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CORPORATE DIRECTOR'S GUIDEBOOK SECTION 1 - Structure of the Guidebook This Guidebook presents general concepts and standards that should be useful to the corporate director. It provides an overview of the functions and responsibilities of a director of a business corporation, an analysis of the structure and operations of the board of directors, and consideration of the applicable legal standards of conduct. Although the Guidebook specifically addresses the publicly owned corporation, it also should provide guidance for both controlled and closely held corporations. In general, the Guidebook deals with broad areas of concern to a corporate director. Its treatment of director conduct is not a legal opinion that contrary conduct will result in violation of the law and possible personal liability. When the issue of personal liability of a director is considered, it is raised explicitly. Accordingly, readers should not infer a forecast of litigation or liability based on failure to conform to recommendations made in this Guidebook. We believe that directors who act within the framework of conduct outlined in this Guidebook will be performing their directorial functions competently and reducing the risk of being successfully charged with deficient performance as a director. However, this Guidebook is not a substitute for legal advice. Corporate directors are urged to engage in continuing review of their responsibilities and conduct and to seek advice on both general and particular matters from competent counsel. SECTION 2 - Responsibilities of a Corporate Director Model Act Section 8.01(b) expresses the relationship between the board and management of the corporation.
This language is used to emphasize the responsibilities of directors, especially directors of publicly held corporations, to oversee the management of the corporation-not to manage, but to oversee. This responsibility includes:
Stated broadly, the principal responsibility of a corporate director is to promote the best interests of the corporation and its shareholders in directing the corporation's business and affairs. In so doing, the director should give primary consideration to long-term economic objectives. However, a director should also be concerned that the corporation conducts its affairs with due appreciation of public expectations, taking into consideration trends in the law and ethical standards. Furthermore, pursuit of the corporation's economic objectives may include consideration of the effect of corporate policies and operations upon the corporation's employees, the public, and the environment. Many states have adopted legislation expressly recognizing that corporate directors may consider the effect of corporate action on constituencies other than shareholders, such as employees, local communities, suppliers, and customers. Nevertheless, the law normally does not hold a corporate director directly responsible to constituencies other than shareholders in the formulation of corporate policy. A director should exercise independent judgment for the overall benefit of the corporation and all of its shareholders, even if elected at the request of a controlling shareholder, a union, a creditor, or an institutional shareholder or pursuant to contractual rights. To be effective, a director should become familiar with the corporation's business. This knowledge should enable the director to make an independent evaluation of senior management performance and allow the director to join with other directors to support, challenge, and reward management as warranted. Accordingly, all directors should have a basic understanding of the:
In addition, a director should be satisfied that an effective system is in place for periodic and timely reporting to the board on the following matters:
Finally, directors should do their homework. They should review board and committee meeting agendas and related materials sufficiently in advance of meetings to enable them to participate in an informed manner. They should receive and review reports of all board and committee meetings. A director should be particularly concerned that the corporation has established and implemented programs designed to meet the following inquiries. 1. Quality of Disclosure. Do the corporation's disclosure documents, such as annual and quarterly reports to shareholders, proxy statements, and prospectuses, fairly present all material information? A director's primary responsibility in the disclosure process is to be satisfied that procedures are being followed that are likely to result in accurate and appropriate corporate disclosure. Although management has the primary responsibility for implementing these processes, directors should review drafts of the annual reports, proxy statements, and prospectuses. 2. Compliance with Law. Does the corporation have appropriate policies directed to compliance with applicable laws and regulations? For example, when appropriate, does the board receive periodic reports regarding compliance with environmental laws, including estimates of the costs of environmental compliance? Employees should be informed of corporate policies directed to compliance with applicable laws, including personnel policies designed to comply with health and safety, antidiscrimination and employment laws, and the securities laws, particularly those prohibiting insider trading. The corporation should establish appropriate procedures for monitoring compliance. All persons involved in the compliance process should have direct access to the general counsel or a designee so that sensitive compliance matters may be raised for consideration. 3. Approval of Commitments. Is there a functioning and effective system in place for approval of commitments of the corporation's financial and commercial resources? Although board approval of all or even most of these commitments is not necessary, the board should be satisfied that such a system exists. 4. Adequacy of Internal Controls. Does the corporation maintain adequate systems of internal controls? 5. Protection of Assets. Does the board receive periodic reports describing the corporation's program for the protection of its assets? In addition to insurance arrangements, such a program should include procedures for protecting intellectual property and safeguarding confidential corporate information. 