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Exxon sues climate activist shareholders in federal court because Gary Gensler's SEC won't do its job

The WSJ reports:

Exxon Mobil is suing two sustainable investment firms in a bid to block them from putting forward a shareholder proposal that would commit the oil company to further curb its greenhouse-gas emissions and target its customers’ emissions. ...

“Defendants are asking Exxon Mobil to change its day-to-day business by altering the mix of—or even eliminating—certain of the products that it sells,” the oil company said in the lawsuit. Their goal, it alleged, is “to force Exxon Mobil to change the nature of its ordinary business or to go out of business entirely.”

The problem Exxon is facing is one about which I have frequently blogged; namely, that Gary Gensler's SEC is now full of ESG activists who he has authorized to allow shareholders to micromanage corporate business operations via Rule 14a-8 shareholder proposals. In July of last year, for example, I noted that:

As I detailed at some length in my article, Revitalizing SEC Rule 14a-8’s Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705 (2016), the SEC shareholder proposal was never intended to allow shareholders to manage--let alone micro-manage--the corporations in which they invest. Yet, in recent decades, the SEC staff has basically eviscerated those safeguards.

Back in November 2021, I had predicted that Gensler approved changes to how the SEC staff interprets Rule 14 a-8 would lead to that result:

In effect, the SEC is saying that corporate proxy statements can be conscripted by somebody owning a trivial amount of stock to solve "societal problems" that may have virtually no nexus to the company.

In addition, the SEC is encouraging shareholders to micromanage the company when it comes to woke issues:

For example, a proposal requesting a company set greenhouse gas emission targets, but providing the company with discretion on a method for its implementation, will no longer meet the threshold for exclusion based on micromanagement.  

How is deciding corporate environmental policy not micromanagement?

Wachtell concludes:

it is not clear which social issues the Staff will deem broad enough to “transcend the ordinary business,” beyond the Staff’s examples of proposals relating to human capital management with a broad social impact or to greenhouse gas emissions targets without specific methodologies.  

Piffle. It is perfectly obvious that the SEC has become a tool of the Warren/Sanders/AOC wing of the Democratic Party and is now leading the charge towards woke capitalism. I feel confident in predicting that woke shareholder proposals will breeze through the process. In the unlikely event that conservatives emulated progressives and started using the shareholder proposals to effect their policy goals, however, I'd bet the SEC allows their exclusion.

The message seems to finally be reaching a wider audience. The WSJ report continues:

Under normal circumstances, companies that want to exclude shareholder proposals from their proxy statements submit a request to the SEC. Exxon’s move is an unusual attempt to bypass that process as the SEC during the Biden administration has become less inclined to let companies block proposals. 

In the lawsuit, Exxon said the shareholder proposal and proxy voting process has become “ripe for abuse by activists.” 

In 2021, the SEC reversed a Trump-era policy that made it easier for public companies to reject shareholder proposals, which—though typically nonbinding—have long been a thorn in the side of executives. The guidance indicated that SEC staff would be more receptive to shareholder proposals regarding issues that have “a broad societal impact” and focus less on an issue’s relevance to a particular company.

It seems woke capitalism remains Gary Gensler's main policy goal.

Lowell Milken Funds New UCLA Center for Philanthropy and Nonprofits

In 2011, Lowell Milken (UCLAW alum Class of 1973) gave the UCLA School of Law over $10 million to start the Lowell Milken Institute for Business Law and Policy, with which I have been proud to be associated since its founding. Lowell's continuing generosity has grown the Center's endowment to substantially higher levels. As such, his generosity has not only supported my work in many ways, but also the work of the whole business law faculty. It has elevated UCLA's visibility and reputation in business law. Along with my colleagues, I am deeply grateful to Lowell for his support.

The law school has just announced gifts from Lowell totalling over $11 million to fund the Lowell Milken Center for Philanthropy and Nonprofits. The initial ddirector will be my friend and colleague Jill Horwitz:

She is a renowned expert in nonprofit law and in health law. Horwitz served as the reporter for the American Law Institute’s Restatement of the Law, Charitable Nonprofit Organizations, a publication that was a landmark step forward in the field.

“Our work brings a much-needed forum to the nonprofit sector, particularly one on the vibrant West Coast,” Horwitz said. “There is a lot of exciting work to be done, and the creation of the center will serve UCLA, Los Angeles, and far beyond.”

