An Interview with Chief Justice Strine

Judy Warner is editor-in-chief of NACD Directorship. This post is based on an interview between Ms. Warner and Delaware Supreme Court Chief Justice Leo E. Strine Jr. The full interview is available here. Research by Chief Justice Strine recently issued by the Program on Corporate Governance includes A Job is Not a Hobby: The Judicial Revival of Corporate Paternalism, discussed on the Forum here; and Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law, discussed on the Forum here. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

As your predecessor Chief Justice Myron Steele was stepping down in 2013, Directorship asked him if he had any words of advice for his successor. Chief Justice Steele suggested that his successor be prepared for crisis management because you never know what’s going to happen. So, I’m curious: have you had a crisis so far?

We’ve had a crisis. For example, we’re dealing very much this week with an emerging development that’s affecting our entire state government around the cost of health insurance for our employees. There are very tough choices that have to be made, that regardless of which choice is going to be made, it’s going to have an influence on the ability of our government to fund other priorities.

What you have to do in all these things is understand that life is sort of a series of planned emergencies. What we have tried to do is identify a set of priorities for future action that builds on existing achievements. I’m very fortunate I had a wonderful predecessor and friend in Myron Steele, who cares very much about our judiciary and worked very hard. I had a very high-quality predecessor, and I can build off that platform of making a very good organization.

One thing we’re doing that your readership might find interesting is we’ve engaged in a long-term partnership with the University of Delaware’s business school that does process improvement training with businesses. The buzzword is “Lean Six Sigma.” I asked our staff to identify the leading process-improvement approach being taken by private sector businesses that have big information flow. The Delaware business school does a lot of work with financial institutions, hospitals, healthcare organizations, and other businesses that do this.

I appreciate your sense of humor, because I’m always looking for opportunities to put some fun in corporate governance. How do you respond to some of your critics who may think that you are sometimes too witty and perhaps not as judicial as they want you to be?

Look, everybody has their preference for certain styles. I try to speak to people plainly and directly and candidly and to talk in human terms. I work extremely hard. There are very, very few times in a day that I’m not actually thinking about what I’m working on. And humor is an important part of human life. It can help people connect. I’m sure there have been things that I’ve said that, at some point, somebody didn’t think were funny. If you read my opinions, they’re pretty careful. If you read my articles, they’re pretty careful. They deal with mature subjects in deep, non-simplistic ways. But I will admit to this: if it’s 1:30 in the afternoon, it’s right in the lull of when people most need caffeine and a nap, and [if] I’m forced to speak to people, because I’ve been asked to speak, I tend to try to do it in some engaging, real way. Sometimes there’s a tendency to feign shock when somebody speaks directly to a real human issue. A person might have said what is actually on everybody’s mind.

My style is my style. I care very much about people and I care very much in particular about the people of my state and the people affected by injustice. And I’m going to give my best. But if you want somebody who’s never going to observe something that might make you smile, I’m not your guy.

I see. Humor is a great way to break any sort of tension.

My wife is an occupational therapist at a children’s hospital, and she treats kids with cancer, burns, head injuries.… And if you don’t ever laugh in a tough job like that, you’re just going to cry all the time. You’ve got to have a human touch, and sometimes you’ve got to take a little bit of risk in being human, if it comes from a caring place where you’re doing it for the right reasons. I poke fun at myself quite a bit. I mean, I had a lawyer say, “Your honor, I can’t understand how anyone could accept that bald argument.” And I replied: “You know, would it be better if it was hairy or are you insulting me?” We all work very hard, and if we can laugh together in the right way, it’s not a bad thing.

After your first year-plus on the high court, what cases do you feel are most important in terms of their effect on how directors do their jobs on a day-to-day basis?

The Nabors decision, in a very dynamic M&A environment, is one that directors would probably find noteworthy. It emphasizes that directors are given credit for dealing with the contextual circumstances that they face, that the world is a dynamic place and not every deal is exactly the same, and that there can be unusual situations where boards have to do something innovative, and that as long as they do it with care and good faith, then they get credit under our law.

As you know, the Nabors decision overturned a trial judge who apparently had ordered the board to hold a 30-day auction—which leads me to ask how far the board needs to go to determine that a deal that they have signed off on is the best deal possible for shareholders.

One of the things that people say they like is discretion, but then what they really like is to be told exactly what to do. With discretion comes the responsibility to exercise it responsibly. The way our law works is you get credit for exercising good faith judgment. Different deals present different contexts. Nabors was an unusual situation because, remember, the person—the party on the buy side—was giving up control. If you’re a buyer, that affects how you deal with the world, so there’s no simple answer.

The key thing that was reaffirmed in Revlon is a reasonableness test. Directors get credit for acting reasonably under the circumstances, and although there’s heightened scrutiny, the court cannot grant relief unless it has a belief that directors have not acted reason ably under the circumstances.

In terms of what sort of market check is appropriate, that’s contextual, and what directors get credit for is their thoughtful reflection on the particular circumstances facing their company and making reasoned judgments about the best way to obtain the best value for their stockholders.

And so, if that gets called into question, then they just have to demonstrate that they have exhibited reasonableness?

Right. If you’re actually going to do something like engage in a change-of-control transaction—which is as important a topic as a board of directors is going to address—the court, plaintiffs, and stockholders are going to ask hard questions like: Did you consider all of the relevant options? Who were the likely strategic buyers? Who were the likely private equity buyers? Were people given an opportunity to look at the situation without the inhibition of deal-protection measures? These are all the things that you would typically expect boards to consider when they face the question of whether they’re going to sell control of the company.

What Nabors makes clear is that in a contextual situation and when a board pursues a reasonable course of action, then they get credit for that. And that has been the law for a long time, and it echoes the iconic decision in QVC.

The passage of Dodd-Frank in 2010 increased the federalization of some corporate governance mandates. How does that affect the courts?

The increased federalization has actually probably helped Delaware because we’re a place of stability and dependability compared to the federal environment, where you get crisis-driven and federal responses that seem to have no logical connection to the crisis.

For example, at the federal level, there’s nothing about the banking crisis that’s connected to some of the mandates around activism. It’s actually fairly implausible. Frankly, the risk taking that companies were engaged in was, well, it tended to be favored by the investment community. And so you would think, if anything, the policy response would be to make people focus more on issues of substantial risk and long-term durability. But you get a response that actually, in some ways, makes companies more, not less, accountable to the immediate whims of short-term traders. In Delaware, our law is relatively stable and dependable, and that actually tends to increase people’s desire to at least use Delaware, because they can depend on that element in their governance structure.

I don’t know that it affects the courts directly, but it certainly affects boards of directors. The concern of federalization—and you have to include the increased mandates of the exchange rules as well—in my view is what I call the “more, more, more” problem. It was a pretty bad disco-era song, and it also is a very bad way to run the world.

I tend to analogize. If you have a kid at one of these schools where they give way too much homework—we don’t have a very long school year in the U.S.A., so we tend to compensate by giving a lot of homework—and if the kid already has a full load of math, science, English, history, and a foreign language, there really isn’t any time to do more homework. One of the problems we’ve done with boards of directors is we’ve assumed that we can just list more things for boards to do. When you create checklists of legal requirements, people tend to do the things that they legally need to do first. There isn’t a checklist requirement that says: spend a quarter of your time as a board making sure you have a good business strategy, spend another quarter of your time making sure that you are looking forward to what the key risks are to the business whether legal, financial or any other kind, right?

What troubles you about that?

One of the things that troubles me is the assumption that directors have a lot more time to give. My sense is directors are spending more hours than they ever have. That doesn’t necessarily mean that they’re spending them in in the wisest way. And one of the concerns about federalization is the effect on how the board spends its time. One of the things that we need to think about is: What are the most important subjects? Let’s make sure that any mandates align with that. And if there are things that are less important, take them out of the mandatory category. We have to be careful when we talk about ourselves internationally that we don’t harm ourselves as a nation because sometimes we have debates within our own borders and fail to understand how that might be perceived abroad. We might think that Sarbanes-Oxley or Dodd-Frank went too far—and that may be true—but from an international, comparative perspective, there might still be much more flexibility for American corporate managers to make decisions than there would be in other markets.

