assessing the legislative ct corporation reform agenda · incentives to keep an eye on employees to...

Assessing the Legislative Reform Agenda

Proceedings from a CT Corporation Thought-Leadership Roundtable

CT Corporation

December 2009

www.ctlegalsolutions.com

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PARTICIPANTS’ WELCOMERaymond J. DiCamillo Director, Richards, Layton & Finger, P.A. Vice Chair, Corporate Department

Today we have a remarkable amount of legislative reform proposed for corporate governance. The last time we’ve had corporate legislation of this magnitude were the events leading into the Sarbanes Oxley Act of 2002.

First of the three big proposals is the Shareholder Bill of Rights Act, introduced in May by Senator Charles Schumer. This bill covers a number of topics, including advisory votes on sale and pay, disclosure and advisory votes on golden parachutes, and proxy access. The senator has proposed a number of requirements for companies to be listed on public exchanges, such as separation of the chairperson and the CEO; annual elections for directors, which would eliminate staggered boards; majority voting for directors; and the requirement that each Board of Directors have a risk committee.

CT Representation ServicesCT Representation Services

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AbSTRACT:

In response to the financial crisis of 2009, federal legislators and

regulatory bodies are proposing reforms that would directly impact

corporations, directors and their legal counsel.

CT Corporation, a leader in corporate legal compliance services,

assembled a distinguished panel of experts to review three of the

leading proposals and the potential legal issues that could arise as

they pertain to corporate boards of directors. The panel discussed

the reforms against the backdrop of Delaware corporate law. As the

leading incorporation state, Delaware is often a bellwether for the

interpretation of corporate law.

Following is a summary of the proceedings.

ASSESSING THE LEGISLATIVE REFORM AGENDA

wHITE PAPER - ASSESSING THE LEGISLATIVE REFORM AGENDA


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“ExECuTIvE COMPEnSATIOn hISTORICAlly hAS BEEn TREATED PRIMARIly AS A MATTER OF PRIvATE ORDERIng FOR BOARDS”

Second is the Securities and Exchange Commission’s (SEC) highly controversial proposal for proxy access, also proposed in May. The SEC’s goal was to have rules adopted by the end of this year. however, now the SEC does not expect to issue new rules until 2010 at the earliest because of the deluge of comments they received, mostly against the proposal.

The other big matter brewing in Congress now is the Corporate and Financial Institution Compensation Fairness Act of 2009, introduced this summer by Representative Barney Frank. Similar in many respects to Senator Schumer’s bill, it has proposals for sale and pay; golden parachutes; independent standards for compensation committees and their advisors; and certain disclosures and prohibitions for incentive compensation at certain financial institutions.

Our discussion will cover some of the broad topics that run across each of these proposals.

SHAREHOLDER bILL OF RIGHTS ACT OF 2009, INTRODUCED bY SEN. CHARLES E. SCHUMER ON MAY 19, 2009.

Presenter: Edward B. Rock Saul A. Fox Distinguished Professor of Business Law, University of Pennsylvania Co-Director, Institute for Law & Economics

TOPIC OVERVIEW:

In order to understand how these proposals for reforming executive pay fit into the overall corporate governance landscape, we have to start with the traditional approach to executive compensation. Executive compensation historically has been treated primarily as a matter of private ordering for boards to decide and as a matter of negotiation between boards and executives.

under current Delaware law there’s no provision that provides for a shareholder vote on the executive compensation, nor are there any barriers to giving shareholders a vote if the company decides to do so. A right to vote can be given by bylaw or by an amendment to the Certificate of Incorporation.

Stock exchange listing requirements provide an overlay to Delaware law on executive compensation. Most prominent among these is the new york Stock Exchange, which has prescribed a set of rules governing executive compensation. For example under their rules the company’s compensation committee needs to be made up of independent directors.



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“ThIS COnCEPT OF A nOn-BInDIng ShAREhOlDER vOTE IS A vERy STRAngE COnCEPT In DElAWARE lAW”

Another layer over and above the compensation rules under the new york Stock Exchange listing requirements is a bit of law in the Internal Revenue Code, under 162(m), that covers the deductibility of certain performance-based executive compensation plans and also requires them to be approved by shareholders.

