Nvidia CEO scandal puts board independence under scrutiny

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Nvidia CEO scandal puts board independence under scrutiny

What the investigation must establish

Corporate governance professors Ann Lipton of the University of Colorado and Todd Henderson of the University of Chicago say the current case is difficult to compare with others. Stories involving extramarital affairs and sexual harassment are familiar, Lipton says, but she knows of no cases that also raised questions about possible harm to national security.

According to Henderson, much depends on circumstances that remain unclear. One key question is whether Alice Huang received any information from Jensen Huang. Information about Nvidia’s factories or chip development could interest the US Department of Justice, while ordinary corporate information probably would not.

The investigation is being conducted by independent Nvidia board members with outside lawyers. Lipton says this is the most standard part of the story, but stresses that the directors themselves will determine how deep the inquiry goes. Henderson adds that law firms conducting internal investigations in Washington know who pays for their work. He is not suggesting, however, that the investigation in this case will lack independence.

Lipton identifies three areas the investigation should examine:

Wired reported on Monday that Huang had hired a public relations firm known for handling sexual scandals a year earlier. That may have been related only to the affair. It is not known when Huang learned that Alice Huang was suspected of espionage. In a statement released on Sunday, Nvidia said it had no reason to believe that national security or company secrets had been compromised.

Henderson says two questions are especially important: exactly what Huang knew and when he learned it. In one scenario, the CEO hired crisis communications specialists over an embarrassing affair without knowing who his partner was. In another, he already knew about the suspicions against her. Henderson says those would be fundamentally different situations for the board. If the head of a company working with sensitive technology concealed a relationship with a suspected Chinese spy from directors, that conduct could, in his assessment, be grounds for dismissal.

What lawsuits shareholders might bring

Lipton expects shareholders to file lawsuits and identifies two possible types. The most obvious is a securities fraud suit, which, she says, is specifically about lying. Nvidia is already facing a proposed class-action lawsuit: plaintiffs allege that the company and Huang misled investors by concealing his relationship with Alice Huang and describing contacts with her former employer as ordinary business interactions.

The second possibility is a claim of improper management under Delaware law, where Nvidia is incorporated. Such suits are harder to bring: employees, Lipton says, constantly do foolish, reckless or harmful things, but courts do not let shareholders sue over every such incident.

To bring a derivative suit on the company’s behalf, shareholders must first show that the board cannot address the problem itself. This usually requires proving that directors were involved in the misconduct or are so dependent on the CEO that they cannot act independently.

Nvidia’s ten board members have a reputation for being loyal to Huang and inclined to defer to him, the New York Times reported on Tuesday morning. But the independent directors’ announcement of an investigation involving outside lawyers makes it harder to prove that the board cannot act on its own.

Lipton cites a shareholder lawsuit against McDonald’s over alleged improper management. Several years earlier, the company’s chief people officer had been accused of harassment, and its CEO had been in a relationship with a subordinate. The court ultimately found that the board could address the misconduct on its own.

Succession and relatives at the company

Even if the situation does not threaten Huang’s job, it draws attention again to how Nvidia is run. The company is known for its flat structure, and more than 60 people report directly to Huang. Nvidia also appears to have no succession plan. Lipton calls the absence of such a plan a risk for any company.

Huang’s children also work at Nvidia: his son Spencer is director of product management, his daughter Madison is senior director of product marketing, and his son-in-law Nico Caprez works in business development. Some employees believe Huang is preparing successors. Last month, Bloomberg asked whether Madison could take his place. Huang did not rule it out, but said he would not wish that job on her.

Lipton considers hiring relatives poor corporate governance, although company founders have long done it. She cited Kimbal Musk, Elon Musk’s brother, who sits on Tesla’s board. Directors are supposed to act in shareholders’ interests, but founders get more leeway as long as the company is doing well.

Henderson also opposes hiring relatives. He said that at the Westinghouse nuclear research laboratory where his father worked, employees’ children were barred from taking jobs. He considers Huang’s children working at Nvidia acceptable, but finds the prospect of one of them leading a public company of this scale highly questionable.

What the absence of dual-class shares means

From a corporate governance perspective, Nvidia may have avoided one problem: the company has no shares with different voting rights. Huang reportedly owns about 3.6% of the shares, so he does not control the vote. Lipton says this makes it easier to remove him, although he is deeply embedded in the company’s operations in other ways.

Neither Lipton nor Henderson takes a position for or against Huang. If his stake gave him control of the vote, the board would have even less room to act. Without that control, the directors have more options.

Dataist’s take: the investigation will show not only what happened between Huang and Alice Huang, but also how independently Nvidia’s board can act from its CEO. Huang’s lack of voting control gives directors more options, but does not resolve the questions around succession or hiring relatives.