ProfessorBainbridge.com

Thanks to The Journal of Law for publishing two of my essays on fee shifting bylaws

The case for allowing fee shifting bylaws as a privately ordered solution to the shareholder litigation epidemic, ProfessorBainbridge.com, Nov. 17, 2014, by Stephen M. Bainbridge

Delaware’s Decision: Viewing fee shifting bylaws through a public choice lens, ProfessorBainbridge.com, Nov. 18, 2014, by Stephen M. Bainbridge

SEC as prosecutor, judge, jury, and executioner

UIUC law professor Suja Thomas and SEC fan Mark Cuban have an article in the NY Times on the problem of the SEC employing judges who pass on cases brought by SEC enforcement lawyers:

After losing several cases before juries, the S.E.C. went to a place where it generally cannot lose: itself. When it accuses a person of a securities violation, the S.E.C. has often brought the case in an administrative hearing where one of its own judges decides the case, not a jury. Rarely does the agency lose such cases before its judges, and when it has lost, the loss is not well-received. At least one judge has reported being criticized for finding too often in favor of defendants. That same judge ultimately resigned. ...

 Specifically, the jury provided such protection. Under the Seventh Amendment, if the government sued a person, a jury was to decide if he was liable and required to pay money to the government.

The federal courts should recognize the constitutional authority granted to juries to decide civil cases as well as the related limitations on the legislature and the executive to determine who decides. Importantly, a defendant accused of wrongdoing by the government and facing significant monetary penalties should have the option of a jury deciding his case.

Kindly go read the whole thing.

Allaire & Dauphin on hedge fund activism

Yvan Allaire and François Dauphin return to a topic on which they have been active and important commentators and analysts; namely, hedge fund activism. Specifically, they report on a new study they conducted:

We ... explored, among other things, the consequences of activism over time when compared to a random sample of firms with similar characteristics at the time of intervention.

Focusing on activist events of the years 2010 and 2011, we obtained a sample of 290 campaigns initiated by 165 activist hedge funds which targeted 259 distinct firms. To map out the actions and performance of these 259 targeted companies, we have set up a random sample of 259 companies selected to match the targeted companies at the intervention year in terms of industry classification and market value.

This research does not provide any evidence of the superior strategic sagacity of hedge fund managers but does point to their keen understanding of what moves stock prices in the short term. Indeed, in none of the 259 cases studied here did hedge funds make proposals of a strategic nature to enhance the long-term performance of the firm.

That should concern society, governments, pension funds and other institutional investors with pretension of a long-term investment horizon.

indeed, it should.

Shareholder activism motivated by "populist/progressive skepticism"

Charles Nathan of RLM Finsbury has a post at the Harvard corporate governance blog that deals, among other things, with why institutional investors lean towards activists rather than managers. I disagree with much of the post, but he does accurately capture one key point:

... the dominant philosophy driving the creation and implementation of ISS’ and institutional investors’ voting policies has consistently been aligned with a populist/progressive skepticism about the motivations and behavior of corporations and their managements.

It is critical to understanding the policy debate about shareholder activism that there is an underlying disagreement not just about corporate governance but also basic normative priors. Although not all of the activists and their supporters share Bernie Sanders' politics, a lot of them are committed people of the left. Look at the heads and boards of major state and local government pensions or union pensions, to cite but the most obvious examples, and you'll find an awful lot of Liz Warren types who are deeply skeptical of corporate capitalism.

New Delaware VC Tamika Montgomery-Reeves

Commentary from Haskell Murray

Regulation is killing the public corporation

Marc Hodak has a great post on the problem. Go read the whole thing, but here's the gist:

 The model I have used for over a decade is quite simple:

A company will choose to be public when the benefits of being a public company exceed its costs, otherwise it will not join, or will exit, the public sphere.

The way it exits is of secondary importance.

So, for example, the fixed cost of being a public company for a $100 million firm (net assets) shortly before SOX was just over $1 million per year. After SOX, that number jumped up to about $3 million per year. ...

After Dodd-Frank, with its voluminous new regulations for public companies, I estimate that few companies under $1 billion in net assets can any longer afford to be public.

All of this, of course, is as I predicted in Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010): http://ssrn.com/abstract=1696303

Ridge Lytton Estate Primitivo (Dry Creek Valley) 2012

This is a really interesting wine from Ridge's ATP program. Primitive, of course, is a close relative of Zinfandel (both are clones of a Croatian grape called Crljenak), but this bottle seems less rustic than most Zinfandels. 

