Saturday, January 14, 2017
A couple of months ago, investors in Theranos filed a class action complaint seeking damages for fraud and negligent misrepresentation under California law. Theranos is based in California; presumably, the plaintiffs intend to argue that any false statements emanated from California and therefore California law covers even out of state purchases. See Diamond Multimedia Systems, Inc. v. Superior Court, 19 Cal. 4th 1036 (Cal. 1999).
The reason this interests me is because it’s rare – not unheard of, of course, but rare – to see fraud-based securities class actions concerning securities that are not publicly traded. SLUSA eliminated the possibility for most companies, but SLUSA alone isn’t the problem; the other hurdle is the difficulty of establishing reliance on a classwide basis, as even before SLUSA, fraud-on-the-market doctrine was largely limited to Section 10(b) claims.
California law, however, is different from most states’, because California’s blue sky law explicitly permits claims for deceit based on price distortion. See Mirkin v. Wasserman, 5 Cal. 4th 1082 (Cal. 1993); Cal. Corp. Code, §§ 25400, 25500.
It will be interesting to see if that’s how the Theranos class plans to approach matters; the difficulty will be establishing that, for example, Investor A’s willingness to purchase stock on such-and-such terms had the effect of distorting the price for other investors, outside the context of an efficient market.
The complaint also alleges certain causes of action, like statutory and common law fraud, that do require actual reliance and do not permit a price-distortion substitute. But investors are also in luck for that, as well; there is a fair amount of precedent for the principle that when similar misrepresentations are made to purchasers, and those misrepresentations are important to the transaction, the mere fact that the purchaser chose to engage in the transaction creates a presumption of reliance. That is, certain kinds of misrepresentations are so fundamental to a purchase that it is difficult to imagine anyone would have engaged in the transaction if they were not relying upon them. Courts in the Ninth Circuit have repeatedly embraced this principle. See, e.g., In re First Alliance Mortg. Co., 471 F.3d 977 (9th Cir. 2006); Poulos v. Caesars World, Inc., 379 F.3d 654 (9th Cir. 2004).
In Theranos’s case, different investors may have heard different statements at different times – the class period stretches for over 3 years – which puts a crimp in the plaintiffs’ case, but presumably all of the statements basically were about the efficacy of Theranos’s product. And since this was a one-product company, it’s not a stretch to assume that all investors expected that the product, you know, actually worked.
Of course, this is just the complaint; it’s possible that Theranos will be able to introduce doubt into the mix by, among other things, presenting evidence of disclaimers/warnings/etc that raise questions about whether each investor relied on the same information.
But that’s the class cert issue; I’ll be interested to see the kinds of arguments defendants raise in their motion to dismiss, due next week.
Saturday, January 7, 2017
A couple of months ago, Snapchat’s parent announced that the company would hold an IPO in 2017 – the largest and most high-profile IPO since Alibaba in 2014. Given the sluggish IPO market, as well as Snapchat’s general name recognition and tech cachet, the announcement was a big deal.
But it’s possible there’s going to be a monkey in the wrench. On January 4, a former Snapchat employee (fired after 3 weeks) filed a lawsuit alleging two of Snapchat’s metrics – and which ones are redacted from the complaint – were fraudulently manipulated in order to inflate Snapchat’s valuations to private investors and in anticipation of the IPO. (The redactions are due to concerns that the allegations are covered by the plaintiff’s confidentiality agreement). The unredacted portions of the complaint allege that the company never built an appropriate team to analyze its metrics, and that the employee was illegally fired in retaliation for blowing the whistle.
Snapchat has given a statement to the media denying the allegations as the fictional creations of a “disgruntled former employee.”
Though the redactions are extensive, the complaint does offer at least a hint of what’s at stake. In Paragraph 24, the complaint lists certain “key performance metrics” for all social media applications. These are Daily Active Users, Monthly Active Users, User Retention Rate, Active User Growth Rate, Registration Completion Rate, Installations, Frequency, Session Length, and Average Revenue Per User. It’s impossible to know whether the two allegedly fraudulent Snapchat metrics are in this group, but these are probably the best hint we have. And these are significant numbers for Snapchat; it has claimed daily and monthly users in excess of Twitter, and – though not on the list in the complaint – has claimed daily video views in excess of Facebook (and that was before Facebook admitted it view counts were wrong).
So this will be an interesting story to watch going forward; until it’s resolved, it could spook potential IPO investors, and may even prompt investigation by Snapchat’s pre-IPO investors.
One point of interest: Apparently, the plaintiff signed an arbitration agreement with Snapchat, and has designed his claims to get around it (and, I assume, make sure his complaint was picked up by the media to pressure the company). According to the complaint, the arbitration agreement permits both parties to seek preliminary injunctions in court – and so, the plaintiff is seeking an injunction to force Snapchat to stop spreading allegedly false stories claiming that he was fired for incompetence. The plaintiff has separately filed an arbitration claim seeking lost wages and damages.
Saturday, December 31, 2016
Happy (Almost) New Year! As 2016 draws to a close, I offer three quick hits of interesting recent business law developments:
First: The endlessly-running case of Erica P. John Fund v. Halliburton has finally settled! Halliburton has been a particular obsession of mine lo these past 6 years or so, and I even attended the Fifth Circuit oral argument held in September. (My report of that argument is here, where I link to my prior blog posts on the subject). I'm sort of sad to see it go, even though I found many of the opinions frustrating. In any event, Alison Frankel has a nice retrospective of the case, including how David Boies ended up as lead attorney for the plaintiffs after the death of his daughter, the previous lead.
Second: I previously posted about Facebook's move to create a nonvoting class of stock, essentially as a mechanism to allow Mark Zuckerberg to have his cake and eat it too (i.e., divest his stock while still maintaining voting control). The move was duly approved by an independent special committee, but - as was recently revealed in a shareholder lawsuit - one of the committee members appears to have been a double agent. According to the plaintiffs, Marc Andreessen kept Zuckerberg informed of the committee's deliberations, even going so far as to text Zuckerberg realtime advice on his negotiations during a conference call with the committee. He apparently contacted Zuckerberg to tell him what the committee's main concerns were, and to warn him what the committee planned to do. He also apparently kept Zuckerberg informed of his progress in persuading the recalcitrant committee member - Erskine Bowles - to accept the proposal. You can read articles about it here and here, or just pull the recently unsealed August 30 brief from In re Facebook Inc Class C Reclassification Litigation, 12286-VCL, but either way, I smell business law exam scenarios. (Maybe I shouldn't have said that.) Notably, Andreessen's loyalty to Zuckerberg, despite his nominal independence, is exactly the kind of thing that apparently has Strine's - and the Delaware Supreme Court's - attention.
