Welcome to the December 2010 edition of The Director's Dilemma newsletter. In kicking off the season with some governance-level Christmas spirit, read to the end for a special Holiday Season offer!

The Director's Dilemma provides case studies that have been written to help you develop your judgement as a company director. These scenarios are based upon real life; they focus on complex and challenging boardroom 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 presents an issue and several responses.

Which response would you choose and why?

Vincent is a director on a government sector board. He has invested a large percentage of his retirement savings in the shares of the national leading telecommunications company and has no intention of selling or trading these shares in the near future.

His Board is due to consider a recommendation from management regarding renewal of the company's telecommunications services contract. This is a large and expensive item for the company; it has strategic implications and will require a decision of the full Board.

Naturally, the leading national telecommunications company is one of the three contenders for the contract. The contract is not material to the telecommunications company even though it is big for Vincent's Board. Similarly, Vincent's shareholding is not significant for the telecommunications company even though it is his biggest investment.

Vincent has listed the shareholding in the company register of directors' interests but is not sure if he should do anything prior to the next meeting at which this item is due to be discussed. He has received the papers and agenda for that meeting and wonders if he has a conflict of interest.

What should Vincent do?

Dean's Answer

Just because a director has a relationship with a mutual third party that is involved with the organisation they are a director of, does not automatically mean that they have a conflict of interest.

In legal considerations, there must be a material benefit involved for there to be a conflict of interest. That is, the director must potentially receive some benefit, financial or otherwise, as a result of making a decision before it is considered a conflict of interest. In Vincent's case, he does not stand to receive a financial benefit from deciding on the telecommunications provider and so his involvement would not legally be considered a conflict of interest.

However, there are two other aspects to consider.

Firstly, Vincent has made a sizeable investment, both in dollar terms and percentage of funds invested, in the leading national telecommunications company. He would have, hopefully, done so because he a strong belief in the ability of the business to generate investment returns above those of other providers. The issue is that this belief may influence his decision making in regards to the telecommunications services contract.

As most marketers know, an existing relationship has a strong influence on future dealings. Already having a relationship may positively influence his assessment of the company's bid. Given that it is a significant contract for his organisation, it is imperative that he and the rest of the Board make a decision in the best interests of their organisation. This is a very grey area. Imagine instead of already owning the shares, he was considering purchasing them. What influence would that have on his contribution to the decision making process?

The other consideration is the outside perception of the impartiality of the Board. As many politicians and public figures have found out, the perception of a conflict of interest occurs no matter how distant the relationship is.

By registering his interest, Vincent has complied with his legal requirements. He should also raise it during the board discussions on the contract and ask the Board to consider if they feel that it will compromise either his ability to make an impartial contribution to the Board's decision or adversely reflect on the impartiality of the Board. These questions need to be asked both at the beginning of discussion and after the decision has been made to ensure that the Board is comfortable with the process.

One approach I have seen used in this type of situation is to make each bid response anonymous. This allows the Board to consider each response solely on its merits and without the preconceptions of the companies involved. It requires some effort to produce but it does remove any question of impartiality. It's also interesting to ask the board members afterwards if they would have made the same decision if they had known the identities of the bidders.

Dean Cording is a Principal at Succurro Corporate Services in Canberra, Australia.

Julie's Answer

Vincent should contact the Chairman and advise her of the conflict before reading the papers relating to the issue.

The Chairman is usually the person to whom a director should refer any query relating to potential conflicts of interest. The Chairman can then advise Vincent how best to proceed. Some options are:

• For extreme conflicts the Chairman may ask the board member to resign (if the director refuses the Chairman may then consider it necessary to raise the issue with shareholders at an EGM)
• For serious conflicts the Chairman may recommend that the board member recuse (absent) himself from discussions of the topic and not receive any papers pertaining to it
• For moderate conflicts the Chairman may recommend that the board member simply abstain from voting but receive papers and take part in the discussion
• For insignificant conflicts the Chairman may remind the Board of the conflict before the discussion and then allow the affected director to take part in the discussion and any vote.

The Chairman must decide how important each conflict is. If the Chairman is unsure how to proceed, the company's probity auditor may advise her.

