Dear reader,

Happy New Year! Welcome to the February 2015 edition of The Director’s Dilemma. To read this email in your browser, go to www.mclellan.com.au/newsletter.html and click on ‘read the latest issue’. 

This month our dilemma focuses on the tricky issue of when to take sides in a divisive debate and how to handle matter with diplomacy and care whilst providing transparent disclosures.  If Paula were your friend, what advice would you offer?

Paula is one of only three directors on the board of a small listed company. The CEO and founder is also the largest shareholder. The Chairman is a well-respected director who sits on two large listed boards but has no start-up experience. The CEO recently informed the board that he had become involved in a private legal dispute. The chairman suggested that the proper course of action was for the CEO to stand aside while the board conducted their own investigation into the matter and considered what effect it might have upon the company and its share price.

The legal dispute concerns a private investment trust of which the CEO is trustee. An investor in the trust has claimed the CEO failed to provide proper reports on the conduct of the trust and used trust funds to pay personal expenses. The CEO has indicated that he intends to admit to ‘administrative failures’ and non-provision of reports but to refute any misuse of funds. The CEO is confident that he can provide the required reports and that he will not be banned from directing or managing a company, although he may be fined and reprimanded for his slackness. He claims that his attention has been focused exclusively on the success of the company and this has led him to neglect other duties, including administration of the trust.

The Chairman says directors and officers should manage their personal lives to the same high standards expected of their listed entities. He believes this court case will undermine trust in the company. The CEO believes he will emerge unscathed and, even if he doesn’t, that he should be allowed to continue in his role until the court case is resolved and the board can stand him aside only if he is banned. Both are looking to Paula to resolve their dispute.
What should Paula do now?

Assuming the CEO is the third board member, and Paula has been forced to cast the determining vote on this predicament, the appropriate first step would be to obtain independent legal counsel on the position of the CEO and at what point he might be required to step down.

The success, or otherwise, of the company might also be considered, as well as the difficulty of replacing a founding CEO. Certainly successful prosecution of the claim against him would be a PR disaster if not handled correctly, but an appropriate communications strategy can be prepared in advance.

My suggestion to Paula is to monitor the progress of the CEO's external case while preparing for the worst case scenario. As the CEO and largest shareholder he should be supported, particularly as he claims to be innocent of misappropriation of funds. Administrative oversights are not uncommon and perhaps not as unforgiveable as the Chair suggests. Paula might also like to undertake due diligence on the other party for further insight.

If things don't go the CEO's way and he is forced to step down, Paula and the Chair should ensure a relationship with him is maintained, providing he understands he can no longer have a leadership or public role despite his majority shareholding.

Vivien Gardiner is an executive director at Erase Group and JMSR. Pty Ltd. She is based in Melbourne, Australia.

This company is listed and a CEO being accused of corporate misconduct is price sensitive information. The CEO should be commended for bringing the issue to the board’s attention. The next issue to consider is how to word an appropriate announcement to the stock exchange. There is no avoiding or delaying this announcement. Some people will already know of the action and the market is at risk of inequities in information.

Discussing what to announce may help the parties to agree what to do. It takes the matter into an impersonal arena and removes emotion. Whatever is announced must be true: If they say the CEO has stood aside then they must stand him aside and disclose how they will manage whilst he is out of the day to day running of the company; if they say the CEO has their confidence and remains in position until the legal issue is resolved then they must support the CEO until settlement or judgment.

Founding CEOs are very hard to replace and unless there is a ready internal successor Paula can expect the search to take up to a year. This may not be survivable. Keeping the CEO in place could undermine investor confidence and lead to a drop in share-price or loss of custom that is equally fatal. Paula must consider the best case, worst case and most likely case and be sure that she is ready for the consequences of her decision.

Paula must forget who appointed her to the board, who she most often agrees with, who she likes or trusts, and concentrate on what gives the best most likely result for the shareholders and the business. A good corporate lawyer will be able to provide verbal advice immediately to help guide the board’s decision but ultimately this comes down to applying her own judgment and using her interpersonal skills to get the remaining board members to support an agreed course of actions.

Julie Garland McLellan is a practising non-executive director and board consultant based in Sydney, Australia.

