The Fall 2021 issue of the American Bar Association’s scholarly journal, The Business Lawyer features an article by Professor William W. Bratton arguing that the “evolutionary erosion” theory that fiduciary obligation of corporate board members has been weakened over time does not apply to management self-dealing. He says that related party transactions involving the executives or directors are still subject to strictly applied fiduciary review. “Disclosure rules make self-dealing transparent to shareholders, who have no reason to like self-dealing and who now stand ready and able to register their preferences regarding such matters in corporate boardrooms. At the same time, the requirement of a majority independent board makes self-dealing transactions by board members highly inconvenient because self-dealing undercuts independence.”

We remain skeptical of this theory and of the benefit of insider transactions for shareholders. the assumption that shareholders are able to register their preferences is not valid, as these transactions are disclosed after the fact and other than a multi-million dollar proxy contest for board seats (Engine No. 1 spent $30 million to elect three of its four nominees to the board of ExxonMobil), in what way do their register their preferences? They cannot vote to invalidate the transaction. They cannot replace the board members who approved it without a prohibitively expensive fight. So, what does “register their preferences” mean?

We are not opposed to all insider transactions. In one case we consider the gold standard, the company was selling an asset. They got three different appraisals, offered it to the market at the average of the three figures, and when no one bought it, allowed an insider to purchase it at that price. All of this was thoroughly explained to the shareholders.

More often, these transactions are not as squeaky clean. Unforgettably, the board of Chesapeake Energy approved a $12 million purchase of the CEO’s antique map collection, appraised by the CEO’s consultant on the purchase of the maps. Occidental Petroleum’s Armand Hammer, the all-time self-dealing champ, got his board to approve payment for his personal biographer and the museum for his art collection.

Bratton argues that business has moved beyond this kind of abuse thanks to better oversight from both boards and shareholders. He looked at related party transactions in 93 proxy statements. About one-third of the companies had none to report. Only a small number were over $1 million, which was his threshold for materiality. “A notable tie connects the red-flag transactions in the proxy statement and the 10 percent minority of controlled companies in the sample.” Here he includes an example that even Armand Hammer did not think of: the sale of a trademark for WeWork by its CEO to the company for $5.9 million, in addition to other self-dealing transactions approved by the board of directors he controlled through his ownership in the company. “The WeWork story forecloses any possibility that this article could close with a generalization to the effect that ‘self-dealing transactions are no longer a problem.'”

In fairness, it was in part the outrageous abuses of these deals that led the WeWork IPO to fail (and should have led the investment bankers to realize it would inevitably fail and right these wrongs before attempting to take it public. So, that is one kind of shareholder oversight. But refusing to buy the stock of a newly public company is a lot easier than preventing a bad deal in a company already in the portfolio.