Compliance, Candor, and the Role of Directors

by Donald C. Langevoort & Hillary A. Sale

How to develop a corporate culture supporting corporate compliance is a key topic. Directors and officers both play roles in creating corporate culture; they are responsible for tone at the top, and that tone is key to compliance. The role of directors is what we explore today – as well as how the securities and corporate laws set the contours of that role. Our interest is in whether and how directors can and do play a role in building a culture of candor and its contribution to a culture of compliance.

Various actors on the federal level have been pushing boards of directors to become more involved in disclosure quality control, and as boards do so, they are increasingly engaged in setting the compliance and candor culture.

The typical situation that leads to federal pressure in this zone is one involving risk management and disclosure, or the lack thereof.  Think Enron. Think JP Morgan and the London Whale.  Crises and scandals create pressure for reform and examinations of corporate climate and culture.[1]  They also create pressure on the regulators to “do something” and on companies to emphasize compliance.  Indeed, both the Sarbanes-Oxley Act and the Dodd-Frank Act delved into the realm of corporate governance to set parameters on board qualifications and committee composition as well as compensation and internal controls, among other issues. Our working theory is that scandals result, in part, from a lack of internal transparency and bad information flow, or, put differently, from corporate cultures in which candor and compliance are lacking.

The board has a very important role to play in establishing culture — through candor and compliance.  To say directors should step up begs the question of how and when – or more precisely, what their role in compliance should be.  Typically, corporate law articulates the role of directors to be one of oversight.[2]   The contours of that duty (at least as imposed through liability), however, have been relegated to “red flag” situations.[3]   The result is that federal law is filling in this space.

Consider the statements by SEC Chair Mary Jo White about the duties and role of corporate directors. Directors must “establish expectations for senior management and the company as a whole, and exercise appropriate oversight to ensure that those expectations are met.“[4]They must also help to “set the all-important ‘tone at the top’ for the entire company.”[5]  Establishing a strong corporate culture is key and part of doing so successfully requires embracing “ethics and honesty,” by “establishing strong corporate compliance programs . . . rewarding employees who do the right thing,” and making compliance an “enterprise-wide effort.”[6]   Backing up these remarks, of course, is the possibility of enforcement against directors.  SEC actions against non-officer directors are rare, but they have occurred – both in the recent past and over the years.[7]

Chair White’s comments are consistent with the development of the case law in the area of securities as well. We have written elsewhere about a recent Supreme Court case, Omnicare Inc. v. Laborers District Council Construction Industry Pension Fund, which focused on whether statements of “belief” about the legality of corporate marketing practices were actionable.[8]  Directors sign the offering documents like those in Omnicare and, thus, are potential defendants. That liability scheme exists to urge directors to take an active gatekeeping role on the front end of corporate disclosures.  And, as we posit, in the context of legal risk, the pressure is now on for directors to ask questions and question answers. As Chair White’s comments reveal, however, directors’ responsibility extends beyond the four corners of offering documents to building strong cultures of internal controls and compliance more generally.  Achieving that sort of culture requires developing a larger corporate tone of candor, ethics, honesty, and compliance.

In short, directors are key to setting tone at the top and building corporate culture.

Nevertheless, they do not, cannot, and should not know everything that is going on day to day. Instead, the people with the knowledge are the employees and officers, who have an agency obligation to disclose and be candid and who are much closer to the internal workings of the corporation than the members of the board.

Directors must emphasize the importance of that candor and its role in compliance.  Pressure on that duty of candor is now also coming from other parts of the federal government. Consider the Yates Memo, where the Department of Justice insisted that corporations share the names of individuals involved in wrongdoing.[9]   Although the focus of the Yates Memo is on sanctions and accountability for individuals, it pushes on corporate culture and candor more generally. Companies now have pressure and incentives to “out” individual wrongdoers at all levels of the company. And, directors have a duty to inquire about and ensure that the general counsel and officers are managing Yates compliance.

More generally, however, the Yates Memo, like federal securities law changes, is arguably a response to holes in corporate culture, with the result being policy that pushes on directors to commit to candor and insist on deeper compliance. Directors and officers are familiar with duties of candor in terms of external disclosure obligations.  But a duty of candor inside the company[10]—how managers communicate with superiors, and how senior management deals with the board, no matter how troubling the information—has to flourish if there is any hope of getting the external disclosure right.


[1] See e.g., Hillary A. Sale, J.P. Morgan: An Anatomy of Corporate Publicness, 79 Brooklyn L. Rev. 1629 (2014); Donald C. Langevoort, Chasing the Greased Pig Down Wall Street: A Gatekeepers’s Guide to the Psychology, Culture and Ethics of Financial Risk-Taking, 96 Cornell L. Rev. 1209 (2011).

[2] See, e.g., Stone v. Ritter, 911 A.2d 362, 364 (2006).

[3] Id.

[4] Mary Jo White, Chair, Sec. & Exch. Comm’n, A Few Things Directors Should Know About the SEC (2014).

[5] Id.

[6] Id.

[7] For descriptions of federal actions focused on directors, see Hillary A. Sale & Donald C. Langevoort, We Believe’: Omnicare, Legal Risk Disclosure and Corporate Governance, DUKE L. J. (forthcoming 2016) at 17-22; and Hillary A. Sale, Independent Directors as Securities Monitors, 61 THE BUSINESS LAWYER 1376 (2006).

[8] Omnicare, Inc. v. Laborers Dist. Council Const. Industry Pension Fund (PDF: 186 KB), 135 S.Ct. 1318 (2015).

[9] September 9, 2015 Memorandum (PDF: 449 KB) from Sally Yates, Deputy Attorney General on Individual Accountability for Corporate Wrongdoing

[10] See Langevoort, Agency Law Inside the Corporation: Problems of Candor and Knowledge, 71 U. Cinn. L. Rev.

Donald C. Langevoort is the Thomas Aquinas Reynolds Professor of Law at Georgetown University School of Law.  Hillary A. Sale is the Walter D. Coles Professor of Law at Washington University School of Law.


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