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The Corporate Contract in Changing TimesIs the Law Keeping Up?$

Steven Davidoff Solomon and Randall Stuart Thomas

Print publication date: 2019

Print ISBN-13: 9780226599403

Published to Chicago Scholarship Online: September 2019

DOI: 10.7208/chicago/9780226599540.001.0001

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Delaware’s Diminishment?

Delaware’s Diminishment?

(p.110) Chapter Five Delaware’s Diminishment?
The Corporate Contract in Changing Times

Hillary A. Sale

University of Chicago Press

Abstract and Keywords

In the world of corporate law, Delaware reigns – or so the theory goes. This Chapter examines the reality of that statement, focusing on directors and their fiduciary duties in the context of the nexus of contracts theory and Delaware’s default-based system of governance. I argue that the nexus of contracts approach fails to explain the reality of today’s corporate governance structure and that the same is true with respect to Delaware’s role as a nexus in the nexus of contracts world. Instead, the private, contract-based space, to the extent it ever existed, has been occupied by the federal government for quite some time – and the occupation takes place both directly and indirectly. Two theories developed in other works are key to this analysis: the theory of publicness and the information-forcing-substance theory, or the manner in which federal securities disclosure provisions develop director fiduciary duties.

Keywords:   Securities regulation, disclosure, publicness, fiduciary duty, financial crisis, disclosure, federalism, directors, oversight, Delaware

In the world of corporate law, Delaware reigns—or so the theory goes. This chapter examines the reality of that statement, focusing on directors and their fiduciary duties in the context of the nexus-of-contracts theory, Delaware’s default-based system of governance, and the expansion of the federal government’s role in the corporate space. I argue that the nexus-of-contracts approach fails to explain the reality of today’s corporate governance structure, and that the same is true with respect to Delaware’s role as a nexus in the nexus-of-contracts world. Instead, the private, contract-based space, to the extent it ever existed, has been occupied, both directly and indirectly, by the federal government, and the public, for quite some time. Two theories developed in other works are key to this analysis: the theory of publicness1 and the information-forcing-substance theory, or the manner in which federal securities disclosure provisions develop and expand director fiduciary duties.2

A considerable amount of scholarship is devoted to the theory of the firm as a nexus of contracts.3 This metaphor, as some have termed it,4 defines the firm as an entity for which rights and obligations are determined by contract. Credit, employee, and other agreements are explicit contracts and extend beyond the governance realm.5 Other contracts are implied and devolve from the default rules, or the rules that the legislature has designed to be those to which the parties, or the stakeholders, would have agreed in the absence of a contract.6 In theory, because they are default rules, they are subject to change via explicit contracts.7 As is typical of economic theory, there is a key assumption at work here: Information is sufficient such that the resulting contracts will be efficient (p.111) and maximize outcomes, or wealth, for the parties and thus be socially optimal.8

This nexus-of-contracts metaphor, as Jim Cox points out, has considerable “substantive bite.”9 Implicit in the approach is that firms are private and that the law governing them is also part of the so-called world of private law. Default rules are essentially publicly provided, private law, stand-ins subject to change.10 Thus, firms can opt out of norms and into their own structures, including, at least theoretically, their own governance systems. In this sense, firms and their governance structures are perceived to be consensual.11

Less frequently discussed, however, is the permissive nature of firms and how they devolve from the public. To be sure, the fact that corporations exist as “private” entities with public permission is not new. Indeed, many of the early corporations were created through legislative grants, on a case-by-case, contract-by-contract, basis.12 The United States followed the British model here, with legislatures taking the place of the king and parliament.13 Not surprisingly, in the early years, many of the most visible entities granted the privilege of incorporation were public-focused, with some resembling what are often “authorities” today. For example, an entity formed to build a bridge, with private funds, was granted the right to incorporate.14 Today, we have airport authorities, port authorities, and more. In addition, as the number and type of entities grew, additional concerns about public impact arose. For example, as banking corporations increased in number, their potential impact on the money supply became a subject of discussion and concern.15 Thus, whether these early entities were authority-like or more typical of today’s corporations, they became functional private entities only as defeasible from, and with the permission of, the legislature, and, through it, the public.

This defeasible status is important, because regardless of the perceived private nature of the firm, its strategy and choices can impact the economy and citizens. As a result, we now supplement—and have for a very long time supplemented—the allowed private ordering with regulation ex ante and enforcement ex post.16 Indeed, regulation and enforcement serve as bounds on the private space or the space in which contracting is allowed to occur. For example, a broad spectrum of regulation and enforcement is aimed at classic externalities, such as environmental regulation.17 Although these types of regulation form boundaries on (p.112) the concept of the firm as a nexus of contracts, they are not the subject of this chapter. Instead, the focus here is on the regulatory space that is connected to the state-based default statutes and particularly to director fiduciary duties. Here, corporate law provides limits on director action and is subject to judicial control and change and, thus, operates outside of the so-called contractual space.18 Further, as we shall see, both the federal government and the public play an increasingly significant, if not dominant, role in regulating fiduciary choices and conduct.

