Understanding D&O conflict of interest

Understanding Directors and Officers conflict of interest

The phrases, “CEO steps down” or “Board of Director resigns” have become all too familiar headlines in the media over the last few years. The reasons for these departures may be varied, but often some form of director & officer conflict of interest occurred at the helm of the business or non-profit organization.

Directors and officers are expected to uphold their duty of loyalty with impartiality while placing the organization’s interests they serve above their own. Their duty of diligence requires them to act in good faith, to be reasonable and well-informed in their decision making, and to be present in the organization while monitoring its affairs. Directors and officers are obligated to their duty of obedience by following the statutes and terms of their organization’s agreements. When one or more of these honourable duties are breached by conflict of interest, turmoil will ensue.

Types of director and officer conflict of interest

• A board member, director, or officer taking advantage of their position in the company or non-profit for financial gain: insider trading, appropriating corporate opportunity, financial rewards and perks. Using manipulation of other board members, compensation or granting favours that benefit the director’s self-interests over the company’s best interests. These types of director/officer conflict of interest violate the duty of loyalty.
• Causing imbalance by serving the needs of some stakeholders while neglecting the needs of others, or neglecting the organization altogether. A director that is compensated as a board member, may also be sitting on several other boards to increase their income, potentially neglecting their duties and not devoting the required time to their position and responsibilities. This type of director/officer conflict of interest violates the duty of diligence.
• Leading a company or organization that chooses to maximize profits by deceiving and exploiting its customer base, the environment, and society in general. Cheating taxes, stiffing vendors/suppliers, and disrespecting nature affects everyone. This type of director/officer conflict of interest violates the duty of obedience.

As you can see, director/officer conflict of interest could appear as a bold action or a subtle maneuver. One thing’s for sure; your business or non-profit’s legal bills will be costly to defend in the event of a claim or lawsuit.The most common allegations requiring defence by directors include:

Acting beyond the scope of their authority

• Giving wrong or unprofessional advice
• Breach of fiduciary duties
• Authorizing excessive company spending
• Failure to supervise subordinates or company affairs properly
• Making unauthorized company borrowing

Avoid conflict of interest

Both public companies and private companies need to investigate the potential for conflict of interest exposure. And even more so for non-profit organizations; a non-profit board both functions and is held to the same level of accountability as its for-profit counterparts, but unlike for-profit, non-profit organizations often have limited resources to cover expensive litigation costs.

Assess potential conflict of interest

It is necessary for both business organizations and non-profits to assess their current and future directors’ and officers’ potential for conflict of interest.

• Are they employed elsewhere or conducting outside business that may conflict with the organization’s best interests?
• Are they from the same place of employment or have financial associations with another board member?
• Are they receiving or is there the potential to receive gifts, favours, or special treatment because of their position?
• Are they effectively respecting and guarding confidential and sensitive information ?
• Directors and officers should also ask themselves the above questions. If their seat on another board, or if they own a related side business or even if their spouse, offspring, or a friend might potentially benefit from their director/officer position, they must disclose this information before signing the position’s contract. They also should divulge potential conflicts of interest prior to any board meetings. The consistent ability to be independent and impartial is critical to every director or officer position.
  

  Conflict of interest policy

  In the event a business or non-profit doesn’t yet have a conflict of interest policy, an assessment for potential conflict of interest is an excellent place to start. The policy must be specific as it will dictate how directors and officers should avoid instances of conflict of interest once signed. Conflict of interest policies should also be adaptable because circumstances often change as companies expand.

  During the orientation of new directors, board members, and officers, the Insurance Bureau of Canada recommends that training should include statutory and civil liabilities, specific directors’ obligations, other rules associated with the organization’s business for which directors may be liable due to acts or omissions of the organization and understanding finances and knowing the organization and its by-laws.

  Director and officer insurance protection

  Beyond a rock-solid conflict of interest policy, preparing your organization for a potential director or officer conflict of interest with a D&O insurance policy is worth the investment. The following example depicts a VP that compromised their duty of loyalty, the eventual lawsuit, and outcome:

  The vice-president of a manufacturing firm determined that diversification into a different product line presented tremendous sales potential. Instead of presenting the opportunity to his company, the VP informed his brother, who started a new company to manufacture that product. On behalf of the company, a shareholder sued the VP, alleging that he wrongly took advantage of an opportunity belonging to the corporation. The suit eventually settled for $2.5 million, which was covered by the company’s Travellers Canada D&O policy.*

  Without constructing a solid conflict of interest policy, and backing it up with Directors and Officers insurance coverage, all types of businesses and, especially non-profits, become extremely vulnerable to liability claims, instability, and scandal.

  Resources
  *Travelers Protection for Organized Leadership
  D&O Insurance critical to commercial and non-profit
  Reliance Directors and Officers insurance
  IMD: Four Tiers of conflict of interest
  Directors and Officers Liability – Risk Management: Insurance Bureau of Canada