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SOX, Corporate Governance andWorking with the BoardHCCA Compliance InstituteNew Orleans, LouisianaApril 18, 2005Lisa MurthaParente Randolph, LLCTwo Penn Center PlazaSuite 1800Philadelphia, PA 19102(215) 972-2479 (?)(215) 972-2429 (?)lmurtha@parentenet.comMichael KendallMcDermott Will & Emery LLP28 State StreetBoston, MA 02109(617) 535-4085mkendall@mwe.com1
AgendaBasics of Corporate GovernanceRecent Considerations, includingSarbanes-OxleyRecommendationsClient RelationsQuestions?2
Basics of Corporate GovernanceBoard of Directors/Trustees: MembershipIndependent directorsInside directors Key CommitteesAudit CommitteeCompensation Committee**Qualified Legal Compliance Committee3
Basics: Directors’ Fiduciary DutiesThe Fiduciary Good Faith Obligation Question of Director’s state of mind Director must put best interests of corporation first Director must not violate known applicable law Director must not consciously or intentionally disregardher responsibilities Lack of good faith may be inferred from a Board decisionthat is irrational, irresponsible, or beyond reasonNote: exculpatory provisions in Delaware statutes that allowcorporate charters to protect Directors who have violatedthe duty of care do not allow protection of Directors whohave violated the good faith obligation4
Basics: Directors’ Fiduciary DutiesThe Fiduciary Duty of Care Generally requires reasonable diligence in:Becoming informed about the subject matter of Boarddecisions andContinued monitoring and oversight of corporate activities Triggers protection of the Business Judgment RuleCaremark compels Directors to assure that anadequate information and reporting compliancesystem is in place5
Basics: Directors’ Fiduciary DutiesThe Fiduciary Duty of Loyalty Directors may not usurp opportunities that aremade available to the corporationDirectors may not use corporate assets forpersonal gainDirectors may not participate in transactions inwhich they have interests other than theirinterests as Directors6
Basics: Directors’ Fiduciary DutiesThe Fiduciary Duty of Obedience toPurpose Applies only in the not-for-profit contextBoard actions and decisions must have bases ineducational or charitable purpose for which entitywas incorporated7
AgendaBasics of Corporate GovernanceRecent Considerations, includingSarbanes-OxleyRecommendationsClient RelationsQuestions?8
Recent ConsiderationsExpanding application of the obligation ofgood faith in caselaw: Walt Disney Co. (Del. Ch. 2003) – knowing ordeliberate indifference to fiduciary duties ofcare or loyalty bad faithEmerald Partners (Del. 2003) – “we don’t careabout the risks” attitude bad faith9
Recent ConsiderationsUSDOJ Corporate Leniency Policy – corporationmay not be criminally charged where it Reports illegal/noncompliant activity to governmentbefore it finds out from other sourceTakes prompt and effective action to terminate suchactivity (including corporate compliance program)Reports such activity with candor and completenessMakes its report a “corporate act”, rather than a seriesof individual onesMakes restitution as appropriateDoes not coerce nor lead other parties to participatein illegal/noncompliant activity10
Recent ConsiderationsSEC Enforcement Model – corporation maynot be charged by the SEC where it Establishes effective compliance and self-policingproceduresConducts a thorough internal investigation andpromptly and completely discloses the resultsUndertakes appropriate remedial and disciplinaryactionsCooperates with SEC in a timely fashion11
Recent ConsiderationsSarbanes-Oxley Act of 2002 Applies directly to public companies, but also affectsprivate and not-for-profit companies by:Establishing new norms and best practicesPossibly serving as a model for state laws ofbroader applicationPossibly providing content for reasonablenessstandards embodied in fiduciary dutiesPossibly providing safe harbors under other rules,regulations, and dutiesServing as a model for forthcoming federallegislation governing not-for-profit entities12
Recent Considerations:Sarbanes-Oxley RequirementsAudit Committee Must be made up of only independent directors (thosenot employed by or under contract with thecorporation other than for service on committee)Must include at least one “financial expert” or mustdisclose absence of such with explanationMust be given sufficient budget and authority to hirecounsel and advisors and to oversee outside auditorsMust pre-approve all audit and non-audit servicesprovided by outside audit firmsMust consider all reports of material violations ofsecurities laws or fiduciary duties (unless QualifiedLegal Compliance Committee fills this role)13
Recent Considerations:Sarbanes-Oxley RequirementsQualified Legal Compliance Committee Creation is optional, but it would replace requirementfor “noisy withdrawal” of attorney reporting materialviolationMust be comprised of at least one member of theAudit Committee and two or more other independentdirectorsMust be given authority to receive reports of materialviolations and require corrective action by thecorporationIf corrective action is not taken, members must reportmaterial violation to SEC14
Recent Considerations:Sarbanes-Oxley RequirementsCompensation and Nominating Committees NYSE and NASDAQ rules adopted pursuant toSarbanes-Oxley require Boards to adoptupdated committee charters spelling outpurposes and responsibilitiesBoards must prepare and adopt: Corporate Governance GuidelinesCodes of Ethics and BusinessConduct15
