I have recently distributed a memorandum entitled “A United Nations Proposal Defining Corporate Social Responsibility For Human Rights,” which discusses a report by a Special Representative to the U.N. Secretary-General. The report has broad implications for global business and particularly for companies operating on a global basis, in emerging markets, in underdeveloped countries, or in countries that lack a democratic system. The report, which will be considered in a June session of the U.N. Human Rights Council, proposes that corporations bear the “responsibility to respect human rights,” that the State has a “duty to protect” against human rights abuses by companies, and that both the State and businesses must provide more effective access to remedies for human rights violations. In the memorandum, we explain that the framework recommended to the U.N. could impose on businesses an array of expansive obligations requiring close attention by corporate management and boards. The memorandum sets forth the core principles which the U.N. Human Rights Council may endorse to guide corporate responsibilities for human rights and additionally considers their implications for directors.

The memorandum is available here.

In Miller v. McDonald, et al., ( D. Del., Bankr., April 9, 2008), the Bankruptcy Court for the District of Delaware decided an issue of great importance to those who follow corporate governance issues related to the fiduciary duties of officers and directors. In this opinion on a motion to dismiss claims against an officer of a company, the Bankruptcy Court relied on decisions of the Delaware Chancery Court and the Delaware Supreme Court to deny a motion to dismiss in the course of ruling that Caremark duties would be imposed on an officer (who was not a director), that was on the management team when the President of the company committed fraud and other actions and omissions that ultimately led to the bankruptcy filing of the company. This is notable in part because there are not as many decisions that address the fiduciary duties of officers, as opposed to directors of a corporation.

Here is a summary of a Delaware Chancery Court decision of a few weeks ago that also imposed fiduciary duties on a corporate officer, (with a link to other similar cases and to a recent article on the topic by Professor Lyman Johnson).

…continue reading: Court Imposes Caremark Fiduciary Duty on Corporate Officer

We have recently distributed a memorandum entitled Delaware Court Rejects Per Se Rules for Financial Advisor Proxy Disclosures, which discusses the ruling of the Delaware Court of Chancery in In re BEA Systems Inc. Shareholders Litigation, a lawsuit arising out Oracle’s $8.5 billion acquisition of BEA Systems. The court denied plaintiffs’ motion to enjoin a special stockholders’ meeting to vote on the merger on the basis of allegedly insufficient disclosure in the merger proxy. The ruling, issued from the bench, provides helpful further guidance regarding the application of Delaware’s materiality standards, especially as the relate to claims challenging the disclosure of investment banker analyses. The ruling also noted the importance of transactional and market context in evaluating claims that seek to interfere with shareholder decision-making or the timing of a proposed transaction.

The memorandum is available here.

The transcript of oral argument and rulings of the court is available here.

The Financial Times recently published the following op-ed piece of mine, entitled Judgment Too Important to be Left to the Accountants.

Two serious asset bubbles–the dotcom explosion of the late 1990s and the recent dizzying ascension in housing prices–have developed in the US economy within the past decade.

Given their damaging consequences, it is time to look for causes. One area that merits attention is fair value accounting, which was adopted as policy by the accounting profession in the 1990s.

This accounting convention requires financial intermediaries to carry their assets at market values, even if those assets are not being held for trading purposes.

When the dotcoms were in vogue, the assets of securities firms and other equity intermediaries were inflated, just as, more recently, rising housing values made banks and other mortgage lenders look flush. Inflated balance sheets and income statements supported more borrowing and more leverage; suddenly, the markets were awash in liquidity and risk premiums fell to unprecedented levels. It could be argued, then, that fair value accounting was the hothouse in which these bubbles bloomed; when prices are rising this system seems both to stimulate and ride the wave of irrational exuberance.

But matters look much less agreeable when the same asset values are falling. Then, the process works in reverse, and the spiral points downwards.

As assets fall in value, leverage rises, creditors and counterparties demand more collateral coverage, and companies must sell assets that they can no longer finance. Forced asset sales drive down prices, causing further write downs of assets under fair value principles–even for those who are not selling. And so it goes on. The downward spiral is continuing as this is written, and where it stops nobody knows.

Fair value accounting also has a one-size-fits-all quality that mimics the inflexibility of over-regulation. Valuing assets with reference to the market seems reasonable for firms that earn their profits from, say, buying and selling securities. In that case, what the market will pay for the firm’s assets and liabilities at any given time may be a good way to assess its overall value. But what about intermediaries such as commercial banks, which are generally in the business of profiting from cash flows? Does it make any difference to an investor in a bank–an investor who is looking to the bank’s success in corralling cash flows–that the market value of the assets that produce these flows may vary?

Many banks point out that the cash flows on portfolios they have substantially written down are doing just fine. A wooden application of fair value accounting to banks–while it may simplify the work of accountants–seems to do a disservice to bank investors, and even more so bank depositors.

If, as banks claim, fair value accounting is causing commercial banks to appear much weaker than they are in fact, it is creating a financial crisis where a mere slowdown might have been warranted.

Fair value accounting is clearly the reigning orthodoxy among accountants, but is that the right test? Accounting is simply a measurement system. What we want to know determines what and how we measure. Which is more important, the balance sheet or the income statement? Do we want to measure financial strength or earnings per share or cash flows? Is the purpose to inform equity investors or creditors and counterparties? Does one measurement system meet all of these objectives?

