Chapter 1

Question 1

T 1.1: What is the definition of a fiduciary?

Answer 1

A fiduciary is an individual or institution obliged to act in the best interests of another individual or institution when engaging in any matter within the context of their relationship.

Question 2

T 1.2: Fiduciary duties of board members - what are 3 sources?

Answer 2

1. Corporate law of all of the states
2. Federal securities laws and stock exchange listing rules
3. A company’s bylaws and governance guidelines

Question 3

T 1.3: What are the 2 (or 3) most important fiduciary duties of a board member?

Answer 3

1 & 1b: Duty of loyalty, which also includes the duty of good faith
2: Duty of care

Question 4

T 1.4: Fiduciary duties - duty of loyalty - what does it require?

Answer 4

• Under the duty of loyalty, directors must place the interests of the corporation above their own interests and those of their friends, family members, and any other associated entities.
• Additionally, directors cannot take advantage of their positions to benefit themselves, even if it would not harm the corporation, such as using confidential information.

Question 5

T 1.5 Fiduciary duties - duty of good faith - what does it require?

Answer 5

The duty of good faith is a component of the duty of loyalty. The duty of good faith states that directors must make decisions honestly and in the best interests of the corporation.

Question 6

T 1.6 Fiduciary duties - duty of care- what does it require?

Answer 6

The duty of care instructs directors to make informed, rational, and prudent decisions through a highly analytical decision-making process.

Question 7

T 1.7 What is the business judgment rule?

Answer 7

The business judgment rule, also called the business judgment presumption, is a legal concept that shields directors from being held liable for their reasonably informed decisions, even if the outcomes of those decisions are negative, as long as the decisions were made in good faith, without conflicts of interest, and with a reasonable level of care.

Question 8

T 1.8 Even if a court determines that the business judgment rule applies, how can a plaintiff still win a lawsuit?

Answer 8

When a company invokes the business judgment rule and the court finds that the presumption applies, then the burden of proof is on the plaintiff to prove that the business judgment rule does not apply due to bad faith, conflicts of interest, or gross negligence. Otherwise, the board may need to provide proof that its process was fair and its decisions were informed. (see also - entire fairness standard)

Question 9

T 1.9 What is the standard of “entire fairness” (when does it apply instead of the business judgment rule? What does it require? When may it get waived?)?

Answer 9

• When does it apply: when one of the parties in a transaction is interested (e.g., owns controlling shares)
• What does it require? Both a fair price and a fair process
• When may it get waived? when a transaction includes protection for minority shareholders

Question 10

T 1.10 Fiduciary duties - in which 4 situations are they most often put to the test?

Answer 10

When there are:
1. conflicts of interests
2. corporate transactions
3. controlled entities or
4. divided loyalties

Question 11

T 1.11 What is the definition of a conflict of interest (for a corporate director)?

Answer 11

Directors have a conflict of interest when they participate in a company matter involving a party with which they are affiliated—often matters involving financial or familial interests. In such a case, the director’s personal interest may conflict with the interests of the organization for which the director serves as a fiduciary.

Question 12

T 1.12 What is a “controlled company” (in general, based on NYSE/NASDAQ rules)?

Answer 12

• In general: A controlled company is one that is controlled through a person, group of people, or entity that holds a certain percentage of the stock’s voting power
• NYSE and Nasdaq: this level of ownership is set as >50 percent.

Question 13

T 1.13 Fiduciary duties - divided loyalties - what are situations where this often arises and what is the guidance for directors in these situations?

Answer 13

Directors who are dual fiduciaries—for example, directors appointed by a VC firm to sit on a portfolio company board—may also encounter conflicts of interest during a transaction when the interests of the VC firm diverge from those of the portfolio company. In this case, directors should consider the interests of all shareholders and consult advisors as needed.

Question 14

T 1.14 Fiduciary duties - what are 4 suggestions on how to uphold them?

Answer 14

1. Ensure that the only relationship you have with the company you serve is through your position as a director. Disclose any conflicts of interest and recuse yourself from decisions where you have a real or perceived conflict of interest.
2. Only use company resources for business purposes, never for personal use.
3. Take adequate time to prepare for and attend meetings. Do your homework before meetings, seek information from external sources, and come to meetings with questions prepared in advance.
4. Don’t be afraid to be the contrarian in board meetings. Ask probing questions, scrutinize the assumptions of management and other directors, and never vote on an issue when you still have outstanding questions or don’t have enough facts.

Question 15

T 1.15 What is the definition of an inside director (2 options)?

Answer 15

• Option 1: Someone who is also employed in a managerial capacity by the corporation
• Option 2: a majority or controlling shareholder of the corporation.

