Corporate Governance (2002—2020)
Derivative Impact? Some Early Reflections on the Corporation Law Implications of the Enron Debacle
Leo E. Strine, Jr., 57(4): 1371—1402 (Aug. 2002)
This Article explores the potential state corporation law implications of the Enron debacle. In particular, the Article considers both the pressures Enron exerts on corporation law's reliance upon independent directors as a device to limit judicial review and to cleanse interested transactions, as well as the corporation law's traditional tests for determining independence. The Article also discusses some of the arguments that plaintiffs' lawyers may make in the wake of Enron if corporate boards and their advisors do not adhere to sound practices. The author acknowledges that the productivity of the post-Enron policy debate about corporate governance, accounting standards and practice, and disclosure law—and the utility of many of these reform initiatives— while cautioning that an overly restrictive and aggressive policy response could undermine a system of corporate regulation that, in general, operates effectively.
Understanding Enron: "It's About the Gatekeepers, Stupid"
John Coffee, 57(4): 1403—20 (Aug. 2002)
Debacles of historic dimensions tend to produce an excess of explanations. So has it been with Enron, as virtually every commentator has a different diagnosis and a new prescription. Yet, in many respects, Enron is a maddeningly idiosyncratic example of pathological corporate governance, which by itself cannot provide evidence of systematic governance failure. Properly understood, the Enron debacle furnishes a paradigm of "gatekeeper failure"— that is, why and when it may not be justified to rely on "reputational intermediaries," such as auditors, securities analysts, attorneys, and other professionals who pledge their reputations to vouch for information that investors cannot easily verify. The author argues that, during the 1990s, the expected liability costs associated with gatekeeper acquiescence in managerial misbehavior went down while the expected benefits went up—with the unsurprising result that earnings restatements and earnings management increased. Diagnosing the circumstances under which "gatekeeper failure" occurs is a precondition to sound prescriptions that realign the incentives of gatekeepers with those of investors.
Sharing Accounting's Burden: Business Lawyers in Enron's Dark Shadows
Lawrence A. Cunningham, 57(4): 1421—62 (Aug. 2002)
Enron-type accounting debacles illustrate that prevailing professional cultures create a crevice between law and accounting that resolute fraud artists exploit, rather than an intersection of law and accounting that should foil would-be fraudsters. The increasing significance of accounting matters in business law practice demands that competent business lawyers grasp basic accounting principles. Yet the resources devoted to teaching the subject by the legal academy have declined dramatically in recent decades. Partly to blame for law school neglect of accounting was the ascendancy of modern finance theory's efficient market hypothesis—stories that relegated accounting to the rear of the academic bus. The string of accounting debacles highlighted by Enron show the folly and fantasy of these stories. Law schools and firms must reverse the trend toward accounting neglect, for the lawyer's ethical duty of competence arguably mandates this skill set for business lawyers and, in any event, should do so.
Special Study on Market Structure, Listing Standards and Corporate Governance
The Committee on Federal Regulation of Securities, American Bar Association Section of Business Law, 57(4): 1487—1567 (Aug. 2002)
This Study analyzes the role and authority of the exchanges and the Securities and Exchange Commission in matters of corporate governance, focusing on current needs and practices, the effect of any change in the structure of the securities markets and alternatives to the present system. Consideration is given to the history, nature and use of governance listing standards, as well as a comparison to the process used abroad of a regulatory-best practices regime. This Study proposes a framework for joint action by the New York Stock Exchange and the Nasdaq Stock Market, subject to SEC authorization, to establish a corporate governance protocol for listed companies to develop non-binding best practices guidelines. In addition, it is recommended that the SEC adopt a rule requiring public disclosure by each listed company as to whether it complies with the guidelines or explaining the reasons for any areas of noncompliance. The guidelines would build on the strengths of the existing system and be limited to those governance matters necessary for, and directly relevant to, the integrity of the securities markets and fundamental fairness to investors. The creation of the best practices guidelines would include an open and collaborative process that includes the participation of representatives of the SEC, investors, issuers, member firms and academicians. The protocol should also include provisions to ensure the uniform application and joint interpretation of the best practices guidelines.
Preliminary Task Force Report on Corporate Governance
ABA Task Force on Corporate Governance, 58(1): 189—218 (November 2002)
Managing Closely Held Corporations: A Legal Guidebook
Committee on Corporate Laws, ABA Section of Business Law, 58(3): 1073—1126 (May 2003)
This Guidebook, prepared by the Committee on Corporate Laws of the Section of Business Law of the American Bar Association, provides a concise, practical overview of important legal principles governing directors, officers and shareholders of closely held corporations. It is intended primarily for nonlawyers. There are other excellent books and articles for corporate directors, officers and shareholders as well as for owners and managers of businesses organized in noncorporate forms, such as limited liability companies (LLCs). A bibliography at the end of this Guidebook lists some of the materials most relevant to the closely held corporation.
The Case for Shareholder Access to the Ballot
Lucian Arye Bebchuk, 59(1): 43—66 (November 2003)
The SEC is now considering a proposal to require some public companies to include in their proxy materials candidates for the board nominated by shareholders. Providing such shareholder access to the corporate ballot, I argue, would improve corporate governance. Analyzing each of the objections that have been raised against such shareholder access, I conclude that none of them provides a good basis for opposing shareholder access. The case for shareholder access is strong.
Election Contests In the Company's Proxy: An Idea Whose Time Has Not Come
Martin Lipton and Steven A. Rosenblum, 59(1): 67—94 (November 2003)
The SEC has proposed rules that, under specified circumstances, would permit shareholders to run an election contest using a company's own proxy statement. The authors argue that the potential harm from this proposal far outweighs any potential benefit. The proposed rules would increase the frequency of election contests, causing significant disruption and diversion of corporate resources every year. The shareholders most likely to seek to nominate directors, such as public pension funds and labor unions, have political agendas and interests beyond the business performance of the company. To the extent dissident directors are elected to boards, these boards are likely to become balkanized and less functional. An increase in the number of election contests is also likely to exacerbate the current difficulties in recruiting qualified new director candidates, and make existing directors more risk averse. Proponents of the proposed rules seem to rest their support on the model of the shareholder as the ''owner'' of a company, just as an individual owns a piece of property. The relationship of shareholders to a public company, however, is far more complex. This relationship does not support the argument that shareholders have an intrinsic right to use a company's proxy statement to nominate directors. Finally, the authors point out that the last two years have already seen the adoption of the most far-reaching corporate governance reforms since the 1930s. These reforms should be given the chance to work before the SEC pursues a whole new set of rules that will likely do far more harm than good.
Institutional Perspective on Shareholder Nominations of Corporate Directors
Robert C. Pozen, 59(1): 95—108 (November 2003)
This paper applies the cost-benefit framework for shareholder activism, utilized by most institutional investors, to the five alternative approaches to shareholder participation in director elections suggested by the ABA Task Force on this subject. I show that none of them would likely generate benefits exceeding its costs, although there are worthwhile components of several alternatives suggested by the ABA. I argue that some of the problems involved in the alternatives under consideration could be avoided by allowing institutional investors to cumulate their votes for one director nominee. However, cumulative voting is not permitted by most company charters, which may be changed only if the company's directors put forward a charter amendment for a vote by its shareholders.
Report on Proposed Changes in Proxy Rules and Regulations Regarding Procedures for the Election of Corporate Directors
Task Force on Shareholder Proposals of the Committee on Federal Regulation of Securities, Section of Business Law of the American Bar Association, 59(1): 109—43 (November 2003)
Report of the American Bar Association Task Force on Corporate Responsibility
59(1): 145—99 (November 2003)
Composing a Balanced and Effective Board to Meet New Governance Mandates
John F. Olson and Michael T. Adams, 59(2): 421—52 (Feb. 2004)
The enactment of the Sarbanes-Oxley Act of 2002 and the recent adoption of new corporate governance listing standards by the major American securities markets have resulted in a number of prescriptions that influence the selection of directors of U.S. public companies. These requirements are in some respects inconsistent with the traditional agency role of the monitoring board and, more important, may conflict with optimal functioning of the board as a group. The authors survey the literature on the role of the board and board dynamics, examine the new constraints and their impact on director qualification and selection, and offer ten practical suggestions for director selection that will help nominating and governance committees of public companies to assemble boards of directors that will effectively perform their critical monitoring functions in the new regulatory environment.
