I was recently introduced as a “leading” advocate of an “expertise” board. I guess I am pleased to be described as “leading,” because “lagging” probably would connote that I am deceased!

I am delighted that the concept of an expertise board is becoming known: A board composed of persons each having particular competencies (i.e., knowledge, skills, experience, and expertise) needed for the board to have as a whole all of the competencies necessary to achieve its future objectives. This is in contrast to a “constituency” board which is composed of persons who represent the view of a particular constituency (such as the US Congress or a state legislature).

In this month's issue of Acredula, we advocate “The Case for the ‘Expertise’ Board: Selecting Board Members on the Basis of ‘Competencies’ rather than ‘Constituencies.’”

Although “words are my business” now, many do not know I have a background in mathematics and statistical analysis. I conducted public opinion polls and focus groups before practicing law, and I have continued to review and extrapolate the empirical data from such polls and groups to the present day. I believe that both existing law and changes in law should be supported by empirical data.

So “The Case for . . .” article begins with empirical data supporting the expertise board. It then discusses basic tenants of corporation law also in its support.

I passionately believe that governing boards are not only the first line of defense against mismanagement and fraud, but also the best line of offense for good governance. Recent failures over the last dozen years show that all organizations can do a better job selecting their board members. Doing so, upon the basis of the collective expertise and competencies of the board as a whole, may reinvigorate confidence in corporate America.

Read past issues of Acredula.

The U.S. Securities and Exchange Commission (SEC) proposed in July substantial revisions to its proxy rules, SEC Release No. 34-60280. The proposed amendments are intended to improve the disclosure public companies provide to their shareholders regarding compensation and corporate governance, and to clarify certain rules governing proxy solicitation.

If adopted, these amendments will increase the information included in proxy and information statements, annual reports and registration statements under the Exchange Act and registration statements under the Securities Act. The additional disclosures will also include information about the relationship of a company's overall compensation policies to risk, director and nominee qualifications, company leadership structure and the potential conflicts of interests of compensation consultants. In addition, the proposed amendments would add a new Form 8-K disclosure item for real-time reporting of proxy voting results.

Noticeable in the proposed amendments is the SEC’s focus on the importance off expertise on the boards of publicly-held corporations. While these proposed amendments do not require a expertise, it speaks volumes that the SEC has determined the expertise on the boards and the structure of the leadership are important disclosures for shareholders to consider speaks volumes.

In previous posts and in Acredula, we have stressed the importance of adding expertise on the board as an effective way to resurrect corporate America in light of the economic crisis and the finger pointing by the media, regulators and government, whether warranted to not, at the boards. The SEC’s proposed amendments further illustrates that board expertise is being monitored.

New Director and Nominee Disclosures and Board Leadership

The SEC’s proposed amendments to Item 401 of Regulation S-K will require a discussion of the particular experience, qualifications, attributes or skills that qualify each director and any nominee for director to serve as a director of the company and as a member of any committee, in light of the company's business. Essentially, a discussion of the expertise on the board. The SEC has taken the first step towards potential board expertise regulation by requiring disclosure of certain expertise on the board. The proposed amendments will also require disclosure of any directorships at public companies held by each director or nominee at any time during the past five years and lengthen the time for which disclosure of legal proceedings is required from five to 10 years. 

The revisions are aimed at providing investors with more information regarding an individual's competence and character and at helping investors determine whether a particular director and the entire board composition is an appropriate choice for a given company.

Further, proposed amendments to Item 407 of Regulation S-K and Item 7 of Schedule 14A will require proxy and information statements to include disclosure of the company's leadership structure. 

This new requirement will make the company explain why it believes its leadership structure is the best structure for it at the time of the filing. 

Companies will also need to disclose:

• whether and why they have chosen to combine or separate the CEO and board chair positions; and 
• whether and why the company has a lead independent director, as well as the specific role the lead independent director plays in the leadership of the company. 

Additionally, the proposed amendments will mandate additional disclosures about the board's role in the company's risk management process and the effect of this role, if any, on the way the company has organized its leadership structure. 