Recent Considerations:Sarbanes-Oxley RequirementsSenior Officers (CEO and CFO) Must certify that financial statements “fairly present inall material aspects” the financial condition of thecorporationMust certify that disclosure controls and procedureshave been put in place and must assess theireffectiveness annuallyMust return bonuses and equityincome if the corporation has toamend financial statements due tomaterial noncompliance of companyas a result of misconduct16
Recent Considerations:Sarbanes-Oxley RequirementsCorporate Counsel Inside and outside counsel must reportknown or reasonably suspected materialviolations of fiduciary duties “up theladder” (including “noisy withdrawal” orreport to Qualified Legal ComplianceCommittee)17
Recent Considerations:Sarbanes-Oxley RequirementsOutside Auditors Cannot “cross-sell” other servicesto corporations that they auditMust rotate audit partners everyfive yearsMay not be fraudulently coercedor influenced by Directors,Officers, or employees18
Recent Considerations:Sarbanes-Oxley RequirementsMiscellaneous Provisions Corporation cannot make loans to Directors orSenior Officers (except generally availablecommercial loans)Shareholders must approve material changes inequity compensation plansCorporation must provideprotection for internalwhistleblowersCriminal penalties fordestruction, falsification,alteration, or concealment ofdocuments19
AgendaBasics of Corporate GovernanceRecent Considerations, includingSarbanes-OxleyRecommendationsClient RelationsQuestions?20
RecommendationsFocus on process Adequate process willprotect the corporation andDirectors even in light ofinadequate resultsDocument! Document!Document!21
RecommendationsTake steps to make Directors more awareof compliance issues arising in thecorporation and better equipped toaddress situations when they arise Tailor Director selection processIncrease Director trainingCraft Director informational materials in easilyunderstandable language and formatRegularly assess Director effectiveness22
RecommendationsDirectors should exercise stricter oversightin the form of “constructive skepticism” Board should ask questions ratherthan simply relying on conclusionsof managementBoard should request additionalinformation when inadequate factshave been providedWhen management overseesresponse to compliance events,Board should require frequentupdates23
RecommendationsExpand the role of independent Directors in dayto-day oversight and response to complianceevents Independent Directors should constitute majority ofBoard membershipBoard may create position for “principal” or “chair”independent DirectorIndependent Directors should meet regularly outsidepresence of managementIndependent Directors should populate AuditCommittee, Qualified Legal Compliance Committee,and Compensation Committee24
RecommendationsCreate additional effective reporting channels Corporate counsel andcompliance officer shouldmeet with Board, AuditCommittee, Qualified LegalCompliance Committee,and/or independent Directorsoutside of presence of otherofficersMeeting should be regular(quarterly?)25
RecommendationsRemember that fiduciary duties arecreatures of equity, rather than law This means that they are flexible and contextdependentThis means that they rely on reasonablenessand common sense rather than formal “checkthe box” requirementsCompliance with Sarbanes-Oxleyrequirements will provide evidence ofreasonableness26
RecommendationsReport all significant compliance problemsto BoardSignificant Material under GAAPSerious Violation of LawStrong government interestPublicity likely27
RecommendationsWhen does Board take Directresponsibility for significant complianceissue?“Materiality” is the issue and must beconsidered carefullyWhere does management’s role end andthe Board’s begin?28
RecommendationsDoes Audit Compliance Committee RetainIndependent Counsel?Counsel Reports Directly to Audit Committee Can you keep management informed?Written or oral reports?29
Recommendations:Disclosure to Outside AuditorsMust Disclose – For public companies expectpress release and public filingMaintain attorney-client privilegeCan public auditor also do forensic audit?30
AgendaBasics of Corporate GovernanceRecent Considerations, includingSarbanes-OxleyRecommendationsClient RelationsQuestions?31
Client Relations: How aBoard/Committee Becomes a ClientCredibility “Do you know our issues?”“Have you experienced this circumstance?”Relationship Skills “Can you hear us?”Engagement “Do you care about this?”32
Client Relations: How to TreatBoards/Committees as ClientsRespect Build a relationshipUnderstand client’s skills and backgroundCommunication Ensure that Board members are confident in their understandingEducation Take responsibility for bringing the content/knowledge to theBoardListening Know where you stand with the clientAddress the issuesOpinions Express your opinionsGive counsel33
Client Relations: How to Bill forCrisis ManagementManage bill expectationsGain agreement on approval process Management or Board approval?Communicate effective projectmanagement34
Client Relations: Check In“I am confident our team is addressing theassignment effectively and economicallybut I am really interested in whether or notwe are meeting your needs as you seethem.”35
AgendaBasics of Corporate GovernanceRecent Considerations, includingSarbanes-OxleyRecommendationsClient RelationsQuestions?36
Questions?Michael Kendall, Esq.(617) 535-4085Lisa Murtha(215) 972-2479 (?)(215) 972-2429 (?)37
SOX, Corporate Governance and Working with the Board Lisa Murtha Parente Randolph, LLC Two Penn Center Plaza Suite 1800 . 28 State Street Boston, MA 02109 (617) 535-4085 mkendall@mwe.com HCCA Compliance Institute New Orleans, Louisiana April 18, 2005. 2 Agenda Basics of Corporate Governance Recent Considerations, including Sarbanes-Oxley .
