ProfessorBainbridge.com

Paternalistic Nondisclosure at BoA

Bank of America CEO Ken Lewis was reelected as a director of BoA, along with all the other incumbents, but was ousted from his position as chairman of the board when the company narrowly lost a shareholder bylaw proposal mandating a non-executive chairman.

We've also just learned that Lewis withheld key information from BoA shareholders:

He’s drawn fire from investors including the California Public Employees Retirement System for agreeing to buy Merrill Lynch last year and failing to tell shareholders before they approved the deal in December that the brokerage’s losses were soaring.

Shareholders weren’t informed because aborting the takeover might have destabilized the financial system and damaged Bank of America, a scenario the board “took very seriously,” Lewis said in a speech at the meeting. The decision to remain silent was “not about selfish desire” to keep management and the board in place, he said. Disclosing talks with the government on how to resolve the matter might have created the “very crisis” they wanted to prevent, he said. ...

New York Attorney General Andrew Cuomo revealed this month that Lewis had testified then-Treasury Secretary Henry Paulson may have threatened to remove the bank’s management and directors in December if the lender tried to back out of buying Merrill.

Lewis balked at completing the deal as the quarterly loss soared toward $15.8 billion, only to have U.S. officials tell him to proceed, according to testimony released by Cuomo. Regulators also instructed Lewis not to disclose Merrill’s losses, his desire to back out of the takeover or the intervention of regulators, according to Cuomo.

This raises some fascinating securities fraud issues. Do Lewis and BoA have a "Nuremberg Defense" for following government orders? Do the officials who gave the orders have liability?

One thing is clear: The withholding of this information was demonstrably inconsistent with well-established securities law policies. As the Supreme Court explained in Basic, Inc. v. Levinson, 485 U.S. 224(1988):

Disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress. We have recognized time and again, a “fundamental purpose” of the various Securities Acts, “was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.” SEC v. Capital Gains Research Bureau, Inc., [375 U.S. 180, 186 (1963)].

If nothing else, this episode should stand as a clear warning of the ills that can arise when government meddles in private business. Indeed, as GM and Chrysler's creditors are finding out, lack of respect for investor rights is now a bipartisan sport.

North Dakota Publicly Traded Corporation Act

Forbes:

Shareholders at a small but growing number of companies will be voting on proposals to ditch Delaware or other states and incorporate in North Dakota. Oil giant Exxon Mobil Corp. ( XOM - news - people ), Continental Airlines Inc. ( CAL - news - people ) and Southwest Airlines Co. ( LUV - news - people ) are among the latest companies to announce that shareholders will vote on resolutions to make the switch. In most cases, management opposes the change.

Two years ago, lawmakers in North Dakota passed an incorporation law designed to be more shareholder-friendly than laws in Delaware, where most U.S. companies are incorporated. If companies trek to North Dakota, it could generate filing fees for the state and new work for lawyers in the capital of Bismarck.

The bolt-for-Bismarck bloc's most prominent supporter is Carl Icahn.

The billionaire investor asked Biogen Idec Inc. ( BIIB - news - people ) to reincorporate in North Dakota, and he wants shareholders to support his four challengers over the biotechnology company's candidates for the board. ...

UCLA law professor Stephen M. Bainbridge, who has written extensively on the North Dakota gambit, said it is doomed to fail.

Bainbridge said investors will prefer Delaware's director-friendly approach to the shareholder-first tack of North Dakota.

You can download my paper Why the North Dakota Publicly Traded Corporations Act Will Fail from SSRN.

Obama's GM: How Bad will the Cars Suck?

The WSJ reports that GM and the Obama administration have settled on a plan of de facto nationalization:

General Motors Corp. outlined a new turnaround plan that would leave the U.S. government controlling the auto maker, as it set up a showdown with bondholders that could determine whether the company lands in bankruptcy court.

Under the plan, GM is asking the Treasury Department for an additional $11.6 billion in loans, on top of the $15.4 billion it has already received. It envisions giving the government at least half ownership of the company as payment for half of the loans. …

The new plan was conceived in cooperation with an Obama administration team that rejected a Feb. 17 GM revamping plan, saying it didn't go far enough.

