It's a basic tenet of US corporate law that a director must be informed, especially when making decisions about important transactions, as well as exercising appropriate levels of oversight. Yet, as a matter of corporate law, rather than securities regulation, directors are rarely held liable for failing to adequately oversee the process of preparing corporate financial disclosures.
In Guttman v. Huang, for example, the plaintiffs alleged that the directors failed "to ensure that NVIDIA had in place the financial control systems necessary to ensure compliance with applicable accounting standards." Chancellor Leo Strine explained that:
Generally where a claim of directorial liability for corporate loss is predicated upon ignorance of liability creating activities within the corporation, in my opinion only a sustained or systematic failure of the board to exercise oversight-such as an utter failure to attempt to assure a reasonable information and reporting system exists-will establish the lack of good faith that is a necessary condition to liability. Such a test of liability-lack of good faith as evidenced by sustained or systematic failure of a director to exercise reasonable oversight-is quite high. But, a demanding test of liability in the oversight context is probably beneficial to stockholders as a class, as it is in the board decision context, since it makes board service by qualified persons more likely, while continuing to act as a stimulus to good faith performance of duty by such directors.
Hence, at a bare minumum, there must be evidence that "specific red ... flags were waved at the outside directors" for liability to arise in this context.
Contrast this US reticence to a recent Australian case described at The Defining Tension, in which "The central question ... was whether the directors were required to apply their own minds to, and carry out a careful review of, the proposed financial statements and the proposed directors report, to determine that the information they contained was consistent with the director's knowledge of the company's affairs, and that they did not omit material matters known to them or material matters that should have been known to them."
The court ruled that:
What is required is that such documents [i.e., the financial reports], before they are adopted by the directors, be read, understood and focussed upon by each director with the knowledge each director has or should have by virtue of his or her position as a director. I do not consider this requirement overburdens a director, or as argued before me, would cause the boardrooms of Australia to empty overnight. Directors are generally well remunerated and hold positions of prestige, and the office of director will continue to attract competent, diligence and intelligent people.
The case law indicates that there is a core, irreducible requirement of directors to be involved in the management of the company and to take all reasonable steps to be in a position to guide and monitor. There is a responsibility to read, understand and focus upon the contents of those reports which the law imposes a responsibility upon each director to approve or adopt. ...
What each director is expected to do is to take a diligent and intelligent interest in the information available to him or her, to understand that information, and apply an enquiring mind to the responsibilities placed upon him or her. Such a responsibility arises in this proceeding in adopting and approving the financial statements. Because of their nature and importance, the directors must understand and focus upon the content of financial statements, and if necessary, make further enquiries if matters revealed in these financial statements call for such enquiries.
It's a securities law case, but it reads like a statement of corporate directors' duties, so the comparison to Delaware law may still be appropriate. As I read the opinion, Australian courts are going to give directors less deference. It seems directors who overlook yellow caution flags may face liability.
That's clearly not the law of Delaware. See Chancellor Chandler's opinion in the Citigroup case:
Even accepting plaintiffs’ allegations as true, the Complaint fails to plead with particularity facts that would lead to the reasonable inference that the director defendants made or allowed to be made any false statements or material omissions with knowledge or in bad faith. Accordingly, plaintiffs have failed to plead with particularity facts creating a reasonable doubt that the director defendants face a threat of personal liability ....
Where Australia seemingly allows impositin of liability for negligence in overseeing financial statements, Delaware requires bad faith or knowledge.
