TO CALL A DONKEY A RACEHORSE - THE FIDUCIARY DUTY MISNOMER IN CORPORATE AND SECURITIES LAW.

• Author: Steinberg, Marc I.

1. Introduction 1 II. Rhetoric and Reality Addressing Fiduciary Conduct in The Corporate Setting 3 A. Fiduciary Duty Application in the Partnership and Limited Liability Company (LLC) Settings 4 B. Fiduciary Duty Application in the Corporate Law Setting 6 1. The Duty of Care 6 2. The Business Judgment Rule 7 3. The Duty of Good Faith 10 4. The Duty of Loyalty 12 5. Fiduciary Duties of Controlling Shareholders 17 6. The Close Corporation Fallacy 20 7. Summation 22 C. Fiduciary Duty Application in the Securities Law Setting 22 1. Application of Fiduciary Standards under Securities Act Section 11 23 2. Application of Fiduciary Standards under Exchange Act Section 10(b) 27 III. The Fiduciary Duty Misnomer 30 IV. Conclusion 36 I. INTRODUCTION

   A recurrent theme in corporate law is the presence of directors and officers owing fiduciary duties of care and loyalty to the respective companies (and, collectively, to the shareholders of such companies) for whom they serve. (1) Although not as visible in the securities law setting, concepts of fiduciary duty-like obligations arise with some frequency. (2) Such fiduciaries, as opined by courts, owe the "utmost duty of care and loyalty." (3) Although this rigorous standard was adhered to by a number of courts in times of yesteryear, (4) its faithful application today largely is nonexistent. (5) Nonetheless, courts continue to embrace language in their opinions that emphasizes the continued presence of fiduciary duty standards. (6) Reality, however, strikes a very different key. In fact, standards of fiduciary duty have become greatly diluted in the corporate/securities law setting--to the degree that they should no longer be characterized as being fiduciary-like. (7)

   This Article explores this glaring gap between rhetoric and reality and proffers an alternative approach aligned with the present-day actuality of so-called fiduciary principles. Unlike partnership and limited liability company law, where fiduciary duties have been diluted and even eliminated upon contractual agreement, (8) corporate law continues to exhort the continual presence of a subject company's officers' and directors' fiduciary duties of care and loyalty. (9) This theme extends, somewhat indirectly, to the securities law context. Although generally premised on concepts of disclosure rather than substantive fairness, (10) the securities laws nonetheless recognize principles of fiduciary duty with respect to the relationship between corporate insiders and the corporations and shareholders for whom they serve. (11)

   This Article thus explores this illusion that courts continue to embrace. First, the Article addresses the multi-faceted contexts in which state courts cling to fiduciary duty principles in their rhetoric yet apply far more lax standards in their liability assessments. Thereafter, a similar phenomenon is analyzed with respect to the application of federal securities laws. What will become clear is that the liability exposure of officers and directors ordinarily is not scrutinized consistently with fiduciary principles. The last part of this Article advocates for the recognition of reality rather than imaginary characterizations, setting forth a cognizable framework for determining the appropriate liability thresholds that should be implemented.

2. RHETORIC AND REALITY ADDRESSING FIDUCIARY CONDUCT IN THE CORPORATE SETTING

   Present-day corporate law continues to embrace concepts of fiduciary duty when analyzing the conduct of corporate officers and directors. Application of fiduciary duty standards prevails in evaluating director and officer conduct in duty of care and duty of loyalty situations, encompassing conflict of interest transactions and the exercise of good faith. (12) Fiduciary duty concepts also arise when assessing the propriety of controlling shareholder conduct. (13)

   The initial inquiry, of course, is the meaning of the term "fiduciary" in this context. Black's Law Dictionary provides a succinct and pointed definition, stating a fiduciary is "[s]omeone who is required to act for the benefit of another person on all matters within the scope of their relationship; one who owes to another the duties of good faith, loyalty, due care, and disclosure ." (14 ) Turning to case law, Justice Cardozo's eloquent statement in Meinhard v. Salmon (15) comes to mind--that a partner's conduct is to be measured "[n]ot [by] honesty alone, but the punctilio of an honor the most sensitive," (16) signifying that "the duty of the finest loyalty" is the governing standard of behavior. (17)

