Guidelines for Directors of Financial Institutions in the Current Business Climate

The current business climate has made it more difficult than ever for a director of a public financial institution to effectively discharge his or her duties to the full satisfaction of all applicable constituencies. The stories making headlines today — Enron, Tyco, WorldCom and others — have cast corporate executives and boards in a very poor public light. While it is not yet clear that the instances of true willful wrongdoing on the part of corporate executives in the current cycle have been any more pervasive than in past business cycles, the dollar amounts involved have been staggering and it is clear, with the benefit of hindsight, that more could and should have been done to monitor executive conduct, instill higher ethical standards and improve the clarity and integrity of financial reports. With numerous reform proposals pending before Congress, the SEC and the NYSE, and more to come, the standards defining best practices in corporate governance are likely to change. In this current environment, boards must be proactive to ensure that they are remaining current with the shifting tides of best practices in all critical areas. The boards of public financial institutions, in particular, have a heightened responsibility to serve not only the interests of their public shareholders, but also to make sure that their institutions are run in a safe and sound manner to the proper satisfaction of their regulators. Bank and thrift directors can well understand the current climate of mistrust, since it was only a decade ago in the period leading up to FIRREA that the savings and loan and banking crisis was capturing the major headlines of the day. And, while meaningful corporate reforms can be expected in response to today’s broader crisis in investor and public confidence, FIRREA and the entire regulatory framework governing banks and other regulated financial institutions already place substantial weight and responsibility on the shoulders of directors of regulated financial institutions. With or without additional rule changes, the fundamental responsibilities of directors of public financial institutions will likely remain largely the same — to be engaged, informed and faithful fiduciaries and gatekeepers protecting the long-term interests of shareholders and the other important constituencies that they serve (including regulators, employees, customers and the public). That job, while more difficult in the current climate, is not an impossible one. Importantly, it requires as much an exercise of common sense business judgment as it does any particular extension of technical expertise (though all directors, and audit committee members in particular, should have a level of financial literacy). It requires skepticism, diligence and a willingness to ask tough (and oftentimes, basic) questions, while making sure that the answers received are understandable. It requires a level of prudence in making sure that an institution does not take on an undue level of risk and a level of vigilance in making sure that any regulatory criticisms or identified audit or control deficiencies are quickly rectified to the full satisfaction of the regulators and/or auditors. The following overview touches on many of the hot button issues of the times. Best practices in these areas are continuing to evolve and no one set of practices will be right for all companies or boards. Also, the issues of today may not be the issues of tomorrow and care must be taken to ensure that changes in reaction to the crisis of today do not lead to unintended consequences in the future. This guidance should be used in conjunction with the many other valuable resources available to directors. REGULAR PERIODIC GOVERNANCE REVIEWS All boards should consider establishing a corporate governance/nominating committee, composed entirely of independent directors, that takes a leadership role in shaping the corporate governance policies of the board. This committee, together with the full board, should conduct an annual corporate governance check-up to ensure that the board is adhering to the best practices in all applicable areas and that the board and all of its committees are functioning effectively. As recently proposed by the NYSE Corporate Accountability and Listing Standards Committee, all corporations should consider adopting a set of corporate governance guidelines and procedures addressing the following general topics: • Director qualification standards and selection (experience, independence, nomination procedures, optimal board size) • Director duties and responsibilities (legal duties, attendance at meetings, approvals and delegations) • Board committees (structure, membership standards, duties and responsibilities, review of committee charters) • Membership and composition of subsidiary boards (satisfaction of regulatory considerations relating to regulated subsidiaries, relationship between holding company and subsidiary boards) • Information requirements (orientation, continuing education, standing reports, notification of events, document retention) • Meeting schedule and agendas (schedules and timing, standing agendas, meeting materials, minutes and record keeping) • Director access to management, employees, internal and external auditors, regulators and independent advisors • Director compensation and D&O insurance and indemnification • CEO and senior management evaluation and management succession • Compliance oversight and risk management • Annual performance evaluation of the board’s effectiveness • Benchmarking against NYSE and other applicable rules and regulations and peer company practices BUSINESS CONDUCT AND ETHICS Perhaps the most important of the board’s responsibilities is to set the tone for the corporation’s code of business conduct and ethics. This is particularly true in the case of regulated financial institutions. The board must establish the proper code of conduct not just for its own members but must also set the tone and