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The Board “Executive Session”

Jeffery E. Smith
Reprinted from Acredula -- Winter 2007

While for years an integral part of corporate governance procedures and board practices for many organizations, issues surrounding the activities of the board in “executive session” have received enhanced scrutiny in the post-Sarbanes- Oxley environment and it is helpful to clarify the role of “executive sessions” of the board in overall board governance. Executive sessions are an important formal adjunct of informal pre- and post-meeting “parking lot conversations”, where non-management directors can engage in open and frank dialogue on matters concerning their institution and its management.

“Executive session” typically refers to the portion of the board meeting where any attending management and management directors are excused, and the remaining non-management directors discuss matters which they prefer to discuss outside of the presence of management attendees. Discussion can and does range from personnel matters involving management (including management competency issues, succession planning, compensation issues, and a wide variety of other issues) to any number of matters for which the “outside” board members desire to undertake open and frank discussion without the presence (and potential influence) of management.

The reasons are endless, and not always articulated. However, executive sessions provide the opportunity for important candor and open dialogue by and among non-management directors relating to the organization, its operations, and its management. In fact, NYSE, NASDAQ and AMEX listing rules adopted in conjunction with Sarbanes-Oxley mandate “executive sessions” for exchange-listed companies. Including a regularly scheduled “executive session” for board members is an important “best practices” consideration for all institutions.

Avoiding Perception Issues

Care must be taken, however, to avoid inadvertently creating perception issues between the board and executive management through use of the executive session process.

How the board uses the executive session (and the manner in which it is portrayed to management) is an important component of that process. Regular use of the executive session at each board meeting helps to maintain and reinforce the notion that meeting in the absence of management is a routine, normal board function and not an indication or inference of lack of confidence in management, or that a specific issue or problem has arisen. Even brief, but regular, executive sessions provide the needed ongoing opportunity for complete candor and open discussion necessary for board deliberations, and more lengthy sessions may be in order when circumstances require additional time. The important part is that the board has the opportunity to meet and exchange views outside of the influence of management, whether real or perceived, a concept which is certainly a “best practices” governance concept even if not technically required by law.

In most instances, the board should debrief management on the general nature of the activities and discussions of the board in executive session, and review the executive session discussions with the absent insider director(s) following the session (assuming such disclosure is appropriate in light of the circumstances) in a spirit of openness which encourages ongoing good board/management relations. Instances may arise where such disclosure may be inappropriate, in whole or in part, but those instances are likely the exception rather than the rule. Care must be taken to maintain a consistent voice by outside directors with management, and it is important to avoid establishing “camps” and “fishing” by insiders to try to determine the discussions undertaken in executive session.

Management should be supportive of the board’s role and of the importance of executive sessions, and should avoid creating awkward and potentially divisive relationships by interrogating directors following the session. Likewise, the outside directors should take care to avoid having the sessions make management feel targeted or “out of the loop” with regard to matters considered in the session, again unless confidentiality is otherwise appropriate.

Decision-making, Voting and Minutes

It is important to note that matters considered in executive session are not generally appropriate for a board vote during the executive session and until the full board is properly reconvened. With few exceptions, matters subject to a board vote require full consideration and the opportunity for discussion by all directors, inside and outside, and while the executive session is a valuable vehicle for open discussion among the outside directors the entire board must have an opportunity to vote on matters under consideration (subject to obvious abstentions by directors who may have an interest in the matter under consideration).

Banking organizations are familiar with this process through the application of Federal Reserve Regulation O, which prohibits directors and executive offi cers from voting (or even participating in the deliberations) with regard to a proposed extension of credit to that director or executive officer or related parties.

In addition to the technical need to assure that actual voting on matters takes place in a forum involving opportunity for participation by all directors, care must be taken to avoid decision-making in executive sessions in the absence of input and banking expertise of management when that input and expertise is relevant to the matters under consideration. Seeking and obtaining the comments and viewpoint of management in matters pertaining to business and regulatory issues impacting the organization is critical in the decision-making process when those issues are involved. When issues arise during the course of the executive session, management can and should be invited to provide input and information when appropriate and then excused from the session so that the non-management directors can discuss matters under consideration with the benefit of management input. Decision-making and formal voting should only take place in the full board setting either once the meeting is re-adjourned or in subsequent full board meetings.

The fact that the board adjourned to executive session should be noted in the minutes of the meeting, along with the fact that the board re-adjourns to a full meeting if appropriate. While a detailed account of the discussion in the executive session is generally not required, boards should check with legal counsel to determine the appropriate method of reporting executive session matters based on the specific institution and circumstances.

Conclusions

The use of executive sessions to provide a forum for open dialogue and discussion among non-management directors is an important element of “best practice” consideration for the governance process. Properly handled, organizations can avoid creating a divisive rift with management by addressing the executive session as a normal part of the board process and by providing feedback to management regarding executive session discussions when appropriate.

While use of the executive session is limited in its scope to discussion and not actual decision-making or voting (subject to rare exceptions which should be discussed, preferably in advance, with legal counsel), the executive session provides a valuable tool for boards to review and discuss matters of interest and to keep apprised of the activities and issues of the organization in an open and non-threatening forum.