Recalling why corporate officers are fiduciaries.

• Author: Johnson, Lyman P.Q.

[T]o say that a man is a fiduciary only begins analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary? In what respect has he failed to discharge these obligations? And what are the consequences of his deviation from duty? (1)

TABLE OF CONTENTS INTRODUCTION I. CORPORATE OFFICERS AS AGENTS: THE ROLES OF LAW, INSTITUTIONAL REALITY, AND THEORY IN SHAPING DISCOURSE A. Officers in Corporate Governance B. Forgetting Why Officers Are Fiduciaries C. Officer Control Subdues the Legal Model D. Fiduciary Discourse Accommodates Reality E. Corporate Theory Blurs Fiduciary Duties II. AGENCY STATUS AND WHY IT MATTERS A. The Fiduciary Duties of Officers B. The Significance of Agency Status 1. The State Law Foundation 2. Fiduciary Duty 3. Officer Liability 4. The Business Judgment Rule C. Corporate Governance Implications 1. Officers' Duty to the Corporate Enterprise 2. Division of Governance Responsibilities 3. Board Composition and Selection CONCLUSION INTRODUCTION

Chief executive officers wield enormous power in the modern corporation. Such well-known names as Michael Eisner at the Walt Disney Company, Martha Stewart, formerly at Martha Stewart Living, Dick Grasso, formerly head of the New York Stock Exchange, and Dennis Kowzlowski, formerly at Tyco, embody the influence of the modern CEO. When they and other senior officers perform well, the enterprise and its stockholders are likely to flourish; when they misbehave--as many have in recent years (2)--the company, stockholders, creditors, employees, and others in society suffer significant loss. Recent concern about officer wrongdoing has resulted in numerous federal and state criminal charges, (3) the initiation of Securities and Exchange Commission (SEC) administrative proceedings, (4) and imposition of new federal responsibilities on officers through the Sarbanes-Oxley Act. (5) At the same time, Congress, (6) the SEC, (7) the New York Stock Exchange (NYSE), (8) and the Nasdaq (9) all have prescribed new functions for boards of directors and their committees. These initiatives, taken together, aim to improve the overall functioning of corporate governance in public corporations, at both the director level and the officer level. This is not only a response to the widespread rash of recent corporate scandals, but also the latest--and most dramatic--episode in a larger effort to restore a healthy governance relationship between corporate directors and corporate officers.

For all the renewed federal attention to regulating--and differentiating--corporate officer and director functions, however, a curious fact remains: state fiduciary duty law makes no distinction between the fiduciary duties of these two groups. Instead, courts and commentators routinely describe the duties of directors and officers together, and in identical terms. (10) To lump officers and directors together as generic "fiduciaries," with no distinction being made between them, suggests--as patently is not the case--that their institutional function and legal roles within the corporation are the same. Such a view, consequently, undermines efforts to distinguish more sharply, not blur, the governance responsibilities of these two groups.

Failure to differentiate the duties of officers, who daily manage corporate operations, from directors, who more remotely monitor corporate affairs, stems from a puzzling failure to address an even deeper issue in corporate law: What exactly is the theoretical and conceptual basis for the widespread claim that corporate officers owe fiduciary duties to a corporation and its stockholders? In other words, to Justice Frankfurter's list of good questions to ask about fiduciary status, we can add another: Why do corporate officers owe fiduciary duties? Hardly a week goes by without yet another Delaware decision addressing the subject of director duties. Yet, surprisingly, no Delaware decision has ever clearly articulated the subject of officer duties and judicial standards for reviewing their discharge. For persons occupying such central places of power in corporations, senior officers have largely succeeded in eluding the distinctive attention of state corporation law. This is a puzzling void.