Question 16

T 1.16 What is the definition of an outside director?

Answer 16

An outside director is a director who is not also employed as a member of management at the company (what about a controlling shareholder??)
Note: an outside director MAY also qualify as an independent director

Question 17

T 1.17 What is the definition of an independent director (general standards, examples)?

Answer 17

• An independent director, as defined by US standards, generally has no links to the organization beyond his or her role as a director.
• For example, the director must have no ties to the company’s management, no financial interest in the company (aside from compensation for service as a director), and no familial or business relationship with the company.

Question 18

T 1.18 What is the definition of an independent director - ADDITIONAL requirements based on NYSE, NASDAQ?

Answer 18

For a director to be considered independent by the NYSE and Nasdaq, the director must not have been a company employee or have had any other relationship with the company (such as a family member working for the company) within the last three years.

Question 19

T 1.19 What is the definition of an independent director - ADDITIONAL requirements based on Institutional Shareholder Services (ISS)?

Answer 19

ISS will never consider a former company CEO or executive to be independent

Question 20

T 1.20 What is the definition of a related-party transaction, what is a relevant Regulation and how does it define “related parties”?

Answer 20

• General definition: This is a transaction involving two parties that had a preexisting relationship prior to the transaction.
• Regulation: Item 404(a) of Regulation S-K requires transactions with related parties be disclosed (under certain conditions)
• Def. related parties based on Reg S-K: directors, executive officers, owners of more than 5% of the company’s stock, or family members of one of the aforementioned

Question 21

T 1.21 Landmark legal cases - Caremark - situation, legal challenge, outcome?

Answer 21

• Situation: Caremark employees were found to have broken the law (by giving illegal referral bonuses to physicians)
• Legal challenge: allegation that the board failed to provide proper oversight (risk, compliance?)
• Outcome: board asked enough question to discharge their compliance oversight

Question 22

T 1.22 Landmark legal cases - Smith vs van Gorkom- situation, legal challenge, outcome 1 and 2?

Answer 22

• Situation: board approved Transunion merger quickly and at $55 per share (above market price)
• Legal challenge: shareholders sued, alleging that the board hadn’t done enough work to ensure that the price was appropriate
• Outcome 1: court declined to apply the business judgment rule, since the board had breached duty of care (not enough time)
• Outcome 2: DE and other states passed rules that allow companies to exculpate directors from personal liability for breach of the duty of care w shareholder approval (can never exculpate for breach of duty of loyalty incl good faith)

Question 23

T 2.1 AT THE MOST FUNDAMENTAL LEVEL, What are the 2 functions of a board and what is the prerequisite?

Answer 23

1. Exercise oversight on behalf of the owners (solution to the principal-agent problem)
2. Advise management, including on strategy BUT without overstepping into mgmt roles
   - Prerequisite: board must have a majority of independent directors (if the board consists of owners of managers like many start-ups, board work differently!)

Question 24

T 2.2 According to Delaware law, what are 5 actions that can only be taken by the full board?

Answer 24

1. Amending charters and bylaws
2. Adopting merger or consolidation agreements
3. Recommending to stockholders the sale, lease or exchange of all or substantially all of the company’s assets
4. Recommending to stockholders the dissolution of the corporation
5. Declaring dividends or issuing stock

Question 25

T 2.3 According to the NACD, what are the 5 areas of responsibility for boards?

Answer 25

1. Oversee corporate strategy 2. Provide risk oversight 3. Ensure leadership 4. Build value 5. Build board culture

Question 26

T 2.4 According to the NACD, overseeing corporate strategy is one of the core responsibilities for a board. What are the 2 specific responsibilities here?

Answer 26

1. Approving (or, if necessary, developing or revising) a corporate mission statement and ensuring that the company upholds it 2. Codeveloping, reviewing, and approving management’s strategic and business plans

Question 27

T 2.5 According to the NACD, providing risk oversight is one of the core responsibilities for a board. What are the 2 specific responsibilities here?

Answer 27

1. Monitoring corporate performance against the strategic and business plans, including periodic reviews of the operating results to evaluate whether the business is being properly managed 2. Ensuring the existence of an adequate corporate compliance and ethics information and reporting system for employees (with adequacy to be determined by the board)

Question 28

T 2.6 According to the NACD, ensuring leadership is one of the core responsibilities for a board. What are the 2 specific responsibilities here?

Answer 28

1. Selecting, evaluating, and compensating the CEO 2. Ensuring an effective executive talent pool by monitoring, evaluating, compensating, and replacing company officers when necessary

Question 29

T 2.7 According to the NACD, building value is one of the core responsibilities for a board. What are the 2 specific responsibilities here?

