Welcome to the April 2010 edition of The Director's Dilemma. I hope you find it interesting, informative and inspiring. If you are new to this newsletter, a compilation of the first two years of dilemmas has been published in a new book and is available at Amazon.com

I advise Boards and Directors on complex and challenging issues which can be resolved in a variety of ways. Each way has different pros and cons for the individuals and companies concerned. Every month this newsletter considers several responses to a real issue. Which response would you choose?

Max is a director on a government sector board in a small provincial town. He has strong financial skills and loves detailed analysis of future strategies and past performance. He frequently clashes with a fellow board member, Norah, who is more intuitive and relationship-oriented than Max.

A friend asked Max if there was any truth in a rumour that was circulating concerning a relationship between Norah and the CEO. Both Norah and the CEO are married. Thinking back Max can remember that the CEO had placed his hands affectionately on Norah's shoulders when passing behind her during a cocktail party. It was crowded and he thought nothing of it at the time. Now, hearing of the rumour, he is not so sure.

Norah heads the Remuneration Committee and the CEO's salary review will be addressed next week. If the allegation is true it would be a conflict of interest. But Max isn't sure if it is true. He is sure that he does not feel comfortable approaching Norah to talk about this.

What should Max do?

Steve’s Answer

Presumably the underlying question is "Will the relationship, if it exists, improperly influence the CEO's compensation?" That should not be difficult to determine after the fact.

If the salary review results in what appears to be appropriate CEO compensation, there is no immediate harm done. Accordingly, prior to the CEO's salary review next week, Max should do nothing more than observe the interaction between the CEO and Norah. After all, he has personally witnessed no overtly inappropriate behavior; he has only been informed of a rumor.

Board members are generally expected to be of high integrity and good moral character, functioning in the best interests of the shareholders or taxpayers. They also typically are required to disclose potential conflicts of interest, as well as the appearance of a conflict.

Norah, then, would be obliged to volunteer the information regarding any appearance of conflict due to an intimate relationship with the CEO, should one exist. Max, too, would be expected to investigate further if he had reason to suspect that the shareholders'/taxpayers' interests were at risk due to a possible conflict of interest.

If the Chairman of the Board is not the CEO (and let's hope this is the case), Max could take his information and suspicions to the Chairman. If the Chairman agrees that questions must be asked, he could approach Norah and/or the CEO individually, or he could raise the question for discussion in an executive session of the Board.

Ultimately, it should be the full Board that decides whether or not a conflict of interest exists.

Steve Bowman is Human Resources Consultant and a Principal at Management Consultants LLC in Richmond, Virginia, U.S.A.

Pankaj’s Answer

A director's duty to the Corporation is to act properly and with care. Given that a relationship between Norah, as a director, and the CEO is likely to affect the reputation of the Corporation, Max must act because doing nothing would be in breach of his duty. If he discusses it with others his conduct would amount to defamation.

Therefore, as much as he might dislike talking to Norah about this he has no option but to approach her and inform her in good faith of the rumour he has heard.

However, he would do well to not ask Norah to confirm or deny the rumour. The privacy of individuals remains of paramount importance. Rather, he can assure Norah that he will not discuss this with anyone else.

Directors cannot be expected to live in a vacuum and remain immune to the push and pull of human emotion. Yet despite these pressures, directors are required to act in the best interests of the Corporation and they generally do. Norah has to be trusted to do the right thing and not let her personal interests get in the way of the impartial discharge of her duties. There is no way that Max or anyone else can anticipate her conduct. Therefore, he should do nothing more than provide feedback to Norah.

Pankaj Rai Mehta is Supply Chain Manager at MM Kembla Products based in New South Wales, Australia.

Julie’s Answer

Apply Socrates' 'test of three':

• Truth - Max has no idea if the rumour is true. Even if it is true, the rumour exists and asking about it will only serve to strengthen it.
• Goodness - This rumour is not something that the subjects would wish to have spread. Max can't expect them to declare it as a conflict without prompting.
• Usefulness - It is 'useful' for directors to know things that may affect the company's reputation. Ignoring this information would breach his duty.

