Saturday, July 14, 2018
Several months ago, I posted about the Chancery decision finding Elon Musk to be a controlling shareholder of Tesla for the purposes of Corwin v. KKR Financial Holdings, 125 A.3d 304 (2015), despite the fact that he held only a 22% stake. The decision took into account both Musk’s stock holdings and his other mechanisms of influence.
One of the reasons the decision stood out was because, while there is a long history in Delaware of considering both voting power and other factors to determine controlling shareholder status, after a certain point, you have to wonder whether the “stockholder” piece is doing any work, and whether instead the question should just be whether someone has effective control, either of the corporation generally or of a particular business decision.
Well, last week, we took a few steps more toward answering that question in Basho Technologies Holdco B, LLC et al v. Georgetown Basho Investors, LLC et al. There, plaintiffs contended that a minority stockholder was a “controller” for purposes of owing fiduciary duties to the corporation. Vice Chancellor Laster agreed, based on a holistic inquiry that took into account, among other things, the stockholder’s contractual rights via preferred stockholdings, its use of those rights (to block alternative transactions), its control over certain board members, and those members’ conduct.
But that’s not the important part. The important part is that Laster laid out a test for “controller” that appears to depend minimally – if it all – on voting power. As Laster put it:
If a defendant wields control over a corporation, then the defendant takes on fiduciary duties, even if the defendant is a stockholder who otherwise would not owe duties in that capacity. One means of establishing that a defendant wields control sufficient to impose fiduciary duties is for the plaintiff to show that the defendant has the ability to exercise a majority of the corporation’s voting power. A defendant without majority voting power can be found to owe fiduciary duties if the plaintiff proves that the defendant in fact “exercises control over the business and affairs of the corporation.” …
To show that the requisite degree of control exists generally, a plaintiff may establish that a defendant or group of defendants exercised sufficient influence “that they, as a practical matter, are no differently situated than if they had majority voting control.” One means of doing so is to show that the defendant, “as a practical matter, possesses a combination of stock voting power and managerial authority that enables him to control the corporation, if he so wishes.”
It is impossible to identify or foresee all of the possible sources of influence that could contribute to a finding of actual control over a particular decision. Examples include, but are not limited, to: (i) relationships with particular directors that compromise their disinterestedness or independence, (ii) relationships with key managers or advisors who play a critical role in presenting options, providing information, and making recommendations, (iii) the exercise of contractual rights to channel the corporation into a particular outcome by blocking or restricting other paths, and (iv) the existence of commercial relationships that provide the defendant with leverage over the corporation, such as status as a key customer or supplier. Lending relationships can be particularly potent sources of influence, to the point where courts have recognized a claim for lender liability when a lender exercises influence over a company that goes “beyond the domain of the usual money lender” and, while doing so, acts negligently or in bad faith.
Broader indicia of effective control also play a role in evaluating whether a defendant exercised actual control over a decision. Examples of broader indicia include ownership of a significant equity stake (albeit less than a majority), the right to designate directors (albeit less than a majority), decisional rules in governing documents that enhance the power of a minority stockholder or board-level positon, and the ability to exercise outsized influence in the board room, such as through high-status roles like CEO, Chairman, or founder Invariably, the facts and circumstances surrounding the particular transaction will loom large.
All of which begs the question whether stockholder status is necessary at all. Are pure lenders, or pure board members, potential controllers? Or is stockholder status a nominal necessity, so that one share is sufficient to begin the inquiry into controller status? These questions are left unanswered by Laster’s opinion.
Now, to be fair, no one who has ever studied Martin v. Peyton or Gay Jensen Farms v. Cargill in their Business Associations class would be surprised to learn that a lending relationship may ultimately transform into a control relationship, with associated duties. That said, it is still striking that Laster concluded that the particular stockholder in Basho was a “controller” for fiduciary purposes without even mentioning how much voting power the controller had, other to say that it was less than a majority. This nominal controller also did not have more than two appointees to a multi-member board. Nonetheless, its contractual rights were sufficient to trigger, in Laster’s view, fiduciary duties.
And that just raises more questions. For example, does a controlling stockholder – versus a controller by any other means – have any special status in this formulation, on the theory that controlling stockholders are uniquely invulnerable to challenge? Or is control the only relevant inquiry? And if control by any means is all that is necessary, can Laster’s analysis square with Corwin? There, the Delaware Supreme Court refused to find controller status where a nominal stockholder nonetheless had complete contractual control of the corporation’s business.
And how are we going to deal with complex capital structures? Both Tesla and Basho dealt with shareholders who had “blocking” rights – i.e., not enough votes to control the Board and dictate corporate action, but enough to block actions with which they disagreed. In Tesla’s case, this was because of a supermajority charter provision; in Basho, it was because a private company had issued multiple rounds of preferred financing with bespoke characteristics. As more companies stay private longer – and as more issue nonvoting stock, and/or high-vote shares – Delaware is going to have to ask more complex questions regarding controlling status and what it precisely entails. On this point, I note that in Third Point LLC v. Ruprecht, 2014 WL 1922029 (Del. Ch. May 2, 2014), the Chancery court determined that Sotheby’s could properly adopt a low-threshold poison pill in order to prevent a hedge fund from obtaining “negative” control, namely, the power to block corporate action, even if it could not generally control corporate policy. Is that what counts as control now? And does that mean – as recommended by Iman Anabtawi and Lynn Stout – that hedge funds now have fiduciary duties? (h/t Eric Goodwin for suggesting the possibility). As I alluded to in my Tesla post, the questions take on a new urgency in the wake of Corwin and Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014).
My final thought is, so much of corporate law these days has a back to the future quality. Complex capital structures with multiple rounds of financing, different classes of stockholders with different rights – many of which are nonvoting – were once the norm. Corporate control was relatively concentrated. For example, when Berle & Means wrote The Modern Corporation, they raised the alarm that one-third of America’s wealth was concentrated among 1800 corporations and 200 men.
That changed. With the federal regulation of the apparatus for securities issuance and trading, control over the Exchanges, and so forth, one-share-one-vote became the norm, as did dispersed share ownership and control.
Today, it feels like the pendulum has swung back the other way. As Jan Fichtner, Eelke M. Heemskerk & Javier Garcia-Bernardo put it, “we witness a concentration of corporate ownership not seen since the days of J.P. Morgan and J.D. Rockefeller.” Hidden Power of the Big Three? Passive Index Funds, Re-Concentration of Corporate Ownership, and New Financial Risk, 19 Bᴜs. & Pᴏʟ. 238 (2017). The statistics are well-known – and I talk about a lot of this in my new article, Shareholder Divorce Court (stealth plug! I am so stealthy!) – but, for example, BlackRock, State Street, and Vanguard together constitute the largest shareholder in 88% of the S&P 500, and 40% of all U.S. listed firms. In 2005 ownership of the S&P 500 was so concentrated that in any hypothetical conflict between two member firms, 15% of the equity on either side would be held by institutions that preferred the other side to win.
Meanwhile, we’ve begun to depart from a one-share-one-vote norm as more companies offer private financing with different terms, and even maintain differential voting rights after going public. Even fiduciary duties are up for debate again; they were a matter of some debate back in the early 1900s, they became standard, and now the fastest growing business form is the LLC, which allows fiduciary waivers. It’s as though in many areas – corporate law being, ahem, but one – we’re going to have to learn the lessons of the 20th Century all over again.
Saturday, July 7, 2018
One of the topics I’ve repeatedly discussed in this space is how layers of doctrine have been so piled on top of inquiries like materiality and loss causation in the Section 10(b) context that the legal analysis has become completely unmoored from the ultimate factual inquiry, namely, did the fraud actually result in losses to investors. As I put it in one post:
[A]ll of our measures of impact and harm and loss are, at this point, so far removed from reality as to border on complete legal fiction. Materiality is a construct from case law, with numerous additional doctrines piled on to it by courts without any heed for actual evidence of how markets behave. …. [W]hat we call “harm” and “damage” for the purpose of private securities fraud lawsuits have become so artificial that it no longer seems as though we’re even trying to measure the actual real-world effects of fraud. I believe private lawsuits are an essential supplement to SEC action but a system of fines or statutory damages would make so much more sense.
