Friday, March 16, 2018
It’s that time of year again! Tulane is hosting its 30th Annual Corporate Law Institute, a 2-day conference devoted to developments in corporate law, particularly mergers & acquisitions.
I was only able to attend some of the panels on the first day, but I very much enjoyed getting a sense of what lawyers – and judges – are thinking about these days. Below is a summary of some of the highlights that I found most intriguing:
[More after the jump]
Saturday, March 10, 2018
I’ve been consumed by the latest twist in Broadcom’s attempt at a hostile takeover of Qualcomm: the dramatic entrance of CFIUS.
For those who haven’t been following the saga, Broadcom, a Singaporean technology company, has been attempting to acquire San Diego-based Qualcomm for months. After its attempts at a friendly merger were rebuffed, it launched a proxy contest, proposing its own nominees to replace Qualcomm’s existing directors.
Qualcomm responded with what is apparently becoming de rigueur in contested proxy solicitations: in addition to setting up a website devoted to making its case to shareholders, it also promoted various tweets on the subject.
One intriguing aspect of Qualcomm’s argument has been that – as a leader in research and development – the merger would be bad for innovation and consumers. This point is reiterated on its website, which fascinates me because it assumes that investors as investors would be persuaded by an argument directed toward consumer wellbeing.
That may not have been the right tack; according to news reports, at least some large shareholders were poised to vote for Broadcom, giving Broadcom a fighting chance at a hostile takeover.
But the day before the crucial shareholder meeting, Qualcomm won a reprieve: the Committee on Foreign Investment in the United States (CFIUS) asked that the vote be delayed so that it could review whether the transaction posed a threat to national security.
CFIUS, Chaired by the Secretary of the Treasury and staffed with representatives of most major federal departments, is charged with reviewing proposed mergers and acquisitions in which a foreign entity proposes to gain control of a domestic one, to ensure that the transaction will not pose national security risks. It can intervene on its own accord when a transaction raises red flags or – more commonly – the parties can ask for pre-acquisition review to ensure that problems will not arise later. In this case, Qualcomm asked for the review, in an elegant example of the use of the regulatory system as a takeover defense mechanism that is sure to serve as a classroom example for decades. (Check out the wording of CFIUS’s letter: “Qualcomm is a global leader in the development and commercialization of foundational technologies… Qualcomm led the mobile revolution in digital communications technologies…” – did Treasury write this or Qualcomm’s PR department?)
CFIUS’s eleventh-hour appearance is quite the eyebrow-raiser. For one thing, it tests the outer boundaries of what counts as foreign control. And that’s not just because of the technical definition of what it means to be foreign – as the New York Times points out, Broadcom’s employees and properties are mostly located in the US, and the company has plans to relocate its headquarters to US this year – but because it’s unclear that Broadcom is, at this time, seeking “control.”
As its proxy filings indicate, Broadcom’s nominees for Qualcomm’s board have no prior relationship to Broadcom and mostly appear to be American. Broadcom is not a controlling shareholder, and its nominees will only gain board positions with the support of Qualcomm’s remaining (American) shareholders. Though of course Broadcom expects that eventually these directors will agree to allow Broadcom to acquire Qualcomm’s stock, that is by no means certain (remember Airgas??) and Broadcom has no legal power to compel them to do so. It is therefore a stretch to categorize the proxy fight itself as a “merger, acquisition, or takeover that is proposed or pending … by or with any foreign person which could result in foreign control of any person engaged in interstate commerce in the United States,” which is the only matter over which CFIUS has jurisdiction. Indeed, this precise point apparently troubled Sec. Mnuchin.
The other stunner is the national security risk that CFIUS identifies, namely, the fact that Broadcom’s investment strategy involves cutting R&D spending, which might hobble Qualcomm’s efforts to develop 5G technology. As CFIUS itself concedes, this is the investment strategy of many – American – private equity firms, and is unrelated to Broadcom’s (nominally) foreign status; it is simply the fact that Broadcom happens to be foreign that gives CFIUS jurisdiction to insert itself into the dispute. Steven Davidoff Solomon calls this an example of “realpolitik,” namely, an acknowledgement that China – our main competitor in the 5G space – has a government policy of assisting private development of technology.
Broadcom has responded to all of this with pledges to continue spending on R&D and even to sponsor a new initiative dedicated to training American engineers, but my bottom line reaction is that if the US is so concerned about keeping American tech companies competitive, it might reconsider all those new immigration policies that are scaring talent away to other countries.
Edit: Jinx, buy me a Coke - after I typed this post up, a Qualcomm shareholder filed a lawsuit in Delaware arguing that by inviting CFIUS to review the deal using spurious arguments of foreign control, Qualcomm directors violated their fiduciary duties. I can't say I have high hopes for the suit's chances, at least to the extent it rests on CFIUS's actions, but I did find one detail interesting: the original CFIUS order apparently required that the shareholder meeting be postponed and proxies cease being accepted or counted; CFIUS then modified the order to call for an adjournment of the meeting and to permit proxies to be solicited. The plaintiff contends this was done at Qualcomm's urging, to permit it to continue to try to lobby shareholders to change their votes.
Saturday, March 3, 2018
George Geis at the University of Virginia has just posted Traceable Shares and Corporate Law, exploring the implications that blockchain technology will have on various aspects of corporate law that – until now – hinged on the presumption that when one person buys a share of stock in the open market, there is no prior owner who can be identified. The ownership history of a particular share cannot, in other words, be traced.
That lack of traceability has a lot of important effects. For example, it means that if a company issued stock pursuant to a false registration statement, but also issued additional stock in another manner, plaintiffs may not be able to bring Section 11 claims because they cannot establish that their specific shares were traceable to the deficient registration. In the context of appraisal, it has led to questions of whether petitioners who obtained their shares after the record date have an obligation to show that the prior owners of the shares did not vote in favor of the merger (an impossible task). If blockchain technology makes it possible to trace the owners of a share from one transfer to another, these areas of law may be dramatically altered.
The most intriguing part of the paper, however, is where Geis goes further, and inquires whether traceability could cause us to rethink fundamental corporate doctrines. For example, he points out that fraud-on-the-market doctrine is often criticized because some shareholders may benefit from the fraud – in the form of rising share prices – but do not have to pay any damages if they sell before the crash. He provocatively suggests that with traceable shares, subsequent purchasers might have claims against the transferors – which might then incentivize selling shareholders to more closely attend to matters of corporate governance.
