Saturday, February 6, 2016
Saturday, January 30, 2016
This piece in the Wall Street Journal reports on a recent article by David F. Benson, James C. Brau, James Cicon, Stephen P. Ferris regarding the language used in charters and bylaws of companies going public. As described in the WSJ, they conclude that companies with shareholder-unfriendly provisions – such as, for example, staggered boards or supermajority voting – are inclined to “camouflage” this fact by using more obscure, harder-to-parse language. And this effect is more pronounced for companies that can expect they won’t be caught – such as, companies with a smaller analyst following and fewer institutional investors. They also find that companies that use camouflage reap benefits in the form of higher pricing. I was intrigued by the description in the WSJ, and thought the findings might be a useful point of discussion in my Sec Reg class, so I tracked down the actual study. But I found myself a bit confused by the evidence offered to support their conclusions.
[More under the cut]
Monday, January 25, 2016
I was going to blog today about Usha Rodrigues’s article on section 12(g) of the Exchange Act, but my co-blogger Ann Lipton stole my thunder over the weekend. If you’re interested in securities law and you haven’t read Ann’s excellent post on section 12(g), you should. Ann discusses Usha Rodrigues’s article on the history and policy of section 12(g); if you haven’t read it, I strongly recommend it. It’s available here. (Even if you’re not interested in reading about section 12(g), I highly recommend Usha’s scholarship in general. I’ve read several of her articles and blog posts over the last few years; she has become one of the leading commentators on securities and corporate law. She blogs at The Conglomerate.)
Instead of discussing section 12(g), I’m going to talk about exams. I finished grading my fall exams about a month ago and I’ve had time to reflect on them. The main reason students don’t do well on exams is that they don’t know or understand the material. But I’ve been reflecting on the difference between exams that are pretty good and exams that are excellent. Those students all know the material, so that’s not the difference.
One of the major differences between a good exam and an excellent exam is in how well students indicate the level of uncertainty in the law.
Sometimes, the law is clear and the answers to issues are certain. Sometimes, the answer is a little fuzzy, but the available authorities point strongly in a particular direction. Sometimes, the answer is completely unclear.
The best exam answers differentiate among those different possibilities and indicate the certainty of the author’s conclusion as to each issue. Bad answers don’t do that. They provide a definite “yes” or “no” to an issue when an unqualified answer is unwarranted. Or they go through a long list of arguments (“on the one hand, . . . ; on the other hand, . . . ) without reaching a conclusion or even indicating which side has the better argument and why.
I can always tell from reading exams which students I would want to consult as attorneys, and this is one of the clues.
Saturday, January 23, 2016
Back in the heady days of 2011, everyone wanted Facebook shares, but Facebook was not yet publicly traded. It was close to bumping up against the then-500 shareholder-of-record threshold, however, which would have triggered reporting requirements under Section 12(g) of the Exchange Act. As a result, Goldman Sachs developed a single investment vehicle to allow clients to invest in Facebook indirectly; the vehicle would purchase Facebook shares (and count as a single shareholder), and then Goldman clients would buy shares of the vehicle. Eventually Goldman ultimately was forced to modify its plan due to a different SEC rule, so its legality was never tested.
Fastforward to 2016. The JOBS Act has now upped the shareholder threshold to 2000 shareholders of record (or 500 unaccredited shareholders), and eliminated the rule that tripped up Goldman’s earlier efforts, so Morgan Stanley and Merrill Lynch are playing the game again with Uber shares. Accredited investors will have the opportunity to buy interests in New Riders LP, whose sole assets will be stock in Uber.
(okay, different New Riders LP).
The minimum price tag is $1 million through Merrill, or a paltry $250K through known-populist Morgan Stanley. The 290-page offering materials are heavy on risk disclosures, but fail to include any financial information about Uber; instead, investors are urged to trust Morgan Stanley’s and Merrill’s valuation.
[More under the jump]
Saturday, January 16, 2016
There has long been a debate about whether corporations should be forced to disclose non-financial information about their operations, particularly information pertaining to social responsibility. For example, as Marcia Narine has repeatedly discussed, Dodd-Frank’s “conflict minerals” disclosure requirement may be not only ineffective to pressure companies into making ethical purchasing decisions, but may even be counterproductive, by causing companies to pull out of the Congo entirely (thus devastating the regional economy) rather than endure the expense of ensuring that their purchases do not indirectly finance armed groups.
Further to this issue, Hans B. Christensen, Eric Floyd, Lisa Yao Liu, and Mark Maffett have recently released a paper studying the effects of Dodd-Frank’s requirement that mining companies disclose information about their compliance with the Federal Mine Safety & Health Act of 1977. They find that after mine-owning companies became subject to Dodd-Frank’s disclosure requirements, they demonstrated a marked decrease in safety violations and injuries, counterbalanced by a decrease in productivity (apparently because they are spending more time on safety compliance). They also find that mines that disclose an “imminent danger order” from regulators post-Dodd Frank not only experience an immediate stock price reaction (especially the first time such an order is received, as compared to subsequent orders), but also experience a change in investor base – specifically, mutual funds (and particularly mutual funds that focus on “socially responsible investment”) divest their holdings.
