Corporate Law & Governance - Emerging Best Practices for ...

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Corporate Law & Governance -. Emerging Best Practices for. Corporate Governance ... corporate system of espionage to ferret out wrong doing which they have ...
Corporate Law & Governance Emerging Best Practices for Corporate Governance Guy Young Bill Nelson

© 2012 Haynes and Boone, LLP

State Law • Graham case (1963): “Red flag case” – Directors failed to uncover and prevent antitrust violations by the company. – “Absent a cause for suspicion, there is no duty upon directors to install and operate a corporate system of espionage to ferret out wrong doing which they have no reason to suspect exists.” 2 © 2012 Haynes and Boone, LLP

State Law • Caremark (1996) – Board failed to uncover illegal payments regarding Medicare – No red flag – Board had a duty to put in place reporting systems – Very high standard for liability “a sustained or systematic failure to exercise oversight”

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State Law • Stone v. Ritter (2006) (Supreme Court): – Money laundering – No red flag – Predicate for director oversight liability: “utterly failed to implement any reporting or information system or controls” or “consciously failed to monitor” – Oversight liability draws directly from concept of director bad faith 4 © 2012 Haynes and Boone, LLP

State Law • Citicorp and Goldman Sachs cases (2009 and 2011) – Board of banks sued for failure to oversee risks in connection with exposure to sub-prime losses. – Failure to oversee: director fulfilled the duty of oversight because the directors satisfied themselves that there was in place a system for managing risks. – The level of risk claims failed because decisions regarding the level of risk a company takes is protected by business judgment rule.

• The Goldman case also alleged that the compensation practices were so risky that the board violated its fiduciary duty. 5 © 2012 Haynes and Boone, LLP

Federal Involvement • Enron scandals – Congress found a failure to detect and deter corporate wrong doing. – Number one priority of Sarbanes-Oxley and related laws: expand the power of independent directors, including the oversight function.

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Federal Involvement • Financial institution instability • Issues here were effectiveness of governance; federal regulation and SEC oversight; failure in risk management • Substantial proven fraud was missing from these events

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Federal Involvement • From Enron and the financial system melt down – Short term thinking – Lack of fraud in the melt down – More involvement from persons with an agenda other than “enhance shareholder value”

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Governance Generally • Enhance shareholder value • Focus on strategic goals • Pressure to conform

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Legal Framework • Legal obligations continue to be Caremark/Citicorp line of cases. • Be wary of red flags; protection is more limited where there are red flags regarding wrong doing. • Business decisions on appetite for risk continue to be governed by business judgment rule. 10 © 2012 Haynes and Boone, LLP

Steps Taken by Boards Regarding Oversight • Board diligence – Basic risk diligence: obtain an understanding of the risks faced by the company – Risk assessment diligence: directors need to satisfy themselves that management has followed a reasonable process to identity and assess risk

• Systems and personnel – Are there systems in place to manage and mitigate risk? – Are the proper personnel in place to manage and mitigate risk?

• Are risks appropriate for the company

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Periodic Update and Assessment; Assignment of Responsibilities • The risk assessment should be reviewed periodically. • Boards assign committees responsibility for risk assessment. – Primarily the audit committee, but also the compensation committee – Some larger companies have risk assessment committees

• Management risk committees 12 © 2012 Haynes and Boone, LLP

A Record of Risk Assessment • Board minutes are important in this area – Which committee is assigned risk oversight in which area? – Record of risks discussed with the board and the committees – Decision making process of board in setting risk appetite

• Consistency with public filings – Periodic SEC reports are required to disclose risks, which should be consistent with board discussions – Other public/internal documents prepared or evaluating material risks should be consistent with board determinations

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Examples • Foreign Corrupt Practices Act (FCPA) • Hedging • Political Contributions

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Tone at the Top • Tone shapes business relationships and social responsibility – Culture of compliance with laws and sound strategic goals – Not an avoidance of risk, but compliance with the appetite set by the board

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