Corporate Governance in Action: Companies and Boards Rising to Meet Their Situational Duties. Philip S. Khinda Steptoe & Johnson LLP

Transcription

1 Corporate Governance in Action: Companies and Boards Rising to Meet Their Situational Duties

2 Corporate Governance The Traditional Role of the Board and Governing Dynamics Fiduciary duties and the Delaware Governance Model Duty of care A director s obligation to act on an informed basis after due consideration and deliberation Reasonable reliance issues, and advice from legal and financial advisors Duty of loyalty Acting in good faith to advance corporate interests The avoidance of self-dealing, and the entire fairness standard 1

3 Corporate Governance The Business Judgment Rule General parameters and protective elements Judicial deference (regulatory too!) Burden on plaintiffs in litigation Must establish gross negligence to prevail Practical and best practice considerations Strategy vs. operational effectiveness Law protects good faith mistakes on strategy Rigor of process is the key (see Caremark and Disney) 2

4 Corporate Governance Past as prologue, and fiduciary duty trends The go-go 80 s: M&A boom, emergence of hostile takeovers, poison pills, and golden parachutes provide stress test to existing standards on care and loyalty The next landmark: Caremark (filed 1994, decided 1996) Underlying action: board oversight of Medicare/Medicaid improper payment investigations (conduct ) [O]nly a sustained or systematic failure of the board to exercise oversight such as an utter failure to attempt to assure that a reasonable information and reporting system exists will establish the lack of good faith that is a necessary condition to liability. In re Caremark Int l Derivative Litig., Delaware Chancery Court

5 Corporate Governance Fiduciary duty trends, continued The late 90 s dot-com boom/bust, and the age of Enron and WorldCom Regulatory move towards deputizing directors Audit committee disclosure rules and new normative standards Sarbanes-Oxley overlay: shift from market-oriented philosophy to highly prescriptive one Personal liability concerns and the WorldCom settlement WorldCom: directors contribute $18 million in personal assets to help resolve class action claims against them (2005) Renewed focus on D&O coverage and exclusions 4

6 Corporate Governance After years of disquieting developments, pendulum appears to be swinging back, rightly, in favor of boards and deference to their business judgment and sound governance principles The Disney decisions Underlying action: board approval of Ovitz termination/ severance agreement ($140 million for 12 months) Negligence and personal liability must be predicated on failure to act in good faith: i.e., where there is an intentional dereliction of duty and conscious disregard for one s responsibilities In re The Walt Disney Co. Derivative Litig., Delaware Chancery Court 2005, affirmed by the Delaware Supreme Court, Delaware law does not indeed the common law cannot hold fiduciaries liable for a failure to comply with the aspirational ideal of best practices. Id. Underscores the protective nature of the business judgment rule Again, informed decisions made in good faith including mistakes 5

7 Corporate Governance in Action The Board: Rising to Meet its Situational Duties Addressing CEO and other dismissal issues Addressing potential changes in control M&A and going private transactions Conducting/overseeing special reviews and investigations In times of crisis, there should be no doubt as to who is in charge of: Investigating perceived problems; Deliberating on their resolution; and Overseeing the company s financial reporting and related disclosure processes 6

8 Facets of the Modern Financial Crisis Multiple fronts and exposures SEC Investigation/Action Private litigation Class action complaints PSLRA Shareholder derivative claims ERISA actions Criminal Pursuit (Rite Aid, Enron, WorldCom) Auditor Issues: 10A letter Liquidity squeeze Retreat of D&O Carriers Incessant Media Barrage Democratization of information under Reg. FD 7

9 Corporate Governance in Action Avoid mistakes made in the first 48 hours Assemble the team Implement document freeze and controls Convene a Special Review Committee (no SLC) Begin internal review and potential loss analysis Notify the SEC (and other applicable regulators) Through counsel and only in true crisis Avoid promises regarding internal review (e.g., production, outcome) Tell the auditors before they tell you Notice to the D&O Carriers Notice to the Banks (waivers?) Release on non-reliance? 8