standards by which the conduct of management and all employees of the institution will be judged and monitored. While putting words to paper is an important start, the more significant effort must be placed on establishing proper training and compliance programs to ensure that the highest standards of conduct and ethical behavior are adhered to throughout the organization. To ensure the integrity and effectiveness of the corporation’s compliance infrastructure, the board should consider designating a senior executive officer who is responsible for overseeing all legal and regulatory compliance and ethics programs with a direct reporting responsibility to the board. This compliance monitor ideally should not have separate business line responsibilities. The board’s oversight of business conduct, ethics and controls should encompass the following areas: • Compliance with laws and regulations • Conflicts of interest • Ethics programs and compliance training and education • Insider trading • Corporate opportunities • Competition and fair dealing • Consumer compliance and fair lending • Discrimination and harassment • Health and safety • Record keeping • Confidentiality • Protection and proper use of company assets • Payments to government personnel • Reporting of illegal and unethical behavior DIRECTORS’ DUTIES AND RESPONSIBILITIES The basic responsibility of directors is to exercise their business judgment to act in a manner they reasonably believe to be in the best interests of the company and its shareholders. Directors of regulated financial institutions also have a responsibility to exercise their sound business judgment in an effort to ensure that their institutions are operated in a safe and sound manner in conformity with all applicable regulatory requirements. In discharging these obligations, directors are entitled to rely on management and the advice of the company’s outside advisors and auditors. In the current environment in particular, however, directors should take extra care in establishing that they have a reasonable basis for such reliance — namely, by establishing that they have a strong foundation for trusting the integrity, honesty and undivided loyalty of the management team upon whom they are relying and the independence and expertise of the company’s outside advisors and auditors. Directors should not be expected to be guarantors that nothing will go wrong on their watch, nor should they (as opposed to management) be expected to certify the accuracy and completeness of the company’s financial statements. Directors are monitors and gatekeepers charged with the duty of installing competent managers and selecting competent auditors who they reasonably believe will serve the best interests of their institutions and diligently monitoring their conduct. They should inquire with due care to make sure that the institution is being run in a safe and sound manner in compliance with applicable laws and regulations, insist that management take the requisite responsibility for ensuring the accuracy and completeness of the company’s financial statements and take all necessary corrective actions when compliance failures or deficiencies are noted. Directors are expected to attend board meetings on a regular basis and the meetings of the committee on which they serve and to spend the time that is needed to properly discharge their functions. Directors should make sure that they are receiving from management and from the company’s auditors and outside advisors all of the information and data they deem relevant to understanding the issues before them and reaching sound business judgments with respect thereto. Perhaps the clearest lesson so far from the accounting and compliance crises making headlines today is that, too often, boards did not have clear information as to what was going on at the companies in question. There is also a growing consensus that smaller boards function better than larger ones. No matter what size board is chosen, all directors on that board should make sure that they are continuing to play an active, constructive and informed role on the board. LOYALTY, CARE AND CANDOR As public companies and the various bodies that regulate their conduct move to address the challenges of the current climate, it is important that directors and officers not lose sight of the basic tenets upon which all of the rules and procedures affecting them are intended to be built. As fiduciaries to the shareholders and institutions they serve, corporate officers and directors have three fundamental duties, as has been long recognized in the law: the duty of loyalty, the duty of care and the duty of candor. In recent years, some have lost focus on these fundamental obligations and instead have tried too hard to please too many constituencies. While some attribute this flaw in corporate behavior to greed and an obsession with personal profit (and certainly there have been some excesses in this regard), most directors and officers are honest and dedicated fiduciaries. Where the system has failed, it has failed as often due to a desire to please and go along (and thus a failure to ask the hard questions and throw up road blocks where they should be established) as it has due to dishonesty or bad intent. Process will be important in restoring confidence in the system of corporate governance, but an attention to substance as always will remain most important. In the current times when complex legal, governance or accounting issues arise — in addition to any specific procedural checklist one follows — it may be useful to ask the following simple questions: • Have I acted with undivided loyalty to the constituents I am serving and have all my personal interests in this matter been fully disclosed? • Have I exercised due care in examining the issues underlying the proposed action, including whether the action is in compliance with all applicable rules and regulations? and • Will the proposed action and the relevant facts relating thereto be candidly disclosed to all affected parties? If the