Bill Ackman’s public disclosure earlier this year of confidential JC Penney board deliberations not only outraged his fellow directors but also stunned the corporate community. His actions, however, were not without precedent. In 2006, a Hewlett-Packard director leaked confidential corporate information to the press and the company came under attack for methods used to ferret out the source of the boardroom leaks. As hedge funds and other shareholder activists increasingly succeed in gaining seats on corporate boards, boardroom confidentiality is an issue that no board of directors can afford to ignore.
Unfortunately, case law regarding a director’s obligation to maintain the confidentiality of corporate information is limited. Under Delaware law, a director’s fiduciary duty of loyalty requires directors not to misuse or disclose confidential corporate information to others to further their own private interests rather than those of the corporation.1 While a director may believe that conveying confidential corporate information to the press is in the best interests of the corporation, a court will decide with 20-20 hindsight whether the disclosure was consistent with the director’s fiduciary duties. In the JC Penney incident, the board reportedly was considering pursuing legal action against Ackman, whose disclosures the company’s chairman characterized as “disruptive and counterproductive.”2 According to at least one report, Ackman sought, in connection with his ultimate resignation from the board, a release from any potential liability.3
Short of pursuing legal action, boards are limited in their ability to sanction a rogue director. Under Delaware law, directors cannot remove a fellow director from the board, nor can they simply exclude the director from board meetings. A board of directors, however, can form a special committee that does not include the offending director and conduct delicate board business through the special committee. One court recently noted, however, that “the degree to which such a committee would need to provide some form of update periodically or upon request to other directors or the board has not been fully determined and is likely fact-dependent.”4 Because of these difficulties, the most likely remedy a board will pursue is to simply not re-nominate the director when he or she stands for re-election.
Despite these limited remedies, there are some steps that a board can take to help preserve boardroom confidentiality:
- Adopt robust confidentiality policy. While almost all public companies have adopted insider trading policies prohibiting the disclosure by insiders of material nonpublic information about the company, few companies expressly restrict the disclosure of boardroom deliberations and other information learned by directors in the course of their service to the company. Companies should review and revise their corporate governance guidelines or other appropriate policies to expressly prohibit such disclosure unless required by law or approved by the board. The policy should clearly identify as “confidential information” any nonpublic information about discussions and deliberations at the board level, as well as information relating to board dynamics and company personnel. Boards should also make sure that their Regulation FD disclosure policy and/or corporate governance guidelines squarely address who is authorized to speak on behalf of the company. If nothing else, a robust confidentiality policy will impress upon directors the importance that the company places on boardroom confidentiality and foster voluntary compliance. Also, Delaware courts do give weight to board confidentiality policies when analyzing confidentiality claims, at least when ruling on shareholder demands to inspect company books and records.5
- Expressly address disclosure by designated directors to their sponsors. The extent to which a director serving at the behest of a hedge fund or other sponsor may convey confidential corporate information to the sponsor is not clearly established under Delaware law. However, in a 2013 decision, the Delaware Chancery Court declared in dicta that “[w]hen a director serves as the designee of a stockholder on the board, and when it is understood that the director acts as the stockholder’s representative, then the stockholder is generally entitled to the same information as the director.”6 To negate any implicit understanding or confusion in this regard, a company’s director confidentiality policy should expressly prohibit disclosure to a director’s sponsor unless the company otherwise expressly agrees. In addition, designated directors often gain their board seats through a negotiated settlement between the company and the sponsor in connection with a pending or threatened proxy fight. The settlement agreement should clearly address the extent to which the director may share confidential information with his sponsor and should impose confidentiality restrictions on the sponsor.
- Consider confidentiality requirements for nomination and qualification of directors. Many companies have adopted “second generation” advance notice bylaws that provide, among other things, that a shareholder nominee for election to the board must, as a precondition to nomination, agree in writing to comply with all company policies that are applicable to directors. When combined with a robust director confidentiality policy as discussed above, this type of bylaw can help deter confidentiality breaches. A company may also wish to consider adding a director qualification bylaw that would render a director ineligible to serve if the director violated the company’s confidentiality policies. Alternatively, a company could require a director to agree in advance to resign from the board if the director violates the policy. Although Delaware law contemplates that a resignation conditioned upon a director failing to receive a specified vote for reelection may be irrevocable,7it is not clear whether advance resignations given in other contexts may be irrevocable. In any event, these types of mechanisms would need to be carefully crafted to ensure that the procedure for determining a violation is fair and does not unduly restrict a director’s disclosure of information that is consistent with the director’s fiduciary duties.
- Send periodic reminders. To enhance compliance, the company should periodically remind directors of their confidentiality obligations under the company’s insider trading, Regulation FD and boardroom confidentiality policies.
The preservation of boardroom confidentiality is critical to the effective operation of a board. Directors cannot be open and honest in their discussions if they fear that their comments or positions will appear in tomorrow’s newspaper. With the increasing success of hedge funds and other special-interest investors in placing directors on boards, there will be less collegiality in the boardroom and a greater risk of leaks. Directors who serve on a board at the behest of special-interest investors must not lose sight of the fact that they nevertheless owe their fiduciary duties to the stockholders as a whole.
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1 See Hollinger International Inc. v. Black, 844 A.2d 1022, 1061 (Del. Ch. 2004).
2 “J.C. Penney Mulls Action Against William Ackman,” The Wall Street Journal, Aug. 12, 2013.
3 M. De La Merced, “Ackman Resigns From Penney’s Board,” The New York Times, Aug. 13, 2013.
4 Kalisman, et al. v. Friedman, et al., Del. Ch. Ct., C.A. No. 8447-VCL (April 17, 2013), at p. 6.
5 See Disney v. The Walt Disney Co., 2005 Del. Ch. LEXIS 94 (Del. Ch. June 20, 2005) (in denying access to certain documents sought by a former director exercising shareholder inspection rights under Section 220 of the Delaware General Corporation Code, the court gave “significant weight” to a written board confidentiality policy barring present and former directors from disclosing information entrusted to them by virtue of their positions, including non-public information about board discussions and deliberations).
6 See Kalisman, supra at p. 8.
7 Delaware General Corporation Law Section 141(b).