Saturday, October 22, 2016
The Economist recently published an opinion piece arguing that bigotry has become a lucrative business. As the magazine puts it:
The country is in an unusually flammable mood. This being America, there are plenty of businesspeople around to monetise the fury—to foment it, manipulate it and spin it into profits. These are the entrepreneurs of outrage and barons of bigotry who have paved the way for Donald Trump’s rise….
Breitbart News, in particular, has excelled in pushing boundaries. … It has provided platforms in its comment section for members of far-right hate groups who rail against immigration and Jews.
The outrage industry has clearly reached a milestone with Donald Trump’s presidential campaign. …He won the hearts of 13m Republican primary voters by recycling conservative media hits such as “build a wall” and “ban all Muslims”. …
There are big bucks in bigotry
Twitter has been a particularly virulent source of online bigotry and abuse. Buzzfeed recently published an article on Twitter’s 10-year failure to halt hate speech – often targeted at particular users – that stems from a combination of corporate dysfunction, failure of (white, male) corporate leadership to recognize the problem, and business exigencies that emphasized user growth. In this election season, Twitter has become a famous platform for bigoted trolling, often aimed at journalists who oppose Donald Trump.
But it appears that bigotry as a profit-center only goes so far. Twitter has been plagued recently by a stagnant user base and correspondingly declining stock price; as a result, it has been seeking an acquirer. But according to recent news reports, Twitter’s troll problems are driving away potential bidders.
So, it seems there’s at least a built-in limit as to how far bigotry can take you.
Saturday, October 15, 2016
That Pascal quote encapsulates why I strongly disagree with Noah Feldman’s Bloomberg column on the new word limits for federal appellate briefs.
The new rules reduce the number of words in opening briefs by 1,000, and in reply briefs by 500. Feldman argues that the reduction will cut down billable hours. He’s wrong; it will do the opposite.
When I was in practice, I spent nearly as much time cutting words from briefs as I did doing the initial draft. Every first draft clocked in at more than the then-limit of 14,000 words; in some cases, I was closer to 21,000 words my first time through. Only after substantial editing – going over each sentence again and again, and (naturally) taking serious liberties with Bluebook format – was I able to bring briefs within the limit. (I never went this far, though.)
(Note to Lexis: You are at a disadvantage relative to Westlaw because your citation format for unpublished cases has more words. I did initial research on Lexis but then translated all citations to Westlaw to bring my word count down. Rookie mistake, guys.)
For what it’s worth, I think the new limits are a travesty. Judges often berate attorneys for prolix writing – particularly when they’re drafting complaints, while trying to meet increasingly byzantine pleading standards – and it’s unfair. Yes, there are extreme cases of bad writing and bad lawyering, but at the end of the day, if lawyers had the talent of Hemingway, they wouldn’t be lawyers, and there’s a certain limit to what can be reasonably demanded. Judges assume that if word limits are reduced, lawyers will cut the excess verbiage – usually unnecessarily florid language, hyperbole, etc – but there is just no assurance of that; lawyers often ex ante misjudge what is hyperbolic and what is substantive. The wasted pages are a small price (for clerks) to pay in order to make sure that attorneys can get their arguments heard. (Especially in light of evidence that word reductions harm appellants more than appellees, which I assume is due to the fact that the appellee has the district court opinion to function as a supplementary brief on its behalf).
Frankly, if there’s a pressing need to reduce judges’ reading load, I recommend jettisoning the reply brief. Though certainly many plaintiffs make good use of replies, in my experience both as a clerk and in practice, the vast majority of replies did nothing more than repeat arguments in the opening brief, without truly responding to the arguments made in the response brief. So if something has to be cut, that's what has my vote.
Wednesday, October 12, 2016
I am preparing to teach the doctrine on controlling shareholders in my corporations class tomorrow, and found the recent Delaware opinions on non-controlling shareholder cleansing votes and the BJR to be helpful illustrations of the law in this area.
In summer 2016, the Delaware Court of Chancery dismissed two post-closing actions alleging a breach of fiduciary duty where there was no controlling shareholder in the public companies, where the stockholder cleaning vote was fully informed, and applied the 2015 Corwin business judgment rule standard. The cases are City of Miami General Employees’ & Sanitation Employees’ Retirement Trust v. Comstock, C.A. No. 9980-CB, (Del. Ch. Aug. 24, 2016) (Bouchard, C.) and Larkin v. Shah, C.A. No. 10918-VCS, (Del. Ch. Aug. 25, 2016) (Slights, V.C.), both of which relied upon Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304 (Del. 2015). (Fellow BLPB blogger Ann Lipton has written about Corwin here).
The Larkin case clarified that Corwin applies to duty of loyalty claims and will be subject to the deferential business judgment rule in post-closing actions challenging non-controller transactions where informed stockholders have approved the transaction. The Larkin opinion states that:
(1) when disinterested, fully informed, uncoerced stockholders approve a transaction absent a looming conflicted controller, the irrebuttable business judgment rule applies; (2) there was no looming conflicted controller in this case; and (3) the challenged merger was properly approved by disinterested, uncoerced Auspex stockholders. Under the circumstances, the business judgment rule, irrebuttable in this context, applies. ....The standard of review that guides the court’s determination of whether those duties have been violated defaults to a deferential standard, the business judgment rule, which directs the court to presume the board of directors “acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company.” In circumstances where the business judgment rule applies, Delaware courts will not overturn a board’s decision unless that decision 'cannot be attributed to any rational business purpose.' This broadly permissive standard reflects Delaware’s traditional reluctance to second-guess the business judgment of disinterested fiduciaries absent some independent cause for doubt. Larkin at 21-22 (internal citations omitted).