answers to those questions are yes, in almost all instances a fiduciary will be properly protected in exercising his or her business judgment and, even if the judgments proved flawed with the benefit of hindsight, the actions should be free of subsequent reproach. DIRECTOR COMPENSATION AND D&O INSURANCE AND INDEMNIFICATION Director compensation is one of the more difficult issues on the corporate governance agenda. On the one hand, more is being expected of directors today in terms of time commitment, responsibility and exposure to public scrutiny and potential liability. On the other hand, the higher the director’s pay, the greater the chance that such pay is used against the director as evidence of a lack of true independence. The form and amount of director compensation should be determined by the compensation committee with appropriate benchmarking against peer companies. While there has been a current trend, encouraged by institutional shareholders, to establish stock-based compensation programs for directors, the form of such programs should be carefully considered to ensure that they do not create the wrong types of incentives for directors. In the current environment, restricted stock grants, for example, may be preferable to option grants, since stock grants will align director and shareholder interests more directly and avoid the perception that option grants may encourage directors to support more aggressive risk taking on the part of management to maximum option values. Perquisite programs and company charitable donations to any organizations with which a director is affiliated should also be carefully scrutinized to make sure that they do not jeopardize any director’s independence or create any potential appearance of impropriety. Any payments to directors for consulting or other services beyond the regular directors fees should be carefully considered and fully disclosed. Whatever the compensation program that is agreed upon for directors, all directors should be fully indemnified by the company to the fullest extent permitted by law and the company should purchase a reasonable amount of director and officers’ insurance to protect the directors against the risk of personal liability for their services to the company absent willful misconduct by the director. Bylaws and indemnification agreements should be reviewed on a regular periodic basis to ensure that they provide the fullest coverage permitted by law. Directors can also continue to rely on their exculpation for personal liability for breaches of the duty of care under charter provisions put in place pursuant to Section 102(b)(7) of the Delaware corporation law and similar statutes in other states. D&O coverage, of course, provides a key protection to directors. While such coverage is becoming more expensive, it is still available in most instances and remains highly useful, despite some recent decisions construing the terms of D&O policies less favorably to the insured. In this regard, it is important to note that D&O policies are not strictly form documents and can be negotiated. Careful attention should be paid to retentions and exclusions, particularly those that seek to limit coverage based upon a lack of adequate insurance for other business matters, or based on assertions that a company’s financial statements were inaccurate when the policy was issued. Care should also be given to the potential impact of a bankruptcy of the company on the availability of insurance, particularly the question of how rights are allocated between the company and the directors and officers who may be claiming entitlement to the same aggregate dollars of coverage. To avoid any ambiguity that might exist as to directors’ and officers’ rights to coverage and reimbursement of expenses in the case of a bankruptcy, many companies are purchasing separate supplemental insurance policies covering only directors and officers and not the company (so-called “side-A” coverage) in addition to their normal policies which cover both the company and the directors and officers individually. INSIDER TRADING AND DIRECTORS’ RESPONSIBILITIES UNDER THE SECURITIES LAWS The federal securities laws prohibit corporate insiders, including directors, from purchasing or selling securities, either in the open market or in private transactions, when they possess undisclosed material information concerning the company. The securities laws also prohibit insiders from giving tips either by revealing nonpublic material information concerning the company to others or by recommending that others buy or sell shares in the company based on material undisclosed information. Insiders are also generally prohibited from engaging in short sales of the company’s shares, and must report their transactions in company shares or related derivative securities (the SEC has recently proposed significant revisions to these reporting requirements, calling for more current disclosure of any insider transactions). Transactions in company shares by directors are also subject to short-swing profit disgorgement provisions, and there are limits on the scope and nature of insider sales that can occur without prior registration of such sales. The logical conclusion of all these rules is that no director should engage in any transaction involving the company’s shares without carefully clearing that transaction with the company’s counsel. And no director should share any nonpublic information concerning the company with anyone outside of the boardroom. Further, there is never an upside for a director in making a recommendation to any person regarding their purchase or sale of securities in the company, even if it is at a time when the director believes that he or she is not in possession of material non-public information. Recent changes in the rules governing insider purchases and sales have made it somewhat easier for directors to engage in purchase or sale transactions. So-called Rule 10b5-1 plans can now be established pursuant to which a director can commit to a pre-established plan for