For most outside of the governance arena, the corporate secretary is viewed simply as the designated minute taker for the corporate board.  This could not be further from the truth.  Corporate secretaries should be trusted advisors who provide the organization with guidance and ensure the company is in compliance with regulatory issues.

While serving as a governance professional in support of the board of directors and corporation itself, the corporate secretary must maintain traditional responsibilities for entity management, corporate records administration and compliance; however, their role today is much greater. 

Today’s business climate’s focus on risk and the current culture of compliance have further impacted the role of the corporate secretary.

With the increased focus on corporate governance practices in light of the financial crisis and the legislative and regulatory response by the Securities and Exchange Commission (SEC) and Dodd-Frank, boards are under pressure to adapt quickly. Failure to adapt and take appropriate steps to create sound governance practices will have a direct negative impact on the entity, its profits, risk management and oversight as well as its perception in its industry.

More than ever, boards are juggling multiple responsibilities, including oversight of the CEO and the organization; succession planning for the board and management; advancing the strategic mission of the organization; and duties to stakeholders, including shareholders for corporations, members or those served by the mission of a tax-exempt entity, or policyholders of mutual insurance companies.

With so much on their plates, how can directors adequately focus on corporate governance best practices? As we have discussed in posts over the past several years director training and education is part of the answer. The other part is as access, whether on the board or through paid advisors, to the requisite expertise needed by the organization to meet its strategic plans.  This is where the corporate secretary’s role has evolved.  The corporate secretary can play a critical role in the oversight of the board practices, planning of education programs and managing the access to experts. 

Beyond taking minutes and other oversight of board practices to ensure appropriate records meet legal compliance, directors should look to the corporate secretary to provide expert counsel on governance issues before taking action, both in and out of the boardroom.  

Sarbanes-Oxley and the intense focus on corporate governance have served to give the position a central role in the organization's compliance obligations. Today, there is a recognition that the organization must be able to track and justify every action that occurs as any action could lead to a potential litigation. In order to do so, there must be a process which functions with accuracy and is based on solid governance principles.  One thing a corporate secretary cannot do is lock the courthouse doors.  That being said, the corporate secretary can ensure that the decision making process followed by the board is appropriate. 

In most instances, it is the decision making process of the board that will be evaluated as opposed to the actual decision of the board. Since discovery and trial on the merits of any matter will not occur for several years after the act occurred, the process taken plays a key role.  Think “objects in the rear-view mirror may appear closer than they are.”  Everything looks different looking back.  This is also true with regard to board decisions.  Three to five years after a matter finally makes it to trial, it may look different than anyone remembers, but the process will not look different and the corporate secretary can provide a valuable service by overseeing this process.

As with all governance practices, what may be a best practice for one organization may not be a best practice for your organization. As such, the role of the corporation for one entity will be different than a separate company.  It is critical that all organizations carefully define (and communicate) the expected role and responsibilities of the corporate secretary to provide appropriate support and training, and to make certain that the right individual occupies that position within the organization.  Similarly, this will aid the board in understanding how to properly utilize the corporate secretary. 

The corporate secretary is and will continue to play an increased role going forward.  Organizations need to embrace this role and start filling the corporate secretary position with those individuals with the appropriate expertise, or access to outside professionals with the appropriate expertise. Directors need to take full advantage of what the corporate secretary can offer.

Like a board of a corporation, the Board of Trustees of Pennsylvania State University (Penn State) is the highest authority of the university with “complete responsibility for the government and welfare of the university and all the interests pertaining thereto including students, faculty, staff and alumni.”  When its president and head football coach apparently ignored and attempted to bypass the Board’s authority, the Board acted quickly and decisively.  Through a designated spokesperson, they dismissed both the president and the coach and then appointed a special, independent committee to investigate in order to protect further loss to the university’s most valuable assets – its reputation.

The president’s ill-advised press release

An article entitled “An Icon Falls, a President with Him,” by Brad Wolverton in the November 10, 2011 issue of The Chronicle of Higher Education (Chronicle) contains a detailed and objective account of the incidents and events leading to the actions by the Board.  On the same day, November 4, 2011, that prosecutors filed 40 charges against Penn State’s former assistant coach, Jerry Sandusky, for sexual abuse of eight boys over 15 years, Penn State President Graham Spanier issued a statement that, according to the Chronicle, “defend[ed] his top officials but barely mention[ed] the victims:”

Soon after the news broke, on November 4, Mr. Spanier issued a statement defending his top officials but barely mentioning the victims.  "Tim Curley and Gary Schultz operate at the highest levels of honesty, integrity, and compassion," Mr. Spanier said.  "I am confident the record will show that these charges are groundless and that they conducted themselves professionally and appropriately."  Those would be the last words he would say publicly as the university's president.

However, President Spanier’s statement apparently was not authorized by, or reviewed with the Board.  Worse still, it ignored facts that he should have known or taken the time to learn.  The Chronicle sets forth a chronology showing that Penn State’s Athletic Director Tim Curley and Senior Vice President of Finance and Business Gary Schultz each apparently had knowledge of incidents of sexual abuse by Mr. Sandusky since 1998:

• In 1998, the mother of an 11-year-old boy reports to Penn State police, who ultimately reports to Mr. Schultz, that Mr. Sandusky touched the boy inappropriately in Penn State’s football locker rooms.
• In 1999, Mr. Sandusky allegedly sexually assaulted a boy multiple times in the newly built Lasch football building.
• In 2000, a Penn State janitor told his supervisor that he saw Mr. Sandusky performing oral sex on a boy in football locker room’s shower.
• On March 2, 2002, a football graduate assistant advised Coach Paterno that the he saw Mr. Sandusky sexually assaulting a boy who appeared to be about 10 years old in the locker room’s shower.  On March 3, 2002, Paterno informs his immediate supervisor, Mr. Curley, about the incident.
• In 2008, the mother of a high school freshman reports to high school officials, who informed the police, that Mr. Sandusky had engaged in inappropriate sexual conduct with the boy on multiple occasions.

Pennsylvania’s child-abuse reporting statute mandates reporting to the Pennsylvania Department of Public Welfare when notified by any staff member of an incident of child abuse.

