BestPractice Governance Standards for Employee Equity Plans

1
Best-Practice Governance Standards for Employee
Equity Plans

• International Association for Financial
  ParticipationDecember 10, 2008
• Conseil Central de lEconomie
• Brussels

2
U.S. Financial Crisis

• Corporate Scandals Accounting Abuses
• CEO Abuses Mutual Fund Scandals
• Hidden Expense Loads Fiduciary Litigation
• Plan-Level Abuses Sub Prime Crisis
• Failures of Large Financial Institutions
• General Lack of Investor Confidence

3
Failed Equity Plans

• Overriding Cause of Failure
• Lack of Corporate Governance
• Governance is Process and Transparency
• Performance Transparency Companies who embrace
  Performance Transparency know explicitly what
  they must do to excel and outperform
  competitors
• Financial TransparencyTiming, meaningful and
  reliable disclosures of financial issues, options
  and decisions

4
Failed Equity Plans

• Overriding Cause of Failure
• Good Corporate Governance is not only
  participation in management decisions
• Corporate Governance is Implementing a PRUDENT
  PROCESS and TRANSPARENCY CONTROLS for Effective
  Governance of the Plan

5
Failed Equity Plans

• Overriding Cause of Failure
• Lack of Prudence
• Prudence is PROCESS and TRANSPARENCYOpen Doors
  to Transparency, Accountability and Seriousness
  of Purpose
• President Bush
• UN Address
• September 23, 2008

6
Best Practice Process
Plan Management Fiduciaries
Board of Directors, Executive Committee
or Benefits Committee of the Board
Named Fiduciaries
Plan Committee, Designated Officers or Separate
Administrative and Investment Committees
Administration (e.g. Chief Administrative
Officer, Senior VP of Human Resources)
Investment (e.g. Chief Investment Officer, CFO or
Treasurer)
Designated Fiduciaries
Plan Administrator (e.g. Benefits
Director) Third Party Administrator Benefits
Consultant
Investment Officers Investment
Consultant Investment Managers
7
Best Practice Process

• Board of Directors is responsible for
• Establishing or amending the plan or
• The selection and retention of the named
  fiduciary through establishment or amendment of
  the plan
• Naming a plan administrator

8
Best Practice Process

• The Corporate Governance Factor
• In the appointment of fiduciaries, the Board
  should receive evidence satisfactory to it that
  such persons have the qualifications necessary
  for service in such positions

9
Best Practice Process

• The Board is responsible to
• Shareholders for performance of company
• Plan Participants for performance of the Plan
• These can be CONFLICTING priorities, but each
  must be accomplished
• Establish Goals and Methods
• Utilize procedures or guidelines
• At least annually review the performance of
  fiduciaries
• Keep minutes of its meetings

10
Best Practice Process

• Plan Administration
• At least an annual review
• Review of the administrative functions prepared
  by each named fiduciary, trustee and/or
  administrator
• Review all interpretations of the Plan decided by
  the named fiduciary that has the authority to
  make such interpretations

11
Best Practice Process

• Investments
• The Board (or named fiduciary) should adopt a
  Statement of Investment Policies in view of duty
  to protect participants
• Periodic report (at least annual) on the
  Statement of Investment Policies demonstrating
  compliance
• The report should include information concerning
  compliance with the requirements of prudent
  investments and transparency (multiple equity
  investments)
• There should be a report on investment activities
  and changes during the most recent reporting
  period

12
Best Practice Process

• The Plans Named Fiduciary should
• Where appropriate, appoint a trustee
• Where authorized, give appropriate directions to
  trustees
• Where authorized, appoint an investment manager
• If desired and authorized, designate other
  fiduciaries
• If desired and authorized, employ persons to
  render advice with regard to such named
  fiduciarys responsibility
• Allocating fiduciary responsibilities among named
  fiduciaries and/or designated fiduciaries

13
Best Practice Process

• The Named Fiduciary for Investments
• Adopt a Statement of Investment Policies
• Identify and delegate areas of responsibility to
  designated fiduciaries within the corporation
• At least annually review the performance of the
  trustee and report to the Board
• At least quarterly review and evaluate the
  investment results of each of the investment
  managers and report (at least annually) to the
  Board of Directors
• Obtain from each investment manager its
  certification of compliance with the Statement of
  Investment Policies and other prudence and
  transparency requirements

