It's not your father's board seat: the evolution of corporate governance in an era of scandal.

• Author: Arnold, Janet
• Position: Report

It's been a rough decade for corporate directors. Business had been pretty good and predictable as we approached the new millennium. Large, publicly traded companies were growing and reaping the rewards of success; the economy was growing nicely; charities were bringing in record donations; stock prices were up; educational institutions were flourishing. Serving as a director of an organization was a mark of distinction, deserving of respect and admiration from peers. Few individuals outside of corporate governance circles ever considered caring about what corporate boards were up to, much less challenging a board or its directors on the decisions they made. What transpired in the boardroom was rather removed from the public conscience.

Then a series of scandals rocked the corporate world with reverberating consequences. Enron. World Com. United Way. Anderson Consulting. Adelphia. Tyco. Ramtek. Disney. American University. The list of prominent entities that that fell from grace beginning in the 1990s is disturbingly long. Many of the names are commonly recognized; others are not. But all had one thing fundamentally in common: failures by directors to do what they were duty-bound to do--be informed; be vigilant; make decisions in the best interests of the organization they serve; and keep it safe.

Relevance of Scandal to Cooperative Boards

Many in the rural electric cooperative community might be sorely tempted to believe that cooperatives are different; declare "that's not us" and ignore any consideration of the impact of recent corporate scandals. As a general rule, rural electric cooperatives tend not to perceive ourselves as multi-million dollar companies. We are cooperatives--small, not-for-profit companies providing essential electric service to rural America, abiding by the Cooperative Principles of voluntary and open membership, democratic control, education, autonomy, cooperation and concern for community (2). Our directors do not collect hundreds of thousands of dollars in retainers and per diems; they don't go on junkets to Switzerland for board meetings; and they certainly don't engage in shady accounting practices or permit outlandish spending by their CEOs. Cooperatives simply do not do those things.

In reality, electric cooperatives are bigger and far more significant than many realize. In 2006, cooperatives provided electric service to approximately 42 million people nationwide. The largest of NRECA's 855 member distribution cooperatives boasted more than 211,000 members and $462 million in total revenues in 2006. The average total 2006 cooperative revenue was $37.4 million, up 9.6% from the previous year. Electric distribution cooperatives provide service to members all over the United States, in both rural and urban areas, and 63 of NRECA's members had total 2006 revenues totaling in excess of $100 million. We have embraced technology, and now run state-of-the-art electric distribution systems and customer contact centers, and are often viewed as the best employers in our area.

As democratically controlled companies, we like the large corporations that have fallen victim to scandal--have boards of directors charged with the weighty responsibility of setting the strategic direction for the organization, overseeing operations and insuring compliance with the law. So despite the perceived dissimilarities between our cooperatives and the big, nationally-known entities spawning the scandals, we are not so different after all. And we ignore the lessons of their actions at our peril.

The Evolution of Fiduciary Duty

Black's Law Dictionary defines "directors" as "persons appointed or elected according to law, authorized to direct the affairs of a corporation or company." Perhaps the most fundamental aspect of being a director is the fiduciary duty each and every director owes to the organization he or she serves. That fiduciary responsibility has not changed appreciably over time. The three primary duties remain as they always have been:

* The Duty of Loyalty

* The Duty of Obedience

* The Duty of Due Care

The duty of loyalty requires that corporate directors be loyal to the organization they serve by not bringing harm to the organization, refraining from engaging in activities that could be construed as a conflict of interest, and maintaining confidentiality of information. The duty of obedience requires that directors comply with applicable laws, bylaws, contracts and policies--including state and federal law, the requirements of the Internal Revenue Service, Rural Utilities Service and other federal and state agencies. It also includes compliance with the cooperative's bylaws and policies, the terms of contractual obligations, and any and all policies of the cooperative, including such things as board policies. Finally, the duty of care requires that a director perform his or her duties in good faith, in a manner that he or she reasonably believes to be in the best interests of the cooperative, and with such care as an ordinarily prudent person in a similar position would use under similar circumstances.

The "Business Judgment Rule" offers protection for directors, establishing a presumption that "the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company." (3)

The "Good Old Days": Fiduciary Duty As It Was

The early court opinions, beginning in the 1920s, are remarkably consistent in their enunciation and definition of a corporate director's fiduciary duty and the application of the business judgment rule. Indeed, many legal rulings of the time show a general disposition towards protecting directors where possible.

The United States Supreme Court, addressing the issue of director duties and liabilities in 1920s, held that they could not hold directors of a bank liable for huge losses when a bank employee stole, over a period of four years, in excess of $310,000--an astonishing amount of money in those days. The Court ruled that the directors could not be held liable for the collapse of the bank because the statements of assets were always correct, and the thefts were quite cleverly concealed in a way that discovery of the theft would only have been possible if individual deposit slips were compared with the general ledger, which was never done, nor ever requested by the board. The Court, in ruling that the directors could not be held liable for the failure of the bank, stated that the fraud was "a novelty;" the directors had confidence in the examinations of the government bank examiners who had found nothing wrong, and they were "encouraged in their belief that all was well by the president, whose responsibility, as an executive officer, interest as large stockholder and depositor, and knowledge, from long daily presence at the bank, were greater than theirs." (4)

One of the first modern cases to address a director's fiduciary duty was Barnes v. Andrews, (5) an opinion penned by famed jurist Learned Hand prior to his appointment to the United States Supreme Court. As the story goes, Charles Andrews became a director of the fledgling Liberty Starters Corporation during its start-up period. The factory manager was, by all accounts, incompetent, and there were seething differences between him and the factory engineer. As a result, the work "languished from incompetence and extravagance." (6) During this time, two board meetings were held, and Mr. Andrews only attended one of them. He made no effort to acquaint himself with the affairs of the corporation, did not press the president for details as the company visibly and obviously struggled, and otherwise, as Judge Hand put it, "allowed himself to be carried along as a figurehead."

Judge Hand, in reviewing the facts of the matter, stated quite directly that he could not acquit Mr. Andrews of "misprison in his office." And yet, the clear failure of a corporate director to insure that he was properly informed on business matters did not result in personal liability for Mr. Andrews. Indeed, at the time, there was no precedent for holding a director liable for the collapse of a business where the director had been "inattentive." (7) Judge Hand explained that...