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Trends and Developments in Director/Officer Liability: Parties with Primary Jurisdiction to Challenge Officer and Director Conduct

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In the second episode of this three-part series focusing on director/officer liability, Rob Gerberry, Senior Vice President & Chief Legal Officer, Summa Health, speaks with Michael Peregrine, Partner, McDermott Will & Emery LLP, about the parties that have primary jurisdiction to challenge officer and director conduct. They discuss the different tiers of parties that have an interest in officer and director conduct, the kinds of circumstances that can create exposure with these parties, and mitigation measures that officers and directors can take to protect themselves from actions by these parties. From AHLA’s Business Law and Governance Practice Group.

Listen to the first episode, which discusses the concept of officer and director liability and related standards of care, here.

Listen to the third episode, which discusses new developments in officer and director liability matters, here.

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Speaker 1:

This episode of A H L A speaking of health law is brought to you by A H L A members and donors like you. For more information, visit American health law.org.

Speaker 2:

Hello again. I'm Rob Gerber, senior Vice President and Chief Legal Officer of Suma Health, and a member of the H L A Board. I'd like to welcome you back to the second and a series of three h l a podcasts on the important topic of trends and developments and director officer liability profiles. This three part podcast is designed as a supplement to our 2022 series of podcasts that explored basic governance issues affecting hospitals and health systems. In this new series, we plan on addressing three specific elements of the officer and director's liability profile. And our first podcast, we explored the basic concept of officer and director liability and related standards of care. Today, we'll identify the parties with primary jurisdiction to challenge those officers and directors on their conduct. Also, in our third and final segment, we'll discuss new developments in officer and director liability matters, including but not limited to the Delaware Chancery Court's recent decision in the McDonald Corporation's stockholder derivative litigation. And as before, I'm pleased to adjoin be joined by my colleague Michael Peregrine of McDermott and Emory, who is here to share some of his perspective with us on these important topics. Thanks again, Michael, for joining us.

Speaker 3:

My pleasure, Rob. Thank you.

Speaker 2:

So, Michael, before we dive into our, our content for today, let's review something we talked about in our first podcast that the sky really is not falling with respect to director and officer liability, but it's actually enough of a concern that it's worthy of h l a membership conversation. Mike, any any thoughts from our first podcast that you wanted to share to start today?

Speaker 3:

Yeah, Rob, I think that's a, an important point to make with our, uh, colleagues, h l a colleagues, the sky is absolutely not falling. Uh, this is not something we, that the last thing we want to do is to, uh, unnecessarily concern our, uh, clients and their ability to recruit and retain directors. Nevertheless, there are a couple of things in play that, that make what I would call risk awareness for directors and officers, uh, much more appropriate. What we're really focusing in on, I think, in our podcast series, uh, Rob, is less risk identification and more the kind of prophylactic measures to mitigate against the risk. But if you wanted to identify the kinds of things that are going on right now that are contributing to, yeah, as I said, what I think is a great, the need for greater awareness of, uh, officer and director risk identification. You know, we start with the obvious, the, just the sheer size of many not-for-profit health systems with revenues in the high nine figures, 10, even 11 figures. It's, these are just enormous business organizations, uh, on their own. And unfortunately right now, they're, uh, obviously many of'em are in county, very tough financial cs, which are requiring a number of cutbacks and layoffs in a variety of departments. And so, uh, we're asking so much of individual managers, and in some situations, positions are going unfilled and that's not helping situations. We have the absolute complexity of business operations, of healthcare systems, uh, and the complexity of their corporate portfolio. What we're talking about here, Rob, is, is just that the extraordinary breadth along the spectrum of the business enterprises, uh, that and the, and the healthcare activities that our clients are entering into right now and the regulatory schemes that they involve. And then also, just if you look at the corporate chart, how complex that is, the number of affiliates and subsidiaries and joint venture entities. It's, it's a headache. Uh, then we also have something concrete. We have the new, uh, compliance focus from the Department of Justice and their concentration on individual accountability, uh, that, uh, perked up again in September of 2022 and continues to this day. We have, as you mentioned, uh, a kind of a broader industry focus on risk and oversight arising from cases like, uh, the McDonald's stockholder Deriv litigation, uh, and the Silicon Valley Bank issues. And I think we're gonna talk about those a little bit in our next podcast. We've got the lack of engagement by some boards, and, and that's obviously something that has to be job number one. We just have to make sure that our boards are up to speed in terms of the level of oversight and an informed decision making. If they're not, uh, they're, they're just simply asking for greater exposure. And then, uh, Rob, I'll offer something controversial, but I I really do believe that it's, uh, out there, it's a combination of the return of what I call the Imperial c e o. Um, uh, and it's a situation where we have, uh, a, a small, uh, but a notable percentage of our client CEOs, uh, thrilled that they brought the institution out of the pandemic, working so hard to address the current financial status. But as a part of that, um, not necessarily engaging with the board in the way they should, uh, in some small number of situations, not even respecting the role of the board, uh, a a as they should, or dealing only with a small percentage of board members and not the whole board. Uh, I think this is, uh, a again, why I'm realized that's a critical observation. Uh, I do believe it's true. And I think in those situations where we have, uh, just a small subset of officers in the board, uh, in, in charge, uh, that is going to be a significant source of risk going forward and let the arrow start flying in my direction there. Rob

