The Latest Research in Corporate Governance: Law

1. The Latest Research inCorporate Governance:Law Paul Graf, J.D.

2. Paul Graf: Involved in preparation, or public statements, or were statements reviewed, no reliance and no duty to disclose. STONERIDGE • “For the NYSE, this is like going bullfighting with your cape behind your back. It will drive up the cost of doing business here.” -Peter Wallison, American Enterprise Institute • “The outcome of Stoneridge will determine whether tens of thousands of Enron investors will secure a day in court.” -Senator Arlen Spector

3. Director Liability – A Couple of “Mickey Mouse” Decisions • Chancellor Chandler: “By virtue of his Machiavellian (and imperial) nature as CEO, and his control over Ovitz’s hiring in particular, Eisner to a large extent is responsible for the failings in process that infected and handicapped the board’s decision-making abilities. Eisner stacked his (and I intentionally write ‘his’ as opposed to ‘the company’s’) board of directors with friends and other acquaintances who, though not necessarily beholden to him in a legal sense, were certainly more than willing to accede to his wishes and support him unconditionally than truly independent directors.”

4. Disney Chancery Case • Business Judgment Rule - Creates presumption that in making business decisions, the directors acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the corporation. • Chandler - Conduct of Eisner and board did not constitute gross negligence therefore conduct protected by the business judgment rule.

5. Disney Supreme Court Appeal • Affirmed the decision of the chancery court on the issue of duty of care” Section 102(b)(7) of the Delaware Corporate Code provides that articles of incorporation by include: (7) A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provision shall not eliminate or limit the liability of a director: (i) For any breach of the director's duty of loyalty to the corporation or its stockholders; (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law; (iii) under ､ 174 of this title; or (iv) for any transaction from which the director derived an improper personal benefit.

6. Disney Supreme Court Appeal • What is “bad faith”? 1. Conduct motivated by an actual intent to do harm. 2. Gross negligence without malevolent intent does not violate the duty to act in good faith. 3. An intentional dereliction of duty or a conscious disregard for one’s responsibilities would be a violation of the duty of good faith.

7. Lessons from Disney Cases • The courts will defer to directors’ actions unless the directors ignore “red flags” • Directors who disable themselves by consciously failing to monitor or oversee operations are acting in bad faith • Directors should implement reasonable information systems and continue to monitor those systems

8. Other Good Faith Cases • AmSouth - Board took steps to ensure regulatory compliance and there was no evidence that the board ignored “red flags.” • In re Caremark - “Only a sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish a lack of good faith that is a necessary condition to liability.”

9. Board Minutes - Boring but… • Minutes that detail a board’s efforts to be fully informed, and evidencing robust deliberative processes serve to bolster the defense against a claimed breach of the director’s duty of care. • On the other hand, minutes have also been described as a ticking time bomb waiting to be exhumed.

10. Board Minutes - Are They Privileged? • §220 - an “information gathering tool before derivative litigation • (b) Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from: (1) The corporation's stock ledger, a list of its stockholders, and its other books and records

11. Board Minutes • Judicial Interpretation 1. Inconsistencies 2. Conflicts 3. Silence 4. Timing 5. Length 6. Deliberations • Regulatory Interpretation 1. Caterpillar

12. Board Minutes - In reNetSmart • “In any event, given the un-minuted nature of the May 19 meeting and the lack of good recollection by the defendants involved, it is difficult to determine what exactly motivated the board’s decision or if decision is really even the right word.”

13. Board Minutes - Recommendations • Identify attendees • Whether attendees left early • Advance materials noted in minutes • Decision-making - some insight into the deliberative process • Review of minutes • Consistency and disclosure • Who should be the minute taker?

14. Revlon and the Private Equity Mergers • In re Toys R Us • In re Lear • In re Netsmart • Matching rights • Termination fee • Expense reimbursement “Go Shop” or “Window Shop”

15. Insider Trading Update • Joseph Nacchio, former CEO of Qwest was found guilty of 19 counts of insider trading involving $52 Million in stock sales. The complaint alleged one-time sales of assets as recurring. Also alleged was that Nacchio fraudulently and materially misrepresented Qwest’s performance and growth to the investing public and that Nacchio traded on the basis of material nonpublic information.

17. Insider Trading Update • Tellabs v. Makor Issues - Proving scienter as an element of securities fraud • PSLRA - “strong inference” - Requires that the inference of fraud is at least as compelling as any opposing inference of non-fraudulent intent

18. Insider Trading Update • Desimone v. Barrows - “Spring-loaded” stock options might constitute insider trading • Ryan v. Gifford - Backdating • In re Tyson - Spring-loading and bullet-dodging • “Market price” • “Spring-loaded” - Directors consciously granting options in advance of the issuance of positive information – however, not a problem if full disclosure so that it would be in the nature of a bonus (or “bullet-dodging”)

19. Insider Trading Update • SEC v. Barclays - Bank’s representative on six creditors’ committees where he obtained nonpublic information • “Big Boy” letters - Seller is in possession of inside information and wants the new buyer to acknowledge that seller has that information and waives any claims under 10b-5.

20. Insider Trading Update - Programs • SEC Official Statements 1. Special concern that Rule 10b5-1 is being abused. 2. SEC has a particular interest in insider trading with emphasis on hedge funds.