Third: Surprise! The Tenth Circuit just held that the SEC's ALJ's are "inferior officers" and therefore their current method of appointment is unconstitutional. The decision creates a circuit split with the DC Circuit in Raymond J. Lucia Companies v. SEC, 832 F.3d 277 (D.C. Cir. 2016), and pretty much assures Supreme Court review - possibly with a newly-appointed justice of Trump's choosing. And that makes me wonder whether we're about to witness some radical changes to the structure of the administrative state.
Here's to 2017 - there will be no shortage of change to keep us busy!
Saturday, December 24, 2016
I previously posted in praise of Sandys v. Pincus for its excellence as a teaching tool – which meant that its reversal was inevitable, as occurred days after classes concluded. (Same with the Salman v. United States decision, though that changed little; naturally; we won’t even what get into what changes midstream when I’m teaching Securities Regulation). The reversal itself is quite interesting, though, as the latest entry in the Delaware Supreme Court’s developing jurisprudence on friendship/social ties as a basis for director disqualification. And, strikingly for Delaware, it generated a dissent.
In Sandys, the basic dispute involves a secondary offering by the social-media game company Zynga. The plaintiffs filed a derivative lawsuit alleging that the secondary offering was designed to allow major insiders – including the controlling shareholder, himself a member of the Zynga board – to cash out before a disappointing earnings announcement. As a result, the secondary offering materials were alleged to have omitted critical facts about the company, ultimately exposing Zynga to a securities fraud lawsuit.
The Chancery decision held that demand was not excused, resting in large part on the court’s conclusion that the directors who were not directly implicated in the scheme were sufficiently independent of those who were to be able to consider the plaintiffs’ demand. The court found that numerous business and social ties among the directors were not sufficient to call these directors’ impartiality into question.
When I taught the case, I told my students that Delaware is largely persuaded by two things: blood and money.
Well, I’m going to have to revise that lesson.
On appeal, the Delaware Supreme Court – per Chief Justice Strine – held that the fuzzy half-business/half-social ties alleged by the plaintiffs were, in fact, sufficient to suggest that the directors were conflicted. (After first excoriating the plaintiffs for failing to pursue a Section 220 request – I don’t know what kind of competitive pressures the plaintiffs may have been under in this particular case, but let’s just say Delaware’s gonna have to do some retooling if it wants that advice to stick. See also Lawrence Hamermesh & Jacob Fedechko, Forum Shopping in the Bargain Aisle: Wal-Mart and the Role of Adequacy of Representation in Shareholder Litigation.)
First, one director co-owned an airplane with her husband, and with the controlling shareholder. The court held that an airplane is such an unusual asset, requiring such “close cooperation in use,” that joint ownership suggests an “intimate personal friendship” sufficient to call the director’s impartiality into question.
Second, two other directors were partners at Kleiner Perkins, a firm with a 9.2% stake in Zynga. Kleiner Perkins had also invested in a company started by the controlling shareholder’s wife, and had invested in a third company that also counted one of the other Zynga secondary-offering sellers (himself also a Zynga director) as one of its investors.
These interrelationships did not make the directors beholden to the controlling stockholder and other sellers in the financial sense, but, the court concluded, were evidence of a “network” of “repeat players” who had created a “mutually beneficial ongoing business relationship.” This created “human motivations” that called the directors’ impartiality into question. Additionally, the court noted that Zynga had not classified these directors as independent for NASDAQ purposes, a determination that itself deserved deference, and had particular relevance in a case, like this one, involving potential wrongdoing by the controlling stockholder.
Justice Valihura dissented. She believed that without more details of the size and scope of the Kleiner Perkins investments, or the financial or personal significance of the co-owned airplane, these relationships could not be used to challenge the directors’ impartiality.
Sandys is thus the latest in a line of Strine decisions pushing Delaware law toward greater legal recognition of the fact that structural coziness may make directors reluctant to accuse each other of wrongdoing. This has always been a delicate area; it’s fair to say that any human being who has lived some time among other humans understands the kind of bias that these relationships may generate, but courts have always feared that formal recognition of them would open the floodgates to frivolous/damaging litigation, and force judges to engage in impossible determinations as to the exact point at which friendship becomes compromising. Strine, plainly, believes that the law has overcorrected – i.e., the complete failure to recognize these informal relationships creates an intolerable artificiality in how questions of conflict are examined, and he’s pushing the law in a new direction.
(If I had to guess, I'd also say that Strine recognizes that as Delaware becomes a mini-SEC for transactions on which shareholders vote - i.e., disclosure becomes the only requirement - Delaware's relevance may hinge on its ability to stake out territory for vigorous court oversight that can't be cured by disclosure.)
What’s particularly striking here is that – as Justice Valihura’s dissent makes clear – Sandys goes much further than its predecessor, Del. County Emples. Ret. Fund v. Sanchez. In Sanchez, the allegedly conflicted director had a 50-year friendship with the interested party as well as a strong financial dependency; the Sandys relationships are nowhere near that scale. So Delaware – presumably at Strine’s urging – seems to be in the process of some rather aggressive redrawing of the lines. Where those lines will end up remains to be seen.
I may still teach the Chancery decision in my business class, though – it’s just so useful, with charts, and you can make alternative hypothetical charts and ask how the case might have come out differently. But then I’ll have to either talk the students through the reversal, or assign them the relevant excerpts.
That's all! Wishing everyone a happy erev Chanukah and erev Christmas!
Monday, December 19, 2016
In her post on Saturday, co-blogger Ann Lipton offered observations about possible legal issues resulting from the President-Elect's tweets regarding public companies. She ends her post with the following:
So, it's all a bit unsettled. Let's just say these and other novel legal questions regarding the Trump administration are sure to provide endless fodder for academic analysis in the coming years.
Today, I take on a somewhat related topic. I briefly explore the President-Elect's conflicting interests through the lens of a corporate law advisor. For the past few weeks, the media (see, e.g., here and here and here) and many folks I know have been concerned about the potential for conflict between the President-Elect's role as the POTUS, public investor and leader of the United States, and his role as "The Donald," private investor and leader of the Trump corporate empire.
The existence of a conflicting interest in an action or transaction is not, in and of itself, fatal or even necessarily problematic. In a number of common situations, fiduciaries have interests in both sides of a transaction. For example, a business founder who serves as a corporate director and officer may lease property she owns to the corporation. What matters under corporate law is whether the fiduciary's participation in the transaction on both sides results in a deal made in a fully informed manner, in good faith, and in the bests interests of the corporation. Conflicting interests raise a concern that the fiduciary is or may be acting for the benefit of himself, rather than for and in the best interest of the corporation.
