The Modern Role of the General Counsel as Corporate Lawyer & Business Executive

by Zina Kiryakos April 7 2010, 12:22

I. INTRODUCTION

The role of the General Counsel (GC) expands beyond the traditional chief legal officer of the company. [1] Scandals involving insider trading, white-collar crime, and the recent economic crisis have lead to the expansion of corporate governance regulations. [2] The GC serves as an overseer of corporate governance and compliance, therefore, it is important to analyze the board of directors’ methods for monitoring the expanding role of the GC. Furthermore, the many hats the GC wears in today’s modern corporation potentially includes holding dual roles as the corporation’s chief legal officer and a member of the executive management team. [3] This dual role will be analyzed to determine if the GC having a seat at the strategic management table benefits the corporation or hinders the GC’s role as the corporate police officer. [4] Given the complexity of the GC role and the important connection of the role to maximizing shareholder wealth, the board of directors need to implement methods to ensure the GC upholds their primary duty as the corporation’s chief legal officer. These efforts may be complimented by regulations and/or guidelines outside the realm of the board of directors, which further limits the GC’s actions.

II. BACKGROUND

GCs advise a company’s board of directors on their oversight responsibilities in an effort to keep the best interests of the company and shareholders at the forefront. [5] Additionally, GCs handle a vast array of tasks including, in-house day-to-day activities, complex corporate transactions, legal cost management, oversight of the corporation’s compliance with federal and state regulations, and outsourcing of legal matters to outside counsel. [6] Furthermore, a GC’s potential dual role as the corporation’s chief legal officer and a member of the executive management team raises issues as to whether the GC will give the board of directors advice as the corporation’s lawyer or as a business executive interested in passing through the management initiatives proposed by colleague executives. [7] On the other hand, conflicts may arise when acting as the corporations’ lawyer a GC disapproves of the CEO’s plans and decisions on how to implement the board of directors’ agenda for the company. Therefore, the GC may have its duties impeded by the possibility of getting fired if the GC delivers disappointing news to the board and/or executives as to which corporate actions are appropriate. [8] For example, a snapshot of current headlines demonstrates the legal wrangling faced by the GC of Bank of America, particularly as to whether or not the GC of Bank of America was fired for advising executives to disclose information on bonuses to Merrill Lynch executives. [9] Therefore, in order to promote compliance with corporate governance and fulfill their fiduciary duties, the board of directors must implement appropriate authority and chain of command for the GC, balancing both the many roles of the GC and potential conflicts of interest.

III. ANALYSIS

From the perspective of the board of directors, overseeing the principal-agent relationship with the GC may take different forms, including: utilizing an outside counsel to monitor the state of the corporation’s compliance program and providing the board with monthly or quarterly corporate compliance reports [10]; requiring the GC to provide the board annual reports on “the day-to-day operations of the compliance program”; and/or setting forth a board structure that includes a number of independent directors that would sit, among others on a Legal Compliance Committee. [11]

As more corporate scandals emerge and government regulations increase, boards have started to separate any tasks involving compliance (e.g. through the role of a corporate compliance officer) from the role of the GC. [12] The corporate compliance officer should monitor the company’s internal policies and procedures to ensure that federal and state laws and regulations are met. [13] The internal compliance program best meets the corporations’ objectives if itis developed with “a more integrated approach also focuses on legal as well as internal compliance to mitigate the risks of fraud, as well as to reach strategic, operational, and financial reporting objectives.” [14] Maintaining a separate corporate compliance officer role from the GC obviously adds additional higher company overhead, but the benefits of having a program that either catches issues early or displays to governmental agencies that proper procedures were in place for monitoring violations may aid in retaining future corporate profits. [15] The corporate compliance officer may be set up to report directly to the GC, or directly to the board of directors, with increased involvement from the GC in compliance and risk assessment reviews. [16] If the corporation’s monetary limitations disallow the separation of the roles, issues may arise when the GC holds the dual roles mentioned previously of chief legal officer and a member of the executive management team. This is especially true if the GC’s compensation package is partially set-up in the form of company stock options that are tied to the profitability of the company. [17] The board could face potential actions for breach of fiduciary duties if they have a GC that is resistant in reporting crucial plans of the executive team. Therefore, separating the roles of the corporate compliance officer and GC may create more benefits in maintaining the best long-run interests of the shareholders, although it increases operational costs.

Furthermore, the board may oversee the role of the GC through the implementation of decision-making restrictions within an employment contract. [18] As one of the main ways to define the boundaries of the agency relationship between the corporation and the GC is through a contractual agreement. [19] Restrictions as to the GC’s authority maybe set up within the GC’s employment contract (in addition to the company bylaws) and any violation of restrictions could mean withholding year-end bonuses. The GC may require additional compensation or benefits to offset the scrutiny of its day-to-day responsibilities. [20] Furthermore, the board ofdirector’s may restrict the GC’s authority in other ways. For example, within large corporations the purchasing department may have restrictions on the amount of contracts they can execute without the review and approval of the GC, although even the smaller size contracts are most likely tailored within the legal department’s pre-approved purchaser order terms and conditions. The board of directors may utilize this type of requirement to restrict the monetary level of contracts a GC can approve without first notifying the board and seeking its approval.

