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Jeffrey Sonnenfeld Misrepresents Milton Friedman ... Again

The Economist gave Yale management professor Jeffrey Sonnenfeld a column this week, in which--as usual--he presents a rosy view of corporate social responsibility. In it, he quotes Milton Friedman:

Milton Friedman, the American economist, acknowledged as much in a famous article published in 1970. “It may well be in the long-run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses from pilferage and sabotage or have other worthwhile effects.” Friedman never said the only social responsibility was “the bottom line”, and neither do today’s responsible ceos.

This is not the first time Sonnenfeld has misrepresented what Friedman said. See Bruce Nelson's letter to the WSJ in response to a WSJ op-ed by Sonnenfeld:

Mr. Sonnenfeld quotes Milton Friedman’s brilliant essay on corporate social responsibility out of context. Friedman plainly states that “the use of the cloak of social responsibility and the nonsense spoken in its name by influential and prestigious businessmen does clearly harm the foundations of a free society.”

It should not be surprising, then, that Mr. Sonnenfeld assumes the mantle of spiritual awakening. Friedman and God in one essay? The purview of our intellectual elites is often quite breathtaking.

(I also criticized Sonnenfeld's WSJ editorial.)

Back to Sonnenfeld's latest nonsense: "Friedman never said the only social responsibility was 'the bottom line.'" Really? Friedman's famous essay was entitled "The Social Responsibility Of Business Is to Increase Its Profits," not "A Social Responsibility ...." When Friedman spoke about an employer "providing amenities" to its community, he wasn't talking about being socially responsible, he was talking about corporations generating "goodwill as a by‐product of expenditures that are entirely justified in its own self‐interest." In other words, Friedman thought the purpose of making such contributions was to increase profit not do good. The disparity between what Friedman actually thought and Sonnenfeld's characterization is made clear by a portion of the former's essay Sonnenfeld leaves out: “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.” In other words, the bottom line is the only social responsibility of business.

SOX 404 at 20

I wrote this. https://t.co/JLyJZLzgNw

— Steve Bainbridge (@PrawfBainbridge) September 23, 2022

More on Caremark liability for cyber security lapses

Apropos the preceding post, Kevin LaCroix explains:

In the immediate aftermath of the Delaware Supreme Court’s 2019 decision in Marchand v. Barnhill, and as part of the discussion of the decision’s possible implications, one question I was asked was whether claimants might seek to assert breach of the duty of oversight claims in the context of cybersecurity and privacy issues. After all, for many companies these days, cybersecurity is mission critical. However, there are now two Delaware court decisions in which attempts to assert an oversight duty claim in the context of a cybersecurity incident have been unsuccessful.

LaCroix goes on to discuss the most recent case on point, Vice Chancellor Glasscock’s September 6, 2022 opinion in the SolarWinds case, which can be found here.

Vice Chancellor Glasscock did not hold that a claimant could never sustain a cybersecurity related oversight duty breach claim. But his opinion does contain a number of points that underscore how difficult it would be for a claimant to succeed on this theory.

He goes on to explain those points. It's a must read column.

 

 

MorganStanley Board: Potential Caremark Liability?

Via Matt Levine, I learn of a SEC complaint against MorganStanley Smith Barney (MSSB):

The Securities and Exchange Commission today announced charges against Morgan Stanley Smith Barney LLC (MSSB) stemming from the firm’s extensive failures, over a five-year period, to protect the personal identifying information, or PII, of approximately 15 million customers. MSSB has agreed to pay a $35 million penalty to settle the SEC charges.

The SEC’s order finds that, as far back as 2015, MSSB failed to properly dispose of devices containing its customers’ PII. On multiple occasions, MSSB hired a moving and storage company with no experience or expertise in data destruction services to decommission thousands of hard drives and servers containing the PII of millions of its customers. Moreover, according to the SEC’s order, over several years, MSSB failed to properly monitor the moving company’s work. The staff’s investigation found that the moving company sold to a third party thousands of MSSB devices including servers and hard drives, some of which contained customer PII, and which were eventually resold on an internet auction site without removal of such customer PII. While MSSB recovered some of the devices, which were shown to contain thousands of pieces of unencrypted customer data, the firm has not recovered the vast majority of the devices.

