PART 2/3: Establishing a D&O Conflict of Interest Code

In my last post – the first in a three-part series – I introduced D&O conflicts of interest and why it’s important to properly manage them. In this post, I’m going to provide you with a high-level framework for developing a D&O conflict of interest code. This code is really important as it’s the corporation’s playbook for managing D&O conflicts of interest.

The conflict of interest code is sometimes part of a broader D&O Code of Conduct that addresses other duties such as those relating to confidentiality, insider trading and information security. In the public sector, a Code of Conduct may also cover duties relating to D&O’s involvement in political activities. Whether the conflict of interest code is embedded in a broader Code of Conduct is a matter of preference and style. In this post, we are only looking at the elements of a conflict of interest code and these apply whether or not the code is embedded in a broader Code of Conduct.

Every conflict of interest code should include the following key elements:

Definition of “conflict of interest”

The definition of a conflict of interest should reflect the definitions in the applicable statutes, at law and in any applicable administrative rules. The definition will normally include actual, potential and apparent conflicts of interest. It may also extend to the personal interests of spouses and other family members.

General Duty to Avoid and Disclose

The code should set out the general duty to avoid conflicts of interest and to disclose them.

Timing and Manner of Disclosure

The conflict of interest code should require a proactive disclosure of conflicts of interest at the earliest opportunity. When in doubt, the director or officer should be encouraged to consult, on a confidential basis, with the Board Chairperson on whether further action should be taken with regard to a particular issue. Where a conflict is identified, the officer or director should be required to report the conflict in writing to the Board Chairperson and/or the full Board. If the Board Chairperson is the director who must report a conflict, then the Chairperson should be required to report to the Chair of the Audit or Governance Committee.

Requirement to consult with Legal Counsel

As covered in my previous article, the identification and proper management of conflicts is not always straightforward and may have legal implications. Legal counsel should generally be consulted to assist with determining whether a conflict exists and if one does exist, legal counsel can be consulted to decide on the proper steps that should be taken to manage the conflict.

Process for Disclosing and then Managing a Conflict of Interest

Some conflict of interest codes require that the full Board decide on whether a conflict of interest exists and to decide on the measures to be taken to manage and/or avoid the conflict. Other codes authorize the Board Chairperson to manage these issues. What is best for a particular corporation will depend on Board culture however it may be unwieldy and inefficient to involve the entire Board in all questions of conflict and may not always be appropriate to broadly disseminate D&O personal information.  If the full Board wishes to be involved but recognizes the difficulty with this, then an alternate approach is to authorize the Chairperson to manage conflicts which are disclosed outside of meetings. The Chairperson should then be required to report off-meeting disclosures and steps taken to manage any conflicts to the full Board at a future in camera session.

For disclosures made at a Board meeting which may involve, for example, Board approval of a contract with which a director or officer has a conflict, the proper course of action is to ensure the director or officer does not receive the materials relating to the decision; have the officer or director disclose their conflict to the full Board at the meeting, and have the director or officer leave the room during the discussion and decision. The disclosure and director or officer’s departure should be recorded in the minutes.

Measures to Avoid a Conflict of Interest

The code should list actions that could be taken to remedy or avoid a conflict of interest and who makes the decision on what actions must be taken. These could include:

  1. Recusal
  2. Resignation of office or activity
  3. Divestiture
  4. Blind Trust
  5. Return (of gifts)

Written Response and Record of Disclosure

This step is often missed, but it’s critical to the proper management of any conflict. After having considered a written disclosure from the conflicted director or officer, the Chairperson should prepare a written response to the director or officer that:

  1. Acknowledges the disclosure and reiterates the organization’s understanding of the circumstances giving rise to the disclosure (to ensure a common understanding of the circumstances);
  2. Advises on whether or not the corporation considers the director or officer to be in a conflict of interest (as defined by the conflict of interest code); and
  3. Sets out the required or agreed actions that will be taken to avoid the conflict.

If a situation is borderline and is determined not to be a conflict, then that should also be stated in the response. In a borderline situation, it’s also important to include any guiding parameters the corporation may wish to impose on future activities. For example, the corporation may conclude that if a director does X with a third party, that is not a conflict, but if doing Y or Z with that same corporation is a conflict, the written response should provide this guidance.

This written response will be invaluable to both the director/officer and the corporation should inquiries be made in the future about the particular circumstances.

As mentioned above, for in-meeting disclosures, the disclosure should be set out in the meeting minutes and the measures taken to avoid the conflict, such as a director leaving the room during a discussion, should also be described in the minutes.

Annual Review of Code

The code should require an annual review by legal counsel to ensure it reflects current regulations and trends.

In my final post on this topic, I’ll give an overview of the training, conflict of interest statement, and disclosures that will help corporations manage the conflicts of interest of directors and officers.

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This is the second post in a three-part series on Director & Officer Conflicts of Interest:
Part 1: Managing Director & Officer Conflicts of Interest
Part 2: Establishing a D&O Conflict of Interest Code
Part 3: Building a Culture of Ethics and Integrity with D&O’s

This post was originally published on the RIZEN Business Lawyers Alliance blog.