117th Annual Illinois Banker

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117th Annual Illinois Bankers Conference June
25-27, 2008 Corporate Governance Best
Practices Presented By Dave Muchnikoff Silver,
Freedman Taff, L.L.P. 3299 K Street, N.W.,
Suite 100 Washington, D.C. 20007 (202)
295-4513 dmm_at_sftlaw.com
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Corporate Governance
USA Today, 2-18-08
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Corporate Governance

• Why Corporate Governance other than because
  banking and securities laws and regulations says
  you must?

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Corporate Governance

• What is your banks legal status? The rules on
  corporate governance are different depending on
  that legal status
• Non-publicly reporting bank or bank holding
  company
• Publicly-reporting bank or bank holding company
• Stock listed on NASDAQ or NYSE or AmEx
• Assets of less than 500 million
• Assets of 500 million or more
• Assets of 3 billion or more

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Corporate Governance

• Fiduciary Obligations
• Directors have a duty to attempt in good
  faith to assure that a corporate information and
  reporting system, which the board concludes is
  adequate, existsfailure to do somayrender a
  director liable for losses causes by
  non-compliance with legal standards.
• In re Caremark Intl. Inc. Deriv. Litig., 698 A.
  2d 959, 970 (Del. Ch. 1996)
• Board liability exists if, after having
  implemented a reporting or information system or
  controls, the Board consciously fails to
  monitor or oversee its operation, thus disabling
  themselves from being informed of risks or
  problems requiring their attention
• Stone v. Ritter, 911 A.2d 362, 370 (Del 2006)

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Corporate Governance

• Federal Sentencing Guidelines Overview
• Culture of Compliance 8B2.1(a) company
  must exercise due diligence to prevent and detect
  criminal conduct and otherwise promote a culture
  that encourages ethical conduct and a commitment
  to compliance with law
• Director/senior management visible commitment to
  clearly articulated values is vital
• Companies/executive penalized when corporate
  culture found to be unethical

Board Leadership/Oversight 8B2.1(b)(2)
directors must take an active leadership role, be
knowledgeable about the content and operation of
the ethics and compliance program and exercise
reasonable oversight over it implementation and
effectiveness Train Everyone 8B2.1(b)(4)
compliance and ethics training includes the board
and senior management
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What Did Sarbanes-Oxley Give Us?
Corporate Governance

• Greater transparency
• Increased scrutiny
• More vocal shareholder activists
• Unprecedented media visibility

• Shareholder frustration and anger.
• Majority voting and proxy access
• Executive Compensation and Option Backdating
• Section 404 refinement

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What Did Sarbanes-Oxley Give Us?
Corporate Governance

• Rise of shareholder activism
• Acceptance, proliferation of governance ratings
• CEO compensation and succession
• Ratcheting up involvement in director succession
• Classified vs. annual elections
• Majority voting vs. plurality
• Targeting of individual director nominees for
  withhold/no votes
• Say on Pay

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Danco Jonovic 1990
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Corporate Governance Best Practices
Corporate Governance

• Topics
• Board Self-Evaluations
• Majority Voting and Other Director Election
  Developments
• Tally Sheets and Other Compensation Committee
  Best Practices
• Equity Grant Procedures
• CEO Succession Planning
• Reminders

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Board Self-Evaluations
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Board Self-Evaluations

• General
• Process by which a board or board committee
  assesses its own performance with the goal of
  enhancing future effectiveness by identifying
  strengths and weaknesses in the primary areas of
  the boards or committees responsibilities.
• Required for NYSE-listed companies, optional for
  all others.
• As with most things, there are pros and cons.

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Board Self-Evaluations

• Benefits
• Compels directors to identify strengths and
  weaknesses and assess how the board or committee
  has actually been functioning compared to how it
  should be functioning.
• Can identify potential problem areas before they
  become real problems.
• Fosters better communication among directors.
• Helps re-focus directors on long-term goals and
  strategies.
• Assists with director nomination process.
• Improves directors sense of personal
  accountability.

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Board Self-Evaluations

• Risks
• Information gathered discoverable in litigation.
• Ways to mitigate
• Limit retention of written materials.
• Follow-up and take corrective action.
• Can negatively affect board collegiality and
  discourage board service.

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Board Self-Evaluations

• Oversight of Process
• For NYSE-listed companies, must be
  nominating/corporate governance committee.
• Audit, compensation and nominating/corporate
  governance committees of NYSE-listed companies
  must conduct their own self-evaluations.
• For non-NYSE-listed companies, should be
  committee charged with corporate governance
  matters or some other independent body of the
  board.
• Use of outside parties (e.g., counsel,
  consultants).