I find these results fascinating for several reasons.
First – as the authors point out – mine safety information has always been publicly available, but hard to decipher. It’s located on the website of the Mine Safety and Health Administration in a searchable database. The Christensen et al. study is a nice demonstration of the principle that piecemeal, hard-to-decipher information has less of an impact than information compiled in SEC filings. Which, by the way, was exactly what the court held in In re Massey Energy Co. Sec. Litig., 883 F. Supp. 2d 597 (S.D. W. Va. 2012). There, plaintiff-stockholders of Massey Energy argued that the company misled investors about its safety profile. The defendants argued that information about their safety record was publicly available in the MSHA database. The court rejected this “truth on the market” argument, recognizing that difficult-to-parse mine-level data might not offset more prominent misstatements announced to the investing public. This new study validates the court’s reasoning in Massey.
Second, the paper seems to document a real, substantive effect of disclosure on companies' behavior. "Name and shame" apparently does work, at least in this context.
Third, the paper adds to the literature regarding the effects of investor “taste” on asset prices– representing a challenge to simpler models that imagine that asset pricing is purely a function of expected returns. Of course, it is possible that investors treat mine safety data as relevant to returns, to the extent that the higher levels of production from unsafe mines comes at the cost of a higher risk of an expensive mine disaster. But the fact that socially-responsible funds react more strongly to mine-safety disclosures than other funds suggests that taste is part of the story. (Caveat: I am confused as to how the authors selected their mutual funds for the study; if they compared socially responsible funds to all mutual funds, including index funds, the greater reaction of socially-responsible funds may be traceable to the fact that the socially-responsible funds are more likely/able to respond to news about individual companies).
In any event, none of this is to say that disclosure is the best way to regulate corporate behavior – direct command and control, or economic incentives, may be preferable for a lot of reasons, including the fact that disclosure only impacts public companies – but, well, it’s not nothing.
Saturday, January 9, 2016
Spring semester classes begin on Monday, and as a newbie professor, I’ve been spending a lot of my break preparing to teach Securities Regulation for the first time. While all my pals hang out at AALS in New York (hi, guys! Hope you’re having a good time!), I’ve chosen to remain at home, with multiple casebooks spread out over my living room floor.
Though the casebooks naturally focus on federal regulation, most have at least some discussion of regulation at the state level, including a brief explanation of the term “blue sky law.” This is a phrase whose etymology has long been shrouded in mystery; Professors Macey and Miller traced it as far back as 1910, but could not find its origins. See Jonathan R. Macey & Geoffrey P. Miller, Origin of the Blue Sky Laws, 70 Tex. L. Rev. 347 (1991). As a result, the casebooks I’ve seen simply quote the Supreme Court’s opinion in Hall v. Geiger-Jones Co., 242 U.S. 539 (1917), describing such laws as designed to prevent “speculative schemes which have no more basis than so many feet of ‘blue sky.’”
I mention this because a few years ago, Rick Fleming, who was then General Counsel to the Kansas Securities Commissioner, offered an alternative origin story, one both credible and colorful. According to Mr. Fleming, J.N. Dolley – the Kansas Bank Commissioner who authored the original blue sky law in 1911 – published an article in the Topeka State Journal in 1935, where he set forth the following explanation:
I have been given credit for naming the “Blue Sky” law. That name goes back to the drouth of the nineties. We had them then, just the same as now, altho they were not so well dramatized and advertised and we had learned less about feeling sorry for ourselves.
Crops were burning up. Stock water and even water for domestic use was disappearing. It was the day of professional rain makers and some of our people felt we should make every effort to get rain. So we raised the necessary money and contracted with some Chicago slicker to supply us with the necessary quantity of moisture.
They arrived at Maple Hill with two barrels of chemicals, a string of iron pipe and some mysterious mechanical doo-dad. They set up their equipment on a platform within an enclosure to which no one was admitted. Their iron pipe pointed toward the sky. At length it began to emit a light milk colored spray. The machinery was set it (sic) motion.
The milky spray was cast up for four days and four nights. But there was no sign of rain. The fifth day our committee visited the rain makers plant, to discover that the rain makers had disappeared, leaving their equipment behind.
Some of our folks had prepared against overflow damage from rains expected, moving valuables to uper (sic) stories and other property to high grounds. Not only did we have no flood but we saved others from such a fate because the rain making equipment was left with us.
When I appeared before the judiciary committee of the Kansas house and senate with the bill to protect our people against fraudulent stock schemes, one of the senators asked me what to call the law. Remembering our experience with the blue sky artists in trying to make rain, I suggested “the blue sky law.” The name stuck.
Mr. Fleming concludes, “After all these years, let the record reflect that the term ‘blue sky’ does not refer to an investment scheme that is worth no more than air. More accurately, it refers to an investment opportunity in which the promoter promises rain but delivers blue sky.” See Rick A. Fleming, 100 Years of Securities Law: Examining a Foundation Laid in the Kansas Blue Sky, 50 Washburn L.J. 583 (2011).
Saturday, January 2, 2016
Marcia’s post about the importance of teaching ethics reminded me of a Bloomberg story from a little while ago.