Two-sided controller transactions (a freeze out merger where a controlling shareholder stands on both sides of the transaction) is covered by the 2014 Kahn v. M & F Worldwide Corp., 88 A.3d 635(Del. 2014) case, which I summarized in an earlier BLPB post here.
To refresh our readers, the controlling shareholder test is a stockholder who owns a majority of stock. Additionally, a stockholder may qualify as a controller if:
Under Delaware law, a stockholder owning less than half of a company’s outstanding shares may nonetheless be deemed a controller where 'the stockholder can exercise actual control over the corporation’s board.'This “actual control” test requires the court to undertake an analysis of whether, despite owning a minority of shares, the alleged controller wields “such formidable voting and managerial power that, as a practical matter, [it is] no differently situated than if [it] had majority voting control.'A controlling stockholder can exist as a sole actor or a control block of “shareholders, each of whom individually cannot exert control over the corporation . . . [but who] are connected in some legally significant way—e.g., by contract, common ownership agreement, or other arrangement—to work together toward a shared goal.' Larkin at 33-34 (internal citations omitted).
Excellent commentary on theLarkin and Comstock cases and their practical implications can be found on the Harvard Law School Forum on Corporate Governance and Financial Regulation, available here.
Saturday, October 8, 2016
I am intrigued by this new genre of financial writing that warns (in increasingly apocalyptic terms) that passive investing will lead to increasingly distorted and inefficient markets.
Nevsky Capital, a large hedge fund, noisily shut its doors last year with an investor letter that blamed, among other things, index investing that distorted correlations among stocks.
Sanford C. Bernstein & Co., LLC. recently published a note declaring that passive investing is “worse than Marxism” because at least Marxism allocates capital according to some kind of principle, whereas passive investing allocates capital by the happenstance of inclusion in an index.
And a research analyst recently posted “The Last Active Investor,” a short story that posits a dystopian future in which all market prices are set by a single person performing the world’s only fundamental research.
It’s true that index investing distorts stock prices to some degree, though there has been plenty of pushback to the claim that there’s any real danger of passive investing overtaking the market, especially since the definition of passive investing itself might be somewhat malleable in an age of increasingly sophisticated computerized trading.
But what I’m mostly curious about is what sorts of policy fixes defenders of active investment would recommend. The Bernstein note is vague on this but apparently objects to government-sponsored initiatives that would favor passive investment of pension funds. Meanwhile, Steve Johnson writing at the Financial Times proposes that passive investing actually be taxed to subsidize active investing. And the author of the Last Active Investor does not say so explicitly, but he appears to favor some kind of loosening of insider trading restrictions – at least, that’s what I gather from the part of the story (spoiler alert!) where the Active Investor’s fundamental research is treated as market manipulation.
Of course, it’s somewhat ludicrous to suggest that workers should invest their retirement funds in a less profitable manner so that white collar business analysts can be subsidized in their important price setting work, and it seems to me that if passive investing is to be taxed to subsidize active investing, we probably want to make sure that active investors are keeping their costs down – which probably means some kind of vetting as well as salary and price controls, and … oh no, I think I maybe just endorsed the Marxism theory.
Saturday, October 1, 2016
I have to say, it pains me that this is even news – that price maintenance as a form of fraud on the market should, I believe, be unexceptionable, indeed, necessary for the theory to function properly.
But the idea has been at least somewhat rejected by the Fifth Circuit – see Greenberg v. Crossroads Sys., 364 F.3d 657 (5th Cir. 2004) – and defendants are vigorously disputing the legitimacy of price maintenance elsewhere.
So it comes as something of a relief that in In re Vivendi, S.A. Sec. Litigation, 2016 U.S. App. LEXIS 17566 (2d Cir. Sept. 27, 2016), the Second Circuit has now joined the Eleventh Circuit, see FindWhat Inv’r Grp. v. FindWhat.com, 658 F.3d 1282 (11th Cir. 2011), and the Seventh Circuit, see Glickenhaus & Co. v. Household Int’l, Inc., 787 F.3d 408 (7th Cir. 2015), with a full-throated endorsement of the idea that even if a fraudulent statement does not introduce “new” inflation into a stock’s price – even if it simply maintains existing inflation by confirming an earlier false impression – that too violates Section 10(b) and is actionable using the fraud on the market doctrine.
Beyond this simple holding, though, there are some interesting nuggets buried in the reasoning that are worth exploring.
First, the Second Circuit discussed the policy reasons for recognizing price maintenance as a form of fraud. It offered a hypothetical example of a company where – due to its past operating history – investors make certain assumptions about the quality of its products. Those assumptions are false with respect to a new product. Under such circumstances, the stock price is inflated, but not because of any fraud by the company. In that situation, if price maintenance is not actionable, the company would be completely free to fraudulently confirm investors’ false assumptions.
I’d only add to that that there are plenty of situations where the initial inflation might be due not to investors’ faulty assumptions, but due to the company’s own actions. In FindWhat, for example, the initial inflation was introduced by the company’s own false statements – but the Eleventh Circuit concluded that the original statements were not made with scienter, so they were inactionable. If price maintenance theory is not accepted, then once a company negligently misinforms the market, it is free to intentionally do so (but see the duty to correct, discussed below).
