Monday, November 13, 2017
Saturday, November 11, 2017
SEC Commissioner Jay Clayton recently gave a speech where he remarked:
I have become increasingly concerned that the voices of long-term retail investors may be underrepresented or selectively represented in corporate governance. For instance, the SEC staff estimates that over 66% of the Russell 1000 companies are owned by Main Street investors, either directly or indirectly through mutual funds, pension or other employer-sponsored funds, or accounts with investment advisers… And, if foreign ownership is excluded, that percentage approaches approximately 79%.
… A question I have is: are voting decisions maximizing the funds’ value for those shareholders?
In situations where the voting power is held by or passed through to Main Street investors, it is noteworthy that non-participation rates in the proxy process are high. … This may be a signal that our proxy process is too cumbersome for retail investors and needs updating.
What’s interesting is that there are two different ideas here. One concerns the voting power of mutual funds and pension funds; the other concerns the votes of retail shareholders themselves.
As for retail votes, Jill Fisch has an article on this very subject forthcoming in the Minnesota Law Review. She recommends that retail shareholders be given access to electronic platforms, similar to those available to institutions, that allow them to set advance voting instructions without requiring them to make a company by company decision.
The broader question, though, is whether we do in fact want to encourage greater retail participation, and what the effects are likely to be. There’s long been an argument that retail investors should not invest directly, and the rules governing securities markets have, to a greater and greater extent, become less hospitable to them. (Stephen Choi, for example, has argued that investors should only be allowed to participate in capital markets if they demonstrate a certain degree of sophistication.) If that’s right, it makes little sense to encourage their participation in corporate governance.
At the same time, though, public companies love retail investors, because they are less likely to coordinate with pesky activists, and are assumed to be more supportive of management. I’ve often wondered if that was the motivating force behind Loyal3 (which recently folded shop), providing a free online brokerage for retail investors that wanted stock in their favorite brands.
Given what appears to be the general Republican preference, I rather suspect that they believe shareholder involvement in corporate governance is a net negative, and I wonder if Clayton’s newfound push for retail investor involvement is actually a stealth attempt to provide management with a bulwark against activist challenges.
Certainly, that appears to be the theme of Clayton’s actions: the rest of his speech expresses concern about shareholder proposals, and a recent SEC staff opinion suggests a shift to more deference to corporate boards when deciding excludability. In that context, his conflation of retail investor voting with mutual fund voting seems like something of a shot across the bow targeting mutual fund voting power. I can imagine, for example, a push to transition to pass-through voting for mutual funds, combined with a few measures that encourage retail investor participation.
But if that’s the kind of thing Clayton is hinting at – and to be sure, no one has suggested it so far, but it would make sense as an endgame – I do wonder how much it (and other efforts to involve retail shareholders) will backfire. I imagine retail investors, if seriously encouraged to participate, might be more – not less – likely to vote for social proposals and other less-than-wealth-maximizing actions that, these days, mutual funds tend to avoid unless pressed. And as Jill Fisch points out, retail investors might adopt advance voting instructions that set automatic triggers to challenge management when certain underperformance benchmarks are met. If the default assumption is that retail investors are less informed and less attentive, encouraging their greater participation may be something of a double-edged sword, from management’s perspective.
Moreover, if we have greater retail involvement in the voting process, Delaware might have to revisit decisions like Corwin v. KKR, 125 A.3d 304 (2015), which rest - at least implicitly - on the assumption of a sophisticated (institutional) shareholder base. And that’s something I'm pretty sure management would not want.
Saturday, November 4, 2017
A lot to like and a lot to dislike in the Republican tax bill: “The tax bill aggressively takes on deductions in the individual income tax code, and channels the proceeds towards across-the-board cuts in income tax. Unfortunately, that good work is undone by expensive giveaways to the owners of firms, and unnecessary windfalls to the heirs of the rich.”
Tax Bill May Deal a Body Blow to LBOs: “The legislation includes a provision that would cap interest deductibility at 30 percent of adjusted taxable income, a dramatic shift from the 100 percent allowed now.”
Sports Stadiums Would Lose Access to Tax-Exempt Bonds Under House Tax Plan: “Lawmakers of both parties have long sought to limit the use of municipal bonds to benefit sports teams.”
Apple Among Giants Due for Foreign Tax Bill Under House Plan: “Earnings held in cash would be taxed at 12 percent while profits invested in less liquid assets like factories and equipment face a 5 percent rate.”
Proposal Aims to Eliminate Tax Break Linked to Performance-Based Pay for Executives: “The proposed changes would eliminate the tax break linked to performance-based pay for senior executives, raising some $9.3 billion in additional tax revenue over the next decade...”
Republican Tax Plan May Leave Future of Stock Options in Flux: “Under the GOP’s bill, option owners would be required to pay income taxes immediately when the contracts can be used to buy shares, instead of when they are actually purchased.”
US tax reform will boost innovation and entrepreneurship: “We will defer the tax on private stock gains until employees can actually realise those gains by selling the stock, or at least give them a reasonable amount of time to pay the tax bill.”
The GOP tax plan has a tiny 'bubble tax' that could end up raising taxes on the rich: “Every dollar after $1 million of income for an individual or $1.2 million for a couple would incur a surcharge. It would add $6 in taxes for every $100 of taxable income earned above those thresholds — essentially, an extra 6% tax.”
Senate Democrats falsely claim GOP tax plan will raise taxes for most working-class families: “The original report referred to 8 million households receiving a $794 tax increase. Somehow, when it got communicated down the line, that nuance was lost and it was translated into a talking point referring to all working-class families.”
How a Tax Cut Turns Into a Tax Increase: “In rolling out their plan, House Republicans focused on an example family — a married couple making $59,000 per year and with two kids. They said that family would get a tax cut of over $1,182 in 2018 (compared to what they paid in 2017). But, what they didn’t say is that a family making $59,000 would face a tax increase by 2024 relative to current law, with the tax increase potentially rising to nearly $500 by 2027.”
Republicans Bank on Future Congresses to Keep Family Tax Credit: “Taxpayers shouldn’t worry, Republicans say, because future Congresses will prevent the tax credit from vanishing. ... Rep. Carlos Curbelo (R., Fla.), said he thought members of both parties would ultimately support extending the break. 'That family credit is de facto permanent and you can take that to the bank,' Mr. Curbelo said.”
