The "innocent shareholder": An essay on compensation and deterrence in securities class-action lawsuits

Wisconsin Law Review

Volumn 2009, Issue 2, 2009, Pages 243-295

  Mitchell, Lawrence E ^a  

^a GEORGE WASHINGTON UNIVERSITY   (United States)

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EID: 72049101688     PISSN: 0043650X     EISSN: None     Source Type: Journal    
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References (207)

1. 6 THE LETTERS OF THEODORE ROOSEVELT 886 (Elting E. Morison et al. eds., 1952).
2. See, e.g., James D. Cox, Making Securities Fraud Class Actions Virtuous, 39 ARIZ. L. REV. 497 (1997);
3. Michael P. Dooley & E. Norman Veasey, The Role of the Board in Derivative Litigation: Delaware Law and the Current ALI Proposals Compared, 44 BUS. LAW. 503 (1989);
4. Joseph A. Grundfest, Why Disimply?, 108 HARV. L. REV. 727 (1995);
5. Joel Seligman, The Merits Still Matter: A Rejoinder to Professor Grundfest's Comment, Why Disimply?, 108 HARV. L. REV. 748 (1995);
6. Keeping Shareholders in their Place, ECONOMIST, Oct. 13, 2007, at 83;
7. SEC Examining Corporate Derivative Losses, J. OF ACCOUNTANCY, July 1994, at 11.
8. See, e.g., Brief for Former SEC Commissioners and Officials and Law and Finance Professors as Amici Curiae Supporting Respondents at 14-16, Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761 (2008) (No. 06-43) [hereinafter Stoneridge Amici]; John C. Coffee, Jr., Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation, 106 COLUM. L. REV. 1534 (2006) [hereinafter Coffee, Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation];
9. Paul G. Mahoney, Precaution Costs and the Law of Fraud in Impersonal Markets, 78 VA. L. REV. 623, 635 (1992) (describing the argument);
10. Joseph P. Monteleone & Nicholas J. Conca, Directors and Officers Indemnification and Liability Insurance: An Overview of Legal and Practical Issues, 51 BUS. LAW. 573, 580 (1996);
11. John C. Coffee, Jr., Memo to Congress: Reform and Its Perils, N.Y. LAW JOURNAL, Nov. 15, 2007, at 5 [hereinafter Coffee, Memo to Congress];
12. Hal Scott, Let Shareholders Decide How to Resolve Disputes, FIN. TIMES (London), July 25, 2007, at 11. The Securities and Exchange Commission (SEC) has also taken a position akin to the circularity argument with respect to seeking damages.
13. See Press Release, SEC, Statement of the Securities and Exchange Commission Concerning Financial Penalties (Jan. 4, 2006), available at http:/www.sec.gov/news/press/2006-4.htm.
14. A point that is important to the circularity argument is that it is the corporation that pays damages, not the officers (and, sometimes, directors) who committed the fraud. See FRANK H. EASTERBROOK & DANIEL R. FISCHEL, THE ECONOMIC STRUCTURE OF CORPORATE LAW 315-52 (1991);
15. Cox, supra note 2, at 509; Donald C. Langevoort, Capping Damages for Open-Market Securities Fraud, 38 ARIZ. L. REV. 639, 646-57 (1996). The evidence seems irrefutable that individuals rarely pay damages in class-action lawsuits.
16. The one exception I could find is Ian B. Lee, Corporate Law, Profit Maximization, and the "Responsible" Shareholder, 10 STAN. J.L. BUS. & FIN. 31 (2005).
17. Professor Lee looks at the obligations of the shareholder as a generalized class for corporate social responsibility. I will examine, in a more targeted yet perhaps a broader way as well, the responsibilities of shareholders for corporate governance in general. See also Harvey J. Goldschmid, Capping Securities Fraud Damages: An Unwise Proposal in an Imperfect World, 38 ARIZ. L. REV. 665, 666 (1996) (arguing that shareholders who have the power to elect and replace directors ought not to escape liability as innocent).
18. For an interesting argument that diversification, the generally presumed posture of rational shareholders, has shifted duties from the corporation and its managers to the shareholders themselves, see David A. Hoffman, The "Duty" to Be a Rational Shareholder, 90 MINN. L. REV. 537 (2006).
19. Professor Coffee claims that the transaction costs in securities class-action lawsuits amount to approximately 50 percent of the recovery, making it impossible even for a fully diversified investor who wins half the time and loses the other half to come close to breaking even on the proposition. Coffee, Memo to Congress, supra note 4, at 5. It is worth noting that, as with all transactions costs, these are only waste if the recipients (in this case, plaintiffs' lawyers), put the money to less good use than do the corporation and insurance companies paying damages. For a historical look at negative attitudes toward plaintiffs' lawyers, see Lawrence E. Mitchell, Gentleman's Agreement: The Antisemitic Origins of Restrictions on Stockholder Litigation (The George Washington University Law Sch., Pub. Law Research Paper No. 44, 2002), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=321680.
20. For arguments that damages in securities class-action lawsuits do not adequately compensate, see Janet Cooper Alexander, Rethinking Damages in Securities Class Actions, 48 STAN. L. REV. 1487 (1996) (proposing a shift from traditional securities litigation to a system of civil penalties to deter fraud); (Pubitemid 126407557)
21. Frank H. Easterbrook & Daniel R. Fischel, Optimal Damages in Securities Cases, 52 U. CHI. L. REV. 611, 641 (1985);
22. Alicia Davis Evans, The Investor Compensation Fund, 33 J. CORP. LAW 223 (2007) (concluding that securities class-action lawsuits are an ineffective and poor means of compensation for defrauded shareholders);
23. Patrick M. Garry et al., The Irrationality of Shareholder Class Action Lawsuits: A Proposal for Reform, 49 S.D. L. REV. 275 (2004) (claiming that shareholder litigation fails to compensate injured investors);
24. A.C. Pritchard, Markets as Monitors: A Proposal to Replace Class Actions with Exchanges as Securities Fraud Enforcers, 85 VA. L. REV. 925, 983 (1999) (advocating an end to securities litigation and outlining an alternative enforcement regime run by stock exchanges with no damages to be paid to victims of fraud).
