May 21, 2011
Citizens United and the Power of "Corporate Democracy"
Over at the Race to the Bottom, Jay Brown has commented on a recent shareholder proposal involving Home Depot that is seeking to get a shareholder vote on corporate "electioneering contributions." The proposal is expressly in response to Citizens United, but Prof. Brown views it as evidence of "a central flaw in the Supreme Court's analysis in Citizens United." Writes Brown:
The Court made it seem like broad dissemination of information about campaign contributions was sufficient. Apparently this was because shareholders could, with the disclosure, effect the company's practices with respect to the contributions. In fact, this is probably not the case. As CA v. AFSME shows, the Delaware courts are highly protective of board discretion and willing to strike down almost any effort by shareholders to tie the hands of directors. As a result, a proposal calling for mandatory limits on campaign contributions would likely be invalidated under state law.
I think the extent to which one views the Citizens United majority's reliance on "corporate democracy" (See, e.g., 130 S. Ct. at 911: "There is ... little evidence of abuse that cannot be corrected by shareholders 'through the procedures of corporate democracy.'") to be sound turns in large part on what one understands the justices to mean by corporate democracy. If one understands them to be arguing that shareholders could force a board of directors to take certain actions vis-a-vis electioneering, then I agree with Jay that the Court was likely wrong. If, on the other hand, one understands the Court to be relying on the ability of shareholders to "vote with their feet" in an effective way, then I'm inclined to not be as critical of the opinion (at least on that particular point). I believe we've already seen one example of that in the case of Target.
Citizens United: the gift that just keeps on giving.
May 20, 2011
The Rule of Law and "Technical Compliance" with Securities Law
I’m a strong believer in the rule of law. I think administrative agencies should promulgate clear, precise rules so people will know with as much certainty as possible what behavior is legal and what is illegal.
Because of that, I have always found language in two SEC regulations, Regulation D and Regulation S, troublesome. Both regulations exempt offerings from the registration requirements of the Securities Act. Regulation S exempts certain offers and sales of securities outside the United States and Regulation D exempts smaller and private offerings. Each of those regulations has detailed requirements, some of which are reasonably clear and some of which, like the “general solicitation” bar in Rule 502(c) of Regulation D, probably should be clarified (or eliminated).
But what really bothers me from a rule-of-law standpoint is a preliminary note that appears in each regulation. Preliminary Note 6 to Regulation D says:
In view of the objectives of these rules and the policies underlying the Act, regulation D is not available to any issuer for any transaction or chain of transactions that, although in technical compliance with these rules, is part of a plan or scheme to evade the registration provisions of the Act. In such cases, registration under the Act is required.
Preliminary Note 2 to Regulation S contains substantially similar language.
What in the world does that mean? The whole point of both regulations is to allow people to evade the registration requirement by technically complying with the rules. All these preliminary notes do is give the SEC license to pursue people who acted within the letter of the law but did something that the SEC subsequently decided it didn't like. This sort of retroactive, ad hoc illegality is precisely what the rule of law is designed to prevent.
Fortunately, courts have not used these preliminary notes very often. I only found five cases where they were cited. But Preliminary Note 2 to Regulation S does appear to have been outcome-determinative in at least one case. In SEC v. Parnes, 2001 WL 1658275 (S.D.N.Y. Dec. 26, 2001), the court rejected a claim that denial of the Regulation S exemption to someone who fully complied with Regulation S would violate due process. According to the court, Preliminary Note 2 provided adequate notice to the defendant that the exemption might not be available even if they complied with its provisions.
I don’t have any problem with the SEC adding additional conditions to its exemptions, as long as those conditions are consistent with its statutory authority. And, if people are exploiting a loophole that the SEC believes should be closed, by all means close it by amending the rule. But deciding after the fact that action is illegal, based on a vague standard like this, is simply inappropriate.
