To restore public trust, we must know why the public continues to distrust corporate America. Today there is little, if any, discernible public trust. Why? Because during the past several years the management and directors of too many of this country’s leading public corporations, both large and small, have put their personal interests before the interests of stockholders. As a result, the country’s public corporations continue to be viewed with distrust and disdain not only because of the scandals at Enron, Worldcom, Global Crossing, Adelphia, Tyco and their ilk, but also because of the Brobdinagian increase in executive compensation coupled with a misguided belief among corporate directors that collegiality and a don’t “rock the boat” mentality in the boardroom trumps independence, leading eventually to corporate America’s loss of its moral compass.

This is what happens when the overarching focus of corporate America is wealth creation, however it can be achieved, even to the extent of making the numbers by “cooking the books” and nourishing a Zeitgeist of corporate hero worship which treated overpaid CEOs like rock stars while honesty and ethical conduct were shunted aside, if not totally ignored.

All of which resulted in the passage of a tough new law by Congress in 2002, known as the Sarbanes-Oxley Act.

While Sarbanes-Oxley has dramatically changed and improved the way our corporations operate and the scope and depth of their public disclosures, serious problems remain as greed and avarice continue to trump the essential ethical elements of good corporate governance.

This environment has led to what has become the most recent debilitating corporate scandal which involves “Excessive Executive Compensation” – or what one corporate governance pundit has described as the “Mad-Cow Disease of American Boardrooms”.

Backdating of Stock Options

Without confusing you, or even worse, boring you with a complex legal exegesis, let me briefly discuss the “Corporate Scandal of 2006” known as “Stock Options Backdating”.

During the past six months, the Wall Street Journal and the financial pages of this country’s leading newspapers have been reporting and investigating a highly questionable widespread corporate practice, which started with the high-tech stock boom in the 1990s, of awarding stock options to corporate executives at the bottom of a steep drop in the granting company’s stock price or just before expected big run-ups in the company’s stock price, all of which occurred in patterns with only a slight chance of occurring randomly.

Scandals move in unpredictable ways. When the news broke, earlier this year, that some companies had backdated stock-option grants to employees in order to make them more valuable, it seemed like a problem that would come and go quickly; the number of companies thought to be involved was small and the impact fairly trivial. But the scandal metastasized, engulfing more than 150 companies, sparking criminal indictments, and forcing the departure of high-profile executives.

In March of this year, the Wall Street Journal published an in-depth article on what appeared to be a widely used practice of backdating stock option grants, under a banner headline which read:

“The Perfect Payday. Some CEOs reap millions by landing stock options when they are most valuable. Luck-or something else?”

The article described the grant of a stock option to the CEO of Affiliated Computer Services on a day in the summer of 2002 that the company’s stock price sank to the lowest level in a year. The option entitled the CEO to buy stock at that low price for several years in the future. Apparently, all of his stock-option grants from 1995 to 2002 were dated just before a rise in the stock price, often at the bottom of a steep decline.

“Just lucky?” – A Wall Street Journal analysis suggested that the odds of this happening by chance are extraordinarily remote – around one in 300 million – the odds of winning the multi-state powerball lottery with a $1.00 ticket are one in 146 million.

Suspecting such patterns aren’t due to chance, the Securities and Exchange Commission commenced examining whether some option grants carried favorable grant dates for a different reason, that is: they were backdated, and if so, they were illegal grants.

The practice of backdating stock options occurs when a date that has already passed has been designated for an option award, typically a date when the valuation of the company’s shares is at a low point. The selection of the earlier date creates a potential opportunity to insure a significant advantageous personal financial gain – assuming the stock price has risen between the date of the options award and the date when the options are exercised.

A particularly lucrative option grant that received extensive analysis and criticism in the financial pages of this country’s leading newspapers was made, on October 13, 1999, to Dr. William W. McGuire, CEO of United Health Group, Inc., which after adjustment for stock splits came to 14.6 million option shares. The 1999 grant date was dated the very day United Health stock hit its low for the year. As of March 2006, he exercised about 5% of the options for a profit of about $39 million and had 13.87 million unexercised options left from his 1999 grant, which if he had exercised then as of the March 2006 date, would amount to about $717 million more. Keep in mind the 1999 grant was dated the very day United Health stock hit its low for the year. Also, grants made to Dr. McGuire in 1997 and 2000 were dated on the day with those years’ single lowest closing price; and a 2001 grant came near the bottom of a sharp dip. In all, the Journal article reports, the odds of such a favorable pattern occurring by chance would be one in 200 million or greater.

