Preemption and Federalism in Corporate Governance: Protecting Shareholder Rights to Vote, Sell, and Sue

Abstract

ROBERT B. THOMPSON [*] I INTRODUCTION The legal rules of American corporate governance come primarily from state law. [1] The basic rights of shareholders relative to directors in the corporate entity have been determined in Delaware and the other states, not in Washington D.C. [2] Federal law supplements these state law rules principally through disclosure requirements that are designed to increase the protection of shareholders. But, traditionally, federal law has not supplanted the shareholder-director relationship as determined by the states. It is a prime example of our federalism. [3] With the enactment of the Securities Litigation Uniform Standards Act of 1998 [4] and other recent changes, the traditional description no longer holds. There has been a noticeable expansion in the scope of federal regulation at the expense of the states, at least as it applies to the role of shareholders in the corporate form. [5] Less noticeable is the shift, led by federal law, to a greater emphasis on the voting role of shareholders relative to other shareholder functions, such as selling or suing. With the preemption decreed by the 1998 Act, important parts of state law that address disclosure to shareholders can survive only if the state law is more restrictive toward shareholders than is the federal law, a reversal of the historical pattern that has characterized state and federal roles during the twentieth century. This article examines the changed roles of the state and federal governments in this new era. Part II presents the traditional roles of the federal and state governments in regulating corporate behavior. Part III describes how that traditional pattern has changed, in part due to elements contained in the traditional system that have not been clearly visible, and in part due to express federal preemption of state law contained in recent congressional acts. Part IV focuses on where these changes have left us: with a greater dependence on federal law, a greater emphasis on the voting function of shareholders, and the likelihood of additional argument over traditional corporate issues such as the internal affairs rule and the distinction between direct and derivative suits. II THE TRADITIONAL FEDERAL AND STATE REALMS IN CORPORATE GOVERNANCE A. The State Law Pattern Under corporate law in all states, directors manage the business and affairs of the corporation. [6] Shareholders have only a limited role: They can vote, sell, or sue. 1. Vote. The shareholder franchise is a key part of corporate law, but that does not mean that shareholders vote on very many things. Most business decisions are left entirely to the board of directors or those to whom they delegate such authority. Shareholders participate only infrequently in a limited set of decisions, including the election of directors, fundamental corporate changes, and ratification. a. Election of directors. Directors are usually elected annually, but this pattern can be varied by the corporation's articles of incorporation or other private ordering. [7] Shareholders also have the power to remove directors in some circumstances. [8] b. Fundamental corporate changes. Mergers and similar transactions require the approval of shareholders as well as directors and, thus, are an exception to the usual rule that leaves corporate decisions entirely in the hands of the directors. [9] Of course, even here the directors act as gatekeepers: The shareholders can vote only on those transactions that are recommended to them by the directors. c. Ratification. Shareholders occasionally vote on the ratification of self-dealing transactions by interested directors. [10] The vote can cleanse the transaction of any taint or shift the burden of proof in a legal challenge. [11] 2. Sell The ability to sell one's shares is a core right for shareholders and one that corporate law has, for the most part, left to the market. …