Networking is a big part of being a board director. In fact, some nominating committees specifically look for board recruits who have extensive business networks that they may be able to tap into. When bringing together board directors who have decades of corporate knowledge and experience, the interconnected relationships can have a powerful influence over people and systems. The old adage, “It’s not what you know; it’s who you know,” still rings true in corporate America.
By nature of their positions, all board directors have fiduciary duties. Duty of Care refers to the duty of board directors to act in the same manner as an ordinary, prudent person would under the same circumstances. Despite the duty of care being a staple of corporate governance, board directors continue to serve on multiple boards that are in the same or related industries. Service on more than one board could constitute a conflict of interest, which is a violation of basic governance principles.
More importantly, fiduciary duties also include the Duty of Loyalty, which specifically states that board directors must at all times act in the best interests of the company. It’s easy to see that the best interests of a competing company may be at odds with the best interests of another company. Once again, directors who sit on more than one board of competing companies may have a notable conflict of interest.
Board directors who accept positions on the boards of two or more companies are called interlocking directorates.
What Are Interlocking Directorates?
In simple terms, board directors who accept positions on the boards of two or more companies are called interlocking directorates. Under most circumstances, that arrangement is legal and perfectly acceptable. However, when the firms that a board director serves are mutual competitors, the waters become a little murky.
The issue of interlocking directorates is usually an undesirable situation for both companies and for the director. A board director who accepts a board seat for a competing company will likely gain access to privileged information, which sets the stage for unfair competition.
The Institutional Shareholder Services (ISS) recommends that boards and shareholders vote against board directors who serve on five or more boards, which is down by one as recent as 2017. Glass Lewis is also closely monitoring board directors who serve on multiple boards. Glass Lewis supports executive directors who serve on no more than two boards.
Regulations Regarding Interlocking Directorates
The issue of interlocking directorates is an antitrust matter. The Federal Trade Commission (FTC) is the federal regulating agency for antitrust laws. As part of the Clayton Act, U.S. antitrust laws disallow interlocking directorates. The general intent of the provision is to prevent anti-competitive coordination between corporations that would upset the stability of the financial marketplace.
Specifically, the Clayton Act prohibits board directors acting as interlocking directorates from serving on more than one board within the same industry, in situations where, if the two companies were combined, it would set up a situation that violates antitrust laws.
The Clayton Act was passed in 1914 as a means for curtailing anticompetitive practices. In spite of this century-old law, researchers have indicated that one in eight interlocks in the U.S. exist between competing corporations.
When Does the Clayton Act Apply to Corporate Directors?
According to the Clayton Act, the interlocking directorate rule refers to a situation where each company competes on at least 2% of their sales and one of the companies competes on at least 4% of one of the company’s sales.
The Act also applies when both companies are over a certain size and the overlapping sales hit a particular threshold for at least one of the companies. The amounts typically increase annually. Currently, the threshold is $26.161 million in aggregate capital, surplus and undivided profits for individual corporations. In addition, the threshold for at least one corporation is $2,616,100 for the Act to apply.
Problems With Interlocking Directorates
Research by GMI Ratings reports three distinct problems with interlocking directorates. They include:
- Extraordinary and egregious retirement or consultant packages
- Excessive board director pay, even in instances of poor performance
- The problem of option back-dating
Some will remember how GE executive Jack Welch made headlines when the media reported the financial details of his divorce. Welch was CEO and chair of General Electric from 1981 to 2001. He saw the company through a period of great prosperity during which the company’s value rose about 4,000%. The media reported that Welch had received one of the most extraordinary director remuneration packages, which afforded him lifetime access to the company’s facilities and services, including access to the company plane, company cars, company apartments and financial planning services, not to mention a $417 million retirement package — the largest payment in our history.
While Welch didn’t sit on more than one board, this is a prime example of the great lengths that companies will go to for director compensation.
A Notable Example of Interlocking Directorates
One of the most notable examples of interlocking directorates occurred in 2002 between Google and Apple. Eric Schmidt was the CEO of Google, and Arthur Levinson was the former chief executive of Genentech Inc. Both men served on the boards of directors for Google and Apple.
The FTC conducted an investigation, citing Section 8 of the Clayton Act. The investigation sought to evaluate the degree that the two companies were competing with each other regarding Apple’s iPhone and Google’s Android products and other products such as netbooks.
As a result of the investigation and ensuing pressures, both executives resigned from Google’s board of directors in 2009, before the matter escalated to litigation.
It’s likely that the FTC intended to hold Google and Apple up as an example that the country is moving forward with a greater emphasis on good governance, and that interlocking directorates will no longer be tolerated, as they’ve been so easily overlooked in the past. Nominating and governance committees are the first gate to preventing interlocking directorships. Where there is awareness, there is transparency, and where there is transparency, there is oversight. A Diligent board portal system is a valuable tool for nominating and governance committees to carefully vet board candidates in a manner that prevents interlocking directorships and that protects the company from unnecessary lawsuits and scandals.