Over the past decade, regulators have been forced to ensure that professional advisors retain their independence when working for boards.
After the Enron and WorldCom scandals of 2002, the Sarbanes-Oxley Act was instituted in the United States to, among other things, increase the independence of outside auditors when they review corporate financial statements. After the financial crisis of 2008, the Dodd-Frank Act ensured that compensation consultants were hired by the board’s compensation committee and not hired by or unduly influenced by the CEO or other management.
In both positions, their primary client is the board of directors and ultimately shareholders, whom the board is there to represent. It’s entirely probable that if you do your job properly as an auditor or compensation consultant, you will make recommendations that management will not like. That’s okay, because you’re not acting on behalf of management. You cannot serve both sides and fulfill your fiduciary duties to only one.
But what about lawyers? It’s not uncommon for lawyers or law firms to serve both sides. Should lawyers who act for management also advise the board of directors? I don’t think so.
Lawyers are equally important in the field of corporate governance. They interpret and apply legislation and offer advice to a variety of constituencies—shareholders, directors, managers and other stakeholders—who have interdependent and even adverse interests in the well-being of the corporation. But if the above reasoning is correct, so far as auditors and compensation consultants are concerned, then strict independence should also apply to lawyers.
At the moment, there’s potential for pro-management bias. When advising both sides, lawyers and firms typically make more money from management than the board. The resulting bias might lead to lawyers drafting protection and entrenchment mechanisms for management such as poison pills, dual-class shares, restrictions on meetings and voting, and staggered boards. Lawyers may then resist pro-shareholder governance reform such as majority voting, say on pay and proxy access.
When interests between management and shareholders become adverse, even through the regular course of events, it’s important for boards to have their own set of lawyers who are independent from management and seen as objective and willing to act in the interest of directors, not management, and ultimately shareholders. Shareholders suffer when the board retains advisors who are beholden to management.
Here are some services this new set of “governance-only lawyers” could offer include:
- Drafting board guidelines, committee charters and position descriptions for the board. (If drafted by management lawyers, as they are now, these policies are often management-friendly and restrict the board unnecessarily.)
- Reviewing board and committee effectiveness.
- Advising the board on activist shareholders, institutional shareholders and overall shareholder engagement.
- Reviewing the annual proxy circular.
- Reviewing the strategic planning process and value creation by management.
- Negotiating and drafting the CEO contract and its terms.
- Assessing risk management and oversight functions. Lawyers would work with independent auditors as necessary.
- Ongoing development and review of policy implementation.
All of the above activities are currently offered by lawyers, but primarily from management’s point of view. This needs to change. There is room for governance lawyers who are unambiguously there to act only for directors, on behalf of shareholders, much like auditors and compensation consultants.
Richard Leblanc is a lawyer, corporate governance academic, speaker and independent advisor to leading Canadian and international boards of directors.