Insurance Covers Boards' Acts

Members of a public company’s board of directors are rarely sued for their conduct on the board, according to a Harvard Business School professor.

“They’re very well protected by insurance policies,” such as directors’ and officers’ liability insurance, said Jay Lorsch, a professor at Harvard Business School who studies corporate boards and teaches a course for board members of publicly traded companies.

And often board members will have the defense that they were exercising “the business judgment rule, and so the courts are quite reluctant to try to second-guess whether that was a good business decision or not,” said Carla Hayn, a professor at the University of California at Los Angeles’ Anderson School of Management. Hayn also is a co-coordinator of a board of directors’ education course.

The Securities & Exchange Commission also said it wouldn’t “second-guess the good-faith efforts of directors,” according to a February 2011 news release that announced three former outside directors of DHB Industries of Pompano Beach, Fla., were charged with accounting fraud. In that case, three directors Jerome Krantz, Cary Chasin and Gary Nadelman, all of Old Westbury, N.Y., were accused of turning “a blind eye to warning signs of fraud and other misconduct by company officers,” the news release said. The directors neither admitted nor denied the allegations in their court filings but agreed to pay hundreds of thousands of dollars to settle the case.

Despite past history, shareholders no doubt will continue to move forward with lawsuits against board members.

One very high-profile example is the suit a shareholder of Wal-Mart Stores Inc. filed in April against the board of directors of the Bentonville retailer for failing to investigate allegations that the company paid millions of dollars to bribe Mexican officials so stores could be built faster.

John Cottrell of Texas filed the lawsuit on behalf of Wal-Mart in the Western District of Arkansas. Cottrell seeks to recover for Wal-Mart and its shareholders “the hundreds of millions of dollars of financial and reputational damages caused by” the retailer’s alleged bribery scandal, reported by The New York Times in April. As of Thursday morning, Wal-Mart’s board members hadn’t filed their response to the shareholder’s lawsuit.