Tuesday, February 7, 2023
Many BLPB readers are likely aware that Stephen Bainbridge recently published a new book, The Profit Motive: Defending Shareholder Value Maximization. I must admit that I’m a fan of the Introduction:
There are a lot of books on the market praising stakeholder capitalism. They proclaim a new age in which big corporations should embrace—and, in fact, are embracing—environmental, social, and governance (ESG) goals. Whether putatively objective academic tomes filled with statistics or mass market books filled with bullet points, the bottom line is the same; namely, that stakeholder capitalism is the right thing to do both morally and financially. This is not one of those books.
For those of you on the fence, there is an hour-long overview on YouTube (here), but if that’s too long you might consider a recent guest post by Prof. Bainbridge on the Corporate Finance Lab discussing the book (here). Below is a brief excerpt from that post.
Three major themes animate the project. First, any conception of corporate purpose that embraces goals other than creating value for shareholders is inconsistent with the mainstream of U.S. corporate law. Second, directors do—and should—have wide and substantially unfettered discretion as to how they go about generating shareholder value. Although many commentators claim that those statements are inconsistent, in fact they both reflect fundamental normative principles deeply embedded in U.S. corporate law. Third, a shareholder-centric conception of corporate purpose is preferable to stakeholder capitalism….
Pursuit of shareholder value maximization leads to more efficient resource allocation, creates new social wealth, and promotes economic and political liberty. To be sure, there will always be externalities. Just as pursuing profit is baked into the corporation’s DNA, so is externalizing costs. There is no such thing as a free lunch. The theory and evidence recounted in The Profit Motive, however, suggests that the balance comes down strongly in favor of shareholder value maximization.
Monday, February 6, 2023
I teach a unit on the legal aspects of valuation in my Corporate Finance planning and drafting seminar every year. I have often been able to secure as a guest speaker on one day during that unit a friend of mine who is a seasoned valuation expert (and was the expert whose opinion carried the day in the most recent Tennessee Supreme Court case on valuation in an M&A context).
There is a relatively large body of academic literature on appraisal (a/k/a dissenters') rights and, more generally, the history of valuation law and practices in the M&A context. In the Business Associations textbook of which I am a coauthor, I excerpt from Mary Siegel's 1995 article, Back to the Future: Appraisal Rights in the Twenty-First Century (32 Harv. J. on Legis. 79). Her 2011 follow-on article, An Appraisal of the Model Business Corporation Act's Appraisal Rights Provisions (74 Law & Contemp. Probs 231 (2011)), also is a good read on appraisal rights history. Other legal academics who have dipped their toes into these waters include George Geis, Bayless Manning, Brian JM Quinn, Randall Thomas, and Barry Wertheimer (who is no longer a law professor), and many more.
I am excited to report that there is a new kid (really, two coauthor new kids) on the block. Bill Carney has coauthored a new article on appraisal rights with Keith Sharfman entitled: The Exit Theory of Judicial Appraisal (28 Fordham J. Corp. & Fin. L 1 (2023)). The SSRN abstract follows.
For many years, we and other commentators have observed the problem with allowing judges wide discretion to fashion appraisal awards to dissenting shareholders on the basis of widely divergent, expert valuation evidence submitted by the litigating parties. The results of this discretionary approach to valuation have been to make appraisal litigation less predictable and therefore more costly and likely. While this has been beneficial to professionals who profit from corporate valuation litigation, it has been harmful to shareholders, making deals costlier and less likely to complete.
In this Article, we propose to end the problem of discretionary judicial valuation by tracing the origins of the appraisal remedy and demonstrating that its true purpose has always been to protect the exit rights of minority shareholders when a cash exit is otherwise unavailable, and not to judge the value of the deal. So understood, judicial appraisal should not be a remedy for dissenting shareholders when a market exit or equivalent protection is otherwise available.
While such reform would be costly to valuation litigation professionals, their loss would be more than offset by the benefit of such reforms to shareholders involved in future corporate transactions. Shareholders presently have adequate protections, both from private arrangements and legal doctrines involving fiduciary duties.
I am grateful that Bill passed a copy of the article along to me yesterday. This is a topic that generates significant interest in a variety of business law courses that I teach/have taught (including, in addition to Corporate Finance, Advanced Business Associations, Business Associations, and Mergