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Is the corporation a "real entity"?

I'm reading an essay by a friend about whether the corporation is a "real entity." It calls to mind my favorite of my own little essays on the topic: "Is the corporation an entity? With application to the SCOTUS" https://t.co/Mqi3wtAN5B

— Steve Bainbridge (@PrawfBainbridge) August 29, 2021

2/ “Corporations have neither bodies to be punished, nor souls to be condemned, they therefore do as they like,” which is usually misquoted as “Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?,” which is better.

— Steve Bainbridge (@PrawfBainbridge) August 29, 2021

The Reader's Digest Condensed Version of my Article, Don’t Compound the Caremark Mistake by Extending It to ESG Oversight, is Up

Here

Flannery v. Genomic Health, Inc.: The Delaware Chancery Court Gets the Geography of Revlon-Land Wrong. Again.

Via The Chancery Daily we learn of a recent Revlon decision by Vice Chancellor Slights that is quite striking. 

As I explained in my article, The Geography of Revlon-Land, 81 Fordham L. Rev. 3277 (2013), the Delaware Chancery Court has gone seriously awry in applying Revlon. 

The Delaware Supreme Court had explained that Revlon duties are triggered in three situations:

The directors of a corporation have the obligation of acting reasonably to seek the transaction offering the best value reasonably available to the stockholders, in at least the following three scenarios: (1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break-up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control. In the latter situation, there is no sale or change in control when “[c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.

Arnold v. Soc’y for Sav. Bancorp, Inc., 650 A.2d 1270, 1289-90 (Del. 1994) (citations, footnotes, and internal quotation marks omitted). In a series of cases, the Delaware Chancery court invented a fourth trigger:

In transactions, such as the present one, that involve merger consideration that is a mix of cash and stock—the stock portion being stock of an acquirer whose shares are held in a large, fluid market—”[t]he [Delaware] Supreme Court has not set out a black line rule explaining what percentage of the consideration can be cash without triggering Revlon.”

In re NYMEX Shareholder Litig., 2009 WL 3206051 at *5 (Del. Ch. 2009).

In Flannery, VC Slights embraced the NYMEX line of cases clearly erroneous approach to all cash deals:

In an all-cash transaction, Revlon applies “because there is no tomorrow for the corporation’s present stockholders.” (59)

NYMEX and progeny were clearly inconsistent with Arnold. They posit that a mix of cash and stock triggers Revlon, but Arnold’s clear implication is that an acquisition by a publicly held corporation with no controlling shareholder that results in the combined corporate entity being owned by dispersed shareholders in the proverbial “large, fluid, changeable and changing market” does not trigger Revlon whether the deal is structured as all stock, all cash, or somewhere in the middle. The form of consideration is simply irrelevant.

The NYMEX line of cases evaded Arnold by misquoting it. VC Slights repeated this sleight of hand in quoting Arnold:

Revlon duties can be triggered in three ways:

(1) when a corporation initiates an active bidding process seeking to sell itself or to effect a business reorganization involving a clear break- up of the company; (2) where, in response to a bidder’s offer, a target abandons its long-term strategy and seeks an alternative transaction involving the break-up of the company; or (3) when approval of a transaction results in a sale or change of control. (37)

The observant reader will note that VC Slights (like the other Chancery Court decisions in the NYMEX line) thereby omitted the critical qualifier Arnold adds to checkpoint # 3. To emphasize the point, let us quote the pertinent part of Arnold again in full:

(3) when approval of a transaction results in a sale or change of control. In the latter situation, there is no sale or change in control when [c]ontrol of both [companies] remain[s] in a large, fluid, changeable and changing market.

But what about cases involving mixed consideration? Again, the correct answer is that the form of consideration is simply irrelevant. Unfortunately, although VC Slights held that Revlon was not triggered on the facts of Flannery--where 58% of the consideration was stock and 42% was cash, he did not reject the erroneous view that mixed consideration cases do trigger Revlon when the ratio tilts sufficiently towards cash (specifically, it appears that 50% cash is the triggering line; see pp. 62-63).

The bottomline is that VC Slights perpetuates the basic error made by the Chancery Court, albeit tweaking it a bit by suggesting where the line is to be drawn in mixed consideration cases.

Having said that, would it have killed him to cite my article?