Given its impact on institutions and whole economies, common sense suggests that we consider whether one means of measurement is the only one we should be looking at. The world view of accountants at a particular time should not determine the answers to these questions.

It is important to recall the famous remark of Clemenceau that war is too important to be left to the generals.

Electronic Arts, Inc. recently submitted to the SEC a no-action request seeking concurrence of the SEC Staff that a shareholder proposal I submitted may be excluded from the company’s proxy materials for the 2008 annual meeting. In response to the company’s no-action request, I filed a complaint, through my counsel, in the United States District Court for the Southern District of New York. The complaint seeks, among other things, a declaratory judgment that Electronic Arts may not exclude my proposal from the company’s proxy materials and an injunction requiring the company to include the proposal.

My proposal is precatory and recommends that the board of directors submit to a shareholder vote an amendment to the company’s charter or by-laws. The suggested amendment, if adopted, could facilitate by-law amendments initiated by shareholders. In particular, the suggested amendment could require the company to submit to a shareholder vote shareholder-initiated proposals for changing the by-laws that meet certain procedural and substantive requirements. The suggested amendment could also require the company to include such proposals in the company’s proxy materials for the annual meeting.

I view my precatory proposal as rather moderate and believe that its passage and implementation could well benefit the company’s shareholders. Many shareholders, I believe, would vote for the proposal if given the opportunity to do so. I also believe that, for the reasons indicated in the complaint, the company’s attempt to exclude the proposal from the company’s proxy materials is entirely without merit. I hope that the company will change its position and allow shareholders to vote on my precatory proposal. The text of my proposal is available here, the company’s no-action request is available here, and my complaint is available here.

I would like to express my appreciation to the law firm of Grant & Eisenhofer for its invaluable legal advice and representation in this matter. I also wish to thank Greg Taxin and Julie Gresham of Spotlight Capital, and my Harvard Law School colleagues Victor Brudney, Allen Ferrell, Howell Jackson, Reinier Kraakman, and Mark Roe, for helpful comments and conversations on my shareholder proposal.

My colleagues, Amy Goodman, Gillian McPhee and I have recently published our thoughts on issues to be considered by boards of directors in setting their own compensation. We outline recent trends in compensation practices, particularly since the passage of the Sarbanes-Oxley Act, and discuss issues confronting boards of directors as they review their compensation programs; the issues include: the appropriate forms of cash compensation and equity compensation; the mix between equity and cash components of compensation; the adoption of stock ownership and retention policies; the use of perquisites; and the process for evaluating director compensation. We find that boards of public companies increasingly seek external guidance on these issues, recognizing that, when the board sets its own pay, it is in an unavoidable conflict of interest situation as are the corporate managers overseen by the board.

The memorandum is available here.

Recently, I blogged about a case brought in the US District Court, Southern District of Texas, by Apache Corporation, who sought a declaratory judgment supporting its exclusion of a shareholder proposal submitted by the New York City Employees’ Retirement System. The case sought to enjoin a lawsuit brought by NYCERS in the Southern District of New York over the exclusion of a employment-related proposal by the Corp Fin Staff under the “ordinary business” basis of the SEC’s shareholder proposal rule (ie. 14a-8(i)(7)).

A few days ago, Judge Miller of the US District Court, Southern District of Texas ruled from the bench for Apache, granting Apache’s declaratory judgment. I have posted the Order and related Memo - even the trial transcript - from the court in the “Shareholder Proposals” Practice Area on TheCorporateCounsel.net.

Interestingly, Judge Miller’s opinion appears to stake out new territory from a judicial point of view. For the first time, a court has endorsed Corp Fin’s view that a proposal that involves some significant policy matters can nonetheless be excluded under Rule 14a-8(i)(7) to the extent that the proposal also deals with core ordinary business matters; here for example, advertising, marketing, sales and charitable giving. We’ll see if the Second Circuit ultimately follows suit (I believe the Texas case isn’t binding on the SDNY one, but under a res judicata theory, it’s likely the Second Circuit would recognize the SDTX’s decision and rule in favor of Apache).

Also interestingly, the Texas court didn’t take the bait offered by Apache with respect to the appropriate standard of review for SEC Staff no-action: Apache asked the court to find that a company that excludes a shareholder proposal in reliance on a no-action letter is entitled to a rebuttable presumption that such exclusion was proper. The court declined to adopt such an approach, however, concluding that Staff no-action letters are only persuasive - but not binding - authority.

The opinion is available here.

(Editor’s note: This post comes to us from Brian Cadman at the Kellogg School of Management at Northwestern University)

I, along with my co-authors Mary Ellen Carter and Stephen Hillegeist, have recently posted a new working paper entitled The Role and Effect of Compensation Consultants on CEO Pay.

The paper examines how compensation consultants influence the level, form and pay-performance sensitivity of CEO pay for a sample of 880 firms from the S&P 1500 for fiscal year 2006. The sample was collected by looking at the Compensation Disclosure and Analysis (CD&A) report in the annual proxy statement, which is required for filings on or after December 15, 2006. Our final sample of 880 firms all have December fiscal year ends. In addition, 86% of the firms in our sample disclosed that they retained a compensation consultant, suggesting that the use of consultants is widespread.

