Saturday, May 27, 2017
And now, there’s the fake news thing:
As a video circulated that appeared to partially absolve President Donald Trump in the administration’s Russian meddling scandal on trading floors on Thursday, stocks surged for the first time in days on the apparent breaking news.
The video, it turns out, was actually two weeks old, misleadingly edited with the intention of falsely accusing former FBI director James Comey of perjury—and was initially aired by conspiracy website InfoWars on Thursday around noon.
Trump wasn’t cleared. In fact, since the video had been around since May 3rd, nothing had changed at all. But by the time traders found out, the dollar index had spiked anyway.
The fallout of the story is leaving analysts wondering how to absorb information in a market that is suddenly waiting on bated breath for the latest rumors to come out of the White House—even when those rumors are intentionally misleading or untrue.
In other words, the news can be fake, but the rally it creates in the stock market is very real.
[Adam] Button, [the chief currency analyst at ForexLive] said that InfoWars isn’t a site that “anyone on Wall Street usually really believes,” but people may change their reading habits after Thursday’s surge.
“People were asking me today, ‘Is Infowars a site I have to start reading now?’ And I said, ‘The answer is yes,’’ said Button.
“You’re not trading on what’s true and what’s false. You’re trading on what the average voter believes is true. It’s a propaganda war.”
The markets chose a particularly inauspicious day to use InfoWars source material to determine what’s happening. Less than 24 hours before the rally, InfoWars host and founder Alex Jones was forced to apologize to and retract articles about Chobani as part of a settlement. …
It’s the second time in two months Jones was forced to apologize and pull down content for claims made on InfoWars. In March, Jones read out a written apology on his show to James Alefantis, whom InfoWars had falsely suggested was running a child sex ring tied to Hillary Clinton’s campaign out of the basement of a pizza shop. Content that had included those allegations were pulled down.
“The idea of trading on propaganda—it’s a strange feeling,” said Button. “Politics is a distraction for the most part, but it’s not anymore. This is taking over.”
Still, would Button recommend reading InfoWars just in case it’s a predictor of how the market might react to bombshell political news—even if it isn’t true?
“I want to say, ‘Yeah, read it now,’” he said. “But the rest of me says, ‘Don’t read that garbage.’”
We have seriously entered Keynesian beauty contest territory; traders don’t care what’s real anymore - all that matters is what other people think is real, at least for a brief period of time.
Saturday, May 13, 2017
Joshua Fershee started a conversation about incompetent male leaders, so in keeping with that theme, here are a couple of other interesting data points.
First, a new study shows that male loan officers are more willing to lend money to other men – especially men they bond with. (Bloomberg story here; paper here). That doesn’t work out so well for the banks; these loans are more likely to default. Women loan officers do not suffer from the same bias.
The critical point, for me, is that these biases exist even though they are unprofitable (in short term thinking, anyway; they may be very profitable for men as a group, long term). It’s an obvious point but it bears repeating: prejudice resists evidence. The market cannot cure problems that prejudice bars it from perceiving.
As for why women do not, in these studies, suffer from the same bias (or do not suffer to the same degree), it's not that women are especially rational as compared to men; it's simply that, to quote the immortal philosopher, Douglas Adams:
It is difficult to be sat on all day, every day, by some other creature, without forming an opinion about them. On the other hand, it is perfectly possible to sit all day, every day, on top of another creature and not have the slightest thought about them whatsoever.
Saturday, May 6, 2017
If you’re like me, you’ve been absolutely riveted by the disaster that was Fyrefest. For anyone who somehow missed the news, the basic recap is that a destination music festival – sold as a luxury getaway in the Bahamas featuring sandy beaches, rock stars, five-star accommodations, and gourmet meals turned out to be, well –
Instead of luxury villas, guests found soggy tents, port-o-potties, and a bank of lockers (without locks). They had to hunt for their luggage in a large shipping container – with flashlights. And so forth.
There have been a number of news articles attempting to deconstruct how things went so horribly wrong, but the focus of my particular interest is – incompetence or fraud? There are already two class action lawsuits pending, so we’ll have more information soon enough, but reports so far indicate a rather stunning willful-blindness on the part of the promoter – 25-year-old Billy McFarland – coupled with the somewhat-contradictory fact that he’s still around, apologizing to disappointed ticketbuyers, and generally not, you know, running off to a country with no U.S. extradition treaty.
[More under the jump]
Saturday, April 29, 2017
The internet is a wonderful thing; this week, it has brought us two powerful new tools related to business law.
First, the Center for Political Accountability has aggregated the political spending disclosures of public companies in a handy, searchable website. Granted, it's a limited tool: it only includes companies in the S&P 500 (or that were in the S&P 500 as of 2015) - and unfortunately the descriptions on the site are less than clear on this point. To that extent, then, it is useful as a sample of corporate behavior, but not as useful for specific shareholder or consumer action. In that vein, I view it as something of a pilot project, demonstrating the theoretical power of the internet to harness these kinds of disclosures. There are already apps that make it easier for consumers to express their political preferences – Boycott Trump and Buycott.com, for example. This new site is another weapon – or potentially one – in the arsenal.