disposing of a specified number or value of shares or alternatively for acquiring a specified number or value of shares over a predetermined period of time. Whether or not a director is using a Rule 10b5-1 plan, extreme conservatism should be applied in the current environment with respect to any decisions to trade in the company’s shares. There are numerous pending lawsuits challenging director transactions which had the misfortune of preceding a significant change in the company’s fortunes, even though the directors may have had no reason to be aware of such potential change in fortune at the time of their sales. Many have argued in the current environment that the best policy is for directors to avoid any sales transactions while serving on the board (or at a minimum to make sure that all such sales are pursuant to Rule 10b5-1 plans adopted during clear window periods). While purchases for long-term investment are less likely to cause problems, here too directors should make sure that there are no developments, whether or not they are about to be disclosed, that could cast such purchases in a bad light. With proposed changes in the reporting timetable for periodic SEC filings and the heightened sensitivity of stock prices to any information that is disclosed, all companies should carefully consider their policies on trading and window periods for insider transactions. Directors should also recognize that they have significant responsibilities under the federal securities laws for the disclosures contained in registration statements filed under the Securities Act of 1933 and in periodic reports, proxy statements and other filings made pursuant to the Securities Exchange Act of 1934. Too often, SEC documents are filed (including statements which have been directly signed by the directors) without a careful review of such documents by the directors. While directors must, as a matter of practical necessity, rely on management and outside advisors to prepare such documents, they should take an active role in making sure such documents fully comply with the applicable disclosure requirements and tell a full and complete story to the public. INDEPENDENCE Under the recently proposed governance and disclosure reforms proposed by the NYSE committee, all boards would be required to have a majority of directors who are “independent.” For a director to be deemed “independent,” the board must affirmatively determine that the director has no material relationship with the company and the basis of that determination must be disclosed in the company’s proxy statement. There would be a five-year cooling-off period before a former employee of the company or the company’s auditor or any immediate family member thereof could be deemed independent. In addition, no director of a company could be deemed independent if he or she is, or in the past five years was, part of an “interlocking” directorate in which an executive officer of that company served on the compensation committee of the company that employs the director. All companies, as part of their broader governance reviews, should carefully consider which directors satisfy these requirements for independence. In all cases, companies should be very careful in the current environment to make full and complete disclosure of any relationships or transactions that could be deemed to affect the independence of a director. As we have witnessed in the case of Enron and other recent high profile situations, many relationships that may have been considered commonplace in the past (such as a director’s involvement with a nonprofit organization that is heavily supported by the company) may in today’s skeptical environment cast doubt on the level of that director’s independence when viewed with hindsight after a crisis has arisen. This is not to say that all such relationships should be prohibited, but rather that all should be considered in assessing a director’s independence and in governing the relationship between that director and any interlocking matters. Once satisfied with the board’s composition, companies should consider available procedural approaches to assure that the benefits of an independent board are fully realized. The recent NYSE governance committee proposals would require boards to convene regular executive sessions in which the outside directors meet without management and to disclose the name of the director who presides at such meetings. They stop short of requiring the designation of a “lead director” from among the outside directors, or mandating separation of the positions of Chairman and CEO. The question of how to empower independent directors to serve as an effective check on management is one that will have to be resolved within the context of the specific requirements and dynamics of each individual company, and there is no one blueprint that will work best in all situations. Nonetheless, regular executive session meetings of the outsider directors will provide a valuable opportunity to candidly address concerns about the company and its condition or the level of performance of the board itself. These sessions should play an important role in ensuring that there is a robust discussion of board matters and a fair and full evaluation of management performance taking place among the independent directors. THE ROLE OF THE AUDIT COMMITTEE The role of the audit committee has come under increasing scrutiny. Especially in the current environment, audit committees will be expected to exercise a level of heightened care in monitoring the integrity of the financial statements of the company, the independent auditor’s qualifications and independence, the performance of both the company’s internal audit function and its independent auditors and the compliance by the company with legal and regulatory requirements. The audit committee should be comprised solely of independent directors, and the standards of independence as applied to audit committee members should be exceedingly strict. The chairman of the audit committee should have accounting or