Alexandra R. Lajoux (photo by Peter Krogh)

Pay Rules Pending
To finish up its implementation of Dodd-Frank, the SEC must produce final rules on investment manager pay votes, compensation committee and advisor independence (proposed but not yet final), pay for performance, CEO-to-median employee pay ratios, executive compensation clawbacks, and disclosure of hedging by employees and directors. Any one of these could create compliance challenges for boards—a truth admitted even by board critics.

At a Dec. 12 conference hosted by the Americans for Financial Reform at the headquarters of the AFL-CIO, investors, academics and advisors expressed hope that the pending rules would thwart excessive CEO pay—and thus help directors to do so. In a keynote address, Rep. Elijah Cummings (D-MD) advised that the SEC should continue what Dodd-Frank started. In response to charges throughout the day that directors “failed” to prevent runaway pay, Professor Robert J. Jackson Jr., associate professor at Columbia Law School, argued that directors are far more vigilant than ever about pay—a point reinforced by Anne Sheehan, director of corporate governance with the California State Teachers’ Retirement System (CalSTRS). Jackson wants to see more disclosures about trader-level compensation in financial firms.

Social Rules Ahead
The three social rules pending at the SEC involve disclosures about conflict minerals, mine safety and resource extraction. The conflict minerals rule, which affects not only products but also packaging and potentially equipment and machinery, has a broad impact (see “Keeping Count,” December 2011). Comments are still being received for this rule.

In one recent comment letter, Sen. Olympia Snowe (R-ME), ranking member of the U.S. Senate Committee on Small Business and Entrepreneurship, urged the SEC to consider a principles-based approach drawn from the guidelines given by the Organisation for Economic Co-operation and Development: Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas. The OECD report provides “guidance regarding due diligence rather than a bright-line approach to compliance, as proposed,” according to the Snowe letter.

Whistleblower Redux
Meanwhile, congressional review may curb a rule already signed, sealed and delivered. In mid-December, the Capital Markets and Government Sponsored Enterprises subcommittee, chaired by Rep. Scott Garrett (R-NJ) began marking up the proposed Whistleblower Improvement Act of 2011 (H.R. 2483), sponsored by subcommittee member Michael Grimm (R-NY), and aimed at improving the whistleblower provisions of Dodd-Frank. The bill, to be approved and fine-tuned by the committee, would amend securities laws to require would-be whistleblowers to report the alleged misconduct first to the company, as long as the company has an anonymous reporting system and anti-retaliation policy. Under the bill, awards would be discretionary, not mandatory, and they cannot go to wrongdoers or to front-line compliance personnel—compliance staff and advisors can’t be rewarded for simply doing their jobs. Finally, the bill would require the SEC to notify a company of its investigation, unless notice would compromise it.

Clearly, the SEC is having a major impact these days. Corporate directors would be wise to keep their eyes on the agency’s unfolding agenda.

Checks and Balances
Nor are the courts out of the SEC’s loop. Courts may review SEC decisions, and the SEC may review court decisions.

In November, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York rejected a proposed settlement agreement between the SEC and Citigroup. Under the agreement, Citigroup would have paid a $285 million fine to the agency without admitting guilt. Judge Rakoff claimed that the agreement, lacking sufficient details on the allegations against Citigroup, was “not in the public interest.” The matter will now go to trial, which is set for July 16.

Still to come is an SEC review of a key court decision. As directed under Dodd-Frank, the SEC in January will tell the world what it thinks of Morrison v. National Australia Bank Ltd, a 2010 U.S. Supreme Court decision that upheld current restrictions against U.S. investors from filing securities lawsuits against foreign-listed companies operating in the U.S. If the SEC finds the decision unfair to U.S. issuers, it could make foreign companies a lightning rod for securities suits.

Reuters

In one of the most egregious examples, Bernard Madoff pleaded guilty in 2009 for his role in a multibillion-dollar Ponzi scheme, but neither admitted nor denied the allegations in a settlement with the SEC.

“It was ludicrous to say the defendant does not admit charges that he’s already pled criminally guilty to,” John Coffee, a professor at Columbia Law School, told the Chicago Tribune.

The practical impact of the change could be limited. Since defendants will not be required to admit to allegations beyond those in a criminal case, it may do little to help private litigants sue on similar grounds, a concern companies have long raised. “It is a very small, marginal change,” but it “does make them look more flexible,” Coffee said.

In a separate action, the SEC filed FCPA charges against eight former Siemens executives, marking the first charges against a board member of a Fortune Global 50 company. The decade- long bribery scheme was aimed at establishing and protecting a $1 billion contract to produce national identity cards for Argentine citizens. “Our investigation reveals that there were few lines the executives were unwilling to cross to win the contract,” Khuzami said in a conference call on the charges in early January, noting that Siemens executives allegedly approved up to $100 million in bribes.

Recipients of those bribes allegedly included two presidents and cabinet ministers in two Argentinean administrations between 1996 and 2007. Of the funds used in the scheme, approximately $31.3 million were made after March 2001, when Siemens became a U.S. issuer.

Law Firm Warns of ‘Time Bomb’ After Comcast’s Roberts Is Fined
Comcast CEO Brian L. Roberts faces a $500,000 fine for acquiring Comcast stock between 2007 and 2009 and failing to notify the Federal Trade Commission and the Department of Justice before receiving voting shares beyond Hart-Scott-Rodino Antitrust Improvement Act (HSR Act) limits. Roberts originally obtained and made appropriate HSR filings for restricted Comcast stock units in connection with the company’s 2002 merger with AT&T. The shares vested to voting shares in 2007, while his approval expired in September of that year. He continued to obtain Comcast shares after the expiration without notifying the FTC or DOJ until August 2009, when he made a corrective filing and admitted to inadvertently violating the requirements due to faulty advice from outside counsel. Roberts did not gain financially from the violation, and reported the issue once it was discovered, according to the FTC. Considering these factors, the FTC opted not to seek the daily fine option authorized under the HSR Act, which could have totaled almost $9 million, according to a Latham & Watkins client advisory. “This case is a reminder for executives that they must be careful to avoid passive and inadvertent violations of the HSR Act. Counsel should also keep this cautionary tale in mind when advising companies and executives on compensation issues, including awards that will convert automatically into voting shares, to be sure that they are not setting time bombs,” the law firm advised.

Shareholders, Firms Disagree on Frequency of Votes
Seventy-two percent of shareholders called for annual compensation votes in the 2011 proxy season, the first in which the Dodd-Frank Act mandated nonbinding “say-on-frequency” votes, finds GMI in the final report in its say-on-pay series. Only 53 percent of management teams recommended annual votes, while 42 percent recommended the maximum triennial votes, citing the need for extra time to evaluate the programs, review shareholder input and implement changes. At the time of GMI’s study, 40 percent of companies had not yet decided which voting frequency to use, 10 percent had adopted a triennial policy, 50 percent had adopted an annual schedule, and just 0.37 percent chose biennial.

