. Jones became President in the early 1960's. He immediately centralized his control and isolated himself at the top. During the next decade Jones hand-picked Board members who were either his social or business contacts, which resulted in the Board becoming a rubber stamp. Hence their allegiance was more to Mr. Jones than to the shareholders and their willingness to support him, even when they did not know the facts, is an example of that blind allegiance.

He did not groom a successor. No one within the Company was in a position to assume the top position. This is undoubtedly the reason the Board has been forced to retain him in a top executive capacity. And, no one on the Board was asking the discerning questions. When the reports began coming out that there may have been some questionable activity engaged in by Mr. Jones, the Board ignored the warning signals and stood steadfastly behind him.

1 The Committee report also stated : "The Executive Committee is not convinced that Mr. Jones has communicated fully and openly with the auditors, with the Committee and with the Board of Directors itself, or recognizes the seriousness of his involvement in the matters addressed by the Committee. The Committee is disappointed that Mr. Jones failed to concede his lack of knowledge regarding certain of the matters discussed in this report. The Committee also is concerned that Mr. Jones failed to acknowledge his familiarity with matters with which the Committee is persuaded that he knew or should have known." Report to the Board of Directors of Northrop Corporation on the Special Investigation of the Executive Committee, pp. 57–58.

Only when they were forced to face the harsh reality of bis conduct because of the involvement of the Securities and Exchange Commission, Northrop's own outside auditors, its outside counsel and the shareholders' litigation did they begin to act.

The terms of the settlement we proposed that were ultimately agreed to by the Company were designed to open up the Board of Directors and break the stranglehold that Mr. Jones had on the company's decision-making. New institutional arrangements were proposed and accepted that would make the directors more accountable and therefore more responsive.

In addition to the requirement of an independent investigation, the following substantive terms presented in the form of bylaw revisions were approved by the court as a part of the settlement:

1. At least 60 percent of the Board of Directors must be composed of independent outside directors, requiring an addition of four new directors. (That term was expressly defined to eliminate anyone who has any significant financial ties to the company.)

2. The four new directors were to be selected jointly by shareholder representatives and the company and approved by the court.

3. Within 18 months, the company must select a new President, and Mr. Jones must relinquish that title. In compliance with this provisison Thomas Paine was selected as President by the company.

4. A new Executive Committee was established that would consist of five members, four of whom had to be independent outside directors.

5. A new Nominating Committee was established consisting solely of outside directors. The purpose of this committee is to select and present directly to shareholders the nominees who are proposed as Board members.

6. A new Audit Committee was established, also consisting solely of independent outside directors. This committee has the responsibility of selecting the auditors, overseeing the scope of the audit and developing various company regulations and guidelines to ensure compliance with strict financial controls.

7. Northrop Corporation must petition the Department of Defense and appropriate trade organizations for new rules nd regulations to govern all defense contractors doing business in overseas markets.

8. A complete ban for at least a two-year period was to be imposed on all political contributions, even those that could be legally collected through various corporate committees. Such committees could only be reactivated after two years with shareholder approval.

9. The company was to implement new procedures for approving all contracts with consultants abroad.

10. Additional funds were to be paid back to the company by various individuals.

Phillips Petroleum Litigation. Our approach to the Phillips Petroleum Company was quite similar to that of the Northrop Corporation.

The complaint was filed after the former Chairman of the Board, William Keeler, and the company pleaded guilty in December, 1973 to felony violations of the Federal Elections Campaign Act growing out of a $100,000 contribution to the Nixon campaign. Subsequent disclosures made by the company indicated that the practice had gone on for a ten-year period and that a political slush fund had again been generated through various foreign transactions and were not recorded on company books. Substantial contributions were made from this fund to political officeholders and candidates on the state and federal levels.

Phillips Petroleum Company, like Northrop, had been dominated over the years by the Chief Executive Officer. But, unlike Northrop where the Chairman maneuvered to put himself into the position of dominating influence over the Board, Phillips Petroleum had a history of Chief Executive Officer domination, Phillips Petroleum Company began as a wildcatting operation back in 1917 up into the present where it is today a $5 billion corporation with profits exceeding $400 million annually. For over forty years, two men ran the company as if it were their very own. They needed and requested little help from the Board of Directors which was made up largely of management personnel. While this tradition has been loosening up somewhat over the past several years, it is quite clear that the Board of Directors of Phillips Petroleum Company has never operated as though it were truly independent representative of shareholder interests. Indeed, until this lawsuit was brought, eight out of the eleven directors were full-time officers/employees of the company. This ar

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rangement, of course, is a contradiction in terms. It is impossible for such an insider-dominated Board to monitor management which involves, of course, monitoring itself. Such a Board can only be expected to operate as a management committee rather than independent representative of shareholder interest.