I find the proposal fascinating, because it would function, essentially, as a kind of targeted veil-piercing. Though I doubt legislatures and courts would have much appetite for such a rule, it makes for an interesting thought experiment to imagine how it might play out. Presumably, such a rule would not depend on inside information – insider trading prohibitions already would permit disgorgement in those circumstances – so we have to assume the selling shareholders were relying on public information when making their trades. I also assume such liability would be more palatable when imposed on institutional investors of a certain size than on retail investors. Would institutions have a defense if they showed they tried to be good corporate stewards, objected to, say, pay packages that encouraged risk-taking and the like? Especially if they could also show they used an index strategy and so engagement was their only tool to monitor their investments?
One downside, of course, would be potential losses to market efficiency. If shareholders cannot gain by selling stock of companies that they believe are overvalued, prices will become less informative. Indeed, the act of selling out may be exactly the best way to exert pressure on management to govern more responsibly.
In any event, I think Geis is correct when he predicts that traceable shares are in our future – and we may have to rethink a lot of corporate law as a result.
Saturday, February 24, 2018
At this point, drawing inferences from corporate jet usage is its own mini-genre in the business literature. There was David Yermack’s famous Flights of Fancy, which found that companies underperform when the CEO makes use of the company jet for personal business (often, apparently, golfing-related business); other studies have found that corporate jet use can enhance firm value, or detract from it, depending on whether the company has weak corporate governance, and that public firms have larger jet fleets than firms owned by private equity funds, suggesting the excessive fleet size is due to agency costs in public firms.
(And these studies, naturally, were conducted before everyone knew about GE’s now-discontinued practice of having its CEO travel with a jet and a spare.)
Now there’s a new contribution to the genre: Corporate Jets and Private Meetings with Investors, by Brian J. Bushee, Joseph J. Gerakos, and Lian Fen Lee.
The authors begin with the previously-documented phenomenon that when investors have the opportunity to engage in private meetings with corporate management, their trading improves. Regulation FD prohibits management from providing these investors with nonpublic material information, but somehow – whether through outright violations of the rule or simply subtle cues that the investors can synthesize with their own information – these meetings benefit investors who are fortunate enough to have the opportunity to participate in them.
The rest of the world, however, usually doesn’t know when these meetings are taking place. If they occur at a publicized conference researchers can deduce their existence, but otherwise, there’s no obvious way to tell.
The authors figured out that they could deduce when private meetings were taking place by tracking corporate jet usage. They found that when the corporate jets were used to rapidly fly to multiple cities where their investors are based, there are increases in the level of local institutional stock ownership, and detectable market reactions (which the authors attribute to investors acting on what they believe to be improved private information). The authors also found that these trips were more likely to occur when the firm was undergoing various conditions that might increase investors’ demand for information.
The part that I find interesting, though, is that evidence was mixed as to whether institutions were actually benefitting from these meetings in the form of trading gains – and they were more likely to do so when the trips were taken to large cities with finance industries rather than to other locations. The authors don’t say it, but that piece makes me wonder if there’s a distinction in investor sophistication at play; all investors are not created equal, and some institutions may be better able to make use of the information revealed in private meetings than others.
Saturday, February 17, 2018
The possibility lurking in Dell, Inc. v. Magnetar Glob. Event Driven Master Fund Ltd, 2017 WL 6375829 (Del. Dec. 14, 2017), has now materialized.
For those of you just joining us, in Dell and DFC Glob. Corp. v. Muirfield Value P’rs, L.P., 172 A.3d 346 (Del. 2017), the Delaware Supreme Court threw some cold water on the practice of appraisal arbitrage. The two decisions suggest that in an appraisal action, courts should not try to conduct their own valuation of a company except in unusual circumstances; instead, where the deal was negotiated appropriately, the deal price itself represents the best evidence of fair value.
That alone would be enough to discourage would-be appraisers, absent evidence of significant dysfunction in the process by which the deal price was reached, but the decisions went further: both contained extensive endorsements of the efficient markets hypothesis and the accuracy of market pricing. In the context of the opinions themselves, the market price discussions were puzzling, because they played little role in the Court's actual analysis. In both cases, the Court ultimately suggested that the deal prices - which were above market price - were appropriate. At the same time, however, in neither case did the defendants argue that the deal price included value arising from the merger itself (which is unavailable in an appraisal action) - a point that the DFC court in particular highlighted.
That left open the possibility that in future cases, defendants would be able to successfully argue that the market price of a publicly traded company is the best evidence of its value, and that any premium above that amount represents value arising out of the merger. Such an argument would leave appraisal petitioners with, at best, market price - which is usually a figure less than the deal price, rendering the appraisal remedy itself not worth pursuing for most publicly-traded companies. Worse, it would do so even in situations where there were significant problems in the deal negotiations. After all, no matter how hair-raising the process by which the deal price was reached, if that price was above market price - and if market price is evidence of the standalone fair value of the target as a going concern - then appraisal provides no remedy.
Well, that's what just happened. In Verition Partners Master Fund, Ltd., et al. v. Aruba Networks, Inc., C.A. No. 11448-VCL, memo. op. (Del. Ch. Feb. 15, 2018), VC Laster concluded that after Dell, he had no choice but to accept the market price as the best evidence of the target's fair value - even in the face of evidence that the acquirer made an employment offer to the target's CEO while negotiations were continuing (in violation of a prior agreement with the target, and without the Board's knowledge), and in the face of evidence that the target's financial advisors were trying to curry favor with the acquirer. As a result, he awarded the dissenters the pre-deal market price of $17.13 per share, a figure significantly below the merger price of $24.67 per share.
It appears that unless the Delaware Supreme Court steps in to say this isn't what it meant in Dell and DFC, going forward, appraisal arbitrageurs will have to show both that there were dysfunctions in deal negotiations, and that there were significant reasons to distrust the pre-deal market price, before they can hope to come out ahead. That'll be quite an uphill climb.
Saturday, February 10, 2018
Socially responsible investing is all in the news these days, as several large asset managers and advisors have publicly declared commitments, of one kind or another, to pressuring portfolio companies to act in socially responsible ways.
