In his private life, a Fortune 500 CEO commits a truly heinous act. It has no connection to the company or the CEO's professional life, except in that newspaper accounts will mention that the CEO is President of Acme.
Has the CEO breached his fiduciary duties to the company and its shareholders. Did the board of directors breach their oversight (aka Caremark) duties by failing to monitor the CEO's private life?
I have dabbled in this area before. In my 2011 post, Can the Berkshire board be held liable for Sokol's trades?, I addressed a question posed by Kevin LaCroix in connection with the case of former Berkshire-Hathaway executive Sokol who resigned after purchasing Lubrizol stock in advance of recommending that Berkshire acquire Lubrizol. LaCroix asked:
Can the directors – or any one of them (say, for example, Buffett) possibly be held liable for failing to take actions that allegedly could have prevented supposed harm to the company?
At the time, my answer was no:
Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart 833 A.2d 961 (Del.Ch. 2003), strikes me as being on all fours with the Sokol case. The Stewart case arose out of Martha Stewart's insider trading troubles. Plaintiff claimed that "the director defendants and defendant Patrick breached their fiduciary duties by failing to ensure that Stewart would not conduct her personal, financial, and legal affairs in a manner that would harm the Company, its intellectual property, or its business." (970-71) In other words, plaintiff claimed that the MSO directors failed to fulfill their Caremark duties by failing to prevent Stewart from engaging in insider trading.
The Chancellor opined that:
The “duty to monitor” has been litigated in other circumstances, generally where directors were alleged to have been negligent in monitoring the activities of the corporation, activities that led to corporate liability.Plaintiff's allegation, however, that the Board has a duty to monitor the personal affairs of an officer or director is quite novel. That the Company is “closely identified” with Stewart is conceded, but it does not necessarily follow that the Board is required to monitor, much less control, the way Stewart handles her personal financial and legal affairs.
And he continued by observing that "it is unreasonable to impose a duty upon the Board to monitor Stewart's personal affairs because such a requirement is neither legitimate nor feasible. Monitoring Stewart by, for example, hiring a private detective to monitor her behavior is more likely to generate liability to Stewart under some tort theory than to protect the Company from a decline in its stock price as a result of harm to Stewart's public image."
Maybe you could argue that Sokol's conduct is somewhat less personal, because he traded in stock of a company he knew he would be pitching to Berkshire as a takeover candidate. OTOH, however, Sokol is far less “'closely identified' with" Berkshire than Stewart was with MSO.
So I think there is zero chance that a Caremark claim against the directors of Berkshire-Hathaway.
For more on Caremark claims see my articles The Convergence of Good Faith and Oversight and Caremark and Enterprise Risk Management.
In my 2004 post, Latest Hollinger News, I examined claims arising out of Lord Black's labyrinthine empire - among them the sale of some assets to Canadian media group CanWest for $1.8bn in 2000. I explained that:
According to minutes of a board meeting four months earlier, directors were told Lord Black and others would receive a total of $53m in non-compete fees and that further payments would go to Ravelston, his private company. Cardinal claims there was never any independent analysis of the size or need for these payments. The claim .... alleges that investors lost out through "misappropriation of corporate assets as well as self dealing - arrangements, for example, where company executives sold company assets to other companies where they had an interest".
In self-dealing claims such as this one, the shareholders have a cause of action against the directors or officers who misappropriate corporate assets or pursue conflicted interest transactions. The claim against the non-participating directors is more complex. Most self-dealing transactions do not require director approval as a matter of law, although many corporate conflict of interest policies go beyond what the law requires. Instead, approval by the disinterested directors provides a partial safe harbor if the transaction is challenged by a shareholder (such approval shifts the burden of proof from the director with the conflict of interest to the shareholder). Ordinarily, the failure of the directors to make an informed decision in this regard is invoked merely to vitiate the safe harbor rather as grounds for an independent cause of action against the approving directors. Yet, under Smith v. Van Gorkom, directors' duty of care requires that when they make a decision they do so on an informed basis. Likewise, the Caremark decision plausibly could be interpreted as imposing an affirmative duty on directors to investigate conflict of interest transactions and to ensure that the conflicted directors do not take advantage of the corporation.
