As noted in the promo for the event:
Board membership is difficult enough these days, even when the relationship between board and management functions well. But when faced with runaway management teams, the situation can quickly devolve, increasing business and legal risks for the company and its board members. What key principles should guide directors and their advisors when a management team ignores the board’s advice or refuses to keep the board fully informed on important business developments and strategic issues? What practical steps should board members consider when facing management teams who will not heed strategic advice? That elevate their own interests above those of the company? Or that engage in questionable and self-serving practices? Should a board member take control of the situation? Call a litigator? Fire the CEO? Resign?
The Panel Discussing Runaway Management
Donald F. Parsons, Jr. is a vice chancellor of Delaware’s Court of Chancery, which is regarded for its deep expertise on corporate governance issues involving board and management duties. Donald regularly handles important disputes and issues affecting corporate governance under the Delaware General Corporation Law and various alternative entity statutes. He also was a senior partner at the law firm of Morris, Nichols, Arsht & Tunnell in Wilmington, Delaware. He served as president of the American College of Business Court Judges.
Linda Grais, MD is president and CEO of Ocera Therapeutics has served on its board since 2008. She also served as a managing member at InterWest Partners, a venture capital firm. Linda was a founder and EVP of SGX Pharmaceuticals, a drug discovery company focusing on new treatments for cancer. She was a corporate attorney at Wilson Sonsini Goodrich & Rosati, where she practiced in such areas as venture financings, public offerings and strategic partnerships.
Elena Norman is a partner at Young Conaway LLP and regularly counsels boards of directors, board committees, executives, stockholders and in-house and outside counsel on Delaware corporate and commercial matters. She frequently represents parties to litigation, most often in the Delaware Court of Chancery, in connection with merger and acquisition transactions, going-private transactions, valuation and corporate stock appraisal, corporate governance, board composition, limited liability companies and limited partnerships and cases involving fraud and breach of contract.
Rick Gallagher is a partner in the business & securities litigation group at Ropes & Gray in San Francisco, Rick’s practice focuses on litigation and pre-litigation advice involving securities and corporate governance issues, including representation of companies, directors and officers involved in class action litigation, derivative actions, internal investigations, shareholder demands, and regulatory investigations and enforcement actions brought under the federal and state securities laws. He also has significant experience advising companies, boards of directors and special committee members in M&A litigation.
Runaway Management Moderator
Dan Siciliano is the faculty director of the Rock Center for Corporate Governance at Stanford University and a professor and associate dean at Stanford Law School. He is co-founder and a director of LawLogix Group, Inc. – a global software technology company named seven consecutive times to the Inc. 500/5000, ranked several times as one of the top 100 fastest-growing private software companies in the United States and named to the Hispanic Business 500 (largest) and Hispanic Business 100 (fastest-growing) for 2010 and 2011.
This program, like all SVDX programs, was subject to the Chatham House Rule, so I’m not quoting participants or disclosing insider information. To get the full flavor, you’ll need to actually attend the events. Proxy season is getting into full swing, so my time is limited – in other words my notes are even more cryptic than usual.
Runaway Management: The Discussion
What is? Unlawful, unethical conduct by CEO/CFO resulting in the inability of board to trust management. Frequently, this results when the board is not able to trust the financial information provided. At least everyone agrees that is runaway management, is wrong and needs to be fixed.
Runaway management involving business judgment is harder to unravel. There is lots of middle ground. To diagnose, we would need to look at competing loyalties and obligations. What is the threshold question? Board members themselves cannot always agree. This is no place for wallflowers that were appointed by the founder.
Vision can lead to passion, over-optimistic hubris and runaway management. All CEOs probably ‘manage’ the board but if management misleads the board, they may need to take corrective steps. Directors have lots of legal rights to get information.
Directors have to know where their loyalties are. A venture capital member on board has to be loyal to shareholders and company of that board (not their outside venture capital allegiances – well, maybe them too). They have divergent affiliations. Private equity affiliated directors often have different view of short vs long-term interests. Beware: often times loudest voice carries. Hard to compartmentalize loyalties but must do so.
