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I need to add a director to my board… Any problem?
by Chris Bull

You are a publicly traded company with a need to add an independent director to your board. Oh by the way, this individual needs to meet all of the requirements to be the Financial Expert on your audit committee, even though there is no definitive statement on what that means. It is guaranteed that this will be more difficult than first imagined. Let's discuss why.

Finding an individual that meets the requirements set out by Sarbanes-Oxley and the other Self Regulatory Organizations ("SRO's"), adds substantial value to the board, and has a desire to take on the role meeting the deadline of April 26, 2003 could create a time crunch.

• There is no "Safe Harbor" here. The Sarbanes-Oxley Act intentionally creates vagueness giving the issuer no "bright line test" to determine whether a candidate is qualified for the role as the financial expert. Summed up, the financial expert must have:

1. An understanding of GAAP and financial statements.

2. Familiarity with preparation or auditing of financial statements of companies generally comparable to the issuer.

3. Familiarity with application of GAAP in connection with accounting estimates, accruals and reserves.

4. Familiarity with internal accounting controls.

• The fact that a person has experience as a CPA or has held the position of CFO, Controller or a similar position would not, by itself, justify the board's determination that he or she is a "financial expert." The Board must confirm that the person has the requisite attributes and the right mix of education and industry-specific experience.

• Insurance carriers providing D&O insurance protecting directors and officers of a corporation have always had the right to rescind coverage in the event of a restatement of earnings. This is true for reasons of misconduct or simply for a technical error. In the current environment, this leaves directors and officers extremely vulnerable to public litigation. New, non-rescindable policies are now available through most of the carriers and should be examined.

• There appears to be a sense of denial among board members as it relates to the definition of "Independence." The various reform acts have put a more rigorous definition of independence on the audit committee members versus other committee members or board members as a whole. Payment for directorial services must be the sole remuneration for audit-committee members. Disallowed compensation includes fees paid for services as a consultant or a legal or financial advisor. There is no restriction as to form of compensation.

• It is estimated that the average time commitment of an individual sitting on the audit committee could increase five fold, going from an average of 50 hours a year to 250 hours a year. What type of compromise is an individual working fulltime as a CFO or CPA going to make to consider taking on this type of time obligation?

• Sarbanes-Oxley lays out that not only does this individual need to meet the criteria to be considered a financial expert, he/she needs to come from an industry similar to that of the issuer (company) that they are asked to serve.

• The figures are just now starting to be released, but it is expected that the cash compensation needed to secure such an individual will increase substantially. Again, this is an individual that brings value to the board, meets the financial expert requirements, comes from a similar domain space and has the available time to take on the duties. It is estimated that the cash compensation will increase from an average of $30,000/yr. to an average approaching $100,000/yr.

The challenge to identify qualified candidates for this director role is simply the beginning. In all reality, you will need to identify several top quality candidates in order to close on one, given the current state of corporate governance reform. The days of a taking on a "sexy" board seat with a public company have been replaced by evaluating "work reward calculus," or the benefits of taking on the duties of a director.

Retained executive search firms are currently active with engagements to fill vacated board seats, or to identify individuals that must be added in order to satisfy all the requirements discussed above. The days of utilizing internal networks to bring in qualified director level talent may be gone for at least the near term leading up to the April 26th deadline.

For questions relating to this subject matter, please contact Chris Bull, Managing Director at McDermott & Bull.