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Case note on Verition Partners Master Fund Ltd. v. Aruba Networks, Inc.

Delaware Supreme Court Clarifies Appraisal Law https://t.co/5cOUFtIllt Case note on Verition Partners Master Fund Ltd. v. Aruba Networks, Inc.

— Professor Bainbridge (@ProfBainbridge) May 1, 2019

Kahn v. MFW requires controller self-disablement early

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review https://t.co/HAgLzLGQJM Controller must self-disable before substantive economic bargaining starts

— Professor Bainbridge (@ProfBainbridge) May 1, 2019

Delaware Chief Justice Leo Strine on independent directors--I've been saying the same thing for years

From an interview of Strine at Directors & Boards:

We have a lot of unrealistic expectations for independent directors, and I think it would be better to rebalance boards a little bit. We need folks who are genuinely independent directors, but we also need directors with expertise, and we need directors who were active in business and who understand the industry. And some of the rules and incentives can get so tight that we actually discourage people with the right kind of qualities from serving on boards.

It doesn’t really matter if you’re independent if you don’t have expertise. But can you be independent and also have the expertise and the knowledge? I’m sure you can.

We just independent directorized the world. We went from having a bare majority of them to having a supermajority of them. We don’t actually empower them. We take away their ability to think long term because we put in place Say on Pay. We don’t do Say on Pay every four years or five years, where you would really have a long-term pay plan, we do it every year as a vote on generalized outrage.

Independent directors are not like trustees at universities, who usually have prior affiliations with the university and the community in which it exists, and that they care deeply about. Independent directors are weather vanes for the market. Not to denigrate them, but let’s think about the definition of an independent director. They tend to have no prior affiliation or current association with the company, and thus they really have no reason to deeply care about it or any aspect of it. Now you can say that’s independence, but it’s also a blank slate.

There’s great competition to be an independent director. Independent director pay has gone up. The typical pay just to be on one company board is higher than my judges in our judiciary. If you’re on three boards, you’re often making more than a half million dollars a year just as a director.

The old concern was that directors had to be popular with management to stay on boards, but now you have to stay popular with the institutional investor community and with the proxy advisers, and therefore these directors are highly responsive to market sentiment.

Maybe my lack of popularity with the self-appointed shareholder spokesmen who run ISS and its ilk, not to mention institutional investors generally explains my lack of board seats?

Anyway, the usually board-bashing/activist-loving folks at The Corporate Counsel observe that:

It’s refreshing to hear somebody with influence in the corporate governance debate finally say something like this. As I’ve blogged previously, my guess is that in 50 years people may really wonder why we thought it was a good idea to demand that the boards of the world’s largest corporations be comprised overwhelmingly of people with no ties to or experience with the company. Who knows? Maybe Chief Justice Strine’s remarks are a signal that we won’t have to wait 50 years for people to start asking that question.

I've been a sharp critic of independent director mandates going back to one of my first articles, see Independent Directors and the ALI Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034 (1992). In my book Corporate Governance after the Financial Crisis, I wrote that:

... the board of directors has three basic functions. First, while boards rarely are involved in day-to-day operational decision making, most boards have at least some managerial functions. Second, the board provides networking and other services. Finally, the board monitors and disciplines top management.

Independence is potentially relevant to all three board functions. As to the former two, outside directors provide both their own expertise and interlocks with diverse contact networks. As to the latter, at least according to conventional wisdom, board independence is an important device for constraining agency costs. On close examination, however, neither rationale for board independence justifies the sort of one size fits all mandate adopted by the exchanges at the behest of Congress and the SEC.

After a lengthy review of the evidence on director independence, I concluded that "the empirical evidence on the merits of board independence is mixed." I then observed that:

The fetish for board independence has costs. Two are already on the table; namely, those associated with the information asymmetry between outsiders and insiders and those occasioned by the need to incent outsiders to perform. A third is the lost value of insider representation.

Oliver Williamson suggests that one of the board’s functions is to “safeguard the contractual relation between the firm and its management.”[1] Insider board representation may be necessary to carry out that function. Many adverse firm outcomes are beyond management’s control. If the board is limited to monitoring management, and especially if it is limited to objective measures of performance, however, the board may be unable to differentiate between acts of god, bad luck, ineptitude, and self-dealing. As a result, risk averse managers may demand a higher return to compensate them for the risk that the board will be unable to make such distinctions. Alternatively, managers may reduce the extent of their investments in firm-specific human capital, so as to minimize nondiversifiable employment risk. Insider representation on the board may avoid those problems by providing better information and insight into the causes of adverse outcomes.

