In an action filed this week, the Securities and Exchange Commission (SEC) charged three outside directors of a public company with securities fraud based on their alleged failures to fulfill their roles and responsibilities as Board members. The SEC contends that by their actions and inaction, the outside directors – Jerome Krantz, Cary Chasin, and Gary Nadelman – facilitated and assisted in a massive accounting fraud at DHB Industries, Inc., a body armor supply company. The SEC identified the directors’ failures as: failing to maintain independence and skepticism; neglecting to ensure adequate financial controls and addressing weaknesses; ignoring concerns and complaints brought to their attention; and allowing management to control investigations of potential problems. This action comes less than a year after the SEC charged an outside director and audit committee chairman of infoUSA Inc., Vasant Raval, for failing to respond to red flags about that company’s financials.

These cases signal the SEC’s emphasis on the important role of outside directors and a new willingness to prosecute those directors who disregard or neglect their duties. Although the facts set forth in the complaint suggest a pattern of egregious inattention and recklessness not typical in the boardroom, the allegations against the DHB directors can provide lessons to all outside directors of public companies and those corporate executives working with them.

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