ROUNDTABLE: The Legacy of 'Smith v. Van Gorkam'.

• Author: Kristie, James
• Position: Landmark decision on corporate governance - Panel Discussion

Revisit an astonishing moment in the governance of corporations as our panel assesses this landmark case's impact on how boards behave.

A shock to the system. That's what the Delaware Supreme Court administered in 1985 when it handed down its decision in the case of Smith v. Van Gorkom -- holding that the board of Trans Union Corp. breached its fiduciary duty of care in transacting in an uninformed manner the sale of the company. The decision reverberated mightily through the boardrooms of Corporate America, contributing to a huge escalation in D&O insurance rates and a reexamination by many executives of the personal risks of board service. To assess the legacy of this watershed case, DIRECTORS & BOARDS assembled a multidimensional group of executives -- corporate directors, lawyers, investment bankers, D&O insurers, and consultants -- all well-versed in the way boards operate (see box on page 31). The roundtable was hosted by Ira Millstein at the offices of Weil Gotshal & Manges, and co-moderated by Milistein and Robert Rock, chairman of DIRECTORS & BOARDS. For those not intimately familiar with the case or who may want to brush up on its e ssential details, we recommend a reading of Stephen Radin's article on page 24. The following discussion will immerse you in a dynamic exchange of views on director duty and the trajectory that board governance has taken since the "Big Bang" of Smith v. Van Gorkom. -- James Kristie

DIRECTORS & BOARDS: Let's first go around the table and see where everyone stands on this question: Was this, indeed, an uninformed board?

Charles Elson: This was a board that was not necessarily uninformed. It was certainly a responsible board, an experienced board, a board that was thoroughly versed both in the affairs of the company itself and vis a vis this particular decision [to sell the company].

The problem with this board was that it was potentially a management-dominated board. All of the outside directors had some relationship with one another and with the CEO, there was quite a bit of serving on each other's boards, and there was little if any equity ownership on the part of this board. That is why the decision that was reached was called into question. Not necessarily because the process by which they made the decision was inherently suspect, but rather over the question: Was this board able to distance itself from its CEO and make an independent decision?

Robert Friedman: I strongly disagree. I think this board was woefully uninformed. I don't think there was a shred of valuation analysis that was provided to them. No investment banker was hired. Management's own financial analysis was very sketchy and had not really been explained to the board. No one read the merger agreement. No one told the directors what was in the merger agreement and what the terms of it were. They weren't even told that the [suggested sale] price was proposed by Mr. Van Gorkom. There was no real testing of the price before the deal was signed. I just think that the process was not in any way justifiable.

Henry Lesser: I am somewhere between you both. By the standards of the day -- realizing that the events themselves happened 20 years ago even though the case came out in 1985 -- this was arguably an informed board. But it turns out that we now realize that it wasn't informed in the right way and on the right facts and with the right tools.

Rereading the case while flying here from San Francisco, I am struck by the fact that virtually everything that took place would have been done differently today. Now whether that is because of the case, or because what was done at the time was inherently grossly negligent, is another question. But if you add up all of the things that were missing in the case -- and that's not just the length of the meeting, not just the absence of the investment banker, not just the failure to read the merger agreement, but the totality of the events that the court hung its hat on -- then I would have to say that, even by the standards of the time, this board was insufficiently informed.

Raymond Troubh: I'll somewhat agree with Henry's remarks in that I think that the directors were not totally uninformed. The information they got was inadequate but not quite to the extent that the court said. For the day, these guys got as much as many directors got.

Certainly what occurred then would never occur today. You've got too many investment bankers and too many lawyers involved. Directors today are inundated with valuation books prepared by firms like Steve's [Waters], who all use the same Lotus Notes and put together 1,600-page volumes of comparisons ad nauseam.

The greatest mistake that Mr. Van Gorkom made was that he should have said he read the merger agreement at the opera. If he read the damn merger agreement, this might not have happened.

Stephen Waters: The M&A "business" only began again in the late 1970s. In 1980, you looked at three things: premium to market, price to book, and price/earnings ratio. That was the guts of what was done, and all the firms created the database from scratch. There weren't EBITDA multiples or detailed DCF analysis. There were occasionally some industry comparables -- e.g., dollars per barrel if you were in the oil business -- but M&A valuation was relatively unsophisticated by current standards.

That being said, based on what is in the record about the case, clearly what the board did would not pass muster today, and by the standards of the time they probably were deficient, too.

Boris Yavitz: I'm trying to put myself back to when I first heard about this case. I had been an active director for some time, and I remember being briefed by the general counsels of the corporations I served with. Despite our genuine sympathy for the directors involved, my reaction and that of my fellow directors was that the board was not adequately informed. We regarded them as a distinguished, well-intentioned group, even as some of us criticized the presence of five insiders on that board. Although I will readily admit that at the time it was not that unusual.

The first thing that hit us was the little time spent. How could they have decided this in two hours without any study or analysis? They couldn't possibly be informed. The second thing was, how can they make a move like that without some outside advice? Those were the two big problems.

Another was the failure to question the CEO any further. While many boards did not generally question the CEO, quite a few directors even then said the situation required closer questioning. The same applied to not having asked for any inside opinions. The CFO got away with some mealy mouthed words without being challenged, and nothing was asked of any other officer of the company. On balance, we felt the directors were uninformed, that it was their own doing, and that it could have been easily rectified if they had taken proper care.

Ira Millstein: Now that I am now spending a good deal of time at the Yale School of Management, teaching governance, competitive strategy, and other subjects, I am starting to look at this case more from a management/director standpoint than from a lawyer's standpoint. I think that the board was uninformed -- but in a different way than what has previously been said. I think the directors didn't know what their obligations were. I don't think that they were properly counseled, and I don't think there was anybody around to properly counsel them at that time.

If you went to most directors at this point in history, they would have been comfortable with the notion that because the vote [to approve the sale] was going to go to the stockholders, there wasn't much for the board to do. "How can you stop this from going to the stockholders? So, what difference does it make what we think?" Well, what they all forgot was that under Delaware law they had a legal obligation to make a recommendation. Apparently there was no lawyer in the boardroom -- as probably there wouldn't have been 20 years ago - saying, "Wait a minute, you people have more to do here than to just give it a quick brush and pass it on to the shareholders. You have a real legal responsibility to think about it."

Kim Hogrefe: As I remember from law school teaching on the case, the board made a monumental decision in two hours -- how could they possibly have done that? However, the more that you delve into the background, it appears that the board members themselves were very knowledgeable and experienced.

Even though the case wasn't about whether $55 was the correct price to sell Trans Union, it is interesting to ask: Did the board come ultimately to the correct decision? If the board had spent 10 hours deliberating the issue, if the board had investment advisers at their sides, would they have come to the same decision? Indeed, if the process had been one by which they had decided after due deliberation to reject Pritzker's offer, would they have been criticized for having not given the shareholders ultimately the opportunity to enhance their values?

I think that the Delaware Supreme Court frankly starts with the result and works back through the facts. If you start with the result that $55 was the right price, I think that clearly the decisionmaking process was defective, but to the extent that it came to the correct decision it was one that benefitted the shareholders.

Robert Dilenschneider: This was not an informed decision. I was in Chicago 20 years ago and I had the privilege of knowing many of the individuals involved in this transaction. All of these people were very cozy. They got together for lunch at the Chicago Club virtually every single day.

It's incredibly instructive to look back to see how far we've come in the area of governance. It's very clear that the board did not have adequate outside counsel. But it wasn't just the board's fault. It was Van Gorkom's fault for not providing outside counsel to them. The general...