Saturday, December 3, 2016
There are always policy questions about the degree to which public regulation should be enforced by government actors, by private actors, or by a combination of both. In securities law, for example, striking the right balance is a perennial debate.
Which is why I read with interest this New York Times story about efforts to combat counterfeiting in China.
China has a serious problem with counterfeit goods. To some extent, that kind of problem can be addressed via government enforcement actions; however, China also suffers from what one might describe as an extreme case of regulatory capture – namely, corruption at the local level that compromises enforcement efforts.
So China has turned to private enforcement, by bolstering its consumer protection laws: consumers who purchase counterfeit goods can get damages equal to several times the value of the product. And predictably, these laws have spawned a new profession: counterfeit hunting.
That by itself would not be so bad – why not let consumers, acting like private attorneys general, ferret out counterfeit goods? The problem is, since damages are based on the number of products purchased, hunters purchase counterfeits in large numbers, filling warehouses with them. They also target minor labeling errors as much as serious fraud.
In other words, they exhibit all of the problems inherent in private enforcement: failure to exercise discretion over where to direct resources, arbitraging claims/creating injuries (and failing to mitigate damage) in order to support a lawsuit. These are precisely the accusations that have been leveled at, for example, stockholder plaintiffs and appraisal arbitrageurs.
China is apparently considering a new law that would ban counterfeit hunting as a commercial activity – akin to PSLRA provisions that prohibit so-called professional plaintiffs. But given the unreliability of government enforcement in China, it strikes me that to do so would throw the baby out with the bathwater. Yet absent such measures, China’s left with an extreme version of a common problem: private plaintiffs don’t draw distinctions between serious problems and minor ones if the monetary payout is the same. That distinction is one that has to be drawn in the substantive law.
We do that in securities by, for example, imposing standing, reliance, and loss causation requirements on private plaintiffs that government does not have to satisfy, and allowing government to bring claims based on an expanded set of violations (e.g., aiding and abetting). And we've done that, in a roundabout way, with state law fiduciary claims: there is no government enforcement in that arena, which has led to increasing limitations on private liability (exculpatory provisions, demand requirements) with no corresponding expansion of state enforcement. But that regulatory gap has been rapidly filled at the federal level with fiduciary-like requirements (independent director requirements, books and records requirements, and so forth) that can only be enforced by regulators.
It's an imperfect system, of course; it'll be interesting to see how China grapples with the same problem.
Saturday, November 26, 2016
Okay, this post has nothing to do with the subject line; given the time of year, I just couldn’t resist.
(Maybe we’ll just characterize that episode of WKRP in Cincinnati as a demonstration of PR tactics gone wrong. See? There’s a business law hook).
Anyhoo, today I want to call attention to the phenomenon of the fake whistleblowing hotline.
As compliance becomes an increasingly large part of corporate operations – and a de facto reconfiguration of corporate governance standards – it seems that companies are fond of creating “whisteblowing hotlines” to demonstrate their commitment to compliance with the law. Public companies, in fact, are required to do so under Sarbanes-Oxley.
Which is why two recent news items are so disturbing. First, in connection with the Wells Fargo fake account scandal – on which both Anne Tucker and Marcia Narine Weldon recently posted– it turns out that employees who offered tips on the Wells Fargo whistleblowing hotline were quickly fired; meaning that the hotline itself operated as a kind of reverse-ethics test to weed out employees most likely to object to Wells Fargo’s practices.
And it turns out that Wyndham Vacation Ownership did the same thing. This company, which sells time shares using legally dubious tactics, also has an “integrity hotline” that it uses, apparently, to identify and fire salespeople who have integrity.
