Weathering a Crisis: Weil in Silicon Valley

On May 8, 2012, Weil, Gotshal & Manges LLP’s Silicon Valley office hosted a one day symposium on Weathering a Crisis for corporate leaders and general counsel. Panel discussions focused on how to effectively handle a crisis before it becomes public; how to navigate the media while preserving your company’s public image; and how to implement sound strategic plans and compliance programs in order to avoid corporate wrong-doing.

Millstein, Simpson, Whitworth, Gregory

Disclaimer: I’m not a quick note taker. I’m thinking and interpreting as I write, so the words used are often mine. Hopefully, they bear some resemblance to what transpired but I am rarely quoting, so be forewarned.

Ira Millstein started us out with discussion of a fundamental issue. Are boards capable of removing management? Silicon Valley has developed a different culture where many founders have stayed with company. Firms don’t need independent boards when financed through private equity/venture capital but when companies sell equities to the public, then they must comply with SEC requirements and others driven by SOX and Dodd-Frank. At that point boards have to do what private equity does, scrutinize and monitor more. Every time anyone trips up, you can get into the paper. (For a more blunt perspective, see Silicon Valley Is Moving Backward on Shareholder Rights, Bloomberg, 5/3/2012)

Everything boards and management do has to be “contestable.” Where was the board? Silicon Valley boards tend to be smaller, younger, with fewer women, less majority voting, and with more classified boards. These are not good characteristics in a crisis. Creative destruction has its pluses but many companies have bent the rules in this insular, backscratching world. Mischief and visibility are undermining reputation. It is very hard to remove management without majority voting, especially in firms with dominant share owners. The JOBS Act may allow companies to go public that shouldn’t.

The dual class share system many are using when they go public provides opportunities to take advantage of minority share owners.  Buyers should beware. Frequently, we see a herd mentality, so the public buys no matter what. Eventually shareowners will get unhappy. Founder governance; nothing is forever. When there is trouble, Silicon Valley will see a problem.

How to avoid? Again, Millstein comes back to the theme that “contestability” is key. That’s difficult if there are too many protective devices insulating management. Companies won’t defy gravity forever. He says Silicon Valley firms should “adapt,” don’t adopt. Keys include: diversity of expertise on the board to see trouble brewing; independent minded members; self-assessments; succession planning; majority voting; declassified boards. These and other measures that may make management vulnerable also keep companies vital.

Anne Simpson reminded everyone where the money comes from. Shareowners are breathing down your neck, demanding majority voting. The idea of an election is one where opposition votes count. Apple, for example, finally adopted a CalPERS initiative for majority voting after 80% of shares were voted in favor. CalPERS is a long-term investor and finds dual class voting unacceptable. CalPERS also doesn’t like staggered boards. They have engaged through their “focus list,” which has shown attractive excess returns over ten years. I might point out, even more important than excess returns for CalPERS, getting their focus has also revitalized many of the companies on their lists.

The market has a lot of traders, a few raiders and some long-term investors. US market protections are designed for sell or sue. Investor rights are weak in comparison with those in several other countries. Companies should understand who their shareowners are and should establish a chain of accountability. Unfortunately, the chain of intermediaries can make this difficult. When things are going well, almost any structure works. Boards should have the tools to throw out management or right the course. Governance at root is steering.  (The word governance derives from a Greek verb which means to steer and was used for the first time in a metaphorical sense by Plato.) Controlling interests are the norm abroad but international minorities often have additional legal rights. We need protections from situations caused by insular governance, like News Corp putting family members on boards. The indexes at CalPERS are actively managed but the onus is on getting things fixed through activism.

Ralph Whitworth remarked that founders are often control freaks, which can have its downsides. Frequently, public offerings are more about founders cashing out, rather than raising funds to operate. Founders set the terms. Dual class aren’t new but collectively many funds have to own the stock if they are indexers and indexed funds are a growing segment. If managements were confident, they would bring on “real” boards. Staggered boards aren’t effective in defending a company. Dual class voting is a powerful tool but Whitworth questions their long-term value.

Accountability is important for long-term performance.  We want the tools. He described several hard fought battles and said that something like seventy percent of companies re controlled by thirty to forty investors. They should be demanding the tools. How many more scandals are required to get there?  There has been a vast improvement of boards over time, led by pressures from shareowners. Engagement has been legitimized. Board  member reputation has become a critical factor with many recognizing that blind loyalty can get you in trouble.  Have good advisors. Hear what shareowners are saying. Markets (should be, must be?) willing to look long-term.

Holly Gregory. Contestability keeps boards on their toes. That helps management be prepared prepared for a crisis. Board culture, cohesion, credibility. Engaged with shareowners and ISS. Boards should be assessing vulnerabilities. Get support from your shareowners, at least get to know them. Establish your credibility during good times. Closely monitor your 13D filers. What do they care about? Build a unified response. Don’t be afraid of majority voting. There is not much value in sitting on the sidelines.