25. For arguments that damages in securities class-action lawsuits adequately compensate, or at least can adequately compensate, see Cox, supra note 2 (predicting that the changes wrought by the Private Securities Litigation Reform Act of 1995 will give the shareholder suit more credit with potential plaintiffs and the courts); James D. Cox, The Social Meaning of Shareholder Suits, 65 BROOK. L. REV. 3 (1999) [hereinafter Cox, The Social Meaning of Shareholder Suits];
26. Jill E. Fisch, Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy, 31 J. CORP. L. 637 (2006) (stating that securities class-action lawsuits enable small investors to successfully litigate their claims).
27. See Ehud Kamar, Shareholder Litigation Under Indeterminate Corporate Law, 66 U. CHI. L. REV. 887 (1999);
28. Mae Kuykendall, A Neglected Policy Option: Indemnification of Directors for Amounts Paid to Settle Derivative Suits - Looking Past " Circularity" to Context and Reform, 32 SAN DIEGO L. REV. 1063 (1995). One exception is Professor Cox. See Cox, The Social Meaning of Shareholder Suits, supra note 9. Professor Coffee has also tried to make the class-action lawsuit fulfill its intended purposes. See Coffee, Reforming the Securities Class Action: An Essay on Deterrence and Its Implementation, supra note 4.
29. See Mukesh Bajaj et al., Securities Class Action Settlements, 43 SANTA CLARA L. REV. 1001, 1010 tbl.4 (2003);
30. Stephen J. Choi & Robert B. Thompson, Securities Litigation and Its Lawyers: Changes During the First Decade After the PSLRA, 106 COLUM. L. REV. 1489 (2006).
31. See, e.g., Jennifer H. Arlen & William J. Carney, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. ILL. L. REV. 691;
32. Tom Baker & Sean J. Griffith, The Missing Monitor in Corporate Governance: The Directors' & Officers' Liability Insurer, 95 GEO. L.J. 1795 (2007) (concluding that, based on their empirical research, the practices of insurers actually diminish deterrence).
33. Professor Cox's eloquent defenses of securities class-action lawsuits exemplify this move. See Cox, supra note 2; Cox, The Social Meaning of Shareholder Suits, supra note 9; see also Private Litigation Under the Federal Securities Laws: Hearing Before the Subcomm. on Securities of the Comm. on Banking, Housing, and Urban Affairs, 103d Cong. 739 (1993) (statement of Frederick C. Dunbar & Vinita M. Juneja); Arlen & Carney, supra note 12, at 725 (establishing that in cases of false positive announcements, "50.5% of the cases involved false positive statements designed to conceal declines in earnings, while another 17.2% of the frauds were designed to conceal bad news about the issuer"); Elliott J. Weiss & John S. Beckerman, Let the Money Do the Monitoring: How Institutional Investors Can Reduce Agency Costs in Securities Class Actions, 104 YALE L.J. 2053, 2083-84 (1995).
34. See Stoneridge Amici, supra note 4, at 15-16; Arlen & Carney, supra note 12; Editorial, Hot Topic: A Class-Action Scheme, WALL ST. J., Oct. 6, 2007, at A20;
35. Roger Parloff, Rethinking Class Actions, FORTUNE, Nov. 12, 2007, at 26;
36. Peter J. Wallison, Capital Complaints, WALL ST. J., Mar. 20, 2007, at A19. Columnist Stuart Taylor, Jr. does not use the phrase, but clearly has it in mind while bemoaning large punitive-damages payments in a broad spectrum of cases.
37. Stuart Taylor, Jr., When Punitive Damages Make No Sense, NAT'L J., Oct. 27, 2007, at 15, 16. Judge Easterbrook and Professor Fischel had earlier described the shareholders trading against the injured shareholders in the open market as the "innocent beneficiaries" of the fraud. Easterbrook & Fischel, supra note 9.
38. For a rare recent questioning of the notion of shareholder innocence in the limited-liability context, see Jennifer Hill, Visions and Revisions of the Shareholder, 48 AM. J. COMP. L. 39, 50-51 (2000).
39. For a contemporary feminist argument that the inability or failure to exercise responsibility does not exculpate the power holder, see Theresa A. Gabaldon, The Lemonade Stand: Feminist and Other Reflections on the Limited Liability of Corporate Shareholders, 45 VAND. L. REV. 1387, 1429-30 (1992).
40. Let me also be clear about what I am not addressing in this Paper. I am not advocating an increased role for shareholders in corporate governance. Nor am I questioning the need for reform of aspects of shareholder litigation. As to these issues, I express no opinion, at least in this Paper. My only point is that the assumption of shareholder innocence diminishes the circularity argument as an adequate reason for reform. Those familiar with my work will know that I am not especially sympathetic to the shareholders' role in corporate governance, at least as presently exercised. This lack of enthusiasm might, however, be altered in an environment in which the average shareholder becomes a long-term investor and takes on some of the responsibilities of ownership. See LAWRENCE E. MITCHELL, CORPORATE IRRESPONSIBILITY: AMERICA'S NEWEST EXPORT (2001). But ongoing research increasingly convinces me that shareholder rights ought to be very limited.
41. Lawrence E. Mitchell, The Legitimate Rights of Public Shareholders (George Washington University Legal Studies Research Paper No. 461, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=1352025.
42. See, e.g., Reckless Banking, N.Y. TIMES, Oct. 25, 1893, at 4;
43. That Third-Track Grab, N.Y. TIMES, Aug. 30, 1891, at 9.
44. See, e.g., Brooklyn Elevated Road, N.Y. TIMES, Jan. 16, 1892, at 8 (discussing fraudulent overcapitalization). Shareholders were sometimes not considered innocent when a corporation had made full disclosure of its business.
