Your hypothetical nicely demonstrates a potential problem with defining “personal benefit” to include non-monetary benefits. I would agree that it’s easiest to show a breach of fiduciary duty when the personal benefit is monetary. When someone receives money or something close to it in return for inside information, there will almost always be a strong case that there is a breach of fiduciary duty. It may also be the case, though, that passing on a non-monetary benefit could also look like such a breach. Consider a CEO who passes on inside information in hopes of wooing a potential love interest who trades on the information. The CEO does not receive anything monetary, but it seems like he is acting in a way at odds with his fiduciary duties with the shareholders.
In my view, your hypothetical demonstrates that we need something more to assess whether the receipt of personal benefit triggers a breach of fiduciary duty. One thought might be that we could also ask whether the receipt of a personal benefit reflects selfish behavior that is against the interests of the shareholders. Though you are careful to note that in your hypothetical part of the CEO’s motivation is personal, I would argue that the situation you describe would arguably not qualify as selfish behavior. The CEO is just trying to relieve his stress so he can work effectively on behalf of the shareholders. He does receive a personal benefit, but I’m not so sure that this benefit is substantially at odds with the interests of the shareholders. Thus, I think there’s an argument that the CEO would not be a tipper and that the psychologist would not be a tippee, at least under the classical theory of liability.
[S]ome tippees must assume an insider's duty to the shareholders . . . because it has been made available to them improperly. And, for Rule 10b-5 purposes, the insider's disclosure is improper only where it would violate his Cady, Roberts duty. Thus, a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.
When one of the constituents of an organizational client communicates with the organization's lawyer in that person's organizational capacity, the communication is protected by Rule 1.6. . . . This does not mean, however, that constituents of an organizational client are the clients of the lawyer. The lawyer may not disclose to such constituents information relating to the representation except for disclosures explicitly or impliedly authorized by the organizational client in order to carry out the representation or as otherwise permitted by Rule 1.6.
Steve describes a psychiatrist who trades after learning about a merger from one of his patients, raising the question, “Does Treadwell’s conduct constitute an illegal tip under SEC Rule 10b-5?” We can ask the same question of the psychologist. Steve’s hypothetical is meant to generate discussion, and the possibility for extended discussion is meant to demonstrate just how much Salmon v. US left unanswered.
Unanswered questions are not unusual in insider trading law, and securities litigation generally, but Steve’s question rings out because of how close we got to clarity.
However, the Court’s decision this month largely overruled Newman, restoring the status quo ante as to quid pro quo. Likewise, the Court declined the government’s invitation consolidate a tougher standard. By refusing both invitations to clarity, the Court again leaves us imagine increasingly puzzling variations on the tipping theme.
Still, a practical attorney might question the value of such puzzles. After all, there is no mystery as to whether these characters are liable for breaking the law (at least assuming the other elements are met):
So the only mystery is whether the government can nail them on the classical theory too. Is that a mystery worth solving? Well, it is a mystery with real consequences because of the way that various elements of insider trading law hang together.
For example, our resolution of the personal benefit question bears directly on the applicable standard in “Possession vs. Use” Debate. Must a trader use proscribed information to plan her trades, or is it enough that she traded (for whatever reason), after having come into possession of such information? Professor Donna Nagy has persuasively argued that the pro-government “use” standard is far more appropriate to the classical theory than the misappropriation theory.
Thus, if the psychologist avoids the classical theory pursuant to Salman, he can argue – successfully or unsuccessfully, as the case may be – that he had long planned to trade and that this information did not influence his conduct. That argument is off the table if we find a personal benefit to the CEO.
My friend, colleague, and coauthor Bill Klein comments on the partnership law issues I discussed the other day:
It seems to me necessary to state your facts more clearly to avoid the distinction between capital losses and operating losses, which to my mind only confuses matters.