I think this is great news. There is a need for serious scholarship in the non-profit sector that I am confident the new Center will promote. In addition, it will serve our students who are interested in legal careers that bridge public service and business.

My only quibble is the title. Shouldn't it be Non-Profits?

I realize that the Chicago Manual does not require use of a hyphen with non as a prefix, but Chicago has become notoriously lax.

I May (Possibly) Have Overreacted to McDonalds: Should Business Associations Teachers Teach It?

A friend who uses my Business Associations casebook asked whether I was going to include the McDonalds case in the 2024 update to the casebook (available to law school faculty here). I responded that I was not, to which she responded "As I read the several posts you had on the decision (before reading it today), I had thought it was important to include!"

Well, yes, but.

Regular readers likely will recall my posts on Vice Chancellor Travis Laster's opinion in In re McDonald's Corp. Stockholder Deriv. Litig., in which the VC held that Caremark's oversight duty applies to officers as well as directors. As I explained in the first post, the decision initially exacerbated my longstanding concern that the scope of Caremark liability just keeps growing and growing.

In the second post, I noted that the estimable attorney and D&O Diary blogger Kevin LaCroix shared my concern that the defendant's conduct, "while doubtless egregious, did not go to the sort of existential, 'mission critical' failures that drove the recent Marchand and Boeing decisions."

My initial reaction to McDonald's admittedly was driven by my deeply held beliefs that:

1. Caremark was wrong from the outset. 
2. Caremark was further mangled by subsequent decisions. 
3. In recent years, there has been a steady expansion of Caremark liability. 

In my third post, which came somewhat later, I acknowledged that some of my concern had proven unfounded. In particular, VC Laster's subsequent decision with respect to the potential liability of the McDonald's board dismissed the plaintiff's claims against the board and reaffirmed that:

The plaintiffs must do more than plead that the directors responded in a weak, inadequate, or even grossly negligent manner. The pled facts must indicate a serious failure of oversight sufficient to support an inference of bad faith.

So where does this leave us? Insofar as teaching the Caremark doctrine is concerned, what McDonald's adds is simply the proposition that Caremark's oversight duty extends to officers. But so what? As I noted in the first post:

There is a certain logic to Laster's conclusion. After all, in general, Delaware law holds that officers have the same fiduciary duties as directors.

To be sure, I still think the conduct alleged in McDonald's was personally appalling, but did not rise to the level one associates with Caremark liability:

• At least by 2018, the Board was aware of the problems and was dealing with them.
• There is no allegation of pervasive criminal conduct (one of Fairhurst's own acts of misconduct is described as "technically" constituting an assault), especially by the people that Fairhurst was charged with supervising. (Presumably, Fairhurst has no Caremarkduty to supervise himself).
• The problem is not a lack of supervision or oversight, but rather one of inaction in the face of a known problem. The decision of how to handle sexual harassment is a business decision. Fairhurst and the McDonald's C-suite handled the decision poorly but that's not what Caremark is supposed to be about.
• As appalling as Fairhurst and CEO's conduct undoubtedly was, it never posed the sort of existential threat that were involved in Marchand and Boeing. 

But, having said that, I don't think that the opinion's arguably erroneous application of the doctrine to the facts at bar merits inclusion in the casebook. After all, since Bill Klein's first edition of the casebook our book has been intentionally the antithesis of the Cary and Eisenberg approach of including every case that comes along. Keep it lean and clean.

Looking to the future, however, McDonald's potentially could result in a significant expansion of officer (and director) liability unrelated to Caremark:

At the end of the opinion, VC Laster addressed the separate question of whether Fairhurst’s own personal misconduct constituted a breach of his fiduciary duties. Laster concluded that:

When Fairhurst engaged in sexual harassment, he was not acting subjectively to further the best interests of the Company. He therefore was acting in bad faith. The allegations against Fairhurst accordingly support a claim for breach of the duty of loyalty.

VC Laster thereby transformed sexual harassment—and who knows how much more of employment and civil rights law—into cognizable corporate law claims.

To be sure, VC Laster anticipated just such a complaint:

Some might ask whether the Court of Chancery should be hearing sexual harassment claims and worry that recognizing such a claim will open the floodgates to employment-style litigation. ...

... Like an oversight claim, a claim for breach of duty based on the officer’s own acts of sexual harassment is derivative, so all of the protections associated with derivative claims apply.

