September 4, 2019

American Psycho: Does the Law Require Sociopathic D&Os?

Shortly before the BRT issued its statement redefining its position on corporate purpose, Andrew Ross Sorkin profiled Jamie Gamble in the NYT DealBook. Gamble is a former Wall Street lawyer who has had a conversion experience and now says that the corporate clients he worked for are legally compelled to act like Patrick Bateman. Here’s an excerpt from his manifesto:

The most important problem in the world is a reasonable sounding provision of the corporate law that governs most major U.S. companies. That’s a big claim. It’s also slightly misleading. A better answer is that the above complex network of horribles all connect back to a common root that is nourished and guarded by the extraordinary power of corporate “persons” who are legally obligated to act like sociopaths.

The rule: corporate management and Boards of directors are obligated by law to make decisions that maximize the economic value of the company. Colloquially: when you invest your money in a company, the people who run that company are required to do their best to bring you the highest possible financial return on your investment rather than using your money to pursue any personal or social agenda.

Sociopath? Yes. The corporate entity is obligated to care only about itself and to define what is good as what makes it more money. Pretty close to a textbook case of antisocial personality disorder. And corporate persons are the most powerful people in our world.

Gamble’s solution – or at least part of it – would be to include language in corporate bylaws requiring boards to consider the interests of a broad range of constituencies beyond shareholders whenever they make a decision. By making this mandatory & providing shareholders with the ability to sue directors for violating these provisions, he thinks the beast can be tamed.

Counterpoint: Like Heck It Does!

Sorkin’s piece initially attracted a lot of attention, but then it sort of got overwhelmed by the sound & fury surrounding the BRT’s decision to bid farewell to shareholder primacy.  That’s too bad, because I think Gamble’s views about the legal obligations of corporate directors are based on a false premise, and it’s the same one that seems to have framed at least some of the reaction to the BRT’s new statement of purpose.

I doubt there’s a single corporate lawyer who would dispute the contention that true sociopaths are by no means absent from America’s boardrooms or C-suites. But does the law really require sociopathic behavior? UCLA’s Stephen Bainbridge says no way – and also says that Sorkin & Gamble’s arguments amount to “a mass dump of uninformed silliness.” (You won’t like the Prof. when he’s mad).  Here’s an excerpt from his recent blog responding to the DealBook article:

This argument is patently absurd. The corporation is a legal fiction. To paraphrase the first Baron Thurlow, who observed that the corporation has neither a soul to be damned nor a body to be kicked, the corporation has neither a mind to be psychoanalyzed not a brain to be diseased. Corporations are run by people, so if “they” act like sociopaths, it must be because they are run by sociopaths. It is estimated that psychopaths make up at most 1% of the population, so are we to believe they are disproportionately located in corporate C-suites?

Second, both Gamble and Sorkin grossly misstate the law. Sorkin writes:

“It may be an oversimplification, but if they veer from seeking profits in the name of other stakeholders, shareholders may have a legal case against them.”

That is not an oversimplification; it is a gross oversimplification. Absent proof that the directors were engaged in a breach of the duty of loyalty or certain takeover situations, the business judgment rule would preclude courts from reviewing director decisions. To be sure, that is not the purpose of the business judgment rule, but that is its effect.

Prof. Bainbridge is absolutely right on the law (see also this 2015 NYT opinion piece by the late Prof. Lynn Stout). But if you asked directors & officers of public companies what they think their legal obligations are, my guess is that their responses would be pretty consistent with Gamble’s characterization of what the law requires. The “value maximization” imperative has been internalized by a whole lot of D&Os, and has been used to justify some pretty cold-blooded corporate decisions.

By the way, if this debate sounds familiar, pundit Matthew Yglesias tweeted a similar comment last year – and got clobbered by legal academics.

“Stakeholder Governance”: What Happens to the BJR?

This recent blog from Alison Frankel poses an interesting question: if corporations undertake obligations to “stakeholders” & not merely shareholders, what does that mean for the business judgment rule?  Here’s an excerpt:

Law firms are beginning to contemplate whether corporate boards will continue to be entitled to the deference afforded by the business judgment rule – which broadly shields directors from liability as long as they’re deemed to have acted in the corporation’s interest – if their decisions are prompted by rationales other than maximizing profits.

That’s particularly relevant in Delaware, where, as Chief Justice Leo Strine explained in a 2015 paper, The Dangers of Denial, corporate law is resolutely focused on stockholder welfare. Strine (who is due to retire from the Delaware Supreme Court by the end of October), is of the view that Delaware precedent does not provide leeway for judges to sanction board decisions that subordinate shareholder interests.

In other words, if directors put the interests of other stakeholders first, they risk losing the protection of the business judgment rule – at least in Delaware. If that’s so, then isn’t Gamble right about the law obligating boards to act like sociopaths in the pursuit of value maximization?

Nope. Except in very limited situations, the authority provided to Delaware directors under Section 141(a) of the DGCL includes the authority to set the time frame for achieving corporate goals without – as the Delaware Supreme Court put it in Paramount Communications v. Time – a “fixed investment horizon.”  Deterimining that time frame is a matter of business judgment.

So, if you’re a director who is thinking about the long-term, you’ve got plenty of discretion to conclude in good faith that considering the interests of other stakeholders may be helpful in maximizing long-term shareholder value. But that doesn’t mean that members of the only stakeholder constituency that can vote won’t still lean on you mighty hard to do otherwise.

The sound & fury surrounding the BRT’s pronouncement prompted it to issue a lengthy “clarification” of its position – and it draws heavily on the idea of promoting the interests of other constituencies as being essential in order to create long-term shareholder value.

Dorsey’s Whitney Holmes shared the following comment, which I think nicely summarizes the issue of what Delaware law requires:

I believe that much of the debate misses the point that impact investors understand and now the BRT are starting to understand: for a given corporate decision not involving a sale of corporate control (or enactment of a preemptive defense against an acquisition), if

– choice A demonstrably returns $100 to shareholders and no benefit to anyone else, and

– choice B demonstrably returns $90 to shareholders and a meaningful but unquantifiable benefit to another interest (e.g. the environment, the wellbeing of employees, the community in which a manufacturing facility sits, etc.) that cannot be supported by a vague future benefit to the corporation that might somehow, someday be worth $10 or more, do the corporation’s directors have discretion in line with their fiduciary duties to choose B over A?

He says the answer under Delaware case law is “no,” and I think that’s right. If you’re ultimately called upon to make some sort of corporate “Sophie’s Choice,” you can’t prefer other stakeholders to shareholders – but given the deference under the BJR to the board’s assessment of the future shareholder value a particular decision would create, it’s doubtful that a board would ever find itself in this position.

John Jenkins