Similarly, in IBEW Local 98 Pension Fund v. Best Buy Co., 818 F.3d 775 (8th Cir. 2016) (which I previously discussed here, the initial false statements were immunized by the PSLRA’s safe harbor. If price maintenance theory is not accepted, companies can simply lie via forward looking statements, and use the resulting artificial inflation to lie about related facts.
The second thing worth discussing is that one of Vivendi’s arguments was that even if a statement confirmed previous (false) information, that statement could only have “propped up” the previously-inflated price if silence would have revealed the truth. That is, in Vivendi’s view, if simply remaining silent would have had the same effect as the confirmatory false statement (and silence was an option, i.e., there were no affirmative disclosure requirements in play), then the statement cannot be said to have impacted price.
That’s an argument that’s been endorsed by Don Langevoort (see Compared to What? Econometric Evidence and the Counterfactual Difficulty, 35 J. Corp. L. 183 (2009); see also Judgment Day for Fraud-on-the-Market: Reflections on Amgen and the Second Coming of Halliburton, 57 Ariz. L. Rev. 37 (2015)), and I’ve also gone back and forth about here and in my essay Searching for Market Efficiency, 57 Ariz. L. Rev. 71 (2015).
But the Second Circuit rejected the silence comparator wholeheartedly. Part of the reasoning was kind of a burden-shifting idea: we’ll never know what would have happened if the company remained silent, because Vivendi chose to speak. And Vivendi is responsible for that.
But additionally, the Second Circuit fell back on the point that once a company chooses to speak, it has a duty to speak fully and accurately. In other words, once Vivendi chose not to remain silent, it did not have the option of failing to reveal the truth.
The reason I find this striking is that it’s a roundabout way of getting at what would have been a much simpler frame: The duty to correct.
The duty to correct is fairly uncontroversial in theory. See, e.g., Overton v. Todman & Co., 478 F.3d 479 (2d Cir. 2007); Gallagher v. Abbott Labs., 269 F.3d 806 (7th Cir. 2001)). Once a company knows it has issued false statements, it has a duty to correct them.
Here, the plaintiffs must have proven that Vivendi was aware of the fraud – we wouldn’t even be discussing price maintenance if it was unaware – so presumably, Vivendi did not have an option of remaining silent; it was legally obligated to confess.
But the duty to correct has always been a bit tough to parse, if for no other reason than it is difficult to pinpoint which person precisely in the corporation has that duty. See United States v. Schiff, 602 F.3d 152 (3d Cir. 2010); but see Barrie v Intervoice-Brite, 409 F.3d 653 (5th Cir. 2005). In Vivendi, the jury found the corporate defendant liable but absolved the individual ones, which renders the problem more complex.
Moreover, it's not clear how the duty to correct comes into play if the original statements were immunized - like, say, via the PSLRA safe harbor.
So rather than discuss whether Vivendi had an affirmative duty to speak once it realized that earlier statements were false, the Second Circuit instead simply said that the confirmatory statements were themselves the equivalent of half-truths that gave rise to a duty of a full confession. As the Second Circuit put it, “in suggesting that, had it remained silent, the misconception‐induced (whether or not fraud‐induced) inflation would have persisted in the market price, Vivendi assumes it is even relevant what would have happened had it chosen not to speak. Yet in framing the argument this way, Vivendi misunderstands the nature of the obligations a company takes upon itself at the moment it chooses, even without obligation, to speak. It is well‐established precedent in this Circuit that ‘once a company speaks on an issue or topic, there is a duty to tell the whole truth…’”
In any event, the upshot is: Price maintenance as an argument solidly prevails; we’ll see if defendants have better luck with their opposition in other circuits.
Monday, September 26, 2016
In recent weeks, co-bloggers Ann Lipton and Anne Tucker both have posted on issues relating to the upcoming Supreme Court oral argument in Salman v. U.S. Indeed, this is an important case for the reason they each cite: resolution of the debate about whether the receipt of a personal benefit should be a condition to tippee liability for insider trading (under Section 10(b) of/Rule 10b-5 under the Securities Exchange Act of 1934, as amended), when the tipper and tippee are close family members. Certainly, many of us who teach and litigate insider trading cases will be watching the oral argument and waiting for the Court's opinion to see whether, and if so, how, the law evolves.
Having noted that common interest (as among many) in the Salman case, as I earlier indicated, I have a broader interest in the Salman case because of a current project I am working on relating to family relationships and friendships in insider trading--both as a matter of tipper-tippee liability (as in Salman) and as a matter of the duty of trust and confidence necessary to misappropriation liability. The project was borne in part of a feeling that I had, based on reported investigations and cases I continued to encounter, that expert network and friends-and-family insider trading cases were two very common insider trading scenarios that implicate uncertain insider trading doctrine under U.S. law.
While I have been distracted by other things, my research assistant has begun to gather and reflect on the data we are assembling about publicly reported friends and family insider trading acting between 2000 and today. Here are some preliminary outtakes that may be of interest based on the first 40 cases we have identified.
- 16 of the cases involve friendships;
- 7 cases involve marital relationships;
- 7 cases involve romantic relationships outside marriage (e.g., lover, mistress, boyfriend);
- 5 cases involving siblings;
- 3 cases involve a parent/child relationship; and
- 3 cases on involve in-laws.
Those categories capture the vast majority of cases we have identified so far. The cases represented in the list are primarily from 2011-2016. Some cases involve more than one type of relationship. So, the number of observations in the list above exceeds 40.
Another key observation is that most initial tippers in these cases are men. Notable exceptions are SEC v. Hawk and SEC v. Chen, described in this 2014 internet case summary. Six cases found and analyzed to date involve female tippees.