Commenters debate whether these managers genuinely believe social responsibility will improve value at portfolio companies, or whether they are trying to appeal to the preferences of clients who themselves favor socially responsible investing, either as a mechanism for improving value, or, more probably, as a matter of, essentially, “taste.” If you’re going to invest an index fund, for example, you may as well invest in the one where you believe your dollars will also be used to push for your preferred agenda – even if little is actually being done in that direction.
The reason it’s so difficult to suss out anyone’s exact motive, of course, is that it’s tough to admit – as an asset manager or any kind of institutional investor – that you’re interested in anything other than financial returns. Not simply because of the publicity you’ll generate, but because it’s not clear how far fiduciary obligations allow fund managers to go in pursuing social goals.
(This is, of course, one of the ways in which reductionistic fiduciary duties strips out the real concerns of the ultimate humans the duties are designed to benefit).
Which is why I found the letter by Jana Partners announcing its new social activism fund – and targeting Apple – so intriguing. In a partnership with the California State Teachers Retirement System (who is not, at least yet, an investor in the fund), Jana is urging Apple to institute stronger parental controls on the iPhone. Now, there’s been a lot of commentary about Jana’s motivations - is Jana truly trying to profit via social activism? Or is this a loss leader so that it can cultivate relationships with kinds of institutions it needs to support its more traditional activist campaigns?– but what intrigues me are the interests of CalSTRS.
Because the letter spends most of its time talking about how better controls will ultimately prove profitable for Apple and thus Apple’s shareholders, but concludes by pointing out that the issue is “of particular concern for CalSTRS’ beneficiaries, the teachers of California, who care deeply about the health and welfare of the children in their classrooms.”
In other words, the subtext is that CalSTRS’ interest is for teachers as teachers – not necessarily for teachers as shareholders.
This is hardly the first time a pension fund has shown its hand in this way, but it does highlight how funds are even more constrained than businesses in terms of openly pursuing socially responsible goals, and the delicate tapdance they sometimes do around that fact.
Saturday, February 3, 2018
All circuits agree that loss causation can be shown via “corrective disclosures” – some kind of explicit communication to the market that prior statements were false, followed by a drop in stock price.
However … there has been an alternative theory that plaintiffs can use to show loss causation, even without an explicit corrective disclosure. The theory is usually described as “materialization of the risk.” It requires the plaintiff to show that the fraud concealed some condition or problem that, when revealed to the market, caused the stock price to drop, even if the market was not made aware that the losses were due to fraud. For example, a company may report a slowdown in sales, causing its stock price to fall, while concealing the fact that the slowdown was due to an earlier period of channel stuffing. By the time the channel stuffing is revealed, it may communicate no new information about the company’s prospects, so the stock price remains unmoved. Under a materialization of the risk theory, the price drop upon disclosure of the fall in sales would be sufficient to allege loss causation.
To be sure, very often cases fall along something more akin to a spectrum, with district courts demanding more or less of a connection between the disclosure and the underlying fraud before permitting plaintiffs to proceed; nonetheless, the broad guidance offered at the circuit level influences those determinations. Thus it was significant that, for a time, three circuits – the Fifth, Sixth, and Ninth – were reluctant to recognize “materialization of the risk” theory, and required plaintiffs to clear the more restrictive “corrective disclosure” hurdle.
In July 2016, as I previously described, the Sixth Circuit joined the majority of circuits and endorsed “materialization of the risk” theory. That left just the Fifth and the Ninth Circuit on the side of corrective-disclosure-only, with a case then-pending before the Ninth Circuit that directly presented the question.
That decision has just been released. In Mineworkers’ Pension Scheme, et al v. First Solar Incorporated, et al, the Ninth Circuit, as well, held that “A plaintiff may also prove loss causation by showing that the stock price fell upon the revelation of an earnings miss, even if the market was unaware at the time that fraud had concealed the miss…. This rule makes sense because it is the underlying facts concealed by fraud that affect the stock price. Fraud simply causes a delay in the revelation of those facts.”
The per curiam opinion stated that the matter had already been resolved by an earlier Ninth Circuit case, which … I, ahem … dispute, but regardless, it’s apparently settled now.
By my count, that leaves the Fifth Circuit standing alone. Your move, Fifth Circuit.
Saturday, January 27, 2018
The Delaware Supreme Court finally issued its decision in Cal. State Teachers Ret. Sys. v. Alvarez, and it appears we don’t have one neat trick for dealing with races to the courthouse in derivative litigation after all.
As I’ve discussed in previous blog posts, Delaware has a substance and procedure problem. Namely, it uses its own court procedures as supplemental mechanisms to substantively police the behavior of corporate actors, but those procedures don’t apply in non-Delaware forums. That leaves Delaware vulnerable to being undercut by other states – and encourages an unhealthy race to the courthouse in other jurisdictions.
As I explained before, in the context of derivative cases, “Delaware’s recommendation that derivative plaintiffs seek books and records before proceeding with their claims simply invites faster filers to sue in other jurisdictions – and invites defendants to seek dismissals against the weakest plaintiffs, which will then act as res judicata against the stronger/more careful ones.”
That’s what happened in Alvarez. While the Delaware plaintiffs spent years litigating a books and records request, defendants won a dismissal for failure to plead demand futility against a competing plaintiff group in Arkansas. The Chancery court then held that the dismissal was res judicata against the Delaware plaintiffs.
On appeal, the Supreme Court remanded with a curious request: to determine whether the dismissal violated the Delaware plaintiffs’ federal Due Process rights. The reasoning, first articulated by VC Laster in In re EZCORP Inc. Consulting Agreement Deriv. Litig., 130 A.3d 934 (Del. Ch. 2016), was that until a court concludes demand is futile, the plaintiff has no right to bring suit on the corporation’s behalf, and therefore acts individually. Laster analogized to the Supreme Court’s decision in Smith v. Bayer Corp., 564 U.S. 299 (2011), which held that a named plaintiff in a class action cannot bind the class until after certification.
On remand the Chancery court couldn’t quite bring itself to hold that federal Due Process was violated, exactly, but did suggest that the Delaware Supreme Court adopt a rule prohibiting preclusion in these circumstances, in part because such a rule would further public policy.