A New Player in the Boardroom: The Emergence of the Independent Directors' Counsel
Geoffrey C. Hazard, Jr. and Edward B. Rock, 59(4): 1389—1412 (Aug. 2004)
When should a secondary actor to a securities fraud—like an accountant or a lawyer—be liable to the same degree as the primary culprit? Ever since the Supreme Court abolished aider and abettor liability for violations of section 10(b) of the Securities Exchange Act of 1934, courts have struggled to answer that question, and the struggle has led to competing standards. In the case of misrepresentations in connection with the purchase or sale of securities, the Courts of Appeal have split between those imposing liability on secondary actors who ''substantially participate'' in making a misrepresentation, and those who also require, as a ''bright line'' test, that the misrepresentation be publicly attributed to the secondary actor before the plaintiff makes his or her investment decision. The court hearing the cases arising from the Enron debacle adopted yet a third alternative, the so-called ''creation'' test, imposing liability on a secondary actor who, alone or with others, ''creates'' a misrepresentation. This Article explores the problem of misrepresentations by secondary actors in securities frauds, analyzes the competing standards of liability, traces the roots of the creation test, and argues ultimately that the creation test and the substantial participation test share deficiencies that the bright line test avoids.
Separate and Continuing Counsel for Independent Directors: An Idea Whose Time Has Not Come as a General Practice
E. Norman Veasey, 59(4): 1413—18 (Aug. 2004)
In their accompanying piece in this issue, Professors Hazard and Rock present a thesis that "independent directors, especially those on the Audit Committee increasingly will be represented on a continuing basis by independent legal counsel." Thus, it is their argument that, as a general practice, there "will emerge a new figure in the boardroom: the Independent Directors' Counsel." Their contention is part prediction/part justification. Either way, it is not likely as a prediction and it is not a good model that can be justified as a general matter. In short, that is my opinion largely because (a) such a general practice is not necessary or desirable; (b) such a general practice may often be disruptive overkill; and (c) the notion that "one size fits all" is not a good model of corporate governance.
Counseling Directors in the New Corporate Culture
E. Norman Veasey, 59(4): 1447—58 (Aug. 2004)
In his March 2004 Tulane speech, former Chief Justice Veasey argues that the business judgment rule is alive and well. Recent Delaware decisions demonstrate that the expectations of director conduct are evolving. This is partly a function of the dynamics of the times and partly because improved pleadings in stockholder complaints have focused more intently on the need for careful, loyal and good faith processes in the boardroom. The quest for best practices of corporate governance is the best prophylactic to avoid liability and to comply with new federal standards.
Should a Duty to the Corporation Be Imposed on Institutional Shareholders?
Roberta S. Karmel, 60(1): 1—21 (November 2004)
The common law principle that directors owe a primary duty to their corporation and a secondary duty to the shareholders of that corporation has been gradually eroded by the federal securities laws so that directors are charged with owing duties to shareholders, with the corporation and other corporate constituents relegated to a lower status. Further, the shareholder primacy model has become the dominant model in scholarship theories with regard to the firm, although other models have been proposed and debated. Under the shareholder primacy model, shareholders are considered the "owners" of the corporation and therefore given rights at the expense of other corporation constituents. Although modern institutional investors do not behave like owners of corporate property, the shareholder primacy norm has been strengthened and reinforced by the Sarbanes-Oxley Act of 2002. Further, in the wake of recent corporate scandals, institutions have been demanding more rights, specifically more rights with respect to the nomination of corporate directors. In view of these demands, this article inquires as to whether large shareholders should obtain any such rights without also acquiring duties to the corporations in which they invest and to other shareholders.
Can a Board Say No When Shareholders Say Yes? Responding to Majority Vote Resolutions
Andrew R. Brownstein & Igor Kirman, 60(1): 23—77 (November 2004)
The past 20 years have witnessed a significant increase in the number of shareholder proposals submitted to American public corporations and in the number of such proposals that have received majority support during shareholder meetings. While some companies have responded to majority vote resolutions by implementing the proposals or reaching settlement with the proponents, a significant number of companies have not adopted the changes suggested by these resolutions. The refusal of companies to adopt such suggested changes, even when doing so after careful consideration by the board of directors, has in turn led some activist shareholders to employ pressure tactics against such companies. After canvassing these changes, this article examines what companies and their directors should do in response to shareholder resolutions that obtain majority shareholder votes. The article concludes that directors retain the ultimate responsibility to act in what they believe to be the best interest of all shareholders, even if that means not adopting majority vote resolutions. At the same time, it also notes that the changed corporate governance climate makes it essential for companies and their directors to treat majority vote resolutions seriously and recommends possible enhanced procedures for considering and acting on such resolutions.
Fiduciary Duties of Directors of a Corporation in the Vicinity of Insolvency and After Initiation of a Bankruptcy Case
Myron M. Sheinfeld & Judy L. Harris, 60(1): 79—107 (November 2004)
This article discusses the general fiduciary duties of directors of corporations and how those duties are altered when a corporation is in the zone or vicinity of insolvency and when the corporation is insolvent. The different tests for determining a corporation's insolvency are outlined. The article also analyzes the fiduciary duties of directors in a Chapter 11 bankruptcy case. In particular, the article discusses directors' duties in managing the bankruptcy estate, directors' responsibilities under Sarbanes-Oxley, and the exculpations of directors that are permitted in Chapter 11 plans of reorganization. The article provides directors with practical guidelines for properly exercising their fiduciary duties in Chapter 11.
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
Independent Directors as Securities Monitors
Hillary A. Sale, 61(4):1375-1412 (August 2006)
This paper considers the role of independent directors of public companies as securities monitors. Rather than engaging in the debate about whether independent directors are good or bad, important or unimportant, the paper takes their existence and basic governance role as a given, focusing instead on what recent statements from Securities and Exchange Commission officials indicating an increased focus on independent directors and their role in preventing securities fraud. The paper notes that the SEC believes that independent directors are on the board to act, at least in part, as securities monitors. This securities monitor role is another aspect of the information-forcing-substance disclosure model that the SEC has used to achieve improved corporate governance. Although directors face heightened risk when they draft or sign disclosure documents, they also have an ongoing responsibility to be informed of developments within the company, ensure good processes for accurate disclosures, and make reasonable efforts to assure that disclosures are adequate. Independent directors with expertise should be involved in reviewing and, sometimes, drafting statements. All directors, however, should be fully aware of the company's press releases, public statements, and communications with security holders and sufficiently engaged and active to question and correct inadequate disclosures. In addition to defining the role of independent directors as securities monitors, the article reviews the liability independent directors might face under private causes of action and contrasts it with the SEC's enforcement powers and remedies. The article describes some of the SEC's prior statements that emphasize the role of independent directors as securities monitors and the importance of their providing both guidance and check and balance.
The Uncertain Efficacy of Executive Sessions Under the NYSE's Revised Listing Standards
Robert V. Hale II, 61(4):1413-1426 (August 2006)
This article briefly explores key issues relating to the use of non-management executive sessions under Section 303A.03 of the NYSE's revised listing standards, including the authority of the SEC to enforce such a requirement, the status of board actions taken at such meetings, and whether such sessions may result in altering the principal roles of the board and management. In this respect, the Disney derivative litigation affords an opportunity to consider the use of executive sessions in relation to these issues, as well as the business judgment rule. Moreover, Disney raises the question whether mandatory non-management executive sessions might have created a different outcome under the circumstances in the case. The article concludes with a discussion of some practical considerations for attorneys and corporate secretaries in complying with the requirement.
The Tensions, Stresses, and Professional Responsibilities of the Lawyer for the Corporation
E. Norman Veasey and Christine T. Di Guglielmo, 62(1): 1–36 (November 2006)
The lawyer for the corporation—whether general counsel, subordinate in-house counsel, or outside counsel—faces tensions, stresses, and professional responsibilities that often differ from those of lawyers who represent individuals. The primary reality that must be faced is that this lawyer's client is—or should be—only the corporate entity.
