Corporate Governance

Delaware Courts and Exonerating the Board from Supervising Risk: In re Citigroup Derivative Litigation (The Judicial Defense of a Mirage)

By J. Robert Brown

We are discussing In re Citigroup. 

The case contains a fair amount of "speechifying", instances where the Chancellor chose to lecture both the parties and, presumably, the American public.  It is clear that he views derivative suits, including the ones against Citigroup, as little more than whining by investors who made bad business decisions.  The Chancellor treats the near failure and nationalization of Citigroup as no different than any other business transaction that ultimately proved unsuccessful. 

In describing the crisis at Citigroup, the Chancellor attributes it to a decline in the market and the "recent problems" in the economy.  He resolutely refuses to leave open the possibility that the crises was not a result of unexpected economic changes but a direct result of mismanagement by the persons running the financial institutions.  As he describes:

• Citigroup has suffered staggering losses, in part, as a result of the recent problems in the United States economy, particularly those in the subprime mortgage market. It is understandable that investors, and others, want to find someone to hold responsible for these losses, and it is often difficult to distinguish between a desire to blame someone and a desire to force those responsible to account for their wrongdoing. Our law, fortunately, provides guidance for precisely these situations in the form of doctrines governing the duties owed by officers and directors of Delaware corporations. This law has been refined over hundreds of years, which no doubt included many crises, and we must not let our desire to blame someone for our losses make us lose sight of the purpose of our law. Ultimately, the discretion granted directors and managers allows them to maximize shareholder value in the long term by taking risks without the debilitating fear that they will be held personally liable if the company experiences losses. This doctrine also means, however, that when the company suffers losses, shareholders may not be able to hold the directors personally liable.

This is a defense of a mirage.  It is another variation of the adage, let the market resolve all disputes.  There is nothing wrong with defending the goal of profit maximization.  But while it is the board's role to determine how this should occur, Chancellor Chandler continues to adhere to the view that there need not be any meaningful standards imposed on directors in making that determination. 

He is, instead, relying on director self interest to protect shareholders.  Yet the reailzation grows that  unemcumbered management is at least in part what got us into this current financial mess.   By leaving management alone, management engaged in risk taking that maximized returns in the short term (often resulting in higher executive compensation) but resulted in long term damage to the company (and the economy).  No less than the former head of the the Federal Reserve Board, Alan Greenspan, has all but confessed that the Delaware approach is entirely misguided.    

The Delaware courts do not get it because they are interpreting a system that they largely helped create.  Nor do they want to take responsibility for a system that has contributed so mightily to the current economic crisis.  Citigroup contains a Lochner like defense of a system that will probably not last much longer.  Indeed, the courts in Delaware are helping to make the case.  By exonerating the board from taking any meaningful role in risk assessment, even for risks that all but bankrupted the company, the courts are demonstrating that they are not up to the task and are accelerating the case for reform.  

As usual, we have posted primary materials on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on March 17, 2009 (boomark / email).