United States: The ‘Unthinkable’ May Need Board Attention

As the Target massive data breach illustrates, plaintiffs' lawyers are increasingly filing derivative and securities fraud lawsuits against companies and their directors based on claims that the board should have recognized and acted on certain risks associated with the company's business. The lawsuit alleges that Target's board breached its fiduciary duties to the company by ignoring the warning signs that a data breach could occur and participated in the maintenance of inadequate cyber-security controls by the company. Target is not unique, as similar suits for data security and privacy breaches have been filed against Google and others. The basis for liability revolves around whether the event could not have been reasonably anticipated by the directors—i.e., was it a ''black swan'' event—or if there were warning signs that were ignored or inadequately pursued by the board.

Before the 9/11 terrorist attacks or the financial meltdown resulting from the subprime crisis, a court was not likely to hold a board legally responsible for failing to recognize these events as risks which the company needed to address; today such risks are no longer black swans. An increasing number of events could impact a company operating in the current environment and, as their complexity continues to rise, the dissemination of information in crisis situations has become more widespread and instantaneous, and the level of scrutiny of the board by an ever-expanding group of constituencies has increased. Indeed, proxy advisory firm Institutional Shareholder Services has even gotten involved in this realm by including risk oversight in its recommendation criteria.

While a board cannot be expected to foresee every potential disaster that might befall the company, it can, in fulfilling its oversight function, ensure that management has adequately taken account of those events that are foreseeable. Natural disasters such as floods or earthquakes, the sudden death of a CEO, ''bad acts'' by rogue employees, cyber-attacks, data security breaches and other misfortunes are no longer so uncommon as to be unforeseeable.

As the recent Target cyber penetration showed, a breach of cyber security can wreak havoc on a company's business and profitability and engender multiple lawsuits from customers and governmental bodies. Similarly, should banks with ATMs have foreseen that Microsoft would abandon Windows XP, leaving the machines that were not upgraded facing significant security vulnerabilities? In light of the magnitude of recent crisis events, boards need to spend time with management to ensure that the risks facing the company are identified and assessed and plans to manage and investigate these risks are formulated, including plans to deal with foreseeable crises.

As a general proposition, the board of directors is legally obligated to discharge its duties in good faith and in accordance with the best interests of the corporation, acting with appropriate loyalty and care. While it is not sufficient to focus solely on the company's financial performance, the board is not required to micromanage the company's operations in fulfilling its oversight obligations. The board should assume, however, that while it need not address events that would not have a significant impact on the company or that are too remote to require attention, its oversight does include an obligation to ensure that safeguards have been implemented to address foreseeable events. In the end, boards are facing risk management decisions—i.e., how much focus, time and money to devote to the oversight of specific risks which they have identified as warranting more attention.

As a starting point, the board should have management identify significant risks to the company's business and operations and present the particular safeguards the company has established to mitigate those risks. Management should present existing crisis management plans to the board so directors can assess their scope and adequacy. As a company's size and complexity change, existing plans may be materially deficient. Therefore, the board or its designated committee needs to review these plans periodically and have management update them regularly.

In performing its oversight of risk, it is critically important that the board ensure that the risk management framework management uses evaluates risks in the context of its assessment of the company's strategic business objectives, as opposed to evaluating risks in isolation. Risk assessment should be ''strategy-centric'' as opposed to ''risk-centric''— i.e., the company's strategic business objectives should be evaluated for the risks that they present, rather than identifying risks and then determining the extent to which they could impact the company. A few of the more common areas that boards now review include the following:

  • IT Infrastructure — In addition to cybersecurity, does the company adequately address data privacy and IT security, including issues created by the increase in the use of cloud computing, social media and a multitude of mobile platforms, as well as the proliferation of personal devices used by employees in the workplace? In addition, does the board understand their company's disaster recovery plan and the potential impacts it may have on the company's business?
  • Regulatory Landscape — The number of regulations companies are subject to, especially those doing business overseas, has risen dramatically in the past several years. In addition, regulators, ever seeking increased revenues through fines and settlements, are more aggressively enforcing regulations, thereby increasing the importance of having an effective compliance program.
  • IP/Confidential Information — In today's global economy, a company's intellectual property and confidential information are key ingredients to its value. Does the company have an adequate program to protect its intellectual property?
  • Corporate Social Responsibility — How will the company's reputation or brand identity be negatively impacted if the company does not adequately address social issues such as the environment?
  • Product Recalls — Product recalls or defects not only have an immediate impact on a company's earnings, but could also subject it to liability to consumers and governmental bodies, as illustrated by the recent $1.2 billion fine the Justice Department levied against Toyota for withholding information related to its products' safety. The proper handling of a recall, as the J&J Tylenol cyanide tampering example indicates, can avert a major reputational disaster. The recent General Motors handling of its fatal accident cases is another example of the need to have an effective crisis management plan in place. Fatalities associated with a company's products or disasters present many challenges. However, some fundamental procedures should be in place to avoid publicity blunders. For example, it does not take a PR guru to tell a company not to inform families of loved one's death by text messaging, as Malaysia Airlines is reported to have done following the recent loss of one of its planes.
  • Executive Compensation — Does the structure of the company's executive compensation program appropriately balance the incentives given to senior management with the risks embedded in the company's corporate strategy?
  • Shareholder Activism — In the past several years, an increasing number of hedge funds and other institutional investors have engaged in shareholder activism with an expanding group of companies. Given the sophistication and breadth of activist's toolboxes, no company is immune to an approach by an activist investor. Each company should analyze its business, financial affairs and governance practices to assess which areas are at risk for attack and should develop action plans that could be used if such an attack materializes to avoid adversely impacting the company's business and shareholder value.
  • Employee Matters — Does the company have adequate policies and procedures in place regarding the use of social media by employees and restrictions on the communication of confidential information to third parties? If the company has employees who are unionized, what is the nature of the relationship with the union and when is their contract up for renegotiation?
  • Political Contributions — As the constraints on political contributions by corporations have decreased, companies are becoming more engaged in the political arena. However, such involvement is not without its risks if management takes a stand on, or directs funds to, controversial issues that can impact its reputation. As a recent example, the CEO of Mozilla resigned after employees complained about his $1,000 contribution to support a 2008 California ballot initiative to ban gay marriage. Boards also need to be vigilant that the company's attempts to influence legislation or regulations, or support candidates, are appropriate to avoid tarnishing the company's reputation.
  • Insider Trading — Dealing with analysts and investors in the current environment is also not without risks, as regulators are increasingly focused on trading on inside information. The board should inquire if the company has the requisite policies in place to minimize the likelihood an insider trading problem would occur as well as to assist the company in defending against an enforcement action by the Securities and Exchange Commission, potential lawsuits and an attack on its reputation.
  • Insurance — Are the scope, exclusions and amounts of insurance coverage adequate for the company's operations? Does the insurance cover business interruption? Is the Directors and Officers insurance policy adequate in light of the legal exposure?
  • Reputational Risks — Does the company understand any reputational risks associated with working with the company's business partners, including with respect to its supply chain?
  • Disclosure of Significant Risks — Does the company disclose material risks in public filings to avoid potential lawsuits?

Some practical steps that boards can take to deal with the ever-increasing need for risk oversight include:

  • Tone at the top — The board should make management aware of the seriousness with which the board views its risk oversight function. It needs to make clear to management that it expects accurate assessments of the risks in the business, that they are being adequately addressed, and that any material issues that arise are brought promptly to the board's attention.
  • Benchmarking and best practices — There are a number of publications that focus on risk oversight by boards, such as the report issued by the National Association of Corporate Directors's Blue Ribbon Commission on Risk Governance and the Governance Center of the Conference Board entitled ''Risk Oversight: Evolving Expectations for Boards.'' These and other sources can assist boards in benchmarking against peers and discerning best practices. In addition, outside consultants can be engaged, if necessary, to assist the board in identifying risks and establishing appropriate oversight functions.
  • Allocation of oversight responsibilities — Some financial institutions are by regulation required to have risk management committees. Other companies need to clearly delineate which committee of the board is responsible for which risk identified by the board as warranting board attention. While the audit committee will be responsible for many of the risks discussed above, other committees may have better insights into the risks and should be clearly allocated the responsibility.
  • Annual review by board or committees — There should be a report from management on risk and whether developments in the company's business or the environment in which it operates have changed the risks associated with its business to an extent that it requires a change in the board's oversight role.

As the above examples indicate, it does not take a disaster of major proportions to have an adverse impact on a company's business, financial performance or reputation. In the exercise of their oversight obligations and to avoid potential liability, directors should at least assure themselves that the company's management is prepared for events that are reasonably foreseeable. The fact that an event had a major negative impact on a company is not in and of itself a basis to hold directors liable. A court may absolve directors for failing to anticipate a risk where there weren't enough red flags associated with such a risk.

But if, for example, a foreign governmental authority starts to target companies in an industry for bribery by its employees, should boards of companies in other industries perceive such action as a red flag and have management address this type of risk? The Chinese authorities investigated a number of pharmaceutical companies for bribery charges relating to their sales operations in China. What if the Food and Drug Administration starts to step up treating violations of manufacturing problems as criminal offenses; should the board take this as a foreseeable event and start to get involved? These situations present an important reminder that the board needs to be vigilant so it will not be caught as having ignored red flags and be at risk for not having taken appropriate measures to address them.

Originally published in in the June issue of BNA's Corporate Counsel Weekly.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.