April 16, 2014

J. Robert Brown, Jr.: Shareholder Protection Act of 2011 – Preemption, Prevention and Protection (Altering the Standards for Fiduciary Duties of the Board) – Part 4

The Shareholder Protection Act of 2011 goes beyond director and shareholder approval.  By requiring shareholder approval in the proxy statement and by requiring disclosure of expenditures for the prior year in the annual report, the Act effectively triggers the application of the antifraud provisions.  To the extent companies do not accurately reveal the purpose of the payments on a going forward basis and the actual use of the payments (the latter will provide a check on the former), they may be liable.

The Act, however, went well beyond triggering the antifraud provisions.  For the first time in the federal securities laws, it would create a treble damage provision.  Moreover, the provision would likely apply on a strict liability basis.

The Act provides that expenditures made in violation of the shareholder approval requirement will be “considered a breach of a fiduciary duty of the officers and directors who authorized the expenditures for political activities.”  Liability will joint and several and equal three times the amount of the expenditure. In other words, authorization is the only element of the claim.  The provision imposes personal liability.  Moreover, it apparently does so on a strict liability basis.  Authorizing officers and directors will be liable even if they do not know about the provision or were otherwise unaware of the shareholder approval requirement.

Moreover, violations are more likely to occur than one might think.  Certainly, the authorization of political expenditures in the absence of shareholder approval will result in exposure.  But the provision is broader than that.  It applies the treble damages provision to any person who authorizes payments that are not “of the nature of those proposed by the issuer”.  So those authorizing contributions will need to make sure that they are consistent with what shareholders actually approved.  This will not always be clear.

Moreover, by defining the claim as a breach of fiduciary duty, boards will potentially be at risk for a derivative suit to the extent they fail to enforce the provision.  Once unauthorized campaign contributions are exposed, boards may find themselves in the unsavory position of having to bring actions against (or collecting treble damages from) authorizing officers or being sued for the failure to do so.  Similarly, boards may find themselves liable to the extent they delegated authority to officers.  Depending upon the terms of the delegation, it may fit the definition of “authorization.”

While Congress has been very willing to preempt state law in recent years, most of the changes have been with respect to process (other than, perhaps, assigning substantive authority to committees).  Congress for the most part has not tampered with fiduciary duty standards.  They have remained within the purview of state law.  Yet this proposal would alter that balance.  It would result in Congress defining fiduciary duty standards and the extent of liability as a result of violations.

For more than two decades, J. Robert Brown, Jr. has taught corporate and securities law, with a particular emphasis on corporate governance. He has authored numerous publications in the area and several of his articles have been cited by the U.S. Supreme Court. He is a professor at the University of Denver Sturm College of Law and blogs for The Race to the Bottom, where this post originally appeared on July 27, 2011.

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