The GOP Tax Plan and Divorce: “The summary estimates that eliminating the deductibility of alimony payments will increase revenues by $8.3 billion over ten years.”
Republican Tax Proposal Gets Failing Grade From Higher-Ed Group: “In broad terms, the bill would eliminate or consolidate a number of tax deductions meant to offset the costs of higher education for individuals and companies, including the Lifetime Learning Credit, which provides a tax deduction of up to $2,000 for tuition, a credit for student-loan interest, and a $5,250 corporate deduction for education-assistance plans. The bill proposes new taxes on some private-college endowments and on compensation for the highest-paid employees at nonprofit organizations, including colleges and nonprofit academic hospitals. The plan would also tax the tuition waivers that many graduate students receive when they work as teaching assistants or researchers. Perhaps most significant, the bill would result in many fewer people itemizing their deductions for charitable gifts.”
Teachers spend nearly $1,000 a year on supplies. Under the GOP tax bill, they will no longer get a tax deduction: “Unlike other professionals, teachers are regularly expected to furnish their own supplies. They are often filling in gaps where students are unable to afford supplies — and where districts are unable to furnish them.”
House tax plan allows unborn children to have college savings accounts: “The tax-advantaged accounts, called 529s, help people save for future college expenses. Anyone -- a relative, a friend, or yourself -- can be named as a beneficiary at the time the account is opened. The House legislation unveiled Thursday would allow unborn children to be named as a beneficiary as well. It defined an unborn child as a 'child in utero' and further as 'a member of the species homo sapiens, at any stage of development, who is carried in the womb.'”
Why top tax writer Rep. Kevin Brady, father of two adopted kids, didn’t protect the adoption tax break: “Brady defended the decision to cut the adoption tax credit by pointing out that some families can't claim the credit because they don't pay enough in taxes or they don't itemize their tax bill.”
The Johnson Amendment Under GOP Plan: “The main concern of the repeal of the Johnson Amendment is churches will effectively turn into giant super PACs.”
Homebuilders tank as the GOP's tax plan caps a big benefit for homeowners: “the tax plan caps the mortgage-interest deduction, which subtracts interest payments from homeowners' taxable income, on new homes at $500,000.”
I'm actually in favor of capping mortgage interest deduction, but it has to be tied to median home prices on market by market basis— Tanya Marsh (@TMAR22) November 2, 2017
Not high-profile,but GOP tax bill ends mortgage interest deduction for 2nd homes. That's great but it'll start a war in vacationer districts pic.twitter.com/9clOagFdyw— David Dayen (@ddayen) November 3, 2017
1. So here are a couple of ways people will abuse the new passthrough rules. The guardrails are shaky, as @DanielShaviro has pointed out.— Victor Fleischer (@vicfleischer) November 3, 2017
And, umm, an outraged twitter thread with associated R-language is here, but I will not embed it because this is a family blog.
Monday, October 30, 2017
The title of this post is hyperbole on some level. But with Halloween being tomorrow, I couldn't resist the temptation to use a festive greeting to introduce today's post. And there is a bit of a method to my titling madness . . . .
I admit that I do feel a bit tricked by the removal of the Leidos, Inc. v. Indiana Public Retirement System case (about which co-blogger Ann Lipton and I each have written--Ann most recently here and I most recently here) from the U.S. Supreme Court's calendar. It was original scheduled to be heard a week from today. Apparently, based on the related filings with the Court, the parties are documenting a settlement of the case. Kevin LaCroix offers a nice summary here. How cunning and skillful! Just when I thought resolution of important duty-to-disclose issues in Section 10(b)/Rule 10b-5 litigation was at hand . . . .
Indeed, I had hoped for a treat. What pleasure it would have given me to see this matter resolved consistent with my understanding of the law! The issue before the Court in Leidos is somewhat personal for me (in a professional sense) for a simple reason--a reason consistent with the amicus brief I co-authored on the case. I share that reason briefly here to further illuminate my interest in the case.
In my 15 years of practice before law teaching, I often advised public company issuers on mandatory disclosure documents--periodic filings and offering documents, most commonly. I also counseled investment banks serving as public offering underwriters, placement agents for private securities offerings, and financial advisors in transactions. Even in those days, I was a bit of a rule-head (self-labeled)--a technically engaged legal advisor who tried to stick to the law and regulations, determine their meaning, and implement them consistent with their meaning in practice. I drove colleagues to distraction and boredom, on occasion, with my explanations of the appropriate interpretation of various rules, including specifically mandatory disclosure rules. (This may be why I love the work of the Sustainability Accounting Standards Board, which is looking at mandatory disclosure rules in context.) I teach my students from that same nerdy vantage point.
In advising issuers and others on mandatory disclosure (and in training junior lawyers in the firm), I always noted that facial compliance with the specific line-item disclosure requirements for a Securities and Exchange Commission ("SEC") form is not enough. I advised that two additional legal constraints also govern the appropriate content of the public disclosures required to be made in those forms--constraints that required them to inquire about (among other things) missing information.
- First, I noted the existence of the general misstatements and omissions disclosure (gap-filler) rules under the Securities Act of 1933 or the Securities Exchange Act of 1934, as amended (as applicable in the circumstances)--Rule 408 under the 1933 Act and Rule 12b-20 under the 1934 Act. Each of these rules provides for the disclosure of "such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made not misleading" in addition to the information expressly required to be included in the relevant disclosure document under applicable line-item disclosure rules.
- Second, I noted that anti-fraud law--and, in particular, Section 10(b) of, and Rule 10b-5 under, the 1934 Act--provides an even more comprehensive basis for interrogating the contents of disclosure that facially complies with line-item mandatory disclosure rules. The overall message? No one wants a fraud suit, and if they get one, they should be able to get out of it fast! If a business and its principals were to be sued under Section 10(b) and Rule 10b-5, I wanted to ensure that the relevant disclosures were accurate and complete in all material respects.
Thus, the existence of the line-item and gap-filling disclosure rules--and the potential for fraud liability based on failed compliance with them--are, taken together, important motivators to the best possible disclosure. In my business lawyering, I believe I used these regulatory principles to my clients' advantage. I would hate to see lawyers lose the important leverage that potential fraud liability gives them in fostering accurate and complete disclosures, fully compliant with law. Hence, my position on the Leidos litigation--that mandatory disclosure rules do give rise to a duty to disclose that may form the basis for a securities fraud claim under Section 10(b) and Rule 10b-5. (The ultimate success of any such claim would be, of course, based on the satisfaction of the other elements of a Section 10(b)/Rule 10b-5 claim.)
