Good morning. “It’s a Whole New Ballgame.” That’s the title that was given to me for my remarks this morning. I am a little reluctant to use a sports metaphor to discuss corporate governance, but I am going to try to work with it anyway.
It is true that corporate governance is, in many respects, a whole new ballgame. But, in other ways, it’s the same old ballgame. Before I tell you why there are both new and old parts to the ballgame, I want to talk about the current climate for corporations.
PUBLIC CONFIDENCE DAMAGED
Corporate failures like Enron, WorldCom, Tyco, Adelphia and others have undermined the trust the public has in corporate America.
Should anyone question that statement – and I doubt many do – all you have to do is look at recent public opinion polls. For example, last year, a USA/CNN/Gallup poll asked: how widespread is the practice of executives taking improper actions to benefit themselves at the expense of the corporation? Seventy-nine percent thought it was either “very” or “somewhat” widespread.
WHY IS PUBLIC SUPPORT IMPORTANT
That bothers me, not only as a General Counsel, but also as an employee. I want to work for a company that has a reputation for being open and honest with its shareholders, employees and other constituents. Those of you who work for corporations undoubtedly feel the same way.
While that is reason enough to care about public opinion, there are three other reasons that are especially important to General Counsels. First, most large corporations are involved in lawsuits, either as defendants or plaintiffs. Therefore, we have a significant stake in the fairness of the judicial process.
In a recent article entitled “Jury Perceptions After Enron”, the authors asked how many prospective jurors agreed with the statement: “If someone sues a major corporation, the case must have some merit”. The answer: 75 percent. The authors concluded: “Without question jurors’ sympathy towards corporations has never been lower.”
The second reason is that corporate scandals have adversely affected efforts to bring about civil justice reform through legislation at the state and federal level. One example will illustrate this point. Most corporations are concerned about runaway juries who award very large damages to plaintiffs. Before the collapse of Enron, 46 percent of mock jurors agreed that there should be a cap on the money damages awarded in civil trials. Post-Enron, the number dropped to 29 percent.
Finally, every corporation needs public support to be successful. Whether you need to obtain a government permit to build a new manufacturing facility, or want to introduce a new consumer product or raise money in the capital markets, corporations depend on the good will of the government, the public and investors to be successful.
This may be more important in the post-Enron environment than at any time in the recent past. Peter Drucker has said the major challenge of corporations in the era we’re in now is dealing with the public. Everyone can make widgets, but if you don’t have the public trust and confidence, that’s going to be your barrier.
Clearly, the decline in trust of corporate America has important implications for every corporation and for everyone whose livelihood involves corporations. We must do what we can to restore public confidence.
THE NEW BALLGAME
Let’s turn to the new part of the ballgame. It is well known that these corporate scandals spurred the Congress to pass the Sarbanes-Oxley Act of 2002. This legislation was the most far reaching securities legislation since the 1930s.
Since the Act was passed, the SEC has issued, and continues to propose, new regulations at a breathtaking pace. Between January of this year and now, over 30 new rules have been issued or proposed. Both major stock exchanges have proposed extensive revisions to their listing requirements relating to corporate governance.
A fundamental role of the General Counsel of any public company is to stay on top of all of these new rules and to make sure his or her company is in compliance. General Counsels are on notice that good governance is one way to restore public confidence in corporations.
Keeping up with the new laws is very important, and Weyerhaeuser’s law department has devoted a lot of time and resources to doing just that. What may surprise you is that I believe that’s the easy part.
THE OLD BALLGAME
When you look at the volume of new rules and their importance, it is a whole new ballgame. But in other ways it is the same old ballgame. What I mean is that, notwithstanding all of the new rules, the real challenge remains the same as it has always been: How do large corporations with far flung operations and lots of employees ensure compliance with the letter, as well as the spirit, of the law? In other words, how do you create a corporate culture that promotes compliance with the rules on the part of the organization and every single employee?
A good deal has been written about the new governance rules, but relatively little has been written about how to create a culture that promotes compliance with these new rules. I would like to turn to that subject now.
TONE AT THE TOP
The single most important factor in creating such a culture is corporate leadership, especially the “tone at the top” set by the board, the CEO and senior management. You cannot have a corporate culture that promotes compliance without the active support of the CEO and senior management.