45. See, e.g., City Ownership of Railways, N.Y. TIMES, Apr. 22, 1897, at 4.
46. At least one commentator argued that shareholders did not want disclosure because they did not want to hear bad news, and that the only real measure of directorial performance was the performance of the corporation's stock price. See A Plea for the Director, N.Y. TIMES, Jan. 12, 1890, at 6.
47. Of course both of the concerns noted in the text were not new in the 1890s. I begin here largely because this is the period during which American stockholding begins to become more widespread and moves beyond railroads and banks to industrial securities. See LAWRENCE E. MITCHELL, THE SPECULATION ECONOMY, at ch. 4 (2007).
48. For the intellectual and social context of progressivism and reform thought, see generally HENRY STEELE COMMAGER, THE AMERICAN MIND: AN INTERPRETATION OF AMERICAN THOUGHT AND CHARACTER SINCE THE 1880'S (1950);
49. RALPH HENRY GABRIEL, THE COURSE OF AMERICAN DEMOCRATIC THOUGHT (1986);
50. ERIC F. GOLDMAN, RENDEZVOUS WITH DESTINY: A HISTORY OF MODERN AMERICAN REFORM (1963);
51. RICHARD HOFSTADTER, THE AGE OF REFORM: FROM BRYAN TO F.D.R. (1955);
52. ROBERT H. WIEBE, THE SEARCH FOR ORDER: 1877-1920 (1967).
53. See V.H. Lockwood, How To Reform Business Corporations, N. AM. REV., Mar. 1897, at 294.
54. The Investment Bankers Association of America, formed in 1912, served lobbying functions as well as the goal of professionalizing investment banking, and maintained on its agenda a concern to bolster the reputation of the industry in order to induce the newly emerging middle class to invest. See VINCENT P. CAROSSO, INVESTMENT BANKING IN AMERICA: A HISTORY, 165-71 (1970). Financial and political conservatives viewed widespread shareholdings as, among other things, a way to prevent socialism from taking root in America. MITCHELL, supra note 19, at 26 (noting the endorsement of securities regulation by the Investment Bankers' Association in 1919).
55. See, e.g., Small Creditors Sue, WASH. POST, Feb. 3, 1903, at 12. This notion of shareholder responsibility persisted.
56. See M.J. Fields, The International Mercantile Marine Company - An Ill-Conceived Trust, 5 U. CHI. J. BUS. 362, 371 (1932) (noting that the company's reorganization plan "indicates, as nothing else can, the utter irresponsibility of most shareholders in the long-range welfare of the corporation of which they are the owners, and demonstrates anew the self-seeking proclivities of the average human being").
57. See, e.g., C.E. Gunn, Letter to the Editor, Ambiguity of Legal Expression, 57 ALB. L.J. 193, 207 (1898);
58. Union Pacific Foreclosure, N.Y. TIMES, Jan. 24, 1897, at 6;
59. Where the Government Comes In, WASH. POST, Feb. 19, 1895, at 6.
60. The Financial World, N.Y. TIMES, June 24, 1894, at 5.
61. J.W. Caldwell, Law Reform, 4 AM. LAW. 539, 540 (1896).
62. The Financial World, supra note 25, at 5.
63. Reports of the Industrial Commission, 35 AM. L. REV. 147, 149 (1901) (book review).
64. The antitrust concern continued, See, e.g., Jean W. Adams, Trustbusting and the Innocent Shareholder: 'Compensation' If Stock Prices Fall?, 10 ANTITRUST L. & ECON. REV. 51 (1978), as it obviously continues in other contexts including securities class-action lawsuits and other forms of corporate crime.
65. For an example of the labor context, see The Issue in Colorado, OUTLOOK, May 16, 1914, at 93, 101-02.
66. This was not always the case. In 1900, The Brooklyn Daily Eagle quoted Professor Clark in calling for investor protection as noting, "There is no antagonism, but complete harmony, between the practical policy that stands guard over honest capital that has been lured into the trust and the one that protects the purchasing public and the workman." How to Tame the Trusts, BROOKLYN DAILY EAGLE, Mar. 27, 1900, at 15.
67. S. REP. NO. 59-1242, at 8-9 (1906). It is worth noting here, as Professor Tsuk Mitchell points out, that the principal internal corporate conflict during this era was not between management and shareholders, but between controlling shareholders (and creditors) and minority shareholders. Dalia Tsuk Mitchell, Shareholders as Proxies: The Contours of Shareholder Democracy, 63 WASH. & LEE L. REV. 1503, 1520 (2006).
68. As to powerlessness, see EDWARD DUDLEY KENNA, THE HELPLESS SHAREHOLDER: A PHASE OF THE RAILWAY QUESTION IN THE UNITED STATES (1911).
69. As to the use of control devices, see ADOLF A. BERLE, JR. & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY (1932);
70. Gardiner Means, The Separation of Ownership and Control in American Industry, 46 Q.J. ECON. 68 (1932).
71. See William Horace Brown, Public Ownership and Popular Government, 12 AM. J. SOC. 328, 331 (1906);
72. Lewis C. Williams, Responsibility of Corporate Control, 12 VA. L. REV. 563, 571 (1926).
73. Professor Dunlavy provides evidence that there was a broader concern with minority-shareholder rights during this period, citing reports in prominent newspapers as evidence. See Colleen A. Dunlavy, Social Conceptions of the Corporation: Insights from the History of Shareholder Voting Rights, 63 WASH. & LEE L. REV. 1347, 1362 (2006). Indeed Dunlavy's fascinating article shows how earlier in the nineteenth century, concern with corporate power and a fear of plutocracy led a substantial proportion of corporations to be governed by a one-shareholder-one-vote rule. By the turn of the twentieth century, a "plutocratic conception" of the corporation had emerged, facilitated by the dominance of the one-share-one-vote rule, the wide dispersal of corporate shares resulting from the merger wave of 1897-1903 (Dunlavy dates it from 1895 to 1904), and the corresponding ability of larger shareholders to overpower small individual shareholders, leading to calls for minority protection. Id. at 1384-86. For a discussion of discrepancies in the periodization of the merger wave, see MITCHELL, supra note 19, at 283-84 n.12.
