st
21
The
Century
Director:
Ethical and Legal
Responsibilities of Board
Members
Written by
John F. Levy
MBA, CPA
Executive Education, Inc.
(734) 475-0600
Page 1
Seminar Objective
To understand:
• The changing roles of directors
• The legal and ethical responsibilities of directors.
• How the failure to make ethical decisions affected
recent business failures.
• What it means to be a “fiduciary” and how that
impacts board members responsibilities.
• How a board member can limit his or her liability and
the importance of directors’ and officer’ insurance.
• The role of the audit committee and the audit
committee financial expert.
Executive Education, Inc. © John F. Levy, 2010
2
Target Audience
• Individuals who current serve, or
aspire to serve, on the Boards, and
particularly audit committees, of
public companies, private companies
and not-for-profits.
• Corporate officers, advisors and
accountants who interact with Boards.
Executive Education, Inc. © John F. Levy, 2010
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Seminar Format
We will spend majority of seminar
discussing 8 cases.
• 60% discussion.
• 40% lecture.
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Case #1
Hospital, Heal Thyself
1) What are the ethical issues?
2) What are the ethical dilemmas?
3) Is the best ethical choice the best
strategic choice?
4) What will you recommend?
Executive Education, Inc. © John F. Levy, 2010
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Creating a Competitive Advantage
• Back in the Day
- Was Ceremonial
• Sarbanes Oxley
- Then Compliance
• New World Order
- Now Competitive Advantage
Executive Education, Inc. © John F. Levy, 2010
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What are Ethics?
• About our relationships with others
• Decisions that affect other people
• Ethics are personal and individual
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Why Board Members are
Responsible for Ethics
•
•
•
•
Tone at the Top
Continuing role with the Company
See the “big picture”
Independent
• Adults in the room
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Case #2
The Irreplaceable CEO
What do you do?
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Why Boards Fail Ethically
•
•
•
•
•
Failure to see ethical issue
Not trained to look for ethical issues
Don’t want to “rock the boat”
Close relationships with CEOs
Short-term focus
Executive Education, Inc. © John F. Levy, 2010
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Case #3
Moving
1)
2)
3)
4)
How do you vote and why?
Is this an ethical issue?
Who are the stakeholders?
If you were not so close to the community,
would your decision be easier?
5) Does made in America matter?
6) What ethical standard are you using?
Executive Education, Inc. © John F. Levy, 2010
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Identifying Ethical Issues
•
•
•
Prudential issues
Legal issues
Ethical issues
Executive Education, Inc. © John F. Levy, 2010
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Case #4
The Tie That Binds
1) What do you do?
2) Does Billy deserve any special treatment?
3) What if Wade, Mary and Billy were not
siblings?
4) What if the public owned 1/3 or 2/3 of the
company?
5) What if Billy were not a director?
Executive Education, Inc. © John F. Levy, 2010
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Developing an Ethical Code
“You who are on the road must have
a code that you can live by…”
- Graham Nash
Teach Your Children
Executive Education, Inc. © John F. Levy, 2010
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The Golden Rule
•
•
•
Simple
Powerful
Universal
Executive Education, Inc. © John F. Levy, 2010
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Ethical Prescriptions
• Turn the other
cheek
• Tikkun Olam
(Repair the World)
• Honor thy father
and thy mother
• Feed the hungry
Executive Education, Inc. © John F. Levy, 2010
• Clothe the naked
• Love your neighbor
• Be a good
corporate citizen
• Provide a positive
work environment
• Be a role model and
mentor
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Ethical Proscriptions
•
•
•
•
•
Don’t harm anyone
Don’t murder
Don’t lie
Don’t pollute
Don’t be jealous of
others success
Executive Education, Inc. © John F. Levy, 2010
• Don’t hire illegal or
underage workers
• Don’t break the law
• Don’t steal
• Don’t practice racial
or sexual
discrimination
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Ethics is Good Business
• Trust builds healthy relationships.
• Unethical behavior violates our trust.
Executive Education, Inc. © John F. Levy, 2010
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Making Ethical Decisions
•
•
•
•
•
The front page test
The mirror test
The lesser of two evils
The mom and kids test
The personal test
Executive Education, Inc. © John F. Levy, 2010
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Case #5
The Leaky Spies
1)
2)
3)
4)
5)
6)
Were Ship’s actions justified?
What about Vallock? Is he a “whistleblower”?
Should the Board member have resigned?
