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: The Race to the Bottom

Citi, the Board and the Myopic Vision of the Delaware Courts

By J. Robert Brown

Back in the 1990s, shareholders challenged the compensation paid to Michael Ovitz.  As part of their challenge, they alleged that the board wasn't sufficiently independent.  In an extraordinary opinion, the Chancery Court found the board independent, a decision that entailed a finding of independence for a principal of a high school, a president of a college where Michael Eisner contributed $1 million and a director who's wife received contracts for her business.  While the court viewed it as independent, the market did not.  Business Week ranked it as the worst board (from a corporate governance perspective) two years in a row.  It demonstrated the myopic view.

A similar thing is taking place today with Citigroup.  The US Government has agreed to take a very large stake in the bank (36% according to published reports).  As part of the investment, the Government has demanded substantial changes in the board.  As the WSJ reported:

The company will reconstitute its board to include a majority of new independent directors. It said of the 15 current directors, three will not stand for reelection and two will reach retirement age, and it will announce new directors soon. Citigroup Chairman Richard Parsons has been scrambling to lure new directors. That has proven an uphill battle, with two candidates Citigroup approached rebuffing the overtures, according to people familiar with the matter.

In other words, the Government views the existing board as having done an inadequate job.  At the same time this is occurring, the Delaware Chancery Court issued an extraordinary opinion involving Citigroup, the board, and allegations that the board did not adequately supervise the excessive risk taking by the bank.  We plan to post on this decision at length in the future. 

For now, though, suffice it to say that the shareholder suit was dismissed, that the court found nothing untoward in the board's behavior, and that it issued an opinion that all but accused the plaintiffs of doing little more than bring a suit because they were unhappy, in hindsight, with business deals that didn't work out.  The case contains a lecture largely defending the very system of governance that has resulted in the current turmoil. 

Disney in the 1990s showed how out of touch with reality the courts were, something that came home with a vengeance in the Enron era and resulted in the adoption of Sarbanes-Oxley, a law that largely preempted state law.  The Citigroup case is the poster child of the new millennium that shows just how little the courts are willing to make the boards responsible for the oversight of the company.  It demonstrates with equal force why more preemption is necessary.

Most of the primary materials on the Citigroup case can be found at the DU corporate governance web site.

Full post as published by The Race to the Bottom on March 02, 2009 (boomark / email).