TCB BestPracticesPostEnron

s p e c i a l
r e p o r t
Corporate Governance
Best Practices
A Blueprint for the Post-Enron Era
SR-03-05
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About the Global Corporate Governance Research Center

The Conference Boards Global Corporate Governance Research Center (Center)
brings together corporations and institutional investors. The Centers objective is
to assist corporations to enhance their governance processes and thereby inspire
confidence and facilitate capital formation in todays globally competitive marketplace.
Members of the Advisory Board
Members of the Center
BP plc (UK)
Baxter International Inc.
California Public Employees Retirement System (CalPERS)
The Coca-Cola Company
The Chubb Group of Insurance Companies
Computer Associates International, Inc.
Heidrick & Struggles
CSX Corporation
Jones Day
Equiserve
KPMG
Fried, Frank, Harris, Shriver & Jacobson
McKinsey & Company
Georgeson Shareholder Communications Inc.
Merrill Lynch & Co., Inc.
Southern Company Services, Inc.
Pfizer Inc
Standard Life Investments Ltd. (UK)
PricewaterhouseCoopers
Teachers Insurance and Annuity Association
College Retirement Equities Fund (TIAA-CREF)
Disclaimer
This report is intended for educational purposes only. Nothing contained in this report is
to be considered as the rendering of legal or accounting advice. Readers are responsible for
obtaining legal advice from their own legal counsel or accounting advisors.
For further information regarding the Center,

please contact Diane Insolia, Center Coordinator at
845 Third Ave., New York, NY 10022
Tel: 212 339 0392
Fax: 212 836 9711
e-mail: diane.insolia@conference-board.org
Best Practices
by Carolyn Kay Brancato
and Christian A. Plath
About this report

Materials for this report were gathered at a series of nation-wide roundtables held
during 2002 in New York; Washington, D.C. (hosted by Potomac Electric Power Company);
Stanford, California (hosted by Heidrick & Struggles International, Inc., and the Stanford
Law Schools Executive Education Program); Chicago (hosted by Baxter International Inc.),
the University of Delaware (hosted by the John L. Weinberg Center for Corporate Governance);
and at the offices of TIAA-CREF in New York.
Roundtable project sponsors
Sponsor/participants
THE CHUBB GROUP OF INSURANCE COMPANIES
Arch Chemicals, Inc.
The member insurers of the Chubb Group

of Insurance Companies form a multi-billion
dollar organization providing property and
casualty insurance for personal and commercial customers
worldwide through 5,000 agents and brokers. Chubbs
global network includes branches and affiliates throughout
North America, Europe, Latin America, Asia, and Australia.
Chubb is a leading provider of directors and officers (D&O)
liability insurance.
Avon Products, Inc.

Corn Products International, Inc.
Footstar Inc.
Oak Technology
Spectrum Brands
Wellmark, Inc.
Contributors
Baxter International, Inc.
Gibson, Dunn & Crutcher LLP
PFIZER INC
Heidrick & Struggles International, Inc.
Pfizer Inc discovers, develops, manufactures,

and markets leading prescription medicines for
humans and animals and many of the worlds best-known
consumer brands.
Potomac Electric Power Company

Stanford Law Schools Executive Education Program
TIAA-CREF
The University of Delawares John L. Weinberg
Center for Corporate Governance
Additional sponsors
KPMG Audit Committee Institute
PricewaterhouseCooopers LLP
Corporate Governance Best Practices: A Blueprint for the Post-Enron Era
The Conference Board
Corporate Governance Best Practices

contents
A New Framework for Corporate Governance

Corporate Governance Practices
10
13
14
16
18
21
23
24
26
29
30
32
34
Role of the Board

Corporate Governance Guidelines
Boards Access to Information
Boards Mix of Skills and Individual Director Qualifications
Board Independence
Board Leadership
Board Committee Structure and Size
Role of the Nominating/Corporate Governance Committee
Role of the Compensation Committee
Chief Governance Officer
Measuring Company Performance
Board and Director Performance Evaluation
Succession Planning and Leadership Development
Audit Practices
36
38
40
43
45
47
Audit Committee Role and Responsibilities

Audit Committee Charter
Audit Committee Composition and Independence
Audit Committee Communication and Reporting
Oversight - Internal Audit
Oversight - External Audit
Disclosure, Compliance and Ethics

51
54
57
59
63
Disclosure Practices
Internal Controls
Risk Assessment and Management
Director and Officer Liability and D&O Liability Insurance
Ethics Oversight
66
Legislation and Proposed Exchange Standards Comparison Chart
94
Hypothetical, Inc., Corporate Governance Principles
96
Independence Comparisons
99
Sample Corporate Governance Committee Charter (General Electric Corporation)
100
Sample Director Self-Assessment Worksheet
Appendices
102
Sample Chief Executive Officer Evaluation Form
106
Sample Audit Committee Charter and Responsibilities Checklist (Microsoft Corporation)
110
KPMG Audit Committee Institute Basic Principles for Audit Committees
112
Excerpt from Internal Control: Guidance for Directors on the Combined Code
Report by The Institute of Chartered Accountants in England and Wales
About the authors

Dr. Carolyn Kay Brancato is the Director of The Conference
Boards Global Corporate Governance Research Center and
the Directors Institute. She also served as Director of The
Conference Boards Commission on Public Trust and Private
Enterprise. She is the author of two books on corporate
governance: Getting Listed on Wall Street and Institutional
Investors and Corporate Governance (both published by
Business One Irwin). Dr. Brancato has appeared as a guest
speaker at major corporate governance programs in the
United States, United Kingdom, France, Germany, Australia,
Sweden, Brazil, Chile, India, Singapore, Hong Kong, Thailand,
Indonesia, Japan, Malta, and Oman.
Christian A. Plath is a Senior Corporate Governance

Consultant with the Conference Boards Global Corporate
Governance Research Center. He was formerly the director
of global corporate governance research at the Investor
Responsibility Research Center (IRRC) and both writes and
speaks widely on corporate governance issues.
Acknowledgments
Participating companies and organizations
Aksys Ltd.
Embassy of France
Marriot International, Inc.
Sequoia Capital
APAC Customer Services, Inc.
Equity Office Properties Trust
Masters Governance Consulting, LLC
Singapore Institute of Management
ArchChemicals
Footstar, Inc.
McKinsey & Co., Inc.
Asian Venture Capital Journal
Freddie Mac
Mercer Delta Consulting, LLC
Skadden, Arps, Slate, Meagher &

Flom LLP
Avon Products, Inc.
Fordham University School of Law
Merrill Lynch & Co., Inc.
Spectrum Brands
Baxter International, Inc.
Friedman, Billings, Ramsey & Co.,

Inc.
Methode Electronics, Inc.
The Boeing Company
Taiwan Semiconductor
Manufacturing Company, Ltd.
Brobeck, Phleger & Harrison
Gear Holdings, Inc.
Motorola
Brunswick Corporation
Genentech, Gibson, Dunn & Crutcher

LLP
Newell Rubbermaid
The Business Roundtable

CDW Computer Centers, Inc.
Chasm Group
Corn Products International, Inc.
Grubb & Ellis Co.

H & Q Asia Pacific
Halo Branded Solutions
Monsanto Company
Oak Technology, Inc.

Olin Corporation
Paul, Hasting, Janofsky & Walker LLP
PeopleSoft, Inc.
CSX Corporation
Heidrick & Struggles International,

Inc.
Davis & Harman LLP
J.P. Morgan Partners Asia
Potomac Electric Power Company
Deere & Company
KPMG
PricewaterhouseCoopers LLP
Pfizer Inc
DelMonte Foods Company
Real Networks
Diamond Cluster International, Inc.
Richards, Layton & Finger
TIAA-CREF
Tribune Company
United Stationers, Inc.
U.S. Chamber of Commerce
USG Corporation
Weil, Gotshal & Manges, LLP
Wellmark, Inc.
Wink Communications
WKB Advisory Services
Woodhead Industries, Inc.
D.J. Hill & Associates, Inc.
A number of facilitators and subject matter discussants

provided special input at the various sessions including:
William K. Brown Jr., Catherine T. Dixon, John W. Edwards II,
June Eichbaum, Anthony S. Galban, Randolf Hurst Hardock,
R. William Ide III, Cary I. Klafter, Richard Koppes, Jon J. Masters,
Nicholas G. Moore, Ronald Mueller, David Nygren,
John F. Olson, Scott A. Reed, Laraine Rothenberg, Alan
Rudnick, Richard Steinberg, Mark C.Terrell, John T. Thompson,
William Torgerson, and Carol Ward.
We are also grateful to Professor Charles E. Elson for

inviting the following members of the Delaware courts to
give us their perspectives: Vice Chancellor Stephen P. Lamb,
Justice Myron T. Steele, Vice Chancellor Leo E. Strine, and
Justice Joseph T. Walsh.
Finally, we would like to thank Donovan Hervig and
William K. Brown for providing draft materials for this report.
Timothy Dennison editor
Peter Drubin design
Pam Seenaraine production
A New Framework for

The Enron bankruptcy, accompanied
by the WorldCom debacle and other
corporate scandals, has caused a sea
change in the attention given corporate
governance and in how directors are
viewed by the public, shareholders,
employees, and the courts.
Directors need to be sensitive and responsive to this

new level of scrutiny and exposure. To address this
new emphasis on corporate governance, The Conference
Boards Global Corporate Governance Research Center
convened a major Director/Senior Executive Roundtable
Project. Meetings were held throughout the year 2002
in New York; Washington, D.C.; Stanford, California;
Chicago; and Wilmington, Delaware. More than
100 directors and executives took part in sharing their
thoughts on evolving corporate governance best practices in the post-Enron era.
Parallel to these efforts, in June 2002, The Conference
Board convened a Commission on Public Trust and
Private Enterprise (Commission on Public Trust)1 to
address the circumstances which led to the corporate
scandals that were widely reported during 2001-2002
and the subsequent decline of confidence in companies,
their leaders and American capital markets. The
Commissions work articulates a series of principles
and best practice suggestions in three major areas
executive compensation, corporate governance, and
audit and accounting issuesas they relate to publicly
held corporations.2
The 12-member Commissionco-chaired by Peter G. Peterson,

Chairman of The Blackstone Group and Chairman of the Federal
Reserve Bank of New York, and John W. Snow, former Chairman and CEO
of CSX Corporation and former Chairman of The Business Roundtable
included prominent leaders from business, finance, public service, and
academia. Although the Commission was sponsored and supported by
The Conference Board, it enjoyed absolute independence and authority
in its findings and recommendations, and was financially supported by
the Pew Charitable Trusts.
This blueprint best practices report is the result of both

the Roundtable Project and the Commissions work and
is intended to serve as a compendium of leading corporate governance practices boards and management
should consider within the context of each companys
unique circumstances.
Corporate governance is defined in this report as a system of checks and balances between the board, management and investors to produce an efficiently functioning
corporation, ideally geared to produce long-term value.
There are several aspects to this governance system that
should be noted at the outset:
1 Any governance system throughout the world is the

product of a series of legal, regulatory, and best practice elements. Each countrys regulatory and corporate
law system will shape the specifics of its corporate
governance. Corporate governance systems in the
United States have been shaped by sets of pressures
from: the Securities and Exchange Commission (SEC)
with its regulatory oversight, stock exchanges with
their listing requirements; the U.S. Congress enacting
wide sweeping federal legislation; the courts, especially those in Delaware that, with case law, set precedents; and institutional investors engaging in dialogue
with corporations and which use certain proxy voting
tactics such as the filing of shareowner proposals.
The Commission issued its first set of findings and recommendations,

Part 1: Executive Compensation, on September 17, 2002. Part 2:
Corporate Governance and Part 3: Audit and Accounting were released
on January 9, 2003. The full text of the Commissions report and recommendations and a full list of the Commissions members can be found at
www.conference-board.org/knowledge/governCommission.cfm
2 Global corporate governance research at The

Conference Board concludes that corporate governance models do not necessarily vary by country (e.g.
there is no one U.S. model of corporate governance
compared to an Asian model, or a European
model). Governance systems are largely determined
by the ownership structure of the company, regardless
of its geographic location. Thus, wherever the corporation is located, certain best practice elements, such
as the number of independent directors, will vary
depending on key ownership structures such as:
How can corporate governance processes be

used to help keep our company viable and restore
public confidence in the capital markets?
How will instituting corporate governance best

practices reduce corporate risk?
The catastrophic corporate failures of Enron, WorldCom,
and other companies have eroded confidence and shaken
corporate America to the core. The result is that corporate governance is more likely than ever to move from
something done as a result of external pressures to something boards can not afford to dismiss if they want to
properly manage risk, provide internal efficiencies in
running the corporation, and assure growth.
companies with widely held and dispersed

shareholders;
companies which are closely held by blocks

of investors;
companies which are family-owned businesses;
Of course, the landmark enactment of the SarbanesOxley Act and the listing requirement changes proposed
by the major U.S. stock exchanges provide a rigorous
framework for a whole host of federally mandated internal controls and corporate governance reforms3 (see
Appendix 1). This document is intended to go beyond
what is required by law and capture best practices4 for
internal corporate governance reform; in short, it is
intended to be a blueprint for success.
and
newly privatized businesses where the

government retains a residual investment.
3 Whatever the regulatory framework and the companys

overall governance structure, this project suggests there
are a series of best practices which companies can and
should consider to generate long term value for the
corporation. It is fair to say that many boards have
begun to embrace good governance, although the collegial format that is the basis for board interaction still
tends to discourage open disagreement. Change therefore tends to come either if there is an individual director/CEO/senior executive who is a corporate
governance champion or if there is a crisis. Post-Enron,
companies can no longer look upon corporate governance as something thrust upon them from the outside.
In every boardroom around the country, directors are
asking themselves questions such as:
The New York Stock Exchange (NYSE) and NASDAQ have both proposed
changes to their listing standards and are expected to be updated to conform
to final SEC regulation at which point they will be resubmitted to the SEC for
final review, public comment, revision (if required), and final approval.
This document provides an overview of leading practices related to

corporate governance and, although references are made to issued or
proposed changes to regulations and listing standards, is not meant to
provide a comprehensive review of these changes. The impact of the
Sarbanes-Oxley Act and any final and proposed rules of the major U.S.
stock exchanges and the SEC have been closely tracked by many law
firms, accounting firms, consultants and other organizations. (See for
example, KPMG LLP, Sarbanes-Oxley: A Closer Look, January 2003
available at www.kpmg.com/aci for discussion of some of the elements
of the Sarbanes-Oxley Act impacting audit committees and the status of
related issued or proposed SEC regulation.) Audit committees and senior
management should consult with legal counsel and accounting advisors
in the application of the Sarbanes-Oxley Act and any final and proposed
rules of the major U.S. stock exchanges and the SEC.
Is the board managed as effectively as

the company is managed?
What processes do we need to put in place

to make us more aware of red flags in
company operations?
How do we fulfill our monitoring role and yet

rely on management and external experts such
as accountants, attorneys, and consultants?
Corporate Governance Practices

Role of the Board
A strong and effective board should have a clear view of its role
in relationship to management. The boards duty is to focus on guidance
and strategic oversight, while it is managements duty to run the companys business,
with the goal of increasing shareholder value5 for the long term. CEOs and management
need to work with the board to establish the right kind of processes and communications
to ensure that the company is running effectively and in accordance with the boards
basic fiduciary oversight requirements. The ultimate responsibility for directing the company,
however, lies with the board, since most state corporation statutes generally provide that
the business of the company shall be managed under the direction of the board.
The specifics of the boards role will vary with size, stage and strategy of the company,
and talents and personalities of the CEO and the board.
Corporate governance best practices are based on two

basic legal requirements that shape the fiduciary role of
the director:
the duty of care to be informed and exercise

appropriate diligence in making decisions and to
oversee the management of the corporation; and
the duty of loyalty to put the interests of the

corporation before those of the individual director.
10
In defining a system of board practices that leads to

board effectiveness, it is clear that instituting governance
best practices will provide the company with an internal
effectiveness structure and a tool to manage corporate
risk. The key to accomplishing this is to: make certain
that the companys board is managed as well as the company itself is managed. Each board will be run differently according to the companys stage of development,
ownership structure and size, and the mix of skills, and
personalities of the individual directors. The one size
doesnt fit all rule clearly applies. On the other hand,
there are basic legal requirements, as well as management skills that boards can and should adopt no matter
their configuration.
U.S. corporate law dictates that companies be run for the benefit of
shareholders, while European companies have more of a stakeholder
focus. Most U S. observers note, however, that companies can not create
shareholder value without taking stakeholders into consideration. A full
discussion of the shareholder versus stakeholder debate is beyond the
scope of this report.
As defined by the American Law Institute, The Business

Roundtable (BRT), the National Association of Corporate
Directors (NACD), and other relevant bodies, general
board responsibilities should include:
approving a corporate philosophy and mission;

selecting, monitoring, advising, evaluating,
compensating, andif necessary replacing
the CEO and other senior executives and
ensuring orderly and proper management
succession;
reviewing and approving managements

strategic and business plans, including
developing an in-depth knowledge of the
business being served, understanding and
questioning the plans assumptions, and
reaching an independent judgment as to the
probability that the plans can be realized;
reviewing and approving the corporations

financial objectives, plans, and actions,
including significant capital allocations and
expenditures;
reviewing and approving material transactions

not in the ordinary course of business;
monitoring corporate performance against the

strategic business plans, including overseeing
operating results on a regular basis to evaluate
whether the business is being properly managed;
ensuring ethical behavior and compliance with
To ensure maximum board effectiveness, boards need to

shift their entire emphasisthey can no longer be just
advisors who wait for management to come to them.
Their new role requires they provide active oversight of
the companys business to minimize corporate risk and
promote creation of shareholder value. In the wake of
the corporate scandals, the new challenge for boards
will be to go beyond their traditional advisory role and
increasingly focus on their oversight role. As fiduciaries,
boards must be active monitors of management.
Board dynamics need to be right for directors to add
real value to the company. While boards need and
value collegiality, this should not turn into complacency.
Directors need to feel that they can raise objections and
still be seen as team players.
An effective board plays an integral role in the strategic
planning process. Management develops the strategic
plan, while the board reviews and approves it. Directors
require a host of both internally-produced and externally-gathered information (see box) to effectively
review and evaluate strategy. Sufficient board time
should be devoted to discussing the strategic plan
openly and regularly with the CEO and in executive
board sessionsso that all board members understand it
well enough to track its progress in an informed manner.
In addition, the board should spend one retreat session
per year on strategic oversight.
The fundamental strategic questions boards
should ask themselves:
laws and regulations, auditing and accounting

principles, and the corporations own governing
documents;
Is our board managed as well as our
assessing its own effectiveness in fulfilling these
Does our board have the strengths it
and other board responsibilities; and
needs to achieve our strategic goals?
performing such other functions as are

prescribed by law, or assigned to the board in
the corporations governing documents.6
company is managed?
How well does our board track our companys

success in reaching its goals?
National Association of Corporate Directors (NACD), Report of the NACD

Blue Ribbon Commission on Director Professionalism, 2001 Edition, p. 1.
11
Information Boards Need to Fulfill Strategy-Related Responsibilities

Internally produced
From external sources
Alternate strategies options considered by management and with comparative analysis.
Current and evolving customer demand with focus

on future.
Strategic plan clear statement of proposed strategy and

how management plans to implement.
Companys current market position i.e., its major

products and services, as well as its sources of
competitive advantage.
Performance measures targets for key non-financial

and financial measures. In subsequent years, the board
will use these measures to evaluate the strategys success.
Major risk factors internal and external factors that
could prevent the company from achieving the strategy,
including likelihood and magnitude of the risks and
means by which management will address them.
Major interdependencies related strategic initiatives
with suppliers, customers or partners, along with
associated risk information.
Resources and investments required including people,
capital, and capacity and tied to the sources of funding
for any major new investments called for the strategy.
Divestiture of existing businesses required should
be identified and addressed.
Strategic alliances, partnerships, and acquisitions
those needed for successful implementation must be
identified with implementation plans.
Competitor intelligence major current and expected

future competitors and a comparison of relative
strengths, competitive advantages, and strategies.
Industry information and trends including the expected
impact of technology and electronic commerce.
Analysis of potential stakeholder reaction including
shareholders, to the proposed strategy, considering
major stakeholder response to similar past moves.
Information on concerns expressed by market
analysts and the media.
The last two items should include managements plans
to address significant concerns that might arise from
these sources.
Source: PricewaterhouseCoopers, Corporate Governance and the Board

What Works Best?, May 2000, p. 5.
Technology implications dependence on, need for,

and opportunities related to expanded use of technology, with its high level of associated risk. Electronic
commerce issues should be clearly highlighted.
Best, worst, and most likely case scenarios related to
the assessment of risks inherent in the strategy.
Evaluation of past strategies including identification of
successful strategies and an analysis of elements that
were not successful.
12
Corporate Governance Guidelines

The board should have a set of corporate guidelines in place to lay down
the framework for the governance of the company and it should review
the guidelines at least annually. By elaborating on the boards and directors
basic duties, the guidelines help both the board and individual directors understand
their obligations and the general boundaries within which they will operate.
A carefully-constructed set of governance guidelines7 will:
delineate responsibilities of the board,

management, directors, and committees;
address important issue areas such as director

selection criteria, board size limits, meeting
procedures, board access to senior management,
and independence requirements;
incorporate new legal and exchange
Director access to management and, as

necessary and appropriate, independent
advisors
Director compensation Director compensation
requirements;
be regularly refreshed, usually on an annual

basis; and
be made publicly available (Web site, proxy, etc.).

The New York Stock Exchange (NYSE) has proposed
rules which will require companies to adopt and publicly
disclose8 their corporate governance policies. Specifically,
the following subjects must be addressed in the guidelines:
Director qualification standards These standards
should, at a minimum, reflect the proposed

independence requirements.9 Companies may
also address other substantive qualification
requirements, including policies limiting the
number of boards on which a director may sit
and director tenure, retirement, and succession.
See Appendix 2 for a model set of corporate governance guidelines.
In order to promote understanding of a companys policies and procedures and encourage stricter adherence by directors and management,
each listed companys Web site must include its corporate governance
guidelines, the charters of its most important committees (including at
least the audit, compensation, and nominating committees), and the
companys code of business conduct and ethics. Each companys annual
report must state that the guidelines are available on the companys Web
site and that the information is available in print to any shareholder who
requests it.
Director responsibilities These responsibilities

should clearly articulate what is expected from a
director, including basic duties and responsibilities
with respect to attendance at board meetings and
advance review of meeting materials.
guidelines should include general principles for

determining the form and amount of director
compensation (and for reviewing those principles,
as appropriate). The board should be aware that
questions as to directors independence may be
raised when directors fees and emoluments
exceed what is customary. Similar concerns may
be raised when the company makes substantial
charitable contributions to organizations to which
a director is affiliated, or enters into consulting
contracts with (or provides other indirect forms
of compensation to) a director. The board should
critically evaluate each of these matters when
determining the form and amount of director
compensation, and the independence of a director.
Director orientation and continuing education
Management succession Succession planning
should include policies and principles for CEO

selection and performance review, as well as
policies regarding succession in the event of an
emergency or the retirement of the CEO.
Annual performance evaluation of the board
The board should conduct a self-evaluation

at least annually to determine whether it,
its committees, and individual directors
are functioning effectively.
See page 18-19 and Appendix 1 for a summary of the NYSEs independence requirements.
13
Boards Access to Information

The effectiveness of the board ultimately depends on the quality and timeliness
of information directors have at their disposal. Information going to the board should be
on the strategic monitoring level, which will help the board understand the big picture,
and directors should ensure they have a thorough understanding of this information.
Both formal and informal communication and information channels and
cross-linkages need to be developed with the full support of the CEO.
The primary ways in which directors receive information
about the state of the company are through:
responsible and intimately familiar with each major

corporate center, and can obtain a more accurate overall
picture of corporate performance, and, by the same
token, the chief executives performance, independently
from the chief executive. This independent source of
information is imperative for achieving an accurate
assessment of performance and ultimately protecting
shareholder value.11
Formal channels financial and

other management reports, board and
committee meetings, executive sessions,
direct communication with management,
technical means (raw data, intranet, etc.),
factory and facility visits
Although directors receive, and should expect to

receive, the bulk of their information from management,
they need to be able to receive input from other sources,
particularly when there is a lack of information or where
the information is perceived as being overly-filtered.
Directors therefore need to apply common sense and
ask thoughtful and inquisitive questions. Commented
one roundtable participant: The best examples I have
seen are those individuals who just ask the questions
they have the personality and the relationship to ask
things like: what do I not know; what have you not told
me; and what have you told me that is in the small print
that I need to focus on?
Informal channels phone or e-mail discussions
among directors between meetings, conversations

with managers, pre-meeting dinners, etc.
The board needs to establish a solid information framework beginning with a thorough briefing of the annual
plan and an overview of the significant risk/reward elements involved with the plan to actively monitor it continuously during the year. Boards should also set a calendar
around board meetings where certain types of information
such as quarterly results are required by the time the board
meets. This serves to establish a routine whereby if information is late or is missing, members of the board realize it
and a red flag is raised. Management must also adequately
explain new developments to directors, such as key acquisitions, new products, etc. as the year progresses.
Directors should have access to top management other

than the CEO. Protocol needs to be established where a
director informs/asks permission of the CEO to speak
with employees to avoid feeling that the director is going
behind the CEOs back. Noted one roundtable participant:
There is no way a good board can function if board
members dont take responsibility for getting the information that they needand if they cant get it from the CEO,
you had better be able to get it from somebody else in the
company. Conversely, directors need to ensure they are
accessible to management and that they are reviewing key
information provided by management to the board.
To assure independence of thought and unvarnished

perspectives,10 the board must have key information
flowing from senior managers directly to the board, as
well as to the CEO. For example, the heads of the legal,
finance/accounting, human resources, and regulatory
(if applicable) departments, and of any major business
division, should regularly meet with the board (or a
committee of the board). In this manner, the board
receives information from those more directly
10 Many CEOs have historically followed a practice that all communication
of information to the board from senior managers would flow first

through the CEO, who would then relay that information to the board.
This has the potential to obstruct information flow to the board.
14
11
R. William Ide, Post-Enron Corporate Governance Opportunities