Speaker 2:

<laugh>, with all that as our backdrop, we've got lots to dive into. So, Michael, as we look at who's the first tier of parties that care about how officers and directors conduct their business, who would you identify as those parties?

Speaker 3:

Well, Rob, you remember well, from our discussions last year, I, I do place this on, on a multiple, uh, tier basis in terms of who gives a darn about, um, officer and director of liability. And actually, you know, traditionally when I have this conversation, I start with the State Attorney General, and I'll start again with that, that, uh, that group, because I think it is the state ag, uh, who has by statute the authority and responsibility to monitor, uh, the, uh, use and preservation of charitable assets, including assets dedicated to the promotion of health. Uh, the ag has an extraordinarily broad, uh, broad, um, uh, range of, uh, equitable and statutory rights to protect charitable assets. And it is their also their responsibility to, uh, manage and supervise the performance of fiduciary duties by boards of directors of not-for-profit organizations. So, the Estate Attorney General, first and foremost, uh, we also, uh, have the Internal Revenue Service, which is not, as many of our listeners know, not as vocal, not as publicly oriented in terms of their enforcement activities in the e exempt organization area as they have been in the past. But historically, going back easily 20, 25 years. The i r s is very focused on corporate governance. They're very focused on the quality of board oversight, uh, because they believe that the more effective oversight will lead to greater tax compliance. So, uh, and the i r s, especially with its its own form of auditing and compliance measures, and with, uh, intermediate sanctions, uh, enforcement actions, they absolutely care about the quality of corporate governance. Um, I'm a big believer that, that we have to count the Department of Justice within this category of parties that care principally because of do J'S focus and its emphasis on individual accountability, oftentimes in that they're looking at officers and, and executives, but it's certainly conceivable, uh, and there, there's precedence in the healthcare area where they will a, they will focus in on the accountability of board members themselves, uh, for, uh, corporate malfeasance. So we have to keep the Department of Justice, uh, in, in that first tier, especially given all of the changes in terms of, uh, corporate fraud enforcement that they've put into play this year, including most recently, the focus on executive compensation. And along with that, we have the Office of the Inspector General, uh, which will, uh, be very concerned with the role of, of corporate boards in terms of supervising compliance and in terms of, uh, monitoring the com, uh, satisfaction of corporate integrity agreements in similar settlements with the OIG G. The second tier is a more motley crew. Um, uh, I'll lead off with in no particular order with unions. Uh, I believe that unions and every, you know, um, nothing saying bad about unions, but I think it has to be recognized as the fact that unions are a significant force in many states in their ability to pressure Texas exempt hospitals not-for-profit hospitals, and, and criticize them and their board operations, uh, uh, in order to, uh, gain a advantage in the organizing and bargaining efforts. Uh, they have tremendous influence with the media in many states. They have tremendous influence in state government, and they will, in my experience, uh, float issues and concerns, uh, with corporate governance as a way of gaining leverage. Uh, I do absolutely believe that another, um, uh, second tier, uh, uh, force in terms of, uh, enforcement, uh, issues against officers and directors is the unsecured creditor or the committee of the unsecured creditors, who in a situation of bankruptcy or financial collapse, will, will chase every dollar down no matter where, and typically they will, will, uh, bring some type of legal action against, uh, the board of directors of an organization that's in financial distress. They want their money, and they'll get it from any source. Uh, the secretary of state of, of, of some states will also independently have, uh, interest in corporate governance, principally through the filing obligations and the accuracy of filing obligations, another