Marcia has expressed doubt that these kinds of campaigns work, and certainly there’s the countermobilization problem – a campaign on one side the political aisle may motivate those on the other side – but my own view is more in the behavioral vein: if you make it easier to do, it’s more likely people will do it. So, yes, there are a lot of reasons why consumers or shareholders might not vote via their dollars, but at each point where you make it easier for them to express political preferences with their spending/investing decisions, the number who do so will increase, and at some point you may see a consistent impact.
Second, we have the white collar crime heat map, which presents a zip-by-zip breakdown of areas where white collar crime proliferates. I was horrified to discover the extent of my daily jeopardy in the years in which I worked in midtown Manhattan; I feel much safer now that I live in New Orleans.
More seriously, the site is not a new joke, but it remains a relevant one: namely, as a comment on what we as a society accept as racial/class/cultural markers of criminality, even as white collar crime remains – numerically speaking – a far greater problem than street crime.
For more analysis of this problem, I leave you with Jessica Williams of The Daily Show:
Saturday, April 22, 2017
I’m sure we’ve all been riveted by the colorful activist campaign led by Elliott Management Corp challenging the board of directors at Arconic Inc. In some tellings, it’s a classic battle over whether companies should focus on immediate returns to shareholders (and whether activist pressure encourages short-term thinking), or whether companies should invest in innovation and research in hopes of a longer-term payoff.
This week, Elliott’s challenge netted it a scalp in the form of the forced resignation of the CEO, Klaus Kleinfeld, for sending a personal letter to the head of Elliott Management that vaguely threatened to reveal some apparently scandalous behavior undertaken during the 2006 World Cup. While denying that any such behavior occurred, Elliot Management demanded Kleinfeld’s ouster, and the Arconic Board complied.
But the battle rages on. Earlier this month, Arconic announced that if investors voted to seat Elliott’s board nominees, it could trigger the change-of-control provisions in Arconic’s deferred compensation and retirement plans, thus forcing Arconic to make a $500 million pay out.
Which just prompted this Section 14 lawsuit by an Arconic investor, accusing Arconic of manufacturing “fake news” because there is, in fact, no risk of a change of control. At which point, I mourn the missed opportunity for a “wolf” reference.
(The plaintiff's argument, by the way, is that a set of directors appointed earlier at Elliott’s urging do not count as part of a new controlling group, and therefore Elliott’s latest nominees constitute only a minority of the board. The case is City of Atlanta Firefighters’ Pension Fund v. Arconic et al., No. 1:17-cv-02840 (S.D.N.Y.).)
Joking aside, courts have recently looked askance at dead hand proxy puts, even if they do have shareholder value-enhancing effects in the context of loan agreements and bond offerings. The Arconic situation is a bit more unusual, however, because the obligations are to company employees rather than lenders, and I don’t know whether the same economic effects exist in that context. The fact that the trust at issue was established for “a select group of management and/or highly compensated employees and former employees” raises the specter – in future cases if not this one – of a new twist on the old golden-parachute-as-takeover-defense. I am curious to see what courts make of it.
Tuesday, April 18, 2017
Please join me in celebrating the one-year blogiversary of the Surly Subgroup! The Surly Subgroup is a tax blog with several contributing tax professors, including my colleague, Shu-Yi Oei (soon to be ex-colleague, sadly, as she will soon be leaving Tulane for Boston College). If you're interested in tax issues with 'tude, you should check it out!
Saturday, April 15, 2017
So I was looking over Snap’s S-1, and I discovered this:
Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for:
- any derivative action or proceeding brought on our behalf;
- any action asserting a breach of fiduciary duty;
- any action asserting a claim against us arising under the Delaware General Corporation Law, our amended and restated certificate of incorporation, or our amended and restated bylaws; and
- any action asserting a claim against us that is governed by the internal-affairs doctrine.
Our amended and restated certificate of incorporation further provides that the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act.
The first provisions are a fairly unremarkable (these days) set of forum selection clauses, but in that last point, Snap has gone a step further by attempting to control the forum of federal claims in addition to state claims. In so doing, Snap is obliquely referring to the ongoing dispute about whether SLUSA requires that Section 11 class actions be litigated in federal court, or whether, instead, class actions under Section 11 may be maintained in state court. The Supreme Court is considering whether to rule on this issue, but Snap has apparently decided to belt-and-suspender it.
I don’t know if this is a common provision in IPO documents these days, but I do hope that if the enforceability of the provision is ever litigated, courts will not blindly assume that such provisions are “contractual” and therefore as binding as any other forum selection provision in an ordinary contract between transacting parties.