Creating a Culture of Greater Board Collaboration and Oversight,
Mercer Law Review, Volume 54, Number 3 (March 2003), p. 838.
Conduct of board meetings Boards should adopt the
Executive sessions Executive sessions of the indepen-
following best practices to ensure effective decisionmaking and exchange of information and ideas at
meetings of the full board and various committees:
dent directors should:
Independent directors should be able to place

issues on the board agenda, with time for
adequate discussion and consideration, and
determine the type and quality of information
flow required for effective board action. Last
minute add-ons to the agenda, especially for
weighty issues, should be discouraged.
Management should provide quality materials to

boards that effectively explain the situation of
the company. Appropriate feedback mechanisms
between management and the board should be
developed to ensure that the materials are
useful, timely, and of appropriate depth.
Meeting materials should contain a cover letter
highlighting the most important issues that
directors should know.
Meetings should be structured to encourage

participation and dialogue among the directors.
Directors have an obligation to ensure nearperfect attendance at meetings and actively

participate in the meetings, including asking the
hard questions.
Management should endeavor to expose

directors to senior management at meetings and
field trips so that directors can, with knowledge
of top management, delve into issues necessary
to carry out their functions.
The NYSE has proposed that the companys

selected mechanisms pertaining to attendance
at meetings and advance review of meeting
materials would be addressed in the companys
governance policy, which must be disclosed in
the proxy.
promote open dialogue among the independent

members and free exchange of ideas,
perspectives and information;
have a feedback mechanism to the CEO for

important issues that may surface;
be scheduled at regular intervals (for example,

before full board meetings) to negate any
negative inferences from the convening of these
sessions; and
be supplemented by additional off-line

informational channels (such as dinners
before board meetings) to help build trust and
relationships among the independent directors.
The NYSEs proposed rules would require the regular
convening of executive sessions of non-management
directors.12 According to the proposals, executive sessions should: (1) be held without management present;
(2) be regularly scheduled to prevent negative inferences
being attached to the calling of these sessions; (3) disclose the presiding directors name in the annual proxy
statement, if one is chosen, or the procedure by which
the presiding director is selected; and (4) disclose mechanisms for interested parties to make their concerns
known to the non-management directors as a group.
NASDAQs proposals would require regularly convened
executive sessions of the independent directors.
Boards access to external advisors The board and board
committees should, as needed, hire external experts such

as counsel, consultants, and other expert professionals,
and investigate any management activities they believe
are required to fulfill the boards duty of care. These
external experts and consultants should have a direct line
of communication and reporting responsibility to the
board and not management.
12 The NYSE defines non-executive directors as those who are not
company officers, and includes such directors who are not independent
by virtue of a material relationship, former status or family membership,
or for any other reason.
15
Boards Mix of Skills and Individual Director Qualifications

The skill set of a board should be linked to the companys strategic vision.
It may, however, vary according to the stage of company growth and should
be reviewed as the company changes.
Though the precise mix of director qualifications will

depend on these factors, at a minimum, directors should:
possess knowledge and expertise to fulfill an

appropriate role within the mix of capabilities
the board and the nominating committee have
decided are appropriate; and
exercise diligence, including attending board

and committee meetings and coming prepared
to provide thoughtful input at the meetings and
during communications in between meetings.
The composition of the board should be tailored to meet
the needs of the company and its stage of development.
However, every board needs to have certain essential
ingredients, with the individual directors possessing
knowledge in core areas such as:
accounting and finance

technology
management
marketing
international markets
industry knowledge
Director selection criteria should be codified in the companys corporate governance guidelines. A skills matrix,
which lists desirable competencies versus those actually
present on the board, is a useful tool in determining
where the holes exist on the board and which skills
complement each other.
Boardroom dynamics are difficult to prescribe, as groups

of people gather together to make informed decisions
about the direction of the company. Although the level
of knowledge, integrity, and independence necessary
to carry out the functions of director are difficult to
summarize, the behavioral characteristics of a good
director should include:
asks the hard questions;

works well with others;
has industry awareness;
provides valuable input;
is available when needed;
is alert and inquisitive;
has business knowledge;
contributes to committee work;
attends meetings;
speaks out appropriately at board meetings;
prepares for meetings;
makes long-range planning contribution; and
provides overall contribution.
The NYSE recommends a listing of director qualification standards be included in the companys corporate
governance guidelines. These standards should, at minimum, reflect the proposed independence requirements.13
Companies may also address other substantive qualification requirements, including policies limiting the number
of boards on which a director may sit, and director
tenure, retirement and succession.
13 See page 18-19 and Appendix 1 for a summary of the NYSEs indepen-
dence requirements.
16
Directors need to devote the proper amount of time and

attention and develop the broad-based and specific knowledge required to fulfilling their obligations. In order to
ensure a high level of commitment, directors should:
carefully assess and guard against potential

entanglements such as service on an excessive
number14 of boards;
prepare for and attend all board and committee

meetings, and consider travel requirements for
these meetings (in particular for foreign-based
directors);
actively participate at meetings;

develop and maintain a high level of knowledge
about the companys business;
keep current in the directors own specific field

of expertise; and
develop broad knowledge about the role and

responsibilities of directors, including legal
responsibilities.
The chairman of the nominating committee should
certify in the proxy that the committee has reviewed
the qualifications of each directorboth standing for
election and on the board generallyand that they fit
into the mix of qualifications the board deems necessary
to achieve diligent oversight.
Every director should receive appropriate training,

including his or her duties as a director when he or she
is first appointed to the board. This should include an
orientation-training program to ensure that incoming
directors are familiar with the companys business
and governance practices. Equally important, directors
should receive ongoing training, particularly on relevant
new laws, regulations, and changing commercial risks,
as needed. Both the NYSE and NASDAQ proposals recognize the importance of initial and ongoing education.
NASDAQ is developing rules for continuing education,
while the NYSE urges companies to establish education
programs for new directors.
In the wake of the many corporate scandals, boards may
have greater difficulty attracting and retaining qualified
directors. Increased scrutiny of boards, a potential for
greater liability, and the due diligence required to ensure
integrity at the management level may make qualified
directors more reluctant to join new boards. This may
be particularly true of active CEOs and lead directors
concerned with serving on too many boards. However,
the opportunity to gain knowledge, add value, and
the prestige of the position will continue to serve as
important motivators.
The Commission on Public Trusts Recommendation

Every board should tailor the mix of directors qualifications
for its particular requirements. Each board should collectively
have knowledge and expertise in business, finance, accounting,
marketing, public policy, manufacturing and operations, government,
technology, and other areas that the board believes are desirable.
Source: Commission on Public Trust, Executive Summary: Findings and Recommendations,

The Conference Board, 2003, p. 9.
14 For example, in general, the National Association of Corporate Directors
(NACD) believes current CEOs and senior executives should hold no

more than one or two additional directorships, other individuals with
full-time positions should hold no more than three or four additional
directorships, and other candidates should hold no more than five to
six additional directorships. See NACD, Report of the NACD Blue Ribbon
Commission on Director Professionalism, 2001 Edition, pp. 14-15.
17
Definitions of Independence in NYSE and NASDAQ
Board Independence
NYSE
An independent, effective, vigorous, and diligent

board of directors is the key to a corporations
corporate governance. Boards must clearly move
from their traditional role as fraternal advisors
(whether perceived or actual) to become active
fiduciaries exercising their oversight responsibilities. To accomplish this, directors must not only
be independent according to evolving legislative
and stock exchange listing standards but also
independent in thought and action qualitatively independent. Such qualitative aspects of
independence will ensure that directors think
and act independently without regard to managements influence.
A critical element of an effective board is its independence from management, in both fact and perception by
the public. In considering independence, it is necessary
to focus not only on whether a directors background
and current activities qualify him or her as independent,
but also whether that director can act independently of
management. Most of the recent high profile corporate
scandals involved boards comprised principally of directors who, by background and activity, qualified as independent. Nonetheless, it is clear that some of these
boards of directors failed to act as a strong independent
check on management leadership.
Qualitative aspects of director independence should
include:
the will and the ability (in terms of knowledge
Under the NYSE proposal, the board of directors must

affirmatively determine, taking into account all of the
relevant facts and circumstances, that a director has
no material relationship with the company (either
directly or indirectly) in order for a director to be considered independent.a The basis for a boards determination
that a relationship is not material is required to be disclosed in the companys annual proxy statement.b The
NYSE proposal, however, also sets forth the following
relationships that would automatically result in a director
not being deemed independent:
No director who is a former employee of the listed

company can be independent until five years after
the employment has ended.
A director who receives, or has an immediate family

member who receives, more than $100,000 a year in
direct compensation from a listed company (other than
director and committee fees, and pension or other
forms of deferred compensation for prior service) is
presumed not to be independent for five years following
the year in which more than $100,000 in annual
compensation was received.c
Practitioners are advising that all relationships, no matter how seemingly

immaterial, should be disclosed to a board of directors in order to allow
for a comprehensive determination as to a directors independence.
The presumption of non-independence is rebuttable a director may be

deemed independent if the board, including all the independent directors, determines that the relationship is not material. Any such determination must be specifically explained in the companys proxy statement.
The board may adopt and disclose categorical standards to assist it in

making determinations of independence and may make a general disclosure if a director meets these standards. Any determination of independence for a director who does not meet these standards must be
specifically explained.
and expertise) to ask the hard questions required

to provide effective oversight and
character and integrity, in general and

especially in dealing with potential conflict
of interest situations.
18
Proposed Listing Rule Amendments

NASDAQ
No director who is an executive officer or employee,

or if the directors immediate family member is an
executive officer, of another company and: (1) that
company accounts for the greater of 2 percent or
$1 million of the listed companys consolidated gross
revenues; or (2) the listed company accounts for the
greater of 2 percent or $1 million of the other
companys gross annual revenues.
No director who is, or in the past five years has been,

affiliated with or employed by a (present or former)
auditor of the company (or of an affiliate) can be
independent until five years after the end of either
the affiliation or the auditing relationship.
Under NASDAQs proposed rules, independent means a

person other than an officer or employee of the company
or its subsidiaries or any other individual having a relationship, which, in the opinion of the companys board
of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities
of a director. In addition, the following persons are not
considered independent:
A director who is employed by the corporation or any

of its affiliates for the current year or any of the past
three years.
A director who accepts, or who has an immediate

family member who accepts, any payments from the
corporation or any of its affiliates in excess of $60,000
during the current or previous three years, other than
compensation for board service, benefits under a
tax-qualified retirement plan, or non-discretionary
compensation.
No director can be independent if he or she is, or in

the past five years has been, part of an interlocking
directorate in which an executive officer of the listed
company serves on the compensation committee of
another company that employs the director.
Directors with immediate family members in the

foregoing categories must likewise be subject to the
five-year cooling-off provisions for purposes of
determining independence.d
A director who is a member of the immediate family

of an individual who is, or has been in any of the past
three years, employed by the corporation or its
affiliates as an executive officer.
Employment of a family member in a non-officer position does not

preclude a board from determining that a director is independent.
A director who is a partner in, or a controlling

shareholder or an executive officer of, any organization,
including charities, to which the corporation made, or
from which the corporation received, payments (other
than those arising solely from investments in the
corporations securities) that exceed 5 percent of
the corporations or organizations consolidated gross
revenues for that year, or $200,000, whichever is more,
in the current year or any of the previous three years.
A director who is employed or was employed in any

of the previous three years as an executive of another
entity where any of the companys executives serve
on that entitys compensation committee.
A director who was a former partner or employee of

the outside auditor who worked on the companys
audit engagement in any of the previous three years.
19
The NYSE and NASDAQ have proposed rules that

will require all listed companies, subject to a single
exception,15 to have a board comprised of a majority of
independent directors. The approaches proposed by the
NYSE and NASDAQ recognize that it is not possible
to predict, or provide for, all situations and relationships
that may compromise a directors independence, and,
therefore, require that the board of directors consider
all factors that may bear upon a directors independence
in connection with the determination of whether or not
a person is independent. The NYSE and NASDAQ also
recognize that certain relationships compromise a
persons independence; therefore, both the NYSE and
NASDAQ provide for a list of relationships that are
incompatible with a finding of independence.
The NYSE and NASDAQ have both proposed practices to
empower non-management directors and to establish procedural requirements that enhance their ability to act free
from management influence. For example, both the NYSE
and NASDAQ propose that boards of directors meet at
regularly convened executive sessions16 without management or employee directors. A major purpose of this
requirement is to establish a procedural norm that facilitates open discussion among non-management directors.
In addition to the NYSE and NASDAQ, many

different organizations such as The Business Roundtable,
the California Public Employees Retirement System
(CalPERS), the National Association of Corporate
Directors (NACD), and the Teachers Insurance and
Annuity Association-College Retirement Equities Fund
(TIAA-CREF) have propounded various criteria of independence. Boards need to ensure they meet the baseline
independence requirements of the exchange listing rules,
but may also want to consider the growing number
of corporate governance ratings systems, such as the
Institutional Shareholder Services (ISS) system,17 that
may penalize the company for a perceived lack of
independence. Appendix 3 compares the independence
proposals of the NYSE and NASDAQ, and the independence guidelines from other key organizations.
The chairman of the nominating committee should certify
in the proxy as to the independence, including qualitative
factors of independence, for each director. In accordance
with the NYSE proposals, boards may adopt and disclose
standards to assist it in determining director independence,
and may make a general disclosure if a director meets
these standards. A determination that a director does
not meet the independence standards must be explained.
The Commission on Public Trusts Recommendations

Directors should display the character, independence, integrity, and will to assert their points
of view. They must demonstrate loyalty exclusively to the corporation and its shareowners.
Every board should be composed of a substantial majority of independent directors.
This goes beyond proposals by the NYSE to have only a majority of independent directors.
Source: Commission on Public Trust, Executive Summary: Findings and Recommendations, The Conference Board, 2003, p. 9.
15 The NYSE and NASDAQ proposals do not require that a controlled com-
pany (i.e. a company in which more than 50 percent of the voting power
is held by an individual, group, or another company) have a majority of
independent directors on its board. In addition, the NYSE does not
require controlled companies to have independent compensation and
nominating/governance committees.
16 Executive sessions of independent directors are discussed in greater
detail on p. 15.
20
17 In June 2002, ISS released its corporate governance rating system, called
the Corporate Governance Quotient (CGQ). ISS analyzes 51 different

metrics in seven general areasboard structure and composition, charter
and bylaw provisions, state laws of incorporation, executive and director
compensation, qualitative factors such as financial performance, stock
ownership of directors and officers, and director educationfor companies in the Russell 3000 Index. Both raw scores and percentile scores
are assigned.
Board Leadership
Boards should consider whether to separate the positions of Chairman
and CEO to help ensure a balance of power and authority and to potentially
enhance the objectivity and functionality of the board. Where the two positions
are combined, boards should consider other corporate governance best practice
approaches such as the creation of a Presiding or Lead Independent Director.
Any approach adopted should seek to achieve the goals of:
1 strengthening the independence and oversight role

of the board;
2 providing appropriate checks and balances

between the board and management; and
3 improving the relationship and flow of information

between the board, CEO, and senior management.
The primary function of the board is to carry out
its responsibilities in the best long-term interests of the
company and its shareowners. Typically, the CEO is a
member of the board, but he or she is also a part of the
management team the board oversees. This dual role can
present a potential for conflict, particularly in cases
where the CEO attempts to dominate the management
of the company and operations of the board. Therefore,
a crucial challenge for companies is striking the appropriate balance between managing the corporation and
providing the independent directors with the necessary
powers and resources to carry out their role.
Proponents of combining the positions of Chairman and
CEO argue that a single CEO and Chairman may be more
effective at leading management and the board of directors, thereby achieving better operation and oversight of
the corporation. The Business Roundtable, for instance,
believes that most American corporations are well
served by a structure with a single CEO and chairman,
since the CEO serves as a bridge between management
and the board, ensuring that both act with a common purpose. According to The Corporate Library, approximately
7585 percent of US corporations currently have a single
individual who serves as CEO and Chairman.
Critics of combining the positions of Chairman and CEO
contend that combination of these positions may lead to
an undue concentration of power in the CEO position;
may erode the ability of independent directors to fulfill

their management oversight responsibilities; and may
create a conflict of interest, since the CEO, who is
responsible for managing the daily operations of the
corporation, is overseen and evaluated by the board of
directors, which is led by the Chairman. Essentially, the
Chairman of the board is allowed to evaluate himself or,
as one Roundtable participant put it, grade his own
homework.
Companies may wish to consider adopting one of the
following principal approaches to improve the functioning of the board and management:
Clearly separating the two roles, with an
independent director as Chairman This
approach clearly delineates the roles and

responsibilities of the Chairman and CEO
and provides the most potential for creating
appropriate checks and balances between the
board and management. In this scenario, the
Chairman would have such responsibilities as
presiding at board meetings, having ultimate
approval over board agendas, and coordinating
CEO and board evaluations.
Appointing a lead or senior independent
director This approach could be employed
where the roles of Chairman and CEO are split

but where the Chairman is not an independent
director. In this scenario, the Lead Director
should not be a member of management or
have any conflicting ties to the CEO. The
Lead Independent Director (or other equivalent
designation) would have such responsibilities
as chairing executive sessions, serving as the
principal liaison between management and the
independent directors, and working closely with
the Chairman to finalize board meeting agendas.
21
Appointing a presiding director This approach

could be employed where the roles of Chairman
and CEO are combined. In this scenario, the
Presiding Director would preside at meetings
of independent directors and have approval of
information flow to the board.
Creating new senior management roles
In this scenario, new positions at the very top

levels of organization, such as President or
Chief Operating Officer (COO) would be
created to divide power and responsibilities
appropriately and improve the flow of
information between the board and
senior management.
In determining the appropriate structure that best fits the

company and its stage of development, boards should
recognize the panoply of structures that exist and that no
one structure has yet proved itself as the model for guaranteeing corporate success. As indicated above, any
approach that is eventually adopted should have clearlydefined roles and achieve the goals of (1) strengthening
the independence and oversight role of the board; (2)
providing appropriate checks and balances between
the board and management; and (3) improving the relationship and flow of information between the board, the
CEO, and senior management. Companies should make
appropriate disclosures for choosing a particular structure and how the structure meets these objectives.

The board should establish a structure that provides an appropriate balance between the powers of
the CEO and those of the independent directors. Three principal approaches are recommended: separating
the offices of Chairman and CEO; having a non-executive Chairman and a Lead Independent Director; or, if
the Chairman and CEO are the same person, establishing a Presiding Director position for leadership of the
independent directors.* Where boards do not adopt any of these approaches, they should disclose how their
board structure provides the appropriate balance.
Each board of directors should adopt processes to ensure that the ability of the independent directors to
be informed, to discuss and debate issues they deem important, and to act objectively on an informed basis
is not compromised. The roles of Chairman, Lead Independent Director, and Presiding Director should be
clearly defined. Where companies have a non-independent Chairman, the Lead Independent Director or the
Presiding Director should have ultimate approval over information flow to the board, meeting agendas, and meeting schedules to ensure that the independent directors have sufficient time for discussion of all agenda items.
* Commissioner Biggs dissented (see page 35 of the Commissions full report). The full text of the Commissions report and recommendations
can be found at www.conference-board.org/knowledge/governCommission.cfm
22
Board Committee Structure and Size

Boards should establish independent board committees that will enhance the overall
effectiveness of the board and promote meaningful discussion on substantive issues.
Directors must realize, however, that the mere presence of committees does not allow
directors to relinquish or delegate their fiduciary responsibilities to the committees.
Having different committees to deal with specific areas
can be useful for boards, particularly if they are large.
Meeting in smaller groups can increase the possibility
of meaningful discussion taking place, particularly on
issues that may get overlooked or pushed to the bottom
of the agenda during the larger board meetings. Getting
the balance right, however, is the key issue as too many
committees can be difficult to administer and may
reduce the input and effectiveness of the full board.
An effective committee structure will possess the following key elements:
Each committee will have a charter to delineate

committee duties and decision-making
responsibilities from those of the full board and
other committees so as to ensure nothing falls
between the cracks.
Each charter will focus on tasks that can

actually be accomplished and should be
refreshed when needed and at least annually.
Committees will be structured to best suit
Under the proposed NYSE requirements, companies

must have the three committees that have long been
part of corporate governance best practice, namely audit,
compensation, and nominating/corporate governance
committees.18 These committees must (1) be composed
entirely of independent directors and (2) have written
charters addressing the committees purpose, general
responsibilities, and how the annual performance evaluation of the committee will be conducted. NASDAQs
proposed rules strengthen independent oversight of nomination and compensation decisions, but do not require
the formation of these committees.
The size of the board demands careful consideration.
Boards need to be large enough to accommodate the
necessary skill sets but still small enough to promote
cohesion, flexibility, and effective participation. Argued
one roundtable participant: When youve got a 20 or
30 person corporate board, its one way of assuring that
nothing is ever going to happen that the CEO doesnt
want to happen. If youve got a small board, eight to
10 people, people do get involved.
underlying responsibilities and should be

revised as needed, both in terms of types of
committees and committee
membership/chairmanships.
Audit, compensation, and nominating/corporate

governance committees will be composed
entirely of independent directors.
Committees will ensure they report regularly

and appropriately to the full board.
18 See page 24-25 for the detailed list of the NYSE recommendations
pertaining to nominating/corporate governance committees, page 26

for recommendations for compensation committees, and page 36 for
recommendations for audit committees.
23
Role of the Nominating/Corporate Governance Committee

Companies should have an entirely independent nominating/corporate governance committee
to enhance the independence and quality of director nominees and the transparency and
integrity of the nomination process. This committee also should take responsibility
for shaping and overseeing all matters of corporate governance for the corporation.
At a minimum, the nominating/corporate governance

committee should:
oversee board organization, including

committee assignments;
determine qualifications for board membership,

including matters such as independence, term
limits, age limits, and ability of former
employees to serve on the board;
identify and evaluate candidates for nomination

to the board;
oversee director orientation and training;

oversee evaluation of the board, of board
committees and of each individual director;
determine an appropriate slate of nominees

for election;
develop and recommend corporate governance

principles for adoption by the full board; and
In accordance with the NYSE proposals, the nominating/

corporate governance committee must have a written
charter19 that addresses:
the committees purposewhich, at minimum,

must be to identify individuals qualified to
become board members and to select, or to
recommend that the board select, the director
nominees for the next annual meeting of
shareholders; and develop and recommend
to the board a set of corporate governance
principles applicable to the corporation;
the committees goals and responsibilities

which must reflect, at a minimum, the boards
criteria for selecting new directors, and
oversight of the evaluation of the board
and management; and
an annual performance evaluation

of the committee.
oversee CEO succession and approve

management succession planning for
senior positions.
19 See Appendix 4 for a sample nominating/corporate governance commit-
tee charter (General Electric Corporation).
24
The NYSE suggests that the nominating/corporate governance committee charter should also address the following
items: committee member qualifications; committee member appointment and removal; committee structure and
operations (including authority to delegate to subcommittees); and committee reporting to the board. NASDAQ
also recognizes the importance of the process of selecting
qualified independent directors in ensuring an effective
board of directors and believes that the process should
be controlled by independent directors. Its corporate
governance proposals require that director nominations be
approved by either an independent nominating committee
or by a majority of the independent directors.20
nominating/corporate governance committee sole authority to retain and terminate any search firm to be used to
identify director candidates, including sole authority to
approve the search firms fees and other retention terms.
Though legislation and stock exchange regulations make
clear the baselines for governance practices, the nominating/governance committee of each board of directors
should determine which additional governance practices
and committee responsibilities are necessary and that will
best suit the corporations business and corporate culture.
Professional outside advice (for example, through an

executive search firm) can professionalize the boards
nominating process and be useful to widen the pool of
potential candidates and affirm director independence.
The NYSEs proposed rules state the nominating/corporate governance committees charter should give the

Every board should establish a nominating/governance
committee composed of independent directors. This committee
should monitor all governance matters for the board, as well as be
responsible for nominating qualified candidates to stand for election.

The Conference Board , 2003, p. 9.
20 A single non-independent director would be permitted to serve on an
independent nominating committee if: (1) the individual is a shareholder

owning more than 20 percent of the issuers securities (even if that person is also an officer of the company); or (2) pursuant to exceptional
and limited circumstances. An exceptional and limited circumstances
exception is available for an individual who is not an officer, current
employee, or a family member of such a person. Additionally, such an
exception may only be implemented following a determination by the
board that the individuals service on the committee is in the best interests of the company and its shareholders. The issuer is also required to
disclose the use of such an exception in the next annual proxy statement, as well as the nature of the individuals relationship to the company and the basis for the boards determination.
25
Role of the Compensation Committee

Companies should have an entirely independent compensation committee that should take
primary responsibility for ensuring that the compensation programs, and values transferred
to management through cash pay, stock, and stock-based awards, are fair and appropriate
to attract, retain, and motivate management, and are reasonable in view of company economics,
and of the relevant practices of other, similar companies. The committee should also recognize
the potential conflict of interest in managements recommending its own compensation levels.
Companies should have an independent compensation
committee, composed solely of directors who are free
of material relationships with the company (except for
compensation received in their role as directors) and its
management and who can act independently of management in carrying out their responsibilities. Under the
proposed NYSE rules, all listed companies would be
required to have a compensation committee composed
entirely of independent directors. NASDAQs proposed
rules do not expressly require companies to have a compensation committee if compensation decisions are made
by a majority of independent directors. If a company
does have a compensation committee, a single, non-independent director may serve on the committee subject to
an exceptional and limited circumstances exception.21
The proposed NYSE rules would require the compensation committee to have a charter addressing its purpose,
which, at a minimum, must be to discharge the boards
responsibilities relating to compensation of the companys executives, and to produce an annual report on
executive compensation for inclusion in the companys
proxy statement, in accordance with applicable rules and
regulations. The compensation committee charter should
also address committee member qualifications, committee member appointment and removal, committee structure and operations (including authority to delegate to
subcommittees), and committee reporting to the board.
The minimum duties for the compensation committee
should include:
reviewing and approving CEO compensation

The compensation committee should vigorously exercise
continuous oversight over all matters of executive compensation policy and all aspects of executive officers
compensation arrangements and perquisites. In addition,
the chair of the compensation committee should take
ownership of the compensation committees activities
and be available at shareholders meetings to respond
directly to questions about executive compensation.
and evaluating and setting CEO compensation

based on meeting performance goals; and
making recommendations to the board with

respect to incentive and equity-based
compensation plans.
21 Available for an individual who is not an officer or current employee or
family member of such a person. The exception may only be implemented

following a determination by the board that the individuals service on the
committee is in the best interests of the company and shareholders. The
company must disclose the use of such an exception in the next annual
proxy statement, including the nature of the individuals relationship to
the company and the basis for the boards determination.
26
The compensation committee should hold executive

sessions as required (for example, to determine CEO
pay and stock option grants), and the committee should
exercise its power to schedule meetings and set its
own agenda.
Compensation policies set by the committee should
include compensation arrangements that link compensation to long-term company performance and strategic
goals. Such incentives should be linked to strategic
performance measurements such as cost of capital,
return on equity, economic value added, compliance
goals, quality improvements, etc., and awards should
be linked to achievement of specific strategic goals.
The compensation committee should exercise independent judgment in determining the proper levels and types
of compensation to be paid unconstrained by industry
median compensation statistics or by the companys own
past compensation practices and levels. The committee
should also be mindful of the differences in compensation levels throughout the corporation in setting senior
executive compensation levels. The proposed NYSE
rules specify that, in determining the long-term incentive
component of CEO compensation, the committee should
consider the companys performance and relative shareholder return, the value of similar incentive awards to
CEOs at comparable companies, and the awards given
to the listed companys CEO in past years.
No compensation arrangement should be permitted that

creates an incentive for top executives to act contrary
to the companys best interests or which could be interpreted as an attempt to circumvent either the requirements or the spirit of the law or accounting rules.
Similarly, the compensation committee should approve
any compensation arrangement for a senior executive
officer involving any subsidiary, special purpose entity
or other affiliate. Because of the significant potential for
conflicts of interest, these compensation arrangements
should be permitted only in very special circumstances.
If the compensation committee retains any outside
consultants who advise it, then the outside consultants
should report solely to the committee. The proposed
NYSE rules state the compensation committee charter
should give that committee sole authority to retain and
terminate the consulting firm, including sole authority
to approve the firms fees and other retention terms.
27
The Commission on Public Trusts Key Recommendations on Executive Compensation

1
The compensation committee should exercise

independent judgment in determining the proper levels
and types of executive compensation to be paid
unconstrained by industry median compensation
statistics or by the companys own past compensation
practices and levels. The committee should also be
mindful of the differences in compensation levels
throughout the corporation in setting senior executive
compensation levels.
compensation should be reported on a uniform and

consistent basis by all public companies in order to
provide clear and understandable comparability.
Fixed-price stock options should be expensed on

financial statements of public companies.b The costs
associated with equity-based compensation should be
reported on a uniform and consistent basis by all public
companies in order to provide clear and understandable
comparability. In addition, the compensation
committee must disclose in conspicuous ways the
effective costs passed on to shareholders through
dilution or share repurchases to limit dilution.
Shareholders should have control over potential
equity dilution resulting from compensation practices.
Existing equity compensation arrangements should
not be materially modified, including the repricing
of options, without shareholder approval.
The compensation committee should retain any outside

consultants who advise it. The outside consultants
should report solely to the committee.
Performance-based compensation tied to specific goals

can be a powerful and effective tool to advance the
business interests of the corporation. The use of
performance-based compensation tools should be
encouraged in a balanced and cost-effective manner.
The compensation committee should establish, with

the concurrence of the board, performance-based
incentives that support and reinforce the corporations
long-term strategic goals set by the board. Examples of
these goals include cost of capital, return on equity,
economic value added, market share, quality goals,
compliance goals, environment goals, revenue and
profit growth, cost containment, cash management,
etc. The award of these incentives should be linked to
achievement of specific strategic goals.
10
Companies should make conspicuous disclosure of

the size, costs, and effects of stock options on both
earnings per share after dilution and the proportion of
future shareholder value that such equity compensation
plans would provide to executives and employees.
A corporations public disclosures should include a
conspicuous statement highlighting both earnings
per share after dilution and the proportion of future
shareholder value that equity-based compensation
plans would provide to executives and employees. Such
disclosure should be in plain English and in plain sight.
The compensation committee should be responsible

for all aspects of executive officers compensation
arrangements and perquisites, including approval of all
employment, retention, and severance agreements.
The compensation committee should approve any
compensation arrangement for a senior executive
officer involving any subsidiary, special purpose entity
or other affiliate, and they should be disclosed in filings
with the SEC.
11
Executive officers should be required to give advance

public notice of their intention to dispose directly or
indirectly (e.g., by hedging or other similar arrangement)
of the corporations equity securities. In this connection,
the compensation committee, with the assistance of
experts as required, should develop and publish
appropriate methods by which disclosure of such
intentions must be made.
28
Compensation policies should encourage a meaningful

financial stake in the corporation through long term
acquire and hold practices by key executives and
directors. This practice provides an additional incentive
to serve the long-term best interests of the
corporation.
Compensation decisions should be based on the
effectiveness of various forms of compensation to
achieve company goals and their respective relative
costs, rather than simply on their accounting
treatment.a The costs associated with equity-based
Source: Commission on Public Trust, Executive Summary: Findings and

Recommendations, The Conference Board , 2003, pp. 6-7.
The Commission on Public Trust recognizes that accounting expertise

and standards-setting authority resides with bodies such as the Financial
Accounting Standards Board (FASB) and the International Accounting
Standards Board (IASB) and urges these bodies to move expeditiously to
determine appropriate accounting treatment for equity-based compensation consistent with the Commission on Public Trusts recommendations.
Commissioners Volcker and Grove dissented (see pp. 13-14 of Report).