So, no treat for me--at least not just yet. But perhaps this post will forestall any real trickery--the trickery involved with avoiding securities fraud liability for misleading omissions to state material information expressly required to be stated under line-item mandatory disclosure rules. For me, that is what is at stake in Leidos and in disclosure lawyering generally. Let's see what transpires from here.
Saturday, October 28, 2017
It seems that in the wake of Donald Trump’s remarkable political ascent, a number of CEOs have developed their own political ambitions.
Facebook’s Mark Zuckerberg famously embarked on an anthropological tour of the United States, rubbing shoulders with the struggling common folk in Iowa, as well as in Wisconsin, Ohio, and South Carolina. Disney’s Bob Iger says a lot of people are saying that he should run. Starbucks’s Howard Schultz (okay, former CEO, still Executive Chair) visited the Houston victims of Hurricane Harvey, later explaining, “I wanted to see the aftereffects, but mostly I wanted to talk to people. And you learn a few things that are heartbreaking. You know, 40 percent of American households don’t have $400 of cash available to them….I think the country needs to become more compassionate, more empathetic. And we can’t speak about the promise of America and the American Dream and leave millions of people behind.”
Now, I suppose one could ask all kinds of questions about whether the Trump phenomenon should be interpreted to mean that America hungers for a closer relationship between corporations and politics, but my immediate reaction is, how do you square the fiduciary obligations associated with running a company with the demands of the political sphere?
I mean, leaving aside the obvious pull on a CEO’s attention and time, Schultz – apparently while harboring presidential ambitions – announced that Starbucks would hire 10,000 refugees (a decision that, arguably, negatively impacted his company’s stock price). Bob Iger has had to navigate such highly charged issues as his presence on Trump’s Advisory Council, and the political commentary of Jimmy Kimmel at ABC, and Jemele Hill at ESPN. Facebook, of course, has had to address issues of foreign interference with American elections, and has recently announced that it will voluntarily require disclosures akin to those required of television ads. And that doesn’t even get into any gratuitous political speeches.
I’m not taking a position over whether these executives did the right or the wrong thing in each instance, but I am concerned that when CEOs simultaneously run their companies and run for president, it’s difficult to discern whether their political moves are intended to benefit the corporation (including, as relevant, all stakeholders), or their own political careers. Under these conditions, how can shareholders be certain that their CEOs’ actions – on everything from labor conditions to executive pay to environmental footprints – are intended to advance the best interests of the company?
Saturday, October 21, 2017
Readers of the blog know that a few months ago, the University of Tennessee hosted a BLPB symposium, with essays to be published in a forthcoming volume of Transactions: The Tennessee Journal of Business Law. It was a terrific amount of fun, where we bloggers who usually just interact over the internet got a chance to see each other face to face (in some cases, for the first time!)
Anyhoo, I just posted my contribution to the symposium, Family Loyalty: Mutual Fund Voting and Fiduciary Obligation, to SSRN. Here is the abstract:
In recent years, institutional investors have increasingly come to dominate the market for publicly-traded stock. Mutual funds have become especially important, controlling trillions of dollars of corporate equity.
The SEC has made clear that it is the fiduciary responsibility of fund administrators to vote their shares in a manner that benefits investors in the fund. Sponsoring companies have responded by creating centralized research offices that determine the voting policies across all of the funds they administer. Though there may be some variation at the individual fund level, most fund families vote as a block.
The practice of centralized voting raises the question whether each fund is promoting the best interests of its investors. For example, one fund may hold stock in an acquisition target, while another holds stock in the acquirer; one fund may hold stock in a target, while another holds debt. These funds have different interests, but voting policies rarely differentiate among them.
This Essay argues that mutual fund boards should develop procedures to ensure that fund shares are voted with a view toward advancing the best interests of that particular fund. If such procedures cannot be implemented in a manner that justifies their costs, funds should refrain from voting their shares at all.
In addition to benefitting fund investors, this proposal may also have a salutary effect on portfolio firms. In recent years, commenters have expressed concern about the voting power exerted by mutual fund managers, who may pressure firms to avoid competition within an industry, or who may encourage short-term financial engineering over long-term growth. Decentralization may diminish asset managers’ power, thereby alleviating these effects.
Thanks so much to the University of Tennessee College of Law, and to all of the students - and especially to Joan - for the opportunity.
Saturday, October 14, 2017
We’ve talked about Uber and its tribulations a few times here at BLPB, including what I feel is one of the remarkable aspects of the saga – the fact that a private company is being treated as public in the general imagination.
In keeping with that theme, Renee Jones just posted The Unicorn Governance Trap to SSRN, with the basic thesis that Uber and companies like it (Theranos, Zenefits, etc) are experiencing governance pathologies precisely because they inhabit a hybrid space between public and private. (George Georgiev made an abbreviated version of the same argument in a column for The Hill several months ago.) Jones contends that these unicorn companies feature the separation of ownership and control typical of a public company, but they are not subject to the same disciplining mechanisms from investors of voice (due to dual-class shares), exit (due to the limits on liquidity inherent in private status), and litigation (due to lack of public reporting obligations, and potential securities fraud claims – though on that last point, but see Theranos and Uber litigation). She distinguishes private companies that grew large in an earlier era, where ownership and control are unified (typically, family-owned businesses). She also points out – though she is not the first – that efforts to increase the number of IPOs by limiting regulatory burdens as the Trump Administration would like to do are misguided; IPOs have likely declined because companies do not need them if they can raise capital privately.
To be sure, there are limits to how far the argument can be taken (Exs. A , B, and C.) And the problems at unicorns may have less to do with securities regulation than with the current fashion for treating founders like auteurs. Still, it does seem like the relatively new ability for companies to raise massive amounts of capital without the discipline of the broader markets encourages a degree of corporate governance laxity.