The Restatement (Second) of Agency is Still Alive and Kicking

According to a Westlaw search I conducted this morning, in the last three years there were 506 cases that cited to the Restatement (Second) of Agency. In that same period, there were 630 cases that cited to the Restatement (Third). Ignoring the fact that some cases cited both, that means over 44.5% of cases in the last three years cited a 63 year old Restatement instead of citing a 15 year old Restatement.  I assume that a large part of the persistence of the Restatement (Second) is driven by lower courts following older higher court precedents that embraced the Restatement (Second). Eyeballing the results seems to confirm that. Yet, there were a fair number of state supreme court cases citing the Restatement (Second).

It might be interesting for someone with a lot of time on their hands to drill down into these results to see if there are doctrinal reasons courts are sticking with the Restatement (Second).

It also suggests that my fellow teachers of agency law cannot yet throw the Restatement (Second) into the dustbin of history.

A Quibble re Delaware's Law on Special Litigation Committees

Keith Paul Bishop writes:

California follows the New York approach to the review of special litigation committee decisions to terminate derivative suits:

While the substantive aspects of a decision to terminate a shareholders' derivative action against defendant corporate directors made by a committee of disinterested directors appointed by the corporation's board of directors are beyond judicial inquiry under the business judgment doctrine, the court may inquire as to the disinterested independence of the members of that committee and as to the appropriateness and sufficiency of the investigative procedures chosen and pursued by the committee.

Auerbach v. Bennett,  393 N.E.2d 994, 996 (1979).   The California Court of Appeal adopted Auerbach in Desaigoudar v. Meyercord, 108 Cal. App. 4th 173, 188 (2003).  Delaware adds a second step to Auerbach in which the court applies its own business judgment to the committee's conclusion.   Zapata Corp. v. Maldonado 430 A.2d 779, 787–789 (Del. 1981).

Not quite. In addition to adding a second step, Delaware also modified the first step of Auerbach. As I explain in my book Corporate Law:

In Zapata, the Delaware supreme court specifically rejected Auerbach’s conclusion that the business judgment rule applies to a SLC’s recommendations. Instead, the court laid out a new set of procedures to be followed in such cases. After an “objective and thorough investigation,” the committee may cause the corporation to file a motion to dismiss the derivative action. The motion should include a written record of the committee’s investigation and its findings and recommendations. Each side is given a limited opportunity for discovery with respect to the court’s mandated areas of inquiry.

In deciding whether to dismiss the action, the court is to apply a two-step test: (1) The court should inquire into the independence and good faith of the committee. The court also should inquire into the bases supporting the committee’s recommendations. The corporation will have the burden of proving independence, good faith, and a reasonable investigation. (2) If the first step is satisfied, the court may but need not go on to apply its own business judgment to the issue of whether or not the case is to be dismissed.

The first step differs from Auerbach in that the Delaware court looks not only at the procedures used, but also at the reasonableness of the basis for the committee’s decision—something Auerbach expressly forbids.

The Alliance for Fair Board Recruitment is also the lead plaintiff in a challenge to the California Board Quota Laws

In addition to suing over the NASDAQ board diversity listing standard, the Alliance for Fair Board Recruitment is also the lead plaintiff in a suit challenging the California board of director racial and gender quota laws. 

Unlike an earlier court challenges, this lawsuit takes on both SB 826 and AB 979.   These bills impose quotas as to the number of female directors (SB 826) and directors from underrepresented communities (AB 979) on the boards of directors of publicly held corporations having their principal executive offices in California. 

This new challenge differs from the others because it takes on both requirements and argues that both quota requirements are contrary to the "internal affairs doctrine".   The plaintiff asserts:

California's race and gender quota laws expressly apply "to the exclusion" of the laws of the state of incorporation.  Cal. Corp. Code §§ 2115.5(a), 2115.6(a).  In other words, these board laws assert that they override other states' laws governing corporations incorporated in their own states.  Therefore, California's "diversity" laws violate the internal affairs doctrine.

As regular readers know, I do not claim expertise to opine on the equal protection issues raised by these statutes, but I do believe that the statutes--as applied to companies incorporated outside of California--are unconstitutional under the internal affairs doctrine.