But so what? Is Laster saying that if Fairhurst had moved to dismiss for failure to make demand on the board per Rule 23.1 that Fairhurst would have won?

I do not see a firebreak between Laster's decision and "employment-style litigation." But I do see a slippery slope.

If that aspect of the opinion is picked up and approved in future cases, I will add a case to the section of the casebook that deals with the subset of the duty of loyalty that deals with the "duty" of good faith.

If you're an adopter of the casebook, let me know what you think.

Elon Musk's Alleged Drug Use and Caremark: What Happens When the Board is Aware of a Problem and Does Nothing?

The WSJ reported today that:

Elon Musk and his supporters offer several explanations for his contrarian views, unfiltered speech and provocative antics. They’re an expression of his creativity. Or the result of his mental-health challenges. Or fallout from his stress, or sleep deprivation.

In recent years, some executives and board members at his companies and others close to the billionaire have developed a persistent concern that there is another component driving his behavior: his use of drugs. 

Those executives and directors allegedly worry about the potential consequences for "the six companies and billions in assets he oversees."

Corporate lawyers in the audience will immediately spot the potential Caremark issue this report raises. As recently and ably summarized by VC Will, allegations that directors failed to exercise appropriate oversight of subordinates "arise from the duty of good faith, which is a subsidiary element of the duty of loyalty."

To plead a viable claim for breach of the duty of oversight, a plaintiff must allege sufficient facts to support a reasonable inference that the fiduciary acted in bad faith. Under Caremark, bad faith can be established when fiduciaries (1) “utterly fail to implement any reporting or information system or controls,” or (2) “having implemented such a system or controls, consciously fail to monitor or oversee its operations,” which disables them “from being informed of risks or problems requiring their attention.”

If the WSJ report is correct, it would seem that neither prong of the Caremark theory would be satisfied on these facts. To be sure, the WSJ reports that although "Tesla board members over the years have talked among themselves about their concerns over Musk’s alleged drug use" they "haven’t said anything formally that would end up as an official board agenda item or in meeting minutes." On the other hand, however, it sounds as though the board and executives are informed of the problem. Does Caremark require more? Does it require a formal system set of internal controls that would simply inform them of what the already know?

In other words, what liability exposure does the board have when it is aware of a problem and decides to do nothing? I think the answer should be that the board would not be held liable. Granted, a board can be held liable for acting in bad faith not only for acting with “'subjective bad faith,' that is, fiduciary conduct motivated by an actual intent to do harm" to the corporation, In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 64 (Del. 2006), "but also intentional dereliction of duty." Lyondell Chem. Co. v. Ryan, 970 A.2d 235, 240 (Del. 2009).

At least on these facts, however, I doubt whether a board decision to do nothing would rise to the level of "intentional dereliction of duty." First, as VC will explained, The Caremark doctrine is not a tool to hold fiduciaries liable for everyday business problems. Rather, it is intended to address the extraordinary case where fiduciaries’ “utter failure” to implement an effective compliance system or “conscious disregard” of the law gives rise to a corporate trauma. ... Officers’ management of day-to-day matters does not make them guarantors of negative outcomes from imperfect business decisions." Hence, even if the board's decision not to act was "imperfect" that board cannot be held liable as "guarantors of negative outcomes."

Second, as I discussed at considerable length in my post My Pillow, Inc. and the perennial question of whether Caremark claims should lie when boards fail to monitor the CEO's personal life, the Delaware courts have held in several cases that "“directors of Delaware corporations generally have no duty to monitor the personal affairs of other directors and officers." Granted, saying there is no duty to monitor such affairs is not the same as saying that there is no duty to intervene when such affairs are brought to the board's attention, but it tends to support the proposition that the board has little liability exposure in this area.

Finally, and related to the first point, "The business judgment rule may apply to a deliberate decision not to act, but it has no bearing on a claim that directors' inaction was the result of ignorance." Rabkin v. Philip A. Hunt Chem. Corp., 547 A.2d 963, 972 (Del. Ch. 1986). This case would seem to fall into the former category rather than the latter.