Finally, Sarbanes Oxley provides for claw-backs of incentive compensation if there’s an accounting restatement.

now we can look at main features of the two proposals meant to be an intervention against this backdrop — that there are a “say on pay” measures already in place at a general level for companies’ overall incentive compensation plans. The Frank proposal in the house follows the Schumer proposal in the Senate pretty closely and adds some additional features.

The Schumer proposal requires an annual shareholder approval of executive compensation, and provides explicitly that the shareholder vote referred to in Subsection (a) shall not be binding on the Board of Directors and shall not be construed as overruling a decision of the Board to create or imply any change to the current fiduciary duties, to create or imply any additional fiduciary duty to the Board, or to restrict or limit the ability of shareholders to make proposals. The same rule governs change in control payments or golden parachutes.

It’s worth noting that this concept of a non-binding shareholder vote is a very strange concept in Delaware law. Delaware law requires some sort of shareholder votes – such as votes on electing directors and on mergers — largely because of 14(a)8 under the Securities and Exchange Act of 1934. Even though the new shareholder proposals are precatory not mandatory, this sits quite uncomfortably with the general pattern in Delaware corporate law, which is that shareholders don’t vote on many things, but when they do vote, it matters.

The Frank bill adds an interesting provision, which is a prohibition of claw-backs where compensation that has been approved by the non-binding shareholder vote is not subject to a claw-back. My reading of this is that it’s a reversal of Section 304 of Sarbanes Oxley, which says there’s automatic claw-back of certain executives’ compensation if there’s a material accounting restatement. It’s interesting that we may lose some claw-back provisions with this non-binding shareholder vote.

In addition, the Frank bill mandates compensation committee independence. The new york Stock Exchange already requires compensation committee independence for companies that list with it under the listing requirements 303(a). There are also a variety of provisions in Delaware law that strongly encourage compensation committees to be independent.



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“InCEnTIvE COMPEnSATIOn IS POWERFul BECAuSE PEOPlE In FACT DO WhAT ThEy’RE InCEnTIvIzED TO DO”

DISCUSSION:

Question: The first finding in Senator Schumer’s bill is that a widespread failure of corporate governance in the matter of pay was among the central causes of the financial and economic crisis. yay or nay?

Mr. Ed Rock (ER): One of the most striking facts to come out of the collapse is the fact that Dick Fuld has a billion dollars in lehman stock and Jimmy Cayne had a billion dollars in Bear Stearns stock. In both companies, managers’ interests were as closely aligned with shareholder interests as anybody could desire, which is the standard goal of corporate governance reforms such as independent compensation committees and independent directors. In my view, this raises a serious question about the political assertion that what caused the collapse was a failure of corporate governance.

Question: Some commentators believe that there was a link between how incentive plans were put together and risk taking. Some think if incentives are not drafted properly they can be a powerful motivation for doing things that may be harmful to the economy. What is your opinion on this?

ER: Barings Bank collapsed because of a rogue trader who took risks that turned out badly. Every investment bank with trading operations knows that internal controls are a key management issue. Incentive compensation is powerful because people in fact do what they’re incentivized to do, and firms have strong incentives to keep an eye on employees to make sure that they’re not taking undue risks with the firm’s money.

At the top level the function of the board is primarily to keep an eye on the managers in structuring the incentives. One way to do that is what they did at Bears Stearns and lehman — to reward the top with stock. Clearly they didn’t understand the risks they were running by having 30-to-one or 50-to-one leverage. But owning a billion dollars of lehman stock should have provided a disincentive for taking an undue amount of leverage.

This also raises the question, how are institutional investors gearing up to figure out how to vote? For example, vanguard has thousands of annual meetings for public companies in the united States a year. We’re proposing a system where in each and every one of those companies shareholders get a say on pay. Moreover in at least one of the proposed statutes, institutional investors’ votes will be disclosed.