Deep ruby color. Strong bouquet of cherries, plums, and spice. On the palate, the key flavor associations are cherries, berries, and a dash of pepper on the finish. Medium bodied and medium length finish. (Some reviewers have found it sweet and/or jammy, neither of which were true for me.)

Soft and smooth tannins make it easy to drink now, despite the high (14.7%) alcohol level. Not a wine for the cellar, but a good quaffing wine over the next few years with simple fare.

Grade: 87

Insider Trading at the Supreme Court: With Newman down, will Salman go?

The Supreme Court’s decision to deny cert in US v. Newman was hardly surprising. In the first place, the procedural posture of the case made it a poor candidate for addressing the personal benefit issue.

The Second Circuit decision “not only overturned Newman’s and Chiasson’s convictions, but [also] dismissed their indictments….” It did so not just because the trial judge used the wrong jury instructions, but “also—and this was the fatal part—[because the government had] failed to come forward with evidence that could have convicted the two men even had the proper instructions been given.”[1]

The government’s cert petition failed to take issue with the latter holding. Accordingly, “even if the Supreme Court were to take the case and agree with [the government] that the Second Circuit’s definition of personal benefit was wrong, it seems that Newman and Chiasson would still walk, for lack of evidence that they knew that their tippees at Dell and Nvidia received any personal benefit.”[2]

To be sure, the government told the Supreme Court that it could send the case back for further fact finding, but the reality is that, in effect, the government was asking the court to issue an advisory opinion on the personal benefit test. The court wisely dodged that bullet.

Of course, I think the court also was correct on the substance. Along with my friends Professor Todd Henderson of Chicago and Jon Macey of Yale, I filed a brief opposing the government’s request for rehearing at the Second Circuit level. We argued that Newman was a correct application of Dirks’ personal benefit test and, moreover, that the government’s interpretation of Dirks would chill valuable analyst-insider communications that Dirks intended to protect.

As Adam Pritchard has demonstrated by reviewing Justice Powell’s papers, Dirks’s approach to tipping was driven in considerable measure by Powell's concern that insider trading laws could seriously infringe on the ability of market analysts to communicate with corporate managers.[3]

In addition, both Chiarella and Dirks reflected a policy concern to protect the market from the threat of prosecutorial over-reaching. In both, the government advocated a far broader liability rule than Justice Powell was willing to countenance. In both, Powell rallied a majority to smack down government overreaching.

With respect to the problem at hand, Powell fashioned the personal benefit test to provide a necessary “limiting principle” for fraud liability and a meaningful “guiding principle” for analysts, insiders and investors. As he recognized, such definite and objective limits on the scope of insider trading liability are necessary to protect the socially beneficial activities of market participants operating under the eye of the SEC. Without those “legal limitations, market participants are forced to rely on the reasonableness of the SEC’s litigation strategy” as their only assurance that their activities will not be subject to prosecution. And that, as he observed, “can be hazardous.”

Newman is a straightforward and correct application of Dirks. In particular, Newman correctly rejected the government’s contention that the “mere fact of a friendship” between the insider and the recipient of information is legally sufficient evidence that the insider sought a personal benefit. The function of the personal benefit test is to gauge whether a disclosure was made for an improper purpose. Unlike the personal benefit test, the fact that an analyst can be characterized as a social “friend” of the insider who discloses information, does nothing to illuminate the purpose for which the disclosure was actually made.

If mere evidence of “friendship” is presumptive evidence of personal benefit, then virtually all disclosures are potentially subject to prosecution, because insiders are far more likely to be involved in discussion of their companies with people they know than with strangers. As such, analysts and insiders who are engaged in industry activity that the Supreme Court correctly understands to be normal, socially beneficial, and important to the integrity of capital markets, and that it explicitly seeks to protect, would operate at peril of prosecution for securities fraud simply because they talk regularly, have common friends with whom they socialize, or have some other point of social interaction that could lead to their characterization as “friends.”

Newman thus protects the integrity of the market by placing a meaningful and objective limit on the scope of insider trading liability, allowing investors analysts and insiders to function with reasonable certainty and security about whether their conduct violates the law. In contrast, the government’s version of the personal benefit test fails to supply a standard to which market participants can reasonably conform their conduct. A recipient of information who tries to determine whether he or she is presently under a duty not to trade will find that there is no clear answer, because even the most nebulous of social relationships with the source of the information might be construed as a sufficient basis for liability.

