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May 14, 2015

Committees of a Corporate Governing Body
 

Committees can be valuable resources of any corporation, but care must be taken in creating and delegating authority to committees.

All states’ corporation laws allow a corporate board of directors to create committees and delegate to those committees any authority of the board under state corporation laws or the corporation’s governing documents (e.g., its articles or certificate of incorporation and any bylaws or regulations governing the board).

Composition of Committees

In some states, committees are required to be composed solely of directors. In other states, a committee may be composed of directors as well as non-directors, but the corporation laws or court decisions of those states generally require that the board must reasonably believe that any non-director is reliable and competent to participate in exercising the delegated authority of the committee.

Protection of Directors When Relying upon Committees

All states’ corporation laws protect directors when they rely upon committees of which they are not members but only for matters which fall within the committee’s designated authority and for which the directors believe the committee merits confidence. In some states, such as Ohio, if the committee is composed of non-directors, a director is protected in relying upon a committee only if the relying director reasonably believes the non-directors are reliable and competent to participate in exercising the delegated authority of the committee.

Because under most states’ corporation laws decisions of a board must be made by persons who have the duty of care, duty of loyalty and duty of confidentiality applicable to directors and executive officers, many corporations do not allow non-directors other than executive officers to be members of a committee upon which the board wants protection of the right of reliance. Some corporations desiring expertise on a committee not present among the corporation’s directors and executive officers may enter into an agreement with those outside members obligating them to exercise the same duties of care, loyalty and confidentiality as directors of the corporation. Other corporations, to avoid this requirement regarding duties, require that any decision made by a committee that includes non-directors must be approved by a majority of its members who are directors.

Types of Committees

Committees may have different authority, including the following:

Executive: Having all authority of the board for the responsibilities delegated to the committee, and

  • Any action or authorization by the committee with executive authority shall be effective for all purposes as the act or authorization of the board,
  • Unless the board otherwise determines or directs by not less than majority vote of those directors having no financial or personal interest in such action or authorization.
Executive committees direct or oversee the actions or authorizations they approve, reporting the results to the board. Examples are audit and executive compensation committees.

Recommendation: Having authority to recommend actions to an executive committee or the board itself

  • With the expectation being that the recommended action will be approved or authorized by the executive committee or board,
  • Unless it is believed that the recommendation does not merit confidence or is not within the recommendation committee’s authority.
Examples are investment, finance and succession planning committees.

Advisory: Having only the right to give advice to an executive committee or the board itself which the executive committee or board has no obligation to adopt or carry out.

Oversight: Having authority to oversee matters critical to the health of the organization for its various stakeholders, such as

  • Accuracy of its financial statement,
  • Reasonableness of its compensation,
  • Appropriateness of its actions taken for succession, and
  • Management of risks to the enterprise, especially solvency.
Indemnification and D&O Insurance

Any corporation having a committee composed of outside members who are neither directors nor executive officers of the corporation should agree to indemnify those outside members at least to the same extent that directors and executive officers are indemnified and to add such outside members as additional insureds to any D&O insurance protecting directors and executive officers.

Committee Charters

The most important matter in creating and delegating authority to a committee is the negotiation of the committee charter. This should be a negotiation between those directors who are not members of the committee but want the protection of being able to rely upon the committee, and those directors and others who will be members of the committee, but cannot rely upon it because of being committee members. The composition, the right of reliance, the authority, the type of committee, and indemnification and D&O coverage should all be negotiated between the relying directors and the committee members.

If care is taken as described in this posting in creating and delegating authority to committees, committees can be valuable resources of any corporation.


 

Posted by J. Beavers in  Governance Best Practices   |  Permalink

 

Apr 30, 2015

Ten Considerations for Making You a Better Board Member
 

Being a board member became less enjoyable during the first decade of the new millennium. First, boards were blamed for the malfeasance that resulted in the burst of the dot-com bubble in the earlier part of the decade, and then boards were blamed for the misfeasance that resulted in the “Great Recession” in the latter part of the decade.

Congress reacted to the dot-com burst by enacting Sarbanes-Oxley, requiring greater independence of members of audit committees. Quasi-government organizations, such as the NYSE and Nasdaq, expanded the independence requirements from audit committees to other oversight committees, such as compensation and nominating, and to the board itself. Regulators such as the SEC, IRS and Treasury, as well as banking and insurance regulators, expanded the independence requirements from publicly held companies to tax-exempt organizations and financial institutions.

Congress and the Obama administration reacted to the Great Recession by enacting Dodd-Frank and placing restrictions on the size and activities of organizations that are considered “too large to fail.” In addition, Congress adopted “say-on-pay” legislation, shareholders’ bills of rights and requirements to disclose of how governing boards are organized and led.

Despite increased responsibility and oversight, board members can protect themselves and effectively serve their organizations. The purpose of this article is to provide some guidance for consideration of independent directors seeking to become better board members.

1. Observe the expectation and right of reliance.

The foremost principle of corporate governance is that boards and their committees are expected – and most states’ laws give boards and their committees the right – to rely upon:

  • Officers or employees as to matters for which the director reasonably believes they are reliable and competent;
  • Professionals such as lawyers or accountants as to matters that the director reasonably believes are within the person's professional competence; and
  • Duly established committees of the board for matters within their designated authority, which the director reasonably believes to merit confidence.
The concept is that the organization is managed “under the direction” of the board, and the most important responsibility of the board is to select management, including at least a chief executive officer, whom the board believes is reliable and competent in managing the organization.

2. Ask and encourage questions, taking into account the impact of the highly improbable, and educate when to stop asking questions.

Your role as a board member is to see that direction is provided but is not to execute that direction or manage the organization, unless you believe that the CEO and management are not reliable and competent to do so. You do this by asking sufficient questions, so you have a reasonable belief that the CEO and management are reliable and competent in what they are authorized or directed to do.

Your questions should not generally be “how are you going to do this?” Management should have the authority to determine “how.” Your questions are to verify or confirm their reliability and competence in making the “how” determination: “How does this benefit the best interests of the business?” “Is it consistent with our business model and strategy for the future?” “What financial, legal, ethical, strategic and reputational issues have been considered?”

As a director, you should take into account the premise of Nassim Nicholas Taleb’s book, The Black Swan: The Impact of the Highly Improbable, that policy-makers, such as board members, must consider all of the possibilities, especially those that could have a high impact, albeit remotely probable, and not just the normal. The 2008-2010 Great Recession is the likely result of a failure to take into account the highly improbable, but high impact, occurrence.

Accordingly, the most important questions that a board should ask are “what if”: Most importantly, “what happens if things don’t go as expected?”

Finally, educate other board members about when to stop asking questions. A board member can stop asking questions when he or she reasonably concludes that the CEO and management are reliable and competent to carry out the action being authorized.

3. Understand the organization’s business model and strategic direction.

To oversee that direction is provided to the organization, you must understand both the current business model as well as the strategic direction for the future. One of the problems in replacing employed officers with independent directors as a result of Sarbanes-Oxley is that some boards as a whole have become less knowledgeable of the organization’s business model and less understanding of its strategic direction. As boards become more independent, the CEO and management have a greater responsibility in educating directors on the current business model and future strategic direction.

The role of most boards is not to initiate the organization’s strategic direction, unless the CEO or management has failed to recommend it, but to agree with the strategic direction recommended by management. Having an agreed strategic direction will give the board benchmarks to measure the CEO and management’s performance, and it will focus the board’s attention on the most important matters— those dealing with the organization’s direction.

4. Abide by the principle that a board speaks with one voice.

Your duty of care and loyalty as a director requires you to abide by the decision of a majority of the board at a meeting at which a quorum is present. This applies to all matters coming before the board for its consideration. The board speaks with one voice on all such matters or not at all. Occasionally, on matters where it is important to have a single message, a board will speak only through its chairperson or the chairperson’s designee.

If you disagree with a decision, your rights are to vote against that decision, to have your negative vote recorded in the minutes and, when and if appropriate, to ask for reconsideration of the decision. Generally, “what happens in a board room remains in the board room,” unless you believe that your remaining silent will result in a material breach of fiduciary duty or violation of law.

5. Assure the board has the expertise to speak with one voice.

To be able to speak with one voice, the board must have sufficient expertise to understand how any action it is asked to authorize is consistent with the business model and strategic direction of the organization. This requires boards to assess the collective expertise of the board as a whole: Does the board have the expertise required to oversee the organization’s current business model and its future strategic direction? You should urge the board to make this assessment if it has not done so recently.

Your goal should be an “expertise” board, composed of persons each having particular expertise or other competency needed for the board to have as a whole all of the competencies necessary to achieve its future objectives. This is in contrast to a “constituency” board, which is composed of persons who represent the view of a particular constituency (such as the U.S. Congress or a state legislature). Unlike a constituency board, assembling an “expertise” board requires the organization to assess the core competencies present among its management team members; to prioritize the additional competencies necessary for its future operations; and to recruit persons having those competencies for nomination as board members.

The major benefit of an “expertise” board is a focus on the best interest of the organization as a whole, because its members are selected to bring to the table particular expertise or other competencies that, when taken with the expertise and competencies of the other members, are to achieve the agreed best interests of the organization in the future. Having an “expertise” board also avoids problems of a constituency board whose members view their duties as representing the best interest of the separate constituency that each member represents, often resulting in:

  • Partisanship similar to Congress and state legislatures;
  • Decisions watered down to the lowest common denominator; and
  • Favoring particular constituencies rather than the organization as a whole
Boards should evaluate and inventory the individual knowledge, skills, experience, expertise and other competencies of each of its members; determine the competencies needed in the foreseeable future; and then determine whether to fill any missing competencies through:
  • Recruitment of new or additional directors;
  • Education of directors to enhance expertise or competencies; or
  • Availability of advice of advisers to provide missing expertise or competencies.
6. Urge your board to grant authority by setting goals and enforcing limits.

The board should not prescribe “how” management should conduct business. Instead, it should set the goals or identify the benchmarks to be achieved by management, allowing management to determine “how.” A board that has the available expertise to understand the organization’s business model and strategic direction can set economic and non-economic goals. This is often done annually through adoption of a business plan, which should articulate the goals for the ensuing year. The board should measure the CEO and management’s performance based upon their achievement of these goals.

Although the board should not prescribe “how” management achieves these goals, management should understand that the board expects these goals to be achieved legally, ethically and in compliance with the organization’s policies. This is typically accomplished with articulated codes of conduct and internal controls enforced through forfeitures and even clawbacks of compensation.

7. Consider the first rule of executive compensation.

The CEO of a publicly held company observed in a directors’ education session conducted at The Ohio State University Fisher College of Business stated that, “the first rule of executive compensation is that shareholders get paid first.” Restated for a mutual insurance company, the first rule is that “the claims of policyholders get paid first.”

The point of this rule is that the executives are not entitled to performance or incentive compensation unless the executives are leading the operations of their organization to have earnings available for dividends to shareholders.

If boards and compensation committees had made this simple rule a condition to any of their executives receiving performance or incentive bonuses, there would not have been the AIG or Merrill Lynch bonuses that outraged the public.

The rule applies to any organization – for-profit or nonprofit. The organization’s leaders should not be entitled to performance or incentive compensation or bonuses unless they are leading the operations of their organizations to result in growing net worth, capital or surplus.

Boards and compensation committees should consider making this rule a condition to payment of any performance or incentive compensation: Compensation committees should consider defining as a “stop” to any incentive compensation failure for net worth (or, for non-stock organizations, capital or surplus) to increase for any performance period. In addition, boards and compensation committees should articulate codes of conduct and internal controls enforced through forfeitures and even clawbacks of compensation.

8. Encourage regular meetings with key management.

To regain the knowledge lost by boards as employed officers were replaced with independent directors, encourage your board to meet regularly with key management other than the CEO. Some of the key oversight committees, such as audit and compensation, should consider meeting in executive sessions separately with key management and without other management members being present.

Benefits of regular meetings with key management are that:

  • It opens communication channels between the board and key management;
  • Doing so regularly usually does not offend the CEO;
  • It facilitates the board’s federal and state obligations not to impede whistleblowing by encouraging communication both from employees to the board, hopefully without anonymity, and from the board to employees; and
  • Board and management will each learn from the other.
Generally, familiarity of management with the board and vice versa will not breed contempt but will foster trust and eliminate contempt.

9. Don’t forget about mentorship.

Mentorship is one of the major functions of board members (the others being direction and oversight). Mentorship is making available to management each board member’s knowledge, skills and the experience of having been there and having done it before.

Benefits of mentorship include:

  • Expanding the board’s effectiveness as an “expertise” board by making available for the benefit of the organization the collective knowledge, skills and experience of each of its members;
  • Making it less lonely at the top of management;
  • Providing coaching and fostering relationships between board members and management; and
  • Making board members and management each accessible to the other.

10. Remember that “one size does not fit all,” and improvement won’t happen overnight.

Governance is the aggregate of an organization’s culture, methods, processes, systems and controls for:

  • Providing direction to the business, operations and other affairs of the organization (i.e., the organization’s mission or purpose); and
  • Executing or carrying out that direction (including the organization’s mission or purpose).
However, it is important to note that because governance of an organization is the aggregate of many things, including its culture, what may be appropriate in terms of governance of one organization may not be appropriate for another.
Culture usually cannot be changed overnight. Just as it typically takes two generations of football coaches to find a successful replacement to a great coach, it takes two generations of board members to institutionalize a change: One generation initially adopts the change, but it does not become institutionalized until a succeeding generation agrees to retain it.


 

Posted by J. Beavers in  Governance Best Practices   |  Permalink

 

Apr 06, 2015

Rules to Avoid Compliance Issues with Minutes and Conduct of Meetings: Use of a Consent Agenda
 

This blog on “Use of a Consent Agenda” is the last of a multiple-part series on rules to avoid compliance issues with minutes and conduct of meetings of boards and their committees. The series focused first on minutes with a posting on “Basic Rules for Minutes,” because minutes should be the official and only record of meetings. We then had postings on special considerations for minutes with “Considerations for Minutes of an Adjourned Meeting” and “Reflecting in Minutes Documents Made Available for Meetings.” The penultimate posting provided some suggestions for conducting meetings to result in minutes that will constitute the desired official record. The rules presented in this series are intended for boards of non-governmental organizations because city councils, public school boards and other governmental bodies are subject to open meeting and other laws that are not applicable to non-governmental organizations.

All authority for decision making as to matters of policy, direction, strategy and governance (the “important matters”) and oversight as to matters critical to the health of the organization for its various stakeholders (the “critical matters”) is to be exercised under the direction of the organization’s board. The best way to facilitate a board’s focus on the important and critical matters is the skill of the chairperson to “diplomatically move the proceeding along” when the board gets sidetracked on minutia, as discussed in our last posting, “Suggestions for Conducting Meetings.”