The institutional investors will have a new burden to cast votes and will do so in the same way they currently do, which is they have groups of people who are not themselves managing money or compensated in any sort of incentive basis, but who have the responsibility to make sure that the institution votes its shares in a timely manner and reports that it has voted its shares. And in the



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“AT ISSuE IS ThE InCREASIng lEgAlIzATIOn OF ThE FunCTIOn OF DIRECTORS”

same number of cases where bad pay practices attract attention currently, now it’ll be focused through “say on pay” rather than “just vote no.” So we’re pretty skeptical about “say on pay.”

My prediction is there’ll be some form of “say on pay” enacted and it’ll turn out to be a non-event, because the risk metrics of the world already have plenty of ways to identify companies where they believe that pay is out of proportion, and plenty of ways for shareholders at those companies to express their displeasure, whether it be voting against the directors. To the extent that “say on pay” does anything it’s going to simply be redundant of what we already have.

Question: With the public outcry over executive compensation in last couple of years, are you finding that compensation committees are being more careful?

ER: Some years ago in the wake of Sarbanes Oxley, Jeff hazard and I wrote an article that came out in Business lawyer predicting that as the legal obligations on outside directors multiplied, we would observe that over time the institution of the standing counsel to the outside directors would emerge. The question is, does it makes sense to have just one lawyer for the outside directors who can then service the compensation and audit committees and so forth, and who would be up to speed on the company and not have to come up to speed on the particular issue each time?

What we explored in our article was how it might work out. Is it causing problems in practice, or are the lawyers chosen by the outside directors doing a good job of working productively with the inside counsel and their normal outside counsel?

At issue is the increasing legalization of the function of directors. As additional layers of legal regulation are imposed on the job of outside director — as occurred with Sarbanes Oxley — it’s perfectly natural that those outside directors would want to have a lawyer to guide them through it. They’re going to want separate counsel so that if they have conflicts, like a management buyout, they have a lawyer who knows the company, who is devoted to them, and isn’t in the pocket of management. That is the direction.



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“ThE SEC BElIEvES ThAT gIvIng ShAREhOlDERS DIRECT ACCESS TO ThE PROxy STATEMEnT...InCREASE ThE POOl OF quAlIFIED DIRECTORS”

SECURITIES AND EXCHANGE COMMISSION (SEC) PROPOSAL FOR PROXY ACCESS, ANNOUNCED ON MAY 20, 2009.

Presenter: Raymond J. DiCamilloDirector, Richards, Layton & Finger, P.A.Vice Chair, Corporate Department

TOPIC OVERVIEW:

The theory behind proxy access is to give stockholders access to the corporation’s proxy statement for the purpose of nominating and electing directors. In May of this year the SEC proposed certain rule amendments and set it up for a notice and comment period. The adoption of the rule amendments at the SEC itself was very controversial. There are five SEC commissioners. The amendments were only passed by a three-to-two vote. The two that voted against it were very vocal.

The rationale behind the SEC proposal is that boards need to be held more accountable. One way to do this is put their election or their incumbency at risk by giving stockholders more say in the nomination process. It’s expensive for stockholders to launch their own proxy contest and the SEC believes that giving shareholders direct access to the proxy statement reduces their costs and thus will increase the pool of qualified directors.

After receiving an outpouring of criticism of these proposals, the SEC has said won’t happen until 2010 at the earliest. The Delaware State Bar Association wrote a letter in opposition to the adoption of these rules and the letter starts out by saying this is the first time that they’ve ever taken this public position against SEC rulemaking. Obviously Delaware has a vested interest in maintaining its prominence in corporation law.

let’s review the proposals. The SEC acknowledges the need to control what types of stockholder can have access to the proxy statement. There are requisite ownership levels for stockholders, with a scale ranging from one to three to five percent, depending on the market capitalization of the company.

Stock owners would have to own the stock for one year. They’d have to provide a statement that they intend to retain ownership until the annual meeting. This is to prevent somebody buying stock, running, proposing nominees and then selling their stock. There would also be some limitation on nominations.

The new proposals are only for minority representation on the board. Any stockholder seeking to change control of the company would be on their own to run their own contest.

