Where to search for red flags?

From The Director's Handbook (2012 Edition) by Thomas J. Dougherty. Copyright [C] 2012 by the author. Published by Corporation Service Co. (www.lexisnexis.com/csc).

DIRECTORS ARE NOT EXPECTED to involve themselves in the day-to-day operation of a business. However, without trying to second-guess every management decision, directors must exercise sufficient vigilance, judgment and experience so as to recognize a red flag (or indeed even a yellow flag) and ask questions. The answers to the questions, or lack thereof, will build insight, which will in turn inform oversight.

But how are directors to know where to search for flags? Is it simply a matter of common sense, or can the search be structured?

One way to structure vigilance is to be on the lookout for gaps in relevant oversight protocols or processes. A director must ask if there is a check or balance against undue risk-taking or compliance failure, and ascertain who owns that check or balance role. Is the responsible person independent of the function being checked? If not, there is a gap.

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Thomas J. Dougherty has been a partner at Skadden, Arps, Slate, Meagher & Flom since 1984. He specializes in the representation and defense of companies and their officers, directors, underwriters and auditors.