The result of the president’s statement despite the numerous incidents of abuse as well as the statute mandating reporting was significant damage to the university’s most valuable assets – its reputation.  According to the Chronicle, in the days following the president’s statement, Penn State received “nonstop pounding in the national spotlight – the New York Time[s] alone had sent four reporters here while hundreds more reporters and cameras parachuted in.”  Penn State’s Board of Trustees apparently first learned of the incident through the news media rather than the president.

The coach’s ill-advised attempt to bypass the Board’s authority

On November 9, 2011, Coach Paterno issued statement “announcing my retirement effective at the end of this season,” which is certainly within his right to do and to announce.  However, it inappropriately attempted to bypass the Board’s authority by additionally stating:

“At this moment the Board of Trustees should not spend a single minute discussing my status. They have far more important matters to address.  I want to make this as easy for them as I possibly can.”

The coach publicly challenged the authority of the Board.

The Board takes action

According to the Chronicle, by the time of Paterno’s announcement, Penn State’s Board “had had enough,” and it dismissed both President Spanier and Coach Paterno effective the evening of November 9, 2011.

The Chronicle cites an article by ESPN commentator, Howard Bryant, Penn State’s culture of “protecting the power” helped prevent “timely reporting the incidents to authorities and the adequate sequestration of Mr. Sandusky from Penn State facilities.”  The power being the football program “which brings in more than $70-million a year.”

The Board has a duty of care to protect the university’s assets, the most valuable of which is its reputation.  In so doing, the Board is to act in the best interest of the university as whole, and not in the interest of just its football program, its legendary coach, or its popular president.  Accordingly, the Board fulfilled its duty by acting quickly and decisively.

The indictments were announced on November 4, the president’s ill-advised press release was also issued on November 4, the coach’s statement attempting to bypass the board was made the morning of November 9, and the Board discharged both the president and the coach during the evening of November 9.  The Board made its dismissals without waiting for the results of any investigation or prosecutorial action.  It did so through a single spokesperson, the Board’s vice chairman, who was flanked by his fellow Board members.

The Board then commenced its own investigation by appointing a special investigative committee headed by two independent trustees, Kenneth Frazier, CEO of pharmaceutical company, Merck & Co., and Ronald Tomalis, the Pennsylvania secretary of education.  On November 21, 2011, the investigative committee announced that it “has engaged former FBI Director and federal judge Louis J. Freeh to lead an independent investigative review into all aspects of the university’s actions with regard to the allegations of child abuse,” and that Mr. Freeh’s “findings and recommendations . . . when completed will be made available to the public.”

An independent investigation by the Board will likely be more valuable to the survival of institution than any prosecutorial investigation if its subject includes the culture of the institution.  A prosecutorial investigation will only impose criminal sanctions against those responsible for past actions or inactions.  To emphasize that everything is subject to the investigation, Mr. Frazier, the special committee’s head, stated at the time of Mr. Freeh’s appointment:

“The entire Board of Trustees is intent on taking all steps necessary to ensure that our institution never again has to ask whether it did the right thing, or whether or not it could have done more.  We are committed to leaving no stone unturned to get to the bottom of what happened, who knew what when, and what changes we must make to ensure this doesn’t happen again.”

The Board’s actions have been quick and decisive.  It had to assume responsibility for preserving the reputation of the institution of the university.  Time will tell whether these actions will be effective.

Since the adoption of Sarbanes-Oxley in 2002, governance commentators, including organizations representing institutional investors, have urged separating the position of the CEO from that of the board chairperson.  For example, one of the governance policies of the Council of Institutional Investors is that:

The board should be chaired by an independent director. The CEO and chair roles should only be combined in very limited circumstances; in these situations . . .

Institutional Shareholder Services (ISS) is advocating allowing shareholders to submit proposals for splitting the CEO and chairperson roles and appointing an independent director as chairperson after the current combined CEO/chairperson leaves his or her office.  However, a policy survey issued by ISS in September 2011 finds that institutional investors and corporate issuers (principally board members) are diametrically split in whether “companies [should] commit themselves to an independent chair?”  70 percent of institutional investors answer “yes” while 73 percent of issuers and board members answered “no.”

Proponents of splitting the roles fear that the board cannot fulfill its obligations of overseeing the process of hiring, firing, evaluating, and compensating the CEO if the CEO also serves as the board’s chairperson.  Although hiring, firing, evaluating and compensating the CEO is a board’s most important responsibility, it is probably best done by a committee of independent directors rather than the board as a whole.  The reason for delegating to a committee is the importance of having consistency from meeting to meeting and from year to year.  The reason for having the committee’s composition be of independent directors is to remove the direct influence of the CEO.

Opponents of splitting the roles cite additional costs of compensating two persons, one for the role of chairperson and another for the role of CEO without significantly reducing the amount of time the CEO must spend in educating and preparing board members on the organization’s business.  A survey of financial institution directors by Harvard Business School after the 2008 collapse found that directors themselves may have suffered from not having a greater presence of CEOs and management in the board room to help boards understand the risks inherent with the business models and strategic direction of the institutions.

The American Bar Association in its Corporate Director’s Guidebook (5th edition) and the Business Roundtable in its Principles of Corporate Governance (November 2005) urge having the independent directors of a board designate one of themselves as a lead or presiding director to have access to the agenda, call for and preside at meetings in executive session, oversee the flow of information to board, and serve, where appropriate, as liaison between the board and the CEO.  This is certainly a good practice for boards subject to the scrutiny of shareholders or regulators who have the right to change the direction of the board and for boards having more than eight or nine members.

A better practice for many boards, especially smaller boards that may feel awkward in appointing one of its members and a lead or presiding director, is to enfranchise each director with certain basic rights.  These would include the rights to:

• Have matters included on the agenda for consideration at any meeting of the board or any committee;
• Create a committee of the board composed of members with appropriate independence and expertise, and otherwise cause any matter to be referred to that committee for its consideration;
• Cause the board or any committee to meet in executive session of the outside or independent members and with or without legal counsel or other advisers deemed appropriate by those members; and
• Cause recusal of any member from consideration by the board or any committee of any matter in which a member has a perceived conflict of interest, including excusing the member not only from speaking or being observed, but also from being able to hear or observe others, during consideration of the matter; waiving the member’s right to withhold approval of any statement in the minutes reflecting the consideration of the matter other than to reflect the member’s absence from the consideration and the member’s absence or abstention in any vote on the matter, and waiving the member’s right for reconsideration of the matter.

