ProfessorBainbridge.com

We are cited in Delaware

Delaware Vice Chancellor Laster cited my article Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189 (1995), at pp. 31-32 and 33 of his opinion in IN RE WAYPORT, INC. LITIGATION, a very interesting opinion dealing with the state law of insider trading. More later.
   

My debate with Larry Cunningham re the corrupt gratuities hedge funds want to pay their Hess director nominees

Continues here.

Duties of corporate officers and directors

In a post on MF Global trustee Louis Freeh's suit against Jon Corzine, Steven Davidoff and Peter Henning explain (I think correctly) that Freeh would have a hard time recovering against MF Global's directors:

Under Delaware law, where MF Global was incorporated, corporate directors cannot be sued to recover monetary damages for anything except a breach of the duty of loyalty, which usually requires showing that they gained improper benefits from their actions. To establish that directors are liable for failing to oversee the company and its risk management practices, Mr. Freeh would have to prove that “the directors demonstrated a conscious disregard for their responsibilities” and acted in bad faith.

This is an extremely high standard to meet, and Delaware courts regularly dismiss such claims. In a shareholder derivative case involving claims that Citigroup’s board failed to properly oversee the bank’s risk management before the financial crisis, for example, a Delaware court refused to find the board liable despite the bank’s near collapse and subsequent government bailout. Indeed, the court stated that under Delaware law “[t]o impose oversight liability on directors for failure to monitor ‘excessive’ risk would involve courts in conducting hindsight evaluations of decisions at the heart of the business judgment of directors.” The case against the Citigroup directors was dismissed because the plaintiffs could not show that the directors had acted in bad faith, but instead may have merely failed in their risk monitoring.

Mr. Freeh is keenly aware that Delaware law presents an almost insurmountable barrier to any suit against the directors. The board certainly looks foolhardy in trusting Mr. Corzine to take the risks that he did, but proving that they acted in bad faith would be quite difficult.

I concur. See my article on the Citigroup case, Caremark and Enterprise Risk Management (March, 18 2009). UCLA School of Law, Law-Econ Research Paper No. 09-08. Available at SSRN: http://ssrn.com/abstract=1364500:

The Caremark decision asserted that a board of directors has a duty to ensure that appropriate "information and reporting systems" are in place to provide the board and top management with "timely and accurate information." Although post-Caremark opinions and commentary have focused on law compliance programs, risk management programs do not differ in kind from the types of conduct that traditionally have been at issue inCaremark-type litigation.

Risk management failures do differ in degree from law violations or accounting irregularities. In particular, risk taking and risk management are inextricably intertwined. Efforts to hold directors accountable for risk management failures thus threaten to morph into holding directors liable for bad business outcomes. Caremark claims premised on risk management failures thus uniquely implicate the concerns that animate the business judgment rule's prohibition of judicial review of business decisions. As Caremark is the most difficult theory of liability in corporate law, risk management is the most difficult variant of Caremark claims.

But then Davidoff and Henning opine that:

.... it is much easier under the law to hold officers liable for misdeeds than it is in the case of directors. 

Delaware law does not afford corporate officers the same level of protection. That means Mr. Freeh can seek to recover for a breach of the duty of due care by showing gross negligence on the part of the leaders of MF Global.

I disagree with that claim. The Delaware Supreme Court has held that:

The Court of Chancery has held, and the parties do not dispute, that corporate officers owe fiduciary duties that are identical to those owed by corporate directors.FN34 That issue—whether or not officers owe fiduciary duties identical to those of directors—has been characterized as a matter of first impression for this Court. In the past, we have implied that officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty, and that the fiduciary duties of officers are the same as those of directors. We now explicitly so hold.

Gantler v.. Stephens, 965 A.2d 695, 708-709 (Del.2009). To be sure, the Court also noted that:

That does not mean, however, that the consequences of a fiduciary breach by directors or officers, respectively, would necessarily be the same. Under 8 Del. C. § 102(b)(7), a corporation may adopt a provision in its certificate of incorporation exculpating its directors from monetary liability for an adjudicated breach of their duty of care. Although legislatively possible, there currently is no statutory provision authorizing comparable exculpation of corporate officers.