Which prompted Larry Ribstein to observe that "the once proud US auto industry will become a WPA project." Larry continues:

Which government agency will handle our complaints about the windshield wipers? Or can we go right to the president? Does this mean that the government will use regulation to hammer its competition? …

Well, at least the government won't have to worry about auto industry cooperation with its environmental or whatever agendas. We can replace corporate social responsibility with the more straightforward corporate social duty. And they will finally get me, by force of law, to invest in a car company.

But I do know this: they can harass me, they can torture me, they can force me to walk on a bed of nails, but I will never, ever, buy a government-built car.

Fair enough? But what if the unholy alliance of greens, UAW, protectionists, and Obamabots decide to start erecting barriers to foreign competition?

In any case, just how bad are the Obama cars likely to be? Fortunately, the guys at Top Gear have given us a glimpse of the future in their episode on commie cars. Watch it and weep:

On the Legality of Firing Naughty Lawyers

ATL reports:

Deidre Dare was our Lawyer of the Day Weekend back in January. Judging from the traffic on that post, we assume most of you know her story. If not, here are the quick and dirty details:

Dare, a Columbia Law grad, was a senior associate in Allen & Overy's Moscow office. She was having fun expat adventures and decided to write about them in an online novella that included lots of alcohol, drugs, sex, donkeys, and dwarves. A&O was not a fan of one of its lawyers publishing porn online and made her stop writing it. Then, A&O fired her.

And the firm, unwisely perhaps, revealed exactly why it fired her (instead of just silently including her in the 10% layoff sweep, which resulted in the booting of many in the Moscow office, including Deidre's Russian boyfriend). From a firm statement published by the Lawyer at the time:

Following our normal disciplinary process, we found that Ms Dare's behaviour - in publishing the material she did in the professional name under which she practises, and the way that she has responded to a number of reasonable requests from us since - was unacceptable and totally at odds with the standards of behaviour that we expect from all of our people.

We've therefore terminated her employment.

Well, Deidre e-mailed us this morning with an update on her situation:

I know how you all love to hate me, so I thought you'd be interested in the following news!

Sex novelist lawyer Deidre Dare sues for being sacked

I have no idea what the law in the UK, where she's suing, may say. All I know is that the case out to be thrown out, as a matter of policy.

A law firm's partners can fire (expel) a member of the partnership for just about any reason they want:

Courts in other states have held that a partnership may expel a partner for purely business reasons. Further, courts recognize that a law firm can expel a partner to protect relationships both within the firm and with clients. Finally, many courts have held that a partnership can expel a partner without breaching any duty in order to resolve a "fundamental schism."

The fiduciary duty that partners owe one another does not encompass a duty to remain partners or else answer in tort damages.

Bohatch v. Butler & Binion 977 S.W.2d 543 (Tex.1998). And see also id. (Hecht, J., concurring):

At least in the context of professional partnerships, the courts have uniformly recognized that a partner can be expelled to protect relationships both inside the firm and with clients.... Despite statements in these cases that partners cannot expel one of their number for personal profit, in each instance the expelling partners believed that retaining the partner would hurt the firm financially and that the firm—and thus the partners themselves—stood to benefit from the expulsion.

Hence, for example, in Holman v. Coie, 11 Wash.App. 195, 522 P.2d 515 (1974), a law firm escaped liability for having fired a partner whose political speech had disgruntled the chief executive of one of the firm's major clients, the Boeing Corporation. The potential damage to partnership business was all the justification the firm needed.

If a firm can fire a partner, to whom the other partners owe what Cardozo called a duty of the "finest loyalty," so as to protect the firm's name and business, there should be no doubt that an associate can be fired for the same reasons.

Toss this suit in the rubbish bin. It's total BS.

North Dakota's Public Corporation Act

My article, Why the North Dakota Publicly Traded Corporations Act Will Fail, which is forthcoming in a symposium issue of the North Dakota Law Review, has just been posted to SSRN.

 

Download here.

 

Abstract: In this short essay for a forthcoming symposium, I comment on the North Dakota Publicly Traded Corporations Act. North Dakota hopes that the Act will empower it to compete with Delaware in the market for corporate charters. In my view, North Dakota is doomed to failure. If state chartering competition is a race to the bottom, managers will prefer Delaware to North Dakota because the former facilitates the extraction of private rents. If state competition is a race to the top, investors will prefer the director primacy approach taken by Delaware to the shareholder primacy one adopted by North Dakota. Either way, North Dakota loses.

