Saturday, December 13, 2014

Did Harvard Violate Federal Securities Law? SEC Commissioner Gallagher Thinks So

Professor Lucian Bebchuk runs the Harvard Shareholder Rights Project, which helps investors filed proposals to be included in corporate proxies under Rule 14a-8.  The Project has filed several precatory proposals to express shareholders' views that corporations should destagger their boards, arguing that research demonstrates that declassified boards improve corporate returns.

In a new paper posted to SSRN, SEC Commissioner Daniel Gallagher and Professor Joseph Grundfest accuse the Project of making misleading statements regarding the benefits of declassified boards.  They suggest that Harvard could be vulnerable to lawsuits by shareholders or the SEC under Rule 14a-9, which forbids false statements in proxy solicitations.  The paper, with the provocative title “Did Harvard Violate Federal Securities Law?” is discussed in the Wall Street Journal here.

The basic argument made by Gallagher and Grundfest is that the proposals misleadingly cite only research in favor of declassified boards, and fail to cite contradictory research. 

Now, I have to say, I’m trying to evaluate how this claim would proceed if brought by a private shareholder, and I don’t like its chances.  First, as Gallagher and Grundfest admit, the proposals are precatory – so even if they succeed, they only have an effect if the corporate directors bow to investor pressure and choose to destagger the board.  Gallagher and Grundfest argue that this is sufficient “causation” to constitute a Rule 14a-9 violation by analogizing to a case where management lied in response to a precatory shareholder proposal, and the court ordered a re-vote.  But that case seems obviously distinguishable, because in that instance, the damage wrought by the misstatement was, in effect, damage to the right to offer proposals in the first place.  And the shareholder had few options other than a truthful revote as a means of vindicating that right.

Here, of course, because the ostensibly misleading proposal is submitted by shareholders, and misstatements are not being used by management as a way to thwart shareholders, it's difficult to see what concrete harm the alleged misstatements are actually causing.  Moreover, there are a variety of remedies for false statements beyond a private lawsuit: management can exclude proposals that are misleading, counter with its own information when opposing the proposal, or simply ignore the vote.

Apparently aware of the weaknesses in their causation theory, Gallagher and Grundfest also argue that these precatory proposals have a substantive effect sufficient to satisfy the causation requirement because proxy advisors like ISS often recommend voting against corporate directors who fail to declassify a board after a shareholder vote in favor of declassification.  Corporate directors may therefore feel pressure from ISS and vote in favor of declassification after a shareholder vote on the subject.

This chain of causation seems speculative, to say the least.  First, not only are ISS’s actions independent of the initial proposal, ISS’s threats are only going to matter if there’s a contested director election, and there usually isn’t one.  Even if votes are withheld from a director in a majority-vote corporation, the director will only actually lose his position if the Board accepts his resignation – which it may choose not to do if it concludes the voting was based on a misleading proxy proposal.

Second, the information that’s allegedly omitted here – countervailing research on a contested subject – is publicly available.  Leaving aside how that affects the analysis of the legal element of materiality (an omitted fact is only material if it affects the “total mix” of information available to shareholders, including public-domain information), if ISS pressure is a key step in the chain of causation, well, ISS is a sophisticated entity, as are the investors it advises – all of whom are no doubt capable of identifying and evaluating the research for themselves.

Finally, no damages would be available in a private action (because there’s no chance of a shareholder demonstrating loss causation).  The only remedy would be for a court to undo a vote in favor of the proposal and possibly order the re-staggering of a board – once again, difficult to imagine given the attenuated causation involved and the public nature of the omitted information.

That said, I’m fascinated by the fact that Commissioner Gallagher has chosen to fight this battle not in his capacity as Commissioner, but as the co-author of a paper posted to SSRN.*  (The paper claims, one suspects disingenuously, Gallagher and Grundfest  are not taking a position on the merits of declassification; they simply want to ensure that proxy proposals are truthful.)  Despite the paper’s suggestion that the SEC could bring an action against Harvard, the authors openly admit that the SEC’s policy has not been to challenge statements made in these proposals, but simply to allow corporate managers to refute them in proxy materials.  If anything, the goal of the article seems to be more about intimidating Bebchuk into altering the wording of his proposals (or intimidating Harvard into reining him in - the paper spends a bit of time on Harvard's responsibility for the Project), giving ammunition to corporate boards to resist such proposals, and firing a shot across the bow of proxy advisory firms that recommend in favor of such proposals.  Commissioner Gallagher has long sought greater regulation of proxy advisors – winning new SEC guidance on the subject in June.  In this article, Commissioner Gallagher seems to be dropping a hint that they should revise their recommendations or be subject to further investigation and regulation.

*Who does he think he is, a Delaware judge?

December 13, 2014 in Ann Lipton | Permalink | Comments (4)

Saturday, December 6, 2014

Fictional shareholders

Particularly in the context of benefit corporations, a lot of us have used this space to talk about whether corporate directors are in fact required to adhere to a shareholder-wealth-maximization norm.  The flipside of this inquiry is to ask what shareholder wealth maximization means from the shareholders' viewpoint.

In his article Fictional Shareholders: For Whom are Corporate Managers Trustees, Revisited, Daniel Greenwood uses the term “fictional shareholders” to describe the mythical share-value-maximizing shareholder to whom corporate directors are theoretically beholden, who does not possess any interests, values, or priorities beyond shareholder wealth maximization.

One of the most striking examples of the “fictional shareholder” notion can be found in the D.C. Circuit’s opinion in Business Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011), where the court rejected the SEC’s proxy access rule in part on the ground that some shareholders might put forth director-nominees for the “wrong” reasons – i.e., reasons specific to their idiosyncratic interests outside of their status as shareholders, unrelated to corporate wealth maximization.  See generally Grant M. Hayden and Matthew T. Bodie, The Bizarre Law and Economics of Business Roundtable v. SEC.

Of course, in real life, shareholders do in fact have interests other than increasing prices of the shares they own in an individual company.  They may care about shares they own in other companies, or care about things unrelated to shares entirely – like the environment in which they live, the wages they are paid for their jobs, the prices they pay for goods as consumers, and so forth.  These varied considerations may "maximize" their wealth overall, even if they do not maximize the value of shares in any specific company.

