Model Questionnaire for Public Company Managers to Complete When a Director is Nominated

Joseph W. Bartlett, Special Counsel, McCarter & English, LLP


On a fateful day in 1935, two Army pilots were at the controls of a Boeing Model 299 as the final phase of aircraft evaluations under U.S. Army specifications were about to begin. The aircraft made a normal taxi and takeoff and began a smooth climb but then suddenly stalled. The aircraft turned on one wing and fell, bursting into flames upon impact, according to Federal Aviation Administration instructor, John Schamel. The investigation found "Pilot Error" as the cause. One of the pilots, unfamiliar with the aircraft, had neglected to release the elevator lock prior to takeoff. After this avoidable accident, it was decided that what was needed was some way of making sure that everything was done and nothing overlooked prior to takeoff. What resulted was the invention of a pilot's checklist.

One cannot underestimate the importance of preparation. In this week's Buzz article, Joseph W. Bartlett, Founder of VC, provides a very important "Model Questionnaire for Public Company Managers to Complete When a Director is Nominated." Completing this questionnaire might not only serve as a valuable checklist for new directors but also provide them with a lifesaving parachute in the event of a crisis.

Full title: Model Questionnaire for Public Company Managers to Complete When a Director is Nominated by the Fund Shareholders to the Board of a Public Company.

Venturecapital, buyout and hedge funds are, increasingly, nominating candidates to the boards of public companies in which the fund holds or is acquiring a significant interest. There are a number of issues for the individual so nominated as he or she steps into the firing range which characterizes today's public sector. The following is a model list of requests to serve on the company's management, counsel and accountants. No list will cover every contingency and not every question will be answered; that said, the case law, federal and state, teaches us that an attempt like this can go a long way towards convincing a judge that the individual did the best he or she could.

The following represents a check list of issues and action items connected with the invitation to you to join the board of [XYX Company] a public company listed on NASDAQ, symbol [XYZ]. The following list is indicative rather than complete; but it covers, in my experience, the high points which can be addressed and/or following your joining the Board. The fact that you are a member does not mean the questions are moot. If the answers are unsatisfactory or incomplete, you can make your continued presence contingent on the appropriate fixes.

The Company is located in [city, state] and incorporated under [state] law. The Company's counsel is [ABC firm] located in [city]; there is no inside counsel. The auditors are [Auditors Inc.]. I am told there have been no shareholder lawsuits but there was a recent proxy contest (in which XYZ may or may not been involved) which resulted or involved litigation.

The following is a list of issues/action items.

1. Review D&O policy. I suggest this review be expeditiously accomplished . by us asking questions of either Company counsel and/or Company's insurance consultant. The type of issues we will raise are included in the material from The Encyclopedia of Private Equity and Venture Capital on VC See Section 2.3.1.t for issues we will raise. To summarize, the review should include the following:

Does the policy:

(i) Provide for separate director-only policies so that all insureds do not share the policy limits;

(ii) Ensure that the "insured vs. insured" exclusion carves out suits brought by an independent bankruptcy trustee ("insured vs. insured" exclusions provides that a claim brought by one insured against another will not be covered);

(iii) Ensure that the policy does not provide for the actions of one insured to be imputed onto any other insured under the policy; and

(iv) Ensure that the policy includes "final adjudication" language providing that before coverage can be denied under any exclusion for public policy reasons or criminal or fraudulent acts, there must be a final adjudication adverse to the director that such bad conduct indeed occurred.

2. Review the umbrella policy maintained by XYZ, if any, protecting individuals nominated by XYZ to serve on boards in which XYZ owns an equity interest.

3. Review the Company charter and/or bylaws for indemnification provisions. See Section 2.3.1.n from VC Experts. Review as well for the [local state] equivalent (if any) of Delaware General Corporation Law õ 102(b)(7). See VC Experts Section 2.3.1.u.

4. Prepare and cause to be executed a contract of indemnification between the company and you. See from VC Experts Section 2.3.1.p for a model form.

