ABA Seminar on Delaware Corporate Law and Potentially Increasing Federalization
I am blogging from the ABA Business Law Section Fall Meeting in D.C. This post is the product of the notes taken at the following panel presentation:
Federalization of Corporation Law in a Time of Crisis - Which Institutions are Best Able to Improve Corporate Governance and Performance Going Forward. Presented by: Business and Corporate Litigation Committee and The Committee on the Federal Regulation of Securities
Moderator: Rolin P. Bissell, Partner, Young Conaway Stargatt & Taylor LLP, Wilmington, DE
Speakers:
Hon. Myron T. Steele, Chief Justice, Supreme Court of Delaware, Dover, DE
Hon. J. Travis Laster, Vice Chancellor, Delaware Court of Chancery, Wilmington, DE
Jill E. Fisch, Perry Golkin Professor of Law and Co-Director, Institute for Law and Economics, University of Pennsylvania Law School, Philadelphia, PA
Thomas J. Kim, Chief Counsel and Associate Director, Division of Corporation Finance, U.S. Securities and Exchange Commission, Washington, DC
Michele E. Rose, Partner, Latham & Watkins LLP, Washington, DC
The financial meltdown injected urgency to the debate about the roles of federal and state law in corporate governance. Members of the Delaware judiciary, federal regulators and practitioners debate who should make the rules on proxy access, executive compensation and fiduciary duties and what those rules should be.
N.B. The following overview is not a transcript and merely constitutes my highlights of some statements made by the speakers on the panel (the members of which may not necessarily agree with the accuracy of my notetaking.) My random notes are below each speaker's name.
The Hon. Myron T. Steele, Chief Justice of the Delaware Supreme Court.
For many years, the corporate governance of the internal affairs of a corporation have been governed by the law of the state of incorporation. The allocation of authority between the board and the shareholders is governed by standards imposed by statute and case law, and by private ordering. The concept of federalization would seek to impose the same statutory standard to govern all 15,000 publicly held corporations. That standard would also be subject to various interpretations by 1,300 federal judges throughout the country. For example, is a federal standard that requires all corporations in all situations to separate the chairman and the CEO, too rigid?
Some suggested federal standards such as elimination of staggered boards, if we are consistent, should also make us reconsider the constitutional procedure of staggered elections for the U.S. Senate, which only stands for election in groups of one-third in each election cycle.
Most proposals are touted as giving shareholders more power, but would a single federal standard for all aspects of corporate governance truly give shareholders more power? The existing system is based on using the states, pursuant to federalism, to experiment with different options which allows shareholders to select which state they prefer. Regarding voting rights of shareholders, Delaware cases have carefully protected this franchise and have consistently prohibited any intereference with it.
As for disclosure, the Delaware Supreme Court (as constituted at that time), in Malone v. Brincat, made clear that the common law duty of disclosure applies when any information is disseminated by the board, even if no shareholder action is required.
The Chief Justice expressed his concern that federal legislation may be based on the false notion that corporate governance was the cause of the recent economic crisis, as opposed to regulatory enforcement, for example. As a concluding aside, His Honor suggested that boards should be enabled to fulfill their duty to focus on long-term maximization of shareholder wealth instead of spending an inordinate amount of time on compliance issues.
Thomas Kim, Chief Counsel and Associate Director, SEC Division of Corporation Finance.
The SEC's role has not changed. One of their goals is to regulate disclosures for the benefit of shareholders. For example, one requirement is that any director who does not attend at least 75% of all meetings be disclosed. Another example is the SOX requirement to disclose whether a financial expert is on the audit committee. Such disclosure requirements tend to impact behavior.
He would hope that state law is not displaced and in his view the SEC covers many matters not covered by state law. For example, disclosures regarding compensation are not covered by Delaware law. He quoted from the Delaware Chancery Court decision in Walt Disney in which the Court explained that the common law cannot require adherence to aspirational best practices. He sees the SEC's role as helping to form those aspirational goals.