74. See generally MARTIN J. SKLAR, THE CORPORATE RECONSTRUCTION OF AMERICAN CAPITALISM, 1890-1916: THE MARKET, THE LAW, AND POLITICS (1988);
75. HANS B. THORELLI, THE FEDERAL ANTITRUST POLICY: ORIGINATION OF AN AMERICAN TRADITION (1954).
76. See GABRIEL KOLKO, THE TRIUMPH OF CONSERVATISM: A REINTERPRETATION OF AMERICAN HISTORY, 1900-1916 (1963); MITCHELL, supra note 19, at 153.
77. A characteristically thoughtful and nuanced evaluation both of the speech and the financial situation preceding it was provided by the dean of financial journalists, Alexander D. Noyes. See Alexander D. Noyes, The Fall in the World's Markets, 39 FORUM 186 (1907).
78. No Change in the President's Policy, INDEPENDENT, Aug. 29, 1907, at 474.
79. Wall Street Gossip, WASH. POST, Aug. 21, 1907, at 10. The positive reaction, however, was not universal.
80. See, e.g., W.R. Givens, [Untitled], INDEPENDENT, Aug. 29, 1907, at 482.
81. See Wall Street View of Speech, N.Y. TIMES, Aug. 21, 1907, at 2.
82. Henry Clews, President Roosevelt and Wall Street, INDEPENDENT, Aug. 21, 1907, at 481, 481-82. Leading investment banker Henry Lee Higginson was more critical of Roosevelt, and agreed with Clews's view of punishing the individual officers, not the stockholders through the corporation. See Justice to Corporations, OUTLOOK, Jan. 18, 1908, at 118.
83. A Review of the World, 43 CURRENT LITERATURE 351, 352 (1907).
84. 6 THE LETTERS OF THEODORE ROOSEVELT, supra note 1, at 886.
85. Special Message of the President of the United States Communicated to the Two Houses of Congress on Jan. 31, 1908, THEODORE ROOSEVELT PAPERS 17-18 (Lib. Cong.).
86. As an example, the idea of punishing the individuals rather than the corporation was defended at the annual Washington's birthday dinner of the Society of the Cincinnati in 1908. See Million Men Needed, Gen. Grant Declares, N.Y. TIMES, Feb. 23, 1908, at 10.
87. Hughes had heavily discounted talk of his potential gubernatorial run in 1906 because of the highly negative reaction among financiers and conservatives, as well as his own party machine in New York. See MERLO J. PUSEY, 1 CHARLES EVANS HUGHES 170 (Columbia Univ. Press 1963) (1951). His progressive and principled performance as governor had not helped his presidential candidacy. Id. at 206, 216.
88. See Hughes in a Larger Field, WASH. POST, Feb. 1, 1908, at 6;
89. Hughes' Platform, WASH. POST, Feb. 1, 1908, at 1, 4;
90. Permanent Prosperity, OUTLOOK, Feb. 22, 1908, at 380-81. The Outlook was well known for its consistent positions in favor of the Roosevelt administration, and in fact Roosevelt was a frequent writer for the journal. The Outlook was also a fan of Hughes. While it might seem odd that an argument in favor of punishing corporate officials would help Hughes gain the support of the financial interests, punishing corporate executives was, at that time, even rarer in fact than it is now, but punishing corporations could, as the Standard Oil ruling demonstrated, significantly damage their financial claimants as well as bring disarray to the markets.
91. [Untitled], LIFE, Jan. 16, 1908, at 70.
92. The concern that innocent shareholders should not be made to bear the burden of official corporate misconduct through enterprise liability was increasingly widespread as a popular matter in all contexts. Indicting a Corporation After Criminal Directors Are Out of Office, 71 CENT. L.J. 437, 437-38 (1910). Democratic support for individual accountability was consistent with that party's general preference for individualism to the collectivism that enterprise liability implied.
93. Editorial, Finding the Individual, N.Y. TIMES, Jun. 9, 1908, at 6.
94. ROBERT H. WEIBE, THE SEARCH FOR ORDER, 1877-1920, 123-32 (1967).
95. See Louis D. Brandeis & Samuel Gompers, The Incorporation of Trade Unions: "No, Thank you!" Says Gompers, 1 GREEN BAG 306, 308 (1998).
96. Corporate Morality, CHRISTIAN OBSERVER, Feb. 23, 1910, at 3.
97. Indicting a Corporation After Criminal Directors Are Out of Office, supra note 61, at 437.
98. See MITCHELL, supra note 19, at 128. Based upon Dill's later conversations with his friend and critic, journalist Lincoln Steffens, it appears more likely than not that, while Dill was not completely insincere, he clearly sided with the trusts. See LINCOLN STEFFENS, THE AUTOBIOGRAPHY OF LINCOLN STEFFENS 193-96 (1931).
99. Dill Talks on Trusts, WASH. POST, Jan. 23, 1910, at 8.
100. Our Judges Lack Power, Says Taft, N.Y. TIMES, May 14, 1911, at 16.
101. Machen had just published two famous articles on the subject of corporate personality in the Harvard Law Review. See Arthur W. Machen, Jr., Corporate Personality, 24 HARV. L. REV. 253 (1911);
102. Arthur W. Machen, Jr., Corporate P ersonality (continued), 24 HARV. L. REV. 347 (1911).
103. The real entity theory of corporate personality had unleashed a "flood of articles ⋯ after the turn of the century," MORTON J. HORWITZ, THE TRANSFORMATION OF AMERICAN LAW, 1870-1960: THE CRISIS OF LEGAL ORTHODOXY 103 (1992), and the theory dominated corporate thinking during the Progressive Era.
