Saturday, April 18, 2015
It was recently announced that the SEC has reached a settlement in its lawsuit against Freddie Mac executives Richard Syron, Patricia Cook, and Donald Bisenius. The basic allegation in the case was that these executives violated Section 17 of the Securities Act and Section 10(b) of the Exchange Act by dramatically understating Freddie Mac’s exposure to subprime mortgages. The executives falsely claimed that Freddie Mac’s portfolio included $2 to $6 billion of subprime loans, when the true figure was closer to $141 billion to $244 billion. Freddie Mac’s exposure to subprime loans ultimately caused it to experience dramatic losses, thus harming investors.
The SEC ran into difficulty because there is no accepted definition of “subprime.” The SEC alleged that investors understood the term to refer to certain loans issued with a high likelihood of default, such as loans with high loan to value and debt to income ratios. The executives, however, claimed that “subprime” was understood by investors only to refer to loans that were designated as subprime by their originators.
The case has now settled, and, under the terms of the settlement, the executives will make payments to a Fair Funds account for the benefit of investors, in the amounts of $250K, $50K, and $10K, respectively.
Unusually, this is not your classic “no admit, no deny” settlement. Instead, it appears to be straight up “no admit,” because after the settlement was reached, Bisenius said that "The dismissal of the case today under these terms vindicates me completely."
Perhaps even more unusually, the payments are characterized as neither fines nor disgorgements. Instead, they are described as “donations.” Meanwhile, the amounts – coincidentally! – were calculated in proportion to the stock and options granted to the defendants during the (alleged) fraud period.
So what gives?
As far as I can tell, the euphemism is because of who’s paying. The settlement amounts will be paid by insurance (which itself is paid for by Freddie Mac). D&O insurance tends to exclude coverage for disgorgement and regulatory fines, see Lawrence J. Trautmana & Kara Altenbaumer-Price, D&O Insurance: A Primer, 1 Am. U. Bus. L. Rev. 337 (2011-12); Jon N. Eisenberg, How Much Protection Do Indemnification and D&O Insurance Provide?, and the SEC has taken the position that contracts to indemnify for Securities Act violations are unenforceable as against public policy. See 17 C.F.R. §229.512.
But I guess the SEC doesn't feel too strongly about it, because by characterizing the payments as donations rather than fines or disgorgement, the defendants are able to get the benefit of insurance and avoid paying out of pocket.
Though the SEC's fair funds statute does contemplate that donations may be included in a fund, see 15 U.S.C. § 7246(b), the settlement is an outlier, by SEC standards. According to Urska Velikonja’s article, Public Compensation for Private Harm: Evidence from the SEC's Fair Fund Distributions, 67 Stan. L. Rev. 331 (2015), executives who pay fines and disgorgement to an SEC fair fund typically pay out of pocket – an important feature, if the SEC is to avoid the criticism that fair fund distributions suffer from the same “circularity” problem that plagues private lawsuits.
Given all of this, one wonders why the SEC even bothered. If they thought they had a case, they could have just taken it to trial, risks be damned. And if they had doubts about the merits of the case, they should have simply dropped the matter.
One possibility is that the SEC believed its legal case was too weak for trial but that the reimbursement to investors was worth it – after all, circularity criticisms notwithstanding, not all investors are diversified, and some may have suffered losses that they did not make up in gains elsewhere. But that's not the motivation here, because the SEC will not establish a new fund to compensate investors for the alleged fraud. Instead, the defendants' donations will be added to an existing fair fund that was set up for the SEC's earlier case against Freddie Mac, brought in 2007, regarding accounting fraud that took place from 1998 through 2002. Which apparently means that the SEC will not even pretend to distribute the funds to the investors who were harmed by the more recent misconduct.
(I suspect this is because the SEC believes it lacks authority to establish a fund consisting solely of donations, with no penalties or disgorgements.)
In any event, $310K is a rather paltry sum if investor compensation was the goal; according to the parallel private lawsuit (dismissed on the pleadings, see Ohio Pub. Emples. Ret. Sys. v. Fed. Home Loan Mortg. Corp., 2014 U.S. Dist. LEXIS 155375 (N.D. Ohio Oct. 31, 2014)), Freddie Mac’s misrepresentation of its subprime exposure resulted in over $6 billion in losses to shareholders.
So the point is, if paid by insurance, the amounts aren’t large enough to deter, and as it stands, they are facially not even intended to compensate. Instead, the settlement seems an exercise in face-saving – the SEC believed it had a weak legal case (though possibly a strong moral one) but didn’t want to exit the field with nothing at all. The whole adventure thus raises the question whether face-saving payments are appropriate for regulators to collect (as well as the question whether much face-saving was actually accomplished).
