One interesting thread of conversation at the ABA session on shareholder power was a discussion about mom and pop investors. Some panelists argued that individual middle income casual investors or so called-mom and pop investors were more imagined than real. However, they pointed out that the image of such investors has been used to distort the discussion regarding the legitimacy of shareholder democracy and power. This is because the rhetoric regarding shareholder democracy suggest that the market is full of small or individual investors at risk of being victimized by powerful corporations. That image gives shareholder democracy credibility because it is consistent with America's broader notions of a democracy whereby participatory rights are necessary to protect relatively powerless individual citizens from a larger more powerful central entity. However, these panelists mainatined that the image of the mom and pop investor so often relied upon by shareholder democracy rhetoric does not recognize and/or has not caught up with the reality that such investors do not exist in any meaningful way. Instead, shareholders tend to be powerful entities in their own right. From this perspective, while shareholder democracy seems appealing when applied in the context of the relatively few mom and pop investors, it loses its force when considered against the reality of investors with tremendous resources and expertise. In this regard, the notion of the mom and pop investor warps the debate on the legitimacy of shareholder democracy.

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It seems that most discussions about increased shareholder power sooner or later focus on whether and to what extent shareholders should have any responsibilities to the corporation or other shareholders.  In a recent article, Lynn Stout and Iman Anabtawi make the case for extending fiduciary duty rules to activists minority shareholders to reduce the possibility of self-interested behavior.  In a less dramatic way, some institutional investors also appear inclined to point out the importance of shareholders exercising their rights responsibly.  Thus, the International Corporate Governance Network --an investor led not for profit company organized under the laws of England and Wales to examine and encourage corporate good governance practices--has generated a statement on shareholder responsibilities, emphasizing the importance of being consistent, engaging in constructive dialogue, and having a clear approach for situations where dialogue fails.

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I just got back from the ABA Section of Business Law's Spring Meeting in Dallas.  One program I attended was the Corporate Law Program entitled Current Tensions in Shareholder and Board Relationships.  The program started off with a discussion on the history of shareholder rights.  Interestingly, the panelists agreed that while we appeared to be in an era of increased shareholder power, and hence increased tension with respect to shareholders and boards, the range of shareholder rights, particularly from a statutory perspective, has remained pretty constant over the years.  Instead, what has changed are the mechanisms used to effectuate shareholder rights and/or the manner in which shareholders have used those rights--such as shareholders' use of the inspection right as a lever to enhance their power in other ways.  What is the importance of the observation that shareholder rights have not changed much over time?

On the one hand, it may suggest that shareholders' recent activism is legitimate because that activism only seeks to effectuate existing shareholder rights; rights historically undermined by procedural and other impediments.  On the other hand, such a suggestion begs the question of whether such impediments were inadvertent or deliberate efforts to ensure that shareholders only exercise their rights in limited contexts.  In which case, the recent efforts to dismantle these impediments should be viewed as more problematic.  Either way, as the panelists suggested, it is worth remembering that the rights to which shareholders are entitled to exercise have not shifted over time, even if shareholders desire and ability to exercise those rights have.

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I grew up eating at The Cheesecake Factory, so I was somewhat disappointed when I heard that the Calabasas, California company had attained the dubious honor of making CalPERS' 2008 Focus List of underperforming companies.  They sell great cheesecake, but according to CalPERS, the company has underperformed its peers by 140.5 percent over the last 5 years.  CalPERS objects to the company's staggered board and supermajority voting requirements for certain bylaw amendments, and the pension fund has a pending shareholder proposal to eliminate its staggered boards.  The four other companies that made the list--all with staggered boards that CalPERS opposes--are:

Hilb Rogal & Hobbs, an insurance brokerage based in Glen Allen, VA;

Invacare, a healthcare equipment supplier from Elyria, OH; 

La-Z-Boy (remember The Price is Right?) of Monroe, Michigan; and

Standard Pacific, which sells household durables and homebuilding supplies, from Irvine, CA.

Interestingly, according to a 2007 report by Wilshire Associates, Focus List companies have annual excess returns of -13.3% below their respective benchmarks for the five years before CalPERS involvement, but enjoy positive annual excess returns averaging 12.2% in the five years following.  Perhaps there is an investment strategy here?  See Riskmetrics for additional commentary.

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Oregon recently amended its corporate code to expressly permit corporations to include in their charter a provision authorizing or directing the corporation to conduct its business "in a manner that is environmentally and socially responsible." The legislative history of the amendment notes that courts in other jurisdictions have interpreted corporations' obligation to act in shareholders' interest to mean that corporations must maximize shareholder profit, even if it results in a corporate failure to act environmentally and socially responsible. Apparently the amendment is designed to counteract this kind of interpretation, and encourage corporations to engage in sustainable behavior. On the one hand, some may argue that this kind of amendment is not necessary. Indeed, to the extent the amendment is designed to ensure that corporations are not prohibited from engaging in socially responsible behavior, the business judgment rule appears to give corporations the flexibility to pay heed to other interests, except perhaps in limited contexts such as takeovers. On the other hand, the amendment appears to go farther, suggesting that corporations that embrace such an amendment have an affirmative responsibility to be socially responsible. From that perspective, it is a clear change. What is not clear, however, is the precise contours of a corporate commitment to engage in responsible behavior, and the kind of exposure generated by the failure to live up to that commitment. Interestingly, the legislature apparently discussed the fact that many corporations have embraced a commitment to engage in responsible behavior in their corporate documents. I have also noticed this trend. But it seems that expressing a commitment to responsibility on a corporate website or even in an annual report is a far cry from embracing such a commitment in the articles of incorporation. Nevertheless, it is an interesting development.

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Here we go ... the Wayne County Employees' Retirement System of Michigan and the Police and Fire Retirement System of the City of Detroit have filed an application for a TRO in the Delaware Court of Chancery. (Bloomberg) The Bear Stearns shareholders are trying to stop the sale of 95 million new voting shares to JP Morgan, which is projected to close on April 8.

We discussed this proposed sale here, and we mentioned Omnicare, Inc. v. NCS Healthcare. In that case, the Delaware Supreme Court invalidated a merger agreement and two voting agreements between an acquiring company and two shareholders of the target company. The two shareholders together controlled over 65% of the target company's votes, and the shareholders agreed to vote their shares in favor of the challenged transaction. In addition, the two companies had agreed that the target board would present the challenged transaction for a shareholder vote, even if the board received a better offer. The Delaware Supreme Court held that "the merger agreement and voting agreements, as they were combined to operate in concert in this case, are inconsistent with the NCS directors' fiduciary duties."

