Judicial Independence: Conflicts of Interest was the primary focus of last week’s first Rock Center / SVDX program of the academic year. It was titled Condos on Lanai, Private Planes, and Electric Cars: Judicial Views of Purported Conflicts Among Silicon Valley Director.
What do airplane co-ownership, condominiums on Lanai, and electric cars have in common? Recent Delaware court decisions involving these situations have concluded that directors cannot be considered independent for the purpose of certain transactions. Director independence and potential conflicts of interest have historically focused on relationships with the company itself, but recent cases demonstrate that companies need to be much more aware of and concerned about interlocking business, investment, and social relationships outside of the boardroom. The panel discussed:
- Situations where independence issues can arise and pose director liability concerns;
- Evolving judicial views on director independence and recent case law involving Oracle, Tesla, and Zynga;
- Tips and best practices for understanding business and personal relationships among directors, anticipating potential conflicts, and avoiding pitfalls; and
- Implications for board and committee composition
Judicial Independence: Featured panelists:
I suggest contacting Katherine Henderson and asking her for a copy of “Current Issues regarding Independence of Public-Company Directors,” which she authored with Nathan Emeritz.
Judicial Independence Differs From Listing Standards
From the above cited paper:
A majority of the board of directors of a corporation listed on the New York Stock Exchange or NASDAQ must qualify as independent under the respective exchange’s definition of independence. That standard tends to focus on whether the director is independent of the corporation and its management. This standard of independence differs from that typically applied by Delaware courts, which also focuses on a director’s independence from significant stockholders and the specific facts of a given situation….
Unlike in the litigation demand context, where directors are presumed to be independent and the plaintiff bears the burden of proving that a majority of the directors are not independent, a special litigation committee bears the burden of proving the independence of its members. The Delaware Supreme Court has described the standard of independence for special litigation committee members as “like Caesar’s wife—above reproach.”…
Independence can act as a powerful cleansing agent, but directors and their advisors must be aware of existing relationships and alert to methods for addressing the potential appearance of conflicts, or otherwise-independent directors may lose the benefits of deference from courts in litigation over their decisions. Such vigilance to identification, management, and monitoring of those potential conflicts can be an important element of a director’s ability to act independently.
Definitions of judicial independence are case specific. Co-investments. Relationships with VCs, social media. An annual questionnaire will not be good enough to define independence. Advice included starting with a risk assessment. What is the probability of an activist showing up? Situations where active involvement of independent directors is important include:
- change in control
- compensation of officers and directors
- controlling stockholder tranactions
- defensive situations
Demonstrating “entire fairness” is challenging, fact-intensive and may include digging into shared experiences of directors, their shared social context and even embarrassing personal facts about directors. The courts have allowed inquiries into social media to determine relationships and have based “should have knowns” on those relationships.
Judicial Independence Recommendations
Boards should try to get a handle on these issue before they surface to the public. Strategies discussed included board self evaluations, independence evaluations, and standing independent committees. Boards could ideally be composed of one set of directors that are independent by exchange standards but another subset meeting judicial independence standards. Those directors meeting judicial independence standards will not have known each other or the other directors before coming on the board. The basic advise was to use a recruiter and nominate directors you do not know.
Silicon Valley is moving to insider/outsider boards. Outsiders will meet the judicial independence standards. When going IPO, that is the best time to get board members who will meet judicial independence standards.
There was also mention of Joeseph Grundfest’s recent paper in opposition to SB 826. While, “well intentioned,” Grundfest argues the better route is achieve the goal of greater board diversity through shareholder action.
- Because of the internal affairs doctrine, SB 826 is unconstitutional as applied to all but 72 publicly traded corporations headquartered in California.
- Affirmative action’s opponents will construct examples of a broad array of governmental intrusions into the private sector that would arguably be permissible if SB 826 is held to be constitutional. These examples will be carefully fashioned to create politically divisive fact patterns. The objective will be to create a parade of horribles designed to stimulate a broader backlash against affirmative action efforts, not just against efforts to add diversity to corporate boards.
- A large number of institutional investors and proxy advisers(should) coalesce around a common benchmark that serves a shared principle guiding exercise of the shareholder franchise.
My Take: Yes, SB 826 is an imperfect solution, but so are California’s clean air laws. Doing right is often messy. California should set an example for the nation, even if there are holes in its legality. See Review: Getting Women on to Corporate Boards. If you feel the same, call Governor Brown at (916) 445-2841 and ask him to sign SB 826.