Can’t Sleep? The Latest on Director Accountability

Climate change, supply-chain risks, and a new interpretation of fiduciary duty are changing the scope of board oversight.

Of the many roles board directors have, taking public walks of shame certainly hasn’t been one of them. But a federal judge has ordered the directors of one large firm in bankruptcy court to hop on a bus this month (and for good measure, he might come along himself) to take a tour of communities that the firms’ operations have allegedly damaged. And these directors weren’t even around at the time of the harm—they are all newly appointed.

It was an extreme decision, to be sure. But experts say that so-called “board accountability” is growing in scope and creating a new level of discomfort for a job once fairly hidden from the public. Indeed, in the last five years alone, federal class action litigation against companies and their boards has risen dramatically, from 168 lawsuits in 2014 to 403 last year, according to research by Stanford University. The issues range from gender, minority representation, cybersecurity, safety, privacy, governance, and the environment.

In the case of demands for ethnic and gender diversity at the highest echelons of companies, the pressure for change is clearly coming from all sides—by politicians, activist shareholders, nongovernmental organizations, consumers, and regulators. Last year, for example, California passed a law that states by July 2021 at least three women must be on each local board with more than six seats. House and Senate bills that just won the required Illinois state legislature hurdle votes would, if passed into law, require boards to include at least one woman, one African American, and one Latino in their ranks.  

Source: Stanford Law School

Activist shareholders, meanwhile, aren’t always waiting for new laws to force change. An asset management firm, for one, recently introduced a proposal that a majority of shareholders at one of its investments approved: the targeted company—and its board—is now responsible for formulating a plan that makes the “executive leadership more diverse in terms of race, ethnicity, and gender.”

Of course, such flashpoints change with the times, so many experts say boards need to react with a longer-term agenda. “Step back,” advises Los Angeles-based Caroline Nahas, vice chair of Korn Ferry and lead member of its Board and CEO Services practice. “Create a road map for the future of your company by strategically analyzing where the company is going and its market dynamics. Then start matching that five-year plan with needed skills and experience—with an emphasis and focus on diversity of all kinds.”

In the case of the board members that are being forced to see their firm’s damage in person, the surrounding topic was climate change. With disasters such as flooding and forest fires harming communities, experts predict more lawsuits will try and link weather damage back to corporations and board decisions. That’s also true in the case of firms that have partners that keep costs down improperly by using child labor. Australia, for example, just passed a law requiring firms to outline “slavery risks” in their supply chain, not unlike a British law, both of which only raise the liability risks for directors there.

For now, United States boards aren’t facing such laws, but experts say companies (in theory at least) may someday have to answer for widespread layoffs or salary cutbacks. Or at least deal with the resulting lawsuits. “You’ve got this growing activism saying to directors, ‘You need to take the community into account,’” says Charles Field, co-chair of the financial services practice at the public-interest law firm Sanford Heisler Sharp.

In the case of layoffs, directors usually respond by pointing out their fiduciary duty is to shareholders and enhancing value, not to the community or employees. But Field says the tension between the directors’ responsibility to shareholders and their responsibilities to the community and employees is tightening, potentially bringing in new laws and, down the road, shifting directors’ fiduciary duties.

Ultimately, experts like Nahas take the issue of accountability back to board composition. She suggests extending the boardroom search beyond the usual CEOs to include C-suite executives who are subject experts in fields where the company needs help. That might require some directors to “rotate out early” to make room for the new, Nahas warns, and that “has to be done thoughtfully and carefully.”