GMI also released its 2011 CEO Pay Survey, which found that total realized compensation in the S&P 500 and the Russell 1000 rose by 36 and 38 percent, respectively. Of the 10 highest-paid CEOs in 2010, three were from the health care providers and services industry, including the top two (John H. Hammergren of McKesson at $145.3 million and Joel F. Gemunder of Omnicare at $98.3 million). Russell 3000 companies saw a median increase in total realized compensation of 27.19 percent, in contrast to a 6.38 percent drop in 2008 and another decrease of 0.28 percent in 2009, often fueled by larger stock option exercises and vested stock profits in 2010.

Global M&A Slow to Return
Limited economic growth and sovereign debt concerns may prevent global mergers and acquisitions from returning to the $4 trillion volume level seen in 2007, according to Bloomberg’s 2012 Global M&A Outlook Survey. Forty percent of those surveyed viewed the energy and power industries as capable of the biggest jump in deal making, while basic materials and financial companies were also expected to succeed in M&A. While the 2011 study found that more than 40 percent of respondents expected equity to be the largest source of M&A funding, the majority of this year’s respondents believed internal cash reserves will be the main source.

Yahoo Explores New Directors
Yahoo Inc. is searching for several board candidates to replace possible outgoing directors, including Chairman Roy Bostock, The Wall Street Journal reported in early January. The executive search firm Heidrick & Struggles International has been hired to help in the effort. Yahoo director Patti Hart, head of the board’s nominating and corporate-governance committee, is spearheading the search. According to the WSJ, directors including Bostock and Yahoo co-founder Jerry Yang have been criticized by some shareholders who have complained about Yahoo’s handling of a strategic review and other issues, including its decision to rebuff a 2008 takeover.

Facebook Aside, Market for IPOs to Stay Cool
A Renaissance Capital study finds more than 200 American firms are waiting to go public, but fragile conditions and a significant backlog of initial public offerings highlight the tepid market, The New York Times reported. Facebook’s upcoming IPO has a market value estimated at $100 billion, but analysts say it will take more than that to heat up the market for IPOs. Nearly 70 percent of companies that went public in 2011 are trading below their offering prices.

Class Actions Stay Steady, Foreign Issuers Scrutinized
The number of shareholder class-action lawsuits filed in 2011 is likely to be on par with annual levels between 2008 and 2010, reports the NERA’s Recent Trends in Securities Class Action Litigation: 2011 Year-End Review. The report projects that there will be 232 shareholder class-action filings in 2011, while 2010 saw 241, 218 were filed in 2009, and 245 were filed in 2008. The study’s authors found that the number of filings remained steady but the composition of shareholder suits changed. Sixty- four cases were filed against foreign issuers, with a particular surge in the number of Chinese companies listed in the U.S. (at 29). Average settlement value decreased to $31 million from the 2010 average of $108 million.

Norway Fund Targets Staples, Schwab, Other U.S. Firms
Norges Bank Investment Management, managers of the $550 billion Norwegian Government Pension Fund Global, is calling on U.S. companies in which they invest to ease their director-replacement processes following financial performance and governance concerns. The fund has asked Charles Schwab, CME Group, Pioneer Natural Resources, Staples, Western Union and Wells Fargo to give shareholders proxy access, allowing them to list director candidates on proxy ballots along with management’s nominees. The Norwegian fund has $98 billion invested in U.S. firms, and is the 19th-largest Wells Fargo shareholder.

China Fund ‘Keen’ to Invest in West’s Infrastructure
China’s sovereign wealth fund, China Investment Corp., has expressed interest in improving infrastructure in the U.S. and Europe to help global economic growth. The fund, established in 2007 to invest abroad and which holds mostly U.S. and European government bonds, reportedly plans to begin the program in Britain. Some Chinese commentators have criticized the fund for investing in only government bonds, and have called for fewer bond purchases with a focus on individual projects in the hopes of being less affected by the sovereign debt crisis.

More Funds Divest From Companies With Iranian Ties
The Massachusetts public employees pension fund has divested all of its stakes in companies with major ties to Iran’s energy industry, according to a story published by Reuters. The decision by Pension Reserves Investment Management follows similar divestitures by other states, most notably Florida, Georgia and New York. In total, a half-dozen companies were divested in accordance with a new Massachusetts law, including Gazprom, Hyundai Heavy Industries and Siemens Ltd.

Expanding Ranks Not in Cards For 2012, Say CEOs
Only 35 percent of U.S. CEOs surveyed by the Business Roundtable in its fourth-quarter CEO Economic Outlook Survey expect to increase their company’s employment rankings over the next six months, down 1 percent from 3Q 2011. Forty-two percent of respondents expected employee populations to remain constant, while 24 percent planned to cut jobs. Fifty-two percent expected capital spending also to stay constant, and 32 percent expected an increase. In contrast, 68 percent expected an increase in company sales in the first half of 2011. The survey found that CEOs’ highest cost pressures stemmed from materials (25 percent), regulation (24 percent) and health care (20 percent).

CEO Safety Net Invites Risk Taking
CEO severance packages can decrease a company’s stock performance by as much as 4 percent over the three years after the agreements are established, finds a new study by Tulane University’s Freeman School of Business Assistant Professor of Finance Peggy Huang.

Those that averaged a 4 percent underperformance rate were companies that offered cash-only contracts, while overall severance agreement establishment resulted in a 1.6 percent rate of underperformance. During the period studied, 1993 to 2007, the number of S&P 500 companies offering CEO severance payments more than doubled, to 56 percent.

New Slate at FASB
Thirteen new members have been appointed to the Financial Accounting Standards Advisory Council, effective Jan. 1. Charles H. Noski, vice chairman of Bank of America, was named chairman for a one-year term that began on Jan. 1.

The Council advises the Financial Accounting Standards Board, the private-sector organization responsible for setting accounting standards for U.S. companies, on technical issues related to FASB’s agenda, project priorities and other issues.

Noski’s appointment was made by John J. Brennan, chairman of the board of trustees of the Financial Accounting Foundation. The FAF is responsible for the oversight, administration and financing of the FASB and its counterpart for state and local governments, the Governmental Accounting Standards Board.