Theories in the cases derive from both classical and misappropriation scenarios. I will say more on that in a subsequent post. For now, however, perhaps the most important take-away is that my intuition that there are many cases involving exchanges of material nonpublic information in family relationships and friendships appears to be solid. Hopefully, the Court will help resolve unanswered questions about insider trading doctrine as applied in these cases, starting with the personal benefit question raised in Salman.
Saturday, September 24, 2016
I’m sure I’m not alone in having followed the spectacular fall of Theranos over the past year. Elizabeth Holmes was a fairytale come to life – and now, the main question seems to be whether she intentionally defrauded her investors and the public, or whether she was simply in denial about the limitations of her technology.
(I personally don’t see the two as mutually exclusive – many fraudsters lie in the expectation that they can soon turn things around and no one will be any the wiser. In this case, there’s just too much evidence that Holmes was consciously evasive when questioned about her technology for me to believe that she wasn’t intentionally misleading people)
It’s probably too tempting to try to draw lessons from the Theranos debacle, but there are some interesting issues it raises.
First, I wonder whether Theranos is an argument for or against initiatives like the JOBS Act that make it easier for companies to raise large amounts of capital without holding an IPO.
On the one hand, because Theranos never went public, the fallout was contained; we haven’t seen the spectre of thousands of retail investors directly or indirectly losing their pensions.
On the other hand, Theranos illustrates exactly why we subject companies to the IPO process. There were, apparently, plenty of red flags right from the beginning, which caused the most savvy venture capitalists to steer clear of it. If the company had been forced to file an S-1 and subject it to general scrutiny, the problems might have been uncovered a lot sooner, and a lot of the damage prevented. If the company had been forced to file an S-1 before raising such large amounts of capital, it probably never would have raised the capital at all.
If nothing else, then, Theranos highlights the inadequacy of the accredited investor definition.
The second aspect of Theranos that I find fascinating is that a young woman was able to pull off this kind of fraud. It’s no secret that women in general have a hard time raising start up capital; in general, it’s the province of white men – relying on a pedigree and an image – to bewitch investors so thoroughly. Yet somehow Elizabeth Holmes was able to sell a convincing story built on technobabble and a romantic story. It’s almost heartening, in a dark sort of way – how far we’ve come! – but more seriously, I worry that Holmes will now serve as a cautionary tale for investors considering companies helmed by women.
With all that said, I'm filled with glee at the prospect of the movie – which apparently will star Jennifer Lawrence, under the direction of Adam McKay (who also directed The Big Short). That’s going to be a hoot!
Wednesday, September 21, 2016
The enticing facts of insider trading have me writing about the topic again (see an earlier post here) as the US Supreme Court prepares to hear oral argument in Salman v. US on October 5th. In Salman, the Supreme Court is asked to draw some careful lines in the questions: what benefit counts and how to prove such a benefit under Dirks v. SEC.
Recall that in Dirks, the Supreme Court focused the test on whether an insider benefitted—either by trading or by tipping in exchange for a benefit from the person to whom she tipped material nonpublic information. After Dirks, the 10b inquiry is whether the insider breached a duty by conveying the information for the insider’s personal benefit, and whether the tippee knows or at least should know of the breach. The Court explained that even in a case against a tippee who trades "Absent some personal gain [by the insider], there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach [by the tippee]."
The Salman case highlights a circuit split: the Second Circuit case United States v. Newman and the Ninth Circuit's ruling in Salman. In Salman, the question is whether prosecutors had to prove that the brother-in-law, Maher Kara, disclosed nonpublic securities information in exchange for a personal benefit. Is it enough that the insider and the tippee shared a close family relationship or must there be direct evidence as required in Newman?
The Ninth Circuit framed the benefit requirement inquiry, established in Dirks, as a gift of confidential information to a trading relative or a friend. The prosecution offered direct evidence of nonpublic information as a gift. The Ninth Circuit, and the Government, relied upon this passage in Dirks:
There may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.
The Second Circuit read the Dirks benefit test more narrowly, saying it required “proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential and represents at least a potential gain of a pecuniary or similarly valuable nature.”
So what is the right answer? The Government lamented the Newman decision as "dramatically limit[ing] the Government’s ability to prosecute some of the most common, culpable, and market-threatening forms of insider trading.” Whereas others (see here) have criticized the Government's position in Newman and the subsequent basis of the Salman ruling as reviving the “parity of information” standard rejected by Supreme Court in both Chiarella and Dirks. Focusing on friendship and defining it broadly weakens the benefit test advanced in Dirks.
As someone who teaches insider trading and has followed the fascinating case facts for years, I am looking forward to oral argument and see the next step in the evolution of insider trading. Co-blogger Ann Lipton tee'd up the Salman case in her post earlier this week with her usual whit and charm.
Saturday, September 17, 2016
As part of my “scared straight” strategy for teaching insider trading, I like to tell my students horror stories of attorneys who have been caught up in scandals (as well as the collective *facepalm* reaction of the bar, which is as much due to the stupidity of the schemes as to their immorality).
Last year, I recounted the curious case of Robert Schulman and King Pharmaceuticals.
Schulman was an attorney representing King Pharmaceuticals, and he learned that the company would soon be acquired by Pfizer. He told his friend and investment adviser, Tibor Klein, who promptly purchased King shares for himself and his clients (some of which were allocated to Schulman’s account). All told, Klein generated about $328K in profits.