This article is an attempt to highlight some of the issues that corporate counsel, directors, and managers should seek to recognize and understand. The various challenges faced by both in-house and outside lawyers representing corporations include the maintenance of professional independence, dealing with "up-the-ladder" reporting obligations, seeking to serve the client's best interests through persuasive counseling, the separation of legal and business advice, and dealing with internal investigations, to name a few.
Moreover, in the case of general counsel, special tensions arise because he or she has only one client (the general counsel's employer) and answers both to the CEO and to the board of directors. When these two "bosses" have potential differences or conflicts, the tensions placed on the general counsel may be palpable and difficult to manage consistently with the lawyer's ethical duties, advancement of corporate interests, and job security. Most general counsel are up to the task and do not take the difficulties of their challenges for granted. It is also important, in our view, that directors understand corporate counsel's roles and challenges, as well as the value that counsel brings to the board's responsibilities.
We attempt to address questions of how to establish and fulfill counsel's obligation to be independent, when to advise the corporate actors to seek outside counsel, when to go up the ladder and to summon up the courage to do the right thing. Although we have tried to survey as much of the practical learning and the literature as is reasonable for an article, we believe we have only scratched the surface.
Internal Investigations and the Defense of Corporations in the Sarbanes-Oxley Era
Robert S. Bennett, Alan Kriegel, Carl S. Rauh, and Charles F. Walker, 62(1): 55–88 (November 2006)
Internal investigations long have been an integral part of the successful defense of corporations against charges of misconduct, as well as an important board and management tool for assessing questionable practices. With the heightened standards of conduct and increased exposure created by Sarbanes-Oxley, this essential instrument for safeguarding corporate interests has become even more crucial in identifying and managing risk in the enforcement arena. This article examines from a practitioner's standpoint when and how internal investigations should be conducted in order to protect the corporation in criminal, civil and administrative proceedings. Particular attention is paid to the issues created by a concurrent government investigation and in dealing with employees and former employees in the course of an investigation. The article also addresses the role of the Audit Committee under Sarbanes-Oxley, and the important issue of reporting the findings of the investigation to appropriate corporate officials. The subject of self-reporting by the Company to enforcement authorities is considered as well. In this context, the article explores the SEC's position on crediting self-reporting and cooperation as set forth in the Seaboard report; Department of Justice policy as embodied in the Thompson Memorandum; and the impact of the Federal Sentencing Guidelines for Organizations.
Report of the New York City Bar Association Task Force on the Lawyer's Role in Corporate Governance—November 2006
New York City Bar Association Task Force on the Lawyer's Role in Corporate Governance,62(2): 427–514 (February 2007)
Form or Substance? The Past, Present, and Future of the Doctrine of Independent Legal Significance
C. Stephen Bigler and Blake Rohrbacher, 63(1): 1–24 (November 2007)
The "bedrock" doctrine of independent legal significance provides that, if a transaction is effected in compliance with the requirements of one section of the Delaware General Corporation Law ("DGCL"), Delaware courts will not invalidate the transaction for failing to comply with the requirements of a different section of the DGCL—even if the substance of the transaction is such that it could have been structured under the other section. Two recent decisions of the Delaware courts have caused commentators to question the doctrine's status, but this Article looks to the foundation of the doctrine and the Delaware courts' use of equitable review (and substance–over–form doctrines) to clarify when the doctrine of independent legal significance does and does not apply and when it may be relied on with confidence by corporate practitioners in the future. The doctrine as applied by the courts is narrower than sometimes assumed by corporate practitioners, and the Delaware courts may reserve the equitable power to look through a transaction's form to its substance even if the doctrine does apply.
Having the Fiduciary Duty Talk: Model Advice for Corporate Officers (and Other Senior Agents)
Lyman Johnson, 63(1): 147–162 (November 2007)
Countless legal materials address the fiduciary duties of corporate directors. These include extensive decisional law, numerous institutes and continuing legal education seminars, several treatises and casebooks, and the well–known Corporate Director's Guidebook, recently released in its fifth edition. By contrast, legal materials on the fiduciary duties of corporate officers—key actors and agents in any company—are quite sparse. Case law is meager and undeveloped, with even such a baseline issue as the applicability of the business judgment rule lacking resolution. Treatises, institutes, and other legal materials frequently lump officer fiduciary duties with those of directors or treat them as an afterthought or, in many instances, overlook the subject altogether. There is no preeminent, standard reference serving as the "Corporate Officer's Guidebook."
This Article seeks to begin rectifying this glaring gap in legal literature and professional practice. Fiduciary duties as a vital component of an effective corporate governance system work on an ex ante basis—i.e., officers must be advised of such duties beforehand if such duties are to influence conduct. This Article describes the sources of legal material for deriving a succinct exposition of officer fiduciary duties and then provides suggested "model" fiduciary duty advice for lawyers to use in counseling corporate officers and other senior managers.
How Many Masters Can a Director Serve? A Look at the Tensions Facing Constituency Directors
E. Norman Veasey and Christine T. Di Guglielmo, 63(3): 761–776 (May 2008)
As business trends change and capital markets evolve, directors may face factual situations that raise new questions about the contours of directors' fiduciary duties. One increasingly common situation that presents tensions for a growing number of directors is the allegiances by individuals elected to the board by, and who may seemingly "represent," particular constituencies of the public corporation. Such "constituency directors" or "representative directors" may include, for example, directors designated by creditors, venture capitalists, labor unions, controlling or other substantial stockholders, or preferred stockholders; directors elected by a particular class of stockholders; or directors placed on the board by or at the behest of other constituencies.
We raise several questions. When a particular constituency causes one or more directors to be elected to the board, to whom or to what is that director loyal or beholden? The corporation? All the stockholders? If "yes" as to the corporation and all the stockholders, may the director give some "priority" to the views of the constituency that caused him or her to be placed on the board? Since the board must act collectively and the majority might not favor the outcome desired by the particular constituency, are these questions largely academic?
In this Article, we suggest that the existing standards of liability for breach of fiduciary duty should not change in order to account for changing circumstances. The existing standards of conduct and liability incorporate the necessary flexibility to balance the potentially competing duties of constituency directors with protection of the interests of various corporate constituencies. And if the fiduciary duty standards in corporation law are not sufficiently flexible to accommodate particular circumstances, constituents may wish to invest in an alternative entity (such as a limited liability company) governed by other law that will accommodate their needs. Or perhaps the investor may be able to effect a legally authorized change in the certificate of incorporation of the corporation to permit it to be governed more to the investor's liking.
Corporate Governance of Troubled Companies and the Role of Restructuring Counsel
D.J. (Jan) Baker, John Wm. (Jack) Butler, Jr., and Mark A. McDermott, 63(3): 855–880 (May 2008)
Officers and directors of a troubled corporate enterprise can expect to face a host of complex decisions as they attempt to restructure the corporation's affairs. These decisions may be made more difficult because officers' and directors' fiduciary duties extend to all stakeholders, including creditors, when the corporation is in the zone of insolvency. The role of corporate restructuring counsel is critical in this uncertain environment. This Article provides a comprehensive overview of recent court decisions and statutory changes relating to the fiduciary duties of officers and directors of troubled companies. It also provides practical applications of these principles to common situations that directors and officers face as they attempt to guide a troubled business toward a successful restructuring.
Consumer Arbitration: If the FAA "Ain't Broke," Don't Fix It
Alan S. Kaplinsky and Mark J. Levin, 63(3): 907–920 (May 2008)
During 2007, Congress showed significant interest in mandatory pre–dispute consumer arbitration agreements. Some in Congress focused on whether to prohibit them altogether. This Article argues that such legislation is unnecessary because the current system of consumer arbitration works well and needs no fix. The authors review case law and empirical studies showing that the current system of checks and balances in the area of consumer arbitration law is sufficiently protective of consumers' rights. These protections emanate from: (1) the Federal Arbitration Act ("FAA") itself, (2) the careful drafting of arbitration agreements, (3) the use of third–party arbitration administrators, and (4) the rigorous enforcement of the FAA by state and federal courts.