The FASB Advisory Council is comprised of:

• Kay Ryan Booth, managing director, Golden Seeds Fund
• Peter Carlson, EVP and chief accounting officer, MetLife
• Susan S. Coffey, SVP-Public Practice and Global Alliances, American Institute of CPAs
• Kenneth Daly, president and CEO, NACD
• Anthony J. Dowd, chief of staff and special assistant to the chairman, President’s Economic Recovery Advisory Board, Office of Paul A. Volcker
• Cynthia M. Fornelli, executive director, Center for Audit Quality
• Jan Hauser, partner, PwC
• Patrick E. Hopkins, professor of accounting and Deloitte Foundation Accounting
• Adam G. Hurwich, portfolio manager, Ulysses Management
• Joseph Longino, principal of Investment Strategy, Sandler O’Neill + Partners
• Patrick T. Mulva, VP and controller, Exxon Mobil
• James R. Taylor, partner in charge – Assurance, Hogan Taylor; faculty fellow, Kelley School of Business, Indiana University
• John W. White, partner, Cravath, Swaine & Moore

William B. Chandler III

The process of choosing Chandler’s successor got underway in May when the Delaware Judicial Nominating Commission, chaired by Andre G. Bouchard, managing partner at Bouchard Margules & Friedlander, issued a public notice soliciting candidates. The court is required by the state constitution to be bipartisan, and all candidates must be Delaware residents. Following interviews, the JNC would refer any finalists to Gov. Jack Markell, who would then recommend one candidate to the state Senate for approval.

The 60-year-old Chandler, the subject of a cover story in NACD Directorship (December 2010/January 2011), notified the Delaware governor in April he planned to resign to seek opportunities in the private sector. His last day on the court was expected to be June 17.

Franklin, Hockaday to Co-Chair BRC on Lead Directors
A group of more than 20 corporate directors and governance thought leaders convened this spring to initiate the 2011 Report of the NACD Blue Ribbon Commission on the Lead Director. Hosted by the NACD, the commissioners will leverage their years of experience to develop recommendations that will define and clarify the role of the lead director in the boardroom. The commission is co-chaired by Barbara Hackman Franklin, former U.S. Secretary of Commerce, and currently a director for Aetna and the Dow Chemical Company and chairman of the board for NACD; and Irvine Hockaday, director for Ford Motor Company, Estée Lauder and Crown Media Holdings. Holly Gregory, corporate partner at Weil, Gotshal & Manges, will serve as governance counsel to the commission.

“As boards rise in accountability and visibility, the role of the lead director has become increasingly important. Lead directors play a critical role in ensuring independence of thought and oversight, and help build consensus in the decision-making process,” said Ken Daly, president and CEO of NACD. “The diversity and depth of experience represented on this year’s commission provide a unique opportunity to study leading practices for the lead director position.”

The new commissioners will meet once more in June as they continue to collaborate on their recommendations. The report is scheduled for release at the NACD Annual Board Leadership Conference on October 2-4 in Washington, D.C.

Delaware VC Cuts Plaintiff Lawyer Fee
What did shareholder plaintiffs lawyers achieve in their litigation over an abandoned tender offer for shares of Sauer-Danfoss? Not much, according to a recent decision by Delaware Vice Chancellor J. Travis Laster. In fact, Laster found that the plaintiffs lawyers did so little of value that he slashed their fee request by 95 percent and awarded them just $75,000 of the $790,000 they asked for, according to Morris James’ Delaware Business Litigation Report. Wrote Laster: “Plaintiffs never engaged in meaningful litigation activity.”

Heidrick Study Finds Number of Directorships in Decline
New director appointments decreased 22 percent from 2009 to 2010, according to the new Heidrick & Struggles Board Monitor Fortune 500 quarterly trend report, with 279 new directors at the studied companies in 2010, down from 356 in 2009. In addition, only one-third of these appointees had non-CEO or –CFO backgrounds, reflecting the growing post-Dodd-Frank disclosure requirements. “The ongoing economic uncertainty is causing companies to lean towards those with top-job experience when they do make an appointment,” said Bonnie Gwin, the leadership advisory firm’s vice chairman and head of the North American Board Practice. Average director age remained at 57, and female placements increased slightly from 17.9 percent to 19.3 percent.

Outside CEOs Cost More, Perform Worse
CEOs promoted from within are more cost-effective and outperform their external counterparts, according to a study conducted by The Kelley School of Business at Indiana University in conjunction with A.T. Kearney, that examined 36 companies that had promoted internally between 1988 and 2007. It compared their performance with other S&P 500 companies that had chosen external candidates. The study found that none of the external CEOs’ companies performed better than the 36 identified companies, and the external CEOs commanded salaries that were 65 percent higher than those of CEOs recruited from within.

Transocean Execs Donate Safety Bonuses to Victims’ Families
After sparking public ire by rewarding executives with safety bonuses, five Transocean senior executives will donate $250,000 collectively to a fund for the families of victims of last year’s Deepwater Horizon explosion in the Gulf of Mexico. Transocean had given safety bonuses because the company had reached two-thirds of its safety target, despite the deaths of 11 workers in the explosion and the subsequent massive oil spill. Overall, the five executives received about $900,000 in incentive bonuses; 25 percent of the bonus equation is determined by safety performance. Transocean reported that 2010 was its “best year in safety performance.”

Judge Orders Borders Bonus Plan Changes
Bankrupt bookseller Borders Group was ordered by U.S. Bankruptcy Judge Martin Glenn to revise its executive bonus plan after the lawyer representing unsecured creditors, Bruce Buechler, notified the judge that the plan rewarded executives for staying with the company though its bankruptcy. The plan had proposed giving the top five executives $4.9 million if unsecured creditors were paid at least $95 million, and a $1.8 million bonus if creditors received $73 million. Glenn instructed the retailer to include a provision that would apply if less than $73 million were returned to creditors.

Basel Establishes Criteria for Globally Essential Banks
The Basel Committee on Banking has established criteria designating banks that must maintain extra capital reserves because they are essential to global financial stability. The international regulatory committee did not compile a list of firms that these rules would affect. Banks will be evaluated based on “size, interconnectedness, substitutability, global activity and complexity,” said the committee’s secretary general, Stefan Walter, who noted that the Basel committee would monitor hedge funds, money market mutual funds and other securitization structures to help prevent another financial crisis.

Class Actions Lose, Arbitrators Win in Supreme Court Ruling
In a ruling expected to provide businesses with significant protections against class-action lawsuits, the Supreme Court ruled that state laws couldn’t override contract clauses that require customers to present complaints to private arbitrators individually. The case in question, AT&T Mobility v. Concepcion, fought over a $30.22 sales tax charge on phones that AT&T had advertised as “free.” The ruling makes arbitration clauses more attractive to companies in consumer contracts, and is expected to apply to employers in employee contracts under the Federal Arbitration Act of 2001.