maintenance of not-for-profit status. Uh, the, and, uh, also we get in with the Secretary State will sometimes be particularly focused on mission creep by nonprofit organizations, a acting beyond the scope of their articles of incorporation. I think a more current, uh, area route for potential concern is the increasing use of, uh, in states that allow derivative actions against the boards of not-for-profit organizations for disgruntled current or former officers to try and leverage a derivative platform to pursue action against the board or members of the board. Uh, this along with, uh, the use by disgruntled directors of books and records requests under state law to similarly pursue, uh, director indirect concerns, uh, uh, by the board of their activity. We obviously have the ftc. Uh, I think what's so interesting is the concern of the FTC now going back into many of their more recent enforcement theories, non-competes, but, um, overlapping board compliance and things of that, that nature where they're very much focused on corporate governance issues. Uh, I do notice, uh, that in some of the more recent decisions, and, uh, especially in some of the F T C court filings in terms of hospital mergers, the F T C hasn't been, uh, uh, shy about calling out, uh, broadly the actions of the board in pursuing a business transaction that the FTC is subsequently, uh, pursuing. Finally, on the second tier, and I think one that's largely, uh, uh, kind of ignored is the role of congressional committees and subcommittees, uh, and individual, uh, representatives and senators to raise issues in regarding not-for-profit, uh, leadership and governance that could lead to individual liability. We've seen this in 2023 with individual senators, uh, challenging, um, board actions, strategic decisions and things of that nature. We can't, um, rule that out. Finally, uh, out there on the fringes in the third tier, uh, we can see state and local tax authorities, the, you know, those tho those bodies often are come outta nowhere, uh, in terms of crazy, uh, actions involving a breach of tax responsibilities by boards who are taking, usually it's, it's where the boards have authorized action by the organization to incorporate something as a not-for-profit, tax exempt, uh, organization under state law. And the state and local tax authorities, uh, pursue that and challenge that. And they name the boards as, as some of the name defendants. Uh, I'm we're seeing increasingly in really bad, uh, quality of care in med mail cases where the plaintiff's attorneys will, uh, will seek to claim a, uh, breach of fiduciary duty, uh, of boards for failing to maintain certain standards of care. But I'll end this long monologue, Rob, by highlighting the single greatest area of concern or, or source of concern for director and officer liability, of which I'm aware of, and it's arisen in the last couple of years, and that's what I call the new media. Uh, we talked a little bit Rob last, uh, in our last program about reputational harm and the risk of a, per a director's reputation is perhaps the most practical and present, uh, concern, uh, uh, pressing against a board member of a not-for-profit healthcare system, um, much more so than financial exposure, and it is most likely to come from the reporting practices of the, the, the new media, the stats, the ProPublica, uh, the other, uh, uh, Capitol Hill, or the org, uh, media organizations, uh, that, that have developed over the last couple of years. Um, their reporting style, their tendency in my mind to drift away from traditional reporting practices, um, the, their great tendency to go for the jugular, uh, their great tendency to identify individuals, their great tendency to leverage what they believe to be, uh, improper board action. I think these are extra, these new media outlets are, uh, very real and significant, uh, sources of allegations that force, uh, board members to react to. So, three tiers, lots of different coming from, lots of different areas. I would just say my number one is the attorney general. My number one A is the new media, Rob.

Speaker 2:

Great, Michael, thank you for that background. So, as we stop and pause and think, uh, about your experience in representing health systems across the country, what are the kinds of circumstances that you're seeing that can create an exposure with these different entities that you mentioned?

