Saturday, January 13, 2018

A modest proposal about proposals

As Joan and Josh previously posted, Stefan organized an excellent AALS panel on Rule 14a-8. We covered a number of topics, including the appropriate role of retail and employee shareholders, the proper sphere of activity for shareholders vis a vis managers, the true audience for shareholder proposals, and how to construct Rule 14a-8 so that frivolous and improper proposals can be easily weeded out.

In my remarks, I focused on the fact that shareholder proposals are usually precatory, even when they don’t have to be.  For example, shareholders have the right to pass bylaws, but even the Boardroom Accountability Project typically sponsors proposals that merely request that directors use their power to craft proxy access bylaws.  (I assume that’s at least in part because a good bylaw must address administrative matters that shareholders are ill-equipped to manage – for example, see management’s response to Proposal Ten, for a majority-rule bylaw at Netflix).

Because shareholder proposals are precatory, their main function is informational: they allow shareholders to communicate with management, with each other, and with the market more generally.  I suspect that this function may become especially important as passive investing’s popularity increases; absent the ability to sell, votes – and votes on specific governance matters – may be the most effective ways for shareholders to signal their views to management.

Given that, I believe that one fairly easy way of enhancing that signal would be to require that companies with multi-class shares disclose the class vote breakdown on shareholder proposals – and other votes as well – when they disclose the vote totals.  I’d also potentially recommend a breakdown that distinguishes the votes of the management group from other shareholders.

Right now, unless a class vote is held separately, companies are only required to release the vote totals.  This can cause some misleading reports.  For example, when Google’s shareholders proposed elimination of the multi-class share structure in 2017 (as they have done in prior years), Google reported that there were 191,712,790 votes for, and 472,583,246 votes against the proposal.

This, of course, obscured the fact that the public shareholders apparently mostly favored the proposal; it was only defeated because Larry Page and Sergey Brin, with their high-vote shares, voted against it. 

Now, obviously, even without a clear disclosure of this type, clever analysts might be able to glean the approximate breakdown from publicly reported information – as the above linked article indicates – but depending on the class structure, it may not always be that obvious.  Moreover, as I recently posted, the SEC’s Investor as Owner Subcommittee of the Investor Advisor Committee thinks clearer disclosures regarding multi-class share structures would benefit the market, even when some of that information might be deducible from a close reading of SEC filings.

There is also evidence that management may intentionally exercise in-the-money options to vote against shareholder proposals that are in danger of passing; because of these and other close-vote scenarios, a vote breakdown would be helpful.

And I think this is useful information to have.  It may assist with pricing of the public shares, and it may assist with pricing of shares of other companies with multi-class structures.  It could also assist with companies and underwriters trying to decide whether to go public with multi-class share structures in the first place.

In other words, I think this is a pretty cheap intervention, and one that would provide real informational benefits.

January 13, 2018 in Ann Lipton | Permalink | Comments (0)

Monday, January 8, 2018

AALS 2018 Wrap-Up

AALS2018(SHProposalPanel)

Last week, I had the privilege of attending and participating in the 2018 annual meeting of the Association of American Law Schools (#aals2018).  I saw many of you there.  It was a full four days for me.  The conference concluded on Saturday with the program captured in the photo above--four of us BLPB co-bloggers (Stefan, me, Josh, and Ann) jawing about shareholder proposals--as among ourselves and with our engaged audience members (who provided excellent questions and insights).  Thanks to Stefan for organizing the session and inspiring our work with his article, The Inclusive Capitalism Shareholder Proposal.  I learned a lot in preparing for and participating in this part of the program.

Earlier that day, BLPB co-blogger Anne Tucker and I co-moderated (really, Anne did the lion's share of the work) a discussion group entitled "A New Era for Business Regulation?" on current and future regulatory and de-regulatory initiatives.  In some part, this session stemmed from posts that Anne and I wrote for the BLPB here, here, and here.  I earlier posted a call for participation in this session.  The conversation was wide-ranging and fascinating.  I took notes for two essays I am writing this year.  A photo is included below.  Regrettably, it does not capture everyone.  But you get the idea . . . .

  AALS2018(Regulation)
In between, I had the honor of introducing Tamar Frankel, this year's recipient of the Ruth Bader Ginsburg Lifetime Achievement Award, at the Section for Women in Legal Education luncheon.  Unfortunately, the Boston storm activity conspired to keep Tamar at home.  But she did deliver remarks by video.  A photo (props to Hari Osofsky for getting this shot--I hope she doesn't mind me using it here) of Tamar's video remarks is included below.

Tamar(Video-HariO)

Tamar has been a great mentor to me and so many others.  She plans to continue writing after her retirement at the end of the semester.  I plan to post more on her at a later time.

On Friday, I was recognized by the Section on Business Associations for my mentoring activities.  On Thursday, I had the opportunity to comment (with Jeff Schwartz) on Summer Kim's draft paper on South Korean private equity fund regulation.  And on Wednesday, I started the conference with a discussion group entitled "What is Fraud Anyway?," co-moderated by John Anderson and David Kwok.  My short paper for that discussion group focused on the importance of remembering the requirement of manipulative or deceptive conduct if/as we continue to regulate securities fraud in major part under Section 10(b) of, and Rule 10b-5 under, the Securities Exchange Act of 1934, as amended.

That summary does not, of course, include the sessions at which I was merely in the audience.  Many of the business law sessions were on Friday and Saturday.  They were all quite good.  But I already am likely overstaying my welcome for the day.  Stay tuned here for any BLPB-reated sessions for next year's conference.  And in between, there's Law and Society, National Business Law Scholars, and SEALS, all of which will have robust business law programs.

Good luck in starting the new semester.  Some of you, I know, are already back in the classroom.  I will be Wednesday morning.  I know it will be a busy 14 weeks of teaching!

January 8, 2018 in Ann Lipton, Anne Tucker, Conferences, Corporate Governance, Joan Heminway, Joshua P. Fershee, Securities Regulation, Shareholders, Stefan J. Padfield | Permalink | Comments (0)

Saturday, January 6, 2018

Saturday Movie Blogging: Molly's Game and The Greatest Showman

Over the holidays, I saw The Greatest Showman and Molly’s Game.  You wouldn’t have thought they’d be all that similar, but in fact, they’re both stories about nontraditional entrepreneurs who build unusual businesses from scratch. Molly’s Game understands that; sadly, Greatest Showman does not.  As a result, Molly’s Game is the more successful film.

The bulk of Molly’s Game is spent on building a business.  She learns the field, she identifies prospects, she finances and markets her game, she maintains her position and handles competition.  This is the heart of the movie and much of its appeal lies in the illustration of her ingenuity and expertise.

Those are also the best parts of The Greatest Showman, yet - and I rarely say this about a movie - the film was too short (1.5 hours). Too short because it quickly moves away from that theme to focus on a different story, namely, something about inclusion and acceptance for people who don't fit society’s mold.  As one review put it, “it doesn’t really tell Barnum’s story. Rather, it appropriates his name for a pop-culture sermon on inclusion that lets us know, just in case we didn’t realize, that 500-pound men and bearded ladies are not just perfectly valid citizens but ‘glorious.’”

Now that’s a problematic theme for Barnum, and it’s more problematic when the whole idea is filtered through able-bodied, gorgeous, and white Hugh Jackman for the grownups and Zac Efron for the kids, but also, it gets away from what Barnum is famous for - what the title of the movie suggests - namely, his marketing genius.

Barnum is sometimes known as the Shakespeare of advertising for developing PR techniques that are still in use today.  He was skilled at writing punchy, eye-catching copy, spinning a yarn – which the movie tells us but only barely demonstrates, most prominently in a single, early moment when he enchants his daughters with an improvised tale to distract from his inability to afford a birthday gift.

