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MCI Adopts Federal Monitor's Governance Rules

MCI (formerly WorldCom) Tuesday unanimously adopted the extensive new guidelines on corporate governance -- aimed at shifting power to shareholders -- designed by Richard C. Breeden, the court-appointed Corporate Monitor for the bankrupt telecommunications giant, and former chairman of the U.S. Securities and Exchange Commission (SEC).

The 78 recommendations in Breeden's Restoring Trust report, filed with Judge Jed S. Rakoff of The United States District Court for the Southern District of New York Tuesday, cover the selection of directors, qualification, conflicts and independence standards for board members, the functioning of the board and its committees, establishment of the position of non-executive chairman, specific limits on compensation practices, equity compensation programs, accounting and disclosure issues, ethics and legal compliance programs, and other areas.

Breeden said the new guidelines should give MCI a set of corporate governance policies and procedures that go beyond those of any other major public company -- all in an effort to prevent future abuses like those which led to what WorldCom investigators believe to be the largest accounting fraud in U.S. history.

"Many of these standards are followed by other companies, though a few, like the process for selecting new directors, will be unique to MCI when put into place," Breeden said in his report. "However, in corporate governance, it is the totality of the system, not its individual parts, that counts. 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. The result will be a stronger, more capable and more independent board of directors, limits on problematic compensation practices, and a much greater emphasis on transparency and integrity in the company's internal operations. Shareholders will in the future have a much stronger voice in setting limits of behavior."

The company is required to implement the recommendations, unless it receives leave of the court not to implement a specific recommendation. However, MCI's directors worked on the report with Breeden, and said Tuesday that they had unanimously approved the adoption of all recommendations.

"Mr. 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," said Michael Capellas, who was brought on board as chairman and CEO of the company last November with the goal of rebuilding the company in the wake of the accounting scandal. "The company has already implemented many of the proposed corporate reforms, but we know we have to do even more to regain public trust."

Breeden's report focuses on 12 major themes:

  1. establishing a governance constitution for the company,
  2. more shareholder communication,
  3. selection of directors,
  4. an active and independent board,
  5. a non-executive chairman of the board,
  6. active board committees,
  7. term limits and auditor rotation,
  8. compensation limits,
  9. equity compensation programs,
  10. enhanced transparency of financial information,
  11. strengthening of the General Counsel's office
  12. and continuance of the new Ethics Programs, and a change in control devices.

First and foremost, the report calls for the new governance standards to be placed in the company's Articles of Incorporation, which will then be used as the 'Governance Constitution' for the company. Once in place, the standards could only be changed with prior shareholder consent.

"This represents an important shift of power from the board to the shareholders," Breeden said. "The board's discretion in matters of business oversight remains extensive, but as to the governance rules themselves, shareholder consent will be required in advance for changes to be made."

The report also requires the board to establish an electronic "town hall" where shareholders can communicate with the board and propose resolutions for consideration -- whether or not the proposed resolution would be allowed under SEC proxy regulations. The report said proposed resolutions adopted through the "town hall" process must be included in the proxy the following year."

Much of the report focuses on the selection and criteria for the company's board. The guidelines require that at least one new director be elected each year -- and gives the shareholders the power to nominate their own candidates for inclusion in the management proxy statement if they don't agree with proposed candidates to fill board vacancies. In addition, all board members, except the CEO, must be 100 percent fully independent. The CEO will not be allowed to sit on any other corporate board, and the independent directors will be limited to a maximum of three boards, including the company.

Also, the guidelines require the full board to meet at least eight times per year, to hold an annual strategic review, and to attend annual refresher training on topics related to board responsibilities. They are also required to visit company facilities each year, independently of board meetings, and to meet at least annually with the CFO and General Counsel independent of the CEO. They must also meet for some portion of each meeting without the presence of the CEO or any other employee of the company.

The guidelines also firmly separate the CEO and chairman positions, requiring a non-executive chairman of the board. In addition, the guidelines require the company to have an Audit Committee, Governance Committee, Compensation Committee and a Risk Management Committee which will be composed entirely of independent directors.

Directors of the company will be limited to 10 years in office under the plan, and independent auditors of the company will also be limited to the same term before a required rotation of auditors.

In the area of compensation, the guidelines require the board to establish a maximum compensation level for any individual in any year without shareholder approval.

"The recommended starting level is not more than $15 million, though the board will be free to set a lower number," Breeden said. "No executive can be granted more than this amount in any year, including cash, equity grants, and all other forms of remuneration, without a vote of the shareholders."

Most 'retention' grants are banned under the guidelines, and maximum dollar limits are placed on severance awards. The guidelines also bar the award of stock options for a five year period, after which shareholders must approve their use in advance. Also, any stock options granted at any time must be expensed in the company's financial statements. Additionally, the report stipulates that equity programs use restricted stock awards exclusively, and that a substantial portion of restricted stock must be retained by senior officers until after they leave the company.

In an effort to enhance efforts to develop more transparent disclosure practices that go beyond SEC requirements, the report also requires the company to work to develop enhanced cash flows and publish a target dividend policy. The report said the initial target for dividends would be "not less than 25 percent of net income annually."

"Restoring Trust definitely shifts the balance of power in governance of MCI in the direction of a bit more power and authority for shareholders," Breeden said. "This is a measured change, and one that seeks to avoid changing the internal balance of power too much. Rather than more regulations to protect shareholders, these recommendations seek to give more power to shareholders to protect themselves. In view of WorldCom's history, the recommendations as a whole concentrate on placing limits on the discretion of management and the board of directors to change the rules of the road for governance. However, both management and the board must retain discretion to handle business issues as they arise, and the recommendations must seek to avoid damaging management's flexibility to meet the world's business challenges as they arise."

In June of 2002, the SEC filed charges against WorldCom and its executives alleging the firm had cooked the books to meet Wall Street expectations and goose its stock price. The SEC said at the time that the fraud pumped up WorldCom's earnings by $3 billion in 2001 and $797 million in the first quarter of 2002.

The SEC's fraud charges, filed in a civil suit in a Manhattan federal court, came just a day after WorldCom's bombshell admission that it had overstated its cash flow by $3.8 billion over five quarters. The SEC had already begun an investigation into Clinton, Miss., company's accounting in February.

WorldCom followed up by filing for Chapter 11 bankruptcy protection in July, making it the largest bankruptcy reorganization in U.S. history. The SEC expanded its investigation in November 2002, when WorldCom warned it would restate $9 billion in revenue.

In July 2003, Judge Rakoff approved a settlement reached between MCI and the SEC to deal with the company's $11 billion accounting scandal.

The settlement called for a civil penalty of $2.25 billion, which would be satisfied by a $500 million cash payment and $250 million in common stock to shareholders and bondholders upon the company's emergence from Chapter 11 bankruptcy protection. The $250 million in stock was added to the settlement last in response to critics of the original $500 million settlement.

The $11 billion accounting scandal originally drew a $1.5 billion fine. The fine, to be distributed among WorldCom's victims, was reduced in light of the company's bankruptcy proceeding.

The settlement also called for the appointment of a monitor by the court.

In the report filed with the court Tuesday, Breeden praised the efforts of Capellas and the company to turn the company around.

"Hopefully, these recommendations, coupled with the strong efforts of the new management team led by CEO Michael Capellas and the new board of directors, will enable MCI to succeed in its goal of becoming a model of excellence in corporate governance," Breeden said. "There is a deep commitment at the company to eradicating the practices of the past that harmed so many, and in their place to follow new standards representing the very best ideas for responsible governance."