This article was previously published in May 2011 issue of Lexpert Magazine.
Board ethics have never been so closely scrutinized by the public and regulators. Having the proper policies and protocols in place – before an ethical lapse is discovered – is critical.
Directors' obligations arise from a variety of sources. At base is the duty set out in corporate legislation such as the Canada Business Corporations Act (CBCA), which requires directors to act honestly and in good faith, with a view to the best interests of the corporation, exercising the due diligence that a reasonably prudent person would in the circumstances, and without conflict.
Further duties are imposed – or strongly suggested – by regulators and by institutional shareholders and shareholder advisory groups. These include obligations that boards develop and publish mandates and policies; that they be comprised of a majority of "independent" directors; that chair and CEO roles be separated; that directors be elected individually by majority voting; and that shareholders be given a "say on pay" (advisory vote on the compensation philosophy).
Media views and ratings on governance can affect board practices, and boards themselves implement a variety of policies (codes of conduct, confidentiality, insider trading, harassment, privacy and whistleblower protections). Taken together, these factors form a complex web of governance duties.
What are directors' responsibilities when it appears that there may have been a failure to comply with a governance duty? Some violations rise to a level at which public disclosure must be made, as for instance when a violation results in a "material change" in the affairs of a public company. Some may suggest confidential disclosure that may operate to exonerate a reporting director. Professional obligations may impose distinct obligations on directors who are lawyers or accountants.
But some violations are more subtle. What is a board to do with a possible violation of a trading blackout? Causes of the violation may range from poor systems administration to illegal insider trading. The Divisional Court, in Rowan, confirmed the OSC's decision that violation of a trading blackout policy is not simply a private matter between the company and the offending director: rather, the OSC can become involved under its public interest jurisdiction, since governance policies form part of the securities regulatory environment.
It is therefore necessary for the board to get the facts, and this will usually mean an investigation. This doesn't necessarily require a grand inquisition. However, a board must accept that the ultimate destination may not be known as the journey begins, and that its own conduct may be reviewed. Boards must take care that their own procedures do not become objects of criticism.
An investigation will typically begin with a request by a board committee to preserve records. Adverse implications may be drawn from document destruction or e-mail deletion occurring once the need for an investigation is known. Thereafter, the matter should proceed by way of a structured inquiry. It will usually be appropriate for the investigation to be led by independent external counsel. Independence may require counsel who do not normally act for the company, and who may therefore be too close to management. Externality means that investigating counsel cannot be called as witnesses, and communications with them are privileged. An independent and external investigation lends credibility to the exercise, particularly in the eyes of regulators or law enforcement personnel who may become involved. The investigation may begin with a review of documentary evidence and a few interviews, but it must be ready to change direction based on what may be learned in its course.
The investigation phase will typically end with a report to the supervising director committee outlining the facts as found, conclusions that may be drawn, and sanctions or revised procedures that may be considered. In the case of trading during a blackout period, the conclusions may be that directors were not adequately aware of the policy, or that the policy may need to be called to their attention regularly. A careless director may require admonition and perhaps re-education on corporate policies. It may be appropriate to introduce revised procedures designed to ensure awareness of policy requirements and prompt reporting of any transgressions. If the facts suggest more than innocent or careless error, additional action may be appropriate. This can include requests that a director resign or disclosure to regulators and law enforcement.
Directors must be vigilant in policing themselves.
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.