Insider representation on the board also will encourage learned trust between insiders and outsiders. Insider representation on the board thus provides the board with a credible source of information necessary to accurate subjective assessment of managerial performance. In addition, however, it also serves as a bond between the firm and the top management team. Insider directors presumably will look out for their own interests and those of their fellow managers. Board representation thus offers some protection against dismissal for adverse outcomes outside management’s control.

Such considerations likely explain the finding by Klein of a positive correlation between the presence of insiders on board committees and firm performance.[2] They also help explain the finding by Wagner et al. that increasing the number of insiders on the board is positively correlated with firm performance.[3]

The fetish for independence cost us these potential benefits from insider representation. Congress’ refusal to permit private ordering means that those firms where those costs are highest are unable to opt out of the one size fits all straightjacket.

Retail investors apparently get why ISS and Glass Lewis are the problem children of corporate governance

The anti-business, pro-left-leaning institutional investors folks at TheCorporateCounsel.net are doubtless disappointed that retail investors understand why activist enablers ISS and Glass Lewis need regulation:

The results of an extensive survey of 5,159 retail investors points to a growing disconnect between the expectations of those everyday investors and the increasing influence of proxy advisors, companies that provide voting services to the investment firms managing retail investor money. The survey presented here directly asks retail investors about issues raised in the debate over proxy advisory firms, revealing retail investors’ level of concern with fundamental flaws in the proxy advisor industry, including, but not limited to, conflicts of interest, robo-voting and insufficient transparency.

The increased focus of fund managers and proxy advisors on political and social activism, rather than maximizing returns, is out of sync with the expectations of ordinary investors. This practice has the potential to negatively impact returns for all retail investors by increasing the burden on public companies with no clear link to shareholder value. The absence of the inclusion of retail investors in the proxy process – as demonstrated by the participation levels and their inability to influence institutional shareholder voting – means that the voice of retail investors, who own 30 percent of public corporations in the United States, is being drowned out.

In terms of specific issues, 36% of investors cited conflicts of interest as their top concern with proxy advisors, 23% named lack of transparency & 20% identified errors in proxy advisor reports. Enabling robo-voting was named as the top concern by only 13% of investors – but 40% ranked it in their top 3.

"Is a board of directors absolutely mandatory in a corporation/company?"

I offered the following answer to the titular question at Quora:

Section 8.01(a) of the Model Business Corporation Act (in force in over 2/3 of the states) provides that: “Except as may be provided in an agreement authorized under section 7.32, each corporation shall have a board of directors.”

In turn, section 7.32(a) provides that: “An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more other provisions of this Act in that it: (1) eliminates the board of directors ….”

Note, however, that such an agreement must be unanimous and be made known to the corporation. It must be disclosed on share certificates.

If the agreement eliminates the board of directors, there is no prescribed replacement. As the Official Comment to section 8.01(a) states, “the shareholders of a corporation may, in an agreement that satisfies the requirements of section 7.32, dispense with a board of directors and structure the corporation’s management and governance to address specific needs of the enterprise.”

Although section 7.32 is not limited to closely held corporations, many states have limited the option of eliminating the bard of directors to closely held corporations.

Indeed, it is essentially unheard of for publicly held corporations to have such agreements and equally unheard of for publicly held corporations to eliminate the board. See, e.g., POST PROPERTIES, INC., SEC No Action Ltrs. WSB File No. 0329200417 (“It is inconceivable, for example, that shareholders of a publicly-traded company such as Post Properties would attempt to eliminate the board of directors entirely, to designate an outside person to manage its business, or to give to one of its shareholders the power to cause corporate dissolution. These limits are totally incompatible with public ownership ….”

Delaware General Corporation Law section 141(a) provides that: “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation. If any such provision is made in the certificate of incorporation, the powers and duties conferred or imposed upon the board of directors by this chapter shall be exercised or performed to such extent and by such person or persons as shall be provided in the certificate of incorporation.”

Catholic readers: I need you to take a poll

I have to give a talk at the end of the week about the Catholic abuse scandal. In connection therewith, I need to take a poll. Without looking it up, do you know what a Metropolitan is? #catholictwitter Please RT, so I get a good sample.