These rights could be either written into an organization’s existing bylaws or regulations or set forth in a separate “statement of directors’ rights.”

In any event, governance of any organization includes the culture of that organization.  Accordingly, a best practice for one organization may not be a good practice for another.  Changing a practice that changes culture generally requires two generations of directors:  One to propose the change, and a successor to retain it.

As a member of the board of directors of any organization, you have certain obligations to the organization and the rest of the board.  In addition, each of your fellow directors has a right to expect that you and the other directors will respectively observe their director obligations.

The following are some of the basic obligations of a director of any organization.  Each director should:

Observe the duty of loyalty to act in good faith, to the extent possible, in the best interests of the organization (1)

When that is not possible, you should disclose to the board any potentially conflicting interest that may adversely affect (2), or have the appearance of adversely affecting, your ability to make independent judgments as a director.  You should excuse yourself from participating in consideration of any matter in which you may be perceived as having an interest opposed to the best interests of the organization, and if that opposing interest is with respect to a matter material to the organization and is likely to be ongoing, you should consider tendering your resignation.

Excusing yourself from participating in consideration of a matter generally means:  You excuse yourself not only from speaking or being observed, but also from being able to hear or observe others, during consideration of the matter; you waive your right to withhold approval of any statement in the minutes reflecting the consideration of the matter other than to reflect your absence from the consideration and your absence or abstention in any vote on the matter; and you waive your right, discussed below, for reconsideration of the matter.

If a director with a conflicting interest with a matter does not so excuse himself or herself, any other director should have the right to move to refer the matter to a committee that does not include the conflicted director (3).

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 (4).  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 (4).  Occasionally on matters where it is important to have a single message, the 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 (5), and when and if appropriate, to request reconsideration of the decision (6).  Because the board speaks with one voice, asking for reconsideration of a matter should be done sparingly.  Reconsideration should not be requested when the matter has been executed, even partially, or something has been done that the organization cannot undo, or when party has received notice of the vote and has taken action in reliance upon it.

Unless otherwise determined by the board, the following procedures will be followed with respect to any request for reconsideration:

A request to reconsider can be made regardless of the time that has elapsed since the vote was taken (unless the matter has been executed, or something has been done that the organization cannot undo, or when party has received notice of the vote and has taken action in reliance upon it).

The request can be made by any director, including one who voted with the prevailing side, or one who voted with the losing side, or one who did not vote at all or was absent.

Unless the directors who vote with the prevailing side are present or have received notice that reconsideration will be moved, Roberts Rules of Order requires a two-thirds vote of directors at a meeting at which a quorum is present in order to adopt any motion to reconsider (7).

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.

Perform the duties and functions of a director with the care that an ordinarily prudent person in a like position would use under similar circumstances (8)

This is each director’s duty of care under general corporation law (8).  Unless consideration of a matter is expressly delegated to a designated committee of the board, you have both (i) the obligation to, and (ii) the right of reliance that each other director will, exercise this degree of care with respect to each matter, and vice versa.

To the extent possible as a best practice, make available to the board and management the benefits of your knowledge, skills and experience

Acting with the care of an ordinarily prudent person is a minimum standard to avoid breaching your duty care.  A better practice is for you to make available to the board and management the benefits of your knowledge, skills and experience.  Mentorship is one of the major functions of board members.  Mentorship is making available your knowledge, skills, and experience of having been there and having done it before (9).

 Benefits of mentorship include:  Expanding the board’s effectiveness as an “expertise” board 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.

Observe the expectation and right of reliance

The foremost principle of corporate governance is that the board and its committees are expected, and Ohio law gives the board and its 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 directors for matters within their designated authority, which the director reasonably believes to merit confidence (10).

The concept is that the organization is managed “under the direction” of the board (11), 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.

A developing principle of corporate governance is that directors who believe that they do not have available to them the expertise to consider a matter have the right for the organization to provide to the board professionals or other consultants having such expertise.

Assure that outside or independent directors have basic rights

Outside or independent directors are not only the first and best line of defense against corporate mismanagement and fraud, but also the best source of best practices for good governance.  Therefore, all directors should assure that outside or independent directors have at least the following basic rights under applicable corporate governing documents, including to:

Have matters included on the agenda for consideration at any meeting of the board or any committee;

• Create a committee of the board composed of members with appropriate independence and expertise, and otherwise cause any matter to be referred to that committee for its consideration;
• Cause the board or any committee to meet in executive session of the outside or independent members and with or without legal counsel or other advisers deemed appropriate by those member; and
• Cause recusal of any member from consideration by the board or any committee of any matter in which a member has a perceived conflict of interest, including excusing the member not only from speaking or being observed, but also from being able to hear or observe others, during consideration of the matter; waiving the member’s right to withhold approval of any statement in the minutes reflecting the consideration of the matter other than to reflect the member’s absence from the consideration and the member’s absence or abstention in any vote on the matter, and waiving the member’s right for reconsideration of the matter.

Endnotes

The following endnote are intended as an integral part of this article providing additional guidance to anyone who serves as a director:

1. Duty of loyalty.  The duty of loyalty in Ohio is a statutory duty requiring each director to perform the duties of a director “in good faith, in a manner the director reasonably believes to be in or not opposed to the best interests of the corporation.”  A director is given a range in his or her statutory duty of loyalty:  i.e., to act in, or not opposed to, the best interests of the corporation.  An officer does not have that statutory range, but must act in good faith, in a manner he or she reasonably believes to be in the best interests of the corporation.  The reason for this is that corporate law recognizes that directors, especially independent directors, may have different affiliations and, therefore, different loyalties.
2. Disclosure of conflicting interests.  Disclosure of conflicting personal or economic interests is a statutory responsibility of each director to other directors.  Under Ohio law, a contract, transaction or other action authorized by a board may be void or voidable if a director has a personal or economic interest in the matter.  Ohio law requires procedurally that the conflicted director’s relationship or interest be disclosed to, or otherwise be known by, the rest of the directors and that contract, transaction or other action be authorized by the affirmative vote of a majority of the disinterested directors.  If a quorum is present including any interested directors, then the affirmative vote of the disinterested directors is valid to authorize the matter even though the disinterested directors themselves may constitute less than a quorum.  If the conflicting personal or economic interest is not disclosed to or known by the other directors, or if there are no disinterested directors to authorize the matter in which there is a conflict, then the board is held to a greater scrutiny in that the transaction must be found as fair to the corporation at the time it is approved.
3. Right to refer to a committee.  Each director generally has the right to move to have any matter laid before a committee of the board unless the governing documents otherwise provide.
4. Only voice is an act of a majority.  Under Ohio law, “the act of a majority of the directors present at a meeting at which a quorum is present is the act of the board, unless the act of a greater number is required by the articles, the regulations, or the bylaws.” Because the act of a majority of the directors present at a meeting at which a quorum is present is the act of the board, there can be only one voice – that of a majority.  If there is no majority, there is no voice.
5. Right to record negative vote, abstention or absence.  A director’s right to have his or her negative vote or abstention or absence in consideration of a matter is an American modification of Robert’s Rules of Order.  Courts generally require organizations to record such a vote, abstention or absence when timely requested by the director.  Timely requested generally means at the time the vote is taken or before the board moves to consideration of the next matter.  As a courtesy, many boards will allow the request to be made and honor if done before approval of the minutes of the proceeding.
6. Reconsideration of a matter.  Reconsideration of a matter is an American adaption of the right of a member of a standing committee, such as a board of directors, to move to repeal and amend a prior action taken by the committee or board under Robert’s Rules of Order (10th edition).  The traditional interpretation of Robert’s Rules based upon parliamentary law is that there must be two motions, one to repeal and then a second moving adoption resolution stating the desired action.  This two-step procedure is considered cumbersome for boards that are not assemblies of a large number of members.
7. Procedures for reconsideration.  Roberts Rules of Order (10th edition) provides an American adaptation of reconsideration differing from traditional repeal and amendment of Parliamentary  law in the following respects:  (1) A motion to reconsider a vote can be made and taken up regardless of the time that has elapsed since the vote was taken, and there is no limit to the number of times a question can be reconsidered; (2) the motion can be made by any member who did not vote with the losing side; or, in other words, the maker of the motion to reconsider can be one who voted with the prevailing side, or one who did not vote at all, or even was absent and (3) unless all the members who voted with the prevailing side are present or have been notified that the reconsideration will be moved, it requires a two-thirds vote to adopt the motion to reconsider.  For better governance, most boards allow any director, regardless of whether or how he or she voted, to request reconsideration.
8. Duty of care.  The duty of care in Ohio is a statutory duty requiring each director to perform the duties of a director “with the care that an ordinarily prudent person in a like position would use under similar circumstances.”  Because this duty is a minimum standard that each director must achieve to avoid liability, directors should consider better practices.
9. Function of directors.  The function of the board is to provide "direction"11 to management through:  (1) Decision making as to matters of policy, direction, strategy and governance; (2) oversight as to matters of policy, direction, strategy and governance; and (3) Mentorship of the CEO and senior management.
10. Expectation and right of reliance.  Ohio law contemplates that directors will consist of those from outside the organization.  Under Ohio law, directors have a range in their duty of care from acting “in” the best interests of the organization on one end, to acting “not opposed to” the best interests of the organization on the other end.  As discussed note 1 above, an officer does not have that statutory range, but must act in good faith, in a manner he or she reasonably believes to be in the best interests of the corporation.
11. Under direction of the board.  Ohio law as well as the law of other states provides that all of the authority of a corporation shall be exercised by or under the direction of its directors.  The regulations or bylaws of most corporations other than those closely held provide for this authority to be exercised “under the director of the board.”
    

A decision by ICANN, the organization that runs the internet domain name system, has added .xxx as a new top-level domain for pornography sites.  You may be asking how this applies to you.  Well, unfortunately the pornography industry has used legitimate trademarks (and misspellings) for years in order to get internet “hits” and redirect people to their websites.  With the new .xxx domain, there is a real potential for your business’ trademarked name to be registered as a .xxx (e.g., .adultcontent.xxx).

There is a “Sunrise Period,” which runs from September 7 through October 28, 2011, when companies in the adult entertainment industry can apply for the new .xxx domains.  During this same time frame, trademark owners who are concerned that their trademarks may be used as a second-level domain name in this registry (e.g., mybusiness.xxx) for pornography can take steps in advance to block the registration of their marks for use as .xxx domains (“Sunrise B”).

Under the Sunrise B Reservation Request program, trademark owners can apply to reserve their registered trademarks in the .xxx registry.  You do not actually register your trademark as a domain.xxx; rather, you register to block a third party from doing so.

To qualify for the Sunrise B period “blocking reservation,” you must own a valid trademark registration as of September 1, 2011, and pay a registrar fee of approximately $200 for a ten-year block.  Once your trademark is recorded, the .xxx registry will not register any second-level domain name that is identical to your registered trademark.  It will not protect against misspellings and variations of your trademarks; however if that occurs, you would still be able to sue them in court. 

For more information or assistance, contact John Beavers at (614) 227-2361, Joe Dreitler at (614) 227-2343 or me at (614) 227-8824.

A new paper published by the Social Science Research Network (SSRN) titled, Effects of Local Director Markets on Corporate Boards, examines how local director labor markets affect board composition and the quality of corporate governance.

The article addresses how the supply of potential directors in the local labor market strongly affects board composition of Standard and Poor’s (S&P) 1,500 companies, namely, the proportion and expertise of independent directors. For instance, in an average sample firm, a third of independent directors in S&P 1,500 firms holding executive positions are employed locally.

Similarly, the authors tests show access to a larger local pool of prospective directors has a positive effect on the proportion of independent directors. At firms located near larger local pools of prospective directors, a significantly higher fraction of independent directors are employed locally. Overall, boards of firms located near larger pools of managerial talent include a larger percentage of independent directors who are executives from other nearby firms.

Additionally, the article examines several dimensions of director expertise, including executive, technology, financial, academic, and legal expertise, and director education, to proxy specialized skills and abilities to perform effective monitoring and advisory roles. The articles found that those organizations closer to a large pool of potential director talent (general or specialized) have a higher proportion of independent directors with these respective types of expertise on their boards.

The findings provide strong evidence of the importance of local director labor markets. 

