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.