The U.S. Supreme Court’s 1977 decision in Santa Fe Industries v. Green drew a line between corporate and securities law that arguably enabled Delaware to become the leading creator of corporate law. Prior to Santa Fe, the federal courts had become receptive to suits brought under Rule 10b-5 alleging corporate misconduct rather than a clear misrepresentation to investors. These decisions emboldened the plaintiff in Santa Fe to argue that a breach of fiduciary duty standing alone could support a federal securities fraud claim.
By rejecting this argument and emphasizing that federal securities law regulates disclosure while state corporate law regulates the internal affairs of the corporation, the Supreme Court helped open the door to Delaware’s dominance of corporate law for the next two decades. Soon after it was decided, the Delaware Supreme Court observed that “Santa Fe is a current confirmation by the Supreme Court of the responsibility of a state to govern the internal affairs of corporate life.” As one Delaware judge noted years later, Santa Fe “abruptly reversed” a “creeping federalization of corporate law.” A prominent corporate law scholar has observed that Santa Fe is a symbol for a “world of weak federal corporate law.”
While it is thus a critical case for understanding our dual system for regulating public corporations, Santa Fe does not seem particularly effective these days in protecting Delaware. Over the last fifteen years, the line between corporate and securities law has become increasingly blurred. More and more, the most important issues of corporate governance are being addressed through federal legislation or in litigation taking place in the federal courts.
My chapter traces the origins of Santa Fe to understand why it no longer seems to serve as a barrier to federalization of corporate law. Santa Fe reversed a trend over two decades where well-intentioned courts, most notably the U.S. Court of Appeals for the Second Circuit, interpreted the scope of Rule 10b-5 broadly. The Second Circuit in various decisions relaxed earlier doctrine limiting Rule 10b-5 to cases involving a purchase or sale of securities as well as a deception. By the time the Supreme Court decided Santa Fe, the Second Courts signaled a willingness to apply the rule to a wide range of self-dealing by a controlling shareholder at the expense of minority shareholders.
The key insight of the chapter is that Santa Fe must be understood within a particular context, suits by minority shareholders who allege some abuse by a controlling shareholder. Almost all of the early Rule 10b-5 cases involved such a fact pattern. While Santa Fe played a role in moving minority shareholder litigation back to the state courts, its disclosure principle never created a complete separation between corporate and securities litigation.
Delaware came to dominate corporate litigation by developing law that better fit the typical dispute between majority and minority shareholders than Rule 10b-5. Most notably, in the Weinberger line of cases, Delaware created a distinct theory of fairness that simply was a better fit for the typical minority shareholder dispute than securities fraud.
In these times, Santa Fe and its disclosure principle have not served as a meaningful barrier to federal intervention. As the federal government has increasingly used securities disclosure to regulate corporate governance, and Delaware has increased its own disclosure litigation, it is becoming more difficult to differentiate between federal securities and state corporate litigation. Delaware may find that it is always competing with the federal courts for cases involving the most interesting corporate governance disputes. Such competition could result in the loosening of barriers to shareholder suits, making it more difficult for Delaware to protect corporations from what may be meritless litigation.
Will Delaware be able to maintain its position as the dominant creator of corporate law? The answer is not so clear. On the one hand, while the federal securities laws have increasingly addressed corporate governance issues, there is still substantial room for Delaware to make corporate law. Moreover, as memories of past financial scandals subside, there may be less pressure to pass federal reform legislation. On the other hand, it can be difficult to reverse prior regulation and there may be additional pressure in the future to federalize corporate law. The difficult question that scholars and policymakers must answer is whether there continues to be a reason to separate securities and corporate law. If there is not, it is unlikely that Delaware will maintain its historical role in making the most important law governing public corporations.
The chapter concludes that another Rule 10b-5 case, Birnbaum, may provide a better way of distinguishing between corporate and securities law than Santa Fe. As discussed more thoroughly in an earlier paper, Birnbaum distinguishes between the protection of investors when trading securities, the province of securities regulation, and the protection of investors while they are holding their shares, the province of corporate law.