(Sidebar:  The X-Files episode “Humbug” features a gem of a scene in which the curator of a local museum of circus oddities illustrates, in delightfully understated fashion, the type of storytelling power for which Barnum is remembered.  You can see it online here, just jump to the 21:14 mark - at least until someone sends a takedown notice.)

Anyhoo, given Greatest Showman’s short runtime, way more space could have, and should have, been devoted Barnum’s publicity stunts, his advertising skills, the efforts it took to build his brand, and his own ethical line (which didn’t, umm, necessarily match the law’s) between salestalk and fraud.  If the movie understood itself better, it could have highlighted those aspects of the character, and it wouldn’t even have had to sacrifice the feel-good-be-yourself message to do it.

So in the end, Greatest Showman didn’t live up to its own hype (Barnum would have been appalled). Molly’s Game, though, was a master class in salesmanship and business savvy.

January 6, 2018 in Ann Lipton | Permalink | Comments (0)

Saturday, December 30, 2017

If a false analyst opinion falls in the computer system, does it make a sound?

There is so much to unpack in FINRA’s recent settlement with Citigroup Global Markets over its analyst ratings. (Press release here.)

The short version is that due to a glitch in one of Citigroup’s clearing firms, there was a nearly five year period when its displayed ratings for 1800 different equity securities (buy, sell, hold) were incorrect.  Buys were listed as sells; securities that weren’t covered received a rating, etc.  As I understand it, the research reports themselves were accurate – so you could probably click through to see the true rating – but in various summaries made electronically available to customers and brokers, the bottom line recommendation was wrong.  My guess – and this is just a guess – is that some brokers and customers probably figured out that the summary ratings were unreliable and made a habit of clicking through to check the research reports, but nonetheless FINRA alleges the mistakes impacted trading in various ways, including by allowing trades in violation of certain account parameters (i.e., accounts that were supposed to be restricted to securities rated “buy,” and so forth).

The problem did not go entirely unnoticed within the firm, but there wasn’t a firm level understanding of how systematic the issue was.  So, brokers would report problems with individual ratings, and maybe they were corrected and maybe not, but no one seems to have had their eye on the system as a whole. 

So, first - wow.

Second, I can’t help but point out that European regulations will soon require that investment banks charge for their research rather than provide it “free” to brokerage clients.  This has created some rather complex questions regarding the value of analyst research as research (rather than as an entrée for schmoozing with corporate insiders, as Matt Levine has extensively discussed).  Which means we now have a new datapoint: if Citi can go nearly five years with no one caring much about systematic mistakes in its analyst recommendations, that, umm, is rather suggestive of the research’s value.  I also look forward to someone doing the empirical work to determine if these mistakes had any impact on market prices.  I mean, Citi leaves a big footprint; it’s not impossible to imagine the errors had some detectable effect on stock prices, if only briefly. 

Third, the extent to which securities laws prohibit false statements of opinion is a perennially hot topic.  Technically, Rule 10b-5, Section 11, and Section 18 prohibit false statements of fact.  Assuming the distinction between fact and opinion is a clear one (which is a whole ‘nother issue) – does that mean people are free to falsely talk up stocks as great buys (in their opinion) even when they are not?

Courts have settled on the rule that when a speaker misrepresents his own opinion – claims that he thinks a stock is a great buy when he thinks it is in fact no such thing – that is a false statement of fact, namely, about the fact of the speaker’s own opinion.  The Supreme Court has also made clear that statements of opinion may be false in the sense that they mislead about the factual basis that underlies the opinion.  Throughout this debate, it has been generally assumed that falsity in the first sense is, functionally, indistinguishable from scienter: after all, how could anyone accidentally misrepresent their own opinion about something? 

Well, it seems Citigroup has now found a way.

Interestingly, this is not a case where a company seems to have accidentally bumbled into a series of mistakes that happily worked out in the company’s favor.  In this case, the false reports were all over the map, and did not appear to result in any particular benefit to Citi.  So, it appears that once computer algorithms get involved, it is in fact possible to falsely state one’s opinion without harboring fraudulent intent.

But only up to a point - some brokers noticed problems with particular stocks and reported them, though Citi took its own sweet time about making a fix.  Does that mean the company acted with scienter with respect to particular false recommendations?  And if so, can we expect to see lawsuits?  (Loss causation will be an issue, naturally, but - well.  We can stay tuned to see if someone comes up with an argument).

December 30, 2017 in Ann Lipton | Permalink | Comments (2)

Saturday, December 23, 2017

It’s beginning to (not) look a lot like Christmas

Christmas is just a couple of days away, and we all know what that means – the end of Winter break is in sight and preparation for the Spring semester must begin in earnest!

In these last few vacation days, however, I leave you with a few articles on the changing face of the Christmas business:

The down-and-out Mall Santa reinvents himself for a modern age

Sorry. Wrap It Yourself, Say Overwhelmed Online Shops

Holiday Windows Brighten a Bleak Retail Scene, but How Long Will They Last?

Merry Christmas to all who celebrate, and for the rest of us – well, I know a great Chinese place :-)!

 

 

December 23, 2017 in Ann Lipton | Permalink | Comments (0)

Saturday, December 16, 2017

Appraisal is the New Fiduciary Duty

This week, the Delaware Supreme Court reversed and remanded Chancery’s appraisal determination in Dell et al. v. Magentar Global Event Driven Master Fund et al..  The decision amplified the Supreme Court’s earlier opinion in DFC Global Corp. v. Muirfield Value Partners, LP, et al..

In DFC, the Delaware Supreme Court held that courts entertaining appraisal claims should place heavy emphasis on the deal price, at least for arm's length negotiations with no apparent flaws.

Dell, however, was a slightly different animal.  Unlike DFC, it involved a management buy-out, which is a scenario rife with potential conflicts of interest.  It was precisely because of these conflicts that the Chancery court refused to accept the deal price, and instead used its own discounted cash flow analysis to determine that the stock was worth more.

On appeal, the Delaware Supreme Court reversed.  Though the Court acknowledged that there may be cause for concern in the MBO context, the Court concluded – based on Chancery’s own findings – that those concerns had been allayed in this particular case due to, among other things, an efficient market for the company’s stock, a robust sales process with full disclosure, and a CEO who was apparently willing to join with any potential buyer.

What was implicit in DFC – and what Dell makes explicit – is that in some ways, the Delaware Supreme Court is using appraisal to recapture ground it gave up in the context of fiduciary duty litigation.

As we all know, after Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), a shareholder vote can cleanse a variety of management sins in the context of negotiating a sale of the company.  Though Corwin may have much to recommend it, the chief criticism is that management may be left with little incentive to conduct a robust sales process.  As management is presumably well aware, so long as there’s some kind of premium over market, stockholders may be feel pressured to accept a deal on the table rather than hold out hope that management, if rebuked by an unfavorable vote, will apply their full efforts towards obtaining a better price (especially given customary break up fees).  Corwin provides management with no incentives to do better than the minimum of what the stockholder vote will accept.

In DFC, the Delaware Supreme Court took the first steps toward filling that gap.  By holding that deal price should carry great weight in the appraisal context absent evidence of a dysfunctional sales process, the court provided new incentives for management to obtain the best possible price for stockholders.

What was implicit in DFC is explicit in Dell.  After explaining all the reasons why Dell’s sales process raised no red flags, and even counterbalanced the ordinary concerns that are raised in the MBO context, the court explained: “If the reward for adopting many mechanisms designed to minimize conflict and ensure stockholders obtain the highest possible value is to risk the court adding a premium to the deal price based on a DCF analysis, then the incentives to adopt best practices will be greatly reduced.”

Thus, the substitution of appraisal litigation for fiduciary litigation is near complete:  improving upon deal price in the context of appraisal may be impossible unless something went wrong in the sales process (at least for the sale of a public company without a controlling stockholder).  In this way, the Delaware Supreme Court ensures that there remain incentives for directors to use best practices when negotiating deals, while avoiding some of the pathologies that have infected fiduciary duty litigation.  See Charles Korsmo & Minor Myers, The Structure of Stockholder Litigation: When do the Merits Matter?, 75 Ohio St. L.J. 829 (2014).