Despite the rhetoric surrounding the private law and the nexus-of-contracts theory, firms have been publicly regulated for a long time, and the nature and source of the regulation has changed considerably in recent years. Although we often describe the enforcement mechanisms as both public and private, these categories may be inaccurate—particularly for publicly held firms. “Private” enforcement, for example, comes in the form of class actions, which are a method of monitoring behavior and providing accountability.19 Yet the ability to bring a class action derives from both the Federal Rules of Civil Procedure and the judiciary.20 Moreover, the markets are public, and the harm from fraud, when it occurs, is also public.21 In this sense then, the class action is arguably a public mechanism designed to counteract shirking and agency costs by providing balance. Indeed, class actions are an example of one way in which the law evolves to provide protections for what might otherwise be deemed “private” decisions.22

In Delaware, “private” litigation comes largely in two forms: class and derivative actions.23 The key difference between the two is the nature of the claim, with derivative claims being those where the shareholder brings the claim on behalf of, and to right a wrong to, the entity.24 Because the Delaware statutory system is largely default in nature, with few mandatory features, even the fiduciary duties are based on common law.25 This alone erodes the contractual metaphor, despite the fact that the focus of the case law is heavily on process and not on defining the content of the duties.26 Put differently, it is possible that the bounds of the law, the fiduciary duty, or the contractual understanding might change, ex post, for a fiduciary.27 When that happens, the fiduciary must adjust to the new expectations.28 Indeed, although it is rare for such cases to result in damages in Delaware, the cases certainly outline areas in which directors must do better.29 Delaware does play a significant role in this space. Nevertheless, it turns out, that publicness has been trimming Delaware’s default-rule space for quite some time.

(p.113) What is publicness? In the context of corporations, the theory of publicness makes clear that the private nature of the entity, as well as the contract theory we associate with it, is defeasible from the public. Indeed, the status of a corporation as private is not a right, but a privilege.30 Corporations do not arise “solely by consent,” but instead require state permission, through filings and other formalities.31 As a result, this status is subject to erosion, over time and particularly in response to crises.32 This should not be a surprise, because the status is a choice by legislatures and, through them, the public.33 Publicness, then, operates as a constraint on the contractual theory of the corporation.

Why? Because corporations are powerful. They control jobs and wealth. Their actions impact the markets, of course, but many other aspects of people’s lives as well, such as the environment. In fact, their outputs impact people both positively (think pharmaceuticals) and negatively (think toxics). In the interests of capital formation, corporations enjoy limited liability.34 This status, however, is a gift from the state, and therefore the public.35 Yet the health and wealth of the entity extends beyond its bounds and its shareholders, and the impact of corporate missteps, screwups, and frauds can be deep and lasting. Consider Enron and Worldcom and the effect of their collapse on the economy and on people’s faith in the fairness and integrity of the securities markets.36 Or consider the investment banks and the 2008–9 financial crisis, which resulted in foreclosures, job losses, and more.37 Indeed, the impact of the 2008–9 financial crisis is ongoing, with the economy suffering from slow growth rates and other challenges.38

Crises force legislatures to take action, and, in the context of corporations, the result has been federal regulatory surges.39 The cycle is common, and it is a form of publicness.40 Here, publicness is what society demands from powerful institutions—accountability and transparency.41 When society pushes back, the reality—that the private realm of corporate contracts exists in the shadow of the public—becomes transparent.42 Thus, publicness accounts for the contraction of the space that used to be the domain of “private” contracts between shareholders and directors. And when Delaware’s space is consumed by the federal regulatory structure, it is publicness at work. In short, the private, default-rule space gives way to the public, increasingly federal, regulatory space.43

In fact, no matter how you categorize it, the federal government’s role in director regulation has increased. Often, the regulatory change occurs through the Securities and Exchange Commission (SEC) with both (p.114) direct and indirect regulatory outcomes. Importantly, each new requirement, in addition to resulting from publicness, chips away at Delaware’s space and the so-called private realm. Indeed, as the federal government has increased the range of its involvement in corporate decision making, the actual independence of Delaware and the private space of its corporate citizens has decreased. There are countless examples, including direct regulations that provide definitions of and mandatory requirements for numbers and types of directors and, thus are very direct in nature. There are also new federal information-forcing-substance regulations that, in an indirect manner, create fiduciary duties for directors. Moreover, in some cases the regulations, in conjunction with federal case law, have developed fiduciary duties that are similar to duties under Delaware law—including some duties that are largely unenforceable in Delaware because of the development of its common law. In short, although the federal regulatory changes are both direct and indirect in nature, the justification for both types of changes is the publicness of the securities markets and, when resulting from a crisis, the harm that has occurred to those markets and the economy.

Consider several recent, direct forms of federal regulation that have occupied what used to be Delaware’s space and were preserved for director decision making, including regulations that define the type of directors and committees that boards must have. These regulations focus on director independence, a concept in Delaware’s common law.44 As it has developed, Delaware’s approach to fiduciary duties and director independence is largely transaction based. Thus, over the years, the Delaware judiciary has set forth a set of standards for scrutinizing financial conflicts as well as the “beholdenness” of directors. The latter standard focuses on directors’ state of mind and whether they, individually, as a group, or a special committee or subset, are able to conduct a process and make a decision in a manner that is sufficiently independent of those that might be conflicted.45

These standards usually work well enough—at least on a transaction-by-transaction basis. They allow for decision making to occur as needed and for some level of confidence in, for example, strategic combination decisions and going-private transactions. Notably, the standards are process oriented and transaction based. The question is whether the directors are sufficiently disinterested and independent to exercise reasonable business judgment with respect to a particular decision or transaction. These standards, however, do not address whether the questioned judgment (p.115) was reasonable, or good, or perhaps even excellent. Instead, the goal is to prevent backward-looking judicial hindsight by focusing on the potentially conflicted state of mind of those running the process and making the decision.46

Although Delaware’s role in prescribing independence ends there, the federal government’s does not. Consider the requirements contained in the Sarbanes-Oxley Act, passed by Congress in the wake of Enron, Worldcom, and other corporate frauds. One requirement in that legislation was that the SEC promulgate regulations to ensure that a majority of the members of the board of directors were independent.47 Note the living nature of this requirement; it is not tied to a specific transaction. Accomplished through stock exchange listing standards subject to SEC approval, the independence measures are largely financial and check-the-box in nature but nevertheless in effect.48 Generally speaking, if a company is listed on an exchange, a majority of its board members must, at all times, meet these requirements and be independent.49 The result is a cap on the number of insiders, or corporate officers and employees, as well as the number of outsiders who consult for and work with the corporation, who can serve on the board.50

Before Sarbanes-Oxley, the background and relationships of the directors on the board or on any committee was not legislated or regulated. It was viewed as a private decision, in theory as part of the contract between shareholders and the board, and was subject to review only through adjudication when an appearance of impropriety occurred. Moreover, even then, for any given transaction, there might have been an available cleansing mechanism. Now, however, due to publicness and the resulting federal law, a majority of the directors on the board of a publicly held company must be independent at all times.