Was the leak, the investigation or the pretexting
worse?
What if this were an item of national security?
What about the internal auditor and the
corporate officers?
Executive Education, Inc. © John F. Levy, 2010
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History of Directors
•
•
•
•
Dutch East India Trading Company
Need for capital
Limited investors
Direct contact between managers and
investors
• More shareholders
Executive Education, Inc. © John F. Levy, 2010
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Delaware Corporate Law
• Delaware laws favor the expansion of
corporate powers and pro-business
attitudes.
• Delaware is the most popular state of
incorporation.
• Other pro-business states modeled
their incorporation laws after Delaware.
Executive Education, Inc. © John F. Levy, 2010
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Case #6
Who is the One?
1. What are the ethical issues?
2. Do any or all of the options present ethical
dilemmas, what are they?
3. Is there a best ethical choice? Why?
4. Is the best ethical choice the best strategic
choice?
5. What will you recommend to the Committee
and the Board?
Executive Education, Inc. © John F. Levy, 2010
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Duties of Directors
• Corporate law of the state of incorporation
governs director duties.
• The Board of Directors manage or direct the
business under under Delaware law .
• In this capacity, members of the Board
serve as fiduciaries of the Company and its
shareholders.
Executive Education, Inc. © John F. Levy, 2010
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Fiduciary
• Comes from the Latin fides, meaning faith
and fiducia, meaning trust.
• Act at all times for the sole benefit and
interests of another,.
• Highest standard of care at either equity
or law.
• Highlighted by good faith, loyalty and trust.
Executive Education, Inc. © John F. Levy, 2010
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Stakeholders
•
•
•
•
Shareholders,
Debtors,
Management,
Employees,
Executive Education, Inc. © John F. Levy, 2010
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•
•
•
Customers,
Vendors,
Community, and
the Government.
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Directors’ Fiduciary Duties
• The duty of care
• The duty of loyalty
• The duty of disclosure
Executive Education, Inc. © John F. Levy, 2010
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Good Faith
• Directors do not act in good faith when
there is:
–
–
–
fiduciary conduct motivated by an
actual intent to do harm;
“gross negligence”; or
intentional dereliction of duty.
Executive Education, Inc. © John F. Levy, 2010
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Business Judgment Rule
The courts will not second guess
directors’ decisions if the directors
can demonstrate that they complied
with the duties of care, loyalty and
disclosure in good faith.
Executive Education, Inc. © John F. Levy, 2010
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Documenting Board Compliance
• A full, complete and considered process
• Consider utilizing legal, financial and other
expert advice
• Complete agendas
• Materials in advance of meetings
• Sufficient time for discussion
• Complete minutes
Executive Education, Inc. © John F. Levy, 2010
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What Directors and Officers
Liability Insurance Covers
•
•
•
•
Individuals
The Corporation
Defense costs
Corporate indemnification
Executive Education, Inc. © John F. Levy, 2010
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Factors to Consider in
Evaluating D&O Insurance
• Policy limits
• Claims made
• “Side A” “Side B” and “Side C”
coverage
• Severability
Executive Education, Inc. © John F. Levy, 2010
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Considerations Before
Accepting a Board Appointment
• Can I add value?
– Do my skills, experience and training match
needs of the Board?
– What are the expectations of the board, the
Chairman or Lead Director and the CEO?
– What are they looking for from me in terms of
committee assignments?
– What is the time commitment?
Executive Education, Inc. © John F. Levy, 2010
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Considerations
(cont’d)
• Does the company have opportunities to
grow and prosper?
– What is the company’s mission and strategy?
– Is the company in a growing, stable or shrinking
industry?
– How has the company responded to industry
trends?
– Does the company have the talent?
Executive Education, Inc. © John F. Levy, 2010
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Considerations (cont’d)
• Is there a conflict?
• Is the Board culture healthy?
Executive Education, Inc. © John F. Levy, 2010
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Company Due Diligence
• Financial reporting:
– Financial results
– Profitability and cash flow
• Trends
• Financing
• Budgeting and
forecasting
• Investor relations
Executive Education, Inc. © John F. Levy, 2010
•
•
•
•
Legal
Audit committee
Strategy and risk
Executive
compensation
• Director
compensation
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Case #7
Lifestyles of the Rich and Fabulous
1) Was the chairperson’s investigation
adequate?
2) Do you have a responsibility to follow
up on the rumors about the affairs
with interns?
3) What are your next steps?