Breaking the Corporate Governance Logjam in Washington: Some Constructive Thoughts on a Responsible Path Forward
Leo E. Strine, Jr., 63(4): 1079–1108 (August 2008)
Void or Voidable?—Curing Defects in Stock Issuances Under Delaware Law
C. Stephen Bigler and Seth Barrett Tillman, 63(4): 1109-1152 (August 2008)
It is not unusual for a Delaware corporation's stock records to have omissions or procedural defects raising questions as to the valid authorization of some of the outstanding stock. Confronted with such irregularities, most corporate lawyers would likely attempt to cure the defect through board and, if necessary, stockholder ratification. However, in a number of leading cases, the Delaware Supreme Court has treated the statutory formalities for the issuance of stock as substantive prerequisites to the validity of the stock being issued, and the court has determined that failure to comply with such formalities renders the stock in question void, i.e., not curable by ratification. Unfortunately, the decisions issued by the Delaware courts have not afforded the necessary certainty to allow practitioners to decide whether a particular defect in stock issuance is a substantive defect that renders stock void or a mere technical defect that renders stock voidable. This Article analyzes the cases giving rise to this lack of clarity and proposes that the Delaware courts apply the policy underlying Article 8 of the Delaware Uniform Commercial Code to validate stock in the hands of innocent purchasers for value in determining whether stock is void or voidable.
The Unreasonable Burden of Proving the Reasonable Care Defense Under the Uniform Securities Act
Mark B. Barnes and Matthew R. St. Louis, 63(4): 1223—1242 (August 2008)
Under the Uniform Securities Act (a version of which has been enacted by most states), an entity that sells securities in violation of the Act is potentially liable to investors under the Act's civil remedy provisions. Directors, officers, partners, controlling persons, and others associated with the entity at the time of the sale are also potentially liable, jointly and severally with each other and the entity, solely on account of their affiliation with the entity. While the Act entitles these "derivative liability" defendants to assert an affirmative defense of reasonable care, the affirmative defense is narrowly drafted, and courts have interpreted the defense strictly. This Article examines the decisions in which courts have interpreted the "reasonable care" defense, in particular the November 2007 opinion of the Indiana Supreme Court in Lean v. Reed, and ends by recommending securities law compliance policies and procedures that entities selling securities in Uniform Securities Act states might consider adopting to assist their associated and affiliated persons in managing the risk of potential personal liability.
Disclosure Obligations Under the Federal Securities Laws in Government Investigations
David M. Stuart and David A. Wilson, 64(4): 973-998 (August 2009)
With the prevalence of government investigations into corporate conduct, public companies frequently face decisions about whether, when, how, and where to disclose to investors the existence of such investigations and the facts learned in the course of, or as a result of, those investigations. While the federal securities laws (and the rules and regulations promulgated thereunder) require disclosure of specific events that may arise during an investigation, neither those laws nor the courts that have interpreted them provide clear guidance for many of the disclosure decisions that must be made over the course of an investigation. As a result, counsel must carefully analyze numerous facts and circumstances, understand the company's previous disclosures, make "materiality" assessments, and determine whether to make disclosure in a current report or wait until the next periodic filing. This Article seeks to present, through an analysis of precedent disclosures, caselaw, rules, and practical ramifications, the considerations counsel must take into account in evaluating disclosure decisions in the context of an investigation. These considerations can help counsel avoid having a disclosure decision worsen the already difficult circumstances posed by the investigation itself.
Are Corporate Officers Advised About Fiduciary Duties?
Lyman Johnson and Dennis Garvis, 64(4): 1105–1128 (August 2009)
This Article reports the results of an empirical study of whether and how in-house corporate counsel advise corporate officers about fiduciary duties. The fiduciary duties of officers long have been neglected by courts, scholars, and lawyers, even though executives play a central role in corporate success and failure. The study's findings, organized by type of company (public or private), size, and attorney position, show several interesting patterns in advice-giving practices. For example, fewer than half of all respondents provided advice to officers below the senior-most rank. The results raise the possibility that, unlike directors who may overestimate their liability exposure, certain shortcomings in giving advice to officers may cause them to underestimate personal liability exposure and engage in more risky behavior than is desirable for the company itself. The Article also offers recommendations for improved practices in advising officers about their duties.
Did Corporate Governance "Fail" During the 2008 Stock Market Meltdown? The Case of the S&P 500
Brian R. Cheffins, 65(1): 1–66 (November 2009)
In 2008, share prices on U.S. stock markets fell further than they had during any one year since the 1930s. Does this mean corporate governance "failed?" This Article argues generally "no," based on a study of a sample of companies at "ground zero" of the stock market meltdown, namely the thirty-seven firms removed from the iconic S&P 500 index during 2008. The study, based primarily on searches of the Factiva news database, reveals that institutional shareholders were largely mute as share prices fell and that boardroom practices and executive pay policies at various financial firms were problematic. On the other hand, there apparently were no Enron-style frauds, there was little criticism of the corporate governance of companies that were not under severe financial stress, and directors of troubled firms were far from passive, as they orchestrated CEO turnover at a rate far exceeding the norm in public companies. Given that corporate governance functioned tolerably well in companies removed from the S&P 500 and that a combination of regulation and market forces will likely prompt financial firms to scale back the free-wheeling business activities that arguably helped to precipitate the stock market meltdown, the case is not yet made for fundamental reform of current corporate governance arrangements.
Report of the Task Force of the ABA Section of Business Law Corporate Governance Committee on Delineation of Governance Roles & Responsibilities
Task Force of the ABA Section of Business Law Corporate Governance Committee on Delineation of Governance Roles & Responsibilities, 65(1): 107–152 (November 2009)
Private Ordering and the Proxy Access Debate
Lucian A. Bebchuk and Scott Hirst, 65(2): 329–360 (February 2010)
This Article examines two "meta" issues raised by opponents of the SEC's proposal to provide shareholders with rights to place director candidates on the company's proxy materials. First, opponents argue that, even assuming proxy access is desirable in many circumstances, the existing no-access default should be retained and the adoption of proxy access arrangements should be left to opting out of this default on a company-by-company basis. This Article, however, identifies strong reasons against retaining no-access as the default. There is substantial empirical evidence indicating that director insulation from removal is associated with lower firm value and worse performance. Furthermore, when opting out from a default arrangement serves shareholder interests, a switch is more likely to occur when it is favored by the board than when disfavored by the board. We analyze the impediments to shareholders' obtaining opt-outs that they favor but the board does not, and we present evidence indicating that such impediments are substantial. The asymmetry in the reversibility of defaults highlighted in this Article should play an important role in default selection.
Second, opponents of the SEC's proposed reforms argue that, if the SEC adopts a proxy access regime, shareholders should be free to opt out of this regime. We point out the tensions between advocating such opting out and the past positions of many of the opponents, as well as tensions between opting out and the general approach of the proxy rules. Nonetheless, we support allowing shareholders to opt out of a federal proxy access regime, provided that the opt-out process includes necessary safeguards. Opting out should require majority approval by shareholders in a vote where the benefits to shareholders of proxy access are adequately disclosed, and shareholders should be able to reverse past opt-out decisions by a majority vote at any time.
The implications of our analysis extend beyond proxy access to the choice of default rules for corporate elections, and to the ways in which shareholders should be able to opt out of election defaults. In particular, the current plurality voting default should be replaced with a majority voting default, and existing impediments to the ability of shareholders to opt out of arrangements that make it difficult to replace directors should be re-examined.
The SEC's Proposed Proxy Access Rules: Politics, Economics, and the Law
Joseph A. Grundfest, 65(2): 361–394 (February 2010)
The U.S. Securities and Exchange Commission has proposed proxy rules that would mandate shareholder access under conditions that could be modified by a shareholder majority to make proxy access easier, but not more difficult. From a legal perspective, this Mandatory Minimum Access Regime is so riddled with internal contradictions that it is unlikely to withstand review under the arbitrary and capricious standard of the Administrative Procedure Act. In contrast, a fully enabling opt-in proxy access rule is consistent with the administrative record developed to date and can be implemented with little delay.
From a political perspective, and consistent with the agency capture literature, the Proposed Rules are easily explained as an effort to generate benefits for constituencies allied with currently dominant political forces, even against the will of the shareholder majority. Viewed from this perspective, the Proposed Rules have nothing to do with shareholder wealth maximization or optimal corporate governance, but instead reflect a traditional contest for economic rent common to political brawls in Washington, D.C.
