#MeToo's Impact on Corporate Law

On January 27, 2018, The Wall Street Journal published an article revealing that Steve Wynn, the Las Vegas casino developer who built Mirage, Treasure Island, Bellagio, Wynn and Encore Casinos and then-Chairman and CEO of Wynn Resorts, Ltd., had sexually harassed and forced employees to perform sex acts on him for decades. [1]  More than 150 witnesses described an atmosphere of terror at Wynn’s casinos.  Female employees said they would be fired if they did not succumb to Wynn’s advances, faked appointments to avoid Wynn’s office, asked colleagues to pose as their assistants to avoid being with Wynn alone, and hid from Wynn in bathrooms and back rooms. 

In the days following the expose, more women came forward.  A cocktail waitress from the Golden Nugget in the 1980s said that Wynn “made a habit of going after single moms who were scared and couldn’t afford to lose their jobs.[2]  Another server said that after she bragged about becoming a grandmother, Wynn harassed her to have sex with him.  He said that he “never had sex with a grandmother before and want[ed] to see how it feels.[3]  

Like many outsized corporate leaders, in many ways Steve Wynn was Wynn Resorts.  His signature graces each of the company’s buildings as its corporate logo.  Each of the company’s annual reports for 2010 through 2016 listed as its first “Risk Factor” that:

The loss of Stephen A. Wynn could significantly harm our business. Our ability to maintain our competitive position is dependent to a large degree on the efforts, skills and reputation of Stephen A. Wynn . . . If we lose the services of Mr. Wynn, or if he is unable to devote sufficient attention to our operations for any other reason, our business may be significantly impaired.  (Emphasis added). 

Indeed, the news of Wynn’s misconduct led to the Company’s loss of over $3 billion in market capitalization within days.  Investigations by gaming regulators imperiled Wynn Resorts’ $2.5 billion hotel casino in Massachusetts.  The company’s annual report for 2017 reframed its first “Risk Factor” as:

The controversy, regulatory action, litigation and investigations related to Stephen A. Wynn and his separation from the company could significantly harm our business. [4]

Derivative Litigation On Behalf of Wynn Stockholders

On February 22, 2018, the New York State Common Retirement Fund filed a derivative lawsuit in Clark County, Nevada against Wynn Resorts’ board of directors (the “Board”) for ignoring numerous “red flags” and allowing Wynn’s behavior to continue unchecked.  The New York City Pension Funds joined the suit as additional plaintiffs. [5] Plaintiffs’ complaint alleged that the Board breached its fiduciary duties by knowingly failing to act on reports of Wynn’s serial sexual misconduct.    

On June 25, 2018, the Board moved to dismiss plaintiffs’ complaint because, among other things, plaintiffs made no pre-suit demand on the Board.  Because derivative plaintiffs seek to displace a board’s role to decide whether to bring a lawsuit suit on behalf of a corporation, plaintiffs are generally required to show that a pre-suit demand on the board would have been “futile.”  To establish “demand futility,” a derivative plaintiff typically needs to plead facts to demonstrate that a majority of the board of directors lacked independence or would not be “disinterested” in the outcome of the potential litigation.  In a case like Wynn, courts generally require the plaintiff to plead that the board knew or should have known about the misconduct, and acted in bad faith by consciously failing to address it.[6]

When plaintiffs filed their complaint against the Board, no court had ever found demand futility based on a board’s failure to address an officer’s alleged sexual misconduct.  But on September 5, 2018, the Nevada court upheld plaintiffs’ complaint, holding that a pre-suit demand on Wynn Resorts’ board would have been futile.  The court found it was reasonably conceivable that the Board knew about Wynn’s serial sexual misconduct based on a litany of red flags, including the sheer magnitude of his conduct (hundreds of instances over decades), numerous reports of his behavior, complaints filed with the U.S. Equal Employment Opportunity Commission (“EEOC”), and the Board’s involvement in a lawsuit relating to Wynn’s $7.5 million payment to settle a company manicurist’s claim that Wynn raped her.[7]  The Court found that the Board’s failure to act in the face of credible and corroborated reports was knowing and intentional, so the Board faced a substantial likelihood of liability and would not be disinterested in considering a demand.[8]

The Wynn decision illustrates the impact that the #MeToo Movement—which erupted in October 2017 after Harvey Weinstein’s decades-long sexual misconduct came to light—has had on corporate law.  The current social climate, which encourages victims of sexual assault to break their silence, may have encouraged the Wynn court to draw more inferences in plaintiffs’ favor about the Board’s knowledge of Wynn’s misconduct.  A brief discussion of prior sexual misconduct-related derivative claims illustrates how the #MeToo Movement has propelled corporate law forward.