Geronzi Resigns, Faces Ruling
Cesare Geronzi resigned as chairman of Italian insurer Assicurazioni Generali after the board threatened a vote of no confidence. He was awarded a payoff of 16.6 million euros ($24.3 million) upon leaving Europe’s No.3 insurer, according to Reuters. The controversial Italian financier has in succession chaired three of the country’s most important financial institutions: Capitalia; Mediobanca, which is Generali’s top shareholder; and Generali itself. Separately, a Rome court is due to rule on whether Geronzi contributed to the 2003 bankruptcy of Italian food group Cirio. Prosecutors are seeking an eight-year sentence for Geronzi, who has denied any wrongdoing.

Wall Street Banker Pay Falling
An unnamed Wall Street paymaster told The Wall Street Journal recently that the median banker pretax salary is currently $1.6 million, down from $2.2 million before the financial crisis hit. The pre-crisis pay was approximately 60 percent cash payments, with bankers taking home about $700,000 a year after taxes. Now, however, more bankers receive deferred compensation rewards, which brings their median aftertax take-home pay to about $380,000.

Director Shortage
Despite median director compensation increasing from $45,000 in 2001 to $119,500 in 2010, Canadian companies are having increasing difficulty finding directors to fill their boards. Spencer Stuart found “a definite increase in the number of first-timers joining boards,” said Andrew MacDougall, president of Spencer Stuart Canada. Over the past three years, almost 25 percent of all directors appointed were joining their first board. One-third of the newly appointed directors in 2010 were from the United States—the highest proportion since Spencer Stuart began tracking Canadian directorship trends. In addition, female board members increased to 20 percent in 2010, from 13 percent in 2009.

Top Paid CEOs in 2010
1. Philippe P. Dauman – Viacom
2. Lawrence J. Ellison – Oracle
3. Leslie Moonves – CBS
4. Martin E. Franklin – Jarden
5. Michael White – DirecTV
6. John F. Lundgren – Stanley Black & Decker
7. Richard C. Adkerson – Freeport-McMoRan Copper & Gold
8. Robert A. Iger – Disney
9. Donald J. Stebbins – Visteon
10. Jeffrey L. Bewkes – Time Warner
11. Alan Mulally – Ford Motor
12. Brian L. Roberts – Comcast
13. John H. Hammergren – McKesson
14. Samuel J. Palmisano – IBM
15. David M. Cote – Honeywell
16. Laurence D. Fink – BlackRock
17. James Dimon – JPMorgan Chase
18. David N. Farr – Emerson Electric
19. Thomas M. Ryan – CVS Caremark
20. Rex W. Tillerson – ExxonMobil
Source: The Wall Street Journal Survey of CEO Compensation

Corporate Reputations
Best:
1. Google
2. Johnson & Johnson
3. 3M Company
4. Berkshire Hathaway
5. Apple
6. Intel Corporation
7. Kraft Foods
8. Amazon.com
9. General Mills
10. The Walt Disney Company

Worst:
11. AIG
12. BP
13. Goldman Sachs
14. Citigroup
15. Chrysler
16. Bank of America
17. General Motors
18. ExxonMobil
19. JPMorgan Chase
20. Delta Airlines
Source: 2011 Harris Interactive

Boardroom Etiquette
The Berkshire Annual Meeting will be open, provocative and orderly. Unlike other public companies’ AGM, there will be no gadflies or noisy activists. Nor will there be protestors unless you consider those spouses who skipped the chance to buy jewelry directly from Warren Buffett at Borsheim’s. Why aren’t protestors and activist rabble-rousers here? Because Berkshire’s shareholders would rally for the company. Courtesy prevails, aided by the fact that no other company is so focused on ethical behavior and corporate performance, and so not focused on personal enrichment or compensation, yet is so very rich and very well compensated.

No other company is so transparent— even on issues such as executive compensation, scandal and succession. Yet it is notoriously private. Therein lies the irony. For Berkshire shareholders, irony is preferable to the agony that greets so many public company annual meetings.

What makes the Berkshire meeting so riveting is the chance to watch Buffett and Munger spend as many as nine hours answering unrehearsed questions from shareholders that have been selected by three outstanding financial journalists— Carol Loomis of Fortune magazine, Andrew Ross Sorkin of The New York Times and Becky Quick of CNBC. The meeting and its full-day questionand- answer format requires the Berkshire leaders to have unfathomable resources of energy for one purpose: to demonstrate their total commitment to the shareholder. There is a reason why See’s Peanut Brittle shares the dais with their microphones.

What’s in it for these two billionaires? It’s how they learn. The prodding and questioning sharpen them and focus their attention. Nothing is opaque and transparency rules. Finally, Buffett has an unshakable faith that telling the complete truth is the only way to ensure you won’t be testifying against someone else’s version years later.

Opening Lines
“Good morning, I’m Warren, he’s Charlie. I can see, he can hear, that’s why we work together.” And so we have the basic requirements for a visionary and his sounding board.

Who Will Succeed Buffett?

Then Buffett makes a short announcement: “We ask that you not use any devices to record this meeting. Participants in our film [Steve Carell and the cast of The Office] have contributed their time as individuals—without pay, of course— and we want to respect their rights to their work. If you happen to see anyone making a recording, please ask them to stop.”

He is pure Old Testament, relies on the rule of law and respect for ownership. He’s a bit cynical, too. And, like the rest of us, he likes things for free.

Sokol and Other Questions
After his opening remarks, Buffett launches into the Q&A focused on the one thing on everyone’s mind: David Sokol. The media have been circling the wagons and shareholders are wondering: Could this be the iceberg that dents, if not sinks, the Berkshire succession plan?

David Sokol, once thought to be a possible successor to Warren Buffett, talks to a shareholder at the 2010 annual meeting.

Buffett reveals his hand by playing a clip from the Salomon Brothers testimony he gave before Congress in 1991. His words then echo his belief today. In his testimony then, Buffett promised “full cooperation” to the committee and offered a fig leaf as well as a sharp-edged sword to his new employees: “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.” As the clip ends, the shareholder audience cheers. They, like their chairman, want to do the right thing. This is what their company stands for. This is how their CEO thinks and lives. This is their annual meeting.

‘Inexplicable and Inexcusable’
Buffett gets down to the details of the Sokol story—he takes it as his duty to explain how psychology and executive behavior could lead a Berkshire executive to violate the company’s code of ethics, although he admits the matter is still incomprehensible to him. And with that, Buffett moves closer to the microphone and relates the details of the matter to his shareholders, skipping none of the embarrassing facts, and not without some sadness (which he then posts verbatim on the Berkshire website).

