When Should a Board Member Resign?

Since the enactment of Sarbanes-Oxley (SOX) on July 30, 2002, many executives and board members have developed an almost palpable degree of anxiety when it comes to corporate governance and board service. In fact, some friends of mine who have been asked to serve on boards of publicly held companies have answered with a resounding “no!” out of fear of the legal implications and entanglements of serving on a board post-SOX.

My advice to people who ask me is that they should by all means consider board service, but approach it with a bit more caution nowadays because of possible directors’ exposure to liability, especially if there has been past malfeasance on the part of directors of the company they are considering joining.

A Well-Run Board

Based upon my experience, it is easy to articulate the characteristics and elements of a well-run board of directors. First of all, there is open communication between the board and senior management. In fact, one friend of mine who serves on the board of an extraordinarily successful tech company tells me that management encourages the board to actually “stroll” through the corporate offices and speak to middle- and high-level management to get a feel for the corporate culture — talk about openness!

Another critical element of a good board is an audit committee that has members with financial expertise who can objectively serve in a check-and-balance function. Such a committee acts as a financial watchdog to assure that the books and financial statements of the company are properly prepared and presented. A good executive welcomes such a committee because there are times when he is so caught up in the everyday management of a company that certain financial situations that might lead to trouble could go unheeded without the intervention of a sound audit committee.

The composition of the board is also critical. I personally like to see at least one board member who is a financial expert, another who is an expert in the industry that the company serves, and another whose high profile can give added credibility to the business. Additionally, it doesn’t hurt to have an attorney as a board member, especially an attorney with securities experience. A well-composed board actually serves as a “security blanket” for management in that it can act as a gatekeeper for the company and protect it from unnecessary risk and exposure.

Finally, a well-constituted board will have no members who are there for the ride. In other words, all members are active participants in the corporation’s affairs. With that in mind, it is certainly in the best interest of a board member to be sure that his proactive deliberations are part of the corporate record. Such proactive behavior actually serves as a firewall to protect directors from untoward claims, or lawsuits by dissident stockholders.

Bad Timing

There certainly are instances when a board member should walk away and resign his post. However, before I discuss the circumstances leading to resignation, I want to make the point about when it is not a good time to resign.

In my opinion, if the fortunes of a company unavoidably turn sour, it may not be a good time to walk away. For example, say that there are circumstances beyond the control of management that inevitably adversely affect the fortunes of a company. Such circumstances could include a natural disaster such as a hurricane, a protracted strike that couldn’t be avoided, etc. In such cases, I personally feel that the board members should stay on and see the situation through.

I fully realize that trying times may frighten a board member, given all of the adverse publicity that came out of Enron and the subsequent enactment of SOX. I feel, however, that there are times when a resignation that follows on the heels of a turn of fortune for the company is not necessarily a good thing. I personally would work through tough times with management and be as proactive as possible, including making sure that my name is a part of the proactive deliberations of the company.

That said, if management starts to stonewall the board and avoids transparency and full communication, I would certainly seriously consider resignation. Most of the times, such behavior by management means that they have something to hide. Besides that, in this day and age, it is absolutely foolhardy for management to be anything other than proactive and transparent with the board.

When It’s the Only Option

I served on the board of a publicly held company that was later acquired by a bigger company. In that particular case, however, I resigned before the acquisition because of the lack of communication by senior management with the board. As chairman of the board’s audit committee, I was tasked with insuring the accuracy of the company’s statements.

When I asked questions that would reasonably insure such accuracy, I was given vague, and in some cases hostile, answers. Resignation was the only alternative that I could see. A well-run audit committee actually protects honest and competent management. For management to avoid the audit committee or be hostile to it raises red flags not only for the audit committee, but also for the rest of the board.

Resignation from a board because of disagreement with management’s policies should be a last resort. Most top executives heavily rely on a competent board to give management another “set of eyes” to insure the good fortune and success of a company. For that reason, resignations by board members for reasons of distrust are not very common. Good luck!

Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at [email protected].

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