Watch Out for the Watchdogs | Skadden, Arps, Slate, Meagher & Flom LLP

Key Points

Watchdog groups that have no direct stake in companies are increasingly raising concerns directly to boards about critical issues like safety, ethics or compliance.
Ignoring such communications can create risks for the company and its directors.
Boards should respond with the same care as they would to whistleblower complaints or shareholder demands, which means understanding the issues and assessing their seriousness.
Documenting the board’s response and reasoning is vital so the board can show that it acted in good faith and with due care if the company or board’s response is challenged later.

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Directors of public companies are no strangers to scrutiny. Shareholders, whistleblowers, analysts, activists, unions, reporters, influencers, consumers, investigators, legislators and regulators all routinely question board decisions and corporate conduct. Add “watchdogs” to that list — organizations or individuals who, without a direct stake in the company, demand board action on issues they believe are critical.

When a watchdog group raises concerns or makes demands, directors must respond thoughtfully and diligently. As a board confronts such concerns, the directors’ mindset is important. Directors should be open to consider inputs from all sources that lead to a more thoughtful review and better outcomes. Proper handling not only fulfills their oversight responsibilities but also benefits the company and creates a defensible record of informed, good faith action. An appropriate response to watchdogs will often mirror a board’s approach to whistleblower complaints or shareholder demands. In every case, directors should ensure they are acting with diligence and care, reflecting a thoughtful process and sound business judgment.

A Recent Example

Consider the recent experience of a major manufacturer. A watchdog group founded by a former employee sent a certified letter to its board demanding an investigation into ongoing safety and design issues with a product. The organization had no financial interest in the company or the outcome; its goal was to alert the board to potential problems and prompt corrective action. Later, the watchdog and others criticized the company’s alleged lack of direct response to the demand. The watchdog’s demands and the company’s response have since been cited publicly.

Should Boards Respond to Watchdogs?

Boards may wonder whether they are obligated to respond to watchdogs or other third parties raising concerns about critical company issues. The board must exercise judgment in each instance about whether and how to respond. As a practical matter, however, the board should at least consider a watchdog’s demands and document its response and reasoning. Doing nothing can be risky for several reasons:

Watchdogs may identify real issues that, if addressed, could benefit the company.
If ignored, these demands could later be cited as “red flags” in litigation or regulatory investigations, suggesting the board failed in its oversight duties.
Plaintiffs’ lawyers and regulators often use hindsight to argue that ignored warnings were clear signs of deeper problems.

Red Flags and Fiduciary Duties

“Red flag” is a key term in fiduciary duty litigation. If shareholders can show that directors ignored credible warnings, directors may face lawsuits alleging failures of oversight — so-called Caremark claims. Red flags are warning signs that put directors on notice of potential legal, financial or compliance risks. Addressing these promptly and thoroughly is essential to mitigating litigation risk, protecting the company’s reputation and safeguarding operations.

How Should Directors Respond?

When faced with a watchdog’s demand, directors should respond as they would to similar issues raised by whistleblowers, shareholders or government agencies. The weight a board puts on various inputs as it evaluates its response will depend on a variety of factors discussed below. A mindset of openness is key; it will lead to a more thoughtful review and process, a more developed factual record in which to respond to potential litigation or regulatory review, a more defensible public facing posture, and overall better outcomes for the company.

Some steps that directors should consider to faithfully discharge their oversight responsibilities include the following:

1. Understand the Issues Raised

Assess the seriousness, credibility and specificity of the allegations.
Key questions to consider:
- How serious are the allegations?
- Are the claims credible, detailed and backed by evidence?
- Have similar issues arisen before, indicating a systemic problem?
- Is the company already aware of or monitoring these concerns?
- Would further steps be helpful and appropriate, considering costs and benefits?
- Would engaging with the watchdog be helpful or harmful?
- What are the benefits and risks of engaging directly with the watchdog?

2. Seek Information and Expertise

Gather information from management and, where appropriate, seek advice from subject matter experts, outside counsel or consultants.
It is often helpful to request that a watchdog provide evidence or facts to substantiate its claims, enabling the board to assess their seriousness and factual support. If the watchdog does not provide support, that may influence the board’s response.
Depending on the issues raised, the chief risk officer or legal department may be tasked with evaluating and reporting on the concerns.
Directors are not required to investigate personally but must ensure that reliable corporate agents or advisers review the issues and report back with facts and recommendations.
Directors are entitled to rely on management and outside advisers, provided that reliance is reasonable and the advisers are qualified and knowledgeable.

3. Tailor the Response

Not every complaint warrants the same level of response. Boards should assess each demand on its merits and the potential impact of the claims.
For the most serious or credible allegations — especially those involving legal, ethical or accounting violations — independent investigations may be warranted. If the integrity of board members or management is implicated, retaining outside counsel or experts to investigate and report to the board or a committee is often advisable where the allegations are credible or non-frivolous.

4. Document the Process

A well-documented process is critical. Board or committee minutes should reflect:
- The steps taken in response to the watchdog’s concerns.
- The individuals involved in advising the board.
- The information considered by directors before making decisions.
The record should demonstrate that directors acted in good faith and with due care.

The Importance of a Good Record

Even if watchdogs lack legal standing to pursue claims against the company, their demands may generate public relations challenges and could become relevant in litigation brought by others. For example, shareholders may seek board materials related to the issues raised pursuant to their rights to inspect corporate books and records. Plaintiffs lawyers may then seize upon a watchdog’s demand as evidentiary support in derivative litigation that asserts fiduciary duty claims against directors. In that scenario, the plaintiffs’ lawyers may argue that the watchdog’s letter was a red flag the board ignored. In that situation, the best defense is a good process and a clear record showing that directors considered the concerns, informed themselves and made a reasoned, good faith decision in the corporation’s best interests.

Conclusion

Watchdog groups are an increasingly prominent source of scrutiny for public company boards. Directors should treat their demands with the same seriousness as those from shareholders or whistleblowers. By following a thoughtful, documented process — understanding the issues, seeking expert input, tailoring the response, and making a good record — directors can fulfill their oversight duties and protect both themselves and the company from future claims.

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