Autores: Sara B. Brody and Jason T. Nichol, Sidley Austin LLP
Being asked to join the board of directors of a public corporation is an honor. Board membership can be an enriching experience and an avenue for personal and professional growth. However, in an increasingly litigious, regulated and complex public company landscape, director candidates should conduct thoughtful and targeted due diligence on a company and its existing board practices before committing to a role that should be expected to extend over multiple years. The following are ten questions director candidates should ask themselves and the prospective company. The answers to many of these questions can be found in a company’s public disclosures. To demonstrate diligence and an earnestness in learning more about a company, a prospective board candidate may choose to start there before confirming the answers through conversations with current and former directors, senior management or a recruiter.
1. What type of commitment am I making and am I the right fit?
The role of a public company director carries prestige and influence, often affording the director a platform to shape the strategic priorities and direction of some of the country’s best and most innovative companies. However, the significant investment of time and energy required for board service, including preparing for, traveling to, and attending board and committee meetings, should be weighed carefully against the director candidate’s existing executive and/or board duties (if any) and other personal obligations. Before accepting a director position, a candidate should have frank discussions with current and former board members about the time commitment required for board and committee service, the frequency and nature of meetings (i.e., in-person vs. telephonic or virtual, single day vs. multi-day and any time zone considerations), and when board materials are typically circulated to directors. Strong board and committee meeting attendance is especially important as the proxy rules require disclosure of the name of any director who attends less than 75% of the aggregate meetings of the board and the committee(s) on which the director serves, and proxy advisory firm ISS will generally recommend votes against any director falling below that threshold. A director candidate should also discuss with current or former directors whether they think the board is the “right” size to not only facilitate robust discussion and a diversified approach to decision making but also to equitably distribute work among the board and its various committees.
Additionally, a potential director should reflect on whether the company has a demonstrated need for the director’s expertise, how his or her skills and experiences complement those of the other board members, and whether the company’s industry, strategic goals, competitive landscape and future opportunities and challenges will enable a potential director to make valuable and lasting contributions to the company. To inform this assessment, the candidate should also inquire as to what committee(s) the candidate would be asked to serve on.
2. What are the internal dynamics of the board and are there any cultural considerations that warrant special attention?
A director candidate should discuss with current and former directors the board’s approach to meetings and decision-making, including whether the board and management value difficult or probing questions, whether dissenting voices and opinions are heard, whether the board strives toward consensus-based decision making, whether there are any specific or recurring areas of disagreement among board members or between the board and senior management and whether the board is interested in taking positions with respect to controversial “issues of the day.” Responses to these questions may be substantiated by inquiring as to the board’s evaluation processes (i.e., are there any common themes or disparate responses that arise in board evaluations; does the board work regularly with a third-party consultant to improve its internal functioning and governance processes?). To the extent the company’s public filings disclose director resignations or unexpected retirements, a candidate should understand the circumstances of the departure, even if no disagreement with management or the board is explicitly disclosed.
A director candidate should also understand any pre-existing or familial relationships between or among directors, significant shareholders, and senior management and, to the extent those relationships exist, whether they are perceived as ultimately beneficial to the company or whether they may inhibit effective governance. To the extent any directors have been appointed or designated by significant shareholders (including activist investors), a candidate should understand the precise nature of such appointment and whether and to what extent such directors are comfortable taking positions that may not fully align with those of the nominating shareholder.
Director candidates should pay particular attention to the board dynamics of a “controlled” public company with one or more controlling shareholders, including whether any specified charter provisions or obligations in a shareholders’ agreement may limit the board’s authority to take specified actions without the controlling person’s consent. In the context of a controlled company, board members may be subject to enhanced judicial scrutiny (often corresponding to increased attention from the plaintiffs’ bar) in certain transactions involving a controlling shareholder. Board members of controlled companies should also be cognizant that their board service is effectively at the pleasure of the controlling shareholder.
Finally, a director candidate should consider the perspective of the board and senior management with respect to environmental, social and governance (ESG) matters, including whether significant shareholders or prominent proxy advisory firms have identified actual or perceived deficiencies in the company’s ESG efforts or related disclosures.
3. What is the relationship between senior management and the board and what type of information flow does the board receive from senior management?
Director candidates should develop an understanding of the Chief Executive Officer’s leadership and working style, including how and to what extent the Chief Executive Officer engages the board in strategy and whether the Chief Executive Officer or other members of senior management regularly seek and take guidance from the board or instead view the board as a group to be “managed.” As director candidates will undoubtedly find after joining a board, “tone at the top” permeates managerial culture and will have a meaningful impact on interactions between the board and senior management.
In addition to board books and other formal briefing materials, director candidates should get a sense of informal opportunities to gain information about the company. Are directors invited and encouraged to visit the company facilities and offices? Do directors communicate (even socially) outside of regularly scheduled board and committee meetings? Do directors have meaningful access to senior management, including outside the presence of the Chief Executive Officer?