It’s been widely reported that today’s students have been shunning investment banks and instead have been seeking careers in Silicon Valley. Well, according to William Dudley, president of the Federal Reserve Bank of New York, that’s not just because Silicon Valley pays more and has an aura of excitement. In fact, it’s at least partly due to the fact that Wall Street strikes students as an unethical place to work – prompting students to seek alternative opportunities.
Obviously, that’s a problem: If the most ethical students shun Wall Street, it can only make matters worse, not better; and there is at least some evidence that the perception of corruption in finance may lead women away from those jobs, contributing to ongoing gender disparities (not that Silicon Valley is all that much better in this regard).
There’s obviously no easy fix, but it does occur to me that one thing we need to teach students is not simply how to think ethically or make ethical choices, but also the concrete, practical skill of saying “no,” even when that means going against your friends, or your boss. Back in my college days as a psychology major, I took classes with people like Philip Zimbardo (who specializes in group dynamics and social pressure). One of the important take-homes was that we assume that teaching students right from wrong in the abstract will be sufficient to lead them to behave in ethical ways in the future. In fact, acting on one’s ethical instincts is a distinct skill, and one that must be taught, right along with how we train students to sit quietly and be respectful and obedient to authority. Or, to put it more simply, to know the good is not to do the good; knowing is not enough.
Saturday, December 26, 2015
I was baffled by the idea of a film adaptation of this book – it doesn’t exactly lend itself to visual storytelling. But my skepticism was unwarranted; I enjoyed it tremendously, and, I have to admit, for a movie where everyone knows the ending going in, it was surprisingly suspenseful.
[Spoilers below the cut - but I'm giving it away now, the world economy collapses in the end]
Saturday, December 19, 2015
It was recently announced that Dow and DuPont plan to merge, and then split into three separate companies – focusing on agriculture, materials, and specialty products. The move has been described as a victory for activist shareholders, and doubts have been raised about the practical viability of the plan.
But the aspect that intrigues me is the tax planning.
Now, I’m not a tax lawyer – I just play one on the internet – but after consultation with my colleague, Shu-Yi Oei, here’s my understanding of how this works.
Ordinarily, if a company spins off an aspect of its business and distributes the shares to existing shareholders, it can be treated as tax free under 26 U.S.C. § 355. The idea is that the existing shareholders once held shares in a single company, but now hold shares in two companies, there has been no substantive change, and the entire transaction is not treated as a realization event. If, however, a company simply sells off a business line to a third party, that is treated as a realization event, and it is taxed.
As a result, companies have tried to structure sales as tax free spinoffs. For example, a target company might spin off one business line tax-free, then sell remaining business lines to an acquirer, rather than have the acquirer buy the entire target (with attendant taxes).
The tax code therefore has a series of provisions designed to distinguish between the two scenarios. In particular, it provides that if a company spins off a business to its shareholders, that will be treated as taxable if 50% of the voting or economic interest in either the original company or the spinoff is acquired in the period immediately preceding or following the spinoff.
The question, then, is whether DuPont and Dow merging “counts” as an acquisition of 50% of the voting/economic interest in either company prior to the three-way split.
Dow and DuPont maintain that it does not. They are structuring the deal as a “merger of equals” – two companies of approximately equal size, combining, so that shareholders of the former DuPont and Dow will each own 50% of the combined new entity. But to avoid tripping the 50% threshold that the IRS treats as an acquisition of one or the other, they’re relying on the significant overlap between the two companies’ shareholders. Specifically, Vanguard Group, State Street, Capital World, and BlackRock own something like (I hope my math is right) 17% of Dow Chemical, and 18% of DuPont. The theory goes, due to this overlap, when these shareholders receive stock in the combined post-merger entity, they have not actually acquired any new interests – they’ve simply consolidated their existing interests. Therefore, their interests don’t count when determining whether there’s been an acquisition of 50% immediately preceding the spinoff.
The fascinating thing here, of course, is that these shareholders – and a handful of others – are the top shareholders of lots of publicly traded companies.
Some literally random examples that I just thought to look up:
Delta. Among the top investors are Vanguard, Capital World, State Street, and BlackRock.
Whole Foods, whose top investors include Vanguard, State Street, and BlackRock.
Microsoft, whose top investors you will be shocked to learn include Vanguard, Capital World, State Street, and BlackRock.
First Energy, whose top investors include – wait for it! – State Street, Vanguard, and BlackRock.
Everyone who's surprised by the news that some of the top shareholders of Activision are Vanguard, State Street, and BlackRock, stand on your head.
And - hey, look! Vanguard, Capital World, State Street, and BlackRock are also sharing a Coke.
Now, many institutional investors, like Vanguard, hold shares through mutual funds or other types of entities, all of which are legally distinct. So if the argument is that all of these funds count as a single “owner” for tax purposes, Dow and DuPont may (I guess?) be relying on 26 U.S.C. § 355(d)(4), which defines “interest” to mean either voting power or economic interest. Vanguard’s mutual funds may be the “owners” of the shares, but Vanguard has broad control over their votes across its fund holdings, which it appears may be enough for the IRS.*
In any event, if overlapping shareholders is the test, that’s one hell of a tax loophole.
