Directors and those that work closely with them know that their experience as a director of one company is often translated into similar practices for other companies where they are a director. The upside is efficiency and rapid transfer of best practices. But it can also work the other way, with the rapid transfer of bad practices. This has been well demonstrated with a very recent US study from a corporate watchdog group that identifies corporate directors who sit on more than one board as a likely cause of the spread of backdating stock option practices. Regulators are now putting the theory to the test.

The U.S. Securities and Exchange Commission is also examining the roles of lawyers, auditors and compensation consultants.

More than 40 percent of 120 companies under government or internal scrutiny for suspicious timing of stock option awards to executives and employees had common directors, according to a study done for the Corporate Library and published last month.

That is a much higher incidence than researchers would find in a random sample.

Researchers were unable to find any other statistically significant governance link between these companies.

The study does not accuse corporate directors of wrongdoing. And none of the study’s findings definitively prove that any of the directors were responsible for disseminating the practice. If corporate directors did spread the word, they may not have known there was anything improper about the practice. In this regard it is unfortunate that a duty of care combined with incompetence has been accepted as a sound defence in litigation matters (see our Disney article).

But the study raises red flags about the role of corporate directors in the swelling stock-options scandal, which has cast suspicion on corporate directors for either knowing about the practice or falling asleep at the wheel.

The Corporate Library also explored the connections between Silicon Valley’s pre-eminent law firm, Wilson, Sonsini, Goodrich & Rosati, and companies embroiled in the scandal. A number of the firm’s senior partners, including Larry Sonsini, wore multiple hats at companies that are under scrutiny, the study found. The law firm maintains that its connection to companies under investigation is simply due to its dominant share of the technology legal market.

We expect there is nothing new in board directors sharing innovative strategies across companies. In fact this should be encouraged. However, the US study emphasises the need for boards’ governance processes to be sufficiently robust in testing all innovative ideas for full compliance and propriety, independent of whether or not they have been applied in other companies.

© Guerdon Associates 2024 Back to all articles