Edited by Jeff Kaplan
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Directors and Officers
How (and how often) should directors and officers be trained on COIs? What general lessons and what sorts of examples should be used in such training and other sorts of C&E communications to company leaders?
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As noted in a previous post, CEO’s tend to have different COIs than the rest of us. Today’s post will look at a few CEO-related COI stories that have been in the news lately.
Most notably, yesterday the pharma company Novartis dropped a controversial plan to pay outgoing CEO Daniel Vasella up to $78 million over the course of six years. As described by Forbes, “The board had originally justified its decision in order to ‘protect’ the drug maker, since Vasella knows ‘the company’s business intimately, having built the leading R&D organization and personally recruited most of the top executives.’ In other words, the payoff was hush money designed to keep him from telling secrets to competitors.” The notion that a board could even consider paying a CEO something extra for keeping shareholder secrets is – at least on its face – pretty distressing.
Public sector organizations have CEO’s, too – and various press accounts have noted that super-lawyer Mary Jo White, who President Obama has nominated to head the Securities and Exchange Commission, will need to take conflict avoidance measures if confirmed for that post. But as noted in this recent story in Bloomberg News , while it is hardly unusual for a lawyer going from private practice to public service to have COIs of this sort, White’s particular contemplated mitigation approach to her potential COIs (which concern not only her law firm partnership but that of her husband, himself a prominent securities lawyer) appears to be of less than optimal efficacy.
I should stress that I don’t think there is any chance that White will personally act in a conflicted way in the discharge of her duties at the SEC. But individual honesty is presumably not the end of the analysis regarding any leader’s COIs – and that is particularly so where a) the leader leads a government agency whose mandate includes, among other things, addressing COIs (at least in the financial services field); b) that agency has an uneven record over the years in enforcing that mandate; and c) there is a reasonably strong concern among press and public that the reason for the agency’s shortfall is one of regulatory capture.
And speaking of the SEC, there is this story from yesterday about a deposition of hedge fund chief Steve Cohen whose firm, SAC Capital, is being investigated for insider trading. Cohen apparently testified: “I’ve read the compliance manual, but I don’t remember exactly what it says,’’ and, according to John Coffee, a noted securities-law professor at Columbia, “That’s a dangerous statement. The fact that he doesn’t know what’s in his compliance manual is useful to the SEC,” should it decide to pursue the firm on a “control person” theory of liability (which essentially involves supervisory neglect).
But is this really a COI issue? It is in the sense that under Delaware law compliance oversight failures by directors and officers can be deemed a violation of the duty of loyalty, which – even if not technically involving a conflict – is from the same neck of the woods as COIs.
Finally, just today an internal investigation cleared former Chesapeake Energy CEO Aubrey McClendon of any “intentional wrongdoing” in connection with the controversial borrowing practices that were the subject of the prior post linked to at the top of this one. But presumably it did not do the same with respect to creating an appearance of a conflict – given the facts as described in the prior post, that could not be done with a straight face. And with CEOs, proper appearances can matter just as much as avoiding actual COIs, as evidenced by the great costs and disruption that befell Chesapeake when the borrowing practices became known to the company’s shareholders and others. Indeed, the company evidently continues to be the subject of an SEC investigation concerning these matters, and COI watchers may be able to look to the outcome of that inquiry for an early view of how seriously that agency will address conflicts in the era of Mary Jo White.
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Directors’ conflicts of interest are one of the favorite topics of this blog. Among our prior posts on this subject are this one on what to cover when training directors on COIs , this one on corporate charitable giving, this one on board COIs in internal investigations and this one on COIs in connection with service on the board of a joint venture. We’ve also addressed the need for directors to monitor the COIs of senior executives in their companies – and the dire consequences that can arise from a failure to do so.
So, what’s new in the area?
First, this recent story from Bloomberg news reported on possible conflicts involving a prominent university’s board: “13.5 percent of Dartmouth’s $3.5 billion endowment is managed by firms that are related to trustees or investment committee members.” Dartmouth is not alone in this respect, but some schools do ban the practice, based on COI concerns: “Trustees shouldn’t manage university money because of the potential for self-dealing and other abuses, says Mark Williams, a former Federal Reserve bank examiner who teaches risk management at Boston University. ‘Even the appearance of conflicts of interest can create reputational risk and harm the institution,’ Williams says. ‘The perception is almost as bad as the act of conflict. It does damage to that reputation, which has taken many universities centuries to create.’”
On the other side of the coin, the alumni in question have apparently been very generous in their gifts to the school, so it is arguable that on a net basis the practice is worthwhile – although balancing tangible gains against possible intangible losses is hardly an easy calculus to undertake in any meaningful way. The piece also noted: “The potential conflicts can be thrown into high relief when funds lose money. As chairman of Yeshiva University’s investment committee, J. Ezra Merkin funneled the school’s money via his hedge funds to con man Bernard Madoff in return for fees. The $1.1 billion endowment lost $14.5 million when Madoff’s Ponzi scheme blew up in 2008.”
