Frederick Krebs: Keeping a handle on scandal
Legal Week reports
November 22, 2006 at 07:03 PM
5 minute read
Unless you have been a hermit, you are likely to have been inundated with stories in the last few months about options backdating. What else is there to say? For many, the current conversation that underlies these scandals is far more interesting; namely, not what happened, but who let it happen? Specifically, people are wondering where were the lawyers in all of this. None of this could have happened if they were not around to paper the deals, could it?
This issue is of more than passing concern to my organisation, the Association of Corporate Counsel, and to its 20,000-plus members (who work in more than 8,000 corporations in 55 countries); in-house counsel are on the front lines of corporate governance reforms and compliance, and are rightly in the spotlight when questions like this arise. So why did corporate counsel in companies where options scandals hit not prevent these problems, and what lessons can we learn from this experience?
The first lesson must be for in-house counsel to own the problem: too often, the Bar has a variety of reasons about why lawyers did not get something done, and without going into the legitimacy of those arguments, it is time to get beyond them and focus on ensuring that problems like this are better handled or prevented in future.
In a nutshell, backdating of grant dates is not necessarily illegal; problems arise when the backdating is not recorded properly or is inappropriately manipulated, leading to a need for a financial restatement. So some back-dating did happen with lawyers' facilitation, and I am sure there are some companies where the in-house counsel should have said: "Stop!" but did not. However, in a larger number of companies we see two things that are instructive: first, we see that lawyers were walled out of the decision-making and papering process on compensation issues, and so could not have an impact; and second, we see that lawyers (like other executives) may have engaged in practices that we condemn now, but which were largely commonplace when they were undertaken, and even deemed acceptable by auditors, the Securities and Exchange Commission (SEC), and outside counsel.
What this teaches us is that in-house counsel must redouble their efforts to ensure that they are at the table when sensitive issues such as executive compensation are being decided. They must be a conduit to the board and its compensation committee leaders. Chief legal officers are not always in the position to decide when they should be included in management conversations. Nevertheless, our association's leadership has proposed a variety of ideas to address this:
. With new SEC rules on compensation practices in place, lawyers can seize the initiative with management and the board by offering their assistance to ensure compliance with new and complex regulations.
. US in-house counsel should follow Europe's lead and ensure questions and answers regarding executive compensation are filed immediately, including a 'rational basis' support that can be offered in the company's annual report. Lawyers can also volunteer for this duty.
. Lawyers can encourage management to be working on the next proxy statement all year round, rather than waiting until the month before it is due. Thus lawyers will be able to show the complete picture, rather than a once-a-year snapshot, on the compensation systems and 'health' of the compensation process.
. Lawyers often serve as corporate secretaries to their companies. Lawyers working in this role and supporting can help tighten the secretaries' processes and review.
. Lawyers can help retain and supervise independent compensation consultants to work with the board and management.
While lawyers are not necessarily trained as compensation experts, they are perfectly able to give directors a perspective on compensation and how it will be viewed, and set compensation standards and processes. They can also ensure a depth and comprehensiveness of conversation that might otherwise be lacking.
Which brings us to the second area for increased attention: the chief legal officers' ability to 'see around corners', beyond what is legal, to a fuller understanding of what is right and the reputational risk to the company. Even when something (for example backdating) is commonplace practice – condoned by auditors and outside counsel – if the in-house lawyer thinks it is questionable, then the company should be so advised. 'Legal, but questionable' problems arise all the time in modern corporations; the difference is that in today's environment there is less tolerance for companies that rely on that excuse. Perhaps the most important role in-house lawyers can play is the keeper of the 'CNN standard' – would you want to be on CNN explaining to the world what you did and why? Or is the mere fact that you are in that seat an indicator that you have failed? Perhaps the most important role for in-house and outside counsel to companies in the future is keeping CNN's guest-list shorter.
Frederick Krebs is president of the Association of Corporate Counsel.
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