If you have any questions about the proposed amendments or about the importance of adding expertise on your board, contact Kevin M. Kinross (614.227.8824) or kkinross@bricker.com.

On Friday, Bank of America announced that 4 new directors joined its Board of Directors. For a board of 18 members a turnover of 4 directors may not seem too radical. However, it is the new composition of the board and the reasons why it made the move that are noticeable.

Bank of America is another large publicly-held company that is moving towards an “expertise” board. As we have posted in the past and written about in Acredula articles, an “expertise” board, as we define it, is a board composed of persons each having particular skills or expertise needed for the board to have as a whole, all of the skills and expertise necessary to achieve its future objectives. 

It is being reported that the move was “aimed at satisfying strong suggestions from federal regulators” that Bank of America improve its corporate governance. The 4 new directors would support that position as each has experience in banking or financial oversight-one former Federal Reserve Governor, one former FDIC Chairman, and two former banking executives.

Wall Street Journal article announcing the new board

Often, the most ignored governing documents for any organization with a governing board are the committee charters. The charter of any committee should be discussed, if not negotiated, between the directors who are on the committee and the remaining directors who will rely on the committee on an annual basis. 

A charter not only protects non-committee members from liability but also imposes that liability on the committee members. For directors, one of the most important protections from liability is the state-law right of reliance of directors upon committees of directors of which they are not members. 

However, a director may rely upon a committee only for matters within the committee's designated authority for which the director reasonably believes merits confidence. The committee to which such authority is delegated has a legal duty of care to carry out that authority as an ordinarily prudent person in a like position would do under similar circumstances and a legal duty of loyalty to do so only in, and not opposed to, the best interest of the organization. 

Accordingly, committee charters should be in writing. More importantly, these charters should be periodically reviewed and discussed by directors. At a minimum, committee charters should be reviewed annually by the board. Therefore, care should be taken in reviewing, discussing and drafting any committee charter to balance both: 

1. the interest of non-committee members to be protected from liability for the matters delegated; and 
2. the competing interest of committee members not to be subjected to unreasonable risk of liability. 

Someone familiar with the legal rights and obligations of directors should lead the review and discussion of charters. This is often a regular function of a governance committee (which if not a standing committee is typically part of an organization's nominating committee). An organization and its individual directors should review the charters of committees with the following questions in mind: 

Is the legal nature (i.e., executive, oversight, recommendation or advisory) of the committee clear from the writing or charter? 

Each committee charter should establish the committee's legal nature or type, which is often in a purpose clause. Committees may be executive, oversight or recommendation. The most common of the three being oversight. 

• An executive committee has all authority to act on behalf of the board during intervals between meetings of the board. For the charter of an executive committee, typical language in a purpose or similar clause would read, "the executive committee will have and exercise the authority of the board in the management of the organization during the interim between meetings of the board, subject to any restrictions established by the board." Typically, any action or authorization by an executive committee is to be effective for all purposes as the act or authorization of the board, unless the board otherwise determines or directs. Executive committees are very common in nonprofit organizations but less common in publicly-held and privately-held for profit corporations. 

• An oversight committee, such as the audit, compensation or nominating/governance committee, generally "carries out" all authority of the board with respect to their matters of responsibility. The carry-out oversight committee is the result of the Sarbanes-Oxley Act and subsequently SEC, NYSE and Nasdaq rules requiring that oversight of the financial statement preparation and audit process and of executive compensation be by a committee composed of, or otherwise by, independent directors. For the charter of a carry-out oversight committee, typical language in a purpose or similar clause would read, "the audit committee will carry out the board's oversight responsibilities for the integrity of the organization's financial statements and reports." As a result, the actions of these two committees are effective for all purposes as the act or authorization of the board, unless the board otherwise determines or directs by not less than majority vote of those directors having no financial or personal interest in such matter. 

• A recommendation committee assists the board in reviewing certain matters but only makes recommendations to the board as to appropriate action. For the charter of a recommendation committee, typical language in a purpose or similar clause would read "the committee will assist the board by reviewing ... and recommending some action for the board's consideration." Accordingly, any act of the committee is not the act or authorization of the board unless the board affirmatively approves or authorizes such action. 