Saturday, April 11, 2015
In Dura Pharmaceuticals, Inc. v. Broudo, 544 US 336 (2005), the Supreme Court held that to bring a fraud-on-the-market action under Section 10(b), shareholders would have to plead and prove the element of “loss causation,” namely, that disclosure of the fraud caused the company's stock price to drop, resulting in plaintiffs’ losses.
Since Dura was decided, there has been concern that companies might try to avoid liability by strategically disclosing information in a manner that would make it more difficult for plaintiffs to establish stock price effects.
In their new paper, Disclosure Strategies and Shareholder Litigation Risk, Michael Furchtgott and Frank Partnoy take significant steps toward establishing that these fears are well-grounded.
[More under the cut]
Saturday, April 4, 2015
When forum selection bylaws first became a thing, the response from the plaintiffs’ bar was a bit muted. This is because at least some plaintiffs’ firms viewed forum selection bylaws as beneficial, in that they had the potential to cut down on competition among plaintiffs’ firms for control over a given case. No longer would a firm filing a case in Delaware have to fear that a competing firm, filing a case in another jurisdiction, would settle on sweetheart terms – or worse, end up getting dismissed, with collateral estoppel effects – before the Delaware firm had a chance litigate.
Which brings us to the Walmart litigation and a dispute between two plaintiffs’ firms.
[More under the jump]
Saturday, March 28, 2015
On Tuesday, the Supreme Court finally issued its decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund (.pdf), concerning the definition of “opinion falsity” in the context of a lawsuit under Section 11 of the Securities Act.
Joan described the case in more detail here, but the basic issue was, what does it mean for a statement of opinion to be false? Or, to ground it more in the facts of Omnicare, if the company files a registration statement - as Omnicare did - that claims that the company "believes" its contracts are in compliance with the law, is that statement false when the DoJ sues for Medicaid fraud?
The defendants argued that opinion statements - such as a "belief" in legal compliance - can only be false if they falsely represent the speaker’s belief, i.e., if the speaker did not really believe that Omnicare was in compliance. If the speaker did believe in such compliance, then even if that belief was unfounded or turned out to be false, the statement itself would be literally true.
The plaintiffs agreed that statements of opinion may be false if the speaker misrepresents his or her own opinion, but also argued that opinions may be false for other reasons. For example, according to the plaintiffs, an opinion statement is false if the statement has no reasonable basis, regardless of the subjective beliefs of the speaker. So in Omnicare's case, its statement about legal compliance would be false if it did not bother to investigate whether its contracts were in compliance with the law, or if it ignored information that suggested the contracts were not in compliance.
In general, the case was pitched as a dispute about the continuing viability of Section 11 as a strict liability statute. Section 11, 15 U.S.C. §77k, provides that issuers are strictly liable for false statements in registration statements, and signatories of the registration statement are liable unless they demonstrate that they conducted a reasonable investigation of those statements. So, if Omnicare prevailed in its argument that belief statements are only false if the speaker misstates his own belief, it would, as a practical matter, require the plaintiffs to demonstrate that the speaker intentionally misled investors, thus importing a scienter requirement into Section 11. The effect would be particularly pronounced because there is a great deal of slipperiness regarding what counts as an opinion statement in the first place.
Ultimately, the Supreme Court adopted a standard that fit within the framework advocated by the plaintiffs, although the Court used a narrower formulation. The Court agreed with the defendants that statements of opinion can only be false if disbelieved by the speaker – if the speaker misstates his or her own belief – but then went on to hold that such statements may be misleading if they omit material information. Such as, if they omit the fact that the speaker had no basis for the belief he or she purported to hold and failed to conduct any investigation into the matter. It depends on context and delicate inferences yadda yadda yadda, but a registration statement is a formal document and investors are likely to assume that statements of belief contained therein are the product of a reasonable investigation, etc.
But none of this is what the case was really about.
[More under the cut]
Saturday, March 21, 2015
The UAW Retiree Medical Benefits Trust recently won a battle with Gilead and Vertex to have those companies include on their proxy statements proposals to require them to explain to shareholders the risks of their drug pricing decisions.
Basically, both Gilead and Vertex have come under fire recently for charging extremely high prices for new drugs. There's an argument, of course, that this is simply a bad business decision - if your customers can't afford your drugs, they won't buy them. And that's the official basis for the Trust's proposal. The Trust describes, for example, how Sanofi was once forced to dramatically cut drug prices because the initial prices were set unrealistically high.
But I find it very hard to believe that the UAW Retiree Medical Benefits Trust is genuinely concerned about drug pricing in its capacity as a shareholder seeking maximum returns. Instead, it seems far more likely that the Trust's concern is, you know, drug prices. That it has to pay. For its beneficiaries. And it's using its status as shareholder of several pharmaceutical companies to try to influence policy in that regard. The fact that the SEC is allowing the proposal to be included on the companies' proxies suggests that the SEC is not terribly concerned about that possibility (unlike Delaware, which does not want shareholders to pursue their own idiosyncratic agendas).
