Director's Dilemma - Handling the aftermath of your predecessor's problems

Giudo had been a senior executive for several years when the CEO left shortly after listing the company. He was promoted to the CEO role. A contract was agreed, announcements were made to the stock exchange and all Guido's contacts, and he started to settle into the role.

After four weeks the Company secretary came to Guido with an invoice for 'services rendered' raised by one of the new major shareholders. The 'service' was purchase of 5 million shares at IPO and the payment requested was $1.25 million dollars or 25c per share. No discount had been disclosed during the IPO and this payment would effectively mean that the shareholder received shares at a lower price than the price paid by other investors.

Guido raised the matter with his chairman who explained that this was why they had fired the former CEO. The board, he said, expected Guido to resolve the matter without any adverse publicity.

What should Guido do?

Mark's Answer

Guido needs to request copies of, and go through, the Board meeting minutes from the meeting at which the Board made the decision to fire the CEO and any other Board meetings where this issue came up, review any other relevant documentation e.g. the IPO due diligence report and IPO legal report and prospectus to ensure that there was indeed no contract for these "services rendered".

I would have thought the Company secretary would have been aware of/provided Guido at least the Board meeting minutes. I would also have thought the Chairman/Board would have advised Guido of this issue prior to his acceptance of the appointment. But, dealing with the facts….

If it is clear that the previous CEO did this without authority and without disclosure to the Due Diligence Committee or Board, or if it is unclear that there is a legal agreement with the shareholder for the purported "services rendered", Guido needs to contest payment of the invoice as there is either no basis for its payment or the CEO was acting inappropriately/without authority (and potentially illegally) in agreeing to the payment and not disclosing it. If indeed there is no underlying agreement, the shareholder would have been applying for shares on the basis of the prospectus, which contains all the terms and conditions of his (and others') investment and the payment of 'services rendered' is not one of them.

Guido should seek legal representation for the event in which the shareholder contests non-payment of the invoice, which Guido, as CEO, needs to ensure that the company defends vigorously. This should not result in adverse publicity.

Mark Baker is Director, Corporate Finance at E G Capital and has significant experience in capital raising, corporate finance and new business start-ups.

Julie's answer

Guido has done nothing wrong but he needs good legal advice. He should consult ASIC in Australia, the SEC if in the USA, or his corporate law firm. This action is unfair to the official brokers and underwriters.

The invoice cannot be paid unless the arrangement is confirmed to be legal. It is normal commercial behaviour to delay payment of an invoice whilst clarifying details of the underlying contract.

It would be best if the chairman went with Guido to the authorities; this would distance the board from the former CEO's actions.

If the transaction is considered illegal the former CEO is probably in trouble and the company is likely to be mentioned in connection with any action taken against that CEO. Some publicity is unavoidable.

If the board did not authorise the arrangement, the company will only be peripherally involved. This should not take much time or effort and will be cheaper than paying that invoice.

If the board sanctioned the arrangement there is trouble ahead. Guido should resist pressure to quietly pay the invoice and conceal an illegality. If he complies with that request what might they ask him to do next?

If the transaction is considered legal and invoice is paid it should be disclosed as a related party transaction.

At the end of the day, Guido needs to feel that he has acted honourably and not done anything amoral.

Attracta's Answer

Guido should inform his Chairman that this transaction is illegal and, as the CEO, he has no choice but to notify the ASIC and the Stock Exchange. Furthermore, the Chairman has an ethical responsibility to set the ethical tone for the organization; such a direction fails to fulfill this role. The question of publicity is out of Guido's' hands however neither he nor the Chairman should put themselves in a position where they can be accused of condoning an illegal activity.

If the chairman brushes him off Guido must notify the other Board members of the chairman's direction and put forward a recommendation that they support Guido in his recommendation to legally rectify the situation or accept his resignation. Guido must remind members of the Board that as an officer of the company, Guido may well be open to prosecution. Over and above the legal accountability, there is also the question of the ethics of concealing an act that is prejudicial to other shareholders. Such actions sets the tone for how an organization's culture will develop into the future CEO and sends a message to other executives that management is prepared to accede to illegal acts in order to avoid public scrutiny. If so, what else is management prepared to do? What do such actions tell employees about "how things are done around here"?

Attracta Lagan is a Principal of Managing Values and has some 15 years experience working with the Boards and senior managements of many of Australia's 'blue chip' companies and government enterprises.

Disclaimer:

The opinions expressed above are general in nature and are designed to help you to develop your judgement as a director. They are not a definitive legal ruling on the issue. Names and some circumstances have been changed to ensure anonymity.

Dilemma number 2 - originally published 1 March 2008

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