This week, I call attention to another recent example of the phenomenon. In Mandalevy v. BofI Holding, 2018 WL 3250154 (S.D. Cal. June 19, 2018), the plaintiffs alleged that the defendant BofI Federal Bank lied about various money laundering offenses and falsely denied that federal authorities were looking into the matter, in violation of Section 10(b). The court dismissed their claims on various grounds, including that the plaintiffs had failed to show that they had experienced any losses caused by the defendant’s false denial of an SEC investigation. The plaintiffs alleged that BofI’s stock price dropped after publication of a New York Post article disclosing the SEC’s interest, but the court observed that the story was based on information that the reporter had obtained by making a FOIA request. Information available via FOIA, the court concluded, is information generally available to the public, and, by extension, the market. As a result, the article itself was deemed to have merely summarized previously-public information, and could not qualify as a corrective disclosure that revealed the truth. As the court explained its reasoning:
The efficient market theory presumes that interested, “information-hungry” market participants are actively and continuously trading a company’s stock. Basic Inc. v. Levinson, 485 U.S. 224, 249 n.29 (1988). One obvious source of information about a particular company is its regulator, particularly when—as we have here—the company has denied the existence of a regulatory investigation in response to reports stating the contrary. The Court must assume that, in the nearly seven months between BofI’s denial [of the investigation] and the October 25 article, a market participant would have made the sensible step of asking the SEC whether BofI’s denial was accurate. The fact that a market participant would have had to jump through a bureaucratic hoop to obtain this information does not mean that the information was not “public.” To the contrary, the Court must assume that “information-hungry” market participants seeking an edge in trading BofI’s stock would expend at least some effort to obtain material information about the company. The Court’s understanding of an efficient market’s collective reach, in other words, cannot be limited to information one can find on Google….
Having been offered no reason to believe that any other market participant could not have made a FOIA request from the SEC about BofI prior to October 25, the Court must assume that he or she did. The CAC therefore fails to allege with particularity a revelation of the falsity of BofI’s March 31 statement.
Let’s take a moment to unpack the factual inferences here that the court is willing to draw at the 12(b)(6) stage: that unspecified investors made a FOIA request, that they got their response faster than the reporter’s own inquiry, and that they used that information to trade in sufficient quantities to completely offset the effects of the initial lie. And that despite the fact that markets, apparently, can be expected to behave in this manner, these investors believed, ex ante, it would be cost-efficient to justify the time and expense of making the FOIA request in the first place so that they could exploit the information that the request – might! – reveal.
And, it should be noted, in drawing these inferences, the court remained untroubled by the fact that the stock did, in fact, drop upon publication of the Post article.
Forgive me if I have a little trouble accepting – without any additional evidence – that markets are imbued with this kind of near-mystical perfection. Indeed, as the Supreme Court made clear, they don’t need to be in order to justify the fraud on the market presumption. Yet, as Stephen Bainbridge and Mitu Gutali put it, “federal judges are claiming--at least implicitly--a level of expertise about the workings of markets and organizations that, in some areas, not even the most sophisticated researchers in financial economics and organizational theory have reached.” Stephen M. Bainbridge & G. Mitu Gulati, How Do Judges Maximize? (The Same Way Everybody Else Does—Boundedly): Rules of Thumb in Securities Fraud Opinions, 51 Emory L.J. 83 (2002).
To be fair, plenty of other courts approach market evidence with more humility. For example, in Pub. Empls. Ret. Sys. of Miss., Puerto Rico Teachers Ret. Sys. v. Amedisys, Inc., 769 F.3d 313 (5th Cir. 2014), the Fifth Circuit concluded that publicly-available raw data – later analyzed and reported in a Wall Street Journal article – could not be presumed to have impacted stock prices because “it is plausible that complex economic data understandable only through expert analysis may not be readily digestible by the marketplace.” Similarly, in In re Massey Energy Co. Sec. Litig., 883 F. Supp. 2d 597 (S.D. W. Va. 2012), the court refused to presume that information in a public database was sufficiently available to the market to offset defendants’ lies about their safety record. (Notably – as I previously posted – the Massey court’s intuition that raw data would not be easily digested by investors was subsequently validated by an empirical study of the impact on such information on stock prices.)
That said, despite my snarky subject line, the goal here is less to attack this particular opinion – which follows a line of similar cases that, while perhaps not quite as aggressive, are also willing to draw broad conclusions about market behavior on a thin record – than to question the value of this entire mode of analysis. It seems increasingly likely that an alternative system that avoids judicial measures of market impact (like, for example, a system of a statutory damages) would better serve investors and deter misconduct.
Saturday, June 30, 2018
One of the odd things about teaching business and securities in the Trump era is that it’s been one of the few areas of law that’s been left largely unchanged by this singularly, umm, disruptive presidency.
That may be about to change.
As most readers are likely aware, the Supreme Court recently ruled in Lucia v. SEC that SEC ALJs are inferior officers, and therefore must be appointed by the Commission directly (instead of, as has been traditional, by the SEC staff). The SEC, anticipating this holding, altered its procedures to have the Commission ratify the staff’s selection. But – even assuming the ratification is sufficient – the next obvious question is whether, as inferior officers, ALJs must have fewer restrictions on their removal – an issue that, it should be noted, the Solicitor General’s office urged the Court to resolve against the SEC. This is a much bigger deal, because leaving aside questions about how such a deficiency would be remedied as a technical matter, without such protections, the impartiality of the ALJs – and thus the fairness and, I suspect, the constitutionality of the entire administrative adjudicative process – would be open to question. Cf. Kent Barnett, Resolving the ALJ Quandary, 66 Vand. L. Rev. 797 (2013) (anticipating these issues).
But that’s only the beginning.
In Janus v. AFSCME and NIFLA v. Becerra, the Supreme Court held that speech that was previously viewed as regulable – namely, required disclosures in the provision of health related services, and dues for union representation – instead would be subject to heightened scrutiny. In both cases, the dissents pointed out that the Court’s reasoning would jeopardize a wealth of ordinary consumer – and securities – regulation. As Justice Breyer put it, “In the name of the First Amendment, the majority today treads into territory where the pre-New Deal, as well as the post-New Deal, Court refused to go.” Justice Kagan was even more blunt in her Janus dissent: “Speech is everywhere—a part of every human activity (employment, health care, securities trading, you name it). For that reason, almost all economic and regulatory policy affects or touches speech. So the majority’s road runs long. And at every stop are black-robed rulers overriding citizens’ choices.”
And then there’s Masterpiece Cakeshop v Colorado Civil Rights Commission. There, the Court largely avoided the free speech claim, but the majority opinion stated, “The free speech aspect of this case is difficult, for few persons who have seen a beautiful wedding cake might have thought of its creation as an exercise of protected speech. This is an instructive example, however, of the proposition that the application of constitutional freedoms in new contexts can deepen our understanding of their meaning.” – suggesting, again, the Court is inviting creative new First Amendment challenges to business regulation. Indeed, a couple of years ago, John Coates empirically demonstrated the increasing use of the First Amendment to challenge business regulation.
As readers are likely aware, the SEC regulates in large part via required (and prohibited) speech. After Citizens United, Larry Ribstein argued that some proposals for corporate governance and securities regulation might violate the First Amendment. And, as it turns out, it was only three years ago that the SEC found itself in First Amendment crosshairs with respect to conflict minerals disclosures (umm, that link is to my post on the subject, and it anticipated that the DC Circuit would reconsider the matter en banc, which it … did not, so that only shows how seriously you should take my prognostications). Rebecca Tushnet has more in-depth discussion of the conflict minerals case. It seems to me that the SEC is long overdue for a First Amendment reckoning, and the climate has never been more ripe.