Agency and Tips, Revisted (or No Tippin' and Dunkin')
Back in December, I wrote about the Massachusetts tip law, and how it modifies (and could modify) traditional agency rules. The case I discussed was DiFiore v. American Airlines Inc., 688 F. Supp. 2d 15 (D. Mass. 2009), which is still pending before the First Circuit. DiFiore involved a changed sky cap policy that eliminated curbside tipping, while adding a $2 per bag airline fee.
These cases are getting even better for teaching this part of agency law. The main agency concept implicated by the tips law is Restatement (Second) of Agency § 388, Duty to Account for Profits Arising Out of Employment: "Unless otherwise agreed, an agent who makes a profit in connection with transactions conducted by him on behalf of the principal is under a duty to give such profit to the principal."
One of our readers let me know that a Dunkin' Donuts franchisee has been sued under the tips law. As a reminder, the Massachusetts "tips law," provides:
(b) No employer or other person shall demand, request or accept from any wait staff employee, service employee, or service bartender any payment or deduction from a tip or service charge given to such wait staff employee, service employee, or service bartender by a patron. No such employer or other person shall retain or distribute in a manner inconsistent with this section any tip or service charge given directly to the employer or person.
. . . .
(g) No employer or person shall by a special contract with an employee or by any other means exempt itself from this section.
Mass. Gen. Laws 149 § 152A.
I couldn't find the complaint, but it appears the Dunkin' Donuts case is asking a question that is not clear on the face of the statute. That is, can an employer have (or enforce) a no tipping policy? It seems that the tips law allows an employer to have a no tipping policy because the employer would not "demand, request or accept . . . a tip or service charge" merely by refusing to allow tips.
As I noted in December, it seems to me that a no-tipping policy is permitted, as long as it is done correctly. That means, in my view, that the stores could refuse tips to employees, and probably fire employees for accepting tips. But, the stores could not, for example, donate the tips to charity because the employer would then be distributing the tips "in a manner inconsistent with this section any tip or service charge given directly to the employer or person."
There is also the question of when the no tipping policy was put in place. If the store opened with a no tipping policy, then it is more likely to be upheld. If the policy was changed at some point there remains another open question: whether the change is a tortious interference with advantageous relations. The DiFiore court indicated that may be a valid cause of action, too.
I can see the contrary argument, but I would think an employer should be able to have a no tipping policy consistent with the Massachusetts tips law, as long as the policy is clear and means that any tips are either refused (the customer keeps them) or the penalty for an employee keeping tips does not involve the employer taking or otherwise diverting the tip to someone else. Either way, I hope employers with no tipping policies are taking notice of these suits so they can try to avoid their own.
May 19, 2011
Chancellor Chandler to join Wilson Sonsini
The NYT Dealbook is reporting that Chancellor William B. Chandler III will be joining Wilson Sonsini Goodrich & Rosati. Chandler has served on the Delaware Chancery Court since 1989, where he has written over 1000 opinions and galvanized his reputation as a leading judicial expert for corporate law cases. Some of his most famous opinions have focused on change control, protective measures, and executive compensation as seen in those cases involving the The Walt Disney Company, Yahoo, Microsoft, Hewlett-Packard, eBay, Citigroup, Dow Chemical, and, most recently, the Air Products/Airgas dispute.
Three Misconceptions About the Coverage of the Securities Act
I spend a lot of time on the Securities Act, and particularly on its application to small businesses. The Securities Act, as most of our readers know, makes it illegal to offer or sell securities without filing a disclosure document known as a registration statement with the Securities and Exchange Commission. But the Securities Act and SEC regulations adopted pursuant to the Securities Act include a number of exemptions, and many small businesses successfully use those exemptions to avoid the expense and burden of registration.
However, some start-ups and micro-entrepreneurs wrongly assume that they don’t have to worry about the Securities Act—that it doesn’t apply to them. Here are the three most common misconceptions I have encountered.
1. It’s only debt.
Some people believe that, unless they are selling stock or some other equity interest in a business, they don’t have to worry about federal securities law. It’s easy to see where this idea originated. We generally only think of stockholders or other equity participants as “owners” of a business, so I'm not really selling an interest in my business if I’m just borrowing money. But, whatever the origins of this idea, it’s simply wrong. As far as the Securities Act (and other federal securities laws) are concerned, there is no hard and fast line between equity and debt.