6. Counseling of Directors. Does the corporation provide board members competent legal advice regarding the corporation's affairs and the conduct of its directors? A director should be able to communicate directly with the corporation's principal external and internal advisers, including its-auditors, legal counsel, and, when such relationships exist, its investment banking and executive compensation advisers. Further, there may be occasions when an outside adviser should be specially retained to assist the board or a committee in connection with a particular matter. If, after a thorough discussion, a director disagrees with any significant action to be taken by the board, the director may vote against the proposal and request that the dissent be recorded in the meeting's minutes. Except in unusual circumstances, taking such a position should not cause a director to consider resigning. However, if a director believes that information being disclosed by the corporation is inadequate, incomplete, or incorrect or that management is not dealing with the directors, the shareholders, or the public in good faith, the director should see that corrective action is taken, replace management, or resign. SECTION 3 - Legal Analysis of the Basic Duties of a Director The legal obligations of directors fall into two broad categories: a duty of care and a duty of loyalty. Model Act Section 8.30 provides that a director shall discharge the director's duties, including duties as a member of a committee (i) in good faith, (ii) with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and (iii) in a manner he or she reasonably believes to be in the best interests of the corporation. Parsing Section 8.30 is helpful in analyzing the components of a director's duties:
B. Aspects of the Duty of Care Compliance with the duty of care is based on diligence applied to the ordinary and extraordinary needs of the corporation, including the following: 1. Regular Attendance. Directors are expected to attend and participate, either in person or by telephone (to the extent authorized by law), in board and committee meetings. Generally, directors cannot vote or participate by proxy; a director's personal participation is required. 2. Agendas. While agendas for both board and committee meetings are generally initiated by management, a director is entitled to place matters the director reasonably considers to be important on the agenda. 3. Adequate Information. Management should supply directors with sufficient information to keep them properly informed about the business and affairs of the corporation. When specific actions are contemplated, directors should receive appropriate information sufficiently in advance of the board or committee meeting to allow study of and reflection on the issues raised. Important time-sensitive materials that become available between meetings should be distributed to board members. On their part, directors are expected to review the materials supplied. If sufficient information is not made available in a timely manner, the director should request that action be delayed until the desired information is made available and studied. If a director believes the board is not regularly provided with enough information to enable the director to vote or act in an informed manner, and is unsuccessful in efforts to remedy the situation, the director should consider changing management or resigning. 4. The Right to Rely on Others and the Need to Keep Informed. A director is entitled to rely on reports, opinions, information, and statements (including financial statements and other financial data) presented by (i) the corporation's officers or employees whom the director reasonably believes to be reliable and competent in the matters presented, (ii) legal counsel, public accountants, or other persons as to matters that the director reasonably believes to be within their professional or expert competence, and (iii) duly authorized committees of the board on which the director does not serve, unless in any such cases the director has knowledge that would make such reliance unwarranted. However, a director relying on others has a responsibility to keep informed of the efforts of those to whom the work has been delegated. The extent of this review function will vary depending upon the nature and importance of the matter in question. 5. Inquiry. A director should make inquiry when alerted by the circumstances. The duty of care is qualified by the business judgment rule. This rule, well established in case law, protects a disinterested director from personal liability to the corporation and its shareholders, even though a corporate decision the director has approved turns out to be unwise or unsuccessful. In reviewing a disinterested director's conduct, a court will not substitute its judgment (particularly in hindsight) for that of the director, provided the director:
Accordingly, the business judgment rule, unlike the standards of conduct encompassed in the duties of care and loyalty, is not a description of a duty or standard used to determine whether a breach of duty has occurred; rather it is an element of judicial review used in analyzing director conduct to determine whether a director should be held personally liable. If the rule applies, directors are presumed to have exercised their judgment in good faith and in the rational belief that the actions were taken in the best interests of the corporation. In such circumstances, a court will not examine the merits of a decision of directors or substitute its judgment regarding the wisdom of a decision within the business judgment of directors. The duty of loyalty requires directors to exercise their powers in the interests of the corporation and not in the directors' own interest or in the interest of another person (including a family member) or organization. Simply put, directors should not use their corporate position to make a personal profit or gain or for other personal advantage. In themselves, conflicts of interest are not inherently improper. It is the manner in which an interested director and the board deal with a conflict that determines the propriety of the transaction and of the director's conduct. The duty of loyalty has a number of specific applications. 