In Search of Director Independence

This story is part of a special series by TheStreet.com investigating shareholders' reaction to corporate corruption on Wall Street. Click here to see a full listing of stories.

There's no question, directors were part of the problem at Enron, WorldCom, Global Crossing and many other companies now charged with fraud and deception.

Can they also be part of the solution? Corporate reformers agree that any effective effort to restore investor confidence will require better oversight from directors. But the first batch of proposed reforms, most notably the new listing standards from the New York Stock Exchange, have significant shortcomings, according to shareholder rights activists and corporate governance experts. Among the most vexing issues:

How can directors be truly independent from the companies they serve? And does independence ensure competence?

Will already strained regulators have the resources to enforce new regulations regarding the independence and competence of directors?

Will companies be willing to commit to wholesale overhauls of their boards to meet the new requirements?

Among the more ambitious proposals from the NYSE is the requirement that directors meet at "regularly scheduled executive sessions in the absence of management." Under existing rules, there is no such requirement.

The presumption is that board members will be less willing to go along with the company line if they're both independent from senior management and compelled to meet outside their direct sphere of influence. Perhaps it would also encourage board members to go public with concerns, such as those raised by Qwest Communications' (Q) board in September 2001, when it fretted there was an accounting "credibility issue" at the firm, according to documents released this month by the House Energy and Commerce Committee. A year after that board meeting, Qwest restated $1 billion in sales. It's fair to say that shareholders might have benefited from advance knowledge of the board's concerns.

Desired Qualities

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Inside, Outside -- We Just Want an Active Board

But even if the playing field is changed to promote independence, the paramount issue is the character and competence of the individual directors.

"You can lead a director to executive session, but you can't make them think," said Nell Minow, founder of the Corporate Library and a shareholder right's activist. "Tell me a way to ensure board members have independence of spirit, commitment and character -- that'd be important. There's really no item in resumes or in related transaction disclosure that's going to provide that assurance."

The NYSE's proposal, which has become the template of the reform effort, requires that companies have a simple majority of independent directors on their boards, defining independence as "no material relationship with the company, either directly or as a partner, stockholder or officer of an organization that has a relationship with the company," including investment banking, commercial, consulting, legal, accounting, charitable and familial relationships.

Current rules require companies have a least three independent directors on their audit committee, but there are no requirements for independence of the board itself.