It strikes me that these incidents are particularly pernicious. They represent traps to catch employees who might be troubled by the company's behavior, while faking compliance with the law - a false compliance that may not easily be detected. And they imply a certain degree of premeditation: if you set up a hotline and then misuse it, presumably, you know what you're doing. I realize that federal and state laws provide penalties for retaliation against whistleblowers; I do wonder if there can be especially tough scrutiny of adverse employment decisions in the wake of utilization of company-established compliance procedures - like, perhaps, a presumption that punitive damages should be awarded. I’m not an expert in this area, though; does anything like this exist? Could it?
Saturday, November 19, 2016
For this week's post, I offer a plug. I just posted to SSRN a draft chapter, Limiting Litigation Through Corporate Governance Documents, for the forthcoming Research Handbook on Representative Stockholder Litigation (Sean Griffith et al., eds. 2017), published by Edward Elgar Publishing. For those who are interested, here is the abstract:
There has recently been a surge of interest in “privately ordered” solutions to the problem of frivolous stockholder litigation, in the form of corporate bylaw and charter provisions that place new limitations on plaintiffs’ ability to bring claims. The most popular type of provision has been the forum selection clause; other provisions that have been imposed include arbitration requirements, fee-shifting to require that losing plaintiffs pay defendants’ attorneys’ fees, and minimum stake requirements. Proponents argue that these provisions favor shareholders by sparing the corporation the expense of defending against meritless litigation. Drawing on the metaphor of corporation as contract, they argue that litigation limits are often enforced in ordinary commercial contracts, and that bylaws and charter provisions should be interpreted similarly.
In this chapter, I recount the history of these provisions and the state of the law regarding their enforceability. I then discuss some of the doctrinal and policy questions that have been raised regarding different types of litigation limits, and the propriety of private ordering in this context. In particular, I explore how corporate managers’ structural and informational advantages may make litigation limits easy to abuse; moreover, litigation itself serves public purposes that may be more appropriately subject to public control.
Saturday, November 12, 2016
The results of Tuesday’s election stunned most people – including internal analysts within the Trump camp – because the polling seemed to give Clinton an insurmountable lead. She was ahead of Trump in many states, and though there was great room for uncertainty in each poll, everyone assumed that even if there were some polling errors, there were not enough to make a difference in outcome. I.e., she could lose Ohio and Florida and still win so long as she held Pennsylvania and so forth, so it seemed as though even accounting for polling error, there was little chance she could lose.
That assumption, however, ignored the possibility that all of the errors were correlated – so that an error in one state’s polls meant that the same error would be replicated across multiple states. That’s something that Nate Silver accounted for in his model, however, and others rejected, and it contributed to Silver's more bearish Clinton predictions.
And of course, that’s what happened with respect to mortgage backed securities as well. Everyone knew that some mortgages would fail – and that some RMBS tranches would fail – but the assumption was that there were enough of them that any errors would not damage an entire pool. What many (though, as with Clinton, not all) people failed to foresee was that the errors were correlated, so that they stood or fell in unison. What seems so obvious in retrospect was difficult to understand at the time.
Saturday, November 5, 2016
I’m traveling today so this will be quick (actually, I drafted this in advance to go up automatically and I’m very much hoping that whatever happens, the appeal won’t have been decided before this post appears).
Earlier this year, Chancellor Bouchard decided Sandys v. Pincus, regarding whether demand was excused in a derivative action against the board of Zynga. And I love this case because it is a shockingly good teaching tool for the concept of demand excusal. The plaintiffs filed three claims – I edit out the last one and just stick with counts I and II.
The opinion beautifully describes the nature of the inquiry, and it even has a nice chart showing the differences in composition between the board accused of wrongdoing, and the demand board.
In the first two counts, there is a sharp distinction drawn between board members who are potentially interested because of liability due to personal benefits/self-dealing, and board members who are potentially interested because they face personal liability for other reasons.
The court also clearly marches through the question of whether any disinterested board members are nonetheless dependent on interested directors, demonstrating how – despite rather extensive social and business ties – none of it is enough to meet the standard to show dependence. To make matters even better, one of the interested directors is a controlling shareholder, allowing for discussion of independence/dependence when a controlling shareholder is in the mix.
