Corporate governance in the courtroom: an empirical analysis.

• Author: Erickson, Jessica

ABSTRACT

Conventional wisdom is that shareholder derivative suits are dead. Yet this death knell is decidedly premature. The current conception of shareholder derivative suits is based on an empirical record limited to suits filed in Delaware or on behalf of Delaware corporations, leaving suits outside this sphere in the shadows of corporate law scholarship. This Article aims to fill this gap by presenting the first empirical examination of shareholder derivative suits in the federal courts. Using an original, hand-collected data set, my study reveals that shareholder derivative suits are far from dead. Shareholders file more shareholder derivative suits than securities class actions, the area of corporate litigation that has received nearly all of the scholarly attention. By writing off shareholder derivative suits, scholars have missed the distinct role that these suits play in corporate law, particularly in the area of corporate governance. Unlike traditional litigation, remarkably few of the suits in my study ended with monetary payments. Instead, these suits more commonly ended with corporations agreeing to reform their own corporate governance practices, from the number of independent directors on their boards to the method by which they compensate their top executives. These settlements reflect the rise of a new type of shareholder activism, one that has gone undocumented in the legal literature. Corporate governance has moved into the courtroom, and this development has important, and potentially troubling, implications for corporate law.

TABLE OF CONTENTS INTRODUCTION I. STUDY DESIGN AND METHODOLOGY II. EMPIRICAL ANALYSIS OF FEDERAL DERIVATIVE SUITS A. The Unseen Importance of Derivative Suits B. Surveying the Complaints 1. Mapping the Complaints 2. Detailing the Parties a. Derivative Plaintiffs b. Plaintiff Corporations c. Defendants 3. Analyzing the Allegations C. Procedural Hurdles in Derivative Suits 1. Demand in the Federal Courts 2. Special Litigation Committees D. Four Paths to Resolution 1. Judgment 2. Involuntary Dismissals 3. Voluntary Dismissals 4. Settlements a. Private Company Settlements b. Public Company Settlements III. ASSESSING CORPORATE GOVERNANCE IN THE COURTROOM A. The Promise of Redress B. The Limits of Reform C. The Possibility of Deterrence CONCLUSION INTRODUCTION

Conventional wisdom is that shareholder derivative suits play a small, and dwindling, role in corporate law. Once the cornerstone of corporate law, (1) these suits are now viewed as relics of an older time, rendered obsolete by more modern means of policing corporate misconduct such as high-stakes securities class actions, sweeping government investigations, and the stringent listing standards of the national stock exchanges. As the tools for monitoring corporate managers multiply, scholars have all but abandoned shareholder derivative suits. In the world of corporate law scholarship, shareholder derivative suits are not just "forgotten," (2) they are "dead." (3)

As a result, few scholars have deemed these suits worthy of empirical analysis. Over the last fifteen years, there have been just two studies of shareholder derivative suits. (4) Although both made crucial contributions to our understanding of these suits, the empirical focus in these studies was on suits filed in Delaware state court or on behalf of Delaware corporations. (5) There remains no comprehensive examination of shareholder derivative suits in the federal courts, where most corporate litigation is centered.

This dearth of empirical data comes at a particularly bad time. As the financial markets have experienced tremendous upheaval, corporate law has been besieged with calls for reform. (6) Scholars and politicians alike have called for a restructuring of market regulations and renewed oversight of private litigation. (7) If shareholder derivative suits are to play any role in these efforts, it should not be based on an incomplete snapshot of this area of the law.

This Article aims to bridge that gap by presenting the first empirical analysis of shareholder derivative suits in the federal courts. My study is based on a hand-collected and original dataset of full case records from complaint through final judgment. (8) In contrast, many studies of litigation examine only reported decisions available through Westlaw or Lexis. (9) As others have recognized, such studies suffer from a selection bias because fewer than 5 percent of decisions are available through these databases. (10) Moreover, neither Westlaw nor Lexis allows scholars to track entire case records, which means that most litigation research is based on a single snapshot of the studied cases rather than a comprehensive review of the entire case record. (11) As scholars are increasingly recognizing, (12) litigation research must be done on the ground, studying case records from start to finish.