104. See Gregory A. Mark, The Personification of the Business Corporation in American Law, 54 U. CHI. L. REV. 1441 (1987);
105. Dalia Tsuk, Corporations Without Labor: The Politics of Progressive Corporate Law, 151 U. PA. L. REV. 1861 (2003).
106. Id. at 184-88 (holding that in fashioning relief for a violation of the Sherman Act, a court must, among other things, show "a proper regard" for the interests of innocent shareholders); see also Frederic R. Coudert, The Record, 194 N. AM. REV. 32 (1911);
107. Tobacco Trust Decision Epitomized, WASH. POST, May 30, 1911, at 5.
108. One financier, while supporting the idea that shareholders had some responsibility in ensuring corporate compliance with the law, decried the absence of a federal corporations law that would have protected shareholders from paying the price for their managers' abuses and noted the lack of sympathy that Taft had shown toward shareholders like those of American Tobacco, who would be punished for that corporation's violation of the Sherman Act. See Lauds Taft's Speech, WASH. POST, Sept. 21, 1911, at 12. Taft was so unconcerned with the plight of the innocent shareholder that none other than Teddy Roosevelt had to coach him to show some compassion during the 1908 presidential contest. See MITCHELL, supra note 19, at 183.
109. Money Trust Investigation: Investigation of Financial and Monetary Conditions in the United States Before the H. Subcomm. of the Comm. on Banking and Currency, 63d Cong. (1913), available at http://fraser.stlouisfed.org/ publications/montru/issue/3642/download/53821/montru-pt16.pdf.
110. LOUIS D. BRANDEIS, OTHER PEOPLE'S MONEY AND HOW THE BANKERS USE IT 99 (1914). It is interesting to note that Brandeis used the terms investor and shareholder interchangeably, presumably because he was talking principally about excessive underwriting fees. But in the larger context both of this book, which was based on the revelations of bankers' corporate control emerging from the Pujo Committee, and Brandeis's other work, his concern with minority shareholders within the corporation is clear.
111. See LOUIS LOSS & EDWARD M. COWETT, BLUE SKY LAW 3-10 (1958).
112. THE CURSE OF BIGNESS: MISCELLANEOUS PAPERS OF LOUIS D. BRANDEIS 74 (Osmond K. Fraenkel ed., 1935).
113. S. DOC. NO. 64-415, at 7660 (1916); THE CURSE OF BIGNESS, supra note 86, at 75.
114. THE CURSE OF BIGNESS, supra note 86, at 75. The perspective that, as between innocent shareholders and the rest of the world, the innocent shareholders should bear the financial burden of corporate misconduct, continued. See, e.g., Stockholder Levy Upheld in Detroit, N.Y. TIMES, Mar. 9, 1934, at 29.
115. See Douglas M. Branson, Corporate Social Responsibility Redux, 76 TUL. L. REV. 1207, 1219 (2002) (citing how institutional activists monitor corporate social responsibility of the companies in which they invest);
116. Marcel Kahan & Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control, 155 U. PA. L. REV. 1021, 1062-69 (2007) (discussing the nature of hedge-fund monitoring);
117. Joel Seligman, The Case for Federal Minimum Corporate Law Standards, 49 MD. L. REV. 947, 955 (1990) (noting that the current trend of activist institutional investors will impact the composition of the boardroom and how businesses run themselves).
118. Security Owners Hit Rayburn Bill, N.Y. TIMES, Mar. 25, 1932, at 32.
119. Franklin Letter on I.R.T., N.Y. TIMES, Feb. 24, 1934, at 7.
120. Gerard Would See Investors United, N.Y. TIMES, Apr. 29, 1934, at N9.
121. Russell B. Kingman, Letter to the Editor, N.Y. TIMES, May 20, 1934, at E5.
122. Robert Quillen, They Rob Peter to Pay Paul Because Paul Was Robbed, WASH. POST, Nov. 22, 1933, at 6.
123. Ultimatum Given to Allied Chemical, N.Y. TIMES, May 25, 1933, at 29.
124. JOHN H. SEARS, THE NEW PLACE OF THE STOCKHOLDER (1929).
125. One reviewer described it as reading like the unedited diary of a busy corporate lawyer. Robert L. Masson, The New Place of the Stockholder, 5 ACCT. REV. 324, 325 (1930) (book review).
126. Dalia Mitchell, Status Bound: The Twentieth-Century Evolution of Directors' Liability, 5 N.Y.U. J.L. & BUS. (forthcoming 2009).
127. William O. Douglas, Directors Who Do Not Direct, 47 HARV. L. REV. 1305 (1934).
128. MITCHELL, supra note 19, at 205-08. In the parlance of the time, shareholders were not investors but were speculators. See BENJAMIN GRAHAM & DAVID L. DODD, SECURITIES ANALYSIS 307-09 (1934).
129. DEMOCRACY AND FINANCE: THE ADDRESSES AND PUBLIC STATEMENTS OF WILLIAM O. DOUGLAS 7 (James Allen ed., 1940).
130. See JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET 270 (1982);
131. Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices, 59 STAN. L. REV. 1465, 1497 (2007); Lee, supra note 5, at 62; Tsuk Mitchell, supra note 39, at 1547-53.
132. See Tsuk Mitchell, supra note 39, at 1547-53; Philip A. Nicholas, Jr., The Securities and Exchange Commission and the Shareholder Proposal Rule: Agency Administration, Corporate Influence, and Shareholder Power, 1942-1998 (2002) (unpublished Ph.D. dissertation, University at Albany) (on file with author).
133. See LEWIS D. GILBERT, DIVIDENDS AND DEMOCRACY 128-32 (1956);
134. Tsuk Mitchell, supra note 39, at 1547-53; John Bainbridge, The Talking Stockholder-II, NEW YORKER, Dec. 18, 1948, at 33-34;
135. Nancy Fraser, Queen of Corporate Gadflies, LIFE, Mar. 18, 1966, at 115;
136. Nicholas, supra note 125, at 212-14. For an argument that while the individual stockholder had been disempowered, the class of stockholders had become an important force thanks to disclosure, regulation like the securities laws, and market power, see J.A. LIVINGSTON, THE AMERICAN STOCKHOLDER (1958). For an earlier attempt to argue that the stockholder should behave like a business owner, see SEARS, supra note 102.
