UNIVERSITY CASEBOOK SERIES ADVANCED CORPORATION LAW

UNIVERSITY CASEBOOK SERIES ADVANCEDCORPORATION LAWA PRACTICAL APPROACH TOCORPORATE GOVERNANCESTEPHEN M. BAINBRIDGEWilliam D. Warren Distinguished Professor of LawUCLA School of LawCommented [AR1]: Author: please update titles oraffiliations, if desired.

The publisher is not engaged in rendering legal or other professional advice, and this publication is not asubstitute for the advice of an attorney. If you require legal or other expert advice, you should seek the servicesof a competent attorney or other professional.University Casebook Series is a trademark registered in the U.S. Patent and Trademark Office. 2021 LEG, Inc. d/b/a West Academic444 Cedar Street, Suite 700St. Paul, MN 551011-877-888-1330Printed in the United States of AmericaISBN: 978-1-68328-622-6

PREFACEThis text is designed for use in an advanced course in corporate lawand governance. It assumes that students have taken a basic course inCorporations or Business Associations.Corporate governance has been much in the news in recent yearsand lawyers are devoting increasing amount of attention to it. Thepassage of major federal legislation in 2002 (the Sarbanes-Oxley Acta.k.a. SOX) and 2010 (the Dodd-Frank Act) were particularly importantdevelopments, generating much new law and, as a result, much new legalwork. Curiously, however, the law school casebook market has largelyignored these trends.Corporate governance is regulated by many of the same laws coveredin the basic Business Associations course, but increasingly is alsoregulated by laws—such as SOX and Dodd-Frank—that get short shriftin the typical Business Associations casebook and course. In contrast,those laws are the core focus of this text.Unlike the more basic topics that dominate Business Associations,which are a product of state corporate law with a minor federal overlay,corporate governance is regulated by a much more complex body of lawthat emanates from multiple regulators. Many of the rules of corporategovernance come from traditional state corporate and federal securitieslaw sources, but many more come from sources such as stock exchangelisting standards or rules issued by the Public Company AccountingOversight Board and similar quasi-governmental bodies. All of these aregrist for the mill in this text.Importantly, however, lawyers practicing in the corporategovernance space must be knowledgeable not only about the law but alsobest practice. As Sir Adrian Cadbury observed in connection with theUnited Kingdom’s adoption of the so-called Cadbury Code, it is temptingfor managers to obey the letter of law while ignoring the deeper purposesbehind it. Sound corporate governance structures thus must be informedas much by best practices as well as formal legal rules.Likewise, this text assumes that mastering the relevant law requiressituating it in an understanding of the contemporary businessenvironment. The legal issues governing executive compensation makeslittle sense, for example, if one does not understand the political andeconomic debate over CEO pay. Similarly, to cite just one more example,mastering the high-profile issues respecting shareholder rights will bemuch easier if the students are familiarized with the changingdemographics of shareholders and the rise of activist hedge funds.Notice that I refer to this book as a text rather than a casebook.Although the text includes many canonical cases presented in thetraditional format, the case method is not the only—or even always thebest—way of teaching students to draft workable contracts anddisclosure documents, conduct due diligence, or counsel clients on issuesiii

ivPREFACEthat require business savvy as well as knowing the law. Accordingly, thebook also relies on textual explication, sample documents, and problemsto build student transactional skills.This approach is driven by my belief that, because lawyers plan atleast as often as they litigate, advanced business law course texts needto adopt a transaction planner’s perspective. Most law school casebooks—even in the corporate law area, where the authors ought to know better—have an inherent bias towards litigation perspectives due to theiremphasis on cases. I avoid that by using additional sources, such as lawreview articles and regulatory materials, and by including numerousproblems—typically at the start of a block of material—requiringstudents to think about how the materials will affect real worldtransactions and planning.The text assumes familiarity with some basic law and economicstools—such as transaction costs and agency costs—that are commonlyused in many business law classes. Indeed, the central theme of this textis the agency costs resulting from the separation of ownership and controlin public corporations. The appendix offers a brief overview of these toolsfor the benefit of those students who have not encountered thempreviously.