Also, our last posting recommended not blindly adhering to Robert’s Rules of Order in determining the order of an agenda, because it does not distinguish between important and unimportant matters. We prefer an ordering of the agenda so that important matters are discussed earlier in the meeting, and that similar matters are grouped together, regardless of whether they are new or unfinished. 

A tool that can be used to focus on the important and critical matters is to incorporate a consent agenda as part of the agenda for any meeting. A consent agenda is a collection of all routine matters not expected to require discussion into one agenda item. The consent agenda can either come at the beginning or the end of the meeting. Matters on the consent agenda are not discussed by the board and are all approved in one vote.

However, either before or at the meeting, board members may move any matter from the consent agenda to be discussed by the board. Unless the board has taken formal action to identify the matters collected in the consent agenda, any board member may remove the matter for discussion. If the board has taken formal action to identify the matters collected in the consent agenda, some boards may require that the removal must receive the vote of a majority of directors present at the meeting at which the agenda is being considered, though this may stifle discussion. A consent agenda typically includes:

  • Minutes of a previous board meeting
  • Acceptance of minutes of committee meetings
  • Routine committee, management, or staff reports not requiring any action by the board other than acceptance or ratification
  • Acceptance of resignations from the board
  • Updates or background reports provided for information only
  • Routine contracts in the regular course of business that fall within policies and guidelines

Certain items should have significant discussion before they find their way onto a consent agenda. These items include:

  • Audit, financial, risk management and similar reports that may require management or professionals to present information or answer questions
  • Executive committee decisions or management actions which are necessary for the board to understand
  • Any important matter or critical matter for which the board as a whole is the highest authority

Rather than being imposed by the chairperson, we recommend that a board agree to implement a consent agenda to see if it saves time for the important and critical matters. As the board gains experience with the consent agenda, it can adopt policies for what should be included in a consent agenda.

A consent agenda only works if the documents related to the matters collected in the consent agenda are made available to the board reasonably in advance of the meeting, and if each director actually reviews the matters and conducts whatever due diligence the director reasonably believes is necessary to approve the matters. Failing to do this could result in breach of the duty of care for a director and the board. 

If a director has a question for clarification of a matter on the consent agenda, the director’s duty of care generally requires the director to ask the question before the meeting. If the answer clarifies the matter, the matter remains on the consent agenda without taking time at the meeting. Otherwise, the matter should be discussed and any issues addressed.

When properly applied and understood, the use of a consent agenda can dramatically improve the efficiency of board meetings. Most boards find the result is that they are more productive in considering the important and critical matters.


 

Posted by J. Beavers in  Governance Best Practices   |  Permalink

 

Mar 19, 2015

Rules to Avoid Compliance Issues with Minutes and Conduct of Meetings: Suggestions for Conducting Meetings
 

This blog on “Suggestions for Conducting Meetings” is the fourth of a multiple-part series on rules to avoid compliance issues with minutes and conduct of meetings of boards and their committees. The series focused first on minutes with a posting on “Basic Rules for Minutes,” because minutes should be the official and only record of meetings. We then had postings on special considerations for minutes with “Considerations for Minutes of an Adjourned Meeting” and “Reflecting in Minutes Documents Made Available for Meetings.” This posting provides some suggestions for conducting meetings to result in minutes that will constitute the desired official record. The rules presented in this series are intended for boards of non-governmental organizations because city councils, public school boards and other governmental bodies are subject to open meeting and other laws that are not applicable to non-governmental organizations.

Our posting, titled “Basic Rules for Minutes,” described two basic rules for preparing minutes of meetings:

  1. Saying less is better.

    Reflect compliance with certain procedural matters: (i) The date, time and place of the meeting to reflect compliance with notice requirements, (ii) who was in attendance to reflect compliance with quorum requirements, and (iii) who presided over the meeting;

    Identify general matters considered: This is for purpose of refreshing the board or committee members’ memories of what happened at the meeting, so they do not need to review notes or other documents other than the minutes.

    Reflect the decisions made: The decisions made are the most important content of the minutes. A record of the decisions made is not only the information needed by most audiences but is also necessary in many jurisdictions to invoke protection of the business judgment rule.

  2. Minutes should be the only record.

    The minutes of a proceeding are the official record of that proceeding. In such cases, minutes should be the exclusive recording of the proceeding. Members of a body who take notes at a meeting should, as a routine practice, destroy those notes after satisfying themselves that the minutes accurately reflect the proceedings. Many organizations collect all written material, including notes, at the conclusion of the meeting, and as a routine or customary practice, this has been accepted by courts of most jurisdictions.

Call and Notice

Regular meetings, the time and place of which are provided in the organization’s or directors’ regulations or bylaws, or other governing documents, generally are deemed called by those provisions of the applicable governing documents, and under most states’ laws, no calling of the meeting is legally required to be made or notice of the time and is legally required to be given. Special or other meetings, the time and place of which are not provided in those governing documents, are generally required to be called by the board’s chair person, or two (or some number) directors, or the president, CEO or some board or senior executive officer. Notice of the time and place of the meeting is legally required to be given typically at least two days before the meeting to each director by personal delivery or by mail, telegram, cablegram, overnight delivery service, or any other means of communication authorized by the director.

In most states, the notice is not required to state the purpose of a meeting, including a special meeting. However, a best practice is to circulate to all members attending any regular or special meeting an agenda and related documents as discussed below.

Agenda and Documents

Regardless of whether a call by an authorized person or notice of the time and place of a meeting is required, a best practice is to circulate to all members attending the meeting an agenda and any documents to be considered at, or as background in preparation for, any board or committee meeting. If notice is required, the best practice is to circulate the agenda and documents with the notice. If notice is not required, a suggested practice is to send the agenda and documents at least four days before a regular meeting and at least seven days before any special meeting. However, in the event of an emergency, two days is acceptable, or, even shorter, if every attendee is available to receive and review the documents.

Following the rules for minutes that shorter is better, the agenda should be short stating the date, time and place of the meeting, listing (not describing) the matters to be considered, stating briefly the action being asked of the board or committee at the meeting, and listing the documents to be considered at, or as background in preparation for, the meeting.

The first two items of every meeting agenda should be the call of:

  1. The meeting to order; and
  2. Disclosure by members of any personal or economic interest, or any other conflict, the member may have in any matter being considered at the meeting.

The call for disclosure of conflicts at the beginning of each meeting is very important because most state laws require the disclosure by any member having a conflict with any matter to all other members before the matter is considered. Knowing this at the beginning of the meeting allows the chairperson or the members to rearrange the agenda and determine whether the member with the conflict should recuse himself or herself during consideration of the matter.

A third item of every board or committee meeting agenda is approval of the minutes of the last board or committee meeting. This is often an item that can be included in the “consent agenda” portion of the meeting which will be discussed in our next posting in this series.

Although we generally do not recommend following Robert’s Rules of Order for the reasons discussed below, Robert’s Rules of Order 4th Edition requires the following items in the following order:

  1. Reading and approval of the minutes.
  2. Reports of Officers, Boards, Standing Committees.
  3. Reports of Special Committees.
  4. Special Orders.
  5. Unfinished Business and General Orders.
  6. New Business.
  7. Adjournment.

We believe blind adherence to this order may not result in the best time utilization of the board or committee under many circumstances because it does not distinguish the difference between important business and unimportant business. We prefer an ordering of the agenda so that important matters are discussed earlier in the meeting, and that similar matters be grouped together, regardless of whether they are new or unfinished.

Documents

We recommend following the suggestions in our prior posting, “Reflecting in Minutes Documents Made Available for Meetings,” including:

  1. Listing the documents by their name or title or, with respect to a memorandum, its re:-line or subject, and not summarizing or otherwise attempting to describe the document. The problem with summaries or brief descriptions is that someone can always find fault that something important was omitted.
  2. Giving each document a number (e.g., Attachment 3 or Exhibit 1) so that, if necessary, it can be retrieved if required.

Although including the agenda of the board or committee meeting with the minutes of the meeting is an acceptable practice, as discussed in “Reflecting in Minutes Documents Made Available for Meetings,” we recommend against including the documents in the minutes or minute book. Instead, we recommend that the minutes reflect that the board or committee requests legal counsel or an appropriate corporate officer (such as the corporate secretary) to retain such documents on the board’s or committee’s behalf.

Robert’s Rules of Order

As discussed above, we generally do not recommend following Robert’s Rules of Order because Robert’s Rules of Order are intended for large assemblies, such as Parliament or Congress or state legislatures, or mass meetings, such as meetings of a large number of members of a church or golf club, or public bodies such as school boards and city councils. These rules tend to stifle discussion and discourage participation by those not understanding the rules.

Instead, if some formality in rules is desired, we recommend the provisions of Article IX of the 4th Edition of the Rules that is for Committees and Boards which can be found here. Even better, in our opinion, are more recent rules for small boards or boards of small organizations that in essence provide that:

  • Members are not required to obtain the floor before making motions or speaking, which they can do while seated.
  • There is no limit to the number of times a member can speak to a question, and motions to close or limit debate generally should not be permitted.
  • Informal discussion of a subject is permitted while a motion is pending.
  • The chairman need not rise while putting the question to a vote.
  • The chairman can speak in discussion without rising or leaving the chair; and, subject to rule or custom within the particular board (which should be uniformly followed regardless of how many members are present), he usually can make motions and usually votes on all questions.
  • Sometimes, when a proposal is perfectly clear to all present, a vote can be taken without a motion having been introduced. A vote can be taken by a show of hands or acclamation.
  • Any member may limit debate by calling informally for the “question” which is short-hand for the formal motion “to close debate and vote immediately on the pending question” or “I move the previous question.”

Chairperson’s Responsibilities

We believe the chairperson has the responsibility to “preside” at the meeting, meaning to facilitate its proceedings. If the chairperson is the CEO, he or she probably has contributed to or determined the agenda for the meeting. If the chairperson is an outside director, he or she should have input to the agenda, including the right to request on the chairperson’s or any other director’s behalf, to have an item placed on the agenda.

The chairperson needs to make sure everyone has an opportunity to ask any questions, or express any thoughts, regarding any matter being considered during the meeting. However, to facilitate the proceeding of the meeting, the chairperson should encourage questions such as:

  1. How does this action further the corporation’s best interest?
  2. Who else benefits from the action?
  3. How does this further the Organization’s strategic direction?
  4. What is being asked of us as a Board?
  5. What is to be expected of management?
  6. And most importantly, what if things don’t go as expected? For example, “What happens if things don’t go according to plan?” “What financial, legal, ethical, strategic, and reputational issues are involved?” Policy makers, such as Board members, must consider all of the possibilities, especially those that could have a high impact, albeit remotely probable, and not just the normal.

A more delicate responsibility of the chair person is to diplomatically move the proceeding along when a director begins second guessing “how” management is going to do something because that’s management’s responsibility.

Executive and Privileged Sessions

Finally, we recommend that every board meeting and every oversight committee adjourn to an executive session that includes just the outside directors or, for public companies and some regulated industries, directors that are independent within the definition applicable to those companies or industries. If the session is for purpose of receiving legal advice or reports, the session should be privileged and not include anyone, even an outside or independent director, who may have a conflict of interest. We do not recommend that minutes be taken of an executive or privileged session. To conclude an executive or privileged session, the board or committee should adjourn the session and reconvene the meeting. Then, a majority vote of whoever is present may adjourn and close the meeting.

Next Posting

Our next posting will focus on use of a consent agenda as part of the meeting so that the board or committee can use their time to consider the important matters.


 

Posted by J. Beavers in  Governance Best Practices   |  Permalink

 

Mar 05, 2015

Rules to Avoid Compliance Issues with Minutes and Conduct of Meetings: Reflecting in Minutes Documents Made Available for Meetings
 

This post, titled “Reflecting in Minutes Documents Made Available for Meetings,” is the third of a multiple-part series that outlines best practices for preparing meeting minutes and conducting meetings to avoid compliance issues. The first blog post described basic rules for preparing minutes. The second blog post described special considerations for preparing minutes of an adjourned meeting. Future posts will describe tips for conducting meetings that produce an accurate and desirable official record of the event. The rules presented in this series, especially in this blog, are specifically intended for the boards of non-governmental organizations. City councils, public school boards and other governmental bodies are subject to open meetings and other laws that are not applicable to non-governmental organizations.

In review, our posting, titled “Basic Rules for Minutes,” described two basic rules for preparing minutes of meetings:

  1. Saying less is better.

    Reflect compliance with certain procedural matters: (i) The date, time and place of the meeting to reflect compliance with notice requirements, (ii) who was in attendance to reflect compliance with quorum requirements, and (iii) who presided over the meeting;

    Identify general matters considered: This is for purpose of refreshing the board or committee members’ memories of what happened at the meeting, so they do not need to review notes or other documents other than the minutes.

    Reflect the decisions made: The decisions made are the most important content of the minutes. A record of the decisions made is not only the information needed by most audiences but is also necessary in many jurisdictions to invoke protection of the business judgment rule.

  2. Minutes should be the only record.

    The minutes of a proceeding are the official record of that proceeding. In such cases, minutes should be the exclusive recording of the proceeding. Members of a body who take notes at a meeting should, as a routine practice, destroy those notes after satisfying themselves that the minutes accurately reflect the proceedings. Many organizations collect all written material, including notes, at the conclusion of the meeting, and as a routine or customary practice, this has been accepted by courts of most jurisdictions.

Below are some rules for documents made available to a board’s or a committee’s members before or at a meeting:

  1. Do not attach the document to the minutes.

    A well conducted meeting will make available to the board or committee members documents to be considered at, or as background in preparation for, the meeting. Following the “saying-less-is-better” and the “minutes-should-be-the-only-record” rules, we generally do not recommend attaching these documents to the minutes. Including documents results in a risk of confidential information being discovered by parties who do not have an obligation to maintain the confidentiality of the information. In addition, many states’ laws make minutes generally available for examination by certain stakeholders, such as shareholders, members, regulators and, under certain circumstances, creditors.

  2. Reflect documents by name in the minutes.

    Instead, we recommend that all documents made available before or at the meeting be listed in the minutes. There is no one correct way to do this, but here are several ways we like to see it done for a fictional organization, “XYZ.”

    • Reflect what was received prior to and at the meeting in an introductory paragraph of the minutes and list the documents at the end of the minutes:

      Each member had received materials prior to the meeting consisting of the agenda and attachments numbered 1 through 11, listed at the end of these minutes, and at the meeting, a Memorandum from Mr. Compensation Consultant, dated December 1, 2014, and with the subject “Recommended Performance Targets for 2015 Incentive Compensation.”

