The internet is buzzing with the news that four orders of Roman Catholic nuns have filed a shareholder derivative suit against Smith & Wesson Brands, seeking to force the company to impose stricter standards for manufacturing and marketing the M&P15 rifle, which is similar in style to the AR-15. What seems to be getting less attention is the question of whether the lawsuit will succeed.
(Spoiler alert: almost certainly not.)
The shareholder derivative suit has long been the bête noire of boards of directors. But plaintiffs in such cases face a tough slog. Although details vary from state to state, as a general proposition the board will prevail as long as its actions, even if mistaken, were business judgments made in good faith. True, the rule has exceptions, but even plaintiffs asserting more traditional governance claims rarely prevail.
For social activists, the slog is tougher still.
Consider: Over the past three years, at least 40 shareholder suits have been filed challenging companies for not living up to their own stated diversity goals. But the claims are at best an uneasy fit within the usual boundaries of derivative actions, a difficulty that helps explain why they tend to be dismissed.
Derivative suits over social issues are hardly limited to any particular spot on the ideological spectrum. Target Corp. faces a suit by an activist shareholder asserting that the retailer lost money by making decisions on LGBTQ issues that were inconsistent with the views of their customers. In the wake of June’s Supreme Court decision in Dobbs v. Jackson Women’s Health Organization, some observers have warned corporations to brace for shareholder suits claiming that the bottom line is harmed when the board adopts policies assisting employees in traveling to obtain abortions. I wouldn’t expect those suits to get far either.
And with all due respect to the sincerity of the plaintiffs, I would expect the suit against Smith & Wesson to meet a similar fate.
The lawsuit reportedly alleges that the board has not done enough to take into consideration the likelihood of future civil liability for mass shootings. Of particular concern to the plaintiffs is last year’s $73 million settlement in the lawsuit against Remington by families who lost members in the Sandy Hook slaughter. According to news reports, the complaint demands that Smith & Wesson alter the gun’s design to make the weapon safer and alter marketing practices to reduce the odds that the weapon will wind up in the hands of troubled users.
As policy proposals, these ideas might have merit. But it’s less clear that they can form an adequate basis for a derivative suit. Weighing the revenues of a product line against the risk of liability is a classic example of business judgment. In 2012, for instance, an Illinois federal court dismissed a shareholder suit alleging that directors of Baxter International, a health care company, had breached their duty by allowing the company to sell what the complaint described as a dangerous product. The court explained that even if, as the plaintiffs claimed, the board’s efforts to remediate the problem were “deeply flawed,” the directors were still protected by the business judgment rule as long as they acted in good faith.
And although, as I’ve mentioned, the standards of the business judgment rule vary somewhat from state to state, it’s hard to imagine a court elsewhere reaching a different result. A derivative suit shouldn’t be a device to reverse board decisions that shareholders (or judges, or commentators) think were wrong. As a much-quoted Delaware case notes, even when a board action leads to an actual loss, the standard is not whether the board was right but whether “the decision made was the product of a process that was either deliberately considered in good faith or was otherwise rational.”
It’s hard to see the nuns’ lawsuit getting past that hurdle.
Don’t get me wrong. I’m not opposed to activist investors who try to focus a corporation’s attention on important social issues. That’s been going on for a long time, generally to the good. Some trace the practice to Jim Peck, who, having partnered with Bayard Rustin to purchase stock in Greyhound in the 1940s, fought for and finally won the right to present the issue of segregated buses to the shareholders. By 1970, Ralph Nader was offering proxy resolutions to press for safer cars. True, for a long time the practice was limited to a tiny handful of gadflies. According to one study, “in 1982, almost 30% of the 972 resolutions submitted to 358 companies came from three individuals.”
Nowadays activism is common. And that’s fine. Shareholder activists serve a vital role in the maintenance of shareholder democracy. They force the corporation’s owners to grapple openly with issues that might otherwise be swept beneath the rug. But absent board offenses as serious as fraud or self-dealing, or in other ways amounting to gross negligence, shareholders who can’t persuade the corporation to adopt their proposals shouldn’t be able to enlist the courts in their perhaps justifiable crusades.
Even when the shareholders are nuns.
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