False and misleading disclosures are an issue to consider. Who is liable for any false and misleading disclosures stockholders make in connection with their access to the proxy statement? Typically the company would be liable



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“In COnTRAST TO ThE SEC’S ACTIOnS, DElAWARE RECEnTly ADDED TWO nEW SECTIOnS TO ThE DElAWARE gEnERAl CORPORATIOn lAW”

for company proxy statements. The SEC rules as proposed would make the stockholder liable for those portions of the proxy statement which they put in.

There are rules about independence. Currently the rules focus on the independence of the nominees from the company. They do not focus on the independence of the nominees from the stockholder that is nominating them.

The Shareholder Bill of Rights Act, Senator Schumer’s bill, essentially instructs the SEC to adopt these rules, but the Schumer proposal is not as detailed as the SEC’s proposed proxy access rule amendments.

In contrast to the SEC’s actions, Delaware recently added two new sections to the Delaware general Corporation law, Section 112 and Section 113. These were a reaction to a couple of things. One was the CA matter. Maybe the most interesting thing was the way the matter got to the Delaware Supreme Court and the way the Delaware Supreme Court handled it. A couple of years ago the Delaware Constitution as well as the Delaware Supreme Court rules were amended to allow the SEC to certify questions of law to the Delaware Supreme Court. The CA matter was the first time and only time that’s been done.

The CA case posed two questions to the Supreme Court. One was whether a proxy reimbursement bylaw was a proper subject for stockholder action. Two, would adoption of the proposed bylaws cause the corporation to violate some provision of the general corporation law or concept of fiduciary duty?

In the end the bylaw was not upheld as valid under Delaware law. however, in answering the first question, if it was a proper subject for stockholder action, the Supreme Court went to great lengths to say that the proxy reimbursement bylaw was a proper subject for stockholder action. Because it dealt with the election process, stockholders had a concurrent right to be as involved in the election process as the company was. In certain circumstances the stockholders’ rights in elections and nominations were even paramount.

It was clear that under that opinion if a proposal for a proxy access bylaw got to the Delaware courts, it was going to have to be upheld. looking at issues that have been raised in the public, the Delaware general Assembly adopted Sections 112 and 113.

note that neither 112 nor 113 are mandatory. unlike the proposed SEC rule amendments, which would be mandatory for all public companies, the Delaware amendments essentially vest the board or the stockholders. Stockholders can adopt bylaws under Delaware law — Section 112 deals with proxy access, Section 113 deals with proxy reimbursement. Both of these statutes set out a non-exclusive list of things that could be in a bylaw if such a bylaw were adopted. For example, in 112 for proxy access, companies can add in a bylaw of minimum levels or minimum duration of stockholdings, for requirements for submission of background information, for restriction on the number or proportion of nominees, for “stand still” restrictions, or requirements that the stockholders indemnify the corporation to the extent there’s any problems to their proxy access.



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“OnE OPInIOn IS ThAT ThE FACT OF PROxy ACCESS AlOnE WIll nOT hOlD BOARDS MORE ACCOunTABlE”

Section 113 allows a company to adopt a bylaw that allows stockholders to be reimbursed by the company for the proxy expenses if their slate gets elected. Again, the statue includes a non-exhaustive list of examples of things that could be in that bylaw; for example, a number of proportions seeking reimbursement, whether stockholders previously requested reimbursement, and conditioning reimbursement on how successful the stockholder was.

The SEC proposals and the Delaware amendments represent the two current paradigms — mandatory federal regulation of proxy access vs. Delaware’s more permissive regulation. Other states are following suit and adopting similar bylaws.

DISCUSSION:

Question: What are your thoughts on the quality of this idea? The discussion on it is, that although the Commission apparently blinked this year, it’s inevitable that this is going to come, especially if the Schumer bill resolves the questions of the authority of the SEC to adopt such a measure.

Mr. Ray DiCamillo (RD): One of the primary reasons the SEC release is proposing proxy access is to hold boards more accountable. One opinion is that the fact of proxy access alone will not hold boards more accountable. Directors are typically subject to election every year, or every three years in the case of a staggered board. giving stockholders the ability to put their 500-word statement on the proxy statement as opposed to either not doing it or having to run their own slate, is not expected to be a driver for board behavior.