Meanwhile, the Supreme Court has already granted cert to consider whether to reinvigorate the non-delegation doctrine, Justice Gorsuch has ostentatiously cast doubt on the viability of Chevron,* and Trump is expected to appoint a new conservative justice in the coming months – which will only encourage more aggressive litigation. All of which suggests we’re about to see a rather dramatic dismantling of the regulatory state – including the SEC’s authority.
*although, to be fair, no one ever deferred much to the SEC anyway – which is like the Rodney Dangerfield of agencies – so Chevron’s fate may not end up making much difference to it.
Saturday, June 23, 2018
The Supreme Court just granted cert in Lorenzo v. Securities & Exchange Commission to decide the scope of primary liability/scheme liability under the federal securities laws. It’s an important issue and I’m glad that the Court seeks to clarify the law, but I have to say that procedurally speaking, this strikes me as an odd grant.
Below is way too long a post; it’s so much easier to write long than take the time to edit down, so forgive the extended backstory. (Also, for the record, I pulled a lot of the citations from my - very first! - real law review article, Slouching Towards Monell: The Disappearance of Vicarious Liability Under Section 10(b), which contains a long discussion of Janus, primary liability, and secondary liability, so, you know, enjoy if you’re into that).
[More under the jump]
Friday, June 15, 2018
Last week, a district court in California denied a motion to dismiss a securities fraud lawsuit brought by Snap shareholders. See In re Snap Inc. Secs. Litig., 2018 U.S. Dist. LEXIS 97704 (C.D. Cal. June 7, 2018). The shareholders alleged that the Snap IPO prospectus omitted certain critical information in violation of Sections 10(b) and 11, namely, information about the effect of competition from Instagram, and information about the risks posed by a lawsuit filed by an ex-employee – a lawsuit that I previously blogged about here (prior to the IPO, it should be noted). There was also an additional claim regarding post-IPO statements, brought only under Section 10(b).
Among other things, the defendants argued that there was sufficient information in the public domain about both the Instagram risk, and the lawsuit risk, to render any nondisclosure immaterial as a matter of law. The district court rejected that argument because Snap’s own prospectus contained the following language:
You should rely only on statements made in this prospectus in determining whether to purchase our shares, not on information in public media that is published by third parties.
Thus, in the district court’s view, Snap's own statements “counteracted” any contrary information made publicly available.
This is an issue that comes up with surprising frequency. For example, when shareholders sued Facebook in the wake of its IPO, Facebook argued that information allegedly omitted from its prospectus had in fact been heavily publicized in the media. At that point, the court hoist Facebook on its own petard, highlighting prospectus language that said, “In making your investment decision, you should not rely on information in public media that is published by third parties. You should rely only on statements made in this prospectus in determining whether to purchase our shares.” In re Facebook, Inc. IPO Sec. & Derivative Litig., 986 F. Supp. 2d 487 (S.D.N.Y. 2013). This point also tripped up the defendants in Fresno Cty. Emples. Ret. Ass'n v. comScore, Inc., 268 F. Supp. 3d 526 (S.D.N.Y. 2017), and S.E.C. v. Bank of Am. Corp., 677 F. Supp. 2d 717 (S.D.N.Y. 2010).
What’s interesting in the Snap example, though, is that all of the prior cases involved claims that did not require proof of reliance. Facebook involved Section 11 alone; comScore decided the issue in the context of Section 14; and Bank of America was a government enforcement action. Snap represents the first time (that I’m aware) that this argument has prevailed even in the fraud-on-the market context – i.e., the context where you could imagine that disclaimer or no, some investors would price the extraneous information into the stock, thereby correcting any artificial inflation in the market price and defeating any allegation of reliance by most public purchasers.
In any event, I gather that at least some companies have gotten wise and omitted or altered these kinds of non-reliance instructions. I couldn’t find comparable language in the prospectuses for Roku and Dropbox at all (did I miss it?), and the Twitter prospectus – issued before the Facebook opinion, but in the midst of the Facebook briefing – says:
In making your investment decision, you should understand that we and the underwriters have not authorized any other party to provide you with information concerning us or this offering.
You should carefully evaluate all of the information in this prospectus. We have in the past received, and may continue to receive, a high degree of media coverage, including coverage that is not directly attributable to statements made by our officers and employees, that incorrectly reports on statements made by our officers or employees, or that is misleading as a result of omitting information provided by us, our officers or employees. We and the underwriters have not authorized any other party to provide you with information concerning us or this offering.
Note the distinction: It’s not telling investors not to rely on extraneous information, or even that all such information is false; it’s just saying some might be false, and none of it was authorized by Twitter.
Point being, I assume that whatever law firms haven’t gotten the message will soon enough.
Saturday, June 9, 2018
This week, I plug my new article, Shareholder Divorce Court, available here on SSRN and forthcoming in the Journal of Corporation Law. Here is the abstract:
Historically, shareholder power within the corporate form has been tightly constrained on the assumption that dispersed shareholders are too inexpert, and insufficiently invested in the business, to contribute positively to governance. In recent years, however, the nature of shareholding has changed. Whereas in the mid-twentieth century, most stock was held by individuals, today, most publicly traded stock is held by large institutions with significant stakes. Corporate law has responded to the increasing sophistication of the shareholder base by expanding shareholder power, but doing so has created a new problem: shareholders have heterogeneous preferences, and when they conflict, the majority may exploit the minority.
The problems are particularly acute when it comes to mergers and acquisitions. Large shareholders may have a variety of investments, and thus be conflicted in their preferences when it comes to merger terms. Their greater influence within the corporate form may influence directors. In this scenario, minority shareholders are left without an effective advocate for their interests, and therefore may be coerced into suboptimal transactions.
This Article proposes that if corporate law is retooled to grant shareholders more power, it should also facilitate “divorce,” namely, provide a mechanism for price discrimination among shareholders with different interests. In particular, states can look to an old solution: the right of appraisal. Appraisal permits a shareholder to petition a court for a judicial evaluation of the fair value of her shares. Before falling into disuse, appraisal was one of the earliest remedies for addressing conflicting shareholder preferences. In recent years, it has enjoyed a renaissance as a mechanism for deterring conflicted or unfavorable transactions. This Article argues that with some modification, appraisal could also be used to satisfy the divergent preferences of a heterogeneous shareholder base.
The project was inspired by the increasing concentration of ownership among a handful of institutional investors, as well as numerous examples of mergers that depended on the votes of shareholders who held stakes in both target and acquirer. I addressed the issue from the shareholder side in an earlier essay, Family Loyalty: Mutual Fund Voting and Fiduciary Obligation. The new paper is a more in-depth examination of the implications on the corporate governance side.
Saturday, June 2, 2018
Institutional shareholders are increasingly using their “voice” in matters of corporate policy, and, in particular, are taking an interest in “environmental, social, governance” (ESG) performance measures at their portfolio companies. Investments are selected, and shareholders engage with management, using a variety of ESG metrics, often concerning matters like climate change, gender and racial diversity, and similar issues. Though it’s often argued that some ESG engagement reflects the investors’ personal policy preferences rather than a sincere attempt to improve corporate performance, it seems that at least some ESG factors are, in fact, wealth maximizing. It’s also been argued that many institutional investors have already diversified away their vulnerability to idiosyncratic risks and, by engaging on ESG matters, are attempting to protect themselves against systemic risks.
Nonetheless, the trend has met with some criticism. One set of concerns pertains to protection of retail investors to whom the institutional investors owe fiduciary duties – fear that their money is being used to advance social causes favored by the investment manager, rather than to benefit investors in the fund.