Suppose Abel contributes $20,000 to the initial partnership checking account. During a year of operations expenses exceed revenue by $30,000. The initial $20,000 was used to reduce the remaining amount owed for expenses to $10,000. Baker does not take a salary.
In this situation, which the Kovocik opinion does not explicitly address, is Abel required to pay the entire $10,000—for which, presumably, both partners are liable (jointly and severally)?
I would suppose not, and if Abel in fact pays the entire $10,000, Baker owes him $5,000. That seems fair enough.
These facts, and those in Kovacik, suggest the need for agreement at the time of formation of the partnership. Lots of luck with that, but to my mind the problem is largely attributable to the failure to pay a salary to Baker for his services or at least to accrue a salary. If, for example, the parties had agreed that Baker was entitled to a salary of $20,000, and if that amount had been owed rather than paid to him, then on my facts that amount would have been part of the expenses (but let’s leave the total the same); Baker would, on liquidation, be entitled to $20,000 as a creditor (maybe subordinated?); Able and Baker are on the hook for a total of $30,000 including $20,000 owed to Baker and $10,000 owed to others; Baker can treat his accrued salary as a capital contribution so Able and Baker are even on that score; each has lost the $20,000 capital contribution and each must contribute $5,000 to pay off the other creditors. That might be more of a burden on Baker than the parties might have wanted at the outset, so a simpler approach might be simply to provide at the outset that Baker would not be liable for any additional contributions to the partnership during its operation or on liquidation.
This suggests that there is another problem that “should” be addressed at the formation stage—namely, the need for additional capital during operation. Again, lots of luck with that, at least with a small operation.
Thanks very much for the publicity and the generous evaluation. A couple of thoughts.
First, on the 'semantic quibble' of director primacy versus what I call 'traditional' shareholder primacy, I agree with you that as between directors and shareholders, directors enjoy primacy. I use the term in a different sense. As between shareholders and the corporation's other stakeholders, shareholders enjoy primacy (voting rights and derivative suit monopolies, for example). But the 'horizontal' point implies nothing about the 'vertical' dimension, because as we both know the law accords very little power to shareholders vis-a-vis directors. I certainly agree with you about that. And I agree that it's a good thing.
Second point: I respectfully suggest that you don't take the director primacy idea as far as you should. I don't think the law requires of directors even the watered-down version of shareholder wealth maximization that you assert. I think Delaware law is actually agnostic on the question of corporate purpose. I think they really mean it when they say 'incorporation for any lawful purpose.' So directors (absent atypical direction in the corporate charter) end up deciding the extent to which the company pursues profit maximization versus various possible alternatives, and this includes selection of the relevant time horizon for pursuit of corporate objectives. (Hobby Lobby is right on the state law corporate purpose question. Lyman Johnson and I have a new paper about this.)
Third, please note that the view of Delaware law that I'm sketching here bears no resemblance to the idea that directors should be subject to specific fiduciary-like duties to corporate constituencies other than shareholders. If the law truly is agnostic about corporate purpose, it makes no more sense to talk about duties owed to nonshareholders than it does to assert a duty owed solely to shareholders. So the ideas about corporate law as a panacea for society's injustices that Gordon Smith criticizes in the article you quote (in your blog piece about Lyman's recent article) have nothing to do with the view of the law that Lyman and I espouse. Broad director discretion as to corporate purpose has been the law for a long time and does not threaten the health of the economy. The real threat comes from shareholder pressures to maximize short-term stock prices. Corporate law tolerates this approach to management but certainly does not require (because it's agnostic). The misguided insistence that the law requires of management that it act as the agent of the shareholders probably makes things worse, but that isn't the law's fault.