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Board Self-Evaluations

• How to Conduct
• No requirements board/committee needs to decide
  whats right for it.
• Questionnaires
• Interviews
• Board discussion
• Summary report
• Follow up!!

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Board Self-Evaluations

• Performance Objectives
• Again, no one size fits all. Typical areas of
  coverage include
• Role of the board.
• Board organization and composition.
• Board meetings.
• Board compensation.
• Committee evaluations should cover same areas
  plus check how well committees are performing
  their obligations outlined in committee charters.

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Board Self-Evaluations

• Individual Director Evaluations
• Controversial.
• Benefits include
• More direct feedback to directors.
• Early warning system for problem directors
  opportunity to turn things around.
• Instills stronger sense of personal
  accountability.
• Risks include
• Negative effect on board collegiality.
• Reluctance of directors to criticize peers.
• Discourage new directors from joining board and
  may lead existing directors to leave board.
• Encourage counterproductive participation.
• Liability risk.

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Board Self-Evaluations

• Methods of Conducting Individual Director
  Evaluations
• Chairman or lead director evaluates each
  director.
• Self-assessment questionnaires.
• Peer evaluations.

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Board Self-Evaluations

• Public Disclosure of Evaluations
• Only the fact that theyre performed, but not the
  results.
• Can be communicated in proxy statement or in
  corporate governance guidelines, if company has
  them.

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Director Nominations
Board Self-Evaluations

• Do directors feel they automatically stay until
  retirement?
• Do you have a formalized selection process?
• Do directors have first-hand experience with
  characteristics of high-performing companies?
• Are board members engaged?

• Ongoing board evaluation is the key
• Selection and replacement of directors
• Should reflect the strategic direction of the
  company
• Are competencies continuously aligned with
  strategic challenges?
• Do directors spend the necessary time?

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Majority Voting and Other Director Election
Developments
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Majority Voting and Other Director Election
Developments

• Overview
• Historically, most companies used a plurality
  standard whoever gets the most votes for the
  position wins.
• Critics say not meaningful where election
  uncontested, as it only takes one vote to get
  elected.
• Under majority voting, number of votes cast for
  must exceed number withheld (or cast against, if
  applicable).
• Majority of companies in SP 500 have adopted
  majority voting.
• Companies without significant institutional
  shareholder bases less likely to feel pressure to
  follow suit.

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Majority Voting and Other Director Election
Developments

• Implementation Options
• Policy
• Bylaw amendment
• Charter amendment

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Majority Voting and Other Director Election
Developments

• Legal/Practical Issues
• Resignation of directors who dont receive
  requisite majority vote.
• Board can find itself in Catch-22 situation.
• Contested elections.

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Majority Voting and Other Director Election
Developments

• Other Important Considerations
• Proposed elimination of broker voting discretion
  for uncontested elections.
• E-proxy (notice and access model) now available
  for companies and dissident stockholders
  starting. Can make it easier for dissidents to
  wage proxy contests.
• Movement for shareholder access to managements
  proxy materials.

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Majority Voting and Other Director Election
Developments

• Related Initiatives by Corporate Governance
  Reform Activists
• Board declassification.
• Elimination of shark repellants and other
  supermajority vote charter provisions.

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Tally Sheets and Other Compensation Committee
Best Practices
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Tally Sheets and Other Compensation Committee
Best Practices
Wall Street Journal, 4-14-08
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Tally Sheets and Other Compensation Committee
Best Practices

• What is a tally sheet?
• Centerpiece of best compensation committee
  practices.
• Identification and quantification of all elements
  of the executives pay, including compensation
  that would be owed to him or her upon retirement
  or other termination of employment.
• Shouldnt just be an annual exercise tally
  sheet should be reviewed and discussed before
  making any decision on the executives pay.

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Tally Sheets and Other Compensation Committee
Best Practices

• What should go into the tally sheet?
• Tailored to fit each executives compensation
  package.
• Should capture all elements.
• Can generally track SEC compensation disclosure
  rules, but not a perfect fit.
• Numerical components of tally sheet will be
  reflected in various areas of compensation
  disclosures.
• Disclosure of compensation committee practices
  should include discussion of tally sheet
  exercise.