Federal regulation of the boardroom and director decision making did not stop here. Instead, the Sarbanes-Oxley Act also provided that the board must have an audit committee composed solely of independent directors.51 Additionally, after the financial crisis of 2008–9 and the resulting Dodd-Frank Act, every public company board must now also have compensation and nomination and governance committees, both of which must also be composed solely of independent directors.52 Whether independence correlates with good business outcomes is a subject of some debate.53 The premise, however, is that limitations on managerial overreaching are important to the willingness of shareholders and others to provide credit to firms and to the fairness and efficiency of the (p.116) securities markets.54 Indeed, Sarbanes-Oxley also made the practice of issuers making personal loans to directors and officers illegal, except for issuers in the business of making loans.55 This provision, a form of direct regulation, also intervened in the state law space, which still allows for such loans.56 And it, too, was a response to perceptions of managerial overreaching. These examples reveal that the existence of regulations and pressure to create changes in and limits on board decision making is present and not going away. It is also formally regulated. You can see this as the federal government occupying Delaware’s space or as the erosion of the nexus of contracts, but either way, the space for directors to exercise decision making on these issues is now gone. The decisions are no longer, if they ever truly were, the subject of private law. Instead, the government now controls them.

How did this happen? Publicness. Corporations interact with and impact the public in various ways, and the public, in turn, pushes back. For example, corporate insiders develop corporate strategies and, in conjunction with the requirements of the federal securities laws and regulations, determine how to share that information with those outside the corporation.57 When this occurs, the groups involved in the process expand beyond the shareholder-officer-director governance triad.58 Thus, the legally defined governance triad is narrower than those who in fact impact governance and decision making. For example, outside actors—including analysts, regulators, media, and regular citizens—absorb, re-frame, and critique those disclosures.59 This interplay is part of publicness, and it impacts the delegation of power and responsibilities between shareholders, officers, and directors.60 The dialectic also affects corporate outcomes—forcing changes in decisions, directors, and governance structures.61

Another outcome of this dialectic is that the federal government has become an increasingly important player in this space, developing corporate regulations in response to pressure.62 Pressure, of course, comes from various interest groups, and it grows in response to market crashes and perceptions of fraud, greed, and corruption.63 In this sense, publicness expands both as a result of decisions that corporate actors make as well as those that they fail to make.64

In addition to the federal regime’s direct regulation of qualifications, committees, and committee composition is a second, complex, and indirect, system: the information-forcing-substance regime.65 Here’s how it works. The regulations are rooted in the Securities Act of 1933, which (p.117) regulates offerings of securities.66 The design of the securities regulatory system is one based on disclosure.67 Thus, the government does not evaluate the merits of an offering; instead, it reviews disclosures for completeness and clarity.68 The purpose of the disclosures is to allow buyers to form opinions about an offering.69 In the initial public offering context, the idea is that the insiders of the issuer have significant information advantages over potential purchasers.70 As I have argued elsewhere, initial public offerings are the most dramatic example of insider trading, and the disclosure provisions are the cure for this informational asymmetry.71 These provisions are also supported by a very strong private cause of action contained in Section 11 of the 1933 Securities Act.72

In addition, there are also provisions that apply to aftermarket securities purchases, or trades in the market. The regulatory lever here is the 1934 Securities Exchange Act and accompanying regulations.73 Here, too, there are private enforcement provisions—most prominently, Section 10 (and Rule 10b-5).74 Thus, for both the 1933 and the 1934 acts and regulations, the basic premise is that disclosure, supplemented with back-end enforcement, will increase transparency and help develop fair and efficient markets in which purchasers are willing to trade.75 Indeed, fairness and efficiency go hand in hand, because no one wants to play in a rigged market.

This federal securities regulatory apparatus is very robust and requires disclosure of information on many topics—from legal compliance to descriptions of financial conditions and operations.76 For the purposes of this chapter and publicness, however, the key aspect of the regulations is how they develop and expand corporate fiduciary duties, or, put differently, how they cabin the space for contracting around default rules. In essence, regardless of the type of disclosure demanded, the fact that it is required and made means (at least normatively) that there is information underlying it. Indeed, directors (and certain officers) must sign the offering document (registration statement) and the issuer’s annual report (10K). All those who sign the registration statement are potentially liable under Section 11 for any misstatement or omission of a material fact.

This cause of action is a strict liability provision, with a due diligence defense.77 To avail themselves of the due diligence defense, the directors must in fact have a reasonable belief that the information contained in the documents is accurate. This is where the information-forcing-substance regime develops traction. To have the reasonable belief, of course, means that the signatories have to, at a minimum, ask questions, (p.118) and in many cases do more, to ensure that the information provided to them is sufficiently accurate to be disclosed.78 Indeed, law firm memos and other materials prescribing best practices emphasize that directors need to meet with both management and counsel to confirm, before signing, that the documents are accurate.79 Thus, federal law dictates and expands directors’ fiduciary duties.