related financial management expertise. The audit committee should have a written charter that spells out in sufficient detail the committee’s purpose and the duties and responsibilities of its members. The audit committee must also prepare the report required by SEC rules to be included in the company’s annual proxy statement. The law is clear that directors and members of the audit committee may rely on management, the internal auditor, the independent auditor, legal counsel and other advisors, absent a reason to doubt their competence or fidelity. Absent enactment of some of the more extreme reform proposals that have been put forth recently, there should be no change in the liability exposure of directors and members of audit committees. The courts recognize the necessity of not changing the rules that assure directors that they will not be held personally liable for failing to discover misrepresentations by management and the auditors, and that this assurance is critical to having competent, independent people continue to serve as directors of public companies. To exercise due care, however, audit committees will need to spend more time and energy and companies will have to reexamine the scheduling of audit committee meetings and the level of staff support that is provided to the committee. The charter and procedures of the audit committee should be reviewed on a regular periodic basis to bring them up to the current state of the art. The audit committee should meet with the company’s independent auditors and legal counsel to obtain advice that this is so. Among other useful reference materials, audit committee members may wish to review the recent March 11, 2002 speech by Robert Herdman, Chief Accountant of the SEC, setting forth his views as to what the requisite practices of an audit committee should be. The audit committee should meet with the outside audit firm and review that firm’s quality control procedures to determine if they are satisfactory. The audit committee should also review any non-audit related work that is being performed for the company by the outside auditors and place strict limits on the extent of any such work that can occur without prior audit committee review and approval (and any such non-audit work should be discouraged except where a good record can be established as to why it makes sense for the auditor to be performing such services and that the performance of such additional services will not impair the independence of the auditor’s audit work). The audit committee should review the company’s “critical accounting policies” with management and the audit firm. The committee should also take the lead in making sure the company’s periodic SEC reports and its regular and special earnings releases are clear and understandable and fully disclose all information that is relevant to investors in gaining a full and accurate picture of the company’s financial condition and prospects. THE ROLE OF THE COMPENSATION COMMITTEE The compensation committee is responsible for discharging the board’s duties relating to compensation of the company’s directors and officers, including through its review and oversight of all compensation plans, policies and programs of the company. The compensation committee must also prepare an annual report on executive compensation for inclusion in the company’s proxy statement. While management may participate in committee meetings as and when appropriate, the committee should be comprised solely of independent directors. It should be clearly established that the committee has the authority to retain and terminate any compensation consultant to be used to assist in the evaluation of director, CEO or senior executive compensation. The committee should also have the right to obtain advice and assistance from internal or external legal, accounting and other advisors as required. The committee should review and approve on an annual basis the corporate goals and objectives relevant to CEO compensation, evaluate the CEO’s performance in light of these goals and objectives, and recommend to the board the CEO’s compensation levels based on this evaluation. The compensation committee should also review on an annual basis the compensation of all directors, officers and other key executives, including under incentive compensation plans and equity-based plans. Special attention should be paid to the rules and procedures governing the administration of the company’s 401(k) plans to make sure the rules relating to investments in the company’s shares are properly protective of employee interests. Especially in light of certain recent high profile criticisms of the adequacy of disclosures relating to director and officer compensation, stock transactions and perquisites, the compensation committee should closely scrutinize the company’s policies with respect to such matters. The committee should request the appropriate assurances from management and the company’s legal advisors that all compensation and perquisites are proper, consistent with law and being fully and properly disclosed to shareholders. No compensation or perquisites should be provided to directors or executive officers without full disclosure to the compensation committee. Any compensation or other benefit received by any director or officer from any affiliated entities (using a low threshold for the definition of an affiliated entity) should also be fully disclosed to the committee and careful reviewed to confirm compliance with the company’s code of business conduct and ethics, and law. In the current environment, all public companies must give careful attention to their current compensation practices and must strive to develop appropriately tailored programs that meet the needs of their institution and serve the best long-term interests of their shareholders and other important constituencies. A more conservative approach to disclosure of compensation plans and awards is also warranted in the current environment. Programs governing loans to executives and policies relating to executive