STIMULATING LONG-TERM SHAREHOLDING - · PDF file · 2012-11-16STIMULATING LONG-TERM...

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STIMULATING LONG-TERM SHAREHOLDING

Emeka Duruigbo∗

ABSTRACT

This Article answers, in the affirmative, two core research questions:

do we need long-term shareholders and can we find them? The economy needs long-term shareholders to provide prudent and profitable patient capital, generate an antidote to corporate short-termism, and spearhead managerial accountability. Finding these shareholders requires a struc-ture that provides the right environment and incentives for such invest-ment. This Article presents a novel application of the trust fund theory—the dominant philosophical paradigm of American corporate finance in the nineteenth century—as a vehicle for stimulating long-term sharehold-ing. The central features of the reformulated trust fund theory include the creation of relatively illiquid trust securities, a permanent fund financed by the sale of the securities, and long-term shareholders who, in exchange for less liquidity, receive an enhanced voice in corporate governance. Apart from addressing the need for long-term shareholding, the revised trust fund theory will also serve the additional functions of providing creditor protection and assuring regulatory compliance.

TABLE OF CONTENTS

INTRODUCTION .............................................................................................................. 1734 I. HISTORY OF THE CORPORATE TRUST FUND THEORY ......................................... 1740 II. REVIVED TRUST FUND THEORY: NATURE AND STRUCTURE .............................. 1746

A. Express Creation ......................................................................................... 1747 B. Permanent Fund ........................................................................................ 1748 C. Class T Common Shares ............................................................................ 1749

∗ Associate Professor of Law, Thurgood Marshall School of Law, Texas Southern Universi-ty. I presented aspects of this Article at the John Mercer Langston Workshop at Southern Methodist University in June 2010 and the Law & Society Association Annual Meeting in San Francisco in June 2011 and received many helpful comments for which I am grateful. Special thanks to Mitch Crusto, Lynne Dallas, Erik Gerding, and Jeff Schwartz for reading and com-menting on earlier versions. I deeply appreciate the invaluable research and editorial assistance of Susan Akinyemi, Shamia Cottrell, Janelle Marshall, and Samuel Sarfo.


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D. Illiquidity and Control ............................................................................... 1749 III. ARGUMENTS IN FAVOR OF THE REVIVED TRUST FUND PROPOSAL .................... 1752

A. Patient Capital ........................................................................................... 1752 B. Exit, Voice, and “Permanent Ownership” ............................................... 1758 C. Increased Managerial and Board Accountability ................................... 1765 D. Long-Term Equity Security ....................................................................... 1771 E. Antidote to Short-Termism ....................................................................... 1773 F. Long-Term Shareholder Primacy ............................................................. 1777 G. Cost Internalization and Creditor Protection ......................................... 1779

IV. ARGUMENTS AGAINST THE REVIVED TRUST FUND PROPOSAL .......................... 1780 A. Impairment of Interests and Disparate Treatment of Existing

Shareholders ................................................................................................ 1780 B. Heightened Vulnerability of Class T Shareholders ................................. 1782 C. Difficulty Raising Funds ............................................................................ 1783 D. Management’s Opposition ........................................................................ 1784 E. Superfluity ................................................................................................... 1787 F. Unreasonable Restraint on Alienation .................................................... 1791 G. Shareholder Empowerment and Agency Costs ....................................... 1791 H. Trigger Fiduciary Duties ........................................................................... 1797 I. Board Cohesion and Effectiveness ............................................................ 1798 J. Class T Short-Termism .............................................................................. 1800

CONCLUSION................................................................................................................... 1801

INTRODUCTION

Long-term shareholding is an essential, but increasingly scarce,

commodity in a society currently consumed with a short-term orienta-tion and an attention span that is mainly amenable to quick fixes.1 The economy needs long-term shareholders to provide prudent and profita-ble patient capital, generate an antidote to corporate short-termism, and spearhead managerial accountability.2 Finding shareholders who are willing to commit to a company for considerable periods of time and

1 MICHAEL T. JACOBS, SHORT TERM AMERICA: THE CAUSES AND CURES OF OUR BUSINESS MYOPIA (1991); Roberta S. Karmel, Should a Duty to the Corporation Be Imposed on Institu-tional Shareholders?, 60 BUS. LAW. 1, 20 (2004) (urging policy-makers to consider adoption of mechanisms to encourage long-term holding of securities by institutional investors, particularly pension funds and endowment funds that theoretically should be focused on the long term); Usha Rodrigues, Corporate Governance in an Age of Separation of Ownership from Ownership, 95 MINN. L. REV. 1822, 1826 (2011) (“In addition, one may question whether long-term inves-tors exist at all today—if they ever did.”). 2 See Jonathan Macey, Uncle Sam and the Hostile Takeover, WALL ST. J., Mar. 21, 2011, at A17 (“[T]he overall economy performs better when companies perform better.”).


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employ a long horizon approach to their investment, however, is a diffi-cult undertaking. It requires a structure that provides the right envi-ronment and incentives for such investment. A revised version of the trust fund theory would provide such a structure.3 Accordingly, this Article presents a novel application of the trust fund theory and hypoth-esizes that its revival will stimulate long-term shareholding, facilitate effective governance, and ensure business success based on a number of reasons developed below.4

The trust fund theory was the dominant philosophical paradigm in American corporate finance in the nineteenth century.5 Through the trust fund theory, the courts beginning in the 1820s postulated that capital contributions by shareholders to a corporation constituted a trust fund for the benefit of the corporation’s creditors.6 Further exten-sion of the doctrine established that shareholders were also personally liable for the shortfall of portions of the stock price that remained un-paid,7 or the difference between the stock’s par value and consideration provided for watered stock.8 Due to a number of problems, ranging from the conceptual to the practical, the theory received the severe dis-

3 See infra Parts I–II. 4 See infra Part III. 5 See James R. Ellis & Charles L. Sayre, Trust-Fund Doctrine Revisited: Part I, 24 WASH. L. REV. & ST. B.J. 44, 44 (1949) (stating that the trust fund theory was once termed the most im-portant doctrine in the law of corporations); Daniel R. Kahan, Shareholder Liability for Corpo-rate Torts: A Historical Perspective, 97 GEO. L.J. 1085, 1096–97 (2009) (stating that the trust fund theory was the dominant philosophical thinking in American law in the nineteenth centu-ry). 6 John C. Coffee, Jr., The Mandatory/Enabling Balance in Corporate Law: An Essay on the Judicial Role, 89 COLUM. L. REV. 1618, 1638 (1989) (“[T]he trust fund theory essentially held that the capital contributed by shareholders to a corporation in return for their shares consti-tuted a trust fund for the benefit of creditors.”). 7 Sawyer v. Hoag, 84 U.S. (17 Wall.) 610 (1873) (establishing that the trust fund doctrine applied to unpaid stock subscriptions); Norwood P. Beveridge, Jr., Does A Corporation’s Board of Directors Owe a Fiduciary Duty to Its Creditors?, 25 ST. MARY’S L.J. 589, 608 (1994) (“If paid-in capital stock is a trust fund, it takes but a short step to hold that an unpaid stock subscription agreement is property of a corporation which is held in trust for creditors . . . . and several courts in the 1800s took that step.”); Sam Denny & Edward S. Howell, Some Problems Raised by Issuing Stock for Overvalued Property and Services in Texas, 40 TEX. L. REV. 376, 379 (1962); James R. Ellis & Charles L. Sayre, Trust-Fund Doctrine Revisited: Part II, 24 WASH. L. REV. & ST. B.J. 134, 134 (1949). 8 FRANKLIN A. GEVURTZ, CORPORATION LAW 130 (2d ed. 2010) (stating that the trust fund theory was developed early in the history of American corporate law as a basis for assigning liability to shareholders who received bonus, discount, or watered stock). While the term “wa-tered stock” is used generically to refer to watered stock, bonus shares, and discount shares, they are three different concepts. See MELVIN ARON EISENBERG, CORPORATIONS AND OTHER BUSINESS ORGANIZATIONS: CASES AND MATERIALS 1260 (9th ed. 2005) (showing that bonus shares refers to shares issued free of charge, possibly as a bonus for purchasing some other class of security; discount shares are shares issued for an amount below the par value; watered shares are issued for property less than the par value); ROBERT W. HAMILTON ET AL., CASES AND MATERIALS ON CORPORATIONS INCLUDING PARTNERSHIPS AND LIMITED LIABILITY COMPANIES 282 (11th ed. 2010).



approbation of critics and fell into desuetude. The reformulated trust fund theory adopts and adapts the original theory by accepting its trust-premise and underlying creditor-protection justification while taking into account valid criticisms of the theory.9

Under this revived theory, the paid-in capital of some shareholders would constitute an expressly created trust fund for the benefit of credi-tors. Companies can create a separate class of common shares (Class T) to fund the trust.10 Holders of these securities will purchase the shares on the understanding that they will hold them for extended time peri-ods, with ten-year restrictions on sale or transfer. Because of the limited liquidity of their holdings, the firm can readily count on the loyalty of these long-term shareholders.11 This sense of loyalty and the attendant investment risk arising from the long, relatively illiquid holding, provide justification for affording these shareholders enhanced participation in the governance of the corporation, including allocating to them a num-ber of seats on the board of directors, facilitating their nomination of candidates to fill those board positions, and allowing them to vote on the corporation’s long-term strategy.12

In this reconstructed form, the trust fund theory can play a role in addressing several contemporary corporate-law problems and assuring business success in several respects. For instance, the theory may be useful in serving its original creditor-protection function. Creditors who

9 See John W. Cioffi, Fiduciaries, Federalization, and Finance Capitalism: Berle’s Ambigu-ous Legacy and the Collapse of Countervailing Power, 34 SEATTLE U. L. REV. 1081, 1083 (2011) (“Future generations are free to refashion and use theories and analytical frameworks in new ways to address new problems, at least when their content and implications are not misstat-ed.”). 10 Companies may also enter into similar arrangements with existing shareholders who purchased their stock from the external capital market and who accept the same conditions as Class T holders. Similarly, companies may allow current shareholders to convert their regular common stock into Class T shares. In these cases, there is no trust fund and the creditor-protection angle will be missing, although other incidents and benefits of the proposed ar-rangement will be preserved. See Rebecca Wayland, The Case of Cummins Engine: Increasing Private Ownership in a Publicly Traded Company, HARV. BUS. REV., Sept.-Oct. 1992, at 74, 75 (illustrating with the case of a company some of whose major shareholders agreed not to sell their shares for six years in order to assist management in building long-term value). 11 Patrick Rey & Jean Tirole, Loyalty and Investment in Cooperatives 4 (IDEI, Working Paper No. 123, 2000), available at http://idei.fr/doc/by/rey/loyalty.pdf (“[E]rect[ing] limited barriers to exit [can] create an appropriate amount of loyalty . . . .”). The shareholder’s lack of loyalty or commitment to the corporation in which she holds shares is legendary. See, e.g., Kent Greenfield, Reclaiming Corporate Law in a New Gilded Age, 2 HARV. L. & POL’Y REV. 1, 9 (2008); Homer Kripke, The SEC, Corporate Governance, and the Real Issues, 36 BUS. LAW. 173, 177 (1981) (stating that the average shareholder sees himself as an investor who is at liberty “to move into and out of the corporation without loyalty”). 12 See Michael E. Porter, Capital Disadvantage: America’s Failing Capital Investment Sys-tem, HARV. BUS. REV., Sept.-Oct. 1992, at 65, 81 (recommending that managers seek a smaller number of long-term or nearly permanent owners and give them a voice in corporate govern-ance as a remedy to transient ownership which constitutes a major weakness in the American corporate system).

http://idei.fr/doc/by/rey/loyalty.pdf



feel more comfortable dealing with firms with a segregated pool of cash or who would otherwise require personal guarantees before transacting with firms may find the option palatable. This protection is even more critical for involuntary creditors whose claims result from the ultrahazardous activities of the corporation. A trust fund approach may also be utilized by companies in certain industrial or commercial activi-ties to meet regulatory requirements.13

A revised trust fund theory could offer a framework for effective shareholder monitoring of management through emphasis on voice instead of unlimited exit, proceeding on the understanding that voice is not likely to be amplified where exit is not substantially constrained.14 In addition, it provides a pathway for creating the elusive class of perma-nent or quasipermanent shareholders that has been viewed as key to ensuring corporate accountability, paralleling the practice that prevailed for a long time in Germany and Japan. Class T shareholders will im-prove board accountability by injecting into the boards nominees who share their view that the primary responsibility of the board is to build long-term shareholder value.15 The refocused board will accordingly prioritize managerial devotion to this goal. Class T shareholders will also improve management accountability by directly monitoring man-agers.16 Further, the “permanent owner” notion can contribute to en-trenching a long-term-shareholder–primacy norm. This norm can promote a long-horizon approach to investment and management, thereby presenting at least a partial panacea to shareholder short-termism and managerial myopia that has caused consternation in cor-porations and the investment community.17 The trust securities also

13 An example is the recently debated imposition of a $10 billion cap for economic losses resulting from offshore drilling in the aftermath of BP’s Deepwater Horizon tragedy. See infra note 299 and accompanying text. 14 Unless otherwise noted, this Article uses the terms “management” or “managers” as shorthand ways of referring collectively to the corporation’s board of directors and senior officers. See David Millon, Theories of the Corporation, 1990 DUKE L.J. 201, 201 n.1. 15 See NYSE, REPORT OF THE NEW YORK STOCK EXCHANGE COMMISSION ON CORPORATE GOVERNANCE 2 (2010) [hereinafter NYSE REPORT], available at http://www.nyse.com/pdfs/CCGReport.pdf (“The board’s fundamental objective should be to build long-term sustainable growth in shareholder value for the corporation, and the board is accountable to shareholders for its performance in achieving this objective.”). 16 Id. (“[T]he Commission believes that shareholders have the right and responsibility to hold a board accountable for its performance in achieving long-term sustainable growth in shareholder value.”). 17 This objective could be strengthened by a complementary arrangement on the manageri-al side in the form of an executive compensation structure that involves further restricted stocks and stock options with holding periods of about ten years. See Sanjai Bhagat & Roberta Roma-no, Reforming Executive Compensation: Focusing and Committing to the Long-Term, 26 YALE J. ON REG. 359 (2009) (proposing the adoption of restricted stock and stock option plans for certain companies to discourage a short-term focus and encourage a long-term perspective by managers); Janice Kay McClendon, Bringing the Bulls to Bear: Regulating Executive Compensa-tion to Realign Management and Shareholders’ Interests and Promote Corporate Long-Term



represent a market-based, as opposed to a government-mandated, ap-proach to creating equity securities that are targeted at long-term inves-tors who are not interested in playing the stock market roulette, but want to hold stock as a means for providing income for their children’s college education and funding their own retirement.18

This proposal advances important corporate governance19 objec-tives, including enhanced shareholder voice, better board composition, and improved corporate performance.20 While sharing the shareholder-empowering paradigm and premise of the recently promulgated and now invalidated21 proxy access regulations by the Securities and Ex-change Commission (SEC), it differs in the sense that it favors private ordering and approaches the holding requirements differently.22 At the

Productivity, 39 WAKE FOREST L. REV. 971, 994–95 (2004) (advocating longer holding periods for stocks held by corporate executives). 18 See Gerald F. Davis, The Twilight of the Berle and Means Corporation, 34 SEATTLE U. L. REV. 1121, 1138 (2011) (“Not only is an economy organized around public corporations an increasingly risky place for workers, it is not a safe bet even for shareholders.”); Leo E. Strine, Jr., Breaking the Corporate Governance Logjam in Washington: Some Constructive Thoughts on a Responsible Path Forward, 63 BUS. LAW. 1079, 1082 (2008) (“Most individual investors are invested for the long term to accomplish two key objectives, having the funds necessary to pay for their children’s college education and to provide for themselves in retirement. These inves-tors have little interest in short-term gimmicks . . . .”). 19 Amir N. Licht, Corporate Governance, in ENCYCLOPEDIA OF FINANCIAL GLOBALIZATION 1, 1 (Gerard Caprio ed., 2011) (“Corporate governance is the institutional framework that regulates the division and exercise of power in the corporation.”). 20 Amar Bhide, The Hidden Costs of Stock Market Liquidity, 34 J. FIN. ECON. 31 (1993) (stating that reduced liquidity improves corporate governance because it would engender shareholder monitoring); Jill E. Fisch, The Destructive Ambiguity of Federal Proxy Access 17 (Univ. of Penn. Inst. for Law & Econ., Research Paper No. 11-05, 2011) (identifying corporate governance objectives to include increased shareholder voice, better board composition and improved corporate performance), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1769061. It may be that stock market illiquidity reduces monitoring, but that is inapplicable here because the liquidity only pertains to a portion of the shares, not all of them. See Ernst Maug, Large Shareholders as Monitors: Is There a Tradeoff Between Liquidity and Control?, 53 J. FINANCE 65 (1998) (arguing that illiquidity would restrict access of potential monitor to a company’s stock). 21 Business Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011). 22 The SEC regulations require a larger investment threshold (at least three percent of the total voting power of the company’s securities) than the present proposal envisions. They also impose a requirement that the right is available only to shareholders who have held a compa-ny’s stock for at least three years. My proposal has no minimum holding period for eligibility to exercise any of the privileges accompanying the holding of these securities, but requires a firm and enforceable commitment to hold the stock for ten years. Unlike the SEC proposal, which is mandatory, this proposal relies on private ordering, leaving it up to corporations to adopt or amend as they see fit. See generally Facilitating Shareholder Director Nominations, 75 Fed. Reg. 56,668 (Aug. 25, 2010); Fisch, supra note 20, at 54–59; Bernard S. Sharfman, Why Proxy Access (SEC Rule 14a-11) is Harmful to Corporate Governance, 37 J. CORP. L. (forthcoming 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1873469 (assailing the SEC’s proxy access rule as wealth-reducing because it has no opt-in or opt-out provisions). For addi-tional discussions of the importance of private ordering in corporate law and generally, see ROBERTA ROMANO, THE GENUS OF AMERICAN CORPORATE LAW 86–96 (1993); Lucian A. Bebchuk & Scott Hirst, Private Ordering and the Proxy Access Debate, 65 BUS. LAW. 329 (2010);



same time, it is open to supportive public policy in the form of positive tax incentives to adopting corporations and their shareholders.23 It re-sponds to a lingering challenge to develop a model of corporate govern-ance that incentivizes major shareholders to invest in a public corpora-tion in the manner that shareholder-managers of a closely held corporation grow and nurture their enterprise for the long term.24 It also contributes to constructing a reformed system for American corpo-rations that would assure the country’s competitive advantage.25 A number of managers of public corporations who long for long-term allies and large institutional shareholders, who want to hold stock for a long time, but also want better corporate risk management, are likely to respond favorably to the opportunity provided by the present pro-posal.26

This Article proceeds in four parts. Part I presents a historical syn-opsis of the trust fund theory. Part II focuses on the nature and structure of the revived trust fund theory. Part III advances arguments in favor of the revived theory, while Part IV examines opposing arguments. This Henry N. Butler & Larry E. Ribstein, Opting Out of Fiduciary Duties: A Response to the Anti-Contractarians, 65 WASH. L. REV. 1, 8 (1990) (“[P]rivate parties to the corporate contract should be free to order their affairs in whatever manner they find appropriate.”); Joseph A. Grundfest, The SEC’s Proposed Proxy Access Rules: Politics, Economics, and the Law, 65 BUS. LAW. 361 (2010); Lynn M. LoPucki & Walter O. Weyrauch, A Theory of Legal Strategy, 49 DUKE L.J. 1405, 1431 (2000) (stating that “private ordering” is the economists’ term for what sociologists refer to as social norms); Charles M. Nathan & Paul F. Kukish, Private Ordering and Proxy Access Rules: The Case for Prompt Attention, DIRECTOR NOTES (The Conference Bd.), Dec. 2010. 23 See infra Part III.D. 24 John H. Matheson & Brent A. Olson, Corporate Law and the Longterm Shareholder Model of Corporate Governance, 76 MINN. L. REV. 1313, 1369 (1992) (“The challenge is to develop a model of corporate governance which provides major shareholders with an incentive to invest in a corporation much as shareholder/managers of a closely held corporation develop and nurture their enterprise for the long term.”); see also Leo E. Strine, Jr., The Delaware Way: How We Do Corporate Law and Some of the New Challenges We (and Europe) Face, 30 DEL. J. CORP. L. 673, 690 (2005) (“Where it can, corporate law should facilitate a greater voice for true long-term investors, willing to put patient capital at risk in pursuit of plans to produce wealth, not through accounting gimmickry, but through the provision of new products and services.”). 25 See Porter, supra note 12, at 82 (stating that a reformed and superior U.S. system “would be characterized by long-term rather than permanent owners, well-informed rather than specu-lative traders, and flexible rather than lifetime employees . . . would produce more careful monitoring of management and more pressure on poor performers than what exists in Japan or Germany”). 26 NYSE REPORT, supra note 15, at 2 (emphasizing the importance for directors to “estab-lish relationships with a core base of long-term oriented investors who understand the corpora-tion’s long-term strategy and recognize that long-term decisions by their very nature will take time to produce results”); see also Bernard S. Black, Agents Watching Agents: The Promise of Institutional Investor Voice, 39 UCLA L. REV. 811, 875 (1992) (“The evidence, both in the U.S. and abroad, suggests that many large institutions would choose illiquidity-with-influence if that were a viable alternative.”); E. Norman Veasey, Address: The Challenges for Directors in Piloting Through State and Federal Standards in the Maelstrom of Risk Management, 34 SEATTLE U. L. REV. 1 (2010) (discussing the increasing relevance of risk management for directors, managers, shareholders and regulators).



Article concludes that the demands of modern investing and entrepre-neurship present favorable opportunities for rediscovering the trust fund theory as a tool for addressing corporate problems. Therefore, it invites public corporations to adopt the revised version and urges public officials to further incentivize the adoption.

I. HISTORY OF THE CORPORATE TRUST FUND THEORY

The trust fund doctrine’s origins trace back to the early nineteenth

century case of Wood v. Dummer,27 in which Justice Story, while riding circuit, relied on public policy and presumed legislative intent to ad-vance the notion that the capital stock of a corporation constituted “a pledge or trust fund” for creditors.28 In the words of the celebrated ju-rist:

It appears to me very clear upon general principles, as well as the legislative intention, that the capital stock of banks is to be deemed a pledge or trust fund for the payment of the debts contracted by the bank. The public, as well as the legislature, have always supposed this to be a fund appropriated for such purpose. The individual stock-holders are not liable for the debts of the bank in their private capaci-ties. The charter relieves them from personal responsibility, and sub-stitutes the capital stock in its stead . . . . To me this point appears so plain upon principles of law, as well as common sense, that I cannot be brought into any doubt, that the charters of our banks make the capital stock a trust fund for the payment of all debts of the corpora-tion.29

While the trust fund doctrine was enunciated in a case involving a bank, its application was not limited to financial institutions but extend-ed to corporations engaged in other types of business.30 In Sawyer v.

27 30 F. Cas. 435 (1824). 28 See Joseph Jude Norton, Relationship of Shareholders to Corporate Creditors upon Disso-lution: Nature and Implications of the “Trust Fund” Doctrine of Corporate Assets, 30 BUS. LAW. 1061, 1063 (1975). Capital stock refers to the assets that shareholders brought into the compa-ny, such as money paid in return for issuance of shares. See Henry T.C. Hu & Jay Lawrence Westbrook, The Abolition of the Corporate Duty to Creditors, 107 COLUM. L. REV. 1321, 1332 (2007). 29 Wood, 30 F. Cas. at 436. 30 Katharina Pistor et al., The Evolution of Corporate Law: A Cross-Country Comparison, 23 U. PA. J. INT’L ECON. L. 791, 821 n.133 (2002) (stating that “although the case involved a bank, the doctrine applied to corporations more generally”); see also Adams & Westlake v. Deyette, 31 L.R.A. 497, 65 N.W. Rep. 471, 473 (S.D. 1895) (holding in a case involving a hardware com-pany that a corporation’s assets are a trust fund for its creditors).



