Former Delaware Supreme Court Justice Leo Strone recently posted a co-authored article, Board Practices in the Digital Era: Maximizing the Benefit-to-Cost Ratio of Information Technology, which argues that:
Information technology can improve the quality of the deliberative processes of corporate boards of directors. Yet, if used imprudently, these technologies can reduce the integrity of corporate decisionmaking and increase business, legal, and reputational risk.
Regrettably, rather than evolving to keep pace with technological developments, corporate governance practices often involve an admixture of obsolete past approaches and ad hoc new ones, a combination that underutilizes the benefits of technology and increases its potential risks. In this article, we look in particular at two types of board-level practices that should evolve to take into account technological developments:
i) board information policies involving (a) the transmission to and use of information by the board of directors and (b) the documentation of action taken by the board and board committees; and
ii) board meeting practices in the wake of the COVID-19 pandemic and the ubiquitous use of web conferencing platforms to conduct director meetings remotely, rather than in person.
These topics are related, because virtual meetings put pressure on board information policies. Virtual meetings require directors and managers to be self-disciplined so that the efficiency advantages that come with virtual meetings are not undermined by inattention, unproductive online interaction, and insufficient in-person time for the board and key managers to meet and develop the chemistry and expectations for information flow vital to successful governance.
This article is not theoretical, but practical. After situating board practice in its historical context, we make recommendations about affirmative steps — “do’s” — that companies could take to improve their board information policies, positive steps that imply actions to avoid — “don’ts”— which we set forth in correlative footnotes. From there, we recommend “do’s” and “don’ts” for board organizational, calendaring, and meeting practices, an understudied area. We then explain how our recommendations facilitate informed, efficient, and credibly-documented decisionmaking.
First, Strine seems untroubled by the prospect that an emphasis on board information flows and meeting procedures is likely to result in directors having greater exposure to Caremark liability. He appears to believe that board failures with respect to overseeing technology and using technology could result in Caremark liability and that that could be a good thing. (See pp. 7-8.)
I have never shared the enthusiasm for Caremark one sees in some circles. To the contrary, I believe Caremark was a mistake from the outset. I also believe the steady expansion of Caremark liability in recent years has been an appalling error. See my article, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight, which is forthcoming in the Business Lawyer, which argues that:
Since the foundational decision in In re Caremark Intern. Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996), Delaware corporate law has required boards of directors to establish reasonable legal compliance programs. Although Caremark has been applied almost exclusively with respect to law and accounting compliance, the original Caremark decision contemplated applying the oversight duty to the corporation’s “business performance.” Accordingly, there is no doctrinal reason that Caremark claims should not lie in cases in which the corporation suffered losses, not due to a failure to comply with applicable laws, but rather due to lax risk management.
The question thus arises as to whether Caremark should be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. Obviously, where existing legislation or regulations impose compliance obligations in ESG-related areas, such as human resources, the environment, or worker safety, Caremark already applies. As such, boards must “ensure that compliance and monitoring systems are in place” to oversee corporate compliance with those laws.
Many ESG issues are not yet the subject to legal requirements, however. The question addressed in this Article is whether the board’s Caremark obligations should be extended to encompass oversight of corporate performance with such issues. In other words, should the board face potential liability not just for failing to ensure that the company has adequate reporting and monitoring systems in place to insure compliance with ESG-related legal requirements, but also to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational.
Let us turn, however, to the main issue that jumped out at me when I read Strine's article; namely, the ever increasing demands for board expertise.Strine repeatedly calls for boards to have more expertise regarding information technology:
- He posits that Caremark liability arose in cases in which companies "failed to set up structures that ensured adequate time for board members with relevant industry expertise to focus regularly with key company officers on the companies' most important industry-specific issues."
- He thinks companies "need to update board committee structures to prioritize the most important issues at the forefront of board time and to make sure that diverse business risk, EESG, and legal issues are addressed with adequate expertise ...."
