Saturday, October 15, 2022

Diversified Standing

A lot of people are talking about this complaint against Meta, filed by James McRitchie, alleging that the Board violates its fiduciary duties to diversified shareholders because it seeks to maximize profits at Meta individually while externalizing costs that impact shareholders’ other investments.   The complaint further argues that the Board, whose personal holdings in Meta are undiversified, labors under a conflict with respect to diversified investors (seeking, apparently, to avoid the business judgment rule and obtain higher scrutiny of the Board’s actions).

The “universal ownership” theory of corporate shareholding has got a lot of traction recently; as I previously blogged, it’s appealing because it suggests that corporations can be forces for social good without actually changing anything about the structure of corporate law.

That said, academic champions of the theory do not necessarily argue in terms of fiduciary duty – that is, they aren’t claiming that either as a normative or descriptive matter, corporate boards are legally obligated to maximize wealth for shareholders at the portfolio level – instead, they tend to elide those kinds of claims and simply argue that as a matter of power, diversified investors have sufficient stakes and influence to control board behavior in this regard.

The problem with making the argument from the legal perspective, as Marcel Kahan and Ed Rock point out, is that it is not terribly compatible with corporate law as it is currently structured.

That comes through very clearly in the McRitchie complaint, which is brought both directly and, in the alternative, derivatively.

As a direct claim, the plaintiffs are only arguing that they are injured in their nonshareholder capacities – that is, with respect to the aspects of their existence other than their investment in Meta, namely, their existence as shareholders in other companies.  The Board of Meta obviously has no duty to maximize the wealth of these shareholders in their nonshareholder capacities, any more than it has a duty to maximize the wealth of corporate employees by paying them larger salaries, simply because the employees might also be shareholders.

As a derivative claim, it fails because derivative claims by definition allege harm to the corporate entity, and the complaint is very explicit that the Board’s actions do not harm Meta, but instead maximize its value (at the expense of others).

That said, the complaint highlights the underlying tension in corporate law, namely, the question whether directors’ fiduciary duty is to advance the interests of a kind of abstract notion of a shareholder (in which case, directors’ duties are a matter of government policy rather than private ordering), or instead, whether the duty is – or should be – to advance the interests of the actual shareholders who actually make investment and voting decisions.

It is worth noting, by the way, that these tensions are also playing out in the context of federal disclosure requirements.  The SEC’s proposed climate change disclosure rule does, to some extent, take into account the preferences of diversified investors who want a portfolio-eye view:

Investors have noted that climate-related inputs have many uses in the capital allocation decision-making process including, but not limited to, insight into governance and risks management practices, integration into various valuation models, and credit research and assessments.  Further, we understand investors often employ diversified strategies, and therefore do not necessarily consider risk and return of a particular security in isolation but also in terms of the security’s effect on the portfolio as a whole, which requires comparable data across registrants.

Commissioner Peirce, however, objects:

The Commission justifies its disclosure mandates in part as a response to the needs of investors with diversified portfolios, who “do not necessarily consider risk and return of a particular security in isolation but also in terms of the security’s effect on the portfolio as a whole, which requires comparable data across registrants.”  Not only does this justification depart from the Commission’s traditional company-specific approach to disclosure, but it suggests that it is appropriate for shareholders of the disclosing company to subsidize other investors’ portfolio analysis.  How could a company’s management possibly be expected to prepare disclosure to satisfy the informational demands of all the company’s investors, each with her own idiosyncratic portfolio?  The limiting principle of such an approach is unclear. 

Edit: After this post was published, the plaintiffs suing the Meta board amended their complaint to eliminate the derivative claims.

Ann Lipton | Permalink


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