The interrelation between the GC as the company lawyer and the GC’s executive colleagues further complicates the evolving role of the GC. [21] In order to best counsel and advise the corporation the GC requires an understanding of the company’s business model and industries, with the possession of business acumen being preferable. [22] Many business executives see the legal department as just an impediment to their plans and may attempt to leave the GC out of the loop. [23] But, if the GC demonstrates that they have a balanced perspective on both the legal and business aspects of decisions to be made, they are more likely to be kept in the loop and the corporation’soverall risk exposure will benefit. [24] Therefore, benefits may arise from providing the GC the dual role of the chief legal officer and a member of the executive management team. [25] 

Although the dual role may provide GC’s with compensation packages similar to other executives, including a portion of their compensation in the form of company stock options. This provides the GC with further incentives to uphold its roleas the chief legal officer, but implementing stock options as a pay-out mechanism may bring into question the GC’s compliance impartiality, because of the possible personal incentive in allowing other company officers to “manipulate financial results and to maximize their option payouts.” [26] Furthermore, questions of impartiality come into play with any transaction involving conflicting interests, such as strategic plans regarding joint ventures or mergers & acquisitions, which may also result in the GC acquiring a higher amount of company shares. Therefore, the board of directors need to design a plan for the GC, possibly based on market trends or the advise of outside expertise, which gives the GC incentives to uphold the role of corporate police officer and mitigates the risks of the GC in a dual role capacity. At the same time the plan should not put the GC into a corner, in which the GC is at the whim of the board or CEO/Executives and faces the risk of getting fired if the GC does not follow the lead of either group. While from the perspective of the GC stock options allow the GC to be more in line with the pay of the other company executives, since the GC’s role and actions as compliance officer ideally maximizes profits and shareholder wealth.

Studies demonstrate that restricting other employee’s abilities through the use of GC approval of their actions limits employees’ ability to confiscate shareholder wealth. [27] The findings in a study by the Stanford University Graduate School of Business regarding the insider trading policy of various corporations found that the ability of the executives to use insider information to “extract rents from shareholders” correlates to the extent of the corporation’s governance program. [28] The corporations’ level of restrictiveness on their insider trade policy correlates to how much power the GC has to approve trades, “we find that the level of restrictiveness is lower when the chair of the board is also an officer of the firm and when there are fewer institutional blockholders.” [29] The study further found that trades within a restricted period that required GC approval were found to be less profitable and a less prediction of future performance than trades without GC approval, indicating that restrictive corporate governance programs assist in maximizing shareholder wealth. [30]

Finally, regulations and/or guidelines outside the realm of the board of directors may benefit the corporation, because they set limits on what the GC can do and may force the GC to be more cautious and conservative in its compliance approach. [31] These may include the GC’s interest in complying with state licensing requirements, following ABA recommendations on the ethical behavior of lawyers, reputation considerations for the GC, civil liability from the corporation or the SEC, and/or the Sarbanes-Oxley Act of 2002. [32] For example, the Federal Sentencing Guidelines for Organizations indicates corporations will be held responsible for the criminal acts of their employees acting within the scope of the employer-employee agency, but that demonstrating the corporation has an “effective compliance program” may mitigate fines. [33] Furthermore, the Sarbanes-Oxley Act specifically sets forth the responsibilities of a public corporation’s chief legal counsel when allegations of “a material violation of securities laws or breach of fiduciary duty of similar violation by the company or any agent thereof” are brought to their attention. [34] SEC Rules require the chief legal counsel to conduct an inquiry into the material violation and make a determination as to whether such violation occurred, and if so, “take reasonable steps to ensure that the issuer adopts appropriate remedial measures and/or sanctions - including appropriate disclosures,” and report such remedial measures “up the ladder.” [35] 

IV. RECOMMENDATION

Two important ways the board of directors may oversee the GC’s role include, the use of outside counsel and the use of a separate and distinct corporate compliance officer reporting directly to the board of directors. [36] First, the use of outside counsel by the GC to resolve complicated matters and/or advise on market and regulatory trends on issues, will demonstrate credibility to the board that the GC exercised duty of care in his capacity. [37] Furthermore, the outside counsel providing copies of compliance assessments to the board or providing directors with independent advice regarding intricate issues may demonstrate to a court or shareholders that the board as well has met their fiduciary duties and their business judgment will be protected. [38] Secondly, the use of a separate and distinct corporate compliance officer that reports directly to the board appears as a strong option. [39] Utilizing this chain of command assists in ensuring the GC does not have conflict of interest issues if the GC has the dual role of chief legal officer and is a member of the executive management team.