Corporate law generally provides several possible ways to overcome concerns that a fiduciary has breached her duty because of a conflicting interest in a particular action or transaction:
- through good faith, fully informed approval of the action or transaction (e.g., after disclosure of information about the nature and extent of the conflicts) by either the corporation's shareholders or members of the board of directors who are not interested in the transaction; and
- through approval of a transaction that is entirely fair--fair as to process and price.
See, e.g., Delaware General Corporation Law Section 144. Yet, if I believe what I read, no similar processes exist to combat concerns about actions or transactions in which the POTUS has or may have conflicting interests. In particular, to the extent one does not already exist, should a disinterested body of monitors be identified or constituted to receive information about actual and potential conflicting interests of the POTUS and approve the action or transaction involving the conflicting interests? Perhaps the Office of Government Ethics ("OGE") already has something like this in place . . . . If it does, then both the public media and I are underinformed about it. While there seems to be OGE guidance on the President-Elect's nominees for executive branch posts (see, e.g., here and here) and on overall executive branch standards of conduct (see here), I have not found or read about anything applicable to the President-Elect or POTUS.
In making these observations, I recognize that our federal government is different in important ways from the corporation. I also understand that the leadership of a country/nation is different from the leadership of a corporation. Having said that, however, conflicting interests can have similar deleterious effects in both settings. The analogy I raise here and this overall line of inquiry may be worth some more thought . . . .
Saturday, December 17, 2016
One of the more … striking ... habits of President-Elect Trump is his tendency to use Twitter to attack specific companies that have displeased him in some way. For example, after the CEO of Boeing criticized him, he tweeted:
Boeing is building a brand new 747 Air Force One for future presidents, but costs are out of control, more than $4 billion. Cancel order!— Donald J. Trump (@realDonaldTrump) December 6, 2016
After Vanity Fair published a scathing review of Trump Grill, he tweeted:
Has anyone looked at the really poor numbers of @VanityFair Magazine. Way down, big trouble, dead! Graydon Carter, no talent, will be out!— Donald J. Trump (@realDonaldTrump) December 15, 2016
And other times, Trump seems to simply be reacting to whatever he sees on the news.
These tweets might explicitly threaten to harm their targets through the exercise of government power – such as the threat to cancel Boeing’s Air Force One contract – but even if they don’t, the implicit possibility is there. As a result, Trump’s tweets move the market. Boeing’s stock reacted negatively to Trump’s tweet (though it rebounded). Shares of Lockheed Martin dropped dramatically after Trump criticized one of its fighter jets as too expensive.
Wall Street traders have begun building a Trump tweet effect into their models. One anecdotal report says that compliance departments have lifted bans on trader Twitter usage, aware that presidential-tweet monitoring is now a necessary part of the job.
The Wall Street Journal even published a blog post recommending four proactive steps all businesses take in anticipation of a Trump twitter attack.
All of this has prompted some accusations of market manipulation and insider trading. For example, it’s been reported that some lucky trader started dumping shares of Lockheed Martin six minutes before Trump tweeted, though that could simply be the result of hedge funders correctly predicting where Trump would tweet next.
For the sake of argument, let’s say that Trump’s tweet attacks – at least some of them – are calculated to drive down stock prices in order to allow someone (maybe Trump himself, maybe someone in his circle) to make a profit. Is there anything illegal here?
[More under the jump]
Monday, December 12, 2016
It used to be that Friday night was Domino's Pizza night in our house . . . . My, how things change if one lets 15-20 years slip by unnoticed. No more of that in our house!
I guess Domino's is doing OK without us, however. Third quarter 2016 financial results for Domino's Pizza, Inc., a Delaware corporation with common stock listed on the New York Stock Exchange, were favorable as compared to the firm's 2015 results, accordingly to the most recent quarterly earnings release. Somebody's eating a lot of Domino's pizza, even if it isn't the Heminway family.
Apparently, Domino's wants to share the wealth--with its customers. Co-blogger Haskell Murray pointed this recent press item out to me and co-blogger Ann Lipton in an email message last week, knowing full well that we both were or would be interested. He was right. Ann may have more to say on this in a later post. (She also noted that other firms are adopting consumer benefit plans similar to the Domino's plan I describe here today.)
Of course, as a corporate finance/securities lawyer, I immediately had visions of Ralston Purina dancing in my head. (Not quite like visions of sugarplums, in this holiday season . . . . But I will take what I can get.) So, I went looking for a registration statement/prospectus. And I found what I sought! No Ralston Purina-like Section 5 violation here.
Domino's has filed a shelf registration statement on Form S-3 and a Rule 424(b)(5) prospectus with the SEC (both filed December 2, 2016). The plan of distribution is summarized in the prospectus in two short sentences: "The Piece of the Pie Program is just one of the ways we are giving thanks to our customers. Through the Plan, we are offering our eligible customers the opportunity to be entered into drawings for a chance to be selected to receive ten Shares."
The prospectus goes on to describe the way the plan operates plan in more detail. Here's a slice off the top:
Shares for the Plan will be purchased in the open market by Fidelity Brokerage Services LLC and o Fidelity Capital Markets,Fidelity or, at our election, provided by us to Fidelity out of our authorized but unissued shares and will be initially deposited in a custody account in the name of the Company (“Custody Account”). Open market purchases will be effected by Fidelity, with all Shares to be credited to the applicable participant’s Fidelity Account. Fidelity has full discretion as to all matters relating to open market purchases, subject to the terms of our agreement with them, including the number of Shares, if any, to be purchased on any day or at any time of day, the price paid for such Shares, the markets on which Shares are purchased (including on any securities exchange, in the over-the-counter market or in negotiated transactions) and the persons (including brokers and dealers) from or through whom such purchases are made.
The Plan is not designed for short-term investors, as participants will not have complete control over the exact timing of redemption transactions or the market value of our Common Stock redeemed pursuant to a Piece of the Pie Award under the Plan. See “—Timing of Purchases.” The Plan is designed primarily for customers who have a long-term perspective and affinity for the Company and its values.
Notably, Domino's is planning to use shares that it repurchases in the market as well as, perhaps, authorized and unissued shares. The use of market repurchases may signal management's belief that the market is undervaluing those shares. It also is a means of preventing dilution to existing stockholders. Public companies often use market purchases to fund dividend reinvestment and other equity-based employee benefit plans.