Specialist Directors: Recommended Reading

I've noticed a trend in recent years for companies to provide data on the skill and expertise set of their directors. Frequently they summarize the information in tabular form:

I'm not sure how useful investors will find such presentations when almost every director is claimed to have virtually every skill. In any case, Roy Shapira and Yaron Nili have posted a very interesting paper discussing this phenomenon (Specialist Directors (November 30, 2023), https://ssrn.com/abstract=4648018:

What determines the effectiveness of corporate boards? Corporate legal scholars usually approach this question by focusing on directors’ incentives, such as counting how many directors are independent or whether the roles of the CEO and Chair are separated. Yet on the ground, the focus has been shifting to directors’ skill sets and experience. Investors, regulators, and courts are now pressuring companies to appoint directors with specific types of expertise. In response, more and more companies are adding what we term “specialist directors”: a DEI director, a climate director, a cyber director, and so on. These changes in board composition could reshape corporate governance and impact broader societal issues such as data privacy and environmental degradation. This Article examines the ongoing shift in board expertise and makes the following three contributions.

First, the Article presents evidence on the scope and magnitude of the changes in board expertise. We hand-collect and hand-code data from the proxy statements of S&P 500 (large cap) and S&P 600 (small cap) companies over the 2016–2022 period. We find that over the past few years companies have not only significantly increased their emphasis on expertise disclosure, but also added hundreds of directors with narrower, ESG-related expertise.

Second, the Article analyzes how these shifts in board expertise could affect corporate behavior, and whether they are likely to prove overall desirable from a societal perspective. It is intuitive to think of board expertise as an unalloyed good. But we merge insights from interviews with nomination committee members with insights from the literature on group decision-making, to highlight five realistic concerns arising from the current trend. The injection of new, narrow types of expertise could distort board dynamics, create “authority bias,” overly increase the size of boards, hinder efforts to promote board diversity, and result in “board washing” whereby human capital disclosure camouflages the company’s actual behavior.

Finally, the Article generates concrete policy implications. For regulators, the main lessons concern rethinking the desirability of legal intervention and ensuring more credible and comparable expertise disclosure. For courts, the main lessons revolve around how to assess board behavior in oversight-duty litigation and what to consider when approving derivative settlements.

In it they discuss the proposal for board service providers that Todd Henderson and I made a few years ago in Outsourcing the Board:

Our focus on board expertise makes our analysis closely related to a couple of recent influential accounts. Consider first Bainbridge and Henderson’s thought provoking proposal to outsource the board. Bainbridge and Henderson start their analysis by highlighting a lack of expertise problem. The decades-long emphasis on board independence has rendered current boards with “generalists with little firm-specific knowledge, skills, or expertise,” they argue.To solve this problem, Bainbridge and Henderson suggest allowing companies to hire an outside governance consulting firm to run (be) their board. Outsourcing the board to (non-human) specialized entities would solve the expertise problem, by permitting the board to “insource its development of expertise.” One important difference between our analyses is that Bainbridge and Henderson focus on firm-specific expertise, whereas we focus on the recent shift to ESG expertise. Another distinction is that Bainbridge and Henderson focus on what ought to happen: removing the legal ban on non-human directors would free up companies to experiment with different types of boards. We, by contrast, focus on a shift that is happening.

Without speaking for Todd, my take is that firm-specific (and industry-specific) expertise is more relevant than ESG expertise, but that's driven by my view on the merits of ESG. Second, theory always trumps description. (I joke, of course.)

Seriously, I liked this paper a lot. Recommended reading.

Matt Levine Quotes my UCLAW Colleague Fernan Restrepo re Insider Trading

Matt Levine's Money Stuff newsletter from a couple of days ago quoted a new paper from my friend and UCLAW colleague Fernan Restrepo:

Here are a fun paper and related blog post by Fernan Restrepo about “How the Misappropriation Theory Affects the Amount of Insider Trading”:

My paper tests this hypothesis by examining the impact of O’Haganon a common proxy for insider trading: target run-ups in mergers and acquisitions (“M&A”) – that is, the cumulative abnormal returns for the shares of the target company before the transaction is publicly announced. The intuition behind this proxy is that individuals who hold non-public information about mergers and acquisitions can make significant profits if they buy shares in the target company before the transaction is announced (since mergers typically involve the payment of a large premium over market prices); as a result, a significant increase in the target’s pre-merger price is likely indicative of a high incidence of trading on confidential information about the transaction. ...