The Supreme Court’s denial of cert leaves Newman intact. So as with the Second Circuit’s refusal to rehear the case en banc, that’s a good outcome. Not as good as a Supreme Court affirmation of Newman, of course, but frankly I prefer to keep securities law cases away from the Supreme Court. As Mitu Gulati and I argued a while back, you simply can’t trust the post-Powell court to get securities cases right.[4]

Which leads me to US v. Salman. Unlike Newman, Salman presents the personal benefit issue without procedural complications. “The Salman defendants’ petition for rehearing was denied on Aug. 13, so they have until about Nov. 13 to file their petition for writ of certiorari with the Supreme Court. While they most likely would have petitioned anyway, the denial of the Newman petition makes a petition all the more certain.”[5]

But this puts the government in a difficult position. “Under ordinary circumstances, it would oppose the Salman defendants’ petition for certiorari to protect its conviction and support the broader view of insider trading.” “But here, if Newman has the destabilizing impact that the government claims, even the government may want the Supreme Court to address insider trading sooner rather than later. Salman would provide the next vehicle to do so.  Otherwise, the government might have to live with Newman for years until a circuit split deepened.”

The government therefore might file a fairly unconventional response to the Salman petition. It potentially could argue that Salman was right, but the court should nonetheless hear the case. Doing so obviously has risk, particularly since about two-thirds of cases accepted by the court are reversed. But arguing against certiorari in Salman means that the government must: (1) disavow its recent argument that a circuit split existed; and (2) live with Newman for the foreseeable future.”[6]

So my guess is that Salman stands a good chance of getting before the Supreme Court,which worries me because they'll probably screw it up. My sole hope is that Ninth Circuit’s reversal rate will help make sure that the Supreme Court upholds Newman’s approach to the personal benefit test.

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[1] http://fortune.com/2015/09/23/supreme-court-insider-trading-newman/

[2] Id.

[3] A.C. Pritchard, Justice Lewis F. Powell, Jr., and the Counterrevolution in the Federal Securities Laws, 52 Duke L.J. 841 (2003).

[4] Stephen M. Bainbridge & G. Mitu Gulati, How Do Judges Maximize? (The Same Way Everybody Else Does--Boundedly): Rules of Thumb in Securities Fraud Opinions, 51 Emory L.J. 83 (2002)..

[5] http://www.natlawreview.com/article/rest-peace-newman-so-will-government-lay-down-salman

[6] Id.

Can directors of corporations be held liable to shareholders when the corporation breaks the law

My earlier post on the corporate law aspects of the VW diesel engine scandal assumed away the issue of corporate criminality. Prompted by a complaint from my friend and coauthor Bill Klein. however, I'm revisiting the question and this time assuming that what VW did was illegal.

I am still making two of the original simplifying assumptions, however. First, VW is incorporated in Delaware. Obviously, that's not the case. But I don't know German law on the subject and, candidly, my purpose here is just to use the story as a thought experiment about US law. Second, the VW board knew about and approved the decision to use the emissions testing software. This lets us eliminate the Caremark issues and their complex body of law.

Note that we are discussing here solely liability to shareholders for a breach the board's fiduciary duties under corporate law. Criminal and civil liability to the state and/or deceived purchasers is beyond the scope of this discussion.

The initial question is what duty is implicated by corporate criminality. Under current Delaware law, it appears that the relevant law is the duty of good faith (which is technically not a separate duty but rather is subsumed by the duty of loyalty). In Walt Disney Co. Deriv. Litig.,[1] the Delaware supreme court defined good faith as encompassing “all actions required by a true faithfulness and devotion to the interests of the corporation and its shareholders. A failure to act in good faith may be shown, for instance, where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation, where the fiduciary acts with the intent to violate applicable positive law, or where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating conscious disregard for his duties.”

In Stone v. Ritter,[2] the court explained that “the obligation to act in good faith does not establish an independent fiduciary duty that stands on the same footing as the duties of care and loyalty.” Instead, the obligation to act in good faith is subsumed wholly within the duty of loyalty:

[T]he fiduciary duty of loyalty is not limited to cases involving a financial or other cognizable fiduciary conflict of interest. It also encompasses cases where the fiduciary fails to act in good faith. As the Court of Chancery aptly put it . . ., “[a] director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation’s best interest.”

I have been highly critical of this line of cases, of course.[3] Assuming Delaware continues with this line of cases, however, intentional board approval of criminality would be bad faith, which automatically results in liability.

Of course, in the usual case, the board is not charged with having intentionally approved criminality but rather with failing to detect criminality by corporate employees. But this would take us off topic and shift us into the Caremark line of cases and its complex body of law. I discuss those cases in The Convergence of Good Faith and Oversight.[4]

I think the automatic liability under the duty of loyalty is bad policy. I also think it’s doctrinally incorrect. Instead, the issue of corporate criminality should be analyzed under the duty of care (and, as a result, the corollary business judgment rule).

