Editorial: Audit committee member: Rent your own house
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Volume 3 Number 1
Editorial Audit committee member: Rent your own house The excitement felt last summer by those who thought that the long-awaited Disney decision had effectively stopped the movement to hold directors more liable for their actions — or rather, for their lack of them — seems to be subsiding as the reaction sets in. The strongly worded appeal at the Delaware Chancery Court last month indicates that plaintiffs are not going to willingly allow directors to have a free pass on their fiduciary responsibilities on the argument that the business judgment rule shields them from what to a shareholder, if not a judge, seems to be the most egregiously incompetent behaviour. Moreover, there is disagreement about the import of the case. Is the bent of the decision in upholding the business judgment rule overshadowed by the new good faith standard he hinted at in exercising the duty of care? In their fervour of excitement at the original trail finding, many corporate lawyers began touting the notion that by contemporaneous documentation of her thoughts, a director who has reservations about a company action could protect herself from liability. Unfortunately, the director may find herself alone when facing the torrents of litigation, the lawyer very probably being insulated from liability for the half-hearted advice proffered at $1,000 an hour. In the Enron and WorldCom cases, no director was adjudicated to be culpable of recklessness, the standard for liability in Private Securities Litigation Reform Act (PSLRA) cases, but the vagaries of the real world, the prospective exhaustion of insurance policy proceeds coupled with the inexhaustible deep pockets of institutional investors, forced independent directors into
out-of-pocket settlements. And there is really no telling what constitutes recklessness under the PSLRA for independent director conduct or gross negligence under Delaware Law. In a 2002 paper, after the enactment of the Sarbanes–Oxley Act, the Chancellor and the Vice-Chancellor of the Delaware Chancery Court, including the author of the Disney decision, posited the notion that violations of the Act by officers and directors might be grounds for a derivative suit under Delaware corporate law.1 Delaware, however, is unlikely to be the driving force in corporate law reform through judicial decisions; neither is it likely to retard changes in corporate law and standards of directors’ liability. As Professor Mark Roe of Harvard Law School has shown, Delaware courts work within the parameters of federal decisions and federal legislation.2 Indeed, for two years after the enactment of the Sarbanes– Oxley Act almost all Delaware case rulings favoured the plaintiffs. Consequently, time spent wasted on reading the tea leaves in the Disney case is counterproductive to understanding the future of officer and director liability. Nor need we wait for federal court cases adjudicating director recklessness in exercising the duty of care. The dynamics of the D&O insurance settlement process coupled with institutional investor
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