What do you do if you are an audit committee member or a director and you don’t know a relevant subject matter area?

The answer to this question might seem easy – you could say (1) “learn the area” or you might say (2) “reply upon other people” or you might say (3) “learn the area and rely on other people.” But learning the area even with a good faith effort isn’t necessarily easy or quick, and you need to ask whether relying on other people will satisfy your responsibilities? Many audit committee and board relevant subject matter areas are difficult or complicated.

Based on the business judgment rule, I recommend the third approach. I say that because you might well in part rely upon other people, but you must do so intelligently, and I would ask, other than simple complete trust or deferral, can you intelligently rely on other people if you don’t have sufficient background to gather information and ask questions, let alone evaluate the information and make decisions?

Let me also add, if it’s a specific subject matter area in which you have an oversight responsibility, such as, for example, for audit committees, oversight of the independent or external audit and of the external auditor, oversight of internal controls, oversight of the internal audit function, oversight of significant accounting practices, policies and principles, and oversight of anonymous reporting, and there are also many other specific areas, then for those areas you really do need to have or obtain (yes, it can be okay to “obtain”) the necessary background knowledge about those areas as they are core areas of your responsibility.

Below is a summary of the business judgment rule that I have taken from Tate’s Excellent Audit Committee Guide (in the Guide I have stated the rule in three different ways, because the business judgment rule is so important), and you can find the January 3, 2016, version of the Guide (183 pages) at the following link (note, I do try to update the Guide every 2-3 months, and please tell other people about this blog and the Guide as they are only worthwhile if people read them) – the link for the January 2016 version of the Guide is  http://wp.me/p75iWX-q

  1. THE BUSINESS JUDGMENT RULE

The business judgment rule provides a director with a defense to personal liability, holding that as a general principle of law, a director, including a director who serves as a member of a board committee, who satisfies the business judgment rule has satisfied his or her duties. Thus, the business judgment rule provides one standard of care, although other standards may very well also apply to specific tasks and responsibilities. I have started with the business judgment rule because it provides a very good overall approach for directors and audit committee members to follow, although lacking in specific detail. In some states the business judgment rule is codified by statute while in other states the rule is established by case law (see, i.e., Cal. Corp. Code §309 for California corporations, Del. Gen. Corp. Law §141 for Delaware corporations, in addition to relevant case law). The rule also applies to directors as board committee members.

In summary, as a general principle the business judgment rule provides that a director should undertake his or her duties:

-In good faith, with honesty and without self-dealing, conflict or improper personal benefit;

-In a manner that the committee member believes to be in the best interests of the corporation and its shareholders; and

-With the care, including reasonable inquiry, that an ordinarily prudent person in a like position would use under similar circumstances.

Reliance Upon Other People Under the Business Judgment Rule

In the course and scope of performing his or her duties, a director must necessarily obtain information from and rely upon other people. The director is not involved in the day-to-day operations of the business. The director provides an oversight function. Pursuant to the business judgment rule, a director is entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, prepared or presented by any of the following:

-Officers or employees of the corporation whom the director believes to be reliable and competent in the relevant matters;

-Legal counsel, independent accountants or other persons as to matters that the director believes are within the person’s professional or expert competence; or

-A committee of the board on which the director does not serve, as to matters within that committee’s designated authority, so long as the director acts in good faith, after reasonable inquiry as warranted by the circumstances, and without knowledge that would cause reliance to be unwarranted.

* * * * *

Advertisements