Customers can enroll in the plan on the Domino's Pizza app at no charge. Here's what the overall offering looks like:
. . . We have established the Plan to provide our eligible customers with the opportunity to be entered into drawings under the Plan to receive ten shares of our Common Stock as a thank you for being a loyal customer. Between December 5, 2016 and November 30, 2017 (the “Offer Period”), we will conduct 25 drawings per month. An eligible customer who has enrolled in the Plan prior to a particular drawing date will be automatically entered into that drawing. Eligible customers will not be eligible to participate in drawings occurring prior to the date of enrollment in the Plan. An eligible customer who is selected in a drawing to receive an award under the Plan will be presented with an offer (the “Offer”) to receive ten shares of our Common Stock (each a “Share” and collectively, the “Shares”) under the Plan (each a “Piece of the Pie Award”).
Redemptions of Piece of the Pie Awards will be fulfilled through Fidelity and will require that, as a condition to redemption of a Piece of the Pie Award, the selected eligible customer open a brokerage account with Fidelity into which the Shares can be deposited. Fidelity will obtain the Shares to be delivered upon redemption of Piece of the Pie Awards through open market purchases or, to the extent determined by the Company, delivery by the Company to Fidelity of newly-issued shares. A Piece of the Pie Award must be redeemed within 30 days of receipt, after which time such Piece of the Pie Award will expire if not previously redeemed. Piece of the Pie Awards are limited to ten Shares per selected eligible customer and no eligible customer may receive more than one Piece of the Pie Award. In order to enter for a chance to receive a Piece of the Pie Award, eligible customers must enroll in the Plan using their account on the Domino’s Pizza App or by registering on the www.dominos.com website. An eligible customer who enrolls in the Plan will only be eligible to participate in drawings occurring after the date of such enrollment.
I am a member of a bunch of consumer loyalty programs--for department and drug stores, restaurants, etc. But few businesses from which I buy goods and services have offered me the opportunity to invest. And none have offered me the opportunity to "win" an equity interest in a firm through a drawing sponsored by a consumer affinity program. Query whether, if equity-based consumer benefit plans like this one are successful and continued to be valued, an exemption like Rule 701 will be promoted in Congress and at the SEC to ensure there is a registration exemption available for these offerings.
I will leave it at that for now. But this is a phenomenon to watch, for sure. And it fits in nicely with my Securities Regulation course next semester. You never know where it might pop up . . . .
Saturday, December 10, 2016
As part of my ongoing effort to sample most pop cultural representations of corporate/business life, I’ve started watching SyFy’s Incorporated. Incorporated envisions a dystopian future where, due to global warming and related environmental catastrophes, the world’s governments have become bankrupt, and in their place, “multinational corporations have risen in power and now control 90% of the globe.”
We learn in the first episode that formal governments still exist, but in almost vestigial form; as a practical matter, multinational corporations are in charge. These corporations compete with each other for resources and market share. They target each other with espionage and sabotage; when one’s stock price falls, the others’ stock prices rise. Employees lead a comfortable life within the corporate compound, so long as they adhere to the rules set by their employers; outside of corporate compounds, life is poverty and anarchy.
I get where this show is coming from; I mean, fear of corporate control of government represents a particularly timely anxiety. And there are lots of sly jokes about today’s political environment – a television news report, for example, tells us that the “Canadian Prime Minister is constructing a fence after 2073 became a record year for illegal immigation. It is estimated that already 12 million US citizens live in Canada illegally.” Ha, ha. But the show perpetuates what I believe is the very damaging misconception that corporations can exist independent of government systems.
For example, it is clear that these corporations have shareholders, and that the shares trade publicly with prices that respond to new information. So, what legal rights do these shareholders have? How are they enforced? What are the regulations that govern the market in which shares trade, and who enforces those regulations? If corporate managers have that much power, why would anyone invest without fear of exploitation – and if there are limits on their power, so that investors are more confident, where do those limits come from?
The backstory of this universe – as described on the SyFy website – is that governments, under financial pressure, sold various police powers to corporations, and exempted them from taxation. The implication must therefore be that the government either taxes everyone else to pay the corporations for their service, or allows the corporations to charge private citizens. But by now, most people are unemployed and surviving as part of the underground economy; the U.S. government, at least, is unable to raise funds to pay for its operations. Wouldn’t the US dollar have collapsed? Wouldn’t it be replaced by corporate scrip?
And why are employees treated so well? In a world where corporations rule, the constituents are the shareholders – not the employees – so that’s who I’d expect to live in luxury. Certainly, today’s corporate theory would suggest that shareholder interests are somewhat adverse to those of employees, so that when shareholders are ascendant, employees suffer. The world of Incorporated is obviously a world with excess labor; why would corporations expend so many resources on their workers?
And who are the shareholders in this world, anyway? Today’s shareholders are – in large part – employees, who have pooled their retirement funds in either defined benefit or defined contribution plans. But with only a few multinational corporations – and the majority of the population shunted into the underground economy – that can’t be the system anymore. If corporations are supplying their employees with all of their needs (healthcare, food, housing, presumably retirement plans), it doesn’t seem like there would be much of an insurance market, let alone a need for 401(k) plans, so those investors have been eliminated.
But I keep coming back to the central problem: If corporations have supplanted governments, then at minimum, arbitration and trust and reputation and guilds must supplant regulation. That’s a fascinating vision of the future, but nothing in the show even hints at this direction. I realize that I’m now stealthily engaging relatively unoriginal debates about the nature of the corporation (artificial/concession, association, real) and the role of the state in constructing the corporate form, but the reality is that corporations are a product of their legal environment. Without something like law emanating from some external source, there is no corporation. To imagine corporations as independent of law fatally ignores the role of law in shaping the corporate form itself.
As a result, I find Incorporated not merely irksome, but actively damaging. It leads lay viewers to accept the current legal framework for the corporate form as baseline, or natural – instead of a set of affirmative set of regulatory choices. I’m not talking about particular salient issues, such as political donations or tax policy; I’m talking about fundamental aspects about the form itself, such as limited liability, the role of the shareholder in the governance structure, and the transferability of ownership interests. The form itself is inseparable from positive law, which means it is subject to change. Incorporated obscures that fact, and thus – rather than presenting a critique of the status quo – ultimately reinforces it.
Saturday, December 3, 2016
There are always policy questions about the degree to which public regulation should be enforced by government actors, by private actors, or by a combination of both. In securities law, for example, striking the right balance is a perennial debate.
Which is why I read with interest this New York Times story about efforts to combat counterfeiting in China.
China has a serious problem with counterfeit goods. To some extent, that kind of problem can be addressed via government enforcement actions; however, China also suffers from what one might describe as an extreme case of regulatory capture – namely, corruption at the local level that compromises enforcement efforts.
