September 4, 2010
The Reasonably Available Data Rule
The Wall Street Journal ran an article this week about the SEC's on-going case against Angelo Mozilo, former CEO of Countrywide. The Journal noted that one of the key issues was whether disclosures by Countrywide subsidiaries (with names such as CWALT LLC) sufficiently put the market on notice as to Countrywide's financial status so as to cure Countrywide's failure to disclose the same information. The SEC is quoted as saying that in order for such information to be deemed part of the relevant total mix, it must be "readily" or "reasonably" available to shareholders.
Dear SEC, just in case you're looking for any additional citations to support your position, might I suggest: Who Should Do the Math? Materiality Issues in Disclosures that Require Investors to Calculate the Bottom Line, 34 Pepp. L. Rev. 927 (2007). In that paper, I argue that (in the context of disclosures that fail to calculate the bottom line impact of various financial results for shareholders):
[C]ourts should apply what I call, for purposes of this paper, the “Reasonably Available Data” rule. The Reasonably Available Data rule builds upon existing materiality doctrines to analyze each particular omission on its own facts. Specifically, I argue that when courts are presented with the question of whether failure to explicitly disclose the bottom line constitutes a material omission, they should ask: (1) whether all the relevant pieces of data necessary to calculate the bottom line were disclosed proximately to one another and in the place where a reasonable investor would expect to find them; (2) whether the data was cross-referenced to; and (3) whether the import of the data was sufficiently highlighted to alert the reasonable investor. In addition, where the bottom line was omitted in a corrective disclosure, that fact should count against defendants. Finally, a presumption of materiality should be applied where the bottom line is subsequently made public and the market reacts negatively to that disclosure.
As always: Why blog, if not to shamelessly promote your own scholarship?
September 3, 2010
Proxy Access: The Added Wrinkle of the North Dakota Corporations Law
Back in 2007, North Dakota passed the North Dakota Publicly Traded Corporations Act (ND Act), which became Chapter 10-35 (Publicly Traded Corporations) of the North Dakota Century Code. The ND Act provided a shareholder friendly alternative to the state's Business Corporations Act, Chapter 10-19.1 for companies that were so inclined. (Find the referenced North Dakota laws here.)
Before the state could pass the law, the state constitution needed be amended, and voters approved the necessary changes in 2006 (for more on the history of the ND Act, see pdf here). A North Dakota-based publicly traded corporation is not subject to the ND Act unless it opts-in, essentially by reincorporating in the state. None of the state's public corporations existing before the ND Act was passed have done so.
One of the main provisions of the ND Act gave proxy access for purposes of nominating candidates for election to the board of directors for a "qualified shareholder" of the publicly held corporation subject to the law. N.D. Cent. Code 10-35-08. A qualified shareholder is a person or group of persons holding 5% of the company's shares authorized to vote for directors, and each person or member of the group must have held the shares for at least two years. N.D. Cent. Code 10-35-02(8).
As has been well documented, now comes the SEC amendments to Rule 14a-11, which allows such access for persons or groups of persons holding 3% of such shares who have owned those shares for three years. The SEC revisions allow the use of state or foreign law for nominations in addition to those permitted under Rule 14a-11, under 14a-19. Thus, as I read it, companies subject to the ND Act will now have to permit proxy access to two sets of qualified shareholders: (1) the SEC-mandated 3%/three-year ownership shareholders and (2) the ND Act-mandated 5%/two-year ownership shareholders.
Is this a big deal? As to ND Act companies, probably not. The only company subject to the ND Act is a public company already controlled by Carl Icahn. Thus, this issue is largely moot. However, there is an indirect North Dakota connection that could loom larger.
At least fifteen companies -- including Staples, Exxon Mobil, and Whole Foods -- have considered and defeated shareholder proposals to reincorporate under the ND Act. Of those companies defeating the proposal, reports indicate that at least seven companies garnered at least 3% of the vote in support of the change. This probably indicates that there is already a group of shareholders with 3% of the ownership ready to nominate directors. And because of the ND Act, they should be relatively easy to find.
