Corporate boards continue to find themselves the subject of scrutiny by plaintiffs’ attorneys alleging violations of fiduciary duties—specifically as a function of a lack of independence—after a significant board decision. Less common are instances of such scrutiny from the US Securities and Exchange Commission (SEC). However, the SEC's recent charges against an independent director for failing to disclose certain information to his board prove it isn’t so rare. It also serves as a powerful reminder of the need for directors and corporate leaders to approach relationships and potential conflicts of interest with full transparency.
This article will provide a brief background of the SEC’s recent enforcement action against an independent director and offer practical steps to take to mitigate risks tied to undisclosed conflicts.
SEC v. Craigie: Independent Director Settles for $175K and Five-Year Officer-and-Director Bar
Recently in Securities and Exchange Commission v. Craigie, the SEC charged James R. Craigie, the former CEO and then current board member of Church & Dwight Co., Inc., for allegedly concealing a close personal relationship with a senior executive of the company. Without admitting or denying the SEC’s allegations, Craigie settled for $175,000 and agreed to a five-year bar from serving as a public company officer or director.
You may be asking: How close does a relationship have to be for the SEC to get involved? To answer that question, it may be best to first focus on what laws the SEC alleged that Craigie violated.
Specifically, the SEC alleged that Craigie violated proxy disclosure rules (Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-9). These rules govern the disclosures in a company’s annual proxy statement, which includes a description of the board and a list of directors the company has determined to be independent. The SEC’s position in the Craigie case was that by standing for election as an independent director without informing the board of his close personal friendship with the executive, he caused the company’s 2021 and 2022 proxy statements to contain materially misleading statements.
You may be thinking this relationship would warrant some form of disclosure to the board by either Craigie or the executive. Craigie didn’t disclose the relationship, but the kicker here is that the complaint notes that he asked the executive not to tell anyone at the company about the relationship. The reason, as noted in the complaint: “Craigie wanted to avoid any appearance of bias towards the executive.”
The SEC’s complaint goes on to detail how Craigie approached CEO succession planning when it came to a head in 2022. Shortly after the CEO informed the board that he would be retiring, Craigie relayed that information to the executive without board authorization. While the executive was one of the internal candidates being considered as the new CEO, the board ultimately chose to search for external candidates, one of whom was a former colleague of the executive. The complaint points to a separate discussion that Craigie had with the executive that outlined a viable path for the executive to succeed that former colleague should they be hired. Again, these relationships and conversations were not brought to the board’s attention.
In 2023, Craigie’s relationship with the executive came to light and the board determined that by not disclosing the relationship, Craigie violated the company’s code of conduct.
Wow. Talk about a shiny object for the SEC to focus on in what otherwise should have been another mundane annual proxy statement.
An Important Lesson in Governance
While the enforcement focuses on Craigie’s failure to inform the board of his close personal relationship with the executive, several lessons can be drawn. The most notable lesson relates to the importance of good governance.
The fact that the SEC hasn’t charged the company speaks to how good governance can serve as a defense. How so? The SEC’s complaint highlighted several times how the company circulated questionnaires annually to its directors to gather information relevant to its independence determination. These questionnaires asked directors to disclose any “material” relationships and asked if they had any relationships, other than work relationships, with the company or management. Further, the questionnaires warned that directors could be subject to personal liability if the proxy statement misstates or omits a material fact.
There wasn’t anything particularly special about this company’s questionnaires. I expect that they would track other public company questionnaires of this sort. The point is the SEC seemed to recognize that the company did what it could in attempting to identify potential director conflicts, but that there is only so much a company can do if the individual completing the form fails to provide adequate disclosures.
On the other side of the spectrum, for an example of a company that was charged with violating securities laws, including the proxy disclosure rules, one need only look at a case from a few years ago. According to the SEC’s order in that case, the company “[failed] to adequately evaluate and disclose in its annual proxy statement the lack of independence of a director and a board committee as well as an ‘interlocking’ board-of-directors relationship between that director and [the company’s] Chief Executive Officer.” Ultimately, the company, without admitting or denying the charges, settled for $325,000.
Practical Steps to Mitigate Risks Associated with Director Conflicts
We covered director conflicts in a previous article, discussing evolving standards and the fiduciary duty of loyalty. Some of the takeaways from that article are relevant here.
With that and with the Craigie case in mind, here are two practical steps to mitigate risks associated with director conflicts.
Annual Conflict Training
Directors can benefit from periodic training in identifying and managing conflicts. This type of training reinforces the importance of disclosing conflicts and provides actionable steps to avoid or mitigate conflicts.
The training doesn’t have to be very involved. It can simply be a review of the company’s code of conduct and a discussion of a case like the one covered in this article. Timing-wise, doing this before circulating the company’s annual director and officer questionnaires may be ideal.
As illustrated in the Craigie case, consider holding similar training for executives.
Annual Review of Director and Officer Questionnaires
Independence standards and how regulators and courts interpret them evolve. Between that and new disclosure rules, companies must review their director and officer questionnaires annually. For calendar year-end companies, that exercise is close, if not already, upon us and law firms typically issue good thought pieces on where companies may want to look to update their questionnaires. As an example, here is one from 2023.
As noted above, good governance can serve as a defense for companies involved in cases, like the Craigie case. An important part of that is a robust director and officer questionnaire that meets the needs of the latest disclosure requirements and focuses on the topics regulators and investors care about.
With this most recent enforcement action in mind, it might be a good idea to give specific examples of what a “close personal friendship” looks like. You may not need to be as specific as calling out $100,000 in travel expenses as something that should be disclosed. It could simply be a reference to vacationing together, socializing outside a professional setting, or covering expenses for one another.
Parting Thoughts
The SEC’s enforcement action discussed in this article provides valuable lessons for boards and executives about the importance of transparency, independence, and rigorous conflict-of-interest policies. By maintaining a culture of proactive disclosure and ensuring clear boundaries between personal and professional relationships, companies can reduce the risks of undisclosed conflicts in their governance practices.