• An advisory committee is not a statutory committee of the board but only advisory to it. 

If the committee is properly composed, the right of reliance entitles non-committee directors to rely upon an executive, oversight or recommendation committee, but not an advisory committee because advisory committees are not statutory. 

Is it clear who the committee's voting members are, and, if so, are they directors? 

Under most states' laws, directors are entitled to rely upon committees only if the committee is composed of directors. This does not mean there cannot be non-voting members of committees, such as non-director officers, but only those members who are directors may have the right to vote. Voting members, accordingly, must have all rights to receive notice, attend, present and consider matters, vote and otherwise participate in any proceedings of the committee. Non-voting members can be entitled to be present in person, to present matters for consideration and to take part in consideration of any business by the committee at any meeting of the committee, but non-voting members cannot be counted for purposes of a quorum nor for purposes of voting or otherwise in any way for purposes of authorizing any act or other transaction of business by such committee. 

Is it clear who can call meetings, what notice is required, how meetings can be held, and what constitutes actions of the committee? 

Although not legally required, it is recommended that each committee's charter contain provisions as to how it conducts its proceedings, such as who can call meetings, the notice requirements for meeting and how meetings can be held (including written consents in lieu of meetings), etc. 

Are specific responsibilities of the committee stated, and, if so, do the stated responsibilities reflect the balance of both (I) the interest of noncommittee members to be protected from liability for the matters delegated and (2) the competing interest of committee members not to be imposed with unreasonable liability? 

The most important provisions of a committee's charter are the committee's responsibilities. These should be written in terms of what is expected of the committee keeping in mind the balance of both (I) the interest of non-committee members to be protected from liability for the matters delegated and (2) the competing interest of committee members not to be imposed with unreasonable liability. 

An example of responsibilities of an executive committee include: transacting all of the business of the organization and exercising the authority of the board in the management of the organization during the interim between meetings of the board, subject to any restrictions established by the board. 

An example of responsibilities of a "carry-out" oversight committee, such as an audit committee, include: carrying out the board's oversight responsibilities for the integrity of the organization's financial statements and reports, including (I) retaining and terminating the organization's public accounting firm responsible for auditing and providing an audit report on the organization's financial statements; and (2) approving the scope of all auditing services and the compensation and other terms of engagement of the external auditor. 

An example of responsibilities of a recommendation committee, such as a finance committee, include: periodically before each fiscal year or other appropriate period review making changes in proposed operating and capital budgets of the organization and recommending to the board adoption of those budgets for such period. 

Is it clear whether the committee has authority to have, at the organization's expense, independent advisors? 

One of the most important authorities of any oversight committee is the right to retain, at the organization's expense, such independent counsel or other advisors as it deems appropriate. This is particularly important for "carry-out" oversight committees. Typically, this may not be an express authority of an executive or recommendation committee and is infrequently an express authority of an advisory committee. 

Is the committee required to evaluate itself, its composition, the performance of its members and the provisions of its charter? 

Self-evaluations by the committee of its proceedings, as well as the skills and experience of its members, are important to the governance of not only the committee but also the board and the organization itself. Typically, a committee should conduct a periodic evaluation of the provisions of its charter, its performance under those provisions and each committee member's contribution to the committee's performance. 

How can the charter be amended? 

Finally, each committee charter is a governing document of the board as a whole, and it may not be amended except by the board. Accordingly, any considerations of the board in its self evaluation become recommendations to the board. The board may defer to such recommendations for consideration of a governance committee. 

Evaluating and answering these questions at the beginning of each year will ensure that all committee charters are current and properly structured. Further, such a review will ensure that all directors are aware of the authority that is delegated to each committee and to understand whether he or she may rely on that committee for an a particular issue that the board is facing.

With a new year upon us, it is incumbent on all boards to step back, take a critical look and assess their structure, composition, committee charters and past performance and determine whether the board is prepared for the current challenges and the challenges and risks associated with its organization's strategic plans. 

