Nvidia stock fell 5.47% on Tuesday, following a 4% drop on Monday, for a two-day decline of about 9.5%, despite not having much big news from the company. CEO Jensen Huang is reportedly trying to carry on with business as usual after admitting to an affair with Alice Huang, who US intelligence agencies believe was spying for China. The biggest development was the board’s hiring of the law firm Wachtell, Lipton, Rosen & Katz to conduct an internal investigation.
What happens next is largely a guessing game, even for those studying how boards should respond to crises. Two corporate governance professors, Ann Lipton of the University of Colorado and Todd Henderson of the University of Chicago, say there have never been any cases in which CEOs have been implicated in honeypot allegations. And while they, like everyone else, have opinions about what questions should be asked in the investigation, they are waiting to see how the investigation unfolds.
“There have been cases of extramarital affairs and cases of sexual harassment,” Lipton said, but quickly added that he was unaware of any past cases involving possible violations of national security. Henderson, whose research interests include corporations, securities regulation, and law and economics, said much of the study relies on facts that most people still don’t know, including, most importantly, what Alice Huang got from Jensen Huang. (Secrets about NVIDIA’s manufacturing facilities and chip designs are important to the Justice Department, but regular company information probably isn’t.)
Lipton described the investigation, led by NVIDIA’s independent directors and its own outside counsel, as perhaps the most “standard” aspect of the entire case to date. She also said the investigation would be “exactly as thorough” as the directors leading it wanted, which is also standard. Mr. Henderson made a related point about incentives, saying the Washington law firm conducting the internal investigation “knows who’s paying the bills.” He didn’t suggest that was happening here.
Lipton said he believes there are three lines of investigation: whether there was a violation of the law, whether Huang violated Nvidia’s internal policies, and whether the board was misled about how aggressive Huang was and when he was notified. It’s worth noting that, as Wired reported on Monday, Mr. Huang hired a PR crisis firm known for handling sex scandals a full year ago. Of course, the driver may have been alone thinking about the matter. It is unclear when Fan learned that Alice Fan was a suspected spy. In a Sunday statement on the matter, the board said NVIDIA “has no reason to believe that national security or NVIDIA’s confidentiality has been compromised.”
Mr. Henderson similarly emphasized the importance of what Mr. Huang knew and when. He described two scenarios. In one of them, Huang hires a PR firm without even knowing who the woman is because infidelity is embarrassing. The other is that he knows she is a suspected Chinese spy. “I think that’s a completely different thing,” he said. “If I were a board member and I was the CEO of a company that handles highly sensitive technology and I was in a situation like that, I would be furious if they didn’t tell me.” Henderson said not telling the board that he had cancer or that he was sleeping with a Chinese spy “sounds like a grave crime to me.”
In any case, Lipton expects shareholder lawsuits, and said there are two possible types of lawsuits. Securities fraud, which she said is “just lying,” is the most obvious, and as we reported yesterday, Nvidia is already facing a proposed class action lawsuit. The lawsuit alleges that Nvidia and Huang misled investors by concealing Huang’s relationship with Alice Huang and portraying her transactions with her former employer as routine. “You can have as many relationships as you want with Chinese spies,” Lipton said. “You can’t lie about that under federal securities laws.”
Mismanagement claims under Delaware law, where Nvidia is incorporated, are much more difficult. He said employees “do stupid, reckless, or damaging things all the time,” but courts don’t force shareholders to sue every time they do something. A shareholder who brings such a claim on behalf of a company, known as a derivative action, must first show that the board cannot address the problem. This is usually done by proving that the director is involved with the CEO or owes the CEO an inability to act independently.
As outlined in a New York Times article Tuesday morning, NVIDIA’s 10-person board of directors has a track record of showing loyalty and respect to Huang. Still, the research these “independent” directors have published with outside counsel makes it very difficult. As an example, Lipton cited a shareholder lawsuit in which McDonald’s chief human resources officer was accused of harassment and a mismanagement case at McDonald’s several years ago after the CEO had an affair with a subordinate. Ultimately, the court saw no reason why the board could not address misconduct on its own.
Even if none of these threaten Huang’s job, this episode raises other governance issues that look bad in hindsight. Nvidia operates in a flat structure, with more than 60 people reporting directly to Mr. Huang and no succession plan, which Mr. Lipton called “a danger for any company.”
Mr. Huang’s children also work at Nvidia. His son Spencer is director of product management, daughter Madison is senior director of product marketing, and son-in-law Niko Caprez works in business development. Some employees believe he is grooming a successor, and when asked by Bloomberg last month whether Madison would take the job, Huang did not rule out the idea, instead saying it was not something she would want.
Mr. Lipton criticized the company’s hiring of children, saying it was against corporate hygiene, even though the company’s founders had long done so. (Kimbal Musk is on Tesla’s board because he is Elon Musk’s brother, she noted.) Directors are supposed to act only on behalf of shareholders, but as long as the company is thriving, the founders have more rope.
Mr. Henderson similarly described himself as a strong “anti-nepotist” and said that when his father worked at Westinghouse’s nuclear lab, hiring the children of employees was strictly prohibited. “It’s good that they work there,” he said of Mr. Huang’s children, who work at Nvidia. But, he added, “the idea that one of your children could be your successor seems insane” at a publicly traded company of Nvidia’s size.
From a governance perspective, NVIDIA’s better decision is something it doesn’t have: dual-class stock. Mr. Hwang does not control the vote, as he reportedly holds about 3.6%. Lipton said that makes him “easier to get rid of” even though he is otherwise deeply integrated into the company.
Both professors made it clear that they neither support nor oppose Hwang. The simple truth is that adding voting control to Mr. Hwang’s wealth holdings will further reduce board flexibility. Without that, there are a few more options on the board.
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