We find evidence of greater compensation in the presence of a compensation consultant, consistent with theory that these consultants facilitate rent extraction. However, we find no evidence of less pay-performance sensitivity when compensation consultants are hired. Among firms that retain consultants, we also examine whether there is greater rent extraction for clients of consultants with potentially greater conflicts of interest. Using a variety of specifications, we are unable to find widespread evidence of more lucrative CEO pay packages for clients of conflicted consultants despite anecdotal evidence to the contrary. Overall, we conclude from our findings that the potential conflict of interest between the firm and consultant is not a primary driver of excessive CEO pay.

The full paper is available for download here.

You are cordially invited to a very special symposium that marks and celebrates the 40th anniversary of the landmark 1967 revision of the Delaware General Corporation Law:

The Delaware General Corporation Law for the 21st Century

The Symposium will be held on May 5th at Widener University School of Law in Wilmington, Delaware. The event has been approved for 6 CLE credits in Pennsylvania and 6.3 CLE credits in Delaware (no ethics). Materials will be provided for self-reporting CLE for other states. We hope you will join us either in person, or remotely via a Live Video Webcast. There is no charge for participants attending remotely who do not need DE or PA CLE. (There is a $100 fee for remote attendance where DE or PA CLE is provided, and for in-person attendance).

For further information and to register, please click here. Corporation Service Company is the principal sponsor of the event.

In the current issue of The Delaware Lawyer, a variety of practitioners and academics (including Lucian Bebchuk, Robert Thompson, Michael Dooley and Charles Elson) present brief appeals for reform of Delaware’s corporate statutes. Many of these individuals, joined by Professors Jennifer Hill, Brett McDonnell, Faith Kahn, Elizabeth Nowicki, and Ann Conaway), will present more extended remarks about their proposals for reform at the Symposium. Vice Chancellor Leo E. Strine, Jr. will present the keynote address. Panels will address these subjects: The Delaware General Corporation Law and Takeovers; Stockholder Litigation Under the
DGCL; Stockholders in Corporate Governance; and What We Can Learn From Other Statutory Schemes.

The Delaware Court of Chancery recently held in Levitt Corp. v. Office Depot, Inc., that a bylaw restricting business that could be conducted at annual meetings to (i) matters contained in the meeting notice and (ii) matters otherwise properly brought by the board or by stockholders (in accordance with advance notice provisions) did not preclude a dissident who failed to give advance notice from nominating directors at the company’s upcoming annual meeting. Vice Chancellor John W. Noble reasoned that the stockholder did not have to give advance notice of its director nominations because the annual meeting notice stated broadly that the business of director elections would be considered. Levitt follows last months’ decision in JANA as the second recent Delaware opinion finding holes in advance notice bylaws. Jim Morphy’s analysis of JANA is available here.

In Levitt, the court began with the threshold matter of interpreting a bylaw providing that “only such business shall be conducted as shall have been properly brought before the meeting.” The dissident argued that the term “business” did not apply to director elections. The court concluded, however, that the plain meaning of “business” included both stockholder proposals and stockholder director-nominations. As a result, the dissident’s director nominations were required to comply with the bylaw provision governing the conduct of annual meetings.

The court then turned to the key bylaw provision at issue, which stated that “[t]o be properly brought before an annual meeting, business must be (i) specified in the notice of the meeting… (ii) otherwise properly brought before the meeting by or at the direction of the Board of Directors or (iii) otherwise properly brought before the meeting by a stockholder… who complied with the notice procedures [including a 120-day advance notice requirement] set forth in this Section.” The corporation argued that the dissident stockholder failed to comply with the advance notice requirement and, therefore, the stockholder nominations would not be business “properly brought” before the meeting. The dissident responded that the nominations would be proper because, under clause (i) of the bylaw, the corporation’s notice of the annual meeting stated that one of the items of business was to “elect twelve (12) members of the Board of Directors.” The court agreed with the dissident, finding that the notice was sufficiently broad to allow for all director nominations—not just those on management’s slate. In other words, because the company “specified in the notice of the meeting” that director elections generally would be a matter of business, all stockholder nominations of directors will be “properly brought before the meeting” in accordance with the bylaws.

The court observed that the notice could have been drafted to avoid this outcome. Presumably, this means that the notice should have said, for example, that the stockholders would vote on the twelve nominees proposed by the nominating committee or specifically identified in the company’s proxy statement. The court also noted that the bylaws did not otherwise expressly address the director nomination process. Thus, a corporation whose bylaws have separate sections addressing stockholder proposals and stockholder director nominations may not need to change the generic language regarding director elections in its annual meeting notice. That corporation may want to make clear, however, that its bylaws distinguish between “director elections” and “business other than the election of directors.” This would avoid any ambiguity created by the court’s finding that “business” meant both director nominations and other proposals.

The Levittt opinion is available here and may be appealed to the Delaware Supreme Court.

(Editor’s note: This post is by John Savarese of Wachtell, Lipton, Rosen & Katz.)