“In looking at what happened a few months ago with Dave Sokol’s failure to notify me at all that he’d had any kind of contact with Citigroup, in fact, he directed my attention to the fact that they represented Lubrizol and never said a word about any contact with them, and then the purchase of stock immediately prior to recommending Lubrizol to Berkshire…I don’t think there’s any question about the inexcusable part. The inexplicable part is somewhat—well, it’s inexplicable, but I’d like to talk about it a little bit because I will tell you what goes through my mind.

Mark Zoradi, former Walt Disney Studios Motion Picture Group president, was appointed to Rave Cinemas’ board.

Walgreens elected Ginger L. Graham to its board. Graham is currently the president and CEO of Two Trees Consulting.

RES Software appointed Klaus Besier CEO. Besier most recently served as president and CEO of Neoware.

Tran B. Nguyen, former CFO of Metabasis Therapeutics, has joined Somaxon Pharmaceuticals as vice president and CFO.

Charming Shoppes named Bruce J. Klatsky to its board of directors. Klatsky served as CEO for Phillips-Van Heusen.

Moody’s released a report on how some large banks have changed their boards to be more effective with strategy. The report reviewed board composition at 20 large  global banks in North America and Europe since the beginning of the crisis in July 2007.

The SEC’s new disclosure rules play an obvious part in the revamping of bank boards. Director nomination standards now require information about the nominee’s experience, qualifications, and attributes and reasons why that person should serve on the company’s board. A new leadership structure rule mandates that a company disclose why it has chosen to either combine or separate the positions of chairman and CEO.

The bank boards included in this report turned over 32 percent of their non-executive directors. This provides boards with an original perspective and new ideas about how to bounce back after the crisis. Author of the report, Christian Plath, said the turnover on bank boards was the most interesting trend post financial-crisis: “The turnover on some of these boards, particularly boards that received extraordinary government assistance, some of those boards saw more than half their board turn over.

Experience in the financial industry is now a much more prominent factor in building bank boards.  Of the 20 banks examined, 46 percent now have outside directors with financial backgrounds. This is up 14 percent from July 2007. Plath said this comes after serious criticism about the quality of board members: “Many of these banks were strongly criticized for not having enough directors with financial backgrounds…All of this points to the criticism that banks were engaged in excessive risk taking…you want some directors on the boards that can know the right questions to ask.”

Banks that received the most government assistance–Bank of America, Citigroup, Lloyds, RBS and UBS–added the most financial experience to their boards, the Moody’s report found.

Several of the banks examined by Moody’s researchers also reduced their board size. Plath said this could be for several reasons concerning the particular bank’s restructuring process. “There are a couple of big advantages of having a smaller board size and one is that it better stimulates discussions at the board level. It enhances the board’s ability to respond in the event of a crisis.” Plath also said that a smaller boardroom means a bigger spotlight for each director: “It also makes it harder for directors to hide in terms of boardroom discussions. It forces all of the directors to speak up.”

The average board size is now 16 members. Bank of America, for example, reduced its board size from 17 to 15. Not every bank downsized the board, however. Four of the 20 banks in the report maintain a board size of 20 or more members. HSBC increased its board size from 18 to 21 members.–Ashley Chaney

One of the most notable cases in 2009 was In re Citigroup Shareholder Derivative Litigation, where the Court of Chancery found no director liability for oversight or Caremark-type duties for Citigroup’s losses resulting from substantial exposure to subprime debt. The Court noted that “to establish oversight liability a plaintiff must show that the directors knew that they were not discharging their fiduciary obligations or that the directors demonstrated a conscious disregard for their responsibilities such as by failing to act in the face of a known duty to act.”  In addition, “a showing of bad faith is a necessary condition to director oversight liability.”  No liability resulted in this case because Citigroup had procedures and controls in place that were designed to monitor risk and the plaintiffs did not contest these standards. And even if there were warning signs or “red flags‘ as the plaintiffs claimed, the Court stated that they are not evidence that the directors consciously disregarded their duties or otherwise acted in bad faith but may only be evidence that the directors made bad business decisions.

Kevin F. Brady and Francis G.X. Pileggi co-authored this post.

In Lyondell Chemical Company, et al. v. Ryan, the Delaware Supreme Court addressed director’s duties as to “Revlon” or “deal protection” claims in the $13 billion sale of Lyondell.  In this case, the Court made clear that Revlon duties arise not because a company is “in play” (such as in this case where there was a Schedule 13D filing), but rather when the company “embarks on a transaction – on its own initiative or in response to an unsolicited offer – that will result in a change of control.”  The Court further noted that “there are no legally prescribed steps that directors must follow to satisfy their Revlon duties” and that the Lyondell directors’ failure to take any specific steps during the sale process could not have demonstrated a “conscious disregard of their duties.”  Finally, the Court stated that instead of questioning whether disinterested, independent directors did everything that they (arguably) should have done to obtain the best sale price, “the inquiry should have been whether those directors utterly failed to attempt to obtain the best sale price.”

In In re Nymex Shareholder Litigation, an action involving challenges to a consummated mixed cash/stock acquisition, the Court of Chancery dismissed allegations against directors regarding breaches of fiduciary duties of loyalty, due care and candor in the sale of NYMEX. In doing so, the Court reaffirmed the considerable deference Delaware law provides to an independent board facing a change of control situation post-Lyondell.  The Court did not address the threshold Revlon applicability issue in a mixed cash/stock deal because NYMEX’s Certificate of Incorporation contained an exculpatory clause authorized by 8 Del. C. § 102(b)(7) that protected the NYMEX directors from personal monetary liability for breaches of the duty of care. If the Plaintiffs failed to show that the either a majority of the directors were interested, lacked independence or failed to act loyally or in good faith, then their only remaining claim would be a breach of a duty of care which is addressed by §102(b)(7). Thus, even if Revlon applied, application of the §102(b) (7) exculpatory clause would lead to dismissal “unless the Plaintiffs have successfully pleaded a failure to act loyally (or in good faith), which would preclude reliance on the Section 102(b) (7) provision.”

In In re John Q. Hammons Hotels Inc. Shareholder Litigation, the Court of Chancery discussed what standard should apply — entire fairness or business judgment — in reviewing this merger.  In this case, the Court stated that the majority shareholder neither stood “on both sides of the transaction” nor made the offer to the minority stockholders; an unrelated party, Elian, made the offer. Elian negotiated separately with the minority shareholders, who were represented by the disinterested and independent special committee and the majority shareholder “who had a right to sell (or refuse to sell) his shares.” However, in order to invoke the business judgment standard, “it is paramount . . . – that there be robust procedural protections in place to ensure that the minority stockholders have sufficient bargaining power and the ability to make an informed choice of whether to accept the third-party’s offer for their shares.”  Here the Court found that the procedures in place (where the special committee could waive the vote of the minority stockholders and required the approval of only the majority of the voting minority shareholders), were not sufficient to warrant business judgment protection. Importantly, the Court stated that the minority vote serves as a complement to, and a check on, the special committee. It also noted that “[a]n effective special committee, unlike disaggregate stockholders who face a collective action problem, has bargaining power to extract the highest price available for the minority stockholders. The majority of the minority vote, however, provided the stockholders with an important opportunity to approve or disapprove of the work of the special committee and to stop a transaction they believed was not in their best interests. Thus, to provide sufficient protection to the minority stockholders, the majority of the minority vote must be nonwaivable, even by the special committee.”

