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Last week, the SEC announced settled charges against James R. Craigie, a former CEO, Chair and board member of Church & Dwight Co. Inc., an NYSE-listed  “manufacturer of consumer-packaged goods,” for “violating proxy disclosure rules by standing for election as an independent director” without advising the board that maybe he really wasn’t quite so independent after all. This omission, the SEC alleged, caused the company’s proxy statements “to contain materially misleading statements.” Maybe you guessed that we’re not talking here about any of the NYSE-enumerated relationships that vitiate independence?  No, we’re talking about something closer to the concept of “social independence”—something more amorphous than conventional, stock-exchange-defined independence—that some suggest can be even more compromising at times than the conventional variety.  Craigie was alleged to have a “close personal friendship with a high-ranking Church & Dwight executive,” including paying more than $100,000 for the executive and his spouse to join Craigie and his spouse on “six trips that spanned eight countries on five continents.”  Because Craigie never disclosed the relationship to the board and encouraged the executive to do the same, the SEC charged, the board was not aware of the relationship and the company’s proxy statements characterized Craigie incorrectly as an independent director.  According to the Associate Director of the SEC’s Division of Enforcement, “[s]hareholders expect independent directors to exercise autonomous judgment in their decision making, free from undisclosed conflicts….By concealing his relationship with a company executive, Mr. Craigie undermined the board’s director independence process and compromised the company’s disclosures.” Craigie agreed to a five-year officer-and-director bar and to pay a civil penalty of $175,000.  The case raises the thorny question of where to draw the line on personal relationships. Is an occasional dinner acceptable? If so, what about a weekend trip? A vacation trip? How many trips is too many? Just how thick do the personal connections have to be to taint independence? Caution seems to be the prescription here. 

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What is  “social independence”?  One concept of “social independence” was described in the academic paper, “Seven Myths of Boards of Directors.”  In that paper,  the authors questioned whether NYSE standards of independence (or presumably, Nasdaq’s for that matter) reliably measure effective independence. In support of that contention, they cited a study distinguishing NYSE “conventional” independence from “social independence,” which is based on “education, experiences, and upbringing—positing that people who share social connections feel psychological affinity that might bias them to overly trust or rely on one another without sufficient objectivity.”  In that study, which sampled directors of Fortune 100 companies between the years 1996 and 2005, the study authors found that “social dependence is correlated with higher executive compensation, lower probability of CEO turnover following poor operating performance, and higher likelihood that the CEO manipulates earnings to increase his or her bonus. They concluded that social relations compromise the ability of the board to maintain an arm’s-length negotiation with management, even if they are independent by NYSE standards.” (Of course, the NYSE definition recognizes the limitations of its definition and advises that, in determining independence, all relevant facts and circumstances be considered.) (See this PubCo post.)  See also this paper, Seven Gaping Holes in Our Knowledge of Corporate Governance, in which the authors contended that research has shown that factors such as “social connections between the board and insiders can impair the ‘independent’ judgment of directors.”  (See this PubCo post.)

Background. In the complaint against Craigie, the SEC charged that Craigie failed to disclose information to the company’s board that would enable the board to make a determination as to whether Craigie could be considered an “independent” director in 2021 and 2022.  From 2004 to 2015, he served as the company’s CEO, from 2007 to 2019, as board chair, and as a non-independent director from 2004 to 2019. As alleged, in January 2019 and 2020, the board affirmatively determined that he was an independent director based on information provided by Craigie that he did not have a material relationship with Church & Dwight. Based on statements in the company’s proxy statements, Craigie was elected by the shareholders as an independent director effective at the 2020 annual shareholder meeting.