The SEC charged Klein with insider trading in 2013. Interestingly, the SEC did not accuse Schulman of tipping; instead, the SEC’s theory was that Schulman had gotten tipsy at dinner and shot off at the mouth, ultimately blurting out, “It would be nice to be King for a day.” (When I tell my students this part, I imagine how that might have been said – presumably, with an exaggerated wink and heavy emphasis on the word “King”). Klein, having been given the information in confidence, wronged Schulman by misappropriating it for his own use.
Except it seemed to me that the SEC never really believed Schulman’s claim that he had never intended to tip his friend. Why? Because most of the time, when the SEC files a complaint that involves nonparties, the SEC is careful to conceal their names. (For example) If necessary, the SEC might describe them as Person A or Witness B, that kind of thing.
But not in the King case. There, the SEC could not have been more forthcoming with Schulman’s name, which it repeated ad nauseam throughout the complaint – along with the potentially career-destroying details of his drunkenness, and his desire to impress his friend as a “big shot.” So it always struck me that the subtext here was, if the SEC couldn’t prove that Schulman intended to tip his friend, by god, it was going to embarrass him as much as it could.
Well, it took another three years, but the SEC has finally gotten its man, in a way: the Brooklyn US Attorney has charged both Schulman and Klein with criminal insider trading, with potential penalties of up to 20 years in prison.
King for a day, under a sword of Damocles.
Saturday, September 10, 2016
I’m finding the controversy over the Epipen price increases fascinating, because of its hoist-by-their-own-petard quality.
When Mylan acquired Epipen in 2007, it wasn't a particularly popular product. Then Mylan started a heavy marketing push, which included increasing awareness of the dangers of allergies, publicizing how Epipen could save lives in emergencies, and lobbying for legislation requiring that Epipens be stocked in public places as an emergency health device, like defibrillators. Because Mylan did a tremendous job of persuading the public that the Epipen was a critical medical device, it was able to raise prices dramatically - and now, having convinced everyone and his mother that Epipens are indispensable, the company is getting backlash for price gouging on this life-saving technology (not to mention becoming the target of investigations and lawsuits over, among other things, Medicaid fraud and state law antitrust violations).
Haskell previously posted about the Epipen situation, and connected the issue to the shareholder wealth maximization norm in corporate law. Going further, he asked whether, from a policy perspective, we particularly want to encourage some other sort of stakeholder model for the healthcare industry.
I guess my point is, the issue is not just price increases; it extends to profit motive in determining what counts as a health threat in the first place.
Further to that, it’s worth highlighting that the FDA has been easing its prior restrictions on off-label drug marketing, out of concerns that suppressing the dissemination of truthful information may violate corporate free speech rights. That has ominous implications for the pharmaceutical industry – why would companies go through extensive hoops to expand a drug’s labeling when they can get it approved for a single use, and then just market it for everything else? – and it also makes me wonder when we’re going to see more First Amendment challenges to securities regulation.
Saturday, September 3, 2016
At this point, it almost feels like I’ve been following the securities fraud case against Halliburton my entire career. I was grimly amused when I heard that the Fifth Circuit had granted an interlocutory appeal – again! – to hear a challenge to class certification – again! and I diligently tracked the docket on Bloomberg, only for it to belatedly sink in that – wait a minute, I actually live in New Orleans now. I can go see the oral argument in person, live, in color.
So I did.
It was … interesting.
[More under the jump]
Saturday, August 27, 2016
I’ve been fascinated by the efforts of various state attorneys general to investigate Exxon for securities fraud on the ground that its climate change denial misleads investors about the risks of investing in the company. Exxon has filed a lawsuit in Texas to halt the inquiries, arguing that they infringe on its free speech rights, and Congressman Lamar Smith, head of the House science committee, has subpoenaed the attorneys general involved, to determine if this is a coordinated political attack on the company. The dispute has even made it into the Democratic party platform, which states that “All corporations owe it to their shareholders to fully analyze and disclose the risks they face, including climate risk. … Democrats also respectfully request the Department of Justice to investigate allegations of corporate fraud on the part of fossil fuel companies accused of misleading shareholders and the public on the scientific reality of climate change.”
An investigation by the Virgin Islands was dropped; as far as I know, both the New York and Massachusetts investigations continue, and investigations by other states. Exxon’s lawsuit remains pending.
It’s not a new idea, to claim that securities regulation impinges on free speech rights – the DC Circuit struck down part of the SEC’s conflict minerals rule on just that ground – but usually these arguments are aimed at rules that require issuers to speak, or prohibit issuers from making truthful statements. The Exxon case is unusual because it comes in the context of, well, false statements.
At the same time, though, one cannot help but suspect that the real concern isn’t investors, but the nature of Exxon’s participation in public political debates.
[More under the jump]
Saturday, August 20, 2016
Upper level classes start next week, and I am scrambling to prepare. So for my post, I’ll just drop some quick links to things I found interesting this week:
First, a nice long read for Saturday: How Lending Club’s Biggest Fanboy Uncovered Shady Loans. This is a deep dive into the story of a retail investor who dug into Lending Club’s loan data – and discovered that Lending Club was padding its loan data before the company confessed publicly. He also seems to have discovered a pattern of repeat borrowers that the company has never disclosed.