The question remains, however, whether Delaware made the right call.  Commenters have argued that the threat of appraisal results in higher deal prices; those salutary effects may be mitigated under the new standards.  It is not clear how proficient courts are at detecting the kinds of subtle distortions in a sales process that might result from even mild degrees of director self-interest, lack of expertise, or distraction – indeed, commenters have argued that it is precisely because appraisal can avoid these inquiries that makes it such an effective remedy. 

December 16, 2017 in Ann Lipton | Permalink | Comments (0)

Saturday, December 9, 2017

Investor Advisor Committee Weighs In on Dual Class Shares

The SEC’s Investor as Owner Subcommittee of the Investor Advisor Committee has just posted a discussion draft regarding dual class share structures in advance of the December 7 meeting at which such structures were under consideration.  (As of this posting, details of what transpired at the meeting are not online).

Dual class structures are increasingly common these days; presumably, that’s in large part due to the fact that institutional investor power has become a serious threat to management control, and dual class shares are a mechanism for pushing back.  (Staying private is another mechanism, and the more that companies choose that route, the more bargaining power they have when they eventually go public, etc etc).

Suffice to say that despite various defenses of dual class shares that have been offered, the Investor as Owner Subcommittee is not impressed.  It highlights a number of risks, which basically come down to that public investors may have different views about corporate strategy than the control group – precisely the feature that endears the structure to some commenters – and that controllers may use their control to further cement their own control (i.e., Google and the nonvoting shares).  And then of course there are the risks that are backlashes the first risks: exclusion from indices and associated decline in share value and liquidity, litigation risks when investors inevitably challenge the controllers’ actions.

Since this is the SEC, the Subcommittee can’t really recommend that dual class shares be barred entirely; the best it can do is recommend additional disclosure, and that it does.  Among other things, it wants clear line items disclosing that holders of x% of equity have x% of the votes, as well as the risks that controllers may use their control to further entrench themselves, and index and listing risks.   And to make absolutely certain investors aren't confused, the Subcommittee recommends that even the label "common stock" be reserved for one share/one vote stock; stock with lesser rights should be called something else.  The Subcommittee also recommends further monitoring to identify the types of disputes that arise out of these structures.

As with many SEC disclosure requirements, the proposals seem aimed less at simply informing investors than to pressure companies into adopting certain forms of governance.  Whether the SEC takes heed in this new, highly deregulatory administration, remains to be seen.

December 9, 2017 in Ann Lipton | Permalink | Comments (4)

Saturday, December 2, 2017

‘Tis the season

To draft end of semester exams.  So while I frantically try to develop fact-patterns that are simple and coherent and yet simultaneously engage a semester’s worth of material, I offer three links that interested me recently.

First, Vice Chancellor Laster’s ruling in Wilkinson v. Schulman (pdf).  In this opinion, VC Laster denied a books and records request on the grounds that the purposes of inspection belonged to Wilkinson’s counsel, and not Wilkinson himself.  Wilkinson had complaints about the company, but the purposes of inspection raised in the demand letter were different, and developed by the attorneys without Wilkinson’s involvement.  As Laster concluded, “Wilkinson simply lent his name to a lawyer-driven effort by entrepreneurial plaintiffs’ counsel.”  This strikes me as the kind of ruling that could have broader implications – we’ll see if future cases pick up these threads.

Second, Bloomberg recently reported on an organization called “Protect Our Pensions,” which purports to be a grassroots effort to fight against fossil fuel divestment, but is in fact industry-backed astroturf.   The reason I find this fascinating is that the standard argument against divestment is that it conveys no new information to the market and therefore will not affect prices.  But the fact that the industry bothered to organize this effort at all tells us that the industry, at least, believes these efforts are having some kind of adverse effect.

Third, Buzzfeed posted an exposé of sexual assaults at Massage Envy franchises across the country.  (Warning for graphic descriptions).  Aside from all of the other issues raised, what struck me was how the franchise model – which allows Massage Envy to use its branding but disclaim responsibility –  appears to have played a role in the cover-ups and lack of response to complaints.  I’m not sure I’d want to use scenarios this fraught in business class, but it would certainly make a change from the standard McDonald’s cases featured in most textbooks to illustrate vicarious and apparent agency theories of liability.

December 2, 2017 in Ann Lipton | Permalink | Comments (0)

Saturday, November 25, 2017

Fourth Circuit Breaks New Ground in Raising the PSLRA Pleading Standard

The PSLRA requires that complaints alleging Section 10(b) violations plead facts that raise a “strong inference” that the defendant acted with intent or recklessness.  15 U.S.C. § 78u-4.  A “strong inference” is one that, taking into account “plausible opposing inferences,” is “at least as compelling as any opposing inference one could draw from the facts alleged.”  Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007).

It has long been an axiom of PSLRA pleading that a strong inference may be raised by alleging that the defendant knew his or her statements were false, or knew facts that contradicted his or her public statements.  See, e.g., Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000); Miss. Pub. Emples. Ret. Sys. v. Boston Sci. Corp., 523 F.3d 75 (1st Cir.2008); Fla. State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645, 665 (8th Cir.2001); Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981 (9th Cir. 2009); Pugh v. Tribune Co., 521 F.3d 686 (7th Cir. 2008).  Indeed, allegations of actual knowledge of falsity are sufficient to plead scienter even in the context of forward-looking statements, which are subject to their own special heightened pleading requirements.  See 15 U.S.C. §78u-5.

In Maguire Fin. LP v. PowerSecure Int'l Inc., 4th Cir., No. 16-2163, the Fourth Circuit concluded that even when a plaintiff pleads that a CEO had knowledge of the falsity of the statements he issued on an analyst conference call, that is not sufficient to allege scienter under the PSLRA.

The basic claim was that the CEO told analysts that the company was “blessed to announce securing a $49 million three-year contract renewal, both the renewal and expansion with one of the largest investor [owned] utilities in the country,” when, in fact, the referenced contract was a new contract with an existing client, rather than a renewal.  As it turned out, the expenses on this new contract caused the corporation to experience losses and, eventually, a dramatic stock price drop.

The Fourth Circuit accepted that the CEO knew the nature of the new contract when he described it to market analysts, but refused to accept the inference that the mischaracterization was intentional or reckless.  Instead, the court argued that the CEO had no reason to believe the new contract would be unprofitable – and thus no reason to want to deceive the market about it – and though ordinary persons may have read the CEO’s statement to mean that a contract had been renewed, the CEO might not have realized that this was the common interpretation.  The court reasoned that if the CEO had, in fact, intended to deceive investors about whether the contract was new, he would have elaborated on his statement, and offered additional false claims about it.  The fact that he had not done so, the court concluded, contributed to an inference that he had not intended to deceive in the first place.  The court ultimately opined, “Appellant alleges facts that permit an inference that Hinton knew his statement was false, and then asks us to infer from that inference that Hinton acted with scienter. We decline to do so because stacking inference upon inference in this manner violates the statute’s mandate that the strong inference of scienter be supported by facts, not other inferences.”

Look, I agree that on these facts, it’s very possible that the CEO misspoke.  And I personally would like to know whether analysts reacting to the original conference call made their misunderstanding clear (so that the company could not claim to be unaware that the market had misunderstood the CEO’s representations).  But this is a complaint.  The issue is whether the plaintiffs have identified sufficient facts to get to discovery.  The Fourth Circuit seems to have lost sight of this basic function of the pleading requirements, and instead interpreted its mandate to require dismissal so long as there is any nonculpable interpretation of the facts.  The Circuit’s eagerness to draw exculpatory inferences from the CEO’s failure to tell an even greater lie bears a resemblance to pre-Tellabs caselaw reasoning that if an executive fails to dump his stock when making allegedly false statements – thus coupling a deceptive statement with a violation of insider trading prohibitions – the executive must not have acted with scienter.  Such logic was, of course, rejected by the Supreme Court in Tellabs: not every instance of fraud is part of a carefully-calibrated scheme.