Option grants are made by “independent” directors who serve on the company’s compensation committee of the Board of Directors. Many companies make their grants at the same time each year, a policy that limits the potential for date fudging; but no law requires this. Until 2005, United Health had a very unusual policy – it let Dr. McGuire choose the day of his own option grants. Where were the “independent” directors of United Health? Were they asleep or did they really believe that Dr. McGuire deserved, or needed, this excessive level of compensation?

On October 15, 2006, United Health announced that Dr. McGuire would step down as chairman and director, and would step down as CEO by December 1, 2006, after an internal formal probe found evidence of backdating.

Approximately 150 companies are currently under investigation or facing investigation for options backdating, and many of them have announced either that they plan to restate their financial statements or that they are the subject of inquiries by the SEC or of offices of the United States Attorney, focusing on the worst behavior such as falsifying documents, creating fictitious employees and lying to auditors. In addition, the scandal scoreboard shows, as of the end of October, the resignation or termination of at least 42 executives or directors, including 10 CEOs (with more departures expected) and the admission of overstatements of past profits, due to misdated options, of about $5.3 billion from nearly 70 companies.

Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, said he believes more people will lose their jobs. He called it “a fundamental breach of trust to [the company’s] investors.” And at minimum, pretending that an option was granted earlier than it actually was generally involves accounting and disclosure violations. The irony is that if the backdating companies disclosed in their financial statements the fact that the options had been backdated, they would not have been charged with wrongdoing. To quote a Washington pundit – “In Washington, people say that its not the crime that gets you, it’s the cover-up.” Christopher Cox, Chairman of the SEC, stated that the corporate response to stock-option abuses was “unprecedented” and reflects how the corporate environment has changed after accounting scandals at companies such as Enron Corp.

H-P’s Spying Mess-Very Stupid!

In September of 2006, Patricia Dunn the chairman of Hewlett Packard’s board of directors resigned because of the problems she encountered in her efforts to catch those who were responsible for leaking confidential information from H-P’s boardroom. The search for the leakers evolved into a fishing expedition into telephone records and even newspaper trash, and included misrepresentations that may have been illegal. She was criticized for efforts employed to trace the press leaker from the board in 2005 and 2006, which included the use of illegal techniques, and particularly “preexisting”, a technique that uses deceit (that is, by masquerading as directors or journalist) to extract phone record information from workers at phone companies. The attorney who was asked by H-P to examine how H-P conducted its investigation concluded that it was ethics and not the law that needed to be paid more heed. He advised that “Doing it legally should not be the test-that is a given. You also have to ask what is appropriate and what is ethical.” If the directors had worried less about who leaked the information than what was leaked and why, H-P would have been far better off.

Role of the Board of Directors

So, despite four years of the Sarbanes Oxley Act, which has been applied vigorously to curtail, if not eliminate, corporate misfeasance, many of America’s largest and most prominent corporations continue to engage in illegal and unethical conduct, demonstrating that strong laws alone do not foster corporate honesty. Directors must realize that, in addition to their legal obligations, they must recognize and address the broad social responsibilities they have to the public at large.

What is needed, in addition to the enactment of appropriate laws, is a reinvigorated system of corporate governance which creates and maintains a corporate culture that demands integrity and compliance with the highest ethical standards by the corporation’s management and employees and monitored by a board comprised of independent, well-informed, ethical directors who possess business or management experience, financial savvy and the ability to create a boardroom culture that embraces and extols independence, integrity and proactive diligence.

But first let’s briefly explore who runs the Company.

Who Runs the Company?

