Tuesday, December 11, 2018

Not Every CEO Opinion is a Breach of Fiduciary Duty (Most Aren't)

Jack Welch, former GE CEO (1981 to 2001) was revered for his ability to maximize shareholder value.  Yet in 2009, he explained that shareholder value was

“the dumbest idea in the world. Shareholder value is a result, not a strategy... your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal… Short-term profits should be allied with an increase in the long-term value of a company.”

This runs contrary to how many people think about the role of the CEO and the board of directors.  I think it's spot on, and it is a key reason the business judgment rule, and its role in preserving director primacy, is so critical.   

Last week, a Wall Street Journal article about Dick's Sporting Goods made the rounds. The article reported: 

Ed Stack, the chairman and chief executive of Dick’s Sporting Goods Inc., arrived at work the Monday after a gunman killed 17 people at a school in Parkland, Fla., nearly certain the outdoor retailer should limit sales of some guns.

. . . .

Dick’s Financial Chief Lee Belitsky asked, “So what’s the financial implication here?” according to Mr. Stack. “I basically said, I don’t really care what the financial implication is, but you’re right, we should look.”

Company executives convened the board via teleconference to explain the proposed plan, took some time to reflect, then gathered again a few days later to vote. “It was unanimous that we should do this and stand up and take a stand,” said Mr. Stack, whose family holds a controlling stake in the retailer.

This revelation led many folks to question whether Stack's statement that he did not "really care" about the financial implications was a breach of fiduciary duty.  The concern was buoyed by the reality that store sales had dropped about 3% to  4% for the year, and the drop was linked to the decision to limit certain gun sales. 

That said, a drop in sales does not mean there was a breach of any duty any more than an increase in sales means no breach occurred. Results may be evidence, but that's all they are. Part of the story. Incidentally, though it is not proof, either way, it is worth noting that Dick's sales dropped, but profits rose after the decision because the company cut costs by replacing some guns with higher-margin items. 

It seems like every time a CEO or board issues a decision that is controversial or chooses to say that he or she supports a certain course of action because they think it is the "right thing to do," the questions begin about whether either the duty of care or loyalty has been breached.  I maintain that a statement (or series of statements) like that is not sufficient to overcome the business judgment rule to allow a review of the decision.  

This is especially true where, like in the Dick's situation, there is evidence that the company deliberated appropriately. The WSJ article noted that company executives called together the board to explain the proposed plan, "took some time to reflect, then gathered again a few days later to vote." The vote was unanimous to end all assault-style weapons sales and to and stop selling guns or ammunition to those under 21 years of age. Interestingly, Walmart Inc. and other retailers followed Dick's lead later that day. If the deliberative process is a concern, it would seem those following Dick's should be more vulnerable to a fiduciary duty/business judgment rule challenge than Dick's. 

For what it's worth, I think Dick's or any store deciding NOT to change their sales practice would also be protected by the business judgment rule, just as I think Chick-Fil-A's decision not to open on Sundays should be protected by the business judgment rule (though if it were a Delaware corporation, I am not sure it would be). 

This is not to say I don't believe in fiduciary duties. I very much do. I just also believe in a strong business judgment rule, ideally enforced as an abstention doctrine. (I believe in lots of things.)  

I need more than a few public statements before I think anyone should be looking behind an entity's decision making. Recent examples raising entity fiduciary duty questions, like Dick's and Nike's Colin Kaepernick ads, have had positive financial outcomes of the entities, but it shouldn't matter.  The business judgment rule is there to protect all the decisions of the board that are not the product of fraud, illegality, or self-dealing, not just correct decisions. 


Corporate Governance, Corporations, Current Affairs, Joshua P. Fershee | Permalink


I’ve lost count of how many times we’ve butted heads on this issue, but as long as you keep defending CEOs who do “the right thing” (according to them) without regard for ROI, I’m likely going to keep pushing back (with all due respect, of course). So, once more unto the breach, dear friends.

You state that the only ways to overcome the BJR are to show (1) fraud, (2) illegality, or (3) self-dealing. What about bad faith? What about the duty of care? What about waste? Also, does deliberation itself satisfy the duty of care, or does the law have something to say about the focus of those deliberations? In other words, if Dick's board deliberated for days, but ignored material information reasonably available, they violate their duty of care -- correct? And what constitutes "material" in this context? Doesn’t it have to have some connection to ROI? So, if Dick’s spent days deliberating the pros and cons of gun regulation, but didn’t make any attempt to calculate the ROI impact of their decision, is that okay? As far as I’m concerned (though I remain willing to be convinced otherwise), when CEOs do whatever they conclude is “the right thing” with no regard for ROI, they are breaching one or more of their fiduciary duties. It’s basically Dodge v. Ford. The fact that we have CEOs who apparently need to be reminded that they should look into the financial implications of their business decisions may well show how badly we need to defend meaningful fiduciary duties. Of course, that’s assuming all this talk of not caring about ROI isn’t just another form of greenwashing.