Speaker 3:

Well, you know, I, I would say that one thing, Robin, maybe as a follow up to the three tiers, uh, what we're willing to, what we're seeing now more than the past, as I said before, are these, uh, concerns arising from, uh, only a small percentage of board members actually being involved in, in decisions and oversight, which I think is a recipe for a disaster. We're also seeing a situation where whistleblowers are concerned. Uh, constituents of an organization are blowing the whistle on their officers and directors where they feel them, uh, uh, taking action, which are inconsistent with the charitable mission or business decisions, which they think are really aggressive or, or stretching the risk profile of the organization. So we, we, you know, and they're doing it out of conscience, sometimes they're not doing out of just pure financial, uh, goals. So I would say if you had to list, um, the kinds of things that are, are, are most problematic in terms of creating exposure for our board members. You, again, you look at it in the context first, that the, that, whether by a whistleblower or just general digging by the new media, it's these, these allegations are more likely to arise in the past. In my mind, you know, we, and we just start with bad faith, uh, in decision making or oversight, uh, bad faith, pain defined as essentially greater than mirror or, or gross negligence. But a situation where not only did you do the wrong thing, but you knew you were doing the wrong thing when you did it, and you didn't, don't give a that you did the wrong thing. So it's the real trifecta, uh, uh, messing up. And I think in those situations, when they meet the, uh, when they get in the press as essentially colossally bad business decisions or colossal failures of oversight, uh, if, if it involves charitable assets, you're just begging for the attorney general to jump in and start asking questions. Uh, I, I think, uh, and perhaps I think it's, it's unfair, but the, uh, a second area is when the organization has suffered, uh, really significant financial losses. Now, we we're part of an industry that over the last year has suffered almost to a, uh, an institution, very significant financial losses. And so what I'm talking about is something that's out of the ordinary, which is an a loss, that's an outlier, um, as opposed to the kinds of trends that our clients have seen and, and had to endure over the last year, uh, in, it's interesting to me that major investment losses, uh, by an institution, uh, are, you know, while they should be the subject of attorney general review, rarely are, in my mind, at least in the public venue part of this is the, is the VAs in the market and the hard, in the hard, um, reality of who, who knows what the best strategy is. Uh, part of it, I think, is a lack of understanding of state statutes that govern prudent investments like upm A, um, but I, I do think that organizations from time to time will pursue extraordinarily risky or unusual investment practices. Those are just begging for state review. Uh, uh, two other kinds of more traditional areas, Rob, where problems will arrive or are any suggestion a any suggestion at all of an insider related, uh, deal or favoritism in favor of an officer director. That's especially where you're going to get, uh, you know, it'll be the secretary, it'll be the assistant vice president. It'll maybe be a member of the general counsel staff, somebody that says, this is awful. Uh, and I just can't stand that. I'm seeing this within our organization, and I'm going to report it. I think that, that, uh, it, there's been news stories in the press recently about a healthcare system in the Midwest, uh, where it's undergoing a series of investigations d due to all sorts of allegations that the senior executive officers and board members were combining to, uh, basically take advantage and use institutional property for their own purposes. Uh, you know, that's always, uh, that's always, uh, going to be an issue when you're talking about money and you're talking about a potential misuse that's just, that's just total fodder for a reporter. Um, conflicts of interest transactions, the same way they have always been, uh, like a, a moth to a flame in terms of attacking attention. Very hard, very, very fact intensive. If you get into a battle as to, in sustaining a, uh, conflict driven transaction, you're talking about time and money, uh, along the same road. I think that we know that while it's not illegal, when we have situations where directors or officers are conducting business with the organization, you're, you're asking for optical concerns. You're cr you're asking for people to, to evaluate why are you doing it this way? And that can certainly lead to exposure. Then a couple of other things. I think that the, the political sensitivity of certain actions taken by the board or with respect to the delivery of care, uh, when you have controversial actions taken by a board, one way to fight back, whether it's by a community or certain segments of the community, are just to go right to the board of directors and say, you are at fault. You approve this, you, and to make all sorts of allegations. We're seeing that o more often, again, with decisions that are politically sensitive in the community, uh, or relate to access to care or the delivery of care. Um, we have ultra virus transactions, uh, uh, whether they are not authorized by the board fully or are not consistent with the, uh, articles of incorporation or some, uh, kink in the approval process. But Rob, just like with the new media, I have one other, uh, major area of exposure here that I think is going to be important in the near future. Uh, and that's artificial intelligence right now. Uh, and even recognizing the extraordinary opportunities for use of AI and healthcare, and we read this, uh, in the media every day, the, there just is no guidance out there, of which I am aware in terms of how corporate boards are supposed to exercise oversight of the acquisition and implementation of ai. I think this is just a lawsuit way to happen that the, as i as parties are able to identify injury or harm that's occurred because of the use of AI by a hospital or health system, they're going to raise questions about the board's role from a risk perspective and evaluating the acquisition and implementation of ai. I suspect if we're having a conversation this time next year, we will see, uh, instances of where, uh, AI-driven action against officers and directors has been instituted. So that's, that's the universe of circumstances that I usually share with clients in terms of, uh, where to look at it, you, you just have to keep your head on a swivel in terms of where the action might come from.

