Corporate Securities Law Blog

A recent Delaware Court opinion, Bay Center Apartments Owner, LLC v. Emery Bay PKI, LLC, Case No. 3658-VCS (Del. Ch. Apr. 20, 2008), provides important guidance regarding whether and to what extent managers and members of a limited liability company (“LLC”) organized in Delaware owe duties to the LLC and its members. Section 18-1101(c) of the Delaware Limited Liability Company Act provides that “To the extent that…a member or manager...has duties (including fiduciary duties) to a limited liability company,…the member’s or manager’s duties may be expanded or restricted or eliminated by provisions in the limited liability company agreement; provided, that the limited liability company agreement may not eliminate the implied contractual covenant of good faith and fair dealing.” However, in Bay Center, the Chancery Court held that where the LLC is silent or ambiguous as to the duties members and managers owe to each other, they will be subject to the traditional fiduciary duties that directors of a Delaware corporation owe. It also imposed the duties of good faith and fair dealing on the manager of the LLC to perform its management functions in good faith. Therefore, the Bay Center decision is important in that it underscores the necessity of LLC participants that do not want to be subject to traditional fiduciary duties to clearly and unambiguously modify or eliminate these duties in the LLC operating agreement.

Governor Schwarzenegger today vetoed AB2944. The bill would have provided that directors may consider the interests of specific corporate constituencies in addition to the shareholders. For a more detailed description of this legislation, see our earlier article here. In his veto message to the California State Assembly, the Governor noted that        "[w]hile this bill proposes a new model of corporate governance consisting of a package of many intriguing concepts, it is just that; a package of concepts that could produce unknown ramifications and the need for which have not been fully demonstrated." For further information, please contact Peter M. Menard at (213) 617-5483.

The NYSE and Nasdaq each recently amended the definition of "independent director" to increase from $100,000 to $120,000 the amount of compensation that an independent director may receive from a listed company in a 12-month period.  In addition, the NYSE amended the definition of "independent director" to allow an immediate family member of an independent director to be employed by the company's auditor provided the immediate family member is not a partner of the auditor or working on the company's audit.

Seven Sheppard Mullin Corporate Partners have been named Best Lawyers in America for 2009.  David Bosko, Larry Braun, Robert Copeland, Tom Hopkins, Richard Kintz, Peter Menard and Mike Moore received this distinguished honor.  In addition to our Corporate Partners, 39 Partners from our Antitrust; Entertainment, Media and Technology; Finance and Bankruptcy; Government Contracts and Regulated Industries; Intellectual Property; Labor and Employment; Land Use and Natural Resources; Litigation; Real Estate; Tax and White Collar Practice Groups were named Best Lawyers in America for 2009.

In Schoon v. Troy Corporation, 948 A.2d 1157 (Del. Ch. 2008), the Delaware Chancery Court held that a former director is not entitled to advancement rights where a later board-approved amendment to the corporation’s by-laws cut off such rights. This case is important for all directors and officers who are concerned about liability coverage after leaving a company or resigning from the board of directors.

Proposed legislation in California would expressly provide that directors may consider the interests of specific corporate constituencies in addition to the shareholders.  This legislation seeks to promote corporate social responsibility by removing the threat of shareholder lawsuits against directors who consider the interests of certain constituencies which may be inconsistent with the interests of the corporation's shareholders.  The bill further seeks to clarify the directors' standard of care in connection with acquisitions.  However, the bill is ambiguous as to whether it applies only to corporations formed under the laws of California or also applies to so-called "quasi-California corporations," corporations with significant ties to California.

A recent Stanford University study casts doubt on the validity of the corporate governance ratings provided by Institutional Shareholder Services (ISS) and its principal competitors.

Governance rating firms seek to measure the effectiveness of a public company's corporate governance.  They maintain that this rating is predictive of the company's future performance.