And as a bonus, the case involves a set of companies that are likely to be familiar to students – Zynga, with discussions of Facebook, LinkedIn, and Mozilla.
Honestly, this case is so ideal for a complex subject that I’m mostly just crossing my fingers that nothing in the appeal – whether the plaintiffs ultimately win or lose – undermines the usefulness of the Chancery decision.
(By the way, the appeal also may represent an opportunity for the Delaware Supreme Court to finally merge Aronson and Rales – which Chancellor Bouchard almost seems to be inviting the Court to do. If nothing else, that much would certainly simplify the teaching.)
Saturday, October 29, 2016
A couple of interesting studies about gender in the business context have recently been released.
First, a study by A. Can Inci, M.P. Narayanan, and H. Nejat Seyhun concludes – based on profits earned from insider trading - that women executives have less access to inside information than do men with similar positions. They attempt to control for the fact that women may simply be more risk averse by controlling for trade size; they find, however, that even when doing so, men make more than women. Of particular interest is the fact that even though their study goes back to 1975 (when there were fewer women executives), they find that the gender differences are stronger in more recent years, from 1997-2012. They believe that the differences are attributable to informal networking that grants men access to better information than women; these differences fall away for firms that have a greater proportion of women executives.
Second, the Rockefeller Foundation finds that when a company experiences a crisis and the CEO is a woman, eighty percent of news stories cite her as a problem; when the CEO is a man, only thirty-one percent of news stories cite him as a problem.
Of course, it’s possible that the reporting is entirely accurate – maybe women CEOs are responsible for crises more often than men. But there are, of course, other potential explanations. For example, biases against women generally – a sense that she doesn’t deserve the position – or perhaps the fact that women generally only achieve CEO status when a company is already experiencing problems. I’ll also throw out another possibility: Salience. There’s a fairly well-documented psychological phenomenon whereby people attribute causality to whatever is salient about a situation. The thing that draws their attention is assumed to be the cause. That thing might be an entirely neutral characteristic – like having red hair in a group of brunettes, or wearing a striped shirt – or, in the case of CEOs, being a woman in a position typically held by men. Of course, if salience is partially the cause, I'd expect successes also to be disproportionately credited to women - and I have no idea whether that's the case, or whether an interaction of biases could prevent such a phenomenon from surfacing.
What it comes down to is, we can really only be sure of our perceptions when enough women occupy the CEO position to make them unnoticeable.
Saturday, October 22, 2016
The Economist recently published an opinion piece arguing that bigotry has become a lucrative business. As the magazine puts it:
The country is in an unusually flammable mood. This being America, there are plenty of businesspeople around to monetise the fury—to foment it, manipulate it and spin it into profits. These are the entrepreneurs of outrage and barons of bigotry who have paved the way for Donald Trump’s rise….
Breitbart News, in particular, has excelled in pushing boundaries. … It has provided platforms in its comment section for members of far-right hate groups who rail against immigration and Jews.
The outrage industry has clearly reached a milestone with Donald Trump’s presidential campaign. …He won the hearts of 13m Republican primary voters by recycling conservative media hits such as “build a wall” and “ban all Muslims”. …
There are big bucks in bigotry
Twitter has been a particularly virulent source of online bigotry and abuse. Buzzfeed recently published an article on Twitter’s 10-year failure to halt hate speech – often targeted at particular users – that stems from a combination of corporate dysfunction, failure of (white, male) corporate leadership to recognize the problem, and business exigencies that emphasized user growth. In this election season, Twitter has become a famous platform for bigoted trolling, often aimed at journalists who oppose Donald Trump.
But it appears that bigotry as a profit-center only goes so far. Twitter has been plagued recently by a stagnant user base and correspondingly declining stock price; as a result, it has been seeking an acquirer. But according to recent news reports, Twitter’s troll problems are driving away potential bidders.
So, it seems there’s at least a built-in limit as to how far bigotry can take you.