Which is why I found this article so interesting.  The AFL-CIO is objecting to Wall Street’s practice of paying out deferred compensation to executives who depart for government.  Deferred compensation packages are intended to encourage employees to remain with the company; the compensation is forfeited if the employee leaves for a competitor.  So why should it be accelerated for government?  (Copies of the letters sent by AFL-CIO can be found here.)

Andrew Ross-Sorkin, adorably, believes the practice encourages “public service” even if it doesn’t benefit shareholders.

I believe the practice - at least in the eyes of the firms that employ it - likely directly maximizes shareholder wealth in particular companies by maintaining close ties between Wall Street and regulators.  Not in crude sense that government regulators “go easy” on Wall Street firms because they wish to curry favor or repay a debt, but in the more subtle sense that firms believe that if they maintain lines of communication and friendly relationships between themselves and their regulators, they can persuade regulators to adopt Wall Street priorities and sensibilities.  And, of course, when Wall Street firms have close ties to regulators, they can use friendship and informal networking to obtain information and cooperation –  the case of Rohit Bansal  is simply an extreme example.  (Probably Mary Jo White is more typical – after she left public service to work at Debevoise, she was accused of using her government connections to assist John Mack in avoiding SEC penalties for insider trading.)

So AFL-CIO’s objection, to me, does not come from its status as an adviser to investment funds investor seeking the highest possible value for their shares.  It comes from its status as a union federation, with members who have interests outside of their status as shareholders. 

AFL-CIO tacitly acknowledges as much.  In its press release describing its objections, it writes, “Unless the position of these companies is that this is just a backdoor way to pay off a newly minted government official to act in Wall Street’s private interests rather than the public interest, it is very difficult to see how these policies promote long-term shareholder value.”

Which is another way of saying that if these employees do act to further Wall Street’s interests, then they do promote shareholder value.  

So that leads to the question – is it legitimate, for the AFL-CIO to object to these practices, even if they increase the value of the pension fund's holdings?  Do corporate managers have any obligation to consider such objections, if they are not motivated by a desire to maximize wealth at a particular firm?

And what if the AFL-CIO did decide to call the banks' bluff by filing a lawsuit claiming that compensation incentives to decamp for government service do not benefit shareholders?  Would the directors have to admit that they hope for benefits like regulatory forbearance, or could the directors claim that, a la Andrew Ross-Sorkin, such pay practices provide a public benefit and represent a mark of good corporate citizenship?

December 6, 2014 in Ann Lipton | Permalink | Comments (6)

Saturday, November 29, 2014

Nice little bond issuance you have there. Shame if anything were to happen to it.

When commenters look back at the financial crisis, many blame the ratings agencies, at least in part - and in particular, the dominance of a small number of firms (Moody's, S&P, and - distantly - Fitch).  This is why, for example, the SEC has been criticized for erecting barriers that prevent other agencies from earning the coveted NRSRO label

Which is why I found this story regarding an apparent effort by Moody's to eliminate a competitor so fascinating.  According to the WSJ:

Moody’s Corp. doesn’t often give away its thoughts free of charge.

But the ratings firm made an exception recently, issuing an unsolicited credit rating to National Penn Bancshares Inc., a small community bank it had never assessed before.

Moody’s grade was lower than one issued just weeks earlier by Kroll Bond Rating Agency Inc., which the bank had hired to rate a new bond.

Kroll contends Moody’s deliberately lowballed its rating—a move that could have ripple effects through the market for National Penn’s bonds—to scare other small banks into hiring it for future deals.

“It seems this was nothing less than intimidation,” said Kroll President Jim Nadler. “Investors and issuers are worried that Moody’s, if it’s not paid their ransom, will continue doing this until they bully their way into the market.”

A Moody’s spokesman said the firm’s unsolicited rating for National Penn was due to the relatively large size of the debt deal for a regional bank. “We thought our opinion would be helpful to market participants,” he said....

Moody’s never met with National Penn senior management. Instead, Moody’s analysts sifted through public disclosures, listened to earnings calls and read news articles, Mr. Tischler said. These types of situations, with no participation from the rated issuer, are “definitely the minority,” he added.

Moody’s hadn’t rated a U.S. bank with assets under $10 billion all year. In its eight-paragraph rating rationale from Oct. 31, Moody’s said National Penn’s “acquisition appetite” for troubled banks “poses risks for creditors,” calling into question the management’s strategy. Few detailed financials were mentioned in the initial Moody’s rating.

Now, this is not the first time Moody's has been accused of this kind of behavior.  In Jefferson County School District No. R-1 v. Moody’s Investor’s Services, Inc., 175 F.3d 848 (10th Cir. 1999), for example, the plaintiff alleged that Moody's publicized an unsolicited low-ball rating as punishment to an issuer for failing to hire Moody's to rate the deal.  In that case, the Tenth Circuit held that ratings are opinions subject to First Amendment protection, and dismissed state law tort claims as well as federal antitrust claims.

It raises really interesting questions, because on the one hand, many observers believe that "ratings shopping" - the practice of one issuer going to different agencies until it receives the rating it wants - corrupts ratings and contributed to the financial crisis.  So we want to encourage agencies to rate securities even when an issuer has chosen a different agency - which necessarily means protecting them from lawsuits by disgruntled issuers.  On the other hand, the last thing we want is for agencies to use ratings as a means to exclude competitors from the market. 

The reality is, the best system would be one in which the issuer itself did not get to choose the agency (or, more creatively, perhaps one in which the rater itself was forced to invest in the securities it rates) - but despite proposals, we haven't been able to adopt a workable system to make that happen (as demonstrated by the fact that investors will sue the agencies for issuing unreliable ratings even as they continue to rely on them as a cornerstone of their investment policy).

November 29, 2014 in Ann Lipton | Permalink | Comments (2)

Thursday, November 27, 2014

Can a socially responsible person shop on Thanksgiving or Black Friday?

As regular readers know, I research and write on business and human rights. For this reason, I really enjoyed the post about corporate citizenship on Thanksgiving by Ann Lipton, and Haskell Murray’s post about the social enterprise and strategic considerations behind a “values” message for Whole Foods, in contrast to the low price mantra for Wal-Mart. Both posts garnered a number of insightful comments.