Posted by: Stefan Padfield | Dec 12, 2018 9:03:47 AM

We will continue to butt heads on this one. Where we differ is the threshold. Of course, one can breach the duty of care, engage in bad faith, or commit waste. But a mere statement about one’s opinion should not open a director or company to a full-blown lawsuit. Talk about waste.

Perhaps I am not being as clear as I could be that I do believe breaches of fiduciary duty happen, but I also think most of the statements being critiqued recently are not significant enough to raise the specter of waste or self-dealing. Further, I just don’t believe that every statement every fiduciary makes needs to be followed by “because that’s what it is in the best long-term interest of the company.” Instead, the business judgment rule, in essence, adds that clause to all statements. I don’t think any of the recent examples of CEOs or directors making public statements about the “right thing to do” need to be reminded to consider the financial ramifications of their decisions. Perhaps they had a sudden change of heart, but I doubt it.

I suppose part of it is that I don’t read Nike or Dick’s leaders to be saying “I don’t care about ROI in any case at any time.” They are saying, “In the instance, I am not overly concerned about ROI as to this specific decision. Nonetheless, we’ll consider it, anyway.” I humbly suggest that this is very different than Henry Ford’s “attitude towards shareholders . . . that they should be content to take what he chooses to give.”

And there are some investments where the ROI analysis could suggest it’s a good idea, and yet, we want people to be able to decide not to invest. See, e.g., Enron. I recall a story I heard awhile back about restaurant whose owner was convinced by a salesman to buy frozen biscuit dough because it would increase the margin on each one sold by 2 or 3 times. The owner made the switch and it almost killed the restaurant. They went back to making the biscuits inhouse and saved the restaurant. He vowed never to buy them from anyone else ever again. Is that a breach of fiduciary duty? I think not.

I think a restaurant could decide “we will never buy any finished products from a vendor, ever” without regard to ROI and still never violate the BJR or breach a duty. Why? Because it is the role of the directors and officers to determine “what it is in the best long-term interest of the company.” That includes determining what to assess in making business decisions, not just determining what the final course will be. That is, those in charge decide both the process and the substance, subject to a whole lot of latitude.

Ultimately, I am not saying a CEO or director can do whatever he or she wants in any circumstance. I just think I have a much higher threshold for what constitutes support for review of such statements/decisions. It’s why I like Van Gorkem so much. Plaintiffs were able to show that he set a price for the company that he was willing to accept (cue self-dealing) and then followed a process more aimed at closing that deal at all costs rather than determining the best deal. In contrast, I just don’t think Dick’s or Nike were saying, “I want this for me and forget everyone else.” They were saying, “At my core, I believe this is right morally, and because of that, it’s good for the company.” I’d even finish that with, “And you hired me for my judgment. I will now exercise it.”

Posted by: Joshua Fershee | Dec 12, 2018 10:55:11 AM

I am more inclined to agree with you in cases where the CEO is not expressly dismissing ROI concerns. When Stack says, "I don’t really care what the financial implication is," or Tim Cook says, "I don't consider the bloody ROI," that strikes me as very difficult to distinguish from Dodge v. Ford, and as far as I’m concerned, the CEO in those cases is either admitting a breach of duty or is consciously “greenwashing,” which might well constitute its own breach of the duty of candor. Admittedly, I am assuming that there’s not a change of heart later, and I would certainly allow room for “heat of the moment” comments – but I believe that once a CEO is on record as making a business decision with no regard for ROI, then some type of burden-shift is appropriate, since we can no longer presume the requisite good faith at the heart of the business judgment rule.

Posted by: Stefan Padfield | Dec 12, 2018 11:20:26 AM

Well, in both the Nike case and the Dick's case, the boards did expressly state that the issues were reviewed and deliberated, which, if nothing else, reflect (to me) valid board decisions not to pursue any concerns about lack of good faith that might exist. That is, a derivative suit would and should fail.

For another example, I don’t think Tylenol would be a product today after the 1982 cyanide tampering deaths had they not pulled all products off the shelves. Many thought it was an overreaction. Others think it saved the product. Whose call should that be? The CEOs. And I think it was right one.

I continue to believe that one can reasonably run a company by doing what they think is best for the business without too much review. My sense is that you feel certain conclusory statements allow courts to presume bad faith or lack of care. I still think plaintiffs need to show bad faith or lack of care, and “I don’t care about ROI” is not enough for me.

We are, it seems, once again locked in our circular BJR debate.

Posted by: Joshua Fershee | Dec 12, 2018 11:51:57 AM

I might frame it as follows: I find it problematic to apply a presumption that a business decision was made on a fully informed basis when the decision-maker has said it wasn’t (e.g., "I don’t really care what the financial implication is" or "I don't consider the bloody ROI"), while you view those statements as little more than inactionable puffery.

Posted by: Stefan Padfield | Dec 12, 2018 12:25:41 PM

I'll buy that. For my part, I'd probably say see the statements as "inactionable puffery that preserves appropriate risk-taking and protection of the firm's reputation and brand," but I will buy that.

Posted by: Joshua Fershee | Dec 12, 2018 1:28:57 PM

Post a comment