That decision was appealed back up to the Delaware Supreme Court, which has now rejected the recommendation. The Supreme Court concluded that a derivative case is unlike a class action, because in a class action, pre-certification, the named plaintiff is suing on his or her own behalf, bringing a claim that he or she is entitled to bring individually. By contrast, in a derivative action, the stockholder plaintiff never has the right to bring a claim individually; the claim always belongs to the corporation. Thus, even absent demand futility, the plaintiff must be viewed as standing in the corporate shoes. By this reasoning, derivative plaintiffs are in privity with each other, and there is a sufficient alignment of interests to satisfy Due Process.
In short, absent a showing of inadequate representation by the first plaintiffs, res judicata applies.
The Delaware Supreme Court did have a curious footnote though and I wonder if it provides an opening in future cases. The Court noted that had Delaware plaintiffs attempted to intervene in the Arkansas action – or, failing grounds to intervene, at least filed a statement of interest or sought to participate as amici – they might “have a more compelling argument before this Court that the Arkansas Plaintiffs failed to adequately represent them.” We’ll see if anyone tries to take advantage of that going forward.
Saturday, January 20, 2018
Sometimes it feels like I’m on the litigation-limiting-bylaw beat.
To briefly recap, in several prior posts, a law review article, and a forthcoming chapter, I’ve argued that corporate governance documents are not contracts in the traditional sense and thus should not be read to impose contract-like obligations on shareholders (critical for, among other things, the applicability of the Federal Arbitration Act). I’ve also argued that a corporation’s governing documents cannot impose forum-selection or other limitations on shareholders’ ability to press federal claims or claims that arise under the law of a nonchartering state.
This is relevant because some companies have gone public with forum selection provisions in their charters purporting to restrict Securities Act claims to federal court. Snap was one, as I discuss in more detail here; apparently, other companies include Blue Apron, Stitch Fix, and Roku. The Supreme Court is set to decide this term whether SLUSA requires that Section 11 class actions be brought in federal court, but that’s a separate issue from whether corporations can use private ordering to require that all Section 11 claims be brought in federal court.
Anyhoo, it looks like New Jersey is getting ready to pass a bill – modeled to some extent on a statute passed by Delaware a couple of years ago – that would allow corporations to include forum-selection provisions in their charters and bylaws. Under the New Jersey bill, forum-selection bylaws and charter provisions could only be used to restrict plaintiffs to New Jersey federal and state courts (i.e., they could not be used to select other fora, including arbitral fora), and - critically - it appears the intent of the provision is to limit its application to state law claims. The text reads:
N.J.S.14A:2-9 is amended to read as follows…
[T]he by-laws may provide that the federal and State courts in New Jersey shall be the sole and exclusive forum for:
(i) any derivative action or proceeding brought on behalf of the corporation;
(ii) any action by one or more shareholders asserting a claim of a breach of fiduciary duty owed by a director or officer, or former director or officer, to the corporation or its shareholders, or a breach of the certificate of incorporation or by-laws;
(iii) any action brought by one or more shareholders asserting a claim against the corporation or its directors or officers, or former directors or officers, arising under the certificate of incorporation or the "New Jersey Business Corporation Act," N.J.S.14A:1-1 et seq.;
(iv) any other State law claim, including a class action asserting a breach of a duty to disclose, or a similar claim, brought by one or more shareholders against the corporation, its directors or officers, or its former directors or officers; or
(v) any other claim brought by one or more shareholders which is governed by the internal affairs or an analogous doctrine.
Now, we usually think of derivative claims as state law claims but they don’t have to be (i.e., Section 10(b) claims can be brought derivatively, etc). Still, I think language like “any other claim … which is governed by the internal affairs or analogous doctrine” suggests the intent here was to limit the bill to state law.
In any event, we may get some clarity on these issues. D&O Diary is reporting that a shareholder lawsuit has been filed against Blue Apron, Roku, and Stitch Fix, seeking a declaratory judgment that the forum-selection provisions of those companies’ governing documents are invalid to the extent they purport to extend to federal law claims.
We’ll see how far along the case gets; it would be nice for courts to explore this issue in more depth.
Saturday, January 13, 2018
As Joan and Josh previously posted, Stefan organized an excellent AALS panel on Rule 14a-8. We covered a number of topics, including the appropriate role of retail and employee shareholders, the proper sphere of activity for shareholders vis a vis managers, the true audience for shareholder proposals, and how to construct Rule 14a-8 so that frivolous and improper proposals can be easily weeded out.
In my remarks, I focused on the fact that shareholder proposals are usually precatory, even when they don’t have to be. For example, shareholders have the right to pass bylaws, but even the Boardroom Accountability Project typically sponsors proposals that merely request that directors use their power to craft proxy access bylaws. (I assume that’s at least in part because a good bylaw must address administrative matters that shareholders are ill-equipped to manage – for example, see management’s response to Proposal Ten, for a majority-rule bylaw at Netflix).
Because shareholder proposals are precatory, their main function is informational: they allow shareholders to communicate with management, with each other, and with the market more generally. I suspect that this function may become especially important as passive investing’s popularity increases; absent the ability to sell, votes – and votes on specific governance matters – may be the most effective ways for shareholders to signal their views to management.
Given that, I believe that one fairly easy way of enhancing that signal would be to require that companies with multi-class shares disclose the class vote breakdown on shareholder proposals – and other votes as well – when they disclose the vote totals. I’d also potentially recommend a breakdown that distinguishes the votes of the management group from other shareholders.
Right now, unless a class vote is held separately, companies are only required to release the vote totals. This can cause some misleading reports. For example, when Google’s shareholders proposed elimination of the multi-class share structure in 2017 (as they have done in prior years), Google reported that there were 191,712,790 votes for, and 472,583,246 votes against the proposal.
This, of course, obscured the fact that the public shareholders apparently mostly favored the proposal; it was only defeated because Larry Page and Sergey Brin, with their high-vote shares, voted against it.
Now, obviously, even without a clear disclosure of this type, clever analysts might be able to glean the approximate breakdown from publicly reported information – as the above linked article indicates – but depending on the class structure, it may not always be that obvious. Moreover, as I recently posted, the SEC’s Investor as Owner Subcommittee of the Investor Advisor Committee thinks clearer disclosures regarding multi-class share structures would benefit the market, even when some of that information might be deducible from a close reading of SEC filings.