      * * *

      Materials Made Available for or at the Meeting:

      Attachment 1: “XYZ Conflicts of Interest Policy”

      Attachment 2: “Minutes of the January 1, 2015 Meeting of XYZ’s Board of Directors”

      Attachment 3: Memorandum from Mr. Compensation Consultant dated December 1, 2014 with subject “Recommended Performance Targets for 2015 Incentive Compensation.”

    • Or, if the board or committee follows a written agenda that lists the documents provided in advance, we will consider attaching the agenda and, in an introductory paragraph of the minutes, referring to it for the description of documents:

      Each member had received materials prior to the meeting consisting of the agenda and attachments numbered 1 through 11, listed the agenda attached to these minutes, and received at the meeting a Memorandum from Mr. Compensation Consultant dated December 1, 2014, with subject “Recommended Performance Targets for 2015 Incentive Compensation.”

    • Or, if the meeting is conducted pursuant to a written agenda and the meeting covers each of the documents, we will consider describing each document by title or subject in the text of the minutes:

      The chairperson asked for disclosure of any personal or economic interests of any member on any matter scheduled to come before the meeting that could constitute a conflict of interest under the “XYZ Conflicts of Interest Policy” in Attachment 1.

      Upon motion duly made and seconded, the Board unanimously ratified the Minutes of the January 1, 2015, Meeting of XYZ’s Board of Directors” in Attachment 2.

      At the chairperson’s request, Mr. Compensation Consultant reviewed his Memorandum dated December 1, 2014, with subject “Recommended Performance Targets for 2015 Incentive Compensation” in Attachment 3.

  3. Number the documents.

    We find that numbering the documents (e.g., Attachment 3 or Exhibit 1) is helpful when a document needs to be retrieved.

  4. Who should retain the documents?

    • We recommend that the minutes reflect that the board or committee request legal counsel or an appropriate corporate officer (such as the corporate secretary) to retain such documents on the board’s or committee’s behalf:

      The Committee requested that Mr. Lawyer cause his law firm to retain these documents on its behalf for a reasonable period of time.

    • We favor a lawyer retaining the documents because a lawyer has an ethical obligation to maintain the confidentiality of the documents except as otherwise required by law.

Our next posting will focus on the conduct of a meeting of a board or committee, beginning with suggestions for the agenda of the meeting.


 

Posted by J. Beavers in  Governance Best Practices   |  Permalink

 

Feb 19, 2015

Rules to Avoid Compliance Issues with Minutes and Conduct of Meetings: Considerations for Minutes of an Adjourned Meeting
 

This blog, titled “Considerations for Minutes of an Adjourned Meeting,” is the second of a multiple-part series on how boards and their committees can avoid compliance issues. The series focused first on minutes, beginning with “Basic Rules for Minutes,” because minutes should be the official and only record of meetings. The series now focuses on special considerations for minutes and will later conclude with some tips for conducting meetings that produce desirable minutes. The rules presented in this series are intended for boards of non-governmental organizations, because city councils, public school boards and other governmental bodies are subject to open meeting and other laws that are not applicable to non-governmental organizations.

Boards and their committees may take action on a matter only by:

  1. Vote of a majority of members entitled to vote thereon at a duly called meeting at which a quorum is present; or
  2. In lieu of a meeting, written consent of the members entitled to vote on the matter (which in Ohio and many states must be unanimous written).

Occasionally, committees will determine that they do not have all of the information that the committee members believe they need to take action. This is most problematic for oversight committees, such as audit, compensation, governance and compliance, where actions should be taken before the next regular meeting of the committee and without taking the time to call a special committee meeting.

This is not problematic for action being taken at a meeting if the information can be obtained while a quorum of the committee remains present. However, it becomes problematic if a quorum is not present when the information is obtained. One solution is to evidence any action taken based upon this information by written consent of the committee members, which in Ohio must be unanimous, effective on the date of the last to sign. However, having the discussion of a matter in the minutes of the meeting and then a separate written consent taking the action may be difficult to read if in separate documents.

A possible solution that we recommend is for the minutes to be:

  1. Drafted to reflect both the discussion of the matter that occurs at the meeting, the directions to obtained further information, and then the taking of the action based upon those minutes, sequentially as they actually occur, reflecting that the effective date the action that took place after the meeting. For example, with respect to a compensation committee approving the forthcoming year’s personal compensation goals:

    “The meeting was then adjourned so that the committee chair person could obtain, and report back to the other committee members, information from Mr. CEO regarding the compensation targets of Mr. CFO and Ms. COO. Each member of the Committee suggested changes, the Committee approved the revised personal goals with those changes.”

    This result is one document that reflects, sequentially as they occur, the discussion of the matter and decision to obtain further information that occurs at the meeting, and the subsequent taking of the action after the information is received.

  2. Signed by all of the committee members so that there is evidence that there is unanimous written to the actions reflected in the minutes, including those taken based upon information received after the meeting. This results in a valid written consent in lieu of a meeting evidencing the taking of the action. We recommend that this written consent be unanimous even if unanimity is not required by the law governing the organization. For example, the format for the signatures would be:

    Verifying approval by the Committee
    ________________________   ________________________
    Chairperson Date
    ________________________   ________________________
    Committee Member Date
    ________________________   ________________________
    Committee Member Date
    ________________________   ________________________
    Committee Member Date

    We suggest dating each signature on the date of the last to approve of the minutes.

  3. Ratified by the committee by a majority of its voting members at a subsequent (hopefully, the next) meeting at which a quorum is present. This results in the action taken after receiving the information being approved at the subsequent meeting by majority vote of the voting members. For example, the minutes of the subsequent meeting would provide:

    Upon motion duly made and seconded, the Committee unanimously ratified the minutes of the January 1, 2015 meeting in Attachment 3, which were approved for signature on, and signed by the Committee members as of, January 15, 2015 [the date of the last to approve the January 1, 2015 minutes].
Following this solution is helpful with tax-exempt charitable organizations subject to Intermediate Sanctions. To avoid Intermediate Sanctions requires the organization’s compensation committee to (1) document its decisions with minutes or written consents showing decisions free of conflicts of interest, and (2) generally to complete those minutes/consents within 60 days of the meeting, which can be problematic with the period between regular meetings of the committee occur quarterly or more than 60 days apart. Intermediate Sanctions can result in a $10,000 fine on each committee member if the committee does not comply with these (and other) requirements.

The considerations provided in this blog are intended for meeting of committees of the board and not for meeting of the board itself. Rules of procedure, such as Robert’s Rules of Order, generally permit less stringent procedure for committees of a governing body than they do for the governing body itself.


 

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Feb 05, 2015

Rules to Avoid Compliance Issues with Minutes and Conduct of Meetings: Basic Rules for Minutes
 

 

 

This blog post, titled “Basic Rules for Minutes,” is the first of a multiple-part series that outlines best practices when keeping meeting minutes. Because minutes should be the only official record of board and committee meetings, it is important to follow basic rules to avoid compliance issues, which are discussed in this first post. Future posts will analyze special considerations for minutes, including the available of adjourned meeting materials and supplemental documents, as well as tips for conducting meetings that produce an accurate and desirable official record of the event. The rules presented in this series are specifically intended for the boards of non-governmental organizations. City councils, public school boards and other governmental bodies are subject to open meeting and other laws that are not applicable to non-governmental organizations.

 

 

  1. Saying less is better

    In order to keep the courtroom from invading the boardroom, the most basic rule is, “saying less is often better.”

    Today’s business climate places heightened scrutiny on corporate governance and the actions of board members in both public and private companies as well as tax exempt organizations. Therefore, what is captured in your organization’s minutes is a potential script for the plaintiff’s bar.  Minutes have two purposes – to inform and to protect.  To accomplish this purpose, consider three questions when preparing minutes:

    “Who is the intended audience for these minutes?”
    Minutes should meet the information needs of the audience without creating undue liability.  With meetings of a board of directors or other governing body, the intended audience is the shareholders, owners or members.  With a meeting of a board committee or other governing body, the intended audience is the board or governing body itself (or whoever may rely upon the committee or to whom the committee is responsible).

    “Who may rely on these minutes for purposes of protection of the business judgment rule?”
    The business judgment rule protects not only the body whose proceedings are reflected in the minutes, but also any other bodies or persons who may rely on decisions of that body.  In many jurisdictions, protection of the business judgment rule requires a duty of care and a duty of loyalty in making that decision.

    “Who else may review these minutes?”
    For almost every organization, “who else” includes government investigators who may be furthering an investigation and plaintiffs’ lawyers who may be preparing a cross examination.  For closely held corporations, “who else” may someday include investment bankers deciding whether the organization is a candidate for a public offering; venture capital companies considering whether to make an investment; or institutional lenders considering whether to make a loan.
    An important element of minutes is that they provide an opportunity for the organization to create a record of compliance with its legal obligations.  This then begs the question—what should be reflected?
  2. Compliance with certain procedural matters

    For protective purposes, minutes should state, typically in an introductory paragraph, (i) the date, time and place of the meeting to reflect compliance with notice requirements and (ii) who was in attendance to reflect compliance with quorum requirements. Some meetings – for example special meetings of a corporation’s shareholders – require notice of purpose as well as time, date and place.  For evidentiary purposes, it is helpful to record who presided over the meeting and who was responsible for the minutes of the meeting, either in the introductory paragraph or by signatures at the end of the minutes.  A person other than an officer, such as the organization’s chair or secretary, who has authority under the organization’s governing documents, may preside or take minutes at a meeting in which the officer is not present.  If this is the case, the minutes should have a simple declaratory statement to the effect that “X served as acting chair to preside at the meeting” or “Y served as acting secretary to take minutes of the meeting.”

    For executive sessions of boards or committees and for important meeting of oversight committees, the board, board chairperson, committee or committee chairperson may have minutes kept by legal counsel in order to protect their secrecy and confidentiality.  However, this practice is generally not available for governmental or other organizations subject to open meeting laws or similar requirements.
  3. Identification of general matters considered

    For protective purposes, especially when a meeting is called for specified purposes or with an agenda, the minutes should identify in general terms the matters considered.  For example, “The directors considered the various documents presented for consummating the merger of X into Y.”  However, for the reasons discussed below, it is generally not advisable for minutes to reflect detail regarding the considerations or the discussions involved.
  4. Decisions made

    For both informative and protective purposes, the decisions made are the most important content of the minutes.  A record of the decisions made is not only the information needed by most audiences but is also necessary in many jurisdictions to invoke protection of the business judgment rule.  Decisions may be either:

    • to take or to authorize the taking of some action, or
    • not to take or to authorize the taking of some action.


    Minutes should reflect either type of decision.  A decision to take or authorize some action typically takes the form of a “Resolved” clause, such as:

    RESOLVED, that each of the following merger documents . . . is hereby approved and adopted in the form presented together with such changes as may be approved by the officer executing the same on behalf of this Corporation, which approval shall be conclusively evidenced by the execution and delivery of the same by such officer.

    A decision not to take or authorize some action is more often than not less formal than a “Resolved” clause:

    The directors considered and decided to decline approval and adoption of the merger documents presented.
  5. Recording of votes

    Generally, minutes are not legally required to reflect who voted and how he or she voted on any particular decision.  Except for abstentions and minority votes discussed below, a simple statement to the effect of either of the following should suffice:  “the directors adopted the following resolution” or “the directors decided to decline . . . .”

    What if I abstain from voting?
    The laws of many jurisdictions require disclosure of any financial or personal interest of any member of a body in any matter being considered by that body.  Further, many jurisdictions require that the interested member abstain from voting in any decision with respect to that matter.  For protective purposes, the minutes should reflect an abstention when it is due to a financial or personal interest.  However, the minutes should reflect only the abstention and not the underlying particular financial or personal interest.  A simple statement to the effect of the following will suffice:  “Mr. X abstained for reasons stated at the meeting.”

    What if I vote “no” on an issue?
    Courts of many jurisdictions hold that members voting on the non-prevailing side of an issue considered by a body may request his or her vote be reflected, and if so, minutes should reflect that requested minority vote.  Many statutes require negative votes on the non-prevailing side of an issue be reflected in the minutes.  For example, Delaware’s corporation law gives a director the right to “cause” his or her dissenting vote to be “entered” in the minutes.

    Under Ohio law, a director is presumed to have voted for any action taken, unless they vote “no” or his written dissent from the action is filed either during the meeting or with the secretary of the corporation within a reasonable time after the adjournment.  Therefore, you will want to have a negative vote reflected in the minutes.

    Courts generally have not required that the minutes reflect the member’s reasons for his or her vote, even if requested.  As with abstaining in order to comply with the duty of loyalty, a simple statement to the effect of the following will suffice:  “Mr. X requested that his negative vote be reflected in the minutes.”
  6. Factors considered in making decisions

    Minutes should record factors considered in making decisions only if needed by the intended audience or, if advisable, for showing compliance with the duty of care.  For example, minutes should reflect any factors that the intended audience wants to have considered.  An example of minutes recording the discussion of an item on the agenda should be as follows:

    “The board next considered the design department’s recommendation of ‘X’ over ‘Y’.  Following a presentation of the issue by Mr. Smith, there followed a general discussion and the board voted unanimously to accept the proposal.”

    In certain situations, legal counsel for the body may advise that minutes list certain factors considered in decisions, if appropriate, to reflect the exercise of due care.  The laws of most jurisdictions allow a body to consider general categories of factors, such as interests of the organization’s employees, suppliers, creditors and customers; the community and society; and the economy of the jurisdiction and nation.  Any statement of such considered factors should be no more detailed than necessary to identify those general factors.

    Minutes should reflect a board’s reliance upon the advice, opinion or report of other advisors, including legal counsel, a committee or an officer.  At times, directors are faced with decisions that require special knowledge or expertise, which the directors themselves do not possess.  Because members of a governing board may not have the time or resources to personally investigate every matter that comes before the board, many governing statutes permit the board to rely reasonably upon information presented by officers, employees, board committees, and independent professional advisors in the board’s decision-making process.  In such cases, the minutes should reflect such reliance with a simple statement that the board “took such action in reliance upon the advice of . . . .”
  7. Privileged discussions

    At times, discussions at a meeting, especially with legal counsel regarding legal rights or obligations, are privileged.  Those discussions should not be memorialized in minutes.  The following simple sentence will suffice: “The board participated in a privileged discussion on the subject matter with counsel.”  The minutes should reflect counsel’s presence in any such session, because discussions between board members and counsel are not discoverable, and saying less will protect directors against charges of misconduct.
  8. Minutes should be the only record

    Under the laws of most jurisdictions, the minutes of a proceeding are the official record of that proceeding.  In such cases, minutes should be the exclusive recording of the proceeding.  Members of a body who take notes at a meeting should, as a routine practice, destroy those notes after satisfying themselves that the minutes accurately reflect the proceedings.  Many organizations collect all written material, including notes, at the conclusion of the meeting, and as a routine or customary practice, this has been accepted by courts of most jurisdictions.