The SEC’s order also finds that MSSB failed to properly safeguard customer PII and properly dispose of consumer report information when it decommissioned local office and branch servers as part of a broader hardware refresh program. A records reconciliation exercise undertaken by the firm during this decommissioning process revealed that 42 servers, all potentially containing unencrypted customer PII and consumer report information, were missing. Moreover, during this process, MSSB also learned that the local devices being decommissioned had been equipped with encryption capability, but that the firm had failed to activate the encryption software for years.

“MSSB’s failures in this case are astonishing. Customers entrust their personal information to financial professionals with the understanding and expectation that it will be protected, and MSSB fell woefully short in doing so,” said Gurbir S. Grewal, Director of the SEC’s Enforcement Division. ...

Without admitting or denying its findings, MSSB consented to the SEC’s order finding that the firm violated the Safeguards and Disposal Rules under Regulation S-P and agreed to pay the aforementioned penalty.

What immediately came to mind was the Marchand line of Caremark cases. Here's a good summary of the law by Seyfarth Shaw lawyers:

In its 1996 In re Caremark decision, the Delaware Court of Chancery articulated a standard of liability with respect to a board of directors’ oversight failures. The Delaware Court of Chancery explained that such oversight duties stem from a directors’ duty to act in good faith and to be “reasonably informed concerning the corporation.” Caremark, 698 A.2d at 970. The Delaware Court of Chancery concluded that in order to fulfill the obligation to be reasonably informed, the board must first assure itself “that the corporation’s information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as matter of ordinary operations.” Id. ...

In June 2019, an en banc panel of the Delaware Supreme Court clarified the pleading requirements for Caremark claims in Marchand v. Barnhill. 212 A.3d at 805. In Marchand, the Delaware Supreme Court reversed the Delaware Court of Chancery’s dismissal of Caremark claims finding that the complaint alleged facts supporting a reasonable inference that the board “failed to implement any system to monitor [the company’s] food safety performance or compliance.” Id. at 809.

The Marchand decision reiterated that the board has a duty to exercise oversight and to monitor “the corporation’s operational viability, legal compliance, and financial performance” by making a good faith “attempt to assure a reasonable information and reporting system exists” and then taking steps to monitor and oversee the system. Id. The Marchand court clarified that failures to either (i) implement reasonable systems or (ii) to monitor the existing systems are “act[s] of bad faith in breach of the duty of loyalty.” Id. In other words, implementing a system that is not reasonable under the circumstances could expose a board to liability as could the failure to monitor the system.

In Marchand, the company manufactured ice cream and, the court determined, lack a board-level system of oversight of food safety. The court described food safety as a "mission critical" component of the business, which heightened the need for board oversight. Similarly, in the subsequent Boeing case, the court zeroed in on the board's lack of oversight with respect to passenger safety, which was a mission critical concern for the airplane manufacturer.

Pertinent to MSSB's situation, cyber security is increasingly regarded as a mission critical issue. The Seyfarth Shaw memorandum continues:

... the Delaware courts have emphasized the importance of the board’s oversight duties, particularly with respect to mission-critical company issues and risks. Possible inadequacies of oversight systems in these mission critical areas will likely cause courts to give added scrutiny to boards oversight of them. Cyber-security poses an area of increasing risk for companies. With the progressive sophistication of cyber criminals in disrupting operations to extort payment, cyber-security is likely to be considered a significant risk for most businesses. Board oversight of cyber-security risks and risk mitigation policies is important for most companies and their directors.

In fact, in a recent Caremark case, the Delaware Court of Chancery acknowledged that cyber-security was “an area of consequential risk that spans modern business sectors.” Firemen’s Ret. Sys. of St. Louis on behalf of Marriott Int’l, Inc. v. Sorenson, No. CV 2019-0965-LWW, 2021 WL 4593777, at *11 (Del. Ch. Oct. 5, 2021).

As Levine explains, this is particularly true for banks:

In recent years it has been popular for investment bank executives to say that they were becoming tech companies: They were hiring developers, building apps, talking about big data.

It may be that Caremark claims against MSSB will be barred by the statute of limitations. It sounds like the problem occurred in 2016 and that MSSB began remediation efforts sometime in 2017. Not my area of expertise.

At the very least, however, it would make a good exam question.

When does appointment of a special litigation committee constitute a concession that demand would be futile?

Thanks to The Chancery Daily, I learned about an interesting new Delaware Chancery Court decision dealing with the demand requirement in shareholder litigation: Rowan v. Infinity Q Capital Management LLC, 2002 WL 4127578 at *5 (Del. Ch. Sept. 12, 2022).

