Are Law Firms Conflicted in this New Governance Normal?

Should a board use the same law firm that management uses? I don’t think so. They teach you in law school that you cannot act for two clients whose interests are, or could be, adverse, e.g., a husband and wife in a divorce, a purchaser and vendor of a home, and so on. You can only act for one client at a time. Governance is really no different. The job of the board is to control management in the interests of shareholders. So how can a board use the same law firm that management uses? The interests of the board are inherently adverse to management.

When a board negotiates compensation for the CEO, it should have independent compensation consultants and lawyers. I sat beside a CEO at a conference once and he remarked to me “I will outgun any compensation committee.” When I asked why, he replied that they do not have the expertise or resources. Well, maybe they should.

Another real example: If a lawyer has drafted anti-takeover devices to entrench management, such as poison pill, should that same lawyer act on behalf of a special committee of the board? This is an inherent pro-management bias, is it not? What about an investment bank that has also done work for management? This is a conflict too.

The issue is that it is far more lucrative for professionals to do work for management, rather than the board. In Sarbanes-Oxley, we now have auditors who cannot do non-audit related services for management, absent explicit approval. The Securities and Exchange Commission, in implementing Dodd-Frank, announced a few months ago that compensation consultants working for the board must now be independent from management. Proxy advisors may be regulated prohibiting their offering consulting services to management. The same rule should apply to lawyers.

The board must be free to retain its own advisors so they are not “out-gunned.” Shareholders will lose when this happens.

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