Id. at 709 n.37. But even so, the Court has also held that "the business judgment rule ... protect[s] corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments.” Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993). So unless you think that a showing of gross negligence suffices to rebut the business judgment rule, which I don't, Delaware law likely treats directors and officers more or less the same in this context.

Hedge Fund Bonuses for Corporate Directors: Cunningham Enters the Fray

Larry Cunningham enters the fray with links to the various debater's statements:

A hot debate rages among corporate law professors amid one of the largest proxy battles in a decade: Hess Corp., the $20 billion oil giant, is the focus of a contest between its longstanding incumbent management and the activist shareholder Elliott Associates.   Ahead of Hess’s annual meeting on May 16, where 1/3 of the seats on Hess’s staggered board are up, antagonists offer dueling business visions.  They battle bitterly over such fundamentals as sectors to pursue, degrees of integration to have and cash dividend policy.

The professorial debate, more civil, is about a novel pay plan Elliott proposes for its director nominees, which Hess’s incumbents condemn and Elliott defends as suited to shareholders. On one side, all quoted in Elliott’s investor materials circulated April 16, are me, Larry Hammermesh (Widener), Todd Henderson(Chicago), Yair Listoken (Yale) and Randall Thomas (Vanderbilt); on the other  Steve Bainbridge (UCLA), Jack Coffee (Columbia) and Usha Rodriques (Georgia), all of whom have blogged since the matter was first reported by Steven Davidoff(Ohio State) in the New York Times April 2 (for which he connected with me for comment). ...

Hess incumbents portray the bonuses as objectionable (and Steve, Jack and Usha agree). Incumbents say they give nominees incentives to maximize short-term shareholder value rather than serve as long-term stewards.   They say the pay somehow makes the directors beholden only to Elliott, preventing the exercise of business judgment for the benefit of the corporation and its shareholders as a whole.

I have taken a different view, set out in Elliott’s materials last month (p. 148):  The bonuses seem surgically tailored to tie the payoff to Hess’s stock price performance compared to competitors. That is intended to align the interests of those directors with those of the company’s shareholders.  Elliott makes the promise at the outset and then has no role to play afterwards, other than to pay up if milestones are met.  No one is beholden to Elliott and the independence of those directors is not compromised.  There is no incentive to liquidate the company or concentrate on the short term but every incentive to manage to outperform peer company stock price performance over three years. ...

In a blog post responding to Prof. Davidoff’s April 7 story, Prof.  Bainbridge perceived a clear conflict of interest for directors in the arrangement, likewise based on the assertion of directors somehow being beholden to Elliott or because of the three-year time horizon.

Actually, the basis of my argument was neither that "directors [are] somehow being beholden to Elliott or because of the three-year time horizon," although I concede that my point was not made as clearly as it should have been.

When I described these transactions as involving a conflict of interest, what I had in mind was the general conflict of interest ban contained in Restatement (Second) of Agency sec 388:

Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal.

Surely the hedge fund payments here qualify as, for example, the sort of gratuties picked up by comment b to sec 388:

An agent can properly retain gratuities received on account of the principal's business if, because of custom or otherwise, an agreement to this effect is found. Except in such a case, the receipt and retention of a gratuity by an agent from a party with interests adverse to those of the principal is evidence that the agent is committing a breach of duty to the principal by not acting in his interests.

Illustrations:

 4. A, the purchasing agent for the P railroad, purchases honestly and for a fair price fifty trucks from T, who is going out of business. In gratitude for A's favorable action and without ulterior motive or agreement, T makes A a gift of a car. A holds the automobile as a constructive trustee for P, although A is not otherwise liable to P.

How is the hedge fund's gratitude for good service by the Hess director any different than T gift to A?

To be sure, directors are not agent of the corporation, but "The relationship between a corporation and its directors is similar to that of agency, and directors possess the same rights and are subject to the same duties as other agents." In re Adams Laboratories, Inc., 3 B.R. 495, 499 (Bkrtcy. Va. 1980). See also Daniel J.H. Greenwood, Looting: The Puzzle of Private Equity, 3 BROOK. J. CORP., FIN. & COM. L. 89 (2008)("Directors are not agents, of course, but they too are bound by almost identical fiduciary duties requiring them to work for the firm rather than themselves.")