In doctrinal terms, the merger agreement and two voting agreements were treated as "defensive measures" under Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del.1985) and Unitrin, Inc. v. Am. Gen. Corp., 651 A.2d 1361 (Del.1995), which prohibit measures that are "preclusive" or "coercive." The Omnicare court reasoned:

Although the minority stockholders were not forced to vote for the [challenged] merger, they were required to accept it because it was a fait accompli. The record reflects that the defensive devices employed by the [target] board are preclusive and coercive in the sense that they accomplished a fait accompli. In this case, despite the fact that the [target] board has withdrawn its recommendation for the [challenged] transaction and recommended its rejection by the stockholders, the deal protection devices approved by the [target] board operated in concert to have a preclusive and coercive effect [because they] made it "mathematically impossible" and "realistically unattainable" for the [alternative] transaction or any other proposal to succeed, no matter how superior the proposal.

In the last section of the opinion, labeled "Effective Fiduciary Out Required," the Court went out of its way to provide an alternative basis for the ruling:

The defensive measures that protected the merger transaction are unenforceable not only because they are preclusive and coercive but, alternatively, they are unenforceable because they are invalid as they operate in this case. Given the specifically enforceable irrevocable voting agreements, the provision in the merger agreement requiring the board to submit the transaction for a stockholder vote and the omission of a fiduciary out clause in the merger agreement completely prevented the board from discharging its fiduciary responsibilities to the minority stockholders when Omnicare presented its superior transaction.
...
The NCS board could not abdicate its fiduciary duties to the minority by leaving it to the stockholders alone to approve or disapprove the merger agreement because two stockholders had already combined to establish a majority of the voting power that made the outcome of the stockholder vote a foregone conclusion.

Omnicare was a divided decision, with three justices in the majority and two in dissent. And post-decision commentary has been almost universally critical. But it serves as a nice base of comparison with the Bear Stearns-JP Morgan transaction. Which board of directors was more faithful to its obligations: the board that allowed existing majority shareholders to commit themselves to a transaction that they viewed as favorable (Omnicare), or the board that is planning to issue stock to the acquiring company to make approval of the transaction over the objections of the existing shareholders much more likely (Bear Stearns)?

That is not intended to be a difficult question. Nevertheless, the lawyers have structured the Bear Stearns-JP Morgan transaction in a manner that elides the obvious pitfalls in Omnicare. That is, it is not technically a fait accompli, and the Acquisition Agreement contains a fiduciary out.

Whatever the result of that line of analysis, the plaintiffs in this initial motion are not limiting themselves to the coercive-or-preclusive standard (aka Unocal/Unitrin). They are also arguing that the "lock up stock sale is designed primarily, if not solely, to eviscerate the voting franchise of the current Bear Stearns stockholders." Sound familiar? This is language designed to invoke the dreaded Blasius "compelling justification" standard.

The Delaware Supreme Court has limited Blasius to cases involving a "contested election for directors" (MM Companies, Inc. v. Liquid Audio, Inc.), but Vice-Chanceller Strine seems to have a more expansive view of the standard, suggesting that it might be applied to any "vote touching on matters of corporate control." Mercier v. Inter-Tel (Delaware), Inc. (2007).

If Blasius applied in this case, the Bear Stearns board would be required to show a "compelling justification" for its actions. According to Strine, "When directors act for the purpose of preserving what the directors believe in good faith to be a value-maximizing offer, they act for a compelling reason in the corporate context."

Could the Bear Stearns board meet that standard? Almost certainly, since they agreed to the lock-up as part of a negotiation to quintuple the price of the deal. A deal that was brokered by the Fed at a time when the prospects of the company looked bleak, to put things charitably. They may not have acted courageously or with all of the skill Bear Stearns' shareholders might have wanted, but this doesn't look like bad faith.

UPDATE: Writing with the benefit of the actual filing, Steve Davidoff analyzes the plaintiffs' claims. Lots of interesting insights, though Steve got a bit carried away at the end:

Here’s one thought. Delaware recently announced a procedure for the Delaware Chancery Court to accept certified questions from the Securities and Exchange Commission. The Delaware court could use this principle to turn the tables and certify a question to the Fed (or even perhaps the S.E.C.) asking this question: "If the share issuance and other lock-ups are knocked out on the usual grounds, would it endanger the financial system and therefore they should still be validated." You can fiddle with the wording but you get the idea.

If the Fed is actually going to orchestrate this deal, they and the Bush administration should bear the responsibility for pushing it through without upending Delaware and its well-reasoned doctrine and rules of law.

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Earlier today, Ashby Jones of the WSJ Law Blog called to talk about the Bear Stearns transaction, and we discussed the possibility of a challenge by shareholders (or a new bidder, as yet unknown) under Delaware law. You can see the results of our conversation here. The interview was pretty hasty, as I was on my way to class, but this post should clarify any lingering ambiguities.

When I first saw the news of this deal on Sunday night, I assumed Bear was being sold for cash. After all, it was only two bucks a share. So I made a snarky remark about how the directors of Bear Stearns should have been trying to get the "best value reasonably available to the stockholders." (Revlon)

The only problem is that Revlon doesn't apply to stock-for-stock transactions unless they result in a change of control. Under QVC, the challenged transaction would have resulted in a shift of control to Sumner Redstone, so that deal was subject to Revlon. In the Bear Stearns-JP Morgan transaction, on the other hand, shareholders would be part of a “fluid aggregation of unaffiliated shareholders” both before and after the deal. No change of control. So it would not be a Revlon case.

Does this line make sense? The usual justification for the line is that the target company shareholders have not been deprived of their ability to receive a control premium. As a result, the market still has the chance to compensate them adequately for their shares, even if the current compensation is not adequate.

The opposing view is that the sale of the company is so important that it should be subject to enhanced scrutiny, not the deferential business judgment rule. Leo Strine seems to endorse this view in a 2001 article, where he remarked on the different treatment of cash and stock sales: "What is striking is how trivial this economic difference is compared to the great difference in the nature of the judicial standard that some practitioners would contend applies to each."

So would the Bear Stearns-JP Morgan merger be subject to business judgment review? Probably not. The key here is whether the Delaware courts would treat the now-famous Section 6.10 as a deal protection device. (The provision is quoted here.) It sure looks like one, though I believe this provision would be new to Delaware. If Section 6.10 (and perhaps 6.11 -- Morgan's option to buy the Bear Stearns building) were treated as deal protection devices, the Delaware litigation would invoke the Unocal-Unitrin standard, as developed in Quickturn, Omnicare, and other cases. I offered some thoughts on those cases in yesterday's post.

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The New York Times Company announced that it has struck a deal to nominate two insurgent candidates to its board.  The candidates were backed by two hedge funds--Harbringer Capital Partners and Firebrand Partners--that now hold some 19% of the company's outstanding stock, making them the largest non-family shareholders at the company.  The agreement to nominate the two candidates came as a result of Harbringer and Firebrands' threatened proxy fight in which they were aiming to capture four board seats at the company's annual shareholders' meeting in April.  Harbringer and Firebrand agreed to call off the proxy fight in exchange for the two seats.  While it is not clear what kind of impact the two new members will have, the company's agreement to such a deal underscores the powerful impact, not only of proxy fights, but also of the realistic ability to wage such fights.