Hoag,31 the U.S. Supreme Court gave its imprimatur to the doctrine.32 The trust fund doctrine has been viewed as “a peculiar creature of equi-ty, having no foundation in common law or general corporate law prin-ciples; an extraordinary device used to achieve fair and just results.”33 Thus, its nature called for circumspection in its application.34

One striking feature of the trust fund idea is that it was pivotal in ensuring the lock-in of capital investments, which in turn helped assure a long-term focus.35 According to Professor Margaret Blair, through the doctrine, “the corporate form made it possible for investors in shares, as well as creditors, employees, and suppliers, to enter into long-term rela-tionships with a firm with greater assurance that the pool of assets would remain in the business to keep the business going forward.”36 For many years, the doctrine was broadly applied to both solvent corpora-tions and those facing insolvency.37 Eventually, a preponderance of sup-port, in terms of opinion and practice, gravitated toward applying the trust fund concept only to corporations grappling with insolvency or dissolution.38

The notions of par value and legal capital were central to the appli-cation of the original trust fund theory.39 Companies issued stocks for a par value, the arbitrary amount below which the company could not sell those shares to subscribing shareholders.40 The sum received from the sale of the stock at that amount constituted the corporation’s legal capi-tal.41 “Although the rules were incredibly complex, the underlying prin- 31 84 U.S. 610, 620 (1873) (“Though it be a doctrine of modern date, we think it now well established that the capital stock of a corporation, especially its unpaid subscriptions, is a trust fund for the benefit of the general creditors of the corporation.”). 32 Morton J. Horwitz, Santa Clara Revisited: The Development of Corporate Theory, 88 W. VA. L. REV. 173, 207 n.163 (1985). 33 Norton, supra note 28, at 1066. 34 Id. 35 Margaret M. Blair, Reforming Corporate Governance: What History Can Teach Us, 1 BERKELEY BUS. L.J. 1, 15 (2004). 36 Id. 37 Union Nat. Bank v. Douglass, 1 McCrary 86, 96 (D. Iowa 1877) (“The truth is that it makes no difference whatever whether a corporation is solvent or insolvent, so far as the doc-trine is concerned that the property is a trust fund which cannot be withdrawn or appropriated by the stockholders until the debts are paid.”); see also Beveridge, supra note 7, at 616; Norton, supra note 28, at 1064. 38 See Norton, supra note 28, at 1065–66. 39 See WILLIAM A. KLEIN & JOHN C. COFFEE, JR., BUSINESS ORGANIZATION AND FINANCE, 228 (11th ed. 2010); Coffee, supra note 6, at 1638 (“The entire concept of par value was simply a means of implementing this theory through a mechanical rule for measuring the size of the trust fund.”); see also Reuven S. Avi-Yonah, The Cyclical Transformations of the Corporate Form: A Historical Perspective on Corporate Social Responsibility, 30 DEL. J. CORP. L. 767, 799 n.112 (2005) (stating that the advent of the no-par stock in the early twentieth century rein-forced the fall of the trust fund doctrine into desuetude). 40 HAMILTON ET AL., supra note 8, at 279. 41 Harwell Wells, The Modernization of Corporation Law, 1920-1940, 11 U. PA. J. BUS. L. 573, 605 (2009). It should be noted that legal capital is the term used in the case of par value



ciples were clear: a corporation could not sell shares for less than par and always had to retain a sum at least equal to its legal capital for the benefit of creditors.”42 The firm was free to distribute the surplus, i.e., the amount above the legal capital, as dividends to shareholders.43 Shrewd corporate managers and resourceful lawyers were able to skirt the par value and legal capital requirements, leading creditors to realize that legal capital did not offer any real protection, as the funds were not secured.44 Moreover, creditors tended to rely more on other indices, such as earnings, to measure the firm’s ability to repay money advanced to it.45 Modern corporation statutes made par value an anachronism and shares are routinely issued for nominal or no par value.46

The trust fund doctrine acquired an important place in American jurisprudence, dominating corporate finance thinking in the nineteenth century.47 Courts and commentators eagerly embraced the concept, but

shares while stated capital is used in the case of no-par stock. See Hamilton E. McRae III, “Wa-tered Stock”—Shareholder’s Liability to Creditors in Arizona, 8 ARIZ. L. REV. 327, 328 (1967). 42 Wells, supra note 41, at 605–06. 43 A corporation may assign a par value of one dollar to its shares. If it sells each share for ten dollars, one dollar of the realized amount will be deemed capital, while nine dollars may be considered surplus. Shareholders may receive dividends to the extent of the surplus, even if the corporation is not currently profitable. See GREGORY V. VARALLO ET AL., FUNDAMENTALS OF CORPORATE GOVERNANCE: A GUIDE FOR DIRECTORS AND CORPORATE COUNSEL 92 (2d ed. 2009). 44 Id. at 606; Hu & Westbrook, supra note 28, at 1333; see also THOMAS R. HURST & WILLIAM A. GREGORY, CASES AND MATERIALS ON CORPORATIONS 281 (2d ed. 2005) (stating that legal capital offered mainly illusory protection as a corporation could exhaust the funds paid in for shares in running its operations). 45 KLEIN & COFFEE, supra note 39, at 226; BAYLESS MANNING & JAMES J. HANKS JR., LEGAL CAPITAL 50–57 (3d ed. 1990); James J. Hanks, Jr., Legal Capital and the Model Business Corpo-ration Act: An Essay for Bayless Manning, 74 LAW & CONTEMP. PROBS. 211, 213 (2011) (“Bayless Manning first identified and revealed the vacuity of traditional legal capital stat-utes . . . .”). 46 See Hu & Westbrook, supra note 28, at 1334; see also Luca Enriques & Jonathan R. Macey, Creditors Versus Capital Formation: The Case Against the European Legal Capital Rules, 86 CORNELL L. REV. 1165, 1174 n.37 (2001) (“Notably, the Model Business Corporation Act dropped the legal capital concept in 1980.”); Craig A. Peterson & Norman W. Hawker, Does Corporate Law Matter? Legal Capital Restrictions on Stock Distributions, 31 AKRON L. REV. 175, 183 (1997) (“[T]he Revised Model Business Corporation Act (‘RMBCA’) jettisoned the ‘out-moded’ concepts of par value and stated capital set out in the MBCA in the apparent belief that the traditional legal capital doctrines were unduly complex, confusing and misleading.” (cita-tion omitted)); Elliot Goldstein & Robert W. Hamilton, The Revised Model Business Corpora-tion Act, 38 BUS. LAW. 1019, 1021 (1983); Changes in the Model Business Corporation Act—Amendments to Financial Provisions, 34 BUS. LAW. 1867, 1867–68 (1979) (explaining that the concepts of stated capital and par value were deleted from the revised Model Act by the Com-mittee on Corporate Law because the concepts no longer served the original purpose of provid-ing protection to creditors and senior security holders); Current Issues on the Legality of Divi-dends from a Law and Accounting Perspective: A Task Force Report, 39 BUS. LAW. 289, 304 (1984) (stating that California abandoned the concept of stated capital and par value even before the Model Business Corporation Act). 47 Beveridge, supra note 7, at 595; Kahan, supra note 5, at 1096–97.



criticisms were equally forthcoming with considerable speed.48 Only a few years after its enunciation, one commentator observed that the the-ory “has been alternately applied and rejected by courts and eulogized and condemned by text writers.”49 Some major complaints about the doctrine focused on the conceptual challenges it raised.50 In the first instance, critics considered the idea of a trust a “misleading misno-mer,”51 as there was no express or constructive trust involved.52 It was not only a trust that was nonexistent, there also was no fund.53 One au-thor sums up these particular doctrinal impediments by noting that it is inapposite to use the term “trust fund” because “capital claims of share-holders are not a ‘fund’ (there are no assets in the ‘capital stock’ account; it is a claim notation only) and it is not a ‘trust.’ There is not really a trustee holding assets of the firm for the benefit of creditor beneficiar-ies.”54

Commenting on Justice Story’s statement that a corporation’s capi-tal stock constitutes a trust fund for creditors, Professor Edward Warren calls it a “venerable utterance, sonorous, and of benevolent connota-

48 15A WILLIAM MEADE FLETCHER, CYCLOPEDIA OF THE LAW OF PRIVATE CORPORATIONS § 7369 (perm. ed., rev. vol. 2000) (stating that “perhaps no concept has created as much confu-sion in the corporate law as has the ‘trust fund doctrine’”); Comment, The Appointment of Receivers at the Instance of Creditors Upon the Mere Insolvency of a Corporation, 14 YALE L.J. 232, 233 (1905) (“The trust fund theory was established by Justice Story [and] has been greatly criticised and quite generally repudiated.”). 49 Note, The “Trust Fund” Theory, 9 HARV. L. REV. 481, 481 (1896); see also Recent Cases, Corporations—Directors and Other Officers—Trust Fund Theory, 23 HARV. L. REV. 309, 309 (1910) (“This doctrine, formerly widely accepted in this country, has been rejected in many jurisdictions and is generally adversely criticized by legal writers.”); James C. Bonbright, No-Par Stock: Its Economic and Legal Aspects, 38 Q.J. ECON. 440, 443 (1924) (“Within recent years the ‘trust fund doctrine’ has been rejected by the best legal authority.” (citation omitted)). 50 See, e.g., Note, The Trust Fund Doctrine as to the Capital Stock of Corporations, 4 VA. L. REV. 131, 131–33 (1916) (explaining some of the doctrinal difficulties with compelling clarity). 51 Note, supra note 49, at 482. 52 See Hospes v. Northwestern Mfg. & Car Co., 50 N.W. 1117, 1119 (Minn. 1892); Gottlieb v. Miller, 39 N.E. 992, 994 (Ill. 1894) (“The supposed trust does not fall within the definition of either an express trust, an implied trust, a resulting trust or a constructive trust.”); G.W. Pep-per, The “Trust Fund Theory” of the Capital Stock of a Corporation, 41 AM. L. REG. 175, 180 (1893) (“[T]he distinctive attributes of a trust fund were wanting in the case of the capital stock of a corporation, whether paid or unpaid and that the use of the term was an abuse of it.”); see also James T. Johnson, Is the Trust Fund Theory of Capital Stock Dead?, 34 ACCT. REV. 609, 609 (1959) (“The corporation is not a formal trustee of the contributions made by shareholders, and the creditors are not beneficiaries.”); McRae, supra note 41, at 330 (“Since corporate assets are not held in trust by the corporation, the trust fund theory, as an explanation of the basis of liability, has been completely discredited . . . .”); Norton, supra note 28, at 1067–71. 53 GEVURTZ, supra note 8, at 130 (“[A] problem with the theory from a doctrinal standpoint is that it is difficult to speak of a trust fund when there is no fund.”); see also JAMES D. COX & THOMAS LEE HAZEN, CORPORATIONS 503 (2d ed. 2003) (“There is in fact no true trust fund at all, but only a legal prohibition against withdrawal of corporate assets that reduce the margin of safety for creditors.”). 54 J.S. COVINGTON, JR., BASIC LAW OF CORPORATIONS: CASES, TEXT AND ANALYSES 284 (1989).



tion,” but also untrue.55 Professor Warren argued that the proper ap-proach would be to view the issues of watered stock and voluntary dim-inution of capital as a negation of the legislature’s intent and therefore illegal, instead of inventing a new doctrine of trust funds.56 Other writ-ers expressed similar sentiments, complaining that the theory’s ques-tionable legal foundation led to inconsistencies in application.57 One court noted that the doctrine “has often been repudiated as a fiction unsound in principle and vexing in business practice.”58

The mode of enforcement of the doctrine and the attendant uncer-tainty placed many shareholders in personal jeopardy while imperiling millions of dollars in investments.59 In one particular case, the U.S. Su-preme Court held investors liable for the difference between the par value and the price for which they purchased their shares twenty-five years after the company’s failure.60 In addition, the Supreme Court, while reaffirming the trust fund doctrine in Handley v. Stutz,61 created a distinction between original subscription to shares and subsequent issue of shares by a corporation as it continued to operate in business.62 The trust fund doctrine, according to the Court, applied to the former but not the latter.63 This leeway enabled corporations to finance their opera-tions by selling stock at a price the market was willing to pay, even if lower than the par value, without the fear of liability that would have

55 Edward H. Warren, Safeguarding the Creditors of Corporations, 36 HARV. L. REV. 509, 546 (1923). 56 Id.; see also Chas E. Carpenter, The Doctrine That the Assets of a Corporation Are a Trust Fund for the Benefit of Creditors, 2 OR. L. REV. 122, 122–23 (1922) (stating that the trust fund theory’s purpose of preserving corporate capital as a fund for the payment of creditors could be adequately explained and accomplished “without invoking any misleading phraseology by saying the law imposes an obligation upon the stockholders not to withdraw the fund which the statutes have required to be set up and maintained for the protection of creditors”). 57 See Edwin S. Hunt, The Trust Fund Theory and Some Substitutes for It, 12 YALE L.J. 63, 74 (1902); Note, supra note 49, at 482 (“Just what the doctrine is, even those who uphold it do not seem to know. It seems to be an accommodating judicial ignis fatuus, which is present or absent as courts seem to require. No court has been able to describe it exactly, or to define its limits.”). 58 Reif v. Equitable Life Assurance Soc’y of the U.S., 197 N.E. 278, 280 (N.Y. 1935). 59 See Horwitz, supra note 32, at 207. 60 Id. at 208. Legislative changes restricted the application of the doctrine in cases such as these. See Drew R. Fuller, Jr., Stockholder Liability—Article 7.12 of the Texas Business Corpora-tion Act Is the Exclusive Expression of the Trust Fund Theory in Texas, 13 ST. MARY’S L.J. 660 (1981) (discussing statutory modification of the trust fund doctrine to limit the time frame in which a shareholder could be held liable for obligations subsequent to the dissolution of the corporation). 61 139 U.S. 417 (1891). 62 Id. (“[A]n active corporation may, for the purpose of paying its debts, and obtaining money for the successful prosecution of its business, issue its stock and dispose of it for the best price that can be obtained.”). 63 See Horwitz, supra note 32, at 211.



dissuaded potential investors from purchasing the stock.64 Yet the ap-parent “incoherence of the Court’s distinction between the liability of different classes of shareholders” only provided additional fodder for those intent on abandoning the trust fund doctrine.65

One of the strongest attacks on the doctrine came from Justice Mitchell of the Minnesota Supreme Court in Hospes v. Northwestern Manufacturing & Car Co.66 Justice Mitchell opted to replace the trust fund theory with a fraud, holding out, or misrepresentation theory,67 reasoning that shareholders were liable for the balance of the par value of their shares that remained unpaid because the business community relied on the corporate capital.68 Accordingly, only creditors who relied on the availability of capital stock in dealing with the corporation were entitled to a remedy.69 Those who dealt with the corporation before the issuance of watered stock or knew of the bonus shares but proceeded to enter into dealings with the corporation had no recourse.70 This ap-proach presented a sharp contrast to the trust fund doctrine, which sought to protect all creditors, regardless of their knowledge or situa-tion.71 Professor John Coffee elaborates on this point and the conceptual difficulties of viewing the corporate assets as a trust fund, noting that “it was difficult to see how creditors who advanced their funds to the cor-poration before the issuance of ‘watered’ stock were in any way injured by the later issuance, since they had not relied on the additional capital so contributed.”72

64 Id. One writer explains the rationale in a case where a company wanted to raise money through new issuance of stock but its existing stock was trading at below par value and no new shareholder would be willing to pay par value for such devalued stock. In such a situation, an existing creditor can hardly complain because the money raised from the watered stock added to, instead of reducing, the capital of the corporation and improved, rather than diminished, the creditor’s chance of recovery. But there is still a problem as to the burden imposed on subsequent creditors. See Pepper, supra note 52, at 176–77. 65 Horwitz, supra note 32, at 211. 66 50 N.W. 1117 (Minn. 1892). 67 See Kenneth B. Davis, Jr., The Status of Defrauded Securityholders in Corporate Bank-ruptcy, 1983 DUKE L.J. 1, 5 (stating that by the turn of the twentieth century, courts had started substituting the trust fund theory with a reliance-based theory); see also EISENBERG, supra note 8, at 1261 (“Hospes substituted a new theory, known as the constructive-fraud, misrepresenta-tion, or holding out theory.”). 68 Hospes, 50 N.W. at 1121. 69 Id. (“[I]t is only those creditors who have relied, or who can fairly be presumed to have relied, upon the professed amount of capital, in whose favor the law will recognize and enforce an equity against the holders of ‘bonus’ stock.”). 70 Id. at 1120–21. 71 It should be noted that the fraud theory has had its fair share of criticisms. See, e.g., GEVURTZ, supra note 8, at 131 (“[W]hile the legal premise behind the misrepresentation theory is unassailable, its factual premise is shaky.”); C. Robert Morris, Some Notes on “Reliance,” 75 MINN. L. REV. 815, 816–20 (1991); see also Comment, Shareholder Liability for “Watered” Stock—A Windfall to Creditors, 9 STAN. L. REV. 191, 201–02 (1956). 72 Coffee, supra note 6, at 1638 n.57.



The criticisms mounted, and after 150 years of its articulation and application, one circuit court opinion agreed with the observation that the doctrine had generated confusion in corporate law.73 While the trust fund doctrine is not completely defeated, it ultimately succumbed to the weight of criticisms, the adoption of alternative means of accomplishing its objectives, and the absence of its respected progenitor to continually animate it.74 The reality is that “today the once proud trust fund doc-trine is but a tattered shadow of its former self.”75

II. REVIVED TRUST FUND THEORY: NATURE AND STRUCTURE

Discussing the ostensible basis of Justice Story’s dicta in Wood,

Professor Joseph Norton makes an observation that is analogous and germane to the status of many public corporations today. First, the pub-lic nature of the corporation involved in that case may have played a significant role and it appeared quite appropriate to use the term “trust” in reference to that type of institution.76 Also, there was widespread suspicion of corporations in 1824.77 This is not remarkably dissimilar to the level of mistrust defining public views of many large corporations today.78 The absence of trust has been linked to corporate short-termism: “Public suspicion and mistrust of large companies in particu- 73 See Am. Nat’l Bank of Austin v. MortgageAmerica Corp., 714 F.2d 1266, 1268–69 (5th Cir. 1983). 74 Bruce A. Markell, The Folly of Representing Insolvent Corporations: Examining Lawyer Liability and Ethical Issues Involved in Extending Fiduciary Duties to Creditors, 6 J. BANKR. L. & PRAC. 403, 406 (1997) (“The trust fund theory rose to prominence primarily on the strength of Justice Story’s reputation. It then fell into disuse after his tenure on the Supreme Court, re-placed by more detailed corporate statutes and by fraudulent transfer law.”); John C. McCoid, II, Corporate Preferences to Insiders, 43 S.C. L. REV. 805, 823–24 (1992) (“Even in its original context, the trust-fund theory generally has been rejected . . . . It was used over and over and is a good example of how a catchy phrase or the reputation of a jurist sometimes can stand in the way of thoughtful inquiry. Even today, the theory is not entirely dead, although its defects are widely recognized.”); see also Beveridge, supra note 7, at 600 (“Through the sheer force of Justice Story’s efforts, the trust fund doctrine entered legal history and became the basis for countless decisions until the closing years of the nineteenth century, by which time, although still somewhat influential, it had generally fallen into intellectual disrepute.”). 75 STEPHEN M. BAINBRIDGE, CORPORATE LAW 420 (2d ed. 2009); see also Johnson, supra note 52, at 609–10 (adducing additional reasons for the decline of the trust fund theory). 76 Norton, supra note 28, at 1064. 77 Id.; see also Coffee, supra note 6, at 1633 n.36 (stating that the rule formulated by Justice Story “lacked precedent in the prior English case law, but reflected the skepticism then preva-lent in the United States about use of the corporate form”). 78 See Michelle M. Harner, Corporate Control and the Need for Meaningful Board Account-ability, 94 MINN. L. REV. 541, 541–42 (2010) (stating that large corporations have the trust of only thirteen percent of the American population and that this level of mistrust portends enormous economic consequences for firms and their stakeholders); Rakhi I. Patel, Facilitating Stakeholder-Interest Maximization: Accommodating Beneficial Corporations in the Model Busi-ness Corporation Act, 23 ST. THOMAS L. REV. 135, 155 (2010).



lar is due to their lack of long-term responsibility or social con-science.”79

The journey toward regaining respect, ipso facto, will incorporate a long-term focus and a mutually beneficial approach that encompasses interests within and outside the corporation, including employees, cred-itors, and host communities.80 It is apposite to undertake an examina-tion of today’s problems in light of the reaction of a previous era sharing similar characteristics. This Part takes up that task in adapting the fea-tures and strong points of the trust fund to the resolution of some of the current problems plaguing corporations and the society. The nature and structure of the revived trust fund will encompass the following ele-ments.

A. Express Creation

Unlike the original incarnation of the trust fund theory, which was

a result of judicial promulgation,81 not involving a real trust,82 the re-vived trust fund will be expressly and voluntarily created as a trust by the corporation. The corporation will be the trustee while the beneficiar-ies will be the involuntary victims of the corporation’s acts and those that voluntarily transact business with the corporation, relying on a segregated amount kept secure for the purpose of meeting the legitimate expectations on the other side of the bargain.83

79 Frederick Beale & Mario Fernando, Short-Termism and Genuineness in Environmental Initiatives: A Comparative Case Study of Two Oil Companies, 27 EUR. MGMT. J. 26, 27 (2009). 80 See Leo E. Strine, Jr., Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance, 33 J. CORP. L. 1, 20 (2007). 81 See Horwitz, supra note 32, at 208 (noting that the trust fund doctrine was promulgated by the courts); Note, supra note 49, at 482 (conceding that the theory was an exercise in judicial legislation but noting that legislation by courts is often demanded by justice in addressing problems raised by insolvent corporations). 82 See Hollins v. Brierfield Coal & Iron Co., 150 U.S. 371, 381 (1893) (“While it is true language has been frequently used to the effect that the assets of a corporation are a trust fund held by a corporation for the benefit of creditors, this has not been to convey the idea that there is a direct and express trust attached to the property.”); Graham v. R.R. Co., 102 U.S. 148, 160–61 (1880). 83 See Anna Fifield & Sylvia Pfeifer, Revenues to Secure Fund for Damages, FIN. TIMES, Aug. 12, 2010, at 8 (providing an example of a corporation serving as trustee of victims’ fund albeit for another corporation). Legitimate questions may be raised about the value of issuing Class T stock if it cannot use the proceeds for capital investments and the possibility of truly segregat-ing the funds, even if a company wanted to do so. A quick response is that the funds raised may be used for other pertinent purposes discussed in Part II.C and Part III.G below, notably in-vestment in conservative instruments and bonding.



B. Permanent Fund

Because business corporations were not “obliged to maintain a rig-

id and carefully guarded fund,”84 the idea of a trust fund for the benefit of creditors ran into conceptual and practical difficulties. Addressing this deficiency invites the existence and maintenance of a rigid and care-fully guarded pool of money available to satisfy appropriate creditor claims, such as cases in which credit was advanced on the faith of the fund. The revived trust fund will adopt the original conception of legal capital in the sense that there will be a pool of assets that is identifiable and reachable by creditors in the event of a stated calamity arising from corporate operations.85 To provide a real, instead of rhetorical safe-guard, this fund would be kept nearly under “lock and key” until needed to satisfy claims or to be returned to the investors by the corporation redeeming or repurchasing the shares.86 The fund may be invested in conservative instruments so that the principal is always secure and available.87 Accordingly, while the yield is expected to be low, it will not be a completely inefficient deployment of capital yet at the same time avoiding the predicament of the legal capital of yore that was not there when creditors needed it.88 The companies would raise and retain the funds as separate from their operating funds.

84 Frederick Dwight, Capital and Capital Stock, 16 YALE L.J. 161, 162 (1907). 85 While this Article favors a segregated fund, it is not unmindful of other creditor-protection options. For instance, bond instruments often describe the assets that secure them, while unsecured obligations of the company are entitled to be paid from whatever pool of assets remains in the corporation. So, in bankruptcy everybody receives in accordance with the level of protection contracted for, not dissimilar from my proposal. Another method to preserve assets, of course, is to have appropriate risk-management policies that support long-term in-vestments, which Class T shareholders will most likely support. Another reason for Class T shares is to oppose the use of the corporation as a short-term arbitrage opportunity through takeovers and other “instant money” shareholder activism proposals. I am immensely grateful to Professor Lynne Dallas for the preceding observations. 86 The money may be returned, with interest, less the cost of settling eligible creditors, in exchange for the shares. Shareholders may opt to keep their stock and forfeit the money. Ulti-mately, they may sell at a price, to a person, and at a time of their choosing. This feature makes the Class T stock a bit similar to preferred stock. See JOSEPH SHADE, BUSINESS ASSOCIATIONS IN A NUTSHELL 326 (3d ed. 2010) (stating that preferred stock may usually be redeemed at a fixed price); see also HAMILTON ET AL., supra note 8, at 275–76 (discussing preferred stocks that are redeemable at the option of the holder, objections to common shares that are redeemable at the option of the holder, common shares that are callable at the option of the corporation, and the MBCA approach that permits the creation of these types of shares without restrictions). 87 See Robert J. Rhee, Bonding Limited Liability, 51 WM. & MARY L. REV. 1417, 1466 (2010) (making a similar point with regard to a compensation fund to be established under a proposed bonded limited liability scheme). 88 Id. at 1466–67.



C. Class T Common Shares

The trust fund will be financed by creating a separate class of

common shares, referred to as “Class T” shares. Thus, the contributing shareholders purchase a special class of shares designed for this particu-lar purpose and on the understanding that the shares cannot be sold or otherwise transferred until the end of a designated period. Prohibition of transfer includes stock lending.89 In addition, holders of the stock will be prevented from hedging away their risks through derivatives and other instruments since, as illustrated by the case of equity-based execu-tive compensation, such hedging has been an impediment to the effec-tiveness of restrictions on stock transfer within a specified period.90 Built into the Class T arrangement is an explicit contractual provision against hedging of Class T stock within the applicable period, enforcea-ble by revocation of all the privileges appurtenant to the Class T status.91 A hedging ban under statute or securities regulations is also an option worth considering.92 This Article arbitrarily suggests a designated hold-ing period of ten years. This is consistent with the original conception of the trust fund doctrine, but with a stronger framework to ensure credi-tor protection.93

D. Illiquidity and Control

In exchange for the loss of liquidity during the specified period,

holders of the Class T shares will receive a measure of control in the corporation. Professor Coffee has persuasively argued that liquidity and 89 See infra notes 259–65 and accompanying text. 90 See, e.g., Lucian A. Bebchuk et al., The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008, 27 YALE J. ON REG. 257 (2010); Lucian A. Bebchuk & Jesse M. Fried, Paying for Long-Term Performance, 158 U. PA. L. REV. 1915, 1951–56 (2010); David I. Walker, The Challenge of Improving the Long-Term Focus of Executive Pay, 51 B.C. L. REV. 435 (2010). 91 See David M. Schizer, Executives and Hedging: The Fragile Legal Foundation of Incentive Compatibility, 100 COLUM. L. REV. 440 (2000) (discussing various approaches for preventing hedging of stocks and stock options under contract as well as tax and securities laws); Michael C. Jensen & Kevin J. Murphy, Remuneration: Where We’ve Been, How We Got to Here, What are the Problems, and How to Fix Them 66–67 (Harvard Bus. Sch. NOM Unit, Working Paper No. 04-28, 2004), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=561305 (advocating a prohibition of stock option hedging in the capital markets). 92 See Schizer, supra note 91, at 502 (discussing mandatory bans of stock and stock option hedging through securities regulations). 93 See Craig A. Peterson & Norman W. Hawker, Does Corporate Law Matter? Legal Capital Restrictions on Stock Distributions, 31 AKRON L. REV. 175, 180 (1997) (“As originally conceived, the ‘trust fund’ theory of legal capital simply prevented shareholders from withdrawing the assets they had contributed to the corporation until its creditors had been paid.”).



control are tradeoffs.94 He observes that “American law has said clearly and consistently since at least the 1930s that those who exercise control should not enjoy liquidity and vice versa.”95 An investor generally has to surrender one in order to acquire or effectively utilize the other.96

Some scholars see an interconnection between the demise of the trust fund theory and the erosion of shareholder power.97 To avoid the injustice of making dispersed innocent shareholders pay for the frauds of others, flowing from the growth of national stock markets, sharehold-ers traded the power that comes from proprietorship for limited liabil-ity.98 Investing in a Class T stock exposes holders to greater personal loss than other shareholders, as they cannot bail out when their investments are endangered but would be compelled to sink or swim with the corpo-ration.99 It stands to reason therefore that the greater exposure to per-sonal liability invites a proportionate increase in shareholder power or control.100 Indeed, this notion is consistent with the evolution of the power-allocation process in the corporation that indicates that share-holders’ enjoyment of limited liability is a function of their surrender of control, in return, to the board of directors.101

Exact details of what this control entails will require additional work. In the interim, a few suggestions may be offered. One suggestion is that Class T shareholders be offered an opportunity to be part of the decision-making process regarding the corporation’s long-term strategy. A couple of seats on the board of directors may also be reserved for holders of the Class T stock.102 Thus, they are guaranteed board repre-sentation because only the holders of the stock are eligible for election to

94 John C. Coffee, Jr., Liquidity Versus Control: The Institutional Investor as Corporate Monitor, 91 COLUM. L. REV. 1277 (1991) see also William W. Bratton & Joseph A. McCahery, Incomplete Theories of the Firm and Comparative Corporate Governance, 2 THEORETICAL IN-QUIRIES L. 745, 760–65 (2001). 95 Coffee, supra note 94, at 1287. 96 Id. 97 Bruce P. Frohnen, The One and Many: Individual Rights, Corporate Rights and the Diver-sity of Groups, 107 W. VA. L. REV. 789, 842–43 (2005). 98 Id. at 843; Horwitz, supra note 32, at 208–09. 99 See Stephen M. Bainbridge, The Case for Limited Shareholder Voting Rights, 53 UCLA L. REV. 601, 619 (2006) (“[R]educed liquidity equates to enhanced risk . . . .”). 100 See Marshall M. Magaro, Two Birds, One Stone: Achieving Corporate Social Responsibility Through the Shareholder-Primacy Norm, 85 IND. L.J. 1149, 1154 (2010) (stating that sharehold-ers surrendered control in exchange for limited liability). 101 See ROBERT A.G. MONKS & NELL MINOW, CORPORATE GOVERNANCE 109 (4th ed. 2008). 102 Lewis H. Lazarus, Directors Designated by Investors Owe Fiduciary Duties to the Compa-ny as a Whole and Not to the Designating Investor, DEL. BUS. CT. INSIDER, Mar. 23, 2011, avail-able at http://www.morrisjames.com/en-US/publications/xprPubDetail.aspx?xpST=PubDetail&pub=99 (“Investors who make substantial investments often demand a seat on their company’s board of directors. That is a reasonable request as it permits the investor to have a representa-tive on the board of directors with a voice in the management of the company.”).