Second, here is an editorial by a Deutsche Bank risk-officer-turned-SEC-whistleblower who says he is rejecting his reward, out of disgust that the company – and its shareholders – will be paying the fines that rightly should be charged to the company’s executives. He blames the SEC's “revolving door,” pointing out that top SEC lawyers had formerly been employed by Deutsche Bank (though they were recused from the investigation). The gesture would be slightly more impressive if it didn’t turn out that most of his reward is going to his lawyers, the experts he hired, and his ex-wife as part of his divorce settlement, and he doesn’t have the legal power to turn it down. But he totally would if he could.*
Third, the jurors in the Sean Stewart insider trading trial report that their deliberations took a long time because they couldn't quite decide if the defendant received a "personal benefit" under United States v. Newman standards by passing tips to his father. Obviously, whether a "benefit" is even necessary for a relationship this close is something that the Supreme Court is set to determine in Salman v. United States; in the meantime, it seems as though courts in New York are stuck asking about the quid pro quo between fathers and sons. Harsh, man. Couldn't the prosecutors have just argued that the father gave his son life?
*okay, I might be being unfair; his award is in excess of $8 million, so even after paying off everyone else, he may be rejecting a sizeable sum. Still, it's funny that he's trying to turn down money that, um, belongs to his ex-wife.
Saturday, August 13, 2016
One of the more interesting aspects of state corporate law – and Delaware law in particular - is the blurring of the line between substantive regulation and procedural regulation. Delaware gives corporate directors a great deal of leeway ex ante to structure transactions as they see fit, but if they structure them in a way that arouses suspicions – like, for example, failing to create an independent committee to negotiate a deal with a controlling shareholder – Delaware increases judicial scrutiny of the transaction, which, in practical terms, means that when the inevitable class action is filed, the defendants cannot win a quick dismissal on the pleadings. The “carrot” that Delaware offers directors to adopt best practices is the possibility of a quick, cheap dismissal of claims. Delaware regulates, in part, via threats of civil procedure.
This particular mode of regulation was on full display in In re Trulia, Inc. Stockholder Litig., 129 A.3d 884 (Del. Ch. 2016). There, Chancellor Bouchard held that Delaware would only approve disclosure-only settlements in deal class actions where the new disclosures were “plainly material.” Note, this is not the substantive standard for disclosures – it is not the standard necessary to win at trial. It is not the standard that an individual plaintiff would have to meet. It is only the standard for the settlement of a merger class action.
Which immediately begged the question: What happens if another state is entertaining a merger case involving a Delaware company? Does the Trulia standard count as a substantive rule of law, subject to the internal affairs doctrine, or a procedural one, that varies based on the forum?
It’s a critical issue, obviously, because if Trulia does not apply outside of Delaware, it will be very easy for plaintiffs and defendants to reach collusive settlements in foreign fora.
Well, we now have some answers, though they point in different directions: In Vergiev v. Cooper, a New Jersey state court held that Trulia is a substantive rule of law, and thus it applies even for cases brought outside of Delaware. (Opinion here; Alison Frankel blogs here). And just a few days ago, the Seventh Circuit applied Trulia in a case involving an Illinois corporation - implicitly suggesting that Trulia is a procedural (but persuasive) rule. Either way, it appears Trulia is on its way to general acceptance in the context of merger litigation.
That said, this only partly takes care of part of the problem of destructive competition among plaintiffs’ firms; as I’ve blogged before, there is still no real cure for the problem of plaintiffs who compete by racing to a settlement. Forum selection bylaws are not necessarily a panacea, because defendants can waive them – which may allow them to strategically pick off stronger plaintiffs and settle with weaker ones. The next step, therefore, is coming up with something like an MDL process for corporate litigation (a suggestion that others have made, see, e.g., Minor Myers, Fixing Multi-Forum Shareholder Litigation, 2014 U. Ill. L. Rev. 469; Elizabeth Cosenza, The Persistent Problem of Multi-Forum Shareholder Litigation: A Proposed Statutory Response to Reshuffle the Deck, 10 Va. L. & Bus. Rev. 413 (2016)).
Saturday, August 6, 2016
Saturday, July 30, 2016
For reasons that don’t need exploring at this juncture, I was in the mood to rewatch two big business movies of the 1980s: The Secret of My Success (dir. Herbert Ross, 1987) and Working Girl (dir. Mike Nichols, 1988).
Eighties business movies are something of their own minigenre – see, e.g., Trading Places, Wall Street, and Baby Boom – but the reason Secret of My Success and Working Girl are worth comparing is that they basically tell the same story, but with the genders flipped.
Both films are about young business naïfs (Michael J. Fox and Melanie Griffith, respectively), who have jobs at the bottom of the corporate ladder (mail room, secretary). Frustrated that their talents and skills are being overlooked, both impersonate corporate executives, colonizing vacant offices and aggressively pursuing their innovative business strategies. There is plenty of farce as they juggle their dual identities, and both enter into conflicted romances with executives who have been taken in by the charade. Ultimately, their identities are revealed but their talents recognized, and they are rewarded with the jobs (and love interests) they deserve.
But despite the nearly mirror-image plots, the two could not be more different in social message.
In The Secret of My Success, Michael J. Fox plays a young college graduate, raised in farm country and new to the big city. He’s been hired for a junior executive position but when he arrives on his first day, he finds his job has disappeared in a wave of layoffs. He is can’t find new work because of his lack of experience, and because employers are only interested in hiring minority women, not white men.
His parents suggest he seek a job from a distant uncle, who just happens to head a multinational conglomerate. The uncle puts him in the mailroom – an indignity not to be borne – which is what prompts Fox to embark on his grand ruse. It turns out that he has greater insight, smarts, and diligence than any of his colleagues.