I think the chairman is correct that the other two members of the board should conduct an independent examination, but unless their findings are fairly unequivocal—e.g., that it is likely the CEO violated fiduciary duties by misusing funds—the board should wait to see how the legal proceedings go. (They should not wait until a trial if the preliminary rulings are adverse to the CEO; adjudication could take years and definitely leave the company under a cloud.) It is relevant that this is a private trust rather than a public one—the laws involving required reporting are far less stringent, and there is a very real possibility that the investor's claim is either highly technical, motivated more by performance considerations rather than any malfeasance of duty, or even founded upon malice: a law firm should be retained to at least go through the potential merits of the claim, assess its seriousness, and the likelihood that if found negligent—or worse–a significant penalty is likely to be imposed. 

The problem is that the chairman comes from a different world: where CEOs have significant resources at their disposal and any such negligence is less forgivable, governance and legal compliance rules are more strictly enforced, shareholdings are widely dispersed, and a replacement for the CEO can be found with relative ease. This is a small company, and it sounds like it is not far from the start-up stage; the CEO is also the largest shareholder. It may be that the other shareholders are more concerned about the continuance of the CEO's tenure than about rather technical violations involving a private trust which is unrelated to the listed company in question. (If it is a fund management company, the issues become much more serious!) It may be difficult to find another entrepreneurial boss dedicated to growing the business in question. 

There is also the problem of what will happen to the CEO's stake if he is forced out against his will: the shares could be dumped in the market, temporarily killing the share price, or more likely, sold to a new controlling shareholder and without even generating a bid. The result could be worse for the company in every way. Absent sanctioning serious fraud or gross negligence, the board's duty is to protect the shareholders. If the charges do turn out to be more serious, and the repercussions on the share price more lasting, the other two directors will at least have had time to look around for a replacement for the CEO, and also to persuade him that it is in everyone's interest that he withdraw. 

Paula's problem is enormously compounded if the chairman is adamantly opposed to the CEO's continuance, and his resignation is a real possibility if the CEO stays on. The chairman's resignation in the face of accusations that the CEO may be guilty of some sort of more serious violation of the law could have enormous impact upon the share price, whether the chairman goes public with his reasons for resignation or not. In such circumstances, there is the possibility that trading in the shares might be suspended (although I think this unlikely, since the alleged offences have nothing to do with the listed company) and a greater likelihood that the company is acquired at a bargain price by a bidder, and the existing shareholders suffer a huge loss. 

In sum, it seems to me that a forced resignation would be premature at this stage, and that Paula should try to make sure that cooler heads prevail. An investigation on behalf of the board, preferably by a respected law firm, is imperative, as is full cooperation and disclosure by the CEO. If the issue seems to be snowballing, the CEO must go, for the good of the company and his own shareholding. If the case against the CEO is strong, and the chairman is insistent, Paula should side with him, even if it means selling the company. But if the case is equivocal, it is probably better to risk losing the chairman.

Andrew Clearfield is CEO of Investment Initiatives LLC. He is based in Greater New York City, USA.

Presenting to Boards - I will start 2015 with a tour of Australia for my 'Presenting to Boards' training program. For details of a course near you please see
https://www.konnectlearning.com.au/system/wp-content/uploads/2014/10/Presenting-to-Boards-Masterclass-0215.pdf

This course is essential for senior executives and consultants who want to be seen as trusted professionals in the boardroom.

Inspirational quote for February - This month my favourite quote is:

“Never look down on anybody unless you're helping them up.”

~The Reverend Jesse Jackson~

I was searching for a quote by Martin Luther King when I found this one. It goes out here with thanks to all who have mentored, led and inspired me over the years.

This newsletter - If you have any ideas for improving the newsletter please let me know. If you are reading a forwarded copy please visit my website and sign up for your own subscription.

Suggestions for dilemmas - Thank you to all the readers who have suggested dilemmas. I will answer them all eventually.

Farewell until the next issue (due 1 March 2015). I look forward to greeting you again then.

Enjoy governing your corporations; we are privileged to do what we do!

Best regards,
Julie

Disclaimer
The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling. Names and some circumstances in the case study have been changed to ensure anonymity. Contributors to this newsletter comment in the context of their own jurisdiction; readers should check their local laws and regulations as they may be very different.