This year, we will address the topics below in a series of articles all with the goal of creating the best possible board for your organization. 

• Annual review of the Roles and Responsibilities of board committees and committee charters 
• Board best practices audit 
• Board evaluations and individual director evaluations
• Board succession planning; and 
• Board education/training. 

For any organization to be successful it must commit to improvement. To improve, an organization must look at its current practices and make changes where necessary. This includes changes to the board's composition and practices. While some boards may be instilling new members this year through election or to fill a vacancy, the majority of the directors on your board today are your organization's team that will lead it over the next year. To get the most out of this team your organization should consider the following: 

Annual Review of the Roles and Responsibilities of Board Committees and Committee Charters

All organizations need to review their committee charters, annually at minimum, to ensure that such committees have the requisite authority necessary to complete their delegated tasks and additionally to ensure that such committees do not have authority greater than what the full board desires to grant. Committee charters are often the most ignored governing document for any organization. The charter of any committee should be discussed, if not negotiated, between the directors who are on the committee and the remaining directors who will rely on the committee on an annual basis. 

A charter not only protects non-committee members from liability but also imposes that liability on the committee members. For directors, state law allows them to rely upon a committee of directors of which they are not members. However, a director may rely upon a committee only for matters within the committee's designated authority and the committee has a legal duty of care to carry out that authority as an ordinarily prudent person in a like position would do under similar circumstances and a legal duty of loyalty to do so only in, and not opposed to, the best interest of the organization. Thus, it is imperative that the authority of a specific committee is properly and clearly designated in its charter. 

Best Practices Audit 

Most organizations, either by choice or regulation, have their financial statements audited on an annual basis. However, very few conduct an audit, either formal or informal, of their corporate governance practices. An annual audit of governance practices goes a long way in creating a productive board. 

Board Evaluations/Individual Director Evaluations

"If you want one year of prosperity, grow grain

If you want ten years of prosperity, grow trees

If you want one hundred years of prosperity, grow people" 

Boards must strive for commitment to excellence in their corporate governance and not just adhering to minimum standards prescribed by law. This requires a goal of continuous improvement. Similar to evaluating the organization's chief executive officer and management for the organization's performance, the board must evaluate itself to constantly 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 team work approach to decision making; and 
• Give a feeling of accomplishment 

Board Composition/Succession Planning 

Succession is critical to the life of any organization, and as such, one of a board's most important responsibilities is succession of management and the board. A good succession plan helps to prevent staleness on the board. Preventing staleness or "institutionalization" of thought on the board is in the best interests of the company. However, adding directors with fresh or non-institutional thoughts comes with a price, whether accomplished through traditional approaches such as term limits or age restrictions or by involving the board in making itself an "expertise" board. Getting your board to buy into a succession plan helps create a multi-generational board that is future oriented and prepared of emergency absences.

Board Education/Training 

"A board's effectiveness depends on the competency and commitment of its individual members, their understanding of the role of a fiduciary and their ability to work together as a group [including] an understanding of the fiduciary role and the basic principles that position directors to fulfill their responsibilities of care, loyalty, and good faith." See "III. Director Competency & Commitment" of the "NACD Key Agreed Principles."  Boards will be measured by their least common denominator, so it is important that all members are knowledgeable not only with the policies and governance of the organization but also educated on how to be better directors. Such education sessions can be reserved for one or two day board retreats or part of a board's regularly scheduled meetings. Either way, it is important that all boards know what it means to be a board and how to fulfill their duties as board members. 

Commitment to continuous improvement requires work.  Committing to accomplishing any of the above five topics, if not all, will lead to improvement with your board. In turn such commitment adds to the growth and performance of the board's organization.

Today, nonprofit corporations are saddled with a changing governance environment that brings with it a need to examine current board practices and consider new ones. These changes in expectations for nonprofit boards have been prompted, in part, by the new Form 990 but also by the economic crisis fueled by the host of for-profit meltdowns of AIG, Lehman Brothers, Freddie Mac, Fannie Mae and others this past year. 