The full text of the Commission on Public Trusts report and recommendations can be found at www.conference-board.org/knowledge/
governCommission.cfm
Chief Governance Officer 22

Considering the increased corporate governance-related responsibilities,
greater director liability and heightened investor, stakeholder and public concern
in the wake of Sarbanes-Oxley and the major U.S. stock exchange proposals, a growing
number of companies are considering the appointment of a chief governance officer (CGO).
These companies view the potential benefits of a CGO
position as helping to:
facilitate board processes;

promote communication internally and with
shareholders and stakeholders to identify and
mitigate governance-related risks; and
demonstrate a commitment to corporate

governance (and thereby instill confidence in
shareholders and other stakeholders).
In general, the CGO would assume a portion of the
corporate governance-related functions of the chief
executive, general counsel, corporate secretary, head of
investor relations and other corporate officers, thereby
allowing these officers more time to focus on their core
responsibilities. The CGO would also help to ensure
important governance-related responsibilities of corporate
officers do not fall between the cracks, and would promote accountability since these functions would largely
be centralized in one position. Companies will, however,
need to consider specific responsibilities, reporting lines,
and specific titles to match their own unique situations.
Specific duties of the CGO position might include:
Liaising with external consultants, the

institutional investor community, corporate
governance ratings agencies and others outside
the company on matters concerning corporate
governance, and communicating governancerelated concerns from external parties to senior
management and the board.
Helping to ensure adherence to corporate

governance and ethics policies and key
committee charters.
Facilitating board processes, including agenda

setting and timely distribution, facilitating
communication across committees and from
management, helping the board focus on its
responsibilities, and assisting with board and
director performance evaluations.
Keeping directors and senior management

current on the latest corporate governance
issues and trends and speaking authoritatively
on governance-related issues.
Assisting with recruitment and training of

independent directors and offering continuing
support once on board.
Serving as part of the team that meets with

insurance underwriters in connection with
securing directors and officers (D&O) liability
insurance and related forms of liability coverage,
such as employment practices liability insurance.
Communicating with employees regarding

potential corporate governance-related concerns.
The CGO position should be of sufficiently high stature
and credibility to have direct access to the Chairman,
the CEO, and other corporate officers and board members when needed. Tone at the top is therefore vital in
ensuring the success of the position. The personality
of the individual filling the position is also critical. The
CGO needs to be able to work well with management
and board members, foster a sense of trust among them,
and be able to communicate effectively both internally
and externally.
22 Relatively few companies make a formal designation for chief governance
officer (CGO) because governance authority is generally spread among

offices of legal counsel and corporate secretary. The formal designation
is less important than whether the functions of a chief governance officer
are accomplished. Most important is whether corporate governance rises
to the board level, governance functions are coordinated among departments and are accorded sufficient importance within the company.
29
Measuring Company Performance

The board must devise ways to effectively and continuously monitor the companys progress
against the stated goals. Strategic performance measures that track both financial and non-financial
progress (such as quality improvements, intellectual capital, customer satisfaction, etc.) are critical
to understanding the strategic direction of the company and to monitoring its progress.
The board should have a limited number of dashboard

measures of success to make certain that the company is
on track to meet its goals or to highlight areas that may
require additional attention. These measures should
include both traditional financial (quantitative) and nonfinancial (qualitative) measures (see box) and should be
built into the strategic performance measurement system.
Certain new metrics (and the methods to collect them)
may have to be created, but many companies are already
collecting much of the data they require to track strategic
performance measurements.
Consensus among boards, management and other company personnel as to which measures track the strategic
success of the company is just as important as which
measures are actually chosen. These measures should

be appropriate for the level of oversight responsibility.
For example, a senior executive would be responsible
for broad oversight of a particular area while a line
manager would have responsibility for tracking specific
performance goals within his or her responsibilities.
While it is the board who should oversee managements
development of the measurements the company will use
to evaluate performance, it is the CEO and the executive
management team who have responsibility for driving
the measures and goals down into the organization. The
board should provide input to the policy framework and
then review management implementation regularly.
Financial and Nonfinancial or Strategic Performance Measures

Financial Measures
Nonfinancial or Strategic Measures
Sales
Quality of output
Pretax profits
Customer satisfaction/retention
Rate of return on investment
Employee turnover
Stock price appreciation
Employee training
Earnings per share
Level of intellectual capital
EVA (net cash return on equity capital, measured by

taking a companys after-tax operating profit, deducting
its weighted cost of capital, then multiplying the result
by the companys total capital)
R&D investments
MVA (difference between the total market value

[the amount investors have put into the company] and
show how much wealth has been created [or destroyed]
over the lifetime of the company)
Market growth/success
R&D productivity
New product development
Environmental compliance
Other measures specific to each company
Source: Carolyn Kay Brancato, Institutional Investors and Corporate Governance: Best
Practices for Increasing Corporate Value (Chicago: Business One Irwin, 1998), p.45.
30
Such performance measurements may also be used as

the basis for considering executive and employee performance bonuses or other stock-based incentive plans.
Compensation plans may include performance measures
reflecting not only the companys overall achievements,

but also specific contributions within the executives or
employees scope of influence.
Core Principles Underlying Effective Performance Measurement

Use a reliable measurement
selection process
Link measurements to value

drivers, strategies and tactics
Key drivers of shareholder value

need to be clearly defined and
understood
A small set of measures should

be selected using a structured
approach that builds consensus
Measures should support and

link to the drivers of shareholder
value
Measures should be easy to

understand, linked to strategies
and support current business
processes
Measures should be derived

from and directly linked to
strategies and tactics and
should be amended when
strategies change
Automate measurement
and reporting
Measures and reports should be

automated and should support
drill down and aggregation
capabilities
Data warehousing and data

mining alternatives should be
utilized where appropriate
for reporting measures and
performing detailed cause
and effect analysis
Shareholder value modeling

should be performed to
determine optimal performance
alternatives
Systems should highlight control

limits and exception reporting
where possible
Appropriate measures should

be selected for each level
of the organization
Set and monitor goals

Balance measurements across
scorecard and key processes
Measurement sets should be

balanced across the key
scorecard categories such as
operations, customer, employee,
and finance/shareholder
balanced across the key value
chain processes for the
company
Balance measurement
viewpoint
Measurement sets should

highlight predictive, processoriented measures as well as
results-oriented measures
(leading and lagging)
both internally and externally
focused
Quantifiable goals or targets

should be set for all measurements at least annually
Progress toward achieving

goals should be assessed and
commented on regularly
Measures should be externally

benchmarked wherever possible
Link measurement
to compensation
Measures that support the

key drivers of value and
strategies should be linked
to the compensation system
for a wide range of employees
Compensation programs should

emphasize both unit and overall
company performance
Ensure consistent measurement and reporting
Measures should use consistent

definitions across locations or
groups
Reports should be formatted
using consistent organizational
dimensions (e.g., function,
geography), presentation,
level of detail and time periods
Source: PricewaterhouseCoopers, Corporate

Governance and the Board What Works Best?,
May 2000, p. 32.
31
Board and Director Performance Evaluation

All directors, management, and employees should be evaluated on an annual basis.
In this context, corporations should consider a three-tier director evaluation mechanism
which includes a means to evaluate the performance of the board as a whole,
the performance of each committee, and the performance of each individual director.
Accountability is an important element of board effectiveness. While shareholders elect the directors, they
likely lack sufficient knowledge of the inner workings of
the boardroom to properly perform any or all of the three
tiers of evaluation. Therefore, boards should develop and
disclose their mechanisms and processes to annually
evaluate, the performance of the board as a whole, the
performance of each board committee, and the performance of each individual director.
There is no one size fits all approach to evaluating
the performance of the board, its committees and individual directors. Therefore, the board of each corporation
should determine a process of evaluation that best satisfies its needs. At a minimum, the director performance
evaluation process should ensure that each director meets
the boards qualifications for membership when the director is nominated or re-nominated to the board. Evaluation
of the board and committees should also determine
whether each has fulfilled its basic, required functions.
Especially important is the boards role in the evaluation
of the independence of outside directors.
Under the proposed NYSE rules, boards are required
to conduct a self-evaluation23 at least annually to
determine whether the board and board committees
are functioning effectively. The mechanisms adopted
by the company should be addressed in the companys
corporate governance guidelines, which would be made
publicly available.
Elements of a successful board and director

evaluation process:
1 It will be controlled by the outside directors.

Affirms the boards autonomy to set and apply
its own standards.
Enables acknowledgement of each members

distinctive capabilities.
2 It will be confidential and collegial.

The process itself depends on atmosphere of
candor and trust.
Confidentiality will encourage openness and

cooperation.
3 Someone (in conjunction with Chairman) will

champion the process and share the results, such as:
a Non-CEO chairman;
the lead Independent Director or equivalent; or
the head of the nominating/governance
committee.
23 See Appendix 5 for a sample director self-evaluation worksheet.
32
4 It will identify needed areas of improvement in areas

such as:
the balance of power between the board and

management;
focusing the board more on long-term strategy;

more effectively fulfilling the boards oversight
responsibilities;
the adequacy of committee structures; and
5 Individual director performance will also be evaluated.

It will be done through self-assessment
and peer review.
It will take into account specific board roles.

It will be used to determine suitability
for re-election.
It will include consideration of independence,

level of contribution, and attendance.
whether the evaluation process itself needs

to be updated.

Each board should develop a three-tier director evaluation mechanism. This should include evaluation of
the performance of the board as a whole, the performance of each committee, and the performance of each
individual director, as necessary. At a minimum, director evaluation should ensure that each director meets
the boards qualifications for membership when the director is nominated or renominated to the board.
Source: Commission on Public Trust, Executive Summary: Findings and Recommendations, The Conference Board , 2003, p. 10.
33
Succession Planning and Leadership Development

Hiring the CEO and planning for CEO succession are two primary responsibilities
of the board. The board should institute a CEO succession plan and selection process,
through an independent committee or overseen by a designated director or directors.
A successful succession planning process will:
be a continuous process;
be driven and controlled by the board;
involve CEO input;
be easily executable in the event of a crisis;
consider succession requirements based on
corporate strategy;
be geared toward finding the right leader at the

right time;
As with director candidates, boards may find it increasingly difficult to attract and retain qualified CEOs in the
wake of the many recent, high-profile corporate scandals. Short-term profit pressures continue to shorten the
lifespan of sitting CEOs, and greater public and shareholder scrutiny along with new civil and criminal liability fears may make CEO candidates more reluctant about
joining new companies and thereby diminish the pool of
qualified candidates. These pressures exemplify the need
to have a carefully considered succession planning
process in place and talent pools developed on lower
rungs of the corporate ladder.
develop talent pools at lower levels; and

avoid a horse race mentality that may lead to the
loss of key deputies when the new CEO is chosen.
General Motors Corporate Governance Guidelines: Leadership Development

Formal evaluation of the Chairman
and the Chief Executive Officer
The full Board (independent Directors) should make
this evaluation annually, and it should be communicated
to the Chairman and the Chief Executive Officer by the
Chairman of the Committee on Director Affairs. The evaluation should be based on objective criteria including
performance of the business, accomplishment of longterm strategic objectives, development of management,
etc. The evaluation will be used by the Executive
Compensation Committee in the course of its
deliberations when considering the compensation
of the Chairman and the Chief Executive Officer.
Succession planning
There should be an annual report by the Chief Executive
Officer to the Board on succession planning.
There should also be available, on a continuing basis,
the Chairmans and the Chief Executive Officers recommendation as a successor should he/she be unexpectedly disabled.
Management development
There should be an annual report to the Board by the
Chief Executive Officer on the Companys program for
management development.
This report should be given to the Board at the same
time as the succession planning report noted previously.
34
The NYSEs proposals state that companies should

develop policies for succession planning in the companys corporate governance guidelines. These plans
should include policies and principles for CEO selection
and performance review,24 as well as policies regarding
succession in the event of an emergency or the retirement of the CEO.
The board may wish to seek outside advice and expertise

to assist with the succession planning process and to
benchmark against outside talent and peers. Where a
search committee has been charged with the task, the
entire board, especially the independent directors, should
be involved.
Once a new CEO has been appointed, the whole board
is responsible for helping that individual to assimilate to
their new role. A new CEO needs to be informed of the
boards expectations in terms of performance as well as
communication. Asking questions such as: Which decisions do directors need to know about? What level of
detail will they require?
24 See Appendix 6 for a sample CEO evaluation worksheet.
35
Audit Practices
Audit Committee Role and Responsibilities
The audit committee plays a critical role, standing at the intersection of management,
independent auditors, internal auditors, and the board of directors. In the wake of the
corporate scandals, the new challenge for audit committees will be to fulfill all of the new
duties and responsibilities assigned it under legislation and exchange rules and to shift to
a more proactive oversight role. Audit committees therefore need to ensure accountability
on the part of management, the internal and external auditors, make certain all groups
involved in the financial reporting and internal controls process understand their roles,
gain input from the internal auditors, external auditors and outside experts when needed,
and safeguard the overall objectivity of the financial reporting and internal controls processes.
The Sarbanes-Oxley Act has defined the audit committee
as A committee (or equivalent body) established by and
amongst the board of directors of an issuer for the purpose of overseeing the accounting and financial reporting processes of the issuer; and audits of the financial
statements of the issuer. The Act sets out requirements
for audit committees in the following areas:25
the audit committee is responsible for the

appointment, compensation and oversight of any
registered public accounting firm employed by
the company employed for audit and related
work, including the resolution of any
disagreements between management and the
outside auditors regarding financial reporting;
external auditors must report directly to the

audit committee;
each member must be an independent26 board

member;
the audit committee must establish procedures

for the receipt and treatment of complaints
regarding auditing, internal accounting and
accounting matters, and the confidential
25 Subject to SEC elaboration no later than April 26, 2003.
submission of concerns by employees

(whistle blowers) regarding questionable
accounting or auditing practices;
the audit committee is empowered to engage

independent counsel and other advisors at its
discretion; and
the audit committee can require the company

to provide appropriate funding for the payment
of compensation to the registered public
accounting firm hired to prepare an audit report
and any other advisors employed by the audit
committee.
The NYSE proposals require companies to have a
standing audit committee composed of a minimum of
three directors and increase the responsibilities of the
audit committees, granting it sole authority to hire and
fire independent auditors and pre-approve all non-audit
services it provides. At a minimum, committees must
assist board oversight of the integrity of the financial
statements; compliance with legal and regulatory
requirements; qualifications and independence of the
internal auditor and the performance of both the internal
audit function and independent auditors. Committees are
also charged with preparing the SEC-required Audit
Committee Report to Shareholders that must be included
in the companys proxy.
26 Defined under the Act (for audit committee purposes) as a director
who is neither affiliated with the issuer or subsidiary and who does not
receive compensation (including consulting and advisory fees) from
the issuer other than for board or audit committee service.
36
NASDAQs proposed rules harmonize its listing standards with the Sarbanes-Oxley Act by requiring audit
committees to:
review and approve related party transactions;

and
engage and determine funding for independent

counsel and other advisors and establish
procedures for the receipt, retention and
treatment of complaints received by the
company regarding accounting, internal
accounting controls or auditing matters.
have the sole authority to appoint, determine

funding for and oversee outside auditors;
approve permissible non-audit services by the

auditor in advance;
Summary of KPMGs Basic Principles for Audit Committees

1
Recognize that the dynamics of each company, board,

and audit committee are uniqueone size does not fit
all.
The board must ensure that the audit committee

comprises the right individuals to provide
independent and objective oversight.
The board and audit committee must continually

assert that, and assess whether, the tone at the top
embodies insistence on integrity and accuracy in
financial reporting.
The audit committee must demand and continually
reinforce the direct responsibility of the external
auditor to the board and audit committee as
representatives of shareholders.
Audit committees must implement a process that

supports their understanding and monitoring of:
the specific role of the audit committee in relation

to the specific roles of the other participants in
the financial reporting process (oversight);
critical financial reporting risks;
effectiveness of financial reporting controls;
independence, accountability, and effectiveness

of the external auditor; and
transparency of financial reporting.

Note: The full text of Basic Principles for Audit Committees has been reprinted as
Appendix 7 to this publication.
Source: KPMG Audit Committee Institute, Basic Principles for Audit Committees, 2002.
37
Audit Committee Charter

The audit committee should have a charter in place that sets out guidelines
for the duties of the audit committee versus those of the full board. It should
be reviewed, at least on an annual basis. By elaborating on the basic duties
of the audit committee, the charter serves to help both the full board and
committee members understand their obligations and the general boundaries
in which they will operate and will ensure compliance with new legal
and exchange requirements.
A carefully-constructed audit committee charter will:
delineate responsibilities of the board and those

of the audit committee;
cover important areas such as structure,

process, and membership;
incorporate new legal and exchange

requirements;
assert the committees authority to hire and fire

internal auditors and external advisors to the
audit committee;
be regularly refreshed, usually on an annual

basis; and
be disclosed to shareholders to promote

transparency.27
The NYSE proposals require the audit committee to

have a written charter that addresses the committees
purpose. At a minimum, the audit committee should
assist board oversight of: (1) the integrity of the companys financial statements, (2) the companys compliance with legal and regulatory requirements, (3) the
independent auditors qualifications and independence,
and (4) the performance of the companys internal audit
function and independent auditors. The charter should
also set out the duties and responsibilities of the audit
committee which, at minimum, should be to:
retain and terminate the companys independent

auditors (subject, if applicable, to shareholder
ratification);
at least annually, obtain and review a report

by the independent auditor describing: (1) the
firms internal quality-control procedures;
(2) any material issues raised by the most recent
internal quality-control review, or peer review,
of the firm, or by any inquiry or investigation by
governmental or professional authorities, within
the preceding five years, and any steps taken
to deal with any such issues; and (3) all
relationships between the independent auditor
and the company (to assess the auditors
independence);
27 See Appendix 7 for a sample audit committee charter and duties check-
list (Microsoft Corporation).
38
discuss the annual audited financial statements

and quarterly financial statements with
management and the independent auditor;
discuss earnings press releases, as well as

financial information and earnings guidance
provided to analysts and rating agencies;
as appropriate, obtain advice and assistance

from outside legal, accounting, or other
advisors;
discuss policies with respect to risk assessment

and risk management;
NASDAQs proposals require the audit committee to

have a written charter that outlines the scope of the committees responsibilities (including structure, processes,
and membership requirements), including all required
duties under the Sarbanes-Oxley Act. The charter should
also specify the audit committees responsibility for
ensuring the receipt from the external auditor of a formal,
written statement delineating all relationships between
the auditor and the company and for actively ensuring
the audit committee take action to safeguard the independence of the external auditors. The committee must
assess annually the need for revisions to the charter.
meet separately, with management, with internal

auditors (or other personnel responsible for the
internal audit function) and with independent
auditors on a periodic basis;
review with the independent auditor any audit

problems or difficulties and managements
response;
set clear hiring policies for employees or former

employees of the independent auditors;
report regularly to the board of directors; and

review annually the performance of the audit
committee.
39
Audit Committee Composition and Independence

Given the audit committees place at the intersection of management, independent auditors,
internal auditors, and the board of directors and its responsibility for overseeing the financial
reporting process, boards need to ensure committee members have the requisite independence
and expertise to ensure the objectivity and overall effectiveness of the committee.
As with membership on the full board, independence

from management, in both fact and perception by the
public, is essential. An independent committee greatly
increases the objectivity and therefore the overall effectiveness of the committee. Perhaps the most important
aspects of independence include: (1) having the will and
the ability (in terms of knowledge and expertise) to ask
the hard questions required to provide effective oversight; and (2) having the character and integrity, in general and especially in dealing with potential conflicts of
interest situations.
The Sarbanes-Oxley Act requires30 that every member of

the audit committee must be unaffiliated31 with the company. NASDAQs proposals state that directors cannot
serve on an audit committee if they are deemed an affiliated person of the issuer or any subsidiary. Members are
prohibited from owning more than 20 percent of the
issuers voting securities, or such lower threshold as may
be established by the SEC in its rulemaking. Committee
members are required to meet NASDAQs new independence requirements.32 Also, they should not receive payment other than that for board and committee service.
The NYSE requires each company to have, at a minimum, a three-person audit committee composed entirely
of independent directors. Beyond the NYSEs standard
definition of independence,28 audit committee members
are subject to the requirement, under the Sarbanes-Oxley
Act, that directors fees are the only compensation members can receive from the company. An audit committee
member may receive his or her fee in cash and/or company stock or options or other in-kind consideration
ordinarily available to directors, as well as all of the
regular benefits that other directors receive. Because
of the significantly greater time commitment of audit
committee members, the NYSE proposal states they may
receive compensation greater than that paid to the other
directors (as may other directors for time-consuming
committee work). The NYSE proposal, however,
disallows the following forms of compensation:
True independence, of course, is hard to define. The

definition of independence must assume the ability to
make objective decisions that may be in conflict with
the interests of management. It is up to the board to
decide on the integrity and independence of an audit
committee candidate, so every members appointment
is an occasion for careful deliberation.33
fees paid directly or indirectly for services as a

consultant or a legal or financial advisor,
regardless of the amount; and
compensation paid to such a directors firm for

such consulting or advisory services even if the
director is not the actual service provider.29
29 Under the NYSE proposals, foreign private issuers would be required to
comply with the independence standards for audit committee members

in Section 301 of the Sarbanes-Oxley Act, which requires that the NYSE
mandate compliance with these standards as a condition of listing.
However, foreign private issuers would not be required to comply with
any additional NYSE independence standards and could instead continue
to disclose significant ways in which their home-country corporate governance practices differ from those of domestic listed companies.
30 Effective upon SEC action of implementing rules; can be no later than
270 days after July 30, 2002.

31 Defined under the Act as a director who is neither affiliated with the
issuer or subsidiary and who does not receive compensation (including

consulting and advisory fees) from the issuer other than for board or
audit committee service.
32 See p. 19 for a detailed list of NASDAQs proposed independence
28 See p. 18-19 for a detailed list of the NYSEs proposed independence
requirements.
40
requirements.
33 KPMG LLP, Shaping the Audit Committee Agenda, 1999, p. 34.
Knowledge and skills As with the full board, committee
members should have the requisite skill sets to ensure

they can make a valuable contribution. Ideally, members
will possess core competencies such as a broad business
background, knowledge of the companys operations and
industry knowledge, along with specific skills such as
accounting expertise. Additionally, upon appointment to
the board, committee members should receive an orientation covering such topics as key risks and accounting
policies as well as ongoing development and education.
The SEC, in its final rule implementing the requirements

of the Sarbanes-Oxley Act requires issuers to disclose
whether the audit committee has or does not have at
least one audit committee financial expert34 (and if
not, why not), the name of the audit committee financial
expert, (if applicable) and whether the audit committee
financial expert is independent of management. The rule
also defines the qualifications of the audit committee
financial expert as having all of the following attributes:
An understanding of generally accepted

Commitment Audit committee members should ensure
they can devote the time and energy required for service
on the committee. The NYSE proposals state each
prospective member should examine carefully existing
obligations, and in particular, other committee memberships, before joining an audit committee. The proposals
require boards to determine that a prospective members
other audit committee memberships are not an impediment to committee service if the prospective member
serves simultaneously on the audit committee of more
than three public companies and disclose such determinations in the proxy.
Financial expertise Since the audit committee has over-
sight responsibility for the financial reporting process,

knowledge of financial statements and accounting is
important. For this reason, the major U.S. stock
exchanges have traditionally built in requirements that
members possess financial literacy and more recently,
that one member should possess financial expertise.
Many feel, however, that although financial literacy
is important, the ability and willingness of committee
members to ask the tough questions of management
is of greater importance.
accounting principles and financial statements.
The ability to assess the general application of

such principles in connection with the
accounting for estimates, accruals and reserves.
Experience preparing, auditing, analyzing, or

evaluating financial statements that present a
breadth and level of complexity of accounting
issues that are generally comparable to the
breadth and complexity of issues that can
reasonably be expected to be raised by the
registrants financial statements, or experience
actively supervising one or more persons
engaged in such activities.
An understanding of internal controls and

procedures for financial reporting.
An understanding of audit committee functions.
34 The SEC final rule No. 34-47262 (Final Rule: Certification of Management
Investment Company Shareholder Reports and Designation of Certified

Shareholder Reports as Exchange Act Periodic Reporting Forms;
Disclosure Required by Sections 406 and 407 of the Sarbanes-Oxley Act
of 2002, January 27, 2003) introduced the term audit committee financial expert to make clear that the financial expertise functions are relevant to the audit committee. The SEC notes this term suggests more
pointedly that the designated person has characteristics that are particularly relevant to the functions of the audit committee, such as: a thorough understanding of the audit committees oversight role; expertise in
accounting matters as well as understanding of financial statements; and
the ability to ask the right questions to determine whether the companys
financial statements are complete and accurate.
41
Under the final rules, the person must have acquired such attributes through
any one or more of the following:
1 Education and experience as a principal financial officer, principal accounting officer,

controller, public accountant or auditor or experience in one or more positions that
involve the performance of similar functions;
2 Experience actively supervising a principal financial officer, principal accounting officer,

controller, public accountant, auditor or person performing similar functions;
3 Experience overseeing or assessing the performance of companies or public accountants

with respect to the preparation, auditing or evaluation of financial statements; or
4 Other relevant experience.