*I gather that there are also special attribution rules for determining whether the 50% threshold has been reached; Skadden (as the tax advisor) clearly thinks they've got it covered.
Saturday, December 12, 2015
A while back, I wondered whether we could expect to see a federal securities fraud lawsuit filed over the Dole Food merger. If so, it would be that rarest of animals – a Section 10(b) claim predicated on the allegation that the defendants intentionally manipulated prices downward rather than upward.
Well, wish granted. A couple of days ago, my old law firm (I swear I had nothing to do with it!) filed a complaint in the District of Delaware alleging that Dole Food, Murdock, and Carter intentionally drove down Dole’s stock price to facilitate Murdock’s buyout. The complaint doesn’t explain the legal theories, but it seems to be setting up a claim that - because Carter was the only one who directly made false statements - he was acting as Murdock's agent when doing so . See, e.g., ¶38 (“With Carter able to serve as Murdock’s mouthpiece, Defendants effectuated Murdock’s buyout of Dole on the cheap.”). Apparently, the federal plaintiffs were waiting for a resolution to the state claims before filing their own action.
I’ve flogged this horse before (is that even a metaphor?) but these kinds of parallel lawsuits (especially when considered in conjunction with situations where the SEC brings an action, or there are even are criminal enforcement actions associated with underlying conduct) really bring into sharp relief questions about the purpose of our securities enforcement regime. No question, the claims brought in this action involve a different set of plaintiffs than the ones in the Delaware action, and a different type of harm; but if you accept the dominant narrative that the purpose of the securities class action is deterrence rather than compensation, all that should matter is the point at which damages are sufficient to deter future frauds – and right now, there is no coherent system for making that calculation.
Saturday, December 5, 2015
Do we have to go back to the creation of LLPs to remember a time when an organizational form was so much in the news?
First, as my co-blogger Joshua Fershee pointed out, news of Mark Zuckerberg’s investment/charitable/political vehicle, the Chan Zuckerberg Initiative LLC, has been making headlines over its structure.
Beyond that, however, the New York Times has run a couple of stories now on the growing use of LLCs in the real estate market – both to hide the identities of wealthy foreign investors in Manhattan property and perhaps skirt bank secrecy laws, and to shield the identity of fraudsters who scam people out of the deeds to their houses. As a result, New York is imposing new requirements for disclosure of LLC members involved in real estate transfers. And this report from the Sunlight Foundation highlights how the minimal disclosure requirements for LLCs has made them a popular tool for obscuring the origin of political donations. It seems there might still be a few kinks to work out in the form, although if jurisdictions go the way of NYC, we'll see patchwork disclosure requirements that apply only within specific areas.
In any event, all of the hoopla about Zuckerberg's initiative provided a valuable jumping off point for discussion in my last Business class, even as it apparently is causing a headache for Zuckerberg himself - the misleading stories that suggest that Zuckerberg is getting a tax break out of this (he isn't; as far as the IRS is concerned, the LLC doesn't exist) have prompted Zuckerberg to put out a statement defending his choice of organizational form. I suppose he has only himself to blame by originally touting the LLC as though it was akin to a charitable effort; as Jesse Eisinger put it, instead of announcing that Zuckerberg was donating $45 billion to charity, the headlines should have reported "Mr. Zuckerberg created an investment vehicle."
Saturday, November 28, 2015
Hillary Sale and Robert Thompson have published a new article to SSRN discussing the role of 10b-5 class actions, and, in particular, how private class actions function to protect the goals of securities regulation more broadly, including investor protection and general confidence in U.S. securities markets. One of their key insights is that the concept of market efficiency is critical both to the current system of regulation, and to the 10b-5 class action - and that there is a basic hypocrisy when large, publicly-traded issuers take advantage of the concept of market efficiency to reduce their regulatory disclosure burdens while simultaneously arguing against market efficiency to defeat securities claims. They contend the presumption of reliance - and what should be a very narrow space for defendants' rebuttal of price impact, thus allowing classes to be certified - fits well with the class action's role in protecting markets.
I agree with their thesis generally, namely, the role that securities class actions play in policing markets, rather than as a direct system for compensating defrauded investors. In fact, I argued in a recent paper that courts have altered their definitions of organizational scienter to account for the changing role of the securities class action, namely, one focused more on policing markets and promoting the various goals of our regime of securities regulation rather than compensating investors for their losses. And I believe there's a strong case to be made - which James Park has explored - that there is value to having private actors, in addition to the SEC, play a role in deterrence/enforcement.
The problem, of course, is that right now, the 10b-5 cause of action is in something of a transitional stage. The element of reliance - as constructed via the fraud on the market mechanism - is well-suited to a deterrence/enforcement purpose, but other elements (including damages and loss causation) are not. These elements remain tied to some construct of specific investor harm that becomes harder and harder to determine the more than the "front end" of the securities class action focuses on marketwide distortion/corruption. If class actions are deterrent devices rather than compensatory ones, there needs to be some kind of rational calculation regarding appropriate damages due to degree of market harm, balanced against the wrongfulness of the defendants' conduct. Right now, nothing in the cause of action provides space for that kind of calculation - instead, all we have are the increasingly artificial constructs of price impact, materiality, and loss causation, which, I believe, is at least one of the reasons for courts' incoherence on this subject.