The CEO and the Company’s executive officers manage the company, while the board of directors is charged by law, in its fiduciary capacity, with overseeing and monitoring the executives’ management of the company. Corporate governance is the oversight of management. And the board’s principal oversight responsibilities are to:

• Advise and assist the CEO;

• Select, evaluate and compensate the CEO and the company’s senior executives;

• Replace the CEO and senior executives if, and when appropriate, and develop and implement a management succession plan;

• Review and approve management’s strategic plan;

• Oversee the company’s financial performance and accounting, and monitor the company’s compliance with its legal and obligatory obligations;

• Manage and resolve any business, governance, or regulatory crisis confronting the company; and

• Review and approve management’s financial plan, commitment of material corporate resources and other material transactions not in the ordinary course of business.

Fiduciary Duties of Directors Under State Laws

Corporate directors select the CEO and members of senior management and fire them if they fail to perform, replacing them with executives whose interests, they hope, are aligned with the interests of the stockholders and who are knowledgeable, ethical, and guided by their fiduciary duties of candor, care and loyalty to their stockholders and by the so-called Business Judgment Rule.

Candor, Care and Loyalty

These words describe duties of directors that arise out of the legal relationship established by most state corporate laws in America and provide that the business and affairs of a corporation are managed by or at the direction of a corporation’s board of directors. In practical terms, what do these duties require?


The duty of candor should be self-evident. It is a duty that requires directors to assure the information that the officers and employees of the corporation provide to the stockholders is timely and materially complete and accurate.


The duty of care requires that a director be fully informed of all material information that is reasonably available to the board. It is the right, and the obligation, of every director to be informed and, after acquiring the appropriate information, to act deliberatively with the diligence and competence of a reasonably prudent person in a similar position under like circumstances. Being informed is not a passive undertaking. If the CEO doesn’t provide the information the director reasonably requires, he or she must insist on obtaining the information; give it careful consideration; and, if necessary, seek the advice of outside advisors and experts before acting.


The duty of loyalty requires a director to act honestly, in good faith and in a manner reasonably and honestly believed to be in the best interests of the corporation and its stockholders, while avoiding any conflicting personal gain or economic interest. If a conflict exists, the conflicted director must recuse himself or herself from any deliberation or decision on the matter of self-interest, and allow the disinterested directors to make the decision.

Business Judgment Rule

The Business Judgment Rule creates a judicial presumption that each of the rule’s key elements has been satisfied and that the directors have satisfied their duties of care and loyalty in good faith. The judicial rationale for this position is that judges will not replace the board’s judgment unless the contesting plaintiff (who has the burden of proof) can overcome the presumption and show bad faith, lack of due care, or the absence of a rational purpose. If this were not the case, it would be unlikely that responsible individuals, who don’t relish being second-guessed, would ever agree to serve as directors.

The Five I’s

It is unlikely that even the best-recognized corporate governance experts will agree on what it takes to create an excellent or ideal board. However, a look at the best run companies teaches us that an excellent board needs independent, well-informed, ethical directors who possess business or management experience and financial savvy and the ability to create a boardroom culture that embraces what I call the “Five I’s of Good Corporate Governance”: Independence, Integrity, Informed, Involved and Initiative.


While independence doesn’t necessarily guarantee wise judgments or guarantee excellence in the boardroom, it does provide directors with the ability and courage to challenge management and fellow directors in an environment that encourages constructive skepticism as well as free and open differences of opinion. Independence means:

• management will have the benefit of the board’s unfettered, best judgment,

• the non-executive directors will not only satisfy the regulatory “check-the-box” criteria for independence, but will also be “independent minded” and make decisions on the basis of what is in the best interests of the shareholders, and

• the “don’t rock the boat” attitude that historically permeated the clubby or conflicted board will become a relic of the past, replaced by a conviction that encourages, in fact demands, free and open discussion and constructive disagreement.

The culture of board fraternalism must give way to a board culture of independence and skepticism. Strong dissent is often discouraged by the implicit standards of social interaction (that is, collegiality), developed by boards that are sometimes too polite or overly tolerant of mediocre performance.