Saturday, October 15, 2016
That Pascal quote encapsulates why I strongly disagree with Noah Feldman’s Bloomberg column on the new word limits for federal appellate briefs.
The new rules reduce the number of words in opening briefs by 1,000, and in reply briefs by 500. Feldman argues that the reduction will cut down billable hours. He’s wrong; it will do the opposite.
When I was in practice, I spent nearly as much time cutting words from briefs as I did doing the initial draft. Every first draft clocked in at more than the then-limit of 14,000 words; in some cases, I was closer to 21,000 words my first time through. Only after substantial editing – going over each sentence again and again, and (naturally) taking serious liberties with Bluebook format – was I able to bring briefs within the limit. (I never went this far, though.)
(Note to Lexis: You are at a disadvantage relative to Westlaw because your citation format for unpublished cases has more words. I did initial research on Lexis but then translated all citations to Westlaw to bring my word count down. Rookie mistake, guys.)
For what it’s worth, I think the new limits are a travesty. Judges often berate attorneys for prolix writing – particularly when they’re drafting complaints, while trying to meet increasingly byzantine pleading standards – and it’s unfair. Yes, there are extreme cases of bad writing and bad lawyering, but at the end of the day, if lawyers had the talent of Hemingway, they wouldn’t be lawyers, and there’s a certain limit to what can be reasonably demanded. Judges assume that if word limits are reduced, lawyers will cut the excess verbiage – usually unnecessarily florid language, hyperbole, etc – but there is just no assurance of that; lawyers often ex ante misjudge what is hyperbolic and what is substantive. The wasted pages are a small price (for clerks) to pay in order to make sure that attorneys can get their arguments heard. (Especially in light of evidence that word reductions harm appellants more than appellees, which I assume is due to the fact that the appellee has the district court opinion to function as a supplementary brief on its behalf).
Frankly, if there’s a pressing need to reduce judges’ reading load, I recommend jettisoning the reply brief. Though certainly many plaintiffs make good use of replies, in my experience both as a clerk and in practice, the vast majority of replies did nothing more than repeat arguments in the opening brief, without truly responding to the arguments made in the response brief. So if something has to be cut, that's what has my vote.
Wednesday, October 12, 2016
I am preparing to teach the doctrine on controlling shareholders in my corporations class tomorrow, and found the recent Delaware opinions on non-controlling shareholder cleansing votes and the BJR to be helpful illustrations of the law in this area.
In summer 2016, the Delaware Court of Chancery dismissed two post-closing actions alleging a breach of fiduciary duty where there was no controlling shareholder in the public companies, where the stockholder cleaning vote was fully informed, and applied the 2015 Corwin business judgment rule standard. The cases are City of Miami General Employees’ & Sanitation Employees’ Retirement Trust v. Comstock, C.A. No. 9980-CB, (Del. Ch. Aug. 24, 2016) (Bouchard, C.) and Larkin v. Shah, C.A. No. 10918-VCS, (Del. Ch. Aug. 25, 2016) (Slights, V.C.), both of which relied upon Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304 (Del. 2015). (Fellow BLPB blogger Ann Lipton has written about Corwin here).
The Larkin case clarified that Corwin applies to duty of loyalty claims and will be subject to the deferential business judgment rule in post-closing actions challenging non-controller transactions where informed stockholders have approved the transaction. The Larkin opinion states that:
(1) when disinterested, fully informed, uncoerced stockholders approve a transaction absent a looming conflicted controller, the irrebuttable business judgment rule applies; (2) there was no looming conflicted controller in this case; and (3) the challenged merger was properly approved by disinterested, uncoerced Auspex stockholders. Under the circumstances, the business judgment rule, irrebuttable in this context, applies. ....The standard of review that guides the court’s determination of whether those duties have been violated defaults to a deferential standard, the business judgment rule, which directs the court to presume the board of directors “acted on an informed basis, in good faith and in the honest belief that the action was taken in the best interests of the company.” In circumstances where the business judgment rule applies, Delaware courts will not overturn a board’s decision unless that decision 'cannot be attributed to any rational business purpose.' This broadly permissive standard reflects Delaware’s traditional reluctance to second-guess the business judgment of disinterested fiduciaries absent some independent cause for doubt. Larkin at 21-22 (internal citations omitted).