From an economic perspective, if the Commission decides to implement an opt-out approach to proxy access, it will then confront the difficult problem of defining the optimal proxy access default rule. The administrative record, however, currently contains no information that would allow the Commission objectively to assess the preferences of the shareholder majority regarding proxy access at any publicly traded corporation. To address this gap in the record, the Commission could conduct a stratified random sample of the shareholder base, and rely on the survey's results to set appropriate default proxy access rules. The Commission's powers of introspection are insufficient to divine the value-maximizing will of the different shareholder majorities at each corporation subject to the agency's authority.
Attacking the Classified Board of Directors: Shaky Foundations for Shareholder Zeal
Michael E. Murphy, 65(2): 441–486 (February 2010)
The practice of dividing the corporate board into classes, with each class up for election in successive years, has venerable roots in corporate practice. However, it has recently come under concerted attack by institutional shareholders that fear its misuse as a takeover defense. Examining the issue from several perspectives, this Article argues that the possible misuse of the classified board as a takeover defense justifies no more than case-by-case consideration. A separate concern is that the classified board may constitute a barrier to a minority shareholder voice. While this concern has some merit, this Article argues that the classified board is a redundant barrier to a minority shareholder voice that has importance only if preceded by other reforms to enfranchise minority shareholders.
Reinterpreting Section 141(e) of Delaware's General Corporation Law: Why Interested Directors Should Be "Fully Protected" in Relying on Expert Advice
Thomas A. Uebler, 65(4): 1023–1054 (August 2010)
Directors of Delaware corporations often rely on lawyers, economists, investment bankers, professors, and many other experts in order to exercise their managerial power consistently with their fiduciary duties. Such reliance is encouraged by section 141(e) of the General Corporation Law of the State of Delaware, which states in part that directors "shall . . . be fully protected" in reasonably relying in good faith on expert advice. Section 141(e) should provide all directors of Delaware corporations a defense to liability if, in their capacity as directors, they reasonably relied in good faith on expert advice but nevertheless produced a transaction that is found to be unfair to the corporation or its stockholders, as long as the unfair aspect of the transaction arose from the expert advice. The Delaware Court of Chancery, however, has limited the full protection of section 141(e) by confining it to disinterested directors in duty of care cases. That limitation, which is not expressed in the statute, unfairly punishes interested directors who act with an honesty of purpose and reasonably rely in good faith on expert advice because it requires them to serve as guarantors of potentially flawed expert advice. This Article concludes that Delaware courts should reconsider the application and effect of section 141(e) and allow directors, regardless of their interest in a challenged transaction, to assert section 141(e) as a defense to liability in duty of care and duty of loyalty cases if they reasonably relied in good faith on expert advice.
The Enforceability and Effectiveness of Typical Shareholders Agreement Provisions
Corporation Law Committee of the Association of the Bar of the City of New York, 65(4): 1153–1204 (August 2010)
One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?
Leo E. Strine, Jr., 66(1): 1–26 (November 2010)
This essay poses the question of how corporations can be managed to promote long–term growth if their stockholders do not act and think with the long term in mind. To that end, the essay highlights the underlying facts regarding how short a time most stockholders, including institutional investors, hold their shares, the tension between the institutional investors' incentive to think short term and the best interests of not only the corporations in which these investors buy stock, but also with the best interests of the institutional investors' own clients, who are saving to pay for college for their kids and for their own retirement. Although the primary purpose of the essay is to highlight this fundamental and too long ignored tension in current corporate governance, the essay also identifies some modest moves to better align the incentives of institutional investors with those of the people whose money they manage, in an effort to better focus all those with power within the corporation—i.e., the directors, the managers, and the stockholders—on the creation of durable, long–term wealth through the sale of useful products and services.
Restoring the Balance of Power in Corporate Management: Enforcing an Officer's Duty of Obedience
Megan Wischmeier Shaner, 66(1): 27–60 (November 2010)
The issue of corporate officers' fiduciary duties has been a neglected area of Delaware law for over seventy years. This is surprising given the power and authority that these individuals wield over a corporation's business and affairs. The transgressions that took place at large public corporations such as Enron and WorldCom serve as reminders, even after all these years, of how officer misconduct can dramatically affect a corporation's fortunes. Following the scandals that occurred in corporate America in the beginning of the twenty–first century, as well as those that emerged in the recent financial crisis, there has been a renewed focus in certain quarters on rethinking the officer–centric model of corporate management that has come to exist.
Viewed as an effective means of achieving good corporate governance, much of the discussions surrounding increasing officer accountability pertain to the appropriate model for officer fiduciary duties and the standard of liability for such duties. This article discusses the application to officers of the duty of obedience that exists in agency law and asserts that emphasizing this duty of officers would be an effective step toward restoring the proper balance of power in corporate management. Based on the concept that certain persons are not only subject to the authority and direction of others in an organization's hierarchy, but have an affirmative duty to implement those directions, the duty of obedience exemplifies the relationship between directors and officers contemplated by corporate statutes and case law. Accordingly, this article asserts that focusing on enforcing the fiduciary duty of obedience would advance efforts to distinguish more clearly the governance responsibilities of officers from those of directors as well as increase officer accountability.
The SEC and the Financial Industry: Evidence from Enforcement Against Broker-Dealers
Stavros Gadinis, 67(3): 679 - 728 (May 2012)
The Securities and Exchange Commission plays a central part in the U.S. regulatory framework for the supervision of the financial industry. How hasthe SEC carried out this mission? Despite recurrent crises, systematic studies of SEC performance data are surprisingly scarce. As the SEC reforms itself to address the shortcomings revealed in 2007–2008, a systematic examination of the agency’s past record can help identify priorities and evaluate the agency’s renewed efforts. This study takes a first step in studying empirically SEC enforcement against investment banks and brokerage houses, examining the agency’s record in the period right before the 2007–2008 crisis. This data suggests that defendants associated with big firms fared better in SEC enforcement actions as compared to defendants associated with smaller firms in three important dimensions. First, SEC actions against big firms were more likely to involve corporate liability exclusively, with no individuals subject to any regulatory action. Second, big-firm defendants were more likely to end up in administrative rather than court proceedings, controlling for types of violation and levels of harm to investors. Third, within administrative proceedings, big-firm employees were likely to receive lower sanctions, notably temporary or permanent bars from the industry. These patterns have important implications for major debates concerning corporate liability, regulatory capture, and the public and private enforcement of securities laws.
General Counsel Buffeted by Compliance Demands and Client Pressures May Face Personal Peril
E. Norman Veasey and Christine T. Di Guglielmo,68(1): 57 - 80 (November 2012)
In the "New Reality" of the world of corporate general counsel, the challenges and tensions thrust upon one holding that office have intensified exponentially. Not only does the general counsel uniquely straddle the world of business and law in giving advice to the management and directors of her client (the corporation) but also she may find herself personally in the crosshairs of regulators, prosecutors, and litigants. So, as the rhetoric and real pressures increase to target the general counsel, she must have and use the skills, balance, independence, and courage to be simultaneously the persuasive counselor for her corporate client while being attuned to the need for self-preservation. The lessons from the past targeting of general counsel and other in-house lawyers are ominous. But the quintessential general counsel, acting as both persuasive counselor and a leader in setting the corporation's ethical tone, will do the right thing and thus be prepared to deal with these challenges and tensions.
The Brouhaha Over Intra-Corporate Forum Selection Provisions: A Legal, Economic, and Political Analysis
Joseph A. Grundfest and Kristen Savelle; 68(2): 325-410 (February 2013)
Three hundred publicly traded entities have adopted intra-corporate forum selection (“ICFS”) provisions either in their charters or as bylaw amendments, often without prior stockholder approval. These provisions have been adopted in response to a sharp increase in intra-corporate litigation outside the state of incorporation. The academic literature suggests that this increase is animated by economic incentives of the plaintiffs’ bar that can be inimical to stockholder interests. ICFS provisions are an effective private ordering mechanism for addressing this trend in a manner that responsibly protects stockholder rights.
