From Tahrir Square to the Boardroom

“Fiduciary duty” might not be the first phrase that comes to mind while watching news of the serial uprisings across the Middle East and North Africa, but there is a link. In Tunisia, Egypt, and Libya, leaders broke trust with their constituents by suppressing dissent, extracting personal gains, and entrenching ruling cliques. Then a spark—in Tunisia, it was a trove of WikiLeaks documents exposing corruption—combined with social media to fuel grassroots rebellion.

A similar (if more sedate) relationship of trust exists between corporate boards and shareowners. Corporate law captures that idea by identifying directors precisely as agents or fiduciaries—the term comes the Latin word for “trust”—of equity holders. If investor confidence in the board is in some way ruptured—say, by directors presiding over outsized pay for management underperformance—corporate boards could experience the capital markets equivalent of Tahrir Square.

Institutional investors have secured new accountability tools such as meaningful director elections, advisory votes on pay, and expansive disclosures on board governance. Plus, funds are communicating and collaborating with each other more extensively through conventional and social media channels. They have more power to act than ever before, in the event they lose faith in their agents. Shareowners can oust directors at annual meetings, inflict confidence-damaging thumbs-down votes on compensation policies, support hostile takeover bids, or short-slate insurgent board candidates. In sum, boards are in a new era of scrutiny and owner empowerment, like it or not.  Directors may need to update their role as fiduciaries, or risk ouster.

No wonder, then, that fiduciary duty—until recently considered a sleepy and settled corner of jurisprudence—has seen a sudden surge in attention around the world. Multiple projects are unfolding, largely under the radar screens of most corporations. As might be expected, much of the focus is on reassessing duties entrusted to corporate board members. But those who influence corporate governance are also concentrating on overhauling the duties of institutional investors, whose behavior and expectations, in turn, affect boards. Let's tour the most important developments, since they could wind up shaping change. Then we will review ways your board can keep ahead of trends.

In a speech to the Directors Forum in January, governance guru Ira Millstein argued that boards have an innate fiduciary duty to think long term and not simply to respond to the loudest shareowner or the latest incremental stock price movement. Millstein contends that an oft-ignored “duty of impartiality” compels corporate directors to balance the differing interests of investors so that the outcome leads to sustainability. “It is not only constructive and sane, but safe under the business judgment rule, for directors to pursue long-term corporate sustainability,” he declared. Millstein is leading a research project at Weil Gotshal and Yale School of Management on fiduciary duty.

Consider turmoil in the Middle East as an extreme reminder of an old adage: Adaptation to new facts on the ground is sometimes the best formula for survival.

Last September, U.K. Business Secretary Vince Cable launched a wide-ranging consultation on “long-termism” triggered, in part, by controversy over Kraft's successful but deeply unpopular acquisition of Cadbury, Britain's iconic chocolate giant. Cable is asking whether board duties should be adjusted to ensure that directors can act for long-term interests, even if they upset some shareowners. Cable also wants to know whether shareowner duties need tweaking. Taking the bait, the Network for Sustainable Financial Markets (NSFM), a global virtual forum of top scholars and experts, filed a detailed reform proposal in January.  NSFM's Fiduciary Duty Working Group targets institutional investors, not boards. Funds fail to fulfill their fiduciary duties, the group contends, when they ignore non-financial and systemic risks. If the British government agrees, virtually all institutional investors will have to incorporate environmental, social, and governance concerns into their investment decisions and engagement with corporate boards. Such guidance could easily be tucked into the country's new investor stewardship code. And remember: Governance reform in Britain often migrates to other markets, including the United States.

The European Union will tackle fiduciary duties faced by both corporate directors and investors when it releases a “green paper” on the E.U. corporate governance framework on April 5. Observers expect the first-phase paper to raise questions—for instance on whether directors have duties to stakeholders even if they are elected by shareowners. Again, revisions in Europe are not likely to stay in Europe—especially as E.U. investors commonly apply new expectations to their equity holdings in the United States.

At home, the U.S. Department of Labor closed the comment period on an ambitious new plan to expand its definition of fiduciaries. Provisions may bring middlemen such as proxy advisers who counsel ERISA funds under a fiduciary umbrella. Why should this bear on corporate boards? Because the Labor Department could wind up taking advice submitted by the International Corporate Governance Network (ICGN) to clarify that funds exercise fiduciary duties of stock ownership by engaging with companies, not just voting proxies. If taken, such a step would rival in impact the Reagan administration Labor Department's Avon letter of 1988, which for the first time established that ERISA funds had a fiduciary obligation to treat share votes as an asset. If Obama's Labor Department agrees that engagement is part of a fiduciary obligation to safeguard the value of fund equity, boards can expect a rapid and wide jump in scrutiny by, and dialogue with, their investors.

Finally, the Securities and Exchange Commission leapt onto the fiduciary duty bandwagon with a January 2011 study recommending that both brokers and investment advisers be held to a common fiduciary standard, rather than the lower “suitability” standard now in effect for brokers. Australia and Canada have taken similar approaches. Regulators want to purge conflicts of interest so that these intermediaries act solely in the interest of their clients—a move that could push them to take a tougher line at companies on governance issues.

Across the landscape, definitions of fiduciary duty are under the microscope—and will almost certainly change at the hands of regulators, lawmakers, courts, or companies and investors themselves. As NSFM observes, the framework around fiduciary duty is an artifact of capital market conditions of the 1970s instead of the 2010s.

So how can savvy boards stay ahead?

First, companies can participate in, rather than simply observe, the movement toward fiduciary standards reform: Join NSFM; enter the debate on Twitter threads such as #corpgov; submit comments to outstanding consultations; and survey the views of others to get the drift of where ideas on duty are heading. Second, consider forming a collective fiduciary duty working group through organizations such as the National Association of Corporate Directors or the Society of Corporate Secretaries and Governance Professionals. The aim would be to generate a director-oriented view on fiduciary duty based on current market features. Third, brief directors periodically on the status of reviews of fiduciary duty—and make sure the general counsel or outside lawyers are reconnoitering the latest developments both at home and abroad.

Consider turmoil in the Middle East as an extreme reminder of an old adage: Adaptation to new facts on the ground is sometimes the best formula for survival.