So China has turned to private enforcement, by bolstering its consumer protection laws: consumers who purchase counterfeit goods can get damages equal to several times the value of the product. And predictably, these laws have spawned a new profession: counterfeit hunting.
That by itself would not be so bad – why not let consumers, acting like private attorneys general, ferret out counterfeit goods? The problem is, since damages are based on the number of products purchased, hunters purchase counterfeits in large numbers, filling warehouses with them. They also target minor labeling errors as much as serious fraud.
In other words, they exhibit all of the problems inherent in private enforcement: failure to exercise discretion over where to direct resources, arbitraging claims/creating injuries (and failing to mitigate damage) in order to support a lawsuit. These are precisely the accusations that have been leveled at, for example, stockholder plaintiffs and appraisal arbitrageurs.
China is apparently considering a new law that would ban counterfeit hunting as a commercial activity – akin to PSLRA provisions that prohibit so-called professional plaintiffs. But given the unreliability of government enforcement in China, it strikes me that to do so would throw the baby out with the bathwater. Yet absent such measures, China’s left with an extreme version of a common problem: private plaintiffs don’t draw distinctions between serious problems and minor ones if the monetary payout is the same. That distinction is one that has to be drawn in the substantive law.
We do that in securities by, for example, imposing standing, reliance, and loss causation requirements on private plaintiffs that government does not have to satisfy, and allowing government to bring claims based on an expanded set of violations (e.g., aiding and abetting). And we've done that, in a roundabout way, with state law fiduciary claims: there is no government enforcement in that arena, which has led to increasing limitations on private liability (exculpatory provisions, demand requirements) with no corresponding expansion of state enforcement. But that regulatory gap has been rapidly filled at the federal level with fiduciary-like requirements (independent director requirements, books and records requirements, and so forth) that can only be enforced by regulators.
It's an imperfect system, of course; it'll be interesting to see how China grapples with the same problem.
Saturday, November 26, 2016
Okay, this post has nothing to do with the subject line; given the time of year, I just couldn’t resist.
(Maybe we’ll just characterize that episode of WKRP in Cincinnati as a demonstration of PR tactics gone wrong. See? There’s a business law hook).
Anyhoo, today I want to call attention to the phenomenon of the fake whistleblowing hotline.
As compliance becomes an increasingly large part of corporate operations – and a de facto reconfiguration of corporate governance standards – it seems that companies are fond of creating “whisteblowing hotlines” to demonstrate their commitment to compliance with the law. Public companies, in fact, are required to do so under Sarbanes-Oxley.
Which is why two recent news items are so disturbing. First, in connection with the Wells Fargo fake account scandal – on which both Anne Tucker and Marcia Narine Weldon recently posted– it turns out that employees who offered tips on the Wells Fargo whistleblowing hotline were quickly fired; meaning that the hotline itself operated as a kind of reverse-ethics test to weed out employees most likely to object to Wells Fargo’s practices.
And it turns out that Wyndham Vacation Ownership did the same thing. This company, which sells time shares using legally dubious tactics, also has an “integrity hotline” that it uses, apparently, to identify and fire salespeople who have integrity.
It strikes me that these incidents are particularly pernicious. They represent traps to catch employees who might be troubled by the company's behavior, while faking compliance with the law - a false compliance that may not easily be detected. And they imply a certain degree of premeditation: if you set up a hotline and then misuse it, presumably, you know what you're doing. I realize that federal and state laws provide penalties for retaliation against whistleblowers; I do wonder if there can be especially tough scrutiny of adverse employment decisions in the wake of utilization of company-established compliance procedures - like, perhaps, a presumption that punitive damages should be awarded. I’m not an expert in this area, though; does anything like this exist? Could it?
Saturday, November 19, 2016
For this week's post, I offer a plug. I just posted to SSRN a draft chapter, Limiting Litigation Through Corporate Governance Documents, for the forthcoming Research Handbook on Representative Stockholder Litigation (Sean Griffith et al., eds. 2017), published by Edward Elgar Publishing. For those who are interested, here is the abstract:
There has recently been a surge of interest in “privately ordered” solutions to the problem of frivolous stockholder litigation, in the form of corporate bylaw and charter provisions that place new limitations on plaintiffs’ ability to bring claims. The most popular type of provision has been the forum selection clause; other provisions that have been imposed include arbitration requirements, fee-shifting to require that losing plaintiffs pay defendants’ attorneys’ fees, and minimum stake requirements. Proponents argue that these provisions favor shareholders by sparing the corporation the expense of defending against meritless litigation. Drawing on the metaphor of corporation as contract, they argue that litigation limits are often enforced in ordinary commercial contracts, and that bylaws and charter provisions should be interpreted similarly.
In this chapter, I recount the history of these provisions and the state of the law regarding their enforceability. I then discuss some of the doctrinal and policy questions that have been raised regarding different types of litigation limits, and the propriety of private ordering in this context. In particular, I explore how corporate managers’ structural and informational advantages may make litigation limits easy to abuse; moreover, litigation itself serves public purposes that may be more appropriately subject to public control.
Saturday, November 12, 2016
The results of Tuesday’s election stunned most people – including internal analysts within the Trump camp – because the polling seemed to give Clinton an insurmountable lead. She was ahead of Trump in many states, and though there was great room for uncertainty in each poll, everyone assumed that even if there were some polling errors, there were not enough to make a difference in outcome. I.e., she could lose Ohio and Florida and still win so long as she held Pennsylvania and so forth, so it seemed as though even accounting for polling error, there was little chance she could lose.
That assumption, however, ignored the possibility that all of the errors were correlated – so that an error in one state’s polls meant that the same error would be replicated across multiple states. That’s something that Nate Silver accounted for in his model, however, and others rejected, and it contributed to Silver's more bearish Clinton predictions.
And of course, that’s what happened with respect to mortgage backed securities as well. Everyone knew that some mortgages would fail – and that some RMBS tranches would fail – but the assumption was that there were enough of them that any errors would not damage an entire pool. What many (though, as with Clinton, not all) people failed to foresee was that the errors were correlated, so that they stood or fell in unison. What seems so obvious in retrospect was difficult to understand at the time.
Saturday, November 5, 2016
I’m traveling today so this will be quick (actually, I drafted this in advance to go up automatically and I’m very much hoping that whatever happens, the appeal won’t have been decided before this post appears).
Earlier this year, Chancellor Bouchard decided Sandys v. Pincus, regarding whether demand was excused in a derivative action against the board of Zynga. And I love this case because it is a shockingly good teaching tool for the concept of demand excusal. The plaintiffs filed three claims – I edit out the last one and just stick with counts I and II.