Corporate Short-Termism—In the Boardroom and in the Courtroom
Mark J. Roe, 68(4): 977-1006 (August 2013)
A long-held view in corporate circles has been that furious rapid trading in stock markets has been increasing in recent decades, justifying more judicial measures that shield managers and boards from shareholder influence, so that boards and managers are more free to pursue sensible long-term strategies in their investment and management policies. In this piece, I evaluate the evidence in favor of that view and find it insufficient to justify insulating boards from markets further: several under-analyzed aspects of the American economy and corporate structure are in play, each of which alone could trump a prescription for more board autonomy. The American economy has alternative institutions that mitigate, or reverse, much of any short-term tendencies in public markets; the evidence that the stock market is, net, short-termist is inconclusive; inside-the-corporation labor market difficulties would be exacerbated by further judicial insulation of boards from markets; other institutions are better positioned to deal with any short-term horizons in business than corporate law courts; and the widely held view that short-term trading has increased dramatically in recent decades may over-interpret the data, as the holding duration for major stockholders, such as mutual funds like Fidelity and Vanguard, and major pension funds, does not seem to have shortened and there is unnoticed evidence that the pay duration of the CEO and other executives is shorter than the average stockholders’ duration, calling into question where the structural sources of potential short-termism lie. Overall, system-wide short-termism in public firms is something to watch, but not something that today should affect corporate lawmaking.
Benefit Corporations: A Challenge in Corporate Governance
Mark J. Loewenstein, 68(4): 1007-1038 (August 2013)
Benefit corporations are a new form of business entity that is rapidly being adopted around the country. Though the legislations varies from jurisdiction to jurisdiction, most statutes are based on a model proposed and promoted by B Lab, itself a nonprofit corporation. The essence of these statutes is that, in making business judgments, the directors of a benefit corporation must take into account the impact of their decisions on the environment and society. The model legislation, though, may create serious governance issuance for the directors of benefit corporations that operate under these laws. This article analyzes the model legislation and identifies its weaknesses, particularly with respect to governance issues.
Benefit Corporation White Paper
Corporate Laws Committee, ABA Business Law Section, 68(4): 1083-1110 (August 2013)
Fiduciary Society Unleashed: The Road Ahead for the Financial Sector
Edward J. Waitzer and Douglas Sarro, 69(4): 1081-1116 (August 2014)
Informational asymmetries, misaligned incentives and artificially elongated chains of intermediation have created a disconnect between the financial sector and the “real economy” that is detrimental to the public interest. Courts and regulators are increasingly intervening to break the cycle. We argue that fiduciary law offers a conceptual framework both for understanding and responding to this trend, and that the financial sector, rather than waiting for this trend to develop and reacting to new rules in a piecemeal way, should be proactive and try to shape the way in which this trend develops. We describe some elements of what such an approach might look like, and consider how regulators and political institutions can encourage financial institutions to adopt this approach, and in so doing support a broader transition to a more sustainable economy.
The Evolving Role of Special Committees in M&A Transactions: Seeking Business Judgment Rule Protection in the Context of Controlling Shareholder Transactions and Other Corporate Transactions Involving Conflicts of Interest
Scott V. Simpson and Katherine Brody, 69(4): 1117-1146 (August 2014)
Special committees of independent, disinterested directors have been widely used by corporate boards to address conflicts of interests and reinforce directors’ satisfaction of their fiduciary duties in corporate transactions since the wave of increased M&A activity in the 1980’s. In 1988, The Business Lawyer published an article titled The Emerging Role of the Special Committee by one of this article’s co-authors, examining the emerging use of special committees of independent directors in transactions involving conflicts of interest. At that time, the Delaware courts had already begun to embrace the emergent and innovative mechanism for addressing corporate conflicts. Now, after over thirty years of scrutiny by the Delaware courts, it is clear that the special committee is a judicially recognized (and encouraged) way to address director conflicts of interest and mitigate litigation risk. This article will examine the role of the special committee in the context of conflict of interest transactions, with a particular focus on transactions involving a change of control or a controlling stockholder, from a U.S. perspective (in particular, under the laws of the State of Delaware), and will briefly consider international applications of the concepts discussed. To this end, this article will examine recent case law developments and compare the special committee processes at the heart of two high-profile Delaware decisions, and, finally, provide guidance to corporate practitioners on the successful implementation of a special committee process.
Corporate Law After Hobby Lobby
Lyman Johnson and David Millon, 70(1): 1-32 (Winter 2014/2015)
We evaluate the U.S. Supreme Court’s controversial decision in the Hobby Lobby case from the perspective of state corporate law. We argue that the Court is correct in holding that corporate law does not mandate that business corporations limit themselves to pursuit of profit. Rather, state law allows incorporation for any lawful purpose. We elaborate on this important point and also explain what it means for a corporation to “exercise religion.” In addition, we address the larger implications of the Court’s analysis for an accurate understanding both of state law’s essentially agnostic stance on the question of corporate purpose and also of the broad scope of managerial discretion.
The Rights and Duties of Blockholder Directors
J. Travis Laster and John Mark Zeberkiewicz, 70(1): 33-60 (Winter 2014/2015)
Delaware corporate law embraces a “board-centric” model of governance contemplating that, as a general matter, all directors will participate in a collective and deliberative decision-making process. Rather than serving as a justification for a board majority to disempower directors elected or appointed by or at the direction of a particular class or series of stock or an insurgent group—which we refer to as “blockholder” directors—this system recognizes the need for a balancing of both majority and minority rights. In this article, we review the rights and duties of all directors and highlight cases where both board majorities and blockholder directors have overstepped their bounds. We caution that board majorities should deliberate carefully before taking action that limits a blockholder director’s rights or excludes the blockholder director from participation in fundamental corporate matters. At the same time, we caution that blockholder directors should take care when exercising their rights, given that their affiliation with investors may make them vulnerable to duty of loyalty claims. We urge both sides to proceed with a sense of empathy toward the other and seek to make reasonable accommodations, and we emphasize the role that experienced corporate counsel can play in mediating disputes, resolving tensions, and striking the appropriate balance in the boardroom.
The Effect of Deferred and Non-Prosecution Agreements on Corporate Governance—Evidence from 1993−2013
Wulf A. Kaal and Timothy A. Lacine, 70(1): 61-120 (Winter 2014/2015)
Non- and Deferred Prosecution Agreements (N/DPAs) are controversial because prosecutors, not judges or the legislature, are changing the governance of leading public corporations and entire industries. To analyze N/DPAs’ corporate governance implications and provide policy makers with guidance, we code all publicly available N/DPAs (N=271) from 1993 to 2013, identifying 215 governance categories and subcategories. We find evidence that the execution of N/DPAs is associated with significant corporate governance changes. The study categorizes mandated corporate governance changes for entities that executed an N/DPA as follows: (1) Business Changes, (2) Board Changes, (3) Senior Management, (4) Monitoring, (5) Cooperation, (6) Compliance Program, and (7) Waiver of Rights. We supplement the analysis of governance changes in these categories with a more in depth evaluation of the respective subcategories of governance changes. We also code and analyze preemptive remedial measures, designed by corporations to preempt the execution of an N/DPA or corporate criminal indictment. The article evaluates the implications of the empirical evidence for boards, management, and legal practitioners.
Consent in Corporate Law
Lawrence A. Hamermesh; 70(1): 161-174 (Winter 2014/2015)
Recent Delaware case law explores and extends what the author describes as the “doctrine of corporate consent,” under which a stockholder is deemed to consent to changes in the corporate relationship that are adopted pursuant to statutory authority (such as by directors adopting bylaws). This essay examines whether and to what extent there may be limits on the application of the doctrine of corporate consent and whether fee-shifting bylaws exceed those limits.
Massey Prize for Research in Law, Innovation, and Capital Markets Symposium—Foreword
70(2): 319-320 (Spring 2015)
Harmony or Dissonance? The Good Governance Ideas of Academics and Worldly Players
Robert C. Clark; 70(2): 321-346 (Spring 2015)
This lecture asks questions concerning ideas about what constitutes good corporate governance that are espoused by academics, such as financial economists and law professors, and by more worldly players such as legislators, rule makers, governance rating firms, large institutional investors, law firms that represent corporate clients, and courts. Are there discernible trends and patterns in the views espoused by these different categories of actors, despite all the differences among individual actors within each category? I propose that there are such patterns, offer some initial thoughts about the characteristic themes and differences, and hypothesize about the reasons for the differences. At the end I reflect on what a benign policy maker interested in increasing overall social welfare might do with these observations.