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Tally Sheets and Other Compensation Committee
Best Practices

• Other Things Compensation Committees Should Be
  Doing
• Reevaluate compensation philosophies and
  components of existing program.
• Accumulated wealth analysis
• Survey use dont cherry pick.
• Internal pay equity.
• Employment agreement provisions
• Evergreen Provisions
• Definition of termination for cause
• Change in Control payouts
• Gross Ups
• Compensation consultants should be engaged by and
  report directly to the compensation committee.
• Annually review compensation committee charter.
• Director Compensation
• Trend away from meeting fees in favor of annual
  retainers
• Increased proportion of pay in equity
• General disdain for director retirement plans
• Reduction or discontinuation of perquisites

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(New Math) ?(SEC Rules) ProxyConfusion
Firms Disclose FormulasBehind Executive
Pay,Leaving Many Baffled
Wall Street Journal, 3-21-08
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Washington Post, 5-5-08
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Equity Grant Procedures
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Washington Post, 5-14-08
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Equity Grant Procedures

• General
• Still a white hot area numerous SEC
  investigations ongoing and shareholder lawsuits
  filed, and guilty pleas continuing to roll-in for
  backdating. Recent Broadcom enforcement action
  shows SECs interest has not waned.
• Restatements.

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Equity Grant Procedures

• Practices Being Scrutinized
• Backdating - choosing a grant date with the
  benefit of hindsight so that the date selected is
  earlier than the date on which the grant was
  actually approved, with the selected grant date
  usually being a date on which the market price is
  lower than the date on which the grant is
  actually approved.
• Spring-Loading - the granting of equity awards in
  anticipation of the issuers disclosure of
  material information that is likely to have a
  positive effect on the issuers stock price.
• Bullet Dodging - purposefully waiting until
  material negative information is publicly
  disclosed before granting an equity award.

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Equity Grant Procedures

• Why are these practices problematic?
• Effectively results in discounted options most
  shareholder-approved plans require options to be
  granted at the market or at a premium.
• Potentially a breach of directors fiduciary
  duties.
• Potential restatements.
• Big potential tax problems if options purporting
  to be granted at the market are later
  determined to be below market
• Lose ISO treatment, if intended.
• Wont qualify as performance-based compensation
  under Internal Revenue Code Section 162(m).
• Constitutes deferred compensation under Internal
  Revenue Code Section 409A, potentially resulting
  in excise tax on executive.

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Equity Grant Procedures

• What should be done to minimize risk of problems?
• Review existing equity grant practices.
• Tighten internal controls.
• Adopt formal written grant policy.

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Equity Grant Procedures

• Adopting an Equity Grant Policy
• No one size fits all approach.
• Determine role played by equity grants in overall
  compensation programs.
• Key components
• Frequency and timing of grants consider
  limiting to fixed dates or during open trading
  windows.
• Designate equity grants compliance person(s).
• Delegation of grant authority to officers
  critical to ensure permissibility of delegation
  under state law and plan documents. Delegation
  should not cover grants to Section 16 reporting
  persons (i.e., Form 4 filers).
• Limit grant approvals to in-person or telephonic
  meetings of board or compensation committee and
  avoid written consents if possible. If written
  consents must be utilized, do not use as of
  dating.
• Forms of equity award agreements. Should be
  approved by compensation committee before grants
  are made and executed as soon as possible after
  grants are made. If multiple forms of agreements
  are used depending on level of employee, critical
  to have controls in place to ensure right form of
  agreement used.

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Equity Grant Procedures

• SEC Compensation Disclosure Implications
• CDA should include disclosure of any practices
  of timing equity grants in coordination with
  public release of material information.
• Disclosure required in Grants of Plan-Based
  Awards table if date on which compensation
  committee approves award differs from grant date
  or if exercise price of a stock option differs
  from closing price on grant date.

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CEO Succession Planning
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CEO Succession Planning

• Why Is It Important?
• CEO plays critical role in implementation and
  development of strategic policy.
• Company always needs to be prepared for a change
  in top executive position, regardless of CEOs
  age.
• CEOs departure could be sudden and unexpected or
  known well in advance company needs to prepare
  for either contingency.
• Delays in replacing CEO may raise investor and
  employee angst.
• Important to plan for succession of other key
  senior executive positions for many of the same
  reasons.

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CEO Succession Planning

• What Should a Succession Plan Entail?
• Prepare early 3-5 years out
• No one size fits all.
• Determine who will lead process. Usually an
  independent committee, such as compensation or
  nominating/corporate governance.
• Communicate/partner with CEO.
• Should cover CEO and other senior executive
  positions.
• Reflect boards understanding of critical factors
  to companys future success, direction and
  culture.
• Identify and periodically update qualities and
  characteristics for effective CEO.
• Should cover sudden and unexpected departures as
  well as planned successions.
• Tie succession planning to the strategic business
  plan.
• Stockholder preferences
• Consider insiders before going outside.