Finally, in Gantler v. Stephens, the Delaware Supreme Court clarified what had been presumed for years by finding that “officers of Delaware corporations, like directors, owe fiduciary duties of care and loyalty…and the fiduciary duties of officers are the same of directors.”

Kevin F. Brady is a partner and co-chair of the Business Law Group of the Wilmington, Del., office of Connolly Bove Lodge & Hutz LLP. His practice includes corporate and commercial litigation in the Delaware Court of Chancery. He can be reached at KBrady@cblh.com.

Francis G.X. Pileggi is the founding partner of the Wilmington, Delaware, office of Fox Rothschild LLP, an AmLaw 200 firm. He started a blog in 2005 at www.delawarelitigation.com that summarizes all the key decisions on corporate and commercial law from the Delaware Court of Chancery and Delaware Supreme Court, and includes posts on legal ethics and related topics. His e-mail address is: fpileggi@foxrothschild.com.

“I believe first and foremost in the need for balance between stockholders and directors,” Laster says. “The director-centric model works well. Directors make decisions, and stockholders have the right to ‘toss the bums out’ if they’re unhappy. Of course the law needs to protect stockholders in that regard.”

Lamb was the judge Laster says he appeared before most often during the 13 years he practiced corporate law in the Chancery Court. “He was a fantastic judge,” Laster says of his one-time mentor. “He was knowledgeable, consistent, always prepared, and he’s a tough act to follow.”

Lamb, who spoke at Laster’s investiture, describes the litigator as experienced on both the plaintiff and defense sides. “I’m very happy that Travis has been chosen to serve on the court. He has appeared before me and other members of the court often, and he’s highly regarded, well known to lawyers around the country. This is very positive for the courts and for Delaware, and there’s no doubt in my mind that Travis will do an outstanding job.”

As for the characteristics Laster brings to the court, Lamb says he has “intelligence, experience, care, and energy.”

Delaware employs what Laster describes as a unique merit selection process that begins with a judicial nominating commission made up of attorneys and lay persons. They screen and interview applicants, ultimately sending recommendations to the governor. Following more interviews, the governor sends a nominee to the Senate, which holds a hearing and votes on whether to confirm. All in all, Laster says, it’s a “more merit-driven, less politicized process” than other jurisdictions.

Laster says he has long aspired to public service. Both of his parents are teachers who taught overseas and his wife is a social worker. “We always knew that at some point in my career I would do public service or work for a nonprofit,” he says, noting that the community around the Delaware bar is “close knit.” Laster says he began to allow himself to think of the possibility of submitting his application as soon as word leaked out that Lamb would not seek reappointment at the conclusion of his 12-year term, which ended in July.

The Delaware Senate confirmed Laster, who was nominated by Governor Jack Markell. Although Markell is a Democrat, he was required to appoint a Republican to fill the position left vacant by Lamb, also a Republican. Delaware’s constitution requires a party balance on the bench of the Chancery Court; the court is a key reason that 60 percent of U.S. corporations opt to incorporate in Delaware, and its decisions are often used as guidance by courts in other states.

Professor Charles Elson, director of the University of Delaware’s Weinberg Center for Corporate Governance, says he has known Laster for years. As a counselor, Elson points out, Laster worked for both the plaintiff and defense sides: “He’s low key, intellectually intense, and legally quite sophisticated. Because of his experience, he really can see all sides of an issue.”

What follows is an edited transcript of Directorship’s first interview with Laster.

Directors are both concerned about the increasing cost of liability (D&O) as well as the burden —too many cases are not being brought for gross negligence and they are uniformly settled with the activists demanding director personal liability. Is there any remedy to the apparent lack of distinction between a company whose board tried unsuccessfully to prevent failure versus a board that failed the company?
We don’t look at things from an after-the-fact perspective. We believe that independent directors should be making good-faith decisions in the best interests of the companies on whose boards they serve. If they do that, a Delaware court will respect their decision. A charge of “failure to protect the company” in our law falls under the duty of oversight. To be liable under that test, you must have acted in bad faith. We understand that corporations are risk-taking entities and that sometimes, even when you make decisions to maximize value, those decisions don’t work out. As a stockholder, that’s the risk you take.

Does Delaware law provide sufficient guidance to directors on their limits and responsibilities in such a way that it can guide beneficial behavior?
Yes, but part of the challenge is [the law] is always evolving. Delaware has given guidance and will continue to give guidance, but that guidance is always being applied to new areas. What Delaware has always required directors to do is think and make judgments. We are not the SEC. We are not giving them a list of regulations to follow. What we want is for independent directors to be thinking, asking questions, and making decisions.

As a vice chancellor, it’s been noted that you are taking a bit of a cut in pay. [The annual salary for a vice chancellor is just south of $175,000.] How do you believe the CEOs of our nation’s public companies should be compensated?
Compensation is a difficult problem and one where I see both sides of the issue. When someone is doing a great job, you need to pay for performance. When they’re delivering value, they need to be compensated. At the same time, when wages for average workers have not improved since the mid 1980s, and when the multiple by which CEO compensation exceeds average worker compensation has expanded significantly, people have a right to be asking questions. It is a tough issue and most of the fascinating issues are tough. What we don’t want is for the Delaware courts to become a national compensation committee. That would be the wrong approach. The right solution for directors, as the decision makers, is to step up to the challenge. I believe in the combination of independent directors and the incentives of meaningful equity ownership — in the form of actual shares, not options. Those two things result in directors who have skin in the game to negotiate hard with the CEO. I would like to see more directors standing up to the CEO, just like they stand up to the negotiators for the unions and the line employees. I do not subscribe to the cult of the CEO, and I would like to see outside directors armed with their own compensation consultants having meaningful negotiations with CEOs based on multiple inputs, not just the goal of compensating them at 70 percent of their peers. If that happened, you would see better results.

What will the litigation fallout be over compensation?
You will see more of it. In the Citigroup decision in February, the chancellor allowed a waste claim to go forward over [former CEO and Chairman] Chuck Prince and his severance agreement. Waste has been a tough standard, but his severance agreement was one that was eyebrow-raising. It’s not clear whether a waste claim will win. At the end of the day, Prince and defendants could prevail once the full record is in, but it’s a shot across the bow. I think you will see more waste claims.