Executive Education, Inc. © John F. Levy, 2010
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The Role of the Board
•
•
•
•
Set strategy
Understand risk
Monitor execution
Select, assess, evaluate and
compensate the CEO
• Comply with laws and regulations
Executive Education, Inc. © John F. Levy, 2010
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Director’s Immediate
Concerns
• Tough times require additional Board
involvement and attention
• Government, shareholders and
activists are watching
• Board focused on risk
• Cash forecasting and cash
management are Board issues
Executive Education, Inc. © John F. Levy, 2010
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Board Structure and
Committees
•
•
•
•
•
Board chairperson or lead director
Governance committee
Compensation committee
Audit committee
Other committees
Executive Education, Inc. © John F. Levy, 2010
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Typical Company Structure
Shareholders
Board of
Directors
Chairman/
Lead Director
Governance and
Nominating
Committee
Compensation
Committee
Audit Committee
Internal Audit
Executive Education, Inc. © John F. Levy, 2010
CEO
Management and
Employees
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Board Charters
• Each committee is responsible to a charter.
• The charter lists the responsibilities and
expectations of each committee.
• Charters may be detailed or broad.
• Charters are typically available on company
websites or in public filings.
Executive Education, Inc. © John F. Levy, 2010
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Assessing and Building Board
• Annual board evaluation
– Entire board
– Each director
• Skills assessment
– Skills required
– Skills of existing board
• Board dynamics
– Big name - small company
– Team players
– Building consensus
Executive Education, Inc. © John F. Levy, 2010
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Training Issues
• On boarding
– The company
– The industry
– The role of board members
– Committee responsibilities and charters
• Ongoing training
– Keeping current
– New committee assignments
– Ongoing education
Executive Education, Inc. © John F. Levy, 2010
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Case #8
A Plethora of Riches
1. Where do you think you can add the most
value?
2. Which assignment is the greatest time
commitment?
3. Are you concerned about liability at any of
the Boards?
4. Which assignment will you accept?
Executive Education, Inc. © John F. Levy, 2010
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The Audit Committee
•
•
•
•
Audit committee requirements
Committee member independence
Audit committee financial expert
Audit committee responsibilities
Executive Education, Inc. © John F. Levy, 2010
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Audit Committee Composition
(For NASDAQ Companies)
• At least 3 members.
• All independent.
• Read and understand basic financial
statements.
• One member must be a “financial
expert”.
Executive Education, Inc. © John F. Levy, 2010
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Financial Expert
Public companies must disclose:
• Audit committee financial expert by
name,
• Independence,
• If no expert, the public company the
Company must disclose and explain.
Executive Education, Inc. © John F. Levy, 2010
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Financial Expert
(continued)
An understanding of:
• GAAP and the ability to assess the
general application GAAP;
• Internal controls and procedures for
financial reporting; and
• Audit committee functions.
Executive Education, Inc. © John F. Levy, 2010
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Financial Expert
(continued)
• Must have :
- principal financial officer, principal
accounting officer, controller, public
accountant or auditor or similar or actively
supervision;
- oversee or assess the performance of
companies or public accountants;
- or other relevant experience.
Executive Education, Inc. © John F. Levy, 2010
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Additional Responsibilities of
the Audit Committee Financial
Expert
• NONE
• Higher Standard
Executive Education, Inc. © John F. Levy, 2010
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Audit Committee
Responsibilities
• Oversee the accounting and financial
reporting processes
• Oversee the audits of the financial
statements
• Prepare the audit committee annual report
• Retention, compensation and oversight of
the independent auditors
•
Approve
Executive Education, Inc. © John F. Levy, 2010
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Audit Committee
Responsibilities
(cont’d)
Approve
• Whistleblower policy and
• Code of business conduct
Receive periodic reports regarding:
• Whistleblower activity
• Compliance with such code of
business conduct.
•
Approve
Executive Education, Inc. © John F. Levy, 2010
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Conclusion
• Use ethics in Board decision-making
to stop repeating past mistakes.
• Boards have great responsibility to
create great wealth, job creation and
innovation.
• Work hard, faithfully and diligently
and make good ethical decisions.
Executive Education, Inc. © John F. Levy, 2010
54
Executive Education, Inc.
CONTACTS
John F. Levy
James R. Lambert
E-Mail: “Levy” or “Lambert”
@ExecutiveEducationInc.Com
734-475-0600
Executive Education, Inc. © John F. Levy, 2010
55