perks should be carefully considered and closely monitored by the board. Additional careful thought will need to go into the structure and design of future performance-based executive compensation programs to better ensure that they protect against the creation of short-term windfalls for executives that do not match long-term sustained benefits for shareholders. Reliance on outside benefit consultants, while helpful, does not replace the need for a thoughtful and informed debate by the members of the compensation committee, and the full board, as to the best structures to be used to achieve the optimal long-term results for the corporation and its shareholders. Survey data, by its nature, tends to develop into a self-fulfilling prophecy and is not a substitute for the exercise of informed business judgment and common sense. Also, the accounting treatment of a proposed compensation plan should take a back seat to the underlying economic incentives created by the plan. Consideration should also be given to creating greater incentives for management to achieve moderate but sustained growth in earnings and share value, rather than creating incentives for extraordinary growth levels that may not be fully sustainable over time or come with too great a risk profile for the institution. DELEGATION TO OTHER COMMITTEES The general model of corporate governance (and the requirements that would be established under the recent proposals of the NYSE corporate governance committee) suggest that boards should establish an audit, nomination/governance and compensation committee, each comprised solely of independent directors. In addition to these core committees, boards may wish to establish a variety of additional standing committees to meet their ongoing governance needs. Some boards also establish executive committees to which the full powers of the board may be delegated between meetings. While it is perfectly appropriate to establish such committees, careful consideration should be paid to what matters are delegated to the executive committee as opposed to being raised with the full board in a special board meeting. Special committees are also used by boards from time to time either to deal with conflict transactions or to address particular special investigations or projects. While, again, the use of special committees is perfectly appropriate and useful in many circumstances, such committees are also often used in situations where it might be best to keep the matter in question before the full board (or before an executive committee of the full board). Special committees can become divisive in sensitive situations and there is a risk that the special committee and its chosen outside advisors may take a matter in a direction that would be different than that desired by the full board. Especially in matters of great sensitivity it is often preferable for all directors (or at least all outside directors) to remain active in monitoring the direction of a given matter. SETTING AGENDAS AND ALLOCATING SUFFICIENT TIME AND RESOURCES As major companies during the past 30 years moved away from predominantly local boards with few outside directors to national boards consisting of a large majority of outside directors who were mostly CEOs of comparable major companies, a pattern of board and board committee meetings developed that in many cases involve a working breakfast for committee meetings followed by a board meeting that ends at noon, with a buffet lunch attended by only a few directors because most leave for the airport as soon as the meeting ends. With this type of schedule, committee meetings, including the audit committee, are usually limited to one-to-two hours and the board meeting itself to not more than three hours. Post Enron, this will not do. The SEC, the President, and the Congress have criticized directors for not adequately monitoring the corporations they serve; the legal community, including prominent judges, have stated that Enron’s short meetings are evidence of failure by the directors to fulfill their fiduciary duties; and the New York Stock Exchange and The Business Roundtable, as well as various organizations representing investors, have advocated more extensive agendas for boards and committees and more intensive discussion and review by directors. These agendas and duties make it difficult, if not impossible, to properly discharge the directors’ obligations in the four-to-five hour time frame that has become customary at many companies. In order to provide the time necessary in the post-Enron environment, committees with extensive agendas, like the audit committee, should consider having their meetings scheduled for early in the afternoon of the day before the board meeting and, to the extent required, continuing them through a working dinner. This time frame could also be used for regular meetings of only the non-management directors. The board meeting itself could then start earlier in the morning and continue through a working lunch, with adjournment planned for mid-afternoon. This schedule should permit the consideration and discussion of all that is today necessary to satisfy post-Enron requirements. In addition, boards should consider the desirability of an annual two-to-three-day board retreat with the senior executives at which there is a full review of the company’s financial statements and disclosure policies, strategy and long-range plans, and current developments in corporate governance. Frequently, this retreat is held at a location close to one of the company’s operations so as to give the directors an opportunity to become acquainted with a number of the company’s operations as the annual retreats are rotated among the company’s various locations. During the retreat, meals and social activities can be arranged in a manner that encourages the directors on a one-to-one basis to get to know the senior executives. Companies should also provide comprehensive orientation for new directors so as to acquaint them with the company’s strategy, long-range plans, financial