— Professor Bainbridge (@ProfBainbridge) April 22, 2019

Assume a Theranos director knew what was going on, what should they have done?

DGCL § 141(b) provides that:

Each director shall hold office until such director’s successor is elected and qualified or until such director’s earlier resignation or removal. Any director may resign at any time upon notice given in writing or by electronic transmission to the corporation. A resignation is effective when the resignation is delivered unless the resignation specifies a later effective date or an effective date determined upon the happening of an event or events.

The American Bar Association’s authoritative Corporate Director’s Guidebook recommends that:

If, after a thorough discussion, a director disagrees with any significant action the board is taking, the director should consider abstaining or voting against the proposal. The director should also consider requesting that the abstention or dissent be recorded in the meeting’s minutes. Except in unusual circumstances, taking such a position should not cause a director to consider resigning. Resignations should be considered if a director believes that management is not dealing with the directors, the shareholders, or the public in good faith or that the information being disclosed by the corporation is inadequate, incomplete, or incorrect and the director is unable to convince the board to take action. Directors may also consider resigning when they feel their point of view is being disregarded entirely. Public corporations are required to disclose director resignations in an SEC filing, and this disclosure, like others, should be done in consultation with legal advisors.[1]

An earlier edition of the Guidebook stated that:

If, after a thorough discussion, a director disagrees with any significant action proposed to be taken by the board, the director may vote against the proposal and request that the dissent be recorded in the meeting’s minutes. Except in unusual circumstances, taking such a position should not cause a director to consider resigning. However, if a director believes that information being disclosed by the corporation is inadequate, incomplete or incorrect, or that management is not dealing with the directors, the shareholders or the public in good faith, the director should first encourage that corrective action be taken. If that request is not satisfied or the problem continues, the director should encourage the board to replace management and, if such a change does not occur, the director should resign.[2]

In Shocking Technologies, Inc. v. Michael,[3]the court held that:

First, fair debate may be an important aspect of board performance. A board majority may not muzzle a minority board member simply because it does not like what she may be saying. Second, criticism of the conduct of a board majority does not necessarily equate with criticism of the corporation and its mission. The majority may be managing the business and affairs of the corporation, but a dissident board member has significant freedom to challenge the majority’s decisions and to share her concerns with other shareholders. On the other hand, internal disagreement will not generally allow a dissident to release confidential corporate information.

In Wechsler v. Squadron, Ellenoff, Plesent & Sheinfeld, LLP,[4]the court held that:

Can a director of a public corporation who believes that the company is engaged in ongoing securities fraud “blow the whistle” by disclosing to the SEC information protected by the company’s attorney-client privilege, where the company’s Board has not waived the privilege? As a matter of public policy, the Court holds that the answer is yes, although the company could sue the whistle-blowing director for breach of fiduciary duty if such disclosure were not in the company’s best interest.

What are the social functions of a stock market?

Merritt Fox offers an interesting primer.

Executive Compensation Trends

CLS Blue Sky Blog reprints ISS' annual analysis of executive compensation trends. Key findings:

• Compensation disclosures so far suggest continued increases in CEO pay across all market segments and almost all industries.
• The proportion of stock-based compensation as a percentage of total pay continues to increase, crossing the threshold of 50 percent of total pay for large companies for the first time this year.
• Performance-based equity compensation also continues to increase despite concerns of a potential reversal in the aftermath of the repeal of 162(m).
• CEO pay ratios remain relatively unchanged on aggregate, despite some fluctuations observed at individual companies.

Mark Lemley's Open Letter to the Harvard Law Review is an Amusing Lesson on Manners

Brian Leiter has it. Law professors will love it.

Bishop Barron on Notre Dame

The seriously flawed "metropolitan model" gains momentum as how the American Catholic Church will purport to hold Bishops accountable

From Crux:

During the February summit in Rome, Cardinal Blase Cupich of Chicago, one of the summit’s organizing committee members, gave a speech instead outlining “new legal structures of accountability,” which would utilize the metropolitan archbishop who oversees the dioceses within his particular province. 

Under the “metropolitan option,” as it has often been referred to, the metropolitan archbishop would be responsible for overseeing the investigation into bishops accused of abuse in conjunction with a local review board, unless there were compelling reasons to hand the case over either to the pope’s nuncio, or ambassador, in the country, or to the Vatican itself.

