As corporate directors and other private actors have taken on public or quasi-public functions like reigning in conflicted executives or approving healthcare claims, fiduciary duties have expanded to protect the vulnerable and bridge the gap between public and private law.[1]  But what if those duties fail to overcome the private actors’ own financial conflicts?

In a new article, I use game theory to demonstrate that fiduciary duties that require individuals to put aside their own self-interest in favor of the best interests of beneficiaries do not work in the long run without targeted regulations and enforcement.  While the promise of selflessness has allowed for increasing delegation to private actors, inherent financial conflicts of interest have shown that labeling people as fiduciaries does not ensure their good behavior.[2]  The use of fiduciary duties should therefore be contracting instead of expanding.  While some of the conflicts may not be disqualifying under Delaware or federal law, they still present actual conflicts that affect decisions.

The Corporate Game: Social Networks and Fiduciary Duties

Most outside directors owe their position – and accompanying salary and stock options – to their business contacts and friendships.  Their desire to retain their positions as directors fundamentally conflicts with their task of deciding and voting on executive pay because good relations with the CEO, for example, can be key to their job security.  Decisions made to retain their positions can conflict with the directors’ fiduciary duty to shareholders not to overpay executives.[3]  The recent Delaware litigation related to Elon Musk’s outsized compensation is illustrative.[4]

In this corporate game, directors must decide on a compensation package for an executive whose approval is necessary for their continued employment, and the executive can use social pressure and threats to pressure directors to overpay.  I demonstrate that whatever the value of the motivation to serve shareholders and the related risk of shareholder litigation, it does not outweigh the payoff from maintaining a high-paying director position.  Absent legislation and regulations limiting the social interaction between the director and officer or imposing reforms such as term limits, the directors will overpay executives.

The Health Game: Insurance Company and Employer Alignment

Most health insurance claims are routine and quickly approved, but many costly ones are not.  The more claims plan administrators reject, the more money they keep.  Administrators of self-insured health plans, typically large insurance companies, receive a deferential arbitrary-and-capricious standard of review for their decisions and are unlikely to have them overturned.[5]  Given that administrators have discretion to interpret the terms of the plan and what is medically necessary for beneficiaries, if they fail to meet their fiduciary obligations to beneficiaries by ignoring financial conflicts of interest, beneficiaries cannot meaningfully seek relief elsewhere.[6]  Because the claims depend on the facts, the inability to bring class actions also limits fiduciaries’ incentives to defer to beneficiaries’ physicians since denied claims are less likely to be litigated.

Employers share in the cost-savings when administrators reject insurance claims since they typically subsidize premiums for employee health insurance plans – leaving them with little incentive to dismiss administrators who deny too many claims.  When deciding whether to continue using a particular administrator for their health insurance plans, an employer does not have a fiduciary duty to employees.[7]  In this health game, administrators will reject expensive claims that are not clearly covered by the terms of the insurance plan – even where the treatments would help beneficiaries and are recommended by their physicians, and employers will retain the administrators because they too are saving money.  Administrators’ and employers’ interests are aligned with each other and not with employees’ interests.

Shrinking Fiduciary Duties

At a minimum, the assumption that calling private actors who exercise public or quasi-public powers “fiduciaries” changes their behavior needs to be qualified.  In addition, aligning fiduciary incentives with beneficiaries’ interests – either through rewards for selfless behavior or enforcement actions and penalties for self-interested behavior – is more likely to help.  Innovative proposals include limiting the amount and type of purely social contact that executives have with outside directors (less golf and pickleball for all).  In the business of health, outside review by a neutral medical expert is the best option to confirm in whose interests fiduciary administrators are truly acting.

ENDNOTES

[1] See Sam Halabi, Against Fiduciary Utopianism: The Regulation of Physician Conflicts of Interest and Standards of Care, 11 U.C. Irvine L. Rev. 433, 443-45 (2020).

[2] See, e.g., Deborah DeMott, The Domains of Loyalty: Relationships Between Fiduciary Obligation and Intrinsic Motivation, 62 Wm. & Mary L. Rev. 1137, 1146-50 (2021); Stephen Galoob & Ethan Leib, Fiduciary Loyalty, Inside and Out, 92 S. Cal. L. Rev. 69, 72-76 (2018).

[3] Benihana of Tokyo, Inc. v. Benihana, Inc., 906 A.2d 114 (Del. 2006) (“[C]orporate action . . . may not be taken for the sole or primary purpose of entrenchment.”).

[4] Hyunjoo Jin, et al., Elon Musk wins Tesla shareholder approval for $56 billion pay package, Reuters, June 14, 2024, https://www.reuters.com/business/autos-transportation/musk-says-both-tesla-shareholder-resolutions-passing-by-wide-margins-2024-06-13/; Elon Musk cannot keep Tesla pay package worth more than $55 billion, judge rules, NPR, Jan. 31, 2024, https://www.npr.org/2024/01/31/1228066397/elon-musk-cannot-keep-tesla-pay-package-worth-more-than-55-billion-judge-rules.

[5] Lauren Roth, Abandoning Fiduciaries in Health Care, in I. Glenn Cohen, Christopher Robertson, Wendy Netter Epstein, Carmel Shacher, Susannah Baruch (eds.), Health Law as Private Law, Cambridge Univ. Press (forthcoming Jan. 2025).

[6] Id.

[7] Dana Muir and Norman Stein, Two Hats, One Head, No Heart: The Anatomy of the ERISA Settlor/Fiduciary Distinction, 93 N.C. L. Rev. 459, 478-89 (2014).

This post comes to us from Professor Lauren R. Roth at Touro University’s Jacob D. Fuchsberg Law Center. It is based on her recent article, “The Fiduciary Game,” available here.