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A Freeh Hand on Governance

Michael W. Peregrine Feb. 13, 2012

Judge Louis Freeh is uniquely positioned to influence the practical application of corporate-governance principles — and he is strongly encouraged to do so.

The estimable former FBI director is playing a leading role in the resolution of two of the most prominent organizational dramas of the year — directing the internal investigation of the Pennsylvania State University sex abuse scandal and serving as the Chapter 11 bankruptcy trustee for the estate of MF Global Holdings Ltd. and MF Global Finance USA Inc. In the former, he is expected to issue a report analyzing the facts, reaching certain conclusions and making recommendations intended to correct identified breaches of law, ethics and judgment. In the latter, one of his express statutory responsibilities is to investigate and report "fraud, dishonesty, incompetence, misconduct, mismanagement, or irregularity in the management of the affairs of the debtor." In particular, he is authorized to assert and prosecute any claims for breach of fiduciary duties on behalf of the MF Global debtors and their estates.

Amid the many legal, financial and ethical issues implicated by those controversies can be found basic issues of corporate governance, including those of independence, conflicts, reliance and oversight. Just what constitutes a "red flag"? How involved must the board be in corporate compliance? Are there limits to the board's ability to rely on its chief executive? When does board confidence in a renowned executive convert to excessive deference? What is management's obligation to keep the board informed?

What is extraordinary is the vastly different nature of the organizations involved — a renowned institution of higher education on the one hand, and an international trading company on the other hand. Thus, should Freeh speak to the underlying corporate-governance issues, the impact will be felt across corporate America — public and private companies, for-profit and nonprofit. His reputation for rectitude will carry near precedential impact. Expect corporate-governance counsel to reference him: "As Freeh concluded in his Penn State report…".

And it is very important that Freeh take advantage of the opportunity. The continued evolution of effective corporate-governance practices depends on reliable guidance based on "real life" fact patterns. This is especially the case as the 10th anniversary of the Sarbanes-Oxley Act places renewed emphasis on corporate responsibility and on the vital role of the board in providing checks and balances to the judgment and actions of executive management. It's not that boards are lacking guidance on governance issues from the Delaware courts. Rather, it's that they are lacking guidance on the real-world issues more likely to present themselves in the boardroom. This is a particular imperative in the nonprofit sector, where the ability to rely on the Caremark line of oversight cases is limited by the absence of a "market factor"; there are no shareholders who can hold directors accountable for imprudent action (or nonaction).

It's also important because of the emotional public reaction to the two controversies, and the potential that it may color the evaluation of board conduct. Penn State is clouded not only by the horrific nature of the underlying sex abuse allegations, but also by widespread concern with the fairness of the termination of Joe Paterno, especially given his untimely death.

MF Global is tarred to a large extent by the continuing public frustration that the financiers thought responsible for the Great Recession have never been held accountable. The role of Jon Corzine, former senator and New Jersey governor, in its demise adds fuel to the MF Global fire. Given such combustible circumstances, the governing board is an easy target for criticism — and potential liability. Bad facts do indeed make bad law, and there is ­significant risk that negative public reaction could lead to a corruption of traditional fiduciary principles. Freeh is extraordinarily well positioned to rise above the emotional, and speak dispassionately and authoritatively to matters of fiduciary duty.

So there is a broader public policy aspect to Freeh's prominent Penn State and MF Global engagements. The opportunity to evaluate the application of fiduciary duties in the context of highly visible and controversial fact patterns. To provide guidance that would benefit both for-profit and nonprofit companies. To recommend new "best practices." To be sure, board conduct is not the centerpiece of attention in either controversy. It's not necessarily of headline-level focus. But it's there nonetheless. For Freeh to pass on a substantive evaluation of these issues would be a true missed opportunity for corporate governance in the broadest sense. After all, he is Louis Freeh! And this would be especially the case in the midst of the upcoming "Sarbanes Summer," when attention will be refocused on those dramatic boardroom failures that happened 10 years ago — and could easily happen again.

Judge, we know you're a very busy fellow these days. But we would really like to hear from you on this.

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