The Hollinger lawsuit thus could be distinguished from the recently dismissed case against Martha Stewart (blogged here). In the Stewart case, the shareolders' suit alleged that Martha Stewart Omnimedia's disclosure documents routinely stressed the importance of Martha Stewart to the company's success. After the controversy over Stewart's trading in ImClone stock broke, MSO's stock price dropped precipitously, ultimately bottoming out at a 65% loss. The suit alleged Caremark violations by MSO directors and execs (click here for a discussion of Caremark), who allegedly failed to "ensure that Stewart would not conduct her personal, financial, and legal affairs in a manner that would harm the Company, its intellectual property, or its business." In dismissing, Chancellor Chandler explained that: (1) plaintiff had failed to allege facts that would have put the board on notice of potential wrongdoing; and (2) the Delaware precedents speak to wrongdoing in a corporate capacity, not in an exec's personal life. Based on what we know thus far about the suit against the Hollinger board, it sounds like both of those criteria will be satisfied. Because the alleged misconduct involved self-dealing with corporate assets and because it is alleged the directors were aware - even approved ex post - of some of the transactions, a strong case is already made out that the board had a duty to investigate and make an informed decision as to the proper course of action.
Tom Lin has posted an article, Executive Private Misconduct (June 11, 2020), available at SSRN: https://ssrn.com/abstract=3624533, that takes an in-depth look at this issue. In particular, he sweeps quite broadly to pick up not just the Caremark issues, but a number of other relevant theories of liability on which either the executive and/or the board of directors could be sued (unsuccessfully in most cases).
ABSTRACT Executives misbehave. In recent years, the world has been outraged and appalled by the shocking misbehavior of corporate executives. Some of their behavior have been plainly unethical; others have been deeply offensive; and still others have been simply criminal. Regardless of the misbehavior, such executive private misconduct—when made public—has frequently damaged their public reputations, harmed their company’s market values, destroyed investor portfolios, and raised serious legal and policy issues.
This Article provides one of the first comprehensive examinations of ex- ecutive private misconduct and its wide-ranging effects on law, business, and society. It begins by providing context for how we got here. It investigates how the unfolding #MeToo movement, shifting social understandings of public and private, and changing corporate social expectations have all fostered a new landscape that is less tolerant of executive private misconduct. Next, it examines why legal gaps and tensions in current business law complicate executive private behavior discussions. It reveals how corporate law principles of fiduciary duties and securities law principles of disclosures were not structurally designed to confront the hard issues and questions raised by executive private misconduct. Moving from causes to consequences, this Article next examines the larger implications of executive private misconduct on corporate governance, corporate policies, and corporate purpose. Finally, this Article recommends pragmatic next steps for corporate stakeholders, regulators, and policymakers in a changing business environment. Specifically, it proposes a new baseline framework for working through perplexing executive private misconduct issues, along with concrete business policy reforms concerning nondisclosure agreements, mandatory arbitration, and annual misconduct reports. Ultimately, this Article seeks to provide an original, workable roadmap and compass for conceptualizing, navigating, and addressing executive private misconduct and its impact on law, business, and society.
Tom concludes--I think correctly--that "The two bodies of law and regulation that govern much of American business—state corporate law and federal securities law—were largely designed to address the professional obligations and duties of executives and not the private matters of their personal lives."
With respect to the Caremark duty issues, with which my blog posts were mainly concerned, Tom doesn't discuss the Martha Stewart case, which strikes me as a bit odd, especially since he discusses that case in the preceding section on the executive's duty of loyalty. Nevertheless, I agree with his conclusion that "the law and business conventions suggest that such monitoring [i.e., board monitoring of an executive's private life] may be unnecessary and undesirable."
This is an extremely useful addition to the literature and highly recommended.