A Letter to the Wall Street Journal on Hobby Lobby
William A. Klein
Dear Editor: One of the first principles I learned in law school was that the outcome of a case often turns on how the issue is stated. Your March 22/23 front page article on the Hobby Lobby case is titled “Are Businesses Entitled To Same Religious Protections as People?” As a long-time teacher of corporate law, I suggest that the article might better have been titled “Do People Lose Their First Amendment Protection When They Engage in Business?” I think most people would say, “certainly not.” And then the next question might be, “Do People Engaged in Business Lose Their First Amendment Protection If They Incorporate the Business?” For those who have adopted the modern, realist approach to law (as most of us have), and who understand the purpose and function of corporate law, the answer should be, again, “certainly not.” That does not end the discussion of whether Mr. Green’s First Amendment protection bars enforcement of the Affordable Care Act, but it does strip away some distracting conceptualism.
A while back I took issue with a post by Mark Underberg in which he raised the fiduciary duties of the directors of companies like Hobby Lobby. I'm pleased to allow Mark the opportunity to reply in a guest post.
Reply to Bainbridge
Mark A. Undeberg
Like most bloggers, I get a constant deluge of offers of guest posts from PR flacks. I just add them to my spam folder. But I'm not opposed to offering guest posting opportunities to my fellow corporate and securities law scholars. I'm delighted to have posted Lyman Johnson and David Millon's short essay on Williams Act preemption. If you're interested in guest posting, let me know.
I'm delighted to offer the first guest post in ProfessorBainbridge.com's decade of publishing.
Preempting Professors Bebchuk and Jackson: Poison Pills, State Corporate Law, and the Williams Act
Lyman Johnson & David Millon
Washington & Lee University School of Law
Professors Lucian Bebchuk and Robert Jackson recently posted a provocative paper, Towards a Constitutional Review of the Poison-Pill, forthcoming in the Columbia Law Review. The paper, regrettably, makes several claims that are flatly wrong, and it also misreads the Williams Act.
First, Professors Bebchuk and Jackson assert that "corporate law scholars have overlooked the unresolved validity of state-law poison-pill rules"; such scholarship has "focused exclusively on anti-takeover statutes, ignoring the validity of state-law poison-pill rules"; and, [the Bebchuk-Jackson paper is the] "first systematic analysis of the possibility that these rules are preempted by the Williams Act…"
These assertions are incorrect. Twenty-five years ago, we wrote a lengthy article that pointedly examined possible Williams Act preemption of all non-statutory state corporate law rules, including those sanctioning poison pills, that might impede corporate takeovers. We took no final position on the preemption issue in that piece (we addressed that larger question in a companion article published in the Michigan Law Review discussed below) but instead sought only to extend the then lively preemption debate beyond its narrow focus on anti-takeover statutes. Thus, we expressly considered whether state legal rules condoning poison pills might be preempted, concluding, critically, that if "the Williams Act mandates shareholder autonomy, this state law rule clearly undermines that federal policy." We also explicitly noted that, under the so-called "meaningful opportunity to succeed" standard crafted by federal district judges in Delaware, state common law rules upholding poison pills lack just such a safety valve, and thus may be preempted under that test.
Moreover, we did not confine our analysis to poison pills, but more broadly subjected to preemption analysis all state corporate law rules that might impede takeover bids, including Delaware's quite extensive judge-made law of takeovers. State decisional law, like state statutes, must, of course, yield to federal law under the Supremacy Clause. Unlike Professors Bebchuk and Jackson, therefore, we were able to explain (in our footnote 15) precisely why it is not the poison pill plans themselves but, rather, judicial rulings upholding them that comprise the state "law" subject to constitutional review. This is a particularly important point for any preemption attack on Delaware poison pill law because it is almost exclusively common law in origin. In focusing on statutes authorizing poison pills and, in the absence of statute, on poison pills as "private contracts," Professors Bebchuk and Jackson therefore continue to underestimate the potential breadth of the preemption issue we first identified in 1989 and actually make the preemption analysis as to non-statutory poison pills much more elaborate than it needs to be.