the reserved positions.103 The adopting company may also create an advisory director position to be filled by one of the long-term share-holder nominees.104 The advisory role is one of the principal functions of the board, in addition to monitoring, but greater focus has been on the latter, sometimes to the detriment of the corporation.105 The adviso-ry director will assume limited or no monitoring role, making it easier for CEOs to be less antagonistic and share relevant strategic information with her.106

Class T holders should also be able to nominate candidates for the allocated director positions.107 Nominations may be facilitated by the inclusion of Class T shareholders in the issuer’s nominating commit-tee.108 Another option could consist of an adaptation of some recom-mendations on proxy access made in a slightly different context.109 Cor-porate managements have long mounted a strident resistance to proxy access reform.110 They have continued to oppose the SEC’s promulga-tion of proxy access regulations.111 Instead of the objections, a further

103 See Lehrman v. Cohen, 222 A.2d 800 (Del. 1966) (validating a corporation’s creation of a separate class of voting stock with the right to vote for and elect one of five directors in order to prevent deadlock by the four directors elected by the other shareholders). 104 Olubunmi Faleye et al., Advisory Directors 1 (Midwest Fin. Assoc., Annual Meetings Paper, 2011), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1866166. 105 Id. 106 Id. at 1–2. 107 For a discussion of how the status quo makes it difficult for shareholders to effectively nominate and elect directors, see Lucian A. Bebchuk, The Myth of the Shareholder Franchise, 93 VA. L. REV. 675 (2007); George W. Dent Jr., Toward Unifying Ownership and Control in the Public Corporation, 1989 WIS. L. REV. 881, 903–07; and Margaret M. Blair & Lynn A. Stout, A Team Production Theory of Corporate Law, 85 VA. L. REV. 247, 310 (1999) (“[L]egal and practi-cal obstacles to shareholder action render voting rights almost meaningless.”). 108 See Fisch, supra note 20, at 62; see also George Dent, The Case for Real Shareholder De-mocracy, 55 CASE W. RES. L. REV. 581, 582 (2005) (proposing a nominating committee com-prised entirely of ten to twenty largest shareholders in a corporation). 109 Leo E. Strine, Jr., Toward a True Corporate Republic: A Traditionalist Response to Bebchuk’s Solution for Improving Corporate America, 119 HARV. L. REV. 1759, 1778–79 (2006); see also Kenneth B. Orenbach, The Religiously Distinct Director: Infusing Judeo-Christian Busi-ness Ethics into Corporate Governance, 2 CHARLOTTE L. REV. 369, 424 (2010) (proposing share-holder proxy access to elect supervisory director). 110 Lucian A. Bebchuk, Another View: Don’t Gut Proxy Access, N.Y. TIMES DEALBOOK BLOG (June 21, 2010, 9:00 AM), http://dealbook.blogs.nytimes.com/2010/06/21/another-view-dont-gut-proxy-access (“Managements have long opposed proxy-access reform and has thus far succeeded in blocking it.”). 111 See, e.g., Business Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011). For reports of conflicting empirical findings on the effect of proxy access on corporate value, see Ali C. Akyol et al., Shareholders in the Boardroom: Wealth Effects of the SEC’s Rule to Facilitate Director Nominations, 47 J. FIN. QUANTITATIVE ANALYSIS (forthcoming 2012) (finding “statistically significant negative market reactions to the SEC’s attempts to empower shareholders”), availa-ble at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1526081; Bo Becker et al., Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Chal-lenge 34, (Harvard Bus. Sch. Finance Unit, Working Paper No. 11-052, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1695666 (finding that on the date that the SEC announced that it would delay implementation of proxy access, “[the] share prices of



concession in this area may be inevitable in order to attract the kind of commitment expected of the Class T investors. Insisting on the status quo, even after shareholders have made a long-term capital commit-ment, will only bolster the case of those who believe that the argument, basing support for the marginalization of some shareholders in corpo-rate governance on the ground that they are transient investors who do not genuinely care about the firm’s future, has no honest foundation.112

The revised trust fund proposal has a number of points in its favor. But it also raises legitimate concerns and faces significant constraints in its implementation. Parts III and IV provide an in-depth evaluation of the proposal, examining its merits and addressing potential objections.

III. ARGUMENTS IN FAVOR OF THE REVIVED TRUST FUND PROPOSAL

A. Patient Capital The notion of patient capital attracted serious scholarly attention a

couple of decades ago, particularly as corporate governance experts compared the experiences of Germany and Japan with that of the Unit-ed States.113 After a while, the precepts of patient capital surrendered companies that would have been most exposed to shareholder access declined significantly compared to share prices of companies that would have been most insulated from the rule”); Steven M. Davidoff, The Heated Debate over Proxy Access, N.Y TIMES DEALBOOK BLOG (Nov. 2, 2010, 4:04 PM), http://dealbook.nytimes.com/2010/11/02/the-heated-debate-over-proxy-access/; David F. Larcker et al., The Market Reaction to Corporate Governance Regulation, 101 J. FIN. ECON. 431 (2011), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1650333 (finding “a weak negative reaction to proxy access regulation”); Jonathan B. Cohn et al., On the Optimality of Shareholder Control: Evidence from the Dodd-Frank Financial Reform Act (Feb. 22, 2011), http://www.sfs.org/Paper%20for%20Cavalcade%20website/On%20the%20Optimality%20of%20Shareholder%20Control.pdf (finding “evidence broadly consistent with greater allocation of control to shareholders increasing firm value”). 112 See Ronald J. Gilson & Reinier Kraakman, Reinventing the Outside Director: An Agenda for Institutional Investors, 43 STAN. L. REV. 863, 863 (1991). 113 William T. Allen et al., Function over Form: A Reassessment of Standards of Review in Delaware Corporation Law, 56 BUS. LAW. 1287, 1288 n.3 (2001) (“Only a few years ago a sub-stantial minority of corporate law academics posited that the “patient” capital supplied by German banks, the Japanese keiretsu and Korean chaebol might offer efficiency advantages over the U.S. system of corporate governance.”); Thomas J. André, Jr., Cultural Hegemony: The Exportation of Anglo-Saxon Corporate Governance Ideologies to Germany, 73 TUL. L. REV. 69, 105–06 (1998) (“The stereotypical German model of governance therefore emphasizes patient capital, consensus management, and the long term welfare of the company and its constitu-ents . . . . The virtual antithesis of the German stakeholder model of governance is usually said to be that found in the United States . . . [which] is said to stress short-term market perfor-mance in which the only legitimate measures of an enterprise’s success are found in daily stock prices and quarterly sales figures.”); John W. Cioffi, State of the Art: A Review Essay on Com-parative Corporate Governance: The State of the Art and Emerging Research, 48 AM. J. COMP. L. 501, 529 (2000) (extolling the virtues of patient capital in the German and Japanese contexts); John Pound, The Rise of the Political Model of Corporate Governance and Corporate Control, 68 N.Y.U. L. REV. 1003, 1067–68 (1993).



some of this prominence.114 With the financial crisis of the past few years, however, patient capital has resurfaced in important discussions of corporate governance and broader economic policy.115 Jurists and commentators are beginning to lament the fact that patient capital is now a scarce staple of public equity markets.116

Patient capital refers to capital provided by investors with longer exit horizons.117 It is defined as “capital that is willing to commit for a long period of time.”118 Patient capital is characterized by such features as length of holding, which may be five to ten years or beyond, and rate of return, which could be relatively low, even bond-like.119 There are various sources of patient capital, including angel investors,120 venture capitalists,121 employee stock ownership plans,122 sovereign wealth

114 Scott H. Mollett, Sarbanes-Oxley Section 307 Domestically and Abroad: Will Section 307 Lead to International Change?, 11 DUQ. BUS. L.J. 1, 11 (2008) (“The main bank model, formerly championed by Japan and Germany, has been in decline and the tenets of patient capital have lost their salience.”); Bliss Burdett Pak, National Markets and New Defenses: The Case for an East Asian Opt-in Takeover Law, 20 COLUM. J. ASIAN L. 385, 391 (2007) (“In Asia more broad-ly, the strong preference for stability and non-confrontational, patient capital characteristic of main bank and state-directed systems of corporate finance are giving way to an active market for mergers and acquisitions . . . .”). 115 Lawrence E. Mitchell, Financialism: A Lecture Delivered at Creighton University School of Law, 43 CREIGHTON L. REV. 323, 334 (2010); see also ASPEN INST., OVERCOMING SHORT-TERMISM: A CALL FOR A MORE RESPONSIBLE APPROACH TO INVESTMENT AND BUSINESS MAN-AGEMENT (2009), available at http://www.aspeninstitute.org/sites/default/files/content/docs/pubs/overcome_short_state0909_0.pdf. 116 See, e.g., Strine, supra note 80, at 10 (“Ironic though it is, private equity investors are now viewed as the nurturing providers of patient capital compared to the public equity markets.”). 117 Darian M. Ibrahim, The (Not So) Puzzling Behavior of Angel Investors, 61 VAND. L. REV. 1405, 1438 n.169 (2008) (referring to angel investors as providers of patient capital because their exit horizons are usually longer than those of the typical investor). 118 Lucian A. Bebchuk, Buying Troubled Assets, 26 YALE J. ON REG. 343, 347 (2009). 119 Stephen Lloyd, Transcript: Creating the CIC, 35 VT. L. REV. 31, 42 (2010); Sverre David Roang, Successful Family Business Transitions Depend on Three Things: Process, Process, and Process, in FAMILY AND BUSINESS SUCCESSION PLANNING (2010), 2010 WL 2828082, at *4; Thomas L. Friedman, ‘Patient’ Capital for an Africa that Can’t Wait, N.Y. TIMES, Apr. 20, 2007, at A23 (“Patient capital has all the discipline of venture capital—demanding a return, and therefore rigor in how it is deployed—but expecting a return that is more in the 5 to 10 percent range, rather than the 35 percent that venture capitalists look for, and with a longer payback period.”). 120 William K. Sjostrom, Jr., Relaxing the Ban: It’s Time to Allow General Solicitation and Advertising in Exempt Offerings, 32 FLA. ST. U. L. REV. 1, 6 (2004) (stating that angel investors supply patient capital, with investments that stay in place for five to ten years or even longer periods); see also Ibrahim, supra note 117, at 1438 n.169 (referring to angel investors as provid-ers of patient capital because their exit horizons are usually longer than those of the typical investor). 121 See Abraham J.B. Cable, Fending for Themselves: Why Securities Regulations Should Encourage Angel Groups, 13 U. PA. J. BUS. L. 107, 122 (2010). 122 See Aditi Bagchi, Varieties of Employee Ownership: Some Unintended Consequences of Corporate Law and Labor Law, 10 U. PA. J. BUS. & EMP. L. 305, 316 (2008).



funds,123 pension funds,124 and other institutional investors, although each investor’s level of patience varies.125

Corporate managers are constantly in search of patient capital.126 Patient capital is favored because the investor’s longer exit horizon pro-vides the manager with the needed time to build value into the busi-ness.127 When stocks have high turnover rates, they “create greater vola-tility and uncertainty in equity prices than exist under a system of more patient capital” and this uncertainty militates against managerial in-volvement in long-term projects.128 By affording managers an oppor-tunity to engage in long-term planning and investment, including ac-quisition of durable equipment, patient capital offers efficiency gains.129

123 See Mark E. Plotkin, Foreign Direct Investment by Sovereign Wealth Funds: Using the Market and the Committee on Foreign Investment in the United States Together to Make the United States More Secure, 118 YALE L.J. POCKET PART 88, 91 (2008) (discussing the benefits and challenges presented by sovereign wealth funds’ investment in the U.S. economy). 124 See Rich Ferlauto, Commentary on Leo Strine’s “Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance,” 33 J. CORP. L. 41, 41 (2007) (stating that public pension systems pro-vide patient capital). But see Poonam Puri & P.M. Vasudev, Canadian Pension Funds: Invest-ments and Role in the Capital Markets and Corporate Governance, 25 BANKING & FIN. L. REV. 247, 267 (2010) (noting that the level of portfolio turnovers of pension funds, discernable from revenue gained from securities trading, raises doubts about the popular notion that pension funds invest for the long term and provide patient capital). 125 Karmel, supra note 1, at 2 (stating that while some institutional investors provide patient capital and hold stocks for the long term, a lot of institutions invest only for a very brief peri-od). 126 See Colleen D. Ball, Regulations 14A and 13D: Impediments to Pension Fund Participa-tion in Corporate Governance, 1991 WIS. L. REV. 175, 201 (“Meanwhile, boards of directors lament the lack of ‘patient capital’ essential for the long-term business strategies that would restore the health of corporate America.”); Mark J. Roe, Foundations of Corporate Finance: The 1906 Pacification of the Insurance Industry, 93 COLUM. L. REV. 639, 650 (1993) (stating that managers claim they want patient capital). 127 Bebchuk, supra note 118, at 347; Gunter Festel et al., Importance and Best Practice of Early Stage Nanotechnology Investments, 7 NANOTECHNOLOGY L. & BUS. 50, 58 (2010); Andrei Shleifer & Robert W. Vishny, Equilibrium Short Horizons of Investors and Firms, 80 AM. ECON. REV. 148 (1990). 128 Sanford M. Jacoby, Employee Representation and Corporate Governance: A Missing Link, 3 U. PA. J. LAB. & EMP. L. 449, 456 n.48 (2001). 129 See Thomas J. Andre, Jr., Some Reflections on German Corporate Governance: A Glimpse at German Supervisory Boards, 70 TUL. L. REV. 1819, 1820 (1996) (noting the contribution of patient capital to Germany’s postwar economic success); Dwight B. Crane & Ulrike Schaede, Functional Change and Bank Strategy in German Corporate Governance, 25 INT’L REV. L. & ECON. 513, 524 (2005) (stating that after World War II, companies in Germany “needed stable funding that would provide patient capital for highly leveraged plant and equipment invest-ment”); Helen Garten, Institutional Investors and the New Financial Order, 44 RUTGERS L. REV. 585, 671 (1992) (stating that patient capital gives rise to stable relationships that facilitate “the long-term corporate planning and capital allocation associated with the Japanese keiretsu”); Nadine Hoser, Nanotechnology and Its Institutionalization as an Innovative Technology: Profes-sional Associations and the Market as Two Mechanisms of Intervention in the Field of Nano-technology, 7 NANOTECHNOLOGY L. & BUS. 180, 187 (2010); Johathan D. Richards, Comment, Japan Fair Trade Commission Guidelines Concerning Distribution Systems and Business Practic-es: An Illustration of Why Antitrust Law is a Weak Solution to U.S. Trade Problems with Japan,



Managers assailed an active market for corporate control on that ground, deriding it as breeding inefficiency by fostering managerial myopia in response to investor short-term orientation.130 Ultimately, both the corporation, deprived of a long-term focus, and the society could suffer significant losses.131 On the other hand, investment and management strategies that emphasize the long-term are socially benefi-cial.132

Patient capital also benefits businesses because patient capital and voice are natural companions. A provider of long-term capital is likely to insist on having a voice in how the investment is managed.133 The converse is also true: one who is afforded a voice is likely to linger much longer than one who is not.134 When shareholders exit the corporation

1993 WIS. L. REV. 921, 923–24 (discussing the Japanese experience with patient capital and how it spurs risk-taking and investing for the long term by companies). 130 Jeffrey N. Gordon, The Rise of Independent Directors in the United States, 1950-2005: Of Shareholder Value and Stock Market Prices, 59 STAN. L. REV. 1465, 1522 (2007) (discussing managerial contention that “an active market in corporate control was itself a cause of ineffi-ciency, because of the ‘short-termism’ induced in managerial time horizons” and that patient capital, by contrast, presented the foundation for success in Europe and Japan). 131 Aleta G. Estreicher, Beyond Agency Costs: Managing the Corporation for the Long Term, 45 RUTGERS L. REV. 513, 546–47 (1993) (stating that it is imprudent for managers to jettison long-term investments in favor of those that would yield short-term gains for shareholders and that such form of decision-making harms both the corporation and the national economy that is dependent on long-term production by private firms); Martin Lipton & Steven A. Rosenblum, A New System of Corporate Governance: The Quinquennial Election of Directors, 58 U. CHI. L. REV. 187, 203 (1991) (“The ascendancy of the institutional stockholder and the hos-tile takeover, however, creates an emphasis on short-term results that makes it increasingly difficult for the corporation to maintain the long-term focus necessary to its own and society’s well-being.”); Stephen B. Young, Moral Capitalism and the Great Financial Meltdown of 2008, 33 FLETCHER F. WORLD AFF. 129, 130 (2009) (arguing that “financial markets have a bias to-ward shortsighted profit-taking, when what successful capitalism actually needs is farsighted ‘patient’ capital.”); Patrick S. Cross, Note, Economically Targeted Investments—Can Public Pension Plans Do Good and Do Well?, 68 IND. L.J. 931, 961 (1993) (discussing the critical role that provision of patient capital can play in general economic growth). 132 See, e.g., HM Treasury: Remarks of Lord Myner at the UBS Corporate Governance Forum, October 6, 2009, in NINTH ANNUAL INSTITUTE ON SECURITIES REGULATION IN EUROPE: A CONTRAST IN EU & U.S. PROVISIONS 241, 244 (PLI Corporate Law & Practice, Course Hand-book Ser. No. 1783, 2010) [hereinafter Lord Myner’s Remarks] (noting that fund managers generally do not supply patient capital and extolling the virtues of the investment approach of Warren Buffet, whose “record has shown the value of taking a longer view, accepting extended periods of relative under-performance as a fair price for avoiding extremes of market valuation or under-valuations; holding a concentrated, high conviction portfolio and taking a real interest in his companies, including in some cases taking Board seats”). For similar observations made two decades earlier, see Lipton & Rosenblum, supra note 131, at 223–24. 133 Robert G. Vanecko, Comment, Regulations 14A and 13D and the Role of Institutional Investors in Corporate Governance, 87 NW. U. L. REV. 376, 382 (1992) (“Advocates of an in-creased voice for institutional investors argue that institutional investors could potentially provide the ‘patient’ capital that American corporations need to enhance their long-term com-petitiveness.” (citation omitted)); Lord Myner’s Remarks, supra note 132, at 244. 134 See Ball, supra note 126, at 196–97 (explaining that opportunity to exercise voice could lead to long-term investing with the resulting opportunity for management to utilize the patient capital to embark on long-term projects); Robert J. Klein, Note, The Case of Heightened Scruti-



instead of working within it to address what is wrong, the corporation may be the worse for it.135 When shareholders have a voice in the corpo-ration, the corporation may be enriched.136 One commentator captures the sentiment succinctly: “[W]ealth creating organizations are built up over decades. Patient capital that can readily choose to rely on voice, not just exit, is an indispensable foundation for long-term wealth creation. If investors make this discovery, directors will not be far behind.”137

Furthermore, with the spate of financial crises in the past decade and the resulting mistrust of corporations and undermining of public confidence in the markets,138 the importance of a long-term focus backed by patient capital can hardly be overemphasized.139 Along those lines, The Conference Board recommended that the restoration of trust in public corporations would require the emergence of a base of share-holders with a long-term orientation to support a management focused on creating long-term economic growth.140

The revised trust fund proposal will follow in the footsteps of the original trust fund theory which, at least tangentially, facilitated the lock-in of capital.141 It also seeks to create the desired base of sharehold-ers, a permanent class of long-term investors, who have an owner’s mentality and disposition.142 Owners commit resources to their venture ny in Defense of the Shareholders’ Franchise Right, 44 STAN. L. REV. 129, 175 (1991) (“Institu-tional investors assured of access to the proxy system can develop the patient capital philosophy favored by managers.”); Vanecko, supra note 133, at 382 n.42 (restating the arguments made by some commentators that “if institutional investors had more freedom to combine forces, seek representation on boards, and press for management changes, they would respond by voting their stock rather than selling it [and] that if pension funds could challenge management effec-tively, they might become permanent shareholders”). 135 See infra Part III.B. 136 Id. 137 Elmer W. Johnson, Making the Board of Directors Function in the Age of Pension Fund Capitalism, in 21ST ANNUAL INSTITUTE ON SECURITIES REGULATION 601, 619 (PLI Corporate Law & Practice, Course Handbook Ser. No. 663, 1989). 138 Arthur Levitt, Jr., Op-Ed., How to Boost Shareholder Democracy, WALL ST. J., July 1, 2008, at A17 (“The meltdown of the subprime mortgage market, the implosion of Bear Stearns, and the revelations of poor risk management on the part of several large companies has injected a dangerously large degree of mistrust into the markets.”); Maxwell Strachan, American Dis-trust of Banks Reaches Highest-Recorded Level: Gallup, HUFFINGTON POST (June 24, 2011, 6:29 PM), http://www.huffingtonpost.com/2011/06/24/banks-americans-poll-distrust-confidence_n_884303.html. 139 THE CONFERENCE BD. COMM’N ON PUBLIC TRUST & PRIVATE ENTER., FINDINGS AND RECOMMENDATIONS 17 (2003) (emphasizing the importance of long-term strategies and devel-opment of a base of long-term investors in creating corporate long-term growth and viability that would restore trust in public corporations). 140 Id. 141 See Blair, supra note 35, at 15. But see Larry E. Ribstein, Should History Lock In Lock-In?, 41 TULSA L. REV. 523, 533 (2006) (arguing that the purpose of the trust fund theory was credi-tor protection not capital lock-in). 142 A proposal based on similar premises, but a different prescription, is the quinquennial election of directors made by Martin Lipton and Steven Rosenblum. See Lipton & Rosenblum, supra note 130, at 224 (stating that their proposal “seeks to make stockholders and managers



or property, taking enormous risks over a considerably long period of time, and adding their entrepreneurial skills to grow the enterprise when needed, while exercising utmost care to avoid activities that nega-tively affect its value.143 Renters, on the other hand, do not have that level of commitment or involvement, and are not as concerned about the effects of their activity on the ultimate value of the property.144 To them, the property presents an opportunity that they milk to their satis-faction and move on to another available one. Stephen Young has ar-gued that in the true sense, ownership of shares in a company, based on its history, is a term that properly refers to “when stock-holding was not a mass phenomenon and when individuals were long-term owners in the style of Warren Buffet or the owner of a family company” while much of what goes on in Wall Street is better characterized as renting.145 Contrasting a renter’s mentality with that of an owner in a broader property context but also applicable to company shares, Young notes that, “[t]he incentives around renting for both lessor and lessee tend to cut off rights from corresponding responsibilities, encouraging cavalier treatment of money and property, whereas ownership tends to bind property rights to responsibilities, with its incentive of profit over time and the inherent burden of care.”146

Similar in some respects to relational investing, the revised trust fund proposal creates “a class of enlightened investors who give compa-nies patient capital [thereby freeing] management to focus on the long term. Over time, that should lift profits, productivity and prospects. And that would boost U.S. competitiveness.”147 More important, the Class T–shares approach is better positioned to accomplish this objec-

think and act like long-term owners by combining the patient capital approach of Warren Buffett, the long-term monitoring approach of the Japanese and German ownership structures, and the financial incentives for managers of the [leveraged buyout]”); see also Ronald J. Gilson, The Political Ecology of Takeovers: Thoughts on Harmonizing the European Corporate Govern-ance Environment, 61 FORDHAM L. REV. 161, 178 (1992) (discussing the virtue of replicating or combining features of existing, including foreign, systems). 143 Young, supra note 131, at 135. 144 Id. 145 Id. at 135–36. Renting, as used by Young, should not be confused with the practice of borrowing shares for a little while by those who want to use it for a variety of purposes, includ-ing empty voting, short selling, and arbitrage strategies. See Reena Aggarwal et al., The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market 13 (2011), availa-ble at http://ssrn.com/abstrat=1688993. 146 Young, supra note 131, at 136–37. Scholars have grappled with this problem for almost a century. See Antony Page & Robert A. Katz, Is Social Enterprise the New Corporate Social Re-sponsibility?, 34 SEATTLE U. L. REV. 1351, 1358 (2011) (discussing the observation made in the 1930s by Adolf Berle and Gardner Means that because shareholders showed little commitment or involvement in the affairs of the corporation, they had forfeited the prerogatives that accom-pany true ownership or property rights). 147 Jayne Elizabeth Zanglein, From Wall Street Walk to Wall Street Talk: The Changing Face of Corporate Governance, 11 DEPAUL BUS. L.J. 43, 71 (1998) (quoting Judith H. Dobrzynski, Relationship Investing, BUS. WK., Mar. 15, 1993, at 68).



tive because it provides a clear structure or framework, instead of the voluntary approach of relational investing that leaves room for uncer-tainty and lack of direction.148 In essence, it adopts the strong points of relationship investing without some of its weaknesses.149

One concern with the concept of patient capital is that it could breed managerial indolence and enable management to use long in-vestment horizons as a smokescreen for masking unproductive ten-ures.150 It is imperative, therefore, to mitigate this impediment by estab-lishing an effective monitoring mechanism—which is also built into this proposal.151 Finally, the nurturing of patient capital does not depend only on shareholders. Management also needs to abhor practices that dissuade patient capital, such as an unhealthy alliance with short-termist investors to institute harmful executive compensation schemes.152

