Leadership by Geoff Colvin

Who is minding the J.Crew store?

December 21, 2010: 9:08 AM ET

At J.Crew, CEO and Chairman Millard Drexler waited seven weeks to inform the board of his discussions to sell the company, exposing the often-overlooked issue that many corporate boards do not enforce internal transparency.

By Eleanor Bloxham, contributor

J.Crew CEO and Chairman Millard Drexler

If you run a division, how long do you think you could wait to tell your bosses you were in talks to sell your division to another company and still hold your job?  Would seven weeks be too long?

At J.Crew (JCG), CEO Millard Drexler waited seven weeks to inform his bosses of his discussions to sell the entire company, discussions in which he and his staff provided confidential information to outside parties and plans that included him, as one of the owners, in the deal.

Strengthening transparency and accountability are two issues that have come to the forefront in the wake of the financial crisis.

When we think of corporate transparency, we think of communication to shareholders or other external stakeholders. But strengthening transparency within a company -- so that it can be governed competently -- is at least as important. This transparency includes providing all employees with the information to do their jobs and providing managers with the early warning signals they need.

Boards of directors also need timely information -- but unlike employees who do not currently have the power to enforce requirements related to the information they need, it is the board's duty and responsibility to specify the information it wants, when it wants it and in what form, and to enforce those requirements.

So, when should the board know that the CEO is in talks or has heard expressions of interest related to selling the company? (And when should they know a board member is interested in buying?)

The short answer is when they specify – and they do have a responsibility to specify.

But what timing should they specify? A manager running a company's division needs the bosses' approval of the division's strategy before embarking on it -- they provide input and final approval of the strategy and the resources allocated to it.

Similarly, the board of directors oversees the CEO, who is a hired manager; their job is to provide input into a company's strategy and give final signoff on it. As a matter of governance, the board is assigned to perform its oversight in the best interests of the company and all of its shareholders and stakeholders.

Major shifts in the firm's strategy or ownership structure are particularly important to a board and shareholders. Because of its importance, the Board should be informed if a potential buyer has approached company management as soon as it happens. (This is information they should want to know in order to govern well.)

But what about when management has an interest in selling the company? In this case, the Board should be involved before the discussions about a sale begin. Possible sales should be s part of the ongoing strategic discussions of the board,  providing the parameters for sales and how those deliberations will be carried out.

At J.Crew, the sale discussions had some twists, however. A member of the board, James Coulter, expressed interest in selling the company, in private, to the CEO because he/his firm would like to buy it.

In that case, because of the inherent conflicts involved, all independent Board members should have been apprised immediately and should have been involved before any sale discussions began.

But Mr. Drexler did not do that.

He did not tell board members about a meeting, on August 23, with a potential suitor, arranged by the previous owner, TPG.  And Mr. Coulter, a founding partner of TPG, did not do that.

He did not bring up his potential interest in a purchase at the September 1 board meeting so all members could discuss and debate the matter. Instead, he brought it up to the CEO, alone at dinner, after the board meeting.

Neither Mr. Drexler nor Mr. Coulter informed the board until after multiple meetings were held, management time was spent, confidential information was exchanged, and a deal was crafted that included Mr. Drexler's future role and equity for management going forward.

This case exposes an all-too-often overlooked board issue -- namely, the need for boards to establish protocols so that information brought to the board's attention is shared with everyone on the board as close to the same time as possible. Think of it like Regulation FD (fair disclosure) in the boardroom.

So why do some boards enforce this kind of protocol and others do not?

One reason is that some boards do not fully understand the negative repercussions from not instituting a culture of open discussion.  Another is that some members may find selective communications work to their advantage in ensuring their agenda is accepted.

At J.Crew, Mr. Drexler's failure to communicate is just one more example for those who favor separation of the CEO and chair positions to point to as a demonstration of the difficulty of one individual holding both roles.

And it will also raise alarms for those who oppose having lead directors on boards because of a fear of special communications between the lead director and CEO that never make it to the board, a hierarchy of communication that would not serve the board well. As it happens, Mr. Coulter is the lead director at J Crew.

But is this issue of board governance something shareholders could have known about?

J.Crew's annual proxy filing with the SEC, early this year (April 19), has several clues that could have sounded the alarm bells to shareholders, presaging the recent lapses of governance at J.Crew.

Clue#1:  James Coulter is considered an independent member of the board, acts as lead director, chairs the compensation committee and sits on the nominating and governance committee, yet "Mr. Coulter is a TPG representative," the proxy states.

But, as a matter of governance, all board members should be acting in the best interests of all of its shareholders and stakeholders. No member should be representing one special interest. Loyalty to the company should be first.

Clue#2: The CEO appointed a majority of the directors to the board.

Clue #3: Several of the directors have conflicts of interest that further suggest a lack of independence of the board.

From the SEC filing:

"Mr. Grand-Jean has been President of Grand-Jean Capital Management for more than five years. Grand-Jean Capital Management provides financial advisory and investment services to the Drexler family, including a family foundation established by Mr. Drexler, and receives customary compensation for those services."

"Sloan is not independent under these rules because of his interest in a limited partnership from which the Company leases space for operation of three of our retail stores."

James Coulter sits on five corporate boards, including J.Crew. Most would consider that too many boards. Given his role as lead director, chair of the compensation committee, and full- time career responsibilities at TPG, it suggests he is "overboarded."

Clue #4: The nominating and governance committee only met three times in 2010, compared to 11 times for the audit committee and six times for the compensation committee. Are the governance and nominating processes considered important?

Clue#5: Despite the fact that the CEO is 65, there is no mention of succession planning -- and no board committee is described as having that responsibility. This is a negative signal in terms of director oversight of the CEO.

Did any shareholders have governance issues with J Crew before the company's latest filings in December? Besides Mr. Drexler, major (5% or greater) shareholders in the firm, as of the annual proxy in April, include FMR LLC (which includes the Fidelity Contrafund), Baron Capital Group, BlackRock, and T Rowe Price, all of whom voted in favor of the directors up for election as well as the other management proposals -- and Columbia Wanger Asset Management (whose parent Ameriprise, did not return requests for information).

Proxy Democracy's website showed that Calvert and CalSTRS were planning to withhold votes for all three director nominees up for election in June. Calvert did withhold on grounds of diversity, according to Shirley Peoples, Manager of Proxy Voting. CalSTRS did not respond to a request for comment.

The proposed sale will come before shareholders for a vote. The preliminary proxy notes: "In considering the recommendation of the special committee and the board of directors, you should be aware that some of the Company's directors and executive officers have interests in the merger that are different from, or in addition to, the interests of our stockholders generally."

In an interview in April 2008, Mr. Drexler told Charlie Rose that he liked "the adversity of bad situations."

Let's hope shareholders plan to read the fine print carefully -- and that the adversity of J.Crew's governance doesn't harm its stakeholders -- in 2010 or beyond.

Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a board advisory firm.

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About This Author
Eleanor Bloxham
Eleanor Bloxham
Contributor, Fortune

Eleanor Bloxham, an authority on governance and valuation, is CEO of The Value Alliance and Corporate Governance Alliance, an independent board and executive educational and advisory firm she founded in 1999. She is author of the books Value Led Organizations and Economic Value Management: Applications and Techniques, and publisher of the Corporate Governance Alliance Digest and her blog The Bloxham Voice.

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