In other words, according to this movie, even though Fox is just out of college with no work experience, he is entitled to a management job on the strength of nepotism, and it is the height of injustice that he’s expected to work his way up through corporate ranks.
In Working Girl, by contrast, Melanie Griffith plays a girl from the wrong side of the tracks (Staten Island), who has been trying to climb the corporate ladder for years. She fought through night school to get her degree; since then, she’s struggled at a variety of low-status business jobs, trying to learn whatever she could along the way. What’s held her back, explicitly, is sexism and classism. When she ultimately snaps and begins her ruse, it’s because the game is stacked against her – as she puts it at the end of the film: “You can bend the rules plenty once you get upstairs but not while you’re trying to get there, and if you’re someone like me, you can’t get there without bending the rules.” Notably, she’s talented and insightful, but the movie revolves around the fact that she has one particular good idea – unlike Fox, who essentially is ready to restructure the company after a couple of months.
Working Girl, then, is about forcing open the doors of the business world to people who have historically been locked out; Secret of My Success is about how, well, people who look like Michael J Fox are just naturally entitled to great jobs.
I’m not saying the politics of Working Girl are above reproach – Sigourney Weaver’s evil-businesswoman character ultimately bears the brunt of the film’s criticism, blunting the feminist message – but the movie goes out of its way to indict the business world for excluding people who don’t begin life with privilege. Secret of My Success does the other thing.
Saturday, July 23, 2016
It looks like the Fifth Circuit is becoming increasingly isolated.
After the Supreme Court decided Dura Pharmaceuticals, Inc. v. Broudo, 544 US 336 (2005), a circuit split developed as to how plaintiffs can satisfy the element of loss causation in a Section 10(b) action.
All circuits agree that loss causation can be shown via “corrective disclosures” – some kind of explicit communication to the market that prior statements were false, followed by a drop in stock price.
However, as I’ve discussed before, there has been an alternative theory that plaintiffs can use to show loss causation, even without an explicit corrective disclosure. The theory is usually described as “materialization of the risk.” It requires the plaintiff to show that the fraud concealed some condition or problem that, when revealed to the market, caused the stock price to drop, even if the market was not made aware that the losses were due to fraud. For example, a company may report a slowdown in sales, causing its stock price to fall, while concealing the fact that the slowdown was due to an earlier period of channel stuffing. By the time the channel stuffing is revealed, it may communicate no new information about the company’s prospects, so the stock price remains unmoved. Under a materialization of the risk theory, the price drop upon disclosure of the fall in sales would be sufficient to allege loss causation.
The Fifth Circuit has rejected materialization of the risk theory, requiring some kind of communication to the market that the earlier statements were false. The Ninth Circuit generally has done the same, but there’s enough wiggle room in its caselaw that it agreed to hear an interlocutory appeal in Mineworkers’ Pension Scheme, et al v. First Solar Incorporated, et al, No. 15-17282, to resolve the issue.
And this week, in Ohio Public Employees Ret. Sys. v. Federal Home Loan Mortgage Corporation et al. - the long-running crisis-era case alleging that Freddie Mac concealed its exposure to bad mortgage loans - the Sixth Circuit joined the vast majority of circuits in holding that materialization of the risk is sufficient to satisfy the element of loss causation (quietly glossing over earlier caselaw that had seemed to endorse the corrective disclosure standard). Among other things, the Sixth Circuit expressed concern that companies will easily be able to evade liability if liability is functionally predicated on a corporate confession of wrongdoing. That’s a reasonable concern: as Barbara A. Bliss, Frank Partnoy, and Michael Furchtgott have found, in the wake of Dura, corporations have adopted disclosure strategies aimed at masking the cause of stock price reactions, allowing them to reduce litigation risk. (I blogged about an earlier version of the paper here).
Saturday, July 16, 2016
You may have seen the news that Gretchen Carlson, a former Fox News anchor, is suing Roger Ailes, the Fox News Chair and CEO, for sexual harassment and retaliation. One of the interesting things about the case is that – like a lot of people – Carlson has an arbitration clause in her contract requiring her to arbitrate all claims arising out of her employment
So how is she able to bring this case?
Well, Carlson is suing Ailes personally – not Fox News. Her argument is that her arbitration agreement is with Fox News alone; Ailes is not a signatory to the agreement, and cannot benefit from it.
I first have to note that this argument is only available to Carlson at all because Ailes is wealthy, and (I assume) covered by insurance; most employees in similar situations don’t have the option of suing only their harasser (rather than their employer), because most individual harassers are likely to be judgment proof.
Beyond that, is Carlson right? Is this a way around her arbitration agreement?
Well, according to Richard Frankel, there is a split of authority as to whether arbitration agreements to extend to agents of the signatories in their individual capacities, even when those agents were never parties to the agreement. See Richard Frankel, The Arbitration Clause as Super Contract, 91 Wash. U. L. Rev. 531 (2014). So there’s a real question as to whether Ailes has the right to enforce Carlson’s arbitration agreement, even though he was not a party to it.
Carlson’s attorneys are not giving up the fight so quickly, though. They claim – with at least some support, see Arnold v. Arnold Corp., 920 F.2d 1269 (6th Cir. 1990) – that even when arbitration clauses extend to corporate agents, they only extend to actions taken by the agent in their capacity as agent; they do not cover actions taken by the agent on their own behalf. In this case, Carlson’s attorneys apparently intend to claim that Ailes was not acting on Fox News’s behalf when he harassed Carlson, even though he may have been an agent of Fox for the purposes of retaliation. Thus, the former claims need not be arbitrated, even if the latter claims must be.