B. Exit, Voice, and “Permanent Ownership”

Under the model devised by the economist Albert Hirschman,

shareholders have two empowerment tools in response to the manage-ment of the corporation, namely exit and voice.153 Exit refers to the 148 See id. at 70 (discussing the anticipation in relational investing that investors would make a voluntary commitment to hold their shares for the long-term, participate in corporate gov-ernance, and generally act like owners, instead of investors). 149 In that sense, the proposal is closer to the political process proposed by Professor John Pound. See Pound, supra note 113, at 1069. For a critique of relational investing, see Edward B. Rock, Controlling the Dark Side of Relational Investing, 15 CARDOZO L. REV. 987 (1994). 150 See Joe Nocera, A Defense of Short-Termism, N.Y. TIMES, July 29, 2006, at C1. 151 See infra Part III.C. 152 Kenneth R. Davis, Taking Stock—Salary and Options Too: The Looting of Corporate America, 69 MD. L. REV. 419, 447 (2010) (“A reckless corporate strategy, in the short term, may increase the market price of a stock, which is what short-term institutional investors need to cash out with a profit. Once out, they have no concern if the risky strategy later backfires and the stock price collapses. Thus, short-term institutional investors will not object to the immedi-ate vesting of stock options, a favorite compensation arrangement which encourages reckless corporate decisionmaking.”); Jeong-Bon Kim et al., CFOs Versus CEOs: Equity Incentives and Crashes, 101 J. FIN. ECON. 713 (2011) (discussing a study that demonstrates that “incumbent investors use stock-based compensation to intentionally encourage managers to adopt short-termist behavior to boost the speculative component of the share price”); Damon Silvers, Commentary on “Toward Common Sense and Common Ground? Reflections on The Shared Interests of Managers and Labor in a More Rational System of Corporate Governance” by Leo E. Strine, Jr., 33 J. CORP. L. 85, 90–91 (2007) (“[E]xcessive executive compensation has been the mechanism by which the management of American corporations has become captive to short-term market forces, while ignoring long-term patient capital.”). For a contrary view on execu-tive compensation, see Steven N. Kaplan, Response, Weak Solutions to an Illusory Problem, 159 U. PA. L. REV. PENNUMBRA 43 (2010) (arguing that current regime of executive compensation does not promote short-termism and that managers are not being compensated for short-term results that are not reflective of long-term performance). 153 ALBERT O. HIRSCHMAN, EXIT, VOICE, AND LOYALTY: RESPONSES TO DECLINE IN FIRMS, ORGANIZATIONS, AND STATES (1970); J.H.H. Weiler, The Transformation of Europe, 100 YALE L.J. 2403, 2411 (1991) (“Exit is the mechanism of organizational abandonment in the face of



practice of abandoning a product or leaving an organization when con-ditions are unsuitable.154 A pertinent illustration is a shareholder’s exer-cise of the option to sell her stock when she is not satisfied with the cor-poration’s direction, often referred to as the Wall Street Rule.155 Hirschman defines voice as

any attempt at all to change, rather than to escape from, an objec-tionable state of affairs, whether through individual or collective peti-tion to the management directly in charge, through appeal to a high-er authority with the intention of forcing a change in management, or through various types of actions and protests, including those that are meant to mobilize public opinion.156

Exit represents economics while voice typifies politics.157 The choice between voice and exit is a salient aspect of the corporate governance discussion. The position each of them occupies in public policy and shareholder minds affects the role shareholders can play in monitoring managers or in corporate governance generally.158 For years, scholars

unsatisfactory performance. Voice is the mechanism of intraorganizational correction and recuperation.”). A slightly different articulation of the concepts presents exit and voice as “vari-ants of the same phenomenon,” rather than as alternate phenomena. See SARAH MAXWELL, THE PRICE IS WRONG: UNDERSTANDING WHAT MAKES A PRICE SEEM FAIR AND THE TRUE COST OF UNFAIR PRICING 76 (2008) (“Having a choice gives consumers voice by allowing them to ex-press their opinion. They are not being forced to buy at one pre-set price or do without.”); Andrew E. Taslitz, Judging Jena’s D.A.: The Prosecutor and Racial Esteem, 44 HARV. C.R.-C.L. L. REV. 393, 428–29 (2009) (“A buyer having a real choice among a range of viable alternatives and the freedom to exit one potential deal for a better one gives the buyer some measure of voice.”). 154 Peter C. Konstant, Exit, Voice and Loyalty in the Course of Corporate Governance and Counsel’s Changing Role, 28 J. SOCIO-ECON. 203, 207 (1999) (“Exit occurs in one of two ways, either by customers no longer buying a product, or by members leaving an organization.”). 155 The Wall Street Rule refers to the practice by stockholders of selling their stock at any point, especially when they are dissatisfied with the management of the corporation. See Wil-liam W. Bratton & Michael L. Wachter, Tracking Berle’s Footsteps: The Trail of the Modern Corporation’s Last Chapter, 33 SEATTLE U. L. REV. 849, 864 (2010); Carol Goforth, Proxy Re-form as a Means of Increasing Shareholder Participation in Corporate Governance: Too Little, But Not Too Late, 43 AM. U. L. REV. 379, 406 (1994) (“The Wall Street Rule holds that share-holders who are dissatisfied with management decisions can ‘vote with their feet’ by selling their shares and finding a different enterprise in which to invest.”). 156 HIRSCHMAN, supra note 153, at 30; Konstant, supra note 154, at 207 (stating that voice denotes “any attempt to change, rather than escape from an unsatisfactory situation”). 157 HIRSCHMAN, supra note 153, at 15. It should be pointed out that exit is not necessarily economically superior nor is voice always less cost-effective. See Lynne Dallas, The Control and Conflict of Interest Voting Systems, 71 N.C. L. REV. 1, 40–45 (1992) (disagreeing with the prefer-ence of some economists and arguing that voice may be more efficient in certain situations). 158 JAMES P. HAWLEY & ANDREW T. WILLIAMS, THE RISE OF FIDUCIARY CAPITALISM: HOW INSTITUTIONAL INVESTORS CAN MAKE CORPORATE AMERICA MORE DEMOCRATIC 148 (2000) (noting the tradeoff between exit and voice and the role of public policy in striking the right balance of incentives).



and market participants placed a lot of emphasis on the economic ap-proach of exit. Yet this approach has not proven a complete panacea.159

More often than not, a rational shareholder is likely to sell her shares when she is dissatisfied with corporate management or direction, although the size and type of holding (e.g., indexers) affects the desire or ability to sell quickly. This appears to be a basic human approach, not limited to the corporate world.160 Furthermore, exit has its merits as a constraining or disciplining mechanism, since “a party can often deter or escape another’s opportunism by withdrawing or threatening to withdraw its capital contribution.”161 The availability or threat of exit can also be deployed as an effective weapon for securing advantages.162 Moreover, exit is intuitive in a business setting because it is traditionally a market-oriented or economic approach while voice is more tradition-ally associated with the political process and therefore somewhat of a strange territory for corporate actors.163 Yet there are times when exit is not in the best interest of the shareholder or the corporation.164 In some cases, exit amounts to a luxury that some shareholders can ill afford.165 159 Konstant, supra note 154, at 210 (examining the weakness of exit in helping failing cor-porations in contrast to a more viable approach of combining economic exit and political voice processes). 160 See, e.g., Kenji Yoshino, The Gay Tipping Point, 57 UCLA L. REV. 1537, 1539 (2010) (stating that “[t]he availability of exit lessens the necessity of voice,” and thus reduces the in-centive of gays to fight discrimination). For a similar reaction by employees, see Hilary K. Josephs, Measuring Progress Under China’s Labor Law: Goals, Processes, Outcomes, 30 COMP. LAB. L. & POL’Y J. 373, 393 (2009) (“There are indications that workers will resort to ‘exit’ rather than ‘voice’ if confrontational tactics do not look promising.”). For an account from the lawyer-client relationship, see William L.F. Felstiner & Austin Sarat, Enactments of Power: Negotiating Reality and Responsibility in Lawyer-Client Interactions, 77 CORNELL L. REV. 1447, 1464 (1992) (“In the face of lawyers’ insistence that they accommodate themselves to the reality of what the law allows, clients generally persist, at least initially, in expounding their needs, explaining their notions of justice, or reiterating their objectives. But rarely do they insist that their lawyer make a particular demand, argue a particular position, or even endorse their view. Where dissatisfac-tion is great, the usual client response is exit rather than voice.”); and compare David B. Wil-kins, Team of Rivals? Toward a New Model of the Corporate Attorney-Client Relationship, 78 FORDHAM L. REV. 2067, 2071 (2010) (discussing how some clients and attorneys utilize voice in their relationship, although the threat of exit remains in the vicinity). 161 George W. Dent, Jr., Venture Capital and the Future of Corporate Finance, 70 WASH. U. L.Q. 1029, 1045 (1992) (citation omitted). 162 Apart from investment in the stock market, this phenomenon can also manifest in other areas, such as the real estate market. See Nicole Stelle Garnett, Unbundling Homeownership: Regional Reforms from the Inside Out, 119 YALE L.J. 1904, 1915 (2010) (reviewing LEE ANNE FENNELL, THE UNBOUNDED HOME: PROPERTY VALUES BEYOND PROPERTY LINES (2009)) (“By virtue of their ability to enter and exit communities, homeowners exert market pressure on both local governments and private developers to offer policies that satisfy their preferences.”). 163 See James Gray Pope, Contract, Race, and Freedom of Labor in the Constitutional Law of “Involuntary Servitude,” 119 YALE L.J. 1474, 1548 (2010); Marc A. Rodwin, Exit and Voice in American Health Care, 32 U. MICH. J.L. REFORM 1041, 1041 n.2 (1999). The terrain is changing in today’s investment environment with institutional investor activism. 164 This result is not limited to corporations, but extends to other economic, or even politi-cal, institutions. See, e.g., Petros C. Mavroidis, Lexcalibur: The House that Joe Built, 38 COLUM. J. TRANSNAT’L L. 669, 670 (2000) (reviewing JOSEPH H. H. WEILER, THE CONSTITUTION OF



Scholars have long highlighted the danger of a constant preference for exit over voice.166 In the first place, there is the problem of the ambi-guity of the message intended by the exit decision.167 Professor Peter Konstant explains the pitfalls of shareholder penchant for exit, noting that since the exiting shareholders are replaced in an instant by new entrants, the exit serves as a weak disciplining mechanism.168 In essence, the Wall Street Walk is different from the type of exit that could im-prove an organization.169 Moreover, the problem is not simply that shareholders are exiting. It is that often it is the type of shareholder that can make a real difference because it is well-informed and is likely to have the resources, motivation, and determination to mount a serious fight for change if the alternative of investing elsewhere was not readily available.170 Acting in concert with the lack of adequate institutions to nurture voice, this type of exit often led to the entrenchment of ineffec-tive managers.171 Overemphasizing exit or underemphasizing voice, therefore, may be inimical to the well-being of the corporation, its shareholders, and other constituents.172

Opportunities to exercise shareholder voice, however, are minimal-ly existent in many corporations.173 Thus, the cycle of suboptimal action

EUROPE: “DO THE NEW CLOTHES HAVE AN EMPEROR?” AND OTHER STORIES ON EUROPEAN INTEGRATION (1999)) (discussing how the virtual absence of opportunity to exit by member states led to the amplification of voice and helped in the building of post–World War II Eu-rope.). 165 See Mark S. Mizruchi & Daniel Hirschman, The Modern Corporation as Social Construc-tion, 33 SEATTLE U. L. REV. 1065, 1102 (2010) (noting that such is the case with some large institutional investors who find the cost of exiting prohibitive); see also Edward Rubin, The Possibilities and Limitations of Privatization, 123 HARV. L. REV. 890, 924 (2010) (reviewing GOVERNMENT BY CONTRACT: OUTSOURCING AND AMERICAN DEMOCRACY (Jody Freeman & Martha Minow eds., 2009)) (discussing examples of lack of exit options outside the corporate context). 166 See, e.g., HIRSCHMAN, supra note 153, at 46 n.3 (quoting some scholars’ decision to “combat the traditional but harmful notion that if a stockholder doesn’t like the way his com-pany is run he should sell his shares, no matter how low their price may be”). 167 See Dallas, supra note 157, at 40–41. 168 Konstant, supra note 154, at 210–11. 169 Id. Shareholders are beginning to see the relative ineffectiveness of the Wall Street Rule as a guiding principle. See Brett H. McDonnell, Setting Optimal Rules for Shareholder Proxy Ac-cess, 43 ARIZ. ST. L.J. 67, 67 (2011) (“Shareholders are getting feisty. They are no longer content simply to abide by the ‘Wall Street rule.’ If they are unhappy with the performance of a compa-ny’s management, they do not simply sell their shares. Rather, they step in to try to change that management or to change some of the rules governing the corporation.” (citation omitted)). 170 See HIRSCHMAN, supra note 153, at 47 (stating that the real tragedy is that “those cus-tomers who care most about the quality of the product and who, therefore, are those who would be the most active, reliable, and creative agents of voice are for that very reason are those who are apparently likely to exit first in case of deterioration”); Konstant, supra note 154, at 210. 171 Konstant, supra note 170, at 210–11. 172 HIRSCHMAN, supra note 153, at 46 (noting that easy exit perpetuates poor management and bad policies). 173 Konstant, supra note 154, at 211 (stating that corporate law made little efforts to design institutions to develop and support voice, considering that voice needs initial support to take



of exiting the firm, when engagement would be preferable, continues.174 Indeed, shareholder voice has sometimes been characterized as a mere “whisper,” making it fair to state that some shareholders do not seek long-term ownership because of obstacles to exercise of voice in corpo-rations.175 Yet voice can serve a corrective or ameliorative function, thereby addressing lapses in productive behavior in organizations. We can remedy the lapse by recourse to a revived and revised version of the trust fund theory. Under this revised version, corporations can create a class of common shares that are relatively illiquid but entitle sharehold-ers to a stronger voice in corporate governance. In the face of illiquidity, activation of shareholder voice is inevitable.176 For obvious reasons, limiting shareholder exit without a corresponding increase in voice ap-pears so dangerous that it would be a virtually impossible idea to sell to investors.177 As one commentator has aptly observed, “[v]oice is handi-capped . . . when exit is not an option, because the dissatisfied actor cannot threaten exit and thereby loses an important way of bringing influence to bear.”178

Another important element in the exit-voice discussion is loyalty. The coexistence of voice and exit in an organization may be optimal for the entity, including a public corporation.179 However, it is difficult to off); Dalia Tsuk Mitchell, The End of Corporate Law, 44 WAKE FOREST L. REV. 703, 725–28 (2009) (arguing that Delaware corporate law has weakened the shareholders’ rights of voice and exit). 174 For an extensive discussion of the value of voice, albeit in a close corporation context, see Benjamin Means, A Voice-Based Framework for Evaluating Claims of Minority Shareholder Oppression in the Close Corporation, 97 GEO. L.J. 1207, 1229–38 (2009). 175 See Konstant, supra note 154, at 206 & n.16. 176 HIRSCHMAN, supra note 153, at 34 (stating that the role of voice would increase as the opportunities for exit decline, up to the point where, with exit wholly unavailable, voice must carry the entire burden of alerting management to its failings); Rob Atkinson, Obedience as the Foundation of Fiduciary Duty, 34 J. CORP. L. 43, 66 (2008) (stating that in the context of a private trust where exit is not an option, the relevant parties have a greater incentive to exercise voice); Avital Margalit, “You’ll Never Walk Alone”: On Property, Community, and Football Fans, 10 THEORETICAL INQUIRIES L. 217, 227 (2009) (“Where exit is unthinkable or generates high costs, only a voice option remains . . . .”); see also Alex Edmans et al., The Effect of Liquidi-ty on Governance (European Corporate Governance Inst., Working Paper No. 319/2011, 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905224 (stating that liquidity causes a hedge fund with a significant block of shares to opt for exit instead of voice as a gov-ernance channel). But see Oyvind Norli et al., Liquidity and Shareholder Activism (European Fin. Assoc., Bergen Meetings Paper, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1344407 (linking liquidity to exercise of certain kinds of voice by shareholders). 177 See Stephen Colt, Alaska Natives and the “New Harpoon”: Economic Performance of the ANCSA Regional Corporations, 25 J. LAND RESOURCES & ENVTL. L. 155, 167 (2005) (viewing shareholders’ ability to exit the firm as their “discipline mechanism [the absence of which] clearly gives management, employees, and outside parasites more leeway to pursue their rent-seeking objectives, including shirking, empire-building, or nepotism” (citation omitted)). 178 Katherine Scully, Blocking Exit, Stopping Voice: How Exclusion From Labor Law Protec-tion Puts Domestic Workers at Risk in Saudi Arabia and Around the World, 41 COLUM. HUM. RTS. L. REV. 825, 846 (2010). 179 See HIRSCHMAN, supra note 153, at 120–26.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1905224



achieve.180 Exit and voice can coexist and both have important roles where the organization enjoys the loyalty of its members and those members believe that they have the ability to influence the organiza-tion.181 There are situations in which both the shareholder and the cor-poration will be better off by the shareholder remaining loyal, but voic-ing concerns and engaging management in crafting effective solutions to identified problems or otherwise trying to induce change within the corporation.182 For instance, loyalty “serves the socially useful purpose of preventing deterioration from becoming cumulative.”183 As the num-ber of exiting actors escalates, so does the threat to an organization’s credibility and continued existence.184 Loyal shareholders will almost invariably utilize their voice.185 A loyal member would figure out ways to exert her energy to move the organization in the right direction.186 On the other hand, a member that perceives his position as strong enough that he can steer the organization in the desired direction “is likely to develop a strong affection for the organization in which he is powerful.”187 Holders of trust securities are likely to be in this position because their long-term commitment evidences loyalty.

180 See Weiler, supra note 153, at 2411 (“Hirschman’s basic insight is to identify a kind of zero-sum game between the two. Crudely put, a stronger ‘outlet’ for Voice reduces pressure on the Exit option and can lead to more sophisticated processes of self-correction. By contrast, the closure of Exit leads to demands for enhanced Voice.”). 181 HIRSCHMAN, supra note 153, at 77. One commentator captures the effect of loyalty as follows:

Loyalty serves as a brake on exit, preventing it from occurring when its use would otherwise be rational. Thus, loyalty often tends to activate voice. Loyalty can be gen-erated by a rational or irrational belief that one’s own influence, or that of others, can move an organization in the direction of improvement. Either way, loyalty helps re-place the certainty of exit with the uncertainty of voice. Loyalist behavior is a “bet” on recovery. By helping to neutralize exit, loyalty helps keep the most knowledgeable and perceptive members or customers of an organization in a position where they can contribute to ameliorating a bad situation.

Konstant, supra note 154, at 208 (footnotes omitted). The trust fund arrangement is a loyalty-grounded mechanism that is positioned to voluntarily limit exit while offering a strong poten-tial to activate voice. 182 See Ruben J. Garcia, Labor as Property: Guestworkers, International Trade, and the De-mocracy Deficit, 10 J. GENDER RACE & JUST. 27, 36 n.53 (2006) (discussing the point that on some occasions, voice is a more potent tool than exit in effecting organizational change); Rodwin, supra note 163, at 1067 (“[C]onsumer voice could help build stronger organizations by putting managers in touch with the experiences and desires of their customers . . . .”). 183 HIRSCHMAN, supra note 153, at 79; see also Mark D. West, Legal Rules and Social Norms in Japan’s Secret World of Sumo, 26 J. LEGAL STUD. 165, 192 (1997) (discussing how loyalty can be collectively and individually rational). 184 Anthea Roberts, Power and Persuasion in Investment Treaty Interpretation: The Dual Role of States, 104 AM. J. INT’L L. 179, 191 (2010). 185 See HIRSCHMAN, supra note 153, at 78 (“As a rule . . . loyalty holds exit at bay and acti-vates voice.”). 186 Id. at 77–78. 187 Id. at 78.



Coupling the loyalty with an opportunity to play a significant role in corporate decision-making, directly or indirectly, will transform cor-porations that adopt the idea into a rare breed of organization in which voice and exit hold important roles. First, the two major recuperation mechanisms of exit and voice would be simultaneously available in such corporations, as most shareholders remain free to leave at any time. Second, trust securities create a structured loyalty188 that, as Hirschman would put it, “holds exit at bay and activates voice.”189 Third, as holders of the trust securities, relying on the enablement to do so, activate and exercise voice continuously, other shareholders may discover some at-tractive qualities in voice and reconsider the penchant for exit when things deteriorate in the corporation. The resulting long-term holdings would augur well for the corporation and its stakeholders, as several constituencies work together to improve things from within, instead of bolting.

Some scholars contend that some institutional investors already hold for the long-term and giving them an incentive in the form of meaningful voice in corporate governance will enable them not only to continue to so hold but also participate in the corporation’s affairs.190 The problem with this contention and belief is that management has no firm commitment from these shareholders that they will hold for the long-term and therefore may be a little hesitant to cooperate. Providing a meaningful voice also does not mean that shareholders will take ad-vantage of it. The present proposal takes away this uncertainty and im-poses a commitment to hold stocks for a defined, relatively lengthy pe-riod of time. This proposal is also tailored to those shareholders that are certainly motivated to take advantage of an enhanced opportunity to participate in corporate governance, as it is built into the structure of the trust securities. Thus, only investors interested in its terms would pur-chase those securities.

Shareholders who commit to hold stock for a long time, effectively becoming “permanent or quasi-permanent owners,” are in a position to exercise a unique form of voice virtually unavailable to other sharehold-ers. This is because management is more likely to respect the voice of shareholders when it is confident that the shareholders are so bound to the enterprise that exit is almost infeasible.191 As Hirschman observes,

188 I use the term “structured loyalty” in the sense that it is simultaneously imposed by the nature of the securities that prohibit transfers and self-imposed because the holders of the securities make the choice to purchase with knowledge of the restriction. 189 HIRSCHMAN, supra note 153, at 78. 190 Matheson & Olson, supra note 24, at 1322. 191 See Porter, supra note 12, at 70 (stating that long-term shareholders in Japan and Ger-many “command the respect of management, having access to inside information concerning the company, and, particularly in Germany, can exert considerable influence on management behavior”).



“the chances that voice will ever act in conjunction with exit would be poor and voice would be an effective recuperation mechanism only in conditions of full monopoly ‘when the customers are securely locked in.’”192 The Class T approach will draw U.S. corporations closer to the model that long prevailed—with notable success—in Germany and Ja-pan, as opposed to the dominance of the Wall Street Rule.193

C. Increased Managerial and Board Accountability

A classic problem of the public corporation, as identified by Adolf

Berle and Gardiner Means, is the separation of ownership from con-trol.194 Ever since their articulation of the problem, “commentators have searched for the corporate equivalent of the Holy Grail: a mechanism to bridge the separation by holding managers accountable for their per-formance.”195 Where ownership and management of a property are in different hands, agency costs are inevitable, as managers may be tempt-ed to further their own interests at any given opportunity.196 Monitoring provides an avenue for reducing these agency costs.197 The revived trust fund theory, while not overstating its importance, offers a mechanism for narrowing the owner-manager gap. For instance, it promotes a form of partnership between shareholders and corporate managers, which in

192 HIRSCHMAN, supra note 153, at 45. 193 See Sanford M. Jacoby, Corporate Governance in Comparative Perspective: Prospects for Convergence, 22 COMP. LAB. L. & POL’Y J. 5, 6 (2000) (stating that the German and Japanese approaches of less mobility and greater communication with management can be thought of as the voice model while the U.S. approach of selling shares when dissatisfied with management is the exit model); see also MICHAEL E. PORTER, THE COMPETITIVE ADVANTAGE OF NATIONS 528 (1990) (“[While] institutional investors in nearly every other advanced nation . . . view their shareholdings as nearly permanent and exercise their ownership rights accordingly, American institutions are under pressure to demonstrate quarterly appreciation.”). 194 ADOLF A. BERLE & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY (1932). 195 Gilson & Kraakman, supra note 112, at 873. 196 See Eric J. Pan, Rethinking the Board’s Duty to Monitor: A Critical Assessment of the Delaware Doctrine, 38 FLA. ST. U. L. REV. 209, 218 (2011). Agency costs include the cost of monitoring incurred by the principal, bonding costs to deter or compensate for harm incurred by the agent, and the residual loss occasioned by the agent’s opportunistic and nondiligent actions not captured by the monitoring and bonding activities. See Michael C. Jensen & Wil-liam H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure, 3 J. FIN. ECON. 305 (1976); see also STEPHEN M. BAINBRIDGE, CORPORATION LAW AND ECONOMICS 35–36 (2002) (“Agency costs are defined as the sum of the monitoring and bonding costs, plus any residual loss, incurred to prevent shirking by agents. In turn, shirking is defined to include any action by a member of a production team that diverges from the inter-ests of the team as a whole. As such, shirking includes not only culpable cheating, but also negligence, oversight, incapacity, and even honest mistakes.”). 197 HAWLEY & WILLIAMS, supra note 158, at 125 (“Monitoring in all of its forms fundamen-tally attempts to reduce agency costs that are inherent in the relationship between either owners and managers, or fiduciary agents and other (fiduciary) agents.”).



turn bridges the separation of ownership and control.198 It also seeks to facilitate direct monitoring of managers by shareholders, which is an important mechanism for addressing the agency problem.199

Corporate accountability requires a critical mass of shareholders that are firmly committed to holding a corporation’s stock for the long haul.200 The chances of getting that core of shareholders, however, are anemic without a change in the structure of the corporation to really empower shareholders in return for their loyalty.201 An incontrovertible fact is that shareholders are passive relative to matters pertaining to the governance of the corporation.202 Individual shareholders are not able or eager to engage management because of the dispersal of share owner-ship, although this picture is changing with growth in more concentrat-ed ownership.203 Due to collective action problems and legal constraints to coordinated action, it is difficult to organize and unite a critical mass

198 See Jennifer G. Hill, Then and Now: Professor Berle and the Unpredictable Shareholder, 33 SEATTLE U. L. REV. 1005, 1011 (2010) (referring to a scenario in which some “shareholders might become full-scale partners with management in corporate decision-making, thereby bridging the historical divide between ownership and control” (citation omitted)). The long-term-shareholder model here also shares characteristics with the Japanese system of near-permanent shareholder-monitors that is viewed as bridging the separation of ownership and control. See Ronald J. Gilson & Mark J. Roe, Understanding the Japanese Keiretsu: Overlaps Between Corporate Governance and Industrial Organization, 102 YALE L.J. 871, 874, 879 (1993). 199 Pan, supra note 196, at 219 (“The most important mechanisms to address the agency problem, however, are those that facilitate direct monitoring of managers by shareholders.”). 200 See Matheson & Olson, supra note 24, at 1313; Cynthia A. Williams & John M. Conley, An Emerging Third Way? The Erosion of the Anglo-American Shareholder Value Construct, 38 CORNELL INT’L L.J. 493, 537 (2005) (suggesting that “the greater concentration of longer-term investors in the UK has led to more attention being paid in that market to longer-term social and environmental risks,” and observing that a core base of long-term investors is vital to a corporation’s implementation of a long-term mandate); see also ALISON ATHERTON ET AL., INST. FOR SUSTAINABLE FUTURES, SOLUTIONS TO SHORT-TERMISM IN THE FINANCE SECTOR 14 (2007), available at http://www.isf.uts.edu.au/publications/athertonetal2007solutionstoshorttermism.pdf. 201 LOUIS LOWENSTEIN, WHAT’S WRONG WITH WALL STREET: SHORT-TERM GAIN AND THE ABSENTEE SHAREHOLDER 12, 209–11 (1988) (noting that a “major obstacle has been that share-holders have no access to the nominating procedures or the proxy machinery, except by con-frontation and contest,” and arguing for shareholder power to nominate and elect a percentage of directors that would be answerable to them). 202 For a general discussion of the problem, see Bernard S. Black, Shareholder Passivity Reexamined, 89 MICH. L. REV. 520 (1990); Christopher Gulinello, The Retail-Investor Vote: Mobilizing Rationally Apathetic Shareholders to Preserve or Challenge the Board’s Presumption of Authority, 2010 UTAH L. REV. 547 (arguing that shareholder apathy is rational and proposing a mechanism to encourage retail investors to vote in director elections). 203 Douglas Litowitz, Are Corporations Evil?, 58 U. MIAMI L. REV. 811, 817 (2004) (“Stock-holders theoretically ‘owned’ the corporation, yet were so scattered and unorganized that they had virtually none of the control that typically comes with ownership of property. For perhaps the first time in history, it became common for persons to invest in an enterprise and remain totally passive . . . .”); see also Ian Ayres & Peter Cramton, Relational Investing and Agency Theory, 15 CARDOZO L. REV. 1033, 1041 (1994) (stating that individual shareholders generally do not hold a sufficient stake in a company to get involved or make a difference).