There is also evidence that management may intentionally exercise in-the-money options to vote against shareholder proposals that are in danger of passing; because of these and other close-vote scenarios, a vote breakdown would be helpful.
And I think this is useful information to have. It may assist with pricing of the public shares, and it may assist with pricing of shares of other companies with multi-class structures. It could also assist with companies and underwriters trying to decide whether to go public with multi-class share structures in the first place.
In other words, I think this is a pretty cheap intervention, and one that would provide real informational benefits.
Monday, January 8, 2018
Last week, I had the privilege of attending and participating in the 2018 annual meeting of the Association of American Law Schools (#aals2018). I saw many of you there. It was a full four days for me. The conference concluded on Saturday with the program captured in the photo above--four of us BLPB co-bloggers (Stefan, me, Josh, and Ann) jawing about shareholder proposals--as among ourselves and with our engaged audience members (who provided excellent questions and insights). Thanks to Stefan for organizing the session and inspiring our work with his article, The Inclusive Capitalism Shareholder Proposal. I learned a lot in preparing for and participating in this part of the program.
Earlier that day, BLPB co-blogger Anne Tucker and I co-moderated (really, Anne did the lion's share of the work) a discussion group entitled "A New Era for Business Regulation?" on current and future regulatory and de-regulatory initiatives. In some part, this session stemmed from posts that Anne and I wrote for the BLPB here, here, and here. I earlier posted a call for participation in this session. The conversation was wide-ranging and fascinating. I took notes for two essays I am writing this year. A photo is included below. Regrettably, it does not capture everyone. But you get the idea . . . .
In between, I had the honor of introducing Tamar Frankel, this year's recipient of the Ruth Bader Ginsburg Lifetime Achievement Award, at the Section for Women in Legal Education luncheon. Unfortunately, the Boston storm activity conspired to keep Tamar at home. But she did deliver remarks by video. A photo (props to Hari Osofsky for getting this shot--I hope she doesn't mind me using it here) of Tamar's video remarks is included below.
Tamar has been a great mentor to me and so many others. She plans to continue writing after her retirement at the end of the semester. I plan to post more on her at a later time.
On Friday, I was recognized by the Section on Business Associations for my mentoring activities. On Thursday, I had the opportunity to comment (with Jeff Schwartz) on Summer Kim's draft paper on South Korean private equity fund regulation. And on Wednesday, I started the conference with a discussion group entitled "What is Fraud Anyway?," co-moderated by John Anderson and David Kwok. My short paper for that discussion group focused on the importance of remembering the requirement of manipulative or deceptive conduct if/as we continue to regulate securities fraud in major part under Section 10(b) of, and Rule 10b-5 under, the Securities Exchange Act of 1934, as amended.
That summary does not, of course, include the sessions at which I was merely in the audience. Many of the business law sessions were on Friday and Saturday. They were all quite good. But I already am likely overstaying my welcome for the day. Stay tuned here for any BLPB-reated sessions for next year's conference. And in between, there's Law and Society, National Business Law Scholars, and SEALS, all of which will have robust business law programs.
Good luck in starting the new semester. Some of you, I know, are already back in the classroom. I will be Wednesday morning. I know it will be a busy 14 weeks of teaching!
Saturday, January 6, 2018
Over the holidays, I saw The Greatest Showman and Molly’s Game. You wouldn’t have thought they’d be all that similar, but in fact, they’re both stories about nontraditional entrepreneurs who build unusual businesses from scratch. Molly’s Game understands that; sadly, Greatest Showman does not. As a result, Molly’s Game is the more successful film.
The bulk of Molly’s Game is spent on building a business. She learns the field, she identifies prospects, she finances and markets her game, she maintains her position and handles competition. This is the heart of the movie and much of its appeal lies in the illustration of her ingenuity and expertise.
Those are also the best parts of The Greatest Showman, yet - and I rarely say this about a movie - the film was too short (1.5 hours). Too short because it quickly moves away from that theme to focus on a different story, namely, something about inclusion and acceptance for people who don't fit society’s mold. As one review put it, “it doesn’t really tell Barnum’s story. Rather, it appropriates his name for a pop-culture sermon on inclusion that lets us know, just in case we didn’t realize, that 500-pound men and bearded ladies are not just perfectly valid citizens but ‘glorious.’”
Now that’s a problematic theme for Barnum, and it’s more problematic when the whole idea is filtered through able-bodied, gorgeous, and white Hugh Jackman for the grownups and Zac Efron for the kids, but also, it gets away from what Barnum is famous for - what the title of the movie suggests - namely, his marketing genius.
Barnum is sometimes known as the Shakespeare of advertising for developing PR techniques that are still in use today. He was skilled at writing punchy, eye-catching copy, spinning a yarn – which the movie tells us but only barely demonstrates, most prominently in a single, early moment when he enchants his daughters with an improvised tale to distract from his inability to afford a birthday gift.
(Sidebar: The X-Files episode “Humbug” features a gem of a scene in which the curator of a local museum of circus oddities illustrates, in delightfully understated fashion, the type of storytelling power for which Barnum is remembered. You can see it online here, just jump to the 21:14 mark - at least until someone sends a takedown notice.)
Anyhoo, given Greatest Showman’s short runtime, way more space could have, and should have, been devoted Barnum’s publicity stunts, his advertising skills, the efforts it took to build his brand, and his own ethical line (which didn’t, umm, necessarily match the law’s) between salestalk and fraud. If the movie understood itself better, it could have highlighted those aspects of the character, and it wouldn’t even have had to sacrifice the feel-good-be-yourself message to do it.
So in the end, Greatest Showman didn’t live up to its own hype (Barnum would have been appalled). Molly’s Game, though, was a master class in salesmanship and business savvy.
Saturday, December 30, 2017
There is so much to unpack in FINRA’s recent settlement with Citigroup Global Markets over its analyst ratings. (Press release here.)
The short version is that due to a glitch in one of Citigroup’s clearing firms, there was a nearly five year period when its displayed ratings for 1800 different equity securities (buy, sell, hold) were incorrect. Buys were listed as sells; securities that weren’t covered received a rating, etc. As I understand it, the research reports themselves were accurate – so you could probably click through to see the true rating – but in various summaries made electronically available to customers and brokers, the bottom line recommendation was wrong. My guess – and this is just a guess – is that some brokers and customers probably figured out that the summary ratings were unreliable and made a habit of clicking through to check the research reports, but nonetheless FINRA alleges the mistakes impacted trading in various ways, including by allowing trades in violation of certain account parameters (i.e., accounts that were supposed to be restricted to securities rated “buy,” and so forth).