Audit Committees should be vigorous in complying with the numerous new requirements imposed by the
Sarbanes-Oxley Act and by the proposed listing standards of the New York Stock Exchange. Boards should
not underestimate these new requirements with respect to Audit Committees and should devote sufficient
resources and time to implement them. Members of the Audit Committee must be independent and have both
knowledge and experience in auditing financial matters. Also, the board should understand the obligations
under the Act that the company must disclose whether or not one or more members of the audit committee
qualify as financial experts within the meaning of regulations promulgated pursuant to the Act and, if not, why not.
There should be an orientation program for each member of the Audit Committee. Members of the Audit
Committee should participate regularly in continuing education programs. Compliance with the Sarbanes-Oxley
Act will require scrutiny and evaluation by top management and the board of issues such as the companys
control environment, business risks, information and communication systems, and monitoring processes.
42
Audit Committee Communication and Reporting

As with the full board, the effectiveness of the audit committee ultimately depends on
the quality and timeliness of information the committee has at its disposal, obtained through
both formal and informal channels. The audit committee chairman should take responsibility
for ensuring management and the board is apprised of audit committee developments.
As with the flow of information to the full board,
the quality and timeliness of information to the audit
committee provided by management plays a large part
in determining the overall effectiveness of the audit
committee. A Spring 2002 KPMG survey found that
19.2 percent of respondents did not believe management
had provided (the audit committee with) the information
to understand the critical accounting policies and judgments and estimates used in financial reporting.35 It is
the responsibility of the audit committee to make the
inquires necessary to ensure they are receiving the information required to effectively provide oversight to the
financial reporting process.
Information the audit committee should obtain through
discussions with management and written reports
includes:
The companys foreign operations, including

locations, and controls over financial reporting.
Insurance coverage for directors and officers,

and other related forms of liability insurance
such as employment practices liability
insurance.
Extent of work performed for governments and

compliance with related contractual terms.
The companys policies and procedures for
reviewing officers expenses and perquisites.36

Although committee members receive, and should
expect to receive, the bulk of their information from
management, they need to be able to receive it from
other sources, both internal and external, including the
internal and external auditors as well as external advisors
when needed.
Managements assessments of the business risks

the company faces, and its planned responses to
those risks.
Controls over treasury activities, including cash

management, hedging, foreign currency
transactions, and use of new or unusual financial
instruments.
The legal environment, including the status of

pending lawsuits or administrative proceedings
and related accruals, if any, and the status of
product and environmental liability and
warranty reserves.
Industry-specific issues, such as regulatory

issues or information about the competitive
environment.
The effect new tax laws and other regulations

may have on the company.
35 KPMGs Audit Committee Quarterly, Fall 2002, p. 28.
Reporting to management and the board The audit

committee chairman plays a key coordinating role
between the audit committee, board and internal and
external auditors. The Chairperson should maintain
close contact with the financial managers and the board
to apprise them of audit committee developments. The
audit committee chairman must also establish a good
working relationship with the chief financial officer
(CFO) to ensure effective information exchange on all
relevant matters. The Chairperson should be in contact
with the external auditors and kept abreast of auditrelated issues and consider the extent and frequency
of communications with the head of internal audit.
In order for the board to be informed of the work and

findings of the audit committee, the committee should
report to the board on a regular basis. The audit committee chairman should also present a report to the full
board at least annually covering the work and findings
36 PricewaterhouseCoopers, Audit Committee Effectiveness What Works
Best?, November 2000, p. 17.
43
of the audit committee during the year. These reports

should include an overview of significant discussions
with management, internal and external auditors, conclusions on the effectiveness of the internal audit function,
and other key items. The committee should also consider
providing the board with meeting minutes to keep the
board apprised throughout the year.
The NYSEs proposals suggest that the audit committee
should review with the full board any issues that arise
with respect to the quality or integrity of the companys
financial statements, the companys compliance with
legal or regulatory requirements, the performance and
independence of the companys independent auditors,
and the performance of the internal audit function.
Access to external advisors Audit committees should
have access, as needed, to external advisors without ties

to the management, including special counsel, consulting
accountants, and other advisors, and access to these
advisors should be codified in the audit committee
charter. These advisors can be useful to delve deeper
into areas of concern to the audit committee, provide
unbiased advice, and increase the overall effectiveness
of the committee. For example, these advisors could
serve as a resource for the committee to evaluate and
report back to the committee on the numerous new tasks
being allocated to it such as the hiring and firing of the
independent auditors, and to provide specialized experience on the complex financial issues the committee must
consider. However, these experts are not a substitute for
the audit committee fulfilling its duties.
Meetings As with meetings of the full board, careful plan-
ning needs to go into the preparation of audit committee

meetings. Meetings should be structured to encourage
maximum participation and dialogue among participants.
In addition to the audit committee members, participants
in these meetings commonly include the CFO or controller, and may include the CEO, other top management,
and internal and external auditors as needed. Best practice
generally calls for committees to meet at least four times
per year, usually coinciding with the reporting cycle. As
for the length of these meetings, the acid test is whether
committee members are satisfied they have thoroughly
addressed all significant agenda items, without feeling
undue pressure to rush discussions.37
Private sessions Audit committee members should meet
periodically with management in private sessions to

discuss sensitive matters such as the reappointment or
dismissal of the external auditors. In addition, the audit
committee should provide for executive sessions of
committee members to promote open dialogue among
committee members and the free exchange of ideas and
should be scheduled at regular intervals. Private sessions
with management, and with the internal and external
auditors are also required in the NYSE proposals. The
committee also needs to build in a feedback mechanism
whereby someoneusually the committee chairman
can communicate any concerns raised to the CEO or
CFO and ensure the concerns are addressed.
The Sarbanes-Oxley Act affirms the audit committees

access to external advisors. The NYSE proposals also
allow audit committees to access outside legal counsel
or other advisors as needed. NASDAQs proposals state
audit committees must have authority to consult with
and retain legal, accounting and other experts in appropriate circumstances.

The Audit Committee should, if necessary, retain professional
advisors to assist it in carrying out its functions. These professional
advisors should have no other ties to the company. Because of
the scope and magnitude of their responsibilities, Audit Committee
members may require additional expertise as well as additional
staff assistance to fulfill their new responsibilities.

The Conference Board, 2003, p. 12.
37 PricewaterhouseCoopers, Audit Committee Effectiveness
What Works Best?, November 2000, p. 54.
44
OversightInternal Audit
Boards should examine company practices relating to the internal audit function
to ensure compliance with relevant legislation and exchange guidelines. Among other
key issues, boards should ensure that: such a function exists within the company;
the audit committee is receiving the requisite information from internal auditors such as
key risks facing the company; the internal audit function is structured to promote operational
independence; appropriate lines of communication exist between the internal auditors,
management and the audit committee; and a forum is provided where internal auditors can
raise concerns without fear of management retribution.
The NYSE proposals would require each company to

have an internal audit function. According to the NYSE,
companies would not need to establish a separate internal audit department or devote full-time employee
resources, only to have appropriate control measures
in place to review and approve internal transactions
and accounting. Companies would also be allowed to
outsource the function to an outside firm. If the function
is outsourced, the company should use a different firm
than the firm used for the external audit.
Communication The audit committee requires information
from the internal auditors to gain an overview of the
strategic, operational, and financial risks facing the
company and the assessment of the controls put in place
by management to manage these risks. The report from
the internal auditors should be prepared periodically and
broadly address the adequacy of internal controls, rather
than being limited to financial controls. The head of internal audit should also, at least annually, present a report on
the state of the companys internal control processes to
senior management and the audit committee.38
Meetings and private sessions The head of internal audit
should have a direct reporting line to the audit committee, including participating at audit committee meetings
and in private sessions. These meetings build trust and
provide a forum for issues to be raised. Meetings should
be held as a matter of course. Discussions with the internal audit director may include issues such as areas of
principal concern to the audit director and performance
of the external auditors. Private meetings play an important role given the internal auditors unique role within
the companyboth employed by management but

also reviewing managements conduct. Private meetings
provide a forum where issues can bubble to the surface and internal auditors can speak candidly about
their concerns. Conversely, audit committee members
need to ask probing questions during these sessions to
ensure all relevant issues are surfaced.
Ensuring independence The internal audit function
should be structured to ensure operational independence

and should have full and direct access to the audit committee and top management. In addition, the internal
audit director should report directly to the audit committee. To promote independence, the Institute of Internal
Auditors (IIA) recommends the audit committee include
certain provisions in its charter pertaining to the internal
audit function:
The audit committee should ensure the internal

audit function is structured in a manner that
achieves organizational independence and
permits full and unrestricted access to top
management.
The audit committee should review the internal

audit functions charter and ensure unrestricted
access by internal auditors to records, personnel,
and physical properties relevant to the
performance of the engagements.
The audit committee should review and approve

the annual internal auditing budget and assess
the appropriateness of the resources allocated to
internal auditing.
38 Internal audit reporting to senior management and the audit committee
is discussed in greater detail on page 43-44.
45
Decisions regarding hiring or termination

of the Chief Audit Executive (CAE) should
require endorsement by the chairman of
the audit committee.
The chairman of the audit committee

should also be appropriately involved in the
performance evaluation and compensation
decisions related to the CAE.
Rotation Audit committees may wish to consider

a rotation policy for both the head of internal audit
and internal audit staff to promote independence. For
instance, the company could institute a policy whereby
internal audit staff are rotated every three or five years.
Staff rotation allows for a new and fresh perspective and
guards against complacencyan important factor since,
at many companies, the positions are used as a steppingstone to senior financial manager positions.
The audit committee should regularly

provide the CAE and the external audit
with the opportunity to confer privately
with the committee, without the presence
of management.39

All companies should have an internal audit function. This should be established regardless of whether it
is an in-house function or one performed by an outside accounting firm that is not the firm that acts as
the companys regular outside auditors. Public companies should revise their internal controls to reflect
a broad risk-based approach and to support the certification process for both financial reports and internal
controls. The internal auditor should have a direct line of communication and reporting responsibility to
the audit committee.
39 Institute of Internal Auditors, Position Paper Presented by The Institute of
Internal Auditors to the U.S. Congress, April 8, 2002, pp. 5-6.
46
OversightExternal Audit
Audit committees should examine their policies with regard to the external audit process
to ensure compliance with relevant legislation and stock exchange guidelines. To ensure
the independence and objectivity of the external audit process, audit committees should
ensure a forum exists in the form of audit committee meetings and private sessions,
and consider the performance of the external auditor and the audit committees
relationship with the external auditor on an annual basis.
The requirements of the Sarbanes-Oxley Act40 make it
clear that the audit committee is directly responsible for
the oversight of any public accounting firm employed by
the company. Specifically, the audit committee is responsible for the appointment, compensation, and oversight
of the work of the external auditor, including the resolution of disagreements between management and the
auditor regarding financial reporting, in the conduct
of issuing an audit report or related work. The external
auditor is also required to report directly to the audit
committee. Additionally, all non-audit services still
permitted by Sarbanes-Oxley41 that are provided by the
external auditor must be pre-approved by the audit committee. Both the NYSE and NASDAQ proposals grant
the audit committee the sole authority to hire and fire the
external auditor and approve fees and terms of the audit
and non-audit services.
Audit process The NYSE proposals explicitly state that
the audit committee should review:
major issues regarding accounting principles

and financial statement presentations;
Under the NYSE proposals, the audit committee should

also review with the external auditor any audit problems
or difficulties encountered during the course of the
auditors work and managements response. Specifically,
the audit committee should regularly review with the
external auditor potential red flag areas (see box on
page 48) such as accounting adjustments noted by the
auditor but approved by management, communications
between the audit team and the audit firms national
office related to audit and accounting issues presented by
the engagement, and reportable deficiencies in the design
or operation of internal controls over financial reporting.
The NYSE proposals specify this review should also
include a discussion of the responsibilities, budget and
staffing of the companys internal audit function.
Audit committee members need to ask detailed
questions related to the external auditors report and
about the audit process. Such areas the audit committee
may wish to cover include:
application of generally accepted accounting

principles;
analyses prepared by management and/or

the internal auditor setting forth significant
reporting issues and judgments made in the
preparation of the financial statements;
the effect of regulatory and accounting

initiatives and off-balance sheet structures
on the financial statements; and
changes to accounting principles and significant

adjustments;
applicability of accounting principles to

competitor companies;
estimates and judgments used in the financial

statements; and
emergence of financial or non-financial
earnings press releases and financial
risk areas.
information/earnings guidance provided

to analysts/rating agencies.
40 Subject to SEC elaboration no later than April 26, 2003.

41 A number of non-audit services were disallowed by Sarbanes Oxley
including: bookkeeping and related services, management and human

resources consulting, and appraisal and valuation services.
47
Financial Reporting Red Flags and Key Risk Factors
Complex business arrangements not well understood

and appearing to serve little practical purpose.
Large last-minute transactions that result in significant

revenues in quarterly or annual reports.
Changes in auditors over accounting or auditing

disagreements (i.e., the new auditors agree with
management and the old auditors do not).
Hesitancy, evasiveness, and/or lack of specifics from

management or auditors regarding questions about the
financial statements.
Frequent instances of differences in views between

management and external auditors.
A pattern of shipping most of the months or quarters

sales in the last week of last day.
Overly optimistic news releases or shareholder

communications, with the CEO acting as an evangelist
to convince investors of future potential growth.
Internal audit operating under scope restrictions,

such as the director not having a direct line of
communication to the audit committee.
Financial results that seem too good to be true

or significantly better than competitors without
substantive differences in operations.
Widely dispersed business locations with decentralized

management and a poor internal reporting system.
Unusual balance sheet changes, or changes in trends

or important financial statement relationshipsfor
example, receivables growing faster than revenues or
accounts payable that keep getting delayed.
Unusual accounting policies, particularly for revenue

recognition and cost deferralsfor example, recognizing
revenues before products have been shipped (bill
and hold) or deferring items that normally are expensed
as incurred.
Accounting methods that appear to favor form over

substance.
Accounting principles/practices at variance with

industry norms.
Numerous and/or recurring unrecorded or waived

adjustments raised in connection with the annual audit.
Apparent inconsistencies between the facts underlying

the financial statements and Managements Discussion
and Analysis of Financial Condition and Results of
Operations (MD&A) and the Presidents letter (e.g., the
MD&A and letter present a rosier picture than the
financial statements warrant).
Insistence by the CEO or CFO that he/she be present

at all meeting between the audit committee and
internal or external auditors.
A consistently close or exact match between reported

results and planned resultsfor example, results that
are always exactly on budget or managers who always
achieve 100 percent of bonus opportunities.
48
Source: Report of the NACD Blue Ribbon Commission on Audit Committees,

Appendix E, 2000.
Evaluation Final SEC rules implementing certain

provisions of the Sarbanes-Oxley Act require the
external auditor to report, prior to the filing of its
audit report with the SEC, to the audit committee:
all critical accounting policies and practices

used by the issuer;
all material alternative accounting treatments of

financial information within GAAP that have
been discussed with management; and
other material written communications between

the accounting firm and management.
The NYSE proposals state the audit committee should
obtain and review a report by the external auditors
assessing, among other areas, internal quality control,
material issues raised by the most recent peer review or
investigations/inquiries made by governmental or professional authorities in the preceding five years (and measures taken to address these issues), along with a review
of all relationships between the company and its external
auditor. This report can serve as a basis for evaluating
the auditors performance, qualifications, and independence. The audit committee should take into account the
opinion of management and internal auditors when making the decision to reappoint the firm.
Independence The audit committee should develop mea-
sures to ensure the objectivity and independence of the

external auditors. Material relationships that may impact
the independence of the external auditors should be considered by the audit committee. Under the SarbanesOxley Act, the external auditors cannot render audit
services to the company if the companys CEO, Chief
Financial Officer (CFO), Chief Accounting Officer
(CAO), or controller was previously employed by the
auditor or participated in the audit of the company in any
capacity during the one year prior to the date of the initiation of the audit. The NYSE proposals require audit
committees to set clear hiring policies for current and
former employees of the external auditor to safeguard
independence and to consider all relationships between
the external auditor and company when deciding
whether the audit firm should be reappointed.
Non-audit services Audit committees should examine

company policies in relation to the provision of nonaudit services by the external auditor. The SarbanesOxley Act makes it unlawful for the external audit firm
to contemporaneously provide both audit and certain
non-audit services. The prohibited non-audit services
are identified in the Act and include bookkeeping and
related services, management and human resources
consulting, and appraisal and valuation services.42 The
Act further stipulates that all non-audit services must be
pre-approved by the audit committee, and any non-audit
services approved must be disclosed to shareholders. The
implementing SEC provisions further define the types of
non-audit services specified in the Act and clarify that an
accountant would not be independent if the audit partner
received compensation based on the partner procuring
engagements with that client for services other than
audit, review, and attest services.
Auditor independence and rotation considerations Audit
committees should evaluate their current public accounting firm at least annually, and perform a more thorough
evaluation and review at least every five to seven years.
The audit committee may wish to consider other public
accounting firms as part of this evaluation and review.
Audit committees should consider changing audit

firms if there is a service issue or circumstances exist
that would call into question the audit firms objectivity.
(See the Commission on Public Trusts recommendation
on auditor rotation.) The primary emphasis in choosing
an audit firm should be the demonstrated experience,
quality and depth of knowledge of all audit personnel to
be assigned to the audit, specific industry expertise, the
scope of work to be performed, and any inspection
reports available about the audit firm.
42 Specifically, the Act stipulates prohibited non-audit services include
the following: bookkeeping or other services related to the accounting

records or financial statements of the audit client; financial information
systems design and implementation; appraisal or valuation services, fairness opinions, or contribution-in-kind reports; actuarial services; internal
audit outsourcing services; management functions or human resources;
broker or dealer, investment advisor, or investment banking services;
legal services and expert services unrelated to the audit; and any other
service that the board determines, impermissible.
49
The Sarbanes-Oxley Act includes measures to ensure

auditor independence by clarifying prohibited services
that can be provided by the external auditor, placing a
time limit before audit firm personnel can be employed
by an audit client in a senior position, and requiring fiveyear rotation of certain of the firms partners who have
participated in the audit. One of the most important
elements of the Act impacting auditor independence is
the requirement for the audit committee to pre-approve
all non-audit services and for the auditor to report
directly to the audit committee.
The NYSE proposals stipulate that, in addition to
assuring the regular rotation of the lead audit partner
as required by law, the audit committee should further
consider whether to set a policy for the rotation of the
external audit firm. The Government Accounting Office
(GAO) will be performing an additional study related to
the rotation of independent auditors as required by the
Sarbanes-Oxley Act.
Meetings and private sessions Similar to the internal
auditor, the external auditors should have direct access

to the audit committee, including participating in audit
committee meetings and private sessions. These meetings build trust and provide a forum for issues of concern to be raised. Meetings should be held as a matter
of course and should include, at a minimum, the engagement partner. Additionally, many believe it is also useful
to include the review partner and other key members
of the audit engagement team to provide additional indepth information. Discussions with the external auditors
may include concerns about management and the internal auditors and other matters the external auditors may
wish to discuss. In turn, audit committee members need
to ask probing questions during these sessions to ensure
all relevant issues are surfaced. Examples of some useful
questions committee members should ask are:
Do you believe your scope is broad enough?

In your opinion, are investors receiving enough
information to understand this company?
Have you had any disputes with management,

and if so, what were they and how were
they resolved?

Audit Committees should consider rotating audit firms when there is a combination of
circumstances that could call into question the audit firms independence from management. The existence
of some or all of the following circumstances particularly merit consideration of rotation: (1) the audit firm
has been employed by the company for a substantial period of time (e.g., over 10 years); (2) one or more
former partners or managers of the audit firm are employed by the company; and (3) significant non-audit
services are provided to the companyeven if they have been approved by the audit committee.
50
Disclosure, Compliance, and Ethics

Disclosure Practices
Boards should examine the companys practices with regard to financial and other
disclosures to ensure the company meets the requirements of the new legislation
and proposed stock exchange listing rules and that it maximizes benefits to
the company that can be gained from instituting a sound disclosure policy.
Besides ensuring compliance under existing or proposed
rules, boards need to take stock of the companys disclosure practices for a variety of reasons:
The Sarbanes-Oxley Act and proposed stock

exchange rules require greater disclosure in
certain areas (and sets out penalties if these
disclosures are not made).
Companies are subject to new criminal penalties

and face greater exposure to civil claims under
the Sarbanes-Oxley Act.
A transparent disclosure approach indicates a

commitment to good corporate governance and
helps to build trust with shareholders and
stakeholders.
Poor disclosure practices can adversely impact

cost of capital and share price.
Companies have ever-growing and more

cost-effective means (Internet, etc.) of
communication with shareholders and
stakeholders.
Responsibilities The board is responsible for the over-
sight of financial reporting and all public disclosures

and typically delegates these responsibilities to the
audit committee. Management has responsibility for
implementation. The audit committee needs to take steps
to ensure the quality, timeliness, and accuracy of all
disclosures and ensure they are complete, fairly represent material information, and comply with all relevant
rules and regulations. Committee members need to feel
comfortable with the information presented to them,
including asking the hard questions when necessary.
Under the NYSE proposals, the audit committee is
charged with preparing the Audit Committee Report
to Shareholders that SEC rules require be included in
the companys annual proxy statement; discussing the
annual audited financial statements and quarterly financial statements with management and the independent
auditor, including the companys disclosures under
Managements Discussion and Analysis of Financial
Condition and Results of Operations (MD&A); and
discussing earnings press releases, as well as financial
information and earnings guidance provided to analysts
and rating agencies.
51
New disclosure requirements New SEC rules add to
the list of items that must be disclosed, tighten filing

deadlines and require public companies to set up and
maintain a disclosure control system to collect, process,
and disclose information. Among the new rules:43
Adds 11 items to the list of events that require a
Requires companies to disclose their Web site

address in the annual report, whether annual,
quarterly, and current reports (and all amendments
to these reports) are made available free of charge
(and if not, why not), and, if not, whether the
company will provide electronic or hard copies
of reports free of charge upon request.
company to file a current report on Form 8-K.
Shortens the filing deadline for Form 8-K to two

business days (formerly five business days or
15 calendar days depending on the event) after an
event triggering the forms disclosure requirement.
Accelerates filing deadlines for annual reports

(10-K) from the current 90 days to 60 days after
fiscal year end,44 and quarterly reports (10-Q)
from the current 45 days to 35 days after fiscal
year end45 over a three year phase-in period.
Stipulates signing officers are responsible for:

(1) establishing and maintaining a system of
disclosure controls, which should cover a
broader range of information covered by
traditional controls over financial reporting;
(2) designing disclosure controls and procedures
to ensure material information is communicated;
(3) evaluating the effectiveness of these
disclosure controls and procedures as of a date
within 90 days prior to the filing date of all
periodic reports; and (4) presenting in the report
their conclusions about the effectiveness of the
disclosure controls and procedures based on the
required evaluation of that date.
The Sarbanes-Oxley Act requires the CEO and the CFO

to certify in each annual or quarterly report filed that:
the signing officer has reviewed the report;

based on the officers knowledge, the report
does not contain any untrue statement of a
material fact or omit to state a material fact
necessary in order to make the statements not
misleading; and
based on such officers knowledge, the financial

statements, and other financial information
included in the report, fairly present in all
material respects the financial condition and
results of operations of the issuer as of, and for,
the reporting period(s).
In addition to greater responsibilities for financial
disclosures, companies face a host of new disclosure
requirements under Sarbanes-Oxley and the major U.S.
stock exchange proposals. As discussed throughout this
report, required or proposed disclosures would include
making available board committee charters and activities, corporate governance and ethics policies, any
waivers of the ethics code, and reports on internal
controls and significant risk factors.
43 Applies to companies that have a public float of at least $75 million,
that have been subject to the Exchange Acts reporting requirements

for at least 12 calendar months and that previously have filed at least
one annual report.
44 The annual report deadline will remain 90 days for year one and change
from 90 days to 75 days for year two and from 75 days to 60 days for
year three and thereafter.
45 The quarterly report deadline will remain 45 days for year one and
change from 45 days to 40 days for year two and from 40 days to
35 days for year three and thereafter.
52
Implementing disclosure practices In light of the new
requirements, and as suggested by the SEC, companies

may wish to establish a separate disclosure committee
with oversight responsibility for the companys entire
disclosure regime. Committee members could include the
general counsel, head of investor relations, the chief risk
officer, and the committee should be chaired by the CFO
or another relevant corporate officer. The committee would
review all public reports, with each committee member
reviewing the portion in his/her expertise area, and the
committee would report directly to the CFO or CEO.
Other processes companies may wish to consider include:
designating a single individual to be responsible

for the operational aspects of disclosure
procedures and who would report to the
disclosure committee;
preparing a detailed disclosure preparation

timetable which reviews on a week-by-week or
month-by-month basis for at least the next year,
critical dates and deadlines in the disclosure
process and addressing specific topics such as
law firm and outside auditor review of filings
and recipients of draft reports;
establishing definitive personnel responsibility

for portions of filings to relevant officers and
business unit heads, where portions of filings
are reviewed and data gathered by the relevant
personnel; and
clarifying the roles of the companys external

counsel and external auditors, including filings
or portions of filings to be reviewed and levels
of involvement beyond traditional areas.46
preparing written guidelines outlining the

companys disclosure processes and procedures
and responsibilities for disclosure;
46 Fried, Frank, Harris, Shriver & Jacobson, Client Memorandum,
September 6, 2002.
53
Internal Controls
As part of its duty of care, the board needs to play an active oversight role
in the area of internal controls by ensuring the company has an effective internal
control framework in place, including the assessment and management of key financial
and non-financial risks and an effective monitoring and oversight process, supported by
timely and accurate information and clear communication channels. The board should
clearly define its role vis--vis senior management, the audit committee, internal and
external auditors, and other parties that may be involved in establishing, maintaining,
or evaluating the internal controls process.
Internal control is a process designed to provide reasonable assurance that an organization is achieving its
objectives by helping to:
protect its assets and shareholders investments;

ensure it is not overly exposed to risks;
improve the reliability of internal and
external reporting;
promote compliance with applicable laws and

regulations; and
improve the effectiveness and efficiency

of operations.
Internal controls can be broadly classified into
three categories:
Financial reporting controls Covers the
preparation of reliable financial statements and

other financial information.
Operational controls Addresses a companys
basic business objectives, including adherence

to performance standards and the safeguarding
of resources.
Compliance controls Covers laws and
regulations to which a company is subject to

avoid damage to a companys reputation or
other negative consequences.47
A sound internal controls framework will be composed

of an effective control environment, an assessment of
key risks, control activities, timely and effective information and communication processes, and an oversight/
monitoring process.
The control environment is the foundation for
the other aspects of the internal control system.
It includes factors such as integrity, ethical
values, and the competence of personnel.
The risk assessment process allows
management to identify and manage risks
relevant to achieving the organizations
objectives.
Control activities are policies and procedures
that help ensure management directives are

carried out properly and in a timely manner.
These include segregation of duties, approval
processes, security of assets and controls over
information systems.
Timely and effective information and
communication processes allow those within
the organization to carry out their respective
responsibilities. This includes preparing reports
of operational, financial, and compliancerelated information as well as day-to-day
communication processes among employees,
supervisors, and senior management.
47 Presentation by Mark Lastner, Vice President, Audit & Control, Marsh &
McLennan Companies, Inc. at The Conference Board Chief Governance

