SEC Changes the Game on CEO Succession

03/18/2010 05:12 am ET | Updated May 25, 2011

It's no secret that a number of companies have had CEO succession issues, notably the Bank of America, which clearly was missing an emergency back up plan when CEO Ken Lewis surprised the board with his intention to leave by the end of the year. Given the general concern about how banks and corporations are managing risk, the issues have broadened beyond financial risk to the quality of leadership in place in public companies. You don't need an MBA to know that not having a strong and effective CEO is a major risk.

A number of factors have raised the bar on involvement of the board of directors in matters that used to be seen as "management's responsibility." Good governance now demands the board's ownership of succession planning, particularly for the CEO position. And the Securities and Exchange Commission has recently decided that aspects of succession can be disclosed to shareholders. Boards who want to get ahead of the curve need to be more proactive in their communication about their plans before being forced to disclose by a shareholder resolution.

The SEC issued a legal bulletin on October 27, "No. 14E on Shareholder Proposals," which reverses their former position that enabled companies to exclude shareholder proposals that focus on CEO succession planning as well as other issues related to how a company is managing risk. The SEC's stance for years was that succession planning activities fall within the normal course of company business and that companies need not disclose their plans. The SEC recently helped Whole Foods, Verizon and others firmly push away shareholders' requests to open Pandora's Box on CEO succession.

According to their bulletin,

one of the board's key functions is to provide for succession planning so that the company is not adversely affected due to a vacancy in leadership. Recent events have underscored the importance of this board function to the governance of the corporation. We now recognize that CEO succession planning raises a significant policy issue regarding the governance of the corporation that transcends the day-to-day business matter of managing the workforce.

In other words, shareholders can now challenge the board to learn more about plans for CEO succession. Companies are encouraged to adopt and disclose written and detailed CEO succession planning policies with specific features: criteria for the CEO position, identification and development of internal candidates and the use of a formal assessment process to evaluate candidates. And while management will play a role in creating these plans and processes, it's clear that the board will be held accountable for them.

This is one more action that will make it less likely that the CEO can populate the board with good old boys who will abdicate responsibility for leadership at the top and leave it in the hands of management. This new policy stance is also related, undoubtedly, to the SEC's recent history (pre-Obama) of being caught asleep at the wheel when many companies with public securities behaved irresponsibly in the overall matter of enterprise risk management. Mary Schapiro's team is taking positive steps to bring the proxy rules in line with its mission to protect investors, maintain fair, orderly, and efficient markets, and serve the public good.

A 2009 survey by the National Association of Corporate Directors (NACD) of over 600 respondents who serve on or work with boards of US public companies revealed these startling statistics:

• 43% have no formal CEO succession plan
• 61% have no CEO-replacement plan in an emergency
• 61% have no internal candidate development plan
• 67% have no long-term (five year) succession plan

The level of transparency regarding successors currently varies: Coca-Cola, Best Buy and Xerox have had or are planning very public transitions to new leaders, with future CEO choices communicated well in advance of the transition. Other companies have communicated a process but have refused to disclose names of potential successors, including Berkshire Hathaway. It's not clear yet that this new stance by the SEC will open the doors to greater transparency regarding candidates in all public companies.

So what are the best practices that companies should be following? Bruce Sherman, CEO and Founder of Integral Advisors, a consultancy that works with boards to assess areas of risk and opportunity for succession and executive leadership, had this to say:

Stakeholders, including the SEC, FDIC, Investors and rating agencies are paying much closer attention to leadership issues, looking at the board, CEO and deeper to consider the organization's executive bench-strength and succession plans as a factor in risk management, stock valuations, credit ratings, and buy/sell decisions.

The board must consider succession planning as more than a sealed envelope with three names inside. It's the central way to fulfill their fiduciary responsibility to shareholders and literally steer the future of the company.

There are a variety of best practices: insuring that the board, not the CEO and HR, owns succession planning for the top jobs, creating a leadership succession committee, ensuring that succession is always on the agenda and investing at least a full day once a year for a deeper dive into the issues and people.

Some companies retain an objective, independent, third party to review factors such as key executive exposure, capability to move the company to the next level, depth of talent in key roles, strategy alignment and assessment of planned and unplanned succession readiness. According to Bruce Sherman, "the data from such a review serves multiple purposes by jumpstarting the conversation within the board, demonstrating commitment to talent management, proactively revealing high risk issues, and providing a baseline for measuring progress." As one experienced lead director said "this is the only way to get the straight skinny."

Note to directors on boards: be afraid, very afraid, if you hide your heads in the sand on the issue of the team at the top.