Is a CEO of a U.S. public company allowed to hire a consulting firm for which he is the sole or primary employee?

Example:

Suppose a compensation committee within the board of directors of company ABC decides the CEO is worth $10mm per year. That said, the CEO believes he is actually worth $20mm per year. To avoid these rules, the CEO starts XYZ consulting corporation for which he is the only employee. CEO then has ABC hire XYZ as a consultant, paying XYZ $10mm per year. As a result, CEO of ABC is effectively being paid $20mm per year even though the board only approved $10mm per year.

This certainly seems like a violation of shareholder trust and like a way of evading the control of a compensation committee. That said, is this actually illegal under U.S. corporate law? If not, under what laws would this be illegal?

Bonus question: is illegal for a Canadian company that trades on a U.S. stock exchange, like the NYSE?

The premise that "CEO then has ABC hire XYZ as a consultant, paying XYZ $10mm per year" suggests that the board of directors is unaware of the CEO's ownership of XYZ. That almost always amounts to fraud and conflict of interest. The CEO in the hypothetical situation you describe failed his ethical (if not contractual) duty to timely disclose to ABC his possible conflict of interest.

  • What if this is disclosed as a related party transaction and the company makes the general statement that "there may be conflicts of interest"? Can this be fraud if this is nevertheless disclosed? If so, what sort of case law or theories of fraud can i look into to better understand this? – griggah Oct 9 at 22:46

Such a situation is at best ethically dubious. It is clearly a conflict of interest on the part of the CEO. If it is hidden from the board of directors it may well be fraud, and thus criminal. If it is disclosed somewhere in the documents submitted, but not obviously, it might not be fraud, but is still a violation of the CEO's duty to clearly disclose any conflicts. It would surely be grounds for termination at least.

Moreover, since this is said to be a public company, this is probably a materiel issue which needs to be disclosed to shareholders. If it is not, that probably violates US SEC regulations, which would apply to any firm traded on a US exchange.

  • Same question as above to Inaki... What if this is disclosed as a related party transaction and the company makes the general statement in their filings that "there may be conflicts of interest"? Can this be fraud if this is nevertheless disclosed? If so, what sort of case law or theories of fraud can i look into to better understand this? – griggah Oct 9 at 22:48
  • That would depend on the specific laws and regulations, and quite probably the case law under them, and i am not sufficiently knowledgeable to respond at all fully. But if the company makes such a statement, then someone in the company, quite possibly including the auditors , must have known the truth, or some part of it. Perhaps such people could be accused of conspiracy. For the SEC issue, I suppose it would be a question whether such a filing was sufficient o put a reasonable stockholder on notice of possible problems. or there may be specific rules on such reports. Consult a lawyer. – David Siegel Oct 9 at 23:52

I think you should look up this: "The Sarbanes-Oxley Act of 2002 (often shortened to SOX) is legislation passed by the U.S. Congress to protect shareholders and the general public from accounting errors and fraudulent practices in the enterprise, as well as improve the accuracy of corporate disclosures"

Something like this would have to be clearly documented, and it would have to be in the interest of the company. So trying to hide the facts would be illegal. And if the company that was hired doesn't provide $10 million worth of value (apparently it provides zero value) then it would be doubly illegal.

Australian law

If the CEO is an “officer” of the company (which she almost certainly is) then her duty to the company is fiduciary. As such she is legally required to act in the best interests of the company above her own interests. Not doing so is a civil and possibly criminal offence punishable by the state.

If she is just an employee then the actions are not an offence but the company can sue for damages - and fire her of course.

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