So, you want to be a public company director?

Taylor Simonton //April 10, 2014//

So, you want to be a public company director?

Taylor Simonton //April 10, 2014//

You have just been asked to join a public company board. How do you make sure you are not joining the next Enron or a board rife with dysfunction a la Hewlett-Packard?

I spoke with Doug Wright, corporate, securities and M&A partner at the Faegre Baker Daniels law firm, following a recent Colorado Chapter of the National Association of Corporate Directors (NACD) program, where he was a presenter. We discussed what a director or candidate can do to protect themselves from major liabilities and lawsuits often associated with boards of directors.  Doug advises director candidates to perform their own “reverse diligence”.  If you are a serious candidate, the company’s Nominating & Governance Committee has already performed due diligence on you. Now you should do the same on the company.  Doug recommends the following:

  • Read the company’s filings on the Securities & Exchange Commission’s EDGAR website.  The Annual Report on Form 10-K describes the company’s business and plans as well as its historical financial performance. Form 8-Ks tell of major changes in business activities and within the company’s C-suite.  The Proxy Statement describes major shareholders, standing board committees and director compensation.
  • Visit the company’s website.  Usually, some information in addition to what is included in the company’s public filings is contained on its website.
  • Compare the company’s financial statements to industry peers and look for trends. What are the financial ratios? Are there good reasons for major variations from peers? Is the company performing on an upward or downward trend both on its own and relative to its peers?
  • Play detective andGoogle” the company’s, directors’ and officers’ names. Search also on the company’s industry to ascertain the relationships within them. You may find lawsuits or regulatory orders against them and discover articles – good and bad.
  • Read what shareholders are saying in internet “investor chat rooms”.  Although posting in chat rooms, such as InvestorsHub and Yahoo Finance, by company officers or directors is a real “no-no” and commentary in chat rooms should be viewed with healthy skepticism, you may glean how some of the shareholder base feels about the company.
  • Obtain company governance and other important documents.  Documents, such as bylaws, director indemnification agreements, committee charters, lawsuits or regulatory orders, and recent minutes of the board of directors and committees to which you may be appointed can help you understand the risks associated with the company and protections afforded to directors.
  • Read the company’s Directors & Officers insurance policy.  This is a very important due diligence step.  If no policy exists, especially if the company is not strong financially, head for the exit.

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  • Talk to the company’s existing board members (or former directors if you know them).  Ask pointed questions.  How well does management work with the board?  Who leads and who follows in the boardroom?  What is the company’s culture and “tone at the top”?  Is there a strategic plan? What really matters about the company’s business?  Be aware that different directors may have varying views on these matters.
  • Discuss matters with current or former C-suite officers.  Ask the questions above to management.  Be more discreet with former officers.  If answers are inconsistent with those from directors, try to understand why there are differences in perspectives between directors and management.
  • Meet with company’s auditor and outside legal counsel. Request in advance that the company instruct these professional advisers to respond to your inquiries.  Understanding that these advisers may be aware of “problems”, expect some nuanced answers.  Evaluate their responses with what you learned elsewhere.
  • Look for “yellow and red warning flags”.  The above actions will highlight most matters that are concerns to a director candidate.  Compare what you learn with your gut feeling developed during your “reverse diligence”. Remember that diplomacy is your watchword as you conduct your diligence as you can inadvertently insult the company and its officers and directors.

Assuming as a director candidate, you see just “green flags” and decide to accept the board position, what can directors do to protect themselves from liabilities? Doug advises there are several protections:

  • Perform your job well as a director.  Foremost, do what is right. Be aware of a director’s responsibilities and diligently perform them.  Be informed and exercise appropriate judgment. That will not keep adversaries from suing you, but you should prevail in the end.
  • Statutory exculpations of directors by company’s charter.  Most state corporate laws exculpate a director from monetary liability for breaches of fiduciary duty except in certain specific instances. While not a total bar to personal liability, this protects directors from informed, good faith decisions even if they are wrong. The company’s charter should have this exculpation clause.
  • Bylaws indemnification and indemnification agreements. Company bylaws should indemnify directors to the fullest extent permitted by law; indemnification agreements coupled with this increases a director’s protection against claims. These are only as good as the company’s financial ability to pay.
  • Directors & Officers insurance policies. D&O policies fill the gaps in statutory and corporate protections described above. Be aware of policy exclusions and definitions. Consider whether “Side A” coverage for only directors exists. Determine whether internal investigations are covered.

Having served on six corporate boards, I agree with Doug’s advice on “reverse diligence” and ongoing liability protections. These are all important; however, you may not have the time or opportunity to perform all of your desired diligence. When that occurs, go with your instincts based on your overall experience and after receiving all available information. My experience is that you will know when potential problems exist. If the situation does not feel right, seriously think about waiting for the next board opportunity and offer a diplomatic excuse for declining. If you join the company’s board of directors and the liability protections described above are not in place, work within the company’s governance and board processes to obtain them for all directors.