The Perils of Governance by Stockholder Agreements

Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance, and Director of the Program on Corporate Governance at Harvard Law School. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware State Bar Association (“DSBA”) and the Council of the DSBA’s Corporation Law Section recently approved a proposal (“the proposal”) to make an amendment (“the proposed amendment” or “the proposed legislation”) to Section 122 of the Delaware General Corporation Law (“DGCL”). The proposed amendment would permit expansive use of stockholder agreements—agreements between a board and a stockholder (or group of stockholders)—to opt out of the governance arrangements set by the company’s charter.

The proposal was sent to the Delaware legislature, and it is contemplated that the legislature would adopt it in the current session of the legislature, which ends in several weeks. As explained below, however, the proposal raises serious concerns. Adopting it would have a wide range of detrimental consequences for institutional investors, and other public investors, as well as for the quality of governance in Delaware companies.


Proposed DGCL § 122(18), Long-term Investors, and the Hollowing Out of DGCL § 141(a)

Marcel Kahan is the George T. Lowy Professor of Law and Edward B. Rock is the Martin Lipton Professor of Law at New York University School of Law. This post is part of the Delaware law series; links to other posts in the series are available here.

Delaware is on the verge of gutting DGCL § 141(a)’s iconic principle of board-centricity: “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” If the proposed DGCL § 122(18) is adopted by the Delaware legislature, § 141(a) will no longer impose meaningful limits on a board’s ability to delegate key governance functions and responsibilities. If such a change is to be made, it should only occur after the Delaware Supreme Court has had a chance to review the Moelis opinion on appeal, only after extensive deliberation among key stakeholders, and only after all of its implications are sorted out. To make such a major change in response to a group of transactional lawyers frustrated by a recent Court of Chancery opinion threatens Delaware’s legitimacy as the de facto promulgator of U.S. corporate law.


Controller’s Ability to Appoint and Remove Directors Insufficient to Establish Demand Futility

Robin E. Wechkin is Counsel at Sidley Austin LLP. This post is based on her Sidley memorandum and is part of the Delaware law series; links to other posts in the series are available here.

In Harrison Metal Capital, an investment fund with an 18% stake in a privately held company called MixMax, Inc. believed the CEO was committing financial improprieties, but found no legal recourse for its complaint.  Although certain features of the case are unusual as a factual matter, the Court of Chancery’s analysis of demand futility in a company with a controlling stockholder will be applicable in more conventional derivative actions as well.

The claims of the investment fund, Harrison Metal Capital, arose during the first twelve months of the pandemic.  During that period, the company received a federal Payroll Protection Plan loan but slashed its workforce.  At the same time, the CEO nearly doubled his own salary.  In soliciting investments under SAFE (Simple Agreement for Future Equity) contracts, the CEO made representations the Fund believed were false.  The Fund also believed the company was recognizing revenue improperly during this period.


SEC No Action Statistics to May 1, 2024

Sanford Lewis is Director of the Shareholder Rights Group. This post is based on his Shareholder Rights Group memorandum.

Evaluation of SEC staff no action decisions on shareholder proposals from November 1, 2023 to May 1, 2024 demonstrates that the SEC has supported company requests for exclusion of proposals roughly 68% of the time. Companies sharply increased the number of requests filed with the SEC during the same period, with these two developments combining to produce a surge of exclusions.

The no action process is an informal review process through which the SEC Staff advises companies and their investors on whether the SEC Staff would likely recommend enforcement action if a company fails to include a submitted shareholder proposal on its annual proxy statement. The Staff “grants” the company’s request if it finds some basis to agree with the company’s arguments that the proposal is excludable under one of the elements of SEC Rule 14a-8, the shareholder proposal rule. It “denies” the request if it is unable to concur with the company’s arguments.


The governance of director compensation

Lily Fang is a Professor of Finance at INSEAD and Sterling Huang is an Associate Professor of Accounting at Singapore Management University. This post is based on their recent article forthcoming in the Journal of Financial Economics.

Despite an extensive literature on CEO and executive compensation spurred by public concerns about corporate governance and excess compensation, director compensation has received limited research attention. One reason could be that for decades before the 1990s, director compensation showed little variation over time and across firms, predominantly comprising a fixed retainer with additional fees allocated for specific roles on board committees (Yermack, 2004). The staid nature of director compensation prompted Fama and Jensen (1983) to suggest that the primary incentive for outside directors stemmed from their intent to cultivate a reputation as judicious decision makers. They further argued that such reputational signals would bear credibility when “the direct payments to outside directors are small, but there is a substantial devaluation of human capital when internal decision control breaks down….” (p. 315).


2024 Caremark Developments: Has the Court’s Approach Shifted?

Gail Weinstein is Senior Counsel, Philip Richter is a Partner, and Steven Epstein is Managing Partner at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. Epstein, and M&A and Private Equity partners Steven Steinman, Maxwell Yim and Liza Andrews and is part of the Delaware law series; links to other posts in the series are available here.