137. See, e.g., Med. Comm. for Human Rights v. SEC, 432 F.2d 659, 676-81 (D.C. Cir. 1970);
138. Lovenheim v. Iroquois Brands, Ltd., 618 F. Supp. 554 (D.D.C. 1985); State ex. rel. Pillsbury v. Honeywell, Inc., 191 N.W.2d 406 (Minn. 1971); American Telephone and Telegraph Corp., SEC No-Action Letter, [1993-1994 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 76, 820 (Jan. 24, 1994). While it certainly is the case that shareholder proposals aimed at profit maximization have proliferated in recent years, socially oriented shareholder proposals have also grown. Lee, supra note 5, at 62. A brief history of the rise in institutional investor activism is provided in LAUREN TALNER, THE ORIGINS OF SHAREHOLDER ACTIVISM 38 (1983).
139. Perhaps the most influential writing in the 1970s on the shareholder-responsibility movement was JOHN G. SIMON ET AL., THE ETHICAL INVESTOR: UNIVERSITIES AND CORPORATE RESPONSIBILITY (1972).
140. The study was published as LEWIS H. KIMMEL, SHARE OWNERSHIP IN THE UNITED STATES (1952).
141. Bayless Manning, 67 YALE L.J. 1477, 1477-78 (1958)
142. reviewing J.A. Livingston, THE AMERICAN STOCKHOLDER (1958).
143. KIMMEL, supra note 128, at 89. Interestingly, the demand for stock, which was a primary driver of increased equity offerings in the late 1940s, came from investors in "the middle and lower income brackets who are less affected by high personal income tax rates." Jules I. Bogen, The Importance of Equity Financing in the American Economy, 5 J. FIN. 170, 174 (1950).
144. By 1967, the average shareholder had relatively high income. See CARTER F. HENDERSON & ALBERT C. LASHER, 20 MILLION CARELESS CAPITALISTS 231-32 (1967). It is interesting to speculate what, if any, effect the demographic changes in shareholding suggested by this data had on shareholder activism, but the answer to this question awaits future work. Institutional ownership was negligible at this point. KIMMEL, supra note 128, at 89.
145. Wyatt Wells, Certificates and Computers: The Remaking of Wall Street, 1967 to 1971, 74 BUS. HIST. REV. 193, 194 (2000).
146. NEW YORK STOCK EXCHANGE, SHAREOWNERSHIP 1985, at 3 (1986).
147. S. Oliver Goodman, Livingston Scalpel Prods Stockholders, WASH. POST, Mar. 12, 1958, at A25.
148. See Joseph W. Bishop, Jr., Review: The Bursting of the Bubble, 83 YALE L.J. 1100, 1100 (1974).
149. See generally JOHN BROOKS, THE GO-GO YEARS (1973).
150. DIV. OF CORP. FIN., SEC, 96TH CONG., REPORT ON CORPORATE ACCOUNTABILITY 199-200 (Comm. Print 1980) (questioning the proper relationship of the holders of institutions' stock to the political process);
151. Victor Brudney, Business Corporations and Stockholders' Rights Under the First Amendment, 91 YALE L. J. 235, 258 (1981);
152. Donald E. Farrar & Lance Girton, Institutional Investors and Concentration of Financial Power: Berle and Means Revisited, 36 J. FIN. 369 (1981).
153. MARSHALL E. BLUME & IRWIN FRIEND, THE CHANGING ROLE OF THE INDIVIDUAL INVESTOR (1978).
154. Professor Gordon marks this period as a shift to shareholder valuism resulting in large part from the newly created institution of the independent monitoring board, as do I. We differ in our evaluation of the causes of the latter, as well as the normative implications we draw from this development. Compare Gordon, supra note 124, with Lawrence E. Mitchell, The Trouble with Boards, (George Washington University Legal Studies Research Paper No. 159, 2005), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=801308. Professor Tsuk Mitchell marks the intellectual shift to shareholder valuism as dating to the work of academic Henry Manne in the early 1960s, even as she evaluates later shareholder political efforts as a fading dream of shareholder empowerment. Tsuk Mitchell, supra note 39, at 1562-64.
155. The theory is thoroughly discussed in a symposium published by the Columbia Law Review in 1989. Symposium, Contractual Freedom in Corporate Law, 89 COLUM. L. REV. 1395 (1989).
156. See P. John Kozyris, Corporate Wars and Choice of Law, 1985 DUKE L.J. 1, 6;
157. Larry D. Soderquist & Robert P. Vecchio, Reconciling Shareholders' Rights and Corporate Responsibility: New Guidelines for Management, 1978 DUKE L.J. 819, 833.
158. See Allan Kaufman, Managers' Double Fiduciary Duty: To Stakeholders and to Freedom, 12 BUS. ETHICS Q. 189, 190-91 (2002);
159. Thomas A. Smith, The Efficient Norm for Corporate Law: A Neotraditional Interpretation of Fiduciary Duty, 98 MICH. L. REV. 214, 214 (1999).