Thus, I believe, even if the hedge fund nominee/tippees are scrupulously honest in not sharing confidential information with the funds, put the interests of all shareholders ahead of those of just the hedge funds, and so on, there would still be a serious conflict of interest here.

FOOLED AGAIN

New York Mayor Michael Bloomberg was denied a second slice of pizza today at an Italian eatery in Brooklyn.

The owners of Collegno's Pizzeria say they refused to serve him more than one piece to protest Bloomberg's proposed soda ban,which would limit the portions of soda sold in the city.

Bloomberg was having an informal working lunch with city comptroller John Liu at the time and was enraged by the embarrassing prohibition. The owners would not relent, however, and the pair were forced to decamp to another restaurant to finish their meal.

via dailycurrant.com

APPARENTLY, I HAVE FALLEN VICTIM TO A HOAX. But wouldn't it be great if had been true?

I've been filed with the SEC

Apparently the Hess Corporation is sending Jack Coffee's and my posts about hedge funds paying director nominees to its shareholders, because it's filed them as definitive additional proxy materials. Heh.

Think Law School Tuition is too High? Blame Liberals

From the WSJ Law Blog:

... in an upcoming essay in Stanford Law & Policy Review, [Washington University at St. Louis Law Professor Brian] Tamanaha [focuses on] what he describes as the hypocrisy of his fellow liberal colleagues, whom he says have milked the system and turned their backs on debt-loaded students.

He writes:

If liberals are to be true to our professed values, we must critically examine our own conduct, however painful and embarrassing it might be. We cannot speak truth to power yet not to ourselves. [P]rogressive law professors, I charge, have profited from a system of legal education with harmful consequences to individuals and society—while claiming (and believing) that they were fighting the system.

He faults left-wing academic groups, like the Society of American Law Teachers, for taking a “a strong and unbending stance against” changes to accreditation standards — particularly tenure and other job-protection mandates — that he argues would slow the rise of tuition. (The co-presidents of the law society declined comment.)

But instead, Mr. Tamanaha says, his liberal colleagues have ignored the tuition problem:

Had professors on a faculty banded together to resist tuition increases, with the support of national organizations, the increases might have been tempered. Law professor organizations and law faculties nationwide sprang into action to effectively fight proposals to remove job protection from accreditation standards. Liberal law professors could have engaged in similar actions to resist tuition increases, but we did nothing.

Explaining why, he writes:

Tuition increases meant yearly salary raises, research budgets to buy books and laptops, additional time off from teaching to write (or to do whatever we like), traveling to conferences domestically and abroad, rooms in fine hotels, and dining out with old friends. A sweet ride it has been.

In contrast, I suppose, he thinks conservatives like me are happy just to enjoy the sweet ride. And, in fairness, I don't lose much sleep about living the law prof life. But then I teach my students something useful, instead of teaching them about speaking truth to power (whatever the hell that means), so I actually earn my money.

Coffee on Side-Payments by Hedge Funds to Director Nominees

I've had my share of differences with Jack Coffee over the years, so it is appropriate to compliment him on his cogent analysis of the growing problem of "incentive" payments being made by hedge funds to their nominees on corporate boards:

This year, two activist investors—Elliott Management Corp. and Jana Partners—have run minority slates of directors for the boards of Hess Corp and Agrium, Inc., respectively, and each has offered to pay special bonuses to its nominees (and no one else).  Elliott will pay bonuses to its five nominees measured by each 1 percent that Hess shares outperform the total rate of return over the next three years on a control group of large oil industry firms.  A ceiling limits the maximum payment to a nominee director to $9 million.  In the case of the Agrium proxy fight, which Jana narrowly just lost, Jana offered to pay its four nominees a percentage of any profits that the hedge fund, itself, earned within a three year period on its Agrium shares.

Both Hess and Agrium have objected that these bonuses are intended to incentivize these nominees to sell the company or promote some other extraordinary transaction in the short-run.  The activists, and their defenders, respond that there is no conflict because all shareholders will benefit if the new directors cause each firm to outperform its peers.

This claim that incentive compensation aligns the nominees’ interests with those of the shareholders ignores much. ...

