a16z Podcast - a16z Podcast: 'The Most Boring Yet Valuable' 20 Minutes, All About Board Minutes

Episode Date: November 3, 2015

"The most boring yet valuable podcast in a16z history" -- he (our guest Joe Grundfest) said it, not we! That’s because in this episode of the a16z Podcast, Stanford law professor and former SEC commissioner Grundfest -- and securities litigation lawyer Nicki Locker of Wilson Sonsini Goodrich & Rosati -- discuss not just the importance, but the almost literary balance ("somewhere between haiku and Tolstoy") behind doing board meeting minutes just right. Yes, that's right: this is a podcast all about board minutes. But it is arguably the most "valuable litigation insurance you can buy for free” ... especially if you learn to create a record that can survive an attack by a conspiracy theorist.

Hi, everyone. Welcome to the A6NC Podcast. I'm Sonal and today I'm here with Joe Grenfess and Nikki Locker. Joe is a professor at Stanford Law School as well as a former commissioner of the SEC or Securities and Exchange Commission. And Nikki is a senior partner in securities litigation and government and internal investigations at Wilson's Suncini. The reason we're having you on the A6NC podcast today is that I heard you guys speak at our Stanford board directors college program about board governance and in particular minutes, which, and you guys, I was like, these guys need their own show. And we have a show, and which is why we're excited to have you here. Well, thanks, Sennell. And let me just sort of try to frame what we're going to talk about today. I think when you look at the history of all Andreessen Horowitz podcasts, this one will be remembered

as being epic. And it's epic, minimally epic, because I think the topic that we're addressing today is going to be the most boring yet valuable topic in the history of all end race and hardware that's an amazing record to aim for and we're striving for this boredom value ratio and let me explain you know if you take the typical bcg two by two matrix imagine setting up the matrix on the horizontal axis you have boredom and at the left you have low boredom items and at the right you've got the high boredom items and on the vertical axis, I want you to imagine the value of a subject to you. So at the bottom, what you have is low value items, and at the top, you have high value items. So what quadrant are we going to be in?

We're going to be high into the right. We are in the quadrant of boring, but valuable. And if you pay attention to what we're going to be talking about today, you may actually get some of the most valuable litigation insurance you can buy for essentially free. This is as close to free legal insurance as you're going to get. So why do you say free litigation insurance? Because that's not what I think of when I think of people taking minutes in a board meeting. Minutes are the formal records of the discussions at a board or a committee of a corporation. And the reason why they're the cheapest form of litigation insurance is because they are heavily relied upon in litigation and

particularly heavily relied upon in litigation involving whether or not a board complied with its fiduciary duties. And if a board member, for example, wants to testify that they acted with great due care and there was quite extensive deliberations and the minutes are either inconsistent with that or don't reflect that, I think the court would look at that testimony quite skeptically. It makes you think that you should actually probably not write anything down then because... Oh, no, no, no, no, no, no. Oh, gosh, no.

No, it's exactly the opposite. The rule of thumb, once you get into court, is if it's not in the minutes, you're going to have to work really hard to demonstrate that it actually happened. So, for example, suppose you're considering a financing transaction at a privately held company at a venture back company, and it's the kind of transaction that could have adverse consequences for the common holders. Well, you're going to want to establish that the board paid careful attention to the consequences to the common and that it reached its decision after due deliberation and giving very full concern to these consequences, and the board was aware of the consequences. Now, if there's nothing in the corporate minutes about that kind of deliberation,

you're going to have a harder time. It's not impossible, but you're going to have a harder time persuading the court that you actually did it. The simple solution, and this is why this is cheap litigation insurance, is if that the law requires that a board considers something, it's a good idea that the minutes show that the board considered it. You mentioned privately held corporations. So you're saying this is different and this only applies to startups and boards for

startups? Oh, no. This applies, the need for properly prepared minutes applies equally to privately held corporations and public companies. And that's not necessarily intuitive. And most people would actually ask and think that properly prepared minutes are only needed at a public company. That's exactly what I thought. And the answer is no. And here's why.