A parallel set of concerns has less to do with protecting fund beneficiaries than with protecting portfolio companies. In the most charitable account, the fear is that inexpert fund managers will improperly meddle in corporate affairs, harming both their own beneficiaries and other shareholders. In a less charitable account, corporate managers hope to avoid accountability to a powerful shareholder base by squelching institutional participation in governance (this is the account described in detail in David Webber’s new book, The Rise of the Working Class Shareholder, which Ben Edwards blogged about here).
The battle plays out to a large extent via federal securities regulation, in everything from the process for bringing shareholder proposals under Rule 14a-8 to new attempts to regulate proxy advisors.
And it also plays out in regulation of the funds themselves, many of which are retirement plans governed by ERISA. Even those retirement plans that do not formally fall within ERISA’s ambit – local government plans, for example – may very well look to ERISA for guidance or best practices, making ERISA regulation a critical battlefield. (Hence Anita Krug’s characterization of the Department of Labor as “the other securities regulator”).
Essentially, the critical question under ERISA has been, to what extent may fund administrators select investments based on ESG factors, and involve themselves in the corporate governance of portfolio companies?
Over the years, the DoL has issued a series of guidelines interpreting fiduciaries’ obligations under ERISA. All emphasize that plan administrators must act to advance the economic interests of the beneficiaries, and may not subordinate those interests to “social” objectives. That said, the Bush, Obama, and now Trump administrations have each put their own stamp their interpretation of an ERISA fiduciary’s obligations. The Bush Administration’s 2008 interpretation emphasized, for example, that when voting proxies, “the responsible fiduciary shall consider only those factors that relate to the economic value of the plan's investment … If the responsible fiduciary reasonably determines that the cost of voting (including the cost of research, if necessary, to determine how to vote) is likely to exceed the expected economic benefits of voting, ... the fiduciary has an obligation to refrain from voting.” The Obama Administration, by contrast, stated that to the extent the Bush bulletin was interpreted to require a cost-benefit analysis for every vote or governance action, this was incorrect; instead, fiduciaries should generally vote unless there is a reason to believe costs exceed benefits, because – it would be assumed – most costs associated with a vote would be minimal.
The Obama Adminstration’s guidance was also more tolerant towards the plan involvement in corporate governance, and consideration of ESG factors in the administration of plan assets, than was the Bush Administration. The Obama guidance stated that the Bush guidance might be “misinterpreted” to require specific cost-benefit analyses with respect to ESG factors, when in fact, fiduciaries may “recogniz[e] the long term financial benefits that, although difficult to quantify, can result from thoughtful shareholder engagement when voting proxies … or otherwise exercising rights as shareholders.” The Obama bulletin went on to emphasize the growing recognition of the importance of ESG factors when making investment decisions, and the benefits of shareholder engagement.
But now the pendulum has swung back hard, via the Trump administration. Trump’s bulletin warns, “Fiduciaries must not too readily treat ESG factors as economically relevant to the particular investment choices at issue when making a decision. It does not ineluctably follow from the fact that an investment promotes ESG factors, or that it arguably promotes positive general market trends or industry growth, that the investment is a prudent choice for retirement or other investors. Rather, ERISA fiduciaries must always put first the economic interests of the plan in providing retirement benefits.” The new bulletin further states that the Obama bulletin:
was not intended to signal that it is appropriate for an individual plan investor to routinely incur significant expenses to engage in direct negotiations with the board or management of publicly held companies with respect to which the plan is just one of many investors. Similarly, the [Obama bulletin] was not meant to imply that plan fiduciaries, including appointed investment managers, should routinely incur significant plan expenses to, for example, fund advocacy, press, or mailing campaigns on shareholder resolutions, call special shareholder meetings, or initiate or actively sponsor proxy fights on environmental or social issues relating to such companies…. If a plan fiduciary is considering a routine or substantial expenditure of plan assets to actively engage with management on environmental or social factors, either directly or through the plan’s investment manager, that may well constitute the type of “special circumstances” that … warrant a documented analysis of the cost of the shareholder activity compared to the expected economic benefit (gain) over an appropriate investment horizon.
The new bulletin goes even further, by discouraging the inclusion of ESG funds within ERISA plans that permit plan beneficiaries themselves to choose among a menu of options. Though the bulletin admits that fiduciaries may include ESG funds if plan participants request such an option, it also includes a footnote that contains a heck of a qualification:
in deciding whether and to what extent to make a particular fund available as a designated investment alternative, a fiduciary must ordinarily consider only factors relating to the interests of plan participants and beneficiaries in their retirement income. A decision to designate an investment alternative may not be influenced by non-economic factors unless the investment ultimately chosen for the plan, when judged solely on the basis of its economic value, would be equal to or superior to alternative available investments
The bulletin also warns against making an ESG fund a “default” option based on “the fiduciary’s own policy preferences.”
So what does all this mean?
As for me, I’ll start with the obvious: the back-and-forth makes clear that a larger debate about the proper role of shareholders in corporate governance is playing out across the stage of ERISA regulation, raising questions about the degree to which actual concern for plan beneficiaries is motivating the shifts (except, perhaps, in the very broadest sense that different administrations have different ideas about what balance of power will ultimately benefit shareholders generally).
Beyond that, the attempts to discourage the inclusion of ESG funds in ERISA plans strikes me as a peculiar elevation of legally constructed investor preferences over the, well, actual preferences of investors – what Daniel Greenwood dubbed “fictional shareholders.”
It’s all well and good to require that ERISA fiduciaries act solely in the economic interests of beneficiaries, on the assumption that this is what beneficiaries would likely want, and on the assumption that wealth maximization functions as “least common denominator” for beneficiaries’ otherwise conflicting interests.
But this reductionistic approach to defining beneficiary interests, adopted for the purpose of making them more manageable, should not stifle opportunities to accommodate the actual preferences of beneficiaries, especially when it is feasible to allow beneficiaries to sort themselves – like, say, when ESG-focused funds can be made available to those beneficiaries who are willing to sacrifice some degree of financial return to advance social goals. Providing these opportunities to beneficiaries who choose them inflicts no damage on the interests of beneficiaries solely interested in financial return, and, in fact, the principle that investors should be able to control their own retirement planning is (supposedly) the reason these types of ERISA platforms are offered in the first place.
The new guidance, then, seems less about protecting beneficiaries from politically-motivated fiduciaries than it is about forcing beneficiaries to participate in the political goals of the Trump administration, namely, minimizing shareholder participation in corporate governance, particularly when those shareholders advance (what are usually) liberal policy priorities.
Saturday, May 26, 2018
Risk factor disclosures are required under SEC rules, and encouraged under the PSLRA (which insulates from private liability forward-looking statements that are “accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement,” 15 U.S.C. § 78u-5). The theory is that investors, armed with adequate warnings, can make intelligent decisions about how to value a company’s securities.
Both the SEC in its guidance, and Congress when passing the PSLRA, emphasized that “boilerplate” warnings are not helpful; investors must be given specific, tailored information about the firm-specific risks that the company faces. For example, the SEC instructs firms, “Do not present risks that could apply to any issuer or any offering. Explain how the risk affects the issuer or the securities being offered.” 17 C.F.R. § 229.303. Meanwhile, in the PSLRA’s legislative history, the Conference Report states that “boilerplate warnings will not suffice.... The cautionary statements must convey substantive information about factors that realistically could cause results to differ materially from those projected.”
Scholars have documented that firm-specific risk warnings are helpful to investors. For example, a while ago I blogged about a study by Karen K. Nelson and Adam C. Pritchard documenting how risk factor disclosures may assist investors.