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
Discipline Involving Multiple Disciplines—Protecting Innocent Executives in the Age of “Cooperation”
James D. Wing and Andrew L. Oringer; 70(4): 1123-1138 (Fall 2015)
In 2008–2009, the global financial system had a near-death experience, and the legal consequences still reverberate. New business, financial, regulatory, and cybersecurity risks abound. Legal risks have become increasingly criminalized, with investigations and prosecutions today directed at corporate directors and officers individually, as companies under investigation choose to “cooperate” with law enforcement. While this “cooperation revolution” already has significantly affected the practice of white-collar criminal defense, its impact is only beginning to achieve general visibility inside three of the other most-affected areas of legal practice: corporate law, insurance law, and civil litigation. These different and largely separate areas must be coordinated if the protection of directors and officers is to be put on sound footing. This article lays out the issues and suggests ways forward in light of developments in the insurance markets.
Financial Advisor Engagement Letters: Post-Rural/Metro Thoughts and Observations
Eric S. Klinger-Wilensky and Nathan P. Emeritz, 71(1): 53-86 (Winter 2015/2016)
The liability of RBC in last year’s In re Rural/Metro decision was derivative of several breaches of fiduciary duty by the Rural/Metro directors, including those directors’ failing “to provide active and direct oversight of RBC.” In discussing that failure, the Court of Chancery stated that a “part of providing active and direct oversight is acting reasonably to learn about actual and potential conflicts faced by directors, management and their advisors.” In the year since Rural/Metro, there has been an ongoing discussion—in scholarly and trade journals, courtrooms and the marketplace—regarding how, if at all, the process of vetting potential financial advisor conflicts should evolve. In this article, we set out our belief that financial advisor engagement letters are an efficient (although admittedly not the only) tool to vet potential conflicts of a financial advisor. We then discuss four contractual provisions that, we believe, are helpful in providing the active and direct oversight that was found lacking in Rural/Metro.
Anti-Primacy: Sharing Power in American Corporations
Robert B. Thompson, 71(2): 381-426 (Spring 2016)
Prominent theories of corporate governance frequently adopt primacy as an organizing theme. Shareholder primacy is the oldest and most used of this genre. Director primacy has grown dramatically, presenting in at least two distinct versions. A variety of alternatives have followed—primacy for CEOs, employees, creditors. All of these theories cannot be right. This article asserts that none of them are. The alternative developed here is one of shared power among the three actors named in corporations statutes with judges tasked to keep all players in the game. The debunking part of the article demonstrates how the suggested parties lack legal or economic characteristics necessary for primacy. The prescriptive part of the article suggests that we can better understand the multiple uses of primacy if we recognize that law is not prescribing first principles for governance of firms, but rather providing a structure that works given the economic and business environment in place for modern corporations where separation of function and efficiencies of managers provide the starting point. Thus, the familiar statutory language putting all power in the board must be read against the reality of the discontinuous nature of board (and shareholder) involvement in governance. Corporate governance documents of the largest American corporations, as discussed in the article, are consistent with this reality, assigning management to officers and using verbs like oversee, review, and counsel as the director functions. The last part examines dispute resolution and the role of judges in such a world, with a particular focus on the shareholder/director boundary. At this boundary there are two distinct judicial roles, the traditional role focusing on use of fiduciary duty to check conflict and other director incapacity and the less-recognized role of protecting shareholder self-help. In this more modern context shareholders, because of market and economic developments, are able to effectively participate in governance in a way that was not practical three decades ago, when the key Delaware legal doctrines were taking root. What is particularly interesting here is how courts, commentators, and institutional investors act in a way that is consistent with a shared approach to power, as opposed to the primacy of any of the theories initially suggested.
Securing Our Nation’s Economic Future: A Sensible, Nonpartisan Agenda to Increase Long-Term Investment and Job Creation in the United States
Leo E. Strine, Jr., 71(4): 1081-1112 (Fall 2016)
These days it has become fashionable to talk about whether the incentive system for the governance of American corporations optimally encourages long-term investment, sustainable policies, and therefore creates the most long-term economic and social benefit for American workers and investors. Many have come to the conclusion that the answer to that question is no. As these commentators note, the investment horizon of the ultimate source of most equity capital—human beings who must give their money to institutional investors to save for retirement and college for their kids—is long. That horizon is much more aligned with what it takes to run a real business than that of the direct stockholders, who are money managers and are under strong pressure to deliver immediate returns at all times. Americans want corporations that are focused on sustainable wealth and job creation. But there is too little talk accompanied by a specific policy agenda to address that incentive system.
This Article proposes a genuine, realistic agenda that would better promote a sustainable, long-term commitment to economic growth in the United States. This agenda should not divide Americans along party lines. Indeed, most of the elements have substantial bipartisan support. Nor does this agenda involve freeing corporate managers from accountability to investors for delivering profitable returns. Rather, it makes all those who represent human investors more accountable, but for delivering on what most counts for ordinary investors, which is the creation of durable wealth by socially responsible means.
The fundamental elements of this strategy to promote long-term American competitiveness include: (i) tax policy that discourages counterproductive behavior and encourages investment and work; (ii) investment policies to revitalize our infrastructure, address climate change, create jobs, and close our deficit; (iii) reforming the incentives of and enhancing the fiduciary accountability of institutional investors; (iv) reducing the focus on quarterly earnings estimates and improving the quality of information provided to investors; and (v) an American commitment to an international level playing field to reduce incentives to offshore jobs, erode the social safety net, and pollute the planet.
The “Long Term” in Corporate Law
J.B. Heaton, 72(2): 353-366 (Spring 2017)
To read influential corporate lawyers, legal academics, and jurists, shareholders are an alarmingly myopic bunch who demand that corporate directors and managers make short-term decisions that sacrifice long-term value. But here is the mystery: there is virtually no evidence that shareholders prefer short-term gains that are smaller than larger (discounted) long-term gains.
This article makes a simple claim: the short term/long term rhetoric in Delaware corporate law masks the real battle, one between a rational desire by clear-sighted shareholders for shareholder value maximization, on the one hand, and a desire by courts and others for corporate longevity— i.e., long-term corporate survival—on the other. Corporate law directs, or at least allows, directors to manage for long-term survival under cover of long-term shareholder wealth maximization, i.e., a state of sufficient ongoing profitability that allows the corporation to exist for as long as possible, regardless whether that level of profitability actually is value-maximizing for shareholders.
The problem this raises is obvious: if Delaware allows corporations to prioritize longevity, then that is a goal often at odds with what shareholders want. Whether this policy is good or bad for society, I leave for another day. But so long as Delaware leaves the power of the vote with shareholders while giving directors a hidden power to act against shareholder interests in the name of corporate longevity, we can expect (and will continue to see) shareholder objections and activist efforts in many cases where corporations are worth more in different form, whether differently oriented, smaller, acquired and merged into larger organizations, or, to put it harshly, liquidated and dead altogether.
SEC Cybersecurity Guidelines: Insights into the Utility Risk Factor Disclosures for Investors
Edward A. Morse, Vasant Raval, and John R. Wingender, Jr., 73(1): 1-34 (Winter 2017/2018)
In October 2011, the SEC issued new guidelines for disclosure of cybersecurity risks. Some firms responded to these guidelines by issuing new risk factor disclosures. This article examines the guidelines and cybersecurity disclosures in the context of existing laws governing securities regulation. It then examines empirical results from firm disclosures following the new guidelines. Evidence shows a relatively small proportion of firms chose to modify their risk factor disclosures, with most firms choosing not to disclose any specific cybersecurity risk. Moreover, disclosing firms generally experienced significant negative stock market price effects on account of making new disclosures. Rather than viewing disclosure as a positive signal of management attentiveness, investors apparently viewed it as a cautionary sign.
