United States: Public Company Directors – Managing Reputational Risks

Public company directors face continuous scrutiny from government regulators (especially the Securities and Exchange Commission [SEC]), activists, the media, and proxy advisory firms such as ISS. Although not comprehensive, the list below outlines steps directors can take to anticipate and manage reputational risks.

Understand risks. Request regular Board briefings on best practices for directors to fulfill their oversight functions as Board and committee members. Informed decisions can head off regulatory actions, activist challenges and negative recommendations by proxy advisory firms. Areas of recent focus include:

Internal controls. Weaknesses in internal controls may appear as failures in financial oversight.

Cybersecurity. Cyber incidents may bring shareholder lawsuits alleging breach of fiduciary duties and a failure to provide effective oversight of business and technology risks.

Auditor oversight. A 2015 concept release indicates that the SEC may require greater disclosure of the audit committee’s oversight of auditors, to help investors inform their votes for audit committee members based on committee performance.

Consider “appearance” issues when determining independence of Board members. When considering director independence, the bright-line SEC and stock exchange requirements provide only a starting point. In addition, the company proxy statement must disclose other factors, such as financial, social and charitable relationships and investments, considered by the Board in determining a director ’s independence. These factors may attract the attention of activists or appear to breach the director ’s duty of loyalty in any lawsuit against the company or the Board.

Monitor potential conflicts of interest. Company policies govern any related party transactions of a director or the director’s related entities and family members. A family wedding or change in a business relationship may present an unexpected conflict of interest or create a related party transaction subject to proxy statement disclosure (or even impair director or auditor independence). Close attention to potential conflicts and changes in family relationships can help resolve disclosure and independence questions in advance.

Don’t assume confidentiality. Regulators use data-driven market surveillance and scrutinize unusual trading patterns to bring insider trading inquiries, with a focus on directors and other insiders and their family, friends, associates and confidants. Indiscreet discussions about confidential business information may lead to “tipping” investigations and even charges (for example, Raj Gupta, who passed on boardroom information to a friend). Prolonged investigations and media coverage can cause lasting reputational harm to the director and their family, friends and associates even if no charges are brought.

Meet deadlines for required filings. The SEC recently brought multiple enforcement actions against insiders for failing to timely report holdings and transactions in company stock (Forms 3 and 4). The SEC takes the position that late or missed filings withhold timely information from the market and may affect trading prices to the detriment of the investing public.

Monitor reportable transactions. Many companies assist directors in preparing and filing stock ownership reports, but the ultimate responsibility for these reports rests with the director. Directors remain responsible for monitoring reportable transactions by related entities, immediate family members and trusts, and for reporting any late filings in the annual D&O questionnaire.

Understand risks of negative votes. Director, Board and committee actions may trigger a negative voting recommendation from proxy advisory firms. Examples include:

Attendance. Attend 75% or more of combined Board and committee meetings, and ensure that the proxy statement clearly discloses director attendance. For any director that falls short of the 75% threshold, disclose reasons for the absences (for example, illness). Informal communications before and after meetings do not substitute for actual attendance.

Overboarding. Voting policies of proxy advisory firms, exchange listing standards, and company policies may limit simultaneous service on multiple Boards and audit committees. Director biographies in proxy statements that include private company and charitable Boards may suggest that the director is unable to devote adequate time to Board service. These optional disclosures may be omitted.

Problematic pay practices. Directors on the compensation committee risk negative voting recommendations if their decisions constitute problematic pay practices or fail to link pay with stock price performance. Consultants and counsel can advise on current positions taken by proxy advisory firms.

Unilateral amendments to governing documents. Consider submitting for shareholder approval any proposed bylaw amendments that might be perceived by ISS to diminish shareholder rights, such as restricting shareholder rights to call a special meeting or act by written consent, or increasing shareholder vote requirements to amend the bylaws.

Board responsiveness. ISS may issue a negative vote recommendation if a Board fails to act on a shareholder proposal that was supported by a majority vote in the previous year. The Board may include disclosures in the proxy statement to highlight the business rationale for its decisions.

Ensure accurate responses to D&O questionnaires. Responses to D&O questionnaires drive many public disclosures and governance decisions. Any inaccuracies or omissions in the questionnaire can result in misleading public disclosures, and the questionnaire can be reviewed by the SEC in any investigation. In 2015, an audit committee member settled charges with the SEC for causing public reporting violations through failing to disclose in the questionnaire his business relationship with an affiliate of the independent auditor.

Scrub biographical information in company filings. Activists look for leverage to conduct a proxy contest, including errors in publicly disclosed biographies of incumbent directors. In 2012, a director and a CEO resigned over inaccuracies in their biographies that were identified by an activist. Biographies should be cross-checked at each company where the director serves as a director or officer to avoid inconsistencies. Optional disclosures (such as academic credentials) may be omitted if they cannot be readily verified.

Specify relevant director qualifications. Boilerplate disclosures of director qualifications do not satisfy SEC proxy disclosure requirements. Instead, highlight specific experience, qualifications, attributes or skills that qualify the individual for service on the Board. Omit irrelevant experience, which can attract unfavorable comments from activists, and avoid any overstatements or claims of specialized expertise that might subject the director to a higher standard.

Conclusion. Directors may benefit from viewing their actions through the eyes of regulators and activists. On an annual basis, the Board self-evaluation can be used to enhance performance of the overall Board and individual directors. Effective directors monitor best practices, adhere to deadlines and legal requirements, and ensure appropriate public disclosures.

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.

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