On March 13, 2015, Donna M. Nagy, Executive Associate Dean and Professor of Law at Indiana University Maurer School of Law, delivered the annual Ruby R. Vale Distinguished Scholar Lecture as part of the 2015 Ruby R. Vale Interscholatic Corporate Moot Court Competition.

Nagy’s lecture began by observing that acts of governing, whether in Congress or in the boardroom, implicate a host of agency issues. Conflicts of interest and other issues of ensuring that agents are acting in the best interest of the principals can exist in both contexts. But while corporate law has safeguards regarding conflicted directors, the discipline of the electoral process is often cited as the reason why there is no need for robust laws against self-dealing in the political context. Yet, directors also stand for election. In practice, Nagy asserted, elections often fail to provide a check: in the corporate context, challenges rarely succeed even where there is high shareholder dissatisfaction, and in politics, incumbency has large structural benefits.

Nagy identified two specific instances that raise questions regarding the ethics of lawmakers: congressional insider trading and the broader use of material non-public information for personal gain, and financial conflicts of interest.

Regarding congressional insider trading, Nagy suggested that the courts and federal prosecutors look to corporate law for an analogy because federal officials serve the public in a fiduciary capacity. According to Nagy, the Stock Act, a 2012 law that bans insider trading by Congress, was not necessary. The Stock Act amended the Securities Exchange Act so that all federal officials owe duties (e.g., of trust and confidence). Though conceding that the Stock Act improved on the status quo by creating a more effective system of transparency, Nagy nevertheless maintained that it was not necessary to amend the SEA to reflect what most ordinary people believe—that federal officials serve the public in a fiduciary capacity.

As to the broader issue of the use of material non-public information by elected officials, Nagy asserted that the Stock Act did not resolve the access that state officials have to inside information, or the ability, even on a federal level, to purchase real estate, or any other property not constituting a security, using material non-public information. Because an elected official’s self-serving use of material non-public information to profit from real estate has already been prosecuted, federal prosecutors should be able to draw upon an analogy from corporate law.

Regarding financial conflicts of interests and the widespread practice of holding personal investments in companies that are the subject of legislation, Nagy noted that members of Congress continue to own interests in companies directly affected by legislation, and disproportionately own interests in industries under their purview. Despite well-established fiduciary principles, Congress’ internal rules insulate financial conflict of interest practices.

In the corporate context, statutory provisions allow for three ways to justify an interested director transaction: (1) full disclosure and approval by disinterested directors; (2) approval by a majority of disinterested directors; (3) entire fairness to stockholders.

For government fiduciaries in the executive branch, there are strict regulations that mostly exceed the prophylactic rules of fiduciary law. 18 U.S.C. 208 is a criminal statute that includes broad anti-conflict regulation. It criminalizes conflicted actions even if it is unlikely that the conflict will influence the executive’s actions. Rather, the mere presence of conflict is sufficient for criminal liability.

In the judiciary, federal judges are prohibited by statute from hearing matters in which their impartiality could be affected. The statute mandates recusal where a judge’s financial interests are implicated, and broadly defines “financial interests” so much so that the ownership of one share of stock is enough to mandate recusal.

Congressional officials, however, are allowed to work and vote on legislation so long as they are not the sole beneficiary. This “sole beneficiary” provision in the rules of Congressional ethics places a gloss on their fiduciary obligations. The commentary to the Congressional rule explains that the rule is intended to be construed narrowly. There is a strong presumption that the lawmaker is working in the public interest and that any personal gain is incidental. Interested directors, however, are not granted any presumption that they are working in the best interests of the stockholders, and the business judgment rule applies only with disinterested transactions. Therefore, Nagy concluded, when personal financial interests are involved, political judgments—at least Congressional judgments—are more insulated than business judgments.

Nagy concluded the lecture by submitting that unlike in other branches of government, however, recusal is not an optimal solution for Congress. Nevertheless, Congress can, and should, prohibit members from holding interests in industries on which committees they serve. Notably, added Nagy, this rule is already applied to committee staffers, who are prohibited from holding interests in industries substantially affected by committee work. A stricter rule would prohibit members of Congress from holding securities interests except for general (mutual) funds.