Finally, director candidates should review the voting results from the company’s recent annual shareholder meetings to understand whether any unusual voting results may warrant further explanation. For instance, if tepid “say on pay” voting results suggest shareholder hesitancy or frustration with management’s performance, candidates should discuss with members of the board’s compensation committee whether any responsive actions from the compensation committee have created points of tension with senior management.
A director candidate should also look out for recent withhold vote campaigns targeting specific directors and understand the basis for any such campaign and whether future campaigns may be on the horizon.
4. How is the company performing operationally and financially and what are the company’s most material risks?
Director candidates should review the company’s financial documents and public filings (e.g., the “Risk Factors” and “Management’s Discussion and Analysis” sections of its periodic filings and registration statements) as well as analyst reports, news articles and consensus or “Street” estimates. In addition to combing through these filings and publications to better understand the stated risks and opportunities described in the company’s own words (and whether those most closely following the company find them persuasive), director candidates should listen to recordings or review transcripts of the company’s recent earnings releases to gauge how the company’s leadership team interacts with its investor base and see the senior management in action. In discussions with senior management, a director candidate should inquire as to the nature and engagement of the company’s shareholder base, how the company maintains and facilitates shareholder relationships, particularly with marquee investors (i.e., is there a dedicated team of investor relations professionals?), and whether any recent fluctuations in share price have generated negative reactions from such investors.
The candidate should understand pending matters likely to materially impact the company’s results of operations and financial performance, including material litigation, supply chain and procurement challenges, governmental investigations and human capital initiatives. If a company’s financial statements and other filings suggest significant headwinds or a weak financial position, a potential director should expect a greater time commitment for board service, particularly if the director is on a labor-intensive committee such as the audit committee, and increased legal and reputational risks that may arise as a result of the company’s financial distress.
A director candidate should also understand how the board approaches its overall responsibility for risk oversight, including whether such oversight is primarily managed by the audit committee, by a separate “risk committee” or addressed by the full board. A director candidate should inquire as to whether the company has identified “mission-critical” regulatory and safety risks over which a board may have a heightened oversight responsibility, a recent focus of Delaware courts.
Finally, a director candidate should understand the board’s role in reviewing and addressing whistleblower complaints. Are whistleblower reports regularly provided to the full board or a committee of the board? Does management appear to earnestly investigate whistleblower claims? Does the board have a process to quickly escalate material whistleblower complaints? Have there been any corrective or remedial actions taken recently in connection with a whistleblower complaint?
5. What is management’s approach to internal controls compliance and who are the company’s auditors?
Potential directors should familiarize themselves with the company’s compliance practices, including the company’s internal control and financial reporting structures. Even candidates with limited experience in accounting or financial controls (and who may not be tapped for the board’s audit committee) should discuss actively with management the internal controls process to ensure that robust reporting policies and procedures appear to be in place. Director candidates should inquire as to whether management has previously identified any significant control failures or material weaknesses in internal controls and, if so, develop an understanding of the resolution and the audit committee’s role throughout that process.
Director candidates should also understand the tenure of the company’s independent auditors and the relationship between senior management and key personnel at the auditor. If the company has changed auditors in the past three or four years, a director candidate should understand why and review the company’s narrative disclosure in its proxy statement to make sure the offered explanation syncs up with the disclosed one.
6. What confidentiality and conflict of interest obligations will apply during and after my board service?
Directors are almost always subject to written confidentiality policies of a company that preclude the disclosure or use of confidential information received in connection with a director’s board service. Director candidates should review carefully any confidentiality policies of the company and inquire as to additional confidentiality obligations that may be imposed by state law or otherwise specific to the company’s industry, particularly if the director candidate is employed by a company or in an industry with potentially overlapping vendors, suppliers or service providers.
Director candidates should strive to actively identify any actual or potential conflicts of interest that currently exist or may arise during the candidate’s term of service and promptly disclose and discuss them with the company’s general counsel and board leaders (e.g., the board or audit committee chair or lead independent director). Typical conflicts may include relationships with key vendors, customers or suppliers, material investments in competitors or large shareholders of the company, or financial or other pecuniary interests in potential acquisition targets of the company. Although many conflicts are successfully managed with adequate disclosure, recusal or other proactive measures, actively identifying potential conflicts of interest prior to beginning board service (and promptly raising new issues that arise during a director’s tenure) will engender goodwill with the other board members and senior leadership and reduce the risk of duty of loyalty-based litigation. Director candidates should also be mindful of Section 8 of the Clayton Act (15 U.S.C. § 19) which, to address antitrust concerns, generally prohibits the same person from serving as a director of corporations that are competitors.
In addition to clearly understanding confidentiality obligations and actual and potential conflicts of interest, director candidates should also receive a comprehensive briefing from the company’s internal counsel regarding compliance with federal and state securities laws (including insider trading laws), the availability and use of Exchange Act Rule 10b5-1 trading plans for directors and any applicable stock ownership guidelines.