    The minutes of the corporation are considered the best evidence of what transpired at the meeting.  Under the best evidence rule, other evidence, such as someone’s notes or memory, is generally not admissible to prove what happened at the meeting, unless it can be shown that the minutes have been lost, destroyed or are otherwise unavailable.  However, personal notes or memory can be used to impeach the competence or integrity of a witness.  An experienced trial attorney can effectively call into question competence or integrity by asking a witness to explain differences between his or someone else’s notes and the minutes or the witness’s memory.
  9. Prior to approving the minutes, read them carefully

    Minutes can not only inform the board but can also make the board more or less vulnerable to potential claims from shareholders and others.

    If a dissident shareholder is considering bringing a claim against the corporation, the least expensive form of discovery, which does not require the filing of a complaint, is to demand to see copies of the minutes.  Thus, initial decisions as to whether to initiate litigation may be based upon a review of the minutes.

    When certified to be true by the secretary, minutes constitute prima facie evidence of the facts stated; all actions recited as having been taken and all elections and appointments are deemed valid until proved otherwise.  Further, a person, who is not a shareholder, who acts in reliance on certified minutes, is deemed to have acted in good faith, regardless of whether the minute’s recital turns out to be accurate.  So, ensuring the accuracy of the minutes before the secretary certifies them is critical.

    When reviewing the minutes, consider the following:

    • Factual inaccuracies.  Every director knows enough to correct material misstatements in the minutes.  However, there can be pressure when the agenda is crowded to let seemingly unimportant misstatements remain unchanged.  This is a mistake.  In a litigation context, if opposing counsel proves that a meeting in fact adjourned 15 minutes before the time stated in the minutes, that fact may not be important in and of itself; but it can cast doubt on other statements made in the minutes.
    • Confirm dates when actions occurred.  Any attempt to make an action effective on an earlier date should precede the date with the phrase “as of” (e.g., “This consent is signed as of January 1, 2015).  While this may raise grounds for challenge of the action’s effective date, it will not result in the making of a false entry, subjecting a director to potential liability under Ohio corporate law.

Conclusion

In today’s era of heightened scrutiny, it is crucial to keep the intended audience in mind when composing meeting minutes, along with other possible readers, such as government investigators and trial attorneys. 

The minutes should give enough detail to show compliance with notice provisions and entitle reliance under the business judgment rule.  Additionally, minutes should reflect only the decisions made, including both those to take and not to take action.  Doing so will keep the court room from invading the boardroom.

Finally, carefully drafted corporate minutes should inform the intended audience and protect against giving a cause of action to the other.  The best approach to accomplish both—saying less rather than more. 

 

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Oct 23, 2014

Who is Responsible for Compliance and Compliance Reporting?
 

We have recently seen a plethora of headlines and news articles on compliance, compliance reporting, and who is responsible for them. Below is a governance perspective of who is responsible and the importance of regular reporting to those responsible persons.

Who is Responsible?

We answered the responsibility question in the inaugural March 27, 2014, post of Acredula for INCompliance: “Corporate compliance for any organization starts at the top with the organization’s governing board.” Most of the recent headlines and lead stories have ignored this very important role of a governing board.

Courts have held that a governing board’s duty of care (i.e., acting with the care that an ordinarily prudent person in a like position would use under similar circumstances) requires the governing board, as the organization’s highest authority, to be responsible for and oversee the organization’s compliance with fiduciary duties, laws, high ethical standards, and other legal and societal obligations. Similarly courts have held that a governing board’s duty of loyalty requires that such responsibility and oversight be conducted in good faith in what the governing board reasonably believes is in the best interest of their organization as whole.

A governing board is permitted to delegate its responsibilities to a committee of board members (often the audit committee for publicly-held companies or a governance or compliance committee for other organizations). However, a governing board may delegate to a committee only for matters within the committee’s designated authority and only if the board reasonably believes the committee merits confidence.

A governing board may also delegate its responsibilities to an officer (typically, for responsibilities as important as compliance, the person serving as chief executive officer). However, boards may delegate to an officer only for matters for which the board reasonably believes the officer is reliable and competent.

For larger organizations, the responsibility and oversight of compliance is typically delegated to the person serving as the organization’s chief executive officer who, in turn, may delegate some of that responsibility to general counsel or a chief compliance officer. However, the person acting as chief executive officer remains solely responsible to the governing board for compliance of the organization even though the chief executive officer may delegate authority to general counsel or a chief compliance officer.

Our experience is that there are two situations in which the risk of a lack of compliance is greatest for any organization:

  • When the chief executive officer or an executive chairperson of the board increases the size of the board to a number greater than the 7 - 11 (generally recommended by most governance experts as the best number for making decisions). Larger boards have to exercise additional prudence to learn “what they don’t know” because it is difficult for a chief executive officer or board chair to keep larger boards well-informed.
  • When a new person from outside the organization becomes chief executive officer and replaces other executives with persons with little or no experience with the organization. Boards have to exercise additional prudence to make sure there a transition that is consistent with the board’s desired strategic direction, including responsibility and oversight for compliance.

New board members should receive orientation and ask questions about previous compliance issues and how current compliance issues are handled. Experience with compliance issues should be included in the criteria for selecting new board members. Likewise, all board members should meet periodically in executive session (as discussed below) with those responsible for the organization’s compliance.

The Importance of Compliance Reporting to the Board

Because of the importance of compliance, we recommend to any organization that its board, or committee responsible for compliance, meet in executive session periodically not less frequently than quarterly with general counsel and any chief compliance. These meetings should discuss compliance issues and reinforce that general counsel and any compliance officer have direct reporting authority to the board or compliance committee for any compliance issue that general counsel or the compliance officer reasonably believe should be known by the board or committee.

We generally recommend that general counsel or the compliance officer follow, as guidance, Rule 1.13 of the rules of professional conduct for attorneys:

If general counsel or a compliance officer for an organization knows facts from which a reasonable person, under the circumstances, would conclude that an officer, employee or other person associated with the organization is engaged in action, intends to act or refuses to act in a matter related to the representation that is a violation of a legal obligation to the organization, or a violation of law which reasonably might be imputed to the organization, and that is likely to result in substantial injury to the organization, then general counsel or the compliance officer shall proceed as is reasonably necessary in the best interest of the organization.

It is too early to tell how the recent headlines and news stories will portray the organizations involved. Suffice it to say that an organization’s most important asset is its reputation, which the organization’s governing board should assume responsibility and oversight for.


 

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Oct 21, 2014

Factual Scenario Simulations for Boards
 

To recap our series of posts from March 2014 to date:

  • Three posts on “Corporate Compliance Starts with Good Governance at the Top” dealing with “Fiduciary Duties of Board Members” (March 27, 2014), “Some Special Areas of Concern for Board Members under Their Fiduciary Duties”(April 10, 2014), and “Protections Afforded to Board Members with respect to Fiduciary Duties” (April 24, 2014);
  • A post on “Standards Set by Federal Sentencing Guidelines,” which may be experienced without good governance at the top (May 12, 2014);
  • A post on “Best Practices” as a standard higher than fiduciary duties (May 29, 2014);
  • Two posts on “Board Evaluations” dealing first with “Why they Are Important (June 12, 2014) and then “How to Proceed” (June 26, 2014);
  • A post on “Engaging the Board in Succession Planning among Its Board Members” (July 10, 2014);
  • A post on “Engaging the Board in Strategic Planning” (July 24, 2014); and
  • Three posts on “Expertise Boards,” with the ultimate goal of good governance at the top, “State Law Encourages an Expertise Board for Corporate Compliance” (August 7, 2014), “Categories of Expertise to Consider for an Expertise Board” (August 21, 2014), and “How to Address Gaps in Expertise” (September 11, 2014).

In order to engage the board and its members in any of these governance topics, we recommend extemporaneous simulation of factual scenarios in which the board participates. We’ve found that engaging a board in a simulated factual scenario is more engaging than a traditional PowerPoint lecture format.

Some of the simulations boards have found beneficial include:

  • Penn State: We re-enact a scenario based upon the day-by-day the events faced by the Penn State board over the five-day period of Saturday, November 5, 2011, through Wednesday, November 9, 2011. In this exercise, we challenge the board to review each issue considered by the Penn State board during that period and then vote as a board. The learning objective of this simulation exercise is the importance of protecting one of your organization’s most valuable assets  - its reputation.
  • Adolph Icon: The board receives a letter from an Adolph Icon on the evening prior to a board meeting demanding a meeting with the board at that board meeting. Icon has a biography that includes getting himself elected to boards and their compensation committees, replacing other members of the compensation committee with colleagues and family members, and eventually firing management and assuming control. The learning objective of simulation exercise is the role of the board and of management in dealing with an unexpected solicitation that can have a draconian result.
  • Mass Board Resignation: At the beginning of a board meeting, the CEO announces that a majority of the board had resigned prior to meeting, and legal counsel has advised that the board needs to fill the vacancies. The board is guided in a discussion of what skill sets it wants in new board members and is gently pushed toward building an “expertise” board composed of persons with competencies needed for the future success of the organization rather than a “constituency” board (such as Congress). The learning objective of this simulation exercise is succession planning of the board.
  • Unexpected CEO Resignation: At the beginning of a board meeting, the board chair announces that the organization’s CEO tendered his or her resignation effective yesterday and the board will need to determine what skillsets the board wants in a future CEO and how it will find such a person. The learning objective of this simulation exercise is CEO succession planning.
  • New Board Member Nightmare: Using stick character cartoon figures, a young person is solicited   ¾ and agrees ¾ to become a new board member of a nonprofit organization. This turns into a nightmare when the new board member becomes an ERISA fiduciary, treasurer where the organization failed to file and report employment taxes, and is imposed with Intermediate Sanctions. The learning objective is what questions should be asked, and what red flags should be warnings, before becoming a nonprofit board member.
  • Adolph Shepard Requests for a Members Meeting to Change Control: The board members of a membership organization ¾  such as an insurance company or a member nonprofit organization ¾  receive a letter demanding a copy of the names and addresses of the members with the purpose of calling members’ meeting to consider a proposal for a reverse merger that will result in change in control of the organization. The learning objective is to assess the current capabilities of the board, individual directors, and executive officers in dealing with such an unexpected event and review steps needed to strengthen those capabilities.

      These factual scenarios are not scripted, but instead simply outlined, in order to allow for a natural reaction to the simulation from the board. After completing the simulation, there is a discussion led by an outside facilitator of what the board did correctly and where it may make some improvements. Except for the “New Board Member Nightmare,” these are generally half-day programs. We find it works best if the board (except for the board chairperson) is unaware of the simulation until the beginning of the board meeting.

      If you’d like further information about these extemporaneous simulations, feel free to contact John Beavers at JBeavers@INComplianceConsulting.com or 614.227.2361 or info@incomplianceconsulting.com.


    •  

      Posted by J. Beavers in  Governance Best Practices   |  Permalink

       

      Aug 21, 2014

      Categories of Expertise to Consider for an Expertise Board
       

      This is the second installment in this three-post series on the use of expertise boards for corporate compliance. The first post described state corporation law’s encouragement for use of an expertise board. This second post discusses the categories of expertise to consider and the third post will discuss how to address any gaps in desired expertise.


      A board can consider numerous competencies in putting together an expertise board. In order to assure some depth as well as structure in the consideration, we recommend that at least the following categories of competencies be considered:

      • Business and professional expertise and experience
      • Character and demographic suitability
      • Personality characteristics and temperament

      Business and professional expertise and experience

      Our experience is that boards and management need little help in inventorying their current expertise and experience. This is typically done by questionnaire and discussion.

      A questionnaire is helpful because it allows each member of the board and management initially to state his or her competencies in his or her own words. We recommend including at least one open-ended question such as, "Do you have any expertise or experience that the organization is not fully utilizing?" We find that almost every board member and many management members believe they have some expertise or experience that is under-utilized.

      Discussion is important because it will give context and depth to those initial statements and is especially helpful in identifying under-utilized expertise and experience.

      A helpful result is an expertise-and-experience matrix showing in tabular form the expertise and experience of each member of the board and management.

      Boards and management may need help in identifying possible desired fields of expertise or experience. The human resource officer or department may be helpful in providing an initial list of possible fields. Boards also should consider fields of expertise and experience considered important by peer organizations. The following is a sampling (but not an exhaustive list) of some fields considered recently by organizations that we have helped:

      • Accounting knowledge of financial reporting, accounting principles (including those for accounting for estimates, accruals and reserves), internal controls, record keeping, the auditing process, and knowledge of related considerations and issues;
      • Audit committee experience with the operations, role and function of audit committees;
      • Board of director experience as a board member of a comparable organization;
      • Brand marketing experience as a board member of a comparable organization;
      • Corporate governance experience with a comparable organization domiciled in the United States;
      • Executive compensation experience with executive recruitment and retention, compensation structures, performance reviews and aligning compensation and incentives with organizational values and performance;
      • Financial officer experience as a chief financial officer or in actively supervising a chief financial officer;
      • Governmental knowledge of a federal or state agency having jurisdiction relevant to the organization’s business;
      • Industry knowledge of one or more of the important business lines of the organization;
      • International or global knowledge of relevant markets;
      • Investment knowledge of investment best practices of comparable organizations;
      • IT experience with information technology systems and developments;
      • Large company experience with directing or managing a large and complex organization;
      • Legal or regulatory knowledge of legal, regulatory issues and public policy relevant to the business of the organization;
      • Merger and acquisition experience in business mergers, including both acquisitions and dispositions, as well as joint ventures and affiliations;
      • Operations experience as a chief operating officer or other role in managing the operations of a comparable enterprise;
      • Public relations experience in dealing and communicating with the traditional media, social and internet media, public officials, trade associations and community groups;
      • Risk management experience in identifying principal enterprise risks to understand whether management has implemented the appropriate systems to manage risk;
      • Sales distribution experience with sales distribution models;
      • Strategic business planning expertise in the strategic planning process for a comparable enterprise.