The opinion beautifully describes the nature of the inquiry, and it even has a nice chart showing the differences in composition between the board accused of wrongdoing, and the demand board.
In the first two counts, there is a sharp distinction drawn between board members who are potentially interested because of liability due to personal benefits/self-dealing, and board members who are potentially interested because they face personal liability for other reasons.
The court also clearly marches through the question of whether any disinterested board members are nonetheless dependent on interested directors, demonstrating how – despite rather extensive social and business ties – none of it is enough to meet the standard to show dependence. To make matters even better, one of the interested directors is a controlling shareholder, allowing for discussion of independence/dependence when a controlling shareholder is in the mix.
And as a bonus, the case involves a set of companies that are likely to be familiar to students – Zynga, with discussions of Facebook, LinkedIn, and Mozilla.
Honestly, this case is so ideal for a complex subject that I’m mostly just crossing my fingers that nothing in the appeal – whether the plaintiffs ultimately win or lose – undermines the usefulness of the Chancery decision.
(By the way, the appeal also may represent an opportunity for the Delaware Supreme Court to finally merge Aronson and Rales – which Chancellor Bouchard almost seems to be inviting the Court to do. If nothing else, that much would certainly simplify the teaching.)
Saturday, October 29, 2016
A couple of interesting studies about gender in the business context have recently been released.
First, a study by A. Can Inci, M.P. Narayanan, and H. Nejat Seyhun concludes – based on profits earned from insider trading - that women executives have less access to inside information than do men with similar positions. They attempt to control for the fact that women may simply be more risk averse by controlling for trade size; they find, however, that even when doing so, men make more than women. Of particular interest is the fact that even though their study goes back to 1975 (when there were fewer women executives), they find that the gender differences are stronger in more recent years, from 1997-2012. They believe that the differences are attributable to informal networking that grants men access to better information than women; these differences fall away for firms that have a greater proportion of women executives.
Second, the Rockefeller Foundation finds that when a company experiences a crisis and the CEO is a woman, eighty percent of news stories cite her as a problem; when the CEO is a man, only thirty-one percent of news stories cite him as a problem.
Of course, it’s possible that the reporting is entirely accurate – maybe women CEOs are responsible for crises more often than men. But there are, of course, other potential explanations. For example, biases against women generally – a sense that she doesn’t deserve the position – or perhaps the fact that women generally only achieve CEO status when a company is already experiencing problems. I’ll also throw out another possibility: Salience. There’s a fairly well-documented psychological phenomenon whereby people attribute causality to whatever is salient about a situation. The thing that draws their attention is assumed to be the cause. That thing might be an entirely neutral characteristic – like having red hair in a group of brunettes, or wearing a striped shirt – or, in the case of CEOs, being a woman in a position typically held by men. Of course, if salience is partially the cause, I'd expect successes also to be disproportionately credited to women - and I have no idea whether that's the case, or whether an interaction of biases could prevent such a phenomenon from surfacing.
What it comes down to is, we can really only be sure of our perceptions when enough women occupy the CEO position to make them unnoticeable.
Saturday, October 22, 2016
The Economist recently published an opinion piece arguing that bigotry has become a lucrative business. As the magazine puts it:
The country is in an unusually flammable mood. This being America, there are plenty of businesspeople around to monetise the fury—to foment it, manipulate it and spin it into profits. These are the entrepreneurs of outrage and barons of bigotry who have paved the way for Donald Trump’s rise….
Breitbart News, in particular, has excelled in pushing boundaries. … It has provided platforms in its comment section for members of far-right hate groups who rail against immigration and Jews.
The outrage industry has clearly reached a milestone with Donald Trump’s presidential campaign. …He won the hearts of 13m Republican primary voters by recycling conservative media hits such as “build a wall” and “ban all Muslims”. …
There are big bucks in bigotry
Twitter has been a particularly virulent source of online bigotry and abuse. Buzzfeed recently published an article on Twitter’s 10-year failure to halt hate speech – often targeted at particular users – that stems from a combination of corporate dysfunction, failure of (white, male) corporate leadership to recognize the problem, and business exigencies that emphasized user growth. In this election season, Twitter has become a famous platform for bigoted trolling, often aimed at journalists who oppose Donald Trump.
But it appears that bigotry as a profit-center only goes so far. Twitter has been plagued recently by a stagnant user base and correspondingly declining stock price; as a result, it has been seeking an acquirer. But according to recent news reports, Twitter’s troll problems are driving away potential bidders.
So, it seems there’s at least a built-in limit as to how far bigotry can take you.
Saturday, October 15, 2016
That Pascal quote encapsulates why I strongly disagree with Noah Feldman’s Bloomberg column on the new word limits for federal appellate briefs.
The new rules reduce the number of words in opening briefs by 1,000, and in reply briefs by 500. Feldman argues that the reduction will cut down billable hours. He’s wrong; it will do the opposite.
When I was in practice, I spent nearly as much time cutting words from briefs as I did doing the initial draft. Every first draft clocked in at more than the then-limit of 14,000 words; in some cases, I was closer to 21,000 words my first time through. Only after substantial editing – going over each sentence again and again, and (naturally) taking serious liberties with Bluebook format – was I able to bring briefs within the limit. (I never went this far, though.)
(Note to Lexis: You are at a disadvantage relative to Westlaw because your citation format for unpublished cases has more words. I did initial research on Lexis but then translated all citations to Westlaw to bring my word count down. Rookie mistake, guys.)
For what it’s worth, I think the new limits are a travesty. Judges often berate attorneys for prolix writing – particularly when they’re drafting complaints, while trying to meet increasingly byzantine pleading standards – and it’s unfair. Yes, there are extreme cases of bad writing and bad lawyering, but at the end of the day, if lawyers had the talent of Hemingway, they wouldn’t be lawyers, and there’s a certain limit to what can be reasonably demanded. Judges assume that if word limits are reduced, lawyers will cut the excess verbiage – usually unnecessarily florid language, hyperbole, etc – but there is just no assurance of that; lawyers often ex ante misjudge what is hyperbolic and what is substantive. The wasted pages are a small price (for clerks) to pay in order to make sure that attorneys can get their arguments heard. (Especially in light of evidence that word reductions harm appellants more than appellees, which I assume is due to the fact that the appellee has the district court opinion to function as a supplementary brief on its behalf).
Frankly, if there’s a pressing need to reduce judges’ reading load, I recommend jettisoning the reply brief. Though certainly many plaintiffs make good use of replies, in my experience both as a clerk and in practice, the vast majority of replies did nothing more than repeat arguments in the opening brief, without truly responding to the arguments made in the response brief. So if something has to be cut, that's what has my vote.