In many instances, interests are directly aligned… that doesn’t mean there won’t be disagreements. Problem may be that board becomes so factionalized it doesn’t work. Board-centric model. You don’t want passive boards. Want different perspectives engaged… making decisions in the best interests of the company you are serving. Good to have at least equal number of non-venture board members.
Delaware law is very process oriented. How many on the board? How many disinterested in that transaction? How much pressure is on venture capital board member to get an exit when big payday is ten years down the road? If in conflicted situation, there will be a lot of second-guessing and looking for a thumb on the scale. Decisions will still survive, if the board uses a straight up process.
Bare minimum legal liability is a low bar. Difficult CEOs? There are plenty. If doing a good job, you don’t mess with success. However, if dysfunctional – when things are not going well and you are not getting all the information you need repeatedly, you may have runaway management. At a certain point some on the board stop paying attention to the data. Hubris.
It takes courage to challenge a founder CEO. You have rights to get information; Section 220 books and records request. You have even more rights as director (although might be reason to exclude you if your interests are in conflict with the company). The law assumes a certain level of sophistication by board members, such as knowledge of director rights.
Board should expect that management has the facts, discloses the facts and faces the facts. CEOs should have a couple of board members to use as sounding boards in preparation for open discussion by the full board. Resorting to legal mechanisms within the board/management framework is often toxic. Usually, there is at least one board member who is able to engage with CEO who they will listen to. Board members need to be empathetic with each other and reasonable. Typically, only big failures go to court.
Board members need to understand decisions and board discussions well enough that you could explain it to someone else. If it is going over your head, you need to be sure others on the board do get it. You need to be able to explain it in your own words.
You also need to know you are coming from a position of strength to if you need to get more information. If you have a nagging feeling, don’t ignore it. Section 225 action allows you to have the court decide who is right, one side or the other. As you are fighting for your rights, the company has to pay your bills and theirs… although you might have to reimburse if you lose.
Foster informal channels of communication between directors and with management that hopefully lead to empathy. If there really are bad actors in a runaway management situation, directors often want to resign or stay silent. However, director obligations can continue. You can’t just ignore and try to escape because that could be breach of fiduciary duty.
It is better to investigate at outset what the problems are or may be, before you join a board. Be willing to invest at least 5% of your wealth in company. If cannot make a contribution to resolving a runaway management situation but another group of board members are handling the situation, it might be okay to quit.
When can you rely on fellow board member? Sharing and reliance on each other can be constant. However, it is not enough to say you relied and zoned out. You still have obligation to get to a level of comfort. Follow up with the experts on board. High-performing boards independently gather information on their own. They didn’t just rely on being spoon-fed by management. That can help avoid runaway management. You can consult others that have expertise, including outside counsel. You need to be adept at identifying what you don’t know.
The CEO needs to take advantage of board expertise. Go-to members can help address various issues. Encourage a culture of asking questions. CEO succession planning needs to be ongoing. Discussion around Trian and Dupont active slugfest. You need to look at performance of management like an activist.
Some discussion of Redlining/Blacklining. A “redlined” and “blacklined” draft both refer to a draft of a document that shows the changes made to a prior draft. When sending out a revised draft of a document by e-mail, it is common to also include a blackline/redline showing all of the changes from the prior draft. This way, everyone can focus on the changes made rather than reading the entire document and trying to figure out what has been changed. Use can save boards from looking through pages and pages of text, focusing primarily on changes.
Runaway Management: Additional Reading
- The Rights and Duties of Blockholder Directors
- Report of the Study Group on Corporate Boards
- Vice Chancellor Laster and the Long-Term Rule
SVDX / Rock Center Upcoming Events
And don’t forget the 21st Annual Stanford Directors’ College, June 21, 2015 to June 23, 2015. Register. There’s a discount for SVDX members.