While the economic crisis was not driven by nonprofit companies, it will impact corporate governance of all organizations. This crisis has generated discussion and rumored regulation, and it requires nonprofit boards to adopt new practices. The evolving changes in today's governance best practices - and the way nonprofits should respond - are critical to the health and sustainability of the organization. 

Wall Street has shattered the public trust and confidence in the for-profit world, and retaining the public trust and confidence in charitable organizations and nonprofits is critical to accomplishing their missions. However, without shareholders, nonprofits are missing the built-in accountability of the for-profit world, which means that the boards and executive directors of nonprofits must play the role of watchdog to ensure that the public trust and confidence is maintained and to do their part to resurrect corporate America without increased regulation. 

To do so, it is incumbent on all boards to take a step back, take a critical look and assess their structure, composition, committee charters and past performance and determine whether they are prepared for the current challenges and risks to the organizations. 

As we embark on what will certainly be an uncertain year, nonprofit boards should consider taking the following steps to maintain the public's trust and confidence in their organizations and to act before the government can react: 

• Board Education. Boards should begin with educating their members to be better directors, to become more familiar with the risks to their organizations, to be more aware of the strengths and weaknesses of the members of management and to learn how to hold management accountable for information being provided.

• Assess Current Board Experience and Add Directors with Needed Experience, Skills and Expertise. Boards should assess and create a database inventorying the experience, skills and expertise of their current members. That database expertise should be reviewed periodically to evaluate whether the correct mix is represented by the current members of the board. The goal of the organization should be to create an "expertised board" composed of persons each having particular experience, skills or expertise needed for the board to have as a whole.

• Access to Independent Advisors Who Can Provide Necessary Counsel. Because it takes time to constitute a board composed of the appropriate mix of experience, skills and expertise, a board should require that it be given access to independent advisors having the experience, skills and expertise to counsel the board. This requires a board to first have access to a database of such advisors and then to have the resources to retain those advisors to counsel the board. This is important because it is likely that boards will be judged by state attorney generals, regulators, donors and eventually courts by the least experienced, least skilled or least knowledgeable of its members unless such members have access to such counsel. 

• Coaching on Asking Questions. Boards should periodically receive coaching or training on how to ask questions, including: the purposes for which they should be asking questions; the extent to which they should ask questions; when they should accept answers and stop asking questions; and when they need to explore more deeply. This should be considered on a matter-by-matter basis for issues a director identifies that may need the help of an independent advisor. It also should be considered periodically as part of the board's continuing education process. 

• Authorize a Standing Committee to Oversee Enterprise Risks. Boards should delegate to a standing committee, or constitute a new standing committee with authority on behalf of the board to investigate, assess and take appropriate action with respect to risks of the organization's enterprise. To facilitate the exercise of this authority, a board should require the organization's management, including each of its executive officers, to report such risks to this oversight committee and to meet at least annually with the committee in executive session.

• Annual Review of the Roles and Responsibilities of Board Committees and Committee Charters. All organizations need to review their committee charters to ensure that such committees have the requisite authority necessary to complete its delegated tasks and additionally to ensure that such committees do not have authority greater than what the full board desires to grant Committee charters are often the most ignored governing document for any organization. The charter of any committee should be discussed, if not negotiated, between the directors who are on the committee and the remaining directors who will rely on the committee on an annual basis. A charter not only protects non-committee members from liability, but also imposes that liability on the committee members. For directors, state law allows them to rely upon a committee of directors of which they are not members. However, a director may rely upon a committee only for matters within the committee's designated authority and the committee has a legal duty of care to carry out that authority as an ordinarily prudent person in a like position would do under similar circumstances and a legal duty of loyalty to do so only in, or not opposed to, the best interest of the organization. Thus, it is imperative that the authority of a specific committee is properly and clearly designated in its charter. 

• Best Practices Audit. Most organizations have their financial statements audited on a yearly basis. However, very few conduct an audit, either formal or informal, of its corporate governance practices. A yearly audit of governance practices goes a long way in creating a productive board and ensuring your board is operating effectively. 

