Whistleblower Speaker Series is Off and Running

We’ve embarked on an interesting new course here: a series of classes led by experts in a variety of aspects of whistleblowing. Our first class featured Jordan Thomas, currently at Labaton Sucharow in New York, and formerly the Assistant Director of the SEC’s Division of Enforcement. Jordan led the students through a terrific exercise in identifying competing policy considerations behind the Dodd-Frank whistleblowing program and the SEC’s implementing rules. [For a recent story on the SEC’s whistleblower program, see this write-up by John Kiernan for CardHub.]

Yesterday’s class was led by Virginia Gibson, currently with Hogan Lovells in Philadelphia, and former director of the civil division of the U.S. Attorney’s office in Philadelphia. She brought her extensive enforcement experience to introduce students to the qui tam provisions of the False Claims Act, which permit citizens to initiate litigation asserting claims of fraud against the federal government.

Having just released a working paper that sharply criticizes the “first-filed” rule in corporate shareholder representative litigation, I was struck by the fairly strict “first to file rule” in Section 3730(b)(5) of the False Claims Act. That rule apparently has its supporters, but it’s hard to see how it doesn’t inappropriately encourage whistleblowers to file claims before developing and maturely evaluating the facts. Ginny Gibson explained that situations with multiple relators (whistleblowers) are becoming increasingly common, but priority (and sharing in a potential recovery) often gets negotiated during the “quiet period” after the complaints are filed but before the Government decides whether to intervene and the complaints become unsealed. Still, I worry that the first to file rule gives the first filer an inappropriate advantage. Hat tip to my student Kerrin Cahill (Widener ’13) whose paper pointed out that the qui tam first to file rule could use a little nuance. (And hat tip to the Ruby R. Vale Foundation for its support of this series of classes).

We’re looking forward to the other speakers in this series, including former Delaware Supreme Court Chief Justice E. Norman Veasey, DuPont General Counsel Thomas Sager, and Prof. Kathleen Clark of Washington University Law School in St. Louis, who also teaches an entire course devoted to whistleblowing.

Freedman vs. Novell — The Latest Adventures of the Business Judgment Rule

Two seemingly disparate recent Delaware court opinions provide an intriguing contrast in the approach to judicial review of fiduciary conduct. In its very brief opinion of January 14, 2013 in Freedman v. Adams,, et al, the Delaware Supreme Court affirmed the dismissal of a claim that the directors of XTO Energy breached their fiduciary duty by awarding $130 million in executive bonuses without doing so through a stockholder-approved plan (a Section 162(m) plan) that might have permitted the company to save $40 million by deducting the cost of the bonuses for income tax purposes. The board recited the belief that insistence on granting bonuses through a Section 162(m) plan “would constrain the compensation committee in its determination of appropriate bonuses.” And, according to the Supreme Court’s opinion, “The decision to sacrifice some tax savings in order to retain flexibility in compensation decisions is a classic exercise of business judgment. Even if the decision was a poor one for the reasons alleged by Freedman, it was not unconscionable or irrational.” The opinion does not indicate that XTO provided any explanation of what constraints the stockholder-approved plan would have imposed, or why the company chose not to pay the bonuses through such a plan.

Eleven days earlier the Court of Chancery’s opinion in the Novell shareholder litigation denied a motion to dismiss claims that a disinterested, independent board of directors acted in bad faith in selling the company, because of the absence of explanation for the decision to inform the successful bidder of a sale of a line of patents while not informing a competing bidder of that sale. The court’s opinion noted:

Why the Novell Defendants did not tell Party C about the proceeds of the Patent Sale has no apparent answer in the record before the Court. That conduct, coupled with the fact that Novell kept Attachmate fully informed, is enough for pleading stage purposes to support an inference that the Board’s actions were in bad faith.

So to editorialize a bit, the Delaware Supreme Court in Freedman might have similarly said:

Why the [XTO] Defendants did not [pay the bonuses through a Section 162(m) plan] has no apparent answer in the record before the Court. That conduct, coupled with the fact that [the Board did not explain in any specific way how use of such a plan could have constrained the determination of bonus awards], is enough for pleading stage purposes to support an inference that the Board’s actions were in bad faith.

But of course, the Supreme Court didn’t say that. Were they wrong? Was the Court of Chancery wrong in Novell? Or neither – are the two opinions consistent? In which case should the courts have been more inclined to defer to board judgment?

On a clean slate, I would have thought that the executive compensation decision at issue in Freedman would be more suspect than the conduct of an arm’s length sale of the company to a third party. In Freedman, one of the recipients of the bonuses was the company’s CEO, who was also a member of the Board. Not to put too fine a point on it, the bonus payments to him were a self-dealing transaction – one perhaps well considered and justified by an independent compensation committee, but one in respect of which the motives that implicate the duty of loyalty were present. In contrast, in Novell none of the directors had any direct conflict of interest.

It’s challenging to think of a doctrinal structure in which these two opinions can co-exist.