In a leading Third Circuit case arising under New York law, for example, the court treated the problem as involving an alleged “a breach of the defendant directors' duty to exercise diligence in handling the affairs of the corporation.”[5] The ALI Principles likewise treat the issue as one involving “a duty of care action.”[6]

The business judgment rule will not insulate from judicial review decisions tainted by fraud or illegality.[7] The key issue in this context is whether the board has a duty to act lawfully. In the oft-cited Miller v. American Telephone & Telegraph Co. decision,[8] the Third Circuit held that directors have such a duty. AT & T failed to collect a debt owed it by the Democratic National Committee for telecommunications services provided during the 1968 Democrat Party’s convention. Several AT & T shareholders brought a derivative suit against AT & T’s directors, alleging that the failure to collect the debt violated both federal telecommunications and campaign finance laws. Ordinarily, a board decision not to collect a debt would be protected by the business judgment rule. Citing a 1909 New York precedent,[9] however, the Third Circuit held that the business judgment rule did not insulate defendant directors from liability for illegal acts “even though committed to benefit the corporation.”[10]

Assuming a duty to act lawfully exists, operationalizing it is a nontrivial task. Should there be a de minimis exception?[11] If a package delivery firm told its drivers to illegally double-park, so as to speed up the delivery process, for example, it is hardly clear that liability should follow. Should the business judgment rule be set aside only where the board ordered violations of criminal statutes or should it also be set aside where the board authorized violation of some civil regulation? The criminal law long has distinguished between crimes that are malum in se and those that are merely malum prohibitum. The latter are acts that are criminal merely because they are prohibited by statute, not because they violate natural law. It is said that “misdemeanors such as jaywalking and running a stoplight are mala prohibita, as are most securities-law violations.”[12] Individuals routinely make cost-benefit analyses before deciding to comply with some malum prohibitum law, such as when deciding to violate the speed limit. Is it self-evident that directors of a corporation should be barred from engaging in similar cost-benefit analyses?[13]

And, yet, still more questions must be answered if a duty to act lawfully is to be imposed. If neither the corporation nor the board was convicted or even indicted, for example, should plaintiff have to make out the elements of the criminal charge?[14] If so, to what extent does the criminal law concept of reasonable doubt come into play? Is a knowing violation of criminal law a per se violation of the duty of care unprotected by the business judgment rule?[15] How are damages to be measured and is causation an issue?[16] And so on.

The point is not that corporations should be allowed to break the law. They should not. If a corporation breaks the law, criminal sanctions should follow for the entity and/or the responsible individuals. The point is only that fiduciary obligation and the duty to act lawfully make a bad fit. If the question is one of reconciling authority and accountability, it is not self-evident that corporate law should hold directors accountable simply for deciding that the corporation’s interests are served by violating a particular statute. After all, “[a] business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end.”[17]

Put another way, the point of the business judgment rule is that shareholders should not be allowed to recover monetary damages simply because the directors made the wrong decision. Allowing shareholders to sue over a decision made with the intent of maximizing corporate profits is nothing less than double dipping, even if the decision proves misguided. This claim is further supported by the realities of shareholder litigation. Shareholder lawsuits alleging that directors violated the purported duty to act lawfully will be brought as derivative actions. The real party in interest in derivative litigation is the plaintiff’s attorney, not the nominal shareholder-plaintiff. In most cases, the bulk of any monetary benefits go to the plaintiffs’ lawyers rather than the corporation or its shareholders. In practice, such litigation is more likely to be a mere wealth transfer from corporations and their managers to the plaintiff bar than a significant deterrent to corporate criminality. Accordingly, the illegality of a board decision—standing alone—should not result in automatic director liability. Indeed, one could make the case that illegality should not constitute a basis—again, standing alone—for rebutting the business judgment rule. At the very least, however, courts should carefully consider whether the decision to cause an illegal act was in fact so grossly negligent as to violate the director’s duty of care.

Update: Stefan Padfield suggested a solution via email:

Couldn't you argue the bouncing ball should work as follows?

1.  VW SHs allege damages resulting from breach of duty in connection with emissions scandal.
2.  Board claims protection of BJR.
3.  Plaintiffs overcome presumption of "in good faith" etc. by pointing to illegality of conduct.
4.  Board loses ability to dismiss on basis of 102(b)(7) due to bad faith = loyalty violation
5.  However, board retains ability to prove "entire fairness" of conduct.