This space, between the required disclosure, and the process for developing the system that allows for compliance with the disclosure requirement, is the home of the information-forcing-substance theory. Here, the regulatory approach is both direct (the disclosure regulation) and indirect (the reasonable belief requirement). It is also potentially very expansive. Each new required disclosure creates its own demands for information. Collecting, managing, reporting, and certifying the information all emphasize both adherence to fiduciary duties and the expansion of those duties.80 In addition, when disclosures are litigated, further potential for expansion occurs as judicial interpretations develop the level of information and knowledge that directors should have when they sign the documents.81 Thus, as we shall see below, the regulations become information forcing substance in nature both as a result of the regulatory demand and search for information to comply with it as well as through the judicial opinions interpreting those obligations.82 In this manner, the regulatory apparatus drives both the process and substance of how directors are supposed to execute business judgments and can even supersede the state law–based fiduciary duties and corporate contract.

Consider a specific example, the disclosure of risk factors required by Regulation S-K, Item 503. Regulation S-K, through the integrated disclosure provisions, requires that offering documents and annual reports include descriptions of and changes in financial conditions, results of operations, and known risks and trends. The purpose of this provision, and the many others like it, is to ensure that potential investors receive information about risks. At the core of the information-forcing-substance theory is the work that goes on behind the disclosure. The first choice is whether a risk requires disclosure. If it does, the next step is to determine how much and what type is necessary to comply with the securities regulations, including the proviso that disclosures must be sufficiently complete so as not to be misleading.

To be sure that the disclosure is accurate, the board must actually plan for risk, understand risk, discuss risk, and oversee management’s (p.119) compliance procedures to control it. When directors sign the registration statement, they are in effect certifying that they have done sufficient work to hold a reasonable belief that the disclosures are accurate. Of course, the board members are not expected to do the underlying risk management work. They do not, and should not, implement programs. That is for management. Nevertheless, board members must engage in an active conversation with and oversight of management, or they cannot attest to the disclosures.83 Further, when the disclosures are financial, the board should be satisfied that the company’s statements accurately present its financial condition and results of operations, that other disclosures about the company’s performance convey meaningful information about past results as well as future plans, and that the company’s internal controls and procedures have been designed to detect and deter fraudulent activity.84 It is in this manner that the regulatory disclosure demand drives behavior: pressing for active monitoring and discussions on the part of the fiduciaries. The goal is richer processes and more accurate and transparent disclosures.85 In short, the demand for information forces substantive, fiduciary behavior.

Importantly, these regulations do not function in a vacuum. They are supported by both public and private enforcement regimes. For example, as discussed above, Section 11 of the 1933 Securities Act supports the disclosure system through its express, strict liability provision. It is a big stick, designed to urge compliance in providing appropriately fulsome and truthful disclosures. To be sure, the due diligence defense tempers the cause of action; nevertheless, it is also a driver of fiduciary duty. In fact, as designed, Section 11 presses directors (and other potential defendants) to scrutinize statements in offering documents and insist on information to ensure accurate and complete disclosures—and a lack of liability. Thus, Section 11 is information forcing substance in action.

Case law amplifies the power of this statute and reveals how the courts have insisted that corporate directors use their skills and knowledge to improve offering documents and, thereby, their oversight of corporate officers.86 Indeed, that same case law contains criticisms of the failure of directors to engage in robust discussions with management about the contents of offering documents.87 This type of dialectic between directors and officers is the fabric of which fiduciary duties are made. In economic theory terms, when the directors engage in this fashion, they are mediating the agency cost space between shareholders and managers.88 Legal scholars have long attributed this role to direc tors through the (p.120) state law–based fiduciary system, but as the analysis in this chapter reveals, the federal government staked a claim on the space early on, and its occupation of the fiduciary zone continues to expand.89 At the core is the information-forcing-substance regime: regulations paired with causes of action (as well as SEC enforcement) pressing directors to ask questions and question answers and forcing the development of knowledge behind the required disclosures.

Next, consider the fact that the categories of information that must be disclosed continue to grow in number and complexity. The result is that in today’s world, when directors sign off on a filing, the breadth of the required information is significant. For every disclosure, the directors’ role is to ensure that the information is in accord with their understanding of the corporate information. Some of the categories, as Don Langevoort and I have written elsewhere, correlate directly with what were once solely discussed as state law–based fiduciary duties, such as risk management.90 Now, however, federal regulation dictates that the disclosure must be made and through the due diligence requirement, and case law in other contexts, inserts the directors into the process.

The role of the federal government in developing and regulating director duties expands beyond the required ex ante disclosures. As mentioned above, ex post enforcement is a key disclosure incentive. As a result, at different points in time, the SEC has engaged in active monitoring of directors, even holding some liable for their fiduciary failures. Recently, although the circumstances were quite specific, the SEC issued complaints against directors in two public companies. In 2013, it settled with eight former directors of Regions Morgan Keegan open-and closed-end funds.91 Although the liability at issue here arises out of a particular statute, this settlement is really one about the directors’ failure to fulfill basic duties under the securities laws, here setting the methodology for determining the fair value of certain portfolio securities and then, in turn, determining that fair value. In addition to actual enforcement actions, former SEC chair Mary Jo White spoke publicly about the important role that engaged, question-asking directors can play in ensuring strong, ethical corporate environments.92 Thus, she pressed the issue with directors, reminding them of their fiduciary roles.

The federal role also extends to the Department of Justice, which, with the introduction of the Yates Memo, became officially involved in the fiduciary zone as well.93 The basic premise of the Yates Memo is that corporations seeking criminal or civil cooperation credit must provide (p.121) information about the actual people involved in any wrongdoing.94 The Department of Justice has been engaged in enforcement actions of this sort for a long time, but the Yates Memo goes further. The goal is to decrease the number of negotiated outcomes that result in corporate agreements, without prosecution of those who engaged in the wrongdoing.95 In doing so, the Yates Memo elaborates a policy that is focused on finding individuals who willfully, and therefore criminally, failed to fulfill their fiduciary duties. It inserts the federal government directly into the director-officer relationship. The board’s fiduciary duty, of course, is to the company, not to officers or individuals.96 As a result, the Yates Memo’s requirement that the company reveal the individuals involved in wrongdoing requires the board to assure itself that it knows what happened and is aware of all the individuals involved, some of whom might well be officers.97 Directors now need to ask for the information and provide it to the federal government.98 Although this information demand is retrospective, it still requires directors to be fully engaged in these discussions, and perhaps even to become the drivers of the investigatory process.99 Thus, the memo arguably incentivizes independent decision making by the directors, who have to run the investigations. Moreover, like the securities regulatory regime discussed above, the Yates Memo also plays an indirect role in the fiduciary space. It pushes directors to be engaged fiduciaries that, for example, ensure appropriately robust compliance systems on the front end.