I’ve written quite a bit about whether charters and bylaws are contractual, and the enforceability of forum selection provisions. See Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, 104 Geo. L.J. 583 (2016); Limiting Litigation Through Corporate Governance Documents, in Research Handbook on Representative Shareholder Litigation (Sean Griffith et al., eds., forthcoming 2017). One of the arguments I've repeatedly made is that courts should not simply assume that charters and bylaws may dictate terms about federal claims as they have about state law internal affairs claims.
Charters and bylaws are not like ordinary contracts; instead, the state of incorporation determines the permissible provisions, the procedures by which they can be amended, the fiduciary duties of managers when invoking these provisions, and the rights and powers of shareholders to influence their content. (For example, states decide whether the clause must appear in the charter, whether shareholders must vote, and whether and under what conditions management may waive these provisions). States are not positioned to make the appropriate policy determinations when the matter involves a federal, rather than state, regulatory scheme.
Indeed, it is not obvious that Delaware even authorizes the charter provision that Snap has adopted. In 2015, Delaware amended its law to authorize corporations to adopt charter and bylaw provisions that select Delaware as a forum for internal affairs claims. See DGCL § 115. As I have argued previously, that statute (and related Delaware caselaw) should be interpreted to mean that only internal affairs claims, and not other kinds of claims, may be governed by charters and bylaws. But even if the statute is interpreted to allow corporations broad freedom to dictate the terms on which plaintiffs may bring federal securities claims, as some have suggested, see John C. Coffee, Update on “Loser Pays” Fee Shifting; Stephen M. Bainbridge, Fee-Shifting: Delaware’s Self-Inflicted Wound, 40 Del. J. Corp. L. 851 (2016), the broader point is that there is no reason that Delaware should be deciding these important matters of federal policy.
To be sure, one might argue that this is no different than ordinary contracts – state law, too, determines the rules that govern ordinary contracts, and yet these contracts may contain enforceable forum selection provisions regarding federal rights.
But that is not quite the same. We may assume that Congress generally intended to import into federal law certain state law standards regarding contracts and corporate law, but that presumption may be overcome depending on the particular state law in question. See generally Kamen v. Kemper Financial Services, 500 U.S. 90 (1991). It is not obvious that Congress intended that state corporate law – including idiosyncratic approaches to shareholder powers within the corporation – would govern forum selection for federal claims, especially since state law did not even grant corporations these powers until 2013. See Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013).
But more fundamentally, as I have explained in the context of arbitration, within the corporate structure, shareholders and directors are not on equal footing. Shareholder power is sharply limited by legal ground rules that vest directors with broad discretion to take action on behalf of the corporation as they see fit. The justification for this power differential is that corporate directors are better positioned to make decisions on behalf of the corporation, and that shareholders are too uninformed, selfish, or heterogeneous to be trusted with the power to determine the corporation’s fate. Such an approach is at odds with the general concept of “contract,” which is predicated on the assumption that each party is capable of bargaining for his or her self interest, and that welfare across parties is maximized when the parties are permitted to bind themselves to arrangements they believe best for themselves. Unlike in contract, within the corporation, shareholders are not treated as autonomous arm's length bargainers. See also Jill E. Fisch, Governance by Contract: The Implications for Corporate Bylaws (California Law Review, forthcoming).
So, bringing this back to Snap’s articles of incorporation, if courts or the SEC decide that – for reasons of federal policy – it is best for companies and their shareholders that corporations be permitted to select a federal forum for federal securities claims in their charters/bylaws, that’s one thing, and on that point I remain agnostic. But what they should not do is assume that Snap’s charter is a “contract” that binds the shareholders to a federal forum, in the same manner as a forum selection clause in an ordinary contract between transacting parties.
Wednesday, April 5, 2017
No, not that conference, although I suppose that one's nice too.
In (very) loose association with that other conference, Tulane hosted a corporate academic conference, made possible by the generous donation of one of our alums, Gordon Gamm, and his wife Grace.
The academic conference, which took place on Saturday, April 1 immediately following the Tulane Corporate Law Institute, was great fun, and allowed me to reconnect with old friends and make some new ones. It was structured on the theme of Navigating Federalism in Corporate and Securities Law, and featured presentations by 11 corporate and securities scholars (including me!).
Discussion ranged from how to encourage retail shareholders to exercise their corporate voting rights to whether to redesign the internal affairs doctrine to controlling corporate political spending to issues of SEC regulatory capture and the intensity of its enforcement efforts to - of course - how, and even whether, we should distinguish corporate law from securities law. Most of the papers were in draft form and are not yet publicly available, but a few are up, including Ed Rock's and Daniel Rubenfeld's Defusing the Antitrust Threat to Institutional Involvement in Corporate Governance, Robert Jackson's, Robert Bishop's, and Joshua's Mitts's Activist Directors and Information Leakage, J.W. Verret's Uber-Ized Corporate Law, and my own Reviving Reliance.