Meanwhile, the Court ignored the very damning fact that the company’s highest officer issued a knowing falsehood and allowed it to stand uncorrected for several months.  The Circuit’s extraordinarily technical reason for rejecting the plaintiffs’ inferences – that the plaintiffs asked for an inference based on other inferences, rather than on facts – not only introduces an entirely unnecessary level of technicality into PSLRA pleading, but also contradicts the basic manner in which humans understand the world and attribute motivations and intentionality to other humans.  When someone says things he knows are untrue, we infer that there was deceptive intent.  Maybe that’s not the case, but the burden’s now on the speaker, not the listener.  And if plaintiffs are not entitled to the basic inference that the defendant knew what his own words meant, the pleading standard serves no legitimate screening function; it’s simply an arbitrary barrier to the filing of securities claims.

If nothing else, the case highlights the essential folly at the core of the PSLRA heightened pleading requirements.  Whether a complaint raises a “strong inference” of scienter depends entirely on the court’s background assumptions about plausible behavior from corporate officers.  To some, it is plausible that a CEO could make such an innocent misstatement and fail to correct it for nearly a year; but surely one could plausibly believe that CEOs carefully prepare before they speak to analysts, and do not often make these kinds of mistakes unintentionally.  One could plausibly believe that if the misstatement was innocently made, then the company would have corrected it shortly thereafter, and the fact that it did not do so suggests the statement was not so innocent after all.  It might also be plausible that CEOs calibrate just how much they’re willing to lie to analysts, and are willing to be somewhat vague on certain matters in hopes of leaving a false impression, without being willing to go so far as to outright invent new facts to mislead the market.  What seems plausible is entirely a function of one’s understanding of, and experience with, the world – and that’s quintessentially the function of the jury. 

November 25, 2017 in Ann Lipton | Permalink | Comments (0)

Monday, November 13, 2017

Oei & Ring: The Senate Tax Bill And The Battles Over Worker Classification

Today's post is by Shu-Yi Oei (Boston College) & Diane M. Ring (Boston College), and originally appeared at TaxProf Blog:

Senate Republicans released their version of tax reform legislation on Thursday, November 9. The legislative language is not available yet, but the Description of the Chairman’s Mark (prepared by the Joint Committee on Taxation) suggests that one of the key provisions in the bill will clarify the treatment of workers as independent contractors by providing a safe harbor that guarantees such treatment. The JCT-prepared description tracks the contents of the so-called “NEW GIG Act” proposed legislations introduced by Congressman Tom Rice (R-S.C.) in the House and Senator John Thune (R-S.D.) in the Senate in October and July 2017, respectively. “NEW GIG” is short for the “New Economy Works to Guarantee Independence and Growth (NEW GIG) Act.” But notably, and as we further discuss below, the legislation is not limited in its application to gig or sharing economy workers.

Assuming the Senate Bill adopts the basic parameters of the NEW GIG proposed legislation — which looks to be the case based on the JCT-prepared description — we have some concerns. In brief, this legislation purports to simply “clarify” the treatment of workers as independent contractors and to make life easier for workers by introducing a new 1099 reporting threshold and a new withholding obligation. But the legislation carries potentially important ramifications for broader fights over worker classification that are raging in the labor and employment law area. Despite possibly alleviating tax-related confusion and reducing the likelihood of under-withholding, we worry that there are quite a few underappreciated non-tax hazards for workers if these provisions go through.

Summary of the Legislation

The legislation (assuming the Senate Bill more or less tracks the NEW GIG Act language) purports to achieve such “clarification” of worker classification status by doing the following:

First, the legislation introduces a safe harbor “which, if satisfied, would ensure that the worker (service provider) would be treated as an independent contractor, not an employee, and the service recipient (customer) would not be treated as the employer.” The legislation creates three objective tests, which, if met, ensure that the worker would be treated as an independent contractor rather than an employee. Very generally, those tests focus on (1) the relationship between the parties (including specificity of the task, exclusivity of the relationship, and whether the service provider incurs their own expenses), (2) the location of services or means by which they are provided, and (3) the existence of a written contract stating the independent-contractor relationship and acknowledging responsibility for taxes and a reporting/withholding obligation. (See JCT-prepared Description pp. 155-57.)

The first two tests are pretty easy for any sharing economy business to meet. In fact, many non-sharing businesses, such as those contracting with a broad swath of freelancers, could satisfy the safe harbor requirements, thereby extending the true reach of the legislation well beyond the gig economy. The “written contract” test is also not onerous. That requirement is essentially met if there is a written contract that makes the right noises in which the parties agree to independent contractor treatment. (Unsurprisingly, a contractual limitation is often not really a limitation at all.)

Second, the legislation clarifies the information reporting rules: It establishes a $1,000 threshold for Form 1099-K reporting and raises the 1099-MISC threshold from $600 to $1,000. (Under current law, there is some question of whether a Form 1099-K needs to be provided if the transactions do not exceed $20,000 and more than 200 transactions. We detail this issue in our article, “Can Sharing Be Taxed?”.)

Third, the legislation also requires the service recipient/payor to withhold limited amounts on payments made to independent contractor workers covered by the safe harbor. From the JCT-prepared description: “The proposal imposes an income tax withholding requirement with respect to compensation paid pursuant to a contract between a service provider and a service recipient (or payer) that meets the [safe harbor] requirements. For this purpose, a payment of such compensation is treated as a payment of wages by an employer to an employee. However, the amount required to be withheld is five percent of the compensation and only on compensation up to $20,000 paid pursuant to the contract.”

Fourth, the legislation limits the IRS’s ability to reclassify service providers as employees (and service recipients/payors as employers) in cases where the parties try in good faith to comply with the safe harbor but fail. The legislation only allows the IRS to recharacterize the relationship as an employment relationship on a prospective basis.

Finally, the legislation amends Tax Court jurisdiction: Under the current IRC § 7436 mechanism for challenging worker classification, only the person for whom the services are performed may petition the Tax Court regarding misclassification of workers. The bill would expand current law to allow the worker/service provider to bring such a case as well. 

[More under the cut]

Continue reading

November 13, 2017 in Ann Lipton | Permalink | Comments (0)

Saturday, November 11, 2017

(Dis)Empowering (retail) shareholders?

SEC Commissioner Jay Clayton recently gave a speech where he remarked:

I have become increasingly concerned that the voices of long-term retail investors may be underrepresented or selectively represented in corporate governance. For instance, the SEC staff estimates that over 66% of the Russell 1000 companies are owned by Main Street investors, either directly or indirectly through mutual funds, pension or other employer-sponsored funds, or accounts with investment advisers… And, if foreign ownership is excluded, that percentage approaches approximately 79%.

… A question I have is: are voting decisions maximizing the funds’ value for those shareholders?

In situations where the voting power is held by or passed through to Main Street investors, it is noteworthy that non-participation rates in the proxy process are high. … This may be a signal that our proxy process is too cumbersome for retail investors and needs updating.

What’s interesting is that there are two different ideas here.  One concerns the voting power of mutual funds and pension funds; the other concerns the votes of retail shareholders themselves.

As for retail votes, Jill Fisch has an article on this very subject forthcoming in the Minnesota Law Review.  She recommends that retail shareholders be given access to electronic platforms, similar to those available to institutions, that allow them to set advance voting instructions without requiring them to make a company by company decision.

The broader question, though, is whether we do in fact want to encourage greater retail participation, and what the effects are likely to be.  There’s long been an argument that retail investors should not invest directly, and the rules governing securities markets have, to a greater and greater extent, become less hospitable to them.  (Stephen Choi, for example, has argued that investors should only be allowed to participate in capital markets if they demonstrate a certain degree of sophistication.)  If that’s right, it makes little sense to encourage their participation in corporate governance.