      Character and Demographic Suitability

      There are a number of character and demographic suitability characteristics that should be considered in selecting board members. Again, for organizations large enough to have a human resource department, the HR department can be helpful, especially in conducting criminal records, credit and drug checks (which are becoming more common in director selection). Assuming clearance in those checks, here are some additional character and fitness considerations:

      • Contributes to the diversity of people and ideas of the board. We find that the primary goal of diversity should be that of ideas. Those generally come from people of differing gender, ethnicity, geography as well as differing backgrounds, experience and personality.
      • Is free of any apparent conflict of interest. A candidate should complete the same conflicts questionnaire or otherwise be screened with respect to personal or economic interests that may adversely affect his or her independent judgment on behalf of the organization.
      • Has a reputation for honesty and integrity. Asking for references and checking them is as important as the criminal records, credit and drug checks.
      • Is able to ask questions appropriately. One of the most important skills of a director is knowing what questions to ask and when to stop asking questions. This may be reflected by a person’s business or professional expertise and experience. For example experience or expertise in law, psychology, social work, recruiting and even teaching may be indicative of being able to ask questions. This also may be reflected by personality type or temperament. However, it is probably best reflected by the questions asked by a candidate in the selection process. When to stop asking questions may be taught through education of directors.
      • Is willing and able to take the time and focus his or her attention on performing the duties and responsibilities of being a director. This includes learning the business model and structure of the organization and successfully committing to prepare for and regularly attend board and committee proceedings.

      Personality Characteristics and Temperament

      Personality characteristics and temperament may be a factor in selecting board members. For example, a board composed solely of CEOs with extroverted, quick-judging, fact-based personality characteristics may focus too much on decision making and too little on the oversight duties of a board. Over time, a board may want to balance those personality types with personalities of different characteristics or temperament.

      Board and committee chairpersons (as well as other members of the board or committees) often find information on the personality types and temperaments of their members to be useful for them to lead efficient and effective board or committee operations. Because of the importance of having directors who have a variety of business and professional experience and diversity in thought and ideas, directors having in common one set of personality characteristics or temperaments should not dominate or frustrate directors having in common a different set.

      Although there are many systems for classifying personality and temperament, there are three that are commonly used:

      • Myers-Briggs personality type indicators based upon C.G. Jung’s personality types (beginning with either “I” for introversion or “E” for extraversion as to mental focus; “S” for sensing or “I” for intuition for processing information; “T” for thinking or “F” for feeling for the basis of making decisions; and “J” for judging or “P for perceiving” for managing life outside of oneself. The Myers-Briggs Type Indicator or “MBTI” is probably the most recognized and used assessment tool. However, its reliance upon initials for personality characteristics can be a deterrent. Information can be found at www.myersbriggs.org. A guide to the use of the MBTI is the MBTI Manual:  A guide to the development and use of the Myers Briggs type indicator (3rd edition 1998) by Briggs Myers, Mary H. McCaulley, Naomi L. Quenk, and Allen L. Hammer.
      • Spectrum Development Temperament Model also largely based upon the Jung’s personality types and Meyers-Briggs classifications, but using colors (lavender or purples for introvert or extrovert interaction styles and then blue, gold, orange and green for temperaments). Information can be found at www.spectrumdevelopment.com
      • Clifton StrengthsFinder developed by Donald O. Clifton with the Gallup Organization that identifies which of 34 talents each person possesses.  It is not generally based upon Jung’s personality types.  Information can be found at http://www.strengthsfinder.com.  A number of written guides are available including Now, Discover Your Strengths (2001) by Marcus Buckingham and Donald O, Clifton, Ph.D. for StrengthsFinder 1.0, and Strengths Based Leadership (2010) by Tom Rath and Tim Harter.

      Each of the three systems assumes that individuals have preferred ways of thinking, interacting and perceiving the world. There are no “best” or “worst” personality or temperament types.

      We find that the Clifton StrengthsFinder 1.0 is the easiest to use if personality characteristics and temperaments are to be a factor for selecting board members because it requires the least facilitation. Candidates can be given the Now, Discover Your Strengths book, which is a quick read. The book gives them access to the StrengthsFinder 1.0 assessment tool over the internet which is a relatively painless process.


      The next and final post in this series will discuss how to address any gaps in desired expertise


       

      Posted by J. Beavers in  Governance Best Practices   |  Permalink

       

      Aug 07, 2014

      State Law Encourages an Expertise Board for Corporate Compliance
       

      This is the first in our three-post series on the use of expertise boards for corporate compliance. In this post, we discuss state corporation law’s encouragement for use of an expertise board and the benefits of having one. The second post will discuss the categories of expertise to consider and the third post will discuss how to address any gaps in desired expertise.


      State corporation law encourages use of an expertise board rather than a constituency board for corporate compliance.

      An “expertise” board is composed of persons each having particular competencies (i.e., knowledge, skills, experience and expertise) necessary for the board to have as a whole to achieve its future objectives. This is in contrast to a “constituency” board, which is composed of persons who represent the view of a particular constituency (such as the U.S. Congress or a state legislature).

      The state law duty of care encourages use of an expertise board by holding each director to the standard of acting as an ordinarily prudent person in regards to the background, skills or expertise of that director. In other words, under the duty of care, a director is to act with the care that an ordinarily prudent person in a like position would use under similar circumstance. Accordingly, a lawyer, accountant or other professional is not held to the standards of his or her profession when serving on a board, but only to that of an ordinarily prudent person. Likewise, a principal with a health care firm, investment firm, banking firm or other business is not held to the standard of someone familiar with that type of business, but only to that of an ordinarily prudent person.

      On the other hand, the state law duty of loyalty requires a constituency board to act in, or not opposed to, the best interest of the organization as a whole and not necessarily in the best interest of any particular constituency. For a stock corporation, a director is required to take into account the interest of stockholders, but generally only stockholders as a whole and not any particular class of stockholders. For a membership corporation, a director is required to take into account the interest of members as a whole.  And for a charitable organization without members, a director is required to take into account the persons who, as a whole, are served by the mission of organization.

      In addition, most state laws require any matter in which a director has a personal or economic interest to be disclosed by the director to the other directors and, to the extent possible, be approved by directors not having such a personal or economic interest.

      Accordingly, the major benefit of an expertise board is a focus on the best interests of the organization as a whole because its members are selected on the basis of their collective competencies to act in those best interests. Expertise boards also do not face the problems a constituency board encounters with members that view their duties as representing the best interest of the separate constituency that each member represents, not the whole. This often results in:

      • Partisanship similar to Congress and state legislatures;
      • Decisions watered to the least common denominator; or
      • Favoring particular constituencies rather than the organization as a whole.

      The first step in having an expertise board is to adopt an agreed-upon strategic direction for the organization. The "agreement" is typically more in the form of the board's confirmation or ratification of direction recommended by management than a strategy initiated by the board. Only after the board and management commit themselves and the organization to a future strategic direction can they determine the particular expertise and other competencies necessary to achieve that direction.

      The next steps generally include:

      1. Inventory the knowledge, skills, experience, expertise and other competencies present among the current members of the board and management. This will be the subject of our second post in this series.
      2. Project the knowledge, skills, experience, expertise and other competencies that are believed beneficial for achieving the agreed future strategic direction. A board and management often need help in identifying the categories of competencies that should be considered.
      3. Compare the current collective competencies with the desired future collective competencies and identify the gaps. This is simply deducting current competencies projected to remain among the board and management from those believed beneficial in the future.
      4. Determine how best to address any gaps. This will be the subject of our third post in this series.


      The next post in this series will discuss categories of expertise to consider for an expertise board.


       

      Posted by J. Beavers in  Governance Best Practices   |  Permalink

       

      Jul 24, 2014

      Engaging the Board in Succession Planning
       

      This is the second post in this two-part series on engaging the board in planning. In the previous post, we discussed how to involve the board in strategic planning, and now we turn our focus on how to engage a board in succession planning.



      Many boards approach succession planning by imposing age or term limits on its board or, by default, the decision is made by death or disability of a board member. This probably does not meet the state law duties to act in good faith, in a manner each board member reasonably believes to be in or not opposed to the best interests of the corporation, and with the care that an ordinarily prudent person in a like position would use under similar circumstances.

      We believe that the board should continuously strive to build an “expertise” board that is composed of persons each having particular competencies (i.e., knowledge, skills, experience and expertise) needed for the board to collectively achieve its future objectives. This is in contrast to a “constituency” board, which is composed of persons who represent the view of a particular constituency (such as the U.S. Congress or a state legislature).

      Our experience is that this is best done if the board has first agreed upon the organization’s future strategic direction (see the July 10, 2014, post on involving the board in strategic planning). As part of the strategic planning process, the board should assess the core competencies among the board members and management team; prioritize the additional competencies necessary for its future strategic direction; and recruit persons having those competencies for nomination as board members (see June 12, 2014, and June 26, 2014, posts on board evaluations).

      We find with succession planning ¾ as with strategic planning ¾ board members’ eyes tend to glaze over and it may be difficult to keep their attention. Often, the board will become more involved in the succession planning process if outside facilitation is used instead of management.

      Our preferred method of engaging the board is to divide into groups of two or three for a customized simulation. Each group is told by the CEO that all of the other board members have resigned prior to the meeting and that legal counsel has advised that as the remaining members of the board, each group needs to fill the vacancies.  Facilitators then guide the groups in discussions on desired skill sets for new board members, gently pushing them toward building an “expertise” board composed of persons with competencies needed for the future success of the organization.

      Advising a board member that someone else will be nominated in his or her place can be difficult unless the board has already reached the conclusion that it needs a different composition of core competencies for its future direction. Getting the board’s commitment on building its expertise allows the group to focus on filling gaps in skills rather than age, terms or the personal attributes of the director.


       

      Posted by J. Beavers in  Governance Best Practices   |  Permalink

       

      Jul 10, 2014

      Engaging the Board in Strategic Planning
       

      Now that we’ve completed our two-post series on board evaluations and five-post series on corporate compliance for governing boards, we shift our focus to how to engage a board in strategic planning for the first time.


      Under state corporation law, all authority for:

      ·         Decision-making as to matters of policy, direction, strategy and governance; and

      ·         Oversight as to matters critical to the health of the organization for its various stakeholders

      is to be exercised under the direction of the organization’s board. Accordingly, the role of the board is to provide direction, and the role of management is to execute that direction. 

      A board provides direction by:

      ·         Granting authority; and

      ·         Setting limitations

      e.g., the board establishes benchmarks to achieve and grants management the authority to pursue, while providing limitations on how.

      Most boards provide direction by approving an annual budget that management is typically authorized to carry out. A more important way to provide direction is the authorization of a strategic plan that covers multiple years (typically three to five). Because of the Great Recession that began in 2007, authorizing a strategic plan is becoming one of most important responsibilities of the board of any organization.

      We find that when board members first engage in strategic planning, their eyes may glaze over and their attentions may wander. Often, the board will become more involved in the strategic planning process if outside facilitation is used instead of management. However, even with facilitation, boards get bored hearing that they must be constructively involved and learning someone’s definition of what constitutes a strategic plan.

      We find the best way to engage the board is to use a customized simulation of a factual scenario where the board is faced with a paradigm shift. The simulated factual scenario is determined in advance, typically with the CEO and board chairperson, and then is played out so that the board is making what it believes are real-time decisions.

      For example, in one scenario the board is informed that one of its major competitors is being acquired by another competitor, or a strategic buyer, that has unlimited resources. The board is then advised by the organization’s legal counsel that its duty of care requires the board to oversee that there is direction as to what the organization should do in response. To make the scenario appear as real as possible,  it includes simulated press releases, phone calls from the competitor CEOs and statements by other stakeholders.

      Outside facilitation is important to remind the board that state corporation law expects, and gives board members protection for, relying upon management to provide input and suggest directions for the board to consider.

      The focus of the facilitation is to get the board to ask management, “What do you recommend we do?” Management needs to come prepared with strategies that address the paradigm shift.  Then the board needs to be led to ask, “Why are you recommending the business should take this strategy?”  The board, as policy makers, should ask:

      ·         Whose interests are benefited by this strategy?

      ·         What red flags are there?

      ·         What is being asked of us as a board?

      ·         What is to be expected of management?

      ·         What financial, legal, ethical, strategic and reputational issues are involved?

      And the most important question:  “What if things don’t go as expected?”  Policy makers, such as board members, must consider all possibilities, especially those that could have a high impact (albeit remotely probable) and not just the normal.


      The next post will focus on how to engage the board in succession planning, which is another of the board’s most important responsibilities.


       

      Posted by J. Beavers in  Governance Best Practices   |  Permalink

       

      Jun 26, 2014

      The Importance of Board Evaluations
       

      This is the second of our two-post series on the increasing importance of board evaluations for corporate compliance by governing boards. The first post of this series stressed the need for board evaluations and this second post will cover how to proceed with performing board evaluations.

      Our first post explained that the state law duty of care is viewed as requiring the board of directors of any organization to attract and retain sufficient prudence or expertise as directors, and to provide direction and oversee matters critical to the health of the organization into the foreseeable future (discussed in our May 12, 2014, post).


      The Objective of the Evaluation

      The first step in the process is to determine the objective or objectives of the evaluation (as discussed in our May 12, 2014, post).  Generally there are at least these three:

      1. Practices Evaluation. The practices of the board and its committees for purposes of improving board governance to meet the future needs of the company;
      2. Skills Evaluation. The background, skills and experience of each individual member of the company’s board for purposes of determining competence of the board for the future of the organization; and
      3. Compliance Evaluation. The organization’s compliance with legal requirements and ethical aspirations, including compliance with any regulatory order, including any corporate integrity agreement.

      The most common evaluation is the practices evaluation. Most practices evaluations are simply each board member evaluating the organization’s, the board’s, and their committee’s practices. However, a more helpful evaluation would be to identify and use some best-practice benchmarks against which the organization’s, the board’s, and their committee’s practices will be compared.

      The skills evaluation is typically used as part of a strategic planning process where the board determines the collective background, skills and experience believed to be required for the future of the organization, compares that with the collective background, skills and experience of the current board, and then determines how to fill any gaps. However, a good question to include in any evaluation, especially a practices valuation, is an open-ended question to the effect of “Do you have any background, experience or skills that may be helpful to the organization and the board that are not being fully utilized?”

      Consideration should be given to conducting any compliance evaluation either under the direction of general counsel to the organization or special counsel to the board, in order to add protection of the attorney-client privilege and for advice on legal issues such as probative value of evidence and materiality.

      The Subject of the Evaluation

      The next step in the process is typically the subject of the evaluation, which can be (with respect to the objectives identified in the first step):

      • Full board and its committee where each individual director evaluates the full board and its committees; or
      • Individual director self-evaluations where each individual director evaluates himself or herself; or
      • Individual director peer evaluations where each individual director evaluates each other director.