 

Keywords: corporation, corporate statute, race to the bottom, race to the top, Delaware, North Dakota, Public Corporation Act

 

JEL Classifications: K22

Does Irrationality = Bad Faith?

Bastiaan F. Assink at The Defining Tension blog offers a very interesting discussion of the possible relationship between waste, irrationality, and bad faith. It's a long and detailed post, which you should read in full, but here's the conclusion:

 

1. Waste is doctrinally one of the situations covered by the general business judgment rule element 'lack of any rational business purpose'.
2. This - quite extreme - objective component may be best understood as a requirement that objective indicators be used, as a matter of evidence, to assess the director's subjective state of mind (the same may apply to the "utter failure" language used by the Delaware Supreme Court in Caremark and Revlon situations).
3. Thus, this type of irrationality - or: egregiousness - is indicative of bad faith, and therefore of disloyalty - as opposed to lack of due care - as framed under the Delaware Supreme Court's opinion in Stone v. Ritter and its progeny.

This is in line with what I concluded in post No. 24, discussing the Delaware Supreme Court's opinion in Lyondell Chemical Company v. Ryan:

1. Violation of the good faith component of the duty of loyalty, to be derived from the circumstances of the case at hand, requires facts that are - from a culpability perspective - clearly more egregious than facts that justify a finding of a duty of care breach. This confirms that the 'lack of good faith' concept is to be applied quite narrowly, at least in the director liability setting.
2. If there is no conflict of interests, and the company's charter has an exculpatory clause (the standard situation), it is terribly difficult for a plaintiff to succeed in a director liability proceeding on bad faith grounds in the absence of any clear direct evidence like memo's or e-mails; not just under the business judgment rule and in Caremark claims (duty of oversight), but also in a Revlon scenario.

I'm inclined to agree. This line of reasoning is largely consistent with the analysis I offered in Corporation Law and Economics of the requirement under the business jusgment rule that a decision be "rational":

In Sinclair Oil Corp. v. Levien, the Delaware supreme court held that so long as the board’s decision could be attributed to any rational business purpose the business judgment rule precluded the court from substituting its judgment as to the merits of the decision for those of the board.  Similarly, in Brehm v. Eisner, the court held that the business judgment rule does not apply when the board has “act[ed] in a manner that cannot be attributed to a rational business purpose.”

 

The reference to a “rational business purpose,” properly understood, does not contemplate substantive review of the decision’s merits. As Professor Michael Dooley observes, “Sinclair’s use of [the word] rational is to be equated with conceivable or imaginable and means only that the court will not even look at the board’s judgment if there is any possibility that it was actuated by a legitimate business reason. It clearly does not mean, and cannot legitimately be cited for the proposition, that individual directors must have, and be prepared to put forth, proof of rational reasons for their decisions.”  Consequently, as Chancellor Allen has stated:

[W]hether a judge or jury considering the matter after the fact, believes a decision substantively wrong, or degrees of wrong extending through “stupid” to “egregious” or “irrational”, provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests. To employ a different rule—one that permitted an “objective” evaluation of the decision—would expose directors to substantive second guessing by ill-equipped judges or juries, which would, in the long-run, be injurious to investor interests.

Instead, as Chancellor Allen observed elsewhere, “such limited substantive review as the rule contemplates (i.e., is the judgment under review ‘egregious’ or ‘irrational’ or ‘so beyond reason,’ etc.) really is a way of inferring bad faith.”

 

Put another way, inquiry into the rationality of a decision is a proxy for an inquiry into whether the decision was tainted by self-interest. In Parnes v. Bally Entertainment Corp., for example, the Delaware supreme court stated that: “The presumptive validity of a business judgment is rebutted in those rare cases where the decision under attack is ‘so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.’”  In that case, Bally’s CEO allegedly demanded bribes from prospective takeover bidders and, moreover, allegedly received such a bribe from the successful bidder. In holding that the plaintiff shareholder had stated a cause of action, the court observed that “it is inexplicable that independent directors, acting in good faith, could approve the deal” when it was so tainted.

 

If that's right, however, why are the Delaware courts insisting that there can be bad faith disloyalty without self-dealing?

North Dakota v. Delaware

The Financial Times' Tracy Alloway tackles the story of how David (North Dakota) is going up against Goliath (Delaware), observing that:

From a Wall Street Journal story in December:

 

Only two publicly traded companies are incorporated in North Dakota. But last year lawmakers there — prodded by out-of-state activists including Carl Icahn — enacted the nation’s most shareholder-friendly corporate-governance law.

