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Lessons from the corporate governance 'mess' at OpenAI

A five-day boardroom drama at OpenAI ended Wednesday with the return of CEO Sam Altman and an overhaul of the board. The lesson that will linger is the importance of governance to the stability of any company.

Four directors were able to sack the co-founder of the pioneering artificial intelligence startup without any input from investors, walking the company into a legal morass and stirring the ire of many OpenAI employees who demanded that the board resign.

The reason this happened, said Case Western Reserve School of Law corporate law professor Anat Alon-Beck, was a predictable "mess" created by OpenAI’s "very unusual" corporate structure.

"I would hope that they learned their lesson and will now go ahead and fix this corporate governance mess. Otherwise, history will repeat itself very soon."

To understand what happened, it helps to go back to 2015, when OpenAI was first established. It began as a nonprofit under the name OpenAI Inc., a nod to its mission of advancing humanity instead of pursuing profits.

In 2019 Altman and his team did create a for-profit subsidiary to raise outside venture capital — including billions from Microsoft (MSFT).

That complicated things. It was structured in such a way that the for-profit subsidiary remained under the control of the nonprofit and its board of directors, while giving its biggest backer (Microsoft) no board seats and no voting power.

If there was any doubt about who was in control, OpenAI even said on its website that "it would be wise to view an investment in OpenAI Global, LLC in the spirit of a donation."

OpenAI note to investors posted to OpenAI's website June 28, 2023.
OpenAI note to investors posted to OpenAI's website June 28, 2023. (OpenAI)

The inherent tension between these two parts of the enterprise is what contributed to the dramatic events of the last week, starting Friday with the surprise ouster of Altman.

The collective decision came from four directors: OpenAI’s chief scientist, Ilya Sutskever; Quora co-founder Adam D’Angelo; tech entrepreneur Tasha McCauley; and Helen Toner, a director with Georgetown University’s Center for Security and Emerging Technology.

The directors said in a statement that Altman "was not consistently candid in his communications with the board, hindering its ability to exercise its responsibilities."

The board-CEO clash was bound to develop, Alon-Beck said, because of the "misalignment of incentives" that resulted from the layering of nonprofit and for-profit entities.

"I was not supportive of [OpenAI] adopting these new charters for several reasons," Alon-Beck said. "And we can see the mess now right, we can see the mess at OpenAI. And that's exactly what I was afraid was going to happen."

There were reports following Altman’s ouster that some investors were in fact exploring legal action against the board. Employees also made it clear they were unhappy, with many signing a letter threatening to leave unless Altman returned.

Sam Altman, CEO of OpenAI participates in the
Sam Altman speaks in San Francisco the day before he was first ousted as CEO of OpenAI. (ANDREW CABALLERO-REYNOLDS / AFP) (ANDREW CABALLERO-REYNOLDS via Getty Images)

Prior to Altman’s initial termination, the company’s 700-plus workers had been anticipating a tender offer allowing them to sell their shares and reportedly valuing the startup at $86 billion. Absent Altman, that valuation was expected to dwindle.

'Duty of care'

Did these implied threats influence the eventual outcome?

It is not yet known why some directors changed their minds. As overseers of a nonprofit, they typically wouldn't face the same legal vulnerability as for-profit board members because maximizing profits was not their top priority, said University of Virginia law professor and corporate structure expert Michal Barzuza.

But had they stayed the course, experts said, these board members would have faced significant legal pressure from investors, employees, state attorneys general, and possibly even Altman.

The fallout from firing Altman exposed them to potential claims that the board had breached its fiduciary duties to both the nonprofit and its for-profit subsidiary by failing to meet legal responsibilities known as the "duty of loyalty and the duty of care."

Any board, she added, is required to make informed decisions, to make a good effort to receive all relevant information, to deliberate, and to consult with experts to make the best decision that is in the benefit of the corporation.

"So if the board was very quick to make decisions, or if the board didn't have sufficient information and didn't try to get all relevant information, that could be one basis for [a lawsuit].”

The failed coup

OpenAI will now have a new board that won’t include three of the four board members who made the decision to oust Altman.

New directors include Bret Taylor, the former co-CEO of Salesforce; former Treasury Secretary Larry Summers, and D’Angelo, the only person from the former board to stay. Taylor will be chair. Altman will not be on the new board.

There were reports that more directors could still be added, and that Microsoft could still have board representation as well. It’s also possible that Altman could join the board eventually. Microsoft owns 49% of OpenAI’s for-profit arm.

"The former now infamous board members are finally gone after the failed coup and now in essence OpenAI will be virtually the same than before this soap opera began," Dan Ives, a technology analyst for Wedbush, said in a note Wednesday.

However, he added, it "will have a much stronger governance now in place which is key."

Alexis Keenan is a legal reporter for Yahoo Finance. Follow Alexis on Twitter @alexiskweed.

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