The role of directors is more challenging than ever given increased volatility and competitive pressures in the business environment coupled with a legal framework that is imperfectly aligned with demands made by increasingly active shareholders and other stakeholders.
Here are eight issues that directors should keep in mind in 2019:
1. Shareholder Engagement
Boards and management have to engage with shareholders and be responsive to their concerns, both because their tenure depends on maintaining the confidence of shareholders and because shareholders have been empowered through greater voting rights as a result of recent corporate governance reforms (e.g., majority voting, say-on-pay). Those concerns are often driven by short-term shareholder value maximization imperatives. Engagement with the shareholder base is appropriate and beneficial: it provides valuable input and protects against distracting and expensive fights. However, under Canadian law, boards, in discharging their obligations to act “with a view to the best interests of the corporation”, are not permitted to equate the corporation’s interests with the interests, short-term or otherwise, of shareholders alone. Directors therefore must be careful to consider the interests of all affected stakeholders and not simply accede to the demands of activist investors.
2. Environmental, Social and Governance (ESG)
The need to consider stakeholder interests is heightened in the current ESG landscape. ESG matters are an increasing focus for investors, including those with specific ESG mandates, and other stakeholders. This creates a difficult dynamic for Boards which are required to balance potentially competing and conflicting interests, such as short-term shareholder value maximization versus long-term sustainability, having regard to impacts on employees, customers, the community and the environment. The Board should ensure that these considerations are factored into the corporation’s strategy and business plan. The Board should also work with management to identify relevant ESG risks (including reputational), and ensure those risks are monitored and managed through the implementation of appropriate policies and regular reporting to the Board or Board committees. Disclosure of ESG risks and the measures in place to manage those risks are an area of focus for regulators and must be carefully calibrated to avoid liability.
3. Oversight of Corporate Conduct
Recent “#MeToo” events and securities regulatory whistleblower programs highlight the need for Boards to be vigilant in the exercise of their oversight responsibilities. Boards must ensure that systems are in place to inform the Board of internal misconduct that could result in legal or reputational exposure for the corporation. In addition, Boards must ensure that such issues are investigated thoroughly and independently. This requires active engagement by the Board given the unavoidable conflict that management has in dealing with internal conduct issues. Boards should assume that their handling of these issues will be scrutinized and have to be satisfied that it will meet the reasonable expectations of stakeholders. There are many examples of situations that have been exacerbated by inadequate Board oversight and have left the directors looking derelict.
Given the centrality to modern business of electronic data storage and transmission, it is critical that Boards provide careful oversight of cybersecurity risk. The Board must ensure that the corporation’s risks in this area have been clearly identified, the corporation’s risk tolerance determined and appropriate resources dedicated to the management of those risks. There should be a protocol to ensure appropriate escalation of incidents so that the Board can properly discharge its oversight responsibility, including with respect to disclosure. Incidents can have significant negative legal and reputational implications for the corporation. The Board’s oversight will be scrutinized from hindsight by investors and regulators.
5. Short Attacks and Disclosure
Short sellers are active and have been recognized by securities regulators as playing a legitimate role in the capital markets. They can be expected to exploit vulnerabilities in the disclosure records of issuers, whether fairly or unfairly, and regulators are likely to remain reluctant to intervene when they do. Boards, in their oversight, should ensure that disclosure decisions are made on a basis that includes an assessment of the risk that the disclosure could be attacked. Second, there must be a good record of the process followed in making disclosure decisions so that the decisions can be defended if attacked by shorts or second-guessed by regulators. Finally, if attacked, the Board should ensure that a multidisciplinary team is mobilized with a coordinated strategy that addresses both legal and investor relations concerns, with regular reporting to the Board.
6. Insider Trading
Securities regulators continue to be focused on insider trading as an enforcement priority. They have sanctioned trading by insiders relying on their “public interest jurisdiction” in circumstances where the trading was not technically in breach of the statutory prohibition. Boards must recognize the risk that all trading by insiders will be judged from hindsight and from a broader perspective that goes beyond technical legality. Decisions regarding trading blackouts should not be left to management alone. The Board must be engaged, have all of the relevant facts and receive appropriate advice.
7. M&A Decision-Making
In the M&A context, Boards must rely on advice from external advisors (legal and financial) to discharge their obligation to make fully informed decisions about key issues such as available strategic alternatives and relative value. There is no invariable need for the Board to establish a special committee or to have separate advisors from those working with management to advise the corporation. However, in every situation, the Board must ask itself whether establishing a special committee or having separate advice would meaningfully contribute to fully informed decision-making by the Board.
Special committees of independent directors are legally required in transactions involving conflicts; but in complex and time-intensive matters, a special committee may be advisable to enable deeper and timely engagement with the issues and the appropriate level of oversight by the Board.
On high-stakes issues, a Board is well-advised to consider getting a second view from separate advisors. It is the norm for financial advisors – and a growing practice for legal advisors -- to have fee arrangements that include a contingent success component. That raises a conflict concern which may make it necessary or desirable for the Board to have separate advice which it can be confident is free from any conflict, including relationship pressures. In any event, given the Board’s oversight responsibilities, directors should have direct access to the corporation’s advisors and should engage directly with them on the key issues on which the directors must decide.
8. Uncertain Economic Conditions
Economic indicators and political developments in major economic centres suggest that 2019 will be a time of increased volatility and business uncertainty. These conditions, which preclude “business as usual” and for which simply cost-cutting is not necessarily the answer, exacerbate the challenges faced by directors in providing effective oversight. To discharge its responsibilities, the Board must ensure that:
the corporation has management in place with the skills and experience to deal with a changing business environment in which a recession is a real possibility;
management is factoring these business risks and concomitant opportunities into the corporation’s business plan and stress-testing against realistic scenarios; and
management’s incentives are properly aligned with the long-term best interests of the corporation.