Officers and Directors

Being a director of a publicly traded company can be a lucrative and prestigious position to be in. Today’s business environment is built on “transparency,” meaning that there are no more secrets. Congress has taken action to implement rules and regulations in order to protect the investment public, including, but not limited to, the Sarbanes-Oxley Act of 2002 and Frank Dodd Act of 2010. These measures require that officers and directors of publicly traded companies live under a microscope and adhere to a myriad of complex regulations, primarily based on disclosure.

Although some directors and officers make decisions that are simply egregious, others find themselves under the gun through no fault of their own for activities that were out of their control or for pursuits they never knew were illegal. These Individuals often fail to realize that the key responsibility of a company’s corporate counsel is to protect the company, not them as individuals. It is up to corporate officers to protect themselves in the event they become subject of a complaint or inquiry.

Outside, independent legal counsel is needed to ensure that their rights are protected, they take all necessary steps to make the best possible decisions, and that they are provided with a proper defense when faced with scrutiny.


Duties and Legal Responsibilities of Directors

The board of directors manages a company’s business and affairs. Directors are governed by such principles as the duty of care, duty of loyalty and the “business judgment rule.” As long as these principles are adhered to, and as long as directors are careful and loyal to corporate and shareholder interests, they have wide discretion to exercise their business judgment as they see fit.


The Duty of Care

The Duty of Care requires directors to be informed, prior to making a business decision, of all material information reasonably available to them in the exercise of their management of the affairs of a corporation.


The Duty of Loyalty

The duty of loyalty protects the corporation and its shareholders and requires directors to act in good faith and in the best interests of the corporation and its shareholders. The prevalent legal standard is that the duty of loyalty requires that the director be disinterested, such that he “neither appears on both sides of a transaction nor expects to derive any personal financial benefit from it” and his decision must be “based on the corporate merits of the subject before the board rather than extraneous considerations or influences.”


The Business Judgment Rule

The Business Judgment Rule is a judicial presumption that protects directors from liability for action taken by them if they act on an informed basis in good faith and in a manner they reasonably believe to be in the best interests of the corporation’s shareholders. The Business Judgment Rule will not apply in cases of fraud, bad faith or self-dealing. In such a case the court will require the director to establish the intrinsic value and fairness of the transaction.

A director’s duty can be shifted in times of takeover attempts and/or mergers and acquisitions. When an offer has been made to takeover a company the board of directors must:

  • determine whether the offer poses a threat to the corporate enterprise
  • if the offer does pose a threat, the board may only take such action to protect the Company as is in proportion to the threat posed.

In their course of maintaining control of the company directors must be very careful not to place their own self-interest above their duty to the stockholders. A diligent board should have a takeover readiness plan and project team in place prior to the point when a crisis situation occurs.

Lawyers, compensation consultants, auditors, underwriters, and other outside experts are indispensable components of sound corporate governance. It is important to the independence of directors and committees that they, and not management, choose the advisors who will guide them. Moreover, in crisis management and control situations, outside counsel should be retained immediately. Not only will this preserve the appearance of independence, but outside counsel will be protected from disclosure by the attorney-client and work product privileges. Advisors should not be the same individuals who act as outside counsel to the company’s management, creating a fundamental conflict of interest. The intricacies of corporate board duties require the guidance and assistance of disinterested, unrelated professionals.


Conflicts of Interest

The most difficult issue for a director to avoid is the conflict of interest. Consequently, directors must learn how to deal with this inevitable situation. The four most common conflict of interest issues faced by directors are:

  • doing business with the company
  • corporate opportunity
  • subsidiary insolvency
  • management buy-outs

Directors are free to do business with the company as long as they fully disclose their personal involvement to the entire board in advance, and as long as the disinterested directors make the decision to permit or disallow the director’s proposed business.


Prohibited Practices

A director may not pursue any activity or potential benefit that is also available to the company without full disclosure to the corporation’s board and first allowing the company the opportunity to pursue the activity or benefit. In order for a director to proceed, the boards’ disinterested members’ must affirmatively decide to reject the benefit or to decline to pursue the activity. It is not sufficient to merely presume the company would not be interested, or could not afford to benefit from the activity.