The definition of security includes various categories of debt: notes, bonds, debentures, “evidence of indebtedness.” And the Supreme Court has made it clear that investors who are promised only an interest payment and not any participation in the business’s earnings can be purchasing securities. SEC v. Edwards, 540 U.S. 389 (2004). That doesn’t mean that all debt is securities. If you go to a single bank and sign a note to borrow money, that’s pretty clearly not a security. But, if you borrow money from a number of people to finance the start-up or operation of your business, it’s quite likely that a security is involved. See Reves v. Ernst & Young, 494 U.S. 56 (1990).
You’re not free of the Securities Act registration requirement just because you’re borrowing money.
2. I’m only raising money from family and friends.
Some people think they don't need to worry about federal securities law if they are soliciting funds only from family members and friends. That’s simply wrong. There is no general exemption from the Securities Act for offerings to family and friends.
The closest possibility is probably the private offering exemption in section 4(2) of the Act and its safe harbor, Rule 506. The exact scope of the section 4(2) statutory exemption is uncertain, but it is generally limited to people who can fend for themselves and don’t need the protection of securities law. SEC v. Ralston Purina Co., 346 U.S. 119 (1953). It’s doubtful that most friends or family fit into that. And the Rule 506 safe harbor is only available if purchasers are either accredited investors or sophisticated. People are not accredited investors just because they’re friends and family, and many family members and friends are not going to meet the sophistication requirement. (Family/friend status may matter for purposes of the rule’s general solicitation restriction, but that’s just one of the rule's requirements.)
Even though you’re limiting your fundraising to family and friends, you still have to worry about the registration requirement of the Securities Act.
3. The SEC won’t go after me.
The argument here is not that the offering complies with the Securities Act, but that there are not likely to be any consequences. The SEC has limited resources, so it is possible the SEC will not discover the violation or may not prosecute if it does discover the violation. But notice the “mays” in that sentence. Over the years, the SEC has spotted and prosecuted many "small fry" who wrongly assumed they wouldn't be caught.
Even if the matter escapes government attention, private liability is a major concern. Section 12(a)(1) of the Securities Act gives a virtually unlimited right of rescission to anyone who is offered or sold a security in violation of the Act’s registration requirement. If the purchaser still owns the security, he can recover the purchase price with interest. If he has sold the security for less than he paid for it, he can recover the difference. The purchaser doesn’t have to show the failure to register harmed him in any way. And when are purchasers most likely to sue to get their money back? When the business takes a downturn and their investment loses value—in other words, just when the business needs the money the most.
But, going back to the second point, the entrepreneur doesn't need to worry if all those purchasers are friends and family, does he? Friends and family members won't sue. Don’t be so sure. When things go badly, family and friendship ties tend to go out the window. If you don’t believe me, scan a corporate law casebook and count the number of small business cases where family members and former friends are suing each other.
The SEC may find and pursue you if you don’t register an unexempted offering and, even if it doesn’t, you have to worry about having to give back the money at an inopportune time.
Books I'd Like to Read: "The Origins of Political Order" by Francis Fukuyama
You can find the book on Amazon. And here's a short excerpt from the Publisher's Weekly review:
The evolving tension between private and public animates this magisterial history of the state. In his hominids-to-guillotines chronicle of humanity's attempts to build strong, accountable governments that adhere to the rule of law, international relations scholar Fukuyama (The End of History) advances two themes: the effort to create an impersonal state free from family and tribal allegiances, and the struggle—often violent—against wealthy elites who capture the state and block critical reforms.
May 18, 2011
Are "New" Techniques in Combating FCPA Violations Worth It?
Law.com reports that a new federal bribery case in the D.C. District Court is underway. The defendants, who were executives for arms and military equipment suppliers, "were indicted last year in an aggressive prosecution that marked the first large-scale use of undercover techniques in a Foreign Corrupt Practices Act [(FCPA)] case."