As I write this on Thanksgiving Day, I’m working on a law review article, refining final exam questions, and meeting with students who have finals starting next week (being on campus is a great way to avoid holiday cooking, by the way). Fortunately, I gladly do all of this without complaint, but many workers are in stores setting up for “door-buster” sales that now start at Wal-Mart, JC Penney, Best Buy, and Toys R Us shortly after families clear the table on Thanksgiving, if not before. As Ann pointed out, a number of protestors have targeted these purportedly “anti-family” businesses and touted the “values” of those businesses that plan to stick to the now “normal” crack of dawn opening time on Friday (which of course requires workers to arrive in the middle of the night). The United Auto Workers plans to hold a series of protests at Wal-Mart in solidarity with the workers, and more are planned around the country.

I’m not sure what effect these protests will have on the bottom line, and I hope that someone does some good empirical research on this issue. On the one hand, boycotts can be a powerful motivator for firms to change behavior. Consumer boycotts have become an American tradition, dating back to the Boston Tea Party. But while boycotts can garner attention, my initial research reveals that most boycotts fail to have any noticeable impact for companies, although admittedly the negative media coverage that boycotts generate often makes it harder for a companies to control the messages they send out to the public. In order for boycotts to succeed there needs to be widespread support and consumers must be passionate about the issue.

In this age of “hashtag activism” or “slacktivism,” I’m not sure that a large number of people will sustain these boycotts. Furthermore, even when consumers vocalize their passion, it has not always translated to impact to lower revenue. For example, the CEO of Chick-Fil-A’s comments on gay marriage triggered a consumer boycott that opened up a platform to further political and social goals, although it did little to hurt the company’s bottom line and in fact led proponents of the CEO’s views to develop a campaign to counteract the boycott.

Similarly, I’m also not sure of the effect that socially responsible investors can have as it relates to these labor issues. In 2006, the Norwegian Pension Fund divested its $400 million position (over 14 million shares in the US and Mexico operations) in Wal-Mart. In fact, Wal-Mart constitutes two of the three companies excluded for “serious of systematic” human rights violations. Pension funds in Sweden and the Netherlands followed the Fund’s lead after determining that Wal-Mart had not done enough to change after meetings on its labor practices. In a similar decision, Portland has become the first major city to divest its Wal-Mart holdings. City Commissioner Steve Novick cited the company’s labor, wage and hour practices, and recent bribery scandal as significant factors in the decision. Yet, the allegations about Wal-Mart’s labor practices persist, notwithstanding a strong corporate social responsibility campaign to blunt the effects of the bad publicity. Perhaps more important to the Walton family, the company is doing just fine financially, trading near its 52-week high as of the time of this writing.

I will be thinking of these issues as I head to Geneva on Saturday for the third annual UN Forum on Business and Human Rights, which had over 1700 companies, NGOs, academics, state representatives, and civil society organizations in attendance last year. I am particularly interested in the sessions on the financial sector and human rights, where banking executives and others will discuss incorporation of the UN Guiding Principles on Business and Human Rights into the human rights policies of major banks, as well as the role of the socially responsible investing community. Another panel that I will attend with interest relates to the human rights impacts in supply chains. A group of large law firm partners and professors will also present on a proposal for an international tribunal to adjudicate business and human rights issues. I will blog about these panels and others that may be of interest to the business community next Thursday. Until then enjoy your holiday and if you participate in or see any protests, send me a picture.

November 27, 2014 in Ann Lipton, Conferences, Corporate Finance, Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Haskell Murray, International Business, Marcia Narine, Securities Regulation, Social Enterprise | Permalink | Comments (0)

Saturday, November 22, 2014

In anticipation of Thanksgiving

I have something of a follow-up to Haskell's earlier post

While companies like Wal-Mart will be open on Thanksgiving - a decision that has garnered no small amount of public criticism- others have conspicuously declared that they will be closed, in order to allow their employees to spend time with their families.

Now, you can call this a sincere commitment to employees' well-being if you like, but my cynical brain views this as a standard share value-maximizing decision - whether management has decided that adverse publicity would harm the brand, or that employees who get holidays off are less likely to agitate for higher wages, or that regulators are less likely to step in if the business makes some minimal concessions to employee welfare, it's still a decision that's about benefitting the bottom line.  If nothing else, it can be cast that way - which is precisely why, precisely as has been frequently argued on this blog, it's difficult to understand why the separate concept of a benefit corporation is necessary, except to the extent it represents the ultimate in marketing commitment.  Or maybe some corporate directors just don't want to have to come up with a shareholder-value-maximizing lie about the reasons for their decisions, even if it would be easy to do.

The Thanksgiving-holiday debate also fascinates me because of the way in which it calls to mind Hillary Sale's concept of corporate "publicness" - the idea that corporations, as large and powerful actors in society, are viewed as public institutions, and suffer when they fail to conduct their affairs with that understanding.  The corporations that have  declared that they will not be open on Thanksgiving seem to be responding to this "publicness" concept.

But that just raises the question, how much does "publicness" represent anything different than the types of pressures that have always existed to force corporations to behave as better corporate "citizens"?  Corporations have always had to fear that customers or employees would turn against them, or regulators would try to control them, if they did not behave appropriately; why are today's corporations any different?

Perhaps it's simply because modern corporations are too powerful to regulate via traditional mechanisms. Public shaming and appeals to (certian classes of) shareholders appear to be the only levers of control available - or, at the very least, in a world where it is expected that regulation is unnecessary, scrutiny of corporations as public actors is a natural response.  Mariana Pargendler argues that corporate governance has only arisen as an important issue in corporate theorizing as a result of the deregulatory bent of modern America - because there is no political appetite for direct regulation, people who would prefer direct regulation instead turn to corporate governance arguments as a second-best solution for controlling corporate behavior.

I suspect this is accurate.  Once upon a time, if we were concerned that workers were being unfairly pressured to work over the holidays, we might consider using direct regulation to remedy the problem.  Today, the idea seems extremely remote, if not utterly impossible.  Public shaming seems the only viable alternative, in hopes that either shareholders or customers will display enough distaste for corporate policies that managers decide to voluntarily reform.

 

November 22, 2014 in Ann Lipton | Permalink | Comments (7)

Saturday, November 15, 2014

What Hath Judge Rakoff Wrought?

