Outsourcing of Critical Thinking by Corporate Boards: Developments in International Law

Profs. Ashley Burrowes, PhD FCA &

John E. Karayan, JD PhD

Duties of Boards of Directors

Role of Boards

Duties derive from Common Law, Statutes, & Ethics

Overall: Fiduciary Duty of Due Care

Duties of Boards of Directors

Enhanced by Company Law

Enhanced By Securities Laws for publicly traded

Due Care and Financial Statements

Excuses for Dumb Decisions

Company Law waters down Common Law rules:

Delaware “business judgment rule”

Securities laws waters down Common Law rules:

Due Care and Financial Statements

SOX: mandatory 1 person on Audit Committee with minimum financial literacy (not expertise)

In re Walt Disney Derivative Litigation (Del. June 8, 2006)

Disney CEO Eisner teams with Pres.Wells

Wells dies sudden; Eisner bad heart

Eisner tries to reteam with Ovitz

Eisner dumps Ovitz (no-fault)

after only 14 months

$10M per Month for Leaving

Ovitz gets $130 million severance under Board-approved 5 yr employment contract

remaining salary+ 7.5M/yr bonus + options

“Shareholders” sue Board for breach of fiduciary duty, etc.

Reliance on Experts

Irwin Russell Disney Director & Chair of Compensation Committee Board lead financial negotiations

Wrote case study warning that terms were “extraordinary”, exceeded Disney + US standards +“raise very strong criticism”

Instead of disclosure, new study

Reliance on Experts, Redux

Exec comp. consultant Graef Crystal + Ray Watson, member Disney Comp. Committee & former Chair of Board

Black Shoales spreadsheetsCrystal memo: 5 year total $23.6m /year

After Announce, Committee meets & gets “term sheets” only

“Empty Head, Pure Heart” Defense

Presumption Defective Judgment excused so long as good faith/not gross negligence

conflicts of interest disclosed

followed process

reliance on experts allowed

Outsourcing Critical Thinking

The Disney Rule allows reliance on outside “Experts”

International Dimensions:

Ministry of Economic Development v Feeney and Ors (District Court, Auckland CRI-2008-044-29199, 2 August 2010) [“Feltex”]

An Unwelcome Export from America

Feltex: ANZAC’s Enron

Financial statements in public offering and subsequent periods did not meet IFRS

standards: true an fair view

E.g., ending balances on one not tie to other; ratio analyses shows very odd trends; defaults on long term loans required reclass to current liability

Reliance on defective Ernst & Young opinions freed the Feltex Five from criminal securities charges