Board Governance – How Do You Deal With CEO Misconduct?

ethicsEven the best of corporations are not immune from the potential damage that can be sustained arising from the alleged ethical lapse or misconduct on the part of their chief executive.  The disruption that such an event may cause the organization if it is not addressed proactively and properly, has the potential to destabilize even the most stable of companies.  In those instances when the company is confronted with allegations of CEO misconduct, how the corporation chooses to respond can become a defining moment for the organization, with the potential to shape its global operations and reputation for years to come.

Given the fact that it is the chief executive’s commitment to ethics and character that drives an organization’s corporate culture, no company, particularly a publicly traded one possesses the luxury of remaining impassive when confronted with allegations that its CEO has become implicated in some form of misconduct or otherwise unacceptable behavior.  Beyond any potential legal liability exposure its facing the organization that chooses to ignore or minimize a CEO’s misconduct, there remains the probability that the organization’s reputation among its key constituencies may become seriously and irreparably impaired.

For a corporation to be successful, establishing and ensuring the proper corporate culture and ethical tone must be more than a theoretical exercise.  No single board process sets the proper ethical tone more than the board’s selection of the CEO.  It is the CEO’s commitment to ethics that sets the proper tone for business integrity or the lack thereof and it is the CEO that influences the scope, orientation and integration of the corporation’s culture. The board’s selection process relating to the CEO needs to remain focused on competence, character and chemistry.

While it is the CEO that is often referred to as the face of the organization, it is the board that is the organization’s backbone. It is the corporation’s board of directors that exercises ultimate authority over the organization. Given the fact that board’s members enjoy ultimate and total authority over the organization, they are expected to possess solid industry insight, product knowledge and operational expertise. Corporations and those seeking appointment to a corporate board can no longer view the board seat solely as a prestige position for someone to hold upon retirement from another position. As the problems surrounding Theranos has demonstrated, corporations do not have the luxury of creating celebrity boards filled with former high level government officials in order to create a “halo” effect in the hopes of gaining or retaining credibility.

It is the responsibility of the corporation’s directors to establish the expectations expected of the chief executive and then exercise the appropriate level of supervision to ensure that those expectations are met. Together the board and CEO set a common ethical vision that is clear, understandable and viable.  However, it can be difficult to maintain the proper corporate ethical tone if the company’s chief executive becomes ethically challenged or engages in some form of egregious behavior.

When the board of a publicly traded organization becomes aware of apparent misconduct by its CEO that is related directly to the company’s business operations, such misconduct may immediately trigger any number of corporate governance and regulatory obligations on the part of the organization’s directors.  Throughout the entire process, publicly traded companies, must remain vigilant with regard to the company’s regulatory reporting obligations. A company’s mandated disclosures may include some type of filing with the SEC, the Justice Department, in addition to state regulators. The SEC for example, requires that public companies disclose legal proceedings concerning their officers, directors and nominees.  It becomes the board’s responsibility to determine what if any regulatory or legal obligations the company may be facing.

A board’s failure to comply with any of its mandatory reporting requirements, has the potential of significantly increasing the organization’s civil and criminal liability exposure.  Should an act of CEO misconduct be serious enough to warrant the termination of the CEO, the process will become significantly more complicated.

Generally, regulatory disclosures are required in those instances where the misconduct in question is material to, or involves the CEO who has been identified as being a subject of a criminal investigation, or having engaged in alleged misconduct that is directly relevant to an evaluation of the CEO’s integrity or ability to fulfill his fiduciary responsibilities.  However, should the CEO’s misconduct be unrelated to the corporation’s business, or shrouded in ambiguity, the board’s required reporting obligations may not become entirely obvious.  Obviously once the matter becomes public, the entire matter takes on another dimension and complication.

When faced with allegations of misconduct on the part of the chief executive, a board may want to undertake a review of the company’s most recent management discussion and analysis filings (MD&A), particularly if the company believes that somehow it may have financially benefited from the executive’s misconduct.  A company’s MD&A disclosures should remain focused on “material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”  The company, should also consider the merits of having the company disclose any suspension or termination of the CEO via a Form 8-K filing. In addition, contingent liabilities arising from the CEO’s misconduct may need to be evaluated in accordance with Statement of Financial Accounting Standards No. 5 (FAS 5) and disclosed appropriately. Depending on the severity of the misconduct, the event may trigger certain corporate protocols, including the determination whether an independent internal investigation is warranted, or initiating policies that may provide for suspension or termination of the CEO.

Equally as important to the organization as the identification of the corporation’s disclosure obligations, is the proper coordination of disclosures made pursuant to these obligations with the rest of the company’s corporate communications strategy.  Over the course of the entire event, the board will be experiencing demands for information from many directions and sources, challenging the board to manage the competing and often conflicting interests of multiple constituencies.  In order to be successful, the board must strike a delicate balance between seeking to avoid liability exposure while responding to its varied constituencies.

When responding to these demands for information, the board must take appropriate care to avoid any inconsistencies between their required regulatory and legal responses and the message it needs to convey to its constituencies including its employees, shareholders, investors and industry analysts.  A corporation’s board cannot make disclosures in a vacuum, otherwise the board runs the risk of making potentially disastrous and inconsistent statements.  Directors need to be mindful that the particular misconduct alleged on the part of the chief executive, may be reflective of systemic compliance gaps and deficiencies in the corporation’s overall compliance program and culture.  In addition, the CEO’s misconduct may implicate others within the organization.

Where the chief executive’s misconduct relates to regulatory or criminal conduct within the organization, the company’s reporting and compliance obligations become much more advanced.  This is particularly true given the Justice Department’s renewed focus on individual accountability as articulated in the directive issued by Deputy Sally Q. Yates entitled “Individual Accountability for Corporate Wrong Doing” (Yates Memo). The increased attention on corporations and their CEOs brought on by the Yates Memo combined with the increased use of traditional law enforcement methods such as search warrants and wiretaps, places additional pressure on corporate directors to ensure they act appropriately.

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Michael D. Celockhttp://www.omegastrategic.com/
Michael's public-private sector experience spans both the advisory and operational spectrums of corporate governance and compliance, international affairs, intelligence, national security and law enforcement. Mr. Celock also has substantial experience regarding compliance with the FCPA and multi-jurisdictional government and corporate investigations. Mr. Celock regularly counsels corporate clients on strategic, operational and political risk, cross-border due diligence, corporate internal investigations, crisis mitigation, the FCPA and international crime and corruption issues as well as devising innovative solutions to complex problems arising from non-traditional corporate situations. Mr. Celock’s work is often of a cross-border and international dimension across a variety of industries and is designed to promptly and effectively identify, assess and manage rapidly changing risks facing the client. Mr. Celock’s intervention provides clients with the ability to respond strategically and in a timely manner to existing or emerging situations that threaten the business and reputation of the organization. Mr. Celock was appointed by President Clinton to the position of Special Advisor to the President for National Security Affairs. Mr. Celock has also served as a consultant to CIA’s Office of Transnational Issues. Responsibilities included providing unique functional expertise to assess existing and emerging threats to the national security interests of the United States and to identify, disrupt and prevent illicit financial transactions that threatened U.S. National Security.
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