There are many other examples of the ways in which the federal government has developed fiduciary duties and occupied the corporate governance space, including proxy regulations as well as settlement agreements that insert the government directly into the boardroom conversation. Or regulation of disclosure around executive compensation coupled with shareholder votes, even though nonbinding, on officer pay. In the end, however, all of these examples point out that the so-called private realm of corporate decision making is considerably more constrained than either academic or other discourse might reveal. In fact, the extensive emphasis on the nexus-of-contracts theory in the corporate literature is impoverished and, as a result, may well contribute to the growth of the federal regime and the role of publicness, simply by failing to include them in its analysis. In short, as the analysis in this chapter makes clear, the public-private distinction is a construct, and the nexus-of-contracts theory must give way to further analysis of publicness and the role of the government in the corporate contract.

Thanks for comments go to Randall Thomas and Steven Davidoff Solomon, Jill Fisch, Frank Partnoy, Don Langevoort, Bob Thompson, and participants in the conference for this volume. Thanks for research assistance go to Kelsey Bolin, Alana Siegel, and Liz Sinclair.


(1.) Hillary A. Sale and Robert B. Thompson, “Market Intermediation, Publicness, and Securities Class Actions,” Washington University Law Review (2015): 493; Hillary A. Sale and Donald C. Langevoort, “‘We Believe’: Omnicare, Legal Risk Disclosure and Corporate Governance,” Duke Law Journal 66 (2016); Donald C. Langevoort and Robert B. Thompson, “‘Publicness’ in Contemporary Securities Regulation after the JOBS Act,” Georgetown Law Scholarly Commons (2013): 340; Hillary A. Sale, “J.P. Morgan: An Anatomy of Corporate Publicness,” Brooklyn Law Review (2014); Hillary A. Sale, “The New ‘Public’ Corporation,” Law and Contemporary Problems (2011); Hillary A. Sale, “Public Governance,” George Washington Law Review (2013).

(3.) See, e.g., Frank H. Easterbrook and Daniel R. Fischel, “Voting in Corporate Law,” Journal of Law and Economics (1983); Frank H. Easterbrook and Daniel R. Fischel, “Close Corporations and Agency Costs,” Stanford Law Review (1985); Frank H. Easterbrook, “Corporate Control Transactions,” Yale Law Journal (1981); Michael C. Jensen and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics (1976); William W. Bratton Jr., “Nexus of Contracts Corporation: A Critical Appraisal,” Cornell Law Review 74 (1989).

(4.) Marcel Kahan and Michael Klausner, “Path Dependence in Corporate Contracting: Increasing Returns, Herd Behavior, and Cognitive Biases,” Washington University Law Review (1996): 347; James D. Cox, “Corporate Law and the Limits of Private Ordering,” Washington University Law Review (2015): 5. Jensen and Meckling refer to it as a theory. Jensen and Meckling, “Theory of the Firm.” While others refer to it as a conclusion. Bratton, “Nexus of Contracts Corporation,” 410. Regardless of the name, the nexus-of-contracts approach to analyzing the corporate form gained considerable traction and is still present.

(6.) Lucian A. Bebchuk, “Limiting Contractual Freedom in Corporate Law: The Desirable Constraints on Charter Amendments,” Harvard Law Review (1989): 1847.

(7.) Frank H. Easterbrook and Daniel R. Fischel, “The Corporate Contract,” Columbia Law Review (1989), 1428. See also ATP Tour, Inc. v. Deutscher Tennis (p.123) Bund, 91 A.3d 554, 558 (Del. 2014); Boilermakers 154 Retirement Fund v. FedEx Corp., 73 A.3d 934, 956 (D.C. 2013).

(9.) James D. Cox, “Corporate Law and the Limits of Private Ordering,” Washington University Law Review (2015): 6.

(10.) Id. at 8. For a Delaware case exploring these issues, see Boilermakers Local 154 Retirement Fund v. Chevron Corp, 73 A.3d 934 (Del. Ch. 2013).

(11.) Easterbrook and Fischel, “The Corporate Contract,” 1427. Scholarly work has increasingly recognized the limits of the nexus-of-contracts theory. One of the most prominent articles is the seminal work by Henry Hansmann and Reinier Kraakman, “The Essential Role of Organizational Law.” In this article Professors Hansmann and Kraakman posit that at least with respect to asset partitioning, or the protection of the entity’s assets from the creditors of its owners or managers, property rights play an important role. The asset-partitioning function, which is property law–based, allows for efficiencies in bonding and monitoring that, they argue, is key to the growth of large-scale enterprises. Henry Hansmann and Reinier Kraakman, “The Essential Role of Organizational Law,” Yale Law Review (2000): 110. More recently, Morgan Ricks has expanded on the property focus, arguing that organizational law, including in organizations beyond the corporate form, has more than one property law aspect. His theory, which he supports with deep historical analysis, focuses on the important role of property relinquishment between co-owners. In this manner, Ricks’s work expands the debate about the theory of the firm to include an examination of entity insiders. Both articles press on the nexus-of-contracts theory, revealing that how we define entities and their powers exceeds the more limited dimension of the nexus-of-contracts theory and, in both cases, in the interests of efficiency and growth. Both works are also focused on actors who are participating in or with the corporation. Publicness, however, reaches beyond to those on the outside, pressing on our understanding of who is in fact governing the rights of the entity participants.