It reminds me of the AFL-CIO's earlier objection to Wall Street banks' practice of paying deferred compensation to executives to leave to go to government. From a wealth max perspective, you'd think this would be an awesome thing for shareholders - which means the AFL-CIO's objections were not really rooted in concern about the banks' financial performance, but in its broader political concerns about the practice. But the SEC didn't have a problem with that - it refused to allow Goldman to exclude the proposal.
So, I repeatedly threatened that I’d eventually post a summary of my paper on arbitration clauses in corporate governance documents – and well, now you’re all finally being subjected to it.
This post was originally published at CLS Blue Sky blog, but I've made some minor edits and added a new introduction.
For many years, commenters have argued that at least some shareholder disputes can and should be arbitrated, rather than litigated, and that this could be accomplished by amending the corporate “contract” – namely, its charter and/or its bylaws – to require arbitration. The possibility was raised in articles by John Coffee and Richard Shell in the late 1980s, and the idea has resurfaced many times since then, including this year by Adam Pritchard. For almost as long as the idea has been kicked around, there have been warnings that if arbitration clauses are “contractually” binding by virtue of their presence in corporate governance documents, then they may be subject to the Federal Arbitration Act (FAA), which would preempt state attempts to regulate/oversee their use. Coffee discussed that possibility in his 1988 piece on the subject; more recently, Barbara Black and Brian Fitzpatrick have sounded further alarms.
For foes of shareholder litigation, this is a feature, not a bug; though they rarely say so explicitly, whenever anyone relies upon FAA cases to justify the insertion of arbitration clauses in corporate charters and bylaws, they are implicitly advocating the idea that not only are charters and bylaws “contracts” for FAA purposes, but that federal law requires their enforcement, regardless of the preferences of the chartering state. After the Supreme Court decided AT&T Mobility LLC v. Concepcion, the notion was particularly powerful, because it meant that corporations would be free to use arbitration clauses to require that shareholder claims be brought on an individual, rather than class, basis. Given the economics of shareholder litigation, this would almost certainly mean the death of most shareholder lawsuits.
And that’s where my paper comes in.
[More under the cut]
Saturday, March 14, 2015
The Delaware Legislature is set to consider new legislation concerning litigation-limiting bylaws and charter provisions.
As discussed here, the new legislation would, among other things:
(1) Explicitly authorize corporations to include in their charter or bylaws forum selection clauses that designate Delaware courts as the exclusive forum for shareholder litigation;
(2) Explicitly forbid corporations from including in their charters or bylaws forum selection or arbitration clauses that prohibit bringing claims in Delaware courts; and
(3) Prohibit fee-shifting bylaws and charter provisions.
[More under the cut]
Saturday, March 7, 2015
There’s been a lot of controversy recently over the SEC’s use – or perhaps I should say, non-use – of the automatic “bad actor” disqualifications for firms that commit securities violations. The disqualification provisions place certain limits on the activities of firms that are found to have committed securities violations. Dodd Frank added a big stick to the list of penalties: It added an automatic disqualification from participating in private placements under Rule 506 of Regulation D. It’s a severe penalty; private placements are extremely lucrative.
But the SEC can waive the automatic disqualification – and frequently does, even for “recidivist” firms that repeatedly rack up securities violations. It imposes fines, perhaps outside monitoring, but it waives disqualifications – especially the Rule 506 disqualification.
The issue has recently hit the public eye because Democratic Commissioners Luis Aguilar and Kara Stein have been objecting to the grant of waivers to recidivist firms. In their view, waivers are an important tool for deterring securities violations, and the SEC has improperly adopted a policy of granting them “reflexively.”
In light of all of this, the SEC has promised to issue guidelines as to how Rule 506 waiver decisions are made; Commissioner Daniel Gallagher thinks the matter may ultimately have to be resolved by Congress.
Until recently, hasn’t been clear just how often these waivers have been granted, and who has received them. But Urska Velikonja just posted a new paper that gathered data on 201 waivers issued between 2003 and 2014. These waivers involved Regulation D disqualification, Regulation A disqualification, and also disqualification from the use of automatic shelf registration statements to raise capital. Velikonja finds that: (1) large financial firms received over 80% of the waivers; smaller firms and nonfinancial firms rarely receive them even though they are much more likely to be the target of an enforcement action; (2) the SEC typically does not offer any real justifications for its decision to grant or withhold a waiver, but the pattern appears to be that the Commission does not grant waivers for firms accused of offering fraud or issuer disclosure violations; usually, they’re granted for firms accused of unrelated misconduct, such as violations of the broker-dealer and investment adviser rules – presumably because the Commission views the latter firms as presenting a lower recidivism risk; and (3) the number of waivers has declined over time, and the SEC has recently begun utilizing partial waivers.