My favorite “tone at the top” story takes place between a father, who is part owner of a small clothing store, and his son.
The boy asked his father, “Say, Pa, what is the meaning of ethics?”
“Well,” says the father, “that’s pretty hard to define, but I can give you an example:
Suppose a woman comes into my store and picks out something for $15 – maybe a pair of gloves. I wrap them up and she hands me a new $20 bill. I give her $5 change, and just as she is going out the door, I notice that by mistake she has given me two $20 bills stuck together.
Now we have a question of ethics: Should I, or should I not, share the $20 with my partner?”
Unlike the father in my story, management must have moral clarity. The ultimate effectiveness of the new corporate governance rules will be determined by how corporate leaders answer the boy’s question: What is the meaning of ethics? Adopting a Code of Ethics will mean little to a corporation if management makes clear, by conduct or otherwise, the code’s provisions do not apply to them.
The failure to have the right “tone at the top” goes a long way towards explaining the corporate scandals. A recent issue of Corporate Board Member magazine contained an interview with a member of the board of Tyco International.
In response to the question: “What happened at Tyco?” the director said: “The short answer is that there was corruption, collusion and concealment at the very top levels of management which made it very hard for outside directors to detect.” The director went on to say: “As a practical matter, even diligent oversight can be evaded if management deliberately sets out to do so.” In other words, the integrity of the CEO and senior management is everything.
ROLE OF DIRECTORS
That brings me to the role of directors. You will hear from a distinguished panel later this morning about the changing role of directors. I simply want to make a few points about their role in building a corporate culture that promotes compliance with the laws.
We know from the Caremark case that directors must require corporations to have management systems in place that give them the right information to carry out their oversight role. The Congress, and the SEC, have adopted new rules that have expanded the role of the board and, in particular, the role of the Audit Committee. I believe you will see state courts extending the Caremark duty of care to cover the new role of the board.
Two recent cases point in that direction. The Disney case involved a challenge to the board’s actions – or more to the point, its inaction - surrounding the hiring and termination of Disney’s President. The court held that directors who fail to inform themselves about an issue of material importance to their corporation will loose the protection of the business judgment rule.
The second case, Abbott Laboratories, involved a suit against directors for losses to the corporation resulting from repeated FDA violations over a six-year period. The court found the business judgment rule inapplicable because, like in Disney, there was a “sustained and systematic failure of the board to exercise oversight.”
These cases do not suggest a change in the scope of the business judgment rule. Instead, the cases find the business judgment rule inapplicable because the board failed to exercise its oversight responsibilities.
In order for there to be a healthy relationship between the board and management, the board must take its Caremark duties seriously. It must understand the key risks facing the company, evaluate the management systems in place to deal with those risks and ask management the tough questions. This is the only way in which the board can successfully carry out its oversight role.
I am fortunate that Weyerhaeuser has such a board with 11 independent directors with diverse backgrounds. Our CEO is the only director who is not independent and he does not serve on the Audit, Compensation or Governance Committees. The independent directors meet in executive session at each meeting with the Lead Director acting as Chair and responsible for bringing any concerns of the directors back to the CEO. The company’s officers responsible for compliance and internal audit, report directly to the board or one of its committees.
MANAGEMENT SYSTEMS
Let’s assume you work, as I do, for a corporation with an excellent “tone at the top”. How do you drive the values of the board and senior management down through the organization? With the support of the board, management must put in place appropriate systems and processes to achieve this result.
General Counsels, working with other members of management, have an obligation to help design and implement these management systems. General Counsels must identify the risks facing the company and help put in place management systems that address each risk.
BUSINESS CONDUCT SYSTEM
Let me illustrate this point by using two of Weyerhaeuser’s management systems as examples. I want to begin with our ethics and business conduct system because, in many ways, it’s the cornerstone.
Management must communicate its values and expectations throughout the organization. Employees want to know where management stands. This is particularly true in the post-Enron environment. And, because there is a constant turnover in employees in large organizations, management must communicate frequently.