At a press conference during the Vatican summit, Cupich said his proposal was different from the original USCCB plan as it would become obligatory, whereas the original proposal gave bishops the ability to opt into it. He also said the proposal would give the plan a more local character necessary to follow up and communicate with victims.

DiNardo told Crux at the time that looking ahead to plans to vote on new measures, that “we have to tweak some things” regarding the original protocols and hinted that the final proposal he hoped to be put to a vote in June will likely “put the two together,” referring to the metropolitan model.

The metropolitan model is seriously flawed, for reasons I discussed in my Public Discourse article Lay Review With Teeth: What (Didn’t) Happen at the Vatican’s Sexual Abuse Summit:

Cardinal Cupich’s ... proposals are limited to developing new mechanisms for holding bishops accountable. This is a necessary but not sufficient reform. Instead, the Church should undertake major reforms of the rules governing sexual misconduct at all levels and by all Church personnel. ...

Cupich’s model has a number of disadvantages. First, in modern times, the role of a metropolitan has been reduced to a virtual irrelevancy. Many Church members have never even heard of a metropolitan. The metropolitan model therefore may not do much to restore confidence in the Church.

Second, although the metropolitan model purportedly contemplates lay participation, it appears that the laity’s role would be limited to experts who will act as assistants to the metropolitan. In other words, the laity will continue to be denied a decision-making role in the accountability process. Cardinal Cupich’s proposal leaves decision-making power in the hands of those authorities that Church members trust least: the bishops and the Vatican hierarchy.

Assigning primary responsibility for investigated claims against a bishop to that bishop’s metropolitan is especially problematic, as Charles Collins of the Catholic news website Crux has observed, because “metropolitan archbishops often have a lot of say in who becomes bishops in their province.” Church members likely will lack confidence in the metropolitan’s ability to be objective with respect to someone who may be regarded as a protégé, friend, or ally of the metropolitan.

The relationship between a metropolitan and his suffragan bishops becomes even more problematic when it is the metropolitan himself who is the accused.

Kindly go read the whole thing. See also my article Restoring Confidence in the Roman Catholic Church: Corporate Governance Analogies, which is available at SSRN: https://ssrn.com/abstract=3249236. Here's the abstract:

Abstract. Events of the Summer 2018 brought the long running sexual abuse crisis in the Roman Catholic Church back onto the front pages, highlighting the role of diocesan bishops in covering up the scandal and enabling abusers. In response to these developments, the Church is again considering reforms to protect victims and punish abusers and enablers. This article proposes that the Church create a system for laity to anonymously report allegations, enact strong protections for whistleblowers, and impose a mandatory whistleblowing requirement on priests. As a 2018 Pennsylvania grand jury report demonstrates, however, the laity was reporting the abuse to the Church but the hierarchy buried those reports in secret files. The ultimate problem thus is not so much the lack of reporting, as it was the lack of action after the report. Accordingly, the article’s principal proposal is the creation of both diocesan and national disciplinary bodies led by expert lay members as the ultimate authorities in sex abuse cases. The proposal draws an analogy between these bodies and corporate audit committees and argues that a number of aspects of how audit committees function can be usefully adapted to the proposed review bodies.

This version of the article has been revised to take into account developments at the February 2019 Vatican summit on the sex abuse scandal. Those developments do not change the recommendations made herein.

At the core of the sex abuse scandal is abuse of clerical and episcopal power. The voice of the laity must be heard. Concerned Catholics need to reach out to their bishops and implore them adopt meaningful reforms rather than a misbegotten metropolitan model that won't work, won't inspire confidence, and won't stop people from leaving the Church.

Should the law regard corporations as a “person”? Why or why not?

The titular question was brought to my attention on Quora, which elicited this response from yours truly:

The idea that a corporation is a legal person with constitutional rights is, of course, a controversial one. Some commentators argue that it's bad policy. In my view, however, it is a well-settled principle of US constitutional law and justifiably so.

On the one hand, the courts have never empowered corporations with "privileges of citizenship." The second clause of the 14th Amendment - the so-called Privileges and Immunities - states that: "No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States." But it is settled that the Privileges and Immunities Clause does not protect corporations, because corporations are not deemed citizens for purposes of the 14th Amendment. Western and Southern Life Ins. Co. v. State Bd. of Equalization of California, 451 U.S. 648, 656 (1981). Conversely, however, "It is well established that a corporation is a 'person' within the meaning of the Fourteenth Amendment." Metropolitan Life Ins. Co. v. Ward, 470 U.S. 869, 881 (1985).