Of course the funds' ability to broker such a deal once again raises questions about the benefits of shareholder activism in general and hedge fund activism in particular.  Moreover, it raises questions about shareholders' role in the corporation as well as the appropriate level of influence any single shareholder should have over the corporation.

To be sure, it is not clear what kind of role or impact these new members will have at the company.  Indeed, Harbringer and Firebrand  wanted the new directors to replace sitting directors.  Instead, the company expanded the board from 13 to 15.  Then too, the New York Times Co. has a dual class structure which ensures that family members elect 10 out of the 15 directors, while public shareholders elect the remaining 5 members of the board.  Hence, it is unclear how much influence one can expect these two members to wield.  Of course, sometimes all it takes is a seat at the table to shake things up.

However, leaving aside for a moment whether this deal will prove beneficial or have any significant impact on future corporate policy, this deal does underscore the power of the proxy fight as compared to other measures aimed at influencing director composition. Indeed, some suggest that withhold the vote campaigns can be just as powerful as the ability to wage a proxy fight.  Yet, two years ago shareholders withheld 30% of their vote from directors and last year shareholders withheld 42% of their vote from directors.  While these votes appeared to have triggered some changes at the company, they did not prompt the company to alter its board.  Then too, some companies insist that shareholders' ability to recommend candidates to the nominating committee is an adequate substitute for proxy campaigns.  In this case, however, Harbringer and Firebrand complained that the New York Times Co. refused to interview any of their nominees.  It was not until the real threat of a proxy fight emerged that the New York Times Co. capitulated.  That capitulation suggests that these alternative measures pale in comparison to the power inherent in a proxy fight--or in this case the power inherent in the legitimate threat of a proxy fight.   

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When Cerberus Capital Management purchased control over Chrysler Holdings LLC, we wondered how the management of the company would change. Hiring Robert Nardelli as the CEO was one immediate signal that this would not be business as usual. Today, Nardelli dropped some news on Chrysler's employees:

Dear Employee,

A willingness to try something new has proven to be an important catalyst as we transform into The New Chrysler and, in many corners of this company, new ways of doing business are firmly taking root. That's not just because of new leadership; it's also a product of an "Own It" mindset. As a private company, we all need to think like owners and do our part to accelerate Chrysler's recovery and transformation.

One idea that we have taken a fresh look at is the implementation of a two-week mandatory vacation shutdown. This year, in order to create better alignment and efficiency across organizational lines and boost productivity, Chrysler will use a corporate-wide vacation shutdown for the weeks of July 7 and July 14. While some operations will need to work during the shutdown to support business-critical activities and others may need to maintain minimal support staffs in place, most organizations should use this two-week time period to schedule employee vacations.

Employees who have already used their earned vacation days, have insufficient earned vacation for the year or are otherwise committed to noncancelable vacation plans during other time periods should work with their local management to make alternative arrangements.

We ask that you approach this idea with an open mind and a team spirit. It's going to take your cooperation and teamwork to achieve success.

Thank you in advance for your cooperation and continued support.

Sincerely,

Bob

Even with an "open mind and team spirit," I would have a hard time figuring out what he is talking about. They have taken a "fresh look" at a "two-week mandatory vacation shutdown"? Was there a stale look on this idea?

Tell me again, Bob, why do you want to do this?

"To create better alignment and efficiency across organizational lines and boost productivity."

Yeah, nothing like a complete shutdown of the company to get your organization in sync and boost productivity.

Reuters is reporting that the real reason is more mundane: saving cash. But I suppose that it would not be very prudent to tell the employees, "People don't like our cars, so we don't need to make so many of them."

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In my current research on shareholders and new voting initiatives, I have been surprised by the number of companies that both allow and encourage electronic voting. That research, though mainly anecdotal at this point, suggests an increase in corporate reliance on electronic voting. Then too, new measures such as the e-proxy rules and state statutes enabling shareholder participation in meetings via electronic communications encourage the use of electronic voting. However, scholars who focus on voting in the context of local, state and federal elections have expressed significant concerns regarding the inaccuracies associated with electronic voting. Hence, I have begun to wonder whether we have sufficiently considered the issue in the corporate context.

Many corporations make electronic voting available to their shareholders. Thus, in addition to allowing shareholders to send their proxies through the mail (and in some cases by fax), some corporations give shareholders the option of submitting their proxies over the phone and/or over the Internet. Then too, some corporations enable shareholders to revoke their proxies electronically over the phone or via the Internet. Corporations that allow such electronic voting contend that it is beneficial because it may increase shareholder participation not only by making it easier for shareholders to submit their proxies, but also by allowing shareholders to make such submissions at the last minute during the shareholder meeting. Electronic voting also appears to be more effective because votes can be recorded instantaneously.

However, the experience with local, state and federal elections reveals defects with electronic voting. Or more specifically, defects with the software used to collect and process vote results. These defects have led to voting inaccuracies including lost votes, switched votes and the recording of additional votes. Thus in 2000 an electronic voting machine in Iowa recorded four million votes in a county with only three hundred voters. One 2007 study found that a number of systems used to tabulate votes had switched thirty to forty percent of the votes cast. Then too, some states, such as California, that certify the technology used to collect and record votes have had to decertify several systems after an audit of those systems revealed significant inaccuracies in recorded votes. As a result of these problems, scholars and others familiar with electronic voting in the context of local, state and federal elections have called for greater monitoring of the electronic voting process and the systems used to implement that process.

Is it likely that this kind of problem would carry over to the corporate context? To be sure, corporations are dealing with a smaller universe of potential voters, especially considering the block votes held by institutional investors. Hence, to the extent the problem with electronic voting relates to additional votes cast, it appears to be a relatively easier problem to detect. Then too, even the problem of lost votes may be easy to detect given that shareholders generally must register prior to voting electronically, unless of course the system fails to record both the vote and the registration. However, the problem of switched votes is much more difficult to detect. Indeed, in traditional elections, such problems usually are not detected unless and until an after the fact audit has occurred and/or another more obvious flaw (such as additional votes recorded) arises in connection with the election at issue. To be sure, the problem of switched votes may not be as significant in the corporate context because most directors run unopposed. However, to the extent recent voting initiatives may increase the probability of contested elections, switched votes may become a bigger issue. Then too, given the increased adoption of majority voting provisions, switched votes may be a concern for candidates needing to receive the requisite majority. Moreover, switched votes represents a concern when shareholders vote on transactions that do not involve director elections because in those cases a particular percentage of votes is required to approve a given transaction.

In this regard, perhaps we should be concerned about the integrity of electronic voting results. To date, many corporate scholars and commentators have expressed concerns about the security issues associated with the increased use of technology in the corporate sector, including measures such as electronic shareholder forums and e-proxies. However, there has been less attention paid to the issue of vote integrity. While it may not be as severe a concern, it still is worthy of more focused discussion.

