A request to join the board: how to determine whether an invitation to the boardroom really means a trip to the courtroom.

• Author: Lerner, Jonathan J.

Anyone who has been asked to join the board of directors of a public company, especially for the first time, has every right to feel flattered by the invitation. After all, the person's wisdom and judgment are being sought by the company and the invitation also reflects the trust that the chief executive is reposing in the invitee to be both a "stand-up" individual while being able to keep the best interests of the corporation and its constituencies uppermost in his or her considerations. Once the cranial swelling subsides and reality sets in, however, board membership is not something that should be accepted cavalierly or automatically, as it may be fraught with the potential for litigation and personal financial risk. A cautious, thoughtful, and careful approach to board membership before accepting the invitation can help avoid enormous exposure later on.

Due diligence

Given the litigious nature of our society and the large potential exposure that can attend a variety of board actions, ranging from the treatment of acquisition proposals to the responsibility for the accuracy of the company's public filings, a prospective board member may be putting his or her personal assets behind the board's decisions. The recently enacted Private Securities Litigation Reform Act of 1995 (the "Reform Act") does provide certain important procedural and substantive protections to directors against federal securities laws claims, which have been a major source of potentially large financial exposure for directors. These protections include more exacting pleading standards to assert fraud claims, a "red light" to costly discovery while a motion to dismiss is pending, a statutory safe harbor for certain unrealized forward-looking statements, the elimination of joint and several liability except for knowing violations, and additional hurdles for would-be class-action plaintiffs.

Nevertheless, recent studies show that the volume of federal securities class actions has not fallen below pre-Reform Act levels. In this context, prudence dictates conducting at least a minimum level of due diligence before agreeing to serve on any board of directors.

Review public filings and check references

Anyone making a substantial investment in a company would read its SEC filings for the past several years. No less is appropriate before joining a company's board. The prospective director's syllabus should include, for at least the two previous years, if possible, the company's Form 10-K annual reports, 10-Q quarterly reports, 8-K interim reports, proxy statements, and the company's latest prospectus. In addition, the company's existing board members, officers and outside advisers can offer a wealth of information about the company, shed light on current issues of particular concern to the board, and provide insight into the degree to which the CEO actually expects the directors to exercise independent judgment. With these resources at hand, the prospective director should personally try to conduct due diligence on the following issues:

Company's Financial Condition. Of course, it is crucial for any new board member to become familiar with the financial situation of the company before joining the board. To be sure, a robust financial condition today cannot guarantee the company's prosperity next year. And no amount of financial success can assure the directors that lawsuits will not be filed against them. However, if the company is on the verge of going into the tank, i.e., filing a petition for Chapter 11, it may present a challenge that a prospective board member may prefer to decline.

Litigation History. Special attention also should be paid to the litigation disclosures contained in the company's SEC filings. Such disclosures should reveal both civil litigation involving the company that is considered "material" from a...