Bernie Ebbers and Board Oversight of the Office of Legal Affairs

Michael W. Peregrine is a partner at McDermott Will & Emery LLP. This post is based on his McDermott Will & Emery memorandum.

It was a small blurb in the December 19 issue of The Wall Street Journal, easily missed by the casual reader. [1] A federal judge authorized the release of former WorldCom chief executive officer Bernard “Bernie” Ebbers from prison after more than 13 years due to deteriorating health. Mr. Ebbers had been serving a 25-year prison term for participating in what was at the time (the early 2000s) one of the largest accounting frauds in history.

This was a so-called “compassionate release” of an individual who had already been incarcerated for a lengthy period for actions that occurred over 20 years ago. There was a judicial perspective that Mr. Ebbers had already been punished enough. So why was this newsworthy? Why should anyone, especially corporate board members and their general counsel, care? Isn’t this ancient history?

From a governance perspective, not at all. Not by a longshot. In many ways, it is the most timely of reminders as to the scope of the board’s risk oversight responsibilities.

While occurring roughly within the same time frame as the better known Enron scandal, WorldCom is historically distinguishable as it relates to the positioning of legal counsel to an underlying accounting fraud. Multiple investigations failed to identify any indication that external or internal corporate counsel were aware of the fraud. This, the investigations concluded, was the result of purposeful efforts by Mr. Ebbers to prevent effective lawyer oversight of senior management.

These facts subsequently served as the catalyst for the adoption of governance principles requiring board oversight of the corporation’s legal affairs, and of a corporate culture that rewards efforts to reinforce legal compliance. These principles remain influential to this day, and are a critical consideration in the current Marchand/Clovis governance environment.

Snapshot of the WorldCom Scandal

WorldCom was a Mississippi based telecommunications company that collapsed in July, 2002 as a result of a steep and sudden decline in its profits and, more importantly, an accounting scandal which operated to hide costs and shift reserves, creating billions in illusory earnings. At the time, it was the largest bankruptcy filing in United States history, reportedly costing investors approximately $180 billion in losses and leading to substantial worker layoffs.

Formed by Mr. Ebbers and others in 1983 as LDDS Communications, the company grew by multiple acquisitions from a small local telephone company to become (as WorldCom) one of the nation’s leading providers of long-distance communications services and handlers of Internet data.

Mr. Ebbers was convicted in 2005 on securities fraud and other charges associated with his role in overseeing the fraud, and received a 25-year sentence. He had been imprisoned since September 2006. [2] In 2009, Time magazine named Mr. Ebbers the tenth most corrupt CEO of all time. [3]

Ebbers’ Marginalization of Counsel

An overarching perspective of the multiple investigations of this particular scandal was that Mr. Ebbers ”created a culture in which the legal function was less influential and less welcome than in a healthy corporate environment.” [4] One particular investigation concluded that the company’s legal department was not “structured to maximize its effectiveness as a control structure upon which the Board could depend.” [5] Furthermore, “at [CEO Bernard] Ebbers’ direction, the Company’s lawyers were in fragmented groups, several of which had General Counsels who did not report to [the company’s] General Counsel for portions of the relevant period; they were not located geographically near senior management or involved in its inner workings and they had inadequate support from senior management”. [6] Neither were members of the internal legal team considered part of Mr. Ebbers’ “inner circle,” and dealt with him only when he deemed it necessary. [7]

The investigative reports noted that the company’s legal department, like much of its operations, was an “agglomeration of carryovers from various mergers.” [8] None of the company’s senior lawyers were located in Jackson, Miss., where Mr. Ebbers was based. Among those senior lawyers there appeared lack of coordination with respect to specific responsibilities and as to supervision of subordinate counsel. There similarly existed a lack of consultation and information sharing on important legal and business matters between senior members of the internal legal team, which the investigative reports attributed in part to Mr. Ebbers’ strong views about controlling discussions within the company. There appeared to be a similar lack of coordination on which members of the legal team were allowed to attend board and committee meetings (and the extent and purposes to which their attendance was limited). [9] Broadly speaking, Mr. Ebbers demonstrated a lack of respect for the internal legal team.

None of the investigative reports concluded that lawyers were complicit in or knowledgeable with respect to the fraud that doomed the company. Yet all such reports documented structural problems and deficiencies within the company’s legal department that contributed to a corporate culture in which such fraud could occur, i.e. “a virtual complete breakdown of proper corporate governance principles. . . .” [10]

The Relevance of Ebbers’ Conduct

Mr. Ebbers’ conduct, in consciously marginalizing the company’s legal department, is highly relevant to today’s corporate boardrooms for at least three reasons.

First, it contributed to the development of important governance principles, advocated by a variety of estimable organizations, that confirm the critical role of the governing board in exercising oversight of the corporation’s legal function. Prominent among these principles are those developed by the New York City Bar Association and the American Bar Association. These principles are reflected in the governance policies of many leading American public, nonprofit and private companies.

Second, it provides a valuable lesson for today’s board members and senior executives, most of whom were not serving in fiduciary or executive positions twenty years ago. These officers and directors likely lack the historical recollection of the Ebbers controversy that more senior, and perhaps now retired, corporate leaders retain. For the unfamiliar, Mr. Ebbers’ conduct provides a clear example of the risks to a corporation that can arise in the absence of a strong legal function operating with the support of the board—and senior management.

Third, it is highly relevant to the recent Delaware decisions in Marchand and Clovis that speak to the importance of vigorous board oversight of principal corporate risk factors, including but not limited to the effectiveness of legal controls and legal compliance programs. [11] These cases signal a significant shift away from the prior, forgiving, standard of director conduct. In both cases, the court allowed a breach of duty action to proceed based on allegations that the board missed, or misinterpreted, significant “red flags” of compliance problems.