Now, at least some courts have endorsed a concept of “concerted misconduct” that might preclude this kind of claim-splitting. See Christopher Driskill, Note, A Dangerous Doctrine: The Case Against Using Concerted-Misconduct Estoppel to Compel Arbitration, 60 Ala. L. Rev. 443 (2009). But more generally, I am concerned about the argument that employees are acting for their own gratification, and not on behalf of the employer, when they harass. Courts have long been suspicious of respondeat superior in the context of harassment claims, suggesting (as Carlson apparently intends to argue) that harassment represents a personal frolic rather than a mechanism for maintaining institutional barriers to the advancement of underprivileged groups. See Burlington Indus. v. Ellerth, 524 U.S. 742 (1998). That means that a court could accept Carlson's argument – particularly a court hostile to arbitration clauses – but perversely end up creating a lot of mischief for the many employees who rely on respondeat superior for any relief at all.
That said, there’s another aspect to this dispute that I find interesting. According to the rumour mill, Roger Ailes has long been targeted for ouster by Rupert Murdoch’s sons. If Fox News had been named as a defendant in Carlson’s suit, the company might have been forced to close ranks around Ailes. But – ironically – because Fox News is not a defendant, the company appears to have the option of leaving Ailes twisting in the wind, and Murdoch’s sons in particular may use the lawsuit as an excuse to get rid of Ailes once and for all.
Saturday, July 9, 2016
Speaking of tactics that managers use thwart shareholder activists -
Sean Griffith and Natalia Reisel have posted a new paper to SSRN, Dead Hand Proxy Puts, Hedge Fund Activism, and the Cost of Capital, analyzing the effects of dead hand proxy puts. These are loan covenants that allow the lender to require complete loan repayment in the event of a change of control that results from an actual or threatened proxy contest, and that cannot be waived by the borrower – i.e., the incumbent directors cannot settle with the dissident, give their blessing to the new directors, and thereby avoid the provisions (the “dead hand”).
Now my instinct on these provisions has always been that they improperly interfere with shareholder suffrage by insulating the incumbent board from the market for corporate control. I wondered whether these provisions were in fact valued by lenders, or whether they were inserted at the behest of management to protect themselves from challenge, with lender acquiescence/indifference.
But the authors find that these provisions do, in fact, have value to lenders – and thus to corporations. They are more likely to be adopted by firms that are potential targets of shareholder activists (unsurprising), and, critically, they lower the cost of the firm’s debt.
The authors also find that though the provisions tend to be found in loan agreements – where they can be easily waived or modified if the lenders believe a change of control will not imperil the loan – their presence may be valued by bondholders, who cannot use such provisions as easily because it is more difficult for them to overcome collective action problems to modify them later. (Question: is it likely activists would bargain with the lenders in advance, and make the lenders’ endorsement part of their platform when soliciting shareholders? Is that a thing activists do? I admit my ignorance. If not – if the activist intends to bargain after gaining control – that would be a helluva risk for shareholders to take.)
In any event, the upshot appears to be, directors can preempt a proxy fight and increase corporate value by adopting this kind of financial technology, which is different than the financial technology that activists would likely adopt, but - unlike typical activist tactics - benefits both shareholders and creditors.
The critical question, then, is whether the value to shareholders generated by these provisions is equal to the value that would be generated by a shareholder activist. The authors state that they will analyze this question in connection with an upcoming paper – and I look forward to seeing what they come up with.
Saturday, July 2, 2016
There have recently been several high profile news items about companies using dual class share structures.
First, Facebook announced that it would issue a class of nonvoting shares so that Mark Zuckerberg could maintain his control over the company via his supervoting shares, in a move reminiscent of a similar tactic by Google a couple of years ago.
(A fun game I like to play with my students: compare the stock prices of voting shares of Google with the prices of nonvoting shares, and then talk about the two, in light of the fact that Sergey Brin and Larry Page control the majority of the voting power regardless due to their supervoting shares.)
Second, Lionsgate announced it would be acquiring Starz, in a partially cash, partially stock deal. Because Starz has a dual class structure – with supervoting power held by John Malone – the arrangement involves Lionsgate creating a new class of nonvoting shares. Holders of Starz A shares will get cash and nonvoting Lionsgate shares, while holders of Starz B shares (e.g., Malone) get less cash, but both voting and nonvoting Lionsgate shares.
Third, Mondelez just made a bid to buy Hershey – one that could be blocked by the Hershey Trust that controls 80% of the voting power via dual class shares.
Dual class share structures are all the rage these days. The growing popularity of dual class structures suggests that as investors gain more power in the governance structure – via legal changes, and via the increasing concentration of share ownership – corporate managers are fighting back with new tools to cabin investors’ influence.
But dual class structures carry some fairly obvious dangers – some of which are now on full display in the show trials regarding Sumner Redstone and Viacom. In brief, Viacom has a dual class structure with most of the voting stock held by a company called National Amusements, which itself is controlled by Sumner Redstone. Redstone is 93 years old and recently ousted the Chair of Viacom, as well as other Viacom directors, setting up court battles in Delaware and Massachusetts regarding his competency.
With dual class structures' increasing popularity, I’m sure we can expect a lot more conflicts (and more development of the law). It will be interesting to see whether there will be enough institutional investor pushback to cabin their use, and/or create some standardized features (sunset provisions, limits on the creation of new nonvoting share classes, etc).