   As discussed in this Article, this standard rarely is applied today in business enterprise law. Nonetheless, unlike corporate law, the applicable framework for partnership and limited liability company law acknowledges that these elevated standards of fiduciary conduct frequently are no longer recognized when the participants contractually elect to limit or eliminate fiduciary duties. (18)

   1. Fiduciary Duty Application in the Partnership and Limited Liability Company (LLC) Settings

      Unlike days of yesteryear, partnership law slights the fiduciary standard enunciated by Justice Cardozo in Meinhard. (19) Indeed, the Uniform Partnership Act (UPA) declines to categorize a partner's duty of care as fiduciary. And for good reason, as a partner's standard of conduct is "to refrain from engaging in grossly negligent or reckless conduct, willful or intentional misconduct, or a knowing violation of law." (20) The 2001 Uniform Limited Partnership Act (ULPA) contains identical language. (21) While meriting kudos for at least recognizing the abandonment of a fiduciary duty of care standard, the same level of candor is lacking in the duty of loyalty context. For example, both the UPA and ULPA specify that a partner's fiduciary duty of loyalty arises in certain situational settings. (22) Nonetheless, pursuant to the partnership agreement, unless "manifestly unreasonable," aspects of the duty of loyalty may be altered or eliminated. (23) This type of behavior clearly is not characteristic of the traditional standards to which fiduciaries have been held accountable. A Comment to the UPA reflects this reality, recognizing that "[a]rguably, the term 'fiduciary' is inappropriate when used to describe the duties of a partner because a partner may legitimately pursue self-interest . . . [but] partners have long been characterized as fiduciaries." (24) Hence, adhering to a contractarian premise, the modern partnership acts minimize traditional standards of fiduciary duty. (25) The fiduciary nature of the partnership relationship thus has been diminished. In its stead, a contractarian approach has become the dominant force. (26)

      Fiduciary relationships in the limited liability company follow a similar pattern. While courts exhort that LLC members owe one another the utmost duty of loyalty, (27) the applicable operating agreement may permit members to engage in self-dealing and related activities that redound to the detriment of the LLC and its members. (28) Like in the partnership context, LLC agreements may contract around fiduciary duties that otherwise would be owed. (29) Indeed, in a number of states, such as Delaware, the LLC operating agreement can eliminate fiduciary duties in their entirety. (30)

      Unlike partnerships and limited liability companies, the recognition of fiduciary duties is ensconced in corporate law. Nonetheless, as the following discussion illustrates, this recognition is largely illusory. Although ringing with rhetoric, the substance of fiduciary duty law in the corporate setting ordinarily lacks meaningful content.

   2. Fiduciary Duty Application in the Corporate Law Setting

      With regularity, courts emphasize that corporate officers and directors owe fiduciary duties to their corporations and, collectively, to the shareholders for whom they serve. (31 ) As phrased by the Delaware Supreme Court, in carrying out their obligatory roles, "directors are charged with an unyielding fiduciary duty to the corporation and its shareholders." (32) This strong language, however, is minimized by the actuality of lax standards that are applied by the courts. This distinction between rhetoric and reality is explored below.

      1. The Duty of Care

         Pursuant to state corporate law principles, directors and officers owe a fiduciary duty of care to their corporation and its shareholders. (33) There is much rhetoric to support this standard. For example, with respect to the standard of conduct for directors, the Model Business Corporation Act provides that these individuals "shall discharge their obligations with the care that a person in a like position would reasonably believe appropriate under similar circumstances." (34) But, as the Comment to the provision sets forth, this standard does not address the liability exposure that a director would incur for noncompliance. (35)

         In fact, director liability for breach of the duty of care is rare. (36) Several reasons explain this situation. As an initial point, the duty of care ordinarily becomes a focus only if the corporate fiduciary declines to make a decision. (37) When a decision is made without a disabling conflict of interest to either abstain or take action, the permissive business judgment rule is normally the prevailing standard. (38) As discussed below, this standard is inconsistent with the faithful application of fiduciary duty analysis. (39) Providing even broader protection, director exculpation statutes authorize the avoidance of duty of care monetary liability altogether, rendering such directors subject to liability exposure for engaging in only more culpable misconduct involving knowing misconduct or duty of loyalty breaches. (40) Moreover, in practice, courts often apply lax interpretations of the requisite conduct that a fiduciary must engage in to comply with the duty of care. (41) The consequence is that a fiduciary's alleged failure to comply with the duty of care has...