September 2, 2010
Federal Court Rules Ohio's Suit Against BofA Can Proceed
Kevin LaCroix has an excellent review of the decision here. As he notes, there is much to discuss. But what jumped out at me in the course of reading reviews of the opinion (I have not read the 140-page opinion itself) is the statement by Judge Castel that the securities complaint failed "to adequately and plausibly explain why a defendant would be motivated to accurately disclose a ‘turbulent’ and ‘tumultuous’ economic forecast for the quarter yet recklessly or intentionally conceal the dire reality as the quarter unfolded."
It seems to me that one could apply a sort of "reverse puffery" analysis here. Courts routinely dismiss securities complaints on the basis of vague statements of optimism allegedly being immaterial. (I say "allegedly" because the issue is far from settled as an empirical matter.) Could one not just as well argue that vague statements of pessimissm are at least in some sense similarly immaterial? In other words, one could argue that there is a meaningful difference between saying "tumult ahead" as opposed to, for example, "we lost $20 billion this quarter." Of course, the burden remains with the plaintiffs to specifically allege why management might be willing to disclose the former but intentionally fail to disclose the latter.
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September 1, 2010
Questioning the Quest for "Shareholder Engagement" -- European Edition
The European Federation for Retirement Provision (EFRP) weighed in today on the potential value of shareholder engagement in response to the European Commission's Green Paper on Corporate Governance in Financial Institutions and Remuneration Policies. The EFRP concluded that voluntary shareholder engagement policies were sensible, but that pension funds (and other shareholders) should be able to decide for themselves whether increased shareholder engagement is worthwhile.
The Green Paper states that there "[s]everal factors" that help explain the shareholder apathy (they say "disinterest or passivity"). I'll pick on one for now: "[C]ertain profitability models, based on possession of portfolios of different shares, lead to the abstraction, or even disappearance, of the concept of ownership normally associated with holding shares."
If one were to believe, as Professor Bainbridge likes to say, the "shareholders don't own the corporation," then this would be irrelevant (or, at a minimum, poorly stated). But beyond that, why does this necessarily follow? People often manage portfolios to keep financial balance and mitigate risk, but certainly they are interested in their holdings doing well. Such investors would be happy if all their holdings did well; they just know it unlikely that all will do well at the same time, so they balance their portfolio. Similarly, if the investor is just trying to turn a quick profit on their holdings, it is not that they lack a concept of ownership, it's just that their goals are different than long-term investors.
If we apply this concept to real goods and not shares, does it make any difference? That is, suppose one were to own a few grocery stores, a few apartments, and a few gas stations, does that mean the owner lacks a "concept of ownership" because they have diversified interests? Does it change if they only own a small part of each business? Does it matter? I think it doesn't. In my view, it's not that the owner doesn't have an concept of ownership -- it's just that their goals are such that active engagement is not something they wish to do. Isn't that why the concept of limited partners came about so long ago?
At the end of the day, I fail to see how greater shareholder involvement would have changed much with regard to the financial crisis. Shareholders often just sell their shares if they are dissatisfied with the direction of the company or they find out about the problems long after the problems cannot be reversed. Once the company is in the tank, the shareholders can vote all they want -- there's nothing left to oversee.
I'm all for rethinking executive compensation and the proper alignment of incentives. There appear to are some real flaws in how the current market operates. It's just not clear to me that mandating "shareholder engagement," when shareholders are already generally not engaged where they can be, is the answer.
August 31, 2010
The SEC and the Foreign Freeze
Late last week, the SEC obtained a court Order authorizing "emergency action" against two Spanish nationals (a research analyst and a brokerage customer) who allegedly engaged in insider trading in Potash Corporation (an NYSE stock) through purchases of options on the CBOE. The two defendants are alleged to have profited handsomely from advance news of a proposed tender offer made by BHP Billiton to Potash disclosed on August 17th; the charges noted that the analyst works for the company advising BHP, and that a letter constituting the offer was circulated between the two companies four days prior to public disclosure. The SEC thus sought (as it has in other cases in the past) a freeze of the brokerage assets of these two defendants before "they will be beyond the jurisdiction and reach of United States Courts."