Two-sided controller transactions (a freeze out merger where a controlling shareholder stands on both sides of the transaction) is covered by the 2014 Kahn v. M & F Worldwide Corp., 88 A.3d 635(Del. 2014) case, which I summarized in an earlier BLPB post here.
To refresh our readers, the controlling shareholder test is a stockholder who owns a majority of stock. Additionally, a stockholder may qualify as a controller if:
Under Delaware law, a stockholder owning less than half of a company’s outstanding shares may nonetheless be deemed a controller where 'the stockholder can exercise actual control over the corporation’s board.'This “actual control” test requires the court to undertake an analysis of whether, despite owning a minority of shares, the alleged controller wields “such formidable voting and managerial power that, as a practical matter, [it is] no differently situated than if [it] had majority voting control.'A controlling stockholder can exist as a sole actor or a control block of “shareholders, each of whom individually cannot exert control over the corporation . . . [but who] are connected in some legally significant way—e.g., by contract, common ownership agreement, or other arrangement—to work together toward a shared goal.' Larkin at 33-34 (internal citations omitted).
Excellent commentary on theLarkin and Comstock cases and their practical implications can be found on the Harvard Law School Forum on Corporate Governance and Financial Regulation, available here.
Saturday, October 8, 2016
I am intrigued by this new genre of financial writing that warns (in increasingly apocalyptic terms) that passive investing will lead to increasingly distorted and inefficient markets.
Nevsky Capital, a large hedge fund, noisily shut its doors last year with an investor letter that blamed, among other things, index investing that distorted correlations among stocks.
Sanford C. Bernstein & Co., LLC. recently published a note declaring that passive investing is “worse than Marxism” because at least Marxism allocates capital according to some kind of principle, whereas passive investing allocates capital by the happenstance of inclusion in an index.
And a research analyst recently posted “The Last Active Investor,” a short story that posits a dystopian future in which all market prices are set by a single person performing the world’s only fundamental research.
It’s true that index investing distorts stock prices to some degree, though there has been plenty of pushback to the claim that there’s any real danger of passive investing overtaking the market, especially since the definition of passive investing itself might be somewhat malleable in an age of increasingly sophisticated computerized trading.
But what I’m mostly curious about is what sorts of policy fixes defenders of active investment would recommend. The Bernstein note is vague on this but apparently objects to government-sponsored initiatives that would favor passive investment of pension funds. Meanwhile, Steve Johnson writing at the Financial Times proposes that passive investing actually be taxed to subsidize active investing. And the author of the Last Active Investor does not say so explicitly, but he appears to favor some kind of loosening of insider trading restrictions – at least, that’s what I gather from the part of the story (spoiler alert!) where the Active Investor’s fundamental research is treated as market manipulation.
Of course, it’s somewhat ludicrous to suggest that workers should invest their retirement funds in a less profitable manner so that white collar business analysts can be subsidized in their important price setting work, and it seems to me that if passive investing is to be taxed to subsidize active investing, we probably want to make sure that active investors are keeping their costs down – which probably means some kind of vetting as well as salary and price controls, and … oh no, I think I maybe just endorsed the Marxism theory.
Saturday, October 1, 2016
I have to say, it pains me that this is even news – that price maintenance as a form of fraud on the market should, I believe, be unexceptionable, indeed, necessary for the theory to function properly.
But the idea has been at least somewhat rejected by the Fifth Circuit – see Greenberg v. Crossroads Sys., 364 F.3d 657 (5th Cir. 2004) – and defendants are vigorously disputing the legitimacy of price maintenance elsewhere.