Recommended Action Steps

These new Delaware decisions are prompting greater director engagement in risk oversight and monitoring activity, renewed emphasis on management-to-board reporting and increased director sensitivity to recognizing possible “red flags.” They also underscore the prophylactic value of formal, documented board and committee level policies, procedures and other actions that demonstrate a good faith commitment to legal compliance efforts. As it relates to the corporation’s office of legal affairs, such policies and actions could include the following (among others): [12]

  1. Providing periodic board education on the nature of the general counsel’s role as counsel to both the board and management.
  2. Mandating a senior, influential hierarchical position for the general counsel (e.g., equivalent to that of the CFO).
  3. Incorporating in the general counsel’s job description the role of promoting compliance with the law and ethical standards.
  4. Asserting a clear expectation that the general counsel is to alert the board and executive leadership to potential major violations of law and reputational damage.
  5. Ensuring that the general counsel has the resources and authority necessary to perform its stated role.
  6. Publicly acknowledging within the organization the general counsel’s role as a valued business partner to management.
  7. Formalizing the board’s role in ratifying the hiring, compensation and termination of the general counsel.
  8. Instituting a reporting relationship of the general counsel to either the CEO or, in limited circumstances, the COO.
  9. Providing the general counsel with direct access to the board and executive leadership in order to provide timely information on legal concerns.
  10. Giving the general counsel access to, and collaboration with, other corporate executives with risk, audit and compliance portfolios.
  11. Extending a standing invitation for the general counsel to attend all meetings of the board and of its key committees.
  12. Providing for general counsel participation in periodic executive session meetings with independent directors.
  13. Establishing effective reporting relationships between general counsel and the in-house counsel assigned to corporate subsidiaries.
  14. Assuring participation by appropriately senior in-house counsel in in board, committee and management meetings relating to risk, legal or compliance matters.
  15. Identifying members of the internal legal team to whom employees may confidentially address concerns.
  16. Confirming that compensation of the general counsel is not determined in a way that might reasonably be considered to compromise the independence of its legal advice.
  17. Monitoring the effective structuring and administration of the office of legal affairs.
  18. Providing the general counsel with the ultimate authority to engage, and define the roles of, external counsel to be hired by the company.

Through these and other suggestions, the board can demonstrate its commitment to the recognized role of the general counsel and avoid the related governance failures that contributed so significantly to the bankruptcy of Mr. Ebbers’s company.

Summary

Bernie Ebbers’ early release from prison should be noted by corporate boards not simply as a generous and empathic exercise of judicial discretion. Of far more importance, it is a reminder of the lessons learned relating to the board’s role in assuring a corporate culture in which the internal legal function is respected, influential and welcomed. In the post Marchand/Clovis fiduciary environment, this is a most opportune reminder.

To be sure, the Ebbers controversy may have occurred a number of years ago, but its oversight lessons remain relevant to this day. As recent headlines suggest, it is still very possible for executives with dominant, demanding personalities to ”push the envelope too far,” fostering corporate cultures that exalt goals such as revenue growth and personal compensation to the exclusion of fulsome participation by lawyers in the oversight of corporate and board affairs. Some things just don’t change; these types of people still exist in executive suites. But a major difference between “then” and ”now” is that Delaware may be less forgiving in 2020 of lax board oversight of legal affairs than it was twenty years earlier. Responding to the Ebbers lessons is an easy, and straightforward way for the board to help satisfy its risk oversight obligations.

Endnotes

1Sarah Krouse, “Ex-WorldCom CEO Bernie Ebbers Granted Early Release from Prison”; The Wall Street Journal, December 19, 2019.(go back)

2Simon Romeri and Riva D. Atlas, “WorldCom’s Collapse: The Overview; WorldCom Files for Bankruptcy; Largest U.S. Case”; The New York Times, July 22, 2002. See also, New York City Bar Association, “Report of the Task Force on the Lawyer’s Role in Corporate Governance”, November, 2006 (nycbar.org) (“NYCBar Report”) at D-3 to D-4.(go back)

3“Top Crooked CEOs”; Time Magazine, June 9, 2009.(go back)

4These include: (i) Special Investigative Committee of the Board of Directors of Worldcom, Inc., Report of the Investigation (Mar. 31, 2003) (Special Investigative Committee Report”); Dick Thornburgh, Bankruptcy Examiner of Worldcom, Inc.:First Interim Report (Nov. 4, 2002); Second Interim Report (June 9, 2003); Third and Final Report (Jan. 26, 2004) (collectively, “Bankruptcy Examiner Reports”) ; and (iii) Richard C. Breeden, Corporate Monitor, Restoring Trust, Report to the Hon. Jed S. Rakoff On Corporate GovernancecFor the Future of MCI, Inc., (August 2003) (“Breeden Report”).(go back)

5NYCBar Report at 100 and D-5, citing to Special Committee report at 31.(go back)

6Id.(go back)

7Id. at 100, citing to Special Committee report at 277.(go back)

8Special Committee Report, at 276-277.(go back)

9Id.(go back)

10Second Bankruptcy Examiner Report, at 3.(go back)

11Marchand v. Barnhill, 212 A.3d 805 (Del. 2019)., 212 A.3d 805 (Del. 2019; In re Clovis Oncology, Inc. Derivative Litig., C.A. No. 2017-0222-JRS (Del. Ch. Oct. 1, 2019).(go back)

12Based in part on recommendations contained in (i) “ABA Task Force on Corporate Responsibility, Report”, 59 Bus. Lawyer 145 (2003); (ii) the NYCBar Report; and (iii) more generally upon the many published articles of Ben Heineman, Jr. on the role of the corporate general counsel.(go back)

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