Saturday, November 21, 2015
... but going back to corporations for a moment - a while ago, I speculated that corporate forum-selection bylaws could unfairly work to favor management, because management can choose to invoke them at will - they can deploy them to dismiss cases when it will benefit them, but also can refuse to invoke them when it would work to their advantage to have plaintiffs' firms compete with each other in different jurisdictions.
Alison Frankel now reports that the FX company is doing just that. According to her report, FX enacted a forum-selection bylaw choosing Utah as the forum; but now, faced with shareholder lawsuits in Nevada and Utah, it is choosing not to enforce the bylaw - precisely because, according to the Utah plaintiffs, it benefits management to have the plaintiffs compete for the opportunity to settle the case on sweetheart terms.
The basic problem is that these bylaws do not resemble contractual forum selection clauses, in that they can only be invoked by management - not plaintiffs. And at least according to Delaware, they are only valid because they allow management the freedom to choose whether to invoke them (i.e., they contain a fiduciary out). As a result, it's critical that courts police their use, and, in particular, make sure they do not bring about the forum-shopping evil they were intended to prevent. Better than that - and I realize it's heresy to suggest - multiforum litigation perhaps is not a problem that should be addressed privately, but instead should be addressed through coordinated action by the states.
Saturday, November 14, 2015
Well, it turns out Halliburton is going – you guessed it – back to the Fifth Circuit on 23(f) review.
If you recall, the Fifth Circuit overturned the district court’s class certification order in the first go-round – a decision that was vacated by the Supreme Court in Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011). The district court recertified the class; the Fifth Circuit granted 23(f) review, and the Supreme Court vacated – again! And then the district court certified the class for a third time, and the defendants petitioned for 23(f) review, and the Fifth Circuit has – again! – granted the petition.
The thing that's so amazing, of course, is that this case has hit the Supreme Court twice, the district court three times, and now the Fifth Circuit three times, and it's the exact same argument, over and over and over, on the same evidence - just using slightly different words. Namely, the defendants' position that if there is no price increase at the time of an initial false statement, and no price drop in reaction specifically to news that later reveals the earlier statements to have been false at the time they were made, therefore it must be concluded that the false statements never impacted prices in the first place.
This time, however, the 23(f) grant comes with a concurrence. I’ve actually never heard of a 23(f) concurrence before – are there others? They can’t be common, and in this case, the concurrence is by Judge Dennis – who has long been hostile to the Fifth Circuit’s strict approach to class certification in Section 10(b) cases. See Erica P. John Fund, Inc. v. Halliburton Co., 2015 U.S. App. LEXIS 19519 (5th Cir. Nov. 4, 2015).
In his concurrence, Judge Dennis expresses open skepticism of the defendants’ argument that they can rebut Basic’s presumption of price impact by demonstrating that any alleged corrective disclosures were not, in fact, corrective. He chides the defendants for rehashing points that the Supreme Court rejected in the first Halliburton case, namely, that if the “truth” was never disclosed in a fraud on the market case, the class cannot be certified. But, given the issue’s importance, he “reluctantly” concurs in the panel’s decision to grant the 23(f) petition, in order to allow the Circuit to clarify the law.
In my view, Judge Dennis is absolutely correct that the defendants’ argument rehashes territory that the Supreme Court has already rejected, but, to be fair, at least some of the problem can be laid at the feet of the plaintiffs – who appear to have accepted defendants’ premise, namely, that there must be some affirmative evidence of price impact – either an upward movement when the statement is first made, or downward movement upon its correction – before a class can be certified. That, of course, is contrary to the notion of a presumption; it is the defendants’ burden, not the plaintiffs’, to show not only that any price movements were not due to the fraud, but also that even price stability means that the fraud had no effect (i.e., that the fraud did not, say, operate to keep prices level instead of falling). Or to put it another way, even if defendants are entirely right that the corrective statements did not reveal any truths, that still does not answer the question whether the initial false statements had an impact on price.
Anyway, in light of Judge Dennis’s concurrence, the defendants must be grateful that 23(f) petitions are usually transferred to a merits panel after being granted. But see Margaret V. Sachs, Superstar Judges as Entrepreneurs: The Untold Story of Fraud-on-the-Market, 48 U.C. Davis L. Rev. 1207 (2015) (arguing that Judges Easterbrook and Posner of the Seventh Circuit have chosen to assign Rule 23(f) petitions to themselves for merits review in Section 10(b) cases).
Meanwhile, we can at least look forward to seeing these issues explored in a novel setting. The Eighth Circuit recently heard oral arguments on a 23(f) appeal from the certification decision in IBEW Local 98 Pension Fund v. Best Buy Co., 2014 U.S. Dist. LEXIS 108409 (D. Minn. Aug. 6, 2014), where - again - the defendants contend that they can rebut price impact by showing that the market did not react to the false statements initially, nor were any later statements corrective of the earlier ones. The case has attracted a degree of industry attention; defense-side amicus briefs have been filed by the Chamber of Commerce and the Securities Industry and Financial Markets Association.
