Fiduciary duties and corporate governance failures exposed by the subprime mortgage crisis

Résumé du document

Corporations' directors are expected to make decisions that produce the best outcome for their businesses. As such, law has a role to play, and it does so differently depending on the legal system concerned.

Common law jurisdictions generally refer to directors as fiduciaries . Directors have to comply with several "fiduciary duties", including a "duty of care" which regulates the care, skills and diligence that directors are show. Civil law jurisdictions, without qualifying directors as fiduciaries, have developed rules with the same aim.

Many of the decisions made by corporations do not involve boards of directors. Operational decisions are made by officers and employees. As such, the duty of care imposes the board to monitor these decision-makers.

The sub prime mortgage crisis, where many corporations were overexposed to low quality credits, caused massive defaults. This essay argues that the duty of care is inadequate to deal with the failures exposed by the financial crisis. To demonstrate this, it will focus on the United States as a sample of common law jurisdiction, where the courts have adopted a deferential approach to the business judgement of directors. It will then look to Germany as a sample of civil law jurisdiction, where judges' reactions to corporate governance failures have been much stronger.

Extraits

[...] It requires the demonstration of a failure to implement type” of risk monitoring system. It makes it de facto impossible to demonstrate because any director can show a de minimis monitoring system. Then, a plaintiff would have to show that directors “consciously disregarded red flags”. However, the concept of red flags appears to be linked to decisions generating business risks. As such, qualifying a red-flag would mean going beyond the process- based approach. It would require the courts to evaluate the decision of directors. [...]

[...] The “Goldman” case In re Goldman Sachs Group, Inc. Shareholder Litigation”[7], a Caremark claim arose from a new angle. Plaintiffs argued that the bank's structure gave managers incentives to take uncontrolled risks. This was described as “unethical and illegal practices” that the directors failed to regulate. The Court decided first that the “unethical conduct” alleged was within the scope of the management business judgement. The Court then observed that it was not impossible for a duty to monitor business risk to exist. [...]

[...] Citigroup suffered huge losses because of its exposure to the subprime lending market. Citigroup's shareholders claimed that directors and officers had breached their duties when investing in collateralized debt obligations (CDO). They stressed that directors should have stopped such investments because of red flags showing that market conditions were getting worse. At first, the Court was reluctant to consider the case under Caremark standard. It was claimed that the defendants failed to monitor Citigroup's business risk, whereas a usual Caremark claim related to failure to “monitor or oversee employee misconduct or violations of law”. [...]

[...] It will then look to Germany as a sample of civil law jurisdiction, where judges' reactions to corporate governance failures have been much stronger. I. The United States and the deference for the business judgement rule The Model Business Corporation Act sets forth the “oversight function of the board”[2]. More precisely, the official comments emphasise the importance of “information and reporting system” Attention will be dedicated to the Delaware Corporate Law[4]. The Caremark doctrine In 1996 in re Caremark Intern. [...]

[...] The duty of care as interpreted by the Court clashes with the financial market logic. Conclusion The aforementioned case studies highlight the inadequacy of the duty of care to deal appropriately with the corporate governance failures exposed by the financial crisis. In the United States, the BJR overprotects the directors. Although one could argue that a duty of directors to monitor risks exists, the standard suggested appears to be almost impossible to achieve. Therefore, despite the losses occurred and the damage to the economy, directors will be protected. [...]