It was genuinely a lively and productive day, capped with a (naturally - this is New Orleans) mouthwatering dinner at Emeril's Delmonico.
I am so grateful to everyone for making it such a special event. And fingers crossed, we'll be able to host a similar conference next year, also timed to follow the Corporate Law Institute. With any luck, it can become a regular annual event.
The full program is here.
Saturday, April 1, 2017
The big news in securities litigation this week is that the Supreme Court has agreed to resolve the circuit split over whether a failure to disclose required information can function as a misleading omission for purposes of Section 10(b).
I've blogged about this split before; basically, my take is that courts are wary of omissions liability not simply because they distrust securities litigation in general, but because they are concerned about further blurring the line between fraud claims and claims for mismanagement.
Which, fortuitously, happens to be the subject of my new article, forthcoming in the Fordham Law Review and just posted to SSRN. I argue that courts are using issues like puffery, loss causation/damages, and omissions liability to draw distinctions between fraud claims and mismanagement claims and - further - to sketch out a (relatively narrow) view of the proper role of shareholders within the corporate governance structure. I hastily amended the piece before posting to account for the cert grant; my quick prediction is that if the Supreme Court does permit omitted information to serve as the basis of a Section 10(b) claim, lower courts - concerned about this fraud/mismanagement line - will find themselves narrowing the scope of what counts as a required disclosure in the first place, which will then impact not only private plaintiffs, but potentially also government enforcement efforts.
Saturday, March 25, 2017
This semester, I’m teaching a seminar on the financial crisis. And because my specialty is corporate and securities law, not property, I brought in a ringer – in the form of Chris Odinet of Southern University Law Center – to talk to my class about the Mortgage Electronic Registration System (MERS) and foreclosures. MERS is a private organization that mortgage bankers have used to track mortgage assignments in the age of securitization, but after the housing bubble burst, it wreaked havoc in the foreclosure process because of sloppy recordkeeping and its inconsistency with the traditional manner in which interests in land have been recorded. See generally Christopher Lewis Peterson, Two Faces: Demystifying the Mortgage Electronic Registration System's Land Title Theory, 53 Wm. & Mary L. Rev. 111 (2011).
As Chris Odinet described it to my class, MERS was formed when several financial institutions (including, as it turns out, the Mortgage Bankers Association, Fannie Mae, Freddie Mac, the Government National Mortgage Association, the Federal Housing Administration, and the Department of Veterans Affairs) decided that publicly recording mortgage assignments in county property offices was too expensive and cumbersome. Instead, these institutions decided to form a shell corporation that would “own” all mortgage interests. Then, instead of formally transferring mortgages from one financial institution to another, MERS would electronically track transfers of ownership. That way, expensive and anachronistic paper recording systems could be bypassed, and mortgages could be quickly transferred to meet the needs of the age of securitization.
It occurred to me that this is exactly what occurred with stock ownership. Stock transfers, too, used to be conducted via paper endorsements, which created a literal paper crisis in the 1960s. See In re Appraisal of Dell. In response, Congress and the SEC adopted a system of “share immobilization,” namely, that almost all stock today is actually owned by a company called DTC. DTC is owned by broker dealers, and DTC electronically tracks which shares are allocated to which brokerage. Those brokerages, in turn, allocate the shares among their clients.
After class, I looked into the history, and it turns out I wasn’t wrong to draw the comparison: MERS was actually explicitly modeled on DTC. See Phyllis K. Slesinger & Daniel McLaughlin, Mortgage Electronic Registration System, 31 Idaho L. Rev. 805 (1995). But – and I suppose hindsight is 20/20 – it’s easy to see why the stock transfer system could not simply be wholesale transferred to mortgages, which is precisely why MERS has created so many headaches.
For starters, the share immobilization system was mandated by Congress, to deal with a federally-regulated system of stock ownership. As a result, the regulatory system adapted to the change, and federal rules were created to allow a “look-through” to the beneficial owner of the security instead of focusing on the formal record holder. See, e.g., 17 C.F.R. § 240.14a-13. Nothing like that happened with MERS, because it was created without the imprimatur of any legislative or regulatory body. As a result, there are no formal procedures that permit a look past MERS to the beneficial owner of the mortgage, which is part of the reason why MERS’s legal status has been so uncertain.
Relatedly, MERS often includes only the name of the servicer in its system, and does not require its members to record transfers between mortgagees (although, Chris tells me, MERS recently has tried to improve its practices in this regard). As a result, MERS records simply do not contain information about who actually owns the mortgage, and these private transfers create opportunities for confusion and mischief. By contrast, stock transfers are heavily regulated, and settlement is required by SEC rule – within 3 days (soon to become 2).
Beyond these regulatory points, mortgage ownership is simply more complex than stock ownership. A stock transfer is a personal property transfer. There is a relatively minimal ongoing relationship with the issuing corporation – more on that below – but for the most part, it’s just property being transferred from A to B.