Coffee goes on to shred the claim into rather tiny pieces, before concluding that:

Third party bonuses create the wrong incentives, fragment the board, and imply a shift towards both the short-term and higher risk.  As with other dubious practices, 50 shades of grey can be distinguished by those willing to flirt with impropriety.  But ultimately, the end does not justify the means.

Precisely right, IMHO. I've previously suggested that such payments probably violate Delaware law and concluded that "If this nonsense is not illegal, it ought to be."

 

Why corporate political spending should be a board prerogative

In defending the use of bylaws to limit corporate political spending, Jay Kesten claims that:

... authorizing shareholders to enact binding bylaws may improve discourse within the firm concerning the costs and benefits of corporate political activity.  When the board is required to negotiate, valuable information is shared among the interested parties.  When shareholders are more informed about the activities within their firms and the consequences of potential regulatory actions, they are likely better able to make reasoned decisions about the appropriate path forward.  And, such discourse may better inform the public concerning corporations’ political activities.

This is, of course, absurd. Public corporations do not have internal discourse. Most retail (and many institutional) investors are rationally apathetic. Boards generally do not bargain with shareholders (too many collective action problems, for one thing). To the extent boards interact with shareholders, they tend to be activists whose interests may well differ from those of the larger mass of shareholders. (I elaborate on these points in Corporate Governance after the Financial Crisis.

Second, shareholders have no right to make "reasoned decisions" about corporate political spending. The law in every state is clear that the business and affairs of the corporatiopn are to be conducted by the board of directors and the managers to whom the board delegates authority. Corporate law in this regard is a system of director primacy, not shareholder primacy. Shareholders have no more right to decide where the corporate spends its lobbying dollars than they do to decide where the corporation builds plants or what products the corporation makes. See, e.g., Paramount Commc'ns Inc. v. Time Inc., Nos. 10866, 10670 & 10935, 1989 WL 79880, at *30 (Del. Ch. July 14, 1989) (“That many, presumably most, shareholders would prefer the board to do otherwise than it has done does not, in the circumstances of a challenge to this type of transaction, in my opinion, afford a basis to interfere with the effectuation of the board's business judgment.”), aff'd, 571 A.2d 1140 (Del. 1990).

Put another way, the law recognizes that "Charitable contributions are made by a corporation in the exercise of discretion by the Board of Directors or proper officers, primarily for public relations purposes ...." Hotpoint, Inc. v. U.S., 117 F.Supp. 572 (CT.CL. 1954). Just so, political contributions are (and should remain) within the discretion of the board of directors to be used as they see fit to advance the corporation's interests.

"The Non-Expert Agency: Using the SEC to Regulate Partisan Politics" Smith & Dickerson respond to Bebchuk & Jackson

Smith, Bradley A. and Dickerson, Allen, The Non-Expert Agency: Using the SEC to Regulate Partisan Politics (March 26, 2013). Forthcoming, 3 Harv. Bus. L. Rev. (2013). Available at SSRN: http://ssrn.com/abstract=2239987:

Over the past 15 years advocates of campaign finance reform, frustrated by the structure and design of the Federal Election Commission, have attempted to offload the duties of campaign finance regulation to other federal agencies, most notably the Internal Revenue Service but also the Federal Communications Commission and, most recently, the Securities Exchange Commission. 

We respond specifically to Professors Lucian A. Bebchuk & Robert J. Jackson, Jr., Shining Light on Corporate Political Spending, 101 Geo. L. J. 923 (2013), who urge the SEC to adopt compulsory disclosure rules to govern corporate political activity. We argue that whatever the theoretical merits of this position, the reality is that the current pressure on the SEC to take adopt new compulsory disclosure laws is a direct result of a desire to use the SEC to regulate not corporate governance or the world of investment and trading, but campaign finance. As a result, we suggest that any rules adopted are likely to be ill-advised and co-opted in the enforcement process. At the core of the theory of the independent agency is that it will develop a unique technical competence and will operate within that sphere of expertise. Pressure on the SEC (or other agencies) to regulate campaign finance takes these agencies out of their area of professional expertise and competence, and is thus likely to result in bad law, damage to institutional reputation, and a distraction from the agency’s core mission.