(12.) Robert B. Thompson, “Why New Corporate Law Arises: Delaware’s Golden Age and Likely Changes in the 21st Century,” (2016): 2.

(13.) Id. at 4.

(14.) Id. at 3.

(15.) Id. at 3.

(16.) This is true even for closely held corporations. Cox, “Corporate Law,” 12–15.

(17.) Classic externalities and how we regulate them; Easterbrook and Fischel, “The Corporate Contract,” 1415; see, e.g., Resource Conservation and Recovery Act, 42 U.S.C. §§ 6901–6992k (1976).

(p.124) (18.) See generally Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985) (providing an example of a judicial change in duty ex post which resulted in pushback). See Daniel R. Fischel, “The Business Judgment Rule and the Trans Union Case,” The Business Lawyer (1985): 1440–41; Mercer Bullard, “Caremark’s Irrelevance,” Berkeley Business Law Journal (2013): 21; Larry E. Ribstein, “Takeover Defenses and the Corporate Contract,” Georgetown Law Journal (1989): 96. Indeed, self-interested and conflicted behavior is proscribed and results in a shift in the burden of proof to the fiduciary, further undercutting the nexus of contracts metaphor. Cox, “Corporate Law.” See also Debora DeMott, “Beyond Metaphor: An Analysis of Fiduciary Obligation,” Duke Law Journal (1988): 900.

(19.) McLaughlin on Class Actions § 1:1 (12th ed.).

(20.) Fed. R. Civ. P. 23.

(21.) Private Securities Litigation Reform Act, 15 U.S.C. 78 (1995); Dodd-Frank Wall Street Reform and Consumer Protection Act 12 U.S.C. 5301 (2010); Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398 (2014).

(22.) It is no surprise that the modern class action evolved from another area where the decision making was “private” and the harm needed monitoring—employment. § 1776 Class Actions for Injunctive or Declaratory Relief Under Rule 23(b)(2)—Civil-Rights Actions, 7AA Fed. Prac. & Proc. Civ. § 1776 (3d ed.). (Before Rule 23 was amended to expand the use of class actions, class actions were used to litigate alleged discrimination in employment.)

(23.) For an empirical evaluation of the relative role of class actions and derivative litigation in Delaware, see Robert B. Thompson and Randall S. Thomas, “The New Look of Shareholder Litigation,” Vanderbilt Law Review (2004): 51.

(24.) Zapata Corp. v. Maldonado, 430 A.2d 779, 780 (Del. 1981).

(25.) See, e.g., Smith v. Van Gorkom, 488 A. 2d 858 (Del. 1985); Broz v. Cellular Info. Sys., Inc., 673 A.2d 148 (Del 1996); Sinclair Oil v. Levien, 280 A.2d 717 (Del 1971).

(27.) The classic case here is Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).

(29.) See, e.g., Edward B. Rock, “Saints and Sinners: How Does Delaware Corporate Law Work?” UCLA Law Review (1997): 1011; Brehm v. Eisner, 746 A.2d 244 (Del. 2000); Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).

(30.) Hillary A. Sale, “The New ‘Public’ Corporation,” Law and Contemporary Problems (2011): 137–48.

(32.) Sale, “J.P. Morgan,” 1654; Langevoort and Thompson, “Publicness in Contemporary Securities Regulation.”

(33.) Id. As others have argued, the line between the public and private is a construct. See, e.g., Martha Minow, “Making All The Difference: Inclusion, Exclusion, and American Law” (1990) (“Tracing the presence of state power in the (p.125) family sphere, historically described as removed from the state, suggests something powerful about boundaries: both sides of a boundary are regulated, even if the line was supposed to distinguish the regulated from the unregulated.”); Laura A. Rosenbury, “Federal Visions of Private Family Support,” Vanderbilt Law Review (2014) (examines the alleged line, or balance between state and federal authority over the family).

(34.) Joy v. North, 328 F.2d 880 (2d Cir. 1982).

(35.) Cox, “The Limits of Private Ordering,” 32.

(36.) Jean Eaglesham, “The Shadow of Enron Still Lingers,” Wall Street Journal, October 17, 2011, http://www.wsj.com/articles/SB10001424052970204774604576633413245885214; Jill E. Fisch and Hillary A. Sale, “The Securities Analyst as Agent: Rethinking the Regulation of Analysts,” Iowa Law Review 88 (2003): 1079; William W. Bratton and Adam J. Levitin, “A Transactional Genealogy of Scandal: From Michael Milken to Enron to Goldman Sachs,” Southern California Law Review 86 (2013): 832–34. See also Urska Velikonja, “The Cost of Securities Fraud,” William and Mary Law Review 54 (2013) (arguing that the harm of fraud extends beyond shareholders, creating economic distortions that impact risk assessments and human and financial capital decisions).

(37.) Eduardo Porter, “Recession’s True Cost Is Still Being Tallied,” New York Times, January 21, 2014, http://www.nytimes.com/2014/01/22/business/economy/the-cost-of-the-financial-crisis-is-still-being-tallied.html?r=0.

(39.) Sale, “Public Governance,” 1013–14. Some have criticized this move. See, e.g., Jill Fisch, “Leave It to Delaware: Why Congress Should Stay Out of Corporate Governance,” 37 Delaware Journal of Corporate Law 731 (2013). In addition, regulatory oversight surges after a market crash are common, in part due to public support for political entrepreneurs who oppose powerful interest groups. Such passion is short-lived, however, and wanes as the market returns to normalcy. See also John C. Coffee Jr., “The Political Economy of Dodd-Frank: Why Financial Reform Tends to Be Frustrated and Systemic Risk Perpetuated,” Cornell Law Review 97 (2012): 1020–29.