21. SEC Enforcement Actions • IBM - Enforcement action for making materially misleading statement concerning the impact of the company’s decision to expense employee stock options. • HP - Administrative charges for failing to disclose the reasons for a director’s abrupt resignation in the midst of the investigation of boardroom leaks. • Take-Two Interactive Software - SEC charged Capitol Distributing with aiding and betting a fraud by agreeing to “park” games at the end of accounting periods. • Tenet Healthcare - Civil fraud for failing to disclose that earnings growth was the result of exploitation of a loophole in the Medicare reimbursement system. • In re Flowserve - Reg. FD enforcement action for holding a private meeting with analysts before issuing an 8K report acknowledging its reaffirmation of its previously estimated EPS. • Titan - FCPA - Payments to election campaign of the president of Benin.

22. SEC Enforcement Actions (cont.) • In the Matter of MetLife - If MetLife had reasonably investigated and responded to the allegations of compliance violations against the defrauding sales rep., through heightened supervision or implementing procedures to review his files, it is likely that MetLife would have prevented or detected the fraud.

23. Disclosure Traps • Failure to disclose all material facts is a breach of a director’s fiduciary duty • An omission of a material fact can also be a breach of the fiduciary duty to disclose • “Materiality” = Reliability

25. Disclosure Traps (cont.) • In re Lear - The failure of the board to disclose all of the DCF iterations was not regarded as a breach because there was no evidence introduced to show that the particular DCF was more meaningful than the ones actually disclosed.

26. Disclosure Traps (cont.) • However, in In re Topps, when Lehman changed the parameters for the valuation fairness opinion and did not have a reasonable explanation (“not confidence inspiring”) then the court found a breach

27. Disclosure Traps:The Truth is Not Enough • Disclosure: The officers and directors were warned not to have discussions with the private equity company. • Non-disclosure: The principal of the private equity company told the officers on many occasions that he planned to keep them in place following the merger.

28. Disclosure Spinning • In re Topps Disclosure: The company is willing to entertain offers. Non-disclosure: The CEO, Shorin, stated that a “quick fix” [sale] was not in the best interests of shareholders.

29. Disclosure Spinning (cont.) • In re Lear Disclosure: The CEO, Rossiter, was appointed as the sole negotiating agent for the company to negotiate against Eisner. Non-Disclosure: Rossiter had expressed an interest in being cashed out on this retirement account [fear of company bankruptcy] and a private equity deal was most likely to give him what he wanted. Also, Icahn frequently told Rossiter that he fully intended to keep him in place following the acquisition.

30. Developments in Shareholder Activism – SEC Rule 14a-8(i)(8) • Stopgap measure in opposition to AFSCME case in 2nd Circuit

31. SEC Rule 14a-8(i)(8) (cont.) • Companies can exclude shareholder proposals that relate to or have the effect of: • An election of the board • Nominations for election to the board • Procedures for nomination or election to the board that would result in an immediate or future election contest • Disqualifying board nominees who are standing for election • Removing a director from office before term expired • Questioning the competence or judgment of one or more directors • Requiring companies to include shareholder nominees in the company’s proxy materials or otherwise resulting in a solicitation on behalf of shareholder nominees.

32. SEC Rule 14a-8(i)(8) (cont.) • Non-excludable proposals include those that relate to: • Director qualifications or board structure (as long as it will not disqualify or remove current nominees) • Voting procedure (such as majority, plurality or cumulative voting) • Nominating procedures (other than those that would result in the inclusion of a shareholder nominee) • Reimbursement of shareholder expenses in contested elections

34. Developments in Shareholder Activism – Board Declassification • SEC no-action letters suggest that the SEC would require a company to include a shareholder declassification proposal if: 1. It is structured as a non-binding recommendation to the board of directors 2. It provides for completion of all terms of directors that would be unexpired at the time that the board is declassified; 3. It is not supported by unsubstantiated or misleading statements

35. Developments in Shareholder Activism – Majority Voting for Election of Directors • In 2006, Section 216 of the DGCL was amended to require that if shareholders adopt a majority voting amendment to the bylaws, the amendment cannot be modified or repealed by the board without a shareholder vote.

36. Patently Obvious • KSR v. Teleflex - Supreme Court changed the standard for patent validity based on obviousness • In re Seagate Technology - Is an opinion of non-infringement sufficient to avoid a willful infringement finding? Also, if the opinion is produced, does it waive the attorney client privilege of the opining counsel and also trial counsel? • San Disk v. STMicroelectronics - Makes it easier to bring a suit for declaratory relief that the patent is invalid

37. Resale Price Maintenance – No Longer Per Se • Leegin Creative Leather v. PSKS - vertical restraints to be decided on a case by case basis. • Factors 1. Number of competitors in the market that have adopted RPM agreements 2. Whether RPM originates with the manufacturer or the retailer 3. Whether the manufacturer or retailer to the agreement has market power.

38. Antitrust Pleading Requirements • Bare assertions of conspiracy will not withstand a motion to dismiss. • There is now a requirement of allegations of “plausibility” suggesting an agreement—not merely consistent with an agreement. • In re Elevator Antitrust Litigation • Bell Atlantic Corp. v. Twombly (127 S. Ct. 1955) (2007)

39. “Say on Pay” • Probably not excludable under 14a-8