The ethical responsibility of directors and trustees.

• Author: Driscoll, Dawn-Marie

No wonder independent trustees and outside directors are nervous these days. They're responsible for the financial security of stockholders, citizens, and municipal entities. Individuals depend on board members' ethics and judgement to protect home purchases, college educations, and retirement accounts.

Yet the markets are increasingly complex and deeply interconnected. Currency traders move a trillion dollars around the world on a daily basis; financial innovations make geography and regulatory bodies nearly irrelevant. Meanwhile, we've experienced the worst bond market in decades. Recently, Wisconsin lost $95 million on peso and currency speculations. A community college fund in Chicago dropped nearly $40 million on mortgage securities. And that wealthy deadbeat, Orange County, filed for bankruptcy.

In the face of such turmoil, directors may be tempted to crawl under a hole and be overly conservative, forgetting that markets are efficient and there is no return without risk. There is another approach, however. Ethical responsibility can be met straight on with a clear head and a steady hand. The role of directors and trustees is not to prevent losses or to maximize return, but to anticipate next year's financial news.

Several Dilemmas

There are several significant ethical matters now facing directors and trustees.

First and foremost, diligent directors must assess risk. The risks, for instance, of investing internationally and--in an increasingly global economy--of not investing some funds in international stocks and bonds. They must assess interest rate risk, inflation risk, risks of private placements and venture capital investments, and credit risk (which many financial reports don't clearly reveal). Board members needn't understand every nuance of each investment but they do have an ethical responsibility to ask questions about risk.

Financial risks aren't the only ones to consider. Directors must asses operational risk as well, from backup phone lines and computer programs to accounting and pricing. Bankers Trust had to restate earnings by $80 million because of pricing disputes over foreign currency options. Every day newspapers carry stories about rogue traders who are allowed to price and account for trades. Always ask if operations management understands and can track investment activities, and also whether the two sides of the house are really separate.

Finally, there is legal risk. In 1990 local authorities in the London...