Or in our opinion the importance of access to a supply of directors with expertise in those areas that fit the strategic direction of your organization

The entire article can be accessed here.  

Do you ever ask yourself how to get your company back on track once its growth has plateaued so you can accomplish your goals? If so, then it might be time to form an advisory board.

Before doing that, however, you need to determine is your company is really ‘off track’ and not simply struggling with a management team that has maximized its expertise and needs some direction to take your company to the next level. If, after reviewing your business and you management team, you are still asking these questions, then it might be time for an advisory board.

An advisory board is a group of advisors selected by the company, who lend insight and counsel to the owner, chief executive officer, or management team. Most advisory boards consist of three to five members. Their role is to provide counsel, advice, contacts and complementary competencies that go beyond that of the management team.

Advisory boards provide independent and objective advice and mentorship, and allow the organization to tap into the knowledge and experience of others that the company’s management team might not have.

Advisory boards have no statutory fiduciary duties and serve at the will of the company. It is important to recognize that an advisory board does not replace the company’s statutory board. The true benefit of an advisory board is that it helps companies focus on business strategies and the issues that matter most as they grow and prosper.

Emerging companies benefit from advice and counsel of skilled advisors to supplement management’s knowledge and experience. Advisory boards lend insight and perspective to business strategies while leaving the implementation to management and employees of the company. Further, an advisory board can:

• Help determine benefits and risks;
• Generate contacts and potential resources;
• Mentor management;
• Provide industry expertise;
• Assist with succession planning; and
• Help hold management accountable to deadlines and tasks.

A good advisory board can be a powerful tool to aid the growth of your company. In order to make the most effective and efficient use of your advisory board you must be willing and able to:

• Confide in others about yourself and your business;
• Present key strategic issues for consideration of others;
• Be able to accept criticism; and
• Take the necessary time to prepare for meetings and communicate.

An advisory board will only be effective if the company and management is willing to expose their skeletons and share their ideas. While a company’s statutory board provides direction and oversight to the company, an advisory board provides discretionary advice for the company as it develops strategies and helps the company reach their future goals and aspirations.

The best way to avoid or resolve a conflict is governance by an independent governing board or, where appropriately structured, an advisory board.

One of my early clients tried this with his two sons. He formed a corporation, appropriately named “Push and Shove Corporation,” and subjected both sons to the overall authority of a statutory governing board composed of the two sons and the parents. Push and Shove was successful in avoiding unresolvable conflicts until the parents were no longer able to actively participate.

Another example is a manufacturing firm that successfully succeeded through five generations of owners who were family members. The first generation of owners consisted of two brothers. The second generation consisted of the children of one of the brothers. The third, fourth and fifth generations were children of those children. The business succeeded through each generation because the owners also followed the corporate formalities of being directed by a governing board that had independent members. This included a cradle-to-grave life cycle from being managed by the family as the executive officers, to being managed by outside or professional managers, and finally to being sold to a publicly held corporation.

A final example is an architectural firm that has successfully succeeded through two generations of owners who were family members, a third, and soon to be a fourth, generation of owners who are non-family members. The architectural firm succeeded in avoiding unresolvable conflicts because it followed the corporate formalities of being directed by a governing board that had at least two independent members. Because of the presence of independent board members elected by the owners, the board met both of the tests for a mechanism to successfully avoid or resolve conflicts: The board appeared to favor no one over the other in any conflict, and there was a chilling effect of having any matter resolved by the board for the reason that, because of the independence of the independent members, no one could predict the outcome.

One of the important roles of independent directors is mentorship: Providing guidance and counsel to management or the business owners. Someone independent of the management and the owners often has the objectivity to see conflicts in a manner that enables them to avoid or propose resolution to conflicts that are unavoidable.

Although each of my examples involved a statutory governing board, a non-statutory or advisory board can accomplish the same result if the owners and the advisory board members agree at the outset that any conflict will be resolved by majority vote of the advisory board and that the owners will be bound by that resolution.

Now that baby boomers are approaching retirement, we are receiving a number of inquiries regarding SERPs. Here are answers to some of the most frequently asked questions:

1. What is a SERP?
A SERP is a supplemental executive retirement plan or supplemental executive retention plan that provides retirement or retention benefits to supplement the basic retirement benefits or regular compensation to which the employee is otherwise entitled. The arrangement is typically a non-qualified deferred compensation plan that is limited to a select group of management or highly compensated employees (e.g., a top-hat employee).

2. What is the difference between a retirement SERP and a retention SERP?
A retirement SERP supplements a top-hat employee’s qualified retirement benefits if the employee remains in service until retirement (or another defined “triggering” severance, such as normal retirement, death or disability). A restorative SERP is a common form of retirement SERP that provides non-qualified deferred compensation to a top-hat employee to restore qualified plan benefits to which the employee is not entitled because of the limitations on contributions and benefits imposed by Internal Revenue Code on highly compensated employees under qualified plans.

A retention SERP provides a cash award, typically in the form of a bonus, to a top-hat employee for remaining in service for a number of years, which is not based upon retirement. Most retention SERPs are defined contribution arrangement as discussed below.

3. What is deferred compensation?
For federal income tax purposes, deferred compensation is compensation that is paid in a year that is later than the year in which the services were performed, or for which the compensation was earned or accrued, regardless of whether it is funded, vested or subject to a substantial risk of forfeiture.

4. What is a qualified plan?
A qualified plan is a retirement plan, or other deferred compensation arrangement, in which the benefit, pursuant to the federal income tax laws, is not included in the employee’s gross income and employment taxes until it is paid, while the employer is entitled to a deduction from gross income for the amount contributed annually to fund those benefits. All other plans are non-qualified plans.

5. What different kinds of SERPs are there?
SERPs may be a defined benefit, defined contribution, cash balance or target benefit arrangement.

• A defined benefit SERP defines the benefit (occasionally a fixed-dollar amount, but more frequently an amount based upon an employee’s compensation or a combination of compensation and years of service) for which the employer bears the investment risk. A common form of defined benefit SERP provides a benefit upon retirement in the form of an annuity that, when added to the employee’s projected qualified retirement plan and Social Security benefits, will equal a specified percentage of the employee’s final average compensation. 
   