(More under the jump)
Tuesday, March 3, 2015
I finally got it together and opened an account on SSRN (I know, I know), and posted two of my forthcoming pieces there.
The first, Searching for Market Efficiency, is a very short comment that will be published in the Arizona Law Review, discussing Donald Langevoort's Judgment Day for Fraud-on-the-Market and Geoffrey Miller's The Problem of Reliance in Securities Fraud Class Actions, both of which will be published in the same issue. The comment discusses the Supreme Court's recent decision in Halliburton, and the reasons behind courts' difficulties in defining market efficiency for the purpose of Section 10(b) class actions.
The second, Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, is a longer article forthcoming in the Georgetown Law Journal, and it deals with the claim that, because corporate governance documents are "contractual," clauses that require arbitration of shareholder disputes must be enforced according to their terms, as required by the Federal Arbitration Act. I've discussed this topic before; the Article spins things out in more depth. I will eventually put up a longer post here summarizing the piece, but if there's anyone who just can't wait for the cliffs notes version, well, you can now download it from SSRN.
Saturday, February 28, 2015
This seems to have been a great week for business stories with a touch of the absurd.
First up, we have Footnoted.org's fantastic catch in Goldman's 10-K. Apparently, Goldman now has a new risk factor:
[O]ur businesses ultimately rely on human beings as our greatest resource, and from time-to-time, they make mistakes that are not always caught immediately by our technological processes or by our other procedures which are intended to prevent and detect such errors. These can include calculation errors, mistakes in addressing emails, errors in software development or implementation, or simple errors in judgment. We strive to eliminate such human errors through training, supervision, technology and by redundant processes and controls. Human errors, even if promptly discovered and remediated, can result in material losses and liabilities for the firm.
We can only speculate as to what specific, as-yet-undisclosed, human error prompted this disclosure, but if I had to make a bet, my money would be on an email address auto-fill mistake that is now the subject of some behind-the-scenes settlement discussions, the details of which will only come to light if negotiations fail and a public lawsuit is filed.
Next up, we have a Hunger-Games inspired video created by Morgan Stanley for its branch managers' meeting. The 10-minute long video depicts branch managers forced to compete to the death to maintain their positions. Apparently, Morgan Stanley shelved the video (which cost $100K to produce) out of concern that it displayed a certain callousness towards the actual real life people who were losing their jobs. So, now, of course, to demonstrate its sensitivity, Morgan Stanley has launched an internal investigation to discover the identity of the person who leaked the video.
Also, the Supreme Court decided Yates v. United States, concerning whether the disposal of undersized fish counted as the destruction of a tangible object intended to impede a federal investigation, in violation of the Sarbanes-Oxley Act. The Court held that it did not. Others have explored the implications of Yates for Obamacare and the case against Dzhokhar Tsarnaev's friends, but I'm far more interested in the headlines the case inspired, including In Overturning Conviction, Supreme Court Says Fish Are Not Always Tangible, Supreme Court: One Fish Two Fish Red Fish Blue Fish (a reference to Justice Kagan's dissent, which cited Dr. Seuss), Fisherman let off the hook in U.S. white-collar crime ruling, High Court SOX Fish Ruling Cuts Hole In Prosecutors’ Net, Supreme Court Throws Prosecutors Overboard in Fisherman Case, Supreme Court tosses ‘fishy’ conviction of Florida fisherman into the drink, and my personal favorite, Cortez case: Small fish, wide net.
Last but not least, the dress may be blue - but it's been nothing but green for the British retailer that sells it. (BuzzFeed didn't do so badly, either; it had to increase its server capacity by 40% to handle dress-related traffic.)
Saturday, February 21, 2015
One of the enduring debates in corporate law concerns whether shareholder empowerment promotes short-termism - i.e., temporary boosts in stock prices that can only be achieved at the expense of longer-term value-building projects, like research and development. Related to this debate is the argument - championed by, among others, Margaret Blair and Lynn Stout - that directors cannot/should not be solely concerned with shareholder wealth maximization; instead, their role is to mediate among various firm stakeholders. This is because a firm cannot thrive unless it offers a credible commitment to its employees and other corporate constituents that they will not be ousted the moment it appears profitable to do so. In other words, in order to induce employees and other stakeholders to invest valuable human capital in the firm, these actors must believe that the firm is committed to them - that shareholders are barred from, for example, insisting on downsizings or outsourcings or what-have-you the moment it appears that doing so will create a share price bump.
Martijn Cremers and Simone Sepe weigh in on this debate in a new paper, Whither Delaware? Limited Commitment and the Financial Value of Corporate Law(summarized here), where they conclude that protections for incumbent management - in the form of strong antitakeover statutes - are associated with higher firm values, in firms where long-term commitment is particularly necessary for profitability. In particular, they classify Delaware as a state where antitakeover protections are not strong, and find that incorporation in Delaware reduces firm value for companies that rely on long-term relationships, as compared to states where antitakeover protections are stronger. The basic idea here is that when management is insulated from shareholder pressures and the market for corporate control, management can more credibly commit to longer term projects and relationships that may not be immediately profitable.