• Board Evaluations/Individual Director Evaluations. Boards must strive for commitment to excellence in corporate governance and not just adhering to minimum standards prescribed by law. This is especially true in today's environment and requires a goal of continuous improvement. Similar to evaluating the organization's chief executive officer, executive director and management for the organization's performance, the board must evaluate itself to constantly 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 teamwork approach to decision making; and 
• Give a feeling of accomplishment 

• Board Composition/Succession Planning. Succession is critical to the life of any organization. As such, one of a board's most important responsibilities is succession of management and the board. A good succession plan helps to prevent staleness on the board. Preventing staleness or "institutionalization" of thought on the board is in the best interests of the organization and its mission. However, adding directors with fresh or non-institutional thoughts comes with a price, whether accomplished through traditional approaches such as term limits or age restrictions or by involving the board in making itself an "expertise" board. Getting your board to buy into a succession plan helps create a multi-generational board that is future oriented and prepared for emergency absences. 

• Update your Organization's Conflict of Interest Policy and Disclosure Process. All nonprofit organizations need to have a well defined conflict of interest policy and disclosure process. A failure in an organization's conflict of interest policy will have an immediate impact on public confidence of any organization in addition to exposing the board to potential liability. 

• Review Executive Compensation. Review and, where appropriate, revise executive incentive compensation arrangements to ensure that they do not encourage executives and others in management to take unnecessary and excessive risks that threaten the value and mission of their organizations. 

What's Next?

Regardless of the cause, the melt down of the for-profit world will directly impact how directors of nonprofit organizations must think, evaluate and make decisions. Whether viewed as an overdue wake-up call or an unfair impugning of the nonprofit director's integrity as a result of the actions of the for-profits, it is important that all directors of nonprofit organizations understand the increased scrutiny on boards and the need for the boards to understand the risks of the organization. This includes understanding and recognizing the state of the environment the organization is operating. The economic crisis is going to have an effect on many organizations that are not interested in making a profit for private inurement. Nonprofits rely on corporate and private donations and interest income from their endowments for programs, operational support and long term sustainability, To maintain and to continue to receive this financial support in these challenging times, organizations need to strive to maintain the public trust and confidence in their operations, financial risk management and direction. 

Directors need to become risk smarter. They need to broaden their view of risk and not limit discussions or analysis only to specific areas of risk This will require directors to evaluate the role of the boards overseeing that there is adequate risk assessment and make changes where appropriate. As the watchdogs for the organization, directors must realize not only that they remain the first and best line of defense against mismanagement and fraud but also that they can be the best line of offense for good management and best practices.

Ever wonder how your board stacks up against S&P 1,500 companies in the emerging corporate governance trends? 

RiskMetrics Group (“RMG”) has recently completed is review of the proxy statements for annual meetings of these SP 1,500 companies. Its results, illustrate the board structure and characteristics of individual directors at S&P 1,500 companies based on RMG’s analysis of their proxy statements for annual meetings between July 1, 2007, and June 30,2008. 

Some highlights of RMG’s findings reveal an uptick in several of the major trends, including:

• The average board independence level rose to 78% in 2008 from 74% in 2007;
• U.S. companies continued to separate the positions of CEO and Chairperson where 46% of the companies had separate individuals serving as chairperson and CEO up 21 points from 2000;
• The number of companies disclosing a committee with formal authority/responsibility for succession planning reached 88% which is double the amount from 2006 and a 60 point increase from 2001; and 
• Director diversity showed a modest increase.

RMG’s Issues Report can be accessed at: http://www.riskmetrics.com/sites/default/files/BP2009.pdf

As the new year begins the United States and the world remain saddled with an economic crisis that has not been witnessed in decades. 

