RED FLAGS! Corporate Officers - Directors and Officers - United States

[Gunnar Larson]

As many Cypherpunks can agree, xNY.io has been screaming about red flags
out of New York, concerning digital asset innovation at the cross border
level.

Here is a terrific example of how board directors who have ignored red
flags at the United Nations (aka JP Morgan) probably have a solvency issue.

Elon Musk said the same thing, before the Twitter LBO about the failing
United Nations. Also, Mr. Musk said that the CEO that banks the United
Nations hates the SpaceX CEO ...

Meanwhile, the Southern District of New York seemingly has never heard of
Bank.org and/or the United Nations.

https://www.mondaq.com/unitedstates/directors-and-officers/1284994/delaware-court-of-chancery-extends-the-fiduciary-duty-of-oversight-ie-caremark-claims-to-corporate-officers?email_access=on


Until the Delaware Court of Chancery issued its recent decision in In re
McDonald's Corp. Stockholder Derivative Litigation1 ("McDonalds"), it was
unclear if claims for breach of the fiduciary duty of loyalty premised on a
lack of oversight first established by In re Caremark International Inc.
Derivative Litigation2 ("Caremark") in 1996, with respect to directors,
also applied to corporate officers of Delaware corporations. In McDonalds,
the Delaware Court of Chancery pronounced, unequivocally, that "[t]his
decision clarifies that corporate officers owe a duty of oversight. The
same policies that motivated [the Delaware Court of Chancery in Caremark]
to recognize the duty of oversight for directors apply equally, if not to a
greater degree, to officers."3

Legal Background and Analysis

Under the Caremark test, as later adopted by the Delaware Supreme Court in
Stone v. Ritter4, liability to directors for failing to properly discharge
their duty of oversight arises under two different "prongs" of the test,
where either: "(1) directors utterly failed to implement any reporting or
information system or controls; or (2) having implemented such a system or
controls, consciously failed to monitor or oversee its operations thus
disabling themselves from being informed of risks or problems requiring
their attention."5

First Prong: Information System Claims. The court in McDonalds referred to
the first prong as an "Information Systems Claim", whereby "the board
lacked the requisite information systems and controls".6 To make an
Information Systems Claim, the board must have consciously failed to make a
good faith effort to establish a board-level information and oversight
system designed to provide timely and accurate information and, at a
minimum, address "essential and mission-critical" legal compliance.7 The
validity of an Information Systems Claim does not depend on whether the
oversight system was actually effective, but only whether the system
existed and was monitored by the board.
Second Prong: Red-Flags Claims. The McDonalds court referred to the second
prong as a "Red-Flags Claim", whereby "the board's information systems
generated red flags indicating wrongdoing and that the directors failed to
respond."8 The basis for liability requires a demonstration that (i)
directors consciously disregarded evidence of red flag wrongdoing or
misconduct in bad faith, and (ii) that the corporate trauma in question
must be sufficiently similar to the red flag misconduct such that the
board's bad faith and conscious inaction proximately caused the trauma.9
Must Act in Bad Faith; Exculpation Unavailable. The McDonalds court found
that the two prongs of the Caremark test would apply equally to officers
and directors, but that the specifics of an officer's duty is
context-dependent, as discussed in more detail below. Regardless, under
either prong of the Caremark test, directors and officers will only be
liable for violations of the duty of oversight if a plaintiff can provide
evidence that they acted in bad faith and, therefore, disloyally to the
corporation. 10 This requires a showing of scienter, i.e., that the officer
consciously failed to make a good faith effort to establish information
systems or the officer consciously ignored red flags.11 As a practical
matter, this means that Section 102(b)(7) of the Delaware General
Corporation Law, which permits a Delaware corporation to include an
exculpatory provision in its certificate of incorporation that eliminates
the personal liability of a director or officer for breaches of certain
fiduciary duties, will not apply to Caremark claims because Section
102(b)(7) specifically excludes bad faith misconduct and breaches of the
duty of loyalty. See "Elimination of the Duty of Care in Delaware?
Statutory Exculpation of Officers: Recent Amendment to Section 102(b)(7) of
the Delaware General Corporation Law".
Applicability to Corporate Officers. The Court of Chancery in McDonalds
then went on to explain how the situational aspects of a corporate
officer's duty of oversight may differ from that of the board of directors
in a couple of important ways. For example, although the board has
oversight duties regarding the whole corporation because it has "plenary
authority" concerning the management of the corporation, a particular
officer only has a duty to establish information systems and follow-up on
red flags issues that comes within the scope of his or her authority and
responsibility (e.g., a chief financial officer would be responsible for
creating financial, but not human resources or legal, reporting systems and
controls).12 The court then went on to note, however, that if a red flag is
sufficiently material, then an officer may have a duty to report upward on
such red flag even if it is outside of his her or her area of
responsibility.13 From the McDonalds decision, it is unclear which officers
of the corporation will be charged with a duty of oversight, i.e., if it
will include all corporate officers or just senior officers. Based on
language from the McDonalds opinion, a reasonable inference can be drawn
that it applies to all corporate officers: "the officers are optimally
positioned to identify red flags and either address them or report upward
to senior officers [emphasis added] or to the board."14 Section 142(a) of
the Delaware General Corporation Law defines the term "officer" as "such
officers with such titles and duties as shall be stated in the bylaws or in
a resolution of the board of directors." Further, in the matter of In re
Walt Disney Co. Derivative Litigation,15 the Delaware Court of Chancery
established a bright-line rule whereby officers and directors become
fiduciaries only when they are officially installed, and receive "the
formal investiture of authority that accompanies such office of
directorship." Taken together, the fiduciary duty of oversight would seem
to apply only to those corporate officers specified in the bylaws or
appointed by board resolution.
In the derivative shareholder lawsuit16 at issue in the McDonalds case, the
plaintiffs did not allege that the Chief People Officer of McDonalds failed
to make a good faith effort to establish information systems (i.e., an
Information Systems Claim), and, instead, made a Red-Flags Claim by
asserting that the Chief People Officer breached his duty of oversight by
consciously ignoring red flags.17 In particular, the complaint cited
statements from employees that the human resources function, under the
supervision of the Chief People Officer, "turned a blind eye" to complaints
about sexual harassment, including coordinated complaints filed by
restaurant workers and a ten-city strike. Further, because the Chief People
Officer also allegedly engaged in acts of sexual harassment, the court
concluded that "it is reasonable to infer that the officer consciously
ignored red flags about similar behavior of others."18

Practice Points Regarding Oversight Duties of Corporate Officers

In order to minimize exposure to liability for a breach of the duty of
oversight by corporate officers, we recommend that management take the
following actions:

Each corporate officer should identify, at a minimum, the essential and
mission-critical compliance with laws or regulatory mandates facing the
company that are within the scope of the officer's authority and establish
a monitoring systems that timely and accurately brings this information to
the officer's attention. There may be heightened risk for a Caremark claim
where risk to life or health or the company's obligation to comply with
positive laws or regulations are involved.
Once the oversight system is in place, the officer should pay attention to
any "red flag" issues that may evidence non-compliance, report that
information to the officer's superior(s), and take corrective actions, as
needed, to address the red flag of non-compliance.
Document all of the above actions, as litigation actions involving alleged
breach of the duty of oversight are preceded by Section 220 books and
records requests under the Delaware General Corporation Law. If this
happens, one should be able to produce ample evidence that such officer
made good faith efforts to properly execute his or her duty of oversight,
including documenting: (i) that an oversight system was established, (ii)
that the officer reviewed and discussed compliance issues, and (iii) that
the officer followed-up on all red-flag issues, and addressed them, as
needed.
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