I learned that panelists hadn’t been warned their remarks might be reported, so I checked with this first panel, composed of people I’d met before, and got their permission to post a few notes on their remarks. However, I didn’t check with subsequent panels, so will refrain from discussing them, other than by noting some overall observations without identifying their origin, as follows:

  • Internal auditors are the trier of facts internally. We’ve exported an internal investigations model around the globe to take remedial steps.
  • Planning is key. The very action of, for example, counting the number of seatbacks to the exit row in an airplane brings consciousness to your cerebral cortex.  Planning and developing protocols can help responses be more automatic.
  • Tips come up from places other than hotlines. If it is serious, get outside help. If politically sensitive or you need to sell the independence of trier of facts, outside help is critical. You can’t be both the trier of facts and the witness. Keep in mind, you’ll get credit for investigating and for saving tax dollars when reporting to the SEC.   In-house counsel needs good relations with board so you can sell your opinion and so they trust your judgement of when to bring in outside counsel.
  • If financial issues, check with auditors. Get them in the fold so you can still issue financial statements.  Figure out talking points with one point of entry in dialogue with press.
  • During the crisis.  Determine scope and goals. How to proceed? Who will oversee? What are the initial critical steps? Who are the key stakeholders.
  • Easier to sell to government agencies if you have it all well scoped. Get them to sign on or not to object but don’t set your scope in stone.  Timing is critical to not interrupt ongoing business. In today’s world, you depend on your relationships so that people don’t post something problematic on the Internet. Have your people do the interviews offsite to avoid creating a toxic environment.
  • Speed is key to keep and attract talent, keep customers and owners. Get in and get out. Have two people interviewing. Ask if being recorded. Don’t share what other people have said. Put yourself in the shoes of those you are interviewing.
  • Disclose who your client is (the company; not the employees) and the fact that their answers are not confidential. Report out. Often gives oral report to general counsel (when presenting to board, take back documents). Follow through critical on remedial measures.
  • Dodd-Frank established bounty for all kinds of activities. None paid yet. Does it undermine company programs?  More avenues to report and vent earlier is what is needed and feedback loops so that people know you are investigating. Make it easier to have more forums… more communication.
  • Information security risks hard to inventory.  Full boards often want to discuss. Report risk factors at least quarterly. Cyber creeping up. What was responsibility at low level has now moved to board level.
  • Preparation is key. Plan while on top. Internet has changed everything. Rumor. Don’t speak first and figure it out later. Start with the premise that everything leaks. Press is totally reactive when it comes to crisis. They aim to beat competition to the facts, even if the facts haven’t been checked. Find those in the press who are willing to dig deeper and get to know them.
  • Many in the press know they need to piece together bits of knowledge until the narrative comes together. They know they won’t be trusted again if caught in a lie.  It cuts both ways. Your effort to make yourself look beter may result in reporters resenting you and not trusting you. Credibility is the only thing you have.
  • Meet with shareholder regularly because the own the company and because you need to build a relationship over time.
  • Credibility is everything and is a two way street. Works best with reporters with whom you’ve established a long-term relationship. Deal with press and shareowners during good times to establish trust for bad times. Speak on background to reporters a lot and they will not betray your trust (or they will be shut out). Examples of tips to the press, which then allow tips to follow to the regulators.
  • A lie gets halfway around the world before the truth has a chance to get its pants on. Winston Churchill, even more true today.
  • Part of good governance is giving boards enough to ask questions… to challenge you. Internal audit function needs teeth and resources, so they can challenge what is going on.
  • No credibility with only accounting backgrounds in audits.
  • Need to engage business leaders actively in convincing them there is value to internal audits. Great place to quickly learn more about the business. Shouldn’t be under the CFO (conflict of interest). Key is to have objectivity.
  • Trust in institutions is declining worldwide but is relatively high in technology companies because they create products which often excede out expectations. Financial services are near the bottom.
  • We distrust large organizations and are more ready to believe people like us. (BP commercials switched from CEO to everyday people.)
  • Communicate with radical transparency. An apology can be like hitting the reset trust button. Trust is like your license to operate. Don’t lose it.

It was a great program. I’d love to see more such programs from Weil. If you get the chance to attend, don’t miss it! It also gave Californian’s a small taste of the quality they can expect at the upcoming Yale Governance Forum, which Millstein and Gregory are heavily involved in. See Governance Without Borders, 6/6-8/2012, agendaExample of prior event. For those in or near Silicon Valley, I highly recommend attending local SVNACD events. In fact, there’s one tomorrow: Red Flags of an Ethical Collapse, Breakfast, Palo Alto, SVNACD, 5/17. Prior event.

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