Back in 2011, Judge Rakoff famously delivered a blistering indictment of the SEC's enforcement tactics when he rejected the SEC's settlement with Citigroup over a CDO alleged to have been designed to fail. 

The decision was immediately appealed (and ultimately reversed), but was pending before the Second Circuit for over two years.  During that time, other district judges followed Rakoff's lead, scrutinizing the SEC's settlements more closely.

Judge Rakoff's criticism was incredibly influential, or perhaps just captured a zeitgeist regarding the lack of serious sanctions against large financial institutions in the wake of the mortgage crisis - the SEC even announced it would revise its "no admit-no deny" settlement policy as a result.

After the Second Circuit reversed Judge Rakoff, he reluctantly approved the Citigroup settlement - but with a footnote warning (1) that the SEC would simply bring more cases administratively to avoid any court review at all, and (2) that such administrative decisions might be unconstitutional.  

Judge Rakoff seems a bit prescient in that respect, because the SEC has openly stated it plans to bring more administrative cases - and the data shows that's apparently a smart move, since its administrative judges, at least recently, deliver victories to the Commission 100% of the time.  (I can't tell whether the data controlled for the types of cases likely to be brought administratively versus in court).  Meanwhile, Judge Rakoff has continued to criticize the SEC - most recently in a speech lamenting the trend toward administrative trials, in part because federal appellate review is deferential.

And many of the "new" defendants are fighting back with challenges to the constitutionality of the SEC's administrative forum.

Most recently, Justice Scalia, joined by Justice Thomas, penned a statement respecting a denial of certiorari in an insider trading case, in which he openly challenged the notion that the SEC may administratively interpret a statute in a manner that deserves deference from courts enforcing the crininal laws.  That argument may be a bit far afield from Judge Rakoff's legally, but the policy concerns are similar - Judge Rakoff, too, extolled the virtues of having a federal court oversee the agency's conduct and guide the development of the law.

(One can't help but notice that this argument seems to have no purchase when private plaintiffs make it in reaction to boilerplate arbitration agreements concerning statutory claims.  But I digress.)

To be sure, there are obvious distinctions between these issues.  After all, the SEC's decision to bring cases administratively may just be a function of new powers granted to it after Dodd-Frank, and may not reflect any desire to avoid scrutiny by judges like Rakoff.  Moreover, the new administrative cases do not concern mortgage-misconduct or even the misconduct of big banks - many involve insider trading, like the case that inspired Justice Scalia's statement.  Finally, Justice Scalia's statement goes well beyond the SEC, and could potentially extend to many administrative agencies. 

Nonetheless, it's very hard not to suspect that Rakoff and other judges of his ilk play some role in the SEC's calculus when deciding where to prosecute a case.  And the throughline of all of this, for me, is that the criticisms of the SEC all look like variations on the ongoing accusation that the SEC (and federal prosecutors) prefer easy wins in insider trading cases to aggressive policing of large financial institutions.  (It is, in a way, the same debate that is dividing the Commission right now regarding penalties to be imposed on Bank of America for crisis-related misconduct.)  Judge Janice Rogers Brown on the DC Circuit just yesterday delievered a similar attack on the SEC, writing that more accountability and openness is required because "Financial institutions and their regulators now frequently operate under a haze of public distrust fueled by repeated regulatory failures and massive, opaque and unaccountable bailouts.  The public now has good reason to doubt the rigor of our financial systems’ reliability and oversight."

So I can't help but wonder how much Judge Rakoff's attack in 2011 is continuing to reverberate throughout the system.

I also have to say, the questions posed in the Scalia opinion are fascinating.  There has long been a palpable tension in courts' interpretation of Section 10(b) between their desire to narrow the statute for private claims, and their desire to broaden it for SEC claims.  In Stoneridge Investment Partners v. Scientific-Atlanta (2008), for example, the Supreme Court dismissed the plaintiffs' Section 10(b) claims by focusing on the element of reliance - applicable in private actions but not SEC actions - which set up a significant divide between the types of conduct that can form the basis of private actions, versus the types of conduct the SEC can target.  The Fourth Circuit then started on a path of interpreting the statute differently for criminal claims (one suspects because it was really trying to distinguish government from private, rather than civil from criminal). 

If Justice Scalia's argument wins the day, will we see a proliferation of interpretations of 10(b) - public civil, criminal, and private?

November 15, 2014 in Ann Lipton | Permalink | Comments (2)

Saturday, November 8, 2014

It's About Civil Procedure

On Tuesday, in my Financial Crisis seminar, we discussed the types of securities claims that have been filed by investors in mortgage-backed securities.  I opened by telling my students that one of the critical takeaway points is the importance of civil procedure.  The substance of the law matters, sure, but (as I posted when discussing class action standing), cases are won and lost on procedural grounds.

Case in point: Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, which was argued before the Supreme Court on Monday.  (Transcript here.)  Omnicare concerns the question of opinion-falsity in the context of claims under Section 11 of the Securities Act of 1933. 

Section 11 of the Securities Act imposes strict liability on issuers who include false statements of material fact in registration statements.  In a case called Virginia Bankshares, Inc. v. Sandberg, the Supreme Court held that even expressions of opinion may count as “material facts” for the purposes of the securities laws – such as, for example, a proxy statement that recommends a merger as “fair” to shareholders.  In Omnicare, the Supreme Court will decide what, exactly, it means for a statement of opinion to be false. Essentially, the dispute is about whether a statement of opinion is only false if it is subjectively disbelieved by the speaker (i.e., if the speaker claims a price is “fair” while secretly believing the price is not fair) or whether a statement of opinion can be false even if the speaker believes it to be true, but the opinion lacks a basis in fact (i.e., the speaker genuinely believes the price to be fair, but has not made any investigation into fairness and so the opinion lacks a factual basis).

Joan Heminway posted about the case here, and I also had a rundown on the issues here (where I argued, at the cert stage, that the issue was not yet ripe for Supreme Court consideration).

Monday's oral argument had a lot of back and forth about specific states of mind and various types of implied representations.  After all, when you issue an opinion in the context of a securities offering, isn’t there an implied factual representation that you have a basis for that opinion, that’s independent of the speaker’s state of mind?  On the other hand, if a statement does lack a factual basis, isn’t that strong evidence of subjective disbelief? 