Upon the conclusion of Nagy’s lecture, Professor Luke Scheuer commented that an outright ban on securities activities for Congressional members sounds attractive because, unlike the corporate context where stockholders can sue as a remedy for director ethical breaches, private suits alleging ethical violations would be problematic in the political sphere. Nagy responded that she has not yet advocated for derivative litigation in politics, but House and Senate rules would empower congressional ethics committee to take action.

In response to a question from Professor James May regarding analogies beyond the corporate context, Nagy noted that the United States is unique in that insider trading regulation is derived from interpretation of anti-fraud statutes, whereas other countries have direct statutory bans. In those jurisdictions that more specifically and explicitly ban uses of material non-public information, public officials can simply be added to the list.

Finally, Professor Lawrence Hamermesh noted that a ban on stock ownership may not face the same challenges as campaign finance laws because there is no First Amendment protections to own stock, whereas campaign contributions are now a form of protected political speech.

The treatment of stock-based compensation as a cash expense when determining fair value has become a point of debate in appraisal litigation. Most investment firms recognize the expense when determining fair value of a company’s shares. The Delaware Court of Chancery, however, excluded stock compensation as an expense when determining fair value in Merion Capital, L.P. v. 3M Cogent, Inc., No. 6247-VCP, 2013 WL 3793896 (Del. Ch. July 8, 2013). In a blog essay written for the Delaware Journal of Corporate Law, DJCL articles editor John Gentile examines the diverging viewpoints of the financial industry and the Court of Chancery, and concludes that to achieve the most appropriate estimate of fair value, the Court of Chancery should count for stock based compensation as a cash expense.

Read more at www.djcl.org.blog.

Recent appraisal litigation in the Delaware Court of Chancery has defendants calling for relief from the Delaware legislature. But is that a good idea? In two blog essays written for the Delaware Journal of Corporate Law, DJCL Internal Managing Editor William Burton and senior staff editor Tom Kramer discuss opposing viewpoints on appraisal arbritrage legislation. Burton examines the arguments raised in two recent cases before the Court of Chancery and ultimately concludes that the Delaware legislature must act to address major concerns with practices in appraisal litigation. Kramer, on the other hand, takes a critical look at the term “appraisal arbitrage” and a forthcoming paper on appraisal litigation in Delaware, and concludes that a legislative fix would be premature. Read both essays in full at http://www.djcl.org/blog.

     On Wednesday, October 22, 2014, the Institute of Delaware Corporate and Business Law presented Bankruptcy: A Look Back and a Look Ahead.  The program was initially intended to feature Judge Helen S. Balick on the subject of the Bankruptcy Act, and bankruptcy as it developed under the Bankruptcy Reform Act of 1978 (the “Bankruptcy Code”).  But due to Judge Balick’s recent accident, Chief Judge Brendan L. Shannon and Judge Peter J. Walsh, of the U.S. Bankruptcy Court, participated in her stead.  The program, conducted in conversation-style format, was moderated by Bruce Grohsgal, the Helen S. Balick Visiting Professor in Business Bankruptcy Law at Widener University School of Law, Delaware.

Early in the program, Chief Justice Shannon recounted Judge Balick’s background and professional history as set forth in an oral history he had conducted in April 2014.  The account of Judge Balick’s remarkable personal and professional career set a tone of tribute that permeated the entire program.

Judge Walsh, when asked what was it like to practice in the 1960s and 1970s compared to now, explained that bankruptcy in Delaware was a local practice until In re Cont’l Airlines, Inc., 125 B.R. 399 (D. Del.) aff’d and remanded, 932 F.2d 282 (3d Cir. 1991) (“Continental”).  There were no New York or Chicago firms and the cases were all relatively small cases.  There were not really a lot of other bankruptcy professionals, and he used to appear before Judge Balick at least once a week.  When he assumed judgeship in 1993, his staff consisted of only three people.  There was only one bankruptcy courtroom, so he and Judge Balick would have to coordinate their schedules to avoid double booking.

Chief Judge Shannon, when asked what is was like to practice before Judge Balick as a young lawyer, explained that Judge Balick was remarkably kind, especially to young lawyers.  Chief Judge Shannon had been admitted to practice in 1992, right after Continental, which was a “staggeringly busy time” for bankruptcy attorneys.  Because of the fast pace, his early practice was challenging, and he had to appear before Judge Balick almost every day.  He described how Judge Balick always gave guidance to young attorneys without embarrassing them.

