Across the country, public employee retirement systems are investing in companies that privatize public employee jobs. Such investments lead to reduced working hours and often job losses for current employees.  Although, in some circumstances, pension fund participants and beneficiaries may benefit from these investments, their actual economic interests might also be harmed by them, once the negative jobs impact is taken into account. But that impact is almost never taken into account. That’s because under the ascendant view of the fiduciary duty of loyalty, pension trustees owe their allegiance to the fund first, rather than to the fund’s participants and beneficiaries. Notwithstanding the fact that ERISA and state pension codes command trustees to invest, “solely in the interests of participants and beneficiaries and for the exclusive purpose of providing benefits,” the United States Department of Labor declared in 2008 that the plain text of the quoted language means that the interests of the plan come first.  Under this view, plan trustees should de facto ignore the potentially negative jobs impact of privatizing investments because that impact harms plan members, and not, purportedly, the plan itself. Thus, in the name of the duty of loyalty, the actual economic interests of plan members in plan investments are subverted to the interests of the plan itself (or, at a minimum, to an unduly constrained version of the plan’s interests that excludes lost employer and employee contributions). As a result, public pension plans make investments that harm the economic interests of their members. This turns the duty of loyalty on its head.
Posts Tagged ‘Duty of loyalty’
This Spring, the Supreme Court will decide whether a for-profit corporation can refuse to provide insurance coverage for birth control and other reproductive health services mandated by the Affordable Healthcare Act (or “Obamacare”) when doing so would conflict with “the corporation’s” religious beliefs. Although the main legal issue in Sibelius v. Hobby Lobby Stores, Inc., et al. and Conestoga Wood Specialties Corp., et al. v. Sibelius concerns the extent to which the guarantee of free exercise of religion under the Constitution and the Religious Freedom Restoration Act may be asserted by for-profit corporations, the Court’s decision may also have important—and unsettling—implications for state corporate laws that define the fiduciary duties of boards of directors.
I’ve recently posted to SSRN a book chapter called “An Economic Theory of Fiduciary Law,” which will be published in Philosophical Foundations of Fiduciary Law by Oxford University Press. The editors are Andrew Gold and Paul Miller.
The purpose of my chapter is to restate the economic theory of fiduciary law. In doing so, the chapter makes several fresh contributions. First, it elaborates on earlier work by clarifying the agency problem that is at the core of all fiduciary relationships. In consequence of this common economic structure, there is a common doctrinal structure that cuts across the application of fiduciary principles in different contexts. However, within this common structure, the particulars of fiduciary obligation vary in accordance with the particulars of the agency problem in the fiduciary relationship at issue. This point explains the purported elusiveness of fiduciary doctrine. It also explains why courts apply fiduciary law both categorically, such as to trustees and (legal) agents, as well as ad hoc to relationships involving a position of trust and confidence that gives rise to an agency problem.
It is a privilege to appear before a group that is so important to the strength and integrity of the fund industry. Independent directors have significant responsibilities, and it requires tremendous effort and time on your part to do your job well. I applaud your efforts to learn from the professionals who are participating in this conference. The insights of the panels you heard yesterday and this morning, and those you will hear after lunch will provide valuable information.
The importance of mutual funds in the lives of American investors is clear. Mutual funds hold close to $14 trillion of the hard earned savings of over 53 million American households. The majority of Americans access the markets through mutual funds. They invest in funds, and hope their investments will grow, for many reasons—to make a down payment on a house, to save for a college education, and ultimately to pay for a retirement.
In In re Bioclinica, Inc. Shareholder Litigation, the Delaware Court of Chancery (VC Glasscock) dismissed a stockholder suit alleging that the members of a board of directors breached their fiduciary duty of loyalty in a sale process for a transaction that had since closed, and where plaintiffs’ allegations previously had been found insufficient to support a pre-closing motion to expedite. Under those circumstances, the court found the chances of those same allegations surviving a post-closing motion to dismiss to be “vanishingly small.” Moreover, the court reaffirmed that reasonable deal protections, such as no-solicitation provisions, termination fees, information rights, top-up options, and stockholder rights plans, in the context of an otherwise reasonable sales process, are not preclusive and do not, in and of themselves, demonstrate a breach of the duty of care or loyalty. Finally, the court dismissed claims against the acquirer that it aided and abetted the directors’ breach of fiduciary duties because no breach of such duties was found.
