Operational Risk and the New Caremark Liability for Boards of Directors

Abstract

This paper identifies a new and previously unidentified trend that is changing corporate governance: board liability for misconduct based on operational risk. Operational risk is serious business. When boards slumber, hundreds of people die in airline accidents, pipelines explode causing massive environmental damage, and mines collapse leaving families with grief unimaginable. These and other corporate disasters were entirely preventable, and board members were asleep at the wheel while the conditions were set for disaster.

This manuscript argues that courts are only now starting to fully recognize the peril of operational risk as a source of liability for boards of directors. Operational misconduct should take center stage alongside financial mismanagement as a critical source of director liability. After closely reviewing the key cases, this manuscript shows how operational risk heralds a fundamental shift in the way boards respond to monitoring the firm. This manuscript also identifies how subtle changes in judicial doctrine is changing the way boards manage operational risk, avoid liability, and protect the lives of stakeholders of the company and society at large.

Keywords: corporate governance, board of directors, shareholder litigation, Caremark

JEL Classification: K22