The difficulty is, how does one distinguish boilerplate risk factors from “meaningful” firm-specific ones? The impossibility of that task has frustrated several courts, with the First Circuit calling the PSLRA’s safe harbor a “license to defraud,” In re Stone & Webster, Inc., Securities Litig., 414 F.3d 187 (1st Cir. 2005), and the Second and Seventh Circuits expressing bewilderment as to how the adequacy of cautionary language is to be assessed, Slayton v. American Exp. Co., 604 F.3d 758 (2d Cir. 2010); Asher v. Baxter Int’l, 377 F.3d 717 (7th Cir. 2004).
Scholars have also assailed the judiciary for adopting unrealistic standards of how investors read and interpret corporate disclosures, and, in particular, for overestimating ordinary investors’ ability to digest corporate disclosures and correctly incorporate them into their decisionmaking. David A. Hoffman, The “Duty” to Be a Rational Shareholder, 90 Minn. L. Rev. 537 (2006); Stephen M. Bainbridge & G. Mitu Gulati, How Do Judges Maximize? (The Same Way Everybody Else Does—Boundedly): Rules of Thumb in Securities Fraud Opinions, 51 Emory L.J. 83 (2002); Stefan J. Padfield, Is Puffery Material to Investors? Maybe We Should Ask Them, 10 U. PA. J. Bus. & Emp. L. 339 (2008).
A new study by Richard A. Cazier, Jeff L. McMullin, and John Spencer Treu supports scholars’ intuition – and courts’ frustration – by demonstrating that standards generated by judges and the SEC appear to encourage firms to include lengthier, less informative risk disclosures in their SEC filings, despite the fact that long, boilerplate warnings may actually harm firms by increasing their cost of capital. In Are Lengthy and Boilerplate Risk Factor Disclosures Inadequate? An Examination of Judicial and Regulatory Assessments of Risk Factor Language, the authors demonstrate that in the event of a lawsuit, judges are more likely to find risk factors adequate if they are lengthier and more boilerplate. Moreover, the SEC is less likely to issue a comment letter if the risk factors match those of peer companies rather than identify firm-specific risks. In other words, the legal system encourages firms to adopt practices that are the opposite of what would benefit the market.
At this point, I just have to quote myself – sorry! – from an earlier blog post:
[A]ll of our measures of impact and harm and loss are, at this point, so far removed from reality as to border on complete legal fiction. Materiality is a construct from case law, with numerous additional doctrines piled on to it by courts without any heed for actual evidence of how markets behave. …. [W]hat we call “harm” and “damage” for the purpose of private securities fraud lawsuits have become so artificial that it no longer seems as though we’re even trying to measure the actual real-world effects of fraud. I believe private lawsuits are an essential supplement to SEC action but a system of fines or statutory damages would make so much more sense.
(As long as I’m plugging myself, I’ve also proposed having distinct damages and liability regimes for investors who can prove actual reliance, since I think the fraud on the market context often leads courts astray). But more immediately, here’s hoping the SEC takes notice of these findings and incorporates them into its practice.
Saturday, May 19, 2018
If you’re anything like me, you’ve spent the last few days procrastinating studying the drama unfolding at CBS. (If you’re not aware, here’s an article summarizing the state of play; the rest of this post assumes readers are familiar with the basic facts).
There’s a lot to chew on here, and I’m sure that as the case develops, there will be much more to say, but here are some off-the-cuff initial thoughts, in no particular order.
[More under the jump]
Monday, May 14, 2018
I always have loved the game of tag, and I love a challenge. More importantly, I love a conversation about business law . . . .
Last week, Steve Bainbridge posted a follow-on to posts written by Ann and me on the application of fiduciary duties to the private lives of corporate executives. As Steve typically does in his posts, he raises some nice points that carry forward this discussion. In a subsequent Tweet, Steve appears to invite further conversation from one or both of us by linking to his post and writing "Tag. You're it."
. . . to what extent should a board have Caremark duties to monitor a CEO's private life. Personally, I think Caremark is not limited to law compliance programs. A board presented with red flags relating to serious misconduct--especially misconduct in a sphere of life directly related to the corporation's business (think Weinstein)--has a duty to investigate. But, again, does that mean the board should hire private investigators to track the CEO 24/7?
I agree that a board's duty to monitor is not limited to compliance programs. Stone v. Ritter makes it plain that the duty to monitor arises from a director's obligation of good faith, situated within the duty of loyalty. Assuming no "intent to violate applicable positive law" or an intentionally failure to act in the face of a known duty to act (demonstrating a conscious disregard for his duties)," however, under Disney, a failure to monitor in this context likely would not rise to the level of bad faith unless the board "intentionally acts with a purpose other than that of advancing the best interests of the corporation"--which seems unlikely (although someone with more time and creativity than I have at the moment may be able to spin out some relevant facts). Of course, the Delaware Supreme Court could add to the Disney list of actions not in good faith . . . . But absent any of that, it is unlikely that a board of directors' failure to monitor an executive's private life will result in liability for a breach of the duty of loyalty.
Second, I want to pass on a further thought on the debate--one that is not my own. In an email message to me, co-blogger Stefan Padfield observed that corporate opportunity doctrine questions are fiduciary duty claims that extend into a fiduciary's private life--specifically, the fiduciary's usurpation of the opportunity for his or her private gain. He also noted that from there the leap is not as far as it may seem to conceptualizing other aspects of an executive's private conduct as being within the scope of his or her fiduciary duties to the corporation. This certainly provides more food for thought.
I want to thank Ann for stimulating all these ideas. Her original post raised a nice question--one that obviously provokes and has encouraged engagement in thoughtful conversation. While we have not yet resolved the issue, we have staked out some important ground that may be covered in extant or forthcoming cases. As Ann's and Steve's posts point out, there are a number of intriguing fact patterns at the intersection of executives' private lives and fiduciary duties that may force courts to wrestle some of this to the ground. I, for one, will be watching to see what happens.
Saturday, May 12, 2018
I've been hunkered down grading exams this week, so all I've got for you is this tale tail of a developing economy:
For the last five years or so, the campus of Colombia's Diversified Technical Education Institute of Monterrey Casanare has been home to a sweet black dog named Negro. There, he serves as a guardian of sorts, keeping watch over things as students go about their studies.
In return, Negro is cared for by the school's faculty, who provide him with food, water, attention and a safe place with them to pass the night.
But the dog has apparently decided that anything beyond that is up to him.
Early on in Negro's tenure at the school, he came to be aware of the little store on campus where students gather to buy things on their breaks; sometimes they'd buy him cookies sold there.
This, evidently, is where the dog first learned about commerce — and decided to try it out himself.
"He would go to the store and watch the children give money and receive something in exchange," teacher Angela Garcia Bernal told The Dodo. "Then one day, spontaneous, he appeared with a leaf in his mouth, wagging his tail and letting it be known that he wanted a cookie."
Negro had invented his own currency, but, of course, it was accepted.
He got a cookie — and it came with an epiphany.
Leaves can buy treats!
As you might expect, after the dog realized his money literally grows on trees, it's been a regular thing.
"He comes for cookies every day," Gladys Barreto, a longtime store attendant, told The Dodo. "He always pays with a leaf. It is his daily purchase."
Still more reliable than Bitcoin.
Monday, May 7, 2018
I was fascinated by Ann Lipton's post on April 14. I started to type a comment, but it got too long. That's when I realized it was actually a responsive blog post.
Ann's post, which posits (among other things) that corporate chief executives might be required to comply with their fiduciary duties when they are acting in their capacity as private citizens, really made me think. I understand her concern. I do think it is different from the disclosure duty issues that I and others scope out in prior work. (Thanks for the shout-out on that, Ann.) Yet, I struggled to find a concise and effective response to Ann's post. Here is what I have come up with so far. It may be inadequate, but it's a start, at least.