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Ever since an investor in Mylan acquired sufficient hedged shares from investment banks to tip the vote in favor of a merger with King Pharmaceuticals - in essence, using votes that were untethered to the economic stakes of the firm to force that firm into an acquisition - there has been a renewed interest in corporate voting.  Three recent papers (and one less recent, by Bainbridge) have got me thinking about the issue.  First, some critics.  Marcel Kahan and Ed Rock note that "The inescapable complexity, combined with the already well studied issues of shareholders’ rational apathy and free rider problems, detract from the case for shareholder voting. To what extent should we put matters to a shareholder vote if we cannot trust in the outcome?"  They appear to conclude that the inadequacy of shareholder voting makes it something of a curio, something that neither vindicates shareholder rights nor legitimates managerial supervision.  (Stephen Bainbridge is skeptical of shareholder voting, but he thinks it just supports the case for unfettered management.)

Matt Bodie and Grant Hayden have a new paper that also recounts the many problems of shareholder democracy.  They argue that the franchise depends on a fiction that shareholders are committed to the maximization of firm value, and that that fiction is increasingly unreliable.  They suggest that shareholder voting should instead embrace a broader vision of what firms are for.  Bodie and Hayden conclude:

To be true to social utility, we must allow for the expression of monetary and nonmonetary utility in our preference aggregation. Finally, we must consider how interests and preferences can be expressed and protected through the entire corporate structure.

It seems to me that this isn't a criticism of the franchise per se, but an effort to claim that since shareholder voting doesn't maximize firm value in practice, it should be perfectly acceptable to use the franchise for other things - divestment campaigns in Zimbabwe, perhaps, or union recognition.

In my view, some of this depends on whether voting is an instrument, as most corporate scholars seem to assume, or whether voting qua voting has its own constitutive value, as voting rights people like Michael Kang appear to believe.  I'm more inclined to take the instrumental view.  But if shareholder voting is supposed to serve other purposes, is that because it vindicates other values?  I wonder if Bodie and Hayden have a view on that.

Anyway, download these new papers - almost all brand new this year - while they're hot, as they say.....

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I don't believe anyone who claims that "insiders make the best CEOs" or "outsiders make the best CEOs." I believe people who tell me that it depends on the circumstances. Joseph Bower is promoting the "inside outsider" over on Marketplace. According to Bower, the "inside outsider" is "an outstanding inside performer who has retained his or her objectivity." This reminds me of one of my students, who resolved a posited conflict in class last week by simply changing the facts to remove the conflict. Of course, everyone wants a CEO who is competent, objective, and fair. In other words, we want a person who combines the best attributes of both an insider and an outsider without the liabilities inherent in either position. The trick is to find that person.

Bower is an HBS professor pitching a new book, and the "insider outside" is one of those cute management concepts for which HBS is renowned. Bower has a rather mundane solution to the succession issue: planning.  Funny that his commentary mentions Time Warner as a company with recent struggles. If you are old enough to remember when Time and Warner were separate companies, you will also remember the famous succession plan that gave us Gerald Levin, architect of T-W's acquisition of AOL. Just an anecdote ... or perhaps a cautionary tale about procedural panaceas.

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I have been doing some research on virtual shareholder meetings—shareholder meetings conducted without a physical venue and thus solely through electronic means of communication—and I must admit to having some questions about their ultimate benefits.

Since 2000, when Delaware became the first state to allow virtual shareholder meetings, some thirty states have amended their corporate codes to allow for completely virtual meetings, shareholder participation through remote means, or some combination of both.  Corporations differ on the circumstances under which virtual shareholder meetings can take place.  For example, in some states, the only procedural requirement is that all participants be able to hear one another.  Other states, like Delaware, impose additional procedural safeguards including ensuring that there is a mechanism for identifying shareholders, and that the corporation retains a record of the proceedings.  Then too, some states allow the board , in its sole discretion, to determine whether a virtual meeting will be held, while other states appear to be more flexible on the issue of who has the ability to call such a meeting.  Finally, at least one state—Massachusetts—restricts virtual shareholder meetings to non-public companies.

This kind of restriction stems from concerns raised by shareholder activists’ groups that virtual shareholder meetings may not be appropriate for corporations with widely dispersed shares.  To be sure, proponents of such meetings argue that they may represent a way to boost shareholder participation by enabling shareholders who would not otherwise participate in a physical meeting to take part electronically.  In addition, for those companies that must pay for physical space to hold a meeting, virtual shareholder meetings also offer cost savings.  However, shareholder advocates worry that supplanting physical shareholder meetings with virtual ones would have a negative impact on shareholders.  This is because they do not allow the deliberation and face-to-face confrontation that occurs in a physical meeting.  This is particularly true for meetings that may involve contentious issues or in which there are many shareholders.  In those cases, it may be difficult to have true dialogue without a physical meeting.  In fact, shareholder advocates worry that virtual shareholder meetings may serve as a way for managers to ignore shareholder concerns.  These advocates point out that emails can be more easily ignored or down-played while it is difficult to ignore questions posed in a physical setting.  These concerns have caused some corporations to abandon plans for virtual meetings.  They also have led some scholars to recommend that the use of such meetings be restricted to smaller companies, or that such meetings only be used in combination with physical meetings, and hence not serve to supplant entirely the traditional physical shareholder meeting.

Ultimately, the fact that only a handful of companies have taken advantage of the ability to host virtual shareholder meetings suggests that most corporations are reluctant to forego physical meetings, even when the issues to be discussed at those meetings seem relatively mundane and uncontroversial.  Certainly, like with all elections, it would be nice to embrace a process that promises greater participation.  Yet our experience with voting inaccuracies in local, state, and federal elections suggest that sometimes technology promises more than it can deliver.  And this may be because sometimes there is just no substitute for human interactions. 

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To continue from yesterday's post on problems with bringing securities-related lawsuits: In addition to the standing and cause-of-action problems, there are other obstacles peculiar to China and its political situation: specifically, the government's fear and distrust of large groups, especially organized ones, that are not under state control. (All social organizations, for example, must be approved by and registered with the state; even fishing clubs and associations for the study of antique furniture have been disbanded for failure to get official recognition.) Securities litigation, of course, is often possible only if the claims of small shareholders can be aggregated through the class action or some other form of group litigation. While Chinese civil procedure does not provide for class actions in the American sense (where non-participants without notice can be bound by the result), it does provide for various forms of group litigation. But the system makes it difficult for plaintiffs in securities litigation to use these forms.

First, one of the criteria for the professional assessment of Chinese judges is the number of cases they handle. Thus, they have every incentive not to aggregate claims, but rather to disaggregate them. Securities plaintiffs coming to court as one group have on occasion been instructed to split up into several smaller groups - based not on any common characteristics, but simply on numbers.

Second, the system of court fees also contributes to the incentive to split up cases. Court fees are a progressively declining multiple of the amount in controversy: the percentage charged for lower amounts is smaller than the percentage charged for higher amounts. Thus, a court earns more hearing 10 claims of $X than hearing one claim of $10X.