My colleague David B. Anders and I have written a memorandum commenting on the guidance recently provided by the Acting Deputy Attorney General Craig S. Mortford concerning principles that DOJ will now consider when negotiating and finalizing monitor provisions for deferred prosecution arrangements. The DOJ guidance addresses, among other matters, possible criteria for monitor selection, the independent nature of the monitor, procedures for resolving disputes over the monitor’s suggestions, and ways to determine the appropriate terms of any monitorship.

The memorandum is available here.

On April 14, my co-author Mark Roe and I presented our paper entitled Public and Private Enforcement of Securities Laws: Resource-Based Evidence at the Law and Economics Seminar here at the Law School.

Recent academic work in finance has generally found that private enforcement for investor protection via disclosure and lawsuits among contracting parties is a relatively more important determinant of financial outcomes than public enforcement via financial, regulatory, and even criminal rules and penalties. However, much legal scholarship has long seen private enforcement of securities laws in the United States as poorly designed, with firms, and hence wronged shareholders, often bearing the cost of insiders’ errors and disclosure failure. Our paper seeks to clarify the discrepancy between these two areas of research.

In our paper, we develop an enforcement variable based on securities regulators’ real resources—their staffing levels and budgets. We then examine financial outcomes around the world, including stock market capitalization, trading volume, the number of domestic firms, and the number of IPOs, in light of these resource-based measures of public enforcement. We find that more intense public enforcement regularly correlates with strong financial outcomes. In comparisons between our measures of public enforcement and the measures of private enforcement prominent in recent finance scholarship, public enforcement is typically at least as important as private enforcement in explaining important financial market outcomes around the world.

The full paper is available for download here.

(Editor’s note: This post is by Randall D. Guynn of Davis Polk & Wardwell.)

Treasury Secretary Henry M. Paulson, Jr. has proposed a sweeping overhaul of the U.S. financial regulatory system that, for the first time, would bring insurance companies, hedge funds, private equity funds, venture capital funds and mortgage originators under direct federal supervision. The proposals, contained in a Blueprint for Financial Regulatory Reform officially released on March 31, would also reorganize the existing financial regulatory infrastructure in ways more fundamental than the United States has seen since the enactment of the Glass-Steagall Act of 1933 and the Securities Exchange Act of 1934.

Although some commentators are suggesting that the details of the Blueprint reflect an effort to limit the federal government’s role in the financial markets, the fact that these proposals have been put forward by a Republican administration in the middle of a financial crisis in the last months of its tenure may indicate that a shift of thought has occurred among federal policymakers. In addition, the Administration can expect both the Federal Reserve and Democratic members of Congress to insist that the Federal Reserve have a broader and more permanent regulatory role with respect to the activities and capital requirements of any groups that have access to the discount window.

The Blueprint acknowledges the practical hurdles to achieving its objectives. Factors such as traditional notions of federalism, the existing Congressional committee structure, the agencies’ powerful instincts for self-preservation and organized pressure from industry lobbyists, are likely to substantially delay or paralyze any attempt at a fundamental overhaul of the U.S. financial regulatory system.

A Davis Polk memorandum describing the highlights of the recommendations in the Blueprint is available here.

It is not often that the Southern District of New York (aka The Mother Court) rules on a stockholder derivative case. Here is a recent ruling in which Judge Swain of the SDNY forcefully applied Delaware law in dismissing a stockholder attack on the Morgan Stanley board arising out of management changes in 2005. The opinion also treats important issues that intersect federal disclosure obligations and corporate governance responsibilities. Our memorandum is available here.

(Editor’s note: This post is by Matteo Tonello of The Conference Board Governance Center.)

The Conference Board’s Working Group on Hedge Fund Activism, established in May 2007, recently released a set of proposed recommendations for those public companies and institutional investors who might find themselves involved in an activism campaign mounted by hedge funds. The proposed recommendations are supported by a white paper discussing the Working Group’s findings. The paper is available here.

The Working Group focused on the following areas:

1. What corporations can do to better monitor securities holdings and learn about those accumulations of stock or extraordinary trading patterns that may reveal a hedge fund’s activism tactic.

2. What measures corporations can adopt to avoid becoming a target.

3. How boards and senior executives can react to an activism campaign and how they should respond to requests for change made by hedge funds.

4. How companies and large institutional investors can ensure integrity of the voting process in those situations where hedge funds borrow shares for the sole purpose of influencing a shareholders’ vote.

5. What considerations institutional investors should be mindful of when allocating some of their assets to hedge funds pursuing activism strategies.

Any interested party is invited to comment on the white paper and proposed recommendations. Comments and requests for information should be addressed to the author, Matteo Tonello, at 212-339-0335 or matteo.tonello@conference-board.org. The comment period will run until April 30, 2008.

(Editor’s note: The blog featured earlier posts on the option backdating and its corporate governance implications by Larry Ribstein here, by Ted Mirvis and Paul Rowe here, and by Lucian Bebchuk here, here, here, here, and here.)

I have just posted on SSRN a paper that analyzes three forms of secret option backdating used by public firms and their significance for various corporate governance debates: Option Backdating and Its Implications. The current draft is available on SSRN here.