The thesis of this Article is that corporate officers are fiduciaries because they are agents. The rules and rationales of agency principles--an entire body of law virtually ignored in corporate governance--provide a coherent beginning point for systematically developing both the reasons for, and the nature of, officer fiduciary duties. Our argument is not that agency principles should be introduced formalistically or uncritically into corporate governance. (11) Rather, the claim, first, is that drawing on the fiduciary duties of agents for guidance in fashioning modern understandings of corporate officer duties--and differentiating those duties from those of directors--can provide much needed structure to what otherwise threatens to be an ad hoc enterprise. Of course, an agent's fiduciary duties being broadly sketched, they can be given shape and content only in particular contexts. This case-by-case "fleshing out" of officer duties must be done consistently with appropriate expectations for senior officers in the early twenty-first century.

Second, providing a conceptual basis both to ground officer fiduciary obligations and to distinguish director and officer functions can substantially enhance the larger project of restoring to reality the legal model of director-officer relations within the public corporation. (12) In this model, directors delegate to officers, acting as agents, the role of managing the business and affairs of the corporation. Although such delegation is entirely proper, both functionally and as fiduciaries, directors must preserve for themselves a critical governance responsibility on behalf of the corporate principal and its stockholders--monitoring the managerial performance of officer-agents. This division of labor within corporate governance is essential because organizational principals--be they corporations, churches, universities, or other groups--differ from individual principals. Having rightly delegated management of an organization to agents, too often members of the governing body fail to do what individual principals do for themselves, but what an organization (lacking human capacity) cannot do: continue to monitor and evaluate the persons to whom management has been delegated. Agency law illuminates the nature of this director-officer interaction and highlights how dysfunctional boards contributed to recent governance scandals. Corporate interests were left unprotected as officers operated free of any meaningful director supervision.

What are the benefits of our thesis? First, by understanding officer duties and director-officer interaction in this way, it can be seen that state law remains the primary source for establishing the basic framework of corporate governance relations, both through corporate statutes and through judge-made fiduciary duty law. With a more highly differentiated state law model of director-officer relations, recent efforts of Congress, (13) the SEC, (14) the NYSE, (15) and Nasdaq (16) to impose new responsibilities on directors--designed to improve their vital role in monitoring corporate officers--can be understood as congruent with, rather than at odds with, the underlying state law framework. The current emphasis on director independence and the special focus on various board committees--audit, nominating/governance, and compensation (17)--can be seen as an effort to develop mechanisms to aid the board both in detaching itself from management and in divvying up the board's key monitoring functions. Moreover, efforts by Congress and the SEC to place additional and different functions on senior officers can be seen as supplementing, rather than displacing, existing state-law-based fiduciary duties of officers.

Recalling the agency law status of corporate officers, however, does more than preserve state law as the cornerstone of governance relationships in our federal system. At a practical level, and this is the second benefit of our thesis, it clarifies immensely why courts can and should scrutinize officer conduct more closely than they now review director performance--i.e., the fiduciary duties of agents are more demanding than those of directors, and officers rightly face a greater risk of personal liability for misconduct. Heightened review of officer performance is especially fitting given that many of the recent corporate scandals involved wrongdoing at the officer level, (18) and given that state law has been eerily silent about why officers owe duties at all, much less holding them to account. It is also important in light of the fact that recent federal initiatives aimed at improving officer performance eventually will be translated into, and will heavily influence, state fiduciary duty analysis. (19)

The third payoff of our thesis is several theoretical implications. These include our belief that we are entering an era when, due both to heavier corporate regulation and re-thinking of a shareholder centered conception of corporate relationships, (20) the entity conception of the firm will be strengthened. Positive law--including agency law--builds on, and so reinforces, that understanding of corporate relations. This current re-thinking follows a span of perhaps twenty years when a highly "disaggregated" conception of corporate relations--the nexus of contracts theory--has predominated. We also believe that in the policy arguments for and against strong fiduciary duties over the years, virtually no attention has been given to distinguishing whether what is fitting for outside directors in the fiduciary duty area--relatively slack duties--is also fitting for corporate officers. Moreover, although agency law suggests greater liability for...