Such is the case with the iconic business duos presented here. These eight famous pairings—one of them infamous for its failure in the final act—present a spectrum of the unique qualities and dynamic teamwork necessary for the effective management of extremely innovative, complex organizations. A variety of top-tier combinations reveal several variations on the theme that two heads are better than one: some, like Richard Sears and Julius Rosenwald, were marriages of necessity; others, such as Sanjay Jha and Greg Brown, co-CEOs of Motorola, were partnered in hopes of salvaging an ailing organization; still others, like Warren Buffett and Charlie Munger, seemed fated to cohabitate in the same corporate host.

The delicate balance required for a successful top-level tandem power structure is no easy achievement, as evidenced by a string of dissolutions; keeping two big personalities in harmony requires a set of unique personality traits on both sides. “It all depends on how they behave and if they can keep their egos in check,” says Harvard Business School Professor Joseph Bower, author of The CEO Within. “It works remarkably well if you also have strong board members who are able to make it work.” The challenge, as Bower sees it, is living up to the age-old adage of “diversity in counsel, unity in command”: however many leaders a company has, it has to move forward decisively. But while having a single visionary at the helm is often just what a company requires, the breadth of experience and wisdom offered by a pair of equally guided leaders can also have its advantages. “As long as there is cooperation, a pair will bring greater assets than can come from one person’s intellect,” adds Bower.

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”  – Warren Buffett, chairman and CEO, Berkshire Hathaway

Today’s activist shareholders urge boards and CEOs to seek a second opinion or appoint a devil’s advocate that can result in what some believe is a bifurcated structure, as evidenced by the recent push for splitting the roles of CEO and chairman. One of the common arguments for not splitting the roles is that it creates confusion about exactly who is in charge. Another is that it hinders the company’s leadership to communicate with one, clear voice. Yet another is that the two get in each other’s way, one reining in the other, forcing a compromised and dulled strategy. However, great business duos learn to sidestep these traps and work together for the greater good of the organization. They improve each other’s ideas without watering them down. They move in concert without stepping on each other’s toes.

The question of what is the optimal executive leadership structure is one the board must answer and be answerable for (though many of the following examples took place before the boardroom had the significance it has today); a director could not find a better starting place from which to view the issue than by looking at the following examples of tandem business success.

“Communication is the cornerstone,” says Belmont University Prof. Jeff Cornwall, who studies business organizational structure. “Successful partners are able to feel comfortable tackling difficult issues without being afraid of hurting each other’s feelings.” Certainly, when addressing high-impact challenges on a day-to-day basis, the best pairings have had a tendency to avoid sugarcoating the issues at hand, and a no-nonsense approach is also required. Says Cornwall, “Partners must have a similar work ethic, and they should have similar values, but not necessarily similar personalities.” Such advice, along with the examples offered below, affirms John Rockefeller’s maxim that friendship founded on business is preferable to business based on friendship. With such an appropriately sober attitude in mind—and with the implicit advice offered by history’s great duos—one should move confidently in building a capable leadership team.

Warren Buffett and Charlie Munger: Berkshire Hathaway
The partnership between Warren Buffett and Charlie Munger has been well documented throughout the pair’s 50-year professional relationship, but for traders, investors, and general profit-seekers at large, their formula for success remains elusive. In their leading roles at Berkshire Hathaway, the two have led investors (and themselves) to steady returns virtually unparalleled in the investment community. Their methods, as the two attest, are deceptively simple, yet their successes have been without peer.

Buffett and Munger are unified in their ability to generate profit for investors in their funds, and the two men share similar investing values that revolve around the simple tactic of targeting undervalued assets and obtaining them. As Chairman and CEO Buffett put it in last year’s letter to shareholders, “Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” However, the individuals behind Berkshire’s success have demonstrated their unique characters, even as they have waged a common investment crusade. Buffett, with his tireless, common-sense approach to investing, his emphasis on wise governance, and his seemingly infinite humor and wisdom, is the prototype for would-be fund kings. His annual shareholder letters offer up world-class insight into the methods by which steady returns are generated, all tinged with the folksy warmth that is no small part of the man’s appeal.

Many TARP recipients are now scrambling to pay back their share of the $700 billion bailout to escape further government meddling. Some banks are believed to be under an undisclosed regulatory sanction that requires them to revamp their boards and focus on risk and liquidity management. Since Bank of America signed on to TARP, four directors have resigned from its board and been replaced, likely with government input.

Recently, Citigroup reshuffled its senior executives, including the removal of CFO Edward Kelly—changes made while under pressure from the Treasury and after discussions between regulators and Citigroup Chairman Richard Parsons. Citi’s chief accountant, John Gerspach, is now the bank’s fifth CFO in five years. Citi also replaced four members of its board since signing on to TARP. Only three of AIG’s original 11-member board remain in place.

“You can at least see an attempt to make government regulators happier,” reflects Jaidev Iyer, managing director of the Global Association of Risk Professionals. “But there is a difference between making changes to appease regulators and making fundamental changes to your board and governance practices.”

“The government is working behind the scenes—but they will get their money back,” assures Simmons, who believes many of the casualties of the financial crisis will need to revamp their boards whether the government says to or not. Says Simmons: “The market is going to demand it.”

Chrysler named five new directors to its board: George F. J. Gosbee, chairman and president of Tristone Capital; Douglas Steenland, former CEO of Northwest Airlines; Scott Stuart, a founding partner of Sageview Capital; Ronald L. Thompson, chairman of the board of trustees for Teachers Insurance and Annuity Association; and Stephen Wolf, chairman of R.R. Donnelley & Sons.

American International Group’s annual meeting resulted in the re-election of Dennis Dammerman, former vice chairman of the board of General Electric; George Miles, CEO of WQED Multimedia; Suzanne Nora Johnson, former vice chairman of Goldman Sachs; and Morris Offit, chairman of Offit Capital Advisors. Liddy said he will step down as CEO as soon as a replacement is found.

Ken C. Hicks has been named Foot Locker’s new CEO. Hicks will succeed Matthew D. Serra, who has been the company’s CEO since March 2001. Serra will continue as the company’s chairman until his planned retirement next year.

Trex Company named Richard E. Posey to its board. Posey has served as chief executive of Moen Inc., a faucet manufacturer, and Hamilton Beach/Proctor Silex.

Bank of America revamped its board by electing four new directors: Susan Bies, William Boardman, Paul Jones, and Donald Powell. Bies previously served on the SEC’s advisory committee. Boardman served as chairman of Visa International until his retirement in 2005. Jones is currently an attorney at law firm Balch & Bingham. Powell is a director of Stone Energy.