At the same time, though, public companies love retail investors, because they are less likely to coordinate with pesky activists, and are assumed to be more supportive of management.  I’ve often wondered if that was the motivating force behind Loyal3 (which recently folded shop), providing a free online brokerage for retail investors that wanted stock in their favorite brands.

Given what appears to be the general Republican preference, I rather suspect that they believe shareholder involvement in corporate governance is a net negative, and I wonder if Clayton’s newfound push for retail investor involvement is actually a stealth attempt to provide management with a bulwark against activist challenges. 

Certainly, that appears to be the theme of Clayton’s actions: the rest of his speech expresses concern about shareholder proposals, and a recent SEC staff opinion suggests a shift to more deference to corporate boards when deciding excludability.  In that context, his conflation of retail investor voting with mutual fund voting seems like something of a shot across the bow targeting mutual fund voting power.  I can imagine, for example, a push to transition to pass-through voting for mutual funds, combined with a few measures that encourage retail investor participation.

But if that’s the kind of thing Clayton is hinting at – and to be sure, no one has suggested it so far, but it would make sense as an endgame – I do wonder how much it (and other efforts to involve retail shareholders) will backfire.  I imagine retail investors, if seriously encouraged to participate, might be more – not less – likely to vote for social proposals and other less-than-wealth-maximizing actions that, these days, mutual funds tend to avoid unless pressed.  And as Jill Fisch points out, retail investors might adopt advance voting instructions that set automatic triggers to challenge management when certain underperformance benchmarks are met.  If the default assumption is that retail investors are less informed and less attentive, encouraging their greater participation may be something of a double-edged sword, from management’s perspective.

Moreover, if we have greater retail involvement in the voting process, Delaware might have to revisit decisions like Corwin v. KKR, 125 A.3d 304 (2015), which rest - at least implicitly - on the assumption of a sophisticated (institutional) shareholder base.  And that’s something I'm pretty sure management would not want.

November 11, 2017 in Ann Lipton | Permalink | Comments (0)

Saturday, November 4, 2017

Suddenly a little less certain

The GOP unveiled its tax bill this week.  Below are a collection of links to commentary that I found interesting (taking a page from Stefan’s book, some are in the form of embedded tweets):

A lot to like and a lot to dislike in the Republican tax bill: “The tax bill aggressively takes on deductions in the individual income tax code, and channels the proceeds towards across-the-board cuts in income tax.  Unfortunately, that good work is undone by expensive giveaways to the owners of firms, and unnecessary windfalls to the heirs of the rich.”

Tax Bill May Deal a Body Blow to LBOs: “The legislation includes a provision that would cap interest deductibility at 30 percent of adjusted taxable income, a dramatic shift from the 100 percent allowed now.”

Sports Stadiums Would Lose Access to Tax-Exempt Bonds Under House Tax Plan: “Lawmakers of both parties have long sought to limit the use of municipal bonds to benefit sports teams.”

Apple Among Giants Due for Foreign Tax Bill Under House Plan: “Earnings held in cash would be taxed at 12 percent while profits invested in less liquid assets like factories and equipment face a 5 percent rate.”

Proposal Aims to Eliminate Tax Break Linked to Performance-Based Pay for Executives: “The proposed changes would eliminate the tax break linked to performance-based pay for senior executives, raising some $9.3 billion in additional tax revenue over the next decade...”

Republican Tax Plan May Leave Future of Stock Options in Flux: “Under the GOP’s bill, option owners would be required to pay income taxes immediately when the contracts can be used to buy shares, instead of when they are actually purchased.”

US tax reform will boost innovation and entrepreneurship: “We will defer the tax on private stock gains until employees can actually realise those gains by selling the stock, or at least give them a reasonable amount of time to pay the tax bill.”

The GOP tax plan has a tiny 'bubble tax' that could end up raising taxes on the rich: “Every dollar after $1 million of income for an individual or $1.2 million for a couple would incur a surcharge. It would add $6 in taxes for every $100 of taxable income earned above those thresholds — essentially, an extra 6% tax.”

Senate Democrats falsely claim GOP tax plan will raise taxes for most working-class families: “The original report referred to 8 million households receiving a $794 tax increase. Somehow, when it got communicated down the line, that nuance was lost and it was translated into a talking point referring to all working-class families.”

How a Tax Cut Turns Into a Tax Increase: “In rolling out their plan, House Republicans focused on an example family — a married couple making $59,000 per year and with two kids. They said that family would get a tax cut of over $1,182 in 2018 (compared to what they paid in 2017). But, what they didn’t say is that a family making $59,000 would face a tax increase by 2024 relative to current law, with the tax increase potentially rising to nearly $500 by 2027.”

Republicans Bank on Future Congresses to Keep Family Tax Credit: “Taxpayers shouldn’t worry, Republicans say, because future Congresses will prevent the tax credit from vanishing.  ... Rep. Carlos Curbelo (R., Fla.), said he thought members of both parties would ultimately support extending the break. 'That family credit is de facto permanent and you can take that to the bank,' Mr. Curbelo said.”

The GOP Tax Plan and Divorce: “The summary estimates that eliminating the deductibility of alimony payments will increase revenues by $8.3 billion over ten years.”

Republican Tax Proposal Gets Failing Grade From Higher-Ed Group: “In broad terms, the bill would eliminate or consolidate a number of tax deductions meant to offset the costs of higher education for individuals and companies, including the Lifetime Learning Credit, which provides a tax deduction of up to $2,000 for tuition, a credit for student-loan interest, and a $5,250 corporate deduction for education-assistance plans.  The bill proposes new taxes on some private-college endowments and on compensation for the highest-paid employees at nonprofit organizations, including colleges and nonprofit academic hospitals. The plan would also tax the tuition waivers that many graduate students receive when they work as teaching assistants or researchers. Perhaps most significant, the bill would result in many fewer people itemizing their deductions for charitable gifts.”

Teachers spend nearly $1,000 a year on supplies. Under the GOP tax bill, they will no longer get a tax deduction: “Unlike other professionals, teachers are regularly expected to furnish their own supplies. They are often filling in gaps where students are unable to afford supplies — and where districts are unable to furnish them.”

House tax plan allows unborn children to have college savings accounts: “The tax-advantaged accounts, called 529s, help people save for future college expenses. Anyone -- a relative, a friend, or yourself -- can be named as a beneficiary at the time the account is opened. The House legislation unveiled Thursday would allow unborn children to be named as a beneficiary as well. It defined an unborn child as a 'child in utero' and further as 'a member of the species homo sapiens, at any stage of development, who is carried in the womb.'”

Why top tax writer Rep. Kevin Brady, father of two adopted kids, didn’t protect the adoption tax break: “Brady defended the decision to cut the adoption tax credit by pointing out that some families can't claim the credit because they don't pay enough in taxes or they don't itemize their tax bill.”

The Johnson Amendment Under GOP Plan: “The main concern of the repeal of the Johnson Amendment is churches will effectively turn into giant super PACs.” 

Homebuilders tank as the GOP's tax plan caps a big benefit for homeowners: “the tax plan caps the mortgage-interest deduction, which subtracts interest payments from homeowners' taxable income, on new homes at $500,000.”

And, umm, an outraged twitter thread with associated R-language is here, but I will not embed it because this is a family blog.

November 4, 2017 in Ann Lipton | Permalink | Comments (0)

Monday, October 30, 2017

Leidos - Trick, Not Treat?

The title of this post is hyperbole on some level.  But with Halloween being tomorrow, I couldn't resist the temptation to use a festive greeting to introduce today's post.  And there is a bit of a method to my titling madness . . . .

