Just Say No To Public Boards

One of the hazards of being in the venture business is service on public boards. 

I’ve done it three times. And the board and company was sued each time by class action lawyers.

I believe that Boards are a great governance system.  Properly structured and incented, Boards provide an excellent mechanism for the shareholders to govern management.  And that is exactly what they are supposed to do - represent the shareholders interests with the day to day management of the company.

I have served on something like 30 boards in my career. I currently serve on seven boards. I enjoy that part of my job more than any other role.

Three of my current companies are nearing that magical moment when they need to decide how the shareholders are going to get cashed out (“liquidity” in the industry vernacular).

I will push each company to consider a sale of the Company over an IPO.

And if they choose to go public, as much as I enjoy sitting on these three boards, I will most likely resign from the board prior to the filing of the registration statement.

I won’t do that in protest of the choice of IPO over trade sale, I’ll do it to protect myself, my family, my business, and my investors from the increasing legal risks of sitting on public boards.

I spent two and half days last week with a dozen or so other VCs talking about the industry, deals, and a bunch of other things.

One of these VCs said about public boards, “you’d have to be crazy to sit on a public board these days”.  I am not crazy and I don’t intend to do it. 

I wonder who will, frankly.

Sarbanes Oxley has made it so hard to be a public company. It’s expensive to comply with all the rules and regulations.  But even if you spend the time, money, and effort to comply with all the rules, the board and management have a much higher standard to meet. And meeting this standard is no guarantee that you won’t be sued.

But recent events have made things even worse. It used to be that non-management directors who weren’t guilty of fraudulent behavior were protected by the public company’s Director and Officers (D&) insurance policy.  Settlements with class action plaintiffs were usually limited to the coverage amount so that no directors would have to come out of their own pockets to pay damages.

That’s over now with the recent precedents of Worldcom and Enron, where the non-management directors came out of pocket millions of dollars to settle the claims against them.

I suspect that this genie isn’t going to go back into the bottle so easily.

There was an op-ed piece in today's New York Times claiming that the Enron settlement wasn't harsh enough on the directors. That may well be true. I am not arguing that these directors didn't screw up, I am simply pointing out that a precedent has been set and risk adverse directors will take notice of the new world they are living in.

Venture capitalists are normally protected (“indemnified” is the technical term) from having to pay these settlements by the funds they manage.  But this means that their investors have to pay the settlements. And that’s a very bad thing to have happen. Maybe not as bad as coming out of pocket personally, but a close second. I do not intend to risk my investors capital in this way lightly.

But if I and my colleagues in the venture business won’t serve on the public boards, who will? 

The retired CEOs, CFOs, lawyers, and public accountants who traditionally have served in this role? Don’t count on it. They don’t even have a fund to indemnify them!

So we’ll either have public directors who are too ignorant of the risks to know better or “professional” public directors who charge enough money per year to offset or personally insure themselves from the risks, or possibly both.

Does that make you comfortable as a public shareholder that your interests are being well represented? I doubt it.

I think the corporate governance system for public companies is broken and needs to be fixed. Sure some boards were too lax and let management get away with criminal behavior in the late 90s.  But what percentage did they represent of the total number of public boards, most of whom acted responsibly and did their job well?

We’ve gone way overboard now and the result will be, ironically, worse boards that govern less not more.

I sure hope this situation gets fixed. But until it does, I’ll probably just say no when asked to sit on a public board. It’s not worth it.

Comments

[Ron McDonald]

I'd have to say you paint a pretty bleak picture. However, after completing (if you could call it that) a SOX project I think we need a anti-SOX lobby in Washington. I can honestly say I have no interest in working at a public company any longer.

[GovernanceFocus]

One of the main problems has been that Board members to date have been part timers and friends of the controlling family or of the Chairman and/or CEO.

What is needed is a professional class of Directors, that are able to spend the time and have the independance (including with insurance backing for loss of income) which will enable them to control and monitor and input. They may even need to be licensed!

If investors, especially the institutional, do not begin to insist on these types of independant, professional Directors, this may require legislation for Boards to include a minimum number of these 'approved' Directors.

[Shivering Timbers]

A different view is that Enron and Worldcom were outliers and the boards of those companies truly were negligent in their duties and should have stopped what was going on there.

Personally, I think companies will still be able to fill their boards: sitting on a board carries a lot of prestige, and the pay isn't bad for the hours.

But you're going to see directors becoming much more selective about which boards they'll serve on, and much more cautious about taking a seat. The best way to mitigate the risk of being a director is to not be on the board of an Enron or a Worldcom--and directors are in a good position to see if there's any monkey business going on.

So prospective directors will insist that they be given the chance to talk to outside auditors, analysts, other directors, etc., before they take the seat. And they'll be quick to resign if they smell something fishy.

I think all this is a Good Thing, because it restores the oversight role to the outside directors. Historically, the board was supposed to both provide strategic guidance and keep management honest. Unfortunately, over the past few decades the "keep management honest" part seems to have withered, both because the stratgic part is more glamorous and fun, but also because directors were largely insulated from the repercussions if the CEO turned out to be a crook.

What's happening now is that we're restoring the balance. But keeping management honest isn't a job for everyone, and it takes a lot of work and sometimes a lot of guts. So if you don't want that job, don't take it. There are others who will.

[Steve]

Fred, aren't you really arguing for tort reform? I know, I know, agreeing with President Bush may be too difficult for you to contemplate, but consider: If you're right, and the vast majority of public boards and directors are doing good honest work yet professionals such as you refuse to go on public boards, then maybe the problem isn't with Sarbanes-Oxley and other such regulation, but rather with the trial lawyers, who know how to exploit the system...?

[Jonathan]

A major CA law firm recently circulated an article for those, unlike Fred, who are considering serving on public boards. You can skip ahead to the bullet points for the advice, but the essence of the article is this:

"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 reward prompt and appropriate corporate actions when questions arise."

So, while it is possible to serve well and safely, it is not a job to be taken lightly!

Full article:

http://www.gibsondunn.com/practices/publications/detail/id/766/?pubItemId=7701