To Call a Donkey a Racehorse: The Fiduciary Duty Misnomer in Corporate and Securities Law

In a new article, I address a subject that has been ignored for too long:  The fiction of meaningful fiduciary standards in the corporate and securities laws contexts. My article explores the standards that legislatures and courts apply to corporate fiduciaries and demonstrates that the commonly-held framework does not reflect the situation that in fact prevails.

Officers and directors as fiduciaries to the corporations they serve is a recurrent theme in corporate law.  Although not as vibrant under the federal securities laws, fiduciary duty concepts also arise there with some frequency (such as in the insider trading context as seen in Chiarella and Dirks).  While vigorous application of fiduciary duties was embraced more fervently several decades ago, adherence to this approach has vanished to a significant extent.  Nonetheless, courts continue to extol the presence of fiduciary duties in their opinions, with reality striking a very different key.  Indeed, fiduciary duty standards are so diluted in the corporate and securities law settings they no longer should be deemed fiduciary-like.

My article explores the multi-faceted settings in which state courts embrace fiduciary duty principles in the language of their opinions, yet invoke far more lax standards when faced with the question of fiduciary liability.  This phenomenon is evidenced in a myriad of situations implicating fiduciary liability exposure, including related party transactions, corporate opportunity takings, and the duty of good faith.  State statutes also play a key role in this process as exemplified by the director exculpation statutes that enable directors to avoid monetary liability for their grossly negligent conduct (so long as such conduct does not breach the duty of loyalty).  On the federal securities level, a glaring example of the distinction between rhetoric and reality is illustrated by the safe harbor for forward-looking statements whereby corporate fiduciaries can deliberately lie yet avoid monetary liability so long as such forward-looking statements are accompanied by meaningful, cautionary disclosures that are tailored to the optimistic statements made.

With respect to state corporation law, two examples will be provided here (while many others are discussed in the article).  The first is seen by contrasting the Delaware Supreme Court’s language in Aronson v. Lewis versus the court’s holding.  Invoking forceful language, the court stated:  “Representation of the financial interests of others imposes on a director an affirmative duty to protect those interests and to proceed with a critical eye in assessing information of the type and under the circumstances present ….”  Yet two paragraphs later, the court ruled that the applicable liability standard to assess whether a defendant director violated his or her fiduciary duty was gross negligence.  (488 A.2d 858, 872-73)  The distinction between rhetoric and reality is crystal clear.

The second example focuses on Stone v. Ritter, where the Delaware Supreme Court addressed the duty of good faith in the context of a director’s oversight function in regard to law compliance.  Quoting from Chancellor Allen’s well-known Caremark opinion (698 A.2d 959, 970), the court’s rhetoric conveyed that meaningful standards would be implemented:  “it is important that the board exercise its good faith judgment that the corporation’s information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations, so that it may satisfy its responsibility.”  This pronouncement amounted, however, to a mere exhortation.  When pronouncing whether corporate directors are subject to liability for lack of good faith in this setting, the court adhered to an abysmally lax standard that mandates a showing that directors “utterly” or “consciously failed” to comply with their law compliance oversight functions.  (911 A.2d 362, 368, 370)  Again, the gap between laudatory rhetoric and the liability standard adopted is immense.

It may well be that in certain situations that implicate alleged director or officer misconduct the liability standards adopted by courts are appropriate.  Nonetheless, these standards typically are not consistent with how fiduciary conduct is to be measured.  The article posits that the time has come to remove the label of fiduciary from director, officer, and control person status.  In its stead, the conduct required of these persons should be categorized as sui generis.  In this manner, the standards for insider conduct would reflect reality.  By eliminating the illusion that currently prevails, a donkey no longer would be called a racehorse.

This post comes to us from Marc I. Steinberg, the Rupert and Lillian Radford Chair in Law and professor of law at SMU Dedman School of Law. It is based on his recent article, “To Call a Donkey a Racehorse — The Fiduciary Duty Misnomer in Corporate and Securities Law,” available here and forthcoming in the Journal of Corporation Law. He is the author of Rethinking Securities Law (Oxford University Press 2021).

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