022: Serving on Board of Directors

Serving on Board of Directors

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Learning Objectives

Upon completion of this Case Study, participants should:

  • Understand basic principles of corporate governance
  • Understand and evaluate critical economic and non-economic issues to consider and learn how to perform due diligence before serving on a Board
  • Develop proper and regular reporting requirements for Board service

State of the Industry

As businesses in all sectors compete in an ever-changing and dynamic marketplace, leaders seek experienced and diverse individuals to serve on their Boards. Companies will typically offer qualified individuals attractive compensation packages for their service, including cash and stock/stock option grants. Often high-profile and successful professionals will serve on multiple Boards.

The Board of Directors (“Board” or “BOD”) is the primary governing entity of a corporation. The Boards of both public and private companies usually include key leaders, such as the Chief Executive Officer or Chief Operating Officer. In addition, companies regularly seek outside experts to create diverse and dynamic governance. Outside directors need to evaluate invitations/nominations to serve on Boards carefully. They should assess potential risks for their current employers, and for themselves.

Background and Analysis

Empire Financial is a financial services company providing comprehensive planning and investment management services to high-net-worth individuals and families. Empire’s typical clients own diversified portfolios of stocks, bonds, mutual funds, and illiquid private investments. 

Tom, a licensed attorney, and Certified Financial Planner, was an Empire partner with more than 25 years of industry experience. Tom earned the respect of his peers and clients.

Several years ago, another party introduced Tom to the CEO of Vista Enterprises, a start-up technology company. Shortly after that meeting, one of Tom’s clients at Empire invested in one of Vista’s early stock offerings. The client had heard of Vista from a friend. Over the years, several of Tom’s other clients at Empire invested in Vista, on Tom’s recommendation.

Vista invested heavily in its technology, but the company had not become profitable.

The CEO of Vista invited Tom to join the company’s Board. Tom discussed the invitation to join Vista’s Board with his client. Since the client had been an early investor in Vista, he thought Tom’s participation on the Board would be a great idea. Tom did not discuss the invitation to participate on Vista’s Board with any other clients that invested in Vista.

A few days later at a social gathering, Tom mentioned the invitation he received to one of his partners at Empire. Tom agreed to join Vista’s Board. He did not sign any documents memorializing the decision, but he began attending Vista’s Board meetings. During those meetings Tom discovered that Vista did not have as much capital as others led him to believe.

The Board offered Tom and other directors generous cash and stock packages for their service. Vista’s CEO announced that Vista would book the cash compensation as a loan against the company’s stock. The CEO confirmed that he and the CFO had researched this creative tax strategy that other companies used.

Vista continued to experience financial difficulties, but Tom did not share this information with his partners or clients. One of Vista’s lead institutional investors sued Vista to remove the CEO and the Board. Several Empire clients learned of the lawsuit and discovered that their investment had plummeted in value. They terminated their client relationship with Empire. 

Empire terminated Tom “For Cause,” citing a violation of the company’s conflict of interest policy.

The SEC launched a government investigation. It sought disgorgement of the compensation Tom received while serving on Vista’s Board, as well as fines and penalties. The SEC also referred the matter to the Department of Justice (“DOJ”) to review potential criminal tax fraud charges.


Tom felt flattered when Vista’s CEO offered him a Board position. He thought the Board position would open opportunities to use his business and legal skills to help the company succeed. Further, the Board position would put him in a position to monitor his clients’ investments in the company.

Tom had served on the local Little League’s advisory board, so he knew how Board meetings worked. Tom did not perceive any legal or ethical improprieties with serving on Vista’s Board. 

Despite good intentions, he failed to understand and disclose his acceptance of the Board position to his colleagues at Empire and to all of his clients. Further, he did not anticipate myriad responsibilities that accompany a Board position.

By participating on Vista’s Board, Tom put himself, his firm, and his clients at risk. Empire also did not have proper procedures in place. The following list summarizes some of the critical issues that the parties did not properly manage:

Tom’s Issues/Responsibilities

  1. Before accepting Vista’s offer, Tom had a responsibility to inquire and review the   following:
  1. Inspect the company’s organizational/legal documents, including corporate resolutions, Board minutes, Bylaws, and Board policies.
  2. Review the financial statements and tax returns and direct any questions to the Audit Committee or independent accountants.
  3. Review the company’s Directors and Officers’ (“D&O”) liability insurance coverage.
  4. Confirm any past Board compensation and potential future compensation.
  1. Tom had a fiduciary relationship both with his Empire business partners and with his clients. Accordingly, he had a duty to disclose the potential board position and provide sufficient information for anyone to determine if a conflict of interest existed.  If a conflict did exist, it would need to be waived in writing. Also, Tom should have received written approval from Empire to serve on Vista’s Board.
  1. When Tom was offered the director’s compensation package, he should have requested independent confirmation from Vista’s accountants and the structure’s attorneys. Tom should have disclosed the compensation to Empire.
  1. Despite Vista’s deteriorating financial condition, Tom failed to disclose this to his Empire Partners or clients, several of whom made follow-on investments in Vista.

Empire’s Issues/Responsibilities

  1. Empire should have had a formal written policy for its partners and employees to serve on boards, including disclosure requirements, reporting requirements, and compensation limits.
  1. Empire’s Client Services Agreement should inform clients of any Board positions held by partners or employees.
  1. Empire should establish minimum D&O liability coverage to protect the firm and its clients adequately.


The Board of Directors is the essential governing body for both public and private companies. Serving as a director comes with enormous responsibility. For this reason, before accepting an invitation to participate as a Board director, individuals should complete their due diligence. They should assess all risks, and make sure that they document all decisions. 

If a potential Director has a position with another company, the individual should consult with the company’s general counsel before accepting an invitation to participate on a Board. Employers should write clear policies regarding employee Board service.

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