Delaware decision may expand director accountability for knowledge of documents never received and further cloud scope of attorney-client privilege
Score one for shareholders. Delaware’s Supreme Court recently ruled that institutional investors should be allowed to inspect corporate documents related to Walmart’s internal investigation of suspected bribes at its Mexican operations.
The ruling in Walmart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW, is significant in the ongoing shareholder challenge over Walmart’s handling of the alleged bribery scheme. According to published reports, Walmart’s Mexican subsidiary issued illicit payoffs to government officials from 2002 to 2005 at the direction of the division’s CEO at the time. Payments were allegedly made to middle-men and government officials who handled processing of permits and licensing for new Walmart stores in Mexico.
According to Grant & Eisenhofer, the law firm that brought the ‘books and records’ suit on behalf of Walmart shareholders, led by the Indiana Electrical Workers Pension Trust Fund, shareholders had sought to inspect internal documents that might determine whether Walmart’s board of directors breached their fiduciary duties by failing to properly pursue the bribery allegations, including ignoring claims brought by whistleblowers, as well as findings from one of the company’s investigators.
In its appeal of a Delaware Court of Chancery decision that ordered Walmart to produce the documents, the company argued the ‘scope of production ordered by the Chancery Court is unprecedented.’ The Supreme Court disagreed and found ‘no abuse of discretion’ in the shareholder’s request and the Chancery Court’s order for document production ‘constituted an appropriate exercise of discretion.’
‘After nearly two years of effort to block shareholders in the courts, Walmart must now comply with our request and we very eagerly await the release of these documents and the truths they will reveal,’ Stuart Grant, co-managing director at Grant & Eisenhofer said in a prepared statement.
The implications of the court’s decision are huge. ‘The most significant portion of the court’s decision is the scope of which shareholders are now able to review internal documents and analyze the decision-making of a corporation for which they are a shareholder,’ says David Reischer, chief operating officer and founder of LegalAdvice.com. ‘This is significant because it completely alters the balance of power between shareholders and management. Previously, boards were considered to be in the best position to scrutinize executive decision-making.’
The ruling is a game changer for shareholders in that they now can discover facts early in the process and decide whether their allegations are supported by the documents they receive. ‘But conversely, it may actually lead some to abandon cases where the documents show no malfeasance,’ says Franklin Snyder, a professor of law at Texas A&M University’s School of Law.
The decision raises troubling possibilities. Despite the fact that officer-related documents never made it to the board, the board wasn’t off the hook. ‘This imputation of knowledge creates a legal issue where the board may be accountable for documents never actually received,’ points out Braden Perry, a partner at KennyHertz Perry and a former federal enforcement attorney. ‘The other issue is the attorney-client privilege. Having the court find these documents essential and necessary only adds to the now cloudy attorney-client status of general counsel or internal counsel.’
Reischer asserts the decision sets the stage for ‘further interference from shareholders even though it is probably against the shareholders’ best monetary interests to have such active shareholder participation.’ He cites the risk of a vocal minority of active shareholders, such as those who brought the lawsuit, now being empowered to act out of ‘a misplaced sense of moral indignation’ that will end up hurting their financial interests.
According to Perry, companies should have clear policies that outline documents subject to books and records requests. There should also be clear reporting and communication lines to ensure board members have knowledge of facts for which they may be held accountable.
‘It is always prudent to review bylaws and policies and procedures to ensure corporate governance issues are addressed and are living documents that adapt to the law,’ he says.
There’s a good chance that from now on it will be difficult to be sure that any particular record will be exempt from production. ‘This creates a conundrum. On the one hand, good boards will want to have thorough and well-documented investigations of wrong-doing, while on the other, they have to realize that any document created – in the famous words of Miranda – can and will be used against them in litigation,’ Snyder says.
Even the best of boards can find themselves in Walmart’s shoes. Snyder says savvy boards will assume that every document produced within the company will be read at some point by angry shareholders, criminal investigators, the media, or all three camps. Furthermore, there should be no assumption that any documents sent to the company’s lawyers will be protected from discovery.
The onus is on boards to insist on internal policies that allow reporting by any potential whistleblowers directly to the board, in parallel with any reporting to upper management, says Reischer.
Board members’ biggest hits don’t usually come as a result of initial wrongdoing, but because of a perceived lack of action that can be interpreted as covering up the wrongdoing, says Snyder. ‘If you’re a director, you should already know that acting promptly to investigate and deal with the problem is your best defense, and in a modern world of instant communication where secrets are impossible to maintain, it’s usually the best thing for the company.’