 

The law prescribes rules that companies incorporating in North Dakota can adopt as a package, including requiring an annual shareholder advisory vote on executive pay and the naming of a chairman who isn’t an executive. The rules also provide for the annual election of directors and make it easier for shareholders to nominate their own director candidates.

She continues:

[J]ust because North Dakota is appealing to shareholders via strengthened corporate governance and Delaware tends to appeal to management because of its company-friendly policies and bottom line-friendly tax exemptions, doesn’t mean this is a clear-cut shareholder vs management conflict.

University of California law professor Stephen Bainbridge, for instance, offers a nuanced discussion of the subject in relation to the North Dakota/Delaware competition, in the form of this paper. Selected extract (emphasis ours):

Those who believe that state competition results in a race to the bottom believe that Delaware’s corporate statute is skewed to favor the interests of corporate managers rather than those of investors. As the story goes, because it is corporate managers who decide on the state of incorporation, Delaware caters to management, allowing them to exploit shareholders.

An alternative view claims that state competition leads to a race to the top. According to this account, investors will not purchase, or at least not pay as much for, securities of firms incorporated in states that cater excessively to management. Likewise, lenders will not lend to such firms without compensation for the risks posed by management’s lack of accountability. As a result, those firms’ cost of capital will rise, while their earnings will fall. Among other things, such firms thereby become more vulnerable to a hostile takeover and subsequent management purges. Corporate managers therefore have strong incentives to incorporate the business in a state offering rules preferred by investors and, as a result, competition for corporate charters should lead to statutes that maximize shareholder wealth. …

Nuance. Our specialty.

Anyway, as my paper argues, this is one fight Goliath is going to win.

Freedom of Contract in Corporations

I once wrote:

The nexus of contracts model has important implications for a range of corporate law topics, the most obvious of which is the debate over the proper role of mandatory legal rules. As a positive matter, contractarians contend that corporate law in fact is generally comprised of default rules, from which shareholders are free to depart, rather than mandatory rules. As a normative matter, contractarians argue that this is just as it should be. …

[Some reject] the positive contractarian story on grounds that corporate law is pervaded by mandatory rules. But this objection is far from fatal. In the first instance, most contractarians probably regard the normative story as being the more important of the two. As such, we cheerfully concede the existence of mandatory rules, while deploring that unfortunate fact.

Community and Statism: A Conservative Contractarian Critique of Progressive Corporate Law Scholarship, 82 Cornell Law Review 856 (1997).

Unfortunately, the Delaware Chancery Court's recent decision in Sutherland v. Sutherland, 2009 WL 750287, rejected the proposition that freedom of contract prevails in corporate law, as it does in partnership and LLC law:

While such a provision is permissible under the Delaware Limited Liability Company Act and the Delaware Revised Uniform Limited Partnership Act, where freedom of contract is the guiding and overriding principle, it is expressly forbidden by the DGCL.

As Larry Ribstein points out, in a post you should go read in full:

In corporations, freedom of contract is not, by negative implication, the "guiding and overriding principle."

As per my prior writings, I hereby deplore that unfortunate fact.

Bad Faith = Utter Failure

With respect to Lyondell Chemical v. Ryan, Eric Chiappinelli notes:

Here in Ryan, Justice Berger brings back some of Chancellor Allen’s language about utter failure and I worry that such a standard might work its way into the standard for duty of loyalty liability in bad faith cases.
For example, when she first mentions the standard she writes (p.11), “We adopted the standard articulated . . . in In re Caremark . . . [now she quotes from Caremark:] only a sustained or systematic failure . . . such as an utter failure to attempt to assure a reasonable information and reporting system exists – will establish the lack of good faith that is a necessary condition to liability.” Likewise, she later writes (p.18), “Only if they knowingly and completely failed to undertake their responsibilities would they breach their duty of loyalty”. Note the phrase, “and completely”. Further on that page she quote a Chancery Court opinion that could lend support to this analysis: “[an] extreme set of facts [is] required to sustain a disloyalty claim premised on the notion that disinterested directors were intentionally disregarding their duties”. Does an extreme set of facts equate with a requirement that the plaintiff show that the directors not only intended to disregard their duties but did absolutely nothing? Finally (p.19) “[T]he inquiry should have been whether those directors utterly failed to attempt to obtain the best sales price.” Note the words, “utterly failed”. All this language might be seen as imposing liability for breach of the duty of loyalty via bad faith only when there is intent and when the directors completely fail to meet their duty or perhaps completely fail to take action.
This can’t be the law. Intent is surely a requisite for finding bad faith and hence a duty of loyalty violation but there’s no case law authority and no policy reason to impose an additional test of utter failure to meet the duty or take action. Surely a director is liable who intends not to meet the duty of loyalty by only a little bit.
Justice Berger has much language, though, that suggests the correct rule, as well, and I’m hopeful that courts will pick up on that language and not on the looser formulations quoted above.