Second, Professors Bebchuk and Jackson state that "no court has ever expressly considered a preemption challenge to the validity of state-law poison-pill rules." That too is an inaccurate statement. In 1995, the Fourth Circuit Court of Appeals rejected a preemption challenge to four of Virginia's corporate statutory provisions, including a provision authorizing poison pills and a provision codifying the director standard of conduct as being 'good faith business judgment." The Williams Act challenge thus went far beyond the Control Share Acquisition and Business Combination statutes. The Fourth Circuit considered the argument made by Tyson Foods, the challenger, that Virginia's statutes were, in concert, so potent that they made it "impossible" in practice to succeed with a bid. The Court, in forthrightly rejecting the Delaware federal court's "meaningful opportunity to succeed" standard, observed that the Williams Act did not protect bidders, and upheld all of Virginia's laws, including the pill provision, against both Supremacy and Commerce Clause attacks. The Supreme Court denied certiorari. Presumably the same analysis would apply to state court judgments validating poison pills in the absence of a statute.
Third, and perhaps of greatest importance, Bebchuk and Jackson's arguments about the Williams Act's preemption of poison pill rules are faulty regardless of whether they are sanctioned by statute or judicial decision. As we explained at length in our Michigan Law Review article cited above, the Williams Act does not mandate a federal pro-takeover policy. Rather, Congress chose not to take a position on one side or the other of the then novel debate about the costs and benefits of hostile takeovers. For example, the Senate Report on the bill that became the Williams Act states that it "avoids tipping the balance of regulation either in favor of management or in favor of the person making the hostile takeover bid." SEC Chairman Cohen echoed this sentiment when he stated that "[t]he Commission does not believe that any bill should be adopted which would either encourage or discourage takeover bids . . .." Instead, Congress' objective was the more modest one of requiring disclosure of information relevant to shareholders confronted with a tender offer (consistent with the basic premise of federal securities regulation) and alleviating pressures on shareholders to tender who might otherwise prefer to hold their shares.
As we noted in our Michigan piece, we think the mistake that scholars like Bebchuk and Jackson make when they ascribe preemptive force to the Williams Act results from a mistaken equation of Congressional assumptions about the world of hostile takeovers in 1968 with Congressional intentions about the appropriate balance of power between target company management and shareholders then and in the future. In 1968 state corporate law did little to limit the freedom of shareholders to decide for themselves whether to accept a hostile bid. Congress took that fact for granted and sought to enhance the ability of shareholders to make these choices in an informed, deliberate manner within the existing legal framework. It is wrong, however, to claim that Congress sought not only to make a limited adjustment to the then current legal regime but sought also to in effect freeze that larger context and preserve it for future generations. In 1968, Congress had no reason to foresee that by the late 1980s state legislation and judicial opinions would confer broad authority on target company management to block shareholder access to hostile bids. That was not the problem that Congress chose to address in the Williams Act. That statute thus is irrelevant to current debates about the lawfulness of poison pills and other state law anti-takeover devices. Those seeking to resolve such questions in favor of shareholder autonomy need to look elsewhere for legal support.
Shareholder decisions about whether to accept hostile tender offers are more than simply choices about whether to sell or hold securities. Because hostile bids are designed to achieve a change of control, shareholder responses have important corporate governance implications. In this respect, efforts to tie target company management's hands by attacking the legality of poison pills are not just an effort to give target company shareholders the opportunity to realize short-term gains. They are also part of the larger shareholder empowerment agenda that would limit the discretion of management to determine the long-run best interests of the corporation and its shareholders. That's a bad idea in other contexts and it's a bad idea here too.
 Lyman Johnson and David Millon, Does the Williams Act Preempt State Common Law in Hostile Takeovers?, 16 Sec. Reg. L.J. 339 (1989).
 Lyman Johnson and David Millon, Misreading the Williams Act, 87 Mich. L. Rev. 1862 (1989).
 WLR Foods, Inc. v. Tyson Foods, Inc., 65 F.3d 1172 (4th Cir. 1995).
 516 U.S. 1117 (1996).