of shareholders for a common purpose.204 The free-rider issue is par-ticularly significant.205 A shareholder may be reluctant to engage in a cause alone that would redound to the benefit of all.206 Similarly, a shareholder would prefer to wait for other shareholders to take charge of the battle, while she lurks in the sidelines, convinced that she cannot be excluded from its benefits that accrue to all.207

The emergence of institutional shareholders as a strong force in share ownership was heralded as a solution to the collective action prob-lem.208 The anticipated strong and effective voice from institutional shareholders has not materialized significantly.209 While these institu-tions do not face the same problem of pooling a sizeable number of shares, the problems of free riding and economic cost continue to loom large.210 In addition, because of relationships with corporations whose 204 Stephen M. Bainbridge, Director Primacy and Shareholder Disempowerment, 119 HARV. L. REV. 1735, 1751 (2006) (“[I]t is improbable that dispersed individual investors with small holdings will ever be anything other than rationally apathetic . . . .”) [hereinafter Bainbridge, Shareholder Disempowerment]; Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 Nw. U. L. REV. 547, 571 (2003); Black, supra note 26, at 821 (stat-ing that shareholder passivity arises from two related collective action problems, namely the concern that other shareholders would free-ride on another shareholder’s efforts and the belief that because of fractional holdings, any shareholder’s efforts would unlikely affect the outcome of a proposal). 205 See Martin Gelter, The Dark Side of Shareholder Influence: Managerial Autonomy and Stakeholder Orientation in Comparative Corporate Governance, 50 HARV. INT’L L.J. 129, 148 (2009) (“Dispersed shareholders are subject to collective action problems caused by rational apathy and the free rider phenomenon.” (citation omitted)); Klein, supra note 134, at 132 (“In the language of economics, shareholders of large public corporations suffer from both collective action and free rider problems.” (citation omitted)); Brian J. Bushee et al., Institutional Investor Preferences for Corporate Governance Mechanisms (2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1070168 (referencing the argument that “the free rider problem makes it cost ineffective for small shareholders to act as monitors of management”). 206 Mark J. Roe, A Political Theory of American Corporate Finance, 91 COLUM. L. REV. 10, 12 (1991). 207 Frank H. Easterbrook & Daniel R. Fischel, Limited Liability and the Corporation, 52 U. CHI. L. REV. 89, 95 (1985); S. Grossman & O. Hart, Takeover Bids, the Free-rider Problem, and the Theory of the Corporation, 11 BELL J. ECON. 42 (1980) (arguing that the free-rider problem makes it unprofitable for small shareholders to undertake the task of monitoring management). 208 See Black, supra note 26, at 821–22 (“A shareholder who owns a large percentage stake is more likely to engage in monitoring than a shareholder who owns a smaller stake.”); Bernard S. Black, The Legal and Institutional Preconditions for Strong Securities Markets, 48 UCLA L. REV. 781, 831–39 (2001); Robin Greenwood & Michael Schor, Investor Activism and Takeovers, 92 J. FIN. ECON. 362, 362 (2009) (“Theory predicts that large shareholders should be effective moni-tors of the managers of publicly listed firms, reducing the free-rider problem . . . .”). 209 See Lisa M. Fairfax, Achieving the Double Bottom Line: A Framework for Corporations Seeking to Deliver Profits and Public Services, 9 STAN. J.L. BUS. & FIN. 199, 226–27 (2004) (stat-ing that evidence suggests that institutional investor monitoring has been limited); Greenwood & Schor, supra note 208, at 362; Lawrence E. Mitchell, Financialism: A (Very) Brief History, 43 CREIGHTON L. REV. 323 (2010) (deriding the unrealized utopia of institutional investor activ-ism). 210 See John C. Bogle, Reflections on the Evolution of Mutual Fund Governance, 1 J. BUS. & TECH. L. 45, 49–50 (2006) (“[P]assivity in governance may pay. Let others undertake the hard work and costs of activism. If their efforts are successful, the “passive-ists” . . . will not only reap



stocks they hold, many institutional shareholders and fund managers are hamstrung by the resulting conflicts of interests from playing an activist role.211 Moreover, while some institutional investors, such as index funds, undoubtedly hold stock for a long term, they are structural-ly passive.212

Shareholder monitoring of the managerial class has evolved into an absolute necessity in today’s investing environment.213 In particular, shareholder monitoring promotes efficiency.214 While monitoring could take several forms, including the very aggressive type in which control-ling block owners determine corporate policy to the very passive in rewards without spending a penny, they will also increase their chances of getting the pension and thrift business of the activists.”); Paul Rose, Common Agency and the Public Corporation, 63 VAND. L. REV. 1355, 1356 (2010) (“[I]nstitutional ownership of public companies has tended to reduce some of the collective action problems that have impeded shareholder activism in the past.”); see also Jill Fisch, Relationship Investing: Will it Happen? Will it Work?, 55 OHIO ST. L.J. 1009, 1012 (1994) (observing that where the result of an investor’s efforts would be beneficial to free-riding competitors, a rational investor would refrain from it). For further discussion of the incentive problems of institutional investors, see Bainbridge, Shareholder Disempowerment, supra note 204, at 1751–54. 211 See Harner, supra note 78, at 552–53 (discussing the constraints facing individual and institutional shareholders); see also Thomas W. Briggs, Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis, 32 J. CORP L. 681, 710–11 (2007) (“The arguments over why shareholders usually remain powerless are extraordinarily complex, but basically boil down to []collective action problems . . . insufficient incentives, conflicts of interest, legal obsta-cles, and management power. Institutional investors consequently generally remain unwilling to spend the time and money to exercise their voting rights fully . . . .”); Usha Rodrigues, Let the Money Do the Governing: The Case for Reuniting Ownership and Control, 9 STAN. J.L. BUS. & FIN. 254, 278 (2004) (“The head of a pension fund or the manager of a mutual fund might not adequately guard shareholder interests, not because of interests divergent from those of small shareholders, but because of conflicting motives to maintain their reputation in the larger business community.”). 212 A Different Class: Would Giving Long-Term Shareholders More Clout Improve Corporate Governance?, ECONOMIST (Feb. 18, 2010) [hereinafter A Different Class], http://www.economist.com/node/15544310 (stating that many long-term index investors that “hold shares for years without taking the slightest interest in how the firms they invest in are run, let alone doing anything to improve matters”); see also Coffee, supra note 94, at 1352–53 (discussing reasons for index investor passivity and providing economic justification for a switch to active monitoring). 213 See Iris H-Y Chiu, The Meaning of Share Ownership and the Governance Role of Share-holder Activism in the United Kingdom, 8 RICH. J. GLOBAL L. & BUS. 117, 156 (2008); MARC GOLDSTEIN, IRRC INST., THE STATE OF ENGAGEMENT BETWEEN U.S. CORPORATIONS AND SHAREHOLDERS 5 (2011) (“Investors, burned by scandals at companies such as Enron and WorldCom and more recently by the collapse of major financial services firms, are more sensi-tive to risks at their portfolio companies and less willing to simply trust boards to oversee management and leave it at that.”). 214 Jean Tirole, Corporate Governance, 69 ECONOMETRICA 1, 5 (2001) (stating that the exer-cise of voice by shareholders and other constituents make a firm more efficient because, among other things, “active monitors may turn down a negative NPV [net present value] project spon-sored by management, force the divestiture of a noncore division, or remove management altogether”); see also Klein, supra note 134, at 175 (“Accountability of managers to shareholders can actually encourage innovation. Entrenchment, on the other hand, lowers the incentives for risk-taking. More efficient monitoring may also lead to the improved competitiveness of U.S. companies.”).



which shareholders feebly endorse management’s recommendations, Class T holders can adopt an intermediate approach.215 This approach is suited for those who hold a significant number of shares for a long peri-od of time and leverage that position to influence management.216 While third-party providers of capital, like insurance companies and banks, have an incentive to monitor the firms being financed or insured, the arrangement proposed here also provides a similar advantage by provid-ing shareholders with the incentive and opportunity to vigorously monitor the firms.217 As some scholars posit, monitoring is likely to be effective when the monitor faces substantial financial harm, which, in turn, motivates her to act.218

Thus, because of their long-term commitment and the attendant vulnerability, these shareholders have a heightened incentive to be effec-tive monitors.219 By virtue of their long-horizon approach to investment, Class T holders also have the incentive and ability to commit resources to gathering information about the companies they invest in, while also eliciting the respect of management that ordinarily disdains transient investors that are only driven by profit-taking, as opposed to a desire to continuously assess the corporation’s ongoing prospects.220 Also, as the preceding Section affirms, shareholder voice is likely to be amplified where exit is difficult.221 Unlike other recent proposals for stemming short-termism such as a securities tax, capital gains tax reform, and loy-alty dividends, which hope that long horizon investing and shareholder participation in corporate governance would result from the applicable inducement or punishment, this proposal offers a more tangible pro-

215 Hawley & Williams, supra note 158, at 125; see also Cohn et al., supra note 111, at 6 (describing a continuum of activist shareholders ranging from those who submit shareholder proposals to those who expend resources to mount a proxy contest to secure board representa-tion). 216 Hawley & Williams, supra note 158, at 125. 217 See James Boyd & Daniel E. Ingberman, Fly By Night or Face the Music? Premature Dissolution and the Desirability of Extended Liability, 5 AM. L. & ECON. REV. 189, 225 (2003) (discussing the incentives of banks and insurers to monitor corporate performance and thereby catalyze better risk management); John Pound, The Rise of the Political Model of Corporate Governance and Corporate Control, 68 N.Y.U. L. REV. 1003, 1041–42 (1993) (stating that share-holders will monitor when it is in their economic interest to do so). 218 Francesca Cornelli et al., Monitoring Managers: Does it Matter? 1 (European Corporate Governance Inst., Working Paper No. 271/2010, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1507762 (“As monitoring benefits all investors while being costly to provide, directors are more likely to engage in monitoring if they have skin in the game.”); see also Macey, supra note 2 (stating that when investors make substantial investments in a target company, “they have strong incentives to agitate vigorously for reforms that will increase the value of their investments”). 219 See Matheson & Olson, supra note 24, at 1388 (“[C]ertain fundamental corporate trans-actions so affect long term shareholders’ financial interests that only they possess the requisite incentives to monitor the integrity of these transactions.”). 220 See Porter, supra note 12, at 70. 221 See supra Part III.B.



spect of that outcome because the parties go into the transaction with that objective and expectation at inception.222 Shareholders who are not interested in both long-term holding and activism are unlikely to be attracted to the arrangement in the first place. Therefore, there is no room for a hollow hope.

Class T shareholders are also better positioned to monitor due to potential access to insider information. The argument has been made that effective monitoring of managers depends on, or is enhanced by, having insider information.223 The law restricts access to such infor-mation, however, in order to “prevent short-term investors from profit-ing at the expense of less well-informed shareholders.”224 On the other hand, “long-term investors don’t trade short-term and, therefore, they cannot profit from short-term uses of insider information. Thus a dis-tinction between traders and long-term investors would better govern insider information rather than the current blanket prohibition.”225 The positional advantage of Class T shareholders is reflected in the fact that the case can more easily be made for such relaxation for that class of shareholders than short-term shareholders and even other long-term shareholders. This is because the difficulty in sorting out short-term shareholders from long-term shareholders that affects such long-term holders as index funds does not apply to Class T shareholders, since it is clear beyond doubt that the latter would hold the stock for the long term.226

Significantly, the envisioned investors here would fit closely into what Professor Coffee has identified as the best example of a corporate monitor, namely one who has no conflicts of interest, holds a substantial stake in the company, and has a long-term investment horizon.227 It is envisioned that as much as practicable, these long-term shareholders will operate as the long-term investment equivalent of short-term-oriented hedge funds, adopting a similar posture of clarity of purpose, aggressiveness, cooperation, and solidarity to accomplish their mis-sion.228 Preferably, they can use their position to participate in construc-

222 For an extensive discussion of these proposals, see Emeka Duruigbo, Tackling Sharehold-er Short-Termism and Managerial Myopia, 100 KENTUCKY L.J. (forthcoming 2012), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1802840. 223 Hawley & Williams, supra note 158, at 152; see also Coffee, supra note 94, at 1346–47 (arguing for relaxation of section 16(b) rules on insider information for long-term holders). 224 Hawley & Williams, supra note 158, at 152. 225 Id. 226 Id. (stating that some index funds have a mix of index and discretionary strategies mak-ing it difficult to argue that all index funds are long-term holders). 227 Coffee, supra note 94, at 1336. Professor Coffee notes that this role would be best filled by a public pension fund. See id. at 1336–37. 228 Research indicates that while the activism of large institutional shareholders has yielded minimal results, hedge funds have been more successful in the task of monitoring management and consequently improving firm performance. See Greenwood & Schor, supra note 208, at



tive dialogue with corporate management, expressing and advocating in unmistakable terms their preference for long-term growth and sustaina-ble corporate performance.229

D. Long-Term Equity Security

The Class T shares are an attractive option for individual and insti-

tutional investors interested in holding equity securities for an extended period of time to accomplish certain goals, instead of engaging in the casino-like experience that the stock market sometimes looks like.230 Jurists and scholars have started weighing in on the need for an invest-ment product geared toward investors that want to put money away for their children’s college education and to fund their retirement.231 Ac-cording to Delaware Chancellor Leo Strine:

Although the challenge of addressing the misalignment between the interests of end-user investors and society in the long run and the incentives of the institutional investor community to think and act myopically is considerable, it is past time to begin. Areas that would be productive for examination include . . . a mandated separation of funds managing 401(k) and college savings investments from more liquid investments, and requiring investing practices consistent with retirement and college investment objec-tives . . . .232

While Chancellor Strine favors an option mandated by the gov-ernment, market-based, private alternatives may be more attractive.233 362; see also WALTER EFFROSS, CORPORATE GOVERNANCE: PRINCIPLES AND PRACTICES 196 (2010) (describing hedge funds’ tactics and success record); William W. Bratton, Hedge Funds and Governance Targets, 95 GEO. L.J. 1375, 1379 (2007) (“When one hedge fund announces a 5% or 10% position in a company, others follow, forming a ‘wolf pack’ that sometimes has the voting power to force management to address its demands. The demands, in turn, likely in-clude one or more actions assuring a quick return on investment . . . .”); Briggs, supra note 211, at 722 (noting that hedge funds’ involvement or activism has been shown to improve the per-formance of some target companies). 229 See MATTEO TONELLO, CONF. BD., REVISITING STOCK MARKET SHORT-TERMISM 13 (2006). 230 See Theresa A. Gabaldon, John Law, with a Tulip, in the South Seas: Gambling and the Regulation of Euphoric Market Transactions, 26 J. CORP. L. 225 (2001) (analogizing stock mar-ket speculation to gambling); Lynn A. Stout, Are Stock Markets Costly Casinos? Disagreement, Market Failure, and Securities Regulation, 81 VA. L. REV. 611, 683 (1995). 231 Strine, supra note 18, at 1082. 232 Leo E. Strine, Jr., One Fundamental Corporate Governance Question We Face: Can Cor-porations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?, 66 BUS. LAW. 1, 18 (2010). 233 Rodrigues, supra note 1, at 1862 (“Ideally the market would provide investment vehicles specifically designed for long-term holders.” (citation omitted)); see also NYSE REPORT, supra note 15, at 4–5 (staking a preference for market-based solutions to corporate governance mat-ters).



The challenge is in devising a private vehicle that is easily accessible, a challenge that this Article responds to by proposing a form of equity security that is based on a revised version of the trust fund theory. Trust securities could be an investment instrument of choice for shareholders who want to hold stock for a long time, without succumbing to the neg-ative pull and impact of the stock market roulette.234

An obvious target of a Class T pitch would be institutional inves-tors that can buy and hold large blocks of stock at a time, especially pub-lic pension funds.235 Wealthy individuals and sovereign wealth funds may also be interested.236 Of particular relevance is that regardless of the stripe in which the shareholders come, as individuals or institutions, nationals or foreigners, they should share certain core values, including a long-term perspective and an interest that goes beyond financial indi-cators, technically construed, to include “intangibles” and “extra-financial factors.”237 For instance, they would likely include the type of shareholders that subscribe to the notion that “actions that prevent en-vironmental disasters or comply with legal and ethical rules can have a significant positive effect in preventing disastrous corporate calamities, even if they cost money in the short run.”238 Some of these shareholders would fit into Steve Lydenberg’s three-component definition of long-term investing that includes long holding periods, assimilation of envi- 234 The proposal may be modified to increase liquidity, with Class T holders being allowed a limited and periodic withdrawal of funds. The greater flexibility may help attract more inves-tors in these shares. 235 See Symposium, The Institutional Investor’s Goals for Corporate Law in the Twenty-First Century, 25 DEL. J. CORP. L. 35, 47–48 (2000) (noting that the charters of some large pension funds specify investing for the long term and advising corporations to search for long-term allies among those firms). 236 It is interesting that investors were attracted while the prospectus for the initial public offering of Google Inc. clearly expressed a vision for the long term and the benefits to share-holders of being a public-spirited company even if it means foregoing some short-term gains. See Ed Waitzer & Johnny Jaswal, Peoples, BCE, and the Good Corporate “Citizen,” 47 OSGOODE HALL L.J. 439, 490 (2009). There may be concerns with sovereign wealth funds, including na-tionalist sentiments against foreigners seeking to “take over” corporate America and the issue of utilizing sovereign powers to avoid liability or thwart investigations, e.g., for insider trading. See generally George S. Everly III, Sovereign Wealth Funds and Shareholder Democratization: A New Variable in the CFIUS Balancing Act, 25 MD. J. INT’L L. 374–94 (2010); Ronald J. Gilson & Curtis J. Milhaupt, Sovereign Wealth Funds and Corporate Governance: A Minimalist Response to the New Mercantilism, 60 STAN. L. REV. 1345 (2008); Michael Green & John I. Forry, Sover-eign Wealth Funds: International Growth and National Concerns, 127 BANKING L.J. 965 (2010); Adam Gutin, Regulating Sovereign Wealth Funds in the U.S.: A Primer on SWFs and CFIUS, 5 FIU L. REV. 745 (2010). 237 See Julie Fox Gorte, Investors: A Force for Sustainability, in SUSTAINABLE INVESTING: THE ART OF LONG TERM PERFORMANCE 31 (Cary Krosinsky & Nick Robins eds., 2008); Nick Rob-ins, The Emergence of Sustainable Investing, in SUSTAINABLE INVESTING, supra, at 3. 238 Avi-Yonah, supra note 39, at 814; Steven J. Haymore, Public(ly Oriented) Companies: B Corporations and the Delaware Stakeholder Provision Dilemma, 64 VAND. L. REV. 1311, 1343–44 (2011) (noting that there is a growing number of investors who are not overly interested in maximizing short-run profits but aim to affect society by the more public-oriented investment approach they adopt).



ronmental, social, and corporate governance factors into investing, and preparedness to add value to investments by engaging with manage-ment to minimize negative externalities or maximize positive externali-ties.239 They are likely to include “universal owners”—institutional shareholders characterized by highly diversified and typically long-term holdings, who are mindful of negative externalities and support the cre-ation or expansion of positive externalities because of the overall effect on their portfolios.240

While this proposal favors private ordering, it does not preclude public-law initiatives or legislative reforms to strengthen the private arrangements. The proposal would benefit from, and endorses, such public policy tools as capital gains tax reform in favor of holders of the trust securities,241 tax breaks for companies that adopt the Class T struc-ture,242 and a tax advantage for beneficiaries of pension and other funds when payments are received from stocks held long term.243 Ultimately, if corporations are slow to adopt this proposal, for whatever reason, and in the midst of these incentives, direct public policy intervention along the lines suggested by Chancellor Strine may be inevitable and accepta-ble.

E. Antidote to Short-Termism

Short-termism refers to the investment approach in which inves-

tors “push managers to invest in short-term projects in order to keep earnings high. In this sense, investors who behave in a short-termistic manner may well have long holding periods, provided managers satisfy the investors’ need for high earnings period by period.”244 Short-

239 Steve Lydenberg, Building the Case for Long-Term Investing in Stock Markets: Breaking Free from the Short-Term Measurement Dilemma, in FINANCE FOR A BETTER WORLD: THE SHIFT TOWARD SUSTAINABILITY 168, 169–70 (Henri-Claude de Bettignes & François Lépineux eds., 2009). 240 Hawley & Williams, supra note 158, at 3–5. 241 See generally Duruigbo, supra note 222. 242 See Orenbach, supra note 109, at 369 (arguing for favorable tax policy to support a pri-vate reform initiative for the governance of corporations); see also Rebecca A. Crawford, Note, Corporate Governance Reform: How to Promote the Long-Term Health and Value of U.S. Corpo-rations, 5 N.Y.U. J.L. & BUS. 905, 933 (2009) (proposing that positive incentives, including tax breaks or subsidies, be granted to companies that adopt a proposal on representation of credi-tors on corporate boards). 243 See Porter, supra note 12, at 77–79 (proposing an equity investment incentive that con-sists of reduced tax rates for pension and annuity beneficiaries where the source of their pen-sion income is stock held for at least five years with the aim of pushing beneficiaries and trus-tees to pressure their investment managers to deliver a greater proportion of their income from long-term equity gains). 244 Øyvind Bøhren et al., Investor Short-Termism and Firm Value 1 n.1 (Aug. 28, 2009), http://finance.bi.no/~bernt/wps/ownership_duration/duration_aug_2009.pdf.



termism promotes a tendency to overvalue short-term rewards, invaria-bly leading to an undervaluation of long-term consequences.245 One observer contends that an excessive focus on the short term engenders misallocation of assets by corporate managers, leads to harmful volatili-ty in the financial markets, and imposes a burden on society to channel productive resources into repairing environmental and social damage occasioned by an unbridled quest for profits.246 Indeed, some market observers and legal commentators link the collapse of energy giant En-ron, and more recently some fabled financial firms, to investors acting like traders and influencing corporate managers to make policy deci-sions based on quarterly earnings statements.247

Short-termism may exist both in investing and in corporate man-agement, necessitating a focus both on shareholder short-termism and the concomitant corporate myopia.248 Shareholder short-termism is said to manifest in two major ways, namely “pressure” and “walk.”249 Some shareholders’ penchant for quick returns on investment puts pressure on corporate managers to fixate on short-term results, even at the ex-pense of long-run performance.250 Besides, as Part III.B has demonstrat-

245 See Kevin J. Laverty, Managerial Myopia or Systemic Short-termism? The Importance of Managerial Systems in Valuing the Long Term, 42 MGMT. DECISION 949 (2004) (discussing the phenomenon of organizations overvaluing short-term rewards and undervaluing long-term consequences). 246 Beale & Fernando, supra note 79, at 27 (“[T]he short-term focus on the share price has been counterproductive for long run economic growth as well as social cohesion and environ-mental sustainability.”); Lydenberg, supra note 239, at 168; Broc Romanek, Can We Overcome Short-Termism?, THECORPORATECOUNSEL.NET (Sep. 22, 2009, 7:00 AM), http://www.thecorporatecounsel.net/Blog/2009/09/ (“Short-term traders have little reason to care about long-term corporate performance—so are unlikely to exercise a positive role in promoting corporate policies and can lead to market failures, social and environmental degradation.”). 247 See, e.g., William W. Bratton, Enron and the Dark Side of Shareholder Value, 76 TUL. L. REV. 1275 (2002); Christopher M. Bruner, Corporate Governance Reform in a Time of Crisis, 36 J. CORP. L. 309 (2011); Jill E. Fisch, Measuring Efficiency in Corporate Law: The Role of Share-holder Primacy, 31 J. CORP. L. 637, 673 (2006) (discussing the role of short-termism in the collapse of fabled energy giant, Enron). 248 Bratton, supra note 94, at 750; Theresa A. Gabaldon, Corporate Conscience and the White Man’s Burden, 70 GEO. WASH. L. REV. 944, 949 (2002); M.P. Narayanan, Managerial Incentives for Short-Term Results, 40 J. FINANCE 1469, 1469–70 (1985) (attributing managerial myopia to reputational incentives). For discussions of managerial myopia and its motivating factors, see Black, supra note 26, at 865 (1992); Eduard Gracia, Corporate Short-Term Thinking and the Winner-Take-All Market (Oct. 28, 2003), http://papers.ssrn.com/sol3/papers.cfm?abstract_id=445260. 249 Lawrence H. Summers & Victoria P. Summers, When Financial Markets Work Too Well: A Cautious Case for a Securities Transactions Tax, 3 J. FIN. SERV. RES. 261, 272–74 (1989); see also LOWENSTEIN, supra note 201, at 91–92. 250 See Lucian A. Bebchuk & Lars Stole, Do Short-Term Managerial Objectives Lead to Un-der- or Over-Investment in Long-Term Projects?, 48 J. FINANCE 719 (1993); Patrick Bolton et al., Pay for Short-Term Performance: Executive Compensation in Speculative Markets, 30 J. CORP. L. 721, 725 (2005); Jeremy C. Stein, Takeover Threats and Managerial Myopia, 96 J. POL. ECON. 61 (1988); see also Bøhren et al., supra note 244, at 14 (discussing “the hypothesis that when short-termist investors influence the firm over extended periods, they pressure managers into myopic



ed, shareholders often exhibit a tendency to prefer exit to voice. That is, they would rather sell their stock if dissatisfied with corporate manage-ment than stay in and affect direction of corporate policy. Ultimately, this works against good corporate performance.