Third, there are two recent rules explicitly aimed at putting the lid on group litigation - probably aimed at social discontent, not securities lawsuits, but nevertheless putting a crimp in the latter. The first rule, issued in the name of the All-China Lawyers Association [PDF here], requires lawyers handling any case involving ten or more plaintiffs to report to the local government for instructions and imposes various other burdens on representation. The second rule, issued in 2006, relaxes the previous (spottily enforced) ban on contingency fees, but keeps it for specific types of cases, including - you guessed it - lawsuits involving multiple plaintiffs (which normally means 10 or more).

Finally, there are special rules governing holders of shares listed on stock exchanges outside the PRC mainland, such as Hong Kong and New York. The China Securities Regulatory Commission requires Chinese companies listing outside of China to include in their articles of association a provision stating that all disputes between holders of non-mainland-listed shares and the company or its high-level management shall be resolved through arbitration. Interestingly, this may well have been intended as a shareholder-friendly measure, on the theory often held in Chinese officialdom that you should require people to do what you think is good for them. We don't see such arbitration clauses in the certificates of incorporation or bylaws of American public companies, and (perhaps because nobody wants to be a test case) it's not at all clear that a federal court would accept such a clause as valid grounds for dismissal of a claim arising out of federal securities law. (My information may be out of date or just wrong; I'm interested in this question, so please add a comment if you know something to the contrary.) But there is little doubt it would be effective in China. Interestingly, this arbitration clause does appear in Article 181 of the Articles of Association of PetroChina, a Chinese company listed (among other places) on the New York Stock Exchange. Do investors generally know it's there? Did the SEC? Does anyone care?

Bottom line: don't look to the Chinese legal system to protect your interests as a small shareholder. (The story is a bit better for holders of significant minority stakes.) There are, of course, other institutions out there that might do the job: for example, equity markets, banks, various gatekeepers, and the financial press. In China I don't think they do the job very well. But that's exactly the paper I'm working on now, and it's a lot more than can be contained in a blog entry.

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In my first post, I mentioned that one question one must always ask about corporate governance rules in Chinese law is: do they matter? One reason the rules often don't matter is because there is no practical method of enforcing them. In this post I propose to look briefly at the obstacles to shareholder litigation against companies and their management.

As I mentioned in my first post, although the Company Law and the Securities Law provide that companies and their directors and officers have certain duties, the court system is not always willing to grant a private right of action if the duty is violated. Very often courts may take the view that the problem is one for administrative agencies to deal with. Sometimes the courts' reluctance to take cases is based not on a legal analysis of whether there exists a private right of action, but on a practical analysis of whether the court system has the capacity to handle such cases. Thus, from 2001 to 2003, the Supreme People's Court (SPC) issued three sets of rules instructing lower courts not to accept shareholder lawsuits under the Securities Law unless (a) the suit was for misleading disclosures, and (b) an administrative or criminal punishment had already been imposed on the defendant(s) for the act complained of. (The rules also provided a set of procedures for hearing such cases.) In effect, a disgruntled shareholder must get a key to the courthouse from a government body, and cannot sue at all for losses from insider trading or market manipulation, even though both are equally prohibited in the Securities Law.

The justification for the key-to-the-courthouse rule offered by the SPC was that this was favorable to plaintiffs: a previous finding against the defendants would reduce their evidentiary burden. I have discussed this rationale with a number of academics in China, and have never really gotten a satisfactory answer to my objection that that rationale justifies allowing plaintiffs to bring in a previous finding as evidence, but not requiring them to do so.

A few months ago I read an article in Caijing, a Chinese business magazine, stating that the "spirit'" of a recent SPC document meant that plaintiffs could now sue for insider trading and market manipulation, but the article did not mention the name or source of this document. I e-mailed the author requesting further details, but got no response. When I was in China in December, I questioned a securities litigator about it, and discovered that the article was referring to a speech by a particular SPC official in which he said that such lawsuits should now be allowed to go forward. Does a speech by an SPC official give standing where an official document says otherwise? I guess if local courts think it does, then it does.

More on barriers to litigation tomorrow.

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ISS has called “say on pay”--proposals seeking a non-binding shareholder vote on executive compensation—the most closely watched issue of the 2007 proxy season.  So how did the issue fare?

It seems to be gaining a lot of momentum.  According to riskmetrics' most recent proxy report, by the first half of the 2007 proxy season, some 41 say on pay proposals had gone to vote, averaging about 42% shareholder support, and seven proposals received majority support.  Moreover, as of January of 2008, some 90 proposals have been submitted calling for a say on pay, while at least three companies have agreed to provide an advisory vote on compensation.  Riskmetrics says all of these figures are remarkably high given the relative newness of the issue.  In fact, Riskmetrics compared them to similar figures in the context of majority voting—which, after considerable activism, many agree now has become the norm in most major corporations.  And like majority voting, the say on pay campaign is getting help from legislators.  Indeed, the House passed legislation that would give shareholders an advisory vote on compensation and a similar bill was introduced in the Senate.

Of course the jury is still out both on whether the Senate bill will gain any momentum and, more importantly, whether say on pay will achieve its desired result.  To be sure, say on pay measures are aimed at giving shareholders a voice in compensation issues in an effort to stem the seeming unending rise in executive compensation, particularly when such rise has occurred in the midst of economic downturn, underperformance and corporate scandals.  Advocates of say on pay point to the UK experience since some UK data suggest that similar nonbinding pay votes have served to curtail the rise in compensation in the UK.  Shareholder activists are hopeful that similar results can be achieved in the US.  But some are skeptical.  Most notably, at a recent corporate governance conference, Martin Lipton suggested that calls for say on pay were ill-advised because such measures would shift the compensation decision from boards to a small group of shareholders.  Pointing to the UK, Lipton notes that because corporations in that region do not want to risk a negative vote on their pay packages, they feel pressured to negotiate with activists’ shareholders, often behind closed doors.

To be sure, one of the primary criticisms of almost all measures aimed at increasing shareholder power is that such an increase will improperly shift the balance of power, while placing such power in the hands of a small number of shareholders whose interests do not necessarily align with the broader shareholder class.  It is a criticism that has some merit.  However, most people seem to agree, albeit sometimes reluctantly, that the current balance of power has produced undesirable results, particularly with regard to compensation.  So for now, I am willing to wait and see where the say on pay movement takes us.

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Many thanks to Gordon for his kind introduction and for inviting me on as a guest blogger. I'm a regular reader of Conglomerate and it's an honor to be asked to join in.

My research interest is in modern Chinese legal institutions generally and corporate governance in particular; recently I've been looking not at the substantive rules of corporate governance, but at the institutions that would make those substantive rules matter, and the extent to which they exist in China.

One can't spend much time studying Chinese law without being struck by the tremendous gap between what the rules say and what actually happens. This goes beyond the usual law-on-the-books versus law-in-practice gap that one can find in any jurisdiction, where the gap is attributable to obsolescence, resource constraints, and political factors such as government unwillingness to enforce certain types of laws. In China it seems to arise sometimes from a different view of law altogether:
essentially a kind of didactic text that regulated parties are supposed to read and obey. If obedience is not forthcoming, the response is to blame the regulated parties for their willfulness. An alternative response would, of course, be to look at the enforcement structure provided by the regulations in question: do regulated parties have any reason to obey? But this response is relatively rare.