The three forms of option backdating analyzed are: (1) the backdating of executives’ option grants; (2) the backdating of non-executive employees’ option grants; and (3) the backdating of executives’ option exercises. The paper shows that each type of backdating less likely reflects arm’s-length contracting than a desire to inflate and camouflage executive pay. Secret backdating thus provides further evidence that pay arrangements have been shaped by executives’ influence over their boards. The fact that thousands of firms continued to secretly backdate after the Sarbanes Oxley Act, in blatant violation of its reporting requirements, suggests recent reforms may have failed to adequately curb such managerial power.

As I am continuing to work on this paper and a number of related projects, any comments would be most welcome.

NYCERS v. Apache Corp: Remember Cracker Barrel?

Ah, Cracker Barrel. A decade ago, the biggest Corp Fin-related controversy was the shareholder proposal’s “ordinary business” exclusion basis and the SEC Staff’s Cracker Barrel no-action letter under Rule 14a-8(c)(7) (the basis has since been renumbered to 14a-8(i)(7)). Those were much simpler times. Back then, the SEC’s dealings in corporate governance matters were pretty much limited to the shareholder proposal rule.

The Cracker Barrel saga arose due to a ‘92 no-action letter under which Corp Fin allowed that company to exclude a anti-sexual orientation discrimination proposal by stating that all employment-related proposals raising social issues were excludable. Enough fuss was raised so that the Commission specifically overruled its Staff’s position in a ‘98 rulemaking and returned the agency’s position on social issues to a “case-by-case analytical approach.” Corp Fin has been making this case-by-case determination when deliberating on social proposals ever since.

Now, a similar case has been brought in the US District Court, Southern District of Texas, by Apache Corporation, which is seeking a declaratory judgment supporting its exclusion of a shareholder proposal submitted by the New York City Employees’ Retirement System. This case seeks to enjoin a lawsuit brought by NYCERS in the Southern District of New York. The facts are as follows:

- For the last two years, NYCERS has submitted proposals to companies in a campaign designed to fight discrimination against gays/lesbians and transgendered people (eg. asking companies to amend their EEO statements a la Cracker Barrel).

- This proxy season, NYCERS submits a proposal to Apache asking for the implementation of a program based on “equality principles” that include additional steps to avoid discrimination against this group of people.

- On March 5th, Corp Fin provides no-action relief allowing Apache to omit the proposal on ordinary business grounds, noting that some of the principles in the proposal relate to ordinary business.

- On April 8th, Apache filed for a temporary restraining order to try to prevent NYCERS from delaying its annual meeting and mailing supplemental materials.

- On April 9th, NYCERS files a lawsuit in SDNY, arguing - among other things - that Corp Fin had denied no-action relief for similar proposals in the past (specifically citing these no-action responses: Armor Holdings ((i)(7) denied on burden grounds) (4/3/07) and Aquila ((i)(10) denied)(3/2/06)) and that the Court doesn’t owe deference to Corp Fin’s positions anyways.

- After it filed its lawsuit, NYCERS subsequently filed for a temporary restraining order, but then quickly changed its request to an affirmative/mandatory injunction to force Apache to deliver supplemental proxy materials ahead of its May 8th annual meeting.

This is where this battle stands today, although it promises to move quickly. We have posted all of the documents filed in the SDTX and SDNY so far in our “Shareholder Proposals” Practice Area on TheCorporateCounsel.net.

On March 28, the Delaware Court of Chancery issued a decision in Schoon v. Troy Corporation, upholding a board-approved bylaw amendment that cut-off advancement rights to a former director. I previously posted here on related litigation between the parties where the court held that directors do not have standing to bring derivative suits.

At issue this time was an amendment to the company’s advancement bylaw, which originally provided that “the Corporation shall pay the expenses incurred by any present or former director.” After a director left the board but shortly before he became involved in litigation with the company, the existing board amended the bylaw to delete the reference to “former” directors.

Once litigation began, the director claimed a vested right to mandatory advancement because the lawsuit related to his official capacity as a former director when the original bylaw was in place. As a result, the bylaw amendment arguably had no affect on his advancement rights. He relied on a prior Delaware decision, Salaman v. National Media Corp., 1992 WL 808095 (Del. Super. Oct. 8, 1992), holding that a board of directors cannot unilaterally terminate a former director’s right to advancement through a bylaw amendment while litigation is pending.

The Court of Chancery rejected the former director’s argument and upheld the bylaw amendment that denied him mandatory advancements. It reasoned that a director’s right to advancement becomes “vested” when litigation is filed, not when the underlying conduct allegedly occurred. This holding may surprise some practitioners, given that the purpose of indemnification and advancement is to encourage board service and assure directors that their expenses relating to their official actions will be paid—even if litigation arises after they resign from the board. In addition, this holding was in spite of another bylaw provision providing that “[t]he rights conferred by this Article shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of such person.” The court explained that this provision “is better understood as providing that a director, whose right to advancement is triggered while in office, does not lose that right by ceasing to serve as a director” (emphasis added).

Decisions affecting directors’ rights to advancement and indemnification are always significant. This decision, in particular, may have important implications for dissident directors and directors who are ousted in proxy contests. Both litigators and drafters should take note.

The opinion is available here.