Fiduciary duties are contextual. One can have fiduciary duties to more than one independent legal person at the same time, of course, proving this point. (Think of those overlapping directors, Arledge and Chitiea in Weinberger. They're a classic example!) What enables folks to know how to act in these situations is a proper identification of the circumstances in which the person is acting.
So, for example, an agent’s duty to a principal exists for actions taken within the scope of the agency relationship. The agency relationship is defined by the terms of the agreement between principal and agent as to the object of the agency. The principal controls the actions of the agent within those bounds based on that agreement.
Similarly, a director’s or officer's conduct is prescribed and proscribed within the four corners of the terms of their service to the corporation. They owe their duties to the corporation (and in Revlon-land or other direct-duty situations, also to the stockholders). The problem then becomes defining those terms of service. For directors, a quest for evidence of the parameters of their service should start with the statute and extend to any applicable provisions of the corporate charter, bylaws, and board policies and resolutions more generally. For officers, the statute typically doesn’t provide much content on the nature or extent of their services. The charter may not either. Typically, the bylaws and board policies and resolutions, as well as any employment or severance agreement (the validity of which is largely a matter outside the scope of corporate law), would define the scope of service of an officer.
I have trouble envisioning that the scope of service (and therefore, reach of fiduciary duties) for a typical director or officer would extend to, e.g., private ownership of other entities and decisions made in that capacity. Yet, even where there is no technical conflicting interest or breach of a duty of loyalty, there is a clear business interest in having corporate managers—especially highly visible ones—act in a manner that is consistent with corporate policy or values when they are not “on the job.” While voluntary corporate policy or private regulation may have a role in policing that kind of director or officer activity (through service qualifications or employment termination triggers, e.g.), I do not think it is or should be the job of corporate law—including fiduciary duty law—to take on that monitoring and enforcement role.
Nevertheless, I remain convinced that better (more accurate ad complete) disclosure of (at least) inherent conflicts of interest may be needed so investors and other stakeholders can evaluate the potential for undesirable conduct that may impact the nature or value of their investments in the firm. As Ann notes, significant privacy rights exist in this context, too. There's more work to be done here, imv.
Thanks for making me think, Ann. Perhaps you (or others) have a comment on this riposte? We shall see . . . .
Saturday, May 5, 2018
Zohar Goshen and Sharon Hannes have just posted to SSRN an interesting paper, The Death of Corporate Law, arguing that markets and private ordering have begun to supplant adjudication as a mechanism for resolving corporate disputes because the increasing sophistication of investors has made private resolutions less costly.
There are many excellent insights in the piece, which furthers the taxonomy developed by Goshen and Richard Squire in Principal Costs: A New Theory for Corporate Law and Governance to add the costs of adjudication into the mix. Yet there may be some ways that the theory is incomplete. For example, the authors focus on the effect of shareholders’ rising “competence” – because of the concentration of investment in the hands of institutions – rather than on shareholders’ rising power, which (according to some) may not be accompanied by greater competence at all. Managers have acted to counteract that rising power (dual class stock regimes, delays in going public), which might represent an efficient bargain to which investors are agreeing (the authors’ view), or simply a forthcoming source of dispute.
But the other piece that’s missing, of course, is the role of securities law. Investors’ rising power and/or competence is not merely a function of markets; it’s a regulatory choice, due to everything from new CD&A disclosures and say-on-pay provisions to the expansion of Rule 14a-8 to permit its use for proxy access bylaws (and, heck, the existence of 14a-8 in the first place), to the loosening of restrictions of on investment in private funds. And what regulators giveth, regulators can taketh away. Thus, there are new efforts to, among other things, limit say-on-pay and shareholder proposals, and to regulate proxy advisors. There is even new Labor Department guidance meant to limit funds’ involvement in corporate governance (which I may or may not make the subject of another post).
At the same time, it's hard not to notice that we likely would be revisiting the old corporate disputes, but with respect to relationships between retail investors in funds and fund managers themselves, were it not for the fact that federal law occupies most of that space.
Point is, reports of corporate law’s death may be slightly, if not greatly, exaggerated. Perhaps another way of putting it is simply to note (as others have done) that the locus of regulation has shifted from flexible, ex post review to mandatory ex ante rulemaking.
Saturday, April 28, 2018
The #MeToo movement has shone a spotlight not only on sexual harassment, but also on the NDAs and arbitration agreements that allow it to flourish undetected for many years – until, in some cases, it finally explodes into a full-grown corporate crisis.
Part of the explanation is that victims choose to enter into settlements rather than conduct lengthy, expensive, and potentially humiliating court battles – which is understandable and a problem for which there is no obvious immediate solution.
But the other part of the explanation is that women (and men, who are harassed at lower rates but still may be targeted) are frequently forced to sign agreements to arbitrate claims confidentially as a condition of employment or the use of various services, and the Supreme Court – with its muscular interpretation of the Federal Arbitration Act – has held that states are virtually powerless to regulate these agreements. These agreements, it is well understood, are less about providing a venue for resolution of claims than about preventing claims at all, if for no other reason than most prohibit class actions. So until Congress is willing to modify the FAA (which, well, I’m not going to hold my breath), the situation continues.
Or does it?
Public pressure has now caused some companies to abandon their arbitration agreements. Microsoft ostentatiously announced it would no longer require them for sexual harassment claims. There was a bit of a tempest when it was discovered that Munger Tolles had them in their employment agreements; after some angry Tweeting – including requests for school-wide boycotts by elite law students and faculty – many firms agreed to withdraw them.
Uber’s user agreement with its riders has long contained an arbitration clause, and of course, we all know of the horror stories where Uber drivers are accused of assaulting passengers, sexually or otherwise. (Law Prof Nancy Leong reported a terrifying close call recently). It’s been my habit in my basic business organizations class to show students Uber’s user agreement, including the part on safety – where, to paraphrase, Uber instructs riders they should tell a friend where they’re going and sit near the car door in case they have to run.
Now, a group of women who allege they were sexually assaulted by Uber drivers have publicly released a letter to Uber’s board demanding that the board waive the arbitration clause. Their attorney argues that the board cannot claim it genuinely cares about women’s rights while forcing these claims into confidential arbitration.
Uber's been plagued by a tsunami of poor press recently, all casting a shadow on its hopes for an IPO next year. Given that, the women’s demand strikes me as a well-timed, savvy move. I don’t know if it can succeed – Uber may depend too heavily on keeping the misconduct of its drivers out of the spotlight – but on the other hand, as Twitter has demonstrated, there’s only so much silencing it can manage. I look forward to seeing whether these straws are what finally break the back of widespread arbitration clauses in consumer contracts.
Saturday, April 21, 2018
I tell my students that corporate waste technically may be a mechanism for defeating the business judgment rule in the absence of any other evidence of lack of compliance with fiduciary duty, but - as one Delaware decision put it - it's really more theoretical than real. See Steiner v. Meyerson, 1995 Del. Ch. LEXIS 95. When my students ask for some kind of real world example of waste, I tell them the facts of Fidanque v. American Maracaibo Co., 92 A.2d 311 (Del. Ch. 1952), where a corporation paid "consulting fees" to a 70-year-old former executive who had recently suffered a stroke that left him sufficiently incapacitated to be noticeable during his deposition.
I assumed that case was sui generis, but it turns out history has a way of repeating, this time in the form of Sumner Redstone's contract with CBS. As described in a recent opinion by Chancellor Bouchard, plaintiff stockholders of CBS adequately alleged that the Board made wasteful payments by refusing to terminate Redstone's $1.75 million contract as Executive Chair once his declining health left him unable to eat or speak, and by designating him Chairman Emeritus - at a $1 million salary - after he resigned from the Executive Chair position.