Thus, for example, the Chinese Company Law provides that joint-stock companies (more or less the equivalent of the Delaware corporation) shall have both a board of directors and a board of supervisors. The latter is supposed to keep an eye on the former. But it is elected by exactly the same body that elects the board (i.e., the shareholders) and, while it can ask questions of the directors or request explanations of certain acts, it has no real power to do anything if the answers aren't satisfactory. A recent revision to the Company Law (in 2005) gave it the power to call a shareholders' meeting, but that's about it.

Another example is the director's duty of care and loyalty. This is stated in one provision of the 2005 revised Company Law, but there is no right of action clearly attached to it. Where the law does not very clearly provide you with a right of action (and even in some cases where it does), Chinese courts are typically very unwilling to give you one.

This in turn stems from another feature of Chinese law: that it often seems to make sense more as a set of instructions to officials than as a rights-granting instrument. For example, one type of company under the Company Law may dispense with a board of directors if it is "relatively small" and has a "relatively small" number of shareholders. But the law provides no clue as to how we are to know what counts as "relatively small" in each case. If we think of the law as a recipe for entrepreneurs, it's bad drafting. But if we think of it as instructions to officials in the bureaucracy that handles corporate registrations, then it's easier to understand: it's telling them to make a discretionary judgment. The same thinking is behind regulations that look like private law but say that something or other "should normally" be done or "should in principle" be done.

One might reasonably ask, "But is that so different from US (or other Western) law? Surely we have vague terms such as 'due process' and 'reasonable' that we happily give to judges, juries, or administrative agencies to interpret." This is not a bad point. I think the difference, though, is in the fact that in the US system, we now have a pretty good idea of who has the power to interpret what; when people draft legislation, they could probably readily tell you which body would be interpreting which term and under which principles. Very few of these matters are well worked out in the Chinese legal system. Legislation will always have problems, but the courts have very little power and prestige, and thus aren't a good institutional solution to these problems. As a result, while all legal systems generate uncertainty and contradiction, China's is unusual in not having well-understood techniques for resolving that uncertainty and contradiction.

The bottom line is that when one hears that Chinese corporate law requires such-and-such or imposes such-and-such a duty, one has to ask whether there's any reason to think that this alleged requirement or duty is at all meaningful. One doesn't have to be a card-carrying Holmesian realist to wonder whether a duty that is in substance wholly hortatory should really count, and be reported, as a legal duty just like the legal duty to drive carefully, refrain from embezzlement, etc.

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Thanks, Gordon, for inviting me.  I am big fan of Conglomerate, so it is an honor to be here.

Having emerged from the post-exam fog, I am finishing writing up a talk I gave at the University of Maryland Law School's Sarbanes-Oxley Conference last October, organized by Glommer Lisa Fairfax.  In my brief essay, I note that most commentators describe Sarbanes-Oxley and related corporate governance reforms as part an effort to "restore trust" in corporate America.  In contrast, I view the value in Sarbanes-Oxley's reforms as creating corporate governance mechanisms that help promote distrust.

The corporate scandals at Enron and Worldcom show how trust too often leads people astray.  The directors of Enron and WorldCom unreasonably trusted CEOs Ken Lay and Bernie Ebbers as they enriched themselves while leading their corporations to financial disaster.  As I have argued in earlier work, these and other scandals show how corporate directors are poorly positioned to monitor executives when they have strong personal relationships based on trust and loyalty.

As examples of reforms based on the need for more distrust, I point to Sarbanes-Oxley's much-maligned ban on loans and the mandatory executive sessions of independent directors required by the stock exchanges.  Both reforms introduce bright line rules that should help liberate corporate monitors from the discomfort of saying no to seemingly reasonable requests, in the case of loans, or "going behind the CEO's back" to discuss important corporate policy issues. 

In working on the piece, I have been able to pull together threads from my earlier article on social norms and corporate governance and reading and conversations that go back to my fellowship year at Harvard's Edmond J. Safra Foundation Center for Ethics.  Director Dennis Thompson's essay "Restoring Distrust" prodded my thinking as I prepared the Maryland talk.  The essay will be published in the symposium issue of the Maryland Journal of Business and Technology Law.

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Shareholder activists were no doubt disappointed with the SEC's recent decision to reject proxy access for shareholder nominated candidates.  However, the latest SEC rules facilitating communications among shareholders over the Internet could boost shareholders' power in important ways.   Indeed, the SEC's most recent rules on shareholder forums make it easier for shareholders to communicate using the Internet by exempting participation in such forums from most of the proxy rules so long as certain conditions are met.   The SEC hopes that the rules will promote greater use of Internet communications, and in so doing "better vindicate shareholders' state law rights."  Indeed, greater use of the Internet for shareholder forums not only should enable shareholders to more effectively communicate with one another, but also should allow shareholders to assess the sentiments of their fellow shareholders on a variety of policy issues including, of course, the relative effectiveness of officers and directors.  In this regard, electronic shareholder forums also may enhance shareholders' ability to wage voting campaigns.  Given the increased adoption of majority voting systems (according to Claudia Allen's most recent study, some 66% of S&P 500 companies and 57% of Fortune 500 companies have embraced some form of majority voting), the ability to wage more effective voting campaigns could have a significant influence on election outcomes.  Hence, while these rules certainly do not substitute for proxy access, they nevertheless could have a tremendous impact on shareholders' ability to impact corporate affairs.

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Tom Perkins asks, then answers:

You meet at 8:30am and planes have to be caught around 1pm. An audit committee meeting can take an hour and you've got all the other committees. And then it's almost time for lunch and you have a few minutes to talk about competition, strategy, growth rate, succession, the future, fundamentally important stuff. And it tends to get scrunched into a very limited amount of time. And if you don't even think it’s important, it doesn't get discussed.

As I tell my students in Business Organizations, all I need is one of those jobs. I'm not greedy.

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Securities Mosaic has compiled a list of the ten highest compensated CEOs and CFOs last year.  Among the CEOs are Stanley O'Neal at Merrill Lynch, Angelo Mozillo at Countrywide Financial, and Terry Semel at Yahoo - all of whom are likely to have new jobs next year.  You'll have to go to SM to see the details.  But check out the kind of money the highest paid CFOs pull down:    

Jeffrey N. Edwards, Merrill Lynch & Co., Inc.   $28,251,601

Stephen I. Chazen, Occidental Petroleum         $19,822,389

Susan L. Decker, Yahoo Inc.                           $15,959,723

Lisa W. Rodriguez, Weatherford Int'l Ltd.        $15,258,299

Kirk R. Oliver, TXU Corp.                                $11,673,990

Lawrence S. Smith, Comcast Corp.                  $11,452,663

Dinyar S. Devitre, Altria Group, Inc.                $11,393,976

Kenneth J. Martin, Wyeth                               $10,726,219

Keith S. Sherin, General Electric Co.               $10,682,288

Alvaro G. de Molina, Bank of America Corp.    $10,634,873

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Dan's post regarding gender diversity on boards makes some very significant points, particularly about the importance of critical mass.  Many scholars worry that without critical mass, women will be marginalized, less willing to voice their opinions, and in some cases, experience pressure to conform.  But Dan's point about critical mass also reminded me about the relative lack of critical mass in American corporations. 

