The Case for Independent Counsel

Since passage of the Sarbanes- Oxley Act (SOX), two clear trends have emerged in corporate governance. First, most directors and CEOs have come to recognize the value of an independent board (See “The Rise of Independent Directors"). In a recent survey, directors identified the two most significant attributes of a well-run board: regular executive sessions outside the presence of management and a high percentage of independent members. The second trend: Directors operating in an increasingly regulated and litigious environment are seeking legal advice more frequently as a regular feature of board diligence. More than three quarters of directors said they anticipated consulting with outside counsel in the coming year.

Most directors now recognize the significant intersection of those two trends. Since your company benefits from having independent directors and sound legal advice, you should ensure that directors are getting independent legal advice.

Some boards now retain counsel to attend all meetings and advise them on an ongoing basis, having concluded that the benefits of independent advice more than outweigh concerns about additional costs and potential inefficiencies. They believe that independent legal advice is unquestionably needed for the numerous ongoing tasks and that, when a crisis erupts, everyone benefits from having a second set of knowledgeable lawyers available immediately to advise the board. Even directors who have not retained regular separate counsel recognize that, under some circumstances, they need independent advice. In the survey of board members, 44 percent of respondents said they anticipate retaining counsel of their own choosing in 2008.

This increasing reliance on independent counsel reflects a trend in best practices and developing legal requirements. SOX requires that corporations authorize their audit committees to retain independent counsel, and various stock exchanges have established similar requirements for compensation committees. Legal experts, including one commissioner of the Securities and Exchange Commission, (SEC) have advised boards operating as a whole to consider independent counsel. And the former Chief Justice of the Delaware Supreme Court suggests that courts may begin looking to such regulatory rules in determining, for purposes of private litigation, whether directors have satisfied their duties. In other words, today’s best practices will likely become tomorrow’s legal requirements.

Rule of Thumb

Directors of companies with complex operations and substantial assets should consider retaining their own attorney on an ongoing basis. Moreover, all directors confronting any issue that may significantly impact company counsel’s personal interests or those of the executives who hire and fire them should consider seeking independent counsel. As a rule of thumb, if an issue merits both discussion in executive session and the advice of counsel, independent counsel is probably needed. Surveys and experience suggest the following examples: 

• Allegations of serious improprieties by senior management 

• External or internal investigations 

• Senior executive compensation negotiations 

• Mergers and acquisitions, especially where poison pills or other personal financial incentives exist 

• Controversial accounting or disclosure issues 

• SOX compliance 

• Board evaluations

Most company counsel strive to recognize when their advice might be influenced by their relationship with senior management and when to advise the board or individual directors to seek independent counsel. But lawyers are only human (contrary to popular belief), and sometimes fail to recognize their limitations, so directors cannot rely entirely on company counsel to spot such situations. Similarly, directors cannot leave the choice of independent attorneys to company counsel, as they may lack independence. Sixty-three percent of directors responding to a recent survey said that directors should ask the general counsel for recommendations but make their own hiring decisions.

The Best Defense

When a company faces significant lawsuits or governmental investigations, its directors must again consider whether their interests and those of the company are best served by retaining separate counsel. If you are not named personally as a defendant, you will generally be concerned with protecting the interests of the corporation.