Mortgages, however, involve transfers between lenders, who must carry on complex and financially significant relationships with borrowers and servicers. Payments from the borrower must be made and applied to the loan; two-way lines of communication must be maintained; in extreme cases, foreclosures must be managed. On top of that, arcane rules govern the distinction between the mortgage itself and the note that represent the debt. It is precisely in these areas that MERS has broken down.
Additionally, America has long had a commitment to creating public, transparent records of interests in real estate, including the chain of title; MERS destroyed that by creating an opaque system that fails to keep track of past transfers. Stock ownership, by contrast, has never been publicly accessible, and the only area where chain of title is relevant is Section 11 (which, incidentally, has also been undermined by DTC).
That said, even the DTC-share immobilization system has been plagued by recordkeeping and legal problems; it is simply that at the end of the day, these problems are far less devastating to the lives of individual people than are the problems with MERS.
For example, stock ownership does involve an ongoing relationship with the issuing corporation (though one far more attenuated than in the ongoing relationships between borrowers and lenders in a mortgage loan), and errors/gaps in recordkeeping can affect that relationship. Marcel Kahan and Edward Rock wrote about the “Hanging Chads of Corporate Voting,” detailing how voting procedures may be inadequate to keep up with share immobilization. Moreover, the DTC system – which operates at the federal level – has created uncertainty with respect to state-level recordkeeping systems. See In re Appraisal of Dell; Dole Case Illustrates Problems in Shareholder System.
But ultimately, a lost or miscounted shareholder vote, or even lost payments in a merger, are peanuts compared someone losing their home in a legally defective foreclosure, or simply the inability of a homeowner to develop a workout plan.
Perhaps fundamentally, then, the difference is about the power imbalances. The corporate issuer of stock - the constant at the center of shifting shareholder bases - ultimately is the one with control over resources; shareholders' rights and powers are fairly minimal. By contrast, the "issuer" of the mortgage note - the individual borrower who remains constant at the center of shifting lenders - is the most vulnerable player in the lending system, at the mercy of a rotating cast of sophisticated mortgagees and servicers. A trading scheme like DTC/share immobilization, designed to accommodate those with very little power vis a vis the obligor, is not one that will do justice when the power relationships are reversed.
Point being, there were a lot of red flags - that might have been evident earlier - in trying to privately model a mortgage transfer system on the federally-mandated system for transferring stock, but here we are. The banks weren't wrong about the problems with dealing with local recording systems in today's economy; but a true fix will require public mandates and coordination across all jurisdictions.
Saturday, March 18, 2017
One of the hottest topics in business news today is the Snap IPO.
It’s the biggest tech IPO in some time (although some smaller ones apparently will be close behind), the company has so far been losing money and its growth has slowed, and oh yeah – its public shares do not have any voting rights.
In some ways, the disenfranchisement of Snap’s shareholders is the natural culmination of the dual-class share structures that have been popular with tech companies for a while. But Snap is obviously taking things to extremes. With no votes, there are no proxy statements. Most of that information will be disclosed in Snap’s 10-K, but it also means there will be no say-on-pay votes and no shareholder proposals. Sure, these are – or tend to be – nonbinding anyway, but Snap has shut down the mechanism by which shareholders as a group initiate conversations with the companies in which they invest.
Some commenters call Snap a one-off; after all, even now, Snap’s shares have fallen well below their first day trading price, and analyst reaction has been less than enthusiastic. But Snap is still trading higher than its offering price (at least for now), and Snap’s founders made hundreds of millions just from the IPO itself, without sacrificing control of the company – plenty of incentive for new players to try to replicate Snap’s results. The matter has caused enough concern that the SEC has begun to examine it, though it’s unclear what – if anything – they expect to be able to do. (I mean, the SEC’s power to directly regulate voting rights is a bit limited, but theoretically listing standards for NYSE and NASDAQ could be modified.).
One of the most interesting developments, at least to me, is the effort by institutional investors to have Snap excluded from major indexes (with a parallel effort across the pond); otherwise, they’d be forced to buy Snap’s shares despite their objections to Snap’s structure, and Snap would get a bit of a boost in its stock price - along with a class of shareholders who cannot vote with their feet. I don’t know what the indexes are likely to do, but if they include Snap, will that open a space for alternative indexes that exclude no-vote shares – like Snap and perhaps Google Class C? I have to admit, that would be an elegant free market solution.
One other interesting aspect of the Snap IPO concerns the nature of its shareholders: millennials. Apparently, millennials have snapped up Snap shares, eager to invest in a company that plays such a role in their lives. Snap doesn’t love them quite as much, of course, but if you view investing as consumption rather than a way to profit, I suppose it’s no worse than any other recreational activity.