Answer 29

1. Reviewing and approving the corporation’s financial objectives, plans, and actions, including significant capital allocations and expenditures 2. Reviewing and approving the company’s major financial statements and reviewing and approving material transactions that fall outside the ordinary course of business (e.g., mergers and acquisitions)

Question 30

T 2.8 According to the NACD, building board culture is one of the core responsibilities for a board. What are the 2 specific responsibilities here?

Answer 30

1. Ensuring optimal board composition, structure, and leadership 2. Serving on committees as assigned

Question 31

T 2.9 A company’s corporate governance guidelines - which items do they typically describe?

Answer 31

the board’s mission and responsibilities the roles of board leaders director qualifications the director selection process director terms and tenure, director independence requirements committees of the board, director orientation and continuing education Performance evaluations of the board and its leaders director compensation board meeting procedures guidelines for ethical and compliant director behavior

Question 32

T 2.10 The state of DE allows boards to delegate many of their powers to committees, including these 5:

Answer 32

1. Compensation of directors 2. Compensation of officers 3. Election of officers 4. Issuance of stock, stock options (or rights), and retirement of stock 5. Reduction of the corporation’s legal capital

Question 33

T 2.11 Fiduciary responsibilities of corporate OFFICERS - how do they compare to the fiduciary responsibilities of directors?

Answer 33

There is no difference and they face the same liabilities for violating their fiduciary duties

Question 34

T 2.12 Role of the board vs role of management - in which 3 situations may the roles overlap?

Answer 34

1. In strategy setting 2. When CEO and board chair are the same person 3. In private companies (think start ups and situations when managers, owners and directors overlap)

Question 35

T 2.13 Role of the board vs role of management in setting strategy - what are 3 considerations (traditional approach, recent trend, what to watch for)?

Answer 35

1. Historically, strategy setting was primarily a management role 2. In recent years boards have become more involved (that is a good thing) 3. THAT SAID - boards should maintain the dividing line and focus on asking questions, advising, reviewing and approving strategic plans (not writing them!)

Question 36

T 2.14 4 guidelines for fulfilling corporate governance requirements

Answer 36

1. Establish a clear dividing line between the role of the board and the role of management. Make sure that your company’s board materials include a director job description 2. Adopt a “nose in, fingers out” approach to your oversight role by asking probing questions, providing advice, and making decisions. But don’t meddle in the everyday operations 3. Encourage management to openly share information with the board, even if that information is negative, to ensure a healthy and open dialogue. Also arrange gatherings between the board and management in both formal and informal settings. 4. Designate a leader of the independent directors to provide independent leadership of board processes and discussions

Question 37

T 3.1 How does this NACD document define strategy?

Answer 37

Strategy is “the means to create economic value by gaining competitive advantage through a unique value proposition,”

Question 38

T 3.2 Strategy development - how can (should?) boards add value?

Answer 38

Boards can provide a holistic viewpoint and help question the underlying assumptions, competitive dynamics, and alternatives

Question 39

T 3.3 Strategy development - what is a tool that the board should consider adopting to reduce the risk of defensiveness from the C-suite and avoid unproductive lines of questioning from the board?

Answer 39

the board should establish guidelines for its level of involvement in both corporate strategy and business unit strategy. However, directors should not refrain from asking tough questions about the rationale of management’s strategic choices.

Question 40

T 3.4 What are 4-5 common challenges that boards face in overseeing strategy development?

Answer 40

1. Short-term focus 2. Fit-for-purpose board - director mindsets (e.g., inquisitiveness) and skills (business, strategy setting) 3. Responding to strategy disruptors 4. Distinction between board and management: board should play role of reviewer and adviser (asking questions but NOT developing the strategy) 5. Divestitures…???

Question 41

T 3.5 What are 5 indicators that there isn’t enough focus on the long-term?

Answer 41

1. Reports and presentations focus heavily on historical issues and metrics, or on topics that have a short-term time frame. 2. Boardroom discussions about business and market trends, emerging risks and opportunities occur infrequently 3. C-suite and key executive compensation is primarily in the form of cash salary and bonuses (same concern for incentive compensation broadly) 4. Nonfinancial performance measures that contribute to long-term growth (e.g., product quality, customer satisfaction, employee engagement) are given little weight in performance assessments 5. The organization experiences a pattern of high CEO and/or C-suite turnover based on failure to perform after relatively short intervals.