160. See Cracker Barrel Old Country Store, Inc., SEC No Action Letter, [1992-1993 Transfer Binder] Fed Sec. L. Rep. (CCH) ¶ 76, 418 (Oct. 13, 1992); see also ABA Section of Business Law, Annual Review of Federal Securities Regulation, 62 BUS. LAW. 1065, 1090 (May 2007) (detailing disclosure standards for related-persons transactions);
161. Christine L. Ayotte, Reevaluating the Shareholder Proposal Rule in the Wake of Cracker Barrel and the Era of Institutional Investors, 48 CATHOLIC U. L. REV. 511 (1999);
162. Robert C. Illig, What Hedge Funds Can Teach Corporate America: A Roadmap for Achieving Institutional Investor Oversight, 57 AM. U. L. REV. 225, 253-58 (2007) (detailing briefly the historical context in which the shareholder-communications rule emerged, and the response to the promulgation of the rule);
163. Maya Mueller, The Shareholder Proposal Rule: Cracker Barrel, Institutional Investors, and the 1998 Amendments, 28 STETSON L. REV. 451 (1998);
164. Paul M. Neuhauser, Facilitating Shareholder Communications, 17 J. CORP. L. 213, 213 (1991);
165. Bethann Roth, Proactive Corporate-Shareholder Relations: Filling the Communications Void, 48 CATHOLIC U. L. REV. 101 (1998);
166. Norma M. Sharara & Ann E. Hoke-Witherspoon, The Evolution of the 1992 Shareholder Communication Proxy Rules and Their Impact on Corporate Governance, 49 BUS. LAW. 327 (1993). While it certainly is the case that shareholder proposals aimed at profit maximization have proliferated in recent years, socially oriented shareholder proposals have also grown. (Pubitemid 24757452)
167. Myron P. Curzan & Mark L. Pelesh, Revitalizing Corporate Democracy: Control of Investment Managers' Voting on Social Responsibility Proxy Issues, 93 HARV. L. REV. 670 (1980);
168. Leila Sadat-Keeling, The 1983 Amendments to Shareholder Proposal Rule 14a-8: A Retreat From Corporate Democracy?, 59 TUL. L. REV. 161, 169 (1984) (outlining a history of calls for increased shareholder communications).
169. George W. Coombe, Jr., Directors' Duties and Responsibilities: New Dimensions, New Opportunities, 95 BANKING L.J. 634 (1978) (detailing the changes directors must make to their boardrooms to accommodate a "shareholder democracy").
170. It is worth reiterating Professor Werner's 1977 observation of managerial sensitivity to the stock market. Walter Werner, Management, Stock Market and Corporate Reform: Berle and Means Reconsidered, 77 COLUM. L. REV. 388, 389 (1977).
171. Probably the most visible proponent of improved shareholder democracy, Professor Bebchuk, is quite explicit that his goal is to improve shareholder value. Lucian A. Bebchuk, The Myth of the Shareholder Franchise, 93 VA. L. REV. 675, 678 (2007).
172. INV. & FIN. SERV. ASS'N OF AUSTL., SHAREHOLDER ACTIVISM AMONG FUND MANAGERS: POLICY AND PRACTICE 1-3 (July 2003), available at http://www.ifsa.com. au/documents/2003-Publications-Shareholder%20Activism.pdf;
173. Stuart L. Gillan & Laura T. Starks, Corporate Governance Proposals and Shareholder Activism: The Role of Institutional Investors, 57 J. FIN. ECON. 275 (2000) (measuring the success of shareholder activism in the 1990s through voter outcomes and short-term market reactions conditioned on proposal type and sponsor identity).
174. Douglas M. Branson, Corporate Governance "Reform" and the New Corporate Social Responsibility, 62 U. PITT. L. REV. 605, 611 (2001) (recounting a history of the corporate social-responsibility movement);
175. Kellye Y. Testy, Linking Progressive Corporate Law with Progressive Social Movements, 76 TUL. L. REV. 1227, 1228 (2002) (distinguishing the "new" corporate social responsibility from the 1970s version).
176. Randall S. Thomas & James F. Cotter, Shareholder Proposals in the New Millennium: Shareholder Support, Board Response, and Market Reaction, 13 J. CORP. FIN. 368, 372 (2007) (describing shareholder proposal types from 2002 to 2004, namely, (1) auditor independence, (2) compensation, (3) environmental/social, (4) external corporate control/governance, (5) internal corporate control/governance, and (6) other social responsibility);
177. Sarah Mulholland, Shareholder Proposals Hit Record High, INVESTMENT MGMT. WKLY., Aug. 18, 2003 (showing an increase in shareholder proposals from 529 received in 2002 to 775 as of August 18, 2003, with a full 41 percent of the proposals dealing with executive pay, 23 percent dealing with poison-pill provisions, and 15 percent dealing with calls to companies to expense stock options).
178. Turnover increased 123 percent in 2007. NYSEData.com, NYSE Group Turnover, 2008, http://www.nyxdata.com/nysedata/asp/factbook/viewer-edition.asp? mode=table&key=3027&category=3 (last visited Feb. 8, 2009).
179. See, e.g., Bebchuk, supra note 168, at 682; Sharon Hannes, Corporate Stagnation: Discussion and Reform Proposal, 30 J. CORP. L. 51, 75 (2004);
180. John H. Matheson & Brent A. Olson, Corporate Law and the Longterm Shareholder Model of Corporate Governance, 76 MINN. L. REV. 1313, 1370 (1992);
181. J.W. Verret, Pandora's Ballot Box, or a Proxy with Moxie?: Majority Voting, Corporate Ballot Access, and the Legend of Martin Lipton Re-Examined, 62 BUS. LAW. 1007 (2007). Professor Tsuk Mitchell explores the foundational understandings of the modern stockholder in Shareholders as Proxies: The Contours of Shareholder Democracy, supra note 39.
182. Lawyers Andrew Brownstein and Igor Kirman provide a thoughtful and detailed analysis of the significant growth of shareholder corporate-governance resolutions under SEC Rule 14a-8, as well as other forms of institutional pressure on corporate boards and management, noting that such efforts have had clearly observable results on board behavior. See Andrew R. Brownstein & Igor Kirman, Can a Board Say No When Shareholders Say Yes? Responding to Majority Vote Resolutions, 60 BUS. LAW. 23, 23-24 (2004).
183. MITCHELL, supra note 17, passim; MATTEO TONELLO, REVISITING STOCK MARKET SHORT-TERMISM (2006);
184. MITCHELL, supra note 19, at 278; John R. Graham et al., The Economic Implications of Corporate Financial Reporting, 40 J. ACC. ECON. 3 (2005).