In fact, there’s a whole startup devoted to encouraging consumers to buy stock in their favorite companies – and the companies will pay your brokerage fees. (Joan posted earlier about a similar type of program at Domino's Pizza.) The theory is, stockholder-consumers are more loyal customers (and, I assume, more pliant voters), so it’s worth it to companies to cultivate a consumer shareholder base. It happened before, that retail investors helped management fend off attacks; I wonder if the next would-be Snap might consider a less draconian approach to shareholder voting, but a more aggressive approach to marketing shares to its user base.
Saturday, March 11, 2017
A couple of days ago, Marcia put out a call for business movie/TV recommendations. A perennial favorite on such lists is the 1983 classic, Trading Places. That movie is about two brothers who make a bet to see whether they can pluck a man off the street and - by providing him with the proper environment - turn him into a successful commodities trader. Its stature is such that a real-life statutory amendment, intended to plug the regulatory loophole exploited by the film's characters, is colloquially known as the "Eddie Murphy rule." The CFTC first exercised its authority under the new rule in 2015.
Well, apparently the movie was just as inspiring to business aficionados in 1983 as it remains today. After seeing the film, two prominent commodities traders of the era, Richard Dennis and William Eckhardt, decided to reenact the brothers' experiment. (Except, rather than kidnap a homeless criminal and then frame one of their own employees for dealing PCP, Dennis just took out an ad in the newspaper). Dennis selected people with a certain affinity for numbers and probability, but with no formal education in commodities, and trained them to trade. The experiment panned out: most of the participants (dubbed Turtles, for reasons that remain the subject of myth) not only generated extraordinary profits for Dennis and themselves, but eventually left for successful Wall Street careers.
The tale is recounted in the book The Complete Turtle Trader, and in this Bloomberg podcast. For the podcast hosts, the unbelievable part of the story is how the methods taught to the Turtles are apparently still in use today - and remain profitable, for anyone disciplined enough to stick to them. I'll add that I also find it kind of unbelievable that anyone decided to risk millions of their own dollars to reenact the events of Trading Places, but, to be fair, it is a very good movie.
Saturday, March 4, 2017
This Saturday, I point you to a colorful long read: Sheelah Kolhatkar’s deep dive into William Ackman’s short bet against Herbalife. Unabashedly sympathetic to Ackman, the article describes how Herbalife was brought to his attention (there are analyst firms that just identify shorting opportunities? Who knew? Please don’t answer that everybody knew; that would be embarrassing) and ultimately ended up as something of a crusade to expose what Ackman believes is a pyramid scheme. (And the FTC believes is a scheme that is awfully like a pyramid scheme but without actually using those words.) According to Kolhatkar, Ackman and his people want to make money, sure, but they also want to expose a fraud that – like Trump’s universities (a comparison Kolhatkar explicitly makes) – robs desperate people of their savings.
The article describes the titanic battle between Herbalife and Ackman (Herbalife’s CEO is described as having an “air of PTSD”), including how Ackman even tried to enlist Latino civil rights groups to advocate on his behalf. It’s reminiscent of that time the NAACP involved itself in the epic battle over debit card swipe fees.
Ackman has held on to this bet for a while, combatting other investors and Herbalife’s own extensive public relations campaign. In a few months, however, the settlement that Herbalife reached with the FTC will take effect, and Herbalife will be forced to ensure that most of its sales are made to actual retail customers, and not distributors hoping to resell the product. One question mark raised by the piece is whether the settlement will finally allow Ackman’s bet to pay off, or whether Herbalife will manage to survive, perhaps by focusing its operations in other countries, where the settlement doesn’t apply.
Saturday, February 25, 2017
It's Mardi Gras season here in NOLA, so I'm afraid I've been a little distracted. It's hard to concentrate when this is what's going on a block away ....
So, for this Saturday, I offer you a game: The Unicorn Startup Simulator. The goal is to reach a billion dollar valuation while keeping your employees happy - it took me a few tries, but I managed it. Good luck!
Saturday, February 18, 2017
In 1995, the Private Securities Litigation Reform Act revamped the procedures applicable to class action lawsuits alleging claims under the federal securities laws.
Concerned about frivolous, attorney-driven litigation, Congress mandated that once a class action complaint is filed, the court must appoint a “lead plaintiff” to take control of the case. This, it was believed, would be preferable to the old tradition of simply giving control of the case to the first plaintiff to file a complaint. The lead plaintiff would be selected based on factors similar, but not quite identical, to those involved in selecting a class representative, using a more preliminary, less searching inquiry than might be expected for class certification. See 15 U.S.C. §78u-4; Topping v. Deloitte Touche Tohmatsu CPA, 95 F. Supp. 3d 607 (S.D.N.Y. 2015).
In enacting the scheme, Congress left a number of questions unanswered. Like, what is the relationship between the lead plaintiff and the class rep? Does the lead plaintiff position disappear once class reps are appointed? It’s not an issue that comes up often, since most lead plaintiffs seek class rep status, and those that don’t tend to cooperate with any class reps who are eventually appointed.