Nasdaq Board Diversity Quotas Challenged in Federal Court by the Alliance for Fair Board Recruitment

From their press release:

On August 9, 2021, the Alliance for Fair Board Recruitment (AFFBR), a nonprofit membership organization incorporated in the state of Texas, filed a Petition for Review in the United StatesCourt of Appeals for the Fifth Circuit seeking a review of the approval by the Securities and Exchange Commission (SEC) of the corporate board diversity quotas proposed by the Nasdaq stock exchange. ...

As AFFBR explained in a comment submitted to the SEC, Nasdaq's discriminate-or-explain rule also exceeds its role and the authority granted by federal securities law and also violates core Bill of Rights guarantees against compelled speech and discrimination based on sex and race by stereotyping all people of the same skin color or sex as being alike and interchangeable. Further, the rule will not deliver the promised benefits. As Harvard law professor Jesse Fried has explained, numerous studies have shown "that stock returns suffer when firms are pressured to hire new directors for diversity reasons."

NASDAQ offers a summary of the listing standard here. SEC Commissioners Lee and Crenshaw's statement in support of the standard is here. SEC Commissioner Peirce's statement in opposition to the standard is here.

Andrew Stuttaford comments here. In a comment on the original draft proposal, Stuttaford observed:

NASDAQ, a private institution, is, of course, entitled to set its own rules, just as (to quote the Journal) “banks and asset managers” are entitled to try to push their clients or portfolio companies to change their ways. Nevertheless, it is hard to miss the mission creep that is currently occurring across a wide range of institutions, some private, some parastatal (take a look at the effort centralbanks are increasingly making with regard to climate change) to impose different aspects of a “progressive” agenda on private companies without the bother of going through the usual democratic mechanisms.

In my view, this is a legitimate concern.

Asking corporate executives to take on governmental functions not only asks them to undertake tasks for which they are untrained and for which their enterprise is unsuited, it also subverts the basis of a liberal democracy. Government efforts to solve social problems are inherently limited by the checks and balances baked into the American political system. "Woke capitalism" bypasses those checks and balances by asking unelected executives to undertake solving social ills.

As Milton Friedman explained, back in 1970, liberals of that era argued that society was plagued by a host of ills that were "too urgent to wait on the slow course of political processes, that the exercise of social responsibility by businessmen is a quicker and surer way to solve pressing current problems.” Accordingly, Sixties-era liberals seized on using CSR as “a quicker and surer way to solve [these] pressing current problems.” 

Friedman rejected this line of argument as fundamentally anti-democratic:

What it amounts to is an assertion that those who favor the taxes and expenditures in question have failed to persua de a majority of their fellow citizens to be of like mind and that they are seeking to attain by undemocratic procedures what they cannot attain by democratic procedures. In a free society, it is hard for “good” people to do “good,” but that is a small price to pay for making it hard for “evil” people to do “evil,” especially since one man's good is another's evil.

Why was the challenge to the Nasdaq diversity rule Filed in the federal court of appeals instead of a district court? Keith Paul Bishop examines the question. https://t.co/5c2OO3v813

— Steve Bainbridge (@PrawfBainbridge) August 20, 2021

Critiquing The WSJ's Reporting on Climate Change Disclosure

There's an article on climate change disclosure in today's WSJ that uncritically accepts two highly contested propositions:

1. Investors want climate change disclosure
2. Climate change disclosure is desirable

I'm not claiming bias. I am claiming shoddy reporting.

As to the question of whether investors want climate disclosure, I have no doubt that some do. But how many? I addressed the related ESG issue of diversity disclosure in my 5/14/201 post SEC Chairman Gary Gensler is not being serious about what investors want:

The best data on what investors really want comes not from surveys (as evidenced by the disastrous performance of the polling industry in recent years, which has cast doubt "on all types of survey research"), but from what people actually do when given the opportunity to vote on shareholder proposals relating to ESG issues. ...

I went back to the Gibson Dunn report I cited in that post. It found that climate change-related shareholder proposals are garnering, on average, about 30% support (p.7). To be sure, Gibson Dunn claims that this shows an increase in investor support but it's still less than 1/3.

On a related topic, see my post Do apolitical investors want corporations to disclose political contributions?, which concludes that some do but most do not.