I don’t know what to add to this except the general comment that many non-profit organizations (i.e., not just universities) could use more rigor in their approaches to COIs. Here is a piece that speaks to that.
Second, this recent post, by Klaus J. Hopt, a professor and director (emeritus) at the Max-Planck-Institute for Comparative and International Private Law, in Hamburg, on the Harvard Law School Forum for Corporate Governance makes an interesting comparison between the duty of loyalty owed by directors under US and UK law and the prevailing approach under the continental system: “The duty of loyalty is highly developed in Anglo-American countries, but it has received more hesitant attention in continental European countries.” However, the piece notes: “More recently there are tendencies to more convergence [and] more attention is paid to prevention, remedies and enforcement.”
At the risk of sounding US centric (whereas I’m really just COI-centric), this does sound like a positive development. Moreover, and beyond the scope of Professor Hopt’s paper (which can be downloaded via the Harvard site), it is interesting to consider that under Delaware law (in particular the Stone v Ritter case) a board’s compliance and ethics oversight duties are actually based on the duty of loyalty – and perhaps the convergence will extend in that direction, as well.
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What do directors need to know about COIs – meaning, for our purposes, what should go into the COI-related training and other communications that they receive?
First, they should be trained on their own personal COI risks, meaning conflicts involving the directors themselves. “Corporate opportunities” – discussed in this post – is a kind of COI that a director might face. Using company confidential information for personal benefit – such as in insider trading (e.g., the allegation in the Gupta/Galleon case) – would be another, and there are, of course, many others to draw from, as well.
Second, directors should understand the need to monitor COIs of senior executives. The Chesapeake case – discussed here – is a pretty compelling vehicle for that sort of discussion. (Note: requirements of disclosure of “related party” transactions are relevant to both this area of awareness and that concerning board members’ own COIs.)
Third, consistent with their Caremark duty, board members should be made aware of compliance measures regarding any high-risk conflict areas – so that they can ask informed questions about such measures. Here is a discussion of that from the FCPA Blog.
Fourth, training should touch on recent behavioral ethics research showing that disclosure may not mitigate COIs. This emerging area of social science is relevant not only to the issue of whether to permit a conflict but also to designing COI management/monitoring plans.
Fifth, they should learn about the potentially devastating legal and other costs of COIs. (On the other hand, one should make clear that not all allegations of COIs are meritorious.) In addition to the costs imposed by the legal system and the marketplace, this part of the presentation should take note of the negative impact that COIs can have on employees’ larger sense of “organizational justice,” and what that can do to their faith in the company’s C&E program.
Sixth, such training should cover the area of “moral hazard” – a “cousin” of COI – and what it means regarding directors monitoring COIs in their companies.
Cross references: here is a post on the related topics of training senior managers on COIs and another on service by company employees on other organizations’ boards .
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F. Scott Fitzgerald famously said that “The rich are different than you and me,” and, along the same lines, CEO conflicts of interest can be pretty different than those involving people like you and me. Consider this story – which likely would not have taken place with anyone other than a CEO – about what in going on at Chesapeake Energy.
As background, the company permits its CEO, Aubrey McClendon, to take personal stakes in the wells it drills. By itself this arrangement – while unusual and controversial – does not, in my view, inherently involve a COI. Indeed, one could argue that by investing side by side with the company, the CEO aligned his interests with those of the company’s shareholders.
However, “[i]n order to pay for stakes in new wells, McClendon borrowed money — using his stakes in existing wells as collateral — from a group that Chesapeake was trying to sell assets to. Investors complained that the arrangement raised a conflict of interest. They worried that Chesapeake might have sold its assets to the firm because the firm agreed to lend McClendon money, and not because the terms of the deal were the best Chesapeake could have received. The arrangement was not previously disclosed to shareholders.” Or, as noted in another (more bluntly written) account: “The overlapping relationship has led many analysts to say that there was at least the appearance of a conflict of interest since Mr. McClendon could give his lenders a sweetheart deal in exchange for a preferential interest rate on his loans.” (Perhaps some of these analysts recall the harm caused by the tangled personal financial dealings of then CEO Bernard Ebbers at WorldCom.)
Where was the board – which included a former governor of Oklahoma and former US Senator – when this was going on? According to this story, Chesapeake’s general counsel initially claimed that the board “was fully aware of the existence of the loans” but the company soon reversed course on this. As described by Ben Heineman, a former General Electric Co. general counsel who teaches corporate governance and business ethics at Harvard: “the Chesapeake board, in effect, is declaring that it would ‘rather just look ill-informed and negligent than complicit in McClendon’s deals.’”