The proxy access proposals are geared towards minority representation. There’s a theory that minority representation on a board leads to a free exchange of ideas, which leads to better governance and a better run company. however, minority representation has also been shown to lead to dissention among the board which may distract from focus on the company’s business purpose.

Question: There is a long-standing principle of Delaware law that the directors owe fiduciary duties to the company and the shareholders, not those who sent them. It’s the principle that serves as a hook for director liability, or challenging director conduct. With shareholder proxy access we may have more circumstances where directors now come not through the normal way, through a nominating committee, but because some shareholder group put them up. how is Delaware law going to respond to this increasing incidence of what you might call constituency directors?

RD: It’s a huge problem, because the law is very clear. Directors owe fiduciary duties to all the stockholders, not the constituent that put them there. let’s say a stockholder with one percent of the stock puts up a slate of directors. In spite of being advised regularly by the company’s counsel that directors owe their fiduciary duties to all the stockholders, this slate will remember who got them elected. If a stockholder nominates great independent candidates, great. More often, it will be the representative of the creditors, the preferred stockholders, or the controlling stockholder.



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“WhIlE ThEy OWE ThE FIDuCIARy DuTIES TO EvERyBODy ThEy TEnD TO ACT In ThE BEST InTEREST OF ThE PEOPlE ThAT PuT ThEM ThERE”

A recent example that came through in the case law involved directors who are representatives of preferred stockholders as opposed to common stockholders in a merger transaction. The question is whether to sell or not. under a sale, all proceeds go to the preferred stockholders to satisfy the liquidation preference, and common shareholders receive nothing. Directors who represent preferred shareholders and directors who represent common shareholders will clearly have different views. The reality is while they owe the fiduciary duties to everybody they tend to act in the best interest of the people that put them there. I don’t see Delaware law yielding to that.

Another situation is directors who have dual fiduciary obligations because they serve on two boards. The director receives information in their capacity as a director of one board, which they’re obligated to keep confidential, but their obligations to the other company may require them to disclose it. The law has really been unforgiving in telling people not to put themselves in that situation. I don’t see a real shift in the law, but it is a huge practical problem.

In whose interest do you act? here’s an illustration of the tension on boards these days, from a case currently being litigated. The controlling stockholder has two designees on a seven-person board; it does not control the board. however, the bylaws provide that certain actions must be approved by both of those controlling stockholder designees. One of the actions is declaration of a dividend, and a dividend must be declared in order to adopt a pill. The controlling stockholder launches a tender offer and a special committee is formed to make the recommendation that’s required under the securities laws. The special committee adopts a pill, which on its face violates the bylaws. One of the arguments being put forward is that they had the fiduciary obligation to stop what they considered an inadequate course of offer.

Question: So much of this discussion could also fall under the umbrella of the so-called shareholder activist agenda, which has also been linked with what might be called “short-termism.” how are the boards going to react to things like increased proxy access and this disease of “short-termism”?

RD: One thing to think about as a practical matter is what should or could boards be doing about proxy access? As of right now the SEC has not adopted the rules, and it’s unclear if they’ll ever become effective. Delaware corporations are currently governed by Sections 112 and 113 which say boards can decide on their own if they want to adopt procedures for proxy access and proxy reimbursement. A number of companies have begun to do that on their own. If the SEC waits until 2010 or 2011 to put these mandatory rules in place, it will be a very powerful argument against it that many public companies have already dealt with this issue on their own.

All corporations should be looking at what’s on the horizon. It’s wise for corporations to take advantage of this time to implement their own proxy measures.



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“ThE JuDgES BOTh In DElAWARE AnD OuT OF DElAWARE ThInK ABOuT ThEIR REPuTATIOnS”

CORPORATE AND FINANCIAL INSTITUTION COMPENSATION FAIRNESS ACT OF 2009, INTRODUCED bY REP. bARNEY FRANK.

