Directors Can (and Should) Talk to Investors, About All Sorts of Stuff

Date: Thursday, June 10, 2010
Author: Hedgetracker.com

As activist investors begin to win director elections, talk turns to the rights and obligations of these directors to share board-level information. To what extent may these new directors (or any directors, really) communicate with investors, and what must remain confidential?

On the one hand, investors think that they bought and paid for the winning election. They feel entitled to know what’s going on at the company, from their “insider”. On the other hand, incumbent directors deliberate privately, and feel free to express honest views among themselves only with the assurance that these views in fact remain private.

I recently had direct experience with this very problem. Investors in a portfolio company succeeded in electing an independent nominee to the Board of Directors. We had high hopes for an open dialogue with the newly-elected director, and even with the entire Board. Unfortunately, this director has disappointed us, and shut down all communication. The director claims that Board policy requires management to mediate all outside communications, and otherwise limits what directors can discuss with investors.

At least one commentator has advice for companies that confront such a situation. Charles Nathan of Latham & Watkins suggests that companies adopt comprehensive policies that limit directors’ communication outside of the boardroom. He worries that a “constituency director” might favor their supporting shareholder over the sanctity of board discussions.

My advice for investors: as well they should. Short of revealing trade secrets, employment matters, or financial results that could lead to insider trading charges, duly-elected directors have an obligation first to investors, and only then to other directors and management.

Back to our company. The independent director won an election outright, rather than taking a seat as part of a settlement between the company and the nominating investor. The nominee has no legal obligation to follow board policy, and (within the vague bounds of fiduciary duty, and the laws around trade secrets, employment, and insider trading) could discuss any board matters with anyone. Nathan generally agrees, stating “effective enforcement of a company’s confidentiality policies … may be difficult”.
Now, as it turns out we’re talking about some rather mundane items, such as the date of an upcoming board meeting (which the independent director refused to divulge). Still, the director insisted on following board policy, appealing to the need for collegiality, much to the chagrin and frustration of investors that went to considerable expense to elect the director.

Suppose investors settled the proxy contest, and appointed the independent director without an election? Many such settlements include an explicit agreement that the appointee will obey board policies, including those pertaining to confidentiality. The agreement might then provide the means for enforcing compliance, such as resigning in the event of a breach of policy.

The bottom line, then: a duly-elected independent director can talk about anything he or she desires from the boardroom, restricted only by laws on trade secrets, employment, and insider trading, and perhaps their desire to get along well with other directors. Whether that desire makes sense is the subject for another day.