And while all of these are interesting existential questions, the really important issue – and what oral argument touched upon – is pleading.

The question of opinion-falsity tends to come up in three different types of private claims under the securities laws.

First, it comes up in the context of Section 11, which imposes strict liability for false statements in registration statements. 

Second, it comes up in the context of Section 14, which imposes liability for false statements in proxy statements.  Most circuits have held that Section 14 liability is rooted in negligence.

Third, it comes up in the context of Section 10(b), which imposes liability for intentionally or recklessly false statements in connection with securities transactions.

Because Section 10(b) requires a showing of scienter, the issues in Omnicare are largely rendered moot for claims under that statute – the plaintiff will have to show intentional or reckless behavior anyway, so “subjective disbelief” gets folded into the scienter inquiry.

Where the “subjective disbelief” issue really makes a difference, therefore, is in the context of Section 11 and Section 14.

Section 14 claims are subject to the heightened pleading requirements of the Private Securities Litigation Reform Act.  That statute requires that plaintiffs plead, with particularity, facts creating a “strong inference” that the defendant acted with the required state of mind.  Some courts have held that negligence is not a state of mind, so this provision does not apply; even if it is, it's often not a difficult one to plead, even under the PSLRA.

Section 11 claims are not subject to heightened pleading under the PSLRA – they are subject to ordinary standards under the Federal Rules.  Normally, because Section 11 is a strict liability statute, plaintiffs need only plead claims in accordance with Rule 8.  But most circuits agree that when a Section 11 claim “sounds in fraud” – when the plaintiffs seem to be claiming that defendants’ actions were intentional or reckless – then Section 11 claims will be subject to Rule 9(b) pleading standards.  And though there’s a circuit split on the issue, many courts would agree that Rule 9(b) also requires that plaintiffs plead facts giving rise to a “strong inference” of fraud.

If “subjective disbelief” is required to show opinion-falsity, courts are likely to treat that as the equivalent of fraudulent intent, and require heightened pleading for Section 11 and Section 14 claims.

Moreover, for securities claims, all discovery is stayed pending the resolution of a motion to dismiss.  That means that the plaintiffs must not only plead fraudulent intent in great detail, but they must also do so without discovery.

The upshot of all of this is that one of the most significant aspects of Omnicare isn't what it means for an opinion to be false, and it isn't the duties imposed on issuers of securities – it’s whether plaintiffs bringing claims under Section 11 and Section 14 are going to be subject to heightened pleading requirements.  This is especially true because the boundaries between what counts as “opinion” and what counts as “fact” are very fuzzy – a point that was made in oral argument.  After all, as I previously posted, the Second Circuit believes that even financial statements are only “opinions.”  If just about anything can be considered an opinion, a requirement that opinions be "subjectively disbelieved" will functionally raise the pleading standards for Section 11 and Section 14 claims across the board.

(Now, the Second Circuit also tried to stake out an odd middle ground, holding both that opinion statements must be “subjectively disbelieved” to be false, and that this “subjective disbelief” is something other than fraudulent intent.  That holding has caused much confusion in the district courts, and it’s difficult to imagine a similar holding coming out of the Omnicare case; and even if Omnicare dodges that point, if the Court holds that "subjective disbelief" is required, the Second Circuit's view is going to come under considerable pressure.)

In other words, the sleeper issue in this case isn't the substance of the law - it's procedure.

November 8, 2014 in Ann Lipton | Permalink | Comments (2)

Saturday, November 1, 2014

I hate to dispute the marketing experts, but as a chocoholic, I object

Skittles

(demonstrating that variety isn't always a good thing)

Well, Halloween was yesterday, but the chocolate-y remains will last for ... at least another 5 3 2 hours.  Which brings me to this article on how, despite increases in chocolate prices, sales of chocolate continue to rise:

Chocolate candy sales for last Halloween hit $217 million, up 12 percent from the year before, the consumer market research firm Packaged Facts reported in September. For all of 2013, the American market for chocolate grew 4 percent, to $21 billion in sales. But chocolate lovers took a hit this summer, when Hershey and Mars announced price increases of 8 percent and 7 percent...  But don’t expect higher prices to dampen sales, analysts said....

Chocolate makers have also adopted a marketing strategy that is increasingly driving sales: the variety bag, a single package filled with several different types of bars. Mars said sales of the variety bag it introduced a few years ago (with Milky Ways, Three Musketeers and such) grew by 14.5 percent in 2012, accounting for 54 percent of its total Halloween sales growth, and have remained strong.

Scientists who research how our brains respond to food have another term for variety: the smorgasbord effect (as in stuffing yourself at Chinese buffets). Studies show that we quickly acclimate to any food or flavor we’re eating, causing the brain to register a feeling of fullness. Variety delays this process by keeping food exciting.

Okay, look, I'm not denying that we habituate to certain flavors, or that variety packs can introduce consumers to things they wouldn't otherwise buy.  But people buy big bags of smaller candies for a reason:  To distribute.  And in that context, they like variety not because they get bored with one flavor, but because as a Halloween candy-giver, you want to give trick-or-treaters a choice.  You never know which kid will hate almonds or love dark chocolate or which kid (uh, kid, yes, we'll go with kid) treats peanut butter cups as a meal replacement.  Variety packs are an easy way of making sure you offer the best treats in the apartment complex no matter who shows up at your door.  I'd rather buy two variety bags than 10 bags of different single-type candies just to give trick or treaters a choice. 

I mean, if I bought 10 bags of candies to make sure I catered to every kid's idiosyncratic tastes, I'd have the equivalent of 8 bags left over.  Which would be... terrible. 

Yes.  Terrible.  That's totally the word I was looking for.

November 1, 2014 in Ann Lipton | Permalink | Comments (3)

Saturday, October 25, 2014

Delaware Litigation – Do the Merits Matter?

Minor Myers and Charles Korsmo have a new paper that compares fiduciary duty merger litigation to appraisal litigation to determine whether fiduciary duty claims add any value for shareholders. 