So it comes as something of a relief that in In re Vivendi, S.A. Sec. Litigation, 2016 U.S. App. LEXIS 17566 (2d Cir. Sept. 27, 2016), the Second Circuit has now joined the Eleventh Circuit, see FindWhat Inv’r Grp. v. FindWhat.com, 658 F.3d 1282 (11th Cir. 2011), and the Seventh Circuit, see Glickenhaus & Co. v. Household Int’l, Inc., 787 F.3d 408 (7th Cir. 2015), with a full-throated endorsement of the idea that even if a fraudulent statement does not introduce “new” inflation into a stock’s price – even if it simply maintains existing inflation by confirming an earlier false impression – that too violates Section 10(b) and is actionable using the fraud on the market doctrine.
Beyond this simple holding, though, there are some interesting nuggets buried in the reasoning that are worth exploring.
First, the Second Circuit discussed the policy reasons for recognizing price maintenance as a form of fraud. It offered a hypothetical example of a company where – due to its past operating history – investors make certain assumptions about the quality of its products. Those assumptions are false with respect to a new product. Under such circumstances, the stock price is inflated, but not because of any fraud by the company. In that situation, if price maintenance is not actionable, the company would be completely free to fraudulently confirm investors’ false assumptions.
I’d only add to that that there are plenty of situations where the initial inflation might be due not to investors’ faulty assumptions, but due to the company’s own actions. In FindWhat, for example, the initial inflation was introduced by the company’s own false statements – but the Eleventh Circuit concluded that the original statements were not made with scienter, so they were inactionable. If price maintenance theory is not accepted, then once a company negligently misinforms the market, it is free to intentionally do so (but see the duty to correct, discussed below).
Similarly, in IBEW Local 98 Pension Fund v. Best Buy Co., 818 F.3d 775 (8th Cir. 2016) (which I previously discussed here, the initial false statements were immunized by the PSLRA’s safe harbor. If price maintenance theory is not accepted, companies can simply lie via forward looking statements, and use the resulting artificial inflation to lie about related facts.
The second thing worth discussing is that one of Vivendi’s arguments was that even if a statement confirmed previous (false) information, that statement could only have “propped up” the previously-inflated price if silence would have revealed the truth. That is, in Vivendi’s view, if simply remaining silent would have had the same effect as the confirmatory false statement (and silence was an option, i.e., there were no affirmative disclosure requirements in play), then the statement cannot be said to have impacted price.
That’s an argument that’s been endorsed by Don Langevoort (see Compared to What? Econometric Evidence and the Counterfactual Difficulty, 35 J. Corp. L. 183 (2009); see also Judgment Day for Fraud-on-the-Market: Reflections on Amgen and the Second Coming of Halliburton, 57 Ariz. L. Rev. 37 (2015)), and I’ve also gone back and forth about here and in my essay Searching for Market Efficiency, 57 Ariz. L. Rev. 71 (2015).
But the Second Circuit rejected the silence comparator wholeheartedly. Part of the reasoning was kind of a burden-shifting idea: we’ll never know what would have happened if the company remained silent, because Vivendi chose to speak. And Vivendi is responsible for that.
But additionally, the Second Circuit fell back on the point that once a company chooses to speak, it has a duty to speak fully and accurately. In other words, once Vivendi chose not to remain silent, it did not have the option of failing to reveal the truth.
The reason I find this striking is that it’s a roundabout way of getting at what would have been a much simpler frame: The duty to correct.
The duty to correct is fairly uncontroversial in theory. See, e.g., Overton v. Todman & Co., 478 F.3d 479 (2d Cir. 2007); Gallagher v. Abbott Labs., 269 F.3d 806 (7th Cir. 2001)). Once a company knows it has issued false statements, it has a duty to correct them.
Here, the plaintiffs must have proven that Vivendi was aware of the fraud – we wouldn’t even be discussing price maintenance if it was unaware – so presumably, Vivendi did not have an option of remaining silent; it was legally obligated to confess.