The General Counsel of the Securities and Exchange Commission and Harvard Law School graduate, Brian G. Cartwright, recently gave the Distinguished Scholar Address at Widener University School of Law. Entitled The Role of the States (Foreign and Domestic), the speech addressed the question of what the increasingly global nature of securities markets and business will mean for Delaware general corporation law. After reflecting on changes in securities investing and commerce in recent decades, Mr. Cartwright envisioned a world in which “a global stockholder base trades the stock of transnational companies in just a few market centers with a global reach.” As greater parts of the world embraced the benefits of free-market capitalism, he predicted, the U.S. might lose the commanding dominance it once enjoyed, although it would likely remain one of the world’s leading capital markets. Mr. Cartwright likened competition for corporate charters in the U.S. to the situation now prevailing in Europe, and questioned how state competition for corporate charters would play out at the international level.

The speech is available here.

(Editor’s note: The Agrawal study is described on our blog here; the initial AFL-CIO response is available on our blog here; two reactions to that AFL-CIO response - from Ashwini Agrawal and from Steven Kaplan - are available here; the subsequent AFL-CIO response is available here).

I am writing to respond to the recent post by Daniel Pedrotty, director of the AFL-CIO Office of Investment, critiquing my study on AFL-CIO proxy voting.

First, in contrast to Pedrotty’s claim that I was never in contact with the AFL-CIO Office of Investment, I contacted Michele Evans, office administrator of the AFL-CIO Office of Investment by email on May 22, 2007, and received a reply from her by email on June 1, 2007. The email exchange is available here.

Second, I would like to respond to Pedrotty’s request that I share my data with the AFL-CIO on a confidential basis with the AFL-CIO committing not to share it with any rival researcher and to use it solely to “check the accuracy” of my findings. Given that the AFL-CIO has not provided me data and information when I have requested it and has made what I consider false and misleading statements about my research, I have serious concerns, as do my advisors, that the AFL-CIO will misuse and mischaracterize any data I send them prior to publication. I therefore will not enter into the requested confidentiality agreement with them. Instead, I suggest they consult the public sources of data I use in writing my paper and replicate the findings themselves.

Third, I would like to respond to Pedrotty’s claim that the study is not possible to replicate using public information. Pedrotty makes a useful point that I did not fully describe the information I obtained from Investor Relations departments, however, as I will make clear in the next version of the paper, the findings in the paper are the same if one relies on the public data sources described in the paper. The next draft will explain that I contacted four companies whose investor relations departments confirmed, consistent with the lack of discussion of unionized workers in their 10-K’s, that they did not have union workers (an assumption I discuss in the paper). I will also make sure to fully describe any information I get from additional investor relations departments or other sources that I may choose to contact while revising my study.

As for other claims raised by Pedrotty, I have addressed them already in my earlier post, available here.

The Program on Corporate Governance has recently issued as a discussion paper my piece, entitled Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling: Bad Appointments and Empty-Core Cycling at the Circus.

On the surface, the Ringling case appears to be an irrational spat over board seats by the heirs of a very successful enterprise. However, a closer inspection reveals that the investors were neither fighting over board seats nor were they irrational. Although Edith Ringling pushed her incompetent son and Aubrey Haley her inappropriate husband, they did so to their private advantage. Although the circus cycled from one management team to another, the investors always promoted the new teams for private gain.

I argue that the root of the Ringling dispute lay in the inability of the law to enforce duty-of-loyalty standards. When the law works as it should, fiduciary duties perform two functions: they remove the incentive to appoint corporate officials by kinship rather than ability, and prevent the empty core cycling that would otherwise plague so many close corporations. Here it performed neither. In the Ringling case, I argue that the various parties had incentives to defect in the next period regardless of the alliances they formed in the current period. When the law does not enforce a duty of loyalty, this allows cycling to occur. If the law gave each investor a return proportional to his or her interest in the firm, investor alliances would not cycle. Not only will investors not appoint inept kin, management will not cycle from alliance to alliance. The Ringling circus did not degenerate into the chaos in which it found itself because the investors were spoiled or irrational. It degenerated because the law could not enforce the duty of loyalty.

The full paper is available for download here.

Chancellor Chandler in litigation captioned TravelCenters of America LLC v. Brog, et al., C.A. No. 3516-CC decided, among other issues, two significant legal questions worthy of broader publication. Since both rulings are contained in memorandum opinions, they will not be reported officially. The first ruling was contained in a pre-trial memorandum opinion and dealt with the admissibility of a law professor’s expert testimony on matters of state and federal law. The second, contained in a bench memorandum delivered at the end of the trial, decided whether provisions contained in an LLC Agreement were required to comport with concepts of “good corporate governance.”

I. Law Professor Testimony
In the pre-trial ruling, the Chancellor held that expert testimony from a law professor (a) could not be presented on the question as to whether, under Delaware law, the LLC’s provisions regarding advance notice were consistent with good corporate governance practices but (b) could be presented as to whether the Notice complied with the Agreement’s incorporation of federal securities law disclosure. The first holding was based on an unreported opinion in the Court’s earlier Disney litigation which had held that “‘in this Court, witnesses do not opine on Delaware corporate law.” The pre-trial ruling foreshadowed the result of the case in chief by stating that: “Delaware does not impose a legal requirement on LLCs to draft their bylaws to be consistent with some abstract notice of good corporate governance. LLCs are creatures of contract designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.”