Artificial lines cannot be drawn easily between "corporate governance" and governing the corporation itself as an entity. He is sensitive to the states' right to address the internal affairs of corporations. He was instrumental in bringing to the Delaware Supreme Court the issue addressed in the CA, Inc. case. His Division as a whole takes seriously the role of Delaware law, and as an example of that he announced the recent addition to their Division's ranks of a respected scholar on Delaware corporate law, Professor Larry Hamermesh.
The Hon. J. Travis Laster, Vice Chancellor, Delaware Court of Chancery.
Although His Honor noted that he has only "been on the job for 42 days", he referred to the knowledge he acquired from spending his entire career before ascending to the bench, involved in Delaware corporate litigation on behalf of both shareholders and management.
He views Delaware and the SEC as having a collaborative and symbiotic relationship especially in the area of disclosure. The common law system is not a regulatory one, and the Delaware Courts can only rule on cases that come before them when a suit is filed.
An important part of the "Delaware culture" is that Delaware is neither "pro-management" nor "pro-shareholder". Rather Delaware is "pro-balance" and in the long run the investors benefit by allowing management to have the presumption of the Business Judgment Rule to maximize the value of the corporation. While in practice, His Honor represented bidders and targets, as well as investors and management, in almost equal measure, as do most firms in Delaware.
As a policy matter, Delaware takes a long term view, and if Delaware was not attractive to investors on an ongoing basis, it could reprise the role of New Jersey of over a century ago, and quickly lose the role that it now plays.
The beneficiaries of fiduciary duties are the shareholders. Delaware does not have a "constituency statute". Another aspect of Delaware is that the board can internalize risk. The board can rely on contract rights for bondholders and fulfill its fiduciary duties to shareholders.
In the Healthsouth case, the Delaware Chancery Court hit hard and early to address the breach of the duty of loyalty in that case. One area where the Delaware Courts cannot act as quickly is the compensation of executives. These issues are classically covered by the Business Judgment Rule, but as the recent Chancery decision in Citicorp demonstrated, Delaware has found situations where, based on existing law, excess compensation will be addressed.
What about federalization issues? Due to the Delaware culture, and the balanced approach it takes, Delaware has not made any drastic changes in policy. In addition, there are only 5 members of the Court of Chancery and then on appeal, only 5 members of the Delaware Supreme Court that make decisions on Delaware corporate law. The history of the savings and loan crisis shows that dozens of U.S. District Courts ruling on the same statute, and conflicting decisions of the U.S. Courts of Appeal on the same statutes, cause more confusion than consistency in the regulation of companies. In addition, unlike Federal judges, who are just are qualified, or moreso, Delaware judges have a more steady diet of corporate law issues, as compared to the more varied types of issues covered in the Federal Courts' docket.
The Delaware Constitution now allows the SEC to certify questions to the Delaware Supreme Court, which it has done. This is an example of collaboration.
The recent economic crisis can be explained more by massive debt and a federal policy that encouraged too much easy debt, as opposed to a problem with corporate governance.
Jill E. Fisch, Perry Golkin Professor of Law and Co-Director, Institute for Law and Economics, University of Pennsylvania Law School, Philadelphia, PA
The benefits of state law controlling this area include: incrementalism and experimenting. Also, there is a serious question about whether the federal proposals are better than the status quo.
There are studies, for example, that demonstrate that it does not always benefit shareholders to separate the CEO and Chairman. There is no statistical or empirical data to support the view that independent boards are necessarily "better" in terms of corporate performance. The NYSE has taken the view that independent boards are required. Delaware, however, has not mandated it in all cases, but takes it into account as a factor in the analysis. Though it impacts the standard of review, Delaware does not impose an independent board as a requirement.
As for executive compensation, the federal scheme pushed an option approach which turned out to be a source of many abuses. The Delaware approach is much more flexible, as befits a very nuanced and sensitive and multifaceted issue, as indicated in the Walt Disney case involving the compensation of Ovitz.
As for proxy access, for example, the recent efforts of the SEC indicate that the "one size fits all approach" is not the best solution.
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