The decision strikes me as significant not merely because it presents a modern example of waste that I can now offer to my students - at a large, public company no less - but also because CBS is contemplating a merger with Viacom. Both companies are controlled by the Redstone family via supervoting shares, though they are - purportedly - negotiating the deal via independent committees. This kind of self-interested transaction was already vulnerable to legal challenge; how much stronger will that challenge be now that there's already evidence of a supine board willing to cater to Redstone?
Saturday, April 14, 2018
As most readers are likely aware, Donald Trump has no love for the Washington Post, which frequently publishes articles that cast him in a negative light. The Washington Post is owned by Jeff Bezos, who also is the founder, Chair, CEO, and largest shareholder of Amazon. Trump’s rage at the Washington Post in general and Bezos as its owner has led him to threaten Amazon, both publicly and privately, with suggestions that – for example – it should pay the Post Office more for shipping, that its taxes should be increased, and perhaps even that it should not have access to certain critical government contracts. Most recently, he even ordered a review of USPS finances, apparently as a mechanism for targeting Amazon. As a result, Amazon’s stock price has suffered.
Egan-Jones Proxy Services recently posted a comment on this state of affairs, ultimately arguing that Bezos’s responsibilities to Amazon’s investors include limiting the Washington Post’s coverage. As Egan-Jones put it, “Unless Mr. Bezos decides and is able to tone down, or better yet eliminate the content which is upsetting the President and his supporters he will continue to find he has created the most dangerous type of enemy for any type of company and its CEO, the politician… The job of a CEO is to act as a good steward for the funds investors have entrusted to him. The job of a CEO is not to promote a particular political path he or she may favor. Mr. Bezos needs to decide, does he wish to remain CEO of Amazon, or does he want to be a political player, Amazon’s investors deserve nothing less.”
Now, at this point I will say, from a pure policy perspective, I am horrified at the thought that any news organization could be bullied by a public figure into moderating truthful, newsworthy coverage. Additionally, by all accounts, Bezos has no input into the Washington Post’s editorial decisions. But putting these points to the side, I actually wish to explore the suggestion that a corporate fiduciary’s duty to shareholders extends to his private conduct, such that even entirely personal actions must be moderated if they might have an adverse effect on the corporation he oversees.
There can be no dispute that a corporate fiduciary’s personal information and behavior might be relevant to investors and to the quality of his/her stewardship. The health of corporate executives has frequently come under scrutiny (e.g., Steve Jobs, Sumner Redstone, Hunter Harrison); Martha Stewart’s private trading in an unrelated corporation ultimately impacted her own company; the private affairs of a partner could have company-wide repercussions; an executive’s drug habit may impact the company in unexpected ways; heck, even a CFO’s golfing habits may be relevant to the quality of corporate financial statements.
As a result, scholars – including Joan Heminway (hi, Joan!) – have tried to unpack the extent of a corporation’s duty to disclose directors’ and officers’ private facts, both under the federal securities laws, and under state fiduciary requirements, recognizing that due respect must be paid both to the informational needs of investors, and to the moral (and perhaps constitutional) rights of privacy possessed by corporate actors.
See, e.g., Joan Heminway, Martha’s (and Steve’s) Good Faith: An Officer’s Duty of Loyalty at the Intersection of Good Faith and Candor; Joan Heminway, Personal Facts about Executive Officers: A Proposal for Tailored Disclosures to Encourage Reasonable Investor Behavior; Ann M. Olazábal & Patricia Sánchez Abril, Celebrity CEOs: Disclosure at the Intersection of Privacy and Securities Law; Allan Horwich, When the Corporate Luminary Becomes Seriously Ill: When is a Corporation Obligated to Disclose That Illness and Should the Securities and Exchange Commission Adopt a Rule Requiring Disclosure?.
It’s an even knottier question when we extend that analysis not merely to disclosure, but to the original behavior. Do corporate fiduciaries have a duty to police their private conduct so as not to harm the company? And in this context, I use the phrase “private” not only to mean unknown to the public, but also to mean personal, unrelated to their jobs as fiduciaries.
When it comes to Bezos, for example, his ownership of the Washington Post is entirely separate from his control of Amazon. Amazon’s 10-K does not even mention the Washington Post, and its proxy statement only discusses the Post in order to disclose potential related-party transactions regarding advertising and digital services; they are entirely distinct companies.
It might therefore seem bizarre to declare that Bezos has a fiduciary duty to Amazon even when acting entirely in his unrelated capacity as owner of a newspaper. Yet the law already recognizes that for some executives, the personal and the professional are nearly impossible to disentangle; for example, I am reminded of corporate opportunity cases where an executive’s close relationship with his company made it impossible to distinguish opportunities presented to him in an individual capacity from those presented in a professional capacity – or, as the Delaware Supreme Court famously put it, “In the instant case Guth was Loft, and Guth was Pepsi.” We might therefore decide that certain controllers – like a Bezos, or a Musk, or a Zuckerberg, or a Gates, or a (formerly) Kalanick, or a Jobs, or a Stewart, or a Winfrey – are so intertwined with their companies, are such auteurs, that they cannot have private pursuits that are distinct from the companies they operate. All of their behavior may impact their companies, and thus all of their behavior must be scrutinized for compliance with the duties of care and loyalty.
Might the constitutional rights of privacy and free expression play a role here? Perhaps; fiduciary duties are obligations ultimately imposed and defined by the state. At the same time, though, there is no constitutional right to be a corporate CEO; unless fiduciary duties are viewed as the equivalent of an unconstitutional condition, there may be few limits to the state’s power to define standards of behavior.
Yet we might nonetheless decide that, as a matter of policy, executives must be granted space for private pursuits, if for no other reason than – as Joan points out – too many talented candidates may simply refuse the top jobs otherwise.
Saturday, April 7, 2018
On Friday, Elisabeth Kempf presented her new paper, co-authored with Oliver Spalt, at Tulane’s Freeman School of Business, Taxing Successful Innovation: The Hidden Cost of Meritless Class Action Lawsuits. Here is the abstract:
Meritless securities class action lawsuits disproportionally target firms with successful innovations. We establish this fact using data on securities class action lawsuits against U.S. corporations between 1996 and 2011 and the private economic value of a firm's newly granted patents as a measure of innovative success. Our findings suggest that the U.S. securities class action system imposes a substantial implicit “tax” on highly innovative firms, thereby reducing incentives to innovate ex ante. Changes in investment opportunities and corporate disclosure induced by the innovation appear to make successful innovators attractive litigation targets.
Using dismissal as a proxy for meritless – a point to which I will return – Kempf and Spalt find that firms that are granted valuable patents are more likely to be targeted by a class action lawsuit than other firms in the following year, and that the difference is driven by meritless lawsuits. The finding persists even controlling for firm size, sales growth, stock price returns, and volatility. They also find that these lawsuits disproportionately cause a drag on the firm’s stock price performance, constituting a hidden “tax” on innovation.
In many ways, I suspect the core finding of the paper is accurate, though I do question the ultimate conclusion, and I think that in future drafts – the version on SSRN is a very early one – other relationships should be tested.
To start, obviously the definition of “meritless” is a controversial one, and speaking as a former plaintiff-side class-action attorney, I do take issue with treating all dismissed cases as meritless ex ante. That said, the authors test using alternative measures of merit and reach the same results. The one I find particularly convincing is the test using the nature of the lead plaintiff, institutional versus individual – it’s not pretty, but in my experience, very often a good rule of thumb for the ex ante merit of a case is the identity of the lead plaintiff.
The authors also do not distinguish between Section 11 and Section 10(b) lawsuits, or control for circuits where lawsuits are filed (though they do control for location of firm headquarters). Section 11 lawsuits are easier to bring, and certain circuits have long had a reputation for imposing more stringent pleading standards – it is possible that a closer examination of these variables will lead to different or more nuanced conclusions.