Based on your position and experience, how do you think American corporate governance is perceived abroad?

We’re perceived as having too much—to use a technical term—“hoo-hah” about everything. What I mean is we have very potent rights for shareholders. We have annual meetings where directors get elected every year. We have hundreds and hundreds of subsidized proposals through the 14a-8 process. So, everything in the United States tends to be dramatic. There tends to be a lot of excitement and emotionalism. We are a more litigation-intensive society. That doesn’t just involve stockholder activism and stockholder litigation. And this is one of the things that directors need to understand.

A lot of the U.S. litigation environment involves businesses suing other businesses. That is something that doesn’t happen as much abroad. So sometimes when U.S. directors and managers talk about litigation, they forget their own role in it. And nothing gets as ugly as when two companies are doing knock-down, drag-out litigation, commercial dispute litigation. These things that can go on for years. They’re very expensive.

So, what’s the solution? Is there a way to solve legal disputes without going to court?

We do need to continue to work on solving legal business disputes in a more prompt, less drawn-out way. That’s a long-term competitiveness issue for the U.S. And this goes to the “hoo-hah” factor, because you want to have vibrant discussions between your investors and your boards. But is it really the case? For example, I’ve written about the 14a-8 proposals—basically, if you own $3,000 worth of stock, you get to command a company proxy with other investors’ money. The use of the manager’s time also costs investors money. Focusing on something other than what is best for making the company a high-integrity, profitable business comes at a cost. And shouldn’t there be ownership thresholds or some other things that strike a little bit better balance? You know, usually even if you have to run for dog catcher, you have to post a filing fee.

When do you think shareholders should be identified in the course of ownership, and then how does that ownership translate into being given access to the proxy in terms of electing directors?

I tend to exclude the so-called social proposals because they’re a different dynamic than a proposal around a poison pill or a takeover defense. If you’re actually going to put something up that’s about a business issue, what’s wrong with a meaningful threshold of ownership? And it can also be something that could be aggregated. But clearly it’s not $3,000. Three thousand dollars would seem to be more like a filing fee. If it isn’t worth $3,000 to you personally, you shouldn’t be costing other investors $100,000 or more to respond to it.

There are lots of dimensions. I mean, you’ve got things like the whole 13D dispute about when people become public. We are behind the world typically in our approach to disclosure around these things. And actually, the world has a different kind of normal order now. When you acquire shares of a certain threshold, you have to become public much quicker in most places than in the U.S. And when you increase your position after that, you have to update. That’s a discussion that is ongoing.

Here is what I fool audiences with all the time. I will ask this: what companies are most Americans stockholders of? And they always yell out Johnson & Johnson or General Electric or whatever is hot, Google. And the answer is that’s not really true. The answer is more like Fidelity, Vanguard, or Barclays.

Most people in the United States—that is, ordinary people—do not own individual stocks. You own through a 401(k) program. Your 401(k) program only allows you to buy mutual funds. Most Americans’ equities are held by institutions. We increasingly have institutions that are not just being passive investors, they’re actually proposing things that have long-term implications for the companies that they are proposing. And these proposals have long-term implications for the other stockholders of those companies.

And so, part of what we’re trying to get at—we’re all struggling with this—is what is the new dynamic? We’ve tended to obsessively focus on the fiduciary duties of people who are directors of public companies and without any urgency around the real power dynamics of current corporate governance in which the direct fiduciaries of most American investors are institutional investors.

What are their duties about things like: When do you file litigation? What as an institutional investor do you do if you believe that there’s a lot of unnecessary litigation being filed? The Revlon decision historically was about resistance to a takeover. It’s now used as a term to deal with any sale. But a sale where the proxy statement says we went through all 25 logical strategic buyers and 15 major private equity firms for six months, then gave them all an opportunity to buy the company without the inhibition of deal protections. You would think the institutional investor community and my friend [shareholder rights activist and Harvard Business School Professor] Lucian Bebchuk would put somebody on the float in the Macy’s Thanksgiving Day parade as the “Board of the Year.” But when directors do what Lucian loves, they still get sued. And they get sued by institutional investors who are supposedly fiduciaries, and they get sued within 24 hours of the announcement.

