Corporate
Officers & Liability Directors
and Officers Need Outside Legal Counsel
Being a director
of a publicly traded company can be a lucrative and prestigious position
to be in. But repeatedly we see captains of industry fall; individuals
such as Dennis Koslowski of Tyco and Sam Waksel of ImClone have taken
their lumps recently, both financially as well as in the media. These
gentlemen made serious mistakes and are now paying the price.
Today's business
environment is built on "transparency," meaning that there
are no more secrets. Congress has taken action to implement new rules
and regulations in order to protect the investment public, including,
but not limited to, the Sarbanes-Oxley Act of 2002. These new 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 all have one thing in common; they failed 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 by them 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.
The board of directors,
rather than stockholders, manage a company's business and affairs. The
board is empowered to delegate various responsibilities to committees
consisting of one or more directors. The committees, in turn, either
execute action on behalf of the board or act as a fact-finding entity,
gathering information and then presenting it to the board along with
a recommended course of action.
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
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 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 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
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.
The law clearly holds that if the board makes the business decision
to sell the company in response to an offer or independently, utilizing
the duties of loyalty and care, then the board is then required to accept
the highest offer, regardless if other terms of the offer may be deemed
"undesirable". Undesirable terms may mean that purchaser would
strip the company, sell its parts and lay off its employees. The bottom-line
financial-interests of the stockholders outweigh any and all social
or humanitarian issues.
There is an exception
to this requirement. If the board makes the decision that the company
will only be sold or merged to an equal entity and that control of the
company would not shift away from the current shareholders, the board
is not required to obtain the highest bidder. This typically occurs
in a cash-out bid,
Taking measures
to ensure that a company is not unwittingly "put in play"
is called "neutral planning." 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
situation, outside counsel should be retained immediately. Not only
with this preserve the appearance of independence, but outside counsel
will be protected from disclosure by the attorney-client and work product
privileges. Advisors will 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.
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. Directors must be careful that the proposed
business relationship does not disqualify them as an independent director
pursuant to the company articles of incorporation and/or bylaws.
A director may
not pursue any activity or potential benefit that is also available
to the company without fully disclosing this pursuit to the corporation's
board. In order for this director to proceed with this pursuit the boards'
disinterested members' must render the decision 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 or to pursue the opportunity themselves.
Simply stated,
a director must always disclose. In today's complex business environment
of multiple directorships and investment companies with numerous investments
and seats on various investee boards, 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.
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 with 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 would 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.
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 form 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 has materially altered corporate governance. 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.
CEO's, officers
and other high-profile business professionals have legal counsel in
place at all times. If a complaint or an inquiry arises they are prepared
to react without hesitation, sometimes eliminating a small problem before
it escalates into a larger one. Remember, fortune favors the well prepared.