14
Best Practice Process

• The Named Fiduciary For Administration
• Establish a manual containing plan administration
  objectives and procedures and codification of
  plan interpretation
• Identify and delegate within the corporation
  (e.g. Human Resources, Controller, General
  Counsel) areas of responsibility with respect to
  plan administration
• Submit a report (at least annually) to the Board
  with respect to plan administration and compliance

15
Best Practice Process

• The Named Fiduciary should
• At least annually review the performance of any
  fiduciaries designated by such named fiduciary
  and persons employed to render advice
• The Designated Fiduciary should
• Review the performance of any person it has
  employed to render advice
• This review should be performed at reasonable
  intervals to ensure that it has no reason to
  doubt the competence, integrity or responsibility
  of such person

16
Best Practice Process

• Consider composition of plan investment committee
• Are there members of the committee with inside
  knowledge (e.g. CFO, treasurer, general counsel)?
• The plans investment policy statement should
  include provisions applicable to employer stock
• Communicate with employees the risks associated
  with investing in employer stock
• Where the investment committee (or some other
  authority) has discretion over investment in
  employer stock, consider objective process for
  evaluating investment
• Independent fiduciary to make decision on
  investment in employer stock
• Volatility Index to trigger objective independent
  process to protect plan assets
• Non-discretionary investment in employer stock
  dictated by the terms of the plan may not protect
  fiduciaries (e.g., Enron)

17
Securities Tag-Along Suits

• Typically follow on the heels of securities
  litigation
• Allegations are identical to those made in
  securities litigation, with the addition of Plan
  Management fiduciary breach allegations
• Failure to exercise prudence in investing plan
  assets
• Failure to take steps to minimize loss to the
  plan
• Failure to diversify plan assets
• Failure to disclose to participants accurate
  information as to the health of the company (and
  thus, the stock)
• Failure to monitor the performance of certain
  plan fiduciaries

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Securities Tag-Along Suits Contd.

• Named in the suits
• The plan sponsor (the company)
• The Named Fiduciary (sometimes a committee,
  sometimes the company)
• The Named Administrator (also sometimes a
  committee, sometimes the company)
• Any plan committee or plan investment committee
• The Board of Directors
• The CEO
• The trustee that holds the assets of the plan

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Examples of Securities Tag-Along Suits

• ADC Telecommunications
• AirTouch
• Allegheny Energy
• Amerada Hess
• American Airlines
• American Electric Power (AEP)
• American International Group (AIG)
• AOL Time Warner
• Aon
• Aquila Inc. (fka Utilicorp United Inc.)
• ATT
• Avaya
• Baxter
• Bell South
• Bristol-Myers Squibb
• Cardinal Health
• Chevron
• Cigna
• CMS Energy Corp.

• Columbia/HCA
• Computer Associates
• Conseco
• Corning Inc.
• Delphi
• Duke Energy
• Dynegy, Inc.
• Electronic Data Systems (EDS)
• Enron
• Ferro Corp.
• General Electric
• General Motors
• Global Crossing Ltd.
• Goodyear Tire Rubber Co.
• Harnischfeger
• Hartford Financial Services Group, Inc.
• HealthSouth
• Honeywell
• Household International

20
Examples of Securities Tag-Along Suits Contd.

• IPALCO Enterprises
• Kmart
• Krispy Kreme
• Lucent Technologies, Inc.
• Marsh Inc.
• McKesson HBOC
• Merck Co.
• Mirant
• Molson Coors Brewing
• Motorola
• Nortel
• Oregon Metallurgical Corp.
• Pfizer Inc.
• Polaroid
• Providian Financial Corp.
• Qwest Communications
• RCN Corporation
• Reliant Energy
• Rite Aid

• Rural Metro
• Schering Plough
• Scientific-Atlantic
• Sears
• Southern Company
• Sprint Corporation
• Stone Webster
• Syncor
• Textron
• TXU Corporation
• Tyco International
• UAL
• U.S. Airways
• Waste Management
• Westar Energy
• Williams Companies
• Winn-Dixie Stores
• Worldcom
• W.R. Grace

21
Securities Tag-Along Suits Settlements

• Some settlements
• 90 Million Royal Dutch Shell
• 85 Million partial settlement Enron (an
  additional 356 Million awarded by bankruptcy
  court)
• 79 Million Global Crossing
• 69 Million Lucent
• 55 Million Williams Companies
• 41 Million Bristol-Myers Squibb
• 29 Million HealthSouth
• 28 Million CMS Energy
• 5 Million Krispy Kreme

22
U.S. Transparency Crisis

• Transparency of Plan Fees and Expense Disclosure
• New Department of Labor (DOL) Proposed
  Regulations and Class Exemption
• Hidden Fee Litigation
• Congressional Oversight and Proposed Legislation

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Transparency Controls

• Required Disclosure By Service Provider
• Plan fiduciary must have reasonable belief that
  the contract or arrangement is reasonable
• Failure of service provider to comply with
  fiduciarys written request within 90 days
  requires fiduciary to notify DOL and determine
  whether to terminate or continue the contract or
  arrangement.