• A defined contribution SERP provides for (i) an individual account for the employee and (ii) benefits based solely on the amount contributed to the employee’s account and any income, expenses, gains and losses for which the employee bears the investment risk. A common form of defined contribution retention SERP provides a contribution of a fixed-dollar amount to an individual account that is invested until the employee completes a period of service, at which time the employee receives the account in one lump sum. A common form of a defined contribution retirement SERP provides a contribution of periodic contributions, typically annually, to an individual account that is invested until the employee has a triggering severance (typically, normal retirement, death or disability), at which time the employee receives the account in one lump sum.
   
• A cash-balance SERP has characteristics of a defined contribution plan, and is intended to constitute a defined benefit plan. Typically, the employee receives a pay credit, such as a percent of his or her compensation over the years of participation, and an interest credit based upon a fixed or variable rate (often an index rate such as the one-year Treasury Bill rate) on the pay credits over the same period. There is a hypothetical accounting of the credits, and the benefit to the employee is the accounted value of the credits at the date of payment. As with other defined benefit plans, the employer bears the investment risk.
   
• A target-benefit SERP has characteristics of a defined benefit plan, and is intended to constitute a defined contribution plan. Typically, the plan defines a target benefit upon reaching retirement age, and then defines a contribution that, using actuarial assumptions (such as interest rates, mortality and employee turnover) determined pursuant to the plan, is projected to result in that target benefit at the payment date. The contributions are credited to an individual account for the employee, and the account also is credited or debited with the actual (not the assumed) income, expenses, gains and losses from the investment of the account. As with other defined contribution plans, the employee’s benefit is the account value at the date of payment, and the employee bears the investment risk.

6. Are there any limitations common to SERPs?
The following are limitations generally common to all SERPs:

• Top-hat limitation. A SERP must generally be limited to a select group of management or highly compensated employees.
    
• No constructive receipt. An employee cannot be in constructive receipt of any SERP benefit or any of the assets securing its payment. The rules of constructive receipt require that (i) an employee’s rights to payment of any SERP amount may be no greater than those of general unsecured creditors of the employer; (ii) the obligation of the employer to pay the SERP may constitute no more than a mere promise to the payments in the future; and (iii) the employee’s rights to payment may not be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment or garnishment by creditors of the employee or his or her beneficiary.
    
• Time and form of payment determined upon commencement of participation. The events triggering payment, and the time and form of payment, of the SERP’s benefits must be determined before the employee has a legally binding right under the SERP, which is generally at the time the employee commences participation or, in some circumstances, by the 30th day after the employee first becomes eligible to participate. The time and form of payment generally is irrevocable and cannot be accelerated, and may be postponed only in limited circumstances.
   
• Inclusion in gross income or wages for employment taxes. The value of non-qualified deferred compensation such as SERP benefits must be included in the gross income and reported as wages of an employee for purpose of federal employment taxes, including Social Security and Medicare taxes, as of the later of when the underlying service is performed or when there is no substantial risk of forfeiture. Some SERPs are designed to require an advanced payment of an employee’s SERP benefit equal to the employment taxes required to be withheld, and if so, the employee’s SERP benefit is reduced by the amount of the advanced payment.

7. How may SERPs be funded?
Assets may or may not be reserved on the employer’s books for the SERP, and any reserved assets may be held by a Rabbi trust:

• Subject to the no-constructive receipt limitation common to all SERPs discussed above, the employer may reserve assets on the employer’s books to satisfy the employer’s obligation to pay the SERP’s benefit in the future. Any reserved assets may be transferred and held in a Rabbi trust discussed below.
    
• In absence of an asset reserve, SERP benefits will be paid from what assets exist on the books of the employer as SERP payments become due.
    
• A Rabbi trust is a grantor trust used to receive and hold assets reserved to satisfy an employer’s obligation in connection with deferred compensation arrangements and comply with no-constructive receipt limitation. The assets of the Rabbi trust are held for the exclusive purpose of satisfying the employer’s obligation to make payments to the employees or their beneficiaries except in the case of insolvency of the employer. In the case of insolvency, the assets of the trust will become subject to the claims of the employer’s general creditors under federal and state law. If the trustee becomes aware of the employer’s insolvency, the trustee is required to discontinue payments to employees or their beneficiaries and is required to hold the assets of the trust for the benefit of the employer’s general creditors. Because the Rabbi trust is a grantor trust, all income of the trust and items of deduction against that income or credit against any taxes on that income are passed through to the employer pursuant to the grantor trust rules.

8. May SERPs be used by tax-exempt or governmental organizations?
Yes, but there are a few differences. Unlike employees of taxable organizations whose non-qualified deferred compensation such as SERP benefits is not included in gross income for federal income taxes, the value of non-qualified deferred compensation of employees of tax-exempt and government organizations is includible for federal income taxes for the first taxable year in which the compensation is not subject to a substantial risk of forfeiture. A SERP for an employee of a tax-exempt or government organization is typically designed to require the employee’s service through the last day of the service period, for a retention SERP, or until retirement (or another triggering severance such as death or disability) for a retirement SERP. If the employee’s service is terminated before the last day of such period or other than by a triggering severance, the employee typically forfeits his or her entire SERP benefit.

9. May the receipt of benefits under a SERP be subject to conditions?
Yes. Benefits may be conditioned upon the completion of a specified term of service, the satisfaction of a vesting schedule, the achievement of specified goals, or some other term. Until the terms are satisfied, the benefits may be considered to be subject to a substantial risk of forfeiture.

10. Is there a monetary limit to the amount of the benefit that may be provided under a SERP?
No, but some governance commentators dislike SERPs other than restorative arrangements designed to restore qualified plan benefits to which the employee is not entitled because of the limitations on contributions and benefits imposed by the Internal Revenue Code on highly compensated employees under qualified plans. Compensation committees should not be so limited as long as they are confident that the value of the potential benefit to the employee is taken into account in determining total compensation and nothing excessive is hidden.

11. Why should an organization consider implementing a SERP?
A properly designed SERP can not only attract and retain a highly-compensated employee important to the organization, but also can facilitate a transition by the employee after a period of service or upon retirement.

