Is the entire special litigation committee (SLC) enterprise just “a high-class whitewash?” Every semester, when I cover SLCs in my corporations class, students ask me, “so what do SLCs decide,” and I say, “they dismiss,” and students nod, their suspicions confirmed. It turns out that I was wrong. Professor Myers concludes that the skeptical view of SLCS, based largely on research from the 1980s, may be unwarranted. He takes on the conventional wisdom and conducts long-overdue empirical research into the outcomes of SLCs. Based on data collected from EDGAR filings, he finds that SLCs settled derivative litigation 30% of the time and took over the litigation to pursue at least one defendant 10% of the time. In addition, he finds that a majority of all cases subject to SLC review end with settlements. Thus, he concludes that “settlement is a much more important part of the picture than heretofore recognized.” The board may create a SLC not to achieve a dismissal of the complaint, but to facilitate a prompt settlement of the dispute.
I confess I have always been somewhat mystified by the significance attached by academics to the SLC as the “death knell” of derivative litigation. To my mind the demand requirement is the greater obstacle to derivative litigation. If the plaintiff makes demand and the board refuses to take up the litigation, that refusal is protected by the business judgment rule; accordingly, plaintiffs want to plead demand futility. Under the Aronson v. Lewis test, demand will only be excused if plaintiff alleges particularized facts that create a reasonable doubt about (1) the disinterestedness and independence of a [majority of] directors or (2) that the challenged transaction was otherwise the product of a valid exercise of business judgment. Particularly since adoption of the requirement that a majority of the directors of NYSE and Nasdaq corporations be independent, plaintiffs who do not make a demand will have their complaints dismissed unless they can persuade the court that, notwithstanding the presence of a majority of independent directors, there is something deeply suspicious about the challenged transaction. Only then is there a need for the creation of the SLC to determine the corporation’s position in the derivative litigation. Professor Myers’ figures confirm the previous research that appointment of a SLC is an infrequent occurrence, at least for claims filed in 1999-2000. His research does show a significant increase in the number of SLC decisions in the period 2002-2004, but as he points out, since his research focuses on the population of SLCs, not derivative lawsuits, it is not possible to determine whether this represents a change in the use of the SLC relative to the number of derivative filings.
Professor Myers makes a good point that perhaps there are broader lessons to be learned from studying the decisions of SLCs. Academics remain deeply skeptical about the ability of independent directors to protect shareholders from self-dealing by insiders. Compensation committees consisting of outside directors, in particular, have not served to curb generous executive compensation packages and indeed may have contributed to increased levels of compensation. Professor Myers argues that his finding that SLC directors do not invariably dismiss derivative litigation should cause us to rethink our views about the behavior of independent and disinterested directors in other contexts.
I have my doubts, however, whether Professor Myers’ data is sufficiently persuasive to bring about the rethinking that he urges. First, the data do show that the SLC made a determination to dismiss all claims in 60% of the cases (Table 1). Thus, while it is an exaggeration to state that SLCs always make a decision to dismiss, it is the most common outcome.
Second, as Professor Myers acknowledges, the data do not shed much insight into the SLC’s behavior. This is understandable since the data are derived from abbreviated descriptions in SEC filings. The other two of his broad categories -- pursue or settle – contain a variety of different outcomes. For example, Professor Myers would classify a SLC determination to pursue just one claim against a former officer and dismiss all other claims against the current officers and directors as a decision to pursue; yet such an outcome might not instill in us any confidence in the SLC’s independence. Similarly, Professor Myers categories as a decision to settle a determination to settle as to just one defendant and to dismiss all other (“and possibly more potent”) claims against other defendants. Moreover, unfortunately, as Professor Myers observes, the information in the securities filings do not allow us to distinguish between a “phony” and a “good-faith” settlement. Professor Myers argues that the essential point is that settlement is a much more frequent outcome than has been previously recognized. While his findings do offer additional information, it is of limited utility in informing us on the behavior of the SLC directors, given the opportunities for gamesmanship.
Indeed, for the skeptical, Professor Myers’ findings may provide more evidence to distrust the behavior of SLC directors. As he reports, settlements of derivative litigation tend to fly under the radar, in contrast to motions to dismiss that may result in judicial opinions because the plaintiff will challenge the SLC’s motion to dismiss. Thus, for a SLC intent upon making the litigation go away, the best route will be to enter into a settlement of the claims; plaintiffs’ counsel may, in turn, be receptive to a prompt settlement so long as significant attorneys’ fees are included. This supports the suspicion that parties may arrive at collusive settlements, with no one looking out for the best interests of the corporation and its shareholders. While judicial approval is intended to safeguard against this practice, in the absence of objecting shareholders, judges may not closely review the settlements. Professor Myers’ data show that the most common ultimate outcome after appointment of a SLC is settlement (Table 6); even in the instances where the SLC made the determination to dismiss, settlement ultimately resulted, and dismissal was the final resolution in 20% of the cases. Professor Myers argues that 20% is not an unreasonably high figure, but we simply do not have enough information to make an informed assessment of the merits of the claims. We are left to ponder the mystery of what really takes place during the settlement process.
Is there some way to get better information? While item 103 of Regulation S-K may requires disclosure of material derivative claims, it does not require disclosure of the appointment of a SLC, still less a description of the SLC’s process or decision. It is unlikely that the SEC could be persuaded to adopt disclosure rules for the purpose of academic research. More disclosure, however, may lead to better behavior. As Professor Myers notes, a possible source of bias in his data is that he is necessarily examining the SLC practices of corporations that have opted for more disclosure; these companies might, given their commitment to transparency, be more likely to hold their colleagues accountable. Similarly, if the SEC disclosure rules required more information about SLCs, it is possible that the SLC directors might undertake their task with greater appreciation of its importance. This could result in both better decision-making by the SLC and additional data for academic research. It is unlikely, however, that additional disclosure requirements in this area are forthcoming.
In conclusion, Professor Myers makes an important contribution to the literature by gathering and analyzing the available data. Given the importance academics have attached to the SLC, it is puzzling that this area of research has been overlooked in the past two decades. Focusing our attention on settlements, and not simply dismissals, of derivative litigation furthers our understanding of SLCs, even if the limitations of the data mean that our understanding is imperfect. Finally, he is right to call attention to the nuances of SLC determinations and the past tendency to paint with too broad a brush the directors’ behavior (i.e., that SLCs always dismiss) and to warn of the dangers of generalities about derivative litigation that some scholars have asserted (i.e., derivative claims are generally meritorious or generally not-meritorious), in the absence of empirical evidence.
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