Stefan Padfield: Enhanced Scrutiny and the Omnipresent Specter of Political Bias

Corporate politicization, when companies take sides in our culture war and risk alienating half their potential customers, is a serious concern. Recent examples of companies that have felt its negative impact on shareholder value abound, including  Bud Light, Target, and Disney. Of course, the business judgment rule creates the presumption that the underlying decisions in those cases were fully informed and rationally expected to maximize shareholder value, but it would be naïve to dismiss the possibility that political bias and a lack of viewpoint diversity skewed the relevant decisions. Essentially, the concern is that decision-makers have become so committed to, or blinded by, their political tribalism and activist mindset that they have an actionable conflict of interest. Alternatively, it’s possible that the personal prestige of, for example, associating with the ESG-crowd at Davos may also be creating a conflict.

Stefan Padfield

One proposed response to this issue is the extension of judicial enhanced scrutiny from the anti-takeover context, which raises the possibility that directors are defending against a takeover to protect their sinecures, to situations that raise the specter of political bias. I advanced a version of this proposal here. I later learned that Fordham University Professor Brent Horton made a similar proposal around the same time. This was closely followed by a related federal statutory proposal from Senator Marco Rubio (linking to my piece). Now the National Center for Public Policy Research, where I work, has offered a shareholder proposal that seeks to implement the enhanced-scrutiny extension through private ordering.

This proposal was submitted to the shareholders of Dick’s Sporting Goods, which is an appropriate venue given that former CEO Ed Stack may be a prime example of a corporate leader who elevated personal political preferences over the duty to maximize shareholder value. The specific political issue in that case was gun rights  – and the key moment was when Stack declared “I don’t care about the financial consequences” of restricting gun sales. Of course, the Second Amendment does not require Dick’s to sell guns, but Delaware law does require the CEO of Dick’s to make fully informed decisions about shareholder wealth maximization. Stack could free himself of that constraint by, for example, starting his own private sporting goods business, but he can’t treat the company like his personal plaything.

Notably, when Stack tried to calculate the financial impact of restricting gun sales, he apparently could find no financial upside. His behavior arguably constitutes (1) a knowing breach of the duty of care (and thus constitutes non-exculpable bad faith) or (2) a waste of assets in the form of knowingly eliminating $250 million in sales with no financial upside (for the underlying details, see here and here). Regardless, it also provides a good example of the type of decision-making that should be subject to enhanced scrutiny under the proposed framework if it is otherwise deemed to fall short of rebutting the business judgment rule.

Dick’s sought no-action relief from our proposal. Notably, the SEC, in denying that relief, rejected a number of relevant corporate law objections to our proposal. Of course, Delaware courts are not bound by the SEC’s conclusions here. But proponents can nevertheless claim to have won a round in this fight. Specifically, the SEC rejected the following arguments: (1) the proposal would cause the company to violate Delaware law; (2) the company lacks the power to implement the proposal; and (3) the proposal is inherently vague and indefinite and subject to multiple interpretations. The relevant no-action correspondence here.

Rebuffing the no-action request was a win, but the proposal received essentially no support from the shareholders who voted. Certainly, this could mean there is no market appetite for subjecting boards to enhanced scrutiny when their decisions raise the specter of political bias. On the other hand, there are a number of reasons for suspending judgment on that point. First, the proxy statement presented the proposal under a misleading heading. It was described as seeking to “amend the Company’s By-Laws to waive the business judgment rule” while the proposal in fact left the protection of the business judgment rule intact but for a narrower set of specific cases. Second, the proposal’s novelty may have turned off voters who might end up supporting it once the details are fleshed out. After all, it took some time for declassified-board proposals to gain momentum. Third, the largest institutional investors have a record of voting against (or recommending voting against) anti-ESG proposals and proposals submitted by ESG critics (see here and here), and this record has many concerned (see here and here). Ask yourself: If you made money selling ESG funds and services, would you support anti-ESG proposals? As Scott Shepard, general counsel of the National Center for Public Policy Research, recently put it in commenting on some related news coverage (here):

The most negative critique they could achieve … was that FEP’s and its allies’ proposals don’t score high shareholder-vote totals — failing to report, as we explained to them, that those low totals don’t demonstrate shareholder disinterest in corporate neutrality, but instead are a measure of the dishonesty, fiduciary breach and potential regulatory and even criminal liability of the big three investment houses (BlackRock, State Street and Vanguard) and the two major proxy advisory services (ISS and Glass Lewis).

It may be that shareholders won’t ever support such proposals, even if they are efficient. This might happen if, for example, there are simply too many details to be worked out in a 500-word proposal. If that’s the case, then legislative and judicial approaches will need to be relied on unless adoption can be negotiated. (Relatedly, it has been noted that: “Not only is the enactment of the market practice amendments expected to restore the status quo that preceded the Moelis decision, but we may also see activists emboldened to seek governance restrictions from the company that heretofore were easily rebuffed as being potentially in violation of Section 141(a) of the DGCL.”) Of course, lawmakers and judges may also require significant additional convincing. Regardless, given the politicized landscape of corporate governance, the proposition that corporate decisions raising the specter of political bias should be subjected to enhanced scrutiny is unlikely to go away, and work will continue on finding the right balance of board accountability and authority (including the use of appropriate safe harbors) to make the proposal appealing to relevant decision-makers.