According to the complaint, Craigie had a “practice of mentoring employees with growth potential.” Around 2017, he began to mentor the Executive, who was the head of a Division, ultimately forming a “personal friendship.”  Craigie also appears to have had a practice of inviting other couples on international vacations with him and his spouse, generally paying “for all guests’ business class airfare and luxury lodging.” Craigie and his spouse vacationed internationally with the Executive and his spouse six times, paying their expenses, which aggregated over $100,000.  There were also domestic vacations, including long weekends, stays at Craigie’s Miami apartment and boat trips in New York, Connecticut and Miami. The SEC alleges that “Craigie did not take similar trips with or pay for travel for any other Church & Dwight personnel.”  As alleged, Craigie “withheld, and instructed Executive to withhold, the nature of their relationship from Church & Dwight,” taking proactive steps to prevent discovery by the company of their relationship.

Consistent with NYSE standards, the company’s corporate governance guidelines required that, in assessing director independence, the board must affirmatively determine that the director has no material relationship with the company, “broadly consider[ing] all relevant facts and circumstances as well as any other facts and considerations specified by the NYSE and specified by the rules and regulations of SEC.”  The company’s D&O questionnaires, which “instructed recipients to ‘exercise great care,’” provided as a non-exhaustive list of examples of “material relationships,” commercial, industrial, banking, consulting, charitable and familial relationships, but did not list friendships.  As alleged, the questionnaire also asked “if directors had ‘any other relationship’ with Church & Dwight or its management. In 2021, 2022, and 2023, Craigie answered ‘no.’” The board found that Craigie was independent in 2020 and 2021, and included that information in the proxy statement, which Craigie, given an opportunity to review, did not correct. The company subsequently discovered Craigie’s relationship with the Executive and did not identify him as independent in the 2023 proxy statement.

The complaint alleged that, as an “experienced public company executive and board member,” Craigie ‘knew, or should have known, the criteria that public company boards use to assess a director’s independence, as well as the factors that are important to that analysis. This included personal relationships with company executives.” He also, the SEC charged, “understood the importance of the D&O Questionnaire for determining director independence,” and that the information would be included in the proxy statement.  As a director of other public companies, Craigie completed other questionnaires that were subject to the same exchange standards, some of which included questions that “further clarified what facts and circumstances Craigie should have considered when responding to the Church & Dwight questionnaire.”

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Similar issues have come up in connection with auditor independence as well, as discussed in this order from 2016.  Under Rule 2-01(c), an accountant is not “independent” with respect to an audit client “if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant’s engagement. In determining whether an accountant is independent, the Commission will consider all relevant circumstances, including all relationships between the accountant and the audit client and not just those relating to reports filed with the Commission.”  The Order alleged that the CFO of an audit client had previously expressed dissatisfaction with certain aspects of the audit firm’s performance and had threatened to change  firms. As a result, the audit partner (who is a subject of the order) was enlisted by the firm to serve as the coordinating partner on a replacement audit team for a “troubled account,” i.e., to mend the account relationship. The allegations in the order suggest that the coordinating partner may have taken his remedial “responsibilities” a bit too far: the SEC alleges that the coordinating partner repeatedly violated firm policies “by developing and maintaining a close personal relationship with the CFO and members of the CFO’s family that was inappropriate for an independent auditor. [He] spent extensive leisure time, including frequent overnight, out-of-town trips, with the CFO and his family. In all, [he] and the CFO took at least seven out-of-town trips together during the relevant period, all of which were social in nature and did not have a valid business purpose” as defined in firm policies. “In addition to these trips, [he] and the CFO attended sporting events and socialized near the Issuer’s headquarters in the greater New York City area to an excessive degree. [He] also gifted tickets to sporting events and other things of value to the CFO.” He also had a “close personal friendship” with the CFO, who shared with the coordinating partner “personal information, including sensitive health information and other information not typically shared with a solely professional colleague….”  According to the order, the coordinating partner incurred approximately $109,000 in entertainment-related expenses in connection with the audits of three fiscal years of the issuer. Again, the SEC concluded that a “reasonable investor with knowledge of all relevant facts and circumstances” regarding the relationship between the issuer’s CFO and the coordinating partner would conclude that the partner “was not capable of exercising objective and impartial judgment with respect to the audits of the Issuer.” (See this PubCo post.)