1. Conflicts of Interest. Directors should be alert and sensitive to any interest they may have that might be considered to conflict with the best interests of the corporation. When a director, directly or indirectly, has a financial or personal interest in a contract or transaction to which the corporation is to be a party, or is contemplating entering into a transaction that involves use of corporate assets or competition against the corporation, the director is considered to be "interested" in the matter. An interested director should seek approval by disinterested directors of interested transactions or conduct and should disclose that interest and describe to the board members all material facts concerning the matter known to the director. The board members should then act on the matter with complete candor, accuracy, and inclusiveness before the action is taken. An interested director should abstain from voting on the matter and, in most situations, leave the meeting while the disinterested directors discuss and vote. A corporation often will enter into transactions with other corporations that share a common director. When possible, the common directors, after having disclosed all pertinent information known to them, should avoid personal participation in approving the transaction and leave review and action to disinterested directors. State statutes usually include procedures that may be used to authorize or ratify transactions with interested directors and should be followed. 2. Corporate Opportunity. In some circumstances the duty of loyalty requires that a director make a business opportunity available to the corporation before the director may pursue the opportunity for the director's own or another's account. Whether such an opportunity must first be offered to the corporation will often depend on one or more of the following factors:
If a director believes that a contemplated transaction might be found to be a corporate opportunity, the director should make full disclosure to the board and seek its authorization to pursue the opportunity. A director should deal in confidence with all matters involving the corporation until such time as there has been general public disclosure. A director of a publicly held corporation is often asked by investors and investment advisers to comment on sensitive issues, particularly financial information; however, an individual director is not usually authorized to be a spokesperson for the corporation and, particularly when market-sensitive information is involved, should avoid responding to such inquiries. A director normally should refer investors, market professionals, and the media to the chief executive officer (CEO) or other individual designated by the corporation. F. Fairness, Documentation, and Policies 1. Fairness to the Corporation. Disinterested directors reviewing the fairness of a transaction having self-dealing elements are essentially seeking to determine whether the proposed transaction is on at least as favorable terms to the corporation as might be available from other persons or entities, whether it is reasonably likely to further the corporation's business activities, and whether the process by which the decision is approved or ratified is fair. If minority shareholders could be adversely affected, the directors should be especially concerned that the minority receives fair treatment. This concern is heightened when a dominant shareholder or shareholder group has a divergent or conflicting interest. 2. Documentation of Conflicts. As a general rule, disclosures of conflicts of interest and the results of the directors' consideration of the matter should be documented in the minutes or reports of the meeting. 3. Written Policies. Many corporations have adopted written policies on conflicts of interest (often in conjunction with other major policies, such as trading in the corporation's securities and compliance with antitrust, environmental, and antidiscrimination laws) and procedures to monitor compliance with these policies. SECTION 4 - Board Structure and Operations Boards of directors should be structured and their proceedings conducted in a way calculated to encourage, reinforce, and demonstrate the board's role as an independent and informed monitor of the conduct of the corporation's affairs and the performance of its management. Board structure and practice will, over time, significantly affect the extent to which a board of directors is likely to exercise its powers and discharge its obligations in a manner that effectively advances corporate objectives. No single governance structure fits all publicly held corporations, and there is considerable diversity of organizational styles. Each corporation should develop a governance structure that is appropriate to its nature and circumstances. In determining board composition, the focus should be on the personal qualities and business experience of the individual directors, and the overall mix of experience, independence, and diversity of backgrounds likely to make the board of directors, as a body, most effective in monitoring the performance of the corporation. If the board of directors is to function effectively, it must exercise independent judgment in carrying out its responsibilities. It is also important that the board not only exercise independent judgment, but also be perceived by shareholders and other corporate constituencies to be doing so. To encourage an environment likely to nurture independence in fact and to communicate that appearance of independence, at least a majority of members of the boards of publicly held corporations should be independent of management. A director who is an executive officer of the corporation or who is an employee devoting substantially full time and attention to the affairs of the corporation, one of its subsidiaries, or any other corporation controlling or controlled by the corporation, will be viewed as a management director. A director who has not been active in the management of the corporation and who is therefore otherwise properly described as a nonmanagement director may nonetheless have some relationship with the corporation or its management that could be viewed as interfering with the exercise of independent judgment. As a general rule a director will be viewed as independent only if he or she is a nonmanagement director free of any material business or professional relationship with the corporation or its management. The circumstances and various relationships that have been often identified as presumptively inconsistent with independence include:
There is considerable discussion of different ways to strengthen the role of independent directors. Suggestions include having:
Some of these suggestions are controversial. Although few have yet been widely implemented or represent common practice, many boards of large, publicly held corporations will likely be addressing these issues in the coming years. Each corporation should determine the best board size to accommodate key objectives, including:
Other factors that might influence board size are the special needs of certain types of corporations to maintain a strong community presence, to establish or maintain relationships with customers or other constituencies, and to respond to other factors that may be idiosyncratic to the corporation or industry in which it operates. In accommodating these other needs, the board size should not be expanded to such an extent as to interfere with its effective functioning. There is substantial variation in the size of boards of publicly owned corporations. Banks, insurance companies, and larger corporations with complex businesses typically have larger boards, averaging about fifteen members. By contrast, the boards of smaller industrial corporations now average about eight or nine members. This may reflect the emerging consensus that, except perhaps in the very largest and most complex corporations, smaller boards (those with twelve or fewer members) function more effectively than larger boards. Directors serving on a smaller board have more opportunity to ask questions, exchange opinions, and otherwise participate in board deliberations. Larger boards may make effective participation by individual members more difficult. Large boards often resolve this problem through delegation of significant activities to various board committees. Nonmanagement directors are expected to devote substantial time and attention to the affairs of the corporation-at least sufficient time to permit the directors to prepare for and attend meetings of the board and board committees and to keep themselves informed about the corporation's business. The time required varies widely. Surveys indicate that, on the average, directors of public companies devote about 100 hours to board service each year-approximately the time required for six full days of meetings and six full days of preparation for meetings and reviewing other materials. The time commitment expected of directors is a subject that should be reviewed by the board and communicated to existing and prospective directors. Directors should take care not to overcommit themselves, and nominating committees should consider a board candidate's ability to devote the necessary time. In times of crises or in similar circumstances, directors of public companies will be required to devote a substantial amount of time in addition to their normal commitment to the corporation. Directors have an unavoidable conflict of interest in fixing their own compensation. That conflict is not reduced if the recommendation is made by management. When directors recognize they have the responsibility to determine their own compensation, they are more likely to make sure they have the data necessary to reach a fair conclusion. That includes data on comparable companies, together with analysis of any special factors that may relate to the particular corporation. Directors should be fairly compensated. A major objective of board compensation plans should be to compensate directors fairly and in doing so to align their financial interests with the long-range objectives of the shareholders. Directors' compensation may take a number of different forms, including annual retainers and attendance fees for board and committee meetings, deferred compensation plans, retirement programs, matching educational or charitable contributions, and accident or other insurance. The board should be alert to avoid compensation policies or the use of corporate perquisites that might tend to subvert the independence of its outside directors or divert their focus from proper long-range corporate objectives. In this respect, some believe that stock options and restricted stock grants to directors strengthen directors' interest in the overall success of the corporation, while others believe that these forms of compensation tend to align directors' interests too closely with those of management. The quality of information made available to directors will significantly affect their ability to perform their roles effectively. Information submitted to the directors should be relevant, concise and timely, well organized, supported by any background or historical data necessary or useful to place the information in context, and designed to inform directors of material aspects of the corporation's business, performance, and prospects. Information should be provided sufficiently in advance to provide time for thoughtful reflection and meaningful participation by the directors. The number of board meetings a corporation finds necessary or useful varies with the circumstances. Some boards prefer more frequent and shorter meetings. Others prefer fewer but lengthier meetings. On average, boards of directors of publicly owned corporations meet six times a year. Time at board and committee meetings should be budgeted carefully. A balance should be sought between management presentations and discussion among directors and management. Written reports that can be given concisely and effectively in advance should be furnished. There are special occasions when the nonmanagement directors may wish to meet alone for consideration of a takeover, leveraged buyout, or similar situation. In such cases special advisers, including legal counsel, may be asked to help the directors address the issues at hand. Whether the meeting is structured as a special committee meeting or as part of a regular board meeting, holding such a meeting is an appropriate exercise of directors' rights. The question of what will be discussed and acted on by the board is typically initially determined by management. Directors should be given an opportunity to place items on the agenda. Further, the board should satisfy itself that there is an overall annual agenda of matters that require recurring and focused attention, such as achievement of principal operational or financial objectives and review of the performance of the CEO and other members of executive management. SECTION 5 - Rights of Directors The law recognizes certain prerogatives as necessary to performance of a director's duties. Among the most important are the rights to:
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