1. Understanding Opportunities & Liabilities in the Current Governance Environment Holly J. Gregory Washington, DC March 14, 2006

2. Pressures for Greater Accountability Corporate Boards & Senior Management  ISS  Governance Metrics  International Corp. Governance Network  Corporate Library  Sustainability indices (e.g., Dow Jones)  Shareholder suits (e.g., Abbott, Oracle, Caremark, Disney)  State Attorneys General  Increased criminalization of certain corporate activities Courts & Legal Governance Rating Standards  Fund managers (e.g., Calpers, TIAA- CREFF)  Labor (e.g., AFL-CIO)  Non-Governmental organizations (e.g., bioethics) Stakeholder/ Advocacy Courts are developing heightened standards of due care and good faith  Credit Rating services  Equity analysts  Insurance underwriting standards Capital Markets The primary focus to date has been on regulatory and legal compliance and on board structure  Sarbanes-Oxley Act  SEC  NYSE/ Nasdaq  Heightened disclosure/ Reg. FD  FDA Regulatory Heightened Media Scrutiny

3. Central Role of the Board: Directing the Affairs of the Company  Forward looking – strategic positioning  Backward looking – monitoring corporate performance & compliance  adjustments in strategy / executive leadership?

4. Requires Board Understanding of “SWOT” ORGANIZATIONALENVIRONMENTAL S trengths W eaknesses T hreats O pportunities STRATEGIC CHOICES

5. Compliance Is Necessary but Not Sufficient  Corporate crises often occur under the watch of honest directors whose downfall is simply not knowing  In an environment of heightened expectations: boards cannot fulfill their duties without relevant and timely information about strategy and risks due care, loyalty and good faith

6. Booz Allen Hamilton Study  Shareholder value lost (1999-2003):  Compliance failures: 13%  Strategic / Operational failures: 87%

7. 2005 McKinsey Survey  Directors want to:  Focus more on the long-term health of the company – developing corporate strategy  Spend less time on audit, compliance and compensation

8. 2005 McKinsey Survey  Directors want more information about:  market health (70%);  the state of the organization (50%);  the nature & level of regulatory risk (40%);  public, media & community attitudes toward the company (40%).

9. 2005 McKinsey Survey  Limited board understanding of company’s:  current strategy: 30% of directors  long-term prospects: > 50% of directors

10. The Independence Paradox More directors without relationships to the company means more dependence on management for information

11. Key Board Responsibility Figure out – Given unique circumstances of the company – What the board should focus on and in what priority.

12. Cadbury Principle Board should attend to those things that senior executives cannot, due to inherent conflict.

13. Board Focus  Setting expectations about the tone and culture of the company.  Ensuring that management has and exhibits integrity.  Formulating with management corporate strategy.  Ensuring that the corporate culture, the agreed strategy, management incentive compensation, and the company’s approach to audit and accounting, internal controls and disclosure are consistent and aligned.  Understanding the expectations of shareholders and regulators.  Responding quickly and responsibly to corporate problems as they arise.

14. The Evolving Duty of Good Faith  Director passivity regarding agenda issues and information needs is dangerous:  Disney  directors adopted a “we don’t care about the risks” attitude  Abbott Labs  directors failed to act “in conscious disregard of a known risk” WARNING: Director passivity regarding agenda issues and information is dangerous.

15. The New [?] Governance Environment It is an “elementary fact that relevant and timely information is an essential predicate for satisfaction of the board’s supervisory and monitoring role under Section 141 of the Delaware General Corporation Law.” - In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, Del. Ch. 1996 It is an “elementary fact that relevant and timely information is an essential predicate for satisfaction of the board’s supervisory and monitoring role under Section 141 of the Delaware General Corporation Law.” - In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, Del. Ch. 1996

16. Disney Decision Post Trial  No Liability: each director “fulfilled... obligation to act in good faith and with honesty of purpose” – no intent to shirk duties  Business Judgment Rule Alive and Well  Aspirational Standards ≠ Liability (Fiduciary Duty) Standards  Post-Reform Standards Don’t Apply to Pre-Reform Behavior  Breach of Duty of Good Faith Appears to Require Intentional Failure

17. Key Federal Liability Concerns Directors can be personally liable under federal securities laws – even without intentional wrongful conduct.  Classic federal securities claims such as fraud and insider trading require intentional wrongful conduct  However, a claim for registration statement liability does not

18. In Re: WorldCom, Inc. Securities Litigations No Summary Judgment for WorldCom Director:  Due diligence and good faith defenses not established for summary judgment purposes:  factual issues remain concerning director’s level of investigation  and whether director should have recognized “red flags” given his expertise in the industry (S.D.N.Y. March 21, 2005)

19. WARNING WorldCom settlement reminds that a director of a public company always has personal assets at risk... even with maximum available  indemnification,  D&O insurance and  exculpatory charter provisions Key: Board Process – and Best Practice

20. Board Practices to Help Avoid Liability: Foundation  Assess:  management integrity  quality of fellow directors  own interest and time  Know the business and strategy  Understand  controls  legal obligations  disclosures

21. Board Practices to Help Avoid Liability: Process  Focus on the agenda and information flow  Attend – prepared to participate actively and skeptically  Review minutes  Hold executive sessions  Require updates

22. Board Practices to Help Avoid Liability: Process  Understand what you sign and review carefully all proposed public filings  Give special care to:  registration statements  interested party transactions  other conflicts  Rely on experts, as appropriate  Embrace best practice  Resist complacency