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 judicial intervention should remedy and deter tortious misconduct that corrupts board decision-making (i.e., misconduct that the Delaware Supreme Court has called “illicit manipulation of a board’s deliberative processes” or “fraud upon the board”). 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. I argue that confronting the problem of fraud on the board has three components. First, virtually all successful breach of fiduciary duty actions should be reinterpreted as occasions when courts determined that a board decision was corrupted by fraud or related tortious misconduct. Second, stockholders should be entitled to examine contemporaneously created books and records in order to detect fraud on the board. Third, when committed by a non-fiduciary, fraud on the board should be considered a free-standing tort, without the need to establish that duped directors 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