What Boards Should Know About CLOs’ Expanding Role

A series of significant developments provides a timely prompt for boards of directors to acknowledge the expanding role and importance of chief legal officers (“CLO”).

These developments include the departure of several high-profile CLOs; the recognition of the CLO as a key board advisor on workforce culture and ethics; the prison release of Jeffrey Skilling; and most particularly, the 2019 survey of the Association of Corporate Counsel (“ACC”).

Any discussion with the board of these developments should be grounded in the following basic fiduciary considerations.

First is director awareness of the increasing commercial acceptance of “Chief Legal Officer” as the title used to describe the highest-ranking corporate executive with specific responsibility for management of the company’s legal affairs.[1] In that regard, having a CLO contemplates a direct reporting relationship to the chief executive officer. While the corporation is the CLO’s client, the CLO serves its client primarily by acting as the main legal advisor to the corporation’s constituents. These include (subject to conflict) the board of directors, chairman of the board, chief executive officer and other senior management.[2] The CLO position typically incorporates those additional duties of business strategy partner and ethics counselor that knowledgeable observers now attribute to the corporation’s senior legal adviser.

The concept of CLO is often popular with large, sophisticated, highly regulated national and international companies with many subsidiaries and a large in-house legal department. In those situations, use of the CLO title facilitates use of other appropriate executive titles when there are other lawyers on staff who are senior, yet in a subordinate position. However, the CLO title is also rapidly extending to a more diverse base of organizations in terms of size and focus.

Second is confirmation that directors fully understand their specific fiduciary obligation to monitor the legal affairs of the organization. This responsibility is most directly satisfied through oversight of the office of the CLO, and extends to hiring, compensation, and termination of the CLO. The essence of the obligation is to assure that the company attributes appropriately high value to matters of legal compliance. This position should never be marginalized by hiring underqualified persons, placing them at significantly subordinated levels, or compensating them far below the industry average.[3]

Given these fiduciary considerations, boards should pay close attention to and learn from these recent CLO-related developments.

ACC Survey.  The 2019 edition of the ACC Chief Legal Officers Survey[4] (“Survey”) represents an important resource from which the governing board may effectively exercise its oversight of the CLO position. Its findings reflect an upward progression of the CLO to positions of power and influence within the company, and assume duties beyond those of technical legal expert. To that end, the ACC findings underscore the organizational value of a CLO hierarchically positioned to influence corporate strategy. Other significant Survey findings include:

Legal and Regulatory Trends.  Survey respondents identified new government regulations, brand and reputation issues, disruptive technology, ethics, and compliance as most likely to affect company decisions in the near term. The fact that each of these issues has clear legal implications increases the importance of the CLO.

Corporate Sustainability.  More than 80 percent of CLOs in companies with a formal corporate social responsibility (“CSR”) program respond that they have a meaningful impact on sustainability-based decisions within their organization.

Member of Business Team.  The CLO is now broadly recognized as a trusted adviser on executive-level strategic matters, as well as on operational issues that affect legal, regulatory, and reputational risks. More than 70 percent of the respondents indicate that they are regularly consulted by executive leadership on business decisions.

Expanding Duties.  CLOs are increasingly providing oversight of areas other than the legal department. The most obvious example is compliance, for which 75 percent of the respondents indicate they have responsibility. Other major areas of responsibility or influence include government affairs, human resources, and administration.

Reporting Relationship.  Notably, the survey confirms as accepted practice a direct reporting relationship from the CLO to the highest-ranking executive officer in the company (CEO or other officer). 78 percent of the respondents indicate they have such a relationship. The survey results are also critical of a reporting relationship to the CFO, as such status diminishes the CLO’s ability to affect major business decisions and to provide advice on operational and risk issues.[5]

Adviser to Board.  The survey also confirms as accepted practice the regular interaction of the CLO with the board, regardless of the exact nature of the relationship. Overall survey data indicate that 68 percent of CLOs regularly attend board meetings. The percentage is higher (75 percent) for CLOs who report to the CEO.  Other data indicate that the board seeks CLO advice on “corporate governance issues, strategic business decision risks and solutions, and corporate compliance.”

Size and Management of Legal Departments.  The board should take particular note of Survey results indicating that the budgets of in-house legal departments will continue to grow. Along the same lines, most respondents anticipate increased staffing levels in 2019 (whether through more in-house counsel, legal operations personnel, or paralegals.) This serves to emphasize to the board the increased use of legal operations staff in managing the legal department.

CLO Departures.  As recent media stories indicate, the departure of a company’s CLO/general counsel is becoming an all-too common event. A prominent recent example is the news that Tesla’s general counsel, a highly regarded attorney recruited from a prominent law firm, resigned after only two months on the job to return to his old firm.[6]

While the reason was reportedly a poor cultural fit, such a short tenure should always be cause for a raised eyebrow in the boardroom. As noted above, the board has a fiduciary obligation to exercise oversight[7] for the office of the CLO. An important extension of this obligation is the need to be notified of, and be fully advised of the reasons for, the termination or other form of departure of the CLO. When the CLO leaves the organization, directors should be especially  alert and conduct a diligent inquiry into the circumstances. The CLO is no ordinary officer, and her departure is no ordinary event. The board must understand why the CLO has left—and may need to hear these reasons directly from her.