Scholars have attributed the emergence and perhaps prevalence of short-termism to a number of more specific factors.251 One of these fac-tors is the executive compensation system that motivated management to take and benefit from excessive risk-taking while offloading the dam-age on shareholders.252 Perhaps nothing exemplifies the link between short-termism and the recent financial collapse more than the famous statement by former Citibank Chairman and CEO Charles Prince: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”253 By steering shareholders toward long-horizon investing, this proposal provides a basis to demand a similar posture from management, including an executive compensation structure that rewards a long-term focus.254

Another factor responsible for short-termism is the disconnect be-tween the interests of asset owners and asset managers.255 This misa-lignment manifests, inter alia, in investment time horizon. “Presently, many owners evaluate their fund managers’ performance quarterly. It is unsurprising, therefore, that asset managers focus on delivering short-term returns, including pressuring investee companies to maximize near-term profits.”256 Since the core characteristic of the plan presented here is long-term holding, this problem is avoided, as the focus of inter-ested parties will be on maximizing long-term value.257 Another area

behavior which reduces firm value [as] managers try to maintain high short-term earnings at the expense of profitable long-term projects”). 251 For an extensive and excellent discussion of the causes of short-termism, see Lynne Dallas, Short-Termism, the Financial Crisis and Corporate Governance, 37 J. CORP. L. 264 (2011). 252 Carmen Giorgiana Bonaci & Jiřĺ Strouhal, Corporate Governance Lessons and Traders’ Dilemma Enhanced by the Financial Crisis, in RECENT ADVANCES IN BUSINESS ADMINISTRA-TION 66, 66 (Alexander Zemliak & Nikos Mastorakis eds., 2011), available at http://www.wseas.us/books/2011/Mexico/ICBA.pdf; Allan C. Hutchinson, Hurly-Berle—Corporate Governance, Commercial Profits, and Democratic Deficits, 34 SEATTLE U. L. REV. 1219, 1221 (2011). But see Danielle Angott Higgins, Regulation S-K Item 402(S): Regulating Compensation Incentive-Based Risk Through Mandatory Disclosure, 61 CASE W. RES. L. REV. 1049, 1058 (2011) (discussing evidence that questions the claim that short-term executive incentives caused the recent finan-cial crisis). 253 Bonaci & Strouhal, supra note 252; see also Dallas, supra note 251, at 74 & n.4. 254 See supra note 17 and accompanying text. 255 Simon Wong, Tackling the Root Causes of Shareholder Passivity and Short-Termism, HARV. L. SCH. F. CORP. GOVERNANCE & FIN. REG. (Jan. 31, 2010, 9:41 AM), http://blogs.law.harvard.edu/corpgov/2010/01/31/tackling-the-root-causes-of-shareholder-passivity-and-short-termism/; see also Lydenberg, supra note 239, at 170. 256 Wong, supra note 255. 257 See Coffee, supra note 94, at 1325–26.



where interests of asset owners and asset managers are misaligned is in asset manager compensation. Because fund managers for some of the institutional investors, such as pension funds, are bound by a compen-sation system that does not particularly incentivize monitoring of cor-porate managers, they are not eager to engage in conduct that, while desirable to the institutions they represent, does not confer adequate reward to the fund managers.258 A number of pension funds maintain a fee structure that involves nonpayment of management fees, which could be assessed as a percentage of assets under management, in ex-change for a permission to lend the stocks and earn a financial return thereby.259In the first place, this form of asset manager compensation further engenders shareholder passivity.260 Further, from the perspective of interest alignment, “this is highly problematic because it removes the asset manager’s incentive to maximize portfolio value while creating severe conflicts of interest.”261 For example, waging a successful proxy contest might require that the lent shares be recalled for the purpose of voting but the fund manager may be reluctant to do so because of the revenue loss that such recall would occasion.262 Worse still, the shares may be lent to activist short-term traders, whose interests differ from the supposedly long-term orientation of the institutional investors.263 Stock lending is unacceptable under the arrangement proposed here, as the stockholder specifically enters into the scheme with the express in-tention of exercising his power to vote, among other ways of participa-tion in the corporation’s affairs.264 Besides, the stock certificate would specifically state that the stock is not subject to any form of transfer, defined to include lending, within the holding period.265

258 Robert C. Illig, What Hedge Funds Can Teach Corporate America: A Roadmap for Achieving Institutional Investor Oversight, 57 AM. U. L. REV. 225, 231 (2007) (noting that the interests of fund managers and their investors often differ and that expensive monitoring is not profitable for fund managers). 259 Wong, supra note 255. 260 See id. 261 Id. 262 Id. But see Aggarwal et al., supra note 145, at 3 (“[I]nstitutions take their responsibility to vote seriously, and are even willing to give up revenue from lending securities in order to exer-cise voting rights.”). 263 See Aggarwal et al., supra note 145, at 10 (discussing research suggesting that securities borrowers include activist investors who are primarily motivated by a desire to gain control of a company); Ferlauto, supra note 124, at 45 (“The main purchasers of lent shares are often hedge funds and short sellers interested in short-term transactional gains, not long-term value propo-sitions.”); Henry T.C. Hu & Bernard Black, Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms, 61 BUS. LAW. 1011 (2006). 264 Roberta S. Karmel, Voting Power Without Responsibility or Risk: How Should Proxy Reform Address the Decoupling of Economic and Voting Rights?, 55 VILL. L. REV. 93, 123 (2010). 265 Technically, stock lending would be considered a form of transfer and therefore prohibit-ed in the context of this proposal. See Aggarwal et al., supra note 145, at 10, 11 (defining securi-ties lending and stating that it involves actual transfer of ownership and voting rights); see also



F. Long-Term Shareholder Primacy

Long-term shareholder primacy denotes a model of corporate gov-

ernance that gives priority to the interests of long-term shareholders. For years, there have been strident arguments on whether the goal of the corporation should be the furtherance of interests of shareholders or whether the competing interests of other corporate constituents—stakeholders—should be accommodated or even preferred.266 Some opponents of shareholder primacy anchor their objection on the ground that many shareholders are short-term oriented and therefore promot-ing their interests could come at the expense of the long-run growth of the corporation.267 A model of long-term shareholder primacy marries the two competing interests by giving preference to shareholder inter-ests, but only in the case of shareholders that are committed to the cor-poration for the long term.268 To that extent, long-term shareholder Onnig H. Dombalagian, Can Borrowing Shares Vindicate Shareholder Primacy?, 42 U.C. DAVIS L. REV. 1231, 1260–61 (2009); Hu & Black, supra note 263, passim. 266 Grant Hayden & Matthew Bodie, Shareholder Democracy and the Curious Turn Toward Board Primacy, 51 WM. & MARY L. REV. 2071, 2082, 2092–95 (2010) (“Scholars have referred to the notion that corporations should seek primarily, if not solely, to maximize returns to their shareholders as the shareholder primacy norm or the shareholder wealth maximization norm. This norm is much more than a descriptive account of shareholders’ rights; it is instead a nor-mative judgment on the most socially efficient way of organizing the economy. Proponents of this norm argue that we will maximize our utility as a society only through a system of corpo-rate law that recognizes and perpetuates shareholder primacy.” (citations omitted)); see also Barnali Choudhury, Serving Two Masters: Incorporating Social Responsibility into the Corporate Paradigm, 11 U. PA. J. BUS. L. 631, 635–40 (2009); D. Gordon Smith, The Shareholder Primacy Norm, 23 J. CORP. L. 277 (1998). Some commentators contest the characterization of the corpo-ration’s goal as maximization of shareholder interests. See, e.g., Lisa M. Fairfax, The Rhetoric of Corporate Law: The Impact of Stakeholder Rhetoric on Corporate Norms, 31 J. CORP. L. 675, 690 (2006). 267 Henry Hansmann & Reinier Kraakman, The End of History for Corporate Law, 89 GEO L.J. 439, 439 (2001) (stating that the debate over the goal of corporate law has been resolved in favor of shareholder primacy but construing the result as a goal to maximize long-term share-holder value); Hayden & Bodie, supra note 266, at 2092–96; Robert Sprague & Aaron J. Lyttle, Shareholder Primacy and the Business Judgment Rule: Arguments for Expanded Corporate Democracy, 16 STAN. J.L. BUS. & FIN. 1, 17 (2010); Lynn A. Stout, Bad and Not-So-Bad Argu-ments for Shareholder Primacy, 75 S. CAL. L. REV. 1189, 1198 (2002). 268 See Porter, supra note 12, at 79 (calling for long-term shareholder to be identified as the explicit, not just appropriate, corporate goal); Alfred Rappaport, The Economics of Short-Term Performance Obsession, 61 FIN. ANALYSTS J. 65, 69 (2005) (“The idea that management’s prima-ry responsibility is to maximize long-term shareholder value is widely accepted in principle but imperfectly implemented in practice.”); Nina Walton, On the Optimal Allocation of Power Between Shareholders and Managers 12 (Univ. of Southern Cal. Law Sch. Law and Economics Working Paper Ser., Paper No. 118, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1654165 (stating that the goal of the corporation is “to maximize the wealth of shareholders in the aggregate, rather than to maximize the wealth of long-term shareholders only, a policy position embraced by [some commentators] but one that is narrower than the current legal conception of the proper goal of corporations”); see also Nadelle Grossman, Turn-ing A Short-Term Fling into a Long-Term Commitment: Board Duties in a New Era, 43 U.



primacy shares similarities with the enlightened shareholder model that is codified in the United Kingdom Companies Act 2006.269 Not only is this approach an additional antidote to short-termism as it cultivates a norm of long-term shareholder primacy permitting management to operate free of short-termist shareholder pressures, but it also virtually erases internal friction within the firm and enhances corporate profita-bility.270

The model proposed in this Article neatly provides the sort of framework that some scholars have cogently argued is necessary for the overall well-being of the corporation because it clearly identifies the long-term shareholders and, in the process, provides management with the needed guarantee of long-term holding by these shareholders.271 As the management gets the freedom to focus on long-term strategy and incentivized shareholders monitor the performance of the managers in the execution of both short- and long-term goals, the corporation and all of its components profit.272 Even short-term shareholders are not left out because their ability to hold and sell stock profitably within a short horizon depends on the belief that the stock’s long-term promise is ro-bust.273

MICH. J.L. REF. 905, 908 (2010) (“While some Delaware courts have expressed a preference for this type of long-term standard, they have generally not required it.”). 269 Iris H-Y Chiu, Standardization in Corporate Social Responsibility Reporting and a Uni-versalist Concept of CSR?—A Path Paved with Good Intentions, 22 FLA. J. INT’L L. 361, 376 n.93 (2010) (stating that the enlightened shareholder model is an adapted form of shareholder pri-macy that rejects short-term shareholder primacy and respects stakeholder interests); Virginia Harper Ho, “Enlightened Shareholder Value”: Corporate Governance Beyond the Shareholder-Stakeholder Divide, 36 J. CORP. L. 59, 79 (2010) (outlining the core elements of the enlightened shareholder value model). 270 Matheson & Olson, supra note 24, at 1369–71. 271 See id. 272 See Fairfax, supra note 238, at 702 (“[P]roponents of the long-term view of shareholder primacy would contend that such a view accommodates non-shareholder issues. This accom-modation occurs because ‘stakeholder’ concerns, such as giving money to charity or behaving responsibly towards employees and customers, inure to the benefit of shareholders in the long-term.” (citations omitted)); Lipton & Rosenblum, supra note 131, at 216 (“The long-term health of the business enterprise is ultimately in the best interests of stockholders, the corporation’s other constituencies, and the economy as a whole.”); Matheson & Olson, supra note 24, at 1326 (discussing the benefits of a long-term model to nonshareholders and society); George G. Triantis & Ronald J. Daniels, The Role of Debt in Interactive Corporate Governance, 83 CALIF. L. REV. 1073, 1079 (1995) (“[T]he governance activities of one stakeholder generally yield positive net externalities to others.”). 273 James R. Repetti, The Misuse of Tax Incentives to Align Management-Shareholder Inter-ests, 19 CARDOZO L. REV. 697, 713–14 (1997).



G. Cost Internalization and Creditor Protection

Creditor protection was at the heart of Justice Story’s formulation

of the trust fund theory.274 The theory’s “supposed strength lay in pre-serving the fund intact, by giving creditors a lien in equity upon the fund against all but bona fide holders.”275 There is hardly any doubt that the theory failed in this undertaking.276 The present proposal is designed to fulfill that original objective. It provides a framework for ensuring that a corporation’s voluntary creditors who contract on the basis of the fund, and its involuntary creditors, such as the ecological and human victims of corporate catastrophes, receive timely and adequate financial redress. This advantage is built into the character of the trust fund, as a form of bonding.277 This role could become larger if bonding is made compulsory as part of broad public policy to ensure that corporations do not transfer their business risks to the society.278 Forced bonding “fosters cost internalization by mandating the existence of capital re-serves dedicated to the satisfaction of liabilities, even after corporate dissolution.”279

An additional advantage is that the generator of harm has an in-centive to avoid the harm, thus giving the trust fund a preventative qual-ity. According to some scholars:

Bonding has a decided advantage relative to extensions of liability to shareholders or business partners. Namely, it shifts the burden of recovery from victims to the risk generator. With extensions of liabil-ity victims must pursue compensation, sometimes years later, from former business partners and shareholders who are understandably reluctant to honor such claims. In contrast, bonding leaves the po-tential injurer as the “residual claimant” to the bond fund. This cre-ates an unambiguous incentive for the producer to minimize its lia-bilities.280

274 Covington, supra note 54, at 284 (noting that Wood v. Dummer states a fundamental rule that protects creditors from withdrawal of capital contributions to their detriment); see also Hyman Zettler, The Trust Fund Theory: A Study in Psychology, 1 WASH. L. REV. 81 (1925) (discussing the evolution and extension of the trust fund doctrine to ensure equal protection of creditors during corporate insolvency, thereby increasing the confidence of widely dispersed creditors to continue to lend to corporations). 275 Note, The Present Status of the Trust Fund Doctrine, 8 COLUM. L. REV. 303, 303 (1908). 276 Id. (“That it held any such effect while the corporation was solvent, is doubtful.”). 277 Boyd & Ingberman, supra note 217, at 224–25. 278 See Eleanor Marie Lawrence Brown, Visa as Property, Visa as Collateral, 64 VAND. L. REV. 1047, 1068–71 (2011) (discussing the advantages of bonding requirements, including ease of enforcement). 279 Boyd & Ingberman, supra note 217, at 224–25. 280 Id. at 226.



Relative to other forms of bonding, trust funds present cheaper implementation costs.281 While some of these other forms may require close monitoring of the quality of the financial instruments and their providers,282 a trust funded from share subscriptions is more transpar-ent and easily verifiable. Creditor protection will also be beneficial to the corporation since the segregated pool of funds will make it easier for firms to access credit because creditors price in the risk of default, re-flected in higher interest rates, when extending credit.283 Because cor-rectly pricing this risk may be cumbersome for creditors, the trust fund also facilitates lending activity as it reduces the difficulty of determining the appropriate price for a given corporate risk.284

IV. ARGUMENTS AGAINST THE REVIVED TRUST FUND PROPOSAL

A. Impairment of Interests and Disparate Treatment of Existing Shareholders

One impediment to the introduction of the proposed trust fund

here is the legitimate concern that granting Class T shareholders superi-or rights would impair the interests of other common shareholders who do not enjoy such rights and privileges. As a threshold matter, it should be stated that a corporation can legally create senior securities that nega-tively affect the interest of existing security holders even without the consent of all the affected shareholders.285 While senior securities would normally refer to debt securities (such as bonds and debentures) and preferred stock, the same idea is relevant here, especially since the pro-posed securities diverge in some respects from the regular incidents of

281 Bonding requirements or indication of financial responsibility can be met in different forms, including trust funds, letters of credit, surety bonds, insurance policies, or evidence of self-insurance. See id. at 225. 282 Id. at 226 n.51. 283 Daniel R. Fischel, The Economics of Lender Liability, 99 YALE. L.J. 131, 136 (1989) (“The greater the amount of anticipated debtor misconduct, the greater the compensation (i.e., the higher interest rate) that a lender will demand. To decrease the amount of compensation de-manded, borrowers will attempt to allay lenders’ concerns by agreeing to various monitoring and bonding mechanisms.” (citation omitted)); see also Crawford, supra note 242, at 932 (“[D]ecrease in risk will be priced into the cost of the loan, providing companies with lower-cost loans.”). 284 Fischel, supra note 283, at 133–34 (stating that a lender needs to access the risk of default by the borrower and the likelihood that the money would be recovered if default occurs, noting that “the ability of the lender to make correct assessments is severely limited, no matter how diligent the lender may be”). 285 See Coffee, supra note 6, at 1640–41 (discussing the move away from the concept of vested rights toward permission to issue new classes of securities that could affect the rights of existing security holders).



common shares.286 The SEC’s proxy access regulations—since invalidat-ed—that granted nominating powers in the corporate proxy statement to shareholders that own three percent of a company’s stock for a min-imum of three years confirmed the point about the legal permissibility of privileging some common shareholders over others.287 Given that the new class of shares is being created for the benefit of the corporation and, by extension, the existing shareholders, the fairness of the transac-tion provides an additional boost that would help in trumping any other consideration.288

The point is that special treatment is permissible in circumstances where the objective is the protection of the firm and shareholders from major damage or serious threat to continuation of the company’s opera-tions. It is not uncommon in an organizational setting, in which the quick exit of members increases the burden on the remaining members or otherwise adversely affects the continued existence of the organiza-tion, to introduce incentives to encourage long-term commitment, such as senior pricing discounts.289 The present proposal falls squarely in this category. In the immediate aftermath of the Deepwater Horizon disaster in 2010, BP was constrained to suspend dividend payments to share-holders shortly after the oil spill worsened, which probably wrought hardship on those shareholders that depended on them.290 The price of BP shares plummeted as investors expressed concern about the compa-ny’s ability to weather the storm.291 Assurance in the form of a pool of ascertainable assets to deal with the financial costs, if it existed, would have lessened the apprehension.

286 Senior securities broadly refer to debt and preferred stock. See, e.g., William W. Bratton, Venture Capital on the Downside: Preferred Stock and Corporate Control, 100 MICH. L. REV. 891, 914 (2002); George W. Dent, Jr., Stakeholder Governance: A Bad Idea Getting Worse, 58 CASE W. RES. L. REV. 1107, 1137 (2008); Jeffrey N. Gordon, The Mandatory Structure of Corpo-rate Law, 89 COLUM. L. REV. 1549, 1563 (1989). 287 See supra note 22 and accompanying text. 288 See id. An additional advantage to the corporation and other shareholders is that the acceptance of illiquidity by Class T holders demonstrates a level of confidence in the company and its stock that would be beneficial to the corporation and its stakeholders. See Edward B. Rock, Shareholder Eugenics in the Public Corporation 13 n.33 (Univ. of Penn. Inst. for Law and Econ., Research Paper No. 11-26, 2011), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1910681 (discussing the beneficial effect to corporations of shareholders willingly entering into an express agreement to restrict the transfer of their shares). 289 See Rey & Tirole, supra note 11, at 5. 290 See John Sauven, BP Should End the Oil Age Early, THE GUARDIAN (U.K.), Jul. 27, 2010, http://www.guardian.co.uk/commentisfree/cif-green/2010/jul/27/bp-end-oil-age-early. 291 Id.



B. Heightened Vulnerability of Class T Shareholders

Another strong objection is that holders of the Class T shares will

be exposed to greater vulnerability than the typical shareholder in the same company or elsewhere. Assuming a group of raiders or short-term-oriented investors launch a successful bid for control of Company X and thereafter start running the company aground, other sharehold-ers may cut their losses and dump their shares. The long-term share-holder who is locked into a ten-year commitment may be left with an empty bag. This outcome certainly puts the Class T shareholder in fi-nancial jeopardy that needs to be resolved to make investing in the shares worthwhile.

One response is that the long-term shareholder is an investor, who by definition has decided to take a risk and should be rewarded accord-ingly.292 Thus, if the company succeeds in the long run, she shares in the upside benefits. And if it fails, she absorbs the consequences. A related response is that the risk can be priced into the shares.

A different approach may be to protect Class T investors, for ex-ample, by inserting a provision that in the event of a major change in the structure of the company, Class T shareholders would be released automatically from their commitment and thereby entitled to liquidate their holdings. Those responsible for the major structural change may also be obligated to purchase the long-term shares at a premium before the transaction can be finalized. In that sense, this added bottle-neck to change in control will be similar to a poison pill in effect, if not in de-sign.293 It would be long-term-shareholder–centric, however, unlike the

292 See Rodrigues, supra note 1, at 1825. 293 For a good description of a shareholder rights plan, commonly known as the poison pill, and its effects, see Paul H. Edelman & Randall S. Thomas, Selectica Resets the Trigger on the Poison Pill: Where Should the Delaware Courts Go Next?, 87 IND. L.J (forthcoming 2012) (“[Poi-son pills] enable a target board to ‘poison’ a takeover attempt by making it prohibitively expen-sive for a bidder to acquire more than a certain percentage of the target company’s stock (until recently 15-20%).”); see also Lucian Arye Bebchuk, The Case Against Board Veto in Corporate Takeovers, 69 U. CHI. L. REV. 973 (2002) (discussing the effectiveness of the poison pill); Lucian Ayre Bebchuk et al., The Powerful Antitakeover Force of Staggered Boards: Theory, Evidence and Policy, 54 STAN. L. REV. 887, 904–05 (2002); Len Costa, The Perfect Pill: A Small Innovation that Transformed Corporate Takeovers, LEG. AFF. (March/April 2005) (ascribing the genesis of the poison pill to corporate lawyer, Martin Lipton); Guhan Subramanian, Bargaining in the Shadow of PeopleSoft’s (Defective) Poison Pill, 12 HARV. NEGOT. L. REV. 41, 42–43 (2007) (“It is widely believed that a poison pill, even a plain vanilla pill, is a ‘show-stopper’ against a hostile bidder because it severely dilutes an acquirer’s stake if triggered.”); Randall S. Thomas, Judicial Review of Defensive Tactics in Proxy Contests: When is Using a Rights Plan Right?, 46 VAND. L. REV. 503 (1993) (providing a historical overview of the emergence of the poison pill); Gina Chon, “Poi-son Pill” Lives as Airgas Wins Case, MARKETWATCH (Feb. 16, 2011), http://www.marketwatch.com/story/airgas-wins-poison-pill-case-against-air-products-2011-02-15-182800.



poison pill that was invented to cater to the interests of the board of directors.294 On that point, it would escape some of the scathing criti-cisms of the pill and enjoy support from some constituencies, such as some shareholder groups, that are not enamored of it.295

A final protective mechanism is to include an insurance compo-nent. As an exception to the nonhedging restriction mentioned earli-er,296 holders of Class T shares may be able to purchase an instrument akin to a credit default swap that allows them only in the instance of a takeover or similar fundamental change to protect themselves against loss.297 To make this class of shares attractive to some risk-averse inves-tors, the corporation may undertake to pay or reimburse the cost or otherwise maintain the insurance policy on their behalf.298

C. Difficulty Raising Funds

A critical challenge that the trust fund proposal faces is the ability

of any corporation to generate from the sale of shares the kind of funds needed to satisfy the claims of involuntary creditors in the event of a major catastrophe caused by the corporation’s activities or meet the huge amount required in some legislative reform proposals to evidence financial responsibility.299 There may only be a small pool of investors

294 See Shira Ovide, Marty Lipton: Why I Invented the Poison Pill, WALL ST. J. DEAL J. BLOG, Dec. 29, 2010, http://blogs.wsj.com/deals/2010/12/29/marty-lipton-why-i-invented-the-poison-pill/ (quoting Martin Lipton’s explanation that he invented the pill “to give boards of a target company a chance to ‘level the playing field’”). 295 See EDWARD JAY EPSTEIN, WHO OWNS THE CORPORATION? MANAGEMENT VS. SHARE-HOLDERS 31–39 (strongly criticizing the poison pill as shareholder disempowering and man-agement entrenching); Guido Ferrarini & Geoffrey P. Miller, A Simple Theory of Takeover Regulation in the United States and Europe, 42 CORNELL INT’L L.J. 301, 309 (2009). 296 See supra notes 90–91and accompanying text. 297 For a similar proposal, see Peter Conti-Brown, Solving the Problem of Bailouts: A Theory of Elective Shareholder Liability, 64 STAN. L. REV. (forthcoming 2012) (proposing a Shareholder Liability Swap (SLS) that guarantees an equity holder payment on the occurrence of the stated event, and noting that “an SLS is similar to a credit default swap, which pays a bondholder the value of the bond in the event the issuer of the bond defaults”); and Mark J. Flannery et al., Credit Default Swap Spreads as Viable Substitutes for Credit Ratings, 158 U. PA. L. REV. 2085 (2010). 298 This would be similar to policy taken out on behalf of directors. See James A. Fanto et al., Justifying Board Diversity, 89 N.C. L. REV. 901, 908 (2011) (stating that corporations purchase comprehensive directors’ and officers’ insurance policies that protect them in the execution of their functions). There is a slight possibility, however, that doing so would lessen shareholder’s interest in monitoring the corporation’s affairs. See Conti-Brown, supra note 297, at 27. 299 See Ronen Perry, The Deepwater Horizon Oil Spill and the Limits of Civil Liability, 86 WASH. L. REV. 1, 68 (2011) (noting calls to raise liability caps under the Oil Pollution Act in the aftermath of BP disaster); Bruce Alpert, Senate Vote on Energy Bill Delayed, Postponing Action on Moratorium, TIMES-PICAYUNE, Aug. 4, 2010, at A; Richard Epstein, BP Doesn’t Deserve a Liability Cap, WALL ST. J., June 16, 2010, at A21 (arguing against the statutory cap); Amy Hard-er, Begich, Landrieu Hunt For Compromise To Reid, GOP Bills, CONGRESS DAILY, July 28, 2010,



who are willing to commit funds of that magnitude for extended periods of time.300 It is a truism that patient capital is difficult to find.301 On a closer look, however, it may not be as difficult as it appears. Although BP issued a denial, there were reports a few months after the Deepwater Horizon incident that BP was scouting for major investors to replenish its coffers and avoid the prospects of a takeover by any of its principal competitors.302 An effort of that kind not only demonstrates the possi-bility of raising substantial amounts of money in a short period of time but could also be viewed as a de facto Class T offering. Certainly, any investor coming in at that juncture would demand some concessions and is not likely to rest content simply with the privilege of holding the company’s stock. It would be in the interest of management to under-take this kind of fundraising before any tragic incident when its bargain-ing hands are stronger—in line with the proposal here—instead of wait-ing for disaster to strike before embarking on the course, at a time that the company would invariably be negotiating from a weaker position.

D. Management’s Opposition

It is foolhardy to expect that managements across America would

be overly excited about this proposal.303 Any effort that seeks to share existing power is likely to evoke strong resistance from the current wielders. Getting management buy-in entails convincing managers that

available at 2010 WLNR 15015990 (reporting on some senators’ objection to an unlimited cap because it would drive small and medium size oil companies out of the competition for offshore drilling permits); Richard H. Thaler, Recipes for Ruin, in the Gulf or on Wall Street, N.Y. TIMES, June 11, 2010, at BU4. 300 See Jeff Schwartz, Fairness, Utility, And Market Risk, 89 OR. L. REV. 175, 214–15 (2010) (stating that because the law requires mutual funds to honor redemption requests by investors almost immediately, mutual funds necessarily tend to be liquid); see also Jeffrey N. Gordon, Institutions as Relational Investors: A New Look at Cumulative Voting, 94 COLUM. L. REV. 124, 130 (1994) (“The shifting needs and investment preferences of the ultimate beneficial owners of institutional claims also militate against an institution’s holding a large, potentially illiquid stock position or committing to an indefinite holding period in any one company.”). 301 Thomas Kelley, Law and Choice of Entity on the Social Enterprise Frontier, 84 TUL. L. REV. 337, 355 (2009); see also Bebchuk, supra note 118, at 347 (“In the aftermath of the finan-cial crisis of 2008, obtaining capital that can be locked in for several years in funds dedicated to buying housing-related loans and securities is difficult.”). 302 Matt Scuffham & Shaheen Pasha, BP Launches Search for New Investors: Report, REUTERS, July 5, 2010, available at http://www.reuters.com/article/2010/07/04/us-bp-new-investors-idUSTRE6630NG20100704; see also James Herron, BP Won’t Issue New Equity to Cover Spill Costs, THE STUART SMITH BLOG (July 6, 2010), http://www.stuarthsmith.com/bp-wont-issue-new-equity-to-cover-spill-costs. 303 See Orenbach, supra note 242, at 415 (“Corporate executives typically believe they de-serve autonomy and control of their company. Measures that intrude upon their authority and influence are likely to be resented and actively opposed, even by executives of high moral recti-tude.” (internal quotation marks omitted)).



this arrangement is not only beneficial to the corporation, but also holds benefits for the managers. Management may evince interest in the pos-sibility of using the Class T structure as a basis for obstructing a takeo-ver bid. That is, an incidental benefit of protecting long-term sharehold-ers would be the room it provides managers to ward off insurgents. This additional arsenal presents an interesting incentive to managers.

