Corporate Governance: A Word of Caution About “Affiliated” Directors

There has been a dramatic increase in the attention given to corporate governance issues subsequent to the spectacular failures of board oversight at such companies as Enron and Global Crossing.  The most noteworthy response to these acts of corporate fraud was the passing of the Sarbanes-Oxley Act in 2002.  While the bill only applies to publicly traded companies, privately held businesses quickly realized that this was the new de facto standard for them.

Specifically, the term independence has taken on increased significance.  Directors who are independent of the day-to-day operation of a firm are deemed better able to represent the interests of shareholders than “inside” directors.

Unfortunately, as the need for qualified independent directors has risen, the risk of personal liability for directors has grown, causing many qualified individuals to think twice before accepting board positions.  Additionally, otherwise qualified, independent, directors must undertake considerable education to fully understand the scope of their oversight and policy making responsibilities in an industry that they may be unfamiliar with.

When CEOs and current board members seek the expertise needed for their boards, they quickly realize that they have such experts right under their noses in the form of the firm’s attorney, CPA, financial advisor, etc. What an elegant solution to their need for informed, non-employee, directors!  Or is it?

Board members who are also professional advisors fall into a category know as affiliated directors.  They may not receive a W-2, like an employee, but they do receive a 1099.  Many board deliberations have direct or indirect impact on the use of professional advisors, thus how independent can these advisors be as board members?

Affiliation takes other forms.  Directors need to be independent of themselves, not just the company.  Golf buddies and old friends on a board are loath to break the “code of congeniality,” the killer of challenging discourse.  Directors with close ties to a specific group of shareholders are likely to be conflicted.  Directors cannot “represent” a particular constituency, they must act on behalf of all shareholders.

CEOs and current board members must have the courage to look for director candidates who have proven talents, principal among which should be the ability to both collaborate and disagree within the decision making process.  Add a lawyer or CPA to your board?  Sure, but not your lawyer or CPA.

As you consider director candidates who would be deemed affiliated, my advice is, “Don’t do that!”  Directors should provide a competitive advantage to the organization.  Make that goal a reality by creating a board of truly independent thinkers.  I leave you with a quote by William Bowen, author of The Board Book: “We don’t learn much when we are surrounded by the likes of ourselves.”

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