10 Corporate Governance in Action Process vs. results-oriented disclosure strategy Public commentary on process only: nothing qualitative or predictive before completion of internal review/investigation Coordinated approach: avoid cross-town hypocrisy Control the events, not vice versa Structured press comments to avoid damaging statements, potential admissions, and public misperceptions Immediate outreach to important constituencies Candor, not stonewalling or compartmentalization ( I didn t inhale ) Telegraph trends in filings, disclosure Crisis precipitated/aggravated by surprise, not adaptation 9

11 Corporate Governance in Action Note to management: never surprise your directors Their business judgment demands adequate information (recall Caremark) Advise directors of trends and uncertainties Avoid the why didn t you tell me? syndrome Provide Section 11 protection (opportunity for due diligence) Even when not leading investigations, directors must remain informed (in the crisis management loop ) Periodic updates Confidential memoranda Cautions regarding commentary 10

12 Corporate Governance in Action When to Investigate Regulatory/grand jury subpoena Demand letter Auditor issues (disagreements, perceived illegal acts ) Filing of civil action Other than ordinary routine litigation incidental to the business (recall Item 103 of Reg. S-K) Whistleblower complaints Informal requests by government authorities Press inquiries about questionable practices Why investigate now? Leading studies on fraud awareness and costs 11

13 Corporate Governance in Action Who Should Investigate? Management reviews under board oversight The merits of a Special Review Committee Independence: outside directors authorized to conduct unfettered review/investigation Top-level commitment by the enterprise Common interests with the government Confidentiality considerations Limits privilege/work product waiver issues Additional benefits/credit when settling govt. actions Also helps limit private action claims against the board Example: Bank One market timing matter 12

14 Cooperation Considerations To cooperate or not to cooperate? Cooperation always the starting proposition Balance of competing institutional interests Incentive to cooperate (allay staff concerns, narrow scope of investigation/action, reduce risk of criminal referral) Franchise preservation and the McNulty memo Incentive to protect company (e.g., against wholesale disclosure of corporate information) Class action, other collateral consequences N.B., full cooperation does not require waiver Ultimate question under existing framework: Are company s interests best served, given all potential exposures and existing flanks of attack, by production of otherwise privileged and protected internal investigation materials to the government? 13

15 Cooperation Considerations Produce only if resounding YES, and only pursuant to confidentiality agmt between the government and the SRC Company may be viewed as adversary to investigators (SEC enforcement staff and federal/state prosecutors) May defeat work product claims Confidentiality agreements with the SEC are not new Done in varying forms since Steinhardt/Leslie Fay (2d. Cir. 1993) Contemplated (invited!) by last footnote in 2001 Seaboard report SEC has model agreement, and has appeared in civil actions to oppose waiver claims but see McKesson litigation SEC/DOJ have also used customized letter agreements Key: Government and SRC must share common interests to investigate and take remedial action Memorialize this and investigator s agreement to maintain confidentiality (FOIA confidential treatment will not suffice) 14

16 Corporate Governance in Action Business Judgment, Analysis and Remediation Issues Working with the company Merits of the orchestrated solution (recall Bank One) The business judgment rule in action: special issues Corrective action and other remedial measures Dismissal or appropriate discipline of wrongdoers Enhanced internal controls and procedures Demands for monetary restitution Coming to the right result Rigor of the board s investigative and deliberative process Intellectual integrity of the analysis and outcome Must withstand the test of time and onslaught of all comers 15

17 Corporate Governance in Action Special Investigative Issues Working with forensic and economic consultants Engagement issues and maintaining the privilege Analytical benefits (enhanced procedural/intellectual rigor) Rules of the road and other practical considerations Shadow investigations by the company s independent auditors The nature and scope of shadow investigations The need to maintain auditor independence Privilege/work product waiver issues in sharing information Unavailability of joint defense arrangements Other considerations 16

18 Corporate Governance in Action The Dual Role of the Modern Board Public watchdog function? Must always serve as guardians of corporate interests Right or wrong, generally taken to mean shareholder interests Focus on culture and tone at the top, leaving details of compliance function to the company and its management Protecting/promoting bold corporate stewardship True measure of success for legal/compliance regime Leading traits of an effective corporate director must be preserved: courage, and the will to act 17

19 Questions and Answers 18

20 Contact Information (202)

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