According to the complaint, in 2022, the company’s CEO advised that he was considering retirement, and the board established a CEO succession committee.  Craigie had previously advised the Executive that, with time, he had CEO potential.  In board meetings, however, “Craigie, among other Board members, voiced concern about the internal candidates, including Executive.”   An outside search firm engaged by the board asked directors for candidate suggestions, and “Craigie and Executive reached out to Executive’s close friend and former supervisor… to solicit the Friend’s interest in becoming a CEO candidate.” Craigie indicated to the Executive that if the company hired his friend, the SEC alleged, the Executive could have an opportunity to eventually succeed the friend as CEO.  Craigie forwarded the friend’s resume without disclosing these relationships, and he became a “strong candidate.”

As alleged, in 2023, the company learned of Craigie’s friendship with the Executive, leading the board to form a Special Committee to assess Craigie’s conduct. The CEO “postponed his retirement indefinitely and Church & Dwight halted the CEO succession process to allow the Board to reconsider how to structure the process in a way to eliminate bias.” According to the complaint, the “Special Committee found that Craigie failed to disclose his close personal friendship with Executive and disclosed confidential information about the CEO search, which he may have done to influence the CEO search to Executive’s long-term advantage. As a result of this conduct, the Board determined that Craigie violated his obligations of confidentiality and candor under Church & Dwight’s Code of Conduct.  The Board determined that Craigie was no longer considered an independent director. Church & Dwight made this disclosure in its 2023 proxy statement.” 

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Charges related to misstatements regarding director independence are not new for the SEC. In this 2022 SEC order, involving settled charges against Leaf Group Ltd., the SEC charged that Leaf did not adequately identify and analyze—and did not maintain effective disclosure controls and procedures to identify and analyze— whether some of its directors were “independent” and whether there were “interlocking relationships between its directors and executive officers,” all of which led to “material misstatements and omissions in certain of its public filings,” including its proxy statement. In this case, a new independent director of Leaf, appointed to chair its “independent” strategic alternatives committee, became CFO of a separate public company.  As it turned out, Leaf’s CEO was on that company’s board and comp committee, thus creating a comp committee interlock. As a result, the new “independent” director was no longer independent under NYSE listing standards. In Leaf’s proxy statement for its 2020 annual meeting, the new director was among directors nominated to the board and up for a vote. The 2020 proxy statement described all of Leaf’s directors, other than the CEO, as “independent” and “independent under NYSE listing standards” and described all of Leaf’s standing board committees, including the strategic alternatives committee, as “independent under all applicable NYSE listing standards.” Finally, and not surprisingly, under the caption “Compensation Committee Interlocks and Insider Participation,” the 2020 proxy statement stated that there were no interlocking relationships at any time during fiscal 2019.  The order characterized all of these statements as “material misstatements.”  As part of the settlement, Leaf was required to pay a civil penalty of $325,000.  (See this PubCo post.)

Violations.  The SEC charged that, because of Craigie’s “concealment,” the company’s proxy statements in 2021 and 2022 contained misstatements of material fact.  Reg S-K Item 407 requires the company to identify all independent directors, and the proxy statements incorrectly identified Craigie as an independent director. According to the SEC, information about director independence is material to shareholders “because shareholders expect independent directors to exercise autonomous judgment in their decision making that is free from any conflicts of interest.“  The SEC charged that Craigie violated Exchange Act Section 14(a) and related Rule 14a-9: he was “directly liable for these misstatements because he failed to disclose his relationship to Executive in the D&O Questionnaires, which resulted in the material misstatements in the 2021 and 2022 proxy statements regarding independence. Craigie then permitted his name to be used in the proxy statements in connection with Church & Dwight’s annual proxy solicitations.”  The SEC also alleged that Craigie benefitted from the misleading proxy statement disclosure because, as an independent director, he could “participate substantively in the CEO succession process, without disclosing his relationship with Executive even though Executive was a CEO candidate.” As noted above, Craigie agreed to a five-year officer-and-director bar and to pay a civil penalty of $175,000. 