Before #MeToo

In 1998 in the Delaware Court of Chancery, an individual shareholder of ICN Pharmaceuticals filed a derivative lawsuit against ICN’s board of directors based on the board’s failure to address allegations of sexual misconduct against ICN’s Chairman, founder and CEO Milan Panic.[9]  The lawsuit, captioned White v. Panic, was based on a July 6, 1998 U.S. News and World Report cover-story entitled “Sex and the CEO,” which revealed allegations that Panic sexually harassed ICN employees and ICN paid $3.5 million to settle those claims.  Relying primarily on U.S. News and World Report’s investigation, plaintiff filed his lawsuit and alleged that ICN’s board breached its fiduciary duties by failing to address Panic’s misconduct.[10]

The court dismissed the case, finding that a pre-suit demand on ICN’s board would not have been futile.  The court held that plaintiff had failed to plead with sufficient detail that the board knew that Panic had engaged in misconduct, especially since Panic never admitted to it.[11] 

In 2012, a federal court in California relied on White to dismiss a derivative complaint on similar facts.  Two individual shareholders filed suit against the board of directors of American Apparel, Inc. for breaching its fiduciary duties by failing to prevent the sexually hostile and discriminatory workplace led by its Chairman and CEO Dov Charney.[12] Plaintiffs’ complaint alleged that Charney walked around American Apparel in thong underwear, used highly derogatory terms with women, condoned managers’ sexual relationships with junior employees whose compliant behavior was rewarded, invited a female employee to masturbate with him, ran business meetings at his home practically naked, and requested that the company “hire young women with whom he could have sex, Asians preferred.” [13] American Apparel employees filed multiple complaints with the EEOC involving Charney’s misconduct.

First the American Apparel court found that plaintiffs’ allegations supported an inference that the board knew or should have known there was possible cause for concern.  But then, relying on White, the court found that the board did not have knowledge of actual problems and, as such, did not act in bad faith.[14]

Thus under White v. Panic and American Apparel, courts had generally held that unless a corporate officer admits to perpetrating sexual misconduct, a court will not find that a board has the requisite knowledge of actual misconduct to make demand futile. 

In Wynn, however, the Nevada court found that the Board knew about Wynn’s misconduct even though Wynn, to this day, denies the allegations against him.  The Nevada court found that “credible and corroborated reports” of Wynn’s misconduct was sufficient to find that the Board knew about his behavior.  This precedent-setting decision makes room for plaintiffs to use the outpouring of stories inspired by the #MeToo Movement to overcome a pleading-stage dismissal even if a company officer (or director) has not admitted to engaging in sexual misconduct.

The Derivative Harm in Failing to Address Sexual Misconduct

The costs of failing to address sexual misconduct can be significant, making derivative claims that seek to recoup these costs valuable.  For example, on November 17, 2017, City of Monroe Employees’ Retirement System settled similar claims against the board of Twenty-First Century Fox, Inc. for $90 million.  The $90 million, paid by Fox and the board’s insurance providers, accounted for, among other things, Fox’s payment of over $130 million in sexual harassment settlements and severance.  Indeed, between 2010 and 2016, American employers paid nearly $300 million to settle sexual harassment claims through the EEOC.[15]

In addition to the legal costs, sexual misconduct has substantial operational, regulatory and reputational costs.  Wall Street has begun to hedge against the risks of a sexual misconduct scandal by including “Weinstein clauses” or “#MeToo reps” in merger agreements.  These provisions require a target company, through its executive officers, to represent that it has no actual knowledge of sexual accusations made against company supervisors over a certain time period.  If the representation is false, the acquirer may be able to terminate the merger agreement.  Some “Weinstein clauses” require the target to put money in escrow for acquirers to claim if social issues arise.[16]  A review of public filings indicates that at least nineteen merger agreements executed since March 15, 2018 include a Weinstein clause, including as recently as October 22, 2018 in connection with American Railcar Industries, Inc.’s $1.75 billion merger with a subsidiary of ITE Rail Fund, L.P.[17]

