Business Judgment Rule of Law:
As I noted in my initial comments on this blog, “I, and other Indymac managers (and directors), made prudent and appropriate business decisions based on the facts available to us at the time.” Regardless of whether those decisions turned out well or poorly, we deserve the protections afforded to us under the law, including the business judgment rule.
“Why should the standard of review applicable to the quality of decisions by corporate directors and officer be only rationality, when the standard of conduct is reasonability or prudence? The answer to this question involves the consideration of both fairness and policy. To begin with, the application of a reasonableness standard of review to the quality of disinterested decisions by directors and officers could result in the unfair imposition of liability. In paradigm negligence cases involving relatively simple decisions, like automobile accidents, there if often little difference between decisions that turn our badly and bad decisions. In such cases, typically only one reasonable decision could have been made under a given set of circumstances, and decisions that turn out badly therefore almost invariably turn out to have been bad decisions. In contrast, in the case of business decisions it may often be difficult for factfinders to distinguish between bad decisions and proper decisions that turn out badly. Business judgments are necessary made on the basis of incomplete information and in the face of obvious risks, so that typically a range of decisions is reasonable. A decision-maker faced with uncertainty must make a judgment concerning the relevant probability distribution and must act on that judgment. If the decision-maker makes a reasonable assessment of the probability distribution, and the outcome falls on the unlucky tail, the decision-maker has not made a bad decision, because some of the outcomes will inevitably fall on the unlucky tail of any normal probability distribution.”
“WHETHER THE BUSINESS-JUDGMENT RULE SHOULD BE CODIFIED”, by Melvin A. Eisenberg, May 1995 (Link to Article)
Nowhere in the business judgment rule is there a requirement for managers to properly forecast an uncertain future, let alone foresee a financial crisis of such magnitude that it had not occurred since The Great Depression (certainly an outcome that “falls on the unlucky tail”); one that almost no one (but a handful of contrarian, high-risk, speculators), including our top government finance officials and banking regulators, foresaw.
In fact, the main purpose of the business judgment rule is to protect directors and officers from the second guessing of judgments with the benefit of hindsight. If this rule of law did not exist, then the concept of a corporation, a cornerstone of our capitalistic system, would effectively be destroyed, as few would be willing to serve as an officer or director where they could be held personally liable for making good-faith, but what turned out to be wrong judgments or “right at-the-time, but unlucky judgments” and losing some or all of the investors’ capital. If we did not have corporations and offer this kind of protection to officers and directors, I believe we would have a smaller, slower growing economy and certainly one that is less democratic and favors established wealth.
The recognition that business ventures involve risk and the potential for failure is an integral part of our capitalistic, free market economy. Honest and capable individual managers, who are hard working, well-informed, and trying to do what’s best for their company should not be held personally liable by plaintiffs or punished by government bureaucrats for business failure, especially in a time of global systemic and macroeconomic crisis.
Even if there were no business judgment rule, and directors and officers could be held liable for negligent business judgments, the FDIC still could not prove its case. As one commentator put it, under California law, “Negligence is the doing of something which a reasonably prudent person would not do, or the failure to do something which a reasonably prudent person would do, under circumstances similar to those show by the evidence. It is the failure to use ordinary or reasonable care. The person whose conduct we set up as a standard is not the extraordinarily cautious individual, nor the exceptionally skillful one, but a person of reasonable and ordinary prudence. One test that is helpful in determining whether or not a person was negligent is to ask and answer the question whether or not, if a person of ordinary prudence had been in the same situation and possess the same knowledge, he or she would have foreseen or anticipated that someone might have been injured by or as a result of his or her action or inaction.” “What is the Law of Negligence in California”, by Richard Alexander.
The FDIC has not alleged one fact in its complaint against me that meets the above definition of even ordinary negligence, let alone the higher standard required in reviewing the quality of business decisions under the business judgment rule (essentially that decisions I made or actions I took were not rational).
September 15, 2011 – M. Perry Files Motion to Dismiss FDIC Complaint (Motion to Dismiss)