I think this might allow you to get some of the things you're arguing for under the current doctrine, especially if one could argue that "fair" in this context means the expected value calculation at the time of the decision equated to a gain for shareholders (expected gain > (cost of detection x probability of detection)).  Of course, I doubt this would ever win the day for policy reasons, but it could at least force discussion/clarification of some of the issues you raise -- especially when one focuses on the fact that we are not talking about the board "getting away with it," but rather whether a successful derivative claim is appropriate on top of everything else.

It's certainly true that "Under Delaware law, when a plaintiff demonstrates the directors made a challenged decision in bad faith, the plaintiff rebuts the business judgment rule presumption, and the burden shifts to the directors to prove that the decision was entirely fair to the corporation and its stockholders." eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 40 (Del. Ch. 2010).

I'm not sure that entire fairness does the necessary work, however. Is entire fairness satisfied by evidence that the board made a decision on the basis of a reasonable cost benefit analysis? So it may not work as a doctrinal matter, even before you get into the policy issues Prof. Padfield correctly suggests would probably scare off the Delaware courts.

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[1]  906 A.2d 27 (Del.2006).

[2]  911 A.2d 362 (Del.2006).

[3] The Convergence of Good Faith and Oversight, available at SSRN: http://ssrn.com/abstract=1006097.

[4] Available at SSRN: http://ssrn.com/abstract=1006097

[5] Miller v. Am. Tel. & Tel. Co., 507 F.2d 759, 761 (3d Cir. 1974).

[6] ALI, Principles of Corp. Governance § 4.01 (1994).

[7]  See, e.g., Shlensky v. Wrigley, 237 N.E.2d 776, 778 (Ill.App.1968).

[8]  507 F.2d 759, 762 (3d Cir.1974) (diversity case arising under New York corporation law).

[9]  Roth v. Robertson, 118 N.Y.S. 351 (Sup.Ct.1909).

[10]  Miller v. AT & T Co., 507 F.2d 759, 762 (3d Cir.1974). See also Abrams v. Allen, 74 N.E.2d 305 (N.Y.1947) (directors can be sued where they used corporate property to commit “an unlawful or immoral act”); Di Tomasso v. Loverro, 12 N.E.2d 570 (N.Y.App.1937) (directors liable for entering into a contract that was an illegal restraint of trade).

[11]  Cf. ALI Principles § 2.01 cmt. g (acknowledging that the “de minimis principle” applies to corporate law compliance “as elsewhere in the law”).

[12]  Black’s Law Dictionary 401 (pocket ed. 1996) (emphasis supplied).

[13]  But cf. ALI Principles § 2.01 cmt. g (“With few exceptions, dollar liability is not a ‘price’ that can properly be paid for the privilege of engaging in legally wrongful conduct.”).

[14]  Miller answered that question in the affirmative. Miller v. American Telephone & Telegraph Co., 507 F.2d 759, 763–64 (3d Cir.1974). Accord ALI Principles § 4.01(a) cmt. d.

[15]  That question is answered in the negative by ALI Principles § 4.01(a) cmt. d.

[16]  Under the so-called net loss rule, directors cannot be held monetarily liable if the overall gains to the corporation from the violation exceed the losses directly attributable thereto, such as fines or legal expenses. See James D. Cox, Compensation, Deterrence, and the Market as Boundaries for Derivative Suit Procedures, 52 Geo. Wash. L. Rev. 745, 765 (1984).

[17]  Dodge v. Ford Motor Co., 170 N.W. 668, 684 (Mich.1919).

Can boards of directors be held liable to their shareholders when their corporations do really dumb things?

Put another way, is there what I call the "rational 5 year old" exemption to the business judgment rule? If a rational 5 year old would tell you "that's a really dumb idea" and the board does it anyway, should the board be liable?

My thoughts on that question are prompted by the VW diesel engine scandal, of course. In a lengthy article on the current state of the investigation, the WSJ reports that:

“Our company was dishonest with the EPA, and the California Air Resources Board, and with all of you,” Michael Horn, head of Volkswagen of America, told dealers last month in New York City. “We’ve totally screwed up.”

In using this story as a case study, I am making three simplifying assumptions. First, VW is incorporated in Delaware. Obviously, that's not the case. But I don't know German law on the subject and, candidly, my purpose here is just to use the story as a thought experiment about US law. Second, the VW board knew about and approved the decision to use the emissions testing software. This lets us eliminate the Caremark issues and their complex body of law. Third, there is no element of self-dealing or illegality, which leaves us dealing with the standard duty of care/business judgment rule analysis.