In addition to returning tangible value to a company, derivative cases can effectuate corporate governance reforms that reduce the risk, and thereby mitigate the costs, of sexual misconduct occurring.  These reforms focus on enhancing management and advancing women in leadership.[18] For example, Monroe’s settlement with Fox included creating a Fox News Workplace Professionalism and Inclusion Council (the “Inclusion Council”) to ensure that Fox News’ workplace has effective reporting practices and human resources training, and recruits and advances women and minorities. 

These measures not only reduce the risk of sexual misconduct occurring, they increase the likelihood of long-term positive investment incomes—another illustration of the value of derivative claims.  For example, a Credit Suisse study of over 2,000 companies from 2006 to 2012 found that companies with at least one female director delivered higher than average returns on equity, had lower leverage, better than average growth, and higher price/book value multiples.[19] A 2015 review by Harvard Law School’s Pensions and Capital Stewardship Program found a positive correlation between human resource initiatives and positive investment outcomes such as total shareholder return, return on assets, return on earnings, return on investment, and return on capital employed.[20] A 2017 MSCI study found that over a five year-period companies with three or more female directors reported 45% higher EPS than companies with no female directors.  A 2018 McKinsey & Company study of more than 1,000 companies found that companies in the top quartile for gender representation were more likely to outperform fourth quartile companies by margins of 33%.[21]

Large institutional investors are paying attention to these statistics and lobbying for the disclosure of management metrics and enhanced gender diversity in corporate leadership.  The Human Capital Management Coalition, whose members include twenty-five institutional investors representing over $3 trillion in assets under management, is lobbying the SEC to require companies to disclose their management metrics.[22] The Sustainability Accounting Standards Board (“SASB”), whose Investor Advisory Group includes thirty asset managers representing over $21 trillion in AUM, has identified management as a “material” issue that requires greater disclosure.[23]

When State Street unveiled its “Fearless Girl” statue on Wall Street on March 13, 2017, it issued a letter urging companies to include women on their boards and threatening to use its proxy voting power to effect that change.[24] During the 2018 proxy season, Glass Lewis “highlight[ed] companies that have no female board members, and [stated that] beginning in 2019 [it would] recommend voting against the nominating committee chair of a board that has no female members . . . .”[25] The California State Teachers Retirement System (“CalSTRS”) has been lobbying for years for companies to include more women on their boards.[26] CalSTRS’ campaign influenced California’s Governor to sign Senate Bill No. 826 (“SB-826”) into law onto September 30, 2018, requiring California-headquartered public companies to have one to three women on their boards, depending on board size.[27] SB-826 will affect ninety-four companies that, as of September 30, 2018, had no female directors.[28]  

Wynn Resorts appears to have gotten the message.  Between January and May 2018, six directors of Wynn Resorts resigned, including Wynn himself.  In April 2018, the Board elected three new female directors, raising its female director ratio to 4/11.

What’s Next?

According to polls conducted by NBC, The Wall Street Journal and MSN just last year, over 45% of women are harassed at work.[29] The #MeToo Movement continues to empower victims and witnesses to speak out.  Just last month, The New York Times exposed sexual misconduct at Google, Inc. [30] As additional victims come forward, derivative litigation will likely be filed by stockholders seeking to recover lost corporate value.  Courts across the country will likely have additional opportunities to evaluate these cases, and will be asked to draw inferences about what each of those boards knew.  Two cases are currently pending, including an action Kessler Topaz filed in Delaware against the board of Liberty Tax, Inc. [31]  The Liberty Tax matter involves allegations that the company’s CEO, Chairman and controlling stockholder engaged in inappropriate sexual activity with company employees in the workplace, and used company resources for his sexual gain.  Investors will be watching the extent to which these derivative cases force companies to take action, including by enhancing management and gender diversity in corporate leadership.