I admit that I do feel a bit tricked by the removal of the Leidos, Inc. v. Indiana Public Retirement System case (about which co-blogger Ann Lipton and I each have written--Ann most recently here and I most recently here) from the U.S. Supreme Court's calendar.  It was original scheduled to be heard a week from today.  Apparently, based on the related filings with the Court, the parties are documenting a settlement of the case.  Kevin LaCroix offers a nice summary here.  How cunning and skillful!  Just when I thought resolution of important duty-to-disclose issues in Section 10(b)/Rule 10b-5 litigation was at hand . . . .

Indeed, I had hoped for a treat.  What pleasure it would have given me to see this matter resolved consistent with my understanding of the law!  The issue before the Court in Leidos is somewhat personal for me (in a professional sense) for a simple reason--a reason consistent with the amicus brief I co-authored on the case.  I share that reason briefly here to further illuminate my interest in the case.

In my 15 years of practice before law teaching, I often advised public company issuers on mandatory disclosure documents--periodic filings and offering documents, most commonly.  I also counseled investment banks serving as public offering underwriters, placement agents for private securities offerings, and financial advisors in transactions.  Even in those days, I was a bit of a rule-head (self-labeled)--a technically engaged legal advisor who tried to stick to the law and regulations, determine their meaning, and implement them consistent with their meaning in practice.  I drove colleagues to distraction and boredom, on occasion, with my explanations of the appropriate interpretation of various rules, including specifically mandatory disclosure rules.  (This may be why I love the work of the Sustainability Accounting Standards Board, which is looking at mandatory disclosure rules in context.)  I teach my students from that same nerdy vantage point.

In advising issuers and others on mandatory disclosure (and in training junior lawyers in the firm), I always noted that facial compliance with the specific line-item disclosure requirements for a Securities and Exchange Commission ("SEC") form is not enough.  I advised that two additional legal constraints also govern the appropriate content of the public disclosures required to be made in those forms--constraints that required them to inquire about (among other things) missing information.  

  • First, I noted the existence of the general misstatements and omissions disclosure (gap-filler) rules under the Securities Act of 1933 or the Securities Exchange Act of 1934, as amended (as applicable in the circumstances)--Rule 408 under the 1933 Act and Rule 12b-20 under the 1934 Act.  Each of these rules provides for the disclosure of "such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made not misleading" in addition to the information expressly required to be included in the relevant disclosure document under applicable line-item disclosure rules.  
  • Second, I noted that anti-fraud law--and, in particular, Section 10(b) of, and Rule 10b-5 under, the 1934 Act--provides an even more comprehensive basis for interrogating the contents of disclosure that facially complies with line-item mandatory disclosure rules.  The overall message?  No one wants a fraud suit, and if they get one, they should be able to get out of it fast!  If a business and its principals were to be sued under Section 10(b) and Rule 10b-5, I wanted to ensure that the relevant disclosures were accurate and complete in all material respects.

Thus, the existence of the line-item and gap-filling disclosure rules--and the potential for fraud liability based on failed compliance with them--are, taken together, important motivators to the best possible disclosure.  In my business lawyering, I believe I used these regulatory principles to my clients' advantage.  I would hate to see lawyers lose the important leverage that potential fraud liability gives them in fostering accurate and complete disclosures, fully compliant with law.  Hence, my position on the Leidos litigation--that mandatory disclosure rules do give rise to a duty to disclose that may form the basis for a securities fraud claim under Section 10(b) and Rule 10b-5.  (The ultimate success of any such claim would be, of course, based on the satisfaction of the other elements of a Section 10(b)/Rule 10b-5 claim.)

So, no treat for me--at least not just yet.  But perhaps this post will forestall any real trickery--the trickery involved with avoiding securities fraud liability for misleading omissions to state material information expressly required to be stated under line-item mandatory disclosure rules.  For me, that is what is at stake in Leidos and in disclosure lawyering generally.  Let's see what transpires from here.

October 30, 2017 in Ann Lipton, Joan Heminway, Lawyering, Securities Regulation | Permalink | Comments (0)

Saturday, October 28, 2017

When the CEO Wants to Be President

It seems that in the wake of Donald Trump’s remarkable political ascent, a number of CEOs have developed their own political ambitions.

Facebook’s Mark Zuckerberg famously embarked on an anthropological tour of the United States, rubbing shoulders with the struggling common folk in Iowa, as well as in Wisconsin, Ohio, and South Carolina.  Disney’s Bob Iger says a lot of people are saying that he should run.  Starbucks’s Howard Schultz (okay, former CEO, still Executive Chair) visited the Houston victims of Hurricane Harvey, later explaining, “I wanted to see the aftereffects, but mostly I wanted to talk to people. And you learn a few things that are heartbreaking. You know, 40 percent of American households don’t have $400 of cash available to them….I think the country needs to become more compassionate, more empathetic. And we can’t speak about the promise of America and the American Dream and leave millions of people behind.”

Now, I suppose one could ask all kinds of questions about whether the Trump phenomenon should be interpreted to mean that America hungers for a closer relationship between corporations and politics, but my immediate reaction is, how do you square the fiduciary obligations associated with running a company with the demands of the political sphere?

I mean, leaving aside the obvious pull on a CEO’s attention and time, Schultz – apparently while harboring presidential ambitions – announced that Starbucks would hire 10,000 refugees (a decision that, arguably, negatively impacted his company’s stock price).  Bob Iger has had to navigate such highly charged issues as his presence on Trump’s Advisory Council, and the political commentary of Jimmy Kimmel at ABC, and Jemele Hill at ESPN.  Facebook, of course, has had to address issues of foreign interference with American elections, and has recently announced that it will voluntarily require disclosures akin to those required of television ads.  And that doesn’t even get into any gratuitous political speeches.

I’m not taking a position over whether these executives did the right or the wrong thing in each instance, but I am concerned that when CEOs simultaneously run their companies and run for president, it’s difficult to discern whether their political moves are intended to benefit the corporation (including, as relevant, all stakeholders), or their own political careers.  Under these conditions, how can shareholders be certain that their CEOs’ actions – on everything from labor conditions to executive pay to environmental footprints – are intended to advance the best interests of the company?

October 28, 2017 in Ann Lipton | Permalink | Comments (2)

Saturday, October 21, 2017

New Essay on Mutual Funds' Fiduciary Obligations When Voting Shares

Readers of the blog know that a few months ago, the University of Tennessee hosted a BLPB symposium, with essays to be published in a forthcoming volume of Transactions: The Tennessee Journal of Business Law.  It was a terrific amount of fun, where we bloggers who usually just interact over the internet got a chance to see each other face to face (in some cases, for the first time!)

Anyhoo, I just posted my contribution to the symposium, Family Loyalty: Mutual Fund Voting and Fiduciary Obligation, to SSRN.  Here is the abstract:

In recent years, institutional investors have increasingly come to dominate the market for publicly-traded stock.  Mutual funds have become especially important, controlling trillions of dollars of corporate equity.

The SEC has made clear that it is the fiduciary responsibility of fund administrators to vote their shares in a manner that benefits investors in the fund.  Sponsoring companies have responded by creating centralized research offices that determine the voting policies across all of the funds they administer.  Though there may be some variation at the individual fund level, most fund families vote as a block.

The practice of centralized voting raises the question whether each fund is promoting the best interests of its investors.  For example, one fund may hold stock in an acquisition target, while another holds stock in the acquirer; one fund may hold stock in a target, while another holds debt.  These funds have different interests, but voting policies rarely differentiate among them.

This Essay argues that mutual fund boards should develop procedures to ensure that fund shares are voted with a view toward advancing the best interests of that particular fund.  If such procedures cannot be implemented in a manner that justifies their costs, funds should refrain from voting their shares at all. 

In addition to benefitting fund investors, this proposal may also have a salutary effect on portfolio firms.  In recent years, commenters have expressed concern about the voting power exerted by mutual fund managers, who may pressure firms to avoid competition within an industry, or who may encourage short-term financial engineering over long-term growth.  Decentralization may diminish asset managers’ power, thereby alleviating these effects.