Wednesday, October 12, 2016
I am preparing to teach the doctrine on controlling shareholders in my corporations class tomorrow, and found the recent Delaware opinions on non-controlling shareholder cleansing votes and the BJR to be helpful illustrations of the law in this area.
In summer 2016, the Delaware Court of Chancery dismissed two post-closing actions alleging a breach of fiduciary duty where there was no controlling shareholder in the public companies, where the stockholder cleaning vote was fully informed, and applied the 2015 Corwin business judgment rule standard. The cases are City of Miami General Employees’ & Sanitation Employees’ Retirement Trust v. Comstock, C.A. No. 9980-CB, (Del. Ch. Aug. 24, 2016) (Bouchard, C.) and Larkin v. Shah, C.A. No. 10918-VCS, (Del. Ch. Aug. 25, 2016) (Slights, V.C.), both of which relied upon Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304 (Del. 2015). (Fellow BLPB blogger Ann Lipton has written about Corwin here).
The Larkin case clarified that Corwin applies to duty of loyalty claims and will be subject to the deferential business judgment rule in post-closing actions challenging non-controller transactions where informed stockholders have approved the transaction. The Larkin opinion states that:
(1) when disinterested, fully informed, uncoerced stockholders approve a transaction absent a looming conflicted controller, the irrebuttable business judgment rule applies; (2) there was no looming conflicted controller in this case; and (3) the challenged merger was properly approved by disinterested, uncoerced Auspex stockholders. Under the circumstances, the business judgment rule, irrebuttable in this context, applies. ....The standard of review that guides the court’s determination of whether those duties have been violated defaults to a deferential standard, the business judgment rule, which directs the court to presume the board of directors “acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company.” In circumstances where the business judgment rule applies, Delaware courts will not overturn a board’s decision unless that decision 'cannot be attributed to any rational business purpose.' This broadly permissive standard reflects Delaware’s traditional reluctance to second-guess the business judgment of disinterested fiduciaries absent some independent cause for doubt. Larkin at 21-22 (internal citations omitted).
Two-sided controller transactions (a freeze out merger where a controlling shareholder stands on both sides of the transaction) is covered by the 2014 Kahn v. M & F Worldwide Corp., 88 A.3d 635(Del. 2014) case, which I summarized in an earlier BLPB post here.
To refresh our readers, the controlling shareholder test is a stockholder who owns a majority of stock. Additionally, a stockholder may qualify as a controller if:
Under Delaware law, a stockholder owning less than half of a company’s outstanding shares may nonetheless be deemed a controller where 'the stockholder can exercise actual control over the corporation’s board.'This “actual control” test requires the court to undertake an analysis of whether, despite owning a minority of shares, the alleged controller wields “such formidable voting and managerial power that, as a practical matter, [it is] no differently situated than if [it] had majority voting control.'A controlling stockholder can exist as a sole actor or a control block of “shareholders, each of whom individually cannot exert control over the corporation . . . [but who] are connected in some legally significant way—e.g., by contract, common ownership agreement, or other arrangement—to work together toward a shared goal.' Larkin at 33-34 (internal citations omitted).
Excellent commentary on theLarkin and Comstock cases and their practical implications can be found on the Harvard Law School Forum on Corporate Governance and Financial Regulation, available here.
Saturday, October 8, 2016
I am intrigued by this new genre of financial writing that warns (in increasingly apocalyptic terms) that passive investing will lead to increasingly distorted and inefficient markets.
Nevsky Capital, a large hedge fund, noisily shut its doors last year with an investor letter that blamed, among other things, index investing that distorted correlations among stocks.
Sanford C. Bernstein & Co., LLC. recently published a note declaring that passive investing is “worse than Marxism” because at least Marxism allocates capital according to some kind of principle, whereas passive investing allocates capital by the happenstance of inclusion in an index.
And a research analyst recently posted “The Last Active Investor,” a short story that posits a dystopian future in which all market prices are set by a single person performing the world’s only fundamental research.
It’s true that index investing distorts stock prices to some degree, though there has been plenty of pushback to the claim that there’s any real danger of passive investing overtaking the market, especially since the definition of passive investing itself might be somewhat malleable in an age of increasingly sophisticated computerized trading.
But what I’m mostly curious about is what sorts of policy fixes defenders of active investment would recommend. The Bernstein note is vague on this but apparently objects to government-sponsored initiatives that would favor passive investment of pension funds. Meanwhile, Steve Johnson writing at the Financial Times proposes that passive investing actually be taxed to subsidize active investing. And the author of the Last Active Investor does not say so explicitly, but he appears to favor some kind of loosening of insider trading restrictions – at least, that’s what I gather from the part of the story (spoiler alert!) where the Active Investor’s fundamental research is treated as market manipulation.
Of course, it’s somewhat ludicrous to suggest that workers should invest their retirement funds in a less profitable manner so that white collar business analysts can be subsidized in their important price setting work, and it seems to me that if passive investing is to be taxed to subsidize active investing, we probably want to make sure that active investors are keeping their costs down – which probably means some kind of vetting as well as salary and price controls, and … oh no, I think I maybe just endorsed the Marxism theory.
Saturday, October 1, 2016
I have to say, it pains me that this is even news – that price maintenance as a form of fraud on the market should, I believe, be unexceptionable, indeed, necessary for the theory to function properly.
But the idea has been at least somewhat rejected by the Fifth Circuit – see Greenberg v. Crossroads Sys., 364 F.3d 657 (5th Cir. 2004) – and defendants are vigorously disputing the legitimacy of price maintenance elsewhere.
So it comes as something of a relief that in In re Vivendi, S.A. Sec. Litigation, 2016 U.S. App. LEXIS 17566 (2d Cir. Sept. 27, 2016), the Second Circuit has now joined the Eleventh Circuit, see FindWhat Inv’r Grp. v. FindWhat.com, 658 F.3d 1282 (11th Cir. 2011), and the Seventh Circuit, see Glickenhaus & Co. v. Household Int’l, Inc., 787 F.3d 408 (7th Cir. 2015), with a full-throated endorsement of the idea that even if a fraudulent statement does not introduce “new” inflation into a stock’s price – even if it simply maintains existing inflation by confirming an earlier false impression – that too violates Section 10(b) and is actionable using the fraud on the market doctrine.
Beyond this simple holding, though, there are some interesting nuggets buried in the reasoning that are worth exploring.
First, the Second Circuit discussed the policy reasons for recognizing price maintenance as a form of fraud. It offered a hypothetical example of a company where – due to its past operating history – investors make certain assumptions about the quality of its products. Those assumptions are false with respect to a new product. Under such circumstances, the stock price is inflated, but not because of any fraud by the company. In that situation, if price maintenance is not actionable, the company would be completely free to fraudulently confirm investors’ false assumptions.