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The Delaware courts consider independence of directors in a number of contexts, such as whether a special committee was independent for purposes of the application of the “MFW framework” for conflicted transactions or assessing demand futility for purposes of derivative litigation.  While, historically, Delaware may have focused more intently on pecuniary factors, in the last decades, social and other non-conventional factors have increasingly had occasion to take center stage. In examining independence, Delaware courts have asked broadly whether a director, for any substantial reason, “is incapable of making a decision with only the best interests of the corporation in mind.” As expressed by then-Vice Chancellor Leo Strine in 2003, “Delaware law should not be based on a reductionist view of human nature that simplifies human motivations on the lines of the least sophisticated notions of the law and economics movement. Homo sapiens is not merely homo economicus.”   In the 2024 decision of In re Match Group, Inc. Derivative Litigation, the Delaware Supreme Court looked at whether a conflicted merger had the approval of an independent Special Separation Committee under the MFW framework. Assessing the independence of one of the directors, the Court agreed that, based on the allegations, the director was not independent:  it was alleged that he worked at the corporation that was a controlling stockholder for 13 years, including seven as CFO, earning over $55 million during his employment. He also served as a director of various controlling stockholder-affiliated companies for a number of years and had expressed gratitude to the controlling stockholder’s Chair for his opportunities. The Court reasoned that “[l]ongstanding business affiliations, particularly those based on mutual respect, are of the sort that can undermine a director’s independence. Directors who owe their success to another will conceivably feel as though they owe a ‘debt of gratitude’ to the individual.” The Court concluded that a reasonable inference could be drawn “that he was not independent” of the controlling stockholder. (See this PubCo post.)

Similarly, in Marchand v. Barnhill, then-Chief Justice Strine, evaluating a claim of demand futility in derivative Caremark litigation, expressed reasonable doubt that one of the directors was independent due to his “longstanding business affiliation and personal relationship” with the CEO’s family: it was alleged that he “owe[d] his career” to the CEO’s father and that the CEO’s family “showed its appreciation” for him, “not only by supporting his career, but also by leading a campaign that raised over $450,000 to name a building at the local university” after him. The court concluded that these allegations were “‘suggestive of the type of very close personal [or professional] relationship that, like family ties, one would expect to heavily influence a human’s ability to exercise impartial judgment.’  [His] apparently deep business and personal ties to the [CEO’s] family raise a reasonable doubt as to whether [he] could ‘impartially or objectively assess whether to bring a lawsuit against the sued party.’” According to the court, “[w]hen it comes to life’s more intimate relationships concerning friendship and family, our law cannot ‘ignore the social nature of humans’ or that they are motivated by things other than money, such as ‘love, friendship, and collegiality.’” (See this PubCo post, discussing the Caremark claim.)

It goes without saying that the fact-based analyses by the courts under these non-conventional standards are often subjective and nuanced and, of course, some courts have rejected allegations that personal relationships have compromised independence. For example, in In re Kraft Heinz, the Chancery Court, applying a new three-part test for demand futility, determined that the analysis “hinged entirely on whether the directors had disabling connections” to a stockholder defendant.  The court rejected arguments that the independence of the various directors was tainted: as alleged, none of the relationships—including a “close-co-investing relationship,” the investment by a private foundation of over 12% of its portfolio in one of the stockholder’s funds at some point, a charitable contribution to a non-profit chaired by one of the directors, or a close relationship with the head of a large stockholder who had walked her “down the aisle at her wedding”—sufficed to taint these directors’ independence.

Posted by Cydney Posner

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