Public Company Virtual-Only Annual Meetings
Lisa A. Fontenot, 73(1): 35-52 (Winter 2017/2018)
Public companies traditionally hold annual shareholder meetings using a formal in-person format. Some companies have more recently supplemented the meeting with audio or video streaming and are now adding an electronic component to a physical meeting to allow for remote participation, commonly referred to as a “hybrid meeting.” A relatively small but fast-growing number of companies are holding their annual shareholder meetings on an electronic-only basis with no physical meeting, known as a “virtual-only meeting.” This article discusses the legal landscape for virtual-only meetings, briefly reviews the history of the practice, and explores the controversy they present with certain institutional investors and activists. Its objective is to provide an initial roadmap of legal and practical considerations for companies considering virtualonly shareholders meetings.
Finding the Right Balance in Appraisal Litigation: Deal Price, Deal Process, and Synergies
Lawrence A. Hamermesh and Michael L. Wachter, 73(4) 961-1010 (Fall 2018)
This article examines the evolution of Delaware appraisal litigation and concludes that recent precedents have created a satisfactory framework in which the remedy is most effective in the case of transactions where there is the greatest reason to question the efficacy of the market for corporate control, and vice versa. We suggest that, in effect, the developing framework invites the courts to accept the deal price as the proper measure of fair value, not because of any presumption that would operate in the absence of proof, but where the proponent of the transaction affirmatively demonstrates that the transaction would survive judicial review under the enhanced scrutiny standard applicable to fiduciary duty-based challenges to sales of corporate control. We also suggest, however, that the courts and expert witnesses should and are likely to refine the manner in which elements of value (synergies) should, as a matter of well-established law, be deducted from the deal price to arrive at an appropriate estimate of fair value.
Human Rights Protections in International Supply Chains - Protecting Workers and Managing Company Risk
David V. Snyder and Susan A. Maslow, 73(4) 1093-1106 (Fall 2018)
Corporate Governance and Countervailing Power
Brian R. Cheffins, 74(1) 1-52 (Winter 2018/2019)
The analysis of corporate governance has been a one-sided affair. The focus has been on “internal” accountability mechanisms, namely boards and shareholders. Each has become more effective since debates about corporate governance began in earnest in the 1970s but it is doubtful whether this process can continue. Correspondingly, it is an opportune time to expand the analysis of corporate governance. This article does so by focusing on three “external” accountability mechanisms that can operate as significant constraints on managerial discretion, namely governmental regulation of corporate activity, competitive pressure from rival firms, and organized labor. A unifying feature is that each was an element of a theory of “countervailing power” economist John Kenneth Galbraith developed in the 1950s with respect to corporations, an era when external accountability mechanisms did more than their internal counterparts to keep management in check.
The Past and Future of Debt Recharacterization
James M. Wilton and William A. McGee, 74(1) 91-126 (Winter 2018/2019)
The bankruptcy doctrine of debt recharacterization, as developed in four federal circuits, uses multi-factor tests derived from tax cases involving solvent companies. Aspects of these tests make no sense when applied to debt of insolvent companies and the U.S. Treasury has determined that, even for the purpose originally intended, the tests produce “inconsistent and unpredictable results.” The Ninth Circuit has now joined the Fifth Circuit in looking to state law as the basis for determining whether debt claims should be recharacterized as equity and disallowed in bankruptcy cases. This Article examines these two approaches, analyzing arguments for and against application of a federal or a state law rule of decision for debt recharacterization. Drawing on U.S. Supreme Court precedent, statutory analysis, and policy, the Article shows that, under long-standing legal principles, state law provides the proper framework for determining whether debt should be recharacterized as equity in bankruptcy and offers both consistency between state and federal courts and a higher degree of predictability concerning the enforcement of insider debt. The article predicts that the U.S. Supreme Court will ultimately resolve the circuit split in favor of a state law rule of decision. In anticipation of such a ruling, the article concludes by providing an overview of choice of law issues and state law approaches to debt recharacterization.
Rethinking the Board of Directors: Getting Outside the Box
Stephen M. Bainbridge, 74(2) 285-296 (Spring 2019)
Externalizing Board Governance Means Changing the Board’s Function
Kelli Alces Williams, 74(2) 297-306 (Spring 2019)
Do Conflicts of Interest Require Outside Boards? Yes. BSPs? Maybe
Usha R. Rodrigues, 74(2) 307-312 (Spring 2019)
Upstream Liability, Entities as Boards, and the Theory of the Firm
Andrew Verstein, 74(2) 313-328 (Spring 2019)
Board Governance for the Twenty-First Century
Faith Stevelman and Sarah C. Haan, 74(2) 329-350 (Spring 2019)
Board 3.0: An Introduction
Ronald J. Gilson and Jeffrey N. Gordon, 74(2) 351-366 (Spring 2019)
Capitalism and Pragmatism Govern New Paradigms for Corporate Governance
Philip C. Thompson, 74(2) 367-372 (Spring 2019)
Outsourcing the Board: A Rebuttal
M. Todd Henderson, 74(2) 373-386 (Spring 2019)
Dilution, Disclosure, Equity Compensation, and Buybacks
Bruce Dravis, 74(3) 631-658 (Summer 2019)
Equity compensation and company share buybacks are complementary: Equity compensation share issuances increase outstanding shares; buybacks decrease outstanding shares. Yet the two types of transactions require very different approval processes and securities and financial disclosures, and generate different financial and tax results, all of which are described in this article, and illustrated by data collected from fifty-nine of America’s largest public companies. This article encourages critics of buybacks to consider the complexity and interrelationship of buybacks and equity compensation.
Reconsidering Stockholder Primacy in an Era of Corporate Purpose
David J. Berger, 74(3) 659-676 (Summer 2019)
Ideology matters. Since the 1980s stockholder primacy has been the dominant ideology shaping corporate law. As a result, case law, director conduct, and our understanding of “best governance practices” have all been viewed under a single prism: how do these rules impact stockholder value? Even the recent debate over corporate purpose has largely been limited to stockholders, directors, and (of course) academics. Excluded from the debate are the vast majority of the population that owns little or no stock, as well as other corporate stakeholders such as employees and communities. This article considers how the discussion of corporate purpose is limited by stockholder primacy, and how a true debate over corporate purpose may require a reconsideration of the dominant ideology over stockholder purpose.
Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets
Jonathan Macey and Joshua Mitts, 74(4): 1015-1064
In this article, we make several contributions to the literature on appraisal rights and similar cases in which courts assign values to a company’s shares in the litigation context. First, we applaud the recent trend in Delaware cases to consider the market prices of the stock of the company being valued if that stock trades in an efficient market, and we defend this market-oriented methodology against claims that recent discoveries in behavioral finance indicate that share prices are unreliable due to various cognitive biases. Next, we propose that the framework and methodology for utilizing market prices be clarified. We maintain that courts should look at the market price of the securities of a target company whose shares are being valued, unadjusted for the news of the merger, rather than at the deal price that was reached by the parties in the transaction.
Interview with Marty Lipton
Jessica C. Pearlman; 75(2): 1709-1724 (Spring 2020)
In September of 2019, after wrapping up meetings of the Mergers and Acquisitions (“M&A”) Committee of the Business Law Section of the American Bar Association (“ABA”), I took the train from Washington, D.C. to New York City to meet with Marty Lipton—the well-known founder of Wachtell, Lipton, Rosen & Katz—in a conference room at his firm. It was perfect timing to have this conversation with Mr. Lipton, given recent developments relating to corporate views on the constituencies corporations may take into account in their decision-making.
Dodge v. Ford Motor Co. at 100: The Enduring Legacy of Corporate Law’s Most Controversial Case
Michael J. Vargas, 75(3): 2103-2122 (Summer 2020)
This article examines Dodge v. Ford on its 100th anniversary. In Dodge v. Ford, the Michigan Supreme Court held that a business corporation is organized for the profit of its shareholders, and the directors must operate it in service to that end. Despite the fact that Dodge v. Ford is rarely cited in judicial opinions, the case continues to spark controversy in legal scholarship. There is little justification for this scholarly attention because the factual basis is little more than a caricature of Henry Ford, and subsequent developments in corporate law have all but eviscerated the precedential value of the case. Rather, the legacy of Dodge v. Ford may simply be that it serves as a convenient talisman, standing for the one sentence anyone actually cares about and rolled out with each new battle in the war between shareholder profit maximization and corporate social responsibility.