Adding to this turmoil – a story has now surfaced of an undisclosed financial tie between the CEO and a director (albeit one dating back several years). And, the Securities and Exchange Commission has opened an internal investigation.
What does all this mean for the shareholders (i.e., people like “you and me”)? Many have apparently lost faith in senior management and the board, which has led to a massive loss in their investments in the company. This is, of course, entirely predictable when a CEO creates an apparent COI of this magnitude and the board – the only meaningful check on a CEO – is either negligent or complicit.
CEO conflicts really can be unique, not only in terms of what they are but also the impact they can have.
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An earlier posting discussed the important – and certainly non-intuitive – finding of behavioral ethics research that doing good can actually increase the risk of doing bad. In addition to an unexpectedly high likelihood of wrongdoing, those in the business of doing good – e.g., charities, foundations and other non-profits – may face outsized impacts from ethical missteps, particularly related to COIs, given their need to maintain the trust of donors and others to fulfill their respective missions. In this post we begin to explore measures that non-profits can take to address COI risks.
According to the National Council of Non-Profits, a “policy governing conflicts of interests is perhaps the most important policy a nonprofit board can adopt. To have the most impact, the policy should be in writing and the board (and staff) should review the policy regularly. Often people are unaware that their activities are in conflict with the best interests of the nonprofit so a goal for many organizations is to simply raise awareness and cultivate a ‘culture of candor.’ It is helpful to take time at a board meeting annually to discuss the types of situations that could result in a conflict between the best interests of the nonprofit – and the self-interest of a staff member or board member.” Indeed, the Internal Revenue Service – which has an oversight role over charities in U.S. – expressly recommends that they develop a COI policy .
Non-profits seeking to draft or revise their COI policies can find plenty of publicly available examples from which to draw ideas and language (including some at the National Council of Non-Profits web site). For instance, the COI policy of the Gates Foundation contains a clear and comprehensive articulation of what generally would be considered a COI at the Foundation; a discussion of the types of situations that could give rise to COIs there; requirements concerning disclosure and management of COIs, including mandating the involvement of the legal team in these matters (see this post on the need for independence in COI management measures); detailed guidance on COI issues regarding the receipt of directors’ fees, authors’ royalties and like matters (for further information on COI issues in serving on outside boards see this post); a provision on outside employment, with – understandably – greater restrictions placed on high ranking employees; and discussions of a range of other COI issues relevant to the foundation, including those concerning matching grants and employee political activities. The Gates Foundation policy also has an extensive series COI-related FAQs that could be an invaluable source of ideas for those drafting/revising a COI policy for another non-profit.
But, by bringing attention to this resource I don’t mean to suggest that non-profits should simply adopt what the Gates Foundation, or any other organization, has done regarding COIs. Different non-profits could have COI issues that are, relatively speaking, unique. For instance, this article about COI policies for cooperative groceries – a very different sort of organization than a foundation – identifies a series of “emotional conflicts of interest” that may pose risks for organizations of that kind. (E.g., “The board president’s daughter is a co-op employee. After she is denied a raise of the size she had expected, her father begins bringing up concerns at board meetings about the fairness of the pay raise system and staff turnover due to low pay.”) As with any other sort of COI mitigation effort, the key for non-profits is to engage in some form of risk assessment before designing policies or other compliance measures. And, of course, the effort should include determining what any relevant legal requirements or expectations are for the entity regarding COIs.
Finally, understanding the COI risks of non-profits is important not only to board and staff members of such organizations but also employees of for-profit organizations who deal with non-profits, under the general imperative (often espoused in this blog) of not causing conflict in others.
A future post will discuss COI training for non-profits.
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Once again, conflicts of interest were much in the news this week – most prominently concerning payments to health care professionals by life science companies. But potentially the most intriguing story for COI aficionados was entited: “Did Al Gore Violate Apple’s Business Conduct Policy?”
The piece, by Fox News, reported that “the National Center for Public Policy Research is urging Apple shareholders to vote for shareholder proposal # 4 in Apple’s 2012 proxy statement. The proposal, submitted by the National Center for Public Policy Research, asks Apple to determine if board member Al Gore violated the company’s Business Conduct Policy. At issue is whether Gore played a role in Apple’s 2009 decision to end its membership in the U.S. Chamber of Commerce as part of an effort to pressure the trade group to stop opposing greenhouse gas regulations. Several companies, including Apple, ended their relationship with the Chamber over the trade group’s aggressive opposition to the Waxman-Markey cap-and-trade bill and EPA regulation of carbon emissions. Gore’s significant personal investments in renewable energy and related technologies would have benefited from these greenhouse gas regulations.”