The findings are, of course, extremely interesting and merit further analysis, but I have some difficulty with the premise that underlies their study, namely, that Delaware's antitakeover protections are weaker than those in the comparator states. Most obviously, one of the ways that the study classifies a state as "managerial" is if it has a business combination statute that prohibits transactions between an acquirer and target for 5 years. While it's true that Delaware's antitakeover statute is not quite as draconian - Delaware prohibits combinations for only 3 years as opposed to 5, and can be avoided if the acquirer increases its holdings from under 15% of the target to 85% in a single tender offer - the reality is, as has been documented elsewhere, Delaware's antitakeover law is more than sufficient to block hostile acquisitions.
Given that, antitakeover statutes that are even more extreme than Delaware's because they include a 5 year limitation instead of a 3 year one are gilding the lily; it's not clear why firms incorporated in those states should offer any more of a credible commitment to long-term stakeholders than firms incorporated in Delaware. And by my count, the study classifies 10 states as "managerial" based solely on this criterion, including New York and New Jersey.*
Additionally, the study is based on an analysis of firm value before and after reincorporation - in and out of Delaware, or in and out of the comparator states. But most reincorporations are associated with particular transactions that can be expected to affect firm value (a point which has been used to criticize post-reincorporation-value studies in the past, as Cremers and Sepe acknowledge in their paper). So I have to wonder whether there are some other factors that are driving the reincorporations and the selection of jurisdiction, and those other factors are having the observed effect.
*32 states have business combination statutes along these lines, making it even more unlikely that the 10 states identified as "managerial" according to this criterion (i.e., based on the 5 year rather than 3 year limit) actually offer any special signaling value regarding management's long-term commitments.
Saturday, February 14, 2015
The news this week in shareholder rights is that GE joined the list of companies that have voluntarily enacted their own bylaws permitting large shareholders to nominate directors to be included on the company proxy.
GE's action comes in the midst of a publicly-announced campaign by the New York City Comptroller to gather support for shareholder-enacted bylaws that would do roughly the same thing. (And a very ugly battle over such bylaws at Whole Foods, as Marcia previously posted.)
In that context, GE’s move seems like something of a Trojan horse. By enacting its own bylaw, GE preempts any attempts by shareholders to do so. Meanwhile, because the bylaw is director-enacted, GE can yank it at any time – like, if it feels there’s a coherent movement that threatens the current board’s dominance. In fact, this strategy was recently on display when Rupert Murdoch announced an unsolicited takeover of Time Warner. The first thing Time Warner’s board did was to repeal a director-enacted bylaw that permitted shareholders to call special meetings.
As a result, I’m not quite yet ready to call this a great win for shareholder democracy.
Saturday, February 7, 2015
In their new paper, Rating Agencies and Information Efficiency: Do Multiple Credit Ratings Pay Off?, Stefan Morkoetter, Roman Stebler, and Simone Westerfeld study whether it benefits investors to have more than one rating agency rate a particular security.
They find that when multiple rating agencies rate a particular tranche of a mortgage-backed security, not only is the initial rating more accurate, but the agencies devote more efforts to ongoing surveillance, increasing the accuracy of the rating over the life of the tranche. They conclude that the increased efforts are traceable to a healthy competition among agencies; as the authors put it, “Since their activities are directly bench-marked to their peers’, rating agencies are induced to show more effort with regard to their monitoring obligations than observed for single-rated tranches.”
One of the reasons the paper is interesting is because Dodd Frank and the SEC implementing regulations impose new restrictions on conflicts of interest within credit ratings agencies, basically forbidding anyone from the business side from having any involvement with the ratings themselves. In light of Morkoetter et al’s conclusions, I do have to wonder whether at least some business-side involvement with the ratings process creates a healthy sort of competition.
Morkoetter, Stebler, and Westerfeld also find that of the three major ratings agencies, Moody’s was consistently the most conservative both at issuance and over a tranche’s lifetime (which, they conclude, may be why Moody's has a very small market share of single-rated tranches). That would certainly explain why S&P was first sued by DoJ (although Moody’s may be next), but it seems inconsistent with the allegation – offered by DoJ both in its complaint and in the stipulated facts in the S&P settlement – that S&P routinely relaxed its ratings criteria to be more like Moody’s.
