Confronting the Problem of Fraud on the Board

Abstract

Recent precedents make it difficult to challenge transactions approved by a board of directors and a stockholder majority. When should such cases be filed, proceed beyond the pleading stage, and prevail? My answer is that litigation rules should remedy and deter tortious misconduct that corrupts board decision-making. Commission of fraud on the board is an omnipresent temptation for self-interested controllers, activist stockholders, officers, financial advisors, and their legal counsel. Fraud can be used to put a company in play, steer a sale process toward a favored bidder, suppress the sale price to a controller, or make a favored bid look more attractive. Successful stockholder actions in recent decades can be reinterpreted as occasions when courts made tentative or final determinations that a board decision was corrupted by fraud or related tortious misconduct. Going forward, problematic legal rules bearing on fraud on the board need to be confronted. Stockholder plaintiffs should be permitted to inspect contemporaneously created electronic books and records to test whether the publicly disclosed narrative of a sale process conceals undisclosed fraud on a board. A non-fiduciary’s corruption of a board’s decision-making processes should be considered a free-standing tort, without the need to establish that duped fiduciaries breached their fiduciary duties. Recognizing a tort of fraud on the board would be consistent with tort principles and a sound stockholder litigation regime.

Keywords: Corporation Law, Mergers and Acquisitions, M&A, Shareholder Litigation, Financial Advisors

JEL Classification: G34, G38, K22, K41