Thanks so much to the University of Tennessee College of Law, and to all of the students - and especially to Joan - for the opportunity.

October 21, 2017 in Ann Lipton | Permalink | Comments (0)

Saturday, October 14, 2017

Unicorn Governance and Power

We’ve talked about Uber and its tribulations a few times here at BLPB, including what I feel is one of the remarkable aspects of the saga – the fact that a private company is being treated as public in the general imagination.

In keeping with that theme, Renee Jones just posted The Unicorn Governance Trap to SSRN, with the basic thesis that Uber and companies like it (Theranos, Zenefits, etc) are experiencing governance pathologies precisely because they inhabit a hybrid space between public and private.  (George Georgiev made an abbreviated version of the same argument in a column for The Hill several months ago.)  Jones contends that these unicorn companies feature the separation of ownership and control typical of a public company, but they are not subject to the same disciplining mechanisms from investors of voice (due to dual-class shares), exit (due to the limits on liquidity inherent in private status), and litigation (due to lack of public reporting obligations, and potential securities fraud claims – though on that last point, but see Theranos and Uber litigation).  She distinguishes private companies that grew large in an earlier era, where ownership and control are unified (typically, family-owned businesses).  She also points out – though she is not the first – that efforts to increase the number of IPOs by limiting regulatory burdens as the Trump Administration would like to do are misguided; IPOs have likely declined because companies do not need them if they can raise capital privately.

To be sure, there are limits to how far the argument can be taken (Exs. A , B, and C.)  And the problems at unicorns may have less to do with securities regulation than with the current fashion for treating founders like auteurs.  Still, it does seem like the relatively new ability for companies to raise massive amounts of capital without the discipline of the broader markets encourages a degree of corporate governance laxity. 

If that's right, then it represents a real-time demonstration of the importance of corporate governance for the broader society.   Typically, corporate governance is treated as “private law,” a function of private contracting among investors and managers.  Corporate governance principles are designed to protect investors from exploitation, but do not usually take protection of other stakeholders as part of their central mandate.  This is, after all, the ideological basis of the internal affairs doctrine.  Scott Hirst recently argued that investors should choose the extent to which companies are subject to federal securities regulation, explicitly adopting the position that only corporate governance externalities – and not other kinds of social welfare externalities – are part of the calculus.

But now we can see that, whether by design or happy accident, obligations placed on firms ostensibly for the protection of investors have very tangible effects on employees, customers, competitors, and general compliance with the rule of law.  It is not clear that external regulation alone can carry this responsibility, because the whole point is that certain managers/controllers may be undeterrable, or only deterrable at significant cost.  They can be contained only via constraints on their power to act in the first place, and that’s where corporate governance comes in.

In sum, as I tell my students on day one, corporate law is about the regulation of power. 

October 14, 2017 in Ann Lipton | Permalink | Comments (0)

Saturday, October 7, 2017

Omissions Liability: Tempest in a Teapot or Gathering Storm?

Readers of this blog know about the case of Leidos, Inc. v. Indiana Public Retirement System, currently pending before the Supreme Court, which will decide whether an omission of required information can give rise to private liability under Rule 10b-5.  In Leidos, the corporate defendant engaged in a scheme of overbilling on a New York City contract, which ultimately resulted in a deferred prosecution agreement and significant monetary penalties.  The plaintiffs alleged that the company violated Rule 10b-5 by failing to disclose the conduct and associated potential penalties as a “known trend”  in its SEC filings, as required by Item 303.  The Second Circuit allowed the claim to proceed; Leidos now argues before the Supreme Court that its failure to disclose required information cannot satisfy the element of falsity in a private claim brought under Rule 10b-5.  In other words, the question is whether – assuming all the other elements of a fraud claim are established (materiality, scienter, loss causation, etc) – can the omission of required information count as a false statement?

Joan Heminway co-authored an amicus brief arguing that Rule 10b-5 does provide for omissions liability, and this is an issue I’ve blogged about a few times, so forgive me if this post treads some familiar ground.

The case has generated a fair amount of commentary from the bar, including various warnings of unlimited liability should the Supreme Court rule for the plaintiffs.  Professor Joseph Grundfest has now jumped into the fray, contending that – while he agrees with various textual arguments as to why no liability should attach – in the end, he doesn’t think it matters very much.   The crux of his argument is that the securities laws require so much disclosure as a matter of course that there will almost never be a case where a pure omission cannot be transmogrified into a misleading half-truth.  In Leidos itself, he notes that the court also upheld the plaintiffs’ allegation that the corporate financial statements violated accounting rules for failure to allege a loss contingency – resulting from fines and recoupment of the overbilling – and speculates that the plaintiffs could have brought claims based on the company’s representations that it did not expect any losses resulting from pending litigation, as well as such “half-truths” as its warnings of potential risks from “[m]isconduct of our employees.”  He also argues that – though the matter is uncertain – required CEO and CFO certifications under Sarbanes Oxley can also constitute affirmative misstatements when information has been omitted from a securities filing, which would once again make omissions liability unnecessary.

I agree that pure omissions cases are relatively rare, and that due to the extensive disclosure requirements of the federal securities laws, most undisclosed misconduct/misfortune can be pinned to an arguably false affirmative statement (a point that I’ve discussed in my articles Slouching Towards Monell and Reviving Reliance).  But I don’t think the matter is quite as trivial as Prof. Grundfest sees it.

First, when it comes to certifications, those are attributed solely to the CEO and CFO.  Not all securities claims depend on the liability of the CEO and CFO; at the very least, at the pleading stage, the plaintiffs may not be able to demonstrate the scienter of the CEO and CFO.  In Leidos itself, for example, for reasons I don’t fully understand, somehow all of the individual defendants were dropped from the case, leaving only the corporate defendant.  Thus, leaving aside other issues of whether such certifications are actionable in the first place, they’re an unreliable predicate for liability.

More broadly, however, what Prof. Grundfest overlooks is that many courts - rightly or wrongly -  treat Rule 10b-5 claims with varying degrees of skepticism, and plaintiffs reasonably want to belt-and-suspender it.   Now, to be sure, if a judge is determined to dismiss a claim, the judge will find a way to do so (naturally, the opposite is true for a judge who is determined to sustain a claim).  But between those extremes there is a great deal of variation, and broadening the grounds for liability will make it harder for even the skeptical judge to dismiss a claim out of hand.

When it comes to omitted information, for sure, public companies are already subject to so many disclosure requirements that there will always be some affirmative statement that is arguably rendered misleading whenever there is a significant undisclosed problem, which should theoretically make pure omissions liability unnecessary.  But courts are often hostile to these kinds of claims – I think of them as icebergs – where major trouble is pinned to a banal bit of boilerplate.  (You know, like an iceberg, where the tiny above-water misstatement is the ostensible hook to bring a claim based on dramatic concealed problems.)   Courts typically recognize – correctly – that in such cases, the plaintiff is not so much complaining about the statement so much as the conduct, and since it is only statements (not conduct) that are regulated by the federal securities laws, they find other grounds on which to base a dismissal.  One favorite is puffery, which is precisely what happened in Leidos – the plaintiffs claimed that the defendants’ representations about ethics and integrity were rendered false by the scheme, and those claims were thrown out on materiality grounds.  Omissions liability, by contrast, is immune from a puffery defense, and thus represents another weapon in the plaintiffs’ arsenal.

Similarly, in many cases the alleged “half-truth” will come in the form of a potentially forward-looking statement, which may then be protected by the PSLRA safe harbor.  If so, pinning liability to that statement (or even to the risk disclosures) may be impossible for the plaintiffs.  Once again, then, pure omissions liability will save the plaintiffs' complaint.