      Full Board Evaluation

      A full board evaluation typically addresses:

      • Understanding of responsibilities
      • Independence
      • Composition and structure of the board
      • Composition and structure of the committees of the board
      • Strategic planning
      • Policy development
      • Board succession
      • Company executive succession
      • Oversight function
      • Financial acumen
      • Business development
      • Conflicts of interests
      • Meetings
      • Communication
      • Understanding of oversight of risks
      • Decision making
      • Board/management relationship
      • Information dissemination
      • Appropriateness of questioning
      • Level of participation
      • System of checks and balances for management decisions

      The most important board evaluation question is open-ended to the effect of:  “The effectiveness of our board could be improved by ______________”.


      Individual Director Self-evaluations


      Each individual director evaluates himself or herself as to matter such as:

      • Understanding role and responsibilities
      • Levels of knowledge (both company and industry)
      • Participation
      • Attendance
      • Willingness to question
      • Independence of thought of action
      • Conflicts
      • Business development
      • Continuing education

      The two most important director self-evaluation questions are “The organization, other directors, and management could improve my effectiveness by ______________,” and “Do you have any background, experience or skills that may be helpful to the organization and the board that are not being fully utilized?”


      Individual Director Peer Evaluations

      Each director evaluates himself or herself and then separately evaluates each other director on the matters described above under “Individual director self-evaluations.  However, we recommend that this be conducted through a third-party evaluator with whom the board has confidence.  The report to each director shows the director’s self-evaluation and the average of the evaluations of that director by the other directors.  Each of these reports must be confidential.  The peer evaluation can be expanded to a 360-degree evaluation where, in addition to other directors evaluating each other director, management, other stakeholders, such as shareholder in a closely-held corporation, and strategic partners, such as outside legal counsel and audit firms also evaluate each director.

      If you have questions on this post, please feel free to contact Kevin Kinross at 614.227.8824 or kkinross@incomplianceconsulting.com.


      The next post will focus on how to engage the board in strategic planning, which is one of the board’s most important responsibilities.


       

      Posted by J. Beavers in  Board Evaluations   |  Permalink

       

      Jun 12, 2014

      The Importance of Board Evaluations
       

      Now that we’ve completed our five-post series on corporate compliance for governing boards, we shift our focus to the increasing importance of board evaluations in this two-part series. This first post stresses the need for board evaluations and the second post will cover how to proceed with performing board evaluations.



      Most institutional investors, regulators (such as the SEC and National Association of Insurance Companies), and governance commentators are taking the position that the state law duty of care requires board directors of any organization to attract and retain sufficient prudence or expertise as directors to provide direction and oversee matters critical to the health of the organization into the foreseeable future (discussed in our March 27, 2014 post). For this reason, board evaluations are often conducted in conjunction with consideration of a strategic plan to determine the organization’s future direction.

      Institutional investors (such as the Council for Institutional Investors) and organizations that rate the corporate governance of public companies (such as Institutional Shareholder Services) were among the first to expect public companies to evaluate at least:

      • The background, skills and experience of each individual member of the company’s board for purposes of determining competence of the board for the future of the company, and
      • The practices of the board and its committees for purposes of improving board governance to meet the future needs of the company.

      In addition, federal sentencing guidelines (discussed in our May 12, 2014 post) generally require, as part of a corporate integrity agreement taken into account in sentencing an organization, that the organization’s board evaluate:

      • The organization’s compliance with the corporate integrity agreement;
      • The practices of the board and its committees for improving board governance to meet the future needs of the organization; and
      • The background, skills and experience of new members added to replace prior members of the board, which is typically required as part of the agreement.
      The SEC began requiring public companies to disclose (in proxy statements at least annually and in prospectuses at each public offering of their securities) a description of  the business experience during the past five years of each director, executive officer, person nominated or chosen to become a director or executive officer and other highly compensated persons of influence. This description includes each person's principal occupations and employment during the past five years; the name and principal business of any corporation or other organization in which such occupations and employment were carried on; and whether such corporation or organization is a parent, subsidiary or other affiliate of the registrant.  In addition, for each director or person nominated or chosen to become a director, briefly discuss the specific experience, qualifications, attributes or skills that led to the conclusion that the person should serve as a director for the registrant at the time the disclosure is made, in light of the registrant's business and structure.  If material, this disclosure should cover more than the past five years, including information about the person's particular areas of expertise or other relevant qualifications.  When an executive officer or highly compensated person of influence has been employed by the company or a subsidiary for less than five years, a brief explanation shall be included as to the nature of the responsibility undertaken by the individual in prior positions to provide adequate disclosure of his or her prior business experience. What is required is information relating to the level of his or her professional competence, which may include, depending upon the circumstances, such specific information as the size of the operation supervised.

      Regulators of non-public companies, such as state regulators of mutual insurance companies, are proposing new rules to describe:
      • The processes in place for the board to evaluate its performance and the performance of its committees;
      • Any board or committee training programs;
      • Processes for identifying, nominating and electing members to the board and its committees, including enough detail to allow each state’s insurance commissioner to determine (i) whether a nominating committee is in place to identify and select individuals for consideration as directors; (ii) whether directors’ terms have limits; (iii) how the election and re-election processes function; and (iv) whether a board diversity policy or skills matrix is in place and how it functions; and
      • The expertise and background of its board members and significant committee members, and how that expertise and background of the collective members are anticipated to meet the future operational needs of the company.

      Finally, best practices (discussed in our May 29, 2014) require boards to strive not to just follow the rules, but strive for a commitment to excellence in governance. Undertaking a board evaluation with a goal of continuous improvement and creating an “expertise” board evidences that commitment.


      The next post in this series will cover how to proceed with board evaluations.


       

      Posted by J. Beavers in  Board Evaluations   |  Permalink

       

      May 29, 2014

      Corporate Compliance Starts with Good Governance at the Top
       

      This is the fifth and final post in this series on corporate compliance issues for governing boards. In the preceding four posts, we discussed fiduciary duties and federal sentencing guidelines. In this post, we will wrap up the series with a discussion on best practices.


      Best practices are higher standards than those set by state law fiduciary duties, federal sentencing guidelines and a maze of other laws including:

      Federal securities law requiring directors to have certain knowledge regarding registration statements filed with the Securities and Exchange Commission (SEC), creating liabilities for wrongdoing as a control person, requiring reports of purchases and sales of the company's securities, requiring disgorgement of profits from any short-swing transaction in the company’s securities and requiring oversight of the audit process and other requirements created by the Sarbanes-Oxley Act of 2002 (SOX). Federal securities laws also include the Securities Exchange Act of 1934 (Exchange Act) and the rules of the New York Stock Exchange (NYSE) and the NASDAQ Stock Market (NASDAQ) for their listed corporations.

      Federal tax law creating liability for certain corrupt practices regarding foreign officials and for allowing unreasonable compensation.

      State securities law, which despite  traditionally regulating the substance of transactions not historically regulated by federal securities laws, are under revision to expand some of the executive accountability provisions of SOX to corporations not covered by SOX.

      State law regarding nonprofit organization fiduciaries, such as UMIFA and other laws creating fiduciary or other standards for nonprofit organization managers.

      Rules regarding regulated industries, such as insurance and banking regulations for management and the safety and soundness of insurers, banks and their holding companies, and SEC rules regarding securities dealers, investment advisers and investment companies.

      Rules of professional conduct such as those for attorneys, accountants and internal auditors that apply not only to directors who are attorneys, accountants or internal auditors, but more importantly to the company’s attorneys, accountants and internal auditors and their relationship with the board.

      Boards should strive to exceed just being compliant with laws. They should focus on best governance practices and should evaluate their practices periodically.

      This should start with an evaluation of the board’s governance operations and practices, beginning with those evidenced by the organization’s and the board’s governing documents. Governing documents should be reviewed against pre-selected sources of best practices that serve as benchmarks, identifying for the board (or an appropriate committee) those operations and practices that meet or exceed the benchmarks, and those that are deficient in comparison with the benchmarks. With respect to those that are deficient in comparison with the benchmarks, considerations for improving those operations and practices should be recommended to the board or committee. Finally, work with the board or committee and its general counsel and other appropriate officers on integrating any desired improvements into the board’s governing documents and practices.

      Practices to be Evaluated

      Generally, boards should use an outside facilitator familiar with board practices and sources of benchmarks to guide the evaluation. Practices that may be evaluated include:

      I. Governing Board

      1. Role of the board
      2.  Composition
        (1) Number of directors
        (2) Outside and independent directors
        (3) Expertise
        (4) Age and tenure
        (5) Former CEO
      3. Nomination and election
        (1) Classification
        (2) Nominations
      4. Leadership
        (1) Independence
      5. Proceedings
        (1) Frequency of meetings
        (2) Access to agenda
        (3) Call for meetings by outside directors
        (4) Attendance
        (5) Outside or independent director meetings
        (6) Location
        (7) Notices and information
        (8) Minutes
        (9) Actions by written consent
      6. Conflicts of interest
        (1) Conflicts of interest
        (2) Change in status
      7. Board compensation
        (1) Annual retainer
        (2) Meeting fee
      8. Training
        (1) New directors
        (2) Continuing education

      II. Committee Independence and Responsibilities

      1. Audit committee
      2. Compensation committee
      3. Nominating committee
      4. Governance/Corporate Compliance Committee
      5. Other committees

      III. Executive Compensation

      1. Independent oversight
      2. Peer data
      3. Documentation
      4. Cash composition
      5. Performance pay
      6. Change in control and severance pay
      7. Review to avoid encouraging unreasonable risks
      8. Limitation on evergreen employment contracts
      9. Transparency of compensation in the income statement

      IV. Role of Management

      1. CEO’s authority and responsibilities
      2. Access of non-CEO management to the board

      V. Other Practices or Policies

      1. Strategy and Risk assessment
        (1) Board responsibilities
        (2) Management responsibilities
      2. Conflict of interest policy
      3. Business conduct policy
      4. Diversity practices
      5. Ethics program
      6. D&O protection
        (1) Governing document provision
        (2) Indemnification agreement
        (3) D&O insurance
      7. Succession planning
        (1) The board
        (2) Management
      8. Whistleblower policy
      9. Document retention policy

      Identifying Benchmarks to Evaluate the Board’s Current Practices Against

      The next step is to identify and select the sources of best practices to be used as benchmarks. We recommend including: ongoing IRS and Treasury initiative for improving governance of tax-exempt entities; recent principals promulgated by the National Association of Corporate Directors; governance issues identified as important by institutional investors; and governance changes required by bankruptcy courts for approval of recent reorganizations.

      There are many sources for best practices, including:

      NYSE and NASDAQ Rules for Publicly-Traded Companies

      Policies of Institution Investors

      • Council of Institutional Investors “Corporate Governance Policies” (updated December 21, 2011); and “Statement in Support of Defined Benefit Plans,” “Statement on Best Disclosure Practices for Institutional Investors,” “Statement on Financial Gatekeepers,” “Statement on Guiding Principles for Trading Practices,” “Commission Levels, Soft Dollars and Trading Recapture,” “Statement on Independence of Accounting and Auditing Standard Setters,” “Statement on Principles for an Effective and Efficient Proxy Voting System, “Statement on the Value of Corporate Governance.” 
      • Teachers Insurance and Annuity Association–College Retirement Equities Fund (TIAA-CREF) Policy Statement on Corporate Governance, 6th edition (2011)
      • California Public Employees’ Retirement System (CalPERS) “Global Principles Of Accountable Corporate Governance,” (2011)
      • Ohio Public Employees’ Retirement System (OPERS) “Corproate Governance 2011 Annual Report" (February 2012)

      Policies of Applicable Trade Associations

      Service Providers

      Universities


      Non-Profit Sites

      • Sample Conflict of Interest Policy and Glossary of Terms for exempt organizations under Internal Revenue Code section 501(c)(3) available in “Instructions for Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code” on the IRS website

      Identifying Practices for Improvement

      The comparison of the board’s current operations and practices with the benchmark will identify those that are deficient in comparison. The next step is recommending to the board or committee considerations for improving those operations and practices. Finally, the board or committee will need to coordinate with its general counsel and other appropriate officers on integrating any desired improvements into the board’s governing documents and practices.


      This concludes the series of posts on corporate compliance issues for governing boards. Stay tuned for more related issues in future posts. If you would like to request a reprint of all the posts in this series, email benews@bricker.com.


       

      Posted by J. Beavers in  Governance Best Practices   |  Permalink

       

      May 12, 2014

      Corporate Compliance Starts with Good Governance at the Top
       

      This is the fourth post in this series of posts on corporate compliance issues for governing boards.  In the preceding three installments, we discussed fiduciary duties. This time we will turn our concentration to the standards set by federal sentencing guidelines for organizations if there is a breach of these fiduciary duties.



      Standards Set by Federal Sentencing Guidelines

      Federal sentencing guidelines penalize organizations found guilty of breaches of fiduciary duty or violations of law constituting felonies or Class A misdemeanors, yet provide for significant reductions in penalties for organizations that maintain compliance programs to detect and correct such breaches of duty or violation of law. According to “An Overview of the Organizational Guidelines” by the Deputy General Counsel of the United States Sentencing Commission (USSC Overview):

       

      While organizations cannot be imprisoned, they can be fined, sentenced to probation for up to five years, ordered to make restitution and issue public notices of conviction to their victim and exposed to applicable forfeiture statutes. Data collected by the Sentencing Commission reflects that organizations are sentenced for a wide range of crimes. The most commonly occurring offenses (in order of decreasing frequency) are fraud [which includes breach of fiduciary duty], environmental waste discharge, tax offenses antitrust offenses, and food and drug violations.

       

      The organizational sentencing guidelines apply to for-profit corporations, partnerships, limited liability companies, labor unions, pension funds, trusts, nonprofit organizations and governmental units. According to the USSC Overview, “Guidelines are designed to further two key purposes of sentencing: ‘just punishment’ and ‘deterrence’.  Under the ‘just punishment’ model, the punishment corresponds to the degree of blameworthiness of the offender, while under the ‘deterrence’ model, incentives are offered for organizations to detect and prevent crime.”

       

      An organization can be subject to criminal liability whenever an owner, director, officer, employee or other agent or representative of the organization commits an act within the apparent scope of his or her employment, even if the agent or representative acted directly contrary to company policy and instructions. An entire organization, despite its best efforts to prevent wrongdoing in its ranks, can still be held criminally liable for the illegal actions of any of its agents or representatives. However, the degree of liability can be mitigated if the organization had an effective compliance program in place at the time of the breach of fiduciary duty or violation of law. According to the USSC overview, an “effective compliance program” contains standards and procedures reasonably capable of reducing the prospect of breaches of fiduciary duty or violations of law through:

       

      • Oversight by high-level personnel
      • Due care in delegating substantial discretionary authority
      • Effective communication to all levels of employees
      • Reasonable steps to achieve compliance, which include systems for monitoring, auditing and reporting suspected wrongdoing without fear of reprisal
      • Consistent enforcement of compliance standards, including disciplinary mechanisms
      • Reasonable steps to respond to and prevent further similar offenses upon detection of a violation

      Accordingly, the American Bar Association’s Corporate Directors Guidebook, 5th Ed. (ABA Guidebook), provides that “directors should periodically satisfy themselves that an appropriate process is in place to encourage attention to legal compliance issues and claims against the corporation and the timely reporting of significant legal or other compliance matters to the board or an appropriate board committee.”