statements, properties and operations, corporate governance guidelines and senior executives. The annual retreat could satisfy a major portion of such an orientation. Assuming directors make good use of the time, this paradigm, which many companies have already adopted, will improve significantly the functioning of boards and board committees and will ensure that the directors cannot be faulted by regulators or in litigation as to the manner in which they performed their duties. CONFIDENTIALITY AND THE RULE OF DIRECTORS OUTSIDE THE BOARDROOM A board should function as a collegial body, and directors should respect the confidentiality of all discussions that take place in the boardroom. Confidentiality is essential for an effective board process and for the protection of the company and its stockholders. Moreover, directors generally owe a broad legal duty of confidentiality to the company with respect to information they learn about the company in the course of their duties. Maintaining confidentiality is also essential for the protection of the individual directors, since directors can be responsible for any misleading statements that are attributable to them. Even when a director believes the subject matter of his or her statements is within the public domain, it is good practice for individual directors to avoid commenting on matters concerning the company. A director who receives an inquiry with respect to the company from someone outside the company may or may not have all of the relevant information and his or her response (based on incomplete information) could involve the company as well as the director in a disclosure violation. Directors should also respect the role of the CEO as the chief spokesman for the company. They should generally not engage in discussions with outsiders concerning company business unless specifically requested to do so by the CEO or the board. Where it is necessary for outside directors to speak on behalf of themselves or the company, here too it is best for one member of the board to be designated as the board’s spokesperson. We have long recommended, in the context of takeover matters, that any overtures to a director be directed to the CEO, and that the directors should not get drawn into separate conversations with outside third parties about the strategic direction of the company. The same recommendation generally holds true with respect to broader governance and operational matters affecting the company. The company should speak in one official voice. Whatever dialogue takes place within the boardroom, the board should strive to maintain a unified voice outside the boardroom. Even where there is dissent on a given matter, those in the minority should voice their dissent but should respect the confidences they are required to observe as directors. While it may be useful in today’s environment for outside directors to take a more active role in meeting with regulators, institutional shareholders and other key constituencies, these meetings should be coordinated through the CEO and senior management of the company, and should be held under the official sanction and approval of the board. CRISIS MANAGEMENT Perhaps the most important test of a board comes in times of crisis. Boards need to be proactive in taking the reigns in the context of any governance, compliance or business crisis affecting their institutions. At the same time, the board needs to be cautious that it does not panic or overreact to any given situation and create a crisis when one need not exist. It is difficult to provide a fair assessment of the way boards have been handling the current crises of the day. It appears that many boards have functioned quite well in taking a careful measured read of the situation and putting in place the right measures for obtaining the necessary information about the issues facing the company and developing the right strategies for reacting to the situation and rectifying any management, disclosure or legal/compliance deficiencies. Others, however, appear to have panicked more than necessary, or to have placed matters in the hands of lawyers, accountants and other outside experts, while losing control of the situation to those outsiders. All crises are different and it is difficult to give generic advice that will be relevant to any particular crisis without knowing the facts involved. All that said, in most instances when a crisis arises, the directors are best advised to manage through that crisis as a collegial body working in unison (with of course the necessary separation of any directors personally implicated in a given matter). While outside advisors (counsel, auditors, consultants and bankers) can play a very useful and often critical role in getting at all of the relevant facts of a given situation and in helping to shape the right result, the directors should maintain control and not cede the job of crisis management to the outside advisors. And, while there is often the impulse to resign from the board upon the discovery of a crisis, in most instances, and particularly in the case of regulated financial institutions, directors are usually best served by staying on the board until the crisis has been fully vetted and brought under control. Even where the institution can not ultimately be saved from bankruptcy, directors that stay to work the problem as best they can and preserve as much value as possible for the institution and its various constituencies will generally be well served by such efforts. * * * Despite the current difficult climate in corporate America, there remain many dedicated and talented individuals who are interested and willing to serve on boards. The interests of shareholders and the public depend upon their continued willingness to serve and their dedication to doing the best job they can. The suggestions set forth above are intended as helpful guidance in that effort. Edward D. Herlihy and Craig M. Wasserman are partners in the corporate practice group of Wachtell, Lipton, Rosen & Katz (www.wlrk.com)in New York.