Saturday, January 31, 2015
Jonas Heese has posted an interesting paper to SSRN, Government Preferences and SEC Enforcement, where he argues that the SEC goes easy on firms that contribute significantly to employment in a particular area. He finds that the effect is magnified in presidential election years in swing states, and for firms that are headquartered in districts senior congresspersons who have SEC oversight responsibilities. This effect cannot be explained by the hypothesis that labor-intensive firms simply have better accounting; according to Hesse, they actually have worse accounting than other comparable businesses (which may in fact reflect their knowledge that the SEC is less likely to target them). He concludes, essentially, that the SEC is responding to political/voter pressures to take a hands-off approach to firms that are responsible for providing jobs.
One of the interesting points he makes is that this kind of pressure is independent of “special interest” lobbying; rather, this kind of pressure is a result of government actors responding to voter preferences.
The paper is available for download here.
Saturday, January 24, 2015
The Second Circuit just split from the Ninth in Stratte-Mcclure v. Stanley, 2015 U.S. App. LEXIS 428 (2d Cir. N.Y. Jan. 12, 2015) regarding whether a company violates Section 10(b) - and is subject to private lawsuits - for failure to disclose required information. The holding would be well-positioned for a Supreme Court grant except that it was not outcome determinative, functionally insulating the decision from Supreme Court review. But this is definitely a split to watch in the future.
[More under the jump]
Saturday, January 17, 2015
In their new article, Litigation Discovery and Corporate Governance: The Missing Story About the ‘Genius of American Corporate Law,’ Érica Gorga and Michael Halberstam argue that the U.S.’s unique, liberal discovery standards in private civil litigation have had an important role in shaping the content of corporate law.
They make a number of interesting claims in the paper, including that civil discovery provides detailed data for courts and regulators to use when creating legal standards, and that the omnipresent threat of civil discovery forces corporate managers to run their companies with more care: they must engage in extensive internal monitoring and recordkeeping in order to protect themselves should a dispute arise. Additionally, the internal process of having attorneys and other experts review documents in anticipation of litigation – even if the documents are never turned over to the plaintiffs – generates information that assists managers, in their monitoring roles, and assists gatekeepers – attorneys, experts, etc – in understanding both the specific firm targeted and the industry in general. Gorga and Halberstam also argue that the standards for adequacy of corporate internal investigations – which themselves play a growing role in corporate governance – are informed by the standards set by civil discovery in litigation. Finally, the authors argue US Style corporate governance and securities laws cannot be easily exported to legal systems that do not have civil discovery, because civil discovery is a necessary part of the US’s ex post enforcement mechanism.
I found the paper very interesting, and I agree that discovery is critical to a regime that depends on private ex post litigation to enforce legal rules. That said, I think the authors do not give sufficient weight to the argument that corporate managers – aware of civil discovery – are incentivized to keep records to the bare minimum necessary to establish that they met their obligations. Board meeting minutes, for example, are often extremely sparse, describing the basic agenda and topics covered, but giving no sense of the color and tenor of the discussion. High level corporate officers have been known to refuse to use email at all for fear of generating incriminating electronic trails. There are limits to managers’ ability to protect themselves this way – modern business often requires electronic communication, and god knows every litigator has, at one point or another, dug up the incriminating email trail that finishes with someone saying “DELETE THIS.” But the point remains that the possibility of discovery can be just as much of an incentive for managers to create misleadingly exculpatory paper trails as to engage in careful monitoring.
Saturday, January 3, 2015
Okay, fine, that’s not what the Second Circuit formally held, but to be honest, I can’t read this decision any other way.
I’ve blogged about this issue before here, here, and here. Basically, the situation is this: In the class action context, there is frequently an issue as to whether the named plaintiff’s own individual claims against the defendant are sufficiently similar to the claims of the rest of the class so as to allow the named plaintiff to sue in a representative capacity. Historically, these issues have been resolved via Rule 23 of the Federal Rules of Civil Procedure, which, among other things, requires a court to decide whether there is “commonality” among the class members, whether the common issues predominate over the individual ones, whether the named plaintiffs’ claims are typical of those of absent class members, and whether the named plaintiff will serve as an adequate representative for the absent class members. Rule 23, of course, is only invoked after there has been substantial discovery, and certification determinations under Rule 23 frequently include expert analysis.
In the wake of the mortgage crisis, more and more courts began making these determinations on the pleadings, framing the question not in terms of class certification, but in terms of whether the named plaintiff has "standing" to bring claims on behalf of absent parties, as I discussed in more detail here. The issue has basically been that if an investment bank underwrites multiple RMBS offerings, and I buy an RMBS issued by a particular trust backed by a particular pool of mortgages, how can a court be certain that my claims are similar enough to purchasers of different RMBS issued by a different trust, backed by different mortgages, such that I should be permitted to represent those purchasers in a securities class action against the underwriter?