The Chancery Daily explains:

Plaintiff mutual fund investor brought derivative claims on behalf of the Delaware statutory trust that issues the fund's securities, alleging that members of the board of trustees and others breached contractual and fiduciary duties, leading to the fund's collapse.

Prior to plaintiff's filing of his complaint, the board had appointed a new trustee and created a special litigation committee ("SLC") composed solely of the new trustee, with authority to investigate potential claims and to "supervise any . . . prosecution, settlement, or other disposition of such Claims." After the complaint was filed, the trust, as nominal defendant, moved to dismiss for failure to plead demand futility.

Plaintiff asserted that, although the full board had authorized the motion, it lacked authority to do so because it had delegated its authority over derivative claims to the SLC.

The Court denies the motion for lack of standing in this Opinion, finding plaintiff raised particularized allegations allowing an inference that, by appointing a special litigation committee comprising a single, unconflicted new director, the non-committee trustees conceded demand futility as to the board as a whole and delegated control over procedural defenses to the SLC.

If plaintiff makes demand on the board before filing suit, that action is deemed a concession that demand was required.[1] Note that making demand only concedes the board’s ex ante good faith and independence, such that plaintiff may not subsequently argue that demand was futile. If the board refuses the demand, the plaintiff is entitled to argue that the board’s refusal was wrongful, although the applicable standard is the business judgment rule, which we will see below is a challenging standard for the plaintiff to meet.[2]

Conversely, however, appointment by the board of a special committee to investigate the challenged transaction is not automatically deemed a concession that demand would be futile. In Seminaris v. Landa,[3] the board responded to a SEC investigation by appointing a special committee to investigate the conduct that had triggered the SEC’s inquiry. Three weeks late a shareholder-plaintiff filed a derivative suit alleging breaches of fiduciary duty in connection with that conduct without making demand. The full board instructed the extant special committee to investigate plaintiff’s complaint. The committee recommended dismissal of the plaintiff’s lawsuit and the defendants moved for dismissal on that basis. Plaintiff argued that appointing the special committee was a concession that demand would be futile and should therefore be excused. (As discussed below, cases in which demand is deemed futile are reviewed under a more shareholder-plaintiff friendly standard than those in which it is required.)

The Seminaris court held that “a disinterested board of directors does not waive its right to control derivative litigation merely by delegating that control to a special committee.”[4] Accordingly, the court went on to determine whether plaintiff had adequately pled demand futility: “To demonstrate that the . . . Board conceded demand futility, plaintiff must allege particularized facts to support a factual determination that the board intended to concede demand.”[5] The court determined that plaintiff had failed to do so.

In contrast, in Abbey v. Computer & Commun. Tech. Corp.,[6] plaintiff made demand before filing suit. Several weeks later, having not received a response, plaintiff filed her derivative suit. The board then appointed a one person special litigation committee. The court held that “that by divesting itself of any power to make a decision on the pending suit, and by adding a new and independent director and by designating him as a special Litigation Committee of one with the final and absolute authority to make the decision on behalf of the corporation, the incumbent board of directors, in effect, conceded that the circumstances alleged in the complaint justified the initiation of the suit by the plaintiff.”[7]

In Rowan v. Infinity Q Capital Management, LLC,[8] the Chancery Court reviewed the relatively sparse precedents on point—including Seminaris and Abbey—and concluded that there are “at least two ways a plaintiff can plead a board's creation of a special litigation committee conceded futility and delegated the ability to bring a procedural motion: (a) a sequence of events in which the board created a fully empowered committee after the complaint was filed, or (b) other particularized facts, perhaps where the committee was created before the complaint was filed but was comprised of new board members that do not labor under an apparent interest that other board members do.”[9] Accordingly, “the most prudent course of conduct for a corporation is to first file a motion to dismiss for failure to make demand before appointing a special litigation committee to investigate the allegations.”[10]

Concern for structural bias presumably influenced this line of cases. Presumably the Delaware courts assume a non-conflicted board would itself review the plaintiff’s allegations rather than delegating them to new, unconflicted directors. In turn, the new directors will be structurally biased in favor of those who appointed them.

 

If nation-states are going to make war on corporations, why wouldn't corporations make war on each other and even nation-states?

