Nvidia's board hired Wachtell Lipton as the stock slid 9.5%

Nvidia's stock fell 5.47% on Tuesday after a 4% drop on Monday, a loss of about 9.5% in two sessions, even though the company issued little news beyond hiring outside counsel for the board's investigation.

The board engaged Wachtell, Lipton, Rosen & Katz to probe CEO Jensen Huang's admission of an extramarital affair with Alice Huang, a former executive at Nvidia customer Megaspeed whom U.S. intelligence agencies believe was spying for China. The board said in a Sunday statement that Nvidia "has no reason to believe that either national security or NVIDIA secrets were compromised."

Two corporate governance professors who study board crisis response say there is no precedent for a CEO caught up in a suspected honeypot. Ann Lipton of the University of Colorado and Todd Henderson of the University of Chicago are watching rather than forecasting.

"There have actually been affair cases and sexual harassment cases," Lipton said, adding that she doesn't know of previous cases also involving potential national security compromises. Henderson said much depends on facts few people have yet, including what, if anything, Alice Huang got out of Jensen Huang. Secrets about Nvidia's fabs or chip designs would matter to the Justice Department; ordinary corporate information probably would not.

What does the board's outside counsel actually control?

Lipton described the investigation, led by Nvidia's independent board members with their own outside counsel, as perhaps the most "standard" aspect of the whole affair so far. She said an investigation will be "exactly as thorough" as the directors running it want it to be, which is also standard. Henderson made a related point about incentives, saying Washington law firms that conduct internal investigations "know who pays their bills." He didn't suggest that is happening here.

Lipton sees three lines of inquiry:

• Whether the law was broken
• Whether Huang violated Nvidia's internal policies
• Whether the board was misled, including how forthcoming he was and when he was on notice

Wired reported Monday that Huang hired a PR crisis firm known for handling sex scandals a full year ago. The driver could have been the affair alone. It's unclear when Huang learned Alice Huang was a suspected spy.

What turns concealment into a fireable offense?

Henderson described two scenarios. In one, Huang hires a PR firm because an extramarital affair is embarrassing, without knowing who the woman is. In the other, he knows she is a suspected Chinese spy. "I think that's very different," he said. "If I were a board member and the CEO of a company with very sensitive technology was in that situation, I would be furious if they didn't tell me."

Not telling the board that you have cancer "or that you've been sleeping with a Chinese spy," Henderson said, "seems to me to be a fireable offense."

Either way, Lipton expects shareholder suits, and she said two kinds are possible. Securities fraud, which she said is "only about lying," is the most obvious, and Nvidia is already facing a proposed class action lawsuit that alleges Nvidia and Huang misled investors by describing the company's Megaspeed dealings as routine.

"You can have as many affairs with Chinese spies as you like," Lipton said. "You just can't lie about it under the federal securities laws."

A mismanagement claim under Delaware law, where Nvidia is incorporated, is much harder. Employees do "stupid or reckless or damaging things all the time," she said, and courts don't let shareholders sue each time. Shareholders bringing such a claim on the company's behalf, known as a derivative suit, must first show the board is incapable of handling the problem, usually by proving directors are implicated or so beholden to the CEO that they can't act independently.

How much leverage does Huang actually have?

Nvidia's 10-member board has a track record of loyalty and deference to Huang, as outlined by a New York Times piece Tuesday morning. Still, the investigation those "independent" directors have announced with outside counsel makes that very hard. Lipton cited a shareholder suit over alleged mismanagement at McDonald's several years ago, after its chief people officer was accused of harassment and its CEO had a relationship with a subordinate. Ultimately, the court found no reason the board couldn't deal with the misconduct on its own.

Even if none of this threatens Huang's job, the episode raises other governance questions that don't look great in retrospect. Nvidia runs a famously flat structure, with more than 60 direct reports to Huang, and the company doesn't appear to have a succession plan, which Lipton called "a danger for any company."

Huang's children work at Nvidia. His son Spencer is a director of product management, his daughter Madison is a senior director of product marketing, and his son-in-law, Nico Caprez, works in business development. Some employees believe he is grooming successors, and asked last month by Bloomberg whether Madison is in line for the job, Huang didn't shoot down the idea, saying instead that it's not something he'd wish on her.

Lipton called hiring the kids poor corporate hygiene, even though founders have long done it. She noted Kimbal Musk sits on Tesla's board because he's Elon Musk's brother. Directors are supposed to act only for stockholders, but founders get more rope as long as the company is thriving.

Henderson calls himself a strong "anti-nepotism person." When his father worked at Westinghouse's nuclear research lab, there was an absolute ban on hiring employees' children. "Like, fine for them to be working there," he said of Huang's children working at Nvidia. But "the idea that one of his kids would succeed him" at a publicly traded company the size of Nvidia "seems crazy," he added.

Why the absence of dual-class shares matters

What Nvidia may have gotten more right, from a governance standpoint, is what it doesn't have, which is dual-class shares. Huang reportedly owns about 3.6%, so he doesn't control the vote. That makes him "easier to dislodge," Lipton said, even though he is deeply integrated into the company in other ways. Neither professor is rooting for or against Huang, each made clear. The simple truth is that with voting control on top of Huang's holdings, the board would have even less flexibility. Without it, the board has a few more options.

The coming weeks will test that flexibility: the scope of Wachtell Lipton's mandate, the timing of any disclosure about what Huang knew about Alice Huang's alleged spying, and whether a Delaware court accepts a derivative suit against a board that already has outside counsel running the probe.