The problem did not go entirely unnoticed within the firm, but there wasn’t a firm level understanding of how systematic the issue was. So, brokers would report problems with individual ratings, and maybe they were corrected and maybe not, but no one seems to have had their eye on the system as a whole.
So, first - wow.
Second, I can’t help but point out that European regulations will soon require that investment banks charge for their research rather than provide it “free” to brokerage clients. This has created some rather complex questions regarding the value of analyst research as research (rather than as an entrée for schmoozing with corporate insiders, as Matt Levine has extensively discussed). Which means we now have a new datapoint: if Citi can go nearly five years with no one caring much about systematic mistakes in its analyst recommendations, that, umm, is rather suggestive of the research’s value. I also look forward to someone doing the empirical work to determine if these mistakes had any impact on market prices. I mean, Citi leaves a big footprint; it’s not impossible to imagine the errors had some detectable effect on stock prices, if only briefly.
Third, the extent to which securities laws prohibit false statements of opinion is a perennially hot topic. Technically, Rule 10b-5, Section 11, and Section 18 prohibit false statements of fact. Assuming the distinction between fact and opinion is a clear one (which is a whole ‘nother issue) – does that mean people are free to falsely talk up stocks as great buys (in their opinion) even when they are not?
Courts have settled on the rule that when a speaker misrepresents his own opinion – claims that he thinks a stock is a great buy when he thinks it is in fact no such thing – that is a false statement of fact, namely, about the fact of the speaker’s own opinion. The Supreme Court has also made clear that statements of opinion may be false in the sense that they mislead about the factual basis that underlies the opinion. Throughout this debate, it has been generally assumed that falsity in the first sense is, functionally, indistinguishable from scienter: after all, how could anyone accidentally misrepresent their own opinion about something?
Well, it seems Citigroup has now found a way.
Interestingly, this is not a case where a company seems to have accidentally bumbled into a series of mistakes that happily worked out in the company’s favor. In this case, the false reports were all over the map, and did not appear to result in any particular benefit to Citi. So, it appears that once computer algorithms get involved, it is in fact possible to falsely state one’s opinion without harboring fraudulent intent.
But only up to a point - some brokers noticed problems with particular stocks and reported them, though Citi took its own sweet time about making a fix. Does that mean the company acted with scienter with respect to particular false recommendations? And if so, can we expect to see lawsuits? (Loss causation will be an issue, naturally, but - well. We can stay tuned to see if someone comes up with an argument).
Saturday, December 23, 2017
Christmas is just a couple of days away, and we all know what that means – the end of Winter break is in sight and preparation for the Spring semester must begin in earnest!
In these last few vacation days, however, I leave you with a few articles on the changing face of the Christmas business:
Merry Christmas to all who celebrate, and for the rest of us – well, I know a great Chinese place :-)!
Saturday, December 16, 2017
This week, the Delaware Supreme Court reversed and remanded Chancery’s appraisal determination in Dell et al. v. Magentar Global Event Driven Master Fund et al.. The decision amplified the Supreme Court’s earlier opinion in DFC Global Corp. v. Muirfield Value Partners, LP, et al..
In DFC, the Delaware Supreme Court held that courts entertaining appraisal claims should place heavy emphasis on the deal price, at least for arm's length negotiations with no apparent flaws.
Dell, however, was a slightly different animal. Unlike DFC, it involved a management buy-out, which is a scenario rife with potential conflicts of interest. It was precisely because of these conflicts that the Chancery court refused to accept the deal price, and instead used its own discounted cash flow analysis to determine that the stock was worth more.
On appeal, the Delaware Supreme Court reversed. Though the Court acknowledged that there may be cause for concern in the MBO context, the Court concluded – based on Chancery’s own findings – that those concerns had been allayed in this particular case due to, among other things, an efficient market for the company’s stock, a robust sales process with full disclosure, and a CEO who was apparently willing to join with any potential buyer.
What was implicit in DFC – and what Dell makes explicit – is that in some ways, the Delaware Supreme Court is using appraisal to recapture ground it gave up in the context of fiduciary duty litigation.
As we all know, after Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), a shareholder vote can cleanse a variety of management sins in the context of negotiating a sale of the company. Though Corwin may have much to recommend it, the chief criticism is that management may be left with little incentive to conduct a robust sales process. As management is presumably well aware, so long as there’s some kind of premium over market, stockholders may be feel pressured to accept a deal on the table rather than hold out hope that management, if rebuked by an unfavorable vote, will apply their full efforts towards obtaining a better price (especially given customary break up fees). Corwin provides management with no incentives to do better than the minimum of what the stockholder vote will accept.
In DFC, the Delaware Supreme Court took the first steps toward filling that gap. By holding that deal price should carry great weight in the appraisal context absent evidence of a dysfunctional sales process, the court provided new incentives for management to obtain the best possible price for stockholders.
What was implicit in DFC is explicit in Dell. After explaining all the reasons why Dell’s sales process raised no red flags, and even counterbalanced the ordinary concerns that are raised in the MBO context, the court explained: “If the reward for adopting many mechanisms designed to minimize conflict and ensure stockholders obtain the highest possible value is to risk the court adding a premium to the deal price based on a DCF analysis, then the incentives to adopt best practices will be greatly reduced.”
Thus, the substitution of appraisal litigation for fiduciary litigation is near complete: improving upon deal price in the context of appraisal may be impossible unless something went wrong in the sales process (at least for the sale of a public company without a controlling stockholder). In this way, the Delaware Supreme Court ensures that there remain incentives for directors to use best practices when negotiating deals, while avoiding some of the pathologies that have infected fiduciary duty litigation. See Charles Korsmo & Minor Myers, The Structure of Stockholder Litigation: When do the Merits Matter?, 75 Ohio St. L.J. 829 (2014).
The question remains, however, whether Delaware made the right call. Commenters have argued that the threat of appraisal results in higher deal prices; those salutary effects may be mitigated under the new standards. It is not clear how proficient courts are at detecting the kinds of subtle distortions in a sales process that might result from even mild degrees of director self-interest, lack of expertise, or distraction – indeed, commenters have argued that it is precisely because appraisal can avoid these inquiries that makes it such an effective remedy.