Another unanswered question was, what if there’s no suitable lead? See In re Cavanaugh, 306 F.3d 726, 731 n.7 (9th Cir. 2002) (raising the possibility). You might say, then the case can’t proceed as a class action, but class certification is supposed to be a different process; it’s one thing to use the lead plaintiff selection process to find – as the statute puts it – the “most adequate plaintiff”; it’s quite another to use the process to deny class certification without so much as a Rule 23 hearing.
Which brings me to the curious case of Finocchiaro et al v. NQ Mobile, Inc. et al, Docket No. 1:15-cv-06385 (S.D.N.Y.). The original class action complaint identified several named plaintiffs – all individuals, rather than institutional investors – but only one person sought lead plaintiff status. That applicant was rejected by the court, on the grounds that he had previously sent obscene and threatening letters to the defendants. The same attorneys sought, and received, an extension of time to find a second lead plaintiff, and recently filed a new motion seeking lead plaintiff status for another one of the individuals named in the complaint. That motion is (unsurprisingly) opposed by the defendants, who argue that the substitute lead is also unsuitable.
I have no idea how the court will come out on that argument; possibly the court will accept the new lead and all awkward questions will be averted. But it does beg the question: if no suitable lead plaintiff can be found, what happens to the case?
Saturday, February 11, 2017
As most readers probably know, one of the problems that led to the crisis was a gradual deterioration in the quality of the credit ratings issued by agencies like Moody's and Standard & Poor's. The basic charge has been that the agencies, paid by the issuers, had an incentive to issue inflated ratings. If they did not, the issuer would simply turn to another agency. The competition for business among agencies was destructive and corrupted the integrity of the rating.
There have been lots of proposals to reform the process - everything from greater disclosure to disgorgement of profits - but Howard Esaki and Lawrence J. White have a simpler idea. They would simply create a rule that if the issuer goes to more than one ratings agency, the issuer is required to drop (or not pay for) the most lenient rating.
They have a couple of variations, but the basic idea is the same - ratings agencies won't compete to give the most lenient rating if the most lenient rating is never used or paid for. They focus specifically on securitizations, and the amount of subordination each agency requires for the top ratings, because (in their view) this is the aspect of the process that needs the most intervention.
I gotta admit, it sounds like this would be a pretty elegant and effective solution.
Saturday, February 4, 2017
It's a drive-by this week, but I wanted to call your attention to the recent Delaware Chancery decision in In re Merge Healthcare Inc. Stockholders Litigation. The plaintiffs challenged IBM's acquisition of Merge, alleging that a 26% Merge shareholder counted as a controller and was conflicted. Therefore, the shareholder vote in favor of the merger could not cleanse the deal under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015).
Vice Chancellor Glasscock rejected the argument. Assuming (without deciding) that the 26% shareholder counted as a controller, he concluded that because the shareholder's interests were aligned with those of the public shareholders - among other things, the alleged controller had no unusual need for liquidity/a fire sale - no heightened scrutiny was required and the stockholder vote in favor of the deal was sufficient to cleanse the transaction.
Of particular interest: It turns out that the Merge corporation did not have a 102(b)(7) exculpatory clause in its charter, which potentially exposed its board to damages for duty of care violations (though, ultimately, the stockholder vote was sufficient to cleanse any problems). I didn't even know that was a thing that could happen.
In other news, the business media is aflutter with reports of Trump's new executive order, which would roll back the Department of Labor's new "fiduciary rule," requiring brokers to adhere to fiduciary standards when giving investment advice to retirement plans. Quoth Gary Cohn, the White House National Economic Council director, "We think it is a bad rule. It is a bad rule for consumers. This is like putting only healthy food on the menu, because unhealthy food tastes good but you still shouldn’t eat it because you might die younger." Um, there may be legitimate reasons to object to the rule - namely, the argument (however spurious) that one way or another, you pay for investment advice, and the old way is cheaper - but treating investment advice like a consumption good is ... not among them.
Saturday, January 28, 2017
I’ve previously posted about Delaware’s vulnerability – namely, to the extent it tries to police shareholder litigation through procedural rather than substantive legal standards, it is vulnerable to losing disputes to other jurisdictions that have rules deemed more favorable by litigants. Plaintiffs and defendants can reach sweetheart merger settlements in jurisdictions that examine the terms less searchingly; defendants can win a dismissal of all claims filed by weak plaintiffs in one jurisdiction and estop stronger plaintiffs who bring suit in Delaware.
So, for example, Delaware encourages derivative plaintiffs to seek books and records under Section 220 before bringing a lawsuit, but that takes time. A plaintiff in another jurisdiction might simply file a lawsuit right away, and if that suit is dismissed, the dismissal can preclude the Delaware plaintiff– which only gives the Delaware plaintiff less incentive to seek books and records in the first place.