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Succession Planning at Community Banks

• Hiring leaders from the outside is risky
• Lack of continuity
• Less loyalty
• Can be disruptive, hurt morale and change the
  culture sometimes for the better but often for
  the worse
• Outside candidates are far more likely to fail
  than internally developed candidates
• Easier for the board to make the wrong choice
  with an outside candidate, particularly if
  selection criteria are not defined
• Promoting leaders from the inside can have its
  issues
• Reward longevity or loyalty, not talent
• Lack of development program or process
• Lose opportunity for cross-pollination from
  other institutions
• But still generally better to grow and develop
  leaders

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Succession Planning at Community Banks
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Reminder Areas
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Reminder Areas

• Reminders
• Executive Sessions of Directors
• Approval of Related Party Transactions
• Insider Trading Matters
• Regular Review of Committee Charters and Other
  Corporate Governance Documents and Additional
  Considerations

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Reminder Areas

• Executive Sessions
• Under NYSE rules, non-management directors must
  meet at regularly scheduled executive sessions
  outside managements presence, and if any
  non-management director is not independent,
  independent directors must meet in executive
  session at least annually.
• Under NASDAQ and AMEX rules, independent
  directors must meet in regularly scheduled
  executive sessions.
• Regularly not defined in NYSE or NASDAQ rules,
  but should be at least twice a year. AMEX
  requires at least one executive session annually.
• No limit on potential topics of discussion, but
  cant act in lieu of full board.
• Who should lead sessions?
• Minutes of executive sessions and feedback given
  to management.

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Reminder Areas

• Related Party Transactions
• Under NYSE, NASDAQ and AMEX rules, audit
  committee or other independent body of
  directors must review and approve related party
  transactions.
• SEC disclosure threshold raised from 60,000 to
  120,000, but must identify any transactions
  below this level involving independent directors.
• SEC rules also now require discussion of policies
  and procedures for review and approval of related
  party transactions.
• Must identify any transaction where policies and
  procedures not followed.

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Reminder Areas

• Insider Trading Matters
• Insider trading alive and well.
• If dont have a written insider trading policy,
  adopt one now.
• Appropriate window/blackout periods.
• Directors and Section 16 officers not only ones
  who should be subject to window/blackout periods
  anyone with regular access to material inside
  information should have to follow them.
• 10b5-1 plans for insiders and issuers. SEC
  closely scrutinizing for abuse.
• Regularly review who Section 16 reporting
  officers are consider having board adopt
  resolution designating these persons.
• Require all directors and Section 16 officers to
  notify filing coordinator in advance to ensure
  timely Form 4 filing and avoidance of short-swing
  profit liability.

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Reminder Areas

• Regular Review of Committee Charters and Other
  Corporate Governance Documents and Additional
  Considerations
• Use as checklists to make sure board and key
  committees doing what theyre supposed to be
  doing and update as needed. Also review codes of
  conduct for same purpose.
• When rotating committee assignments, make sure
  members satisfy applicable independence and other
  membership requirements
• Audit general NYSE/NASDAQ/AMEX independence
  definition, heightened independence standard of
  SEC Rule 10A-3 and financial sophistication
  requirements.
• Compensation general NYSE/NASDAQ/AMEX
  independence definition plus Non-Employee
  Director definition of SEC Rule 16b-3 and
  Outside Director definition of Internal Revenue
  Code Section 162(m).
• Corporate governance guidelines not required
  unless listed on NYSE if adopting voluntarily,
  dont set too many rules to follow.

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Dave M. Muchnikoff

• Former Senior Attorney and Assistant Branch
  Chief, SEC Division of Corporation
• Selected to 2005 BTI Client All-Star Team level
  on a Survey of Fortune 1000 companies
• Certified Public Accountant

• Frequent contributor on financial institution
  issues to financial services organizations.
• Specializing in SEC reporting, corporate
  governance, public and private debt and equity
  offerings, mergers and acquisitions, charter
  alternatives, bulk loan sales and purchases and
  securitizations.

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Silver, Freedman Taff, L.L.P.

• Debt and Equity Securities Offerings
• SEC and Shareholder Reporting
• Recapitalizations
• Compensation and Employee Benefit Matters
• Securitizations
• Credit Union to Thrift Conversions
• Mergers and Acquisitions
• Charter Conversions
• Holding Company and MHC Formations/Reorganizations
  
• Bank and Thrift De Novo Formations
• Regulatory and Enforcement Matters

• Our attorneys regularly practice in the
  financial institutions area with many having
  governmental experience. We have represented
  over 300 financial institutions over the past 30
  years.

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THANK YOU