Courts have been unwilling to go the traditional route and wait until a class certification hearing to make this decision; instead, they have been seeking to limit a named plaintiff’s ability to represent absent RMBS purchasers. They have been fundamentally troubled by the idea that a purchaser of one RMBS could represent all purchasers not only of that RMBS, but of multiple other RMBS, with face values totaling in the billions of dollars. Courts have come up with a variety of bright-line rules limiting how the class can be defined, at the pleading stage - for example, some courts have held that plaintiffs may only represent purchasers of RMBS from the same trust; others have held that plaintiffs may only represent purchasers of RMBS from the same tranche within a trust.
That orientation has spread to other kinds of claims - similar disputes have arisen in the context of false advertising, for example, where a single misrepresentation is alleged to have been plastered across multiple similar products. (Say, a false representation that ice cream flavors are "natural," appearing on chocolate, vanilla, and strawberry - is it necessary that the plaintiff have purchased neapolitan in order to represent absent purchasers of all three flavors?).
[More under the jump]
Saturday, December 27, 2014
That markets are less than perfectly efficient is hardly a controversial proposition; indeed, several examples of notable market efficiencies were presented to the Supreme Court this past Term when it considered the continuing vitality to the fraud-on-the-market challenge in Halliburton. Many of those examples, however, are several years old - which is why it was so amusing for me to see two new instances of dramatic inefficiencies just in the last month.
First, the New York Times published a piece, How Our Taxi Article Happened to Undercut the Efficient Market Hypothesis, explaining how publication of an article on falling medallion prices sent the stock price of Medallion Financial - a company that issues loans secured by taxi medallions - tumbling. This was surprising because information about taxi medallion prices is public, so the stock should not have been reacted to the news. Josh Barro, author of both pieces, speculates that the price drop may have occurred because some of the information in his article may have been difficult for investors to obtain, particularly since false information regarding medallion prices had been (inadvertently) circulated by the New York Taxi and Limousine Commission.
(Which, by the way, suggests that courts are correct to be wary of the "truth on the market" hypothesis - the argument often advanced by securities fraud defendants that even if their statements were false, it was canceled out by publicly available truthful information. In the case of Medallion Financial, the false information apparently dominated over truthful information, at least so long as the truthful information was piecemeal and required effort to gather.)
The second example of market inefficiencies occurred when President Obama announced that the U.S. would be resuming diplomatic ties with Cuba. The news sent the price of the Herzfeld Caribbean Basin Fund soaring, because that fund invests in companies that stand to benefit from improved diplomatic relations. It also, apparently, boosted the price of any company that even appeared to be associated with Cuba, including shares of Cuba Beverage, which makes energy drinks and has nothing whatsoever to do with Cuba, the country. The Wall Street Journal article on the subject offers other examples of similar sorts of investor confusion.
Also, here is a blue Christmas tree that has been decorated to look like the Cookie Monster:
Saturday, December 20, 2014
Joshua Fershee has previously noted that men and women experience careers in business differently. If women want to get to the top, they often have a longer haul than men.
Previous research has also shown that women are evaluated negatively for seeking raises (an attitude that Microsoft's CEO inadvertently seemed to endorse) and that (at least in the tech industry) performance reviews of women tend to be more critical than those of men, and include more personality-based criticism.
Now a new study in the Harvard Business Review shows that men and women have very different expectations regarding how they balance their careers and their personal lives when they graduate from Harvard Business School – and men’s expectations are more accurate than women’s.
According to the study, in general, men who graduate from HBS expect their careers will take precedence over their spouses’ careers – and they turn out to be right. Women expect that their careers will have equal importance – and their hopes are dashed. (It should be noted that men’s responses differ along racial lines; men of color tend to expect a more equal division of career precedence).
The authors conclude:
Whatever the explanation, this disconnect exacts a psychic cost—for both women and men. Women who started out with egalitarian expectations but ended up in more-traditional arrangements felt less satisfied with how their careers have progressed than did women who both expected and experienced egalitarian partnerships at home. And in general, women tended to be less satisfied than men with their career growth—except for those whose careers and child care responsibilities were seen as equal to their partners’. Conversely, men who expected traditional arrangements but found themselves in egalitarian relationships were less satisfied with their career growth than were their peers in more-traditional arrangements, perhaps reflecting an enduring cultural ideal wherein men’s work is privileged. Indeed, traditional partnerships were linked to higher career satisfaction for men, whereas women who ended up in such arrangements were less satisfied, regardless of their original expectations.
Which is why I watched this video made by Columbia Business School students with both amusement and sadness:
(Warning: The video contains explicit language and sexual innuendo. Perhaps that's more of an advertisement than a warning? Anyway, yeah, the lyrics are pretty explicit so, you know, go in with that expectation.)
Anyway, the basic theme of the video is that the women proclaim that they will not tolerate sexism and double standards, they will not tolerate being told that they should be nicer or less abrasive, and they will still succeed in business regardless of the obstacles placed in their path. I appreciate and applaud the attitude and determination, but the reality is – as the HBS study concludes – it’s not simply about women’s determination and goals. So long as women work within institutional structures that place higher values on male contributions - when even professors are more likely to offer guidance and mentoring to white males over women and people of color - women can be assertive and produce high quality work, but their individual determination not to back down in the face of criticism won't solve the problem.