The use in recent bad faith opinions of terms like "completely" and "utter" does suggest that bad faith requires a showing of an intentional and utter failure on the board’s part. It’s hard to imagine sufficiently “egregious” facts to satisfy that standard. (AIG suggests that, in oversight cases, culpable participation may be necessary.)

Yet, that does appear to be the emerging standard. In his recent Citigroup decision, Chancellor William Chandler explained that "a plaintiff must also plead particularized facts that demonstrate that the directors acted with scienter." 964 A.2d 106, 125 (Del Ch 2009). As I explained in Caremark and Enterprise Risk Management, Chandler hewed closely to the "utter" and "completely" position.

In effect, bad faith may be in the process of becoming the functional equivalent of the so-caled egregious or irrational decision exception to the business judgment rule; i.e., a theoretical claim that in practice is an empty set.

Chicken Fried Chicken

• ½ cup all-purpose flour
• ¼ cup yellow corn meal
• 1 teaspoon baking powder
• 1 teaspoon salt
• 1 teaspoon freshly ground black pepper 
• ¼ teaspoon ground cayenne pepper
• ½ cup milk
• 1 egg, beaten
• 2 skinned and boned chicken breast halves
• Vegetable oil

One at a time, put chicken breasts on a cutting sheet and cover with a heavy duty plastic bag. Pound with a rolling pin or mallet until the breasts are about a half inch thick. Combine flour, corn meal, baking powder, salt, and both peppers in a pie plate. Whisk together milk and eggs in a second pie plate. Dredge a breast in seasoned flour, shake off excess, dip in egg/milk mixture, and dredge again in seasoned flour. Transfer to a wire rack over a sheet pan. Repeat with second breast. Allow breasts to rest 5 minutes.

Add enough vegetable oil to a 12-inch cast iron frying pan to bring to a depth of ½ inch. Heat to 350°. Add chicken breasts. Cook until downward facing side is golden brown (it took me about 7 minutes). Flip over and continue cooking until other side is also golden brown (it took me about 5 minutes). Transfer breasts to a wire rack over a sheet pan and tent loosely with foil. Allow to rest while you make pan gravy.

Drain off all but about 2 tablespoons of fat from the frying pan. Add 2 and ½ tablespoons seasoned flour mix. You're making a roux. Cook until it just begins to color, stirring constantly. Blonde is good, but brown is too far and means you have to start over with fresh fat. Add ¾ cup chicken stock. Allow to thicken slightly. Add ½ cup whole milk. Cook until gravy coats the back of a spoon. Season with salt and freshly ground white pepper to taste. (I like it very peppery, but YMMV.)

Plate breasts and pour gravy over. Mashed potatoes or corn on the cob would make a nice accompaniment, along with an obligatory green vegetable of some sort, but frankly sometimes (okay, most of the time) I'm content with just the chicken.

How Rome Fell and the Moral for the USA

I've been reading with great interest Adrian Goldsworthy's new book, How Rome Fell: Death of a Superpower. It's an instructive tale of how the Roman Empire's failure to develop a succession process with social legitimacy led to a series of debilitating civil wars, which left the empire too weak to fend off outsiders. The conclusion draws some obvious parallels with the fate of subsequent empires, including the British and American:

Nothing suggests that the United States must inevitably decline and cease to be a superpower in the near future. ... This certainly does not mean that America can afford to be complacent.

 

The Roman experience suggests that imperial decline is likely to start at the top.