From another article, we also learn that the “Apple board issued an accompanying statement recommending shareholders vote against the request, arguing such a disclosure is ‘not necessary nor a useful undertaking to foster transparency or accountability at the Board level’… Apple already has ‘a robust set a of policies’ in place to deal with any potential conflicts of interest, so the goal of the request has already been achieved in their view. ‘The decision in 2009 did not ‘harm Apple’s business interests in other policy matters’, nor does the Board believe it will in the future,’ the company said. Just a few weeks before resigning from the Chamber, Apple launched a vigorous new ‘green’ policy intended to make its product line more climate-friendly and energy efficient. It was that policy which led to the company’s decision, the board said, not ‘undue influence by any member of the board.’”
Comment: while COIs at the board level can, of course, be harmful, it is difficult (at least based on these public reports) to see the basis for the claim here, which is questionable on two levels. First, it seems to assume without any basis that Gore failed to disclose the investments in question; indeed, his investing heavily in this sector was evidently a long standing matter of public record at the time of the events in question. Second, the proposal also seems assumes that public companies may not as an ethical (and possibly legal) matter pursue socially responsible efforts; if true, this would come as a shock to the countless corporate board members and executives (of all political persuasions) who have undertaken clean energy and other socially responsible measures for their companies.
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Some codes of conduct and C&E policies and certifications identify outside board service as a potential COI. What should an analysis of COIs of this sort entail? This is a topic about which relatively little has apparently been published. Below are links to some helpful resources on it combined with a few hopefully helpful thoughts of my own.
First, in this post on the Business Ethics Blog, Chris MacDonald notes that serving on a board typically involves significant compensation (and hence should be considered an interest for COI purposes); an individual’s board member duties could conflict with her employee duties if the entities in question did business with each other; and given the sheer time commitment expected of board service, there could be a significant time-management conflict in situations of this sort. This is a good foundation for analyzing COIs in these types of situations, to which one might add that even where the two entities don’t do business with each other a conflict could arise if they both do business with a given third party, i.e., employee of Company A joins the board of Company B, which is seeking to do business with Company C, a supplier to Company A. (This would not necessarily be a COI – but, depending on a variety of circumstances, might be one.)
Second, another valuable post on this topic comes from Meghan Daniels of SAI Global – who offers various questions companies might ask when considering whether to allow an employee to join the board of another entity based on: a) the employee’s role at the company; b) the time commitment involved in the contemplated board service; c) the status of the external company; and d) the relationship between the two entities.
Third, here is a useful code provision on board service from a publicly available code of conduct:
Entergy recognizes that there may be limited cases where it is in the Company’s best interest for you to hold a position on the board of directors of a for-profit entity not affiliated with Entergy. However, the position must not place you or the Company in a potential conflict of interests situation, must meet all regulatory and legal requirements, and must be appropriately disclosed to all relevant parties. There are certain laws and regulations that can impact this service and you must discuss the situation with your supervisor and receive appropriate approvals prior to taking action.
Two points about this language: a) the need to make disclosure to “all relevant parties” is important, as disclosing to the company alone might not be enough; b) the policy appropriately focuses on the company’s interest in deciding the issue at hand. Note, too, that the laws and regulations referenced here may be largely specific to the industry that this company is in, and being familiar with any relevant laws applicable to one’s own organization can be critically important for addressing issues of this sort.
Fourth, worth considering (although perhaps of less immediately obvious relevance to our topic) is a judicial decision in a case called Raley v. Superior Court. In Raley, the Court ordered the disqualification of a lawyer’s firm from participation in a litigation against a corporation that was owned by a trust, the trustee of which was a bank on whose board the lawyer sat, based, in part, upon the fact that the lawyer’s fiduciary duties to the bank and trust “require him to make every reasonable effort to maximize” the assets of the trust, which could lead to his acting contrary to the firm’s client in the litigation.
As relevant to the issue addressed in this posting, this language underscores just how strong the ethical and legal duty that arises from board service is – which, in turn could support a strict approach to determining COIs when an employee of one entity seeks to serve on the board of another. The case is indeed a reminder that serving on a board is serious business, and before agreeing to such service an individual – and, if relevant, her employer – should think through all that that entails from an ethical and legal perspective.
Fifth, in some situations a company might decide to permit an employee to join another company’s board subject to management of any COIs flowing therefrom. If going this route, all concerned need to consider the implicatons vis a vis the confidentiality of the latter’s information.
Finally, I should stress that there are a host of possible advantages to an organization in having one of its employees serving on the board of another entity (as reflected in the language from the Entergy code). Here is a good piece identifying some of those and my post should not be read as suggesting any presumption against permitting such service – it is offered only to help identify what some of the relevant COI issues might be.
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