The latest Catalyst study reveals that women not only hold a small percentage of corporate board seats and other leadership positions at major companies, but also that the growth in such positons was stagnant from 2006 to 2007.  According to the study, the percentage of women board members, corporate officers, and top corporate earners was virtually unchanged from 2006 to 2007 at 14.8%, 15.4%, and 6.7%, respectively.  Moreover, the percentage of women in line positions--which analysts believe represents important gateways for promotion into top leadership positions--fell by 1.8% from 29% to 27.2%.  To be sure, the story is not all about decline or stagnation.  The number of women CEOs at Fortune 500 companies rose from 10-12.  Also, according to the Catalyst study, the number of women holding board committee chairs increased over the past year.  However, the relative stagnant growth in numbers for women business leaders suggests that women may be at an impasse, a concern raised by some scholars who worry about company executives who no longer feel inclinded to promote women once a few have been elevated to leadership positions.

Of course, many have recognized that the number of women in these positions is relatively low.  Indeed, Douglas Bronson's book No Seat at the Table is a good example of this recognition.  However, there is considerable debate about the impact of women on boards and as executive officers (economic or otherwise).  As Dan suggests, with such a small US sample size, it is difficult to get real insight into that debate.  But while we wait for the US sample size to improve, it will be nice to have some comparable data from other countries.

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In a memo entitled, Some Thoughts for Boards of Directors in 2008, Martin Lipton sets forth some of what he identifies as the key issues boards will face in the new year, and gives some advice on how to navigate those issues.  In general, Lipton pinpoints two problematic trends confronting boards.  First, he notes that in the last five years, hedge funds and other shareholder activists, through a variety of mechanisms such as proxy access proposals and majority vote campaigns, have sought to reshape the governance landscape in ways that pressure boards to focus on realizing short-term stock-market gains at the expense of promoting long-term shareholder value.  Second, he maintains that legal and regulatory reforms, as well as these efforts by shareholders , have served to shift the board's role "from guiding strategy and advising management to ensuring compliance and performing due diligence."  While Lipton insists that procedural safeguards and compliance are important, he notes that the current environment has not struck the right balance and thus threatens not just the important role of the corporate board, but also the success of American business more generally.

With this in mind, Lipton sets forth five key issues about which boards should be prepared to confront and tackle.  1) Balancing short-term performance and long-term success (which he believes may prove difficult as activist shareholders continue to mount campaigns to shift decision-making power away from boards).  2) Director elections (though he notes that the SEC finally voted to adopt a proposal reaffirming a company's right to exclude shareholder proposals for proxy access).  3) Shareholder proposals, especially pressure to implement those proposals that receive majority support.  4) Direct lines of communication with shareholders, apparently because such lines could create incentives for directors to appease shareholder activist.  And 5) Executive compensation, including say on pay issues and option backdating.  After pinpointing these issues, Lipton gives some guidance on the roles and duties of boards in seeking to address these issues.

Ultimately, the memo is an interesting examination of the governance trends of 2007 and their impact on boards--even if one does not agree with Lipton's assessment of that impact.  At bottom, the memo underscores the notion that shareholders have in fact been active over this last year.   And it depends on your vantage point whether you think that activism has yielded good or bad results.   Indeed, one could view their results as glass half empty (proxy access) or glass half full (majority vote).   Interestingly, of course, while some of the issues covered in the memo may be new, the overall theme is not, suggesting that broadly speaking boards confront the same challenge every year--that is, how best to achieve long-term value in the midst of pressures to produce short term results.  More importantly, the memo highlights the difference in views about how best to achieve that value, that is, through board dominance or some measure of shareholder control.  These are certainly not issues that will be resolved in 2008, but it will be interesting to what the attempts produce.

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The December 2007 edition of the Harvard Business Review has an article entitled "Deals Without Delusions" (by Dan Lovallo, Patrick Viguerie, Robert Uhlaner, and John Horn).  This article caught my eye because of my interest in behavioral corporate finance (the psychology of managerial decision making).  Focusing on M&A decisions, the article offers an interesting assessment of various psychological biases that can impact managers. 

A particularly tough question in this area is what to do about managerial psychological bias, if anything?  One prospect is to do more by way of formalizing dissent on boards, such as through the appointment of a formal devil's advocate (although I would never mandate such a thing).  Lots of studies, for example, suggest that dissent can counter various biases.  Without question, there are lots of challenges with this idea.  As many have pointed out, too much dissent can foster distrust.  Managers may start playing things too close to the vest.  Managers may become timid.  The devil's advocate may start competing against the CEO for power.  And the like.  That said, it strikes me that there is room for the board to participate more in managerial decision making in a constructive way.  Perhaps board members do not have the time or expertise to override managers' business recommendations (hence, the ascendancy of the monitoring board).  However, board members might be able to press managers (in a way they often do not) so that managers themselves make better, more informed, more rational (i.e., less biased) decisions.  That's what the devil's advocate function envisions.

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According to an interesting column in yesterday's Wall Street Journal, which you can find here, only about half of corporations have CEO succession plans.  I have to admit that I found that statistic surprising.  I understand that a CEO probably doesn't want to even contemplate being replaced, but how could a board fail to ensure that a succession plan is in place? 

Those of us who teach the basic corporations class spend a fair amount of time discussing the responsibilities of the board of directors, and, arguably, at the very top of the list is the selection of the CEO.  A board knows that the CEO won't be the CEO forever, so failing to implement a succession plan seems to be pretty sloppy corporate governance. 

Of course, sloppy corporate governance isn't necessarily illegal.  And I would doubt that a board's decision not to implement a succession plan constitutes a breach of fiduciary duty.  The decision would probably be protected by the business judgment rule.  If the board didn't inform itself about the succession issue, the business judgment rule might be rebutted, but I doubt that occurs very often.  More likely, boards are aware of the succession issue, but choose defer to the CEO, who may not want to work with a successor.  Perhaps a plaintiff could argue that the board's decision not to require a succession plan reflects a "we don't care about the risks" attitude amounting to a breach of the duty of good faith.   But I doubt that would be a winning argument.   Any thoughts on this issue?

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Via Feminist Law Professors, this study of U.S. publicly-held corporations pegs the current median director compensation at just over $100k.  Female directors earn more, with a median compensation of $120k, even though women directors are outnumbered by male directors 8:1.  The article provides no explanation, but I would hypothesize that larger companies have more female directors on their boards and that larger companies also pay directors more than smaller companies.  That's just a guess.