Officer Workshop in Boston, MA, January 27, 2003.
54
An effective monitoring and oversight process

allows senior management and the board to
assess whether controls are functioning as
intended and whether they are modified
when necessary to accommodate changes in
conditions. This can be accomplished through
ongoing monitoring activities, separate
evaluations of internal control such as
self assessments and internal audits,
or a combination of the two.48
Roles and responsibilities for internal controls
Management has primary responsibility for developing

and instituting an effective system of internal control.
Management delegates responsibility to each area of
the companys operations and assigns responsibilities
as appropriate to implement the control system. Most
commonly, the heads of business units and the CFO are
responsible for establishing internal controls, the internal
and external auditors test various components of internal
controls, and the CFO, board/audit committee, and internal and external auditors consider the results of internal
controls testing.
The board (and in particular the audit committee) is
responsible for protecting and enhancing the long-term
value of the corporation as part of its duty of care. The
Delaware Chancery Court in In re Caremark International
Derivative Litigation49 noted that directors have a duty
of oversight and monitoring of the companys activities.
Both senior management and the audit committee should

obtain information from the internal auditors to obtain
their view of the strategic, operational, and financial risks
facing the company and the assessment of the controls
put in place by management to manage these risks.
The report from the internal auditors should be prepared
periodically and broadly address the adequacy of internal
controls, rather than being limited to financial controls.
The head of internal audit should also, at least annually,
present a report on the state of the companys internal
control processes to senior management and the audit
committee. The Institute of Internal Auditors (IIA) states
that, in order to provide comprehensive information and
to ensure multiple viewpoints are considered, the report
on controls should be based on information from a variety of sources including:
independent evaluations of risk and control

systems performed by internal auditors;
reviews of internal controls performed during

the external audit;
management opinions on significant risks and

the sufficiency of controls and associated
reports provided to the board of directors; and
the results of special investigations or other

activities that could have a material impact on
the boards consideration of risk management
and the sufficiency of internal controls.50
During the course of their work, the audit committee
should also obtain information from the external auditors
on the adequacy of the companys internal controls,
including the internal audit function.
48 Presentation by Mark Lastner Vice President, Audit & Control, Marsh &
McLennan Companies, Inc. at The Conference Board Chief Governance

Officer Workshop in Boston, MA, January 27, 2003.
Internal Auditors to the U.S. Congress, April 8, 2002, p. 4.
49 698 A.2d 959 (Del. Ch. 1996).
55
The audit committee has responsibility for insuring any

reported deficiencies in the internal controls are
addressed and that the necessary actions are being taken
to address the deficiencies in a timely fashion. Equally
important, it needs to ensure follow-through by requesting progress reports from management or other means.
The audit committee should also address whether deficiencies identified warrant a more through evaluation of
the system of internal controls.
CEO and CFO certification The Sarbanes-Oxley Act
requires annual reports contain an internal control report

which: (1) states the responsibility of management for
establishing and maintaining an adequate internal control
structure and procedures for financial reporting; and
(2) contains an assessment, as of the end of the most
recent fiscal year, of the effectiveness of the internal
control structure and procedures for financial reporting.
In addition, the CEO and the CFO must certify they
have taken responsibility for:
establishing and maintaining internal controls;

designing such internal controls to ensure that
material information relating to the issuer and
its consolidated subsidiaries is made known to
such officers by others within those entities,
particularly during the period in which the
periodic reports are being prepared;
evaluating the effectiveness of the issuers

internal controls as of a date within 90 days
prior to the report;
presenting in the report their conclusions about

the effectiveness of their internal controls based
on their evaluation as of that date;
disclosing to the issuers auditors and the audit

committee of the board of directors (or equivalent
function): (1) all significant deficiencies in the
design or operation of internal controls which
could adversely affect the issuers ability to record,
process, summarize, and report financial data and
have identified for the issuers auditors any
material weaknesses in internal controls; and (2)
any fraud, whether or not material, that involves
management or other employees who have a
significant role in the issuers internal controls; and
indicating in the report whether or not there

were significant changes in internal controls or
in other factors that could significantly affect
internal controls subsequent to the date of their
evaluation, including any corrective actions with
regard to significant deficiencies and material
weaknesses.
Internal control limitations A sound system of internal
control reduces, but cannot eliminate, the possibility of

poor judgment in decision-making; human error; control
processes being deliberately circumvented by employees
and others; management overriding controls; and the
occurrence of unforeseeable circumstances. A sound
system of internal control therefore provides reasonable,
but not absolute, assurance that a company will not be
hindered in achieving its business objectives, or in the
orderly and legitimate conduct of its business, by circumstances which may reasonably be foreseen. A system
of internal control cannot, however, provide protection
with certainty against a company failing to meet its
business objectives or suffering material errors, losses,
fraud, or breaches of laws or regulations.51
51 The Institute of Chartered Accountants in England and Wales, Internal
Control, Guidance for Directors on the Combined Code, September 1999, p. 7.
56
Risk Assessment and Management

Management and boards should give thoughtful consideration to the benefits of implementing
a robust and effective risk management system which include: greater flexibility, less frequent and
severe sudden shocks, and greater investor confidence. It is managements responsibility to assess and
manage the various risks facing the company while boards must ensure that a system is in place; that
the key risks are identified and transparent; that the system is robust, independent and fully aligned
with the overall strategy; and that the company develops and supports a true risk management culture.
In a McKinsey & Company survey conducted during

April and May of 200252 of over 200 directors serving
on the boards of 500 companies, 43 percent of directors
indicated that the boards on which they serve have either
an ineffective process or no process at all for identifying,
safeguarding against and planning for key risks. As a
result, 36 percent of directors felt that they lacked a
full understanding of the key risks facing the companies
they oversee.
Boards need to fully understand their role and that
of management in the area of risk management.
Management is responsible for assessing and managing
the companys exposure to the various risks facing the
company, and assigns responsibilities to different areas.
(See the box on page 58 and Appendix 9, which provides
a list of questions which the board may wish to consider
when assessing the effectiveness of the companys risk
management and internal controls processes.) The board
is responsible for ensuring that the company has a
process in place to assess and manage risks and to
ensure that both the management and the board receives
timely and accurate information on key risk areas, that
steps are taken to manage these risks, and that the system is re-evaluated on a regular basis.
Typically, the board delegates responsibility for risk
management oversight to the audit committee, although
it may assign it to another committee. The NYSE proposals would require the audit committee to discuss the
guidelines and policies by which the company governs
risk, along with the companys major financial risk
exposures and the steps management has taken to
monitor and control such exposures.
There are four key processes that boards should monitor

in the area of risk assessment and management:
1 The companys overall risk strategy is defined and

clearly articulated.
Management defines the risks that should be

taken, the level of risk and the benchmark
returns required for undertaking these risks.
Management defines how the companys risk

appetite should be communicated, both
internally and externally to ratings agencies,
equity analysts and investors.
Management should continually test whether the

risk strategy is understood and being implemented.
2 The risks faced by the company are identified and

made fully transparent.
Key risk areas such as strategic, operational, and

financial risk areas are identified, along with
specific risks in each major category.
Management develops a dashboard measure,

such as a heat map to help management and the
board assess standard types of risk for each
business unit and the overall firm and to facilitate
board and management discussions about key risks.
3 The risk organization and process is robust, independent, and fully aligned with the companys overall
strategy.
The roles of management, board, audit

committee, internal and external auditors, and
other groups/individuals involved in the risk
management process are defined and understood
by all parties involved in the process.
52 McKinsey & Company Discussion Document, Current Issues In Board
Governance and Risk Management, November 11, 2002, pp. 5-6.
57
The chief risk officer should be of sufficient

stature to ensure effective voice and should
report directly to the CEO or CFO and to the
audit committee or full board.
There should be a separation of duties between

risk policy setting, monitoring and control on one
hand, and business and management on the other.
4 The company instills a true risk management culture

throughout the organization.
The board, CEO, and senior management

are clearly supportive of the process (tone at
the top) and management makes appropriate
investments in risk management professionals
and infrastructure.
Management holds employees accountable for

violations of the companys risk policy.53
The Institute of Internal Auditors (IIA) recommends high

risk areas be targeted for special consideration or reviews,
including areas involving accounting estimates, reserves,
off-balance sheet activities, material open items from
internal and external audit reports and areas rated unsatisfactory, special-purpose entities, major subsidiaries, contingent liabilities and pending litigation, closing/adjusting
entries, and accounting practices differing from standard
industry practices.54 The company may also wish to create
a checklist of potential red flag areas to assist the internal auditors in highlighting, documenting, and reporting
significant potential problem areas.
Risk identification and management is an

ongoing process, with new risks identified as
they emerge and incorporated into the overall
risk framework.
53 Source: McKinsey & Company Discussion Document, Current Issues In
Board Governance and Risk Management, November 11, 2002.

Internal Auditors to the U.S. Congress, April 8, 2002, p. 3.
Responsibilities for Risk Management

Business unit line managers
Directly responsible for identifying, managing, and
reporting critical risk issues upstream.
Chief Risk Officer

Acts as line managers coach, helping them implement a
risk management architecture and work with it ongoing.
As a member of the senior management team, the CRO
monitors the companys entire risk profile, ensuring
major risks identified are reported upstream.
Internal audit
Monitors how well business units manage their risk,
in coordination with the CRO. Increasingly, internal audit
functions are focusing attention on business units risk
management and control activities, bringing their skills
and added value to the business. They also leverage
knowledge of the lines risk management architecture
in targeting audit activity.
Chief Financial Officer

Handles risk management activities traditionally falling
within the CFOs purview, such as treasury and insurance functions. Applies concepts of value-based management and linking risk to value through performance.
58
Some CFOs use models relating shifts in risk factors

such as interest rates or commodity prices to movements in share value. Also, acts on behalf of the chief
executive spearheading implementation of the risk
management architecture. An increasing number of
CFOs play a key operating role, and are well positioned
to drive their companies to competitive advantage
through leading-edge risk management.
Legal counsel
Typically reports to top management and the board on
significant external exposures (from lawsuits, investigations, government inquiries) and internally generated
matters (criminal acts, conflicts of interest, employee
health and safety issues, harassment). These reports
help complete the picture of company risks.
Chief Executive
Brings the power of the CEO office to risk architecture
implementation. The CEO needs to support, and be
perceived as clearly supporting, the necessary focus
on risk management.
Source: PricewaterhouseCoopers, Corporate Governance and the Board

What Works Best?, May 2000, p. 17.
Director and Officer Liability and D&O Liability Insurance

It is essential for every corporation to review the changing climate for potential
liability of directors and officers and resulting effects on the D&O Liability
Insurance underwriting marketplace. Corporations need to identify the areas
of potential riskincluding corporate governance-related risksthat involve potential
personal D&O liability and then to consider how such liability can be minimized.
The consulting firm of Tillinghast-Towers Perrin, in
announcing the results of its 2001 Directors and Officers
Liability Survey, as of June 2002, reported alarming
increases in the costs of litigation against directors and
officers, particularly shareholder litigation, as well as
widespread concerns about high-profile bankruptcies and
the quality of corporate accounting and financial reporting which are among the principal reasons for a dramatic
increase in D&O liability insurance premiums.55 Similar
trends of litigation against corporations and their directors and officers are reported in other recent studies,56
indicating increased frequency and severity of such cases
and resulting settlement amounts.
The Sarbanes-Oxley Act and associated SEC rules have
created additional areas of potential liability for directors
and corporate officers, about which directors and officers
need to be aware. They include the following:
Greater responsibilities for directors and,

especially, audit committee members to play a
more active oversight role, which may increase
their exposure to liability.
CEO and CFO certifications verifying the

accuracy of the companys financial statements
and internal controls, which may be used as
evidence in the event of a legal proceeding.
Tighter disclosure standards, which require

companies to make additional disclosures on a
rapid and current basis potentially creates
additional evidence around which plaintiffs may
build a case. Furthermore, the additional
evidence may assist plaintiffs in surviving a
motion to dismiss (for failing to prove fraud
with adequate specificity).
A more stringent SEC enforcement regime, such

as the requirement under the Sarbanes-Oxley
Act for the SEC to review public company
disclosures at least every three years, which may
lead to a greater number of SEC enforcement
actions. This may in turn result in concurrent
civil actions by private litigants.
An extended statute of limitations period will

result in longer class periods, which in turn may
potentially result in higher damage awards
during the class period. Plaintiffs now have until
the earlier of two years from discovery of a
violation and five years from the act itself to
bring a claim. The previous statute was within
three years of the act, or one year of the
discovery of the act.
55 Tillinghast Towers Perrin Press Release, June 17, 2002.

56 See, for example, PricewaterhouseCoopers LLP 2001 Securities
Litigation Study.
59
In addition to the heightened exposure to liability as a

result of the new legislation, the Delaware courts have
clearly signaled the intent to apply a greater focus on
corporate governance issues and the conduct of independent directors, in particular. These observations are
supported by recent Delaware Supreme Court rulings,
observations made by Chief Justice E. Norman Veasey
and articles written by other Delaware judges. For example, Chief Justice Veasey observed: If directors claim to
be independent by saying, for example, that they base
decisions on some performance measure and dont do so,
or if they are disingenuous or dishonest about it, it seems
to me that the courts in some circumstances could treat
their behavior as a breach of the fiduciary duty of good
faith.57 These developments are important, given the
large percentage of companies incorporated in Delaware
and because other courts take their cue from the
Delaware courts on corporate law matters.
A January 2003 Weil, Gotshal & Manges memorandum
observes that plaintiffs arguing on the grounds that
directors breached their fiduciary duties by not acting
in good faith in the conduct of their oversight responsibilities may ask courts to decide such questions as:
Could directors have had a good faith belief that

they devoted enough board and/or committee
time to oversight in light of the size and scope
of the corporations activities andwith 20-20
hindsightwhat went wrong?
Could directors have had a good faith belief

that an audit committee of a multi-billion dollar
multi-national corporation that meets for an
hour or two quarterly (and possibly with some
members participating by phone) devoted
enough time and attention to oversight?
Could directors have had a good faith belief

that a chief executive officer would have left
the corporation or not performed up to his or her
potential if he or she were offered less money
than the millions or tens of millions of dollars
the compensation committee agreed to pay?
Could directors who have full time jobs and/or

serve on multiple boards (and/or multiple audit
committees) have had a good faith belief that
their multiple obligations provided them enough
time to exercise sufficient oversight over the
affairs of each corporation they serve?58
Impact on the D&O Liability Insurance marketplace
The increased frequency and severity of claims involving the D&O underwriting marketplaceas well as the
regulatory response to recent corporate scandalsis
resulting in:
a contraction of the direct and reinsurance

underwriting market and a reduced availability
or unavailability of coverage, particularly for
companies in high-risk industries such as
technology or telecommunications;
reduced policy limits;

increased deductibles, self-insured retentions,
and other provisions requiring the insured to
assume a participation in the risk;
increased premiums;
revisions of policy terms;
the addition of specific exclusions, such as
exclusions for restatements, and exclusions
arising from bankruptcy or insolvency; and
a general tightening of the application process

whether for new or renewal businesswith
increased underwriting and documentation
requirements, a longer time for the underwriting
review process, and the need for senior
executives and directors of the applicant
company to be involved in the process.
57 See Chief Justice Veaseys full remarks in Whats Wrong With Executive
Compensation? Harvard Business Review, Volume 81, Number 1 (January

2003), pp. 75.
60
58 Weil, Gotshal & Manges LLP Client Memorandum, Director Liability
Warnings from Delaware, January 10, 2003, pp. 2-3.
The new liability climate will also continue to impact

the D&O Liability Insurance marketplace. Companies
may fall under greater pressure to settle lawsuits quickly
rather than face the larger expenseand larger potential
damage awardsof having the case decided, damage
to the companys and executives reputation, and for
the fear of producing additional evidence that could
damage defendants in any parallel proceedings. In
addition, defense costs may increase given the number
of forums in which companies may face litigation and
the number of lawyers required for the defense of both
civil and criminal cases. These factors will continue to
exert upward pressure on premium costs as long as
companies continue to face legal challenges.
Process suggestions The first step in the review process
must be for individual corporations, through their risk

management structure, to identify the areas of risk that
involve potential personal D&O liability and then to
consider how such liability can be minimized. For most
public corporations this second step will include:
confirming that the organization has

implemented whatever limitation of liability
provisions are available under state law, through
charter or by-law;
confirming that the organization has provided

the broadest provisions for mandatory or
permissible indemnification of directors and
officers under state law; and
reviewing the use of directors and officers

liability insurance as a protection for corporate
assets in the event of indemnification payments
and, most importantly, for protection of the
assets of individual directors and officers in
cases where corporate indemnification is not
permissible or otherwise unavailable.
According to the Tillinghast-Towers Perrin surveys and

other studies, D&O Liability Insurance is purchased by a
high percentage of corporations of all sizes, characteristics and industry categories. However, especially in the
current unsettled market conditions, the insurance must
be constantly reviewed and considered as part of an
overall risk management program for the corporation
and its management. Commentaries from the Conference
Board Round-tables also indicate a continued need for
better understanding of this specialized insurance product by its purchasers. A particularly timely and important
area for consideration is the impact recent legislative and
regulatory developments such as the Sarbanes-Oxley Act
and proposed NYSE listing requirements can have on
D&O policy provisions and application requirements, so
review of this area with corporate counsel is critical.
Board and audit committees should also consider having
D&O policies reviewed by independent legal experts
knowledgeable about this type of coverage. Finally, it is
essential to review in advance how the insurance will
operate in the event of a claim to get a feel for the
respective parties that will be involved and for the various types of scenarios that may play out.
Even in these difficult conditions, the state of the market
is such that opportunities do exist for negotiation of coverage proposals with secure underwriting facilities. The
challenge is for applicant corporations to differentiate
themselves according to quality of risk, including implementation of new governance guidelines. Best practices
require that the corporation carefully identify its particular needs for a D&O insurance program, including its
tolerance for assumption of risk, and also the relationship to other areas of corporate coverage. Other specific
areas of consideration should include:
appropriate policy limits;

what individuals and entities should be covered;
whether coverage should extend to the direct
liability of the corporate entity itself;
whether the D&O contract should include

related areas of risk such as Employment
Practices Liability, or whether separate
insurance programs are preferable; and
whether separate and independent limits of

coverage should be provided for the directors
and/or officers.
61
This process should involve coordination of information

and planning among the risk management, financial,
legal, and corporate governance elements of the corporation, and the use of outside resources including insurance
brokerage and underwriting representatives who should
be able to provide information on market conditions and
peer group data relevant to the individual corporation.
One especially important area for boards to consider
is the quality of disclosures made to the insurance underwriters when applying for coverage. As with disclosures
made to the investing public, disclosures made to underwriters should be full, timely, and accurate, since the
provision of inaccurate or misleading information to
the underwriter could result in denial of coverage,
regardless of the intent on the part of directors or
officers. Especially important are financial disclosures,
which are used by the underwriter to evaluate the financial risk profile of the company, and disclosures of other
relevant information that may give rise to a future claim.
Directors and officers should also review their D&O
policies to determine whether the policy includes a
severability clause that will protect them from a denialof-coverage claim based on inaccurate or misleading
information provided by the company. Similarly, directors and officers should review the policies to ensure that
if coverage is denied based on the actions of one director
or certain directors, the insurance will continue to provide coverage for the other innocent directors.
Corporate governance-related process suggestions
Corporate governance questions are increasingly being

entered into the review process. In addition to provision
of the companys financial statements, the application
may include the minutes of board and audit committee
meetings, information about the companys executive
compensation policies, to what extent the company uses
its external auditors to perform non-audit services, and
the like. In general, the more engaged the board, the less
potential liability the company will face and the fewer
difficulties the company will have with its D&O policy.
Chief Justice Veaseys comments in the January 2003
issue of the Harvard Business Review underscore this
point. He remarked: I would urge boards of directors to
demonstrate their independence, hold executive sessions,
and follow governance procedures sincerely and effectively, not only as a guard against the intrusion of the
federal govenment but as a guard against anything that
might happen to them in court from a properly presented
complaint. Furthermore, directors who are supposed to
be independent should have the guts to be a pain the
neck and act independently.59
59 See Chief Justice Veaseys full remarks in Whats Wrong With Executive
Compensation? Harvard Business Review, Volume 81, Number 1 (January

2003), pp. 75-76.
62
Ethics Oversight
As ethical conduct is vital to a corporations sustainability and long-term
success, boards should undertake greater responsibility for overseeing ethical
conduct throughout the corporation, including oversight, development, review
and monitoring of the companys code of business conduct and ethics, ensuring
compliance with the code and establishing appropriate whistleblowing procedures
to encourage employees to report misconduct without fear of reprisal.
Good ethics practices originate at the top and flow down
through an organization. Increasingly, boards have an
affirmative requirement to ensure a strong ethics framework is in place. A growing body of evidence suggests
that ethical conduct, including adherence to applicable
legal and regulatory standards, contributes to corporate
sustainability and to long-term sustainable success in
several ways, including enhancing organizational effectiveness (e.g., through heightened trust and cooperation,
enhanced creativity, and improved efficiency), reducing
the risk of damaging misconduct, and strengthening the
corporations reputation among its core constituencies.60
Code of conduct The board should undertake responsibil-
ity for overseeing the development, review and monitoring of the companys code of business conduct and ethics.
The code of conduct can focus the board and management
on areas of ethical risk, provide guidance to personnel to
help them recognize and deal with ethical issues, provide
mechanisms to report unethical conduct, and help to foster
a culture of honesty and accountability. However, the
board should realize that the code of conduct cannot
replace the thoughtful behavior of an ethical director,
officer or employee. A code of conduct may set the
parameters but directors and management set the tone.
The Sarbanes-Oxley Act and the proposed NYSE and
NASDAQ rules recognize the importance of ethics to a
company. The Act contains provisions requiring companies to disclose whether they have adopted a code of
ethics for senior financial officers (and if not, why not)
and whether there have been any waivers of the code of
60 See Lynn Sharp Paine, Value Shift: Why Companies Must Merge Social and
Financial Imperatives to Achieve Superior Performance, (New York:

McGraw-Hill Trade, 2002), Chapter 5.
ethics for such officers. In addition, the NYSE and

NASDAQ proposals would require listed companies to
adopt and disclose a code of conduct. The NYSE and
NASDAQ proposals also set forth minimum requirements61 that must be included in such code and require
prompt approval62 and disclosure of any waivers to such
code for directors and executive officers.
Besides developing a code of conduct, the board and the
CEO have the responsibility to ensure that all employees
understand and abide by the corporations ethical principles and rules of conduct. These goals should be reinforced as an important and explicit part of each
directors and each employees annual review.
Code implementation and compliance monitoring As
with the development of the code of conduct, the board

should become involved in the development of the companys policies and practices for implementing ethical
behaviors and for determining that appropriate behaviors
are understood and followed. Tone at the top is critical
to appropriate behavior throughout the corporation, and,
therefore, ethical standards should be among the core
qualifications for CEO and other senior management.
61 The NYSE proposals state companies should, at a minimum, address
the following topics in the code charter: conflicts of interest; corporate

opportunities; confidentiality; fair dealing; protection and proper use of
company assets; compliance with laws, rules and regulations (including
insider trading laws); and encouraging reporting of illegal/unethical
behavior. Under the NASDAQ proposals, codes must address, at a minimum, conflicts of interest and compliance with applicable laws, rules and
regulations, with an appropriate compliance mechanism and disclosure
of waivers to directors and officers.
62 The NYSE would require waivers of the code for executive officers
or directors be made only by the board or a board committee, while

NASDAQ would require waivers be granted by independent directors.
63
Among the practices which boards should consider for

establishing an ethical corporate culture are:
Continued and repeated emphasis by the board

and the CEO of the importance of ethical
conduct to the corporation and its business.
Ensuring that employees throughout the

corporation at all levels understand the code of
ethics and its application to the workplace.
Establishing processes that make it safe and

easy for employees to report possible violations
of the companys code of conduct.
Development of a culture in which it is socially

acceptable to report ethical lapses.
Prompt investigation of complaints and

allegations of violations of the code of conduct.
Disciplining violations of the code of conduct

promptly.
Including ethical conduct as a criterion in an

employees annual performance review.
Boards may wish to employ the following tools to assist
the company in the systematic implementation of ethical
conduct:
develop and utilize metrics designed to measure

employees understanding of, and compliance
with, the corporations ethical requirements;
consider establishment of an ethics officer or

ombudsman position;
designate a board committee with

responsibilities for overseeing ethics issues; and
disclose the practices and procedures that the

company has adopted to promote ethical behavior.
Like any other required business activity, companies

should have ethics-related measurements to determine
whether ethics initiatives and activities have succeeded
or need improvement. These measurements should be
designed to measure employees understanding of, and
compliance with, the companys ethics code. For example, one common measurement is employee usage of
company hotlines/helplines. However, because of the
variety of businesses, working situations, geographic
differences, and, often, global business activity, each
organization must develop its own measures of success
in implementing ethics programs designed for its own
business and circumstances. To help build and maintain
the corporations credibility with investors, insurers, and
creditors and help emphasize to officers and employees
the importance of ethical conduct, the company should
consider making the measurements used publicly available. The board must then ensure these kinds of disclosures do not turn into safe, boilerplate statements
whose value is then diluted.
Whistleblowing procedures The recent scandals
demonstrate the importance of encouraging employees

to report misconduct as soon as they become aware of it
without fear of reprisal. However, it is clear that some
employees are currently afraid to report misconduct
many are fired after reporting unlawful conduct or
may face on-the-job harassment or unfair discipline.
Companies must therefore design a system tailored
to the companys particular situation, which allows
employees to report suspected wrongdoing without fear
of reprisal. Such a system may involve the following
reporting mechanisms:
an internal reporting channel as well as an

external channel through an outside consultant
accountable directly to the board or a
subcommittee of the board;
anonymous helplines/hotlines;
an ethics ombudsmen;
corporate ethics offices;
a procedure for anonymous email submissions;
reporting channels for misconduct, including
channels to the board of directors; and/or
a designated outside director for ethics concerns.
64
The Sarbanes-Oxley Act and NASDAQ proposals

require the audit committee to establish procedures
for the receipt, retention and treatment of complaints
received by the issuer regarding accounting, internal
accounting controls or auditing matters and confidential,
anonymous submission by employees of the issuer of
concerns regarding questionable accounting or auditing
matters. The NYSE proposals specify companies should
encourage employees to talk to supervisors, managers or
other appropriate personnel when in doubt about the best
course of action in a particular situation. Additionally,
employees should report violations of laws, rules, regulations or the code of business conduct to appropriate
personnel. To encourage employee reporting and participation, the company must ensure that employees know
that the company will not allow retaliation for reports
made in good faith.
Hiring special investigative counsel The recent spate of
corporate scandals has raised the question of whether a

companys regular outside counsel is capable of conducting a truly independent investigation of the clients business dealings. This dilemma is particularly acute when
regular outside counsel is called upon to investigate matters related to, or stemming from, substantive work those
attorneys have performed for the company. Typically,
lawyers and law firms with the assistance of other specialists are in the best position to conduct investigations,
and care must be taken that these investigations are
conducted thoroughly, vigorously, and objectively. It is
important, therefore, that investigative counsel be chosen
by and report directly to the board. To assure that special
counsels interests are not aligned with, or influenced by,
management, special counsel should not be one of the
corporations regular outside counsel or a firm that
receives a material amount of revenue from the company. If a significant investigation is needed , the board
may wish to designate a committee composed solely of
independent directors to select and retain outside counsel
to better ensure the necessary investigation will be conducted vigorously and objectively.