V. CONCLUSION

With the ever-changing, complex role of the GC, the board of directors implementing efficient mechanisms to oversee the principal-agent relationship with the GC assists the board and the GC to fulfill their fiduciary duties as overseers of the corporation’s compliance program. While the costs of these mechanisms may extract shareholder profits in the short-term, they will certainly maximize shareholder wealth in the long run when the board and the GC work together to limit corporate exposure.

End Notes:

[1] See, e.g., Alan D. Jagolinzer, David F.Larcker, & Daniel J. Taylor, Corporate Governance and the Information Content on Insider Trades (Stanford Univ. Rock Ctr. for Corporate Governance, Working Paper Series No. 3, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1138723

[2] See Ron Kral, Effective Corporate Compliance Programs, Corporate Compliance Insights, Nov. 30, 2009, http://www.corporatecomplianceinsights.com/2009/effective-corporate-compliance-programs-ron-kral-candela; see also Office of Inspector Gen., U.S. Dept. of Health and Human Services & Am. Health Lawyers Ass’n, An Integrated Approach to Corporate Compliance (2004) [hereinafter Office of Inspector Gen.], available at http://oig.hhs.gov/fraud/docs/complianceguidance/Tab%204E%20Appendx-Final.pdf.

[3] See The Evolving Role of the Chief Legal Officer, Foley & Lardner’s Nat’l Directors Inst. (2010) [hereinafter The Evolving Role of the Chief Legal Officer], available at http://www.foley.com/files/tbl_s88EventMaterials/FileUpload587/2564/NDICLOEvolvingIssues.pdf

[4] Id.

[5] See General Counsel Board Effectiveness, Foley & Lardner’s Nat’l Directors Inst. (2005) [hereinafter General Counsel Board Effectiveness], available at http://www.foley.com/files/tbl_s31Publications/FileUpload137/2683/NDI_GCBoard_FINAL.pdf

[6] Jagolinzer et al., supra note 1, at 2.

[7] The Evolving Role of the Chief Legal Officer, supra note 3.

[8] Ashby Jones, So Why Was BofA’s General Counsel Fired? Here’s BofA’s Answer, Wall St. J., Feb. 17, 2010, http://blogs.wsj.com/law/2010/02/17/so-why-was-bofas-general-counsel-fired-heres-bofas-answer/tab/article/.

[9] Id.

[10] Office of Inspector Gen., supra note 2.

[11] Id.

[12] Id.

[13] Kral, supra note 2.

[14] Id.

[15] U.S. Sentencing Comm’n, An Overview of the Organizational Guidelines [hereinafter U.S. Sentencing Comm’n], available at http://www.ussc.gov/corp/ORGOVERVIEW.pdf.

[16] OIG Issues Corporate Compliance Guide for Boards, (Crowell & Moring, Wash., D.C.), Jul. 2, 2004, available at http://www.crowell.com/NewsEvents/Newsletter.aspx?id=534 

[17] See generally Market Mechanisms for Public and Private Decision Making, Reduction in Agency Costs, Predictocracy.org, Jan 22, 2008 [hereinafter Predictocracy.org], http://predictocracy.org/blog/?p=50.

[18] See generally Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. of Fin. Econ. 305 (1976), available at http://ssrn.com/abstract=94043

[19] Id.

[20] Id.

[21] The Evolving Role of the Chief Legal Officer, supra note 3.

[22] Id.

[23] F. Douglas Raymond III, Where to Turn for Legal Advice? Both Inside and Outside Corporate Counsel Play an Important Role in Advising the Board of Directors, Directors & Boards, Aug. 2003.  

[24] Id.

[25] The Evolving Role of the Chief Legal Officer, supra note 3.

[26] Predictocracy.org, supra note 17.

[27] Jagolinzer et al., supra note 1, at 4.

[28] Id.

[29] Id.

[30] Id. at 25.

[31] Office of Inspector Gen., supra note 2.

[32] Id.; Press Release, U.S. Sec. & Exch. Comm’n, SEC Proposes Rules to Implement Sarbanes-Oxley Act Provisions Concerning Standards of Professional Conduct for Attorneys (Nov. 6, 2002) (onfile with author) [hereinafter U.S. Sec.& Exch. Comm’n], available at http://www.sec.gov/news/press/2002-158.htm

[33] U.S. Sentencing Comm’n, supra note 15.

[34] U.S. Sec. & Exch. Comm’n, supra note 31.

[35] Id.

[36] Office of Inspector Gen., supra note 2.

[37] General Counsel Board Effectiveness, supra note 5.

[38] Office of Inspector Gen., supra note 2.

[39] Id.

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