But the duty to correct has always been a bit tough to parse, if for no other reason than it is difficult to pinpoint which person precisely in the corporation has that duty. See United States v. Schiff, 602 F.3d 152 (3d Cir. 2010); but see Barrie v Intervoice-Brite, 409 F.3d 653 (5th Cir. 2005). In Vivendi, the jury found the corporate defendant liable but absolved the individual ones, which renders the problem more complex.
Moreover, it's not clear how the duty to correct comes into play if the original statements were immunized - like, say, via the PSLRA safe harbor.
So rather than discuss whether Vivendi had an affirmative duty to speak once it realized that earlier statements were false, the Second Circuit instead simply said that the confirmatory statements were themselves the equivalent of half-truths that gave rise to a duty of a full confession. As the Second Circuit put it, “in suggesting that, had it remained silent, the misconception‐induced (whether or not fraud‐induced) inflation would have persisted in the market price, Vivendi assumes it is even relevant what would have happened had it chosen not to speak. Yet in framing the argument this way, Vivendi misunderstands the nature of the obligations a company takes upon itself at the moment it chooses, even without obligation, to speak. It is well‐established precedent in this Circuit that ‘once a company speaks on an issue or topic, there is a duty to tell the whole truth…’”
In any event, the upshot is: Price maintenance as an argument solidly prevails; we’ll see if defendants have better luck with their opposition in other circuits.
Monday, September 26, 2016
In recent weeks, co-bloggers Ann Lipton and Anne Tucker both have posted on issues relating to the upcoming Supreme Court oral argument in Salman v. U.S. Indeed, this is an important case for the reason they each cite: resolution of the debate about whether the receipt of a personal benefit should be a condition to tippee liability for insider trading (under Section 10(b) of/Rule 10b-5 under the Securities Exchange Act of 1934, as amended), when the tipper and tippee are close family members. Certainly, many of us who teach and litigate insider trading cases will be watching the oral argument and waiting for the Court's opinion to see whether, and if so, how, the law evolves.
Having noted that common interest (as among many) in the Salman case, as I earlier indicated, I have a broader interest in the Salman case because of a current project I am working on relating to family relationships and friendships in insider trading--both as a matter of tipper-tippee liability (as in Salman) and as a matter of the duty of trust and confidence necessary to misappropriation liability. The project was borne in part of a feeling that I had, based on reported investigations and cases I continued to encounter, that expert network and friends-and-family insider trading cases were two very common insider trading scenarios that implicate uncertain insider trading doctrine under U.S. law.
While I have been distracted by other things, my research assistant has begun to gather and reflect on the data we are assembling about publicly reported friends and family insider trading acting between 2000 and today. Here are some preliminary outtakes that may be of interest based on the first 40 cases we have identified.
- 16 of the cases involve friendships;
- 7 cases involve marital relationships;
- 7 cases involve romantic relationships outside marriage (e.g., lover, mistress, boyfriend);
- 5 cases involving siblings;
- 3 cases involve a parent/child relationship; and
- 3 cases on involve in-laws.
Those categories capture the vast majority of cases we have identified so far. The cases represented in the list are primarily from 2011-2016. Some cases involve more than one type of relationship. So, the number of observations in the list above exceeds 40.
Another key observation is that most initial tippers in these cases are men. Notable exceptions are SEC v. Hawk and SEC v. Chen, described in this 2014 internet case summary. Six cases found and analyzed to date involve female tippees.
Theories in the cases derive from both classical and misappropriation scenarios. I will say more on that in a subsequent post. For now, however, perhaps the most important take-away is that my intuition that there are many cases involving exchanges of material nonpublic information in family relationships and friendships appears to be solid. Hopefully, the Court will help resolve unanswered questions about insider trading doctrine as applied in these cases, starting with the personal benefit question raised in Salman.
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)).