We are discussing In re Orchard Enterprises, Inc. Stockholder Litigation, a decision by VC Laster.
In allowing the matter go to trial, the court was influenced by a variety of factors. There were alleged personal ties. There were alleged economic ties. And there was the director's purportedly unique role in the process. He was the chair of the special committee and alleged to be the "point person" for the target company. Trial will sort out the facts. The court could still find that the director met the standard for independence.
Nonetheless, the case has the capacity to significantly alter board behavior. The case provides some insight into the types of personal relationships that can result in a loss of director independence. Loss of independence can make it easier for derivative suits to go forward. They can result in the refusal of a court to give a board decision maximum deference. As a result, directors have an incentive to know about these relationships and minimize their presence on the board.
Likewise, the case has the potential to intersect with the federal regulatory process. Public companies must determine whether directors meet the definition of independent. In doing so, boards of NYSE companies must consider any "material relationships" with the listed company. Material relationships can include business and personal ties between directors and management. As the Agency has noted:
- Although personal and business relationships, related party transactions, and other matters suggested by commenters are not specified either as bright-line disqualifications or explicit factors that must be considered in evaluating a director’s independence, the Commission believes that compliance with NYSE Arca’s rules and the provision noted above would demand consideration of such factors with respect to compensation committee members, as well as to all Independent Directors on the board.
The requirement is discussed here. Moreover, to the extent a business or personal relationship is considered but not deemed sufficient to affect independence, disclosure must occur. See Item 407(a) of Regulation S-K (providing instructions for disclosure "by specific category or type, any transactions, relationships or arrangements . . . that were considered by the board of directors under the applicable independence definitions in determining that the director is independent.").
Orchard provides some insight into the types of relationships that can result in a loss of independence. Under the federal system, these relationships need to be considered and possibly disclosed. Increased disclosure of personal and business relationships between directors and management will in some circumstances engender criticism by shareholders, including "just say no" campaigns. They may facilitate legal challenges that center upon the independence of directors. These possibilities could result in a reduction in the nomination of directors with these types of relationships.
Orchard is an isolated case. Nonetheless, the decision may have a large impact on the make up of boards. Directors with close personal relationships to management may become less common. In other words, boards will actually become more independent.
Primary materials can be found at the DU Corporate Governance web site.