The common law had long recognized the legal personality of corporate bodies. See Book I, Chapter 18 of Blackstone, Commentaries on the Laws of England (1765-1769). But what of the Constitution?

The key case for constitutional law purposes is Santa Clara County v. Southern Pacific Railroad, 118 U.S. 394 (1886). Curiously, if one carefully reads Justice Harlan's decision in that case, one will find neither a clear statement nor a citation of authority concerning whether corporations are "persons." That point, instead, is made in the syllabus by the Reporter, who related that at oral argument the Chief Justice had stated that:

The court does not wish to hear argument on the question whether the provision in the Fourteenth Amendment to the Constitution, which forbids a State to deny to any person within its jurisdiction the equal protection of the laws, applies to these corporations. We are all of the opinion that it does.

Despite it's somewhat odd parentage, the principle is sound.

The legislative history of the Fourteenth Amendment suggests that Congress substituted the word ''person'' for the word ''citizen'' precisely so that the provisions so affected would protect not just natural persons but also legal persons, such as corporations, from oppressive legislation. We see this view further confirmed Roscoe Conkling's recounting of the relevant legislative history in Conkling's arguments in San Mateo County v. Southern Pac. R.R., 116 U.S. 138 (1885). Conkling had been a member of the Joint Congressional Committee that drafted the 14th amendment and in Southern Pacific argued to the Justices that it had been the intent of Congress for the word "person" to include "legal" persons (corporations) as well as "natural" persons within the protective scope of the due process and equal protection clauses of the amendment. The Court accepted Conkling's argument.

As Larry Ribstein argues, this development made policy sense:

... corporations are people – the owners and others the corporation represents in litigation. These people have speech rights, rights not to be discriminated against, and so forth. I’ve written on this ...:

The Constitutional Conception of the Corporation, 4 Supreme Court Economic Review 95 (1995); Corporate Political Speech, 49 Wash. & Lee L. Rev. 109 (1992) and in my book with Henry Butler, The Constitution and the Corporation (1995) ....

So the African-American owners of this SBA-certified minority-owned contractor shouldn't lose their civil rights because they chose to do business in the corporate form. They might be required to sue as a corporation, as in this case, because that’s a convenient way to handle litigation, but that doesn’t determine their individual rights.

But courts also should recognize that, by the same principle, people shouldn't lose their speech rights just because they exercise these rights though the corporation in which they have invested.

Evelyn Y. Davis: The ugly face of shareholder activism

Broc passes along this story, which I suspects he likes a lot better than I do:

Evelyn Davis was at the very first shareholder meeting I ever attended – at the then-new, post-merger Manufacturers Hanover Trust Company. A callow youth in the mid-1960s, I was pressed into duty because I was good at long-division. The only ‘calculators’ back then, other than human ones, were mechanical monsters that weighed about 75 pounds and made ear-shattering noises as they literally ‘spun their wheels’ to come up with percentages. “From the moment Evelyn Y. Davis grabbed the mike, in the old American Stock Exchange auditorium, I knew this was a business I wanted to stick close to.”

Davis had just begun to branch out from her first-career – and what a first impression she made on the audience. All of them were in their best business attire, as was the custom then. She was wearing a tight black sweater with a plunging neckline, a mini-skirt that was 10 or 11 inches long at most, black net stockings, thigh-high black boots, and a short chinchilla jacket.

Her opening remarks were to fawningly compliment the Chair – and to ask if she could come up on stage, sit on his lap, and give him “a big juicy kiss.” Our then Chairman, Jeff McNeill, was an incredibly strait-laced, old-school Southern Baptist, with a big old-fashioned Florida drawl – and when he recovered himself sufficiently to politely demur, she turned on him with a vengeance, peppering him with one question after another, never pausing to wait for the answer, which was her usual habit at all meetings. Her loud, sarcastic-sounding tone that she favored during the first half of her career. After a few minutes, people in the audience began to shout, “Sit down! Shut up! Go home!”

“You’re all just jealous of me” she yelled.

She personified everything that is wrong with shareholder gadflies.

This obituary has gone viral ... and deservedly so

RIP Tim Schrandt