It's a race to see which circuit produces an opinion first; the Eighth Circuit has a large head start but then, it's not like the Fifth Circuit needs any extra time to familiarize itself with the facts.
Saturday, November 7, 2015
One of the best news stories to come in the wake of the financial crisis was L’Affaire du Chaton, in which the accusation was lobbed that Goldman Sachs literally abandoned a group of stray kittens. Goldman, apparently recognizing that there are limits to the amount of profit-seeking the public is willing to tolerate, set not one, but two spokespeople to quell the looming media disaster.
Which is what I’m reminded of when I read this story about Goldman Sachs’s investment in social impact bonds sold by Utah to fund its preschool program.
As I understand it, Utah’s Granite School District needed money to finance its preschool program – which, it believed, prevented at-risk students from needing expensive special education later.
So Utah’s United Way of Salt Lake sold Goldman bonds. The money was used to finance the preschool program, and Goldman was to be paid by the United Way and Salt Lake County to the extent that the program did result in cost-savings by reducing the need for special education.
The problem was that Utah itself set a rather specious standard for determining whether the pre-school program avoided the need for special education, by inflating the numbers of at-risk students. Because the at-risk student metric was inflated, the program appeared to be wildly successful – providing Goldman with a hefty profit.
This is fascinating on a couple of different levels. First – if I’m understanding the situation correctly – it highlights a problem with social impact bonds. I’m guessing that it's typical in politics to exaggerate the benefits of expenditures. Here, the founders of Utah’s preschool program wanted to “sell” the program to the state, and made inflated claims about how much money could be saved later. Their goals may well have been benign – they wanted funding for a good program that would help people – but in a world of political calculation, limited resources, and lobbying, they felt that they needed to overstate the benefits of their program in order to get anyone’s attention.
I assume that this is business-as-usual in politics - not a great thing, but not exactly shocking. And it’s mostly fine until Utah decides that it will pay actual cash money to an actual outside investor based on these inflated savings projections. Which, I assume, is a problem that plagues all social impact bonds.
But the other level on which this situation fascinates me is Goldman’s (apparently) kitten-abandoning level of venality. It is difficult to believe that Goldman was unaware of the flaws in the metrics when it made the investment; yet, it had no compunction about draining Utah’s school districts of funds that were intended for preschool and special education.
In this case, however, there probably aren't many people agitating for Goldman to make reparations. Utah, the United Way, and the Granite School District aren’t going to want to admit the flaws in their own metrics, so we don’t have a kitten-defending constituency. Just lots and lots of payouts to Goldman.
Maybe Goldman would have done better to have purchased social impact bonds for the kittens.
Saturday, October 31, 2015
Corporate social responsibility is a perennial topic of interest here at BLPB, and, in particular, the question whether corporations – especially publicly-traded ones - can in fact credibly commit to a non-profit-seeking goal.
Which is why I found this Financial Times column so hilarious. Lucy Kellaway gathered the “values” statements from 24 different British companies – you know, statements like “We stand for innovation and integrity!” – read them aloud at a conference of the companies’ managers, and asked the managers to identify the statements from their own companies. Only 5 were able to identify their own company, and in 3 cases, it was because they’d been the ones to draft them in the first place. The remaining nineteen managers picked the wrong one.
From this, Kellaway concludes that values statements are useless – and she notes that among FTSE100 companies, not having a values-statement is correlated with higher share prices.
I’d reframe it, though, and say that a values statement – or any corporate declaration of commitment to values – is useless unless it’s backed by real content. It has to be operationalized in specific terms that are credibly communicated to employees. The problem with the values statements that Kellaway describes is that they are so generic as to be meaningless – suggesting that the companies themselves were simply using them as PR, to cloak themselves in good feelings without any actual change in the underlying business (and ineffective PR, if you can’t tell one from the other - the companies should at least borrow from Google's playbook and choose something more memorable, like "Don't Be Evil").
And on another note, in honor of the season, here is Sally Richardson, the winner (loser?) of Tulane Law's Halloween costume drive - the professor with the most student donations has to teach class in costume:
Wednesday, October 28, 2015
Earlier this month BLPB editor Ann Lipton wrote about the Delaware Supreme Court opinion in Sanchez regarding director independence (Delaware Supreme Court Discovers the Powers of Friendship). On the same day as the Del. Sup. Ct. decided Sanchez, it affirmed the dismissal of KKR Financial Holdings shareholders' challenge to directors' approval of a buyout. The transaction was a stock-for-stock merger between KKR & Co. L.P. (“KKR”) and KKR Financial Holdings LLC (“Financial Holdings”). Plaintiffs alleged that the entire fairness standard should apply because KKR was a controlling parent in Financial Holdings. The controlling parent argument hinged on the facts that:
Financial Holdings's primary business was financing KKR's leveraged buyout activities, and instead of having employees manage the company's day-to-day operations, Financial Holdings was managed by KKR Financial Advisors, an affiliate of KKR, under a contractual management agreement that could only be terminated by Financial Holdings if it paid a termination fee.