All of which calls to mind Barack Obama's twin policies of expanding bureaucracy and apologizing to the world for American hegemony. As Dorothy Rabinowitz observes:

He had gone to Europe not as the voice of his nation, but as a missionary with a message of atonement for its errors. Which were, as he perceived them -- arrogance, dismissiveness, Guantanamo, deficiencies in its attitudes toward the Muslim world, and the presidency of Harry Truman and his decision to drop the atomic bomb, which ended World War II.

No sitting American president had ever delivered indictments of this kind while abroad, or for that matter at home, or been so ostentatiously modest about the character and accomplishment of the nation he led. He was mediator, an agent of change, a judge, apportioning blame -- and he was above the battle.

None of this display during Mr. Obama's recent travels could have come as a surprise to legions of his supporters, nor would many of them be daunted by their new president's preoccupation with our moral failures. Five decades of teaching in colleges and universities across the land, portraying the U.S. as a power mainly responsible for injustice and evil, whose military might was ever a danger to the world -- a nation built on the fruits of greed, rapacity and racism -- have had their effect. The products of this education find nothing strange in a president quick to focus on the theme of American moral failure. He may not share many of their views, but there is, nonetheless, much that they find familiar about him.

The WSJ review of How Rome Fell: Death of a Superpower touches on these issues, as well:

Adrian Goldsworthy's "How Rome Fell" begins and ends with reflections on Edward Gibbon, whose classic work of the 1770s and 1780s, "The Decline and Fall of the Roman Empire," set a standard for all successors. Mr. Goldsworthy sees Gibbon as instinctively relating imperial Rome to imperial London and growing ever more pessimistic as the years swept by. When the first volume of "The Decline and Fall" appeared in 1776, the prospect of Britain keeping its American colonies seemed bright. By the time of the second and third volumes, in 1781, Britain's trans-Atlantic empire was trundling shakily toward Yorktown. In 1788, Americans were able to read the final three volumes in a new country. The tone of the great British historian, Mr. Goldsworthy says, took a noticeable change during this time.

His own tone toward Britain -- Mr. Goldsworthy is himself British -- moves equally toward depression. He notes that, like the Roman Empire in the fourth and fifth centuries, his country has had a growing share of incompetence, corruption and blatant deceitfulness. It, too, has seen the number and the power of military bureaucrats rise while the number of soldiers has fallen. ...

Although Britain's decline is much on Mr. Goldsworthy's mind, the U.S. is the main focus of his practical historiography. Predominantly a military historian, he has enjoyed the attention of Washington policy makers eager to learn about the similarities between then and now -- overstretched forces, domestic greed, declining shared values, determined foreign foes. It is "an odd sensation," he says, "for an historian to talk to an audience that is actually listening to what you are saying." In universities it is more common for the members of a seminar to be thinking about their own contribution in reply. Americans, he discovers, are also more likely to have taken a general classics course and to have some knowledge, at least in outline, of the time between Julius Caesar and the beginning of the Middle Ages.

I was favorably impressed by Goldsworthy's biography of Caesar, but this is an even better and more important work. Highly recommended.

 

To order your own copy, follow this link: How Rome Fell: Death of a Superpower.

Executive Bonuses at the NY Times

Huffington Post:

At a time when New York Times managers are forcing all employees to take a five percent pay cut, and demanding even larger sacrifices from the NYT-owned Boston Globe, top executives of the beleaguered newspaper received substantial bonus and fringe benefit payments over and above their salaries, according to a proxy statement released on March 11.

These bonuses and benefits to top Times company executives have provoked growing resentment among Times staffers, and frank anger from Globe reporters who have been warned by Times executives that their paper will be folded if they do not come up with $20 million in pay cuts and layoffs.

On Tuesday, the Times disclosed a $74 million first quarter loss, 221 times larger than the $335,000 loss in the first quarter of 2008. ...

Last year, from January 2, 2007, to January 2, 2008, NYT stock fell by over 50 percent, from $17.45 to $7.59.

The paper's 2008 revenues, $2.95 billion, were down 7.7 percent from $3.20 billion in 2007. After reporting net income of $208.7 million in 2007, the company declared a net loss of $57.8 million in 2008.

For Sulzberger, who became NYT publisher in 1992, the circulation figures since he took over are depressing. If trends continue, weekday circulation will fall below 1 million this year.

