CORPORATE GOVERNANCE Expert Witnesses

Part 2:  Fiduciary Duty Experts
By Donna C Kline, Attorney at Law
The conceptual and moral nature of corporate governance and corporate negligence litigation
The elements and nature of corporate governance litigation are well known to all commercial litigators, but a brief review of the conceptual structure of corporate governance places the role of experts in perspective.  In particular, it shows how an expert on fiduciary duty can help counsel formulate the story of the case.

In the abstract, corporate governance is the legal structure for the allocation of power and responsibility for corporate actions.  Although shareholders are the plaintiffs in most corporate negligence litigation, there are actually other stakeholders in corporate affairs.  On the broadest view, the management of a corporation may have to balance responsibility to several different and sometimes conflicting interests.  For example, a particular business policy may strengthen the corporation’s financial position in the long run but depress share prices in the short term, which will benefit the corporation but potentially cost speculators some profits.  For another example, a business decision to move corporate headquarters from a deteriorating downtown to a suburban area may be a convenience for executives but a severe detriment to the city’s efforts to keep the downtown viable.  Outsourcing jobs may improve the company’s profitability but at the cost of a small community losing jobs that are essential to the community’s prosperity.

Corporate negligence litigation typically involves a challenge by stockholders to some action of the corporation based on allegations that those in charge did not fulfill their fiduciary duty to the corporation or did not fulfill their duties to the shareholders.  Traditionally, such litigation involved criticism of the board of directors’ actions.  However, recent law has expanded liability to officers as well as directors, particularly for failure to disclose relevant information.

Three paradigmatic breaches of fiduciary duty are alleged in corporate governance cases.  These involve (1) a failure to exercise due care in directing the business affairs of the corporation; (2) accusations of self-dealing to the effect that those in charge personally profited unduly at the corporation’s expense; and (3) a misrepresentation or failure to make a required disclosure.

Obviously, shareholders sue when the stock price falls dramatically.  Many such cases arise from financial decisions, such as making a particular investment decision, including decisions about compensation for management.  The shareholders may, of course, complain that required disclosures of financial facts were not made or were made in a misleading way.  However, a corporate governance case may be a spinoff from an industrial accident or product failure; the directors may be accused of paying insufficient attention to safety procedures or product testing.

The legal structure of corporate governance is a mixture of state and federal law.  In simplest terms, state law usually prescribes the nature of a director or officer’s fiduciary duty to the corporation, while federal law sets the standard for disclosure to the investing public.  Since state laws also afford varying protection to minority shareholders from abuses by controlling shareholders, which rests on holdings that the majority or controlling group owe some duties of fairness to the minority.

Nearly all corporate governance cases involve allegations about breaches of fiduciary duty.  Even cases that involve bad business decisions by the officers or directors usually also involve allegations of some form of self-dealing or other misconduct.  The reason is that the business judgment rule protects directors from liability for mere errors in judgment.  However, the law increasingly requires greater diligence from directors in informing themselves about the affairs of the corporation.

Fiduciary duty is a legal concept but one with moral components.  The elements of fiduciary duty are described in moral terms, such as honesty, good faith, and loyalty.  The trial attorneys in a case will of course understand the legal definitions of these terms.  However, the jury will likely respond both to the legal instructions given by the judge and to their own moral understanding of those concepts.

Here is another hypothetical example.  Suppose that a large financial firm has a policy of socially responsible investments.  The firm’s policy is that such investments must meet somewhat weaker financial criteria as well as being socially worthwhile.  A charismatic community leader applies for a loan to provide sheltered workshops for disabled persons.  The workshops are also to be funded with investments from people in the community.  The community leader turns out to be a con artist.  The sheltered workshops are never built.  The investors sue the financial firm.  The shareholders sue on the ground that the board and officers breached their fiduciary duties, either by failing to investigate the proposals adequately or by granting themselves large salary increases based on their achievement of “socially relevant” investment goals.

A full understanding of this case would be assisted by consultation with an expert in fiduciary duty in the context of corporate social responsibility.  Here, the field of stakeholders can be expanded to include the community and disabled persons. From a defense perspective, the jury’s evaluation of the board’s conduct can, ideally, take into account the concept that a corporation need not exist solely to maximize return on the dollar.  From the plaintiffs’ perspective, the jury needs to see that the board was not free to indulge their personal social commitments with company funds.

An expert on corporate governance and fiduciary duty in particular can contribute a variety of insights.  He or she can evaluate the case from the perspective of accepted business standards.  He or she may also suggest avenues of criticism or defense that are somewhat outside the legal matrix.

The ethics expert may likely be a business school professor.  In one case, counsel profitably consulted a distinguished professor of business ethics.

Although liability of directors and officers has been expanded, substantive law and procedural rules require that plaintiffs’ counsel be able to demonstrate very early in the case that he or she has a plausible claim.  Consultation with experts prior to filing the case can help counsel shape an initial complaint that clearly states a case.

Interestingly, also, at least one court has held that an expert on fiduciary duty could not properly testify about whether the actions in question comported with the legal elements of fiduciary duty.  The court reasoned that although an expert witness can opine as to the ultimate issues in a case, the concept of fiduciary duty was a legal one and, therefore, the testimony would amount to testimony on a point of law.

Creative use of an expert in the industry and transaction at issue, coupled with an expert on fiduciary duty, can enable the trial attorneys to prepare their case effectively and efficiently.