Saturday, December 9, 2017
The SEC’s Investor as Owner Subcommittee of the Investor Advisor Committee has just posted a discussion draft regarding dual class share structures in advance of the December 7 meeting at which such structures were under consideration. (As of this posting, details of what transpired at the meeting are not online).
Dual class structures are increasingly common these days; presumably, that’s in large part due to the fact that institutional investor power has become a serious threat to management control, and dual class shares are a mechanism for pushing back. (Staying private is another mechanism, and the more that companies choose that route, the more bargaining power they have when they eventually go public, etc etc).
Suffice to say that despite various defenses of dual class shares that have been offered, the Investor as Owner Subcommittee is not impressed. It highlights a number of risks, which basically come down to that public investors may have different views about corporate strategy than the control group – precisely the feature that endears the structure to some commenters – and that controllers may use their control to further cement their own control (i.e., Google and the nonvoting shares). And then of course there are the risks that are backlashes the first risks: exclusion from indices and associated decline in share value and liquidity, litigation risks when investors inevitably challenge the controllers’ actions.
Since this is the SEC, the Subcommittee can’t really recommend that dual class shares be barred entirely; the best it can do is recommend additional disclosure, and that it does. Among other things, it wants clear line items disclosing that holders of x% of equity have x% of the votes, as well as the risks that controllers may use their control to further entrench themselves, and index and listing risks. And to make absolutely certain investors aren't confused, the Subcommittee recommends that even the label "common stock" be reserved for one share/one vote stock; stock with lesser rights should be called something else. The Subcommittee also recommends further monitoring to identify the types of disputes that arise out of these structures.
As with many SEC disclosure requirements, the proposals seem aimed less at simply informing investors than to pressure companies into adopting certain forms of governance. Whether the SEC takes heed in this new, highly deregulatory administration, remains to be seen.
Saturday, December 2, 2017
To draft end of semester exams. So while I frantically try to develop fact-patterns that are simple and coherent and yet simultaneously engage a semester’s worth of material, I offer three links that interested me recently.
First, Vice Chancellor Laster’s ruling in Wilkinson v. Schulman (pdf). In this opinion, VC Laster denied a books and records request on the grounds that the purposes of inspection belonged to Wilkinson’s counsel, and not Wilkinson himself. Wilkinson had complaints about the company, but the purposes of inspection raised in the demand letter were different, and developed by the attorneys without Wilkinson’s involvement. As Laster concluded, “Wilkinson simply lent his name to a lawyer-driven effort by entrepreneurial plaintiffs’ counsel.” This strikes me as the kind of ruling that could have broader implications – we’ll see if future cases pick up these threads.
Second, Bloomberg recently reported on an organization called “Protect Our Pensions,” which purports to be a grassroots effort to fight against fossil fuel divestment, but is in fact industry-backed astroturf. The reason I find this fascinating is that the standard argument against divestment is that it conveys no new information to the market and therefore will not affect prices. But the fact that the industry bothered to organize this effort at all tells us that the industry, at least, believes these efforts are having some kind of adverse effect.
Third, Buzzfeed posted an exposé of sexual assaults at Massage Envy franchises across the country. (Warning for graphic descriptions). Aside from all of the other issues raised, what struck me was how the franchise model – which allows Massage Envy to use its branding but disclaim responsibility – appears to have played a role in the cover-ups and lack of response to complaints. I’m not sure I’d want to use scenarios this fraught in business class, but it would certainly make a change from the standard McDonald’s cases featured in most textbooks to illustrate vicarious and apparent agency theories of liability.
Saturday, November 25, 2017
The PSLRA requires that complaints alleging Section 10(b) violations plead facts that raise a “strong inference” that the defendant acted with intent or recklessness. 15 U.S.C. § 78u-4. A “strong inference” is one that, taking into account “plausible opposing inferences,” is “at least as compelling as any opposing inference one could draw from the facts alleged.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308 (2007).
It has long been an axiom of PSLRA pleading that a strong inference may be raised by alleging that the defendant knew his or her statements were false, or knew facts that contradicted his or her public statements. See, e.g., Novak v. Kasaks, 216 F.3d 300 (2d Cir. 2000); Miss. Pub. Emples. Ret. Sys. v. Boston Sci. Corp., 523 F.3d 75 (1st Cir.2008); Fla. State Bd. of Admin. v. Green Tree Fin. Corp., 270 F.3d 645, 665 (8th Cir.2001); Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981 (9th Cir. 2009); Pugh v. Tribune Co., 521 F.3d 686 (7th Cir. 2008). Indeed, allegations of actual knowledge of falsity are sufficient to plead scienter even in the context of forward-looking statements, which are subject to their own special heightened pleading requirements. See 15 U.S.C. §78u-5.
In Maguire Fin. LP v. PowerSecure Int'l Inc., 4th Cir., No. 16-2163, the Fourth Circuit concluded that even when a plaintiff pleads that a CEO had knowledge of the falsity of the statements he issued on an analyst conference call, that is not sufficient to allege scienter under the PSLRA.
The basic claim was that the CEO told analysts that the company was “blessed to announce securing a $49 million three-year contract renewal, both the renewal and expansion with one of the largest investor [owned] utilities in the country,” when, in fact, the referenced contract was a new contract with an existing client, rather than a renewal. As it turned out, the expenses on this new contract caused the corporation to experience losses and, eventually, a dramatic stock price drop.
The Fourth Circuit accepted that the CEO knew the nature of the new contract when he described it to market analysts, but refused to accept the inference that the mischaracterization was intentional or reckless. Instead, the court argued that the CEO had no reason to believe the new contract would be unprofitable – and thus no reason to want to deceive the market about it – and though ordinary persons may have read the CEO’s statement to mean that a contract had been renewed, the CEO might not have realized that this was the common interpretation. The court reasoned that if the CEO had, in fact, intended to deceive investors about whether the contract was new, he would have elaborated on his statement, and offered additional false claims about it. The fact that he had not done so, the court concluded, contributed to an inference that he had not intended to deceive in the first place. The court ultimately opined, “Appellant alleges facts that permit an inference that Hinton knew his statement was false, and then asks us to infer from that inference that Hinton acted with scienter. We decline to do so because stacking inference upon inference in this manner violates the statute’s mandate that the strong inference of scienter be supported by facts, not other inferences.”