After scrutinizing takeover challenges between 2004 and 2013, they find that the larger the deal, the more likely it is to be targeted in a fiduciary duty class action.  By contrast, whether there is a smaller merger premium – regardless of deal size – does not appear to be correlated with class action litigation.  Appraisal litigation, however, works differently; plaintiffs who bring appraisal claims tend to do so when the merger premium is low, regardless of deal size.

They also found that fiduciary suits are not associated with an increase in merger consideration.  I.e., they do not generate statistically significant benefits to shareholders.

Myers and Korsmo conclude from this that fiduciary duty class actions are not usually based on merit, and that such actions are brought for their nuisance value.  They recommend changes to the structure of fiduciary litigation, such as allowing investors who acquire stock after the deal announcement to serve as lead plaintiff, and switching to an opt-in model.

But there’s a wrinkle that comes in the form of a paper by C.N.V. Krishnan, Steven Davidoff Solomon, and Randall S. Thomas.  That paper compares fiduciary merger litigation brought by different plaintiffs’ firms, and concludes that not all firms are created equal.  Specifically, the top plaintiffs’ firms target more suspicious transactions, and when the litigation is controlled by these firms, the class members are more likely to win an increase in merger consideration.  They also find that top firms prosecute actions more vigorously, in measurable ways.

Obviously, these two papers, put together, raise an interesting question: what would happen if the Myers/Korsmo study were conducted with a view to the identity of the lead plaintiff’s law firm?  Would they see the same results?  And if the problem here is just that there are better and worse law firms, is that something that can be addressed via more exacting standards for the award of attorneys’ fees?

(Okay, full disclosure - one of the top plaintiffs' firms in the Krishnan et al study is my former firm, BLBG.  But hey, I didn't do the study - I'm just reporting the results.)

October 25, 2014 in Ann Lipton | Permalink | Comments (0)

Saturday, October 18, 2014

Must … resist … joke … about …. no wonder they … missed Madoff….

The Columbia Journalism Review blog reports:

Since 2008, one particular federal government agency has aggressively investigated leaks to the media, examining some one million emails sent by nearly 300 members of its staff, interviewing some 100 of its own employees and trolling the phone records of scores more.  It’s not the CIA, the Department of Justice or the National Security Agency.

It’s the Securities and Exchange Commission. …

All that effort was for naught. Despite the time and resources that have been poured into them, none of the SEC’s eight investigations in the past six years have uncovered the leakers.…

The article further points out that the SEC’s pursuit of leakers has ramped up in the wake of the financial crisis, and it has no problem with leaks (if you call them “leaks”) when the leaks make the agency look good.

The SEC’s argument is that it needs to protect against the release of market moving information, and I'm quite sympathetic to that point, but the leaks involved here seem to be at least in part about concealing internal problems or dissension within the agency.  

Considering how at least two Commissioners have recently spoken out about their dissatisfaction with the SEC’s enforcement efforts (not to mention the best SEC speech ever), I tend to be sympathetic to the argument that sunlight - or at least less intimidation - is in order.

(Also, if they can't catch their own leakers.... )

October 18, 2014 in Ann Lipton | Permalink | Comments (2)

Saturday, October 11, 2014

Loss causation by hindsight

One of the most complex issues in Section 10(b) litigation concerns loss causation, i.e., the question whether the fraud ultimately resulted in a loss to the plaintiffs.

The reason loss causation is so complex is because companies rarely simply admit to wrongdoing, out of the blue.  Most of the time, the "truth" behind the fraud - whatever that truth may be - is revealed gradually or indirectly.   The first revelations concerning an accounting fraud, for example, might simply be a drop in earnings, as the company tries to "make up" for past premature revenue recognition without admitting to wrongdoing.  A company might announce a slowdown in product sales without ever admitting that it had previously lied about the product's features.  A key officer might resign without explanation.  And very often, the first rumblings of a problem come from the announcement of a government investigation - without any further details - that may or may not ultimately culminate in an enforcement action.

In response to any of these announcements, the company might experience a stock price drop, even though the market either is unaware of the possibility of fraud or uncertain as to whether a fraud exists and/or its scope.  In such situations, can the fraud be said to have "caused" a loss?

In a pair of decisions by the Fifth and Ninth Circuits, it appears that whether such early warning signals constitute "loss causation" depends very much on what happened later.

[More under the cut]

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October 11, 2014 in Ann Lipton | Permalink | Comments (5)

Saturday, October 4, 2014

Lucky timing

As I previously posted, this semester I’m co-teaching a seminar with an old law school friend, Tanya Marsh (well, seminar-ish – we ended up with 17 students) on the financial crisis.

A couple of weeks ago, I dedicated a class to the concept of “regulation by deal” – inspired Steven Davidoff Solomon and David Zaring’s article with that title.  We talked about how Treasury and the Fed used dealmaking approaches to save individual firms, and thus the economy as a whole, and the corporate law issues that the government’s approach raised (lots of great inspiration also came from Marcel Kahan and Edward Rock’s When the Government is the Controlling Shareholder).  I assigned excerpts of the Regulation by Deal article, as well excerpts from the complaint filed by Fannie & Freddie shareholders, the AIG complaint, and the SIGTARP report on AIG’s payments to counterparties.  We also talked about the mergers between JP Morgan and Bear Stearns, and between Bank of America and Merrill Lynch.

Well, it was lucky timing, because that class – by sheer happenstance – was scheduled just before the AIG trial began, and then earlier this week, the Fannie & Freddie complaint was dismissed.  So now I have even more to talk about with the students.

One point I see in a lot of the commentary on the AIG trial is that the shareholders’ claims are pretty weak, but at least the trial itself will shed some light on one of the unanswered questions about the crisis, namely, why did Geithner and the NY Fed agree to pay AIG’s CDS counterparties 100 cents on the dollar, instead of demanding that they take a haircut?  I.e., one of AIG's major problems was that it had sold credit default swaps (CDS) on mortgage-backed assets held by a number of banks - it had sold insurance, essentially, against a drop in value of those assets.  AIG promised to pay out if those assets failed.  And when asset values began falling, the counterparties demanded that AIG post collateral - and those demands contributed to AIG's liquidity crisis.  To solve that problem, the NY Fed bought the assets underlying the CDS contracts - allowing the counterparties (banks like Goldman Sachs, Morgan Stanley, etc) to collect 100 cents on the dollar for assets that were, at the time, pretty toxic. 