If that's right, then it represents a real-time demonstration of the importance of corporate governance for the broader society. Typically, corporate governance is treated as “private law,” a function of private contracting among investors and managers. Corporate governance principles are designed to protect investors from exploitation, but do not usually take protection of other stakeholders as part of their central mandate. This is, after all, the ideological basis of the internal affairs doctrine. Scott Hirst recently argued that investors should choose the extent to which companies are subject to federal securities regulation, explicitly adopting the position that only corporate governance externalities – and not other kinds of social welfare externalities – are part of the calculus.
But now we can see that, whether by design or happy accident, obligations placed on firms ostensibly for the protection of investors have very tangible effects on employees, customers, competitors, and general compliance with the rule of law. It is not clear that external regulation alone can carry this responsibility, because the whole point is that certain managers/controllers may be undeterrable, or only deterrable at significant cost. They can be contained only via constraints on their power to act in the first place, and that’s where corporate governance comes in.
In sum, as I tell my students on day one, corporate law is about the regulation of power.
Saturday, October 7, 2017
Readers of this blog know about the case of Leidos, Inc. v. Indiana Public Retirement System, currently pending before the Supreme Court, which will decide whether an omission of required information can give rise to private liability under Rule 10b-5. In Leidos, the corporate defendant engaged in a scheme of overbilling on a New York City contract, which ultimately resulted in a deferred prosecution agreement and significant monetary penalties. The plaintiffs alleged that the company violated Rule 10b-5 by failing to disclose the conduct and associated potential penalties as a “known trend” in its SEC filings, as required by Item 303. The Second Circuit allowed the claim to proceed; Leidos now argues before the Supreme Court that its failure to disclose required information cannot satisfy the element of falsity in a private claim brought under Rule 10b-5. In other words, the question is whether – assuming all the other elements of a fraud claim are established (materiality, scienter, loss causation, etc) – can the omission of required information count as a false statement?
Joan Heminway co-authored an amicus brief arguing that Rule 10b-5 does provide for omissions liability, and this is an issue I’ve blogged about a few times, so forgive me if this post treads some familiar ground.
The case has generated a fair amount of commentary from the bar, including various warnings of unlimited liability should the Supreme Court rule for the plaintiffs. Professor Joseph Grundfest has now jumped into the fray, contending that – while he agrees with various textual arguments as to why no liability should attach – in the end, he doesn’t think it matters very much. The crux of his argument is that the securities laws require so much disclosure as a matter of course that there will almost never be a case where a pure omission cannot be transmogrified into a misleading half-truth. In Leidos itself, he notes that the court also upheld the plaintiffs’ allegation that the corporate financial statements violated accounting rules for failure to allege a loss contingency – resulting from fines and recoupment of the overbilling – and speculates that the plaintiffs could have brought claims based on the company’s representations that it did not expect any losses resulting from pending litigation, as well as such “half-truths” as its warnings of potential risks from “[m]isconduct of our employees.” He also argues that – though the matter is uncertain – required CEO and CFO certifications under Sarbanes Oxley can also constitute affirmative misstatements when information has been omitted from a securities filing, which would once again make omissions liability unnecessary.
I agree that pure omissions cases are relatively rare, and that due to the extensive disclosure requirements of the federal securities laws, most undisclosed misconduct/misfortune can be pinned to an arguably false affirmative statement (a point that I’ve discussed in my articles Slouching Towards Monell and Reviving Reliance). But I don’t think the matter is quite as trivial as Prof. Grundfest sees it.
First, when it comes to certifications, those are attributed solely to the CEO and CFO. Not all securities claims depend on the liability of the CEO and CFO; at the very least, at the pleading stage, the plaintiffs may not be able to demonstrate the scienter of the CEO and CFO. In Leidos itself, for example, for reasons I don’t fully understand, somehow all of the individual defendants were dropped from the case, leaving only the corporate defendant. Thus, leaving aside other issues of whether such certifications are actionable in the first place, they’re an unreliable predicate for liability.
More broadly, however, what Prof. Grundfest overlooks is that many courts - rightly or wrongly - treat Rule 10b-5 claims with varying degrees of skepticism, and plaintiffs reasonably want to belt-and-suspender it. Now, to be sure, if a judge is determined to dismiss a claim, the judge will find a way to do so (naturally, the opposite is true for a judge who is determined to sustain a claim). But between those extremes there is a great deal of variation, and broadening the grounds for liability will make it harder for even the skeptical judge to dismiss a claim out of hand.
When it comes to omitted information, for sure, public companies are already subject to so many disclosure requirements that there will always be some affirmative statement that is arguably rendered misleading whenever there is a significant undisclosed problem, which should theoretically make pure omissions liability unnecessary. But courts are often hostile to these kinds of claims – I think of them as icebergs – where major trouble is pinned to a banal bit of boilerplate. (You know, like an iceberg, where the tiny above-water misstatement is the ostensible hook to bring a claim based on dramatic concealed problems.) Courts typically recognize – correctly – that in such cases, the plaintiff is not so much complaining about the statement so much as the conduct, and since it is only statements (not conduct) that are regulated by the federal securities laws, they find other grounds on which to base a dismissal. One favorite is puffery, which is precisely what happened in Leidos – the plaintiffs claimed that the defendants’ representations about ethics and integrity were rendered false by the scheme, and those claims were thrown out on materiality grounds. Omissions liability, by contrast, is immune from a puffery defense, and thus represents another weapon in the plaintiffs’ arsenal.
Similarly, in many cases the alleged “half-truth” will come in the form of a potentially forward-looking statement, which may then be protected by the PSLRA safe harbor. If so, pinning liability to that statement (or even to the risk disclosures) may be impossible for the plaintiffs. Once again, then, pure omissions liability will save the plaintiffs' complaint.
To be sure, as Prof. Grundfest points out, in Leidos, the Second Circuit agreed that the failure to account for potential losses due to the fraud rendered the corporate financial statements false. But that was highly unusual, and likely due to the fact that the misconduct was already the subject of a criminal investigation. Courts have often refused to treat financial statements as false simply because the income was generated in an illicit manner, see Steiner v. MedQuist, Inc., 2006 WL 2827740 (D.N.J. Sept. 29, 2006), and that’s particularly likely to be true when there is no governmental investigation underway.
The same goes for Leidos’s statements about potential liability from pending claims/litigation. Prof. Grundfest might be correct that these were also false statements, but only after 2010, when the first criminal complaint was filed. Though the plaintiffs altered their claims along the way, the original class period began in 2007 – before there was any pending litigation.