12. How are SERPs taxed to the employee?
The rules for federal employment (Social Security and Medicare) taxation are different than the rules for federal income taxation of nonqualified plans such as SERPs. For federal employment taxation, SERP benefits of employees of all employers are subject to Social Security and Medicare taxes (i) when the related services are performed or (ii) when there is no substantial risk of forfeiture with respect to their right to receive payment of their SERP benefits. For federal income taxation, SERP benefits of employees of tax-exempt and government employers are subject to federal income taxes when there is no substantial risk of forfeiture with respect to their right to receive payment of their SERP benefits, which generally is earlier than for employees of taxable employers whose SERP benefits are subject to federal income taxes as the SERP benefits are paid or made available for payment.

Succession planning is a key strategy of any organization. Planning succession is often most successful if the organization helps plan the retirement of its key executives.

In order to keep the courtroom from invading the boardroom, saying less is often better. As discussed in an earlier issue of Acredula, this topic continues to attract attention from our readers, and it continues to hit home for many organizations.

Today’s business climate places heightened scrutiny on corporate governance and the actions of board members in both public and private companies, and tax-exempt organizations. Therefore, what is captured in your organization’s minutes is a potential script for the plaintiffs’ bar. Minutes have two purposes: to inform and 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 committee of the board 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 by 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 decision with 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 plaintiff’s lawyers who may be preparing a cross examination. For closely held corporations, “who else” may some day 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?

1) 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. Reflecting that purpose in the minutes is evidence of compliance with notice requirements, and, as discussed below, the minutes can do so simply by identifying the matters considered.

For evidentiary purposes, it is helpful to reflect 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 reflect so with 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.”

2) 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.

3) 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
• 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.

4) 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 within a reasonable time after the adjournment with the secretary of the corporation. 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 reason for his or her vote even if requested. As with the abstention for compliance 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.”

5) Factors considered in making decisions

Minutes should reflect 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 investigate personally 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 . . . .”

6) 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.

7) 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.

8) 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, and 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. When in a litigation context, 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, 2007). 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.

In today’s era of heightened scrutiny, it is crucial to keep the intended audience in mind, 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 is often more.

“Why can’t they just rely upon me and not keep asking questions?” This is a frequent question asked of me by many CEOs after meetings with their boards.

Although all of a corporation’s power and authority are vested in its governing board, a basic tenet of corporate governance is that a board does not directly exercise all of that power and authority, but it is exercised “under the direction” of the board. Boards are expected to rely principally upon management in recommending, and especially executing, that direction, and each board member is protected from liability if the board member has a reasonable belief that management is reliable and competent in recommending such direction.

Courts generally require that, in order to have such a reasonable belief for a matter, board members must ask questions verifying the reliability and competence of management for the matter.

We generally advise the CEO that “the role of your board members is to exercise reasonable care to oversee that your organization has direction, but not to execute that direction or mange the organization unless the board believes that you as the CEO or management as a whole are not reliable and competent to do so. Boards do this by asking sufficient questions until they have a reasonable belief that you and management are reliable and competent in what you are authorized to do.”

Sometimes boards, or individual board members, need coaching on what questions to ask and when to stop asking them. The questions should not generally be “how are you going to do this.” Management should have the authority to determine “how.”

Instead, the purpose of most questions by a board should be to verify or confirm the reliability and competence of management 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?”

We have learned from the events that led to the recent crisis among large financial and investment institutions 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. Accordingly, the most import question is “what if?” “What happens if real estate prices fall?” “What happens if things don’t go as expected?”

Finally, directors can stop asking questions on a matter when they reasonably believe that management is reliable and competent to handle the matter. This generally occurs after management has shown that they have considered and answered the “what if?” questions.

Whether faced with natural disasters like the tornadoes in Alabama and flooding in Mississippi, or man-made disasters such as the gulf oil spill last summer, what are the duties of corporate directors of organizations when such disasters strike?

As we have discussed in past entries, the role of directors in corporate governance is to provide direction and oversight to the organization. In determining the role of the board in an emergency situation, whether man-made or natural, questions surround the board’s obligation to effectively oversee and manage the potential risk to the organization.

Directors can assume that any action or inaction will be scrutinized to determine what steps, if any, they took to mitigate any damage to the organization. As such, boards must prepare for possible high-impact crises. As we learned from the recent crisis among financial institutions, board members must consider all possibilities, especially those that could have a high impact, albeit remotely probable, and not just the normal. Given the amount of time that directors are increasingly spending in their duties, directors tend to focus on the now and ignore tasks that seem in the distant future (i.e., board succession planning and CEO succession planning). They tend to put off planning for an abnormal, but high-impact event, such as the recent natural and man-made disasters.

While not every potential disaster can or needs to be planned for, good governance requires that boards are prepared and in a position to act when a disaster does arise.

The best laid schemes o' mice an' men/Gang aft a-gley

It is important to remember that even a good plan will not cover every emergency, because it is difficult plan for everything. Thus, any emergency response or action plan must be flexible to adapt to the type and severity of a disaster facing the organization.

Some key considerations for any plan include the following:

• How will the board and management communicate with each other at the outset?
• What if one group is cut-off from communications?
• Do the organization’s governing documents provide special authority for the board to act, if less than quorum, in such an emergency? What types of events fall under the governing documents definition of an emergency?
• What will be the procedures for communicating with customers, suppliers, employees, the media, the general public, etc., in the event of a disaster?
• How is the communication plan impacted if the disaster is community or regional versus a disaster that is organization specific?
• Is there a different message for different target audiences, and is there a designated spokesperson or two to contact such audiences?

The optimal risk-management approach and policies for each organization will vary widely; this is an area where a tailored approach in implementing governance objectives is particularly critical.

It is important to remember that one of the basic principles of corporate governance is that the board cannot and should not be involved in actual day-to-day operations of the organization, which includes risk management. However, directors should satisfy themselves that the risk management approach, policies and procedures are consistent with its corporate strategy, and that such a plan provides for the black swan event that may require the board to step in and take certain actions. All too often the unknown leads many organizations to not begin the planning process; however, as Peter Drucker once said, “[t]rying to predict the future is like trying to drive down a county road at night with no lights while looking out the back window.” We will never know exactly when disaster will strike and the form it will take. The key here is the planning process and not necessarily planning for every contingency because that is impossible. The planning is indispensable.

