Agenda
August 13, 2007
Facing increasing shareholder scrutiny and forced by the SEC to disclose more about the business dealings their companies have with directors, boards are reforming their policies for allowing so-called related-party transactions and the disclosure of them.
Bob Evans Farms, for one, eliminated, or is in the process of eliminating, three of its related-party transactions between the restaurant chain and companies its board members are affiliated with. Two of the relationships were terminated because of shareholder concerns about conflicts of interest, while the other relationship is being terminated because Bob Evans found a cheaper supplier. “The business at stake was minimal and we wanted to avoid the appearance of impropriety,” says Mary Garceau, general counsel at Bob Evans.
Meanwhile, the board of Dominion Resources has approved new written guidelines for related-party transactions. The new guidelines require the corporate secretary to at least annually distribute a questionnaire to directors and executive officers to identify potential conflicts of interest. Results are evaluated by the general counsel and reported to the compensation, governance and nominating committee. In any case where the committee decides not to ratify a related-party transaction, the matter may be referred to legal counsel. This could result in the termination of a transaction.
The momentum to reform related-party deals is a marked change from years past. Before Sarbanes-Oxley, companies touted the benefits of having directors on the board that were affiliated with other companies they did business with. They argued that these inside relationships made better, more informed and interested directors.
Now, companies want to be able to stand up to shareholder scrutiny of potential conflicts of interest and cozy financial deals, real or perceived.
What is happening at these companies is substantive and symbolic, says James Post, a business professor at Boston University. Eliminating the appearance of conflicts of interest between directors and the company falls into SEC compliance but also “sends a signal to investors about the commitment of the board.”
New disclosure rules passed last summer in some ways increased the scope of reportable related-party transactions and in other ways narrowed them. The threshold for reporting transactions increased from $60,000 to $120,000. But many experts say that is a negligible change because most related-party transactions of any significance are more than $120,000. Plus, many companies are voluntarily choosing to report transactions less than $120,000.
Yet, the new disclosure requirements were intended to be more principles-based and require disclosure for direct or indirect material-interest relationships. Disclosure is also required for any relationships that were considered when determining whether a director is independent.
After the SEC passed the new disclosure rules, Bob Evans reevaluated its related-party transaction policies and how it disclosed the transactions. The company decided to have the nominating and governance committee — rather than the audit committee — review potential conflicts of interest among the board. The audit committee had a full plate and the nom-gov committee was already responsible for reviewing board independence.
Bill Ide, partner with McKenna, Long & Aldridge and a director of AFC Enterprises and Albemarle, believes most of the motivation behind reform of related-party transactions is fueled by director independence requirements as well as liability fears.
Regardless of what is causing the reform, boards would be wise to look closely at their insider relationships. There is the potential for shareholders to scrutinize these transactions with the same fervor as executive compensation packages.
Just take the recent example of Commerce Bank. Under pressure from investors and regulators, the board fired CEO and Chairman Vernon Hill in June after being criticized for doing business with Hill’s family and other insiders.
“These related-party transactions have become a distraction,” said CFO Douglas Pauls in a conference call after the announcement.
Commerce promised to end real estate and vendor deals with company insiders and review prior deals.