Richard Breeden, the court-appointed corporate monitor for WorldCom Inc., Aug. 26 filed a report laying out 78 corporate governance requirements for the company, including new rules for director selection and board operation, as well as limits on executive compensation.

Accounting and corporate failures at WorldCom last year resulted in the largest corporate fraud in history. The Breeden report, Restoring Trust, aims to correct the company's problems at the root. WorldCom is in bankruptcy proceedings and a hearing on its reorganization plans is set for Sept. 8.

The report was submitted to Judge Jed Rakoff of the U.S. District Court for the Southern District of New York.

Under the company's recent settlement with the Securities and Exchange Commission, WorldCom, which is changing its name to MCI, must implement the report's recommendations unless the court provides a specific waiver (35 SRLR 1183, 7/14/03).

In a statement issued Aug. 26, MCI said that its board of directors unanimously approved the adoption of all recommendations a week earlier.

Record SEC Settlement.

On July 7, Rakoff approved a record SEC settlement with WorldCom under which the company will pay $500 million in cash and $250 million in stock into a trust for victims (35 SRLR 1183, 7/14/03). The commission had alleged that WorldCom misled investors by overstating its income from at least as early as 1999 through the first quarter of 2002, as a result of undisclosed and improper accounting.

According to the court, the "company's income [was] overstated by an estimated $11 billion, its balance sheet overstated by more than $75 billion, and the loss to shareholders estimated at as much as $200 billion."

MCI Chairman and Chief Executive Officer Michael Capellas said that Breeden's report "not only sets new standards for good corporate governance but also establishes a roadmap that helps us build our foundation for the future."

"The company has already implemented many of the proposed corporate reforms," he added, "but we know we have to do even more to regain public trust."

Breeden said in the report's executive summary, "The totality of the governance system at MCI as a result of implementing all the recommendations of Restoring Trust will be a set of policies and procedures that go beyond what any major public company has in place today."

Executive Compensation.

In what the report called "an important shift of power from the board to the shareholders," most of the company's governance standards "are to be placed in the Articles where they can only be changed with prior shareholder consent."

On compensation, Breeden stipulated that no executive can be paid more than $15 million (or a lower amount set by the board) in any year, including cash, equity grants, and all other forms of remuneration, without a vote of the shareholders. "Most 'retention' grants are banned, maximum dollar limits are placed on severance awards, and so-called 'evergreen' contracts are prohibited. All personal use of corporate aircraft and other corporate assets is prohibited," the report said.

Board members are slated to receive a base pay of $150,000 a year and will have to use 25 percent of their salary to buy stock.

These directives are intended to right the compensation abuse at WorldCom, which, the report said, is "most vividly symbolized" by more than $400 million in board-approved "loans" from shareholders to former WorldCom Chief Executive Officer Bernard Ebbers.

Breeden outlined new procedures for nominating directors and required the election of one new director each year. A group of shareholders that does not agree with proposed candidates to fill board vacancies will have the power to nominate its own candidates for inclusion in the management proxy statement, creating a contested election.

Serving on Multiple Boards.

With the exception of the chief executive, all of the members of the board will have to meet strict independence requirements. The chief executive officer will not be allowed to sit on other corporate boards, the report said, and the independent directors will be limited to sitting on a maximum of two other boards.

In addition, no director will be permitted to serve more than 10 years and one board member must be replaced annually. This is to be done in a manner determined by the board or, otherwise, through the drawing of lots by the directors.

The full board will be required to meet at least eight times each year and to hold an annual strategic review. Among other requirements, the board will have to meet at least annually with the chief financial officer and general counsel independently of the CEO. Further, the board will be obligated to meet for some portion of each meeting without the presence of the CEO or any other company employee.

One of the recommended restrictions that MCI said it had previously agreed to was the prohibition on stock option compensation to board members and executives. Consistent with the report, MCI will issue restricted stock instead.

Non-Executive Chairman.

Other directives of the report contemplate that MCI will:

• create the position of non-executive chairman of the board to coordinate the board's work, chair meetings, organize CEO and board performance reviews, and similar tasks;

• establish an electronic "town hall" where shareholders can communicate freely with the board and propose resolutions for consideration regardless of whether the proposed resolution would be allowed under SEC proxy regulations;

• work to develop enhanced reports of cash flows and to publish a target dividend policy in which dividends will be not less than 25 percent of net income annually;

• strengthen the role of the general counsel's office, enhance existing ethics standards and programs, and enhance legal compliance standards; and

• adhere to limits on the types of change in control devices that the board can use, including a ban on "dead hand" poison pills and a staggered board.

Looking at the board's role in the company's blow-up, Breeden concluded, "While it is not clear that the independent directors could have discovered the fraud, WorldCom's board didn't do many things that might have prevented or limited the tragedy." He cited the board for inadequate involvement with the company and its personnel, and for infrequent meetings and an inadequate amount of time spent in the meetings and in decision-making processes. "This was sufficient for blind ratification of actions, but not sufficient for informed, independent decision making," the report said.

Too Little Time Spent.

As reported by the bankruptcy examiner, Breeden related, "the Audit Committee spent as little as three to six hours per year in overseeing the activities of a company with more than $30 billion in revenue, while the WorldCom Compensation Committee met as often as 17 times per year."

The board's "worst failing," however, according to the report, was that Ebbers "ran the Company with iron control, and the board did not establish itself as an independent force within the Company." Breeden also reported, "The failures of governance allowed the reckless pursuit of wealth by the CEO, and his domination of compensation decisions throughout the Company."

Another area marking the board's downfall was the striking absence of meaningful involvement in risk assessment of liquidity risks, control risks, and risks in either the traditional telephony or data markets. The report observed that WorldCom "was betting tens of billions of investment dollars predicated on executives' wild guesses about internet growth."

The SEC sued WorldCom on June 26, 2002, the day after the company announced that it intended to restate its financial results for five quarters--all of 2001 and the first quarter of 2002 (34 SRLR 1065, 7/1/02). A week later, at the SEC's request, the court appointed Breeden, a former SEC chairman, as corporate monitor (34 SRLR 1118, 7/8/02).

On Nov. 26, 2002, the commission obtained a judgment imposing a permanent injunction against WorldCom (34 SRLR 1965, 12/9/02). In addition, the judgment ordered WorldCom to review its corporate governance and internal controls, and to establish certain legal compliance programs for WorldCom officers and employees.

By Rachel McTague