Tigerhawk:

Have you ever watched a war and wanted both sides to lose? Well, if you have you can imagine my delight in the Huffington Post's hectoring of the New York Times Company for paying excessive executive bonuses while it is beating up on its unions for wage and rules concessions. Normally, my view is that executives should earn big bonuses by squeezing concessions out of unions -- after all, that's what the stockholders want the management tools to do -- but since the editors of the Times and its affiliated newspapers would denounce that idea as evil I support the suits in this case with something less than my usual ardor.

I wonder what Gretchen Morgenson will say?

Corporate social responsibility

I got an email from a reader today who asked whether I thought a "proactive stance" on corporate social responsibility would have prevented the Martha Stewart situation. I don't see how, but that may be because I don't really believe in CSR. I've got several articles that explain why in more detail:

1. In Defense of the Shareholder Wealth Maximization Norm: This essay was written as a reply to an article in the same symposium by Professor Ronald M. Green - "Shareholders as Stakeholders: Changing Metaphors of Corporate Governance," 50 Wash. & Lee. L. Rev. 1409 (1993) - in which Professor Green criticized the dominant view of corporate governance, according to which directors have a fiduciary duty to maximize shareholder wealth. In sharp contrast, this essay argues that the principle of shareholder wealth maximization is both a valid positive account of corporate law and also a legitimate normative proposition.
2. Catholic Social Thought and the Corporation: Human dignity and freedom are central principles of Catholic social thought. This essay argues that preserving the economic freedom of corporations to pursue wealth is an essential part of effective means for achieving human freedom. To the extent prudential judgments about corporate regulation are required, the Church and civil society should strive towards a nuanced balancing of freedom and virtue.
3. Community and Statism: A Conservative Contractarian Critique of Progressive Corporate Law Scholarship: The bulk of this essay is devoted to exploring the emerging communitarian theory of the firm. In the course of doing so, however, I also begin developing an explicitly conservative version of the law & economics account of corporate law. The essay looks to the intellectual tradition that runs from Edmund Burke to Russell Kirk to articulate an alternative to both the left communitarianism of progressive corporate law scholars and the classical liberalism embraced by many practitioners of law and economics.

Institutional Investor Micromanagement

Institutional investors routinely claim that they don't want to micromanage corporations and, accordingly, that "reforms" intended to "empower" shareholders will not be used towards that end.

At least insofar as executive compensation and union pension funds are concerned, micromanagement is the order of the day.

Jeremy Goldstein explains:

The SEC staff has denied a no-action request by Regions Financial to exclude a shareholder proposal requesting that Regions impose numerous restrictions on executive compensation in light of the company’s participation in the TARP Capital Purchase Program (CPP). Several unions have reportedly submitted the proposal (or a variation thereof) at nearly two dozen financial institutions. Its restrictions, if adopted, would severely hamstring a company in designing compensation to attract, retain and incentive senior management. The union proposal would micromanage executive compensation with a laundry list of rigid, inflexible restrictions, including an annual cap on incentive compensation, a requirement of performance vesting for most long-term equity compensation, a requirement that stock option strike prices be peer-indexed, a bar against executives selling more than 25% of their equity awards while they remain employed, a prohibition on accelerated (e.g., non-cause firing) vesting for all executive equity awards, a limit on severance payments to no more than annual salary and a freeze on the accrual of retirement benefits under SERPs.

Regions argued that the proposal is actually multiple proposals in violation of Rule 14a-8 and is vague and indefinite (among other reasons, for failing to say whether the restrictions would be permanent or limited to the period of TARP participation). Regions also argued that it had substantially implemented the proposal by agreeing to limit executive compensation in its CPP investment agreement with the U.S. Treasury. Last December, the SEC staff granted no-action relief to SunTrust on a substantially identical shareholder proposal. In denying Regions’ request for no-action relief, the staff provided no explanation for its about-face.

This is precisely the sort of thing about which I warned in my fight with shareholder empowerment champion Lucian Bebchuk.

In this case, however, it's not just micromanagement. It's also class warfare.

My guess is that shareholders will vote down these proposals. After all, it's hard enough for struggling financial institutions to attract top management in light of the TARP restrictions. Adding even more restrictive governance bylaws would simply compound the problem.

The question remains, however, why we want to force companies to jump through these sort of hoops.

Would Delaware Courts Follow Baron v. Allied Artists Pictures Today?

In Baron v. Allied Artists Pictures Corp., 337 A.2d 653 (Del. Ch. 1975), app. dismissed, 365 A.2d 136 (Del. 1976), Allied?s articles of incorporation provided that if six or more quarterly dividends were missed the preferred shareholders, voting as a class, would have the right to elect a majority of the board of directors.

