Board Service Risk Management

Congratulations, you’ve been nominated and then selected to serve on a company board! You will have your chance to shape the future of that company, engage with other top-level professionals, and receive compensation in the process.  Before you sign on to the board, here’s a few items regarding the risks and responsibilities you are taking on that you should thoughtfully consider.

Legal Risks Of Board Service  

The board of directors has a dual mandate:  advisory (consult with management regarding the strategic direction of the company) and oversight (monitoring the company’s performance and reduce costs).  The legal obligations imposed on directors come out of both state and federal law and are as follows:

1. Directors owe fiduciary duties. A director’s fiduciary duty requires the board member to make decisions with due deliberation.

2. A duty of loyalty is imposed on the director which requires him/her to act “in the interest of the corporation” (interpreted by some as in the interest of shareholders).

3. A duty of candor requires the director to inform shareholders of information that is important to their consideration of the company.

4. Under federal securities laws, directors have a legal obligation to disclose all “material information” that an investor would consider important. Disclosure requirements are established by the Securities and Exchange Commission and the board relies on internal and external auditors to fulfill its disclosure obligations.

Fiduciary duties are enforced by judicial intervention — either an injunction to stop the board from taking a specific action; or by a lawsuit for damages (often millions!) for something the board did or did not do.  Securities laws are enforced through private lawsuits or SEC actions.

So how can you avoid being sued?

Do Your Due Diligence on the Opportunity

The importance of doing your homework on a board opportunity cannot be overemphasized.  By asking the right questions, following up on responses and getting the right safeguards in place, prospective board members can mitigate their risk of service.

The first piece of due diligence is about the company and the current members of the board and management team.  You should review the company’s recent public filings, press releases, analyst reports, and media coverage.  After review, the candidate should meet with the CEO and some current and former officers and directors.

Critical here is acquainting yourself with the company’s strategic goals, its challenges, its place in the industry with a keen eye towards the company’s financial outlook.  The candidate should get a firm grasp on the ramifications of any ongoing litigation, shareholder disputes and government investigations.  You will want to get a sense of the internal dynamics of the board, including the interaction between directors and management.  Is the board properly constructed and well organized to handle the workload?

The next step for the candidate is to evaluate the potential risks and liabilities attendant to board service.  Since directors are required to sign annual reports and registration statements, they are routinely named in lawsuits stemming from those filings.  Accordingly, a wise board candidate will engage personal legal counsel to review the company’s D&O insurance policies, charter and bylaws regarding indemnification and exculpatory provisions to ensure they are up to date and provide sufficient coverage.

Third, the candidate should become comfortable with the company’s confidentiality obligations, as well as the company’s compliance and oversight practices.  While it is not necessary for a director to have a detailed understanding of every rule or law applicable to a business, a candidate should join a board only if he or she feels confident compliance is a priority for the company.

Finally, the candidate should insist on a rigorous onboarding program which will help the candidate understand the company inside and out.  Our system of corporate governance depends on the service of qualified committed professionals on public boards.  While there is often compensation for this service, most individuals generally chose to serve as directors not for the remuneration, but for the opportunity to contribute to the success of the company.