Look, I agree that on these facts, it’s very possible that the CEO misspoke. And I personally would like to know whether analysts reacting to the original conference call made their misunderstanding clear (so that the company could not claim to be unaware that the market had misunderstood the CEO’s representations). But this is a complaint. The issue is whether the plaintiffs have identified sufficient facts to get to discovery. The Fourth Circuit seems to have lost sight of this basic function of the pleading requirements, and instead interpreted its mandate to require dismissal so long as there is any nonculpable interpretation of the facts. The Circuit’s eagerness to draw exculpatory inferences from the CEO’s failure to tell an even greater lie bears a resemblance to pre-Tellabs caselaw reasoning that if an executive fails to dump his stock when making allegedly false statements – thus coupling a deceptive statement with a violation of insider trading prohibitions – the executive must not have acted with scienter. Such logic was, of course, rejected by the Supreme Court in Tellabs: not every instance of fraud is part of a carefully-calibrated scheme.
Meanwhile, the Court ignored the very damning fact that the company’s highest officer issued a knowing falsehood and allowed it to stand uncorrected for several months. The Circuit’s extraordinarily technical reason for rejecting the plaintiffs’ inferences – that the plaintiffs asked for an inference based on other inferences, rather than on facts – not only introduces an entirely unnecessary level of technicality into PSLRA pleading, but also contradicts the basic manner in which humans understand the world and attribute motivations and intentionality to other humans. When someone says things he knows are untrue, we infer that there was deceptive intent. Maybe that’s not the case, but the burden’s now on the speaker, not the listener. And if plaintiffs are not entitled to the basic inference that the defendant knew what his own words meant, the pleading standard serves no legitimate screening function; it’s simply an arbitrary barrier to the filing of securities claims.
If nothing else, the case highlights the essential folly at the core of the PSLRA heightened pleading requirements. Whether a complaint raises a “strong inference” of scienter depends entirely on the court’s background assumptions about plausible behavior from corporate officers. To some, it is plausible that a CEO could make such an innocent misstatement and fail to correct it for nearly a year; but surely one could plausibly believe that CEOs carefully prepare before they speak to analysts, and do not often make these kinds of mistakes unintentionally. One could plausibly believe that if the misstatement was innocently made, then the company would have corrected it shortly thereafter, and the fact that it did not do so suggests the statement was not so innocent after all. It might also be plausible that CEOs calibrate just how much they’re willing to lie to analysts, and are willing to be somewhat vague on certain matters in hopes of leaving a false impression, without being willing to go so far as to outright invent new facts to mislead the market. What seems plausible is entirely a function of one’s understanding of, and experience with, the world – and that’s quintessentially the function of the jury.
Monday, November 13, 2017
Saturday, November 11, 2017
SEC Commissioner Jay Clayton recently gave a speech where he remarked:
I have become increasingly concerned that the voices of long-term retail investors may be underrepresented or selectively represented in corporate governance. For instance, the SEC staff estimates that over 66% of the Russell 1000 companies are owned by Main Street investors, either directly or indirectly through mutual funds, pension or other employer-sponsored funds, or accounts with investment advisers… And, if foreign ownership is excluded, that percentage approaches approximately 79%.
… A question I have is: are voting decisions maximizing the funds’ value for those shareholders?
In situations where the voting power is held by or passed through to Main Street investors, it is noteworthy that non-participation rates in the proxy process are high. … This may be a signal that our proxy process is too cumbersome for retail investors and needs updating.
What’s interesting is that there are two different ideas here. One concerns the voting power of mutual funds and pension funds; the other concerns the votes of retail shareholders themselves.
As for retail votes, Jill Fisch has an article on this very subject forthcoming in the Minnesota Law Review. She recommends that retail shareholders be given access to electronic platforms, similar to those available to institutions, that allow them to set advance voting instructions without requiring them to make a company by company decision.
The broader question, though, is whether we do in fact want to encourage greater retail participation, and what the effects are likely to be. There’s long been an argument that retail investors should not invest directly, and the rules governing securities markets have, to a greater and greater extent, become less hospitable to them. (Stephen Choi, for example, has argued that investors should only be allowed to participate in capital markets if they demonstrate a certain degree of sophistication.) If that’s right, it makes little sense to encourage their participation in corporate governance.
At the same time, though, public companies love retail investors, because they are less likely to coordinate with pesky activists, and are assumed to be more supportive of management. I’ve often wondered if that was the motivating force behind Loyal3 (which recently folded shop), providing a free online brokerage for retail investors that wanted stock in their favorite brands.
Given what appears to be the general Republican preference, I rather suspect that they believe shareholder involvement in corporate governance is a net negative, and I wonder if Clayton’s newfound push for retail investor involvement is actually a stealth attempt to provide management with a bulwark against activist challenges.
Certainly, that appears to be the theme of Clayton’s actions: the rest of his speech expresses concern about shareholder proposals, and a recent SEC staff opinion suggests a shift to more deference to corporate boards when deciding excludability. In that context, his conflation of retail investor voting with mutual fund voting seems like something of a shot across the bow targeting mutual fund voting power. I can imagine, for example, a push to transition to pass-through voting for mutual funds, combined with a few measures that encourage retail investor participation.
But if that’s the kind of thing Clayton is hinting at – and to be sure, no one has suggested it so far, but it would make sense as an endgame – I do wonder how much it (and other efforts to involve retail shareholders) will backfire. I imagine retail investors, if seriously encouraged to participate, might be more – not less – likely to vote for social proposals and other less-than-wealth-maximizing actions that, these days, mutual funds tend to avoid unless pressed. And as Jill Fisch points out, retail investors might adopt advance voting instructions that set automatic triggers to challenge management when certain underperformance benchmarks are met. If the default assumption is that retail investors are less informed and less attentive, encouraging their greater participation may be something of a double-edged sword, from management’s perspective.
Moreover, if we have greater retail involvement in the voting process, Delaware might have to revisit decisions like Corwin v. KKR, 125 A.3d 304 (2015), which rest - at least implicitly - on the assumption of a sophisticated (institutional) shareholder base. And that’s something I'm pretty sure management would not want.