 

Allied missed the requisite number of preferred dividends, triggering the preferred shares' contingent voting rights. The idea behind contingent voting rights, of course, is that the preferred shareholders' board representatives will change corporate policy so that the firm can begin paying dividends on the preferred. Once the missed dividends are caught up, the preferred shareholders' representatives step down and control returns to the common. (Classically minded readers will note the parallel to the story of Cincinnatus, the Roman general who left his farm to defeat the Aequi and Volscians and, after victory, went back to his farm.)

 

In Allied's case, however, the board failed to begin paying dividends on the preferred stock. As a result, the preferred retained their right to elect a majority of the board--for a period of ten years.

Plaintiff was a common shareholder who sued, in effect, to compel the board to declare such dividends as would be necessary to return control to directors elected by the common. The Chancery Court rejected plaintiff's claim, holding that the directors have discretion to declare dividends or to refrain from doing so. The exercise of that discretion is not unbounded, of course. A board elected by the preferred does have a fiduciary duty to see that the preferred dividends are brought up to date as soon as possible in keeping with prudent business management.

 

Note, however, that the latter qualification substantially eviscerates the scope of the stated duty. The board need not begin paying dividends on the preferred the moment sufficient funds have become available, so long as there is a good business reason for retaining earnings. Worse yet, the business judgment rule precludes the court from second-guessing the board's decision absent "fraud or gross abuse of discretion." In light of the volatile nature of the motion picture business and the resulting need to retain sufficient reserves against major losses, the court refused to grant relief.

Two conceptions of the business judgment rule compete in the cases--some view it as a rule of abstention, while others treat it as a substantive standard of review. As its invocation of an "abuse of discretion" standard suggests, Allied Artists leans towards the view that the business judgment rule is a substantive standard of review, albeit a quite deferential one. That impression perhaps is confirmed by the relatively extensive analysis in the decisions of the firm's ability to pay a dividend in the circumstances.

Ironically, however, everyone seems to have ignored the fact that over half of Allied's preferred stock was owned by a single shareholder--Kalvex, Inc.--which owned almost none of Allied's common stock. Because the preferred voted as a class without benefit of cumulative voting, Kalvex controlled the outcome of board elections, despite owning only 7 percent of Allied's total equity. As a result, there was a substantial interlock between the two companies? boards and management. Allied's president, for example, was also the president of Kalvex.

 

Although Kalvex was mainly a preferred shareholder, the court could have (and should have) been treated as Allied's controlling shareholder subject to the attendant fiduciary duties. Under the duty of loyalty applicable to controlling shareholders, the question would be whether Kalvex received a benefit at the expense of and to the exclusion of the other shareholders. If so, Kalvex would have to justify that benefit under the intrinsic fairness standard. Plaintiff would have argued that control of the corporation is itself a benefit, which the preferred shareholders seized to the exclusion of the common, and also pointed to the highly remunerative compensation Kalvex's officers received by virtue of their positions at Allied. Would plaintiff have won? Maybe not, but certainly plaintiff's chances would have been far greater than under the theory actually used.

The result in Baron rests uneasily in today's post-Unocal jurisprudence, in which Delaware courts have been much more sensitive to issues of management entrenchment. In addition, it's noteworthy that Kalvex's principals were using a technically lawful set of actions to entrench themselves in office. Jack Jaobs and Leo Strine, among other modern Delaware jurists, have revealed themselves to be quite sensitive to appropriate invocations of the court's equitable powers under Schnell v. Chris-Craft. See, e.g., Strine's opinion in Portnoy v. Cryo-Cell Intern., Inc., 940 A.2d 43 (Del.Ch.,2008.), in which he noted "the potency of a good old-fashioned inquiry under precedent such as Schnell, which proscribes conduct that is disloyal in the well-understood sense that it was undertaken not to advance corporate interests, but to entrench managers in office." Id. at 71. See also Frantz Mfg. Co. v. EAC Industries, 501 A.2d 401, 407 (Del.,1985.) (holding that "Schnell prohibits incumbent management from entrenching itself by taking action which, though legally possible, is inequitable.").

It would not take a particularly aggressive application of those principles to a Baron-like fact pattern to force Kalvex to pay the required dividends.