Here's why people think what you just asked, and here's why it's not the correct answer. In a public company, those sitting around the board room table are much more attenuated to those who actually hold our owners of the company and the people to whom they're accountable. And you must have, that's exactly right. You must have an excellent record, therefore, that they comply with their fiduciary duties to the owners of the corporation. in a privately held company, particularly a VC-backed company, the owners, or at least the representative of the owners, are usually sitting around the table, and therefore everyone who actually matters is usually has a seat at the table. And so you would think, okay, you don't really need minutes. Right, because you're not worrying about their interest. They're represented at the table. That's exactly right. But there's many situations where there are conflicts, potential issues of lack of independence, because the, Those people sitting at the table are the VC-backed corporation.

They prefer shareholders, yes, they owe fiduciary duties to the common shareholders, and that takes priority and precedence over everything as a director. And therefore, they must have a record that they acted in conformity with their fiduciary duty to the common shareholders. And it's even, I mean, it's just critically important. That said... The best interests of the company, basically. That's right. And writing minutes is an art, not a science, and the question of the balance between too much detail, who asked what question, what were the answers to each question, which is too much detail, has to be balanced against too little detail.

A topic came up, discussion ensued, questions were asked and answered, period. So what is that? How do you write that balance? Nikki's right. It's almost a literary form, and you need to contemplate. how the minutes are going to look if there's an issue that comes up three years from now and there's a dispute and a controversy. So you need to think about the level of detail you want to present given the nature of the issue that you're addressing. So how do you strike that balance then, Joe, between? The answer usually

lies somewhere between Haiku and Tolstoy. Okay. All right? It's going to be somewhere in that range. And if there's an issue where you know that it's litigation prone. and we're dealing with something that could be toxic, you want to have enough detail in the midst to make sure that when a hostile third party goes back and reads the record, that hostile third party will say, you know, it looks like they covered all their bases, and I'm going to have a hard time arguing that this board

breached its fiduciary responsibility. And that hostile third party could come like three years later. It doesn't have to be anyone in the sphere of anyone's awareness at the current moment. Absolutely. And the important thing is when you're a lawyer doing the minutes, what you want to do is read your work product from the perspective of somebody who wants to attack it. So you want to build something that is appropriately bulletproof, but you don't want to go to the level of doing what they call in reportage TikTok. What are some quick examples of those types of situations or topics that you can know in advance could lead to those kinds of heated. discussions or issues in the future. And let me also say there are some times where you have just ordinary course of business topics

where relatively brief, not detailed minutes are absolutely appropriate. There's no question. But then there are certain topics. The screamer in Silicon Valley is anything that involves a conflict. A conflict of interest. Anything that involves, no, there's a conflict among any of the constituencies. that are involved.

So, for example, if a certain financing transaction can raise a conflict between the preferred and the common, or if there's a certain complexity and you want to demonstrate that you appropriately address your duty of care, or if you've got a director who might be sitting on two boards where there's a potential argument that one company is competing with another company, anything that smells like it might be a conflict either today or evolve. into a conflict in the future really requires attention. That's the big red flag. Let me give some examples of what the principles that Joe just laid out,

which is if imagine a situation where you're doing a down round, and it's led by the existing investors, where the common shareholders, as opposed to the preferred shareholders who will actually be participating in that round, the common shareholders are going to be diluted. or imagine a situation where you're looking at a potential acquisition. But the acquisition price is such where the preferred shareholders will probably get some significant percentage of a return of their investment,

but there really won't be anything left over for the common shareholders. Even if it might be a decision that could be the best interest of the company, you just have to show that it has that. Well, and you might need to do more than just show there was a discussion. You may actually have to try to set up a committee. of independent directors. I mean, another example is you have a startup that's struggling. Do you give up and basically distribute whatever is left over,

although there's not going to be enough for the common shareholders, or do you spend every last penny trying to make a go of it? But there are also situations that you might not think would lead to potential conflicts or potential independence issues. And that's why actually sometimes having a lawyer, just sitting and listening or at least being consulted with is so important. So imagine a scenario where one of your board members is the CEO of a second company, Company B.