Simply stated, a director must always disclose. In today’s complex business environment directors find themselves conflicted as to whether an opportunity exists, or whether such opportunity is potentially one that the company could pursue and benefit from.

Subsidiary insolvency can create conflicts of interest as between the stockholders of the parent company and stockholders of the subsidiary. Should the parent company provide funds to and breathe life into an insolvent or dying subsidiary? Moreover, a conflict can exist as between creditors and stockholders opening directors up to lawsuits from litigious and angry creditors.

Finally, management buy-outs create conflicts that are rather obvious. Management wants to pay the least and stockholders deserve the most. A director often wants to maintain a relationship with the bought-out entity. Advice of counsel is imperative to prevent potentially legal and regulatory liability in each of these conflict situations.


Public Company Disclosures

Board members and corporate management feel an enormous amount of pressure to respond to market rumors, engage in analyst teleconferences, or make announcements about a myriad of operational details. Many board members mistakenly assume that all material developments require a press announcement. Legally, a company only has a duty to speak:

When a statute or regulation requires (such as quarterly and annual reports; or reportable events such as the hiring of new auditors occur)
When the company is trading in its own stock or public convertible debts (such as when the company conducts its initial public offering, secondary offerings or stock repurchase programs)

When the company learns that a statement previously made was incorrect when made, or has been made incorrect by more recent information

Even when a legal duty exists a company is only required to disclose material facts. That is facts that would effect a stockholder’s decision to buy or hold stock, or to vote or not vote on any issue put to the stockholders for a vote. A company and its board should more advisably keep quiet and adopt a “no comment” policy. Moreover, the Sarbanes-Oxley Act has increased the duty to correct prior statements even if made unintentionally and without a duty to do so. Public company directors have some protection by the safe harbor for forward looking statements which was enacted with the Litigation Reform Act of 1995. However, once again, it is highly recommended to discuss the issue in depth with independent legal counsel.


Trading in the Company’s Securities

Directors are entitled to invest in their own public company, however, the SEC’s Short-Swing Profit Rule prevents directors from profiting on the buying and selling of company stock within a six month period. The six month period is closely monitored, and directors must file forms 3, 4 and 144 when buying or selling stock in their own public company.

In addition, a director may never buy or sell the company’s stock when he or she is in possession of material non-public information. This prohibition does not apply to the exercise of already granted stock options, or trades made in compliance with and pursuant to an effective 10b5-1 Plan. Directors are always advised to consult with legal counsel prior to buying or selling their company’s stock to ensure that they are not unwittingly violating the SEC’s strict insider trading rules.


The Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 materially altered corporate governance. For large issuers, Sarbanes-Oxley requires that a majority of directors be independent directors and sets forth strict independence standards. These independent directors, although not devoted full time to the company and although most assuredly dealing with a full time career and corporate issues, are held to increasingly higher standard of conduct and responsibility to be educated and informed and to make the best possible decisions. Sarbanes-Oxley is forcing directors to be prepared and to monitor their company performance and make independent investigation as to corporate governance, management, disclosure and compensation issues.

Prior to enactment of Sarbanes-Oxley, corporate governance was a matter of state law and a few rules and regulations of the exchanges. Sarbanes-Oxley has federalized certain issues and overrides state laws pertaining to those matters. Companies, under the control of directors, are required to establish a code of ethics and certify that they have done so, or if not, why not. However, state law still governs on issues not addressed by Sarbanes-Oxley. Careful attention must be taken to ensure not to violate either set of rules and regulations and to know when each applies.

The attorneys at Legal & Compliance, LLC understand the needs of corporate officers and directors. The time to establish a relationship with personal, outside counsel is before a problem arises, not after. The guesswork is then removed and the stress of having to scramble to find experienced and aggressive legal counsel during a time of crisis is eliminated as well.