Corporate boards are run on the principle of fiduciary duty, and that principle has been taking a beating lately.
and its progeny have assured that corporate governance has been hot topic on Wall Street over the last six months. The zeitgeist spiked again this week when
sued former director Frank Walsh for accepting a $20 million fee from now ousted CEO Dennis Kozlowski to broker the company's acquisition of CIT Group. Kozlowski himself has been accused of evading sales tax on art, which the Tyco board might have lent him the money to buy.
New York Stock Exchange
proposed tightening their listing requirements earlier this month to encourage better corporate governance. But the body of law governing directors' fiduciary obligations, or their legal duties to shareholders, probably won't fundamentally change, experts said.
"It's simple to explain, but it's not always simple to execute, or we wouldn't have these kinds of problems," said Nel Minnow, a frequent commentator on corporate governance and editor of the
, a Web site devoted to the topic. "All I can say is, the fiduciary standard is the strictest standard ever developed under the Anglo-American legal system," she said.
Rights and Duties
Under state corporate law (usually Delaware's, where most companies are incorporated), directors have a duty to put shareholders' needs before those of anyone else, especially their own, and are obligated to devote time and energy to fulfilling that duty. These basic principles are called the duty of loyalty and the duty of care. Beyond these, there is a vast history of case law and a diverse body of corporate bylaws, experts said.
"There are some guidelines under company law, but a lot of it is left to the discretion of individual companies," said Bernard Black, a professor at Stanford University Law School. Each company writes its own by-laws.
Certain lawyers would have you believe that standard has become radically harder to meet over the years. It's reflected in the skyrocketing number of securities lawsuits -- 500 in the past year alone -- that have been filed. While suing companies anytime they release bad news is now a cottage industry, few would argue that more scrutiny isn't being leveled on directors these days.
In many of the current scandals, corporate directors are accused of putting their own financial interests, or those of other board members, ahead of shareholders'. The board of
, a stock that is now trading for about 15 cents, extended $2.3 billion in bank loans to the founding family, which owns 20% of the company. The board of debt-saddled
lent former CEO Bernie Ebbers hundreds of millions of dollars, money he used to bet on his company's shares. And Kozlowski paid Frank Walsh $20 million for his help on the CIT deal, a payment that allegedly was never cleared by the board.
According to case law, most financial decisions must be authorized by the full board or one of their committees. "The basic standard is disclosure to the board any time you have a material transaction with the corporation, and then obtaining the approval of disinterested directors," said John Coffee, a Columbia Law School professor.
And while a company's bylaws can authorize the CEO of the company to spend a certain amount of money without consulting the board or allow him to get approval after the fact, big payments are hard to justify if an executive can't prove that they made good business sense. For example, payments to directors for additional services, like consulting, have to fall in line with market values.
Ultimately, most lawsuits against corporate boards challenge the wisdom of particular takeovers and acquisitions, says Minnow. "Sometimes there are lawsuits about other improper business actions, but it can't be issuing new Coke," she says. "It has to be something big, that usually means a business combination of some kind."
To protect against rampant second-guessing of executive decisions, the courts have established the Business Judgment Rule. Lots of business decisions go awry, and they can't all be subject to legal inquiry lest directors stop taking risks all together, the thinking goes. The rule says that if fiduciaries act on an informed basis and in a manner they believe to be in the best interest of shareholders, they aren't liable for actions that cause shareholders to lose money.
"So if you did everything in your power to make sure New Coke was going to be a success, we're not going to say you should have known that," says Minnow. "We're going to say, OK, you followed all the right steps, because if we don't say that no one will ever take a risk. And for every new Coke that's a failure, there's a Diet Coke that is a success."
Case law indicates that when considering a purchase or acquisition, companies have to appoint an independent committee, internal legal counsel and investment banker to examine the deal, she said.