A reputation of integrity and probity is vital for government-owned organisations. Rumours spread very fast in small towns and this would be harmful, especially given the upcoming review.

It would be best to speak with either the CEO or Norah but if Max does not feel able to broach the matter with them he should raise it with the Chairman. He must be careful of defamation. He must create a 'proper forum' where Board confidentiality may provide some protection against defamation. He should ask for a confidential meeting concerning an issue that may affect corporate reputation. No Chairman will refuse that request. He should explain the paucity of evidence for this suspicion so that the Chairman does not give the matter undue credence.

They should therefore watch and listen. If it appears there is substance to the rumour then the Chairman should ask Norah to resign from the Remuneration committee. Only the Minister may ask that she leave the Board. They should not inform the Minster now as it would be defamatory. This is a Board problem and they must deal with it. If evidence is revealed, they should get legal advice from defamation and board specialists. If they see no evidence Max should tell his friend that fact.

Directors often disagree. It is worrying that Max's disagreements have led him to a fear of speaking with Norah. He should, in any event, work on disagreeing without damaging relationships. It is a useful skill.

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

Andy’s Answer

If you look at Max's interpersonal style, he is comfortable with facts. Norah is comfortable with feelings. Presented properly, facts will trump feelings every time.

"Presented properly" is a very big hurdle though, and in this case it is going to be difficult for Max to find facts: his "friend" is dealing in rumour and innuendo. So step one is for Max to go back to his "friend" and try to turn the rumour and innuendo into a fact, by asking a good question: "Is there anybody who is willing to go on record with an allegation that Norah is having an affair with the CEO?"

No matter what the answer to that question is, he will have a valuable fact, and he can use it. If somebody will go on record, have it documented and signed. He can use that to present to Norah when asking her to excuse herself from the Remuneration review of the CEO. Naturally, he would do so in private, in the first instance, hoping that Norah would be professional enough not to require the matter to be tabled to the Board.

If nobody will go on record -- as is most likely the case -- Max is still dealing with two facts: there is a rumour of a potential conflict of interest, and that he has been made aware of it by his "friend". He can now decide whether he has a Duty of Care as a Director. He arguably has plausible deniability: it is still only a rumour. I'd argue that he does have a Duty of Care, and he needs to discharge it carefully.

I suggest his next move should be a direct approach to Norah, in private. He needs to put the matter to her in a direct, factual manner, short and sweet: "Norah, I have been advised of a rumour that you are in a relationship with the CEO. As you are head of our Board's Remuneration Committee, if this rumour is true it would place you in a position of conflict of interest when reviewing our CEO's salary."

He then needs to wait for her response. If she denies it, he is off-the-hook as he has made diligent enquiry. If she confirms the rumour then he can confirm with her that she will be excusing herself from the review. And if she does neither -- if she blows up in hysterics, for example -- he needs to put the matter, quietly, to the Chairman and leave it to him.

Max's Duty of Care ends when he has made diligent enquiry.

Finally, Max should not approach the CEO on this matter: it is Norah whose position is improper if she is having an affair with the CEO. Moreover, the CEO is an employee of the Board, and Max's enquiries might provoke cause for an employment grievance.

Andy Cawston is CEO and Chairman, International Alliance of Guardian Angels NZ Charitable Trust.

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 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.

What's new

Book reviews – Directors need to read. It is a great way to learn from other people's experience. This month I have reviewed Corporate Governance by Ken Kim, John Nosfinger and Derek Mohr. I have also received a review of Dilemmas, Dilemmas; Practical case studies for company directors by Kristian Kaas Mortensen, President of the Baltic Institute for Corporate Governance.

Where's Julie? – A few readers manage to catch up with me on my travels and it is such a pleasure to meet them that I now share my business travel plans each month.