EDITORIAL NOTEEditorial footnotes run consecutively, starting over at 1 at thebeginning of each chapter, except that footnotes in excerpted materialsretain their numbering from the original source, with no renumbering totake account of omitted footnotes. Editorial footnotes in excerptedmaterials are indicated using an asterisk and have the footnote text inbrackets.Citations and footnotes in cases and other excerpts are generallyomitted without indication thereof, except where they provide the sourceof quoted language or otherwise seemed noteworthy.A number of abbreviations are used throughout the text, as follows: DGCL: Delaware General Corporation Law Dodd-Frank: Dodd-Frank Act of 2010 MBCA: Model Business Corporation Act Rule: A rule promulgated by the SEC under either theSecurities Act or the Securities Exchange Act SEC: Securities and Exchange Commission Securities Act: Securities Act of 1933 Securities Exchange Act: Securities Exchange Act of 1934 SOX: Sarbanes-Oxley Act of 2002The text makes active use of text boxes to highlight certainmaterials: Case in Point. These boxes offer a concise summary of casesthat illustrate the point being made in the text. For More Information. These boxes point students toadditional resources to consult for more information on asubject. FYI. A self-explanatory category that shares useful orsimply interesting information relevant to material in thetext. Practice Pointer. These boxes provide commentaryespecially relevant to junior associates’ legal practice. Think About It. These boxes pose questions that promptstudents to pause to think about various issues presentedby the material or raise critical reading questions designedto focus student attention on the key issues. What’s That? These boxes explain the meaning of speciallegal terms that appear in the main text.v

SUMMARY OF CONTENTSPREFACE . IIICommented [AR2]: Author: this table is automaticallygenerated from headings in the text. Final formatting will occurlater in the production process. Please do not edit this tabledirectly.EDITORIAL NOTE . VTABLE OF CASES . XVIIPART I. INTRODUCTIONChapter 1. Regulating Corporate Governance in a FederalSystem . 3A. The Means and Ends of Corporate Governance . 4B. The Federal Role in Regulating Corporate Governance . 11PART II. THE BOARD OF DIRECTORSChapter 2. The Roles and Duties of the Board of Directors . 29A. Why a Board? . 29B. Board of Directors Housekeeping Rules . 35C. The Board’s Fiduciary Duties . 39D. The Board’s Real-World Functions . 46E. Codifying the Monitoring Model . 54F. Boards Today . 57Chapter 3. Director Independence . 61A. State Law . 62B. Stock Exchange Listing Standards . 69C. Evaluating Director Independence . 77D. Choosing Directors . 84E. Should the CEO Also Serve as Chairman of the Board? . 113Chapter 4. Operationalizing the Monitoring Model: StateCorporate Law . 119A. State Law: Oversight Duties . 120Chapter 5. Operationalizing the Monitoring Model: FederalLaw . 157A. Independent Auditors . 157B. The Audit Committee . 184C. Internal Controls . 219PART III. EXECUTIVESChapter 6. Executive Compensation . 239A. Introduction and Overview . 239B. The Policy Debate . 243C. State Law . 254D. Federal Law . 285E. Director Compensation . 331vii