7. What sort of protections from legal risks will I be afforded as a director?
As referenced above, director candidates may be named in litigation, particularly in claims arising out of securities offerings or alleging breach of fiduciary duties. Many companies have robust indemnification obligations in their organizational documents that obligate a company to bear a director’s legal costs and any settlement or judgment amounts as long as a director has satisfied certain minimum requirements and not engaged in self-dealing or conduct otherwise conflicting with the director’s duty of loyalty.
A director candidate should review carefully the company’s charter and bylaws to understand the company’s indemnification obligations and also request from the company’s general counsel any indemnification agreements provided to directors that offer supplemental protections. In particular, a director candidate should understand whether a company’s charter exculpates directors for personal monetary liability for breaches of the duty of care (subject to exceptions under applicable state law) and also whether a company is obligated to advance expenses to directors in the event of pending or threatened litigation to avoid a director having to pay out of pocket for legal fees and seek subsequent reimbursement from the company. Director candidates should consider engaging outside counsel to review the company’s indemnification obligations and ensure they are both compliant with, and offer the full extent of protection available under, applicable state law.
Although indemnification obligations in a company’s charter and bylaws should insulate directors from liability in normal circumstances, robust D&O insurance coverage is a critical component of a company’s risk management enterprise and should be in place to protect directors in the event of future financial distress or bankruptcy. Potential directors should confer with the company’s general counsel or custodian of its insurance program to understand the company’s D&O coverage, including the size and layers of the program and the insurers providing coverage. In addition to gaining a general understanding of the company’s D&O coverage, a director candidate should understand whether there is an independent directors’ liability policy or a “Side A Only” policy (and what those distinctions mean in light of the company’s comprehensive insurance portfolio), whether any material claims have been paid under the policy, whether any key insurers have recently changed under the policy, and if the company has a long-standing relationship with its insurance broker. Director candidates should also consider guidance from independent counsel on the adequacy of the company’s D&O insurance program and how such coverage intersects with the company’s contractual obligations to indemnify directors set forth in the charter and bylaws.
8. In addition to the structural director protections against financial exposure described above, what are the practical protections against both financial and reputational exposure I may face as a director?
Aside from the financial protections in the charter and bylaws (as may be supplemented by standalone indemnification agreements and D&O coverage), candidates should understand the practical protections, both in terms of personnel and processes, established by the company that will serve as a “first defense” to minimize the risk of reputational harm and financial exposure during a director’s service. In terms of personnel, director candidates should inquire as to the quantity and quality of the company’s legal and compliance department(s), the background of the General Counsel or Chief Legal Officer, the strength of the internal auditing team and the experience of the company’s investor relations and communications teams.
In terms of processes, in addition to understanding the internal control functions described in Question 5 above, director candidates should also discuss with the company’s General Counsel or Chief Legal Officer the company’s efforts to comply with applicable law, promote cyber-security (both internally and with respect to third-party service providers), comply with national and international data privacy regulations and, to the extent the company maintains international operations, comply with the Foreign Corrupt Practices Act and other anti-bribery legislation. For companies in heavily regulated industries, a director candidate should understand in general terms the overarching impact of both domestic and international regulations on the company’s operations. When discussing these processes with the company’s internal legal counsel, a director candidate should also confirm that the company uses qualified outside legal counsel and other consultants and advisors where appropriate to assist in compliance and anticipate legal and regulatory risks.
9. What sort of “onboarding” or orientation process is in place?
Following a director candidate’s election or appointment, most companies host a formal orientation process to introduce the director to the company, its senior management and directors, operations and competitive landscape, and certain regulatory and industry-specific considerations that may arise during service. Director candidates should inquire as to the nature and scope of the onboarding process, including its duration (some onboarding processes involve two to three days of in-person meetings prior to the outset of board service) and whether the candidate will be responsible for completing any materials that may require advance review by outside counsel or other third parties (e.g., indemnification agreements, stock ownership certifications, conflicts inquiries). Director candidates should understand what members of senior management will participate in the onboarding and, if possible, meet with a wide swath of key personnel, including the heads of the company’s investor relations/communications department and compliance and oversight functions and the Corporate Secretary (if different from the General Counsel). Further, candidates should ask whether they will have the opportunity to meet with key external advisors, including the company’s external auditors, and whether the company has implemented any ongoing director education initiatives that extend beyond the formal orientation.
10. How will my service as a board member be compensated?
Board member compensation is fully disclosed in a public company’s annual proxy statement. That said, director candidates should make sure they understand and appreciate the company’s approach to board compensation and perquisites, including the split between cash compensation and equity-based compensation, equity vesting requirements, stock ownership guidelines and any enhancements to compensation for committee chair service. Director candidates may wish to review these compensation and perquisite matters with their personal accounting and legal advisors.
Reflecting on answers to these questions and engaging in thoughtful due diligence will help a candidate evaluate a directorship opportunity and develop a sense of what to expect after board service begins. Careful and thorough due diligence at the outset of a candidacy will pay dividends in determining fit and ultimately positioning a candidate to make a positive and lasting impact on a public company.