Boards should be responsible for overseeing corporate ethics. A major challenge to corporations
and their leaders is to create a tone at the top and a corporate culture that promotes ethical conduct
on the part of the organization and its employees. The single most important factor in creating such a
culture is the quality of corporate leadership, especially the tone at the top set by boards, CEOs, and
senior management. Leaders must also put in place appropriate management systems and processes
to achieve and regularly monitor these results. Ethical conduct should be encouraged and reinforced by
including it as an important and explicit part of each employees annual review. Corporations should work
to support responsible behavior and build environments in which employees are encouraged and feel safe
to take the initiative to address misconduct rather than waiting until after the damage is done. Prevention
is the best cure for malfeasance.
If an independent investigation is reasonably likely to implicate company executives, the board
and not management should retain special counsel for this investigation. Investigative counsel should
be chosen by, and report directly to, the board and should not be one of the corporations regular
outside counsel or a firm that receives a material amount of revenue from the company.
65
66
Defined for audit committee purposes

(see below).
Not addressed.
Not addressed.
Definition of
Independence
Independent
Majority
Cooling-Off
Period
in the
receives, direct payments from the

company in excess of $100,000.3
receives, or immediate family member
foregoing categories;2 and
immediate family
members1
auditor of company.
former partners or employees of outside
relationships; and
interlocking compensation committee
as executive officers (company or affiliate);
family members who have been employed
relationships;
interlocking compensation committee
receipt of payments in excess of $60,000
former affiliates or employees of
by director or family member other than

for board service;
former employees (company or affiliate);
former employees;
(present or former) auditors of the
company (or of an affiliate);
3 years for:
A majority of the board must be independent. Controlled companies are exempt.
Definition applied consistently throughout

proposals.
NASDAQ Proposals
5 years for:
A majority of the board must be independent. Controlled companies (more than

50 percent of the voting power held by
an individual, group, or another company)
are exempt.
Definition applied consistently throughout

the proposals, save for the additional restriction on compensation for audit committee
members (see below).
NYSE Proposals
Not addressed.
A substantial majority of directors should

be independent, in both fact and appearance, as determined by the board.
Listing standards of major securities markets relating to audit committees provide

useful guidance in determining whether a
director is independent.
Business Roundtable Principles
The presumption of non-independence is rebuttable a director may be deemed independent if the board, including all the independent directors, determines that the relationship is not material.
Any such determination must be specifically explained in the companys proxy statement.
Employment of a family member in a non-officer position does not preclude a board from determining that a director is independent.
An immediate family member includes a persons spouse, parents, children, siblings, mothers and fathers-in-law, sons and daughters-in-law, brothers and sisters-in-law, and anyone (other than employees) who shares such persons home.
Sarbanes-Oxley
Issue
Board Independence
Legislation and Proposed Exchange Standards Comparison Chart
Appendix 1
67
Not addressed.
Stock
Ownership
Not addressed.
Not addressed.
Material
Relationships
Executive
Sessions
Sarbanes-Oxley
Issue
ties to make their concerns known to the

presiding director or non-management
directors as a group.
disclose mechanisms for interested par-
in the annual proxy statement, if one is

chosen, or the procedure by which the
presiding director is selected; and
disclose the presiding directors name
be regularly scheduled;
be held without management present;
Regular convening of non-management

directors required. Sessions should:
Stock ownership not a bar

to independence finding.
A director cannot be considered independent if the director is an executive officer or

employee or if the directors immediate family member is an executive officer, of
another company and: (1) that company
accounts for the greater of 2% or $1 million
of the listed companys consolidated gross
revenues or (2) the listed company accounts
for the greater of 2% or $1 million of the
other companys gross annual revenues
NYSE Proposals
Regular convening of independent directors

required. Controlled companies exempted.
Limit placed on stock ownership

by audit committee members
(see below).
A director cannot be considered independent if the company makes payments to an

entity where the director
is an executive director and payments
exceed the greater of $200,000 or
5% of the companys gross revenues.
NASDAQ Proposals
Independent directors should have the

opportunity to meet outside the presence
of the CEO and other management
directors.
A meaningful portion of directors compensation should be in the form of longterm equity. Corporations may wish to
consider establishing a requirement for
directors to acquire and hold stock in an
amount that is meaningful and appropriate for each director for as long as the
director remains on the board.
Independent director relationships with

nonaffiliated not-for-profits and their effect
on independence should be assessed by
the board or corporate governance committee on a case-by-case basis, taking into
account the corporations contributions to
the organization and nature of the independent directors relationship.
Independent directors should be free of any

relationship with the corporation or its management that may impair, or appear to impair,
the directors ability to make independent
judgments.
68
Audit committees mandated (see below).
Not addressed.
Establishment
of Committees
Independence
All committee members must
be independent.
Companies must have independent

nominating/governance and compensation
committees (in addition to audit committeessee below) or independent committees that serve these functions. Controlled
companies are exempt.
NYSE Proposals
A single non-independent director may

serve on the compensation committee
(if applicable), for two years, subject to
the same exceptional circumstances
exception.
A single non-independent director may

serve on the nominating/corporate governance committee (if applicable) if (1) the
individual is an officer owning/controlling
more than 20% of the voting securities or
(2) pursuant to an exceptional and limited
circumstances exception.4
Audit committees mandated (see below).

Nominating/corporate governance and
compensation committees not required if
nominating/compensation decisions made
by majority of independent directors.
Controlled companies are exempt.
NASDAQ Proposals
Committees addressing nominating/

corporate governance and compensation
issues should be comprised solely of
independent directors.
All public companies should have committees addressing nominating/corporate

governance and compensation issues.
Available for an individual who is not an officer or current employee or family member of such a person. The exception may only be implemented following a determination by the board that the individuals service on the committee is in the best
interests of the company and shareholders. The company must disclose the use of such an exception in the next annual proxy statement, including the nature of the individuals relationship to the company and basis for the boards determination.
Sarbanes-Oxley
Issue
Nominating and Compensation Committees
69
Sarbanes-Oxley
Not addressed.
Issue
Charter/Duties
with respect to incentive and equitybased compensation plans.
making recommendations to the board
tion and evaluating and setting CEO compensation based on meeting performance
goals; and
reviewing and approving CEO compensa-
compensation for inclusion in the companys annual report;
producing an annual report on executive
relating to executive compensation;
discharging the boards responsibilities
The minimum duties for the compensation

committee should include:
board a set of corporate governance principles.
developing and recommending to the
overseeing the evaluation of the board; and
director nominees for the next annual

meeting;
selecting, or recommending for selection,
become board members;
identifying individuals qualified to
corporate governance committee should

include:
The minimum duties of the nominating/
Both the nominating/corporate governance

committee and compensation committees
must have a written charter that spells out
the committees purpose, goals and responsibilities, and annual evaluation.
NYSE Proposals
Not addressed.
NASDAQ Proposals
tion for management and the board.
encouraging a diverse mix of compensa-
overall compensation structure to ensure

appropriate incentivization for employees
at all levels; and
taking a broad look at the companys
pensation programs and setting CEO and

senior management compensation;
overseeing the corporations overall com-
The responsibilities of the compensation

committee include:
and management (separate committee

comprised of independent directors may
also be formed for this purpose).
overseeing the evaluation of the board
corporate governance principles; and
developing and recommending a set of
providing information to the board;
overseeing and reviewing processes for
pendence;
monitoring and safeguarding board inde-
to board committees;
recommending directors for appointment
recommending nominees to the board;
The responsibilities of the nominating/

corporate governance committee include:
Committees should have charters or there

should be a board resolution establishing
the committees.
70
Prohibits listing of companies that do not

have an audit committee.
All members of the audit committee must

be independent, defined by the Act as not
receiving fees from the company other than
for board service and being otherwise affiliated with the company and subsidiaries.
External audit firm cannot provide audit

services to the company if the companys
CEO, CFO, or CAO (Chief Accounting
Officer) or controller was previously
employed by the auditor or participated in
the audit of the company in any capacity
during the one year prior to the date of the
initiation of the audit.
Establishment
of Committee
Independence
Employment
Prohibitions
SEC Rulemaking: Jan. 29, 2003

SEC final rule implements this provision
in full.
Sarbanes-Oxley
Issue
Audit committees must set clear hiring policies for current and former employees of
the external auditor to safeguard independence and to consider all relationships
between the external auditor and the company when deciding whether the audit firm
should be reappointed.
firm for such consulting or advisory services even if the director is not the actual
service provider.
compensation paid to such a directors
as a consultant or a legal or financial advisor and
fees paid directly or indirectly for services
Disallowed forms of compensation include:
Audit committee members cannot receive

compensation other than for board service.
No new requirements.
NYSE Proposals
Not addressed.
Audit committee members may not control

more than 20% of the companys voting
securities, or such lower number as may be
established by the SEC.
Limits time non-independent directors can

serve on the committee pursuant to the
exceptional and limited circumstances
exception to two years and prohibits these
persons form serving as chairman.
Audit committee members should not

receive payment other than for board
service.
Small Business issuers no longer exempt

from audit committee requirements.
NASDAQ Proposals
Audit and Audit Committees
Audit committees should consider whether

to adopt policies on the hiring of auditor
personnel such as cooling off periods.
Any policy should be flexible enough to
allow for exceptions (only if approved by
the audit committee).
Audit committees should be comprised

solely of independent directors.
All public companies should have an audit

committee.
71
Companies required to disclose whether

the audit committee has at least one financial expert and, if not, the reasons for the
absence. The SEC rule must consider
whether the person has, as the result of
education and prior experience as a public
accountant or auditor, principal financial or
accounting officer of an issuer, comptroller
of an issuer, or analogous position:
Financial
Literacy/
Expertise
mittee financial expert.
define the qualifications of the audit com-
committee financial expert is independent

of management; and
require disclosure of whether the audit
audit committee financial expert(s), if

applicable;
require disclosure of the name(s) of the
audit committee has or does not have at

least one audit committee financial expert
(and if not, why not);
require issuers to disclose whether the

SEC final rule introduces term audit committee financial expert to clarify the expertise functions are relevant to the audit
committee. In addition, the rules:
functions.
knowledge of audit committees and their
trols; and
experience with internal accounting con-
principles for estimates, accruals and

reserves;
experience in the application of GAAP
financial statements of comparable companies;
experience preparing or auditing the
accounting principles (GAAP);
an understanding of generally accepted
Sarbanes-Oxley
Issue
Not addressed.
NYSE Proposals
Requires that all audit committee members

be able to read and understand financial
statements at the time of their appointment
rather than within a reasonable period of
time thereafter.
Companies required to consider whether a

person has, through education and experience as a public accountant or auditor or a
principal financial officer, comptroller, or
principal accounting officer of an issuer or
from a position involving the performance
of similar functions, sufficient financial
expertise in the accounting and auditing
areas specified in the Sarbanes-Oxley Act.
NASDAQ Proposals
Of greater importance than financial expertise is the ability of committee members to

understand the corporations business and
risk profile and apply their business experience and judgment to the issues for which
the committee is responsible with an independent and critical eye.
Audit committee members should meet

minimum financial literacy standards, and
at least one member should have accounting or financial management expertise, as
required by exchange listing standards.
72
Not addressed.
Not addressed.
Charter/Duties
Sarbanes-Oxley
Commitment
Issue
The charter should also specify the audit

committees responsibility for ensuring the
receipt from the external auditor of a formal, written statement delineating all relationships between the auditor and the
company and for actively ensuring the audit
committee take action to safeguard the
independence of the external auditors.
The committee must assess annually the
need for revisions to the charter.
the companys compliance with legal and
Audit committee must also prepare the

report that SEC rules require be included in
the companys annual proxy statement.
internal audit function and independent

auditors.
the performance of the companys
and independence; and
the independent auditors qualifications
regulatory requirements;
statements;
the integrity of the companys financial
Audit committees should have a written

charter that outlines the scope of the committees responsibilities (including structure, processes, and membership
requirements), including all required duties
under the Sarbanes-Oxley Act.
Not addressed.
NASDAQ Proposals
Audit committee must have a charter

addressing the committees purpose and
minimum requirements, which should be to
assist the boards oversight of:
Board must determine that a prospective

members other audit committee memberships are not an impediment to committee
service if the prospective member serves
simultaneously on the audit committee of
more than three public companies and disclose such determinations in the proxy.
NYSE Proposals
annual financial statements with management and the external auditors;
reviewing and discussing the companys
relating to compliance with the law and

important corporate policies, including
the governance and ethics codes (unless
these functions are performed by another
committee);
reviewing the companys procedures
internal controls and reviewing the adequacy of internal controls with the internal and external auditors on a periodic
basis;
understanding the companys system of
ing policies and judgments with management and the external auditors;
reviewing and discussing critical account-
dence;
safeguarding external auditor indepen-
with its external auditor;
supervising the companys relationship
and overseeing the companys risk

assessment/management practices;
understanding the companys risk profile
The primary functions of the audit committee include:
Committees should have charters, or there

should be a board resolution establishing
the committees.
Not addressed.
73
Audit committee is directly responsible for

appointment, oversight, and compensation
of the external auditor, including the resolution of disagreements between management and the auditor regarding financial
reporting, in the conduct of issuing an audit
report or related work. The external auditor
is also required to report directly to the
audit committee.
External Auditor
and
Audit Services
between the accounting firm and

management.
other material written communications
treatments of financial information within

GAAP that have been discussed with
management; and
all material alternative accounting
practices used by the issuer;
all critical accounting policies and

SEC final rule requires the accounting
firm to report, prior to the filing of its audit
report with the Commission, to the audit
committee:
All auditing services must be pre-approved,

including underwriting comfort letters or
statutory audits required for insurance
companies.
Sarbanes-Oxley
Issue
Audit committee has the sole authority to

hire and fire the external auditor and
approve fees and terms of the audit and
non-audit services.
NYSE Proposals
Audit committee has the sole authority

to hire and fire the external auditor and
approve fees and terms of the audit and
non-audit services.
NASDAQ Proposals
Audit committee is responsible for supervising the companys relationship with its
external auditors, including recommending
the audit firm, evaluating the audit firms
performance and considering whether to
periodically rotate the audit firm or its
senior personnel.
personnel.
considering policies for hiring auditor
the board from internal/external auditors

and other officers; and
providing a channel of communication to
function;
overseeing the companys internal audit
74

SEC final rule requires the lead and concurring on the audit engagement team rotate
after a five-year cooling off period. Other
significant audit partners will be subject to a
seven year rotation requirement with a twoyear cooling off period.
Companies required to change lead audit

partner or second review audit partner
every five fiscal years.
sion of non-audit services.
include a de minimis exception for provi-
not be independent if the audit partner

received compensation based on the partner procuring engagements with that client
for services other than audit, review, and
attest services; and
establish rules that an accountant would
audit services specified in the Act;
define the nine prohibited types of non-

SEC adopts final rules to strengthen auditor
independence and improve disclosures to
investors about services provided by external audit firms. The rules:
External audit firm may not simultaneously

provide both audit and non-audit services.
The prohibited non-audit services include
bookkeeping and related services, management and human resources consulting, and
appraisal and valuation services.5 All nonaudit services must be approved by the
audit committee and disclosed to shareholders.
Sarbanes-Oxley
Rotation of lead audit partner required.

Audit committee should further consider
whether to set a policy governing rotation
of the external audit firm.
Audit committee has sole authority to

approve terms and fees for non-audit
services.
NYSE Proposals
Not addressed.
Audit committee must pre-approve terms

and fees for non-audit services.
NASDAQ Proposals
Audit committee should decide whether

periodic rotation for external auditor or
senior audit personnel is necessary based
on annual due diligence assessments and
should make a recommendation to the
board based on its conclusions.
Audit committee should develop policies for

the provision of non-audit services by the
external auditor. When making the determination, the committee should consider the
appropriate degree of review/oversight
for new/existing services and consider
the nature and dollar amount of services
provided.
Specifically, the prohibited non-audit services include the following: (1) bookkeeping or other services related to the accounting records or financial statements of the audit client; (2) financial information systems design and implementation;
(3) appraisal or valuation services, fairness opinions, or contribution-in-kind reports; (4) actuarial services; (5) internal audit outsourcing services; (6) management functions or human resources; (7) broker or dealer, investment advisor,
or investment banking services; (8) legal services and expert services unrelated to the audit; and (9) any other service that the board determines, by regulation, impermissible.
Rotation of
Audit Firm
and Partners
Non-Audit
Services
Issue
75
Unlawful for company officers, directors, or

affiliated persons to fraudulently influence,
coerce, manipulate, or mislead any independent public or certified accountant engaged
in auditing the companys financial statements, for the purpose of rendering such
financial statements materially
misleading.
Improper
Influencing
of Audit
Not addressed.
Meetings and
Private Sessions
Not addressed.
Audit committee should have access to

external counsel and other advisors.
Access to
External
Advisors
Internal Audit
Sarbanes-Oxley
Issue
Not addressed.
All listed companies must have an internal

audit function.
Audit committees should meet separately,

periodically, with management, internal
auditors (or other personnel responsible for
the internal audit function), and external
auditors.
Audit committee should have access to

advice and assistance from outside counsel, accounting, and other advisors without
having to obtain board approval.
NYSE Proposals
Not addressed.
Not addressed.
Not addressed.
Audit committees must have authority to

consult with and retain legal, accounting,
and other experts in appropriate circumstances.
NASDAQ Proposals
Not addressed.
Audit committee should oversee the internal audit function.
Audit committees should meet with the

internal and external auditors without management present at every meeting and
communicate with them between meetings
as necessary.
Audit committee meetings should be held

frequently enough to allow the committee
to appropriately monitor the annual and
quarterly financial reports and should be of
sufficient length to permit and encourage
active discussions with management and
the internal and external auditors.
Board and committee access to outside

advisors is an important element of an
effective corporate governance system.
76
Financial reports required to be prepared in

accordance with GAAP under the Securities
Exchange Act of 1934 and filed with the
SEC should reflect all material correcting
adjustments that have been identified by a
registered public accounting firm in accordance with GAAP and SEC rules.
Financial
Reporting
Audit committees must discuss the annual
audited financial statements and quarterly
financial statements with management and
the independent auditor, including the companys disclosures under Managements
Discussion and Analysis of Financial
Condition and Results of Operations.
NYSE Proposals
Not addressed.
NASDAQ Proposals
The board, through the audit committee,

should have a broad understanding of the
companys financial statements, including a
rationale for use of certain accounting principles, which key judgments and estimates
were made and why, and the impacts of
such judgments on the company.
Senior management is responsible for the

integrity of the companys financial statements and for putting in place and supervising the operation of systems that allow the
company to produce financial statements
that fairly present the companys financial
condition.
Defined by the Commission as a numerical measure of a registrants historical or future financial performance, financial position or cash flows that (1) excludes amounts or is subject to adjustments that have the effect of excluding amounts, that are included in the comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows (or equivalent statements) if the issuer; or (2) includes amounts, or is subject to adjustments that have the effect of including amounts, that
are excluded from the comparable measure so calculated and presented. Statistical and operating measures are not covered.
SEC also proposed amendments to existing

rules to address the use of non-GAAP financial information in filings to the Commission.
SEC Rulemaking: Nov. 5, 2002

SEC proposed new Regulation G, which would
apply whenever a public company discloses or
releases material information containing a
non-GAAP financial measure.6 Regulation G
would prohibit material misstatements or omissions that would make the presentation of the
material non-GAAP financial measure misleading and would require a quantitative reconciliation of differences of the non-GAAP financial
measure presented and the comparable financial measure(s) calculated and presented in
accordance with GAAP.
SEC to issue final rules providing that pro

forma financial information included in any
periodic or other report filed with the SEC
pursuant to the securities laws, or in any public disclosure or press or other release, shall
be presented in a manner that: (1) does not
contain an untrue statement of a material fact
or omit to state a material fact necessary in
order to make the pro forma financial information, in light of the circumstances under
which it is presented, not misleading and (2)
reconciles it with the financial condition and
results of operations of the issuer under
GAAP.
Sarbanes-Oxley
Issue
Financial Reporting/Disclosures
77
SEC to review disclosures made by issuers

reporting under Section 13(a) of the
Securities Exchange Act of 1934 (including
reports filed on Form 10-K), and which have
a class of securities listed on a national
securities exchange or traded on an automated quotation facility of a national securities association, on a regular and
systematic basis for the protection of
investors. Such review shall occur no less
often than once every three years and
include a review of an issuers financial
statement.8
Accelerated filers are also required to disclose their Web site address in the annual
report, whether annual, quarterly, and periodic reports are made available free of
charge (and if not, why not), and, if not,
whether the company will provide electronic
or hard copies of the reports free of charge
upon request.
Not addressed.
Not addressed.
NYSE Proposals
Not addressed.
Harmonizes NASDAQ rule on disclosure of

material information with SEC Regulation
FD so that issuers may use Regulation FD
compliant methods (conference calls, press
releases, etc.) so long as public is provided
adequate notice and is grated access.
Requires going concern qualification in an

audit opinion be disclosed through
issuance of press release.
NASDAQ Proposals
Not addressed.
Not addressed.
For purposes of scheduling these reviews, the SEC shall consider, among other factors: (1) issuers that have issued material restatements of financial results; (2) issuers that experience significant volatility in their stock price as compared to other issuers;
(3) issuers with the largest market capitalization; (4) emerging companies with disparities in price to earning ratios; (5) issuers whose operations significantly affect any material sector of the economy; and (6) any other factors that the Commission may consider relevant.
Defined by the Commission as public companies that have a common equity public float that was $75 million or more as of the last business day of its most recently completed second fiscal quarter,
have been subject to the Exchange Acts reporting requirements for at least 12 calendar months and have previously filed at least one annual report.
SEC Review
of Financial
Disclosures
Companies must disclose on a rapid and

current basis additional information concerning material changes in their financial
condition or operations, in plain English.
Real Time
Disclosures
SEC Rulemaking: Sept. 5, 2002

SEC final rule accelerates filing deadlines for
annual, quarterly, and periodic reports for
accelerated filers.7 The rule shortens the
filing deadlines for annual reports from 90 to
60 days and quarterly reports from 45 days
to 35 days after the companys fiscal year
end over a three-year phase-in period and
accelerates the filing deadline for Form 8-K
to two business days (formerly 515 days
depending on the event) after the required
disclosure event occurs.
Sarbanes-Oxley
Issue
78
CEO/CFO
Certification
of Financial
Statements
Issue
SEC Rulemaking: Aug. 29, 2002

SEC final rule requires the principal executive and financial officers to certify the
above-listed information in the companys
annual and quarterly reports.
financial statements and other financial

information included in the report, fairly
present in all material respects the financial condition and results of operations of
the issuer as of, and for, the reporting
period(s).
based on such officers knowledge, the
report does not contain any untrue statement of a material fact or omit to state a
material fact necessary in order to make
the statements not misleading; and
based on the officers knowledge, the
the report;
the signing officer has reviewed
CEO and CFO must certify in each annual

or quarterly report filed that:
Sarbanes-Oxley
Not addressed.
NYSE Proposals
Not addressed.
NASDAQ Proposals
Not addressed.
79
Not directly addressed.
Disclosure
Controls
sions about the effectiveness of the disclosure controls and procedures based on the
required evaluation as of that date.
have presented in the report their conclu-
issuers disclosure controls and procedures as of a date within 90 days prior to

the filing date of the report; and
have evaluated the effectiveness of the
and procedures to ensure that material

information is made known to them, particularly during the period in which the periodic report is being prepared;
have designed such disclosure controls
for establishing and maintaining disclosure controls and procedures (a newlydefined term reflecting the concept of
controls and procedures related to disclosure embodied in Section 302(a)(4) of the
Sarbanes-Oxley Act) for the company;
that the certifying officers are responsible

SEC adopted new Exchange Act Rules
requiring the principal executive and financial officers to certify the following in the
companys annual and quarterly reports:
Sarbanes-Oxley
Issue
Audit committee must discuss annual and
quarterly financial statements with management and the internal auditor and must discuss earnings press releases, as well as
financial information and earnings guidance
provided to analysts and rating agencies.
NYSE Proposals
Not addressed.
NASDAQ Proposals
Audit committees should review and discuss the companys annual financial statements with management and the external
auditors and, based on these discussions,
recommend to the board that the financial
statements should be approved.
80
Requires SEC to prescribe rules requiring

each annual report required by Section
13(a) or 15(d) of the Securities Exchange
Act of 1934 to contain an internal control
report, which: (1) states the responsibility
of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting
and (2) contains an assessment, as of the
end of the most recent fiscal year of the
issuer, of the effectiveness of the internal
control structure and procedures of the
issuer for financial reporting.
Internal
Controls
Each registered public accounting firm that

prepares or issues the audit report for the
issuer shall attest to, and report on, the
assessment made by the management of
the issuer. An attestation shall be made in
accordance with standards for attestation
engagements issued or adopted by the
Board. Any such attestation shall not be the
subject of a separate engagement.
Sarbanes-Oxley
Issue
Audit committee must obtain and review a
report by the external auditors assessing,
among other areas, internal quality control,
material issues raised by the most recent
peer review or investigations/inquiries
made by governmental or professional
authorities in the preceding five years (and
measures taken to address these issues),
along with a review of all relationships
between the company and external auditor.
NYSE Proposals
Not addressed.
NASDAQ Proposals
Internal Control/Compliance/Risk Management
The audit committee should understand

and be familiar with the companys system
of internal controls and should review the
adequacy of the system periodically with
internal and external auditors.
Companies should have an effective system

of internal controls providing reasonable
assurance that books and records are
accurate, that its assets are safeguarded,
and that it complies with applicable laws.
The internal control system should be periodically reviewed and updated.
81
The signing officers (CEO and CFO) must

certify they have taken responsibility for:
CEO/CFO
Certification
there were significant changes in internal

controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation,
including any corrective actions with
regard to significant deficiencies and
material weaknesses.
indicating in the report whether or not
audit committee of the board of directors

(or equivalent function): (1) all significant
deficiencies in the design or operation of
internal controls which could adversely
affect the issuers ability to record,
process, summarize, and report financial
data and have identified for the issuers
auditors any material weaknesses in internal controls; and (2) any fraud, whether or
not material, that involves management
or other employees who have a significant
role in the issuers internal controls; and
disclosing to the issuers auditors and the
about the effectiveness of their internal

controls based on their evaluation as of
that date;
presenting in the report their conclusions
issuers internal controls as of a date

within 90 days prior to the report;
evaluating the effectiveness of the
that material information relating to the

issuer and its consolidated subsidiaries is
made known to such officers by others
within those entities, particularly during
the period in which the periodic reports
are being prepared;
designing such internal controls to ensure
trols;
establishing and maintaining internal con-
Sarbanes-Oxley
Issue
Not addressed.
NYSE Proposals
Not addressed.
NASDAQ Proposals
Not addressed.
82
Audit committees must establish procedures to receive, retain, and treat complaints and handle whistleblower
information regarding questionable
accounting or auditing matters.
Employee
Whistleblowing
Procedures
Employees of issuers and accounting firms

extended whistleblower protection, prohibiting the employer from taking certain
actions against employees who lawfully disclose private employer information to,
among others, parties in a judicial proceeding involving a fraud claim. Whistleblowers
are also granted a remedy of special damages and attorneys fees.
Not addressed.

