Corporate Governance

Delaware Courts and Exonerating the Board from Supervising Risk: In re Citigroup Derivative Litigation (Introduction)

By J. Robert Brown

Anyone other than the comatose knows that Citigroup is in deep trouble. The financial institution has suffered massive losses and has seen its share prices fall to below $3.

Citigroup has probably survived this long only because of the government bailout.  Yet even the $45 billion in bailout funds has proved inadequate.  The financial institution has had to seek even more, giving up a huge equity stake to the US government. The equity stake edges the government closer to nationalization.

Moreover, the government has turned its attention to the board of directors.  As the WSJ reported:

• Amid pressure to shake up its board, Citigroup initially suggested it would begin making director changes at the April shareholder meeting. The Fed rejected that, pushing lead director Richard Parsons to act sooner. The Fed has also frowned upon some potential nominees that Citigroup has informally pitched to the agency, saying Washington would prefer "tough-minded independent thinkers."

With this in mind, we turn to the latest case coming out of Delaware that had, within its grasp, the opportunity to define director duties with respect to risk assessment. 

Plaintiffs sued essentially alleging a lack of oversight by the board of Citigroup's exposure in the subprime market, something that led to, as the Chancery Court conceded, staggering losses.  Instead of using the case as an opportunity to define meaningful responsibilities by the board or meaningful standards for reporting systems that funnel information to the board, the Chancery Court dismissed the case on demand excusal grounds.  The court did so only after lecturing the plaintiffs about the US  system of capitalism and the importance of the business judgment rule.  The court more or less characterized the case as nothing more than shareholders dissatisfied with a business deal that had not turned out as expected.

We'll explore the case over a series of posts.  The Delaware model is under extraordinary attack in the area of executive compensation.  As the Disney case illustrates, the Delaware courts resolutely refused to impose meaningful standards of review on directors in connection with executive compensation.  The result has been palpable anger at run away compensation and massive federal preemption of the area in TARP. 

The same will happen here.  There is extraordinary frustration with the excessive degree of risk taken by companies currently in trouble and requiring a public bailout.  Likewise, there is furstration with the perceived inactivity of the board.  The decision in In re Citigroup cuts off examination of the board's role in the "staggering" losses by Citigroup and essentially exonerated the board of directors.  It is the wrong approach, particularly given the current disastrous state in the US financial markets.

Interestingly, the court did allow one piece of the case to go forward.  The piece involved a severance package paid to the resigning CEO of Citigroup.  In other words, the court was aware that the eyes of Congress are focussed on executive compensation and the lax decisions by Delaware.  As has happened in the past, the court, likely influenced by a desire to ward off further federal preemption, engaged in an uncharacteristically strict approach on the compensation issue.  But what this court doesn't apparently realize is that the refusal to allow for the possibility that the board might have a role in the "staggering" losses demonstrates even more clearly that Delaware cannot be trusted to define fiduciary obligations for directors.

With all of that in mind, on to In re Citigroup.  As usual, we have posted primary materials on the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on March 12, 2009 (boomark / email).