Note that we are discussing here solely liability to shareholders for a breach of the duty of care under corporate law. Criminal and civil liability to the state and/or deceived purchasers is beyond the scope of this discussion.

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.[1] 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.”[2]

The reference to a “rational business purpose,” properly understood, does not contemplate substantive review of the decision’s merits. As the late Professor Michael Dooley observed, “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.”[3] 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.[4]

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.”[5]

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.’”[6] 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.

Litwin v. Allen is often cited as an exception to the foregoing proposition.[7] Put another way, Litwin supposedly creates an “incredible stupidity” exception to the business judgment rule. Under this reading of the opinion, it stands as an example of a board decision so irrational as to not deserve the protection of the business judgment rule. One problem with this analysis is that Litwin involved the directors of a bank, who are typically held to a higher standard of accountability than directors of other corporations. Another is that Litwin is a sport—a case that falls well outside the norm. It is cited so often, because it stands alone as plausible precedential support for the irrationality exception to the business judgment rule. Finally, consistent with our hypothesis that courts use rationality as a code word for self-dealing, the Litwin court found the transaction in question to be “so improvident, so risky, so unusual, and unnecessary as to be contrary to fundamental conceptions of prudent banking practice.” Although the court expressly declined to find a violation of the duty of loyalty, it seems fair to ask whether “we have reason to disbelieve the protestations of good faith by directors who reach ‘irrational’ conclusions?”[8]

In theory, it may be that there are some board decisions that are so dumb that the business judgment rule will not insulate them from judicial review. But, in practice, the set of such decisions appears to be an empty one to date.[9] 

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[1] Sinclair Oil Corp. v. Levien, 280 A.2d 717, 720 (Del. 1971).

[2] Brehm v. Eisner, 746 A.2d 244, 264 n.66 (Del. 2000).

[3] Michael P. Dooley, Two Models of Corporate Governance, 47 Bus. Law. 461, 478-79 n.58 (1992).

[4] In re Caremark Derivative Litig., 698 A.2d 959, 967 (Del. Ch. 1996).

[5] In re RJR Nabisco, Inc. S’holders Litig., 1989 WL 7036 at *13 n.13 (Del. Ch. 1989).

[6] 722 A.2d 1243, 1246 (Del. 1999) (quoting In re J. P. Stevens & Co., Inc., 542 A.2d 770, 780-81 (Del Ch. 1988)).

[7] Litwin v. Allen, 25 N.Y.S.2d 667 (Sup. Ct. 1940). Delaware Justice Henry Horsey, Technicolor’s author, asserts that Litwin articulates a Technicolor-like formulation of the business judgment rule under which, “for the rule of judicial deference to be invoked, directors of a board must be found to have met not only their duty of loyalty but also their duty of care.” Henry Ridgely Horsey, The Duty of Care Component of the Delaware Business Judgment Rule, 19 Del. J. Corp. L. 971, 976 (1994). As described in the text, however, we regard Litwin as being even less defensible than Technicolor.

[8] Michael P. Dooley, Fundamentals of Corporation Law 263 (1995).

[9] See Gagliardi v. Trifoods Int’l, Inc., 683 A.2d 1049, 1051-52 (Del. Ch. 1996) (“There is a theoretical exception . . . that holds that some decisions may be so ‘egregious’ that liability for losses they cause may follow even in the absence of proof of conflict of interest or improper motivation. The exception, however, has resulted in no awards of money judgments . . . .”; emphasis supplied).

Supreme Court denies cert in US v. Newman insider trading tipping case

The WSJ reports that:

The Supreme Court on Monday turned away a closely watched Justice Department appeal seeking more leeway to bring insider-trading prosecutions, a move that ends the government’s effort to overturn a court ruling favoring Wall Street defendants.

The justices, without comment, said they wouldn’t consider the department’s challenge to a major appeals-court decision from last year overturning two insider-trading convictions of hedge-fund portfolio managers.

That ruling, from the Second U.S. Circuit Court of Appeals in New York, said it wasn’t enough for prosecutors to show that someone who received an inside tip traded on material nonpublic information about a corporation.

Instead, prosecutors also had to prove that the tip recipient knew the confidential information came from an insider, and that the insider disclosed the information for a personal benefit, the appeals court said.

SCOTUS Blog explained:

The new insider-trading case that the Court declined to review marked a significant break in a string of scores of victories by prosecutors in Manhattan against those who buy or sell stock by relying on corporate data that was not yet known to the public, including other investors.  Prosecutors had won convictions of two hedge-fund portfolio managers, Todd Newman and Anthony Chiasson, who had made millions by trading in information that was passed along to them through a chain of contacts, traced back to corporate insiders for high-tech companies.

