A very informative and helpful article from law firm Gibson, Dunn & Crutcher, LLC. The checklist in the second part of the article is recommended.
The Director Settlements at Enron and Worldcom; Lessons for Directors
January 18, 2005
As widely reported in the press, a number of former non-management directors of both Enron and WorldCom have entered into agreements to settle pending federal class action lawsuits. What is remarkable about both of these settlement agreements is that the settling directors have agreed to make substantial personal payments - beyond director and officer insurance proceeds - to fund part of the settlement. Not since Smith v. Van Gorkom twenty years ago, when prominent directors of Trans Union Corporation were held personally liable in a state fiduciary duty case, has there been such well-publicized instances of non-management directors reaching into their own pockets to pay investor plaintiffs.
At the same time as these two settlements, the Delaware Chancery Court trial of the Walt Disney Company case continues. There, the plaintiffs claim that the directors breached their state law duties of due care and good faith in failing to appropriately monitor and oversee generous compensation and severance packages for former Disney President, Michael Ovitz. Another case with similar allegations has been brought by creditors against former directors of Integrated Health Services and is apparently headed for trial in the Delaware Chancery Court. In both these cases, if the directors are found to have so neglected their duties that they were not acting in good faith, they may end up having to personally pay damages to the extent that they do not have enforceable and adequate insurance coverage.
In light of these developments, should non-management directors of other corporations be worried? The answer to that question, it seems to us, is clearly "yes." In our judgment, however, the greater risk of liability in cases of major corporate fraud should not discourage director service where a corporation and its board are committed to a culture of integrity and to strong board oversight processes. The more relevant question is, what should concerned directors do to reduce the likelihood of personal liability to an acceptable level?
First, some observations about these four cases that help put the recent developments in perspective.
Thus, each of the four cases differs both as to its factual bases and the legal standards it presents. Yet, in each case, personal financial responsibility of the directors has become an issue and several of the Enron and WorldCom outside directors each have agreed to pay substantial sums to avoid further litigation.
Second, a few other factors have contributed to the current riskier environment.
These are among the factors that may well have prompted several of the Enron and WorldCom non-management directors to settle now even if they and their counsel believed that they have strong defenses to claims made against them.
What, then, can directors of public companies do? While there is no one-size-fits all solution, here are some helpful guidelines:
The audit committee should regularly receive a summary of employee hotline calls, not just formal "whistle blower" complaints, and should meet regularly, in executive sessions, with the general counsel to hear directly about significant litigation and contingent claims. This "homework" will help to disclose the yellow and red flags that will lead to appropriate board inquiry before problems get out of hand. Similarly, the audit committee should be promptly notified of any governmental investigations, or assertions of regulatory non-compliance or accounting deficiencies (including comment letters from the SEC staff) and should oversee, and monitor to completion, the company's responses and appropriate corrective actions.
Board service does present greater liability risks than in the past and anyone who says it doesn't is kidding you. But, these risks can be managed by directors who think carefully before accepting a board seat, insist on an ethical corporate culture, require thoughtful board processes, keep their eyes and ears open for potential problems, and require prompt and appropriate corporate action when questions arise. Board service can be both interesting and rewarding, and informed, independent directors are a cornerstone in the corporate governance structure of public companies. Recognizing this, personal financial liability of individual non-management directors should continue to be a relatively rare phenomenon limited to cases where there are serious questions about the directors' independence from management or an egregious failure to meet reasonable standards of care and diligence.
Gibson, Dunn & Crutcher lawyers are available to assist clients in addressing any questions they may have regarding these issues.
Please contact the Gibson Dunn attorney with whom you work, or
John F. Olson (202-955-8522, firstname.lastname@example.org) or
Amy L. Goodman (202-955-8653, email@example.com).
© 2005 Gibson, Dunn & Crutcher LLP