Well, that's actually pretty common with a lot of serial entrepreneurs. They always want to have like two companies at one. But if your company and Company B are backed by the same venture fund, the question is whether or not the CEO of Company B is behold. to that VC fund when he's considering activities in connection with your company. And that's a potential, and that's been a scenario that the Delaware courts have actually addressed where there is indeed an independence issue. So it's kind of like a minefield.

Yeah. You, in effect, have to look at yourself through the eyes of conspiracy theorist. Right. You can be sitting on a board of directors and you can be entirely comfortable that the decision that you're making is a reasonable business decision, but you have to understand that plaintiff's lawyer looking at what you do is going to try to blow a torpedo through every assumption that you make. So you have to look at your own behavior with a very, very critical eye and you can't afford to give yourself the benefit of any doubt. So what are situations that

are not minefields? I mean, is everything a minefield basically? Pretty much, yeah. Wow. No, I'm kidding. So for example, you know, there are business decisions that could be made that wouldn't be viewed as a conflict because the decision is going to be in everybody's best interest. Do we invest in Project A or in Project B, all right? That's typically a low index of concern when you talk about conflict. Do you want to do a marketing campaign A or a marketing campaign B? It's not going to impact the preferred shareholders differently than the common shareholders. We have three candidates for chief operating officer.

Which one do we hire? So there are lots of issues that come up. and that can implicate board decisions that are entirely non-problematic from a conflict. To me, all those examples you just shared, to me, those are more minefields in some ways because you're looking at it through the lens of preferred versus common. I mean, there are other legal issues a board can face as well. Yes, but if you don't have a conflict broadly defined, you're likely to get the protection of what we lawyers call the business judgment rule.

So if there's no conflict, the odds are that courts will say, wait a minute, you can exercise your business judgment and we understand that business is a risky thing and people are allowed to make mistakes. And as long as we have no reason to believe that you're behaving in a disloyal manner or you have an incentive to be disloyal, primarily because of a conflict, we're going to give you a lot of deference. There are, however, certain situations where there may not be a conflict where it is still extremely important, and let me give you one example, that the minutes reflect do care. So, and this is a public company example, it was a secondary offering of a company where in connection with the issuance of what's called a registration statement, you as a board member need to be able to establish your due diligence, which means the record, and therefore, for hopefully the official records, that is the minutes, need to reflect that you carefully read the registration statement, which is the offering document. You asked questions. You received answers that there was a discussion at the board level.

And if that's not reflected in the minutes or not reflected at least, then you have to end going to e-mails, which is not ideal. You're not, it's going to be very difficult. You have to work 10 times harder, basically. Correct. To establish what's called your job. due diligence defense, which basically allows you to escape liability for any false or misleading statements in the registration statement. Do you guys have any examples of any of these

minutes, Nikki? Yes, I do actually. So let me read and talk about what's wrong with these minutes. Quote, after discussion, the board unanimously voted in favor of authorizing the company to issue one million shares of the company's Class A common stock, subject to the appropriate organization of, and this is a subsidiary, and I'm not going to name the subsidiary, as an unaffiliated legal entity, and approving the secondary, including among other things, authorizing the company to file a registration statement on Form S1 and take such other steps as appropriate or necessary in connection with the secondary offering. That is the record of the board's deliberations of the registration

statement and its accuracy. That is not a good record. It was actually a conversation about the secondary, and then the board authorized management to file the registration statement. So it actually undercuts, not just as inconsistent with, but undercuts a due diligence defense because it basically says it authorizes the management to file the registration statement without the board reviewing it. It could actually be read that way.

So what you ideally want is a record that establishes that all of the directors who are signing the registration statement have actually read the registration statement. It's hard as a matter of law to prove that a director exercised due diligence, meaning that they behaved appropriately the way an investor would when investing their own money with regard to the accuracy of an SEC filing if you can't demonstrate that the director even read the SEC filing. So you're saying that you would have had that align to the effect of Sonal, Joe, and Nikki, where the three people on this fake board read the statement, reviewed it, and agreed to this action? You would want more, and that we had the opportunity to ask questions? Wow, even more detail, okay? All right. Or, for example, if Joe is the business expert, it might actually say, you know, Mr. Grunfest asked several questions regarding the description of the industry and the products.