It is also worth observing that omissions cases might be easier to litigate procedurally. When plaintiffs allege the existence of affirmative misstatements, defendants often argue that the misstatement failed to result in a detectable impact on stock prices, and that therefore fraud on the market liability is unavailable (an argument I’ve repeatedly discussed). That’s not an issue for omissions liability.
Point being, I don’t think my disagreements with Prof. Grundfest are too dramatic – I’ll concede that we’re not talking about a massive number of cases – but I think there are enough to make a difference.
That said, I disagree with the “sky is falling” pronouncements of practitioners who fear that they will have to bury investors in an “avalanche of trivial information,” Basic, Inc. v. Levinson, 485 U.S. 224 (1988), if the Supreme Court permits the claims in Leidos to proceed. As I argue in Reviving Reliance, I actually think that if liability is expanded to cover omissions, courts will push back by narrowing their interpretation of the scope of required disclosures in the first place – which will have real repercussions for SEC enforcement.
Saturday, September 30, 2017
Earlier this week, the Wall Street Journal reported that many institutional investors – including large mutual fund complexes like BlackRock and State Street – have become concerned about “overboarding,” namely, the phenomenon where corporate directors sit on multiple boards.
There are good reasons to be concerned. Researchers have found that in many, though perhaps not all, cases when corporate directors are “overboarded” – and thus presumably unable to devote their full attention to governance at particular companies – companies are less profitable and have a lower market to book ratio. (Similarly effects are found for distracted directors.)
That said, there’s a particular irony in seeing mutual fund companies, of all investors, leading the charge. Most mutual fund companies employ a single board – or a few clusters of boards – to oversee all of the funds in the complex. This can result in directors serving on over 100 boards in extreme cases. State Street’s Equity 500 Index Fund, for example, reports trustees who serve on 72 or 78 boards within the complex. BlackRock’s Target Allocation Funds have trustees who serve on either 28 and 98 different boards (depending on how you count).
I’ll admit this is something of a cheap shot: presumably each fund is much more similar to the other funds than are the various companies at which overboarding concerns are raised. Still, when you get to over 20 funds per director, that’s a lot, no? Or 50 funds? Especially since the funds have varying interests – they might stand on opposite sides of a merger, or invest at different levels within a single firm’s capital structure, or compete for limited opportunities like IPO allocations and pre-IPO shares. Different funds might even be differently invested in firms within an industry, and thus have divergent interests regarding competition between the firms. (Cf. Jose Azar et al., Anti-Competitive Effects of Common Ownership). Not to mention the fact that the independent directors of a mutual fund are supposed to be the fund’s “watchdogs” against exploitation by the sponsor, but service on multiple boards - with associated salaries - may cause the relationship to become suspiciously cozy.
Point being, the overboarding concern is a real one. But… I’m not quite sure BlackRock is the right face for the resistance.
Saturday, September 23, 2017
States frequently compete with each other to attract businesses. They’ll offer tax credits, subsidies, and regulatory waivers to persuade corporations to set up shop locally. (Right now, Amazon is asking cities to compete to host its second headquarters.) These incentives may or may not work out well for the state; it’s not uncommon for the promised jobs to disappear. Meanwhile, competition among states can promote a race to the bottom, with states offering increasingly generous – and unaffordable – financial packages in exchange for a temporary boost in economic activity.
Wisconsin’s new deal with Foxconn represents a striking new frontier in these wars between the states. Foxconn is a Taiwanese company with a history of reneging on its promises to establish manufacturing plants in exchange for rich government incentives. Nonetheless, Wisconsin has promised it $2.85 billion over 15 years if it will build a $10 billion plant and hire 13,000 workers. And to sweeten the deal, Wisconsin has also promised Foxconn preferential treatment in the Wisconsin court system.
Apparently concerned that its grant of certain environmental waivers may prompt local lawsuits, Wisconsin has promised Foxconn an expedited litigation process, including automatic stays of trial court orders, interlocutory appeals, and priority review by the Wisconsin Supreme Court for any legal challenges to Wisconsin’s decisions regarding Foxconn. The legislation does not single out Foxconn specifically for these benefits; it simply says that they apply to any litigation concerning an Electronic and Information Technology Manufacturing Zone, but I gather Foxconn’s is the only such zone around.
A memo from the Wisconsin Legislative Council expresses concern that the litigation provisions may violate Wisconsin’s constitution by interfering with the independence of the judiciary. (I’d also wonder about equal protection, since Foxconn is being singled out, if not by name). But leaving aside the constitutional issues, I’m deeply troubled by the precedent. If Wisconsin is promising favorable treatment in court, other states may feel they have to match those benefits in the future. Corporations can already opt out of the legal system in many respects via arbitration agreements inserted into contracts of adhesion; I fear a future where for noncontractual disputes, we get a tiered court system, in which corporations are able to buy their preferred rules of civil procedure.
Sunday, September 17, 2017
As I earlier reported, on Saturday, The University of Tennessee College of Law hosted "Business Law: Connecting the Threads", a conference and continuing legal education program featuring most of us here at the BLPB--Josh, me, Ann, Doug, Haskell, Stefan, and Marcia. These stalwart bloggers, law profs, and scholars survived two hurricanes (Harvey for Doug and Irma for Marcia) and put aside their personal and private lives for a day or two to travel to Knoxville to share their work and their winning personalities with my faculty and bar colleagues and our students. It was truly wonderful for me to see so many of my favorite people in one place together enjoying and learning from each other.
Interestingly (although maybe not surprisingly), in many of the presentations (and likely the essays and articles that come from them), we cite to each other's work. I think that's wonderful. Who would have known that all of this would come from our decision over time to blog together here? But we have learned a lot more about each other and each other's work by editing this blog together over the past few years. As a result, the whole conference was pure joy for me. And the participants from UT Law (faculty, students, and alums) truly enjoyed themselves. Papers by the presenters and discussants are being published in a forthcoming volume of Transactions: The Tennessee Journal of Business Law.
My presentation at the conference focused on the professional responsibility and ethics challenges posed by complexity and rapid change in business law. I will post on my related article at a later date. But if you have any thoughts you want to share on the topic, please let me know. A picture of me delivering my talk, courtesy of Haskell, is included below. (Thank you, Haskell!) So, now you at least know the title, in addition to the topic . . . . :>) Also pictured are my two discussants, my UT Law faculty colleague George Kuney and UT Law 3L Claire Tuley.
