A chicken game in Delaware

Francis Pileggi links an interesting opinion by Delaware Vice Chancellor Lamb in the Vesta Insurance case, swiftly affirmed by the Supreme Court (no link yet).  The company was trying to further delay its annual meeting to give its accounting firm time to supply audited statements required by the SEC.  The company had already gotten a 90 day extension, and the court refused to allow another one. 

The company argued that it would be required to violate either Delaware or federal law.  The court said that its order was

consistent with the important policies underlying the internal affairs doctrine that the power of the state of incorporation to mandate stockholder meetings in appropriate circumstances not be lightly overturned. As the Delaware Supreme Court has recently explained, the internal affairs doctrine is the basic understanding that “only the law of the state of incorporation governs and determines issues relating to a corporation’s internal affairs.15 The doctrine is rooted not only in the decisions of the United States Supreme Court,16 but also in the Fourteenth Amendment’s implicit guarantee of the stockholders’ right to “know to what standards of accountability they may hold those managing the corporation’s business and affairs.”17 There are, of course, some circumstances in which a state’s governance of internal corporate affairs is preempted by federal law, but those instances are rare, and occur only when the law of the state of incorporation is “inconsistent with a national policy on foreign or interstate commerce.”18

The footnotes cite Vantagepoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108, 1113 (Del. 2005), discussed here.

The Delaware courts obviously have gotten a bit touchy about federal inroads on state corporate law.  For example, Chief Justice Steele recently said:

There can be little debate about the fact that SarBox purports to authorize the SEC to regulate elements of internal corporate governance of State chartered corporations “in a manner traditionally left to state law”. The real questions are whether the SEC has acted beyond the scope of the authorization and secondly whether the SEC will continue to push the envelope beyond its authority in a manner that adversely affects sound principles of corporate governance. In an article written shortly after people began to get a handle on what Congress intended, Chancellor Chandler and VC Strine published a thoughtful article addressing how the feds, even given the outer limits of SarBox, and the States could work together on parallel tracks to enhance principles and practices in the boardroom that would foster the goal of enhanced shareholder wealth and sound structural governance. It remains to be seen whether their optimism was justified. In my view regulation in a prescriptive, one size fits all methodology without any substantial regard to relative costs and benefits is destructive to shareholder wealth building and does not encourage good people to serve on boards. Ironically much of what SarBox does discourages exactly what Congress intended to promote–responsible, talented and thoughtful risk takers seeking board service. The SEC is shareholder biased, albeit in its view in a positive way. The shareholder of today is not Ma and Pa Kettle holding 100 shares of AT&T for retirement earnings. Increasingly institutional shareholders dominate the market. Do they need an advocate in DC wedded to prescriptive regulation or can their complaints, if any, be as readily and more equitably addressed by private ordering in State civil law litigation on a case by case contextual environment? Moving corporate governance to DC means increased costs with little effort to determine benefit, an arena for dispute resolution decisionmaking that is not unbiased and portends no guarantee that the guidelines, regs or pronouncements from the banks of the Potomac will enhance long term shareholder value. Those who advocate a drift from the common law resolution of disputes by a highly trained and experienced cadre of jurists to the bureaucracy in DC should be careful what they wish for.

The Chancery Court noted in Vesta that the SEC was proceeding under Section 14(c) of the 1934 Act, which was intended to prevent firms from avoiding disclosure by not soliciting proxies.  Therefore, the aims of both Delaware and federal law to protect the shareholder vote were consistent. The court also observed that the SEC had not clearly said that “compliance with this court’s Order could violate any SEC rules.”

So what's going to happen if the SEC decides to hold the company to providing audited statements? It would seem that the dream of consistency would evaporate.  We would then clearly have a chicken game.  And as the SEC and Congress seek increasingly to federalize corporate law, these confrontations are likely to become more common. 

The Delaware courts have served notice that they’re not going to give in easily.  Will we see federal troops marching on Wilmington?  Stay tuned.

Comments

[Francis Pileggi]

Excellent commentary, as usual.

[John Baker]

Where's the conflict? Corporations are supposed to have annual meetings, and they're supposed to disseminate annual reports. Their failure to disseminate an annual report shouldn't be a license for the current board to entrench itself by refusing to hold an annual meeting. There would only be a conflict if the SEC threatened to enjoin the annual meeting, which it did not do.

I'm no expert, but I believe the conflict lies in Section 14(c) of the '34 Act. That section requires companies that are holding an annual meeting to disseminate an annual report and an information statement, even if the company is not soliciting proxies. Thus, complying with the Delaware Court's Order would effectively force the company into non-compliance with the federal regulations.