Historically, Caremark claims—that is, claims of breach of directors’ duties of oversight over key risks facing the company—were among the least likely types of claims to lead to director liability; and the Court of Chancery almost always dismissed such claims at the pleading stage. However, in the past few years, the Caremark cases brought by the plaintiffs’ bar have been met with increased receptivity, and the court has found in several cases, at the pleading stage, that it was reasonably conceivable (the Delaware standard to survive a motion to dismiss) that directors or officers may have breached their Caremark duties. Notably, in the most recent Caremark cases, decided in late 2023 and early 2024—WalgreensSkechersProAssurance and Segway (discussed below)—the court has re-emphasized a very high bar to success on Caremark claims.

In our view, however, the facts in these most recent cases arguably were not so egregious as to present a real test of the court’s overall approach to Caremark cases—and, as such, there is no indication that the court would be unlikely to find potential Caremark liability in cases involving egregious facts following the occurrence of an extreme corporate trauma. Indeed, in that very context, recently, the Delaware Supreme Court, in AmerisourceBergen (discussed below), overturned the Court of Chancery’s pleading-stage dismissal of Caremark claims in connection with that company’s role in the national opioid crisis.


Delaware Courts Are Asking Just When a Stockholder Vote Is ‘Fully Informed’

Jenness E. Parker is a Partner and Amanda L. Day is an Associate at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum and is part of the Delaware law series; links to other posts in the series are available here.

Key Points

  • Delaware courts are scrutinizing disclosures made to obtain stockholder approvals, particularly where there is an alleged conflict of interest in the decision-making.
  • If disclosures for a vote are incomplete or misleading, directors may not enjoy the benefit of the business judgment rule if their decisions are later challenged in court.
  • Some alleged conflicts have involved directors’ relationships with the counterparty or management, or financial or legal advisors’ work for the counterparty.
  • Courts have allowed suits to go forward where a controlling person allegedly steered the board to a particular bidder in ways that were not disclosed.


The Limits on Sharing Confidential Information with Activists

Gail Weinstein is Senior Counsel, and Philip Richter and Warren de Wied are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. de Wied, Steven Steinman, Randi Lally and Bret T. Chrisope and is part of the Delaware law series; links to other posts in the series are available here.

In connection with a stockholder activist campaign by certain Icahn-affiliated funds (the “Icahn Funds”) against Illumina, Inc., the Icahn Funds (which collectively owned less than 2% of Illumina’s stock) launched a proxy contest for three seats on Illumina’s board. One of the Icahn Funds’ nominees, who was also an employee of a different Icahn-affiliated entity, was elected to the board (the “Icahn-Affiliated Director”). The Icahn-Affiliated Director then obtained and shared confidential and privileged company information with the Icahn Funds, which the Icahn Funds used in crafting a derivative complaint against certain current and former Illumina directors.

In Icahn Partners v. deSouza, the Court of Chancery, in a letter opinion (Jan. 16, 2024), ruled that the Icahn-Affiliated Director was not entitled to share the information with the Icahn Funds. The Delaware Supreme Court, in a letter ruling (Apr. 11, 2024), rejected interlocutory appeal of the issue.


Statement by Chair Gensler on Amendments to Regulation S-P

Gary Gensler is Chair of the U.S. Securities and Exchange Commission. This post is based on his recent statement. The views expressed in this post are those of Chair Gensler, and do not necessarily reflect those of the Securities and Exchange Commission or its staff.

Today, the Commission is considering amendments to Regulation S-P that will require covered firms to notify their customers of data breaches. I support these amendments because, through making critical updates to a rule first adopted in 2000, these amendments will help protect the privacy of customers’ financial data.

In 1999, Congress passed a provision to help ensure that financial firms protect customers’ nonpublic personal information. As a member of the U.S. Department of Treasury team at the time, I was proud to work with then-Congressman Ed Markey on this important legislation. The provision mandated that federal financial regulators adopt rules to advance consumers’ privacy. The SEC did so in 2000, through Regulation S-P, which requires covered firms to notify customers about how they use their nonpublic personal information.


Weekly Roundup: May 10-16, 2024

More from:

This roundup contains a collection of the posts published on the Forum during the week of May 10-16, 2024

Fee Variation in Private Equity

Investment Advisers and Sponsors Compliance Policies: Hot Topics

Insider Trading and Off-Channel Communications in the Age of Remote and Hybrid Work Environments

Delaware Supreme Court Holds MFW Inapplicable Based on Banker Conflict Disclosure Deficiencies

Seven Questions about Proxy Advisors

The CEO Pay Problem Is Solvable with A.I.

Corporate Governance, Board Oversight & the 2023 Banking Crisis

The Payoffs and Pitfalls of ESG Due Diligence

The Lost Promise of Private Ordering

Mapping TCFD to the IFRS S2 on Climate Disclosure

ACGA Open Letter: Strategic Shareholdings in Corporate Japan

The Governance of Corporate Use of Artificial Intelligence

Four ways boards can support the effective use of AI

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