SEC adopted new Exchange Act Rules
requiring the principal executive and financial officers to certify the above-listed information in the companys annual and
quarterly reports.
Sarbanes-Oxley
Risk
Assessment and
Management
Issue
The company should proactively promote

ethical behavior. The company should
encourage employees to talk to supervisors, managers, or other appropriate personnel when in doubt about the best
course of action in a particular situation.
Additionally, employees should report violations of laws, rules, regulations, or the
code of business conduct to appropriate
personnel. To encourage employees to
report such violations, the company must
ensure that employees know that the company will not allow retaliation for reports
made in good faith.
The CEO and senior management assess

and manage the companys exposure to
risk, but the audit committee must discuss
guidelines and policies to govern the
process by which this is handled. The audit
committee should discuss the companys
major financial risk exposures and the steps
management has taken to monitor and control such exposures.
Audit committee must discuss policies

with respect to risk assessment and risk
management.
NYSE Proposals
Audit committees required to establish procedures for the receipt, retention, and treatment of complaints received by the issuer
regarding accounting, internal accounting
controls or auditing matters. Committees
required to ensure that complaints are
treated confidentially and anonymously.
Not addressed.
NASDAQ Proposals
Employees should have a means of alerting

management and the board to potential
misconduct without fear of retribution.
The audit committee should understand the

companys risk profile and oversee risk
assessment and management practices.
Senior management identifies and manages

the risks the company undertakes in the
conduct of its business and manages the
companys overall risk profile.
83
Requires the SEC to issue rules setting forth minimum standards of

professional conduct for attorneys appearing and practicing before
the SEC in any way in the representation of public companies. The
rules must:
Attorney
Whistleblowing
Procedures
but will not preempt the ability of a state to impose more rigorous
obligations consistent with the rules.
state that the rules govern in the event of a conflict with state law
violate attorney/client privilege, such as disclosure of confidential

information to the Commission; and
set forth specific circumstances under which an attorney does not
tee (QLCC) as an alternative procedure for reporting evidence of a

material violation. The QLCC would consist of at least one member
of the audit committee or equivalent committee of independent
directors and two or more independent board members, and would
have the responsibility, among other things, to recommend that the
company implement an appropriate response to evidence of a
material violation;
allow an issuer to establish a qualified legal compliance commit-
committee, another committee, or the full board in the event an

appropriate response if the CLO or CEO does not respond appropriately to the evidence;
require the reporting attorney to report up the ladder to the audit
mined according to an objective standard) to, initially, the CLO or

CEO of the company or the equivalent positions;
require attorneys to report evidence of material violations (deter-

SEC adopts final rules relating to standards of professional conduct
for attorneys appearing and practicing before the Commission in any
way in the representation of issuers. The key rules:
tee of the board of directors of the company or to another committee of the board of directors comprised solely of outside
directors. if the counsel or officer does not respond appropriately
to this evidence.
require the attorney to report the evidence to the audit commit-
CEO of the company any evidence of a material violation of securities law or breach of fiduciary duty, or similar violation, by the
company or its agents and
require an attorney to report to the chief legal officer (CLO) or
Sarbanes-Oxley
Issue
Not addressed.
NYSE Proposals
Not addressed.
NASDAQ Proposals
Not addressed.
84
Related Party
Transactions
Generally unlawful for companies to extend

credit to any director or executive officer,
subject to certain exceptions (e.g., consumer credit companies may make home
improvement and consumer credit loans
and companies may issue credit cards to
directors and executive officers) if it is
done in the ordinary course of business on
the same terms and conditions made to the
general public. Personal loans already in
existence may continue in effect provided
no material modifications to terms or
renewal made.
Loans to
Directors and
Officers
Amends Section 16(a) of the Securities

Exchange Act of 1934 to require enhanced
disclosures by management and principal
stockholders. Directors, officers, and 10%
owners must report designated transactions by the end of the second business
day following the day on which the transaction was executed. Designated disclosures
must be filed electronically and posted in
near real time on the SECs and companys
own Web site.
As enacted, overrides laws of some states

(e.g. Delaware Corporations Law Section
143), which allows companies to extend
credit to corporate officers.
Sarbanes-Oxley
Issue
Not addressed.
Not addressed.
NYSE Proposals
Exploring requirement for accelerated disclosure of insider transactions that would

harmonize and reinforce Sarbanes-Oxley
provisions and SEC rules.
Audit committee or comparable body must

review and approve all related party transactions.
Prohibits loans to officers and directors

through the adoption of a rule that mirrors
provisions of the Sarbanes-Oxley Act.
NASDAQ Proposals
Conflicts of Interest/Insider Transactions
Not addressed.
Not addressed.
85
Requires SEC to issue final rules providing

that each annual and quarterly financial
report shall disclose all material off-balance
sheet transactions, arrangements, obligations (including contingent obligations), and
other relationships of the issuer with unconsolidated entities or other persons that may
have a material current or future effect on
financial condition, changes in financial
condition, results of operations, liquidity,
capital expenditures, capital resources, or
significant components of revenues or
expenses.
Off-Balance
Sheet
Transactions
of its overall contractual obligations in a

tabular format and an overview of its contingent liabilities in either a textual or tabular format.
requires registrants to provide an overview
closures in a separately-captioned subsection of the MD&A section in its disclosure

documents; and
requires a company to include these dis-
sure that companies must provide in the

MD&A section of the companys disclosure
documents arrangements that are likely
to have a current or future effect on the
companys financial condition, changes in
financial condition, revenues or expenses,
results of operations, liquidity, capital
expenditures, or capital resources that is
material to investors;
specifically addresses the types of disclo-

SEC final rule to implement relevant provisions of the Act:
Sarbanes-Oxley
Issue
Not addressed.
NYSE Proposals
Not addressed.
NASDAQ Proposals
Not addressed.
86
Companies must have a code of conduct,

and the code must be publicly available.
NASDAQ Proposals
Companies should have a code of conduct

with effective reporting and enforcement
mechanisms.
Defined as standards as are reasonably necessary to promote: (1) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; (2) full, fair, accurate, timely, and understandable disclosure
in the periodic reports required to be filed by the issuer; and (3) compliance with applicable governmental rules and regulations.
that it will provide a copy of the code without charge upon request.
disclosing in the appropriate SEC filings
disclosing the Internet address in the

appropriate SEC filings; or
posting the code on its website and
principal executive, financial and accounting officer or controller as an exhibit to the

annual report;
filing a copy of its code that applies to the
Listed companies must adopt and disclose

a code of business conduct and ethics for
directors, officers, and employees and the
code must be made publicly available.
NYSE Proposals
10 Defined as written standards that are reasonably designed to deter wrongdoing and to promote: (1) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; (2) full, fair, accurate,
timely, and understandable disclosure in documents that a company files with, or submits to, the Commission and in other public communications made by the registrant; (3) compliance with applicable governmental rules and regulations; (4) the prompt internal reporting of
code violations to an appropriate person or persons identified in the code; and (5) accountability for adherence to the code. Points 4 and 5 supplement the requirements of the Sarbanes-Oxley Act.
SEC to issue rules requiring each company,

together with periodic reports required pursuant to Sections 13(a) and 15(d) of the
Securities Exchange Act of 1934, to disclose whether or not (and if not, why not)
the company has adopted a code of ethics9
for senior financial officers, applicable to its
principal financial officer and comptroller or
principal accounting officer, or persons performing similar functions.
Code of Ethics

Final SEC rule requires a company to disclose whether it has a code of ethics10 that
applies to its principal executive officer as
well as its senior financial officers, and if
not, why it has not done so. The final rules
give companies the option to choose
between alternative methods of disclosing
the ethics code:
Sarbanes-Oxley
Issue
Code of Ethics
87
SEC to amend its rules to require the

immediate disclosure, by means of the
filing of a form, dissemination via the
Internet, or by other electronic means,
of any change in or waiver of the code
of ethics of the company.
Not addressed.
Code Content
Code Waivers
Sarbanes-Oxley
Issue
Code of ethics must require that any waiver

for executive officers or directors be made
only by the board or a board committee and
be promptly disclosed to shareholders.
unethical behavior.
encouraging reporting of illegal/
(including insider trading); and
compliance with laws/rules/regulations
company assets;
protection/proper use of
fair dealing;
confidentiality;
corporate opportunities;
conflicts of interest;
Listed companies must publish codes of

business conduct and ethics and key committee charters. Each company may determine its own policies, but all listed
companies should address the most important topics, including:
NYSE Proposals
Waivers can only be granted by independent directors and must be publicly disclosed.
Code should address, at a minimum, conflicts of interest and compliance with

applicable laws, rules, and regulations, with
an appropriate compliance mechanism and
disclosure of any waivers to executive officers and directors.
NASDAQ Proposals
Not addressed.
Not addressed.
88
Sarbanes-Oxley
Not addressed.
Not addressed.
Issue
Executive
Compensation
Shareholder
Approval of
Stock Plans
Brokers may vote customer shares on

proposals for such plans only pursuant
to customer instructions.
Excluded are employment-inducement

options, option plans acquired through
mergers, and tax-qualified plans such as
ESOPs and 401(k)s.
Shareholders must be given the opportunity

to vote on all stock-option plans.
Compensation committees responsibilities

include review and approval of corporate
goals and objectives relevant to CEO compensation, evaluating the CEOs performance in light of those goals and
objectives, setting the CEOs compensation
level based on this evaluation, and making
recommendations to the board with
respect to incentive-compensation plans
and equity-based plans.
NYSE Proposals
Excluded are inducement grants to new

employees if such grants are approved by
an independent compensation committee
or majority of independent directors and
certain tax-qualified plans (e.g., ESOPs) and
for assumption of pre-existing grants in
connection with acquisition or merger.
Existing option plans unaffected unless
material modifications are made.
Shareholder approval required for adoption

of all stock option plans and for any material modification of plans.
Independent director approval of other

executive officer compensation required
(either by independent committee or by
majority of independent directors in a
meeting at which CEO may be present).
Independent approval of CEO compensation required (either by independent

compensation committee or by majority
of independent directors meeting in
executive session).
NASDAQ Proposals
Compensation Review and Approval
Not addressed.
Compensation committees should determine whether the benefits provided to

senior management, including post-employment benefits, are proportional to management contributions.
Generally, an appropriate compensation

package for management includes a carefully designed mix of long term and short
term incentives. Management compensation packages should be designed to create
a commensurate level of risk and opportunity based on business and individual performance and should link the interests of
management, individually and collectively,
to the long-term interests of shareholders.
Equity compensation should be carefully

designed to avoid unintended incentives,
such as an undue emphasis on short-term
market value changes.
89
Creates new crimes and penalties in the

following areas:
Criminal
Penalties
Not directly addressed.
Lowers the threshold for barring an

individual from service as an officer or
director of a company to if any unfitness
has been found and permits the SEC to
issue the bar order if, after notice and
hearing, it has found that the individual has
violated (or is about to violate) the general
anti-fraud provision.
Corporate
Governance
Violations
Service Bans
tences for other existing securities-related

crimes.
Increases maximum fines and prison sen-
investors punishable by imprisonment of

up to 25 years.
Knowingly executing a scheme to defraud
records with intent to impede or influence

a federal investigation or bankruptcy proceeding punishable by fine and imprisonment of up to 20 years.
Destruction, alteration, or falsification of
cation is open to a fine of up to $1 million

and imprisonment of up to 10 years.
The fines and imprisonment increase
to $5 million and 20 years for knowing
violation is made willfully.
CEO or CFO knowingly filing a false certifi-
Sarbanes-Oxley
Issue
Not addressed.
CEO must certify each year that he or she

is not aware of any violation of NYSE listing
standards.
The NYSE may issue a public reprimand letter for violation of a corporate governance
standard, in addition to the existing penalty
of delisting.
Not addressed.
NYSE Proposals
Not addressed.
Clarifies the authority of NASDAQ to deny

relisting based upon a corporate governance
violation that occurred while that issuers
appeal of the delisting was pending.
Clarifies that a material misrepresentation

or omission by an issuer may result in
delisting.
Not addressed.
NASDAQ Proposals
Enforcement/Penalties
Not addressed.
Not addressed.
Not addressed.
90
SEC Rulemaking
Amends bankruptcy code to prevent use of

bankruptcy to avoid liability incurred due to
federal or state securities law violations.
Civil Liability
SEC given authority to promulgate rules

and regulations in furtherance of the Act.
Extends statue of limitations for private

securities actions involving a claim of
fraud, deceit, manipulation, or contrivance
from one to two years after the discovery of
the facts and increases the absolute ban on
litigation from three to five years after the
occurrence of the alleged fraud.
CEO and CFO must forfeit bonus or other

incentives received and any profits realized
from sale of securities if the issuer is
required to restate due to noncompliance
with financial reporting requirements.
Sarbanes-Oxley
Reinstatement
Penalty
Issue
Not addressed.
Not addressed.
Not addressed.
NYSE Proposals
Not addressed.
Not addressed.
Not addressed.
NASDAQ Proposals
Not addressed.
Not addressed.
Not addressed.
91
Sarbanes-Oxley
Not addressed.
Not addressed.
Issue
Director Training
Change of
Control
Provisions
Not addressed.
All listed companies urged to establish an

orientation program for new board members. In conjunction with leading authorities, the NYSE will develop a Directors
Institute.
NYSE Proposals
Other Provisions
Clarifies that NASDAQ will presume that a

change of control occurs when an investor
acquires 20% of an issuers outstanding
voting power, unless a larger ownership
and/or voting position exists after the
transaction by: (1) a shareholder or an identified group of shareholders that is unaffiliated with the investor; or (2) the issuers
officers and directors that are unaffiliated
with the investor.
Mandates continuing education for all directors, pursuant to rules to be developed.
NASDAQ Proposals
Not addressed.
Companies should provide educational

opportunities to directors on an ongoing
basis to enable them to better perform their
duties and to recognize and address issues
that arise.
92
Applies to all companies that have registered equity or debt securities with the SEC
under the Securities Exchange Act of 1934,
as amended. Subject to any exemptions
the SEC might grant, the Act applies to
companies (organized within or outside the
U.S.) who have registered a public offering
of their securities in the U.S. (and therefore
incurred a reporting obligation under
Section 15(d) of the Securities Exchange
Act, regardless of whether the securities
thus offered were ever sold or trade in the
U.S. public markets), although in such
cases compliance may be required only
during the period when they have such
reporting obligation, which will continue, at
the least, until the fiscal year of the company following the fiscal year in which it
registered its offering of securities.
Not addressed.
Applicability
Disclosure /
Transparency
Companies must disclose any significant
ways in which their corporate governance
practices differ from those followed by
domestic companies under NYSE listing
standards. Summary of differences can be
a brief statement and must be made publicly available on the companys Web site
and/or annual report. Materials provided
must be in English.
Applies to all NYSE-listed non-U.S.

companies.
NYSE Proposals
Sources: Heidrick & Struggles; Institute of Internal Auditors Research Foundation; Weil, Gotshal & Manges, LLP
Sarbanes-Oxley
Issue
Requires companies file with the SEC and

NASDAQ all interim reports filed in their
home country and, at a minimum, a semiannual report, including a statement of
operations and interim balance sheet prepared in accordance with the home countrys requirements. Materials provided must
be in English.
Companies required to disclose exemptions

to NASDAQs corporate governance requirements, permissible under the SarbanesOxley Act or SEC rules, at the time the
exemption is received and on an annual
basis thereafter along with any alternative
measures taken in lieu of the waved
requirements.
Companies must satisfy the SmallCap initial and continued listing requirements for
bid price and market value of publicly held
shares that are currently applicable to
domestic issuers, subject to an 18-month
phase-in period.
Requires underlying shares of Small-Cap

issuers with listed ADRs satisfy the same
publicly held shares and shareholder
requirements that are applicable to domestic issuers.
Applies to all NASDAQ-listed non-U.S.

companies.
NASDAQ Proposals
Non-U.S. Companies
Not addressed.
Not addressed.
93
Source: Heidrick & Struggles
Final SEC approval of

Exchange Proposal
All changes regarding

board composition at
the first annual meeting
(following the 4 months)
4 Months (NASDAQ)
Adopt corporate governance guidelines

and code of business conduct and
ethics
Establish internal audit function
Increase power of audit committee
Establish mandatory committees,

with charters
At least one independent

director per mandatory
committee
Regular meetings of only nonmanagement/independent directors
Only independent directors

on the mandatory committees
All SOA provisions

listed above
12 Months (NYSE)
Majority Independence
24 Months (NYSE)
April 2003 (SOA)
6 Months (NYSE)
Important Time Periods

Unless otherwise specified, all periods begin as of final SEC approval of an exchanges proposal
Implementation Timeline
Appendix 2
Hypothetical, Inc., Corporate Governance Principles

Corporate Governance Topics
Separation of Chairman and CEO1

Board policy and the Companys by-laws allow flexibility to
separate or consolidate these positions as the Board, from time
to time, may determine to be best for governance and effective
Board and Company functioning.
Appointment of Lead Director

There is no position of lead director, and the appropriate committee chairman leads the discussion in executive sessions when/if
the Chairman of the Board is not present. Any director is free to
contact the appropriate committee chairman to request a special
committee meeting or to contact the Chairman of the Board for a
discussion of an issue at a full Board or executive session.
Number/Structure of Committees
Committees are formed, filled, modified, and terminated as part
of the organizational and governance work of the Governance
and Nominating Committee and the full Board. In any event, the
Company would have at a minimum three committees, namely,
a Governance and Nominating Committee, an Audit Committee,
and a Compensation Committee.
Assignment and Rotation of Committee Members

Board committee assignments and committee chairmanships
are reviewed annually and rotated periodically, usually every
three to five years, consistent with the directors interests,
areas of expertise, and regulatory requirements.
Frequency, Length, and Agenda for Meetings

The Board meeting schedule and agenda are developed with
direct input from directors. Meeting lengths vary as business
dictates. Teleconference meetings may be used between regularly scheduled meetings to assure continuity of Board information flow and actions.
Executive Sessions
The Board meets in executive session (the outside directors and
the Chairman and Chief Executive Officer) at every Board meeting. The Chairman and Chief Executive Officer leave these sessions during the annual review of his/her performance or when
the independent directors feel it is appropriate; however, the
independent directors will meet at least twice each year.
Director Compensation and Review

The Governance and Nominating Committee reviews director
compensation annually. The Committee then makes recommendations to the Board for action. Stock-based compensation is an
important component of the director compensation program.
Size of Board
The Certificate of Incorporation authorizes a Board of seven to 17,
allowing flexibility for sizing the Board as structure, organization,
activity, and availability dictate. The Governance and Nominating
Committee will review and recommend changes as needed.
Independence of the Board

The Board is committed to having a substantial majority of independent, non-employee directors. Periodic review is done to
assure compliance with this commitment and with SEC, IRS,
and NYSE requirements as to filling committee assignments
with independent, non-employee directors.
10
Board Membership Criteria and Selection

The Governance and Nominating Committee is responsible for
developing criteria for Board membership and guidelines for
Board tenure (attached). Using these, when director nominees
are needed, the Committee develops and reviews candidates,
makes recommendations to the Board, and oversees the
process of selection and nomination.
Annually, each committee reviews its performance. Then, in

consultation with the committee executive, it agrees upon a
meeting schedule (including frequency and length of meetings)
and tentative agenda for the upcoming year. Agenda items are
added and deleted over the coming year at the members
requests and as business developments warrant.
94
For a discussion on separating the positions of Chairman and CEO, see pp 21-22.
11
Board Evaluation
The Governance and Nominating Committee establishes
criteria for evaluation of Board performance and effectiveness
(attached). Annually, the Board and each of its committees
conduct an evaluation of their performance.
12
Retirement Age for Directors

Board policy requires outside directors to retire no later than
the annual meeting following their 70th birthday. Employee
directors, including the CEO, are required to retire from the
Board upon retirement as an employee, unless the Board determines otherwise in unusual circumstances.
13
14
15
16
Formal Evaluation of the CEO

The independent, non-employee directors, under the leadership
of the chairman of the Governance and Nominating Committee,
conduct an evaluation of the CEO annually and may do so on a
less formal basis from time to time during the year. The evaluation is timed to coincide with the Boards action on the performance pay program and is tied to the Companys annual
performance and the CEOs delineated personal objectives.
17
The CEO and Outside Boards

The primary obligation of the CEO is to the Corporation, but it is
recognized that service by the CEO on outside boards can be
beneficial.
Change in Directors Position

Individual directors who change the primary job responsibility
they had when last elected to the Board tender their resignations so that the Governance and Nominating Committee and
the Board can determine, on a case-by-case basis, whether
their Board membership would continue to be free from conflict
of interest and is otherwise appropriate.
Term Limits
The Board does not impose term limits, as this could unnecessarily interfere with the continuity, diversity, developed experience
and knowledge, and the long-term outlook the Board must have.
Stock Ownership Guidelines for Directors
No specific minimum shareholding is required, except a director
must own some shares within sixty days of joining the Board.
However, directors receive a minimum of one-half their annual
retainer in stock or stock-equivalent units and director deferral
programs include stock or stock-equivalent units as investment
options.
Prior to accepting an outside director position, the CEO is

expected to discuss with the Board his/her desire to hold a
position on another board. The Governance and Nominating
Committee will be responsible for determining the consensus of
the Board on this matter. The number of outside boards upon
which the CEO may serve will be determined on a situational
basis.
18
Board Interaction with Investors, the Press, Customers,

and Others
In general, management speaks for the Company. Inquiries from
the press, shareholders, or others are referred to management
for response. Management regularly presents reports to security analyst groups, and provides key analyst reports to the
Board.
19
Confidential Shareholder Voting

All voted proxies are handled to protect employee and individual shareholder privacy. No vote is disclosed except: as necessary to meet any legal requirements, in limited circumstances
such as a proxy contest, to permit certification of the vote, and
to respond to stockholders who send written comments with
their proxy cards.
Source: Hypothetical Case Study presented by Alfred C. DeCrane, Jr., former

Chairman and CEO, Texaco Inc., at The Conference Boards Directors Institute,
New York, May 79, 2003.
95
96
3-year cooling off

period from end of
employment.
3-year cooling off
period for partners or
employees of outside
auditor who worked on
a companys audit
engagement.
5-year cooling off

period from end of
employment.
5-year cooling off

period from end of
affiliation or end of
auditing relationship.
5-year cooling off

period from end of
compensation committee interlock.
Directors with immediate family members

in the above categories are subject to
the same 5-year
cooling off period.3
Employee
Affiliated with present

or former auditor of
company
Interlocking
directorship
Family Member
**California Public Employees Retirement System
A director who is
related to an executive
or director of the company is not considered
independent.
A director who is an
officer of a firm on
which the companys
chairman or CEO is
also a board member
is not considered independent.
Not discussed
A former employee is
never considered independent.
Not discussed
AFL-CIO
****National Association of Corporate Directors
2-year cooling off

period if immediate
family member was
senior executive.
***Council of International Investors
A director who is a
member of the immediate family of an individual who is, or has
been in any of the
past three years,
employed by the corporation or any of it
affiliates as an executive officer.
Not discussed
Not discussed
2-year cooling off

period from end of
employment.
Not discussed
ALI*
A director who is a
member of the immediate family of any
person in these seven
categories is not considered independent.
A director who is
employed by a
company at which
the executive officer
of the company is also
a board member is
not considered
independent.
Not discussed
5-year cooling off

period from end of
employment in an
executive capacity.
Not discussed
CalPERS**
Employment of a family member in a non-officer position does not preclude a board from determining that an officer is independent.
Both the NYSE and NASDAQ criteria listed in this appendix refer to the proposed standards and not existing standards.
The Sarbanes-Oxley Act provides that in order for an audit committee member to be considered independent, such member may not accept any consulting, advisory or other compensation from the issuer.
*American Law Insititue
Not discussed2
Yes
Independence
affirmatively
determined by BOD?
3-year cooling off

period from end of
compensation committee interlock.
NASDAQ
NYSE1
Criteria
Criteria for Director Independence
Independence Comparisons
Appendix 3
5-year cooling off

period if relative was
an executive of the
company.
5-year cooling off

period from end of
interlocking directorship.
Not discussed
5-year cooling off

period from end of
employment in an
executive capacity.
Not discussed
CII***
A director who is
a relative of any
employee of the company is not considered
independent.
Not discussed
Not discussed
A former employee
is never considered
independent.
Not discussed
NACD****
97
A director is not independent if the director

is an executive officer or employee, or if
the directors immediate family member is
an executive officer, of
another company and:
(1) that company
accounts for the
greater of 2% or $1
million of the listed
companys consolidated gross
revenues; or (2) the
listed company
accounts for the
greater of 2% or $1
million of the other
companys gross
annual revenues.
A director is not
independent if he or
she is a director,
controlling shareholder or executive
of, any organization to
which the company
made, or from which
the company received,
payments that exceed
the greater of 5% of
the organization or
companys revenues
for that year, or
$200K, in the current
or previous three
years.
3-year cooling off

period for a director
who receives, or
whose family member
receives, payments,
other than directors
fees, in excess of
$60K.
NASDAQ
A director who is a
principal manager of
an organization that
receives payments
that exceed the
greater of 5% of
companys revenues
or $200K, during
either of the two
preceding years is
not considered
independent.
A director who
receives commercial
payments during
either of the previous
two years in excess
of $200K is not
considered
independent.
ALI
A director who is a
significant customer
or supplier is not
considered
independent.
A director that has a

personal services
contract with the
company is not considered independent.
AFL-CIO
A director who is a
significant customer
or supplier is not
considered
independent.
A director that has a

personal services
contract with the
company is not
considered
independent.
CalPERS
NASDAQ defines an independent director for purposes of serving on the audit committee as a person other than an officer or employee of the company or its subsidiaries or any other individual
having a relationship which, in the opinion of the companys board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.
The presumption of non-independence is rebuttablea director may be deemed independent if the board, including all the independent directors, determines that the relationship is not material.
Any such determination must be specifically explained in the companys proxy statement.
Affiliated with
customers or
suppliers of the
company
5-year cooling off

period for a director
who receives, or
whose immediate family member receives,
direct payments from
the company in
excess of $100,000.4
Fees other than

directors fees
Not independent for

purposes of the audit
committee
NYSE1
Criteria
A director who is, or

was in the past 5
years, a significant
customer or supplier
is not considered
independent.
A director that has

a personal services
contract with the
company is not
considered
independent.
CII
Not discussed
A director who
receives any
compensation from
the company other
than directors fees
is not considered independent.
NACD
98
Would likely disqualify

a director from serving
on the audit committee.
Not discussed, but

practitioners are
advising that all relationships, no matter
how seemingly immaterial, should be disclosed to a board of
directors in order to
allow for a comprehensive determination
as to a directors independence.
Affiliated with
Paid Advisers5
Affiliated with nonprofit organizations

receiving money
from company
Source: Simpson Thacher & Bartlett
NYSE1
Criteria
A director is not independent if the company makes payments

to a charity where the
director is an executive officer and such
payments exceed the
greater of $200K or
5% of either the companys or the charitys gross revenues.
A director who
receives, or whose
family member
receives, payments,
other than directors
fees, in excess of
$60K is not independent. Audit committee
members are prohibited from receiving
any compensation
except for board or
committee service.
NASDAQ
A director who is
employed by a firm
that is one of the companys paid advisers
or consultants is not
considered independent.
A director that is
employed by a
foundation or
university that
receives grants or
endowments from
the company is
not considered
independent.
Not discussed
AFL-CIO
A director is not
considered independent if affiliated with a
law firm that is the
primary legal adviser
or investment banking firm, either of
which was retained by
the company within
the preceding two
years.
ALI
A director that is
affiliated with a notfor-profit entity that
receives significant
contributions from
the company is
not considered
independent.
A director who is
affiliated with a
company that is one
of the companys
paid advisers or
consultants is not
considered independent.
CalPERS
A director affiliated
with a foundation,
university, or other
non-profit receiving
significant grants or
endowments from the
A director who is, or

in the past 5 years
has been, affiliated
with a firm that is
one of the companys
paid advisers or
consultants is not
considered
independent.
CII
Not discussed
A director that is
affiliated with any
organization providing
major services to the
NACD
Appendix 4
Sample Corporate Governance Committee Charter