Chief Justice Strine, writing an en banc opinion for the Court, upheld Chancellor Bouchard's finding that KKR could not be considered a controlling parent where "KKR owned less than 1% of Financial Holdings's stock, had no right to appoint any directors, and had no contractual right to veto any board action."
The Delaware Supreme Court upheld the familiar standard of effective control, absent a majority, which focuses on "a combination of potent voting power and management control such that the stockholder could be deemed to have effective control of the board without actually owning a majority of stock."
Chancellor Bouchard had noted that plaintiff's complaint stemmed from dissatisfaction at the contractual relationship between KKR and Financial Holdings which limited the growth of Financial holdings. Chancellor Bouchard wrote:
At bottom, plaintiffs ask the Court to impose fiduciary obligations on a relatively nominal stockholder, not because of any coercive power that stockholder could wield over the board's ability to independently decide whether or not to approve the merger, but because of pre-existing contractual obligations with that stockholder that constrain the business or strategic options available to the corporation.
Sometimes a "nothing new" case provides a good reminder of an established standard and provides clear language for recapping the concept to students. This will become a note case on "effective" control in my ChartaCourse corporations casebook and also a good illustration of the role of private agreements in shaping how legal standards are applied.
You can read the opinion at: Corwin et al. v. KKR Fin. Holdings et al., No. 629, 2014, 2015 WL 5772262 (Del. Oct. 2, 2015).
Saturday, October 24, 2015
On the one hand:
Dropbox Inc. had no trouble boosting its valuation to $10 billion from $4 billion early last year, turning the online storage provider’s chief executive into one of Silicon Valley’s newest paper billionaires.
But the euphoria has begun to fade. Investment bankers caution that the San Francisco company might be unable to go public at $10 billion, much less deliver a big pop to recent investors and employees who hoped to strike it rich, according to people familiar with the matter.
BlackRock Inc., which led the $350 million deal that more than doubled Dropbox’s valuation, has cut its estimate of the company’s per-share value by 24%, securities filings show.
Dropbox responds that it is continuing to increase its business, added 500 employees in the past year, including senior executives, and has no need for additional capital from private or public investors.
Still, the company is a portent of wider trouble for startups that found it easy to attract money at sky’s-the-limit valuations in the continuing technology boom. The market for initial public offerings has turned chilly and inhospitable, largely because technology companies have sought valuations above what public investors are willing to pay....
Many U.S. based companies that went public this year have seen their stock prices suffer, posting a median return of zero compared with their IPO price.....
Since going public in December, online-lending marketplace LendingClub Corp., located 10 blocks from Zenefits in the trendy SoMa district of San Francisco, has seen its valuation shrink from $8.5 billion after its first day of trading to $5.4 billion. The share price has fallen amid concern that competition and regulation threaten LendingClub’s business model of matching borrowers with lenders.
New York City firefighter Brian Gitman bought 250 shares of LendingClub during the IPO and held on to them as the price slid. He regrets it.
Knowing that big-name investors put money into LendingClub when it was private gave Mr. Gitman, 33 years old, a false sense of security, he says. “It feels like that should be like the bumper in bowling,” he says.
meanwhile, in entirely unrelated news:
A new effort is under way to put the public back in the initial public offering.
J.P. Morgan Chase & Co. and Motif Investing Inc., an online brokerage, are joining in a program to allow individuals to invest as little as $250 in IPOs.
It is the latest of several efforts by banks and brokerage firms—including startup online broker Loyal 3 Holdings Inc., Fidelity Investments andMorgan Stanley—to make the IPO market more accessible to the smallest investors, who can find it almost impossible to buy into new stock offerings.
Since late 2013, at least 17 companies, including four billion-dollar-valued startups, have offered small portions of their IPOs to the public or customers through new online platforms. And more deals of this kind are in the works.
Thursday, October 22, 2015
Just as I was in the middle of preparing for my class on shareholder proposals - for which I have assigned the opinion in Trinity Wall Street v. Wal-Mart Stores, Inc. - I got an email notification that the Division of Corporate Finance Staff had issued a new legal bulletin announcing that it disagrees with the majority opinion in Trinity, and instead agrees with the concurring opinion.
I discussed the Trinity opinion here, but basically, the issue was whether Walmart could exclude a shareholder proposal, submitted by Trinity Wall Street, requesting that Walmart develop a policy for oversight of sales of guns with high capacity magazines (the proposal was framed to encompass harmful products broadly, but the narrative made clear it was aimed toward gun sales). In the Third Circuit opinion, the majority and the concurrence disagreed regarding the proper interpretation ordinary business exclusion for social-responsibility proposals. The majority held that to determine whether a proposal is excludable, the court must first analyze whether it concerns ordinary business, next determine whether it involves a significant issue of social policy, and finally determine whether - despite involving ordinary business - the social policy issue is so important as to "transcend" day to day business operations. The majority ultimately concluded, essentially as what appears to be a bright line rule, that certain "core" matters of business operations can never be transcended in this manner.