Almost all of the people who were implicated in the creation and maintenance of the political slush fund in a position of decision-making had left the company by the time the case was brought.

The approach of the Phillips Board of Directors in negotiating the settlement in this case was constructive. Direct negotations took place between the Center attorneys and the three outside members of the Board and its Chairman. Center attorneys presented terms quite similar to those previously described in the Northrop case, and we discussed each of them in great detail. Our position was quite clear: we could defend each of these terms from the standpoint of sound corporate policy, and we argued that it was in both the shareholders' and the company's interests to adopt them.

The attitude of these four company representatives was refreshingly open and direct. It was not the typical attitude of "how can we get out of this lawsuit with as little change as possible." Rather the representatives examined these proposed terms in light of broad shareholder interests. The Center's proposals were adopted after several months of negotiations which called for major restructuring of the Board of Directors similar to the lines previously described in the Northrop litigation. It called for an immediate change from a heavily dominated insider Board (8 out of 11) to a majority of independent outside directors, which necessitated the addition of six new independent outside directors jointly selected by both the shareholder representatives and the company. The director search process took approximately two months, and six highly qualified individuals were culled from a list of approximately 40 names. Both sides of the litigation were most gratified to find that those six people who were all on the priority list were all anxious and willing to serve on the Board and found it to be a unique opportunity and challenge.

It is clear that the settlement in the Phillips Petroleum case will have a dramatic impact on the affairs of that company for decades to come. In many ways it is the most significant non-financial event in the company's history. The Board of Directors for the first time will have a majority of outside members (moving up to 60% upon resignations) who will be actively involved in establishing policy and monitoring the performance of management, something that has never been done in the past. It will open up the process and bring to bear enlightened, diverse and sophisticated business judgment to deal with the critical social and financial issues that will confront the company for the rest of this century and beyond.

These two cases afforded a unique opportunity to impose institutional corporate reform measures on two major corporations that will serve as a model for other lawyers or corporations who wish to consider similar structural reforms of their own companies. However, it is unlikely that many cases like this will be presented that will provide the same leverage for achieving the same kind of reforms. The sad truth is that shareholder lawyers who bring these cases are frequently more interested in attorneys' fees rather than lasting and positive results for the corporation. And, shareholder proposals to other shareholders contained in proxy materials have been largely unsuccessful.

The question is thus presented : How can companies either be persuaded or be required to re-evaluate their present board structure and decision-making process with a view to creating greater accountability to shareholders and the public and achieving closer scrutiny of management's performance.

The weaknesses found in the Boards of the Phillips and Northrop corporations are typical of those found in many other corporations. Structural changes that were adopted as part of the settlement in both of those could be applied to most other major corporations.

Our experience in these two cases has taught us that if the Board is required by a mandated statement from either the Securities and Exchange Commission, Congress, or in the context of litigation to consider these issues, there is every reason to believe that many of them may be adopted. Such a requirement will give the present outside directors the opportunity to discuss the benefits from the standpoint of sound corporate policy. Once considered, they will find that the arguments supporting these changes and their implementation are extremely strong.

It is clear today that corporations and members of these corporate boards view themselves as being under attack. They have muddled through the last decade embattled and scarred. Most of them now realize that they must come to grips with their public responsibility and the responsibility to their sbareholders to open up the Board of Directors and its decision-making process, to be more responsive and sensitive to the needs and interests of not only shareholders but also of society. This, of course, is in their enlightened self-interest, and it is not inconsistent with their responsibility to the shareholders. These corporate executives also recognize that if they fail to take significant action over the next few years, they may find that increasing public pressure may result in more close regulation by the federal government with agency intrusion into the corporate boardrooms.

The task, therefore, is to come up with an effective way to require the corporations to address these certain fundamental issues. It is hopeful that this could be achieved without the passage of federal legislation imposing requirements on the corporations. If corporations prove to be non-responsive, the regulation option, however reluctantly, must be vigorously pursued.

I would like to now turn my attention to a discussion of some of the problems that presently exist with typical corporate board structures of major corporations and how changes may be brought about with some artful prodding by Congress and/or the SEC.


FULFILL THEIR RESPONSIBILITIES Industrial development over the past century has seen a dramatic transformation from small-scale to large-scale capitalism. Ownership has been divorced from control through the diffusion and purchase of small lots of stock by large numbers of investors. The controlling group of large corporations now consists of directors and officers themselves. Boards of directors in practice do not fulfill the responsibilities established in the theoretical model that holds directors as the accountable group responsible for all results and actions of the corporation, elected by the stockholders and trustee of their interests. The generally accepted purposes of the board of directors are to:

1. monitor the performance of management;
2. establish the objectives and policies of the corporation ;
3. elect, advise, and approve actions of corporate officers;
4. approve changes in corporate assets ;
5. approve financial decisions and report to shareholders ;
6. delegate special powers requiring board approval ;
7. maintain, revise and enforce the charter and bylaws; and
8. maintain the board through the elections and filling of vacancies.