5. Meet, if only telephonically (at first), with [Auditors Inc.] and ask to review, e.g., the following:

(i) comments by the auditors on the company's compliance with GAAP and Sarbanes-Oxley (SOX), including the last three so-called management letters;

(ii) review submissions by the auditors to the audit committee which are, in the opinion of the auditors, outside the ordinary course of business for, say, the last three years, including the following:

(iii) [Auditor's] evaluation of the company's internal controls and disclosure systems . any weaknesses?,

(iv) Request the auditors to produce any and all so-called "whistle blower" complaints of which the auditors have knowledge. This request should be extended as well to the CEO, the CFO and Company counsel.

6. Meet with, if only telephonically, Company outside counsel and ask for commentary on the following issues:

(i) The Company's corporate governance principles or guidelines, and committee charters,

(ii) disclosure of any litigation . underway, pending or threatened and outside the ordinary course . including cases decided or settled within the past three years;

(iii) disclosure and discussion of, see above, any complaints of the whistle blower type, including complaints under any section of SOX:

(iv) discussion of (a) the code of conduct/ethics for CEO, CFO, and for all employees; and/or (b) information on general compliance programs and ongoing employee education related to compliance.

(v) the composition of the board and its committees as compliant with SOX, e.g., majority of "independent" or outside directors:

(vi) disclosure and discussion of any independent investigations conducted by outside counsel and/or consultants at the direction of the board of directors or a committee thereof into the internal affairs of the Company;

(vii) disclosure of any criminal violations, within the past 5 years, involving employees or independent contractors acting on behalf of the Company;

(viii) disclosure of any complaints or proceedings initiated by a governmental agency, state or federal, involving the Company and/or its employees or agents, including but not limited to issues arising under the Foreign Corrupt Practices Act, federal or state securities laws and/or the Patriot Act;

(ix) disclosure of any issues involving the proper dating of stock option grants approved by management and/or the compensation committee;

(x) disclosure of any actions pending or threatened affecting the Company's intellectual property assets, including but not limited to patent infringement claims . either as plaintiff or defendant; and

(xi) Disclosure of any special arrangements with any executives . e.g. Golden Parachutes and other severance benefits; discussion of compliance with new SEC rules on compensation disclosure.

7. Provide access to us of the most recent (if any) digital data room prepared by or on behalf of the Company in connection with a financing or other transaction or event occasioning the discharge of due diligence responsibilities by independent third parties.

8. Review of material in the press mentioning the Company, as reported on Nexis/Lexis, for the past, say, five years, to be conducted by us.

9. Review, by you, with a notation to us that you have reviewed the same, and coincidentally a review by us, of the Company's public disclosures on forms 10K, 10Q, 8K for the past 2 years.

10.Review of analysts' reports on the Company for the past [three] years, such reports to be requested from the Company.

This looks like a long list but, as indicated, much of the material should be readily available from existing files and can be summarized for your (our) benefit.

The point of all this is to show that you have used reasonable best efforts to uncover any so-called "red flags" (see the analysis from VC Experts, Section 2.3.1.v), which would alert you to a problem you should deal with at the outset of your acceptance of a seat on the board, and/or as you continue in that capacity. You need not be perfect in this regard; but, a good faith effort is required if a director is to be immunized from subsequent exposure.

Once you join the board, you understand that your responsibilities are to the shareholders as a body, not to (and only to) XYZ. The Section 10.15.3 from VC Experts makes suggestions in that regard which I, for obvious reasons, recommend.

Finally, we, along with [local counsel], should provide guidance for your benefit on:

(i) the law on the impact of XYZ's ownership of the Company's stock, in view of your position as a Company insider, under Sections 13 and 16 of the Securities Exchange Act of 1934;

(ii) the Company's policy (assuming it has one) on trading (by you and/or XYZ) in the Company's securities in light of the civil and criminal penalties respecting trading on the basis of material non-public information;

(iii) Company policy covering selective disclosure (however inadvertent . within XYZ, for example) of non-public information (see Regulation FD); and

(iv) any relevant State statutes.

Joseph W. Bartlett, Special Counsel,

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