Outside corporate directors named as defendants in D&O litigation are rarely required to pay settlements or judgments out of their own personal assets, as prior research has shown. But the question of how frequently outside directors are held liable is a different question from the question of whether and to what extent directors are held accountable.


A June 2013 paper by Harvard Business School professors Francois Brochet and Suraj Srinivasan entitled “Accountability of Independent Directors – Evidence From Firms Subject to Securities Litigation” (here) takes a look at this question of independent director accountability. The authors report that while directors are rarely held liable, independent directors that are named as defendants in securities suits are more frequently held accountable. A July 26, 2013 post on the Harvard Business School website about the paper can be found here.


The authors start by noting that investors have two mechanisms for holding independent directors accountable. Investors can name independent directors as defendants in lawsuits and they can also express their displeasure with the ineffectiveness of the directors’ oversight of manager by voting against the directors’ reelection. In order to assess the extent to which directors are held accountable, the authors studied the incidence of independent directors being named as securities suit defendants and the record of shareholder votes against those directors.


The authors examined a database of 921 securities class action lawsuits filed between 1996 and 2010. The authors found that with respect to the companies that were named as defendants in these suits, 11% of their directors were named as defendants. The likelihood of an independent director being named as a defendant is much higher for directors serving on the audit committee (54% of named independent director defendants); for directors that sold shares (16% of named independent director defendants); or that have been on the board for the entire class period. The incidence is also higher when the lead plaintiff is an institutional investor and when the lawsuit is files under Section 11.


The authors then examined subsequent shareholder votes involving the directors named as defendants. The authors found that these independent director defendants have a great percentage of withheld votes (5.47%) than a controlled sample of independent directors whose companies had not been sued.


The authors also noted that accountability can also be reflected in a greater turnover among independent directors who have been named as defendants. The authors found that independent directors that are named as securities suits defendants are more likely to lave the board of the sued company within two years of the lawsuit than other directors in the same firm. The propensity of directors to leave the board is greater in lawsuits that are not dismissed and for audit committee members. The likelihood of leaving the board increased for both independent directors named as defendants and for other directors of companies that have been sued after 2002 (post-SOX), which the authors “use as a proxy for greater governance sensitivity.”


The authors also examined lawsuit outcomes when independent directors are named as defendants. They found that the more independent directors are named as defendants, the less likely the lawsuit is to be dismissed, settle faster, and settle for a larger amount. The authors noted that “some of our evidence points to the strategic naming of independent directors by plaintiffs to gain bigger settlements.”


The authors conclude that “overall, shareholders use litigation along with director elections and director retention to hold some independent directors more accountable than others when firms experience financial fraud.” In other words, though independent directors are only infrequently held liable, that does not mean that they are not held accountable.