These functions, however, are more illusory than real. Directors have become management appointees and shareholders are an amorphous mass lacking effective representation or the machinery to organize. Management has become self-perpetuating, unmonitored and ingrown. Director nominees are frequently selected from the inside, so that the members of the board of directors are subordinates of the managers they theoretically monitor and control. The result is that management monitors itself, and board meetings tend to be cursory superficial affairs. Ray Garrett, former chairman of the Securities and Exchange Commission, acknowledged this when he stated in a recent speech, “The typical, well-orchestrated board meeting, with a quick agenda, followed by some report of general interest on the operation of the business, followed by lunch, all on a tight schedule, induces an atmosphere of compliance and not inquiry that may be dangerous."

And who are these board members? They are usually hand-picked by the chief executive officer of the company and rubber-stamped by the board. People who serve on boards are drawn from a very small segment of society: bankers, corporate lawyers, other chief executive officers and businessmen. They have become inbred. The recent attempts by many large corporations to infuse a sense of public presence into the boardroom by appointing women, blacks and con. sumer representatives have been more cosmetic than part of an overall re. thinking of what criteria ought to be used to select new directors. While this effort is commendable, it is woefully inadequate and superficial.

The motivation for people serving on boards is frequently open to question. Many regard such service as a new feather in their cap or a credential rather

than a serious undertaking requiring a major commitment of time and energy. It is not uncommon to have a chief executive officer of a major corporation sitting on boards of six or seven other major corporations. It is obvious that given these impossible commitments he is in no position to play an active role in the affairs of any of those corporations.

One of the basic problems is the inadequacy of the information presented to board members themselves. There is limited interchange outside the context of board meetings among outside directors. And procedures that would encourage this type of communication are lacking.

But it is fair to say that the attitude of many board members is changing rather dramatically and quickly because of various events. The recent disclosures of illegal campaign contributions, international bribery and general corporate wrongdoing, and most importantly, the increased potential liability of the outside director has resulted in a genuine attempt on the part of many boards and outside directors to try to redefine their role and purpose. As previously noted, they would, of course, prefer to adopt corrective measures themselves rather than run the risk of a new form of government intrusion into corporate activity. Thus it has become clear that voluntary changes of board structure and policy have been and may be forthcoming. Attempts to live up to the theoretical objectives of a board of directors are on the rise.

There is, however, one point that must be underscored. Institutional procedures must be implemented by these corporations to ensure accountability of directors to shareholders and to the public: reliance should not be placed upon the willing. ness of outside directors in the context of a formal board meeting to raise these reform proposals on his or her own. As a practical matter, it simply will not happen.

The following are a list of objectives that I have referred to repeatedly throughout this statement that I will put forward once again in more detail for your consideration.

1. Definition of Board Role in a Comprehensive Manner.-The board should define in written form its collective role and the role and responsibilities of its individual members. It should be clear to each board member precisely what is expected of him or her as a condition of service on the board. Something so fundamental as this, one would think, would have litle difficulty in being adopted by all corporations. It is surprisng that few have done it.

2. Outside Directors.-At a minimum, at least 60% of the directors ought to be people who qualify as independent outside directors: that is, having no significant financial ties to the company. This is the only way that one can assure independent review of management. Others have called for 100% of independent directors. That may be an ultimate goal that corporations ought to aim for, although there will by necessity need to be a transition period.

It is essential to have a substantial number of outsiders (and at the very least a majority) on the board. If they are worth their salt and fulfill their responsibilities they will do the following: effectively review the actions of the chief executive officer; objectively appraise and audit company performance; fix officer compensation; bring breadth of viewpoint and respond to board trusteeship concepts without departmental bias; challenge management and ask discerning questions; aspire to upgrade industry standards; and ensure adequacy of community performance and social purpose. These are all challenging tasks which require competence and commitment. It is the role of the independent nominating committee to seek out such qualified individuals.

3. Nominating Committee.-Establishment of a nominating committee consisting exclusively of independent outside directors. This is a critical provision because it will decide who the new members ought to be and whether present members should be renominated. It will also establish the allegiances of the new members brought on to the board and will do away with the notion that the new member owes his or her position on the board to the chief executive officer. The loyalty of the independent outside director must be to the shareholders and not to management.

The nominating committee should establish guidelines on the director-selection process; attempts should be made to move out of the tight circle of friends and business acquaintances that presently form the basis of invitations to join corporate boards. It should require that any person who agrees to serve as a director is willing to make a substantial (and defined) commitment of time to fulfill his or her responsibilities. The committee should define the kind of relevant experience that should be considered when determining the qualifica

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