Directorship: Handling the Risks in Serving

I continue to smile at the unbridled enthusiasm of professionals who jump to  say “Yes, I want to do that” when engaged in a conversation about board service.  It’s actually quite encouraging, considering the  personal, professional, financial, and reputational liabilities these people may have to put on the line.  Although the topic has been bantered around by current and prospective directors, there is a certain lack of depth in discussions about the exposures from joining a board that I find simply fascinating. Some directors have told me that, with the combination of the law of averages, consistently favorable Delaware Chancery rulings, and existing company indemnification policies and Directors’ & Officer’s Liability Insurance, a director has virtually all the protection anyone needs these days.  Generally, these do work in one’s favor,  except when they don’t.  In fact, understanding your potential risks/liabilities, whether it be  litigation, bankruptcy, permanent damage to your reputation, even criminal prosecution, and the  full extent of your coverage should be more important to you than the nuances of your board compensation.  Fortunately, with more issues arising to impact the health and well being of companies (i.e. cyber infiltration, social media, new sustainability issues, to name a few), more directors now appear to be focusing on the gap. But not enough.

Consider these cases:

A director of a foreign company board retired from his post.  Within two years of leaving, the company became embroiled in a heated legal battle in which the all the board members were also named.  The departed director signed in relief stating “I’m glad this is not my issue anymore.”  A few short weeks pass before he received notice he was also named in the suit.  What’s worse, he also learned he was liable for his own costs of representation. Concerned, he called the GC to ask why this was an issue for him and why he was being invoiced for legal services.  As it turned out, the annual D&O no longer covered him, leaving him fully exposed upon his retirement  Four years into the battle he was still trying to get coverage on the company’s policy – after paying out several hundred thousand dollars of his own money.

Another intelligent director we know served on a large public company board that has been the front and center of several cases.  When the first exposure hit the press, she counted back the date from her retirement.  She exhaled in relief to learn any personal responsibility she may have had (and yes, she checked her coverage years after departing to confirm that her protection was still in force), was well past the statute requirements.  Still another director we know shared that she has been named in litigation cases at least 17 times.

One director we know of has also suffered permanent reputational risk.  He has worked hard to recoup from the stigma of being on a board when the company collapsed due to fraud, He has served since on not-for-profit boards and donated large amounts of time and funds to good causes, as well as other types of “give backs”.  Still, the community and industry holds him, and all other board and senior management fully responsible, to this day.  When his name comes up in the course of conversation, board members bluntly shy away.

Another director on a public company board,  served for successfully for years with his fellow board members until faced with an unexpected legal challenge.  Addressing the issue, the directors went to work and brought in their own counsel.  Shortly after starting on the case they reviewed the D&O coverage and learned that existing policies did not cover the entire extent of their legal costs.  They eventually found out (and still bitterly complain) that they were personally out of pocket nearly $800,000.

The risks associated with board service will always be present (in addition to the rewards), and, in general you should look at these “risks” as typically having two components: likelihood (of occurrence), and impact (usually monetary).   In dealing with both aspects you (first) want to understand the risks you might be/are facing; (second) work to reduce their likelihood of occurrence through certain actions (control those risks); and (third) get help from others to soften the impact (insure yourself against the impact should they occur).

Understand your risks:

You need to assume that, as a board member of a public company (and many private ones) that the company’s risks are now YOUR risks too.  Any failure, and those affected will turn their eyes right to you and maybe your bank account.  Before, during, and after joining a board, understand the environment in which you’re working.  Do you have a pretty sound grasp of the company’s business, industry, and general operational/industry exposure? Does the company have large investors, or many small investors who could be easily hurt by a misstep? How volatile is the industry and the company’s business? How well do you know your board members (before, during, and after service)?    Is the top management team up to snuff?  Where does management need to be shored up or supported?  Are you able to clearly follow all discussions among your peers, and presentations given by management and outside consultants?  If so, great.  If not, you’d better be a quick learner.

Control risks (than you can) through your own actions:

To reduce the likelihood of getting into a lawsuit, always try to do the right thing as a director.

Your role as a director should be oversight, not management. If you find that you are giving specific directives in how to conduct the company’s affairs, something is wrong. 

Get the best information you can (inside and outside of management, as a reality check) so you can grasp the risks and upsides in the business. Use consultants as you need, to understand complex business issues, proposals, innovations, and opportunities, among other things.  You should be comfortable discussing all points during board meetings.

Understand those around you so that you can have a positive and productive influence:

Don’t worry as to whether management likes you.  Ask them the tough questions, have a healthy level of  skepticism (without being abusive or negative — but don’t wimp out either). Your trust, and theirs is to be earned and built upon.

Does management have the right programs in place to deal with risks? Are there strong internal systems and controls? Has management identified compliance issues and risks such as, money laundering, bribery, data protection, security, crisis management, record retention, etc.

Does the board have the right programs in place? Does the board have a good system in place for addressing complaints – example:  if there are material weaknesses in the company’s financial structure, is there a system in place for  employees, vendors, or others report them directly to the Audit Committee?   How trusted is our whistle-blower program? Are whistle blowers protecting with anonymity from retaliation?

How well do you know those around you? What’s the CEO’s risk appetite? Do you have detailed understanding of each of the senior management team’s capabilities? How are they executing board directives? Are each of your fellow directors well-qualified?  Do they display integrity, good judgment, and are they engaged at all meetings? Do they welcome and openly engage in periodic self-assessment and evaluation?

Insure the risks you can’t anticipate.

Reducing the likelihood of things going wrong, doesn’t mean something won’t happen.  Board work and responsibilities are growing ever more intricate, in line with the increased complexity of running any business these days. What’s key is how to protect yourself against those who want to punish you for not doing your job the way they think it should have been done. Right or wrong can often become a matter of great, lengthy, and expensive legal debate.

You need to fully understand  your coverage and review it annually – at least. It’s important to understand what layers of protection have been put in place for you as a director of the company, so that you can focus your attention on doing what’s right for the company and stakeholders.  You should understand the company’s indemnification policy for directors, when it was last reviewed and updated, and by whom.  You need to understand the D&O policies in place, (in particular, Side A coverage).  For example: what are the individual and aggregate limits, how exclusions work, layering, whether advance payments are available for legal costs (lawyers like to get paid timely if you want to continue to be defended), and the effects of settlements on additional coverage,  just to name a few.

You also need to know how long you are covered for after service.  New regulations can extend your liabilities five years out.  Many companies don’t cover directors once they leave.  If necessary, supplemental individual policies should be discussed and considered.  In any case, getting legal and financial advice should always be sought, unless you’re already an expert in this area. Another tactic to consider with your advisors is the wisdom and prudence of sheltering your personal assets.  As the saying goes: “hey, you never know.”

Many directors face legal liabilities during and after their board service.  If it’s any comfort, the law of averages and your odds are still pretty good: most directors don’t get sued, and for those who do, most times their defenses prevail.   In closing, my best wishes and, as the saying goes: ” may the odds be ever in your favor.”

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