The proposed arrangement is also attractive because it presents a corporate management focused on long-term strategy with a new cadre of allies that are committed for the long haul and have an incentive to ensure that short-term maneuvers do not jeopardize the company’s long-run prospects.304 Managers have long anchored their objection to greater shareholder involvement in corporate governance on the fact that many of these shareholders are transient investors who demon-strate little interest in the corporation’s long-term future or act like owners in the true sense of the term.305 The situation and style of these investors sharply contrast with those of the small business proprietor or long-term investor of yore, thus making it difficult to support their claim to an enhanced status.306 Class T shares reintroduce a proprietary approach to investment, thus taking away this complaint. In view of the foregoing, the revised trust fund proposal has a good chance of eliciting management cooperation and overcoming the elusive quest for share-holder-management cooperation to enhance long-term value.307 As

304 See Mark J. Roe, A Political Theory of American Corporate Finance, 91 COLUM. L. REV. 10, 14 (1991) (“Management would more willingly reveal proprietary information to the large long-term shareholder, who has the incentive to maintain secrecy. The large shareholder would protect secrets and protect managers from outsiders who would second guess truly profitable long-run investments.”). 305 Ball, supra note 126, at 196 (“This perspective is widely shared by corporate manage-ment, which has long viewed institutional investors as ‘“transient shareholders” and not “own-ers” in the real sense.’ Pension funds, according to management, do not deserve a larger role in corporate governance, because they are not concerned with the long-term future of the corpo-rations in which they invest.”); see also Estreicher, supra note 131, at 543–45 (stating that shareholders in public corporations do not behave like owners, have no enduring relationship with the underlying business, and are generally drawn to shares because of the liquidity it offers compared to other asset classes). 306 Lipton & Rosenblum, supra note 131, at 204 (stating that self-interest based on largely immobile ties and need for survival propelled a proprietor to grow and keep the business suc-cessful for the long term, whereas the modern owner in a public corporation, with separation of ownership and control, “highly liquid stake and betting-slip mentality,” could not be counted on to be automatically dedicated to the long-term health of the business); Tara J. Wortman, Unlocking Lock-In: Limited Liability Companies and the Key to Underutilization of Close Corpo-ration Statutes, 70 N.Y.U. L. REV. 1362, 1368 (1995) (contrasting the nature of investment in public and close corporations and noting that “governance and livelihood are strongly at stake in a close corporation”). 307 Gordon, supra note 300, at 129 (“A credible commitment to an extended holding period similarly increases management’s willingness to engage because it indicates that the investor shares management’s desired time-frame for the measurement of success.”); Lipton & Rosenblum, supra note 131, at 233 (“Only when these stockholders redefine the success of their investment in terms of long-term operating returns, rather than takeover or other short-term



shareholders indicate interest in engagement with management to en-trench a long-term approach, corporate managers need to respond posi-tively.308 Indeed, a common and legitimate assumption is that managers are more likely to cooperate with long-term shareholders and share proprietary information with them.309

Generally, the level and length of shareholder commitment to the company is directly proportional to the extent of the management’s cooperation in treating shareholders as significant participants in the corporate enterprise.310 The reverse is also true: if the management does not trust shareholders with good quality information and an appropri-ate voice in governance, shareholders are unlikely to make longer capital commitments to the company, exiting at the earliest opportunity.311 This proposal presents a chance for management and a core base of shareholders who have a long-term disposition to give effect to their “need to coalesce around the appropriate long-term value creating strat-egies.”312

The call for engagement and cooperation does not end with share-holders and management. Beneficiaries, i.e., the investing public that own stock through institutional intermediaries, naturally have a long-term perspective.313 Investors in pension and mutual funds have an im-portant role to play in the successful entrenchment of long-termism “by demanding a longer-term perspective from [these institutions] that they have entrusted with their money.”314 Already, initiatives are emerging to

premiums, will increasing their power to influence directors and managers promote the long-term health of the corporation.”). 308 Gordon, supra note 300, at 129 (noting that managers should not mistake investors’ patient commitment of capital for a vow of passivity); see also Silvers, supra note 152, at 88 (calling for a deal uniting CEOs, workers, and long-term investors on the understanding that CEOs and boards should be meaningfully accountable to investors with a long time horizon). 309 See Roe, supra note 126, at 649–50 (“[M]anagers should more willingly reveal proprietary information to major long-standing shareholders than they do to the market as a whole [and] [t]his tightening of the bonds between managers and stockholders could well be beneficial.”). 310 DEAN KREHMEYER ET AL., CFA CTR. FOR FIN. MARKET INTEGRITY/BUS. ROUNDTABLE INST. FOR CORPORATE ETHICS, BREAKING THE SHORT-TERM CYCLE (2006), available at http://www.cfapubs.org/doi/pdf/10.2469/ccb.v2006.n1.4194. 311 Id.; see also Jacobs, supra note 1, at 10 (“Lack of communication prevents investors from understanding management’s long term goals and objectives.”). 312 Garten, supra note 129, at 632 (discussing the “forging of temporary alliances between managers and permanent institutional owners”); Schacht, supra note 310, at 599; see also Lisa M. Fairfax, Government Governance and the Need to Reconcile Government Regulation with Board Fiduciary Duties, 95 MINN. L. REV. 1692, 1711 (2011) (“[R]eforms aimed at enhancing shareholder power may lead to a climate of more active engagement between shareholders and directors.” (citation omitted)). 313 See Strine, supra note 18, at 1082; see also Ho, supra note 269, at 64 (noting that pension fund beneficiaries have a long-term perspective). 314 A Different Class, supra note 212.



keep beneficiaries informed and involved.315 The fusion of the energy of active long-term shareholders, responsive management, and vigilant beneficiaries is expected to yield positive results and avert disasters asso-ciated with a short-term orientation.316

E. Superfluity

Another objection focuses on what could be considered a fixation

with equity securities. Critics would argue that there is no real distinc-tion between equity and debt securities and therefore emphasis should be about stimulating long-term investing, not necessarily long-term shareholding.317 Another variant of the criticism dwells on the point that those interested in holding securities for a long time can scout for cor-porate bonds, debentures, preferred stock, or a bucket of instruments specifically designed for long-term investors.318 In other words, there could be legitimate questions about the desirability of creating and ex-perimenting with a new class of securities when existing debt and equity securities can serve the purpose. A corporation may issue, and investors may purchase, long-term bonds, debentures, and preferred stock. This argument is further strengthened by the fact that holders of these securi-ties can be positioned to participate in corporate governance or play a key monitoring role under contracts with the corporation.319 315 See Ruth Sunderland, The Responsible Investment Revolution Begins Here, THE OBSERV-ER, Feb. 21, 2010, at 50 (discussing how pension fund beneficiaries can make their views count in the corporate governance debate). 316 This indirect participation in corporate governance is imperative in view of the fact that the “retail” investor involvement can only be limited seeing that the individuals have already engaged the institutions to represent them in relating with the portfolio companies. See Eric John Finseth, Shareholder Activism by Public Pension Funds and the Rights of Dissenting Em-ployees Under the First Amendment, 34 HARV. J.L. & PUB. POL’Y 289, 316–23 (2011) (arguing that employees that disagree with the positions taken by pension funds in particular corporate matters should have the right to limit pension funds’ voting to the extent of the dissenting employees’ holdings in the fund). 317 See P.M. Vasudev, Law, Economics, and Beyond: A Case for Retheorizing the Business Corporation, 55 MCGILL L.J. 911, 940 (2010) (“Economic theory does not recognize any signifi-cant difference between share capital (equity) and debt. They are bracketed together as sources of corporate finance.”); see also Adam Feibelman, Commercial Lending and the Separation of Banking and Commerce, 75 U. CIN. L. REV. 943, 948 (2007) (demonstrating that equity and debt investments are functionally similar). But see Vasudev, supra note 317, at 942–43 (stating that debt is more perilous and destabilizing to the corporation than equity). 318 See Rodrigues, supra note 1, at 1862–65 (identifying target date funds as market-based investment vehicles that can cater to the interests of long-term investors). For more on target date funds, see Jill E. Fisch, Rethinking the Regulation of Securities Intermediaries, 158 U. PA. L. REV. 1961, 2022–24 (2010); Jeffrey S. Puretz, Target Date Funds, in A.L.I.-A.B.A. CONTINUING LEGAL EDUCATION: CONFERENCE ON LIFE INSURANCE COMPANY PRODUCTS: CURRENT SEC, FINRA, INSURANCE, TAX, AND ERISA REGULATORY AND COMPLIANCE ISSUES 607 (2009). 319 See JAMES J. HANKS, JR., MARYLAND CORPORATE LAW § 7.9, at 246 (perm. ed., rev. vol. 2010); Douglas G. Baird & Robert K. Rasmussen, Private Debt and the Missing Lever of Corpo-



From the company’s perspective, bonds and debentures are con-sidered cheaper because interests paid on them are tax-deductible, as opposed to dividends.320 Debt would also allow managers (and indirect-ly shareholders) to gamble with other people’s money, with little risk to themselves.321 Also, equity holders stand a chance of sharing in the up-side potential of the company, whereas, as soon as the debt is liquidated, debt holders have no future claim on the company.322 In that case, issu-ing more equity dilutes the interest of existing shareholders the way debt does not.323 From an investor’s perspective, equity is also riskier than debt since the debt holder is guaranteed regular interest payments and a full repayment of the debt.324 All of the above factors make debt securi-ties a more attractive option for a company looking for long-term capi-tal and investors interested in providing it, while also enjoying the favor of existing shareholders who do not want to expand the circle of benefi-ciaries of future corporate growth.

rate Governance, 154 U. PA. L. REV. 1209 (2006); Donald S. Bernstein & Amit Sibal, Current Developments: Fiduciary Duties of Directors and Corporate Governance in the Vicinity of Insol-vency, in 23RD ANNUAL CURRENT DEVELOPMENTS IN BANKRUPTCY AND REORGANIZATION 676 (2001); Crawford, supra note 242, at 933 (“[Creditors] have both the ability to require signifi-cant and ongoing disclosures about the assets and liabilities of the company and the incentive to challenge the CEO in the interest of enhancing the long-term health and value of the compa-ny.”); Lawrence E. Mitchell, The Puzzling Paradox of Preferred Stock (And Why We Should Care About It), 51 BUS. LAW. 443, 448 (1996); Eric G. Orlinsky, Corporate Opportunity Doctrine and Interested Director Transactions: A Framework for Analysis in an Attempt to Restore Pre-dictability, 24 DEL. J. CORP. L. 451, 498 (1999); D. Gordon Smith, Independent Legal Signifi-cance, Good Faith and the Interpretation of Venture Capital Contracts, 40 WILLAMETTE L. REV. 825, 844 (2004); Jeffrey S. Stamler, Arrearage Elimination and the Preferred Stock Contract: A Survey and a Proposal for Reform, 9 CARDOZO L. REV. 1335, 1351 (1988); Frederick Tung, Leverage in the Board Room: The Unsung Influence of Private Lenders in Corporate Governance, 57 UCLA L. REV. 115 (2009). 320 Roberta Mann, Is Sharif’s Castle Deductible?: Islam and the Tax Treatment of Mortgage Debt, 17 WM. & MARY BILL RTS. J. 1139, 1165 (2009); Katherine Pratt, The Debt-Equity Distinc-tion in a Second-Best World, 53 VAND. L. REV. 1055, 1061 (2000). 321 Jensen & Meckling, supra note 196 (discussing the agency costs of raising capital through debt). 322 Meredith R. Conway, With or Without You: Debt and Equity and Continuity of Interest, 15 STAN. J.L. BUS. & FIN. 261, 289 (2010) (“The traditional label of equity applies to an instru-ment held by a shareholder in a corporation, which bears the risk of the corporation but also reaps the rewards—greater risk for potentially greater reward. Conversely, the traditional debt holder is typically given more of a guarantee in his instrument and more protection that he will be paid back. Further, the debt holder typically receives a fixed return on his investment. How-ever, less risk often comes at the cost of limited opportunity to share in the growth of the cor-poration.” (citations omitted)). 323 ROBERT W. HAMILTON & RICHARD D. FREER, THE LAW OF CORPORATIONS IN A NUT-SHELL 266 (6th ed. 2011) (“Existing shareholders may worry when the corporation issues new stock to others, because their interests in the business will be diluted.”). Dilution may be miti-gated by preemptive rights, which entitles existing shareholders to be issued a proportionate number of shares in the new issue to maintain the percentage of their holding. However, such right is unlikely to exist in many public corporations. 324 Conway, supra note 322; Hamilton & Freer, supra note 323, at 267, 269.



Debt securities, however, lack the needed lock-in component that some companies need.325 For a company that needs immediate cash for on-going operations and continued growth, equity may be more favora-ble because interest on debt is regularly scheduled and needs to be paid out regardless of net income,326 while no obligation to pay dividends arises when the company is not profitable.327 Moreover, even when the company is profitable, it may still choose not to pay dividends to com-mon shareholders and those preferred stockholders that have not bar-gained for an automatic right to dividends in the event of profitability.328 Issuing debt also does not remove the constraint that managers face when shareholder’s transient investing puts pressure on managers to manage for the short-term.329 There remains the need to get a critical mass of shareholders that are determined to hold stock for a long term and thereby act as a countervailing force to short-term trading.330 Debt and preferred stock cannot address that issue for management. 325 See Erik F. Gerding, Code, Crash, and Open Source: The Outsourcing of Financial Regula-tion to Risk Models and the Global Financial Crisis, 84 WASH. L. REV. 127, 196 (2009) (“Equity has other advantages for issuers. First, derivatives, options and debt instruments allow counter-parties to transfer or terminate their bearing of risk through the use of assignment provisions, margin calls and redemption provisions. By contrast, equity has the virtue of being what bank-ing scholars call ‘patient capital.’ Capital raised through equity is locked into a company for a longer time, increasing its capacity to absorb risk.” (citation omitted)); Vasudev, supra note 317, at 933 (“Shareholders’ funds represent the more stable portion of a corporation’s capi-tal . . . .”). 326 There are exceptions to this rule. See HAMILTON & FREER, supra note 323, at 271 (“Not all debt instruments carry a fixed interest rate. Some corporations have issued ‘income bonds,’ in which the obligation to pay interest is conditioned on adequate corporate earnings. Some-what rarer are ‘participating bonds,’ with which the amount of interest increases or decreases with corporate earnings.”). In many instances, a corporation would prefer to solve immediate cash needs through short-term debt, while reserving equity offerings mainly for capital invest-ments. 327 Barring exceptional circumstances, the declaration of dividends is entirely at the discre-tion of the directors. See Margaret M. Blair, Reforming Corporate Governance: What History Can Teach Us, 1 BERKELEY BUS. L.J. 1, 26 n.89 (2004) (“Under case law dating back to 1868, shareholders have not had the legal right to receive any dividend at all unless it was declared by the directors.”); Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919) (discussing one such exception, to wit, where there has been a huge accumulation of profits); Gottfried v. Gottfried, 73 N.Y.S.2d 692 (Sup. Ct. 1947); Patton v. Nicholas, 279 S.W.2d 848 (Tex. 1955); see also Daniel R. Fischel, The Law and Economics of Dividend Policy, 67 VA. L. REV. 699, 700 (1981) (stating that the “legal rules giving management virtually unlimited discretion in making the dividend decision maximize shareholder welfare” in public corporations). 328 See SHADE, supra note 86, at 326 (stating that unlike bondholders, preferred stockholders do not have a right to be paid dividends and that the decision as to whether to pay dividends to common and preferred stockholders lies at the discretion of the board of directors). 329 See Lord Myner’s Remarks, supra note 132, at 244 (“[I]nvestors’ emphasis on short-term return communicates itself to the thinking of business leaders who feel obligated to think and act short term—perhaps not as short as the perspective of fund managers, but shorter than many corporate leaders believe to be optimal.”). 330 See NYSE REPORT, supra note 15, at 2 (articulating the importance of establishing rela-tionships with a core base of long-term oriented investors for accomplishing the board’s job in creating long-term value); see also ROBERT A.G. MONKS & NELL MINOW, POWER AND AC-COUNTABILITY 243–44 (1991).



From the shareholder’s perspective, while more equity has a dilu-tive effect, more debt also somewhat imperils the interests of existing equity holders because in the event of liquidation or bankruptcy, debt holders stand in priority over equity holders.331 Moreover, it is normal for an investor to have a healthy mix of securities or assets that includes equity, a fact that is made more significant with the current quest for an investment vehicle designed for long-term shareholders.332 Some people simply may want to own a piece of an enterprise, not just lend money to it.333 Further, long-term common shareholders are the most vulnerable of the vulnerable risk bearers and therefore in a more plausible position than debtholders and preferred stockholders to promote the long-term health of the corporation.334 Finally, common shareholders are the only corporate constituents with powers legally built into the corporate struc-ture to participate in governance—such as voting on fundamental trans-actions and in the election or removal of directors.335 Other stakeholders obtain their rights by contract.336 Thus, common shares fit more neatly into the objective sought here, that is, investors who commit for a long time but also are properly positioned to monitor the managers of the investment.337

331 Manuel A. Utset, Complex Financial Institutions and Systemic Risk, 45 GA. L. REV. 779, 804 n.115 (2011); see also Ronald J. Gilson, Controlling Family Shareholders in Developing Countries: Anchoring Relational Exchange, 60 STAN. L. REV. 633, 647 (2007). 332 See supra notes 231–33 and accompanying text. 333 See Richard A. Booth, The Promise of State Takeover Statutes, 86 MICH. L. REV. 1635, 1644 n.32 (1988) (“There are other reasons for owning stock besides purely passive invest-ment—for example, in order to control and manage the company or perhaps in order to ce-ment a customer or supplier relationship.”). 334 Donald C. Langevoort, Capping Damages for Open-Market Securities Fraud, 38 ARIZ. L. REV. 639, 649–50 (1996) (illustrating one instance of the vulnerability of long-term investors); Lawrence E. Mitchell, The ‘Innocent Shareholder’: An Essay on Compensation and Deterrence in Securities Class-Action Lawsuits, 2009 WIS. L. REV. 243, 246 (examining the argument that long-term investors are vulnerable and, thus, “most in need of protection”). But see LYNNE L. DALLAS, LAW AND PUBLIC POLICY: A SOCIOECONOMIC APPROACH 479–522 (2005) (examining the vulnerability of employees vis-à-vis shareholders, especially since diversification of shares reduces shareholder exposure to risk). 335 See Ho, supra note 269, at 376–77; Vasudev, supra note 317, at 933 (“The shareholder capital’s greater exposure to risk and the shareholders’ proprietary position are the theoretical justifications for the powers that shareholders have in corporate law. These justifications also explain the absence of similar powers for creditors of all varieties, including bondholders, lending banks, and vendors who sell goods or services on credit.”). 336 See, e.g., Vasudev, supra note 317, at 933 (“Creditors, whose capital is also tied up in corporations, have no statutory powers of control . . . .”); Baird & Rasmussen, supra note 319, at 1212 (stating that creditors have acquired extensive control rights by contract). 337 See Feibelman, supra note 317, at 944 (lamenting that notwithstanding creditor activities that could be described as monitoring or managerial discipline, observations about creditor participation in control or governance “are still surprisingly peripheral to prominent accounts of corporate law and corporate governance”).



F. Unreasonable Restraint on Alienation

A core characteristic of the corporate form, especially public cor-

porations, is the free transferability of equity stakes.338 Restraints on alienation of shareholder interest in a corporation are permissible pro-vided they meet the requirements of reasonableness and conspicuous-ness.339 An absolute restraint on alienation is per se unreasonable and is void as against public policy.340 It may be argued that the restriction on transfer of Class T shares comes close to being an absolute restraint. But the arrangement does not cross the line into absolute prohibition. Hold-ers of Class T stock are not permanently barred from alienating it, only for a certain period of time, after which they may sell the shares back to the company or convert them into other securities. From that angle, it resembles resale restriction agreements that govern the initial sale of homes and bind homeowners to refrain from selling their homes within a number of years after the purchase.341 It also shares similarities with the restricted stock or stock option plans that have been proposed to steer managers away from speculative influences and elicit long-term commitment.342

G. Shareholder Empowerment and Agency Costs

There is a continuing debate on the desirability or otherwise of

shareholder empowerment, a debate that has taken increasing signifi-cance with the recent global financial crisis.343 Without question, the

338 ROBERT A. RAGAZZO & DOUGLAS K. MOLL, CLOSELY HELD BUSINESS ORGANIZATIONS: CASES, MATERIALS AND PROBLEMS 276 (2006). 339 Allen v. Biltmore Tissue Corp., 141 N.E.2d 812 (N.Y. 1957); Ling & Co., Inc. v. Trinity Sav. & Loan Ass’n., 482 S.W.2d 841 (Tex. 1972). 340 For the view that stock transfer restrictions should not be strictly construed, see Bruns v. Rennenbohm Drug Stores Inc., 442 N.W.2d 591, 596 (Wis. Ct. App. 1989). 341 See generally Michael F. Keeley & Peter B. Manzo, Resale Restrictions and Leverage Con-trols, 1 SPG J. AFFORDABLE HOUS. & CMTY. DEV. L. 9 (1992); James J. Kelly Jr., Homes Afforda-ble for Good: Covenants and Ground Leases As Long-Term Resale-Restriction Devices, 29 ST. LOUIS U. PUB. L. REV. 9, 23–25 (2009); Laura M. Padilla, Reflections on Inclusionary Housing and a Renewed Look at Its Viability, 23 HOFSTRA L. REV. 539 (1995). 342 See supra note 17 and accompanying text. 343 William W. Bratton & Michael L. Wachter, The Case Against Shareholder Empowerment, 158 U. PA. L. REV. 653 (2010) (arguing that shareholder empowerment could not have prevent-ed the financial crisis of 2008, contrary to the claims of its proponents); Lisa M. Fairfax, The Model Business Corporation Act at Sixty: Shareholders and Their Influence, 74 LAW & CONT. PROBS 19 (2011) (providing a historical overview of the increase in shareholder influence); Daniel R. Fischel, The Corporate Governance Movement, 35 VAND. L. REV. 1259, 1260 (1982) (criticizing the movement toward greater shareholder participation); Gulinello, supra note 202,



issue is quite complicated.344 For instance, while some long-standing critics of investor short-termism are quite vocal in their opposition, they do not view further shareholder empowerment as the panacea.345 In fact, they rather tend to believe that the solution to the problems associated with it lie in substantially disempowering shareholders.346 Professor Lawrence Mitchell has argued that shareholder power propels directors toward pleasing stockholders and that freeing directors from sharehold-er oversight would enable them to manage responsibly and with a focus on the long term.347 Yet, these arguments could be construed as opposi-

at 564–71 (presenting arguments in favor of, and against, shareholder empowerment); Levitt, supra note 138, at 17 (arguing for increased shareholder voice as a tool for healing the mistrust in the markets arising from the 2008 financial crisis and for enhancing management accounta-bility); Fenner Stewart, Jr., Berle’s Conception of Shareholder Primacy: A Forgotten Perspective for Reconsideration During Rise of Finance, 34 SEATTLE U. L. REV. 1457, 1493 (2011) (“[I]nvestor empowerment is evolving into a new and powerful layer of global governance that may not adequately meet social needs.” (citation omitted)); Fenner Stewart, Jr., The Place of Corporate Lawmaking in American Society, 23 LOY. CONSUMER L. REV. 147, 163–64 (2010) (reviewing the positions of both sides of the debate); see also Lucian Ayre Bebchuk, The Case for Increasing Shareholder Power, 118 HARV. L. REV. 833 (2005) (discussing the marginalization of shareholders under corporate law and proposing changes to reverse the situation); cf. Bain-bridge, Shareholder Disempowerment, supra note 204, passim; Gelter, supra note 205, at 194 (urging caution in proceeding with proposed legal reforms to increase shareholder influence); Martin Lipton & William Savitt, The Many Myths of Lucian Bebchuk, 93 VA. L. REV. 733 (2007); Lynn A. Stout, The Mythical Benefits of Shareholder Control, 93 VA. L. REV. 789 (2007). 344 See, e.g., Rose, supra note 210, at 1416–17 (stating that while shareholder empowerment is often characterized as a form of democratic reaction and resistance to imperial CEOs and their collaborators on the board of directors, “a reactive reallocation of power in the name of corporation democracy may result in oligarchies in which managers and influential sharehold-ers share power and occasionally act at the expense of passive shareholders and other corporate constituencies”). 345 For instance, Martin Lipton is a strong opponent of short-termism, but also strongly opposes shareholder empowerment. See, e.g., Martin Lipton & Paul K. Rowe, The Inconvenient Truth About Corporate Governance: Some Thoughts on Vice-Chancellor Strine’s Essay, 33 J. CORP. L. 63, 63 (2007); Stephen M. Bainbridge, Shareholder Activism in the Obama Era (UCLA Sch. of Law, Law-Econ. Research Paper No. 09-14, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1437791 (arguing that shareholder empowerment is inefficient); cf. Bebchuk, supra note 107, at 678 (arguing that shareholder empowerment is efficient); Jen-nifer G. Hill, The Rising Tension Between Shareholder and Director Power in the Common Law World, 18 CORP. GOVERNANCE: AN INT’L REV. 344 (2010) (discussing the divergent viewpoints on shareholder empowerment); James McConvill, Shareholder Empowerment as an End in Itself: A New Perspective on Allocation of Power in the Modern Corporation, 33 OHIO N.U. L. REV. 1013 (2007) (stating that shareholder empowerment is justified even on non-financial grounds because shareholders would be happier with participation than passivity). 346 See, e.g., LAWRENCE MITCHELL, CORPORATE IRRESPONSIBILITY: AMERICA’S NEWEST EXPORT 119 (2001); John Haberstroh, Activist Institutional Investors, Shareholder Primacy, and the HP-Compaq Merger, 24 HAMLINE J. PUB. L. & POL’Y 65, 95 (2002) (discussing the conten-tion that empowering institutional investors is not the right approach to entrenching a long-term perspective in corporations). 347 MITCHELL, supra note 346, at 101, 119; see also id. at 3 (stating that accomplishing corpo-rate long-term focus requires freeing managers from stockholder and capital markets pres-sures). But see Michael Ilg, An Essay on Social Responsibility and the Limits of the Corporate Form: A Perspective on Environmental Protection, 17 J. ENV. L & PRAC. 115, 130–33 (2007)



tion to shareholder power when shareholders are short-term oriented and that some of the objections would evaporate if shareholders are being empowered only to work for the long-term value of the corpora-tion.348 Shareholder disempowerment is also supported on efficiency grounds, with financial theorists reasoning that shareholders should not influence firm decisions because the domain of shareholders is risk-bearing, not decision-making.349

