A recent Governance Briefing from Davis Polk* details an interesting decision from the Delaware Supreme Court on the importance of boards exercising oversight of risk. The case revolved around a listeria outbreak at an ice cream production facility, which resulted in devastating losses, including several deaths.
To quote from the article, “the case tells us that (i) a director must make a good faith effort to oversee risk; and (ii) failing to make that effort breaches the duty of loyalty, where good faith means “to try” to put in place ‘a reasonable board-level system of monitoring and reporting’ . . . .” The court decision in favor of the plaintiff relied heavily on lack of a process in place to keep the board apprised of risks (safety risk in this case), and lack of evidence in board minutes that key risks were disclosed to the board. The importance of policies regarding material risk, and board awareness of information regarding material breaches of those policies was also emphasized in this briefing.
When used as intended, Policy Governance® provides a systematic way of ensuring such processes are in place.
- It includes a set of Executive Limitations policies, in which the board outlines in advance for the CEO the organizational circumstances or situations that are unacceptable because they are imprudent or unethical. This allows the board to identify the amount of risk it considers unacceptable.
- In those Executive Limitations, the board can also indicate what information it needs from the CEO about risk to ensure the policies are sufficiently robust. This would include disclosure of material risks.
- It provides a place where the board can specify in its own processes how often it will review those policies for adequacy.
- It clearly identifies the routine frequency with which the board will monitor to ensure the policies are followed. Monitoring involves measurable evidence of policy compliance, not just vague reports or “trust me” statements from the CEO. In addition to the routine monitoring, the board may choose to monitor at any time circumstances warrant.
- The board’s assessment of monitoring reports is clearly recorded in the minutes, providing evidence that the board did exercise oversight.
A systematic approach to oversight of risk enables a board to address the “good faith” element of its fiduciary responsibility.