(40.) Langevoort and Thompson, “Publicness in Contemporary Securities Regulation,” 373–78.

(41.) Langevoort and Thompson, “Publicness in Contemporary Securities Regulation,” 340; Sale, “Public Governance,” 1032–35.

(42.) Langevoort and Thompson, “Publicness in Contemporary Securities Regulation,” 378–83; Sale, “Public Governance,” 1032–35.

(43.) The key work in this space is Mark Roe’s article, “Delaware’s Competition,” Harvard Law Review 117 (2003). In this piece, Professor Roe challenged the long-standing, race-to-the-bottom argument, analyzing the role of the federal government in providing competition to Delaware in regulating entities. For additional works by Professor Roe in this space, see “Delaware’s Politics,” Harvard (p.126) Law Review 118 (2005) and “Delaware’s Shrinking Half-Life,” Stanford Law Review 62 (2010).

(44.) In re Ltd., Inc., No. CIV.A. 17148-NC, 2002 WL 537692 (Del. Ch. Mar. 27, 2002).

(45.) In re Ltd., Inc., No. CIV.A. 17148-NC, 2002 WL 537692 (Del. Ch. Mar. 27, 2002); Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 845 A.2d 1040 (Del. 2004).

(46.) Although the nexus-of-contracts proponents see these fiduciary duties as private, they are not. They “yield important externalities,” including compensation to those injured and support for investment through protection for overreaching. Cox, “The Limits of Private Ordering,” 33; DuPont v. Delaware Trust Co., 320 A.2d 694 (Del. 1974).

(47.) Sarbanes-Oxley Act sec. 301, § 10A, 116 Stat. at 775–77; 17 C.F.R. 240.10A-3.

(48.) John C. Coffee Jr. and Hillary A. Sale, “Redesigning the SEC: Does the Treasury Have a Better Idea?” Virginia Law Review 95 (2009): 769.

(49.) 17 C.F.R. 240.10A-3.

(50.) 17 C.F.R. 240.10A-3; Johnathan Macey and Hillary A. Sale, “Observations on the Role of Commodification, Independence, and Governance in the Accounting Industry,” Villanova Law Review 48 (2003): 1183–87.

(51.) Sarbanes-Oxley Act sec. 301, § 10A, 116 Stat. at 775–77.

(52.) Dodd-Frank Act sec. 952, § 10C, 124 Stat. at 1900; 17 C.F.R. 229, 240 XX.

(53.) For articles questioning the value of independence requirements, see Sanjai Bhagat and Roberta Romano, “Event Studies and the Law: Part II: Empirical Studies of Corporate Law,” American Law and Economics Review 4 (2002): 403; Sanjai Bhagat and Bernard Black, “The Non-Correlation Between Board Independence and Long-Term Firm Performance,” Journal of Corporation Law 27 (2002): 231; Sanjai Bhagat and Bernard Black, “The Uncertain Relationship between Board Compensation and Firm Performance,” Business Law 54 (1999): 922; Lisa M. Fairfax, “The Uneasy Case for the Inside Director,” Iowa Law Review 96 (2010): 131. And for articles arguing that independence correlates with positive financial and governance outcomes, see Dain C. Donelson, John McInnis, and Richard D. Mergenthaler, “The Effect of Governance Reforms on Financial Reporting Fraud,” Journal of Law, Finance, and Accounting 1 (2016) 235 (finding that increases in board independence produced significant decreases in rates of fraud); Vidhi Chhaochharia and Yaniv Grinstein, “CEO Compensation and Board Structure,” Journal of Finance 64 (2009): 232 (finding that a significant decrease in CEO compensation occurred at firms required to implement stock exchange board oversight requirements, including majority board independence, after the 2001 and 2002 corporate scandals); James F. Cotter, Anil Shivdasani, and Marc Zenner, “Do Independent Directors Enhance Target Shareholder Wealth during Tender Offers?” Journal of Financial Economics 43 (p.127) (1997): 214 (finding that independent boards enhance target shareholder gains from takeovers); Michael S. Weisbach, “Outside Directors and CEO Turnover,” Journal of Financial Economics 20 (1988): 457 (finding that independent boards are more likely to replace a CEO in response to poor performance).

(54.) James D. Cox, “The Social Meaning of Shareholder Suits,” Brooklyn Law Review 64 (1999): 7–40.

(55.) Sarbanes-Oxley Act sec. 401, § 10A, 116 Stat. at 775–77.

(56.) 8 Del. C. § 143.

(58.) Id. at 1643–55.

(59.) Although the process often results from regulation, it occurs in both publicly-held and privately-held entities through press releases and the like. Sale, “J.P. Morgan,” 1630–35.

(61.) Id. at 1643–55.

(62.) Donald C. Langevoort, “The SEC as Lawmaker: Choices about Investor Protection in the Face of Uncertainty,” Washington University Law Review 84 (2006): 1598–603. Sale, “J.P. Morgan,” 1654–55.

(63.) Robert B. Thompson and Hillary S. Sale, “Securities Fraud as Corporate Governance: Reflections upon Federalism,” Vanderbilt Law Review 56 (2003): 870–78. Sale, “J.P. Morgan,” 1634–35.

(64.) Sale, “J.P. Morgan,” 1634–35. This theory of publicness connects with institutional questions about compliance, regulation, legitimacy, and social license. See, e.g., Jodi Short and Michael Toffel, “Making Self-Regulation More Than Merely Symbolic: The Critical Role of the Legal Environment,” 55 Administrative Science Quarterly 361 (2010). Compliance is key to whether organizations and directors will encounter push back from the public. For an article examining the role of culture in compliance, see Donald C. Langevoort, “Cultures of Compliance,” American Criminal Law Review 54 (2017): 733.