This is, of course, the subject of the SIGTARP report, which concluded that the decision was not particularly well thought out, but was essentially foreordained by the NY Fed’s own self-imposed restrictions on its behavior, which limited its ability to apply any leverage in negotiations.

Among other things, the NY Fed was uncomfortable using its status as regulator to extract concessions on the CDS contracts when it was acting as a creditor of AIG, a more “private” sort of role. 

(Also, the phrase phrase “sanctity of contracts” appears so many times in the SIGTARP report that I wondered if I was going to start seeing graven idols.  But that’s me.)

The problem, of course, was that the NY Fed refused to use its regulatory power while wearing its "private creditor" hat, but at the same time, it also refused to truly behave as a private creditor - making it neither fish nor fowl.  For example, a private actor might have threatened bankruptcy – which the NY Fed was unwilling to do because, in its role as regulator, it could not allow AIG to declare bankruptcy.  A private actor would have been fine with striking different deals with different counterparties – which again, the NY Fed as regulator was unwilling to do, allowing any one counterparty to veto deals with the others.

And perhaps even more strikingly to me as a former litigator, the NY Fed also agreed not to sue any of the counterparties for fraud/misrepresentation.  That doesn’t strike me as anything like what a private actor would have done – which we know for a fact, given lawsuits filed by entitles like MBIA and Syncora.  A private actor could have at least demanded concessions in exchange for not filing a lawsuit – claiming, say, that the counterparties misrepresented the quality of the mortgages backing the assets – and dragging the matter out in court for years.  But the last thing the NY Fed as regulator wanted was that kind of publicity.

Anyway, however it shakes out, it'll make for a fun follow-up class.

October 4, 2014 in Ann Lipton | Permalink | Comments (3)

Monday, September 29, 2014

I guess it won't be a hat trick after all

Today, the Supreme Court DIG'd (dismissed as improvidently granted) the cert petition in the Section 11 case of IndyMac, which means we will not, at least for now, get resolution on the issue of whether American Pipe tolling applies to statutes of repose.

To be honest, I'm really not surprised.  The DIG was apparently in response to an announcement of a settlement of most of the IndyMac claims, but that's a bit odd, since the parties all agreed that the settlement left alive enough claims to render the case not moot (specifically, the plaintiffs' claims against Goldman Sachs would proceed if the plaintiffs prevailed before the Supreme Court). 

But as I previously posted, I think IndyMac was in an awkward procedural posture to begin with. Not because the split wasn't real, but because the entire issue regarding the statute of repose was necessarily intertwined with prior unsettled issues regarding class action standing and the scope of Rule 15c.  Frankly, I can't help but wonder if the Justices saw the settlement as an excuse to get rid of a bad grant, and they grabbed it.

That just leaves one, and possibly two, Section 11 cases for the Court to decide this Term.

 

September 29, 2014 in Ann Lipton | Permalink | Comments (0)

Saturday, September 27, 2014

Fee shifting, again

I previously posted about Delaware's approval of fee-shifting bylaws, and a legislative attempt to ban them.  That attempt was tabled until next year. 

In the meantime, several companies have adopted such bylaws, although some early challenges to the bylaws ended up being settled before courts could rule on their validity.   J Robert Brown at Race-to-the-Bottom blog reports that a company just went public with a fee shifting charter provision in place (the provision purports to cover securities claims as well as governance claims, but, as I previously posted, I don't think that's possible).

Most interestingly, Oklahoma recently passed a law requiring "loser pays" rules for all derivative litigation.  Which certainly creates an opportunity for a natural experiment in the idea of the market for corporate charters - will companies flock to Oklahoma?  Will investors pressure managers to stay out of Oklahoma (or to go to Oklahoma, if they doubt the value of derivative litigation)?

Stephen Bainbridge reports that the SEC's Investor Advisory Committee will be considering fee-shifting bylaws at its next meeting, and asks (via approving linkage to Keith Paul Bishop) why should the Investor Advisory Committee be conferring with the SEC on a state law contract question?

Well, my answer would be, because the corporate form - by definition - includes judicial oversight as part of the corporate "contract" (if you call it a contract).  Judicial construction of "terms" (if you call them terms) is inherent in its nature, and an important part of ensuring that corporate managers do not exploit shareholders.  Fee-shifting undermines that bargain, especially if applied to representative litigation (where the shareholder has only a small upside but a very large potential downside).  For that reason, the Investor Advisory Committee and the SEC have an interest in making sure that investors "get" what they expect to get - a corporation, which includes judicial oversight as inherent in the organizational form.

And it's not like the SEC hasn't - under the guise of investor protection - policed matters of internal corporate governance before.  For example, the NYSE (which acts under the SEC's direction) requires shareholder votes for certain large new stock issuances in terms of equity or voting power.  The NYSE also forbids disparate reduction in common stock voting power.  One could easily imagine that, even if the SEC doesn't act directly, the NYSE could adopt a rule requiring that listed companies not adopt fee-shifting bylaws.

Oklahoma, however, adds a new wrinkle - I imagine it's not home to many publicly traded corporations, but it's difficult to imagine the SEC relishing the idea of preempting Oklahoma law on this subject, or the NYSE categorically refusing to list Oklahoma corporations.

September 27, 2014 in Ann Lipton | Permalink | Comments (1)

Saturday, September 20, 2014

It’s rare to see so many people interested in a proxy battle

But that’s what happened when hedge fund Starboard Value delivered a 294-slide presentation on the terrible food at Olive Garden as part of its fight for control of Darden Restaurants. (You can see the presentation in all of its glory here.)

The presentation not only received news coverage in standard outlets like WSJ and Bloomberg, but even attracted the attention of Slate and Mother Jones, who were amused by such detailed accusations as “Darden stopped salting the water in which it boils pasta,” that the crispy Parmesan asparagus is “anything but,” and Starboard’s lament that Olive Garden wait staff bring multiple breadsticks to the table at once, instead of delivering one per customer with a right of replenishment – which leads, according to Starboard, to cold breadsticks that “deteriorate in quality,” and encourages customers to fill up on the free stuff instead of ordering more things that cost money.