Biogen Idec confirmed two of billionaire activist Carl Icahn’s picks to its board: Richard Mulligan, a professor of genetics at Harvard Medical School and director of the Harvard Gene Therapy Initiative; and Alex Denner, a managing director at Icahn Partners.

Jeff Huber, senior vice president of engineering at Google, has joined Electronic Arts’ board. Huber was in charge of technology development for Google’s AdWords and AdSense, as well as Google Apps. Prior to Google, he served in a number of management roles at eBay and Excite@Home.

David L. Calhoun has been named to Boeing’s board. Calhoun is CEO of The Nielsen Company. Prior to his work at Nielsen, Calhoun spent more than 25 years at General Electric.

Sonoa Systems named Tsvi Gal to its board. Gal is a general partner at Exigen Capital and previously served as Deutsche Bank’s Investment Bank and Assessment Management’s CTO.

Anne Egger has been appointed to Optical Sciences’ board. Egger has been working with Electro-Optic Sciences as a consultant since her retirement earlier this year.

Michael Gelmon and Cory Gelmon have been named to Safeguard Security Holdings’ board. Michael Gelmon has replaced Tom Montgomery as chairman of the firm and Cory Gelmon has been elected director and appointed new CFO.

Best Buy’s Brad Anderson will retire as the company’s CEO. Brian Dunn is believed to be Anderson’s successor. Dunn currently serves as the company’s president and COO.

E*Trade Financial named Kenneth C. Griffin, founder and CEO of Citadel Investment, to its board. Griffin currently sits on the Advisory Council for Chicago 2016, working to bring the 2016 Olympic Games to the Windy City.

George E. Minnich has been appointed to Kaman’s board. Minnich retired as senior vice president and CFO of ITT in 2007.

MarineMax appointed Russell J. Knittel to its board. Knittel has been executive vice president of Synaptics since 2007, and CFO  since 2001.

Ray Powers has been appointed to MediaG3’s board. He served as COO and executive vice president of International Communications, a wholesale carrier that owned nearly 460 wireless transmission sites in the U.S.

Robert Half International appointed Barbara J. Novogradac to its board. Novogradac is currently president of Novogradac Investment Company, a private real estate investment company.

FedEx elected Susan C. Schwab, U.S. Trade Representative from 2006 to 2009, to its board. Schwab is currently a professor at the University of Maryland’s School of Public Policy.

Qualys CEO Philippe Courtot has been elected to Tech-America’s board. Courtot served on the board of the Cyber Security Industry Alliance (CSIA). He previously was chairman and CEO of Signio, an electronic payment start-up that he repositioned to become a significant e-commerce player.

James K. Brewington has been named to Sonus Network’s board. Brewington retired as president of Developing Markets at Lucent Technologies in 2007.

Boston Scientific CEO James Tobin will leave the medical-device maker. Tobin will be succeeded by Raymond Elliott, the former CEO of orthopedics maker Zimmer Holdings.

ScanSafe, a provider of Software as a Service web security, appointed Bernard Liautaud to its board. Liautaud was founder and CEO of Business Objects, an enterprise software company.

John McCartney was elected to Covance’s board. McCartney currently serves as chairman of the board of A.M. Castle, a provider of products, services, and supply chain solutions. McCartney previously served as president and COO of U.S. Robotics.

George E. Minnich has been named to Kaman’s board. He retired as chief financial officer from ITT in 2007.

Given the federal response, the business law community was anxious to analyze the response of the Delaware Court of Chancery, the nation’s preeminent court for litigating business disputes. A review of the Court of Chancery’s recent decisions shows that it has not allowed the current political climate to influence its historically balanced approach. These decisions illustrate that the Court understands the role of corporate risk-taking with investment capital and will not automatically equate corporate losses with directorial or executive liability. At the same time, however, the Court will allow suits to proceed where plaintiffs plead factual allegations of corporate wrongdoing. Two recent decisions illustrate this balanced approach.

The first decision involved shareholder derivative litigation (filed on behalf of the company) against current and former directors of Citigroup, which received billions in government aid. In that case, the plaintiffs alleged that the directors breached their fiduciary duties by failing to properly: (1) monitor and manage risks associated with Citigroup’s exposure to the subprime lending market in the face of  “red flags”; and (2) publicly disclose Citigroup’s exposure to subprime assets. Based on these allegations, the plaintiffs sought to hold the Citigroup directors personally liable for alleged shareholder losses.

Despite Citigroup’s substantial losses, the Court of Chancery dismissed almost all of the claims in the lawsuit at the pleading stage for failure to make a “demand” on the board prior to bringing suit. The Court refused to engage in a substantive hindsight review of the business judgment that gave rise to the losses because, as was alleged in the complaint, Citigroup had policies, procedures, and controls in place designed to monitor risk. As the Court stated: “Citigroup was in the business of taking on and managing investment and other business risks. To impose oversight liability on directors for failure to monitor ‘excessive’ risk would involve courts in conducting hindsight evaluations of directors at the heart of the business judgment of directors. Oversight duties under Delaware law are not designed to subject directors, even expert directors, to personal liability for failure to predict the future and to properly evaluate business risk.”

In the second decision, involving AIG, now largely owned by the federal government, the shareholder plaintiffs alleged that AIG management secretly used offshore subsidiaries to mask losses and misstated the company’s financial performance in order to convince investors that AIG was more financially secure than it actually was. In denying motions to dismiss the complaint, the Court of Chancery found that the plaintiffs had alleged facts that, if ultimately proven true, would show “pervasive, diverse, and substantial financial fraud” involving senior managers at AIG. Because the plaintiffs pled facts that would support a conclusion that the former CEO and CFO, among other former senior executives at AIG, had “personal knowledge” of the widespread financial corruption and “direct involvement in a variety of allegedly improper transactions,” the Court permitted the case to proceed to discovery.

While the boundaries between these two cases are extreme, it is easy to see some lines of demarcation. Where plaintiffs allege a lack of effective oversight and risk management by directors, Delaware courts will look to determine if any oversight processes are in place to monitor risk. If risk management processes exist, then Delaware courts will not typically subject business decisions to an unfair hindsight analysis colored by the passage of time and the outcome, regardless of the efficacy or effectiveness of those processes. That is in contrast to cases where executives are credibly alleged to have engaged in, or acquiesced to, financial fraud. This balanced approach should continue to encourage the corporate risk-taking necessary to help the economy recover from the recent downturn, while at the same time provide an effective deterrent to wrongdoing. It should also continue to make Delaware the preeminent forum for incorporation and choice of law clauses in contracts.