viiiSUMMARY OF CONTENTSChapter 7. Executive Duties . 347A. State Law . 349B. Federal Law . 365C. SEC Responsibilities of Legal Counsel . 370Chapter 8. Insider Trading . 377A. Disclose or Abstain . 380B. Misappropriation . 394C. Compliance Programs . 413D. Regulation FD . 427E. Concluding Exercise. 433F. Section 16 . 435PART IV. SHAREHOLDERSChapter 9. Voting and Proxies . 459A. State Law . 461B. Federal Proxy Regulation . 485Chapter 10. Shareholder Activism . 515A. The Rise of Institutional Investor Activism . 518B. Institutional Investors and Their Propensity to Activism. 522C. Concerns About Empty Voting . 535Chapter 11. Shareholder Activism via Proxy Contest . 539A. Types of Proxy Contests . 541B. Historic Disincentives to Activism via Proxy Contests. 542C. Defenses Against Proxy Contests . 561Chapter 12. Shareholder Activism via Proposals . 597A. Rule 14a–8 . 600B. Proposals as an Activism Tool . 610C. Management Resistance to Proposals: Grounds for Excluding aProposal . 614Chapter 13. ESG Activism . 667A. What Are a Board of Directors’ Responsibilities to Shareholders,Stakeholders, and Society? . 670B. ESG Activism . 700Appendix A. The Tools of the Economic Analysis of CorporateGovernance . 715A. The Nature of the Corporation . 717B. Transaction Costs . 724C. Agency Costs . 726

TABLE OF CONTENTSPREFACE . IIICommented [AR3]: Author: this table is automaticallygenerated from headings in the text. Final formatting will occurlater in the production process. Please do not edit this tabledirectly.EDITORIAL NOTE . VTABLE OF CASES . XVIIPART I. INTRODUCTIONChapter 1. Regulating Corporate Governance in a FederalSystem . 3A. The Means and Ends of Corporate Governance . 4Questions . 10B. The Federal Role in Regulating Corporate Governance . 111) The Race to the Bottom Debate . 11William L. Cary, Federalism and Corporate Law: ReflectionsUpon Delaware . 11Notes and Questions . 162) A Brief History of Federal Corporate Governance Regulation . 19Note on Corporate Federalism in the Supreme Court . 203) SOX . 224) Dodd-Frank . 24Note on SEC Periodic Reporting Requirements . 25PART II. THE BOARD OF DIRECTORSChapter 2. The Roles and Duties of the Board of Directors . 29A. Why a Board? . 29Questions . 33B. Board of Directors Housekeeping Rules . 35C. The Board’s Fiduciary Duties . 39Lyman P.Q. Johnson & Mark A. Sides, The Sarbanes-Oxley Act andFiduciary Duties. 39Notes and Questions . 41D. The Board’s Real-World Functions . 46E. Codifying the Monitoring Model . 54Note on Internal Controls . 56F. Boards Today . 57Questions . 58Chapter 3. Director Independence . 61A. State Law . 62Delaware County Employees Retirement Fund v. Sanchez . 64Notes and Questions . 67Problems . 68B. Stock Exchange Listing Standards . 69Note on Stock Exchange Listing Standards . 70Problems . 76C. Evaluating Director Independence . 77ix

xTABLE OF CONTENTSD.E.Choosing Directors . 841) The Nominating Committee . 85Notes and Questions . 892) The Nominating Committee Charter . 91Exercise: Evaluate the Nominating and Corporate GovernanceCommittee Charter of Apple, Inc. (2018) . 913) Diversity . 95Deborah L. Rhode & Amanda K. Packel, Diversity on CorporateBoards: How Much Difference Does Difference Make? . 95Notes and Questions . 104Sample Diversity Disclosures . 104Questions . 106Problem . 106Questions . 108Stephen M. Bainbridge, California Corporate-Board QuotaLaw Unlikely to Survive a Constitutional Challenge . 108Note and Questions . 111Problem . 112Should the CEO Also Serve as Chairman of the Board? . 113Problems . 114Note. 115Chapter 4. Operationalizing the Monitoring Model: StateCorporate Law . 119A. State Law: Oversight Duties . 1201) Substantive Law. 120William L. Cary, Federal

UNIVERSITY CASEBOOK SERIES ADVANCED CORPORATION LAW A PRACTICAL APPROACH TO CORPORATE GOVERNANCE STEPHEN M. BAINBRIDGE William D. Warren Distinguished Professor of Law UCLA School of Law Commented [AR1]: Author: please update titles or affiliations, if desired.