24
Transparency Controls

• Compensation/Fees
• Service provider must disclose compensation it
  will receive, directly or indirectly, and any
  conflicts of interest that may arise in
  connection with its services.
• Arrangement not reasonable unless service
  provider furnishes required information to
  responsible plan fiduciary.
• Applicable to service providers who provide
  banking, consulting, custodial, insurance,
  investment advisory, investment management,
  recordkeeping, securities, investment brokerage,
  or third party administration services.

25
Transparency Controls

• Conclusion
• Plan fiduciary must engage in objective process
  designed to elicit information necessary to
  assess not only reasonableness of fees but also
  qualifications of service provider and quality of
  services that will be provided.
• Solicitation of bids among service providers is
  prudent means to obtain information relevant to
  decision-making process.
• Responsible plan fiduciaries must continue to
  monitor service arrangements and performance of
  service providers.

26
Hidden Fee Litigation

• More than 15 major class action lawsuits
• Against Fortune 100 companies and members of
  board of directors and senior officers
• Allowing employees to be overcharged by their
  401(k) vendors for administration services and
  investment management

27
Hidden Fee Litigation

• Hidden Fee Lawsuits
• ABB
• Bechtel
• Boeing
• Caterpillar
• Deere
• Exelon
• Fidelity Investments
• General Dynamics
• General Motors
• Kraft Foods Global
• International Paper
• Lockheed Martin Southern
• Northrop Grumman
• RadioShack
• United Technologies

28
Increased Litigation

• ELIOT SPITZER v. RICHARD GRASSO and THE NEW YORK
  STOCK EXHCHANCE
• In 73-page opinion New York State Supreme Court
  ruled that Grasso had to return over 100 million
  in retirement benefits and interest
• Failure to disclose size of supplemental pension
  to NYSE Board of Directors is breach of fiduciary
  duty
• Board Compensation Committee criticized for
  approving 55 million in-service hardship
  withdrawal under Supplemental Executive Savings
  Plan
• Harsh Words for the Board That a fiduciary of
  any institution, profit or not-for-profit, could
  honestly admit that he was unaware of a liability
  of over 100 million is a clear violation of the
  duty of care
• This court is not imposing a new corporate
  standard to review annual benefits assessments,
  as Mr. Grasso charges. Rather, the Court is
  acknowledging the fundamental duty of each member
  of a board to understand the business of the
  company upon whose board they sit.
• Court urged parties to adopt real structural
  protections that involve a real infusion of some
  backbone into the Board

29
Congressional Oversight

• Commentary on DOLs Proposed Reg. led by George
  Miller, Chairman of the Committee on Education
  and Labor.
• DOL must go much further than these proposed
  regulations.
• DOL should focus only on plans that primarily
  consist of employee contributions.
• Require DOL to annually survey employers and
  enhance existing reporting requirements.
• DOL must work better with other agencies such as
  SEC.
• Regulators knew that subprime mortgages were
  being consolidated into risky securities but took
  little or no action to warn investors.

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The Solution

• Have independent counsel review whether fees
  paid to service providers and other expenses of
  the plan are reasonable - Avoids potential
  fiduciary liability and prohibited transaction
  exposure for failure to examine this issue.
• - Safeguards statutory employer protections that
  may be negated by failure to identify and
  disclose all plan fees and expenses to plan
  participants.
• Such a review can recapture significant
  assets for the benefit of both the employer and
  plan participants.

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The Solution

• Reasonableness of fees not easily ascertained
• Traditional investment consulting firms may not
  be able to perform forensic investigation and
  provide negotiation necessary to uncover embedded
  and undisclosed fees.
• Independent counsel who specializes in this area
  can provide analysis on confidential basis.
• Helps to avoid participant and government
  litigation for excess fees that may come to light
  as the result of the forensic plan expense review
  process.