Certainly, the circumstances could be benign, as with the planned retirement of a long-serving CLO or one who is moving to an even higher executive position within that or another organization. Indeed, the job could be a bad cultural fit for some people. But the circumstances could also be quite problematic, such as when the CLO is leaving because of the unwillingness of the CEO to accept her advice (including departure as contemplated by the professional rules of conduct) and where the CLO position is marginalized through low compensation, limited duties, or subordinate position within the organization.

Workforce Culture.  One of the most pressing areas of board responsibility is addressing matters of gender discrimination within the organization, particularly as it relates to compensation and promotion. A recent report from McKinsey (prepared with assistance from LeanIn.org) [8] has increased boardroom awareness of internal issues associated with the promotion of women (in addition to issues involving allegations of sexual discrimination and harassment).

These issues directly affect the board’s broader fiduciary obligation to exercise oversight of workforce culture, as that obligation has been articulated by the National Association of Corporate Directors[9] and other governance policy organizations. Because of the multiple legal and reputational issues involved with this oversight responsibility, the CLO should be a primary adviser to the board. Indeed, the NACD encourages the board to assess whether the CLO/general counsel is sufficiently positioned within management and in relationship to the board to support an appropriate culture.[10]

The Skilling Release.  The release of Jeffrey Skilling, the last incarcerated former Enron executive,[11] is a dramatic reminder for the board of the important nexus between that seminal corporate scandal and now broadly-accepted corporate responsibility principles about the role of the CLO in advising on corporate governance.

Conduct failures woven through Enron (and the other corporate scandals that led to the Sarbanes-Oxley Act) included the marginalization and misapplication of the role of the corporate legal function. These seriously affected the provision of timely and effective legal advice to executives and especially the board. The problems associated with the general counsel’s role in these circumstances led to significant changes to the lawyers’ rules of professional responsibility, and also prompted useful commentary on the role of the inside counsel as it relates to corporate responsibility.[12]

While Skilling has paid his debt to society, his release makes relevant a discussion with a new generation of corporate officers and directors on how Enron and other corporate scandals have affected the role and responsibilities of the in-house counsel.

Conclusion

The current transformation of the business sector is, as the ACC Survey notes, having a direct impact on the role and prominence of the company’s CLO. This impact is underscored by a series of related, high-profile events.

It is now well established that the board has an oversight obligation over the company’s legal function. Its ability to properly exercise this obligation will be enhanced by an awareness of the ACC Survey results and these other developments. From this awareness is likely to come greater appreciation for the contributions of the CLO to a culture of legal compliance and ethical performance within the organization.

ENDNOTES

[1] Black’s Law Dictionary (10th ed. 2014), chief legal officer; see also, E. Norman Veasey & Christine T. Di Guglielmo, Indispensable Counsel: The Chief Legal Officer in the New Reality, (New York: Oxford University Press, 2012).

[2] See, e.g., American Bar Association, “Model Rules of Professional Conduct” Rule 1.13(a), Cmt. 1.

[3] See, e.g., Report of the American Bar Association Task Force on Corporate Responsibility, The Business Lawyer Vol. 59, No. 1 (November 2003), pp. 145-199 (“ABA Report”); The Association of the Bar of New York City, REPORT OF THE TASK FORCE ON THE LAWYER’S ROLE IN CORPORATE GOVERNANCE (2006), p. 96-111 (“NYC Bar Report”).  https://www.nycbar.org/pdf/report/CORPORATE_GOVERNANCE06.pdf

[4] 2019 ACC Chief Legal Officers Survey, 2019 The Association of Corporate Counsel, http://www.acc.com/surveys.

[5] NYC Bar Report, supra at 105 (“The Task Force believes that the General Counsel should not report to the CFO due to their respective roles in financial reporting and disclosure. These two positions generally should be on the same reporting level within the corporation”).

[6] Neal E. Boudette, “Tesla’s Top Lawyer Is Leaving. His Tenure at the Company: Two Months”; The New York Times, February 20, 2019.

[7] See, NYC Bar Report, supra at 104 (“The selection, tenure and compensation of the General Counsel, including any decision to discharge him, should be approved by the Board or a committee composed of independent directors.”)

[8] https://www.mckinsey.com/featured-insights/gender-equality/women-in-the-workplace-2018?reload

[9] Report of the NACD Blue Ribbon Commission on Culture as a Corporate Asset (2017, National Association of Corporate Directors, NACDonline.org)

[10] Id., at p.17, 24.

[11] https://www.chron.com/business/energy/article/Skilling-scheduled-for-release-after-12-years-in-13634433.php

[12] See, e.g., Report of the Special Investigative Committee of Enron Corporation (February 1, 2002) http://i.cnn.net/cnn/2002/LAW/02/02/enron.report/powers.report.pdf; Michael W, Peregrine, “Why Enron Remains Relevant”, Harvard Law School Form on Corporate Governance Financial Regulation (December 2, 2016) https://corpgov.law.harvard.edu/2016/12/02/why-enron-remains-relevant.

This post comes to us from Michael W. Peregrine, a partner at the law firm of McDermott Will & Emery, who advises corporations, officers, and directors on corporate governance, fiduciary duties, and officer and director liability issues. His views do not necessarily reflect the views of the firm or its clients.