Chief Judge Shannon then highlighted Judge Balick’s “no nonsense” tone, and noted that her approach has been adopted to varying extents by other judges.  He explained that Judge Balick set the tone that the court would get to the merits and would not let procedural issues hang up the case.  This tone created a really valuable dynamic that enabled the parties to proceed to the merits.  He further noted that the importance of proceeding to the merits is part of Judge Balick’s legacy, and has been instilled to a certain extent in the courts today.

Judge Walsh and Chief Judge Shannon remarked that Continental, followed by In re Columbia Gas Sys., Inc., 136 B.R. 930 (Bankr. D. Del. 1992), changed the practice of bankruptcy in Delaware.  Perhaps not coincidentally, Judge Balick presided over both cases.  Chief Judge Shannon expressed that the two cases were dealt with promptly and that Judge Balick’s “no-nonsense” approach minimized uncertainty and delay, which was important to counsel on both sides.

As Chief Judge Shannon and Judge Walsh recounted cases that had been argued and heard before Judge Balick, the program developed a nostalgic atmosphere.  Reminiscing about past cases from their days in practice, the judges described a much smaller and tight knit bar, prior to the advent of the larger cases that began in the 1990s.  Judge Shannon and Judge Walsh’s high regard for Judge Balick, as formers and as colleagues, reflected the enduring impact of Judge Balick’s career and legacy.

At the 30^th annual Francis G. Pileggi Distinguished Lecture in Law, Brian R. Cheffins, the S.J. Berwin Professor of Corporate Law at the University of Cambridge, evaluated Delaware’s contribution to the development of corporate governance over the past forty years.  Professor Cheffins posited that although Delaware is often identified as having a substantial impact in the field of corporate governance, it has not been the sole player and has not always been the dominant player in the development of corporate law.  Yet, any analysis of the historical development of corporate governance would be seriously incomplete without a consideration of Delaware and Delaware courts.

In the lecture, Professor Cheffins first asserted that due to the nature of the legislature and the judiciary, Delaware’s key corporate players, expectations concerning Delaware’s potential impact should be kept in check.  He then explained his position that Delaware has not been as impactful in the areas of shareholder activism and executive pay, but has made substantial contributions in the development of boards of directors and takeovers.

Delaware’s Key Corporate Players—the Legislature and the Judiciary

Beginning with the Delaware General Corporation Law (“DGCL”), which has been identified as the formal apex of the structure of Delaware Corporate Law, Professor Cheffins noted that the DGCL has not been overhauled since 1967, before corporate governance became prominent.  Therefore, it was not likely to be the “first mover” on corporate governance; put differently, Professor Cheffins asserted that because the DGCL predated the prominence of corporate governance, it cannot be said to have had a transformative effect on the development of governance standards.  He further noted that Chief Justice Strine has stated that the “Delaware Model” for corporation law makes the DGCL an unlikely foundation for the imposition of governance standards.

Next, in analyzing the role of the Delaware judiciary, Professor Cheffins observed that because of Delaware’s approach to corporate law, Delaware courts have a broad scope to define director’s duties.  This discretion has created the potential for the Delaware judiciary to play a significant role in the development of corporate governance.  But while they have had a profound impact on changes in corporate governance law, Delaware Courts tend to reinforce already-existing trends, rather than foster radical change.

In comparing the legislature and the judiciary, Professor Cheffins explained that with the judiciary, cases tend to be skewed because most filings involve one type of case: a class action challenging actions taken by directors in an acquisition.  Nevertheless, Delaware judges are skilled at creating broad rules and exerting influence on matters not specifically raised by litigants and not before the courts.  The legislature, on the other hand, is not constrained by doctrine and precedent, and can create wide regulatory schemes.  Where courts are constrained, the legislative body can open up doctrine and theoretically investigate and formulate new doctrine.

Delaware’s Influence on Areas of Corporate Governance

After summarily concluding that Delaware’s contribution to shareholder activism has been marginal largely because of institutional constraints, and that Delaware played a largely peripheral role in the transformation of executive pay in the late 20^th century, Professor Cheffins, examined Delaware’s role in the development of corporate boards and the decline of hostile takeovers.

