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Compliance Lessons in Cardinal Governance Fight

We have an update to that corporate governance drama at Cardinal Health, where the Teamsters were trying to strip the CEO of his role as board chairman, and cited excessive pay to the company’s chief compliance officer as evidence of poor leadership.

Their campaign worked.

Granted, their shareholder proposal failed to win a majority at last week’s shareholder meeting. But two days before the meeting, Cardinal announced that CEO George Barrett will step down from that job on Dec. 31 and then remain as executive chairman until next November. Then the board’s lead independent director, Gregory Kenny, will become chair.

That outcome is the inverse of what the Teamsters had proposed (stripping Barrett of the chairman’s role), but the Teamsters were quick to hail the move as a victory for their campaign nevertheless.

“Cardinal Health’s announcement of leadership changes … demonstrates the strength of a growing investor movement led by the Teamsters to hold America’s largest drug distributors accountable for their role in fueling the opioid epidemic,” Ken Hall, general secretary-treasurer of the union, said in a statement. “Cardinal’s decision to appoint a new CEO and transition to an independent board chair, as demanded by the Teamsters, signals that our message for strengthening corporate governance and setting a new tone at the top is getting through.”

Self-serving words, but Hall has a point. The Cardinal fight was the second time this year that the Teamsters had muscled through corporate governance changes at a major pharmaceutical distributor. They went after McKesson Corp. in the first half of 2017, encouraging investors to strip CEO John Hammergren of his chairman’s role, and to vote against his compensation package.

McKesson investors didn’t go for the CEO-chairman split, but they did vote against Hammergren’s compensation package—a nasty rebuke, even if say-on-pay votes are only advisory. The company then announced that it would split the CEO and chairman roles sometime in the future, presumably after Hammergren moves on. (He is still chairman and CEO today.)

And the Teamsters can’t claim all credit for Cardinal’s changes; the company’s unimpressive stock price in the last year certainly helped to send CEO Barrett out to pasture. Share price went from the low $80s in April to the low $60s this month. Earnings for fiscal 2017 also fell from 2016.

Still, the Teamsters got what they wanted: change at the highest levels.

Lessons in Oversight

The Teamsters’ beef with drug distribution companies is that the companies’ loose business practices led to legions of their members getting hooked on opioids. As I mentioned in my first post about Cardinal, their point can’t be dismissed easily: these are mammoth firms with sophisticated supply chain management, shipping huge amounts of pain pills to some very tiny communities.

For example, according to a lawsuit filed against McKesson by the state of West Virginia, McKesson shipped 100.5 million oxycodone and hydrocodone pills to the state from 2007 to 2012. West Virginia has a population of 1.83 million. That’s 55 pills for every person in the state. Cardinal, meanwhile, was accused of shipping 309,000 pills over a two-year period to Van, West Virginia—a town of only 215 people.

When state attorneys general began filing lawsuits in the early 2010s, the boards of both companies started paying attention. Special committees were created. Investigations ensued. Promises of reform were made.

And then more abuses kept happening, which led to more litigation, and more regulatory settlements. Cardinal, for example, first faced allegations of shoddy distribution practices in 2008 with the Drug Enforcement Agency, and then again in 2012. Its special board committee conducted its inquiry in 2014. But states are now piling on the lawsuits, which allege excessive shipments of opioids well into 2015. West Virginia settled its lawsuit against Cardinal only 10 months ago, for $20 million.

So, as I said, the Teamsters have grounds to be upset. You would be, too, if you had friends living places like Van, W. Va.

Lessons for Compliance Officers

The Teamsters’ fight with Cardinal fascinated me because it put compensation for the chief legal and compliance officer, Craig Morford, in the spotlight.

The sticking point for the Teamsters was Morford’s incentive pay. In fiscal 2014, for example, Cardinal’s total revenue fell 9.9 percent to $91 billion. Morford, however, received $553,000 in incentive pay (145 percent of the original target) because of “his significant leadership role in continuing to develop our regulatory and compliance programs in a rapidly evolving regulatory landscape.”

Fast-forward to fiscal 2017. Cardinal missed an earnings goal that would have netted Morford a performance bonus equal to 85 percent of his base salary. But “In recognition of our strategic and operational accomplishments during fiscal 2017,” the compensation committee gave Morford $117,300 anyway, equal to 25 percent of that target bonus. And meanwhile, the company was facing lawsuits alleging poor oversight well into 2015.

Can a compliance officer receive a bonus for performing his or her job well, even when the company overall is limping along? Sure.

But was Cardinal incentivizing Morford the legal officer to settle cases; or Morford the compliance officer to strengthen ethical business practices?

I suspect Cardinal’s board would say “both.” That strikes me as a bit of a cop out. The compliance and legal functions don’t serve the same purpose. A legal officer can do a great job settling cases quickly and on good terms—but that can give rise to accusations of an inadequate compliance program, since so many instances of misconduct end up in litigation. Which is exactly the point the Teamsters made.

Is that fair? I’m not sure. But the Teamsters could not have made it if Cardinal had separate legal and compliance functions.

A separate, strong compliance function would have shown that the board took the matter of distribution practices seriously—and the board’s approach to governing its distribution practices was always the Teamsters’ complaint. Morford’s compensation was just Exhibit A in their argument for change.

Food for thought, next time your board is talking about the structure of the compliance function.

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