Newman, a portfolio manager at Diamondback Capital Management, made about $4 million in gains and Chiasson, a co-founder of Level Global Investors, gained about $38 million.  They were convicted of criminal trading on inside information; Newman was sentenced to fifty-four months in prison and Chiasson to seventy-eight months.   They were prosecuted on the basis of a “gift theory” — that is, they benefited in the market from transactions that were based on something that was handed to them indirectly.

The U.S. Court of Appeals for the Second Circuit overturned their convictions, declaring that prosecutors failed to prove that Newman and Chiasson, as “tippees,” knew when they made trades that an insider had disclosed confidential information and that the insider did so in exchange for a personal benefit.  That ruling, the government argued in seeking Supreme Court review, created a difficult new legal standard that will “impair the government’s ability to protect the fairness and integrity of the securities market.”

The Justices, as is their custom, made no comment as they denied review.  There were no notations that any individual Justice had dissented from the order.

I'm pleased that the Court denied cert. As we argued in a brief opposing rehearing en banc at the Second Circuit level, which I was privileged to co-sign:

The panel’s opinion in Newman is both a correct application of the personal benefit test adopted by the Supreme Court in Dirks v. SEC and an important corrective to the government’s drive to expand the limits of insider trading liability. As the Dirks court appreciated, in the economically critical area of analyst-insider communication, a liability standard that is overly broad or unclear will deter market participants from seeking quality information on which to trade and thereby damage the healthy functioning of capital markets. The Supreme Court fashioned the personal benefit test accordingly, to draw a clear line between permissible and impermissible information gathering, so that analysts and investors would know when trading was permissible and not be needlessly deterred from seeking the best information available to them.

The government now seeks to dilute the Supreme Court’s test to the point where it would become, in the Newman court’s words, “a nullity.” Newman op. at 22. Under the government’s interpretation of personal benefit, almost any non- public insider disclosure could qualify, and the recipient of information would have no way of determining when trading on that information was permitted. The government’s misreading of Dirks would fundamentally undermine the policy imperatives that led the Supreme Court to adopt the personal benefit test as an important market-protective limit on insider trading liability, and would deter valuable analyst-insider communications, to the detriment of the market and of all market participants. 

For prior commentary on the Newman case, see:

Evaluating the Government's cert petition in US v. Newman ...   Jul 31, 2015 ... Newman, which overturned the insider trading convictions of two hedge ... Newman and the personal benefit requirement in insider trading ... www.professorbainbridge.com/.../evaluating-the-governments-cert-petition- in-us-v-newman.html

Newman was no game changer - ProfessorBainbridge.com   Aug 27, 2015 ... Moreover, all of the district courts to have addressed the post-Newmanpersonal benefit question have found the 2nd Circuit is in accord with ... www.professorbainbridge.com/.../newman-was-no-a-game-changer.html Prior posts on US v. Newman and the personal benefit requirement ...   Jul 31, 2015 ... I'm working up a post on the government's cert petition in US v. Newman. In the meanwhile here are some earlier posts: The personal benefit ... www.professorbainbridge.com/.../prior-posts-on-us-v-newman-and-the- personal-benefit-requirement-in-insider-trading-tipping-cases.html   Pritchard on Newman's Interpretation of Dirks' Personal Benefit ...   Aug 10, 2015 ... Adam Pritchard reviews the evolution of the personal benefit element of the test developed by Justice Lewis Powell for determining tipping ... www.professorbainbridge.com/.../pritchard-on-newmans-interpretation-of- dirks-personal-benefit-standard.html

Does CalPERS #SJW efforts violate its fiduciary duties to retirees?

When pension fund boards turn their funds into social justice warriors, do they violate their fiduciary duties? Keith Paul Bishop raises this pertinent question:

Yesterday, UCLA Law School Professor Stephen Bainbridge noted the publication of a recent study that reaches some devastating conclusions for public pension funds.  The study by Professor Tracie Woidtke at the University of Tennessee found that “public pension funds’ ownership is associated with lower firm value”.  To make matters even worse, Professor Woidtke found:

Social-issue shareholder-proposal activism appears to be negatively related to firm value.  In this paper, the negative relationship between public pension fund ownership and firm value is significant for firms targeted by public pension funds engaging in social-issue activism—across two different firm samples—in 2008–13, when the two large funds focused on social-issue activism, CalSTRS and the NYSCR, were engaged in shareholder-proposal activism.