Presenter: Stephen A. RadinWeil, Gotshal & Manges LLPVice Chair, Corporate Department

TOPIC OVERVIEW:

In commenting about the current judicial environment, we have to remember that judges really are people who read newspapers. We see this manifest in how the law develops and cases are decided in different ways in Delaware and outside of Delaware. The judges both in Delaware and out of Delaware think about their reputations. This plays out differently depending upon whether judges try these types of cases for a living, which is the case in Delaware, or whether a judge is outside of Delaware and encounters these cases only once every five or ten years.

let’s start in Delaware and look at the two very different ways this has manifested itself. Side one of the coin is the Citigroup subprime decision that came out around February 2008. The allegation was that the corporation got into the subprime mess because the directors of Citigroup didn’t do their jobs correctly. Therefore the directors should pay back the company out of their pockets or out of the D&O insurance for all the monies Citigroup lost.

Chancellor Chandler knew that this case was pending all over the country in any number of courts against the directors of any number of companies. he also knew that the same case was pending against the Citigroup directors in federal court in new york. It was a battle to the finish line. Both the plaintiffs in new york and in Delaware had filed complaints, and it was being briefed in both jurisdictions. The Delaware case was two or three weeks ahead of the new york case and briefing. Everybody thought that there was going to be an argument in Delaware.

It’s pretty unheard of in Delaware to have a major corporate law decision come out without any argument. yet that’s what happened. Chancellor Chandler wanted to be the person who said what the law in Delaware was, and he wanted to do it before a judge in new york could say what the law was in this very case involving Citigroup. The day the decision came down was the day the last brief was due in new york. Chancellor Chandler must have known that, so it was not coincidence.

I’ll read some passages from the decision to provide a sense of the rationale the Chancellor wanted the world to hear for why the Citigroup directors shouldn’t be held liable for what happened at Citigroup, i.e., why most directors in most companies shouldn’t be held liable for things like subprime issue.

he said, “The plaintiff’s theory essentially amounts to a claim that the directors should be personally liable to the company because they failed to fully



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“IT WAS A vERy POWERFul MESSAgE ExPlAInIng Why DElAWARE lAW DOESn’T hOlD ThESE PEOPlE lIABlE FOR ThIS TyPE OF COnDuCT”

recognize the risks posed by subprime securities. When one looks past the lofty allegations of duty, of oversight and red flags used to dress up these claims, what is left appears to be the shareholders attempting to hold the directors liable, personally liable for making or allowing to be made business decisions that in hindsight turned out poorly. Delaware courts have faced this type of claim many times and have developed doctrines that deal with them and fiduciary duty of care in the business judgment rule.”

later in the decision the Chancellor says, “It is almost impossible for a court in hindsight to determine whether the directors of a company properly evaluated risk and made the ‘right’ business decision. In any investment there is a chance the returns will be lower than expected, and generally a smaller chance that they will be far lower than expected. When investments turn out poorly it is possible that the decision-maker evaluated the deal correctly, but just got unlucky in that a huge loss, the probability of which was very small, actually happened. It is also possible the decision maker improperly evaluated the risk. And that is the reason the company lost large amounts of money. Business decision makers must operate in the real world with imperfect information, limited resources, and an uncertain future. To impose liability on directors for making a wrong decision would cripple their ability to earn returns for investors by taking business risks.”

The Chancellor essentially said, everybody wants to blame somebody, but that’s not how the law works. It was a very powerful message explaining why Delaware law doesn’t hold these people liable for this type of conduct. Clearly the Chancellor was thinking about Delaware law and a rationale that could be used elsewhere and that would hopefully hold up and not subject the court to a lot of criticism.

On the other side of the coin, Supreme Court Justice Steel from Delaware was quoted in the same month the Citigroup decision came down as saying that, “The role of state law is going to be determined by the federal government in the next several months to year. I equate what is going on to the Frankenstein movie, with the villagers with pitchforks. It’s a populous frenzy.”

you see in Delaware a fear of federal intrusion and a need to defend Delaware’s turf. The Delaware courts are pro whoever’s got the right side of the law. If I’ve got a good case I want to be in Delaware because a Delaware judge is going to do what’s right. Anyone with a bad case in representing directors, the last place on earth they’d want to be is in Delaware. They might want to be in a state court somewhere else where they might have a chance to convince a judge of something that they could never convince a Delaware judge. In Delaware they look to make examples out of people who don’t follow the rules.

however, 90 percent of the action is outside of Delaware. Most decisions aren’t reported because judges outside of Delaware don’t write decisions unless the case is going up on an appeal.