Saturday, September 16, 2017
Here at BLPB, Joan Heminway has written a couple of posts discussing comparisons between norms in corporate theory, and norms in democratic theory. A few months ago, she discussed the potential conflicts between Donald Trump’s private business interests, and his role as a “fiduciary” for the United States. As she pointed out, in corporate law, we have procedures to address potential conflicts, which include fully informed approval by the principal or unconflicted fiduciaries, and external review to determine fairness. But there is no similar procedure to address conflicts in the political realm.
Well, it appears that Joan’s not the only one thinking along these lines. I read with interest this amicus brief submitted in the Supreme Court case of Gill v. Whitford, posted by Professor D. Theodore Rave at the University of Houston. The case itself is about political redistricting, but Prof. Rave makes the intriguing argument that redistricting should be addressed the same way we address conflicts of interest in business law. Specifically – and drawing on his earlier article in the Harvard Law Review, Politicians as Fiduciaries – he proposes that districts drawn by independent commissions receive a lower level of scrutiny than districts drawn by “interested” political actors, in much the same way that we scrutinize interested business transactions more closely than disinterested ones. Under such a system, as in corporate law, political actors would retain the flexibility to draw districts as they see fit, but they would be encouraged to use certain practices over others.
From a precedential standpoint, we may have traveled too far from this path for the Supreme Court to change course now, but it’s a fascinating idea that I would love to see the Court seriously entertain.
I also note that in their article Beyond Citizens United, Nicholas Almendares and Catherine Hafer make the related argument that statutes should receive heightened judicial scrutiny if they implicate the interests of major campaign contributors. They don’t draw the comparison to corporate law directly, but they offer the same idea: conflicts in the political realm can be identified just as they are in business, and receive a closer look as a result.
Monday, September 11, 2017
Last Thursday, Jay Brown filed an amicus brief with the U.S. Supreme Court coauthored by him, me, Jim Cox, and Lyman Johnson. The brief was filed in Leidos, Inc., fka SAIC, Inc., Petitioners, v. Indiana Public Retirement System, Indiana State Teachers’ Retirement Fund, and Indiana Public Employees’ Retirement Fund, an omission case brought under Section 10(b) of and Rule 10b-5 under the Securities Exchange Act of 1934, as amended. An abstract of the brief follows.
This Amicus Brief was filed with the U.S. Supreme Court on behalf of nearly 50 law and business faculty in the United States and Canada who have a common interest in ensuring a proper interpretation of the statutory securities regulation framework put in place by the U.S. Congress. Specifically, all amici agree that Item 303 of the Securities and Exchange Commission's Regulation S-K creates a duty to disclose for purposes of Rule 10b-5(b) under the Securities Exchange Act of 1934.
The Court’s affirmation of a duty to disclose would have little effect on existing practice. Under the current state of the law, investors can and do bring fraud claims for nondisclosure of required information by public companies. Thus, affirming the existence of a duty to disclose will not significantly alter existing practices or create a new avenue for litigants that will lead to “massive liability” or widespread enforcement of “technical reporting violations.”
At the same time, the failure to find a duty to disclose in these circumstances will hinder enforcement of the system of mandatory reporting applicable to public companies and weaken compliance. Reversal of the lower court would reduce incentives to comply with the requirements mandated by the system of periodic reporting. Enforcement under Section 10(b) of and Rule 10b-5(b) under the Securities Exchange Act of 1934 by investors in the case of nondisclosure will effectively be eliminated. Reversal would likewise reduce the tools available to the Securities and Exchange Commission to ensure compliance with the system of periodic reporting. In an environment of diminished enforcement, reporting companies could perceive their disclosure obligations less as a mandate than as a series of options. Required disclosure would more often become a matter of strategy, with issuers weighing the obligation to disclose against the likelihood of detection and the reduced risk of enforcement.
Under this approach, investors would not make investment decisions on the basis of “true and accurate corporate reporting. . . .” They would operate under the “predictable inference” that reports included the disclosure mandated by the rules and regulations of the Securities and Exchange Commission. Particularly where officers certified the accuracy and completeness of the information provided in the reports, investors would have an explicit basis for the assumption. They would therefore believe that omitted transactions, uncertainties, and trends otherwise required to be disclosed had not occurred or did not exist. Trust in the integrity of the public disclosure system would decline.
The lower court correctly recognized that the mandatory disclosure requirements contained in Item 303 gave rise to a duty to disclose and that the omission of material trends and uncertainties could mislead investors. The decision below should be affirmed.
More information about the case (including the parties' briefs and all of the amicus briefs) can be found here. The link to our brief is not yet posted there but likely will be available in the next few days. Also, I commend to you Ann Lipton's earlier post here about the circuit split on the duty to disclose issue up for review in Leidos.
Imv, this is a great case for discussion in a Securities Regulation course. It involves mandatory disclosure rules, fraud liability, and class action gatekeeping. As such, it allows for an exploration of core regulatory and enforcement tools of federal securities regulation.
Saturday, September 9, 2017
It's Saturday morning, and I'm guessing a lot of us are watching apprehensively as Irma heads for Florida (others of us are probably trying desperately to escape the storm's path, possibly receiving an impromptu lesson in dynamic pricing). Meanwhile, Jose and Katia are close behind, even as Houston faces years-long recovery efforts from Harvey, and then there's, well:
It's impossible to consider these events - which, in addition to the human toll, will inflict billions if not trillions of dollars of damage - without thinking that this is what climate change looks like.
The reason I mention it on this blog is that climate change is an increasingly popular subject for shareholder proposals. More and more, shareholders are seeking information from companies about how they are responding to climate change, including the precautions being taken, and the expected costs of disasters.
Considering that we are now being treated to a dramatic demonstration of just how climate change can have a devastating impact on economies generally and individual companies in particular, isn't it time for critics of the shareholder proposal mechanism to at least admit that climate change proposals belong in the "corporate governance" category, and not the oft-derided "social policy" category, the latter of which is alleged to have only an"attenuated connection to shareholder value"?
Saturday, September 2, 2017
So last week I posted about the problem of buyer/customer discrimination; we have laws to deal with discrimination by employers, by businesses that sell to the public, by landlords – but there isn’t much to address discrimination that runs in the other direction.