Stanford's study claims to be the first objective analysis of the predictive value of corporate governance ratings.  It examined more than 15,000 ratings of 6,827 separate companies from 2005 to 2007.

In In re Netsmart Technologies, Inc. Shareholders Litigation, C.A. No. 2536-VCS (Del. Ch. Mar. 14, 2007), Vice Chancellor Strine held that the shareholder plaintiffs demonstrated a probability of success on the merits of their claim that the Netsmart board of directors failed to fulfill their Revlon duties in considering and approving a cash sale of the company to two private equity firms.  The Court determined that the board’s decision not to conduct a broad market canvass for strategic acquirers, and instead focus the search for acquirers solely on private equity firms, did not appear to be reasonable under the circumstances.  The Court also held that the post-signing “market check” recommended by the company’s financial advisers was not appropriate for a small-cap company like Netsmart, thus was far too passive to have been effective in mitigating the narrowness of the pre-signing market canvass.  This decision provides guidance to boards when considering a sale to a private equity firm — an increasingly common situation affecting boards of directors of public companies throughout the country.

The SEC and PCAOB have taken significant new steps to implement promised reforms to the implementation of Section 404 of the Sarbanes-Oxley Act, which has been widely perceived to be unduly expensive and burdensome.  On May 23, 2007, the SEC approved new interpretive guidance for management’s assessment of internal controls, and amendments to certain Section 404 related rules.   The new guidance provides a principles-based framework intended to help public companies strengthen their internal control over financial reporting while reducing unnecessary costs, particularly for smaller companies.  On May 24, 2007, the PCAOB voted to adopt Auditing Standard No. 5 to replace its previous internal control auditing standard, Auditing Standard No. 2.

The SEC today announced that the staff would recommend an amendment to the proxy access rules to respond to the issues raised in AFSCME v. AIG, and scheduled an open meeting on October 18 to consider the recommendation. In making the announcement, the chairman of the SEC noted that shareholder rights in the proxy process "are best secured under a consistent national application of Rule 14a-8 to shareholder proposals" and that the SEC would schedule public comment and final consideration of the proposal "to allow a final rule to go into effect in time for the 2007 proxy season."

In AFSCME v. AIG, the Court of Appeals for the Second Circuit today provided a powerful impetus to the efforts of institutional shareholders to expand proxy access. The court’s decision does not directly grant shareholders the right to present their own slates of director nominees in the company’s proxy statement. However, it does challenge the long-standing interpretation of Rule 14a-8(i)(8) as permitting a company to exclude a shareholder proposal granting shareholders increased proxy access. If the SEC fails to respond to the court’s decision by clarifying or amending Rule 14a-8(i)(8), shareholder activists predict a surge in shareholder proposals to establish liberal proxy access procedures on a company-by-company basis.

The U.S. Sarbanes-Oxley Act of 2002 ("SOX") requires audit committees of public companies to establish procedures for the anonymous submission by employees of that company of concerns related to accounting and financial matters. Multinational corporations, however, have to be careful to consider data protection, labor and human rights legislation in the EU and other countries in the design of their whistleblower programs. 

In January 2006, the SEC staff rejected the argument of Hewlett-Packard Company that it could exclude from its proxy statement a stockholder proposal to adopt a majority vote standard in the election of directors. Hewlett-Packard had argued that it could exclude the proposal under the SEC proxy rules because its existing voting policy "substantially implemented" the proposal. At its annual meeting on March 15, 2006, 53.0% of the votes present voted against the proposal, 43.5% voted for the proposal and 3.5% abstained.

Senator Richard Alarcon (D: San Fernando Valley) has introduced a bill that would require a company incorporated in California to elect directors by a majority of the votes cast in an uncontested election. The bill codifies a majority vote standard similar to those already adopted by Intel Corporation, Dell Inc., PepsiCo, Inc., Texas Instruments and others.

Two standards are emerging in the push to replace the current plurality vote standard in the election of directors.