Tom Lin has an article at CLS Blue Sky Blog on wars on business:

For example, the United States banned Huawei, one of China’s largest and most prominent technology companies, from doing business in the country due to national security concerns.  Foreign drones affiliated with Iran attacked oil installations of state-owned Saudi Aramco, one of the world’s most valuable companies. China’s military hacked into data corporate giant, Equifax, to gather private, sensitive information about American officials and intelligence officers for bribery and blackmail. North Korea initiated an unprecedented attack on Sony in response to a movie’s unflattering portrayal of the nation’s president. Hackers affiliated with Russia targeted large American corporations and large swaths of the federal government.  Regardless of form, motivation, or severity, these attacks and aggressions raise critical, interlocking questions about law, commerce, society, and warfare.

Go read the whole thing. As always, Tom's hit an interesting problem and offered some very useful insights.

Being something of a science fiction nerd going back to my youth in the 60s, what came to my mind was Mack Reynolds' Joe Mauser series. In a future caste society, the military castes were one of the few that allowed upward mobility. But there are no wars among nation-states. Instead, corporations wage war on one another on reservations set aside for that purpose. It provides dispute resolution and entertainment for the masses who follow the military who fight the wars the way we follow the athletes that play pro sports today.

The short story that started the series is here. I think it would be fun to do a law review article on how the legal system in such a culture would work, blending dispute resolution and the laws of war.

Kevin LaCroix on Suit Against Starbucks Over DEI Policies

From Mr LaCroix's blog:

In October 2020, Starbucks announced on its corporate website its adoption of a series of policies calculated to realize the company’s “commitment to Inclusion, Diversity, and Equity.” At the time of the policies’ adoption, the company committed to “taking further actions toward tangible and lasting change.”

The National Center for Public Policy is a conservative non-profit think tank based in Washington, D.C. The organization also claims to be a Starbucks shareholder. On March 25, 2022, the American Civil Rights Project, acting on behalf of the plaintiff, published an open letter to the directors and officers of Starbucks warning the company’s executives of “the risks to which the Policies expose Starbucks and its shareholders.” A copy of the letter was also sent to the company. The letter alleges that the company’s DEI policies violate federal and state civil rights and anti-discrimination laws and expose the company to substantial legal liabilities. The letter demanded that the company retract the policies and immediately cease implementing them. On July 22, 2022, the company’s legal counsel sent a response letter stating that it would not be in the company’s best interest to retract the policies.

On August 30, 2022, the plaintiff filed a complaint in the Spokane County (Washington) Superior Court against certain Starbucks officers and directors. ...

... The defendants, the complaint contends, should be stopped from violating the civil rights laws and “from diverting the shareholders’ corporate resources to their personal use in buying themselves social credit.

Mr. LaCroix "noted in a recent post [that] there is a form of anti-ESG backlash that is emerging." This suit fits the emerging pattern.

He observes:

As the lawsuit shows, the backlash can also take the form of litigation as well. The lawsuit also shows that there not only are advocates that will challenge companies for the lack of ESG initiative, there also are advocates that will challenge companies that are proactive on ESG.

Keith Paul Bishop spots a corporate law mystery

Keith Paul Bishop spots a mystery: why is there a right to a jury trial when the corporation brings a complaint seeking damages for breach of fiduciary duty but not if that same allegations are brought derivatively. https://t.co/2OilerqSyE

— Steve Bainbridge (@PrawfBainbridge) September 10, 2022

From the Department of Self-Promotion

As Bertie Wooster said, “while one lives for one’s Art, so to speak, and cares little for the public’s praise or blame and all that sort of thing, one can always do with something to paste into one’s scrapbook, can one not?”https://t.co/ZhCYorQOvI

— Steve Bainbridge (@PrawfBainbridge) September 9, 2022

According to @BrianLeiter I’m the #40 law professor as ranked by H-index. https://t.co/WCBFi2mExa

— Steve Bainbridge (@PrawfBainbridge) September 9, 2022

My upcoming course "The Law of Elon Musk" featured in New York Magazine's Intelligencer Column

Here.