(General Electric Corporation)
Nominating and Corporate Governance Committee Charter
The nominating and corporate governance committee of the board of directors of General Electric Company
shall consist of a minimum of four directors. These should include the chairs of the audit and the management
development and compensation committees. Members of the committee shall be appointed and may be removed
by the board of directors. All members of the committee shall be independent directors, and shall satisfy the proposed
New York Stock Exchange standard for independence for members of the audit committee.
The purpose of the committee shall be to assist the board in identifying qualified individuals to become board members,
in determining the composition of the board of directors and its committees, in monitoring a process to assess
board effectiveness, and in developing and implementing the companys corporate governance guidelines.
In furtherance of this purpose, the committee shall have the following authority and responsibilities:
To lead the search for individuals qualified to become

members of the board of directors and to select director
nominees to be presented for shareowner approval at the
annual meeting. The committee shall select individuals as
director nominees who shall have the highest personal and
professional integrity, who shall have demonstrated
exceptional ability and judgment and who shall be most
effective, in conjunction with the other nominees to the board,
in collectively serving the long-term interests of the
shareowners.
The committee shall have the authority to delegate any of its

responsibilities to subcommittees as the committee may deem
appropriate in its sole discretion.
To review the board of directors committee structure and to

recommend to the board for its approval directors to serve as
members of each committee. The committee shall review and
recommend committee slates annually and shall recommend
additional committee members to fill vacancies as needed.
To develop and recommend to the board of directors for its

approval a set of corporate governance guidelines. The
committee shall review the guidelines on an annual basis,
or more frequently if appropriate, and recommend changes
as necessary.
The committee shall report its actions and recommendations to

the board after each committee meeting and shall conduct and
present to the board an annual performance evaluation of the
committee. The committee shall review at least annually the
adequacy of this charter and recommend any proposed changes
to the board for approval.
To develop and recommend to the board of directors for

its approval an annual self-evaluation process of the board
and its committees. The committee shall oversee the annual
self-evaluations.
To review on an annual basis director compensation and

benefits.
The committee shall have the authority to retain any search

firm engaged to assist in identifying director candidates, and to
retain outside counsel and any other advisors as the committee
may deem appropriate in its sole discretion. The committee
shall have sole authority to approve related fees and retention
terms.
99
Appendix 5
Sample Director Self-Assessment Worksheet*

In evaluating your individual performance as a Director, and the performance of the Board as a whole, you and
the Board should examine factors such as independence, experience, judgment and knowledge, time commitment,
and teamwork. In assessing your performance as a member of the XXXX Board of Directors, and in preparation
for discussions with the Chairman of the Board, please describe yourself in response to the questions below.
For each of the questions covering your activities and performance, please identify areas that you consider
to be your relative strengths and weaknesses. Add additional sheets if the comments space is insufficient.
Please return the completed form to YYYY prior to the (date) Board meeting.
Directors name: _________________________________________________________

1. DIRECTOR INDEPENDENCE, OBJECTIVITY, AND OVERSIGHT: A Directors participation in Board deliberations should be objective, fair, and
forthright, and be based on independence of judgment. A Director should constructively test and challenge managements plans and recommendations and provide advice, counsel, and direction in fulfilling the Directors oversight role. How do you evaluate yourself with respect to
these attributes and responsibilities?
Comments: _______________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
2. KNOWLEDGE AND EXPERTISE: A Director should be able to draw on his or her past experience relevant to significant issues facing the
Corporation, such as technology, non-U.S. operations, and finance. A Director should have the ability to assess the Corporations strategy, business plans, and key issues and to evaluate the performance of management. How do you evaluate yourself in using your experience as an aid
and a tool in addressing the Corporations plans, operations, and management?
Comments: _______________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
3. BOARD TEAMWORK: Directors should be team players as well as team leaders. A Director must be able to work with fellow Directors, while not
necessarily always agreeing with them. What are the roles you play on the Directors team, and are those your best positions?
Comments: _______________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
* This evaluation is in a descriptive format. Other options include taking similar questions and having directors score themselves for each element
on a scale of 1-5 (with 1 being the highest). Then, directors are asked to rate the importance of each element on a scale of 1-5. By comparing
the importance score with the elements score, directors will be able to zero in on areas in greatest need of improvement.
100
4. BOARD LEADERSHIP: How effective is the Boards leadership, both at the Board and the Committee level? How effective is each Committee
and the Lead Independent Director function?
Comments: _______________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
5. BOARD GOALS: Are the Boards goals, expectations, and concerns honestly and effectively communicated to the CEO? What is your role in setting and expressing these goals and concerns?
Comments: _______________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
6. BOARD CONTACT WITH EMPLOYEES: Is the contact between the Board and senior staff and operating management adequate and appropriate?
Is the Director site visit program being used by you? What additional contacts, if any, would you want?
Comments: _______________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
7. INFORMATION TO THE BOARD: Is the quality, quantity, and timing of information sent to and presented to Directors adequate? Are scheduled
Board meeting sufficiently frequent to allow Directors to discuss the companys performance and major issues that could affect its future? Is
enough time devoted to reviewing strategic issues? What additional data input do you want to receive?
Comments: _______________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
8. MY BOARD CONTRIBUTIONS: Overall, I believe that my areas of greatest and least likely contributions to the Board are:
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
9. PARTICIPATION AND INPUT: For the coming year, I plan to increase my participation and contribution to Board activities through:
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________________
101
Appendix 6
Sample Chief Executive Officer Evaluation Form

Process:
Evaluation sheet distributed (date) to active independent board members

Completed evaluation sheets returned to xxx by (date)
Xxx will summarize input and pass on anonymously to yyy
yyy will circulate to the Board and preview with zzz, adding his own feedback
Active independent board members discusses evaluation with zzz at (date) board meeting
Evaluation:
Your name: ___________________________________(will be removed by xxx)
Please return to xxx prior to (date)
Section A: Primary Responsibilities of the CEO

Consider the factors listed below when forming your evaluation. Provide relevant examples when possible.
1. Development of the primary strategy and objectives of the company
Appropriateness given the external environment
Clarity & consistency of the strategy
Process that encourages effective strategic planning
Grade (check one)
q Outstanding
q Good
q Needs Improvement
Comments/examples: _______________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
2. Tone and structure of how the company operates

Appropriateness of organizational structure to the primary strategy
Alignment of management with the strategy
Clearly communicated with a process for identifying and measuring progress toward the strategy
Timely adjustments in strategy when necessary
Fosters a culture of ethical behavior that includes effective compliance programs, strong auditing, and financial controls
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
102
3. Leadership and development of the management team

Succession planning in place at higher levels that includes an effective plan for developing candidates for the long term
Turnover of management
Energy of management team
Motivates and inspires employees to realize the companys vision
Effective role mode for the organization
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
4. Relationship with the board

Keeps the board fully informed of important aspects of the company
Practices and encourages open, honest, and timely communication
Effective presentations
Ability to raise and explain key issues
Ability to draw on past experiences in issues facing the corporation
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
Section B: Performance to (Company) values

The CEO should set the tone by role modeling (Company) values. Please consider the CEOs strengths, areas for development as well as the factors listed below. Provide relevant examples when possible.
1. Results Orientation
Sets challenging and competitive goals
Focuses on output
Assumes responsibility
Constructively confronts and solves problems
Executes flawlessly
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
103
2. Risk Taking
Fosters innovation and creative thinking
Embraces change and challenges the status quo
Listens to all ideas and viewpoints
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
3. Discipline
Conducts business with uncompromising integrity and professionalism
Makes and meets commitments
Properly plans, funds, and staff projects
Learns from our successes and mistakes
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
4. Quality
Strives to achieve the highest standards of excellence
Does the right things right
Continuously learns, develops, and improves
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
5. Customer Orientation
Listens and responds to our customers, suppliers, and stakeholders
Clearly communicates mutual intentions and expectations
Delivers innovative and competitive products and services
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
104
6. Great Place to Work

Style: open and direct
Works as member of a team with respect and trust for each other
Recognizes and rewards accomplishments
Manages performance fairly and firmly
Makes (Company) an asset to our communities worldwide
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
Section C: Overall Summary.

1. Greatest strength as a CEO
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
2. Major highlights and lowlights of the past 12 months

___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
3. Words of advice to the CEO

___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
4. Overall Performance
Grade (check one)
q Outstanding
q Good
q Needs Improvement
___________________________________________________________________________________________________________________________
___________________________________________________________________________________________________________________________
105
Appendix 7
Sample Audit Committee Charter and Responsibilities Checklist

(Microsoft Corporation)
Microsoft Corporation Audit Committee Charter
As part of the commitment of the Company and the Board of Directors to good governance practices, the Audit Committee
regularly reviews its charter and recommends to the Board changes to the charter. The Board adopted changes to the charter in
August 2002, in part to take into account the adoption of the Sarbanes-Oxley Act of 2002.
Role
Education
The Audit Committee of the Board of Directors assists the

Board of Directors in fulfilling its responsibility for oversight of
the quality and integrity of the accounting, auditing, and reporting practices of the company, and such other duties as directed
by the Board. The Committees role includes a particular focus
on the qualitative aspects of financial reporting to shareholders,
and on the companys processes to manage business and financial risk, and for compliance with significant applicable legal,
ethical, and regulatory requirements. The Committee is directly
responsible for the appointment, compensation, and oversight
of the public accounting firm engaged to prepare or issue an
audit report on the financial statements of the company.
The company is responsible for providing the Committee with

educational resources related to accounting principles and procedures, current accounting topics pertinent to the company
and other material as may be requested by the Committee. The
company shall assist the Committee in maintaining appropriate
financial literacy.
Membership
Responsibilities
The membership of the Committee shall consist of at least

three directors who are generally knowledgeable in financial
and auditing matters, including at least one member with
accounting or related financial management expertise. Each
member shall be free of any relationship that, in the opinion of
the Board, would interfere with his or her individual exercise of
independent judgment. Applicable laws and regulations shall be
followed in evaluating a members independence. The chairperson shall be appointed by the full Board.
The Committees specific responsibilities in carrying out

its oversight role are delineated in the Audit Committee
Responsibilities Checklist. The responsibilities checklist will be
updated annually to reflect changes in regulatory requirements,
authoritative guidance, and evolving oversight practices. As the
compendium of Committee responsibilities, the most recently
updated responsibilities checklist will be considered to be an
addendum to this charter.
Communications/Reporting
The public accounting firm shall report directly to the
Committee. The Committee is expected to maintain free and
open communication with the public accounting firm, the internal auditors, and the companys management. This communication shall include private executive sessions, at least annually,
with each of these parties. The Committee chairperson shall
report on Audit Committee activities to the full Board.
106
Authority
In discharging its oversight role, the Committee is empowered to
investigate any matter brought to its attention, with full power to
retain outside counsel or other experts for this purpose.
The Committee relies on the expertise and knowledge of management, the internal auditors, and the public accounting firm
in carrying out its oversight responsibilities. Management of the
company is responsible for determining the companys financial
statements are complete, accurate, and in accordance with generally accepted accounting principles. The public accounting
firm is responsible for auditing the companys financial statements. It is not the duty of the Committee to plan or conduct
audits, to determine that the financial statements are complete
and accurate and are in accordance with generally accepted
accounting principles, to conduct investigations, or to assure
compliance with laws and regulations or the companys internal
policies, procedures, and controls.
MICROSOFT CORPORATION
Audit Committee Responsibilities Checklist
WHEN PERFORMED
Winter
Audit Committee Meetings

Spring Summer Fall
A/N*
1. The Committee will perform such other functions as assigned by law,

the Companys charter or bylaws, or the Board of Directors.
2. The Committee shall have the power to conduct or authorize investigations into any
matters within the Committees scope of responsibilities. The Committee shall be
empowered to retain independent counsel, accountants, or others to assist it in
the conduct of any investigation.
3. The Committee shall meet four times per year or more frequently as circumstances
require. The Committee may ask members of management or others to attend
the meeting and provide pertinent information as necessary.
4. The agenda for Committee meetings will be prepared in consultation

between the Committee chair (with input from the Committee members),
Finance management, the General Auditor and the public accounting firm.
5. Provide an open avenue of communication between the internal auditors,

the public accounting firm, Finance management and the Board of Directors.
Report Committee actions to the Board of Directors with such recommendations
as the Committee may deem appropriate.
6. Review and update the Audit Committee Responsibilities Checklist annually.
7. Provide a report in the annual proxy that includes the Committees review and
discussion of matters with management and the independent public accounting firm.
8. Include a copy of the Committee charter as an appendix to the proxy statement

at least once every three years.
9. Appoint, approve the compensation of, and provide oversight of the
public accounting firm.
10. Review and approve the appointment or change in the General Auditor.
11. Confirm annually the independence of the public accounting firm, and
quarterly review the firms non-audit services and related fees.
12. Verify the Committee consists of a minimum of three members who are
financially literate, including at least one member who has financial sophistication.
* As needed
107
WHEN PERFORMED
Winter

Spring Summer Fall
13. Review the independence of each Committee member based on

NASD and other applicable rules.
A/N*
14. Inquire of Finance management, the General Auditor, and the public
accounting firm about significant risks or exposures and assess the steps
management has taken to minimize such risk to the Company.
15. Review with the General Auditor, the public accounting firm and
Finance management the audit scope and plan, and coordination of audit
efforts to assure completeness of coverage, reduction of redundant efforts,
the effective use of audit resources, and the use of independent public
accountants other than the appointed auditors of MS.
16. Consider and review with the public accounting firm and the General Auditor:
a. The adequacy of the Companys internal controls including computerized
information system controls and security.
b. Any related significant findings and recommendations of the independent public

accountants and internal audit together with managements responses thereto.
17. Review with Finance management any significant changes to GAAP and/or
MAP policies or standards.
18. Review with Finance management and the public accounting firm
at the completion of the annual audit:
a. The Companys annual financial statements and related footnotes.

b. The public accounting firms audit of the financial statements and its report thereon.
c. Any significant changes required in the public accounting firms audit plan.
d. Any serious difficulties or disputes with management encountered during
the course of the audit.
e. Other matters related to the conduct of the audit which are to be communicated
to the Committee under generally accepted auditing standards.
19. Review with Finance management and the public accounting firm
at least annually the Companys critical accounting policies.
20. Review policies and procedures with respect to transactions between
the Company and officers and directors, or affiliates of officers or directors,
or transactions that are not a normal part of the Companys business.
21. Consider and review with Finance management and the General Auditor:
a. Significant findings during the year and managements responses thereto.
b. Any difficulties encountered in the course of their audits, including any
restrictions on the scope of their work or access to required information.
c. Any changes required in planned scope of their audit plan.
108
X
X
WHEN PERFORMED
Winter

Spring Summer Fall
22. The Chairman of the Audit Committee will participate in a telephonic

meeting among Finance management and the public accounting firm
prior to earnings release.
23. Review the periodic reports of the Company with Finance management,
the General Auditor and the public accounting firm prior to filing of
the reports with the SEC.
24. In connection with each periodic report of the Company, review
A/N*
a. Managements disclosure to the Committee under Section 302

of the Sarbanes-Oxley Act.
b. The contents of the Chief Executive Officer and the Chief Financial Officer
certificates to be filed under Sections 302 and 906 of the Act.
25. Review filings (including interim reporting) with the SEC and other published
documents containing the Companys financial statements and consider whether
the information contained in these documents is consistent with the information
contained in the financial statements before it is filed with the SEC or other regulators.
26. Monitor the appropriate standards adopted as a code of conduct for

Microsoft Corporation. Review with Finance management and Legal and
Corporate Affairs the results of the review of the Companys monitoring compliance
with such standards and its compliance policies.
27. Review legal and regulatory matters that may have a material impact on the
financial statements, related Company compliance policies, and programs
and reports received from regulators.
28. Meet with the public accounting firm in executive session to discuss
any matters that the Committee or the public accounting firm believe
should be discussed privately with the Audit Committee.
29. Meet with the General Auditor in executive sessions to discuss
any matters that the Committee or the General Auditor believe
30. Meet with Finance management in executive sessions to discuss

any matters that the Committee or Finance management believe
* As needed
109
Appendix 8
KPMG Audit Committee Institute

Basic Principles for Audit Committees
Recognize that the dynamics of each company, board, and

audit committee are uniqueone size does not fit all.
The organization and operational approach followed by any
audit committee should take into account the unique aspects of
the organizational and governance structures of the company
that the committee serves.
In addition, the delegation of responsibilities to an audit committee by the board of directors must be explicit and responsive
to the needs and culture of the company and the board as a
whole.
The basic responsibilities of an audit committee are to oversee
the financial reporting process of the company as implemented
and maintained by management, including risks and controls
related to that process, and the internal and external auditors
roles and responsibilities within the financial reporting process.
The audit committee should not be overloaded with activities or
the committee may (1) lose sight of its major objectives or (2)
perform its duties superficially.1
Once delegated, the ongoing support of the board for the activities of the audit committee, including appropriate management
interaction, is critical.
110
The board must ensure the audit committee comprises the

right individuals to provide independent and objective
oversight.
It is the responsibility of the board of directors to ensure that
audit committee members are independent, financially literate,
and have the characteristics to serve as effective audit committee members.
The 1987 Report of the National Commission on Fraudulent
Financial Reporting (known as the Treadway Commission
Report) captured the basic attributes that every audit committee should possess. The audit committee must be informed, vigilant, and effective overseers of the financial reporting process.
To have those attributes, the individual members of the committee must possess certain characteristics. First, the individual
should have a general understanding of the companys major
economic, operating, and financial risks. In addition, the individual should have a broad awareness of the interrelationship of
the companys operations and its financial reporting. Further,
the audit committee member should understand the difference
between the oversight function of the committee and the decision-making function of management.
Audit committee members must have the ability to formulate
and ask probing questions about the companys financial
reporting process. According to the 1999 Blue Ribbon
Committee on Improving the Effectiveness of Corporate Audit
Committees (Blue Ribbon Committee), a members ability to ask
and intelligently evaluate the answers to the necessary questions hinges on intelligence, diligence, a probing mind, and
financial literacy. In fact, perhaps the most important characteristic of a good audit committee member is a willingness to challenge management when necessary. This is the essence of
independence.
Frank M. Burke and Dan M. Guy, Audit Committees: A Guide for

Directors,Management, and Consultants, 2nd edition (New York:
Aspen Publishers, Inc., 2002), p. 117.
The board and audit committee must continually assert that,

and assess whether, the tone at the top embodies insistence
on integrity and accuracy in financial reporting.
The company must have the right tone at the top. What is the
right tone at the top from the perspective of the audit committee and its oversight of the financial reporting process?
The audit committee, as a check and balance on management,
is the guardian of the companys financial reporting integrity.
Thus, in establishing the right tone, according to Michael R.
Young, a litigation partner of Willkie Farr & Gallagher and counsel to the American Institute of Certified Public Accountants,
the company must have an unrelenting insistence:
on accuracy in financial reporting;

that numbers and financial statements not be massaged or
manipulated; and
on truthfulness as the foremost objective of the company.
Young says, It is a tone that makes financial misreporting
unthinkable.2
The audit committee must demand and continually reinforce

the ultimate accountability of the external auditor to the
board and audit committee as representatives of
shareholders.
The ultimate accountability of the external auditor to the board
and the audit committee must be more than words in the audit
committee charter. The audit committee, external auditor, and
senior management must all acknowledge this reporting relationship and allegiance by their actions and deeds.
Audit committees must implement a process that supports

their understanding and monitoring of the:
specific role of the audit committee in relation to
the specific roles of the other participants in the
financial reporting process (oversight);
critical financial reporting risks;
effectiveness of financial reporting controls;
independence, accountability, and effectiveness
of the external auditor; and
transparency of financial reporting
The audit committee process provides a framework for coordinating the activities of, and information provided by, the participants in the financial reporting process that support the audit
committees understanding, and monitoring, of the key risks
and controls related to the companys financial reporting
process. A strong audit committee process allows a company,
including its shareholders, to benefit from the collective insight
and experience of each member of the committee.
The Blue Ribbon Committee described the participants in the
financial reporting process as a three-legged stool of responsible disclosure and active oversight. The three legs are (1) management, including internal audit, (2) the independent external
auditor, and (3) the audit committee. The audit committee must
not only understand the specific and unique roles that each
leg plays in the financial reporting process but also hold these
participants accountable to the board and the audit committee.
When a company establishes an audit committee and the board
delegates oversight of the financial reporting process to the
committee, implicit in that delegation decision is that the audit
committee is thereby assigned oversight responsibility for financial reporting risks (including fraud risks) and controls related
to those risks. Therefore, the audit committee must have an
understanding of (1) significant risks related to financial reporting reliability and (2) the controls that the company has established to address those risks.
With a well-defined process predicated on an understanding of
the specific roles of management, including the internal auditor
and the external auditor, the audit committee will have established the framework within which to exercise effective oversightlisten, ask, assess, and challenge.
Michael R. Young, Accounting Irregularities and Financial Fraud,

2nd edition (New York: Aspen Publishers, Inc., 2002), p. 231.
Source: KPMG LLP, Basic Principles for Audit Committees, 2002.
111
Appendix 9
Excerpt from Internal Control: Guidance for Directors on the Combined Code
Report by The Institute of Chartered Accountants in England and Wales
Assessing the effectiveness of the companys risk and control processes
Some questions which the board may wish to consider and discuss with management when regularly reviewing reports
on internal control and carrying out its annual assessment are set out below. The questions are not intended to be
exhaustive and will need to be tailored to the particular circumstances of the company.
This Appendix should be read in conjunction with the guidance set out in this document.
Risk assessment
Does the company have clear objectives and have they been
communicated so as to provide effective direction to
employees on risk assessment and control issues? For
example, do objectives and related plans include measurable
performance targets and indicators?
Are the significant internal and external operational, financial,
compliance, and other risks identified and assessed on an
ongoing basis? (Significant risks may, for example, include
those related to market, credit, liquidity, technological, legal,
health, safety and environmental, reputation, and business
probity issues.)
Is there a clear understanding by management and others
within the company of what risks are acceptable to the board?
112
Control environment and control activities

Does the board have clear strategies for dealing with the
significant risks that have been identified? Is there a policy on
how to manage these risks?
Do the companys culture, code of conduct, human resource
policies, and performance reward systems support the
business objectives and risk management and internal control
system?
Does senior management demonstrate, through its actions as
well as its policies, the necessary commitment to competence,
integrity, and fostering a climate of trust within the company?
Are authority, responsibility, and accountability defined clearly
such that decisions are made and actions taken by the
appropriate people? Are the decisions and actions of different
parts of the company appropriately co-ordinated?
Does the company communicate to its employees what is
expected of them and the scope of their freedom to act? This
may apply to areas such as customer relations; service levels
for both internal and outsourced activities; health, safety, and
environmental protection; security of tangible and intangible
assets; business continuity issues; expenditure matters;
accounting; and financial and other reporting.
Do people in the company (and in its providers of outsourced
services) have the knowledge, skills, and tools to support the
achievement of the companys objectives and to manage
effectively risks to their achievement?
How are processes/controls adjusted to reflect new or
changing risks or operational deficiencies?
Information and communication

Do management and the board receive timely, relevant, and
reliable reports on progress against business objectives and
the related risks that provide them with the information, from
inside and outside the company, needed for decision-making
and management review purposes? This could include
performance reports and indicators of change, together with
qualitative information such as on customer satisfaction,
employee attitudes, etc.
Are information needs and related information systems
reassessed as objectives and related risks change or as
reporting deficiencies are identified?
Are periodic reporting procedures, including half-yearly and
annual reporting, effective in communicating a balanced and
understandable account of the companys position and
prospects?
Are there established channels of communication for
individuals to report suspected breaches of laws or regulations
or other improprieties?
Monitoring
Are there ongoing processes embedded within the companys
overall business operations, and addressed by senior
management, which monitor the effective application of the
policies, processes, and activities related to internal control
and risk management? (Such processes may include control
self-assessment, confirmation by personnel of compliance
with policies and codes of conduct, internal audit reviews, or
other management reviews).
Do these processes monitor the companys ability to reevaluate risks and adjust controls effectively in response to
changes in its objectives, its business, and its external
environment?
Are there effective follow-up procedures to ensure that
appropriate change or action occurs in response to changes in
risk and control assessments?
Is there appropriate communication to the board (or board
committees) on the effectiveness of the ongoing monitoring
processes on risk and control matters? This should include
reporting any significant failings or weaknesses on a timely
basis.
Are there specific arrangements for management monitoring
and reporting to the board on risk and control matters of
particular importance? These could include, for example, actual
or suspected fraud and other illegal or irregular acts, or matters
that could adversely affect the companys reputation or
financial position.
Source: The Institute of Chartered Accountants in England and Wales, Internal

Control: Guidance for Directors of the Combined Code (London: Accountancy Books,
1999), pp. 13-14.
113
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Corporate Governance Best Practices: A Blueprint for the Post-Enron Era

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