March 3, 2009
How Boards Should Manage Risk
Tomorrow’s webcast – “How Boards Should Manage Risk” – should be a “biggie” given the events of the past year. The focus will be on how boards should now deal with risk management, including analysis of the important Citigroup decision decided last week in Delaware (and noted below).
Part of the course materials is this recent thought leadership survey produced by KPMG International, in cooperation with the Economist Intelligence Unit. This survey reveals industry insight into how institutions are addressing the risk management shortfalls. Some of the key findings include:
– Main areas of focus are risk governance, risk culture, and the reporting and measurement of risk, with over 75% of respondents indicating increased attention in each of these areas
– While 71% surveyed believe their organization’s risk function has more influence now than two years ago and a full 81% consider risk management to be an essential source of competitive advantage, 76% say that risk management is still stigmatized as a support function
– Fewer than half the banks in the survey acknowledge that their Boards are short of risk knowledge and experience – a surprisingly low figure given the recent troubles. It is of some concern that many are not even planning to address this issue – particularly at the non-executive level where the need for expertise is at its most acute. Almost eight out of ten respondents are seeking to improve the way risk is measured and reported, a clear recognition that previous models did not give sufficiently accurate forecasts
– Incentive and remuneration issues are cited more than any other aspect for creating the preconditions for the credit crisis, followed closely by risk governance and risk culture
The research included a survey of over 400 professionals involved in risk management (30% at the C-level) in 79 countries, as well as several in-depth interviews with senior executives, undertaken in the fall of 2008.
Delaware Dismisses Caremark Claims Against Citigroup: CEO Pay “Waste” Claim Survives
From Travis Laster of Abrams & Laster: Delaware Chancellor Chandler’s opinion in In re Citigroup Inc. Shareholder Litigation came out last week. The complaint alleged Caremark claims against the Citigroup directors based on Citi’s subprime losses. The Chancellor dismissed all but one aspect of the case – a waste claim based on former Citi CEO Charles Prince’s exit compensation agreement. [We have posted memos regarding this case in our “Risk Management” Practice Area.]
The opinion confirms that existing principles of Delaware law apply even in the midst of an unprecedented financial crisis, and that the Delaware courts will not go looking to hold directors up as examples for the economy’s current difficulties. It provides a good summary of existing Delaware law principles governing Caremark claims, which I won’t repeat.
Here are a few nuances worth highlighting:
1. The Chancellor distinguishes between (i) a Caremark monitoring system designed to protect against financial fraud and criminal wrongdoing and (ii) the identification of and protection against business risk. He holds that Citi’s problems fell squarely under the heading of unanticipated business risk. This will be a helpful distinction for other companies faced with similar problems brought on by the current financial crisis.
2. The Chancellor makes clear that “Directors with special expertise are not held to a higher standard of care in the oversight context.” (n.63). Likewise, for directors who sit on committees with oversight responsibility, “such responsibility does not change the standard of director liability under Caremark and its progeny.” (Id.)
3. Prior experience with scandals at other companies is not sufficient to make a director “sensitive to similar circumstances” and hence susceptible to a Caremark claim. (37).
4. In a point of interest to those who litigate in Delaware and face competing litigation in other fora, the Chancellor questions whether a lower standard should apply to a motion to stay in favor of a prior pending action versus a motion to dismiss, noting correctly that both have the same practical effect. (n.16).
5. In what I view as the most noteworthy section of the opinion, the Chancellor holds that the plaintiffs stated a claim for waste based on former CEO Prince’s $68M exit package. He explains: “[T]he discretion of directors in setting executive compensation is not unlimited. Indeed, the Delaware Supreme Court was clear when it stated that ‘there is an outer limit’ to the board’s discretion to set executive compensation, ‘at which point a decision of the directors on executive compensation is so disproportionately large as to be unconscionable and constitute waste.'” (55-56). The Chancellor held that there was a reasonable doubt as to whether the exit package awarded compensation that is beyond the “outer limit.” (56).
It used to be said that waste claims were easy to plead – but difficult to prove. Then for a long time they were also hard to plead. This one survived. It’s too early to say whether the Delaware courts will now be more receptive to compensation challenges based on waste theories, but I feel safe predicting that this aspect of the decision will not go unnoticed by members of the plaintiffs’ bar. Look for more waste claims to come based on big exit comp numbers.
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– Broc Romanek