Regarding the board of directors, Professor Cheffins set forth that Delaware played a substantial role in rise of independent directors and in establishing standards of deliberation.

Citing Delaware cases in which the independence of the board was seen as a factor in the outcome—Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), Moran v. Household Int’l, Inc., 500 A.2d 1346, 1349 (Del. 1985), and Paramount Comm’ns, Inc. v. Time Inc., 571 A.2d 1140 (Del. 1989)—Professor Cheffins observed that an indication by Delaware courts that decisions by independent directors would be less scrutinized than decisions by interested parties helped lead to a rise in the importance of independent directors. Yet, despite acknowledging that Delaware courts contributed to the rise of the independent director, Professor Cheffins maintained that Delaware courts were merely reinforcing already occurring key trends in changes to the board.  He further explained that Sarbanes-Oxley and other regulatory reforms in the early 2000s were not transformative because they largely conformed to corporate governance norms shaped by Delaware case law.  Delaware courts had helped transform the legal landscape, and the regulatory reforms went a long way towards mandating the numerical dominance of independent directors and independent committees on boards.

As to the standards of deliberation, Professor Cheffins acknowledged the influence of Delaware case law, but maintained that Delaware’s impact could have been more extensive.  Noting that Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), a case where outside directors of a publicly traded company faced out-of-pocket liability, was widely credited with sensitizing the business community to the deliberative responsibilities of boards, Professor Cheffins expressed that the fears of personal liability may not have been well-founded because a statutory amendment, DGCL § 102(b)(7), permitted restrictions on board liability in the corporation’s charter.  Later, the Disney/Ovitz litigation, In re Walt Disney Co. Derivative Litig., 907 A.2d 693 (Del. Ch. 2005) aff’d, 906 A.2d 27 (Del. 2006), further eased the fears of growing liability risks in Delaware courts.  According to Professor Cheffins, Disney, characterized as “the corporate governance case of the century,” provided Delaware courts with a fresh opportunity to adjudicate on directors’ responsibilities to be more attentive; but the court’s ruling of no liability on the directors likely muted its impact.

Regarding takeovers, Professor Cheffins contended that factors outside of Delaware must have helped to prompt the switch in emphasis from the market for corporate control to internal governance mechanisms.

Observing that Delaware courts were “in the center of the action” during the Deal Decade,[1] Professor Cheffins acknowledged that Delaware rulings that upheld defensive steps taken by boards may have helped bring the deal decade to a close.  He nevertheless put forth that while the Paramount decision, Paramount Commc’ns, Inc. v. Time Inc., 571 A.2d 1140, 1142 (Del. 1989), is largely credited for helping to bring the deal decade to an end, Delaware case law was only one component of a legal matrix that worked to the disadvantage of a hostile bidder.  Explaining that changing market conditions at the end of the 1980s made banks reluctant to lend to those seeking to carry out takeovers, Professor Cheffins posited that other factors must have helped to prompt the switch to internal governance mechanisms at the close of the deal decade.

To further support his contention that factors outside of Delaware must have helped to prompt the switch to internal governance mechanisms, Professor Cheffins examined DGCL § 203, Delaware’s anti-takeover law.  He noted the general thinking that § 203 was of limited practical importance so long as boards had substantial discretion to adopt poison pills.  He then asserted that Delaware case law indicating that boards had substantial discretion to deploy poison pills was not decisive because poison pills are relatively harmless unless coupled with a staggered board, and only a subset of Delaware companies had staggered boards combined with the poison pill.  Therefore, a poison pill did not necessarily render § 203 moot.

Conclusion

Professor Cheffins concluded the lecture by emphasizing that any discussion of the development of corporate governance in the United States would be seriously incomplete without accounting for Delaware’s role.  Nevertheless, other players and factors were at play, and even in the areas where Delaware was most influential, it tended to reinforce trends rather than foster radical change.

In response to a question posed by Professor Lawrence Hamermesh, director of the Institute of Delaware Corporate and Business Law, Professor Cheffins explained that the ability of Delaware to accept certified questions was not crucial to past developments but could be significant moving forward.