       

      According to the ABA Guidebook, organizations “should have formal written policies designed to promote compliance with law and corporate policy, which should be periodically monitored for effectiveness, particularly if the corporation operates in an industry subject to laws and regulations that demand special compliance procedures and monitoring." Although public companies initially assigned compliance oversight to the audit committee, the trend has been to form a separate compliance or legal affairs committee because of the burdens already on the audit committee.

       

      The seven key elements of an effective compliance program according the Sentencing Commission and Office of Inspector General are:

       

      1. Designation of a Board-Level Compliance Committee and a Compliance Officer as an Executive Officer.  Doing so satisfies the most important requirements of the USSC Overview:  oversight by high-level personnel. Following the trend of public companies, we recommend that the board-level compliance committee be a committee separate from the audit committee and composed of persons with background or experience to evaluate legal and compliance matters. As discussed below, the compliance committee should report matters that may affect financial reporting to the audit committee and material matters to the board as a whole.  The compliance officer should be an executive officer with reporting responsibilities to the CEO, general counsel (either inside or outside) and the compliance committee.
      2. Written Charters Policies and Procedures. Policies should be developed that address: written charters of the compliance committee; reporting channels, authority and responsibilities of the compliance officer (including when to report to the compliance committee directly, when to report to the general counsel and when to report to the CEO); whistle-blowing procedures and protections; standards of conduct; and written policies and procedures that promote the organization’s commitment to compliance and address specific risk areas of the organization
      3. Conducting Effective Training and Education. Regular, effective education and training programs should be developed and implemented for all employees, especially programs on identifying compliance violations internally and whistle-blowing procedures.
      4. Effective Lines of Communication.  A process should be developed, such as a hotline to receive complaints and the adoption of procedures to protect the anonymity of complainants and protect whistle-blowers from retaliation. We recommend that whistle-blowing procedures be handled by the compliance officer or general counsel and if an appropriate response is not received from either of them then referred to the compliance committee.
      5. Enforcing Standards through Well-Publicized Disciplinary Guidelines. A system should be in place to respond to allegations of improper/illegal activities and enforce appropriate disciplinary action against employees who have violated internal compliance policies, applicable statutes, regulations or federal health care program requirements.
      6. Auditing and Monitoring. Audits and/or other evaluation techniques should be used to monitor compliance and assist in the reduction of identified problem areas. The compliance committee, compliance officer, CEO, CFO and general counsel should each have a direct reporting responsibility to the audit committee to report any matter that may affect financial reporting.
      7. Responding to Detected Offenses and Developing Corrective Action Initiatives. Systemic problems should be investigated and policies addressing the non-employment or retention of sanctioned individuals be developed. We recommend the general counsel or special outside counsel oversee this.


       

      The next post will conclude this series on corporate compliance for governing boards by reviewing best practices.


       

      Posted by J. Beavers in  Federal Sentencing   |  Permalink

       

      Apr 24, 2014

      Corporate Compliance Starts with Good Governance at the Top
       

      This is the third post in this series of posts on corporate compliance issues for governing boards. We will wrap up our discussion on fiduciary duties, this time concentrating on the protections afforded to board members. Future posts in this series will expand on federal sentencing guidelines and best practices.


      Protections Afforded to Board Members with Respect to Fiduciary Duties

      In order to encourage independent persons to serve as board members, state law offers a number of legal protections to persons serving as board members.

      1. The Business Judgment Rule


      In evaluating a board member’s compliance with his or her fiduciary duties, courts generally follow the business judgment rule. Under the business judgment rule, courts do not inquire into the wisdom of actions taken by board members in the absence of self-interest, fraud, bad faith or abuse of discretion. The business judgment rule specifically applies to any situation board members make a decision which, in retrospect, was or is argued to be a bad one. If the board members are thereafter sued because of that decision, a court applying the business judgment rule will not second-guess the merits of the decision as long as the court finds all of the following to be true:
      • The board members made a business decision (the rule does not apply to acts of board members which do not constitute business decisions);
      • The board members were disinterested (that is, they are not “on both sides of the transaction” and will not derive any personal benefit from the decision);
      • The board members exercised “due care” (as noted above, this means acting like an ordinarily prudent person would act);
      • The board members acted in good faith; and
      • The board members did not abuse their discretion.
      If one or more of these factors is not satisfied, the court will interpose its own judgment to determine whether or not the transaction in question was in the best interests of the organization.

      It is important for board members to note that having a personal or economic interest in the matter decided rebuts the business judgment rule for those board members having a personal or economic interest, unless those interested board members can show that the material facts of their interest were disclosed or otherwise known to other board members and at least a majority of the non-interested board members.

      The business judgment rule will also be rebutted for non-interested board members who approve the matter unless they can show that, despite the personal or economic interest of the interested board members, the non-interested board members believed the matter to be in or not opposed to the best interests of the organization or that the transaction was fair to the organization from a substantive point of view.

      When the business judgment rule is rebutted, courts generally require board members to prove fairness not only from a financial viewpoint, but also from a procedural or “fair dealing” viewpoint.

      Officers generally are also protected by a similar business judgment rule. However, the business judgment rule does not protect officers in derivative matters or matters when officers’ actions are in violation of their authority.

      Nevertheless, although the business judgment rule protects board members from mistakes in judgment, the rule does not protect board members who misleadingly hide or fail to disclose such mistakes.  Shareholders are entitled to judge board members’ mistakes in determining whether to vote for or against the election of such board members. Manipulating financial statements not to reflect such mistakes or intentionally hiding mistakes from shareholders or the investing public may result in liability to board members under federal and state securities, federal and state tax laws, state corporation law, as well as under theories of common law fraud.

      2. Right of Reliance on Others


      Board members are permitted to rely reasonably upon information presented by officers, employees, board committees and independent professional advisors in making their decisions.

      Source of Information Presented to the Board member: Reliance is Appropriate if:
      Other board members, officers or employees of the organization The board or committee reasonably believes such persons are reliable and competent in the matters prepared or presented.
      Legal counsel, public accountants or other experts The board or committee reasonably believes that the matters prepared or presented are within the person’s professional or other competence.
      A committee of the board on which the board member in question does not serve The committee has been duly established in accordance with the organization’s governing documents, is acting within its designated authority, and is reasonably believed by board members to merit confidence.

      Under Ohio law, a board member, officer, employee or other agent of an organization who is successful on the merits or otherwise in defense of any action, suit, or proceeding in which he or she is named by reason of being a board member, officer, employee or other agent is entitled to be indemnified against expenses, including attorney fees actually and reasonably incurred by him in connection with the action, suit or proceeding.

      3. Contractual Indemnification

      Ohio law permits corporations and certain other organizations to indemnify or agree to indemnify board members, officers, employees and agents in advance of a decision on the merits and even if he is she is not successful on the merits, provided that the person:
      • Acted in good faith;
      • In a manner the person reasonably believed to be in or not opposed to the best interests of the organization; and
      • With respect to any criminal action or proceeding, had no reasonable cause to believe the person's conduct was unlawful.
      The organization may pay or reimburse the indemnified person for all expenses (including attorney fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding.

      In order for there to be protection, there must be a determination that indemnification is proper by:
      • A majority of board members who are not parties to such action, suit or proceeding; or
      • A committee of such disinterested board members; or
      • If there are no such board members, or if the board members so direct, by independent legal counsel; or
      • The shareholders; or
      • A court of competent jurisdiction.
      As discussed above, indemnification is mandated by statute if the indemnified person is successful on the merits or otherwise in defense of any such action, suit or proceeding.

      In a derivative or other action by or in the right of the organization, only expenses are indemnified unless the indemnified person is successful in defense of the claim. No indemnification of even expenses is available if the board member is adjudged to be liable to the organization unless the presiding court determines the board member is entitled to indemnification.

      Many state courts have held that indemnification is not available for intentional misconduct and federal courts have held that indemnification is not available for securities law violations for reasons of public policy.

      4. D&O Insurance

      One value of Directors and Officers liability insurance (D&O) is that Ohio and most other states’ laws permit broader coverage under D&O insurance than under statutory indemnification. Another value of D&O insurance is that it is available even if the organization is insolvent and even after a change in control.

      D&O insurance is typically a claims-made policy that pays losses or reimburses the organization for its payment of losses incurred by a covered person for claims of wrongful acts made during the policy period. The policies often insure against breaches of duty, neglect, errors, misstatements, misleading statements, omissions or acts, whether in a personal action or a derivative action. The policies sometimes include intentional wrongdoing, usually in the absence of dishonest or criminal conduct.

      These policies often contain a securities law exclusion excluding coverage claims for wrongful acts in the purchase of sale or the organization’s securities. For this reason, board members of publicly-traded organizations will generally need to have a securities law endorsement expanding coverage to include claims of such wrongful acts.

      These policies also exclude coverage claims that are not reported to the insurer in a timely fashion as well as claims alleging:
      • Death, bodily injury, sickness, disease or tangible property damage or destruction;
      • Environmental discharge or damage;
      • Libel or slander;
      • Disgorgement of profits under section 16(b) of the Exchange Act;
      • Employee benefit plan liability;
      • Illegal remuneration (unless approved by shareholders);
      • Suits by other insureds; and
      • Dishonest or criminal acts.
      Steps to Enhance Board Members’ Protections

      Coupling the basic tenet that board members “direct” management and must therefore delegate with the conditions to a board member’s right of reliance on others offers a framework for determining a board member’s duties. Because a board directs rather than manages and because management manages under that direction, a board must determine reliability and competence of management for each matter that the board delegates to them.

      The best way to determine reliability and competence is to ask questions.  Accordingly, the purpose of the questions must be to test management’s reliability and competence.

      The same questions should be asked separately of different persons, trying to include where appropriate someone independent of management. Possible persons independent of management include the person serving the internal auditor function, representatives of the external auditor, outside legal counsel, and outside experts with experience in the matters under consideration.

      The consistency of the different answers should be compared. The answers among different constituencies will unlikely be the same. For example, management is more likely to view certain business issues more positively than the external auditor or chief legal officer.  On the other hand, the external auditor and chief legal officer are more likely to view risks of liability as more material than management. And often a chief financial officer views a matter from a different perspective than the chief executive or chief operating officer. Accordingly, answers will differ, but there should be consistency.

      The skill is to learn when to stop asking questions. Nothing is more bothersome to management than irrelevant, unnecessary questions. As a general rule, board members should stop asking questions and accept the answers when those answers are consistent. On the other hand, board members should delve deeper when the answers to the questions are inconsistent.

      Board members and management should expect there will be some tension between them during this process. Management needs to understand that board members must ask questions to determine whether management is reliable and competent for the matters delegated to them. The board should understand that management will fear “being micro-managed” or “not being trusted.”  For this reason, the chair or lead board member of the board should from time to time remind management that board members are required to ask such questions to fulfill their duties and that management should not necessarily view this as an adversarial process.

      An additional way to relieve this tension is for the board to have regular separate executive sessions with different members of management so that it becomes part of the routine operation of the board.  A board should consider meeting regularly with the CEO, CFO, chief legal officer, internal auditor and representatives of the external auditor.



      This is the third and final post on fiduciary duties in this corporate compliance series. The next post will cover discuss sentencing guidelines: what can be learned?


       

      Posted by J. Beavers in  Fiduciary Duties   |  Permalink

       

      Apr 10, 2014

      Corporate Compliance Starts with Good Governance at the Top
       

      This is the second post in this series of blogs on corporate compliance issues for governing boards. We will continue to discuss fiduciary duties, this time concentrating on some special areas of concern for board members under their fiduciary duties. Future posts in this series will expand on fiduciary duties, federal sentencing guidelines and best practices.


      Some Special Areas of Concern for Board Members under Their Fiduciary Duties

      A board member should be particularly concerned that the organization has established and implemented programs designed to address the following:

      1. Managing Risks of the Enterprise

      Non-ERISA Plan Assets

      Managing risks of the enterprise is a developing area of law for both the board and its management. The duties for managing risks for fiduciaries of employee benefit plans subject to ERISA with respect to plan assets are different than those for board members and officers with respect to other assets.

      With respect to assets other than those that are part of an employee benefit plan subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA), the duties of boards and officers are their corporate law duties of care and loyalty (i.e., to act with the care that an ordinarily prudent person in a like position would use under similar circumstances and in a manner believed to be in the best interests of the organization; or, with respect to board members, not opposed to the best interests of the organization). A developing area of the duty of care is a duty to minimize the risk of large losses to the extent that an ordinarily prudent person in a like position would do so under similar circumstances for the best interests of the organization.

      Because boards are not expected to manage assets, their duty with respect to management of risks is one of oversight. Boards, or an appropriate committee of the board under its direction, should periodically review with appropriate officers and, in some cases, the internal and external auditor:

      • The systems of internal financial control and the monitoring of their adequacy;
      • The systems for protecting the organization’s assets, including the adequacy of insurance as well as protecting intellectual property and safeguarding confidential corporate information; and
      • The systems for assuring that transactions are executed in accordance with management's general or specific authorization.

      The NYSE and NASDAQ have delegated this duty of oversight to the audit committee or, if it does not do so, all of the independent board members. The Sarbanes-Oxley Act (SOX) requires management of public reporting companies, with the participation of their CEOs and CFOs, to annually evaluate the portion of these systems related to financial reporting as part of management’s report on internal controls over financial reporting.

      ERISA Plan Assets

      The duties are greater with respect to assets of an employee benefit plan subject to ERISA, a fiduciary of the plan is to act solely in the interest of the participants and beneficiaries and—

      (A) For the exclusive purpose of providing benefits to participants and their beneficiaries and defraying reasonable expenses of administering the plan;

      (B) With the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims;

      (C) By diversifying the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so; and

      (D) In accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with ERISA.

      A fiduciary’s duties are different from the corporate law duty of care and loyalty in several significant ways. The duty of care is also greater in that a fiduciary is to act with the care that a prudent man acting in a like capacity and familiar with such matters would use, which is a higher standard than the care that an ordinarily prudent person in a like position would use.  More significantly, the duty of loyalty is not to the organization, but is “solely” for the interests of the participants and beneficiaries for the “exclusive” purpose of providing benefits and defraying reasonable expenses of administering the plan.  Most significantly, a fiduciary has an express duty to diversity the investments of the plan so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.