The Court did allow expert testimony (a) on the requirements of federal securities law and, (b) citing an unreported opinion in the Court’s Wells Fargo v. First Interstate Banking litigation, as to the materiality of omissions as measured by the standards of federal securities law. Wells Fargo, relying on TSC v. Northway, had held that “issues of materiality are generally held to be mixed questions of law and fact but predominantly questions of fact.”

The pre-trial ruling is available here.

II. LLC Agreement Provisions
In the case in chief, the Chancellor granted TravelCenters’ declaratory judgment that the activist stockholder plaintiff’s notice of intended nomination of board members at the annual meeting (the “Notice”) was contrary to the LLC Agreement and “of no force or effect.”

The Court found that the Notice violated a requirement in the Agreement that such notices disclose all the information that the Exchange Act would require to be disclosed in a proxy solicitation. The decision was based on the legal proposition that LLC’s are “creatures of contract” and are not limited by general rules applicable to corporate governance. Since valid notice was required for the nominations to be accepted at the meeting, the management slate would be expected to be unopposed.

The bench memorandum is available here.

My colleague Laura A. McIntosh and I have written an article entitled Corporate Governance Update: Advice for Directors in Complicated Times: The Fundamentals Still Apply. The article considers directors’ oversight responsibility in a volatile business environment, including directors’ obligations as a company approaches the zone of insolvency and the extent to which directors are entitled to rely on management’s and experts reports, advice and decisions. The article also discusses directors’ exposure to potential liability, including the degree of vigilance required to discharge fiduciary obligations and how active directors should be in seeking information from management.

(Editor’s note: This post is by Linda McKenzie of Ernst & Young.)

In light of all of the recent market turmoil, the importance of transparency and risk management has certainly been elevated. These issues along with some of the shifts in global capital markets activity are at the center of a speech delivered by my CEO at Ernst & Young, Jim Turley, to a Washington D.C. audience at the U.S. Chamber’s 2nd Annual Capital Markets Summit. The speech describes how the interconnected, complex, and dynamic nature of global capital markets is demanding greater transparency, increased focus on risk management, and development of common standards and practices around the globe. Jim suggested the launch of a sustained multi-party dialogue — some mechanism involving issuers, auditors, and investors as well as governments and regulators — to facilitate a private and public sector dialogue that would monitor, assess, and address the challenges of operating in global capital markets and help to identify best practices. Tackling these issues could set a foundation for higher levels of investor confidence. The full text of the speech is available here.

(Editor’s note: This post by Jun-Koo Kang and Jin-Mo Kim is part of the series of posts on corporate governance articles accepted for publication in prominent Finance Journals.)

Our forthcoming article in the Journal of Finance entitled The Geography of Block Acquisitions, extends the literature on geographic proximity by studying how corporate governance activities of block acquirers in targets and target announcement returns are affected when the acquirers are located near the targets.

Using a sample of 799 partial acquisitions in the U.S. during the 1990 to 1999 period, we find that:

The full paper is available for download here.

It is often said of Congress that it can’t act on anything important except in a crisis. What is seldom noticed is the corollary that Congress puts off acting until ordinary problems develop into crises. For years, Congress has had before it two serious problems—the gradual loss of U.S. preeminence in financial transactions and the inadequate regulation of Fannie Mae and Freddie Mac—and has done nothing about either. This gives rise to a suspicion that we face these crises because a dysfunctional Congress can’t act until a crisis actually occurs. The developing situation with Fannie Mae and Freddie Mac is a test of this proposition. If the Senate Banking Committee doesn’t act on the current GSE legislation, which would give their regulator receivership powers, the outcome will be a crisis in which the necessary congressional action will be devastating for the taxpayers.

These issues are addressed in a recently circulated AEI Financial Services Outlook entitled “Dangerous Dithering: Congressional Inaction Plants the Seeds of Crisis”. It is available here.

Vice Chancellor Lamb’s recent memorandum opinion in the Delaware Court of Chancery, In Re SS&C Technologies, Inc. Shareholders Litigation, adds an interesting twist to the “readily available plaintiff” question.

The SS&C opinion and order imposes sanctions on the plaintiffs and their counsel for filing, in bad faith, a motion to withdraw. The defendants contended, and the Court found, that the motion was filed in an effort to cover up the discovery record relating to the “litigation spawning purpose” of a web of partnerships alleged to have been formed to provide plaintiffs in derivative and class litigation against publicly traded companies.

In the recent and well known Lerach and Weiss cases, the lawyers had ensured a stable of potential representative plaintiffs by paying them about ten percent of the attorney’s fees awarded by the court. In SS&C, the defendants allege that the managing partner of one of the plaintiff partnerships manages “a web of small investment partnerships – for the sole purpose of bringing stockholder lawsuits through his attorney.” Each of the nine investment partnerships cited “owns only a few shares … in roughly 60 to 80 public companies.” That would amount to about 500-700 companies subject to suit. Although the managing partner denied that the partnerships served only to bring stockholder lawsuits, he admitted that they were “economically irrelevant to him.” He acknowledged that he had, himself, been a party in fourteen proceedings and had been involved in “bringing roughly 30 stockholder lawsuits on behalf of himself and many of … [the partnerships].” The partnerships are consistently represented by the same law firm.