Speaker 2:

Great. Michael. Thank you. So in my experience, as we onboard and go through our orientation program with our new board members, their biggest concern is our, their role in the community, making sure that we keep our stakeholders and our constituents happy. There. Also, their role in keeping the medical staff happy, but as you've highlighted, there's a lot of other parties they all obligations to. How would you advise during that orientation process some mitigation measures that board members can take to protect themselves from any, uh, action by the parties we just outlined?

Speaker 3:

I think very easily, rob, trust their judgment. Do your homework, play by the rules. Uh, and by that I mean you're on the board to exercise judgment. If something looks to you that, like it's funny, uh, it doesn't make sense, uh, it's a yellow flag or red flag, well, it might well be. And so don't sit on your hands, uh, by playing by the rules. Uh, that means adopt making sure that you're a, uh, a part of and adopting, uh, rules with respect to conduct of boards, not just ethical conduct, but the manner in which they exercise oversight and decision making. And, and the third area in, in terms of what they can do is, is be involved, be engaged. I think you see much of the, the derivative action these days focus on boards that the, are the, that are alleged to be, uh, out of touch, unaware, uninvolved. And this comes back again to my concern about the Imperial c e o who tends to rely more on a kitchen cabinet, that the full board for advice and input. If you don't like to involve the full board, cuz you think your board is too big, that's great, shut, cut the size down. But otherwise, if you're, if your decision, uh, group is a, is five or six directors and you've got 10 or more who, who are living outside the circle of decision making, you're again begging for trouble. So, uh, on onboarding, it's, you know, uh, trust your judgment. It's do your homework and stay engaged.

Speaker 2:

So Michael, as we all know, it's getting more challenging to recruit volunteer board members with the expertise needed to run health systems in this challenging industry. If they're listening to our podcast before they decide to join, what would you tell those board members about the type of risk they're walking into? Is it something the average board member needs to realistically be worried about or if they follow the things that you just outlined, should they be okay?

Speaker 3:

I, I, I don't, I think it's something that the chief legal officer, uh, and the c e o should be worried about. They have a responsibility to put in place the systems that'll allow board members to function free of, of any reasonable concern about, uh, financial exposure. Uh, it's, it's really important. This is why I, I cha I commend those organizations who have organized governance functions. It's really important that I think management, uh, drive, uh, a system of policies and procedures and, and processes that are designed to result in effective governance. That's a perk of board service that you, you, you are serving an organization that's very serious about putting it, its board members, uh, in a good place, not just with respect to indemnification and, uh, insurance and advancement and things of that nature, but, but effective board policies, uh, that drive, uh, uh, strong oversight, that drive informed business decisions that help them avoid conflicts of interest that encourage them and fo help them focus on the kinds of information that they need. Uh, again, the, it's, I think there's should be no concern in situations where there's a strong culture of corporate governance, a culture of information flow to the board, and a strong commitment to engagement and activities. It's just not something that I think should even be broached on the table about risk, because I think that's creating an issue when it's not there. Uh, for, for organizations that lack, uh, those that discipline to have strong organizational, uh, uh, governance culture, then we're talking about a different story.

Speaker 2:

Well, Michael, thank you so much again on behalf of our membership for your insights today. We appreciate today's discussion and look forward to our next podcast related to the McDonald's deriv of litigation. So thank you, Michael.

Speaker 3:

Thank you, RO.

Speaker 1:

Thank you for listening. If you enjoy this episode, be sure to subscribe to a H L A speaking of health law wherever you get your podcasts. To learn more about a H L A and the educational resources available to the health law community, visit American health law.org.