The boards of CalPERS and CalSTRS each have “fiduciary responsibility for investment of moneys and administration of the system”.  Cal. Const. Art. XVI, § 17.  The board members are further obligated to “discharge their duties with respect to the system solely in the interest of, and for the exclusive purposes of providing benefits to, participants and their beneficiaries, minimizing employer contributions thereto, and defraying reasonable expenses of administering the system.”  Cal. Const. Art. XVI, § 17(b).  Professor Woidtke’s findings raise the question of whether the pursuit of social-issue shareholder proposals is consistent with these constitutional obligations.

The problem, of course, is that weasel word "benefits." CalPERS claims that things like social justice are just as much of a benefit as higher returns. Personally, I'd disagree, even if I agreed with CalPERS as to the meaning of social justice. Which brings me back to the basic breach: It's not just that CalPERS has decided to be a SJW, it's that the board decides what social interests to pursue regardless of whether their beneficiaries share those views.

Leftist law professors are making a huge stink about corporations spending money to advance political causes that some shareholders might not share. But you rarely hear them say anything when unions or outfits like CalPERS do the same.

Where will the VW class actions end up?

As a corporate lawyer, the VW emissions scandal interests me mainly as an example of how large corporations run by supposedly smart people can make incredibly dumb decisions. But, as a lawyer, I will be following the class actions suits with interest.

Alison Frankel speculates on the various possibilities as lawsuits against VW proliferate:

Six jurisdictions have been floated so far by different lawyers for car owners. (VW has not yet signaled whether it agrees the cases should be consolidated and, if so, where.) ...

The more compelling candidates for the VW MDL are Los Angeles; Newark, New Jersey; and Alexandria, Virginia, all of which have also been proposed in filings with the MDL panel. New Jersey, which is backed by Lieff Cabraser and Seeger Weiss, is Volkswagen’s state of incorporation in the U.S. and is the home of the company’s U.S. engineering and environmental office as well as other VW corporate operations. New Jersey is also easily accessible to air travelers from Germany, where Lieff and Seeger Weiss assert the supposed emissions-evading scheme was devised and executed.

The “rocket docket” of Eastern Virginia was proposed by Burns Charest, which can’t be accused of hometown chauvinism because it is based in Dallas. Virginia is the headquarters for the U.S. operations of Volkswagen and Audi, making it “their nerve center and the center of their decision-making process,” the Burns firm said. (Clearly, the plaintiffs will have to do some digging to figure out which continent was actually the site of VW’s fateful emissions-rigging decisions.) Burns Charest also points out that Alexandria is a mere 200 miles from Morgantown, West Virginia, where researchers from University of West Virginia first exposed VW’s manipulation of the cars’ emissions. (For however much that is worth.)

VW sold more clean diesel cars in California than any other U.S. state, and more class actions by car owners have been filed there than anywhere else, according to a brief filed Wednesday at the JPML by Bernstein Litowitz Berger & Grossmann. Federal judges in Los Angeles, in particular, have already handled sprawling products liability litigation against Kia and Hyundai, which were accused of misrepresenting their fuel efficiency, and against Toyota in the sudden acceleration litigation.

Of course, picking the court will just be the opening round of a litigation morass that is likely to drone on for years.

Noval 10 Year Old Tawny (Porto) NV

This example was bottled in 2014. In color, it's closer to ruby than most 10 year old tawny ports. The bouquet is modest and somewhat hot, but suggests walnuts, candied fruits (cherry?), and raisins. On the palate, it is sweet, fairly acidic, and hot. Prunes, walnuts, and toffee. The alcohol is not well integrated, as the wine tastes hot and simple. The finish is short and vaguely methylated. 

Not up to the standards of, say, Dow or Taylor Fladgate 10 year old tawny ports.

Grade: 82

Ridge Vineyards Buchignani Ranch Carignane (Sonoma) 2013

One of the fun things about belonging to Ridge Vineyards wine clubs is getting their small batch wines that are unavailable in stores. Often, these wines come from heritage vineyards with obscure varieties, as is the case with the Carignane we drank (with grilled steaks) tonight.

Usually, Carignane is a modest wine with much to be modest about (to paraphrase Churchill). But Ridge has long used it as a blending wine in its Zinfandels, where it adds complexity and interest.

Sourced from a ranch in the Alexander Valley, this 100% old vine Carignane is a deep ruby. The bouquet is modest and did not expand much with time to breathe. On the palate, it is not very tannic, which makes it easy to drink now but suggests that it has limited aging potential. I pick up notes of pomegranate, dried figs, with vanilla (American oak) and pepper on the finish.

Nice match for steak but not a vin de grade.

Grade: 87