It was timely, then, that this article has been making the internet rounds:
When Penelope Gazin and Kate Dwyer decided to start their own online marketplace for weird art, they didn’t expect it to be easy. After all, the L.A.-based duo of artists were bootstrapping the project with a few thousand dollars of their own money and minimal tech skills. But it wasn’t just a tight budget that added friction to the slow crawl toward launching; the pair also faced their share of doubt from outsiders, spanning from the condescending to the outright sexist.
… After setting out to build Witchsy, it didn’t take long for them to notice a pattern: In many cases, the outside developers and graphic designers they enlisted to help often took a condescending tone over email. These collaborators, who were almost always male, were often short, slow to respond, and vaguely disrespectful in correspondence. In response to one request, a developer started an email with the words “Okay, girls…”
That’s when Gazin and Dwyer introduced a third cofounder: Keith Mann, an aptly named fictional character who could communicate with outsiders over email.
“It was like night and day,” says Dwyer. “It would take me days to get a response, but Keith could not only get a response and a status update, but also be asked if he wanted anything else or if there was anything else that Keith needed help with.”
Dwyer and Gazin continued to deploy Keith regularly when interacting with outsiders and found that the change in tone wasn’t just an anomaly. In exchange after exchange, the perceived involvement of a man seemed to have an effect on people’s assumptions about Witchsy and colored how they interacted with the budding business. One developer in particular seemed to show more deference to Keith than he did to Dwyer or Gazin, right down to the basics of human interaction.
“Whenever he spoke to Keith, he always addressed Keith by name,” says Gazin. “Whenever he spoke to us, he never used our names.”
Stories like this are pretty common; for company founders, they may be disadvantaged but they can just try to power through it – as these women did – but when the woman on the receiving end is someone else’s employee, it can affect her job performance, as illustrated by this twitter thread.
In sum, plus ça change, plus c'est la même chose.
Monday, August 28, 2017
I am excited and proud to make the following announcement about a cool (!) upcoming program being held on Saturday, September 16 at UT Law in Knoxville:
The University of Tennessee College of Law will host a conference and CLE program that will focus on trends in business law. Discussions will take place throughout the day featuring panel discussions that center upon business law scholarship, teaching and law practice.
Topics will include business transaction diagramming; risks posed by social enterprise enabling statutes; fiduciary obligations and mutual fund voting; judicial dissolution in LLCs; Tennessee for-profit benefit corporation law and reporting; corporate personality theory in determining the shareholder wealth maximization norm; and professional responsibility issues for business lawyers in the current, evolving business environment.
The presenters for the program panels are . . . well . . . us! All of the BLPB editors and contributing editors, except Anne Tucker (we'll miss you, Anne!), are coming to Knoxville to share current work with each other and conference attendees. Each editor will anchor a panel that also will include a faculty and student discussant. The BLPB blogger papers and the discussants' written commentaries will all be published in a future issue of our business law journal, Transactions: The Tennessee Journal of Business Law. We also have secured one of our former visiting professors as a lunch-time speaker.
UT Law looks forward to hosting this event. For more information, you can look here. I expect some of us will post on the conference and the conference papers at a later date.
Saturday, August 26, 2017
As Anne Tucker pointed out, there was a flurry of news items a couple of years ago suggesting that hedge fund activists were more likely to target female CEOs over male CEOs.
Well, someone’s now done a systematic study of the issue and confirmed – yes! That is a thing that happens!
In their paper, Do Activist Hedge Funds Target Female CEOs? The Role of CEO Gender in Hedge Fund Activism, authors Bill Francis, Victor Shen, and Qiang Wu control for a variety of firm characteristics, including the “glass cliff” (that women are more likely to be elevated to CEO in times of turbulence), and still find that the presence of a woman CEO makes it more likely that a company will be targeted by activists. They attribute the difference to a couple of things. First, they find that women CEOs respond differently to activist attacks: instead of going into a defensive posture, they are more likely to cooperate. As a result, activists seek cooperative measures like board seats, and settle without proxy fights. The more cooperative posture of women CEOs makes it easier – and thus more profitable – for activists to target them. This finding, they conclude, is consistent with other findings that the market does not respond as positively to activist intervention when the firm uses aggressive defensive tactics, unless the activist further increases the hostilities with even more expensive and aggressive interventions.
The study’s authors reject the notion that pure sexism is at work, because (they find) the market responds to activism at women-led companies with larger abnormal returns both in the short term and over the course of a year. According to the authors, it is implausible that the market, as well as the activists, would be misled by pure gender bias for such a prolonged period.
On this point, I’m a little more skeptical. For one thing, if I’m reading this correctly, their long-term findings of higher abnormal returns for women-led companies are less consistent across different specifications than the short-term findings. Plus, I think it’s entirely plausible that even if the activists themselves are not “motivated” in some subjective sense by gender bias, they suspect that the other investors on whose cooperation they rely may be less trustful of women CEOs. So they know that if they target those companies, other investors will respond more positively. Indeed, the authors find that activists take smaller positions in women-led companies than men-led ones, suggesting that the activists anticipate more cooperation from the existing shareholder base.
That said, I certainly find it plausible that part of activists’ motivation stems from differential responses of men and women CEOs, so there’s a great irony in the fact that women CEO responses end up adding value to the company, yet at the same time – as the study’s authors find – women end up suffering more for it, with a greater loss in compensation and higher turnover than men CEOs who find themselves targeted, even though women begin with less compensation than their men counterparts.
In addition to having interesting implications on its own terms, this study I think can be viewed as part of a larger emerging literature on the problem of customer or end-user discrimination. As Kate Bartlett and Mitu Gulati discuss in their essay on the subject, we have a variety of laws that prevent, say, employers from discriminating against employees, and businesses from discriminating against customers, but we don’t have laws that work in the opposite direction. For the most part, buyers/customers can discriminate with impunity (with limited exceptions, like programs funded by the federal government) – which in practice means that we have real discrimination problems in the gig economy. Airbnb, for example, has been trying to address discrimination by homeowners who will not rent to people of color, and people of color who sell products on eBay may receive less than white sellers (.pdf). One article reports that women gig economy workers are used to experiencing harassment by customers, and – because they are considered to be independent contractors – don’t view themselves as having many options. Of course, this is not just a gig economy phenomenon; among other things, medical patients may not want to be treated by nonwhite doctors (here is an extreme example).