Other interesting tidbits:  In the sample of 25,000 directors, over 80 directors earned more than $1 million for their part-time director stint.  Also, as a group, individuals with the title of knight earn more than their non-knighted counterparts.  Judges also earn more, but not as much as knights.

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After my lecture on corporations and their boards, a student directed me to a website called "They Rule".  The website, which appears to have a clear underlying agenda of activism, provides the names of individuals who sit on boards of major corporations, and allows you to create maps of interlocking directors.  Indeed, when you click on the name of a corporation, you can also link to the directors who sit on the board, and the individuals with the most directorships appear relatively fatter than other directors on the board.  Unfortunately, the information is dated--it only reflects data collected from websites and SEC filings as of 2004.  And there certainly have been board changes since then.  Indeed, since SOX, many directors have been less willing to sit on multiple boards, and my research suggests that not only has the number of people holding more than one directorship declined, but also that the absolute number of multiple directorships has declined.  Nevertheless, it is an interesting site that allows you to create some interesting maps of interlocking directorships--just in case you need something to do in your spare time. 

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Check out the NYT story (front page!) on Katie Porter and her research into foreclosure fees.

Bankruptcy specialists say lenders and loan servicers often do not comply with even the most basic legal requirements, like correctly computing the amount a borrower owes on a foreclosed loan or providing proof of holding the mortgage note in question.

“Regulators need to look beyond their current, myopic focus on loan origination and consider how servicers’ calculation and collection practices leave families vulnerable to foreclosure,” said Katherine M. Porter, associate professor of law at the University of Iowa.

In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.

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Apparently the subprime mortgage crisis has claimed its second CEO victim.  Less than a week after Merrill Lynch CEO E. Stanley O'Neal resigned, Citigroup CEO Charles Prince announced his resignation.  As the Washington Post reports, last month Citigroup reported a 57% decline in profits and $6.5 billion in write-offs, both stemming from losses in the company's mortgage-backed securities business.  Similarly, O'Neal was forced out after acknowledging $7.9 billion in write-downs related to mortgage-backed investments.  Indeed, the company reported the biggest losses in the firm's history.  To be sure, these CEOs have different stories.  However, the crisis in the subprime mortgage market made the outcome of their stories the same.

Indeed, Prince's time at Citigroup has been anything but smooth as, despite Prince's efforts, the company's stock price has declined during his tenure and the company has lagged behind its peers.  By contrast, last year, O'Neal was being celebrated.   His admittedly risky investment strategy appeared to be paying off as Merrill posted impressive numbers, and seemed to be an acknowledged leader in its field.  But this past success was not enough to overcome the most recent crisis, and O'Neal was shown the door. 

In the end, one could offer a variety of different reasons for the down-fall of these seemingly different CEOs, reasons ranging from leadership styles to the nature of their decision-making.  Yet the fact that both leaders suffered the same fate seems to suggest that it is not about the leaders at all; rather it is simply difficult to be at the helm of a company when it is hit with significant losses.  Which of course does not bode well either for the CEOs tapped to replace O'Neal and Prince or the CEOs in this industry that are still standing.

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Donald Langevoort has an article entitled 'On Leaving Corporate Executives Naked, Homeless and Without Wheels": Corporate Fraud, Equitable Remedies, and the Debate Over Entity Versus Individual Liability'.  The quote is from former SEC Chairman Richard Breedan who once threatened that his agency would pursue corporate executives so as to leave them “naked, homeless and without wheels.”  If the title does not grab you, the article itself is a very interesting and important read on the extent to which our current regime enables us to effectively go after individual executives involved in corporate malfeasance, particularly in order to recoup monetary rewards received in the context of such malfeasance.

                To be sure, Breedan’s words were uttered in the context of insider trading scandals.  Yet many in law enforcement expressed a similar sentiment on the heels of the more recent corporate scandals, suggesting that corporate executives should and would be held accountable for their misdeeds.  And that they would be stripped of their ill-gotten gains.  Yet as Langevoort points out, too often law enforcement efforts appear to miss the mark as it relates to individuals.  Certainly several high-profile criminal prosecutions reveal that since 2002, there has been some increased focus on corporate executive liability.   However, even when executives go to jail, some of them retain their incentive compensation.  Moreover, criminal enforcement efforts increasingly have included a focus on entity liability.  A similar phenomenon occurs on the civil side.  Thus, Langevoort notes that reports reveal that settlements in fraud on the market lawsuits tend to be paid by companies or D&O insurers, while fines extracted from SEC enforcement actions tend to be paid by companies—and not executives.  In fact, while some people feared that the personal settlements crafted pursuant to WorldCom and Enron would prompt a trend towards greater personal liability in civil settlements, they instead appear to stand as the exception to a system that generally relies on corporate payouts.

                Of course the recent focus on entity liability, particularly in the criminal context, not only has sparked debate, but also has generated some degree of consensus that the justifications for such corporate payouts are not clear.  Langevoort’s article uses the debate regarding entity versus individual liability as a springboard to examine the available tools for going after executives complicit in corporate fraud.  As he notes, entity liability emerged as a solution for the difficulties with holding individual executives liable.   Thus, while individual liability may be preferable to entity liability, it is appropriate to ask, if we pull back on entity liability, will individual liability will take its place?  In particular, Langevoort focuses on the equitable remedies of rescission and restitution as applied to corporate executives.  Langevoort concludes that while there are some remedies available in this area at both the state and federal level, they are underutilized because of legal and practical impediments.

                Langevoort’s article pinpoints an important issue that merits further attention.  In fact, many appear frustrated by the fact that current law enforcement efforts appear to leave executives’ monetary rewards intact.  Certainly one oft-cited complaint regarding the ousting of underperforming CEOs is that, despite their underperformance, they manage to leave with very lucrative severance packages.  So while we may not be interested in leaving executives “naked, homeless and without wheels,” there is an interest in ensuring that they do not reap the monetary benefits of corporate misconduct.  And it appears that our current regime does not effectively respond to that interest.

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In the comments to my last post on shareholder access, a couple of people raised the issue of whether my proposal could run afoul of the directors' authority to run the business and affairs of the corporation.  I believe that it does not, although I may be in the minority.

The issue stems from the fact that there seems to be two contradictory provisions in corporate law.  On the one hand, Delaware GCL § 141(a) provides that "[t]he business and affairs of every corporation ... shall be managed by or under the direction of the board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation."  On the other hand, Delaware GCL § 109(b) provides that a corporation's "bylaws may contain any provision, not inconsistent with law or with the certificate of incorporation, relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers or employees."  There have been many scholarly attempts to reconcile the conflicts between these provisions, and plenty of interesting policy considerations have been raised.  However, I believe the issue is less complicated than it seems.  I have addressed it in the introduction of my article, Just Do It: An Antidote to the Poison Pill, 52 Emory L.J. 849 (2003).  The following is a brief summ