Starboard also complained that the Olive Garden menu has expanded to non-Italian offerings like tapas and burgers, that Olive Garden overstuffs its salads and lards them with too much dressing, and that the wait staff fail to push alcohol sales.

All of this, of course, led to such glorious headlines as “Olive Garden Defends Breadstick Policy,”  and a Business Insider review of Olive Garden restaurants (the verdict: Starboard was right; but for a contrary opinion, see the New Yorker's take).

The real debate, though, isn’t about food – it’s about the value of the real estate on which Darden’s restaurants sit – which didn’t really make it into most of the headlines.

That said, in a fairly ironic bit of timing, just days after the presentation, CalPERS announced that it was dumping all of its hedge fund investments, because they just aren’t delivering enough of a bang for the buck. CalPERS’s announcement, though, didn’t get quite the same news coverage – maybe it should have used power points.

September 20, 2014 in Ann Lipton | Permalink | Comments (7)

Saturday, September 13, 2014

The Solicitor General Recommends a Grant in Moores v. Hildes

The Solicitor General recently filed a brief with the Supreme Court recommending that the Court grant certiorari in the Ninth Circuit case of Moores v. Hildes, No. 13-791.  If the Court takes this recommendation (which I’m guessing it will), it will be the third Section 11 case scheduled to be heard this Term.  (I’ve blogged about the prior two here and here.)

[More under the cut]

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September 13, 2014 in Ann Lipton | Permalink | Comments (0)

Saturday, September 6, 2014

Mandating Arbitration of Securities Claims via Corporate Governance Documents?

Since Delaware decisions like Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013) and ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), there have been renewed calls for corporations to amend their charters and/or bylaws to require that shareholder lawsuits – including securities lawsuits – be subject to individualized arbitration. 

This is actually a big interest of mine – I’m currently working on a paper concerning the enforceability of arbitration clauses in corporate governance documents.  Critically, I do not believe these decisions support the notion that arbitration provisions can control securities claims – at best, they suggest that arbitration provisions in corporate governance documents can control governance claims (i.e., Delaware litigation – concerning directors’ powers and fiduciary duties). 

[More under the cut]

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September 6, 2014 in Ann Lipton | Permalink | Comments (7)

Saturday, August 30, 2014

MBS Settlements – The Money Got Lost in Standing

Adam Levitin at Credit Slips has an interesting breakdown of MBS litigation settlements.  He points out that of the $94.6 billion in settlement funds, only 2% has gone to private investors alleging securities-fraud-type claims.

He concludes:

First, it shows that legislative reforms and court rulings have seriously impeded the effectiveness of securities class action litigation. If ever there were an area ripe for private securities litigation, private-label RMBS is it, yet almost all of the recoveries are from six settlements.  This should be no surprise, but it's rare to see numbers put on the effect.  This is what securities issuers and underwriters have long wanted, and the opposition has mainly been the plaintiffs' bar, but perhaps investors will take note of the effect too. 

Second, the distribution shows how badly non-GSE investors got shafted. Remember, that private-label securitization was over 60% of the market in 2006. Yet investors have recovered only 38% of that which the GSEs/FHFA have recovered, and most of that is from the trustee settlements or proposed settlements (I'm not sure that any have actually closed). Private securities litigation has recovered a mere 4% of what the GSEs/FHFA have recovered. 

The real question is whether investors have learned that they cannot rely on either trustees or the securities laws to protect them from fraud, and if they have, what they plan to do about it. One sensible thing would be simply to invest in other asset classes. The other would be to try and reform the trustee system and/or the securities laws.

I'm sure there are many reasons for the disparity, but I think one major contributor is a series of rulings narrowing the definition of standing in the class action context. 

 

(okay, that was my attempt to jazz up a procedural post)

Anyway, these standing issues are now pending - sort of - before the Supreme Court, as I previously posted.  What's interesting is that these standing rulings have had a dramatic effect on private investors' ability to bring claims, but they aren't usually mentioned in the same breath as other, more obvious, limitations on securities class actions. 

[More under the jump]

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August 30, 2014 in Ann Lipton | Permalink | Comments (0)

Monday, August 25, 2014

Sex, Lies, and . . . Crowdfunding

This follows on Ann's post yesterday on Gender and Crowdfunding.  Ann, so glad you've joined me and Steve Bradford as securities crowdfunding watchers!  Delighted to have you in that informal, somewhat disgruntled "club."

I have been interested in whether securities crowdfunding will democratize business finance.  (I note here that Steve Bradford's comment to Ann's post raises the broader question of crowdfunding's ability to better engage underrepresented populations in general.)  My interest has, however, been more on the investor (backer) side of the crowdfunding equation than on the business (entrepreneur) side.  

As Ann notes, given the delay in the Securities and Exchange Commission (SEC) rulemaking under Title III of the Jumpstart Our Business Startups (JOBS) Act, the information on gender and crowdfunding that we have so far comes from other types of crowdfunding.  This information may or may not map well to markets in securities crowdfunding.  But it's still worth reviewing the information that we do have.

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August 25, 2014 in Ann Lipton, C. Steven Bradford, Entrepreneurship, Joan Heminway, Securities Regulation | Permalink | Comments (1)

Saturday, August 23, 2014

Crowdfunding and Gender

The SEC is in the process of crafting rules to facilitate crowdfunding of unregistered securities offerings.  There's been a lot of back and forth about the merits of this idea - Michael Dorff, for example, has argued that it's a sucker's game, because the only businesses that will require crowdfunding are those too toxic for angel investors to touch.  Meanwhile, Steve Bradford just posted about a study suggesting that the "crowd" is better at identifying winning business ideas than individual investors - even the professionals.

One idea that's been floated, however, is that crowdfunding will open doors for disadvantaged groups - like women.

Indiegogo, a crowdfunding website, recently boasted that women founders reach their target funding in much greater numbers than do women who seek startup capital through traditional means.  Women have had similar results on Kickstarter.

There's been a lot written recently about how women fare poorly in the tech world when they seek startup funding.  Women report navigating a lot of pretty toxic sexism from the mostly-male angel investors with whom they must negotiate.

I have my doubts about the viability of crowdfunding, but I'll be interested to see whether it can also level playing fields in unexpected ways.

August 23, 2014 in Ann Lipton | Permalink | Comments (2)