Why is that the case? What did the board do wrong?

If the board did something wrong, why is the institutional investor settling the case for meaningless disclosures 30 days later with the same price? That’s the thing where, within the institutional investor community, they need to begin the discussion about what are the expectations about duties. Obviously, there’s important litigation that ought to be brought. It’s supposed to be brought thoughtfully. The same thing with proposals—all the mutual funds will tell you quietly that they believe there’s too much voting that they have to do. It’s difficult to keep track of and, as a result, you have things like the emergence of proxy advisors. And that puts a little bit more focus on what’s important and a little bit less, as I’m calling it, “hoo-hah” would probably be a useful maturation. What are the issues most on your mind that relate to the boardroom these days? I think the biggest topic for everybody is whether the system is aligned. Are incentives aligned for everyone in a way that makes sense for society? If you think about the interests of those who run a business in a sensible way and when you think about the interests of actual ordinary American investors, there’s a lot of alignment.

What do you mean by that?

A new product line or service takes long-term planning. If you’re running a business, you need to be looking ahead. You need to be watching out for the things that can make the business crash. It doesn’t really make any sense to be managing from quarter to quarter. If you have bubble profits in year two and then it hurts your business in the succeeding years, does that really make any sense? Now, with ordinary investors, you’re really saving for two things in your life, if you’re an ordinary person: to put your kids through college and then pay for yourself in retirement.

But again, that’s going to require some structural change.

Yes. I’ve written a lot about this. Again, I don’t believe in simple solutions and I don’t think these are stories about bad people. One of the things I find frustrating is the extent to which people try to make this into some sort of moral drama—the bad, bad directors versus the good, good stockholders or vice versa. These sorts of things do very little to advance a rational discussion about what’s in the best interest of our society.

You can’t have one without the other. They need each other.

So they’re a problem for journalists, too, and it affects directors. Journalists like the simple quote that they can fill in to the paragraph where they need the quote from the stockholder-activist outraged by board behavior. Then for the paragraph about the short-term activist who doesn’t care anything about the long-term interest of society, you need a quote. Journalists tend to go to the same people over and over again, sometimes because they’re actually the right person to go to, but oftentimes it’s because they’re the ones willing to give the simple quote. Whereas the quote where somebody says, “You know, it’s a grayer issue. Here are the problems I see on one side, here are the problems I see on the other, here is the potential middle ground.” What you often hear in response is, “Well, that’s a really interesting thing, but I’ve [only] got 2,000 words.”

You don’t think activism should go away. Why not?

No. It would be pretty irresponsible to think that American investors are essentially required by federal tax policy to fund their own retirement and give their money over to fiduciaries and those fiduciaries not have any responsibilities to actually be relatively active and engage investors on behalf of those individuals. What we really need to think about is what type of activism and what is really socially useful in terms of the responsibility that the activism has for the underlying investors. Being an active and engaged investor in a way that is useful for long-term, ordinary Americans whose capital you hold may be different than the kind of activism that we’re now getting.

Do you think that corporations, in general, should give up quarterly reporting?

I’ve written about this. What I have suggested is that you should not be able to get quarterly reports unless you’ve actually articulated a long-term plan and the quarterly reports come in the context of a sensible long-term vision that gives context if we’re talking about any particular quarter.

So, companies would be reporting against the long term as opposed to by quarter?

Right, and when I hear, for example, that a company always hits its quarterly estimates for some ginormous number of quarters, it suggests that the estimates for the quarter are not the real estimates. You’re engineering stuff, because if you could predict life that well, you should just take a single bet of all the company’s cash and put it on the Powerball. You can really be Nostradamus. That isn’t how the world tends to work. Stuff happens. And so, you’re telling us that for basically 13 years, stuff never happened to you. Or perhaps you had a cushion or made it look like stuff didn’t happen. The incentives might go away if there was a long-term benchmark out there.

The full interview can be read here.

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