As for the desirability of climate change disclosure, see my 3/14/21 post Objecting to Climate Change Disclosure: It's Just Progressive Political Theater. In it, I make three points:

1. Even if we assume that climate change disclosure would lead to public corporations reducing their carbon output, it would still be at best a minor change. It doesn't effect output in other countries.
2. Disclosing climate-related risk factors will not bend the curve on climate change.
3. Climate change disclosure is likely to be hugely expensive.

And, finally, I continue to recommend

Mahoney, Paul G. and Mahoney, Julia D., The New Separation of Ownership and Control: Institutional Investors and ESG (March 22, 2021). Columbia Business Law Review, Forthcoming, Virginia Law and Economics Research Paper No. 2021-09, Virginia Public Law and Legal Theory Research Paper No. 2021-18, Available at SSRN: https://ssrn.com/abstract=3809914

Scholars and policy makers have long debated whether corporations should serve social purposes at the expense of shareholder wealth. The SEC has recently been drawn into the debate as it faces calls to mandate environmental, social, and governance (ESG) disclosures. This Article urges the SEC to proceed with caution. The adoption of ESG disclosure mandates in order to serve environmental or social goals is not well-aligned with the SEC’s stated mission of protecting Main Street investors and maintaining fair, orderly, and efficient markets. Accordingly, the SEC should decline to act absent a showing that ESG disclosures will serve the financial interests of the households for whom institutional investors are fiduciaries and whose retirement and other savings they manage.

My Article "A Critique of the Insider Trading Prohibition Act of 2021" is now online at the University of Illinois Law Review Online

A Critique of the Insider Trading Prohibition Act of 2021, 2021 U. Ill. L. Rev. Online 231 (Aug. 8, 2021), https://www.illinoislawreview.org/online/a-critique-of-the-insider-trading-prohibition-act-of-2021/

The Insider Trading Prohibition Act of 2021 has been passed by the House of Representatives and, as of this writing, is awaiting action in the Senate. The Act’s proponents claim that it simply codifies and clarifies ex- isting law. In fact, the Act does neither. It likely will expand the scope of insider trading in undesirable ways and introduce new ambiguities into the law.

The ways in which the Act likely will expand the insider trading pro- hibition, coupled with the new ambiguities it introduces, threatens the cen- tral policy on which the insider trading prohibition rests. The Supreme Court has recognized that the work of market analysts and other investment professionals inherently entails seeking information advantages. In turn, as the Court also recognized, that work is an essential part of maintaining efficient stock markets. By increasing the risk of liability, especially in light of the draconian penalties associated with insider trading, the Act likely will chill this vital activity to the detriment of all investors.

When a very similar bill passed the House in the 116th Congress, the legislation died in the Senate. The Insider Trading Prohibition Act of 2021 now awaits Senate action. The Senate would be well advised to let this bill die as well.

A New Paper by Yours Truly: Don’t Compound the Caremark Mistake by Extending it to ESG Oversight

Posted to SSRN: Don’t Compound the Caremark Mistake by Extending it to ESG Oversight.

Abstract: Since the foundational decision in In re Caremark Intern. Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996), Delaware corporate law has required boards of directors to establish reasonable legal compliance programs. Although Caremark has been applied almost exclusively with respect to law and accounting compliance, the original Caremark decision contemplated applying the oversight duty to the corporation’s “business performance.” Accordingly, there is no doctrinal reason that Caremark claims should not lie in cases in which the corporation suffered losses, not due to a failure to comply with applicable laws, but rather due to lax risk management.

The question thus arises as to whether Caremark should be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. Obviously, where existing legislation or regulations impose compliance obligations in ESG-related areas, such as human resources, the environment, or worker safety, Caremark already applies. As such, boards must “ensure that compliance and monitoring systems are in place” to oversee corporate compliance with those laws.

Many ESG issues are not yet the subject to legal requirements, however. The question addressed in this Article is whether the board’s Caremark obligations should be extended to encompass oversight of corporate performance with such issues. In other words, should the board face potential liability not just for failing to ensure that the company has adequate reporting and monitoring systems in place to insure compliance with ESG-related legal requirements, but also to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational. 

Buffett expert Larry Cunningham on Buffett

Larry Cunningham on Warren Buffett’s Evolution Into a Great Manager https://t.co/cEDGlIlLoe via @YouTube

— Steve Bainbridge (@PrawfBainbridge) August 1, 2021