 

Corporate Law and the Utopian Fallacy

New paper by Beate Sjåfjell, Re-embedding the Corporation in Society and on Our Planet: Company Law as a Vehicle for Change (January 13, 2022). Chapter 12 in Beate Sjåfjell, Carol Liao and Aikaterini Argyrou (eds), Innovating Business for Sustainability: Regulatory Approaches in the Anthropocene (Edward Elgar Publishing). Available at SSRN: https://ssrn.com/abstract=4008062

The corporation needs to be ‘re-embedded’ in society and on our planet. Business is an integral element of the disembedding from society, through the way the corporation, a dominant legal form for undertaking business, has been conceptualised in the dominant legal-economic theories. This has formed the basis for and has been exacerbated through the social norm of shareholder primacy. Re-embedding the corporation requires a reconceptualisation of corporation’s role in society and the environment, and challenging a deeply gendered approach not only within business but also within sustainability science. Employing an interdisciplinarity feminist sustainability perspective, I make the case for using company law as a lever to re-embed the corporation through the embedding into the core of company law, key societal concepts of sustainability, drawing on sustainability research. The reform proposals concentrate on EU law but the reform ideas and the basis for them are of global relevance.

Sorry, but I don't buy it. Compare and contrast with D. Gordon Smith, The Dystopian Potential of Corporate Law (March 2007). Univ. of Wisconsin Legal Studies Research Paper No. 1040, Available at SSRN: https://ssrn.com/abstract=976742.

The community of corporate law scholars in the United States is fragmented. One group, heavily influenced by economic analysis of corporations, is exploring the merits of increasing shareholder power vis-a-vis directors. Another group, animated by concern for social justice, is challenging the traditional, shareholder-centric view of corporate law, arguing instead for a model of stakeholder governance. The current disagreement within corporate law is as fundamental as in any area of law, and the debate is more heated than at any time since the New Deal.

This paper is part of a debate on the audacious question, Can Corporate Law Save the World? In the first part of the debate, Professor Kent Greenfield builds on his book, THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGRESSIVE POSSIBILITIES, offering a provocative critique of the status quo and arguing that corporate law matters to issues like the environment, human rights, and the labor question.

In response, Professor Smith contends that corporate law does not matter in the way Professor Greenfield claims. Corporate law is the set of rules that defines the decision making structure of corporations, and reformers like Professor Greenfield have only two options for changing corporate decision making: changing the decision maker or changing the decision rule. More specifically, he focuses on board composition and shareholder primacy. Professor Smith argues that changes in corporate law cannot eradicate poverty or materially change existing distributions of wealth, except by impairing the creation of wealth. Changes in corporate law will not clean the environment. And changes in corporate law will not solve the labor question. Indeed, the only changes in corporate law that will have a substantial effect on such issues are changes that make the world worse, not better.

I stand with Gordon.

Conservative activists are finally discovering SEC Rule 14a-8 and using it to make shareholder proposals: Will the SEC apply neutral principles?

I have long wondered why conservative activists don't make use of the shareholder proposal rule to the extent liberal activists do. In 2004, for example, I asked:

Every time I teach the shareholder proposal rule (Securities Exchange Act Rule 14a-8) in Business Associations, I always wonder the same thing: Why don't conservative activists use the rule more often?

An informed reader responded:

t seems that conservatives have attempted to push a limited agenda through the 14a-8 process. In almost all of these cases, these types of proposals were excluded under 14a-8(i)(7) [as an ordinary business matter]. Which brings me to your point. I think that most proposals pushing a conservative agenda would deal with ordinary business matters.

He had a point. But the SEC under Gary Gensler seems to have liberalized the ordinary business exception to allow a slew of social and environmental proposals from progressives to be included on company proxy statements. Which raised the question: Would he apply neutral principles and allow conservative proposals?

Accordingly, last fall, I took to Twitter to propose that "What I need are some really rich conservatives to finance a Rule 14a-8 shareholder proposal campaign."

It seems others have stepped up to the plate. Bloomberg reports:

More conservative proposals were filed this proxy season by activists looking to bend the ears of CEOs on social issues, aligning with a political crusade to skewer “woke capitalism.”

Conservative or anti-ESG proposals have doubled this proxy season, according to consulting firm Georgeson Inc., which counted 52 such resolutions filed this year—double the 26 filed 2021. ...

The resolutions, most of which target major companies including Walmart Inc.and Comcast Corp., received very few shareholder votes on corporate ballots, regularly securing less than 3% support. But the number of proposals won’t be letting up, said Scott Shephard, a fellow at the National Center for Public Policy Research, one of the main organizations driving conservative shareholder activism.

“I wouldn’t expect the numbers to sink,” said Shephard, explaining that one of his aims is to put CEOs on notice for allegedly violating their fiduciary duties when they project personal preferences.