Question 42

T 3.6 What are 10 guidelines for effective strategy oversight

Answer 42

1. Expect change and understand how it may affect the company’s strategic course,. 2. Engage with management on strategy issues on an ongoing basis 3. Evaluate strategy options and underlying assumptions 4. Review critical assumptions, business trends, and performance drivers 5. Communicate to the CEO and management the expectation that strategies are brought to the board in the early stages to allow for open discussion and engagement. 6. Establish an effective and collaborative relationship between the board and CEO 7. Consider director experience and expertise in relation to the strategic role of the board 8. Develop consensus with management on the forward-looking metrics specific to the company that will be early indicators of the success or failure of a chosen strategy. 9. Hold executive sessions, at a minimum, at the beginning and end of each board meeting 10. Establish a relationship with key investors when performance is good

Question 43

T 4.1 What are 3 situations that are generally considered “not in the ordinary course of business” that boards are expected to approve under state corporation law?

Answer 43

1. Acquisitions that increase company size 2. Divestitures that reduce company size 3. Mergers that combine companies of similar size

Question 44

T 4.2 In M&A transactions, what does the Revlon Standard require of the board of the selling company?

Answer 44

Finding the best value for the shareholders (once the transaction is underway) - role of the board as “neutral auctioneer”

Question 45

T 4.3 What are the 6 phases in the M&A life cycle (incl key considerations for each phase)?

Answer 45

1. Strategy, incl. role of organic vs inorganic growth and divestitures 2. Valuation and pricing, incl. proving that the price was fair 3. Structuring, incl. financing options (cash vs stock) and transaction type (taxable?, company vs assets?) 4. Due diligence - identification of material risks to the value 5. Negotiation and closing - mgmt’s job, but director should be aware of the issues at stake 6. Post-deal integration - ideally ensure that synergy-related metrics are identified pre-closing and can be tracked post closing

Question 46

T 4.4 5 challenges directors face during M&A oversight

Answer 46

1. Lawsuits - expat them, prepare for them (and familiarise yourself with the relevant standards) 2. Duty of care - scrutinize how the deal relates to strategy and what disclosures are required 3. Duty of loyalty - consider creating a sub-committee of uninterested directors and getting 3rd party advisors 4. Merging boards - particularly if entities are of similar size 5. Driving and evaluating merger synergies

Question 47

T 4.5 Fraudulent conveyance - what is this concept and how does it relate to M&A transactions?

Answer 47

Fraudulent conveyance is a legal concept that arises in leveraged buyouts collateralized by assets. Under this concept, directors have a duty to make sure the company being sold is represented accurately to the buyer. Accuracy of representation helps to ensure that the buyer is not left with less than the equivalent value of the asset and therefore unable to repay the loan it took to buy the assets.

Question 48

T 4.6 4 guidelines for effective M&A oversight

Answer 48

1. Engage management in an ongoing dialogue about possible deals. Be alert to filings on Schedule 13D or Schedule 13G 2. Identify criteria that will help determine whether or not a proposed deal advances company strategy and will result in revenue and/or cost synergies. Set in advance a specific range for the company’s bid. Encourage management to more aggressively pursue deals if they are overly risk-adverse. Consider divestitures for business lines that are underperforming. 3. Provide general guidance for due diligence. Analyze target company risks in key areas. Consider the deal in the overall geopolitical and economic environment. Consider whether the cultures of the two companies are a good fit, and if the management team has the right skills and experience to lead the company and business units through the integration process. 4. Establish metrics to measure the success of the merger during the post-merger integration process. Perform a formal postmortem one year after the merger, and potentially further out as well

Question 49

Bonus - 8 landmark legal cases

Answer 49

1. AB Stable VIII, LLC v. MAPS: A buyer may be relieved of its obligation to close and may terminate an agreement if the seller has made significant changes to its business (COVID-19). 2. Corwin v. KKR: When a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies. 3. Gantler v. Stephens, ( 2009): Just because stockholders approve a decision does not mean the board’s decision-making process is exempt from a review for fairness. 4. Morrison v. Barry, (2018). As directors review company disclosures about a transaction, they need to ensure inclusion of all material information. 5. Paramount Communications, Inc. v. QVC (1993): In a change of control, directors have the burden of proving that they were adequately informed and that they acted reasonably. 6. RBC Capital Markets, LLC, v. Jervis, (2015): A financial advisor may be liable for aiding and abetting a board’s breach of its fiduciary duty if the advisor knows that the board is breaching its fiduciary duty and participates in the breach. 7. Revlon, Inc. v. MacAndrews & Forbes: The board's role is that of a price-oriented “neutral auctioneer” 8. Time Inc. v. Paramount Communications (1989): Directors can say no to a proposed transaction if they have a better plan.