Opposition to shareholder empowerment is further strengthened by the fact of shareholder limited liability and liquidity.350 That being the case, shareholders that have taken additional risk by surrendering a significant measure of their liquidity ought not to be treated in the same manner as those who have not made similar sacrifices. Professor Lynne Dallas’ cogent argument is right on point: “All shareholders should not be disempowered or disenfranchised because of the behavior of some of their number.”351 Simply put, because these long-term shareholders have more skin in the game, their position and views would be met with greater trust and treated with more seriousness.352 Besides, the idea of complete freedom from shareholder oversight is not only utopian, it is also not necessarily in the best interests of the corporation, especially as it allows managers almost a free rein to engage in actions that primarily

(presenting a brief critique of Professor Mitchell and this management elite model of corporate governance). 348 See, e.g., Hayden & Bodie, supra note 266, at 2092–95, 2116–17; Martin Lipton, Corporate Governance in the Age of Finance Corporatism, 136 U. PA. L. REV. 1, 36 (1987) (“Although shareholders may be able to liquidate their investments quickly, those who choose to invest for the long-term are surely deserving of management consideration.”); John F. Olson, Is the Sky Really Falling? Shareholder-Centric Versus Director-Centric Corporate Governance, 9 TENN. J. BUS. L. 295, 299 (2008) (“[T]he movements toward shareholder-centrism, director insecurity, and enhancing the power of activists who try to change management, might well have increased the pressure on management to produce ‘good’ short-term financial results each quarter, rather than to focus on longer-term strategy and thoughtful assessment of risks.”). But see Lawrence E. Mitchell, The Legitimate Rights of Public Shareholders, 66 WASH. & LEE L. REV. 1635 (2009) (arguing that public shareholders’ right to vote should be eliminated); Lawrence E. Mitchell, On the Direct Election of CEOs, 32 OHIO N.U. L. REV. 261, 263 (2006) (arguing for ending of share-holder exclusivity on the right to vote and for extending the right to creditors and employees). 349 Johnson, supra note 137, at 617 (addressing the question about the rationale for “making it easier for investment managers, who may be experts in investing but certainly not at corpo-rate governance, to influence the make-up of boards and managements”); Mark J. Roe, Some Differences in Corporate Structure in Germany, Japan, and the United States, 102 YALE L.J. 1927, 1933 (1993). 350 Dennis J. Block et al., Proxy Contests and Institutional Investors, in INSTITUTIONAL IN-VESTORS: PASSIVE FIDUCIARIES TO ACTIVIST OWNERS 161, 193, 217 attachment C (PLI Corpo-rate Law & Practice, Course Handbook Ser. No. 704, 1990) (stating that the privileges of limited liability and liquidity enjoyed by shareholders dictate that they be less aggressive in seeking to be more directly involved in corporate governance). 351 Dallas, supra note 251, at 65. 352 Stephen Bainbridge, The USA’s Creditworthiness, PROFESSORBAINBRIDGE.COM (Jan. 13, 2011, 12:02 PM) http://www.professorbainbridge.com/professorbainbridgecom/2011/01/the-usas-creditworthiness.html (“I always lean towards trusting folks with skin in the game.”).



benefit them.353 The key to ensuring effective governance is balance in the allocation of powers between shareholders and managers, not tilting it to favor one side over the other.354

One additional concern with increasing the power of institutional investors in corporate governance is that it would result in identical or higher agency costs that characterize company directors and conse-quently have provided the rationale for proposing greater empower-ment of shareholders.355 In other words, there would be a transition from separation of ownership from control to separation of ownership from ownership.356 One proposed solution for reducing or eliminating the resulting agency costs is to more closely align the interests of inves-tors and fund managers through a more personally rewarding compen-sation scheme.357

Shareholder empowerment concerns are exacerbated by the fact that conflicts of interests abound in the universe of potential Class T shareholders. Unlike the case a few decades ago, when individual share ownership held sway, today’s equity investment sphere is dominated by 353 See Sanford M. Jacoby, Finance and Labor: Perspectives on Risk, Inequality, and Democ-racy, 30 COMP. LAB. L. & POL’Y J. 17, 26 (2008) (“[G]iving shareholders a larger role in corpo-rate governance promotes efficiency. When shareholders lack influence, executives build over-staffed empires, pay themselves too much and, to avoid conflict and enjoy a quiet life, overpay and coddle employees. When shareholders gain power, the effects are attenuated.”); Julian Velasco, Taking Shareholder Rights Seriously, 41 U.C. DAVIS. L. REV. 605, 637 (2007) (stating that not only would insulation from shareholder accountability be an enormous price to pay to achieve director focus on the long term, it is questionable that the reduced accountability lead to directors adopting a long-term perspective). 354 See Fisch, supra note 20, at 48 (“Critically, to function well, corporate governance must maintain a balance between managerial and shareholder power. Excess managerial power increases managerial agency costs. Excess shareholder power creates inefficiency and may, in some cases, create intra-shareholder agency costs.” (citation omitted)). 355 Stephen M. Bainbridge, The Politics of Corporate Governance, 18 HARV. J.L. & PUB. POL’Y 671, 722–24 (1995); Bratton & Wachter, supra note 343, at 662; Strine, supra note 24, at 687 (stating that institutional intermediaries like mutual and pension funds have their own agency costs and often evidence a misalignment of interests between them and the individuals indirect-ly investing in stocks through them). For an examination of a similar issue in a slightly different context, see Roe, supra note 126, at 1931 (“Institutional ownership discourages entrepreneurial leadership, risks conflicts of interest, and may make adaption to change more difficult. Moreo-ver, agency problems may simply shift from the firm to the intermediary.”). 356 See Strine, supra note 80, at 6–7 (cautioning against this problem and calling for scholarly efforts in addressing it); see also Jill E. Fisch, Securities Intermediaries and the Separation of Ownership from Control, 33 SEATTLE U. L. REV. 877, 881 (2010) (“The separation of ownership and control within the intermediary is analogous to that identified by Berle and Means. With respect to the underlying portfolio companies then, intermediation creates two levels of separa-tion. The intermediary’s separation of ownership from control creates a second layer of agency costs.” (citations omitted)); Strine, supra note 18, at 1083–84 (“[T]here are forceful arguments that support doing more to constrain the ability of institutional investors to exploit the separa-tion of ownership from ownership for their own ends.”). For a discussion of concerns of benefi-ciaries with institutional investors, see Peter Clapman, Walking the Walk on Corporate Govern-ance, PENSIONS & INVESTMENTS (Aug. 6, 2007), http://www.pionline.com/article/20070806/PRINTSUB/70803016. 357 Illig, supra note 258, at 253.



institutions, including banks, insurance companies, public and private pension funds, hedge funds, and mutual funds that pool resources from individuals and invest on their behalf.358 The public recognizes and ex-pects the role large institutional investors can play in advancing strategic long-termism.359 According to an Australian government report, a di-rector may not easily be persuaded that it is in her true self-interest to jettison the market’s short-term expectations in favor of valuable pro-jects that do not provide profit in the near-term.360 But the influence and direct action of longer-term institutional investors may embolden the director to adopt a socially and environmentally responsible ap-proach to governance.361

Nonetheless, institutional conflicts of interest threaten the realiza-tion of that expectation. For instance, while mutual funds, private pen-sion funds, bank trusts, and insurance companies may hold sizeable percentages and some do invest for a longer-term than most investors, they are hobbled by conflicts of interests and fear of economic loss.362 Public pension funds hold significant blocks of shares, are generally free from conflicts of interests, and typically invest for a long term. Moreo-ver, their beneficiaries expect to survive their postretirement years through their pension fund investments and presumably would prefer their trustees and asset managers to make investment decisions that

358 See Roberta S. Karmel, Mutual Funds, Pension Funds, Hedge Funds and Stock Market Volatility—What Regulation by the Securities and Exchange Commission is Appropriate?, 80 NOTRE DAME L. REV. 909, 909 (2005) (stating that about seven decades ago, individuals consti-tuted the bulk of investors in the public securities markets but that the situation has changed today with the dominance of institutions investing on behalf of their beneficiaries); see also John C. Bogle, Reflections on “Toward Common Sense and Common Ground?”, 33 J. CORP. L. 31, 31 (2007) (stating that financial intermediaries currently hold approximately seventy-four percent of the stock of U.S. corporations); Fisch, supra note 356, at 879–80 (“By 2009, institu-tional investors owned 50% of total U.S. equities, and retail investors (the household sector) held only 38%. Institutions own a higher percentage of the largest corporations; at the end of 2007, institutions owned 76.4% of the largest 1,000 corporations.” (citation omitted)). 359 Tonello, supra note 229, at 13; see also PAUL MYNERS, INSTITUTIONAL INVESTMENT IN THE UNITED KINGDOM: A REVIEW 10–11 (2001), available at http://archive.treasury.gov.uk/pdf/2001/myners_report.pdf (emphasizing the importance of the intervention of long-term institutional shareholders at underperforming companies, engaging with their management with a view to improving them and enhancing returns); Brian J. Bushee et al., Institutional Investor Preferences for Corporate Governance Mechanisms 6 (Jan. 2010), http://accounting.wharton.upenn.edu/documents/research/Bcg012010.pdf (stating that the voting block of insti-tutional shareholders confers on them the ability to influence the direction of corporations). 360 PARLIAMENTARY JOINT COMM. ON CORPS. & FIN. SERVS., CORPORATE RESPONSIBILITY: MANAGEMENT RISK AND CREATIVE VALUE 67 (2006), available at http://www.aph.gov.au/senate/committee/corporations_ctte/completed_inquiries/2004-07/corporate_responsibility/report/report.pdf. 361 Id. 362 See Illig, supra note 258, at 249 (stating that private pension funds “are almost universally controlled by their corporate sponsors” and that “significant conflicts of interest make banks, insurance companies and private pension funds poor candidates as corporate monitors” (cita-tion omitted)).



reflect, enhance, and assure that expectation.363 Yet public pension funds face their own unique challenges in the form of political factors that affect their operations.364 Pension fund trustees are appointed by state governors who may want them to toe a line that favors their politi-cal interests; this is so even when in conflict with the long-term orienta-tion that the funds would be promoting.365 Similarly, some of the trus-tees, being politicians, may have their own causes to advance and con-constituencies to satisfy in furtherance of their own ambition.366

There is also the potential problem of rent-seeking, self-dealing, and other forms of opportunistic behavior.367 Class T shareholders could use their power and position to pursue their private interests by extracting concessions from management that redounds only to the benefit of these shareholders and consequently destroys shareholder value.368 While a counterargument can credibly be made that sharehold-

363 David Hess, Public Pensions and the Promise of Shareholder Activism for the Next Fron-tier of Corporate Governance: Sustainable Economic Development, 2 VA. L. & BUS. REV. 221, 235 (2007). Some recent works have addressed the nature and potential of increased participation of public pension funds in corporate governance. See id. For a much earlier discussion of the role of the potential role of pension funds in corporate governance, see William H. Simon, The Prospects of Pension Fund Socialism, 14 BERKELEY J. EMP. & LAB. L. 251, 270 (1993) (suggesting coordination among pension funds to influence corporate governance). But see Roberta Roma-no, Public Pension Fund Activism in Corporate Governance Reconsidered, 93 COLUM. L. REV. 795 (1993). 364 Edward B. Rock, The Logic and (Uncertain) Significance of Institutional Shareholder Activism, 79 GEO. L.J. 445, 471 (1991). 365 Id.; see also Marcel Kahan & Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control, 155 U. PA. L. REV. 1021, 1059–62 (2007). 366 See Iman Anabtawi, Some Skepticism About Increasing Shareholder Power, 53 UCLA L. REV. 561, 574–76, 590 (2006); see also Bainbridge, Shareholder Disempowerment, supra note 204, at 1755 (ascribing some activist efforts of California’s public employee retirement system, CalPERS, to the gubernatorial ambitions of the state’s former treasurer and fund trustee, Phil Angelides). But see Hess, supra note 363, at 230 (stating that it is an inappropriate assumption that when investors apply pressure on management, they are necessarily “acting from self-interested political beliefs rather than a belief that higher social and environmental perfor-mance will improve long-run performance”). For extensive counterarguments and solutions to the politicization question, see Hess, supra note 363, at 260–63. 367 See Bainbridge, supra note 345, at 16 (stating, in the context of proxy access, that some shareholders may “use their position to self-deal—i.e., to take a non-pro rata share of the firm’s assets and earnings—or to otherwise reap private benefits not shared with other investors”); Bainbridge, Shareholder Disempowerment, supra note 204, at 1754–55; Stacey Dahl, North Dakota’s Novel Approach to Corporate Governance: A Shifting Landscape in Corporate Man-agement or a Futile Assertion of Large Shareholders’ Rights?, 84 N.D. L. REV. 1161, 1188–89 (2008). For a valuable definition of rent-seeking, see Blair & Stout, supra note 107, at 249 n.4 (stating that the term encompasses “situations where individuals expend time, money, and other resources competing for a fixed amount of wealth, in effect squabbling with each other over the size of their individual pieces of a fixed group pie” and adding that since “rent-seeking itself is costly, the net result is to reduce total wealth available for distribution”). 368 See Anabtawi, supra note 366, at 574–76, 590; Dombalagian, supra note 265, at 1242; Gelter, supra note 205, at 154–55; Rose, supra note 210, at 1359 (“The potential for inefficien-cies and rent-seeking calls into question the expansion of shareholder power under the current regulatory model and raises the question of how existing shareholder power and influence



ers cannot get their wishes unless they also secure the votes of other shareholders,369 the fact remains that some of these advantages may be secured through private negotiations requiring no shareholder vote.370 However, the criticism may be exaggerated because Class T sharehold-ers would be squandering any latent influence and incinerating every potential for cooperation if they eviscerate their credibility upon the revelation that they secured such secret deals to the detriment of other interests within the corporation. Soon, the management would leak the information making it unwise for these shareholders to place themselves in the unsavory position of easy susceptibility to blackmail to avoid ex-posure of the secret bargains.371

H. Trigger Fiduciary Duties

Institutional investors that have a long-term activist posture may

face the complaint that “fiduciary duties require asset managers to stay away from long-term investment decisions whose financial return is not clearly assessable.”372 Fiduciary duties may need to be strengthened not only to clarify that it is safe for these institutional investors to focus on the long-term but also to actually require that a lack of a strong long-term orientation could be a breach of fiduciary duties.373 Also, the sug-gestion that investments that incorporate environmental and social val-ues will generally underperform those that do not is not necessarily borne out by experience.374 Another fiduciary duty issue that may crop up pertains to whether there is a need for balancing the increased share-holder power with fiduciary duties to other shareholders and the corpo- should be regulated.”); Stewart, supra note 343, at 1494 (“[I]nstitutional investors ‘rent seek’ at the expense of the long-term value of the corporation and society.” (citation omitted)). 369 See Stewart J. Schwab & Randall S. Thomas, Realigning Corporate Governance: Share-holder Activism by Labor Unions, 96 MICH. L. REV. 1018, 1082–84 (1998). 370 Anabtawi, supra note 366, at 596 (“Majority rule may also fail to check opportunistic behavior by shareholders if they can use private negotiations with management to obtain greenmail-type payments in exchange for agreeing to support managerial interests.” (citation omitted)). 371 Marcel Kahan & Edward B. Rock, The Insignificance of Proxy Access, 97 VA. L. REV. 1347, 1427 (2011) (“Efforts to extract political concessions, or otherwise pursue personal interests, are unlikely to stay secret for long. For one, the company requested to make these concessions has a strong interest in revealing this request in order to discredit the dissident group.”). 372 Tonello, supra note 229, at 44. 373 See Hess, supra note 363, at 248 (stating that “an investment strategy based on utilizing environmental and social factors to increase value is clearly not a violation of a trustee’s fiduci-ary duties” and that it might “be a violation of fiduciary duties not to consider environmental and social issues in certain situations” (citations omitted)); Stephen Viederman, Fiduciary Duty, in SUSTAINABLE INVESTING, supra note 237, at 189, 190–94 (advocating a redefinition of fiduciary duty for long-term investors and corporations). 374 See Cary Krosinsky, Sustainable Equity Investing: The Market-Beating Strategy, in SUS-TAINABLE INVESTING, supra note 237, at 19, 19–20.



ration.375 While there is strong scholarly argument in favor of such im-position, formidable opposition also exists.376 Along similar lines, there may also be the case for increasing director fiduciary duties in matters of interest to Class T shareholders to ensure that this class of shareholders does not receive any extra advantage to the detriment of other stake-holders and the corporation.377

I. Board Cohesion and Effectiveness

Opponents of a vibrant shareholder role in the nomination and

election of directors argue that the current system works better and should not be encumbered by a problematic alternative.378 They argue that shareholder-nominated directors create problems for board cohe-sion and effectiveness.379 In fact, so strong is the opposition to share-holder nomination that boards are already receiving advice on how to thwart the new rules on proxy access.380 Opponents argue that the re-sulting dissident board will lead to underperformance of the corpora-

375 See Iman Anabtawi & Lynn Stout, Fiduciary Duties for Activist Shareholders, 60 STAN. L. REV. 1255 (2008) (advocating the imposition of fiduciary duties on shareholders that exercise enormous influence over corporate policy, even when they do not hold a controlling stake); Karmel, supra note 1, at 21 (“[P]erhaps those activist institutions that are demanding greater rights as shareholders should be more cautious. If they obtain some of their wishes, they may find that with new rights come new responsibilities and liabilities.”). 376 See Chiu, supra note 213, at 158 (noting weaknesses in the argument for shareholder fiduciary duty); Paula J. Dalley, The Misguided Doctrine of Stockholder Fiduciary Duties, 33 HOFSTRA L. REV. 175 (2004); Paula J. Dalley, Shareholder (and Director) Fiduciary Duties and Shareholder Activism, 8 HOUS. BUS. & TAX. L.J. 301, 302 (2008) (arguing against imposition of fiduciary duties on shareholders on the ground that “[s]hareholders may have indirect power or influence, but they have no legal power over corporate property, and certainly no legal power over other shareholders’ property”); David A. Hoffman, The “Duty” to Be a Rational Sharehold-er, 90 MINN. L. REV. 537, 538 (2006) (stating that real experience indicates instances in which courts hold shareholders to responsibility analogous to a duty of care); Rose, supra note 210, at 1401–04 (reviewing arguments in favor of and against imposition of fiduciary duties on activist minority shareholders, including possible economic risks for the shareholders and states com-peting for incorporations). 377 See Harner, supra note 78, at 547 (arguing for the imposition of a higher fiduciary stand-ard on directors regarding matters in which certain stakeholders have material interests). 378 See, e.g., ELAINE BUCKBERG & JONATHAN MACEY, NERA ECON. CONSULTING, REPORT ON EFFECTS OF PROPOSED SEC RULE 14A-11 ON EFFICIENCY, COMPETITIVENESS AND CAPITAL FORMATION (2009). 379 Ho, supra note 269, at 69 (noting criticism that shareholder democracy would lead to the balkanization of boards, through the production of constituency directors that champion the interests of particular groups, instead of the interests of all shareholders). 380 J.W. Verret, Defending Against Proxy Access: Delaware’s Future Reviewing Company Defenses in the Era of Dodd-Frank, 36 J. CORP. L. 391 (2011) (discussing sixteen state-law defenses that could be deployed to defeat or blunt the effect of SEC proxy regulations). For an opposing view, see J. Robert Brown, Jr., Access and a Desperate Response, THERACETOTHEBOTTOM.ORG (July 29, 2010, 6:00 AM), http://www.theracetothebottom.org/home/access-and-a-desperate-response.html.



tion.381 Another complaint is that “shareholder nominees will impede companies from achieving the skill and experience balances they need for their boards to function effectively.”382 The clear undertone in these objections is that shareholders, as a class, are either woefully ignorant or completely unconcerned about the well-being of the firm and anyone with a stake in it.383 It is hard to believe that this is true, sidestepping for a moment the notion that it smacks of patronizing condescension.384 Besides, concerns about the quality of shareholder-nominated directors could be ameliorated by corporate by-law amendments that set mini-mum qualifications for nominees.385 In any event, the opposition to shareholder nomination softens when the nominating shareholders have long-term holdings in the company, as is the case under the pro-posal in this Article.386 That shareholder nomination will not necessarily be harmful is accentuated by the point that these constituency directors, like the other directors, owe fiduciary duties to the corporation and all its shareholders.387 Accordingly, they are under an obligation to act in the best interests of the corporation and not look out only for the inter-ests of the nominating investors.388 Further, diversity of perspectives in 381 BUCKBERG & MACEY, supra note 378, at 9 (“Several empirical studies establish that when dissident directors win board seats, those firms underperform peers by 19 to 40% over the two years following the proxy contest.”); Joseph A. Grundfest, Measurement Issues in The Proxy Access Debate (Rock Ctr. for Corporate Governance, Working Paper No. 71, 2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1538630. 382 BUCKBERG & MACEY, supra note 378, at 10; Fairfax, supra note 312, at 1718–19 (noting concerns that shareholders could “elect directors without the skill-set to tackle important prob-lems, or that the overall board will not have the appropriate mix of skills necessary to perform its responsibility” (citation omitted)). 383 See McDonnell, supra note 169, at 80–81 (stating that shareholders may deliberately act against other shareholder interests in director elections or harm general shareholder interests unintentionally when they are not well-informed but notes that the shareholders likely to vote are institutional investors who tend to be properly informed). 384 See Lucian Arye Bebchuk, The Case for Shareholder Access to the Ballot, 59 BUS. LAW. 43, 56–57 (2003); Joseph A. Grundfest, The SEC’s Proposed Proxy Access Rules: Politics, Economics, and the Law, 65 BUS. LAW. 361, 370–71 (2010) (discussing the premise that shareholders pos-sess sufficient intelligence to nominate directors). 385 Jack Gravelle, Proxy Access For All Shareholders, 12 TENN. J. BUS. L. 173, 185 (2011). 386 See BUCKBERG & MACEY, supra note 378, at 10–11 (stating that conditioning nomination on long-term shareholding ensures that shareholders would be careful about who they select to be on the board because they would be around to experience the effect of their decision). 387 Grossman & Hart, supra note 207, at 906 (stating that every director owes fiduciary duties to the corporation and its stockholders); Lazarus, supra note 102 (analyzing judicial decisions that demonstrate that “directors designated by particular stockholders or investors owe duties generally to the company and all of its stockholders”). 388 Lazarus, supra note 102 (“Where the interests of the investor and the company and its common stockholders potentially diverge, the directors cannot favor the interests of the inves-tor over those of the company and its common stockholders.”); see also Joshua P. Fershee, Different Fiduciary Obligations for LLC Managers and Corporate Directors, BUSINESS LAW PROF. BLOG (Mar. 30, 2011), http://lawprofessors.typepad.com/business_law/2011/03/different-fiduciary-obligations-for-llc-managers-and-corporate-directors.html (“Sponsors generally can’t bind directors to a specific vote, and they don’t usually require notice of a director’s intended votes.”). But see Stephen Bainbridge, Constituency Directors, PROFESSORBAINBRIDGE.COM



groups that make decisions that involve judgments is an important in-gredient for better outcomes, as some studies suggest.389

J. Class T Short-Termism

While Class T shareholders are expected to have a long-horizon

approach to investment and bring this approach to bear in performing their governance functions, it is also possible that they would switch to short-term thinking toward the end of their holding period.390 At such point, their votes and other actions would be geared toward corporate ventures and measures that maximize profit and share price in the short run. In other words, they revert to regular shareholder thinking to en-sure the best returns on their investment. This is a legitimate concern that could be confronted with available tools to counter shareholder opportunism, including, but not limited to, the imposition of re-strictions on divestment like a fifteen percent unwinding-per-year re-quirement.391 Moreover, Class T holders would need the support of oth-er shareholders to actualize their short-termist tendencies. With the vigilance of other Class T holders who are at the earliest stage of invest-ment, the exiting Class T holders could face significant opposition. Shareholder fiduciary duties may also provide a solution.392

(Mar. 29, 2011), http://www.professorbainbridge.com/professorbainbridgecom/2011/03/constituency-directors.html (agreeing with the central point but noting that there may be instances where constituency directors are expected to vote in a manner consistent with the interest of the nominating investors). 389 See Regina F. Burch, Worldview Diversity in the Boardroom: A Law and Social Equity Rationale, 42 LOY. U. CHI. L.J. 585, 591 (2011) (“In fact, commentators have emphasized that boards should strive for viewpoint diversity, not simply gender and racial diversity, because independent thinking—which may lead to better governance—is one goal of diversity, and that goal is best served by having a variety of different viewpoints on corporate boards.” (citation omitted)); Lynne L. Dallas, The New Managerialism and Diversity on Corporate Board of Direc-tors, 76 TUL. L. REV. 1363, 1391–92, 1399–1401 (2002). 390 I am grateful to Professor Jeff Schwartz for drawing my attention to this point. 391 My gratitude goes to Professor Lynne Dallas for the point about an unwinding require-ment; see also Robert P. Bartlett, III, Venture Capital, Agency Costs, and the False Dichotomy of The Corporation, 54 UCLA L. REV. 37, 110 (2006) (outlining tools for constraining shareholder opportunism, including contractual agreements, reputational constraints, and fiduciary duties that run from a shareholder to other shareholders); Andrew Keay & Mao Zhang, Incomplete Contracts, Contingent Fiduciaries and a Director’s Duty to Creditors, 32 MELB. U. L. REV. 141, 163–69 (2008) (exploring some tools for addressing shareholder opportunism to creditors); Richard Squire, Shareholder Opportunism in a World of Risky Debt, 123 HARV. L. REV. 1151 (2010) (discussing and addressing a type of shareholder opportunism). 392 See Anabtawi & Stout, supra note 375, at 1294–95 (proposing the use of fiduciary duties, particularly the duty of loyalty, to address the opportunism of influential minority sharehold-ers).



CONCLUSION

The trust fund theory was the dominant philosophical view of cor-

porate finance in the nineteenth century until it was widely discredited and largely discarded. This Article has advocated for the revival of the trust fund theory as a tool for stimulating long-term shareholding and addressing several contemporary corporate-law problems. The revived theory is only applicable to a category of long-term shareholders who hold a separate, relatively illiquid class of common shares. Long-term shareholding is needed to provide patient capital, curb short-termism, and energize managerial accountability. A core component of the re-vised theory is a trust fund that is financed by this class of shares that, in return for their relative illiquidity, enjoy special privileges in corporate governance, including voting on the corporation’s long-term strategy, nominating directors on the company’s proxy materials, and holding a number of seats on the board of directors.

The trust fund will serve a plethora of purposes. It will serve a cred-itor-protection function and thereby increase confidence in, or satisfy-ing condition for, dealing with the firm. Second, it could also provide at least a partial cure to the short-termism problem that has caused con-sternation in corporations and the investment community. The pro-posed arrangement also provides an investment vehicle capable of meet-ing the needs of investors interested in holding equity securities for a long period of time to fund their retirement and children’s college edu-cation. Finally, the proposal will provide an opportunity for amplifying investor voice on the belief that a corporation would be better served by shareholders who exercise voice, instead of exiting as soon as the oppor-tunity comes. On that point, this Article proceeds on the understanding that voice is not likely to be amplified where exit is not substantially constrained. This model is compatible with the view that a system of active shareholder monitoring would necessarily incorporate a tradeoff between voice and exit. In essence, a successful scheme for increasing shareholder influence may need to accompany a corresponding decrease in liquidity. This arrangement should be attractive to traditional long-term investors and corporate managers that seek such investors as allies in the promotion of long-run, sustainable growth.

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