The problem is that a combination of increasing regulatory requirements for board expertise, such as the need for financial expertise on the audit committee that resulted from the Sarbanes-Oxley "reforms" to the audit committee, plus the demands of expertise flowing from the steady expansion of Caremark liability, is already forcing companies to seek directors with increasingly specialized expertise. In turn, the demand for specialized firm-specific expertise bumps up against the requirements forcing companies to have almost all board members to be independent directors.
The problem, as Todd Henderson and I explained in our book, Outsourcing the Board: How Board Service Providers Can Improve Corporate Governance:
In contrast to insiders, who possess significant firm-specific human capital, independent directors tend to be generalists with little firm-specific knowledge, skills, or expertise. Modern boards thus tend to be “composed of individuals who are not qualified to assess the strategic viability of the corporations they direct.” Unfortunately, the rules mandating director indepen- dence virtually ensure that this problem will remain insoluble, because they effectively “rule out just about anybody who has firsthand knowledge of the company and its industry.”...
A board composed principally of generalists will typically lack the sort of specialized skills and expertise many board tasks require.
We also pointed out that the increasing desire on the part of boards to embrace stakeholder theory (a trend I deplore, but that's a story for another day) compounds the needs for board-level expertise:
For the traditional board to manage these stakeholder interests, it will have to have a board member with labor or environmental expertise. Some boards may have these people, but perhaps not. Since the range of potential stakeholders is large, it is unlikely that a firm will have a board member that can claim expertise or networks in all the areas in which a firm may want to deploy the board. After all, boards already need a range of expertise in areas like accounting, finance, strategy, the particular industry, compensation, and a host of other topics.
Strine proposes bringing an insider onto the board:
We also think that the case could be made for adding another member of management to the board; although that individual would not be an independent director, the added expertise and experience would benefit the board as a whole.
But as Henderson and I explained:
Even if there is an expert on labor or environmental issues on the board, there is a potential weakness in relying on an individual board member to be solely responsible for managing this process. Although boards routinely dele- gate authority to committees or subgroups of the board, there is additional risk from having a single individual board member be the only person on the board with the information, expertise, and authority to handle the management of an important stakeholder relationship.
There is, however, a solution. It is a solution that would reduce the risk of Caremark liability and bring a huge increase in expertise to the board. It is what Henderson and I proposed in out book Outsourcing the Board: How Board Service Providers Can Improve Corporate Governance. We asked:
Why does the law require governance to be delivered through individual board members? While tracing the development of boards from quasi-political bodies through the current “monitoring” role, the authors find the reasons for this requirement to be wanting. Instead, they propose that corporations be permitted to hire other business associations – known as “Board Service Providers” or BSPs – to provide governance services. Just as corporations hire law firms, accounting firms, and consulting firms, so too should they be permitted to hire governance firms, a small change that will dramatically increase board accountability and enable governance to be delivered more efficiently.
With regard to the board expertise issue, we pointed out that:
When board members currently need outside expertise, it all too often comes from outsiders hired by or influenced by the CEO, which creates serious conflict-of-interest problems. In the BSP model, by contrast, we assume that the board-service company would have an internal expert staff backing up the individuals who provide the board functions. ... This is a classic example of the choice between “building” (that is, having expertise inside a particular firm) and “buying” (that is, hiring the expertise in the market) that firms face in a host of activities.
As we demonstrate in the book, buying board expertise by outsourcing the board function to a consultant firm is going to be much more efficient.
BSPs are highly adaptable. They are well suited to perform the monitoring function as required by current law and best practices, but they are equally well suited to performing service and managerial functions. Indeed, as we shall see, because BSPs are less subject to time and expertise constraints than individual directors, they are capable of fully carrying out the monitoring function while also simultaneously providing more effective advisory, networking, and managerial services.
So the solution seems to be revisiting the possibilities offered by BSPs.
