We constantly hear about the importance of “accountability,” meaning that organizations and individuals have to be held accountable for misconduct or failures to act. The focus on accountability is a positive trend, consistent with our ideas of justice and fairness, Within an organization, accountability is a cornerstone of organizational justice.
When demands for accountability reach the board room and individual board members, however, there are significant obstacles to board accountability. At the root of this absence of accountability is a legal doctrine, commonly referred to as the Caremark standard governing individual board member liability for corporate malfeasance. Notwithstanding the supposed high bar established by a corporate board member’s fiduciary duties, the Caremark standard provides an excessive amount of protection against board member liability.
The Caremark standard requires directors to ensure in good faith that companies maintain a compliance program and reporting system to deter and detect corporate misconduct. As part of this obligation, board members have to exercise some effort to monitor the program to make sure it is working.
Board member personal liability is limited to those circumstances when a board member fails to make a good faith effort to oversee the company’s operations. These claims are “among the most difficult of corporate claims” to sustain because a required element is a showing of “bad faith.” In other words, only a “sustained or systematic failure of the board to exercise oversight — such as an utter failure to attempt to assure a reasonable information and reporting system exists will establish a lack of good faith.
For years, board members have escaped personal liability behind this high burden. Yet, we have seen some movement toward accountability in the last decade with Delaware Court decisions stemming from the Boeing 737 MAX safety debacle, the Blue Bell ice cream listeria outbreak, and a case involving clinical drug trial misconduct and fraud. But these cases — which have chipped away at the Delaware Court’s “protective” standard — have occurred only in especially damning facts where serious safety and life or death concerns may have arisen.
Until the Delaware Courts (or legislative) adopt a more meaningful standard, individual board members will in almost every case escape accountability. This continuing protection surrounding the corporate board room cannot continue in response to social, investor, government and public demands for improved corporate governance performance.
The Environmental Social and Governance (“ESG”) movement is one of several reasons for a new approach. We all know that corporate stakeholders are demanding improvements in corporate performance and overall governance. Corporate board rooms are in the midst of a significant transformation — diversity, equity and inclusion includes the corporate board. Governance improves with diversity of viewpoint and membership. At the same time, once constituted, the new set of corporate boards have to exercise their fiduciary duties in a manner that is reasonable and commensurate with their qualifications and responsibilities.
The standard of “utter failure” or “bad faith” is not necessary to ensure that individual board members apply themselves to ensure that an effective ethics and compliance program is implemented and that the board monitors the performance of the compliance program.
Corporate boards should be held accountable based on a higher standard of performance. The list of corporate board malfeasance of failures to supervise is long and matches the ever-growing list of corporate scandals. Individual board members exercise great responsibilities and with that responsibility comes accountability. In today’s fast-changing world of corporate governance, surely board members, when they accept a position on a board, should embrace their responsibilities with a standard of care that is above that of “utter failure” or “bad faith.” Indeed, like any other fiduciary duty, individual board members should be held accountable for exercising due diligence and prudence to ensure that corporate ethics and compliance program has been implemented and is operating effectively.