As we previously detailed here, BioClinica engaged in an eight-month sale process, which led to a two step tender offer acquisition that closed on March 13, 2013. Before the closing of the tender offer, the court found that plaintiffs’ allegations that the board members had breached their fiduciary duties were not colorable, and the court declined to expedite the litigation (or enjoin the transaction). Such a finding typically leads to a voluntary dismissal by plaintiffs. Here, however, plaintiffs nonetheless chose to pursue this action, and, because the exculpation provisions in the company’s certificate of incorporation absolved the directors from monetary damages arising out of breaches of the duty of care, plaintiffs were forced to allege that the directors breached their duty of loyalty or acted in bad faith.
On February 6, 2013, Chancellor Strine of the Delaware Chancery Court issued a bench ruling addressing the duty of independent directors of a Delaware corporation with significant operations or assets outside the United States. In re Puda Coal, Inc. Stockholders Litigation, C.A. No. 6476-CS (Del. Ch. Feb. 6, 2013). In a short but important bench ruling, Chancellor Strine refused to dismiss a breach of fiduciary duty claim against independent directors of a Delaware corporation who had failed to discover the unauthorized sale of assets located in China by the company’s chairman. Importantly, Chancellor Strine’s remarks implicated the duty of loyalty, which creates a risk of personal liability for directors and, potentially, the absence of corporate indemnification. While the facts in the case were somewhat extreme, the ruling in Puda Coal highlights the risks and challenges that may exist for directors of Delaware corporations with significant foreign assets or operations. Although Chancellor Strine recognized that each situation is undoubtedly dependent on its facts and will turn on the nature of the foreign operations, his ruling did include the following remarks:
This article concentrates on conflict of interest, secrecy and insider information of corporate directors in a functional and comparative way. The main concepts are loans and credit to directors, self-dealing, competition with the company, corporate opportunities, wrongful profiting from position and remuneration. Prevention techniques, remedies and enforcement are also in the focus. The main jurisdictions dealt with are the European Union, Austria, France, Germany, Switzerland and the UK, but references to other countries are made where appropriate.
In an October 1, 2012, ruling in Shocking Technologies, Inc. v. Michael, the Delaware Court of Chancery held that a dissident director breached his fiduciary duty of loyalty by sharing confidential information with a third party and trying to discourage that third party from investing in the company. The court’s post-trial ruling came in spite of the director’s claim that he acted in good faith and believed his actions would address certain governance disputes that he had with the other directors. The court observed that “fair debate” is an important issue in corporate governance, but there are clear limits on director conduct in trying to resolve disagreements. Among other things, the court’s decision serves as a reminder to stockholders who sit on boards or otherwise have board representation that directors’ duties run to all stockholders.
The decision involved a dissident director who was the sole board representative of two series of preferred stock. Over time, significant disagreements between the director and the other board members arose over executive compensation and whether there should be increased board representation for the preferred stock. The director argued that the company’s governance problems needed to be resolved before it could attract additional equity funding. The company alleged, however, that these disagreements were pretext for the director’s desire to increase his influence and control over the board at a time when the company faced financial difficulties.
A September 2011 Delaware Court of Chancery decision refused to dismiss claims alleging that a board of directors breached its fiduciary duty of loyalty in authorizing a sale of a corporation to a third party. The stockholder plaintiff alleged that the sale was motivated by the corporation’s former chairman and chief executive officer, who owned 37% of the corporation’s common stock and needed liquidity. The decision is significant for refusing to dismiss allegations of disloyal conduct against outside directors who were disinterested in the transaction and otherwise unaffiliated with the former CEO.
New Jersey Carpenters Pension Fund v. infoGROUP, Inc. involved the 2010 sale of infoGROUP, Inc., to a private equity fund. The stockholder-plaintiff alleged that the sale was motivated by the corporation’s former chairman and chief executive officer, who owned 37% of the company and “desperately needed liquidity” to fund a new venture and to satisfy $12 million in settlement obligations stemming from a Securities and Exchange Commission action and a derivative suit brought against him. The plaintiff claimed that the board of directors breached its fiduciary duties by capitulating to the former CEO’s pressure and approving a transaction that was not in the best interests of all shareholders.
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.