And recently, there have been a spate of articles about discrimination by venture capitalists, who are much less likely to fund women-led startups and, apparently, have engaged in a pattern of serious sexual harassment against women entrepreneurs. Activists who target women CEOs seem to be another data point.
The reality may be that there are forms of discrimination that the law can’t reach, but as the Bartlett and Gulati article concludes, we might start to seriously think about areas where legal intervention could be a practical, if partial, solution.
Saturday, August 19, 2017
I did a Lexis search, and found zero citations to Dodge v. Ford in the New York Times (though it appears there was at least one online reference in 2015), and only three in the Wall Street Journal – two of which were factual recitations regarding the history of corporate governance debates.
The third was yesterday’s op-ed, arguing that the shareholders of the companies that quit Trump’s manufacturing council (an issue discussed earlier this week by Marcia), as well as shareholders of other companies that purport to take a “moral” stance, should sue corporate executives for destroying shareholder value. The authors, Jon L. Pritchett and Ed Tiryakian, argued:
Memo to activist CEOs: Dust off your notes, open your textbooks, and reread the basics of corporate finance taught at every credible university. The fiduciary responsibility of a CEO is to safeguard the company’s assets and acknowledge this overriding principle: “It’s not our money but that of the shareholders.”
In today’s heated political climate, some executives have rejected the fundamentals in favor of short-term publicity for themselves and their corporations. When several CEOs quickly resigned over the past few days from the now-disbanded White House Council on Manufacturing, they cited personal views or political disagreement as their reason for leaving. Those may be truthful reasons, but are they in the best interests of the companies they represent? Wouldn’t shareholders be better off with their interests represented in this powerful group of government officials who control regulatory policy?
In the landmark 1919 case Dodge v. Ford, the Michigan Supreme Court laid out the ruling that has guided corporate America ever since. Ford Motor Co. must make decisions in the interests of its shareholders, the court ruled, rather than in a charitable manner.
As any business law professor knows - and as Marcia made clear in her earlier post - the matter is not nearly that simple. Even if we accept a pure shareholder wealth maximization frame, what would it mean for these companies’ ability to function if they remained? #SoupNazi became a popular hashtag on Twitter to force Denise Morrison of Campbell’s Soup to quit the council; the celebrity endorsements of Under Armour may have been under threat due to Kevin Plank’s presence, and employees of Silicon Valley were in open revolt over their leaders’ cooperation with the Trump administration, which just goes to show why Dodge v. Ford is generally considered not good law, at least to the extent it proposes that courts second-guess the wisdom of business decisions.
That said, there’s the macro-level view. Political instability is bad for business. The perception that America strives for certain moral ideals, and its adherence to the rule of law, are good for business. It’s reached the point where multiple companies are listing Trump as a risk factor in their SEC filings.
America’s CEOs may have limited options for pressuring for more stability – and refusing to lend their credibility to Trump’s (largely ceremonial) business councils may be one of the few tools available.
Friday, August 18, 2017
The University of Richmond School of Law seeks to fill three tenure-track positions for the 2018-2019 academic year, including one in corporate/securities law. Candidates should have outstanding academic credentials and show superb promise for top-notch scholarship and teaching. The University of Richmond, an equal opportunity employer, is committed to developing a diverse workforce and student body and to supporting an inclusive campus community. Applications from candidates who will contribute to these goals are strongly encouraged.
Inquiries and requests for additional information may be directed to Professor Jessica Erickson, Chair of Faculty Appointments, at firstname.lastname@example.org.
Saturday, August 12, 2017
Whenever new corporate governance terms are developed that function to diminish shareholder power – like arbitration provisions, or forum selection, or loser-pays – concern develops among (at least some) investors that these terms will become the norm. It’s not about one company that does or doesn’t adopt the term; it’s about the fear that several companies will adopt them, and eventually it will become standard, so that shareholders will not be able to exert discipline by avoiding companies with the disfavored provision.
In other words, companies will behave as though they’re in a cartel when selecting these terms, and they’ll be able to do it because they can easily coordinate with each other. There are a limited set of underwriters and white shoe law firms that will advise them, and those entities will propagate the new development throughout the system. Cf. Elisabeth de Fontenay, Law Firm Selection and the Value of Transactional Lawyering, 41 J. Corp. Law 393 (2015) (explaining the value-added by elite law firms – knowledge of the latest in deal technology); Roberta Romano & Sarath Sanga, The Private Ordering Solution to Multiforum Shareholder Litigation (finding that law firm advice is behind the adoption of forum-selection clauses at the IPO stage). Investors may prefer to coordinate with each other to boycott companies that adopt these terms, but investors are widely dispersed, and have no obvious coordination mechanism.
Except it seems they do. They have ISS, for one – which doesn’t help with buying, but does help with voting. ISS, according to The Power of Proxy Advisors: Myth or Reality? 59 Emory L.J. 869 (2010), by Jill E. Fisch, Stephen J. Choi, Marcel Kahan, bases its recommendations very much on the preferences of its clients, more so than other advisory services. In other words, ISS serves as a coordination point.
And now on the buying side, we have the indexes.
As I’m sure readers of this blog are aware, a couple of major indexes, under heavy pressure from investors, decided to exclude companies with certain multiple-class share structures. The investors’ concern was that if these companies were included, indexed investors would have to buy them even if they didn’t want to. And that’s an odd argument, of course, because nothing is stopping them from setting up their own index or buying according to a modified index, though we can agree that doing so would be at the very least impractical (though it’s fascinating to contemplate why). That said, the exclusion is unusual, because index investors aren’t supposed to be actively picking stock characteristics, and – until now – the indexes did not make specific governance characteristics part of the criteria for inclusion.
So this latest move suggests that as passive investing gains more power, the indexes have become – or have the potential to become – a kind of cartel mechanism. They are a means by which dispersed investors can coordinate their buying and thereby express preferences collectively.
What happens, for example, if a company accepts Michael Piwowar’s invitation and tries to eliminate class actions via arbitration at the IPO stage? Will we see investor pressure to keep those companies out of the index as well? Time will tell, but recent events suggest this is another tool that investors can use to coordinate with each other.