The results show that the run-ups in fact decreased significantly in relation to the announcement returns after O’Hagan. Before O’Hagan, the average relative run-up was 7 percentage points lower than the announcement returns; after the decision, the difference became 9 percentage points. In this sense, after O’Hagan, there was less anticipatory trading explaining the overall valuation effect of M&A bids, which is consistent with the notion of less insider trading.

I suppose a thought experiment would be: If the US got rid of its current rules and replaced them with a simpler, “if you know about a merger that hasn’t been announced yet, it is illegal to trade the stock of the target”-style rule, would that change the average run-up? My guess is no: My guess is that the current hodgepodge of rules covers basically every practical situation, so expanding them wouldn’t have much effect.[4] But I’m not sure.

If the controller paid a fair price but dealt unfairly with the minority, what liability (if any) does the controller have?

This is a question that has periodically come up over the years here at PB.com.

Calculating Damages Where the Breach of Fiduciary Duty Involves a Flawed Process: What Happens if There is Unfair Dealing but the Price is Fair

Tweeting with Ann Lipton re What Happens if there is Unfair Dealing but a Fair Price

It now has an answer from the Delaware Chancery Court (HT: Andrew Czerkawski on Francis Pileggi's blog):

Minority shareholders of a former publicly traded telecommunications company brought suit in the Delaware Court of Chancery, alleging the controlling shareholder, with the aiding and abetting of the company’s pre-spin-off parent, breached his fiduciary duty of loyalty he owed to the minority.  The lead plaintiff claimed the controller caused the company to unfairly sell a litigation asset in In re Straight Path Communications Inc. Consolidated Stockholder Litigation, 2023 Del. Ch. LEXIS 387 (Del. Ch. Oct. 3, 2023). ...

... because the parent paid the company $10 million to release an essentially worthless claim, the parent paid a “not unfair” price. ...

Emphasizing the unified analysis, finding a fair price paid did not end the Court’s decision: “the question is one of entire fairness, and what the stockholders could have achieved, absent the iniquities.”  The Court pointed out its precedent on fair process—“[t]his court has held that a fair price ‘does not ameliorate a process that was beyond unfair.”  The defending fiduciary must satisfy “[b]oth aspects of the entire fairness test – fair dealing and fair price.”  “This assessment provides an opportunity to evaluate the transaction holistically and ‘eliminate the ability of the defendants to profit from their breaches of the duty of loyalty.’” 

The takeaway?

In disputes challenging the fairness of conflicted controller transactions, fiduciary liability does not live and die on price alone.  Even if the controller forces an otherwise sweetheart deal, the court will still closely scrutinize the manner in which the controller exercised that force.  If the transaction’s process tips the deal’s unfairness past equipoise, then the controller faces nominal damages along with a judicial rebuke.

Weird Caremark ruling from Delaware Supreme Court

@AnnMLipton observes: "it would be kind of odd if a Delaware court held that a board violated its fiduciary duties by causing the company to break the law, if the company’s primary regulator determined that the company had not broken the law." Very odd. https://t.co/NjyH3qUeaQ

— Steve Bainbridge (@PrawfBainbridge) January 3, 2024

On @fpileggi's excellent blog on Delaware corporate law, Frank Reynolds has a detailed treatment of the AmerisourceBergen case to which @AnnMLipton referred. https://t.co/fKun1AgLmr

— Steve Bainbridge (@PrawfBainbridge) January 3, 2024

Vice Chancellor Will Nails Caremark

As one of those commentators who has worried about the seeming expansion of Caremark liability, I was heartened by VC Will's opinion in the Segway case. (H/T: TCD.) 

“Oversight duties under Delaware law are not" ... “designed to subject [fiduciaries] to personal liability for failure to predict the future and to properly evaluate business risk.” Bad things can happen to corporations despite fiduciaries exercising the utmost good faith.

The Caremark doctrine is not a tool to hold fiduciaries liable for everyday business problems. Rather, it is intended to address the extraordinary case where fiduciaries’ “utter failure” to implement an effective compliance system or “conscious disregard” of the law gives rise to a corporate trauma.

VC Will also clarified how Caremark applies to officers:

Segway’s claim rests on the misimpression that an oversight claim pursued against an officer is easier to plead than one against a director. Irrespective of the defendant’s corporate title, a Caremark claim is “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” At a minimum, a plaintiff pursuing an oversight claim against an officer would need to demonstrate that the officer failed to make a good faith effort to monitor central compliance risks within her remit that pose potential harm to the company or others.

Excellent.