To be sure, as Prof. Grundfest points out, in Leidos, the Second Circuit agreed that the failure to account for potential losses due to the fraud rendered the corporate financial statements false.  But that was highly unusual, and likely due to the fact that the misconduct was already the subject of a criminal investigation.  Courts have often refused to treat financial statements as false simply because the income was generated in an illicit manner, see Steiner v. MedQuist, Inc., 2006 WL 2827740 (D.N.J. Sept. 29, 2006), and that’s particularly likely to be true when there is no governmental investigation underway.

The same goes for Leidos’s statements about potential liability from pending claims/litigation.  Prof. Grundfest might be correct that these were also false statements, but only after 2010, when the first criminal complaint was filed.  Though the plaintiffs altered their claims along the way, the original class period began in 2007 – before there was any pending litigation.

It is also worth observing that omissions cases might be easier to litigate procedurally.  When plaintiffs allege the existence of affirmative misstatements, defendants often argue that the misstatement failed to result in a detectable impact on stock prices, and that therefore fraud on the market liability is unavailable (an argument I’ve repeatedly discussed).  That’s not an issue for omissions liability. 

Point being, I don’t think my disagreements with Prof. Grundfest are too dramatic – I’ll concede that we’re not talking about a massive number of cases – but I think there are enough to make a difference. 

That said, I disagree with the “sky is falling” pronouncements of practitioners who fear that they will have to bury investors in an “avalanche of trivial information,” Basic, Inc. v. Levinson, 485 U.S. 224 (1988), if the Supreme Court permits the claims in Leidos to proceed.  As I argue in Reviving Reliance, I actually think that if liability is expanded to cover omissions, courts will push back by narrowing their interpretation of the scope of required disclosures in the first place – which will have real repercussions for SEC enforcement.

October 7, 2017 in Ann Lipton | Permalink | Comments (3)

Saturday, September 30, 2017

Asset Manager, Heal Thyself

Earlier this week, the Wall Street Journal reported that many institutional investors – including large mutual fund complexes like BlackRock and State Street – have become concerned about “overboarding,” namely, the phenomenon where corporate directors sit on multiple boards.

There are good reasons to be concerned.  Researchers have found that in many, though perhaps not all, cases when corporate directors are “overboarded” – and thus presumably unable to devote their full attention to governance at particular companies – companies are less profitable and have a lower market to book ratio.  (Similarly effects are found for distracted directors.)

That said, there’s a particular irony in seeing mutual fund companies, of all investors, leading the charge.  Most mutual fund companies employ a single board – or a few clusters of boards – to oversee all of the funds in the complex.  This can result in directors serving on over 100 boards in extreme cases.  State Street’s Equity 500 Index Fund, for example, reports trustees who serve on 72 or 78 boards within the complex.  BlackRock’s Target Allocation Funds have trustees who serve on either 28 and 98 different boards (depending on how you count).

I’ll admit this is something of a cheap shot: presumably each fund is much more similar to the other funds than are the various companies at which overboarding concerns are raised.  Still, when you get to over 20 funds per director, that’s a lot, no?  Or 50 funds?  Especially since the funds have varying interests – they might stand on opposite sides of a merger, or invest at different levels within a single firm’s capital structure, or compete for limited opportunities like IPO allocations and pre-IPO shares.  Different funds might even be differently invested  in firms within an industry, and thus have divergent interests regarding competition between the firms.  (Cf. Jose Azar et al., Anti-Competitive Effects of Common Ownership).  Not to mention the fact that the independent directors of a mutual fund are supposed to be the fund’s “watchdogs” against exploitation by the sponsor, but service on multiple boards - with associated salaries - may cause the relationship to become suspiciously cozy.

Point being, the overboarding concern is a real one.  But… I’m not quite sure BlackRock is the right face for the resistance.

September 30, 2017 in Ann Lipton | Permalink | Comments (1)

Saturday, September 23, 2017

A New Front in the Race to the Bottom

States frequently compete with each other to attract businesses.  They’ll offer tax credits, subsidies, and regulatory waivers to persuade corporations to set up shop locally.  (Right now, Amazon is asking cities to compete to host its second headquarters.)  These incentives may or may not work out well for the state; it’s not uncommon for the promised jobs to disappear.  Meanwhile, competition among states can promote a race to the bottom, with states offering increasingly generous – and unaffordable – financial packages in exchange for a temporary boost in economic activity.

Wisconsin’s new deal with Foxconn represents a striking new frontier in these wars between the states.  Foxconn is a Taiwanese company with a history of reneging on its promises to establish manufacturing plants in exchange for rich government incentives.  Nonetheless, Wisconsin has promised it $2.85 billion over 15 years if it will build a $10 billion plant and hire 13,000 workers.   And to sweeten the deal, Wisconsin has also promised Foxconn preferential treatment in the Wisconsin court system.

Apparently concerned that its grant of certain environmental waivers may prompt local lawsuits, Wisconsin has promised Foxconn an expedited litigation process, including automatic stays of trial court orders, interlocutory appeals, and priority review by the Wisconsin Supreme Court for any legal challenges to Wisconsin’s decisions regarding Foxconn.  The legislation does not single out Foxconn specifically for these benefits; it simply says that they apply to any litigation concerning an Electronic and Information Technology Manufacturing Zone, but I gather Foxconn’s is the only such zone around.

A memo from the Wisconsin Legislative Council expresses concern that the litigation provisions may violate Wisconsin’s constitution by interfering with the independence of the judiciary.  (I’d also wonder about equal protection, since Foxconn is being singled out, if not by name).  But leaving aside the constitutional issues, I’m deeply troubled by the precedent.  If Wisconsin is promising favorable treatment in court, other states may feel they have to match those benefits in the future.   Corporations can already opt out of the legal system in many respects via arbitration agreements inserted into contracts of adhesion; I fear a future where for noncontractual disputes, we get a tiered court system, in which corporations are able to buy their preferred rules of civil procedure.

September 23, 2017 in Ann Lipton | Permalink | Comments (0)

Sunday, September 17, 2017

The Business Law Prof Bloggers ROCK Knoxville!

BLPBConferenceLogo

As I earlier reported, on Saturday, The University of Tennessee College of Law hosted "Business Law: Connecting the Threads", a conference and continuing legal education program featuring most of us here at the BLPB--Josh, me, Ann, Doug, Haskell, Stefan, and Marcia.  These stalwart bloggers, law profs, and scholars survived two hurricanes (Harvey for Doug and Irma for Marcia) and put aside their personal and private lives for a day or two to travel to Knoxville to share their work and their winning personalities with my faculty and bar colleagues and our students.  It was truly wonderful for me to see so many of my favorite people in one place together enjoying and learning from each other.

Interestingly (although maybe not surprisingly), in many of the presentations (and likely the essays and articles that come from them), we cite to each other's work.  I think that's wonderful.  Who would have known that all of this would come from our decision over time to blog together here?  But we have learned a lot more about each other and each other's work by editing this blog together over the past few years.  As a result, the whole conference was pure joy for me.  And the participants from UT Law (faculty, students, and alums) truly enjoyed themselves.  Papers by the presenters and discussants are being published in a forthcoming volume of Transactions: The Tennessee Journal of Business Law.

My presentation at the conference focused on the professional responsibility and ethics challenges posed by complexity and rapid change in business law.  I will post on my related article at a later date.  But if you have any thoughts you want to share on the topic, please let me know.  A picture of me delivering my talk, courtesy of Haskell, is included below.  (Thank you, Haskell!)  So, now you at least know the title, in addition to the topic . . . .  :>)  Also pictured are my two discussants, my UT Law faculty colleague George Kuney and UT Law 3L Claire Tuley.

Heminway(BLPBConf2017)

September 17, 2017 in Ann Lipton, Conferences, Haskell Murray, Joan Heminway, Joshua P. Fershee, Marcia Narine Weldon, Stefan J. Padfield | Permalink | Comments (0)