I. IN THE WAKE OF CORPORATE SCANDAL
The "irrational exuberance"1 of the late 1990s, marked by frenzied stock trading and risky investment strategies,2 fueled aggressive accounting practices that exaggerated real achievements and camouflaged setbacks.3 During that time, investors accepted business practices that measured performance by revenue, rather than earnings or cash, and by the number of "eyeballs hitting Internet sites."4 According to Federal Reserve Chairman Alan Greenspan, "when greed swept through our nation, we were not prepared to address it."5 The result was accounting scandals at Enron, WorldCom and other organizations, in which directors failed to ask "questions of management to determine whether the stock was rising solely as a result of smoke and mirrors."6 In 2002, Congress responded to these scandals with the Sarbanes-Oxley Act, which modified governance, reporting and disclosure rules for public companies.7
Beyond the federal legislative response, these corporate scandals occasioned a new judicial and regulatory focus on directors' good faith performance of their corporate responsibilities. This trend has been evident in recent state and federal court decisions addressing directors' fiduciary duty of good faith and the business judgment rule.8 Most notably, in the 2003 decision In re The Walt Disney Co. Derivative Litigation, a Delaware chancery court declined to apply the business judgment rule in a derivative action where the court found that the company's directors failed to exercise any judgment in their decision making.9 According to one commentator, the court's decision raised concerns among many corporate directors about their own personal liability when making decisions on behalf of their corporations, and "serves as a warning to corporate directors that state courts are now willing to allow plaintiffs to prove that directors who fail to exercise due care in carrying out their fiduciary duties should be liable to the shareholders of the corporation, even without the suggestion of self-dealing."10 The Disney case seems to have been well-received by the Delaware Supreme Court,11 suggesting that this approach will influence other jurisdictions.12
In the regulatory context, the Securities and Exchange Commission (SEC) has recently displayed a "willingness to pursue cases against outside directors who [are] reckless in their oversight of management and asleep at the switch . . . ."13 Specifically, in SEC v. Adley, the SEC brought its first charges ever against an outside director who allowed securities fraud to occur under his watch.14 The Adley action may signal a new regulatory emphasis on directors' good faith performance of their duties and, as a result, directors may face increased liability exposure.
Corporate directors' concern for the continued viability of the business judgment rule15 underscores the importance of understanding the current status of the law. Part II of this Note surveys the development of directors' fiduciary duties and the business judgment rule in Delaware and details the SEC's initiative targeting directors. Part III gauges the extent to which recent case law and regulatory action signal a change in the application of the business judgment rule or signal expanded regulatory liability for directors. Part IV provides practical guidance to corporate practitioners, who may counsel outside directors, about procedural failures that may expose directors to liability and steps those directors can take to minimize their exposure. Part V considers the policy implications of stricter directorial liability and offers suggestions for courts and the SEC to proceed in this area.
II. BACKGROUND ON DIRECTORS' LIABILITY: CASE LAW AND REGULATORY ACTION
A. Delaware's Business Judgment Rule
In the Disney case, the central issue was whether to apply the business judgment rule to the board of directors.16 Under Delaware law, the business judgment rule is a presumption that in making a business decision, corporate directors "acted on an informed basis, in good faith and in the honest belief that their action was in the best interests of the corporation. …