A new administration in Washington takes over today, and there still exists uncertainty in how this administration, or Congress, will act to address this crisis in what commentators, and politicians, scream was a failure at the board level to understand and assess the risks of the organization and the boards failure to independently assess management of the organizations. Rumors abound speak of the Democratic Senate considering a bill to federalize fiduciary duties and impose a standard to act with the care that a prudent person acting in a like capacity and familiar with such matters would use -similar to the ERISA standard- as opposed to the state law ordinarily prudent person in a like position would use under similar circumstances. Yet to date we wait to see what the formal response will be.

As a result of the economic crisis, boards of directors will need to respond to unknown challenges and pressures. Boards need to review their past actions in monitoring performance, compliance and risk management—and understand the role they must play going forward. The risk oversight role of the board has never been more critical and challenging than it is today.

In reviewing their role in overseeing risk to the organization, boards need to understand the changes that are likely coming, either through the courts applying new standards or interpreting existing ones, that will directly impact how these boards perform their functions and fulfill their fiduciary duties and likely increase board responsibility for risk management. While the current standard for director liability, established in Delaware by the Caremark case, requires that directors act as reasonably prudent person in a like or similar situation and provides the protection of the business judgment rule, if rumors are true there is real possibility that, as a result of the current economic crisis, boards will need to change how they act. Boards’ decisions will be in the crosshairs and will provide courts with repeated occasions to second-guess board decisions. 

The only certainty going forward is uncertainty. Uncertainty as to the when the recession will end, when the liquidity markets will thaw, when things will return to “normal”—whatever that is. 

One thing that we can be certain of is that there will be some kind of regulatory response to the economic crisis: just as the federal government reacted to the market crash of 1929 with the 33’ and 34’ Acts, just as the federal government reacted to expansion of United States businesses into foreign countries with the Foreign Corrupt Practices Act, and just as the federal government reacted to the Enron and WorldCom scandals with the Sarbanes-Oxley Act. Yes- there will be a regulatory response. But again there is uncertainty as to what the end product will look like. Boards need to be proactive in addressing new risks and new challenges this year will bring. By doing so Boards will be well prepared to handle and adjust to whatever regulatory response comes out of Washington.

The SEC initiated an administrative action against Mark C. Thompson (“Thompson”) who sat as an outside director on the boards of directors for three public companies during the time that Ernst & Young (“E&Y”) served as the auditor for each company.

In October 2002, E&Y entered into a business relationship with Thompson for the creation of a series of audio CDs designed for business development purposes. The relationship lasted 19 months– during which Thompson served on the board of the three public companies and even sat on the audit committee of one of the companies. E&Y was the auditor for each company during this 19 month time period. As a result of this relationship, E&Y’s independence was impaired and caused each company to lack independently audited financial statements. The SEC determined that Thompson was the cause of each issuer’s reporting violations by “entering into and participating in this independence-impairing relationship, by failing to disclose the resulting conflict of interest, and by signing three annual reports and one audit committee report incorrectly claiming that the companies’ auditor was independent. . .” 

In making the determination above, the SEC ordered Thompson to pay disgorgement of $100,662.33 (his fees director compensation from the three companies) and prejudgment interest of $23,254.94, for a total of $123,917.27 to the SEC. In doing so, the SEC essentially sanctioned Thompson, an outside director, for not being independent. However, to do so the Commission based its finding on the violations of the proxy rules and the periodic reporting requirements, including Rule 14a-9. 

Director independence is at the foundation of corporate governance. As mentioned in our opening post yesterday, one of the basic principles of corporate governance, which comes the basic principle of SOX, “is that the first and best line of defense against corporate mismanagement and fraud is oversight of management by directors independent of the organization with the assistance of independent advisers, including independent audits of financial statements by independent auditors, and with accountability of executives for information provided.” 

While the SEC stopped short of finding violations by the company and the entire board for listing a director in its SEC filings as independent, who was not independent, the SEC has shown that it will police the independence standards and find a way to sanction those who fail to adhere to its mandates. 

This action by the SEC is a strong reminder that all boards must be careful, especially those of publicly-held companies, to pay close attention to its conflict of interests policies, director’s questionnaires, and the disclosures of conflicts by directors. Failure to do so can bring harsh consequences on the directors and potentially the entire board or company.