The concurring judge, however, believed that social policy = transcendence - i.e., that the proper inquiry is whether the social policy raised is of such significance that it inherently transcends the day to day business operations.
In its legal bulletin, the Staff agreed with the concurrence.
But that only raises more questions than it answers. As I previously posted, the concurring judge also believed that the proposal at issue in the Trinity case was not sufficiently significant to "transcend" ordinary business operations for a variety of reasons, including that the proposal was framed in terms of benefits to Walmart. I criticized this analysis because, among other things, most social responsibility proposals are framed in terms of benefits to the company - they might fail as improper under state law otherwise. The concurrence also faulted the proposal for discussing harmful products generally instead of guns specifically - a fact that did not bother the majority.
Now we know the Staff agrees with the concurrence that the inquiry hinges on the significance of the social policy itself; but we also know that the Staff earlier issued a no-action letter concluding that Trinity's proposal was excludable. So I'm left a bit baffled as to the Staff's basis for that conclusion. Did the Staff agree with the concurrence that Trinity should have framed the proposal in terms of societal benefits? That the proposal failed because it was framed in terms of harmful products rather than guns specifically? The Staff's no-action letter did not mention the significance of the social policy at all - instead, it focused solely on the business operations to which it was directed. Does that make the no-action letter inconsistent with the Staff's new bulletin?
Moreover, what is the precedential effect of Trinity now? In its opinion, the Third Circuit majority stated that only a binding SEC ruling could overrule it; the Staff's bulletin is not binding. Does this mean courts in the Third Circuit are bound by Trinity while courts outside of the Third Circuit are free to rely on the Staff bulletin as persuasive authority?
Only time will tell - but surely this adds at least some fuel to Trinity's pending cert petition. I note, however, that Walmart ultimately caved and removed assault rifles from its shelves - even without including the proposal in its proxy.
In any event, I guess this means in addition to the Third Circuit opinion, my students will be reading the Staff bulletin and the original no-action letter.
On another note - the Staff bulletin also deals with the problem of shareholder proposals that are excludable because they conflict with management proposals in the same proxy under Rule 14a-8(i)(9). Recently, some companies (*cough*Whole Foods*cough*) have tried to exclude shareholder proxy access proposals by including management-sponsored proposals with much higher - nay, unachievable - threshold ownership levels, and then arguing that the shareholder proposal conflicts with management. The Staff bulletin seems to put the kibosh on these efforts, adopting a new rule that a "conflicting" proposal is one that is irreconcilable with the management proposal, such that a reasonable shareholder could not support both.
Saturday, October 17, 2015
Jessica Erickson has just published a fascinating article on the structure of lead plaintiffs’ counsel arrangements in corporate cases.
Erickson documents how Delaware courts have formally identified “factors” that will be used to select lead counsel, but have informally sent the message that the parties must work out the leadership structure amongst themselves. This means that multiple law firms have an incentive to file claims with no intention of performing serious legal work, solely to negotiate a position in the leadership structure so that they can collect a portion of the fees.
This practice not only results in duplicative lawsuits, but allows lawyers to engage in rent-seeking – extracting fees without performing serious legal work – that can damage incentives for the “real” lawyers, and harm the class.
At this point, I just have to interject with an account of my experiences. I was at Milberg Weiss for a few years (though I was more involved in securities cases under the PSLRA than corporate cases). Milberg frequently worked with co-counsel, and most of the time – no matter which firm was formally appointed lead – Milberg was functionally in charge of the litigation. Co-counsel generally was added to the case because they had a close relationship with an institutional plaintiff, but they tended to have little skill – or even interest – in the actual litigation. Due to our fee agreements, we were required to allocate them some amount of work, and it was usually an administrative hassle – co counsel frequently failed to submit their work product by the relevant deadline, and what they did submit was often subpar and needed to be rewritten.
What this meant, of course, is that the class suffered, through duplicative and unnecessary fees.
Eventually I landed at Bernstein Litowitz, and by then, the landscape had changed. There were fewer co-lead firms, and the co-leads that existed were more functional – I could rely upon them to do serious work. So there was a real change in the landscape of securities litigation between the time when I left Milberg in 2005, and when I joined BLBG in 2009. Erickson’s article confirms my experience; she describes how, over time, judges overseeing PSLRA litigation became more suspicious of complex leadership structures that combined groups of unrelated plaintiffs.
Delaware litigation, however, has not undergone that kind of change, and remains driven by the same dynamics that governed earlier securities litigation – namely, small firms, existing mainly to file complaints, holding larger firms hostage. In the securities context, small firms could only exert that kind of leverage if they at least had enough credibility to land an institutional client; Delaware, however, doesn’t use the PSLRA’s bright line largest-loss rule, and so any firm can hold up an entire case. And because Delaware courts avoid injecting themselves in disputes among plaintiffs’ firms, as Erickson points out, firms cannot privately order their arrangements in an optimal matter.
Erickson’s central point is this: if courts are unwilling to enforce the standards they set, parties cannot bargain in the shadow of the law, and parasitic firms have correspondingly greater power. Courts must demonstrate a willingness to select a single lead counsel when no private agreement is reached, in order to enable attorneys to bargain for optimal results.