The authors offer a number of explanations for their findings, including that innovative firms are more likely to make optimistic/forward looking statements, which they conclude attracts plaintiffs’ attorneys looking for an easy target. On this, I both agree and disagree. I do not agree that plaintiffs’ firms treat these statements as easy “gets” – the PSLRA and the safe harbor ensure that they are not, and every plaintiffs’ attorney knows that. But these statements may nonetheless influence the firm’s stock price, such that the firm is more likely to experience a stock price drop when the rosy predictions do not materialize.* And that drop is what will attract the attention of a plaintiffs’ firm, which may then latch on to the forward-looking statements and the – yes, puffery – if there’s nothing else to grasp.
Which brings me to my final observation. Much of the discussion at Prof. Kempf’s presentation focused on whether she could prove her ultimate point, namely, that securities lawsuits constitute a type of tax on innovation that may ultimately deter firms from innovating in the first place. Even if the paper is correct that securities fraud lawsuits do impose a tax on innovative firms, the question remains: will that tax deter innovation? Or will it deter overclaiming by innovative firms? Because if the latter, then – you know. Yay.
*The authors find that “innovative” firms are no more likely to experience a large stock price drop in reaction to a negative earnings announcement than other firms, but they have not – yet – tested to see whether these firms are more likely to experience a large stock price drop in reaction to other types of announcements.
Saturday, March 31, 2018
Another week, another Delaware Chancery decision in which a powerful, visionary minority blockholder is deemed to have “control” over a corporate board’s decision to acquire a company in which he has an interest.
In In re Oracle Corporation Derivative Litigation, which I blogged about last week, Larry Ellison’s control was enough to show that demand was excused for the purpose of a derivative lawsuit, while the court avoided the question whether Ellison should be formally deemed a controlling stockholder.
In In re Tesla Motors Stockholder Litigation, however, the question could not be avoided. That’s because – unlike in Oracle – the remaining stockholders voted in favor of the acquisition, which led the defendants to argue that the entire deal had been cleansed under Corwin v. KKR Financial Holdings LLC. Since Corwin does not apply to controlling stockholder transactions, Elon Musk’s status became critical.
Briefly, Elon Musk is the Chair, CEO, largest stockholder (22% at the time of the acquisition), and dominant face of Tesla. He was also one of the founders of SolarCity, along with his cousins. When SolarCity neared bankruptcy, Tesla acquired SolarCity at a significant premium to its market price. Though Musk formally recused himself from the Tesla board’s vote, he badgered the board into considering the acquisition (proposing it on three separate occasions within three months), hired the board’s financial and legal advisors, and ran the deal process. Meanwhile, the board voted to approve the deal without forming a special committee. (Sidebar: If the documents are made available under Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW, I cannot wait to find out what Wachtell – the board’s deal advisor – had to say about that.) Tesla shareholders sued, alleging that the transaction was a bailout of Musk’s company, paid for with Tesla’s assets.
The court, per VC Slights, concluded that, at least for pleading purposes, plaintiffs had alleged that Musk was a controlling shareholder. Slights rested his decision on Musk’s status as a visionary CEO, his substantial stockholdings, his close business and personal ties to Tesla board members who earned multi-million dollar salaries for their service, his domination of the process which led to the acquisition, the board members’ own ties to SolarCity, and SolarCity’s precarious financial position.
Slights recognized the awkwardness of his holding when compared with the Delaware Supreme Court’s recent conclusion in Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd that Michael Dell was not a controlling stockholder of the company that bore his name. Nonetheless, he justified his conclusion on the ground that the buyout in Dell involved several procedural protections (including the use of an independent special committee and Michael Dell’s pledge to cooperate with any buyer) that the Tesla board’s decision lacked.
But that reasoning collapses two separate ideas: whether someone has controlling shareholder status, which requires them to utilize heightened procedural protections to win business judgment deference, and whether a controlling stockholder has, in fact, employed such protections.
What both Tesla and Oracle really illustrate, then, is the inadequacy of pinning the level of judicial scrutiny to a bright line distinction between controlling and noncontrolling stockholder status in the first place. Yes, Musk was a large stockholder, but his stockholdings were the least important mechanism by which he dominated the board (and potentially influenced voting stockholders as well). We can call this yet more Corwin fall out: by heightening the significance of the stockholder vote only for transactions that fall into a specific category, the Delaware Supreme Court wound up placing pressure on the boundaries of that category.
What also stands out about the Tesla opinion – as with Oracle before it – is Delaware’s continued willingness to cast a gimlet eye on the webs of social and business relationships (especially with venture capital firms) that often tie boards together, particularly in tech companies. This is a point that Chief Justice Strine has been pushing, most recently at Tulane’s Corporate Law Institute, and what we are apparently seeing is that such relationships may not only evince a lack of independence, but may even count toward controlling shareholder status, as courts try to grapple with Corwin’s constraints.
Saturday, March 24, 2018
I am intrigued by VC Glasscock’s recent decision in In re Oracle Corporation Derivative Litigation, where he found that demand was excused with respect to a claim that Larry Ellison breached his fiduciary duties by functionally directing that the company acquire Netsuite, in which he owned a 39% stake.
First, the treatment of Larry Ellison: He only owns 27% of Oracle and, though he remains Chair of the Board, he no longer occupies the role of CEO. Nonetheless, the court was willing to draw the pleading-stage inference that he functionally has control of the company, such that both the outside and inside directors would fear for their positions if they crossed them. Yet at the same time, the court was unwilling to go so far as to formally designate him as a “controlling shareholder,” with all of the scrutiny that role would attract. In some ways, this is a welcome recognition that control is not simply an on/off switch: degrees of control may exist along a spectrum, and may compromise (nominally) independent directors’ judgment only so long as the relevant decision is not too extreme. At the same time, Delaware law tends to treat control status as binary, and in the past has only recognized the existence of control under a fairly narrow set of circumstances (cf. Corwin v. KKR, 125 A.3d 304 (2015), where the court refused to recognize KKR as a controlling shareholder of Financial Holdings, despite the fact that Financial Holdings was run by a KKR affiliate and existed to provide financing services to KKR).
Second, the treatment of the Board members: The court concluded that 6 board members were conflicted, in large part because – following Sandys v. Pincus and Delaware County Employees Retirement Fund v. Sanchez – nominally independent directors in fact were entangled in a web of business and social relationships with Ellison and Oracle that would likely hinder their ability to impartially consider whether to file suit against Ellison. None of these relationships would, by themselves, have disqualified any of the Board members (such as, for example, dependence on Ellison for participation in a cross-firm consulting initiative, and involvement in venture capital firms that look to Oracle as a potential acquirer), but the court found that the relationships collectively functioned to render the directors beholden to Ellison. This holding signals that going forward, corporate directors are taking a risk if they tolerate or encourage extensive relationships with each other outside of the boardroom.
Thirdly, the treatment of shareholder votes: In determining that one board member lacked independence from Ellison, the court took into account the fact that as a member of the compensation committee, he had ignored repeated shareholder “withhold” votes and shareholder votes to reject Oracle’s executive pay practices. In previous decisions, courts have refused to treat precatory shareholder votes on pay as having any legal significance, see Lisa Fairfax, Sue on Pay: Say on Pay’s Impact on Directors' Fiduciary. Duties, 55 Ariz. L. Rev. 1 (2013); it seems someone found a use for them. (I do wonder if there’s bitter with this sweet: Do approvals of "comically large" pay packages signal that directors’ actions have been approved by shareholders and therefore merit less judicial scrutiny?)
Finally, the court reserved judgment on the question whether In re Cornerstone Therapeutics Inc. Stockholder Litigation, 115 A.3d 1173 (Del. 2015) requires it to dismiss the complaint as to board members who lacked independence from Ellison for demand purposes, but against whom no claim had been stated regarding the underlying transaction.
All in all, it’s a fraught opinion and I look forward to seeing how it influences other decisions going forward.
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]