185. See Shareholder Communications Rules, 17 C.F.R. §§ 240, 249, 274 (2007); Electronic Access Rules, 17 C.F.R. §§ 232, 270 (2007). But on November 28, 2007, the SEC amended Rule 14a-8(i)(8) to make it clear that shareholder proposals to create proxy-access procedures were excludable by management from its proxy materials, although Chairman Christopher Cox, who supported the amendment, stated that he "favors shareholder access in the long term," treating the amendment as a temporary stop-gap measure to cover the 2008 proxy season. Divided SEC Acts to Allow Exclusion by Firms of Shareholder Access Proposals, 76 U.S.L.W. 2331 (2007).
186. See Aaron Bernstein, Power to the Shareholders, DIRECTORSHIP, Oct/Nov. 2007, at 18;
187. Brownstein & Kirman, supra note 178, at 68 (describing managerial responses to shareholder pressure); Hail, Shareholder!, ECONOMIST, June 2, 2007, at 65;
188. Hillary Jackson, Raising Its Profile by Raising Its Standards, INSTITUTIONAL INVESTOR, Dec. 2007, at 1;
189. Louis Lavelle, So That's Why Boards Are Waking Up: The Prospect of More Voting Power for Investors Has Companies Listening at Last, BUS. WEEK, Jan. 19, 2004, at 72.
190. James J. Angel & Douglas M. McCabe, The Ethics of Managerial Compensation: The Case of Executive Stock Options, 78 J. BUS. ETHICS 225, 231 (2008);
191. Thomas W. Briggs, Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis, 32 J. CORP. L. 681 (2007);
192. see also James D. Cox & Randall S. Thomas, Does the Plaintiff Matter? An Empirical Analysis of Lead Plaintiffs in Securities Class Actions, 106 COLUM. L. REV. 1587, 1605 (2006) (noting the desire of public pension funds, among other things, to improve financial reporting through corporate-governance reforms);
193. James MacGregor & Ian Campbell, Dealing with Investor Activism: Investors Seek Cash Returns from Pushing Your Buttons - There Are Things You Can Do to Prepare for an Attack, 5 INT'L J. OF DISCLOSURE & GOVERNANCE 23 (2008) (describing how companies can circumvent activist proposals);
194. Lawrence C. Strauss, A Blueprint for Growth, BARRON'S, Oct. 22, 2007, at 46 (predicting that companies will offer alternative assets to accommodate institutional investors);
195. Warren de Wied, New Year's Resolutions for Boards, DIRECTORSHIP, Dec. 2006/Jan. 2007, at 44 (stating institutional investors are reluctant to wholly change board composition). I am not here making the argument that such activism necessarily has been positive; only that it illustrates the power shareholders are capable of exerting.
196. Jonathan W. Miller et al., Changing Face of Class Actions, N.Y. L.J., July 9, 2007, at 10.
197. Brownstein & Kirman, supra note 178, at 23; see also MITCHELL, supra note 17, at ch. 7; Aaron A. Dhir, Realigning the Corporate Building Blocks: Shareholder Proposals as a Vehicle for Achieving Corporate Social and Human Rights Accountability, 43 AM. BUS. L.J. 365 (2006);
198. Theresa A. Gabaldon, Milberg Weiss: Of Studied Indifference and Dying of Shame, 2 MD. J. BUS. & TECH. L. 207 (2007) (examining the problem with a particular focus on the law-firm context);
199. Ian B. Lee, Citizenship and the Corporation, 34 LAW & SOC. INQUIRY (forthcoming 2009) (suggesting a significant, if limited, role for shareholder "citizenship" as a deliberative component of the corporate polity); Lee, supra note 5, at 31.
200. Goldschmid, supra note 5, at 666. I can think of no instance in American jurisprudence in which the abdication of, or misuse of, power by an empowered beneficiary leads us to treat that person as innocent. The opposite tends to be true. What follows is just a small sample of the cases that illustrate my point. For corporate directors: Diedrick v. Helm, 14 N.W.2d 913, 919 (Minn. 1944) (ruling on the accountability of corporate directors and officers for misuse of business information received by reason of their position in the corporation).
201. (reviewing MARSHALL E. DIMOCK & HAROLD K. HYDE, BUREAUCRACY AND TRUSTEESHIP IN LARGE CORPORATIONS (1940)) (stating that in the context of corporate managers, "[i]n any society which deserves to be called a civilization, power implies responsibility");
202. Joseph L. Weiner, The Berle-Dodd Dialogue on the Concept of the Corporation, 64 COLUM. L. REV. 1458 (1964).
203. Lee, supra note 5, at 31. To be sure, I have not been an advocate for increased shareholder participation in corporate governance. My position has been based not only on my view of the superiority of directorial management, as others have well articulated, See Stephen M. Bainbridge, Director Primacy and Shareholder Disempowerment, 119 HARV. L. REV. 1735 (2006), but even more upon the adverse effects on business policy of an emasculated and unaccountable shareholder body subsumed into an increasingly irresponsible market. See MITCHELL, supra note 17, Chs. 6 & 7;
204. Lawrence E. Mitchell, The Legitimate Rights of Public Shareholders (Mar. 2, 2009) (unpublished manuscript), available at http://papers.ssrn.com/sol3/ papers.cfm?abstract-id=1352025. I am not here arguing for, nor do I suspect I would argue for, shareholder involvement in the actual management of the corporation. But a shareholder body that took even its limited responsibilities seriously and was held to account by law and society for its behavior might well be a class of shareholders that, at a minimum, deserved more say in the election of their corporations' directors. In any event, the current state of corporate law suggests that, regardless of my views or the views of others, shareholders are indeed gaining power. This development is sufficient in and of itself to call into question the shareholder paradigm on which the circularity argument is built.
205. Woodrow Wilson, An Address to a Joint Session of Congress, Aug. 8, 1919, in 62 WOODROW WILSON, THE PAPERS OF WOODROW WILSON 209, 214 (Arthur S. Link et al. eds., 1990).
206. Lawrence E. Mitchell, The Morals of the Marketplace: A Cautionary Essay for Our Time, 20 STAN. L. & POL'Y REV. (forthcoming 2009).
207. Landon Thomas, Jr., Investment Banker and Client: A Bond Deepens, N.Y. TIMES, Jan. 26, 2005, at C1.