Vincent has no ability to influence the tender submissions, and management are making the recommendation based upon pre-established criteria, so this conflict may be considered moderate or insignificant. If the company has a particular sensitivity, high public interest, controversy or a history of poorly managed tenders, then the Chairman may prefer to escalate the issue. Many government sector boards have a higher sensitivity to conflicts of interest than their commercial counterparts and manage them with stricter controls.

Best practice would be for the Board to have a policy for such issues, consider the conflict before the papers were sent out, and decide what action they wished to take. As these issues can occur without much forewarning, it is good practice for the Board to formally resolve to delegate the task of assessing conflicts that arise to the Chairman, as this one has.

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

Andy's Answer

There is no question of him being permitted to participate in this decision: he cannot and he must not, in order to avoid any appearance of impropriety. This is most especially so as the Board is owned by the government: any suggestion of conflict-of-interest will potentially enter the political arena, and accusations of corruption will be the certain result.

There is no downside to Vincent recusing himself, and there is no benefit to him participating: the telecommunications company is unlikely to see an increase in their share value arising from the vote's outcome, so Vincent would risk his own good name and reputation on a vote that will deliver no personal benefit anyway.

Therefore, even if Vincent's moral sextant and ethical compass are wavering on this very clear, cut-and-dried Governance issue, the risks far outweigh any potential for reward. This dilemma shouldn't even present an issue for a thinking Board member: recuse, and let the others make the decision.

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

Teresa's Answer

Most people will not read the fine print that says this is not a material transaction for the telecommunications company, or that Vincent's share of the telecommunications company stock is insignificant. However, they will note this is Vincent's largest investment and if he happens to show a profit on his investment, related to this contract or not, there is always the chance someone could make Vincent appear conflicted. These situations must be communicated as clearly as possible.

Not managed properly, this situation could tarnish Vincent's reputation as a company director without any basis for accusation or any undeserved financial benefit to him. These days it seems the impression of a conflict of interest can be just as harmful as a real one.

Theresa Wilt is an MBA Accounting Consultant specializing in Government Contracts and Grants, based in San Diego, USA.

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.

What's new

Book reviews – Directors need to read. There are so many new books each month that it is hard to keep pace with the supply or to assess the likely quality of each new publication. Each month I publish a review of a book I have read. This month I have reviewed Strategic Speed by J R Davis, H M Frechette and E H Boswell. It provides a valuable new perspective on strategy implementation that will be helpful for boards.

E-governance Training for Directors – Last month I presented a course on the risks and benefits of digital media for directors. It included discussions of how digital media impact the business, the Board and individual directors. We followed the session with a practical hands-on tour of cyberspace, including all the popular sites, learning how to set up profiles, post comments and make connections. We discussed the suitability of each site for directors. It was popular and I have decided to add it to the repertoire of regular sessions. Email me for details of the next public session or to arrange a session tailored specifically for your board.

Holiday Season Special Offers – I have two special offers for loyal reads of The Director's Dilemma this year:

Evolving Models of Governance and Accountability Conference
This conference focuses on public sector boards and will be held at the National Convention Centre in Canberra on February 23 & 24, 2011. As a contributor to this conference, I have organised a 20% discount on the conference price for readers of The Director's Dilemma. To redeem your gift voucher, please email elias.sodir@criterionconferences.com or contact him directly on 02 9239 5785 and quote voucher code: SPK20. If you register online you will not be able to get the discount. I look forward to seeing some of you there!

Dilemmas, Dilemmas
I have organised a US$15 discount on the list price of this book. This discount will be available throughout December. To purchase, visit https://www.createspace.com/3413182 add the book to your shopping cart and enter discount code 5SZX4QH5.

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 travel plans each month.

Please call or email me if you would like to schedule a meeting or find out more about attending one of these events.

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. It is (still) free. As an existing subscriber you will continue to receive a free subscription when a charge is introduced.

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

Farewell until next issue (due 1 February 2011). Have a peaceful, prosperous and pleasant holiday season, best wishes for Christmas, Hanukkah, and Eid al-Adha. Enjoy governing your corporations; we are privileged to do what we do!

Best wishes
Julie

www.mclellan.com.au | PO Box 97 Killara NSW 2071
email julie@mclellan.com.au | phone +61 2 9499 8700 | mobile +61 411 262 470 | fax +61 2 9499 8711