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“ShAREhOlDERS REgulARly BRIng CASES AgAInST ThE DIRECTORS OF DElAWARE COMPAnIES ThAT ShOulD BE gOvERnED By DElAWARE lAW”

Delaware law should govern the conduct of a Delaware director no matter where the case is brought. But in 40 to 45 states in the union that principle has not been tested in appellate court decisions. Shareholders regularly bring cases against the directors of Delaware companies that should be governed by Delaware law. They get judges who have never heard of these issues before, who won’t throw out a case on a motion. Delaware law says one must act in good faith. good faith is always a question of fact. how can judges decide that on a motion? There’s no law in those jurisdictions that Delaware law applies. The cases survive motions to dismiss and usually get settled for the payment of an attorney’s fee and some corporate governance therapeutics. here are examples of what’s happening in some other states.

A lot of these cases are in Texas. An attorney tried to explain to the judge that Delaware law governed the conduct of Delaware directors. And the judge’s response was, “They’re a small, little state. It’s a long way from here.”

Regarding a question of when you have to make a demand in a derivative action, nobody makes demands in Delaware. Everybody knows that the business judgment rule governs the decision, so no judge in Delaware has written it for 15 years. We asked that a case be dismissed before a judge in new york because the plaintiff hadn’t made a demand. The judge believed everyone had to make a demand, and made the plaintiff make a demand. Delaware courts would laugh at that.

What’s happening outside of Delaware is getting worse, not better. The judge in some small town knows that this is the biggest case he or she’s ever had. And if he or she lets the directors go in the one case in that jurisdiction, where the town is full of people who’ve lost money because stocks went down last year, the judge fears being ridiculed in the newspaper.

Chancellor Chandler helped by writing the Citigroup decision. his lengthy decision explained these principles and provided a rationale that other judges are following, particularly in federal courts where these cases are coming up. Citigroup has already been followed in four or five decisions.

DISCUSSION:

Question: Related to the point about the difficulties in the interpretation of Delaware law outside of Delaware, can a firm have a choice of forum clause in their standard Delaware charter? Can you include in the charter that all disputes arising out of this corporation will be adjudicated in Delaware? The charter itself is a choice of law provision, i.e., by incorporating in Delaware you’re choosing Delaware law. under Delaware law and under general conflicts law could you put a charter provision to chose a Delaware forum and avoid that problem?

Mr. Steve Radin (SR): It’s different to open your courts to anybody who wants to sue a Delaware company than to close somebody else’s courts. There are constitutional questions that have been raised about states enacting statutes — much less corporations enacting charters — which restrict access to courts.



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“ThE STAnDARDS OF lIABIlITy DOn’T ChAngE, BuT ThE BACKgROunD AgAInST WhICh ThOSE STAnDARDS ARE JuDgED DO ChAngE”

Question: Regarding the Citigroup case with the parallel Delaware and new york actions. After Chandler handed his decision down, what happens in the new york action? under your interpretation of full faith and credit, does the fact that Chandler acted first mandate that the new york court has to dismiss its case?

SR: There’s been some law on this in the last few years. A federal judge in new york recently agreed that the fact that one court had ruled that demand was required bound the second court. If one shareholder loses their claim that demand is required, that same issue can’t be litigated in another forum. Citigroup’s lawyers didn’t make that argument in new york. They simply argued that the Citigroup decision in Delaware was highly precedential. And the federal judge hearing that case in new york wrote a decision some months later, saying that there were no differences in the facts between the two cases and he therefore was going to rule the same way the Delaware judge had ruled.