At Weyerhaeuser, we have been governed by a written code of ethics and a business conduct program since 1976. It is a values-based code rather than a legalistic one. One of the things we learned early on was that large manuals explaining how to comply with various laws didn’t work for most people. What did work was a set of guidelines. Our goal in putting together these guidelines has been to sensitize people throughout the organization to issues and then provide the right resources to help them think through an issue before acting.
We use a number of tools to communicate these guidelines. Our internal web site contains our code of ethics along with information about resources available to employees to address specific issues. We also target more detailed educational programs at the relevant audiences. For example, we have an environmental compliance program that is targeted at individuals who are responsible for complying with our air and water permits.
Every two years we have a company-wide refresher course on our code of ethics. Each manger, starting with the CEO and his management team, leads his or her direct reports in a discussion of ethical issues. In this way, the discussion cascades down through the organization.
This year we used a video-tape featuring real life situations as the basis for group discussion. The tape also included every member of our senior management team discussing these situations and talking about the importance of doing business in an ethical manner. Twenty- seven years after we introduced our code of ethics, we continue to look for new ways to make the code a living guide for everyone and continue to work to make sure everyone in the company is internalizing our guidelines.
REPORTING ISSUES
We tell our employees: If you are involved in something that makes you uncomfortable, then talk to your supervisor about it. And if for some reason that is not appropriate, then raise the issue with a company officer, or a member of the senior management team.
Employees can also bring issues forward on a confidential basis to our Ethics and Business Conduct Office. Each year we work to improve our business conduct processes. For example, this year, in response to the Sarbanes Act, our Audit Committee amended our existing procedures by giving employees an opportunity to raise financial and accounting issues directly with the Chair of the Audit Committee.
Our ethics and business conduct system is not perfect, but we have tried to create a culture in which employees are comfortable raising any ethical or business issue rather than waiting until after something goes wrong.
PUBLIC DISCLOSURE MANAGEMENT SYSTEM
The second management system I want to discuss is our public disclosure process. This system is designed to ensure that material financial and non-financial information is collected, evaluated and accurately disclosed.
At Weyerhaeuser, this comes together with our Disclosure Committee, a multi-disciplined group that is responsible for making sure we have the right procedures in place and that public disclosures are made in an appropriate and timely manner. The Committee, which is chaired by our Vice President and Corporate Controller, reports directly to our CEO and CFO and to our Audit Committee.
I am stressing the importance of management systems because they are essential to successfully complying with the new governance rules. As you know, the SEC now requires certification of disclosure and financial reporting by CEOs and CFOs. It also has adopted rules requiring management assessment of internal controls over financial reporting.
While these rules focus accountability at the top, where it has always belonged, the CEO and CFO of large corporations must be able to rely on management systems and processes to meet these obligations.
Every company will have different management systems. There isn’t any one system that is right for everybody. The kind of management systems you need depends on your analysis of the kinds of risks that your company faces as well as the size of the company. This is influence by the nature of the business you are in. For example, every manufacturer should have an environmental management system. The management system needs to have credibility and use generally accepted standards. At Weyerhaeuser, for example, we have adopted standards set by the International Organization for Standardization for all of our environmental management systems worldwide.
CONCLUSION
I want to end my remarks this morning with two simple truths about the recent corporate scandals and the new governance rules.
The first truth is that a corporation, particularly a large one, must have management systems in place to ensure compliance with the laws. I don’t care if you are talking about compliance with the new governance rules or the old environmental rules, you must have processes in place that can be audited by both your internal and external auditors. There must be clear accountability for these management systems.
The second lesson from the recent corporate scandals is that none of this will work without the support of your board and the CEO. This is what I have called the “tone at the top”.
Many of the corporate scandals took place against a corporate governance backdrop that looked pretty good on paper. The lack of independent directors, financial experts or codes of ethics was not the problem.
What was the problem? I come back to the question the boy asked his father: What is the meaning of ethics? Everyone in the organization needs to understand how management answers this question. Corporate lawyers cannot create a company culture. Only management and the board can do that. In other words, the moral compass must be firmly in place at the top in order for the new governance rules to work as intended. We all have a stake in this because without the successful implementation of the new governance rules, we won’t restore public confidence in corporations.
Thank you.