I’d only add to that that there are plenty of situations where the initial inflation might be due not to investors’ faulty assumptions, but due to the company’s own actions. In FindWhat, for example, the initial inflation was introduced by the company’s own false statements – but the Eleventh Circuit concluded that the original statements were not made with scienter, so they were inactionable. If price maintenance theory is not accepted, then once a company negligently misinforms the market, it is free to intentionally do so (but see the duty to correct, discussed below).
Similarly, in IBEW Local 98 Pension Fund v. Best Buy Co., 818 F.3d 775 (8th Cir. 2016) (which I previously discussed here, the initial false statements were immunized by the PSLRA’s safe harbor. If price maintenance theory is not accepted, companies can simply lie via forward looking statements, and use the resulting artificial inflation to lie about related facts.
The second thing worth discussing is that one of Vivendi’s arguments was that even if a statement confirmed previous (false) information, that statement could only have “propped up” the previously-inflated price if silence would have revealed the truth. That is, in Vivendi’s view, if simply remaining silent would have had the same effect as the confirmatory false statement (and silence was an option, i.e., there were no affirmative disclosure requirements in play), then the statement cannot be said to have impacted price.
That’s an argument that’s been endorsed by Don Langevoort (see Compared to What? Econometric Evidence and the Counterfactual Difficulty, 35 J. Corp. L. 183 (2009); see also Judgment Day for Fraud-on-the-Market: Reflections on Amgen and the Second Coming of Halliburton, 57 Ariz. L. Rev. 37 (2015)), and I’ve also gone back and forth about here and in my essay Searching for Market Efficiency, 57 Ariz. L. Rev. 71 (2015).
But the Second Circuit rejected the silence comparator wholeheartedly. Part of the reasoning was kind of a burden-shifting idea: we’ll never know what would have happened if the company remained silent, because Vivendi chose to speak. And Vivendi is responsible for that.
But additionally, the Second Circuit fell back on the point that once a company chooses to speak, it has a duty to speak fully and accurately. In other words, once Vivendi chose not to remain silent, it did not have the option of failing to reveal the truth.
The reason I find this striking is that it’s a roundabout way of getting at what would have been a much simpler frame: The duty to correct.
The duty to correct is fairly uncontroversial in theory. See, e.g., Overton v. Todman & Co., 478 F.3d 479 (2d Cir. 2007); Gallagher v. Abbott Labs., 269 F.3d 806 (7th Cir. 2001)). Once a company knows it has issued false statements, it has a duty to correct them.
Here, the plaintiffs must have proven that Vivendi was aware of the fraud – we wouldn’t even be discussing price maintenance if it was unaware – so presumably, Vivendi did not have an option of remaining silent; it was legally obligated to confess.
But the duty to correct has always been a bit tough to parse, if for no other reason than it is difficult to pinpoint which person precisely in the corporation has that duty. See United States v. Schiff, 602 F.3d 152 (3d Cir. 2010); but see Barrie v Intervoice-Brite, 409 F.3d 653 (5th Cir. 2005). In Vivendi, the jury found the corporate defendant liable but absolved the individual ones, which renders the problem more complex.
Moreover, it's not clear how the duty to correct comes into play if the original statements were immunized - like, say, via the PSLRA safe harbor.
So rather than discuss whether Vivendi had an affirmative duty to speak once it realized that earlier statements were false, the Second Circuit instead simply said that the confirmatory statements were themselves the equivalent of half-truths that gave rise to a duty of a full confession. As the Second Circuit put it, “in suggesting that, had it remained silent, the misconception‐induced (whether or not fraud‐induced) inflation would have persisted in the market price, Vivendi assumes it is even relevant what would have happened had it chosen not to speak. Yet in framing the argument this way, Vivendi misunderstands the nature of the obligations a company takes upon itself at the moment it chooses, even without obligation, to speak. It is well‐established precedent in this Circuit that ‘once a company speaks on an issue or topic, there is a duty to tell the whole truth…’”
In any event, the upshot is: Price maintenance as an argument solidly prevails; we’ll see if defendants have better luck with their opposition in other circuits.
Monday, September 26, 2016
In recent weeks, co-bloggers Ann Lipton and Anne Tucker both have posted on issues relating to the upcoming Supreme Court oral argument in Salman v. U.S. Indeed, this is an important case for the reason they each cite: resolution of the debate about whether the receipt of a personal benefit should be a condition to tippee liability for insider trading (under Section 10(b) of/Rule 10b-5 under the Securities Exchange Act of 1934, as amended), when the tipper and tippee are close family members. Certainly, many of us who teach and litigate insider trading cases will be watching the oral argument and waiting for the Court's opinion to see whether, and if so, how, the law evolves.
Having noted that common interest (as among many) in the Salman case, as I earlier indicated, I have a broader interest in the Salman case because of a current project I am working on relating to family relationships and friendships in insider trading--both as a matter of tipper-tippee liability (as in Salman) and as a matter of the duty of trust and confidence necessary to misappropriation liability. The project was borne in part of a feeling that I had, based on reported investigations and cases I continued to encounter, that expert network and friends-and-family insider trading cases were two very common insider trading scenarios that implicate uncertain insider trading doctrine under U.S. law.
While I have been distracted by other things, my research assistant has begun to gather and reflect on the data we are assembling about publicly reported friends and family insider trading acting between 2000 and today. Here are some preliminary outtakes that may be of interest based on the first 40 cases we have identified.
- 16 of the cases involve friendships;
- 7 cases involve marital relationships;
- 7 cases involve romantic relationships outside marriage (e.g., lover, mistress, boyfriend);
- 5 cases involving siblings;
- 3 cases involve a parent/child relationship; and
- 3 cases on involve in-laws.
Those categories capture the vast majority of cases we have identified so far. The cases represented in the list are primarily from 2011-2016. Some cases involve more than one type of relationship. So, the number of observations in the list above exceeds 40.
Another key observation is that most initial tippers in these cases are men. Notable exceptions are SEC v. Hawk and SEC v. Chen, described in this 2014 internet case summary. Six cases found and analyzed to date involve female tippees.
Theories in the cases derive from both classical and misappropriation scenarios. I will say more on that in a subsequent post. For now, however, perhaps the most important take-away is that my intuition that there are many cases involving exchanges of material nonpublic information in family relationships and friendships appears to be solid. Hopefully, the Court will help resolve unanswered questions about insider trading doctrine as applied in these cases, starting with the personal benefit question raised in Salman.