(65.) Bob Thompson and I began to develop the theory of this information-forcing-substance regime elsewhere and have continued to work on it. Thompson and Sale, “Securities Fraud,” 875. Hillary A. Sale, “Independent Directors as Securities Monitors,” Business Lawyer 61 (2006): 1375.

(66.) Securities Act of 1933, 15 U.S.C. § 77a et seq; Hillary A. Sale, “Disappearing without a Trace: Sections 11 and 12(a)(2) of the 1933 Securities Act,” Washington Law Review 75 (2000): 430–34; Langevoort and Thompson, “Publicness in Contemporary Securities Regulation,” 375–79.

(67.) Sale, “Disappearing without a Trace,” 430–34; Langevoort and Thompson, “Publicness in Contemporary Securities Regulation,” 375–79.

(68.) Securities Act of 1933, 15 U.S.C. § 77a et seq. Sale, “Disappearing without a Trace,” 472. Langevoort and Thompson, “Publicness in Contemporary Securities Regulation,” 352.

(p.128) (69.) Securities Act of 1933, 15 U.S.C. § 77k. Sale, “Disappearing without a Trace,” 470. Langevoort and Thompson, “Publicness in Contemporary Securities Regulation, 69.

(70.) Securities Act of 1933, 15 U.S.C. § 77k. See also Sale, “Disappearing without a Trace,” 470; Langevoort and Thompson, “Publicness in Contemporary Securities Regulation,” 352.

(72.) Securities Act of 1933, 15 U.S.C. § 77k.

(73.) Securities Exchange Act of 1934, 15 U.S.C. § 78(a) et seq. Section 13 of the 1934 Securities Exchange Act actually works in conjunction with the 1933 Act requirements through what is referred to as integrated disclosure. Securities Exchange Act of 1934, 15 U.S.C. § 78(m).

(74.) See Securities Exchange Act of 1934, 15 U.S.C. § 78(j) and Employment of Manipulative and Deceptive Devices, 17 C.F.R. § 240.10b-5 (2015). See also Sale and Thompson, “Market Intermediation,” 872.

(77.) The 10b-5 cause of action is the provision for 10Ks. Employment of Manipulative and Deceptive Devices, 17 C.F.R. § 240.10b-5 (2015). See also Sale, “Disappearing without a Trace,” 472.

(78.) See, e.g., In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y. 2004) and Escott v. BarChris Construction Corp., 283 F. Supp. 643, 688 (S.D.N.Y. 1968).

(79.) See, e.g., “SEC Issues Final Rules on CEO/CFO Certification under Section 302 of the Sarbanes-Oxley Act.” Skadden, Arps, Slate, Meagher & Flom LLP. September 2002. https://www.skadden.com/sites/default/files/publications/841library.pdf. Jeff G. Hammel and Robert J. Malionek, “Statements Made and Not Made: An Auditor’s Duty to Correct, and the Scope of Liability for Statements Made by Others,” Latham & Watkins Securities Litigation and Professional Liability Practice (First Quarter 2007), https://www.lw.com/thoughtLeadership/securities-litigation-and-professional-liability-practice-issue-15. Paul Vizcarrondo Jr., “Liabilities under the Federal Securities Laws: Sections 11, 12, 15, and 17 of the Securities Act of 1933 and Sections 10, 18, and 20 of the Securities Exchange Act of 1934,” Wachtell, Lipton, Rosen & Katz (August 2013), http://www.wlrk.com/docs/OutlineofSecuritiesLawLiabilities2013.pdf.

(80.) See Robert B. Thompson, “Federal Corporate Law: Torts and Fiduciary Duty,” Journal of Corporation Law 31 (2006). See also Sale and Langevoort, “We Believe”; Sale and Thompson, “Market Intermediation.” The Corporate Laws Committee, “Corporate Director’s Guidebook—Sixth Edition.” Business Lawyers 61 (Aug. 2011): 985, 987.

(82.) The scienter requirement under 10b-5 is intended to limit what might otherwise be a very flexible cause of action. Nevertheless, it could have the unintended consequence of decreasing the incentive of directors to develop knowledge. Jennifer H. Arlen and William N. Carney, “Vicarious Liability for Fraud on the Securities Markets: Theory and Evidence,” University of Illinois Law Review 691 (1992): 714–15.

(83.) Indeed, in an additional indirect layer, the directors’ behavior will drive management behavior, thereby enforcing yet another set of fiduciary duties. Sale and Langevoort, “We Believe.” See also Sale, “Independent Directors,” 1382.

(84.) See 2016 Principles of Corporate Governance, Business Roundtable 8 (Aug. 2016), https://businessroundtable.org/sites/default/files/Principles-of-Corporate-Governance-2016.pdf.

(85.) This is true whether the process drives a change in a proposed disclosure or no change. Sale and Langevoort, “We Believe.”

(86.) See, e.g., Escott v. BarChris Construction Corp., 283 F. Supp. 643, 688 (S.D.N.Y. 1968) and In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y. 2004).

(87.) Id. at 683–93 (analyzing the relevant conduct of each director).

(89.) See Thompson, “Federal Corporate Law.” See also Thompson and Sale, “Securities Fraud as Corporate Governance.” See also Jill E. Fisch, “Federal Securities Fraud Litigation as a Lawmaking Partnership,” http://ssrn.com/abstract=2869523 (exploring the relationship between Congress and the federal courts in further developing securities law).

(93.) Sally Quillian Yates, “Individual Accountability for Corporate Wrongdoing,” Department of Justice (Sept. 9, 2015), https://www.justice.gov/dag/file/769036/download.

(94.) Id. at 1

(95.) Id. at 3.

(97.) Holly J. Gregory, “Board-Driven Internal Investigations,” The Governance Counselor: Capital Markets and Corporate Governance (May 2016), http://www.sidley.com/~/media/publications/may-2016-practical-law-journal.pdf.