From this in-depth examination of shareholder derivative suits, three important conclusions emerge. First, contrary to the conventional wisdom, shareholder derivative suits are anything but dead. Shareholders actually file more shareholder derivative suits than securities class actions, (13) the area of shareholder litigation that has received nearly all of the scholarly attention. (14) Corporate law scholarship has missed this fact because most shareholder derivative suits are filed in federal court and nearly half are filed on behalf of companies incorporated outside of Delaware. (15)

Second, corporate governance reform has moved into the courtroom. Remarkably few of the suits in my study ended with the corporation receiving a meaningful financial benefit. Instead, shareholder derivative suits more commonly end with the parties agreeing to corporate governance settlements. In these settlements, corporations agree to reform their corporate governance practices, from the number of independent directors on their boards to the method by which they compensate their top executives. These settlements have not been studied at all in the legal literature. The rise of shareholder activism in the courtroom has simply flown under the radar of corporate law scholarship.

Third, there is significant reason to question the wisdom of corporate governance's move from the boardroom into the courtroom. Drawing on business and finance literature, this Article demonstrates that corporate governance settlements often fail to live up to their potential because they include reforms that are unlikely to benefit corporations or their shareholders. (16) Yet despite the minimal benefits to corporations, the plaintiffs' attorneys studied still received substantial fees, confirming the view that "[t]he real incentive" to file shareholder derivative suits "is usually not the hope of return to the corporation, but the hope of handsome fees to be recovered by plaintiffs' counsel." (17) By writing off shareholder derivative suits, scholars have missed the problematic role that these suits continue to play in corporate law.

This Article proceeds in three parts. Part I explains the design and methodology of the study. Part II sets out the empirical results of the study, examining the shareholders who file derivative suits, the companies named in the suits, the types of claims alleged, and, most importantly, the resolution of these suits. Part III adds a normative component, drawing on business and finance scholarship to evaluate corporate governance settlements and concluding that many of these settlements do little to enhance corporate value. In the end, "corporate governance at gunpoint" may not be the best strategy for reform. (18)

1. STUDY DESIGN AND METHODOLOGY

   This Part explains the methodology of the study and provides an overview of its significance and limitations. Before turning to this discussion, however, a brief explanation of the role of derivative suits and securities class actions in corporate law is warranted. Derivative suits and securities class actions are the procedural mechanisms to enforce two different branches of corporate law.

   Derivative suits are the procedural mechanism to enforce state fiduciary duty law. (19) In a derivative suit, the corporation is the functional plaintiff--that is, the real party in interest--and the allegations are that the corporation's current or former officers and directors breached their fiduciary duties to the corporation. (20) Any recovery in a derivative suit is returned to the corporation. (21) In a derivative suit, despite the fact that the suit is brought in its name, the corporation's role is limited because shareholders, whom I will call derivative plaintiffs, file these suits on behalf of corporations. (22) The law gives shareholders this power because corporate officers and directors, who normally decide whether corporations should file lawsuits, are often implicated in the alleged wrongdoing and cannot be trusted to make unbiased decisions regarding the merits of these suits. (23)

   Securities class actions are the procedural mechanism to enforce the federal securities laws. (24) In a securities class action, the plaintiffs are shareholders alleging that a corporation and its individual officers and directors violated the federal securities laws by making false or misleading public statements. (25) Any recovery in the lawsuit goes to the corporation's shareholders. (26)

   Although derivative suits and securities class actions are both key procedural tools in corporate law, scholars have focused nearly all of their attention on securities class actions, studying these suits from every angle. (27) As a result, scholars now know almost everything there is to know about securities class actions, but next to nothing about derivative suits. (28) The time has come to explore the unexplored side of shareholder litigation.

   To understand the role of derivative suits in the federal courts, this study examined the full case records of derivative suits filed in federal...