Today's tweet

@securitiesattny says "in past 5 yrs only 10% of venture backed companies exited w/ IPO" Here's why:ssrn.com/abstract=16963…

— Stephen Bainbridge (@ProfBainbridge) May 1, 2013

STOCK Act partially gutted

Yahoo Finance reports:

A year ago President Obama signed the so-called STOCK Act. The point of the act was to allow the public to see for themselves if members of Congress and their employees were trading on material, non-public information. "The STOCK Act: Bans Members of Congress from Insider Trading" was the bolded headline at the top of a lengthy and self-congratulatory press release.

Last Monday the White House website took the guts out of the STOCK Act in one run-on sentence under the headline "Statement by the Press Secretary on S. 76." Those so inclined are invited to read the memo themselves. The gist is that disclosures will no longer be practically available for all employees but only for the elected officials, which means staffers, lobbyists, employees, aides and anyone who works for or is close to a serving politician can do whatever they want. Corrupt officials could theoretically still dish insider info with little fear of discovery — it's just hard for them to trade off of the information themselves.

The idea of transparency is to remove doubt about conflicts of interest and malfeasance, real or imagined. When the rules are quietly changed to such a degree, it defeats the purpose entirely.

On the one hand, the STOCK Act's prohibition on insider trading remains intact, which is a good thing. On the other hand, I agree completely with the author that transparency via disclosure was essential. As Justice Brandeis that sunlight is the best disinfectant and electric light the best policeman.

The scandals and routine abuses Peter Schweizer exposed in Throw Them All Out cried out for reform. Congress was dragged kicking and screaming into reform, but now has started chopping back on it. Time to hold their feet to the fire yet again.

If the SCOTUS had ducked Bush v. Gore, the All-Democrat Florida Supreme Court would have stolen the election for Gore

Megan McArdle on what might have happened if the Supreme Court had not decided Bush v. Gore:

Democrats who are mad about Bush v. Gore seem to sort of forget just how awful the Florida rulings looked.  A court composed entirely of Democrats ruled that they thought it was fine for Al Gore to cherry pick the four biggest Democratic counties in Florida and request precisely the manual recount that was most likely to deliver him the election even if he had, in fact, received less than a majority of the votes in the state.  This was a terrible idea, and it made a mockery of later Democratic claims that they just wanted to count all the votes.  They wanted to count only votes that would make Al Gore president, and the Florida Supreme Court did everything it could to help, short of just stepping in and ruling that Al Gore was the winner.  The Republican outcry against the Florida Supreme Court and the US Supreme Court would have been intense--in my opinion, justifiably so.

The villains of this story never were the conservative justice on the US Supreme Court. Nope. The bad guys were the Democrats on the Florida Supreme Court who blatantly favored Gore at every stage. Not that you can get a Democrat to admit it.

What I'd like for Christmas before the Apocalypse

I've been reading a lot of post-apocalyptic fiction lately and watching some of those zombie TV shows, so when I saw a Top Gear blurb on the nuew Mercedes unimog, I knew that what I wanted for Christmas is a Unimog-based customized and luxed out RV. With front and rear 50-caliber remotely operated weapon stations to deal with zombies and a MK19 Mod3 40mm grenade machine gun ROWS to service your larger mutants. Plus, of course, you'd want tear gas cannons to fend off the starving masses, solar panels, water purification, biodiesel generation capability, etc. In sum, something like this:

But with lots of guns.

Email Bankruptcy, Inbox Zero

I’d like to begin this with an apology. If you sent me an email in the past four years or so and I didn’t respond, I’m sorry. It’s not that your message wasn’t important to me. It’s just that I didn’t read it. Or else I did read it but then I clicked “Mark Unread” to trick myself into thinking I didn’t read it.In fact, the more important your message, the more likely it is I handled it it this way. I wanted to give your email the thoughtful response it deserved, so I set it aside to deal with later. Then later became never....

This is no way to live. So, as of today, I’m not going to live this way anymore. I’m going Inbox Zero. The minute after I publish this post, I’m going to select all 28,487 messages in my inbox and archive them. Thereafter, I pledge that, at least once a day, I will clear my inbox of everything.

via www.forbes.com

Ditto. If you haven't heard from me within about 4 weeks, assume I've declared another e-mail bankruptcy and try a phone call.