Other judges outside of Delaware want to make decisions based on the impact on their jurisdiction, for example if the company is a big employer in the area. This is where the problem arose. Who cares that it’s a Delaware company?

Question: you can see the change in popular mood reflected in Chancellor Chandler’s first Disney opinion and his second Disney opinion, where he takes a very different approach. To what extent is taking external influences into account appropriate in corporate decision-making and judicial decision-making?

SR: I think it’s appropriate. The standards of liability don’t change, but the background against which those standards are judged do change. Directors today know about the subprime mortgage crisis and what’s happened with compensation. Directors in 2004 knew about off-balance sheet problems. The directors of 2000 didn’t. If a director today fails to deal with an issue that anybody reading the newspapers knows is a potential problem, they’re going to have trouble. It’s the same standard of gross negligence or sustained indifference, but directors reach a different conclusion using that standard based upon what they know from their real world existence.

Question: under all these developments that have been discussed, is there a difference between what directors are supposed to do and what they can be sued for not doing?

SR: There’s a huge difference. The duty of care is aspirational; “best practices” are not mandated. liability only comes into play when a director’s decision is grossly negligent. In the context of oversight or monitoring, gross negligence is not even enough. There’s got to be a sustained indifference.

It could be argued that a lack of good faith may lead into sustained indifference or gross negligence. But as long as a director is trying, it’s almost impossible to do something that triggers liability, at least on the duty of care side, simply because they haven’t fulfilled what they’re “supposed” to have done.



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PRESENTATION CONCLUDES

CT Corporation thanks the esteemed panel, Raymond J. DiCamillo, Stephen A. Radin and Edward B. Rock.

SPEAKER bIOS

Edward B. Rock is the Saul A. Fox Distinguished Professor of Business law, university of Pennsylvania law School and Co-Director at the Institute for law & Economics. In addition to teaching and research, Professor Rock applies his well-honed expertise to c-directing Penn’s Institute for law and Economics, shaping the Institutes’ programs in corporate governance. With Michael Wachter and Jill Fisch, he serves as convener and moderator for nationally known roundtable conferences that bring together eminent legal scholars, practitioners, judges and policy makers.

Raymond J. DiCamillo is a director of the firm Richards, layton & Finger, and a vice chair of their Corporate Department. his practice focuses on advisory and litigation matters related to Delaware business organizations and its fiduciaries and constituents. Mr. DiCamillo also advises corporate boards and board committees with respect to governance, litigation, investigational and transactional issues.

Stephen A. Radin is a member of the law firm of Weil, gotshal and Manges llP. he has litigated, counseled, written and lectured for more than 25 years on corporate governance subjects, including the business judgment rule, fiduciary duties of corporate directors, controlling shareholder and going private transactions, special committee investigations, contests for corporate control and proxy contests, disclosure requirements, and indemnification and insurance of corporate directors. Much of Mr. Radin’s practice focuses on shareholder derivative and class action litigation. Mr. Radin is the author of the recently published sixth edition of The Business Judgment Rule: Fiduciary Duties of Corporate Directors, a four-volume, 6,000 page treatise, prior editions of which have been cited in over 50 court decisions.



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CONTACT

Stacy M. NoblesSr. Manager, Corporate CommunicationsCT & Wolters Kluwer Corporate legal Servicesp 212.590.9058f [email protected]

CT Corporation111 Eighth Avenuenew york, ny 10011800 624 0909 telwww.ctlegalsolutions.com

no part of this document may be reproduced in any form by any means, nor may it be distributed without the permission of CT, a Wolters Kluwer business, nor may it be resold by any entity other than CT, a Wolters Kluwer business, without prior written authorization of CT, a Wolters Kluwer business. ThIS DOCuMEnT IS PROvIDED “AS IS”. All ExPRESS OR IMPlIED REPRESEnTATIOnS, COnDITIOnS AnD WARRAnTIES, InCluDIng Any IMPlIED WARRAnTy OR FITnESS FOR A PARTICulAR PuRPOSE, ARE DISClAIMED, ExCEPT TO ThE ExTEnT ThAT SuCh DISClAIMERS ARE DETERMInED TO BE IllEgAl.

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