Trust & transparency: promoting efficient corporate disclosure through fiduciary-based discourse.

• Author: Siebecker, Michael R.

TABLE OF CONTENTS I. INTRODUCTION II. THE TRAGEDY OF TRANSPARENCY A. The Allure of Corporate Social Responsibility B. The Campaign of Corporate Images C. Corporate Communication Failures 1. Definitional Ambiguity 2. Incoherent Standards 3. Data Dumping 4. Corporate Silence 5. Greenwashing 6. Dilemmas and Tragedies III. ENCAPSULATED TRUST AND CORPORATE TRANSPARENCY A. The Fiduciary Framework for Disclosure B. Encapsulated Trust Revitalized 1. Tenets of Encapsulated Trust 2. Encapsulated Trust in Corporate Contexts IV. REPERCUSSIONS OF ENCAPSULATED TRUST A. Efficiency B. Engagement C. Ethics V. CONCLUSION I. INTRODUCTION

Could embracing the philosophy of "encapsulated trust" as the basis for a fiduciary duty of disclosure improve the integrity and effectiveness of corporate communications?

The question arises because, despite a host of federal and state statutes mandating disclosure of various corporate practices, corporations seem reluctant to disclose fully what consumers and investors want to know, when they want the information, and in a manner they find accessible. For example, in January 2009, USA Today reported that Monster.com "quietly posted an online notice Friday disclosing that its customer databases had been hacked for the second time in six months." (1) The disclosure did not occur until five days after Monster.com became aware of the breach. (2) Around the same time, Heartland Payment Systems learned of a massive security breach that potentially put at risk the financial information of 100 million credit card users. (3) A week after confirming the breach and several months after beginning the investigation, Heartland ultimately disclosed the breach publically--on Inauguration Day, when other news obviously occupied the headlines. (4) Those are just two of many examples where corporations arguably failed to disclose--or to disclose effectively important information relevant to consumers and investors.

Ineffective corporate disclosures become especially problematic in the context of the CSR movement, where consumers and investors employ various social, environmental, or ethical screening criteria before purchasing a company's stock or products. As the bases upon which consumers and investors make purchasing decisions grow, calls for greater corporate transparency increase as well. Excessive amounts of disclosure, or communication of poor quality information, can actually impede rather than promote corporate accountability. Unintentional obfuscation may turn into bald deception, as corporations seek market advantages by promoting a false socially responsible image. Absent effective dissemination of reliable information regarding socially responsible business practices, a tragedy of transparency may result that threatens the basic viability of the CSR movement.

The basic problem of corporate disclosures on CSR represents a version of the classic Prisoner's Dilemma. In an efficient market, fully informed consumers and investors could reward companies that engage in CSR by purchasing their products or stock, and, conversely, punish companies that fail to engage in desired practices by refusing to purchase their products or stock. Unfortunately, corporations increasingly engage in a sort of "strategic ambiguity" in their public communications an ambiguity made possible by a variety of static, yet inconsistent, standards regarding the collection, auditing, and dissemination of information concerning CSR practices. In a slight modification of the classic dilemma, the cooperative postures are for corporations to embrace and report accurately CSR practices and for consumers and investors to purchase the services or stock of compliant companies. In contrast, the defective postures are for corporations not to embrace and to report inaccurately compliance with CSR preferences and for consumers and investors not to purchase the services or stock of those non-compliant companies. Assuming consumers and investors are willing to offer greater rewards to compliant companies than the cost to those businesses of adopting desired CSR practices, the cooperative position represents true economic gain. Moreover, because corporations, consumers, and investors represent repeat players who could punish defection in continual iterations of the game over time, the equilibrium position should be mutual cooperation or embracing CSR practices.

But absent trustworthy auditing processes, enforcement mechanisms, or robust disclosure requirements that ensure full transparency, it becomes difficult for consumers and investors to detect when a company in fact adopts a defective posture. What results is true economic waste a destruction of the market for good CSR practices, because consumers and investors will not be willing to pay a premium for CSR practices, unless they can rely on the accuracy of a corporation's statements.

As a general matter, looking to the philosophy of trust for guidance on how to correct this disclosure dilemma should not seem terribly odd. After all, the fiduciary duties that officers and directors owe to the corporation represent essential trust relationships. Although the fiduciary duties of care and loyalty provide the backbone of modern corporate law, they remain frustratingly amorphous as currently applied by courts. Many assert that reliance on abstract concepts of fiduciary duties results in a system of inconsistent and indeterminate regulation of corporate behavior. According to critics, that fiduciary duties of care and loyalty exist says precious little about the particular contexts in which those duties necessarily arise or the content of the duties in any circumstance.

Reshaping those currently indeterminate fiduciary duties around the concept of encapsulated trust, however, could promote a kind of "best practices" regarding corporate communications on CSR issues. But what is encapsulated trust? In simple terms, encapsulated trust constitutes a rational expectation that others will take our interests into account when determining what course of action to pursue. Considered in that light, maintaining encapsulated trust requires an ongoing discourse within the trust relationship to determine competently the interests at stake and to assess the best means though which others encapsulate those interests in pursuing a particular course of action. Applied in the context of corporate disclosures on CSR, encapsulated trust would require that directors and officers take into account the interests of shareholders of the corporation in determining the substance and form of corporate communication. Satisfying a duty based on encapsulated trust would require engaging those corporate constituencies in an ongoing dialogue about the preferred level of corporate communication and the form for reporting information.

So with that basic understanding, how would courts apply encapsulated trust in the context of a fiduciary duty of disclosure? Arguably, if challenged, directors and officers would need to demonstrate that in making a particular disclosure, they competently took into account the interests of shareholders regarding the substance and form of the disclosure. If a disgruntled shareholder argued that the officers and directors violated their duty of care by failing to disclose effectively important information about CSR practices, company actors would need to demonstrate only that the disclosure took into account the interests of shareholders following an ongoing dialogue about the content, form, and timing of disclosures on such matters. In essence, the duty is a process-based standard that relies on enhanced discourse to improve the integrity of decisions on corporate disclosures. Although perhaps rather modest in scope, that emphasis on improved discourse between the corporations and their constituencies should provide substantial improvements over the current disclosure regime.

Perhaps most important, encapsulated trust promotes "best practices" in corporate disclosures by encouraging an efficient level of corporate communication. Efficient corporate communication represents the level of disclosure that corporate managers, shareholders, consumers, and other stakeholders would hypothetically negotiate in a world of perfect information and without the burdens of transaction costs in bargaining. The precise outcome of that hypothetical negotiation would necessarily change as the preferences of any party evolve.

Without doubt, fiduciary duties based on encapsulated trust would impose a more stringent duty of care on officers and directors, at least with respect to the process of attending to those duties. Some might charge that the inherent flexibility in the common law duties would produce a lack of clarity and predictability, resulting in significantly increased litigation costs. Those costs, however, do not necessarily impede moving toward an efficient level of corporate communication. Instead, those costs actually facilitate a Pareto improvement over a statutory disclosure regime by encouraging corporations to pay continual attention to the evolving preferences for disclosure of CSR practices.

Although adhering to existing static statutory disclosure standards would promote predictability, the very immovability of those standards could not accommodate changing market preferences regarding the desired content of corporate communication. Thus, determining whether a malleable fiduciary duty approach or a much more static statutory framework would enhance the likelihood of an efficient level of disclosure depends on an assessment of the nature of market preferences. If those preferences remain static, enduring the costs of a malleable approach would seem wholly unnecessary. On the other hand, if market preferences regarding the substance and character of corporate communication evolve, only a malleable common law approach could attend adequately to those changing preferences.

Considering the...