Successful companies insist on integrity even at the risk of restraining entrepreneurship, a concept that often is difficult to sell to executives who believe that their companies must make the projected numbers even if it means “making up the numbers.”. By setting the right tone at the top, the CEO and the board create a corporate culture that censures extravagance, dishonesty, self-dealing and disloyalty and extols integrity and ethical behavior. Enron had plenty of rules, codes of conduct, checklists and compliance programs, but apparently they were ignored or violated by company employees and executives while the directors failed to properly oversee and monitor their compliance. Beware of a “check-the-box” mentality. Monitoring compliance means more than simply affirming that the proper boxes have been checked.

History has taught us that reliance on compliance standards alone is inadequate. Corporate leaders, particularly those whose corporations have been sanctioned for improper behavior, are beginning to demand not only adherence to their corporate compliance programs, but also to the corporation’s cultural and ethical standards.


A director may be independent and possess integrity but what good is a director if he/she is not informed? An individual who agrees to serve as a director must, as a condition to his/her service, commit to spend the time and make the effort necessary to become and remain fully informed about the company’s business, industry, competitors, finances, revenue plans, strategy, internal controls and risk factors, anticipating future obstacles and problems, maintaining the level of business savvy that allows the director to contribute to the development of the company’s strategy, and maintaining a level of financial literacy required to evaluate the company’s financial performance. Ignorance is not bliss! Directors have too often taken the approach of distancing themselves from things they didn’t want to know. This forced state of ignorance will no longer be tolerated since it is clear that today directors have a duty to become and remain knowledgeable, ask tough questions, become involved, take a proactive approach and go beyond the minimum legal obligations. Uninformed directors are liabilities, make bad decisions and consume valuable management and board time.


Effective oversight of management requires availability, commitment, and dedication of the time required to discharge the director’s fiduciary duties responsibly. Directors should be enthusiastic and excited about their service on the board. If they are, they will devote whatever time is required to ensure that they are fully prepared and know enough about the corporation’s business to perform their duties assiduously and intelligently.


A director must be competent, forward looking, proactive, ask questions, probe, insist on answers, avoid “group think” and questionable conventional wisdom, listen carefully, participate in the preparation of the agendas and discussion topics for board and committee meetings and be prepared to take the initiative when management stumbles or needs help. The board has no room for insouciant directors who are not committed or who believe they can serve as passive observers. Directors who lack initiative or fail or are unable to contribute should resign. Effective directors are not afraid of being bold.

Finally, in addition to adhering to the duties and obligations I have described, directors should judge themselves by applying the so-called “Front Page Standard” – that is: They should ask themselves whether they would be comfortable if the decisions or actions by their Board, or the manner in which the directors made their decisions, were reported on the front page of the New York Times or Wall Street Journal.

Corporate directors must be aware of and respect the concerns and needs of the shareholders they serve who, for too long a period of time, have been ignored by those who operate and govern the company. Shareholder activism is alive and well, and is demanding, and in certain cases is producing a new and enlightened response from directors to the demands for reform by shareholders, and particularly reform of the rules relating to the nomination and election of board directors.

As Nell Minow, a shareholder activist and an executive at the Corporate Library has noted:

“Boards are like subatomic particles – they behave differently when observed, and with shareholders participating in the nomination process, they may not only act differently, but better.”

Arthur Levitt, former Chairman of the Securities and Exchange Commission, made the case more succinctly, and without the prolixity that customarily attends and burdens legal analysis, when he stated in March of 2005:

“In demand are corporate leaders who don’t think of themselves as the soul of their corporation, but who do their part to create a corporation with a soul.”

With that, let me close with my one-page guide for corporate directors, who are committed to providing effective, ethical corporate governance.

By Paul  P. Brountas
(November 8, 2006)

HCS readers are invited to view other articles about SNHU or business ethics at our extensive, permanent archives under the Business Ethics section at the URL or the Christos and Mary Papoutsy Distinguished Chair in Business Ethics at Southern New Hampshire University at

The purpose of the distinguished chair in ethics is to promote and enhance students and community members awareness of ethics in personal and professional settings through teaching, community lectures and conferences. These events will foster understanding and assist in the application of lessons taught by current and classical ethicists to 21st-century settings.The chair serves as the cornerstone for an integrated university program in business ethics that encompasses the undergraduate and graduate levels. For more information about these events or about the ethics chair, contact Jane Yerrington at SNHU (603-668-2211 x2488) or visit the webpages of the ethics chair at

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