Earlier in my career, I had to deal with the aftermath of an angry director who went from the board room to the employees' cafeteria, announcing angrily at a table of employees, "Can you believe those other idiot-directors just decided to sell the company!"

The angry director violated his duty of care and loyalty. The duty of care and loyalty requires a director 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 a director disagrees with a decision, the director's rights are to vote against that decision, to have his or her negative vote recorded in the minutes, and when and if appropriate, to ask for reconsideration of the decision. A director may always voice a concern to a higher authority within the organization, such as shareholders, to take into account when electing directors or, if applicable, approving a transaction related to the other board's decision.

The angry director's outburst spread quickly through the company, resulting in not only employee discontent, but worse, insider trading by one of the employees. The SEC investigated the insider trading and questioned the angry director. Although no legal proceedings were brought, the director incurred expenses in terms of time, legal fees and loss of reputation.

Because the angry director did not believe there was a breach of fiduciary duty or violation of law involved in the decision to sell the company, he should have remained in the board room, or talked outside the board room separately to each of the other directors and asked for reconsideration. Or he should have waited and voiced his concern to shareholders at the next election of a director or when their approval of the sale of the company was sought.

What happens in a board room should remain in the board room unless a director believes that remaining silent will result in a material breach of fiduciary duty or violation of law or that a high authority, such as shareholders, has a need to know.

A recent study published by the Columbia Business School and the University of Delaware’s Weinberg Center for Corporate Governance determined that gaps remain between what boards can do and what they actually do. The study, titled “Bridging Board Gaps,” led to recommendations in specific areas, which coincide with the recommendations that we have been discussing in Acredula since the beginning of the economic crisis.

The key recommendations of the study focused on:

• Purpose
• Culture
• Leadership
• Information
• Advice
• Debate
• Self-Renewal

As it relates to points on the above list, some of the key areas and proposed actions boards should focus on to increase effectiveness and performance include the following:

1. Focus from the top is based on the correct fundamentals. The “tone at the top” should be long term and include the effect on net worth, surplus and capital of the organization. It should include being compliant with legal and ethical standards, and continuous improvement of the organization’s operations and practices.

2. Necessary or required information is being provided, and it is accurate and complete. Boards should assure that there are periodic evaluations to determine that all necessary information is being provided to the board and management, and that the information is accurate and complete; determine whether all required information is being provided to other stakeholders, and that it is accurate and complete; determine if there are safeguards to provide corrected information when it that information becomes materially misleading due to adverse events or otherwise.

3. Retain or make available appropriate expertise on the board. Boards should evaluate and inventory the individual skills, experience and other expertise of each of its members, determine the expertise needed in the foreseeable future, and then determine whether to fill any gaps in such expertise through:

• Recruitment of new or additional directors
• Education of directors to enhance expertise
• Availability of advice of advisers to provide missing expertise

4. Implement a regular and formal process for board evaluation. Boards must strive for commitment to excellence in their governance and not just adhere to the minimum standards prescribed by law. This requires a goal of continuous improvement. Similar to evaluating the organization’s Chief Executive Officer and management, the board must also evaluate itself in order to improve. A yearly board evaluation will allow an organization to:

• Check progress against mission and goals
• Give directors a meaningful measure of accountability
• Allow for a check of strengths and weaknesses
• Emphasize the accomplishments of the board
• Provide a yardstick with which the goals of the coming year can be measured
• Encourage a teamwork approach to decision making.

Pursuant to the duty of care, each director—believing he or she does not have sufficient expertise—should act prudently to obtain expertise necessary for consideration of any matter coming before the board. Traditionally, missing expertise has been provided through advisers retained by or for the board. In the future, recruiting new or additional directors with the needed expertise is often the best practice.

5. The board is prepared to lead in a crisis. At least one outside director, such as a lead outside director, should regularly participate in preparing the agenda for meetings and approving information being provided to directors. Outside directors should assure their ability, under applicable governing documents, to call and preside at meetings— including executive sessions—where appropriate. Boards should have strategies for providing succession.

6. The board and management are reasonably protected against liability. Boards should assure that its members and management are periodically reminded of what precautions should be taken to reduce risks of liability, including what to do if any claim or potential claim should arise. Indemnification provisions should be reviewed periodically to the extent that indemnification is currently permitted by law. Directors and officers (D&O) coverage should be reviewed for its adequacy in the event of insolvency, bankruptcy and government funding. The solvency of the D&O insurers should be checked, too.

Finally, as with any governance practice, what is good for one organization may not be good for another. An organization’s culture must be considered when determining whether or not to adopt any new governance practice. It is critical to not simply adopt best practices, but to focus on whether or not a governance “best practice” will be the best for your organization and become its next practice.

Many years ago the CEO of a client called with this question, "My board chair says I can't fire the CFO because the board elected him as an officer. I think I should be able to fire him because he reports to me. Who's right?"

The highest management authority in most organizations is its governing board. State corporation laws provide that all of the authority of a corporation shall be exercised by or under the direction of its directors except where the law, the articles or the regulations require action to be authorized or taken by shareholders or members. Shareholders or members often retain the right by law or governing documents to approve a change to the organization's articles, certificate or charter of incorporation; sale of substantial assets; issuance of substantial number of shares of stock; merger or consolidation; or dissolution.

As the highest management authority, most organization's boards elect the CEO or president and those other officers—typically a secretary and treasurer—that the organization is required to have by law. Many organizations elect those officers who directly report either to the board or to the CEO.

Throughout the 1980s and ’90s the American corporate model has evolved into a structure having a strong CEO with the authority to hire, discharge and determine the compensation and scope of work of all other officers and employees. Benefits of this CEO-centric model are believed to be:

• Quick “execution,” which is the function of management, subject to oversight by the board
• Accountability to the board of all management through the CEO
• Quick removal of management by replacing the CEO if something goes wrong

A strong CEO under the American model has authority to hire, discharge, and determine the compensation and scope of work of all other officers and employees except those reporting solely to the board. Typically this authority is set forth in the CEO's employment agreement or in separate governance policies of the organization's board.

However, even a strong CEO remains subject to the overall authority of the board.

The CEO of my client would likely have had authority under the evolved American model to fire the CFO. However, given that the highest authority remains the board, a wise CEO would advise the board of the decision before firing the CFO unless circumstances require acting sooner for the best interest of the organization.