Well, until now. In Cal. State Teachers Ret. Sys. v. Alvarez, 2017 WL 239364 (Del. 2017), that exact scenario occurred in the long-running action against Wal-Mart for violations of the foreign corrupt practices act in Mexico. While the Delaware plaintiffs sought books and records to bolster a derivative claim, federal plaintiffs in Arkansas ploughed ahead using public information, only to see their suit dismissed for failure to plead demand futility. And Delaware Chancery concluded that the Arkansas ruling was res judicata against the Delaware plaintiffs.
Not so fast, said the Delaware Supreme Court last week. Following VC Laster's analysis in In re EZCORP Inc. Consulting Agreement Deriv. Litig., 130 A.3d 934 (Del. Ch. 2016), the Supreme Court expressed concern that, as a matter of constitutional due process, until demand futility is established, any single group of plaintiffs represents only its own interests, and not the interests of the corporation. Therefore, they bind only themselves – not the corporation – in any litigation, and a dismissal of one claim cannot preclude a subsequent claim.
The Court did not so hold definitively, though; it simply remanded to Chancery for further consideration of the issue.
This is certainly a dramatic solution to the problem of multiforum shareholder litigation. Prior proposals have suggested a more searching inquiry into the adequacy of the first plaintiff; this approach, however, would mean that in derivative actions, no plaintiff is ever precluded by another plaintiff’s failure to plead demand futility. Talk about firing off a canon to kill a bug.
It still leaves Delaware in a precarious position, because it rests wholly on federal constitutional law – and there’s no telling how federal judges will rule once they get hold of the problem. They certainly don’t have the same interests in protecting Delaware law that Delaware has.
Saturday, January 21, 2017
I’ve been waiting for The Founder to open for months. Starring Michael Keaton as Ray Kroc, it tells the story of the founding of McDonald’s restaurants. As business junkies and professors know, McDonald’s was an innovation: it created the modern franchise, identical restaurants run by individual entrepreneurs in locations across the country and, eventually, the world. It also represented a critical development in the history of fast food, transferring the assembly line from the factory floor to the kitchen. Most basic business classes talk a lot about McDonald’s, because the franchise system – and the degree of control that McDonald’s corporate exercises – raise interesting questions about agency law and the definition of employment.
[Spoilers under the cut, not very if you already know the story]
Saturday, January 14, 2017
A couple of months ago, investors in Theranos filed a class action complaint seeking damages for fraud and negligent misrepresentation under California law. Theranos is based in California; presumably, the plaintiffs intend to argue that any false statements emanated from California and therefore California law covers even out of state purchases. See Diamond Multimedia Systems, Inc. v. Superior Court, 19 Cal. 4th 1036 (Cal. 1999).
The reason this interests me is because it’s rare – not unheard of, of course, but rare – to see fraud-based securities class actions concerning securities that are not publicly traded. SLUSA eliminated the possibility for most companies, but SLUSA alone isn’t the problem; the other hurdle is the difficulty of establishing reliance on a classwide basis, as even before SLUSA, fraud-on-the-market doctrine was largely limited to Section 10(b) claims.
California law, however, is different from most states’, because California’s blue sky law explicitly permits claims for deceit based on price distortion. See Mirkin v. Wasserman, 5 Cal. 4th 1082 (Cal. 1993); Cal. Corp. Code, §§ 25400, 25500.
It will be interesting to see if that’s how the Theranos class plans to approach matters; the difficulty will be establishing that, for example, Investor A’s willingness to purchase stock on such-and-such terms had the effect of distorting the price for other investors, outside the context of an efficient market.
The complaint also alleges certain causes of action, like statutory and common law fraud, that do require actual reliance and do not permit a price-distortion substitute. But investors are also in luck for that, as well; there is a fair amount of precedent for the principle that when similar misrepresentations are made to purchasers, and those misrepresentations are important to the transaction, the mere fact that the purchaser chose to engage in the transaction creates a presumption of reliance. That is, certain kinds of misrepresentations are so fundamental to a purchase that it is difficult to imagine anyone would have engaged in the transaction if they were not relying upon them. Courts in the Ninth Circuit have repeatedly embraced this principle. See, e.g., In re First Alliance Mortg. Co., 471 F.3d 977 (9th Cir. 2006); Poulos v. Caesars World, Inc., 379 F.3d 654 (9th Cir. 2004).
In Theranos’s case, different investors may have heard different statements at different times – the class period stretches for over 3 years – which puts a crimp in the plaintiffs’ case, but presumably all of the statements basically were about the efficacy of Theranos’s product. And since this was a one-product company, it’s not a stretch to assume that all investors expected that the product, you know, actually worked.
Of course, this is just the complaint; it’s possible that Theranos will be able to introduce doubt into the mix by, among other things, presenting evidence of disclaimers/warnings/etc that raise questions about whether each investor relied on the same information.
But that’s the class cert issue; I’ll be interested to see the kinds of arguments defendants raise in their motion to dismiss, due next week.