The Court’s opinion is highly skeptical of the managing partner’s claims. He and his counsel were found to have made a number of statements in documents filed with the Court which, the Court wrote, “are easily susceptible to the inference that they were made to conceal the existence of this web of partnerships and their evident litigation spawning purpose.” (emphasis supplied) The defendants, for their part, characterized the entire operation as “a litigation kennel.”

To support its findings, the Court sets out an extensive series of misstatements, mischaracterizations, inconsistencies and misrepresentations which the plaintiffs described at argument as “honest mistakes.” Although the Court could not find, based on the “sparse record before it,” that the partnerships could never serve as representative plaintiffs, it nevertheless sanctioned the plaintiffs for bad faith and abuse of judicial process in filing a spurious motion to withdraw as counsel.

The full opinion can be found here.

In a decision issued on March 13, 2008, the Delaware Chancery Court in JANA Master Fund, Ltd. v. CNET Networks, Inc. held that CNET’s advance notice bylaw applied only to shareholder proposals that are sought to be included in the company’s proxy materials pursuant to Rule 14a-8 under the Securities and Exchange Act of 1934, as amended, and therefore did not apply to independently financed shareholder proxy solicitations. The decision is based upon the somewhat unusual wording of the CNET advance notice bylaw, the relevant portion of which is quoted below. Chancellor Chandler cited three principal reasons based on the specific language for limiting the bylaw’s applicability: (i) the language that “any stockholder…may seek to transact other corporate business at the annual meeting” does not make sense outside of the context of Rule 14a-8 because shareholders using their own proxy materials do not need management approval; (ii) the bylaw’s deadline for shareholder notice to the company is tied to the mailing date of the company’s prior year’s proxy materials, as is the deadline under Rule 14a-8 and unlike most advance notice bylaws; and (iii) in the Court’s view, most importantly, the final sentence of the bylaw (which states that “such notice must also comply with any applicable federal securities law establishing the circumstances under which [CNET] is required to include the proposal in its proxy statement…”) makes it clear that the scope of the bylaw is limited to proposals that shareholders seek to have included in the company’s proxy materials.

A memorandum summarizing the decision is available here.

The Delaware Chancery Court has issued its decision in the closely watched trial between Barry Diller and John Malone and their respective companies, IAC and Liberty Media.

Liberty owns all the high-voting stock and a majority of the votes in IAC but it has granted Diller, IAC’s CEO, an irrevocable proxy to vote these shares. IAC has proposed to spin-off four of its subsidiaries as independent public companies, and the dispute between IAC’s management (including Diller) and Liberty (including its Chairman, John Malone) is whether or not to replicate the IAC two-tiered voting structure in these spin-offs. Diller is contemplating voting Liberty’s shares in favor of the proposal which Liberty vehemently opposes.

The clear winner in this round seems to be Diller. The court concluded that Liberty failed to demonstrate that Diller breached or threatened to breach any contractual duty he owes to Liberty, and rejected Liberty’s claim that the proposed single-tier spin-off gives rise to any right of consent on Liberty’s part. The court held that it was premature to rule on claims relating to the fiduciary duties of the IAC board of directors. IAC was represented by our frequent blog contributor Theodore Mirvis and his partners at Wachtell Lipton Rosen & Katz.

The full opinion can be found here.

JCPenney became the third company this proxy season to reach an agreement with me to amend its by-laws to limit the adoption of poison pills.

The adopted by-law is based on a shareholder proposal to amend the company’s by-laws that I submitted for the company’s upcoming annual meeting. Following my agreement with the company, the company’s board adopted the new by-law and I withdrew the shareholder proposal. The company’s amended by-laws were filed yesterday and are available here.

Under the new by-law provision, any extension of a poison pill plan not ratified by the shareholders must be approved by at least 75% of the members of the board of directors, and a pill not so extended will expire one year after its adoption or last such extension. An article about my model pill by-law on which this provision is based is available here.

JCPenney’s adoption of my poison pill by-law was preceded in this proxy season by an adoption by Safeway and an adoption by CVS Caremark, as well as an earlier adoption by Disney and an adoption by Bristol-Myers Squibb. Disney amended its by-laws after my proposal won 57% of the votes in Disney’s annual meeting. Safeway, CVS Caremark, and Bristol-Myers Squibb, like JCPenney now, amended their by-laws following an agreement with me that made a shareholder vote unnecessary. I hope that other public companies will follow the example set by these five companies.

I would like to express my appreciation again to Michael Barry and Ananda Chaudhuri from the law firm of Grant & Eisenhofer for their valuable legal advice and legal representation in connection with my shareholder proposals in general and the pill by-law proposals in particular. I also wish to thank again Greg Taxin and Julie Gresham of Spotlight Capital Management for advising me on engagement with companies.

The materials generated in the drafting of the 1967 revision to the Delaware General Corporation Law (including the report by Professor Ernest Folk to the Corporation Law Revision Committee and the minutes of that committee’s deliberations) are now available online here.

These materials, not widely available before, provide extensive background about the substance and process of the major 1967 corporate law revision project. Janet Lindenmuth and the staff of the Widener Law School Legal Information Center arranged to gather, scan and post this material.