An Illinois district granted the freeze Order on an ex parte basis, with the battle for more sanctions still to come. Perhaps the daunting Complaint is simply a product of the trend and the times, but the document is much more noteworthy for what it doesn't say. Undeniably most glaring among the omissions is the absence of any alleged "tip." The allegations are based largely upon such circumstantial evidence as the existence of the letter offer, the "suspicious" trading in call option contracts, and the huge profits; additionally, it is noted that one defendant subsequently attempted to transfer his profits to a bank in Madrid. Absent are allegations concerning not only the specific source of the information but also the nature of the Commission's theory of liability (the notion of inside information as contraband absent other circumstances was rejected by the Supreme Court 30 years ago).
And thus rings the most alarming shot in the Commission's war on insider trading. Although the statutes, rules and case law contemplate defenses for reliance upon other sources of information, lack of duty to any source, and/or just plain luck in either obtaining news or guessing takeovers, the asset freeze prizes immediacy and deterrence over these possibilities.
Also noteworthy is the alleged 'inside information' itself: The news that a tender offer had been rejected. If the sole consideration in a materiality analysis diminishes to whether or not a company is "in play," then countless are the possibilities for finding alleged Rule 10b-5 violators. More importantly, such generic news anticipates a rational market reaction; such premise is laid threadbare by the facts of this case alone (investors drove up the price Potash nearly 28% in the day after the disclosure of a tender offer that would have paid a 16% premium).
Finally, the Complaint alleges (in the conjunctive) violations of all three sub-divisions of Rule 10b-5 (i.e., employing artifice, making untrue statements, and fraudulent acts), whereas the 'untrue statements' charge is normally not included in insider trading cases. It remains to be seen whether this signals a new, aggressive trend in 10b-5 enforcement.
The Charges thus make for great discussion of both asset feezes in civil cases and the elements steadily becoming expanded or subsumed in Rule 10b-5 case law. For the SEC's descriptive Press Release (with a link to the actual Complaint), see www.sec.gov/news/press/2010/2010-153.htm .
August 30, 2010
Explaining Court Ordered Dissolution
The Delaware Court of Chancery issued an opinion on August 2 in Lola Cars International, Ltd. v. Krohn Racing, LLC (pdf) that provides a detailed example of how things can go wrong in a joint venture. The eighty-four page opinion provides a long list of difficulties between two parties to an auto racing joint venture, which led to one party seeking judicial dissolution.
This opinion provides a nice LLC companion to Owen v. Cohen and Collins v. Lewis, which I use for our discussion of partnership dissolution. (Plus, as you may have noticed, I like cars.) I particularly like the way the opinion explains the court's reluctance to impose dissolution where no violations of fiduciary duty or other significant misconduct is shown (but is reasonably alleged). In denying the request for dissolution, the court explains:
If Lola had proven at least some of those claims [of gross negligence and other violations of fiduciary duties], judicial dissolution might very well be appropriate. But without such success, Lola’s frustration amounts to little more than disappointment with how [the joint venture] Proto-Auto is structured and managed and how Proto-Auto is attempting to expand its market presence. Unfortunately for Lola, it agreed to this arrangement when it partnered with Krohn Racing. Given its overzealous role in escalating this dispute, the Court will leave it to Lola to assess whether to exercise the deadlock procedure contained within the Operating Agreement—a provision that provides a no less reasonable means by which the Member Parties may disentangle themselves than dissolution.
The Court concludes by emphasizing that a party to a limited liability company agreement may not seek judicial dissolution simply as a means of freeing itself from what it considers a bad deal. (footnotes omitted) (emphasis added).
Finally, I spend a lot of time talking about how business owners (and, of course, their counselors) need to plan for eventual breakups. This case also provides a nice reminder that breakups are still hard, even when you plan ahead.