      A person is a fiduciary if he or she:

      • Exercises any discretionary authority or discretionary control respecting management of such plan or
      • Exercises any authority or control respecting management or disposition of its assets
      • Renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or
      • Has any discretionary authority or discretionary responsibility in the administration of such plan

      Boards are fiduciaries if they have or exercise the authority or control of a fiduciary described above.  Department of Labor regulations provide that a board or committee of the board is a fiduciary responsible for the selection and retention of plan fiduciaries, such as the trustee or plan administrator.
      Boards and officers should confirm whether or not they are named fiduciaries of any ERISA employee benefit plan.  A named fiduciary has both statutory as well as contractual responsibilities and, accordingly, corresponding liabilities.  Although a named fiduciary has a right of reliance on others, that right of reliance is only on others who are also named fiduciaries and only to the extent the plan documents permit such delegation of authority or responsibility.

      2. Quality of Disclosure

      Do the organization's disclosure documents (quarterly and annual reports to shareholders, proxy statements, prospectuses, press releases, web pages and other key communications to shareholders and the investing public) fairly present material information?  A board member's primary responsibility in the disclosure process is to be satisfied that corporate procedures are reasonably designed to produce accurate and appropriate public disclosures.  Management has the primary responsibility for implementing these processes, subject to board members' oversight and periodic review of the steps taken by management.

      3. Compliance with Law

      Does the organization have appropriate policies designed to result in compliance with applicable laws and regulations?  Does the board receive reasonable assurances that employees of the organization are informed of corporate policies directed at compliance with applicable laws, including antidiscrimination and employment laws; environmental and health and safety laws; antitrust laws; and securities laws, particularly those prohibiting insider trading? 

      The organization should have appropriate procedures for monitoring compliance with such laws throughout the organization. All persons involved in the compliance process should have direct access to the general counsel or other compliance officer so that sensitive compliance situations may be raised for prompt consideration. Board members do not administer legal compliance programs, but should review their functioning periodically and endeavor to be reasonably satisfied that appropriate programs are in place.

      Most large, publicly owned organizations have adopted codes of business conduct expressing principles of business ethics, legal compliance and other matters relating to business conduct. Subjects commonly addressed by such codes are legal compliance (antitrust laws and policies, Foreign Corrupt Practices Act of 1977 and insider trading, to name a few), conflicts of interest, corporate opportunities, gifts from business associates, misuse of confidential information and political contributions.

      A program of legal compliance that is well-conceived and properly implemented can significantly reduce the incidence of violations of laws and corporate policy. It may also reduce or eliminate civil lawsuits, penalties or prosecution against the organization for those violations of law that occur in spite of such a program. Since the enactment of the United States Sentencing Commission's sentencing guidelines, organizations have been given further reason to review and reassess their compliance policies and procedures. These guidelines greatly increase the penalties for businesses found guilty of criminal violations, but provide significant fine reductions for convicted organizations that maintain appropriate programs to prevent and detect violations of law.

      4. Approval of Commitments

      Is there a functioning and effective system in place for approval of commitments of the organization's financial and commercial resources?

      Although board approval of all or even most corporate commitments is not necessary, the board should be satisfied that a reasonable approval system exists and should have a clear understanding with management, which may be embodied in a formal policy, as to which major commitments require board approval.

      5. Adequacy of Internal Controls

      Does the organization maintain appropriate systems of internal financial control, and is there a functioning and appropriate system for monitoring their adequacy? Periodic review of the functioning of these systems is appropriate.

      Protection of Assets

      Does the board receive periodic reports describing the organization's program for the protection of its assets? In addition to insurance arrangements, such a program should include procedures for protecting intellectual property and safeguarding confidential corporate information.

      6. Counseling of Board members

      Does the organization provide board members competent legal advice regarding the organization's affairs and the conduct of its board members?  In addition to the organization's general counsel or regular outside counsel, there may be occasions when an additional outside legal advisor should be specially retained by the board or a committee in connection with a particular matter.

      7. Disagreements

      If, after a thorough discussion, a board member disagrees with any significant action proposed to be taken by the board, the board member may vote against the proposal and request that the dissent be recorded in the meeting's minutes.  Except in unusual circumstances, taking such a position should not cause a board member to consider resigning.  However, if a board member believes that information being disclosed by the organization is inadequate, incomplete or incorrect, or that management is not dealing with the board members, the shareholders or the public in good faith, the board member should first encourage that corrective action be taken.  If that request is not satisfied or the problem continues, the board member should encourage the board to replace management and, if such a change does not occur, the board member should resign.


      The next post in this series will continue on the topic of fiduciary duties with focus on the protections afforded to board members with respect to fiduciary duties.


       

      Posted by J. Beavers in  Fiduciary Duties   |  Permalink

       

      Mar 27, 2014

      Corporate Compliance Starts with Good Governance at the Top
       

      Corporate compliance for any organization starts at the top with the the organization’s governing board. This is the first blog of a series of blogs on compliance issues for governing boards. The complete series will include posts on the following topics:

      • Fiduciary duties under state corporation law which are the minimum standards to avoid legal liability;
      • Federal sentencing guidelines which are taken into account in determining legal liability; and
      • Best practices which are practices boards should use as benchmarks.

      Fiduciary Duties of Board Members

      We begin with fiduciary duties under state corporation law because we set the minimum standards to avoid personal liability to board members, and generally board members lose (i) their rights to indemnification by the organization and (ii) protection of a Directors and Officers (D&O) insurance.

      Board members have fiduciary duties under either state statutory law or state common law.  Under Ohio law, these duties are statutory. The duties include:

      • Duty of care – to exercise the care that an ordinarily prudent person in a like position would use under similar circumstances.  Under most states’ laws, a board member must perform his duties as a board member, including his duties as a member of any committee of the board members upon which he may serve, with the care that an ordinarily prudent person in a like position would use under similar circumstances.
      • Duty of loyalty – to act in good faith, in a manner he or she reasonably believes to be in or not opposed to the best interests of the organization.

      Duty of care

      The duty of care requires that a board member inform himself of all material information reasonably available before making a business decision.  This duty also requires board members to inform themselves of alternatives to a proposed business decision.  The more important the decision, the greater the need to consider additional information and alternatives.  Once a board member has become adequately informed, the board member must act with the requisite care in performing his or her duties.  A claim of “good faith” alone is no defense if a board member fails to exercise the duty of care in order to arrive at an informed business decision.

      The duty of care requires board members to become and stay reasonably informed.  This generally includes:

      • Attending meetings of the board and of the committees to which they belong;
      • Reviewing and understanding financial statements, financial reports (especially forms 10-K or 10-KSB and 10-Q or 10-QSB filed with the SEC and the annual report and any interim report sent to shareholders) and materials furnished by the organization for review by board members;
      • Asking questions (in order to be able to rely upon management and others on any matters, you must have a reasonable belief that they are reliable and competent for such matters.  The best way to form a belief on competence is to ask questions, and the best way to form a belief on reliability is to ask the same questions of different persons); and
      • Making reasonable attempts at detection and prevention of illegal conduct.

      Courts have held that a board member's responsibilities include “a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances may . . . render a board member liable.”  The level of detail that is appropriate for such an information system has been held as a question of business judgment.  Nevertheless, the leading case held that “only a sustained or systematic failure of the board to exercise oversight – such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.”

      Duty of loyalty

      In General

      There are three components to the duty of loyalty:

      1. A board member should act to the extent possible in a disinterested manner.  That means not being influenced by any financial or personal interest in the matter under consideration by the organization.  A board member should be alert and sensitive to any interest he or she may have that might be considered to conflict with the best interests of the organization. When a board member, directly or indirectly, has a financial or personal interest in a contract or transaction to which the organization is to be a party or is contemplating entering into a transaction that involves use of corporate assets of or competition against the organization, the board member is considered to be "interested" in the matter.  This then requires disclosure by the board member of that financial or personal interest.
      2. The second component, which naturally follows from the first, is full disclosure, especially of possible financial or personal interests in any matter under consideration.  In common law before statutory corporate law, courts often treated as void or voidable any contract or transaction approved by a board if a board member had a financial or other personal interest in the contract or transaction.  Many states’ statutory laws provide that any contract, action or transaction considered by the board or one of its committees is not void or voidable because of a financial or personal interest of a board member if the material facts regarding that interest are disclosed or otherwise known to the board or the committee before the consideration.  Any board member having a possible financial or personal interest in any contract or transaction to which the organization is to be a party should first make full disclosure to, subject to any confidentiality obligations owed to others outside the organization, and seek approval of the contract or transaction by, those of the other board members who do not have any such interest.  This generally requires the interested board member to abstain from voting on the matter and, in most situations, after disclosing the interest, describing the relevant facts, responding to any questions and not further participating in the meeting while the disinterested board members complete their discussion and vote.
      3. The third component is substantive “fairness.”  Under many states’ statutory laws, no contract, transaction or other action of a board is void or voidable, even if there is a financial or personal interest which is not fully disclosed, if the action is “fair to the organization” as of the time it is authorized or approved.  However, because what is “fair to the organization” is a question of fact upon which reasonable minds may differ, board members should rely on full disclosure.  Substantive fairness generally requires disinterested board members to determine:
         
        • Whether the proposed transaction is on terms at least as favorable to the organization as might be available from other persons or entities;
        • Whether it is reasonably likely to further the organization's business activities; and
        • Whether the process by which the decision is approved or ratified is fair.

      If minority shareholders could be adversely affected, the board members should be especially concerned that the minority interests respecting the transaction receive fair treatment.  This concern is heightened when a board member or dominant shareholder or shareholder group has a divergent or conflicting interest.

      Officers also have common law duties that are similar to board members’ duties of care and loyalty. Officers too must act as an ordinarily prudent person in a like position would act under similar circumstances.  They too must act in good faith and in a manner they reasonably believed to be in or not opposed to the best interests of the organization.

      Whose Interest?

      In determining the best interests of the organization, a board member is required to take into account the interest of stockholders, if the organization is a stock organization; members, if the organization is a member organization; partners, if the organization is a partnership; and similar constituents of other forms of organization.  In certain cases, the best interests of the organization may include its creditors.

      Confidentiality

      An important part of both the duty of care and the duty of loyalty is to keep confidential all matters involving the organization that have not been disclosed to the general public.  Board members and officers should presume and treat as confidential all matters involving the organization until there has been a general public disclosure or unless the information is a matter of public record or common knowledge.  This presumption should apply to all current information about legitimate board or corporate activities.

      Problems may arise when board members and officers of one organization are board members or officers of another organization that may benefit from knowing confidential information of the organization.  For this reason, board members and officers of the organization should disclose to the organization positions held with other organizations.  In such situations, board members and officers of the organization should presume that their duty of confidentiality to the organization prevails over any duty of care or loyalty that might compel unauthorized disclosure to the other organization.  If a board member or officer believes this presumption may conflict with his or her duty to the other organization, the board member or officer should consider resigning from his or her conflicting positions either with the organization or with the other organization.

      A board member of a publicly held organization is sometimes asked by investors, analysts or investment advisors to comment on sensitive issues, particularly financial information; however, an individual board member is not usually authorized to be a spokesperson for the organization and, particularly when confidential or market-sensitive information is involved, should avoid responding to such inquiries.  Even information that is not market-sensitive may be confidential – for example, information about new products or proprietary processes or strategic plans.  A board member who improperly discloses such information to persons outside the organization can cause the organization to violate federal securities regulations and can cause damage to investor relations, trigger personal liability as a "tipper" of inside information and harm the organization's competitive position.  Board members should refer requests for corporate information to the CEO or other person designated by the organization to deal with such inquiries.

      Corporate Opportunity

      Another part of both the duty of care and the duty of loyalty is to protect corporate property and opportunity.  A board member must exercise care that he does not usurp a business opportunity that is related to the business of the organization and is otherwise available to the organization.  The duty of loyalty may require the board member to first offer that opportunity to the organization before taking the opportunity for his or another’s account, including the account of any other company of which he is a board member, officer or employee.

      Whether such an opportunity must first be offered to the organization will often depend upon one or more of the following:

      • The correlation of the opportunity to the organization's existing or contemplated business;
      • The circumstances in which the board member became aware of the opportunity;
      • The possible significance of the opportunity to the organization and the degree of interest of the organization in the opportunity; or
      • The reasonableness of the basis for the organization to expect that the board member should make the opportunity available to the organization.

      If a board member believes that a contemplated transaction might be found to be a corporate opportunity, the board member should bring it to the attention of the board.  If the board, acting through its disinterested board members, disclaims interest in the opportunity on the part of the organization, then the board member is free to pursue it. A board member should bear in mind that the obligation to put the organization's interests first also applies to opportunities for subsidiaries or affiliates of the organization.

      Speak with One Voice

      Another important part of both the duty of care and the duty of loyalty is that organizations and their governing boards should speak with one voice or not at all.  Board members should presume that this applies to all matters coming before the board for its consideration.  An individual board member has no authority under applicable law.  Instead, authority is vested in board members collectively as they determine by a majority vote at a meeting at which a quorum is present.  This does not require unanimity in decisions, but instead requires a recognition that a board speaks only as a board as determined by a majority of its members at meeting in which a quorum is present.  Occasionally on matters where it is important to have a single message, a board will speak only through its chairperson or the chairperson’s designee.

      A board member who dissents has the right to have his or her dissent reflected, with attribution, in the minutes of the meeting and may continue soliciting support for his or her position until the minutes are approved.  Thereafter, the board member may, subject to any rules of the board, request the board’s reconsideration of the matter.  However, the confidentiality obligation that is part of each board member’s duty of care requires that the matter remain within the board room, and the board member’s ultimate right in any disagreement is to resign.

      Other Duties

      Board members have duties from other sources.  These other sources include:

      • Contractual Sources:  Often, the organization’s governing documents, especially the committee charters, as well as any board member agreements will generally create duties or obligations on the part of board members.  The audit, compensation and nominating/governance committee charters are intended to create duties for the members of those committees on which other board members may rely.
      • Federal securities laws:  These include duties regarding registration statements filed with The U.S. Securities and Exchange Commission; duties as control persons; duties to report illegal acts not timely remedied; duties not to mislead an auditor; duties to disclose stock ownership; duties to avoid short-swing transaction in stock; duties to receive the audit report; duties to appoint independent board members to an audit committee; et seq.

      The next post will continue on the topic of fiduciary duties with focus on some of the special areas of concern for board members under their fiduciary duties.


       

      Posted by J. Beavers in  Fiduciary Duties   |  Permalink

       

       

       

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