Let's assume I was the audit committee expert. on, you know, on the board, it might say, it wouldn't say the exact questions, but it would say, you know, Ms. Locker asked the CFO certain questions about the income statements or certain questions about the balance sheet. So to demonstrate the analysis taking place. You don't have to actually ask the actual questions. You have to record the actual discussion. No, you don't. So it's not a transcript. You don't want a transcript. Okay. So that's the other extreme. That's the other extreme. You want to avoid, you want more than haiku, but you don't want to get to Tolstoy. You don't want to transcript, all right, because you don't need a recording of what actually happens in the room.

You know, the kind of a record that might be good in this situation is you want to establish all the directors read it, that there was an opportunity for questions. Several topics were discussed. You'd want to make sure that if you're going to list the topics discussed, you don't leave anything out because if there are eight important things in the registration statement and you list only six. you know you're going to get in trouble on the two you don't list. Because someone's going to find the holes no matter what. Exactly. Remember, you always have to read the minutes like a conspiracy theorist. Okay.

And, you know, from that perspective, you want to establish, you want to have minutes that establish that the board exercised its fiduciary responsibilities, asked questions about this document, got answers, and only after doing that level of inquiry, did it authorize the executives to file the document with the SEC? The minutes that Nikki read have none of that. So what if someone says recusing themselves from a discussion? Do the minutes have to say so-and-so-in-person actually left the room?

Or is it good enough to just say who was present for that discussion? Do you actually have to share some of the movements in and out of the room as well? So I think it's a good idea to do that. I actually think it's a very good idea for the minutes to reflect that the board recognized a potential conflict, that they discussed the potential conflict, and took action, the action being maybe perhaps the recusal of the person with the conflict from the room, and discusses at least and recognizes the action taken. And that's the same thing, for example, if you have any one of the situations that Joe or I mentioned as raising a potential conflict, a down-round, and you want to therefore form an independent committee of independent directors who are not affiliated with the preferred shareholders. The board minutes, ideally, should recognize that the board recognize the potential conflict, even better if a lawyer, provided a discussion of their fiduciary duties in connection with a potential conflict,

then what did they do to take care of this potential conflict? They created an independent committee, and then what were the considerations of the independent committee? Right. You know, and when you're dealing with situations of individual recusal, there are a variety of different styles that people use. So, for example, you could say, you know, at this point in the conversation, Ms. Locker left the room, or if it's on a telecom, at this point in the conversation,

Ms. Locker dropped off the telecom, and then when Ms. Locker reenters the room, you put that into the minutes, or comes back on the telecom, you put that in. It's a little bit like a stage play, enter stage left, remove, you know, stage right. Like, it's actually a little bit like that. The literary metaphors are exactly right. You want to know who's on the field, all right? You know, who's on stage when this particular scene is happening. Another way to do it is up front is, say, you know, in the periods involving conflicts and

discussion of the following matters, Ms. Locker did not participate. So there are many, many different styles that achieve the objective, but you have to understand what the objective is. Create the record you want that can survive an attack by a conspiracy theorist. Create the record you want to survive an attack by a conspiracy theorist. I think it's worth repeating, so I wanted to make sure that I got that. Could you repeat that? Don't make me repeat it a third time.

Well, Joe, Nikki, thank you so much for joining the A6 and Z podcast. I actually disagree wholeheartedly with you, Joe. This is not the most boring podcast in A6 and Z history. Don't ask me which one was. So now what was the most boring podcast? Come on now. There wasn't one and some we haven't put on. I'll say we would never publish a boring podcast.

I thought it was incredibly interesting. Oh, you should see what we can do with stuff that's really exciting. Well, that we're going to have to say for the next podcast. And I do want you guys to come back on to share some more insights on board governance and some of the other exciting stories from the field. Thank you. Thank you.