Saturday, December 13, 2014
Professor Lucian Bebchuk runs the Harvard Shareholder Rights Project, which helps investors filed proposals to be included in corporate proxies under Rule 14a-8. The Project has filed several precatory proposals to express shareholders' views that corporations should destagger their boards, arguing that research demonstrates that declassified boards improve corporate returns.
In a new paper posted to SSRN, SEC Commissioner Daniel Gallagher and Professor Joseph Grundfest accuse the Project of making misleading statements regarding the benefits of declassified boards. They suggest that Harvard could be vulnerable to lawsuits by shareholders or the SEC under Rule 14a-9, which forbids false statements in proxy solicitations. The paper, with the provocative title “Did Harvard Violate Federal Securities Law?” is discussed in the Wall Street Journal here.
The basic argument made by Gallagher and Grundfest is that the proposals misleadingly cite only research in favor of declassified boards, and fail to cite contradictory research.
Now, I have to say, I’m trying to evaluate how this claim would proceed if brought by a private shareholder, and I don’t like its chances. First, as Gallagher and Grundfest admit, the proposals are precatory – so even if they succeed, they only have an effect if the corporate directors bow to investor pressure and choose to destagger the board. Gallagher and Grundfest argue that this is sufficient “causation” to constitute a Rule 14a-9 violation by analogizing to a case where management lied in response to a precatory shareholder proposal, and the court ordered a re-vote. But that case seems obviously distinguishable, because in that instance, the damage wrought by the misstatement was, in effect, damage to the right to offer proposals in the first place. And the shareholder had few options other than a truthful revote as a means of vindicating that right.
Here, of course, because the ostensibly misleading proposal is submitted by shareholders, and misstatements are not being used by management as a way to thwart shareholders, it's difficult to see what concrete harm the alleged misstatements are actually causing. Moreover, there are a variety of remedies for false statements beyond a private lawsuit: management can exclude proposals that are misleading, counter with its own information when opposing the proposal, or simply ignore the vote.
Apparently aware of the weaknesses in their causation theory, Gallagher and Grundfest also argue that these precatory proposals have a substantive effect sufficient to satisfy the causation requirement because proxy advisors like ISS often recommend voting against corporate directors who fail to declassify a board after a shareholder vote in favor of declassification. Corporate directors may therefore feel pressure from ISS and vote in favor of declassification after a shareholder vote on the subject.
This chain of causation seems speculative, to say the least. First, not only are ISS’s actions independent of the initial proposal, ISS’s threats are only going to matter if there’s a contested director election, and there usually isn’t one. Even if votes are withheld from a director in a majority-vote corporation, the director will only actually lose his position if the Board accepts his resignation – which it may choose not to do if it concludes the voting was based on a misleading proxy proposal.
Second, the information that’s allegedly omitted here – countervailing research on a contested subject – is publicly available. Leaving aside how that affects the analysis of the legal element of materiality (an omitted fact is only material if it affects the “total mix” of information available to shareholders, including public-domain information), if ISS pressure is a key step in the chain of causation, well, ISS is a sophisticated entity, as are the investors it advises – all of whom are no doubt capable of identifying and evaluating the research for themselves.
Finally, no damages would be available in a private action (because there’s no chance of a shareholder demonstrating loss causation). The only remedy would be for a court to undo a vote in favor of the proposal and possibly order the re-staggering of a board – once again, difficult to imagine given the attenuated causation involved and the public nature of the omitted information.
That said, I’m fascinated by the fact that Commissioner Gallagher has chosen to fight this battle not in his capacity as Commissioner, but as the co-author of a paper posted to SSRN.* (The paper claims, one suspects disingenuously, Gallagher and Grundfest are not taking a position on the merits of declassification; they simply want to ensure that proxy proposals are truthful.) Despite the paper’s suggestion that the SEC could bring an action against Harvard, the authors openly admit that the SEC’s policy has not been to challenge statements made in these proposals, but simply to allow corporate managers to refute them in proxy materials. If anything, the goal of the article seems to be more about intimidating Bebchuk into altering the wording of his proposals (or intimidating Harvard into reining him in - the paper spends a bit of time on Harvard's responsibility for the Project), giving ammunition to corporate boards to resist such proposals, and firing a shot across the bow of proxy advisory firms that recommend in favor of such proposals. Commissioner Gallagher has long sought greater regulation of proxy advisors – winning new SEC guidance on the subject in June. In this article, Commissioner Gallagher seems to be dropping a hint that they should revise their recommendations or be subject to further investigation and regulation.
*Who does he think he is, a Delaware judge?