I have to say that I am a little surprised that this is the first "large-scale use of undercover techniques" in an FCPA bribery case. I admit, I have little to no idea what goes into an FCPA investigation, but I find it hard to imagine trying to combat bribery cases without undercover work. I suppose it could happen, but I would think undercover work would be reasonably effective in this arena.
That said, I can't help but wonder if this is the best use of resources. The FCPA investigations are apparently becoming quite elaborate, and I am pretty sure there are more pressing matters that should be dealt with first. I remain anti-bribery and believe people should be accountable for knowingly breaking the law even if the law might be dumb. But it appears that the DOJ, SEC, and other investigators are focusing on high-profile cases they think they can close, rather than pursuing the worst offenders. I'd add these types of FCPA cases to the recent criticisms of insider trading enforcement from Stephen Bainbridge and Steve Bradford.
Maybe just raising the specter of any investigation and conviction will cause other would be criminals, terrorists, and other evil doers to think twice. But I rather doubt it.
May 17, 2011
Over the legal limit
Yesterday was the official OTNDC (over-the-national-debt-ceiling) Day, and a bleak moment as the United States' debt surpassed its legal borrowing limit of $14.294 trillion. TRILLION. Try saying out loud or even typing it-- the absurdity is sobering.
What are the business implications of reaching this milestone and existing in the limbo that we are currently in until August 2, 2011, when the US will begin defaulting on debt if the limit isn't raised? Will the markets respond negatively to the lack of security with regard to US debt or are the markets immune to the DC political theory and grid lock after the threats earlier this year to shut down the Government over budget disputes? It seems to be unclear at the moment, although all three major indices were down yesterday and again today. Given the 11 weeks of lead time between now and August 2nd, the threat of default may seem as absurd as the number. If the uncertainty stretches to the end of the summer, expect to see stronger and stronger reactions in the market, especially if the price of oil continues on its upward trend and there is concern over the end of stimulus money.
An immediate consequence will also be a decrease in the strength of the doller, both in the short-term conversation rate (good for exporters) and potantially in the long-term as the world's reserve currency.
What consequences, if any, do you predict will stem from the debt dilemma this summer, or are you too immune from the antics of political theater?
May 16, 2011
The Chicken/Egg Problem for Aggressive/Insubordinate SEC Investigator
The SEC apparently took its time ferreting out R. Allen Stanford's huge Ponzi scheme. In 1997, an SEC investigator raised concerns, but it wasn't until 2009 that the SEC brought action. The Dealbook reports:
But no good deed goes unpunished, Ms. Preuitt [the investigator] testified before Congress on Friday, saying she had been marginalized and demoted at the S.E.C., where she once oversaw examiners in the agency’s Fort Worth office.
The falling-out stems from a 2007 effort by S.E.C. officials in Fort Worth to increase their examinations of financial firms. Ms. Preuitt, who still works in the Fort Worth office, warned that the policy change was superficial and would cause regulators to avoid investigating complicated schemes, like the $7 billion fraud that Mr. Stanford is accused of running.
Ms. Preuitt brought the concerns to her bosses and later complained to officials in the agency’s Washington headquarters. In turn, Ms. Preuitt received a letter of reprimand. The agency later transferred her to a nonsupervisory position, which in essence was a demotion.
So, on the one hand, we have an aggressive investigator who was willing to buck authority in light of what she viewed as major mistake in pursuing fraud. And it appears she was right. On the other hand, we have an employee who was not following the chain of command. Further, the reports indicate she "failed to follow orders and issued her complaints in an antagonistic way."
Who's right? Odds are both. I don't know any of the people involved, but I suspect the same traits that make someone an especially aggressive investigator are likely to make that investigator especially aggressive with their superiors. Add the overlay of a government bureaucracy, and you have a highly likelihood of fireworks.
Unfortuately, that bureaucracy probably also explains twelve years of investigation to make the case.
The Harm of Insider Trading
One more post on insider trading and I promise to leave it alone for a while. Steve Bainbridge considers whether investors are harmed by insider trading. His conclusion? Not really. Holman Jenkins also has a piece in Saturday's Wall Street Journal rejecting the "level playing field" idea with respect to insider trading. Each argues that small investors shouldn't be trading in individual stocks in any event -- that they ought to be in diversified index funds. I wonder if Jenkins read Bainbridge's book before writing his own article?
Worth reading, no matter how you come out on the insider trading issue.
May 15, 2011
Boliek on Antitrust
Babette Boliek has posted Regulation Versus Antitrust: How Net Neutrality is Defining the Boundaries on SSRN with the following abstract:
This Article challenges the various jurisdictional theories that underpin the FCC’s net neutrality regulation. The assertion of jurisdiction by the FCC over any aspect of the Internet ecosystem has raised populist, congressional, and even judicial rhetoric to a crescendo and resulted in a recent vote to defund the FCC’s efforts. This Article places the current crisis squarely in context of the long-standing jurisdictional struggle between regulation and antitrust law. These two regimes are often at jurisdictional cross-purposes because, even though they both purport to maximize the social good, they do so by inapposite means. Indeed, there is a policy choice inherent in the very jurisdictional authority permitted each regime – a choice that the FCC’s jurisdictional bases for net neutrality may actually circumvent and obfuscate. Focusing on the Supreme Court’s recent decision in Trinko and the D.C. Circuit’s even more recent decision in Comcast, this Article examines the jurisdictional boundaries between these regulatory and antitrust camps. In analyzing the jurisdictional limits of each through the lens of the net neutrality debate, this Article reveals opportunities for congressional reforms beyond mere rhetoric. To identify problematic uses of regulatory authority, this Article: (i) creates an innovative grouping of possible bases for regulatory authority labeled “satellite jurisdiction,” and (ii) proposes a new framework to classify possible jurisdictional overreach in what the author brands as either procedural or substantive opportunism. Finally, this Article recommends a new standard by which both procedural and substantive jurisdictional opportunism may be tempered and antitrust authority maximized where most salutary and appropriate.
-Eric C. Chaffee
Shareholder say on Corporate Political Spending
At it's June 2nd annual meeting, shareholders of The Home Depot will vote on a proxy proposal that would require disclosures and shareholder approval of corporate political spending. The proposal, presented by NorthStar Asset Management, asks that the Board of Directors include in its annual proxy statement the company’s policies on political contributions, a report on spending from the previous year, and projected spending for the upcoming year so that shareholders may vote in support/disapproval of these policies. NorthStar also recommended that the proxy disclosure analyze whether the company's political spending is consistent with the company’s values and whether it poses risks to the company’s brand, reputation, or shareholder value (think of the public relations backlash against Target for its support of anti-gay rights candidates last summer).
The Home Depot opposed inclusion of this resolution, however, the SEC issued a no action letter (Download No Action Letter) clearing the way for the resolution to be voted on by shareholders next month. Even though the resolution is included in the proxy statement, it is opposed by The Home Depot on the grounds that its existing corporate governance policy ensures compliance with laws and transparency of process with regard to political spending.
The upcoming vote is certainly being watched by those concerned with the impact/success of Citizens United. Today, for example, The New York Times ran on Op-ed by John Bogle, the founder and former CEO/chairman of Vanguard, urging for support of the resolution. If successful, look for this resolution to be replicated in proposals for major public corporations. If unsuccessful, then the Executive Order under contemplation by President Obama will be seen as even more critical by the reformists.
I'm a few minutes away from sitting down for our annual Commencement Brunch, following which I will have the pleasure of watching our latest batch of graduates cross the stage to receive their diplomas. With Akron reporting a 100% pass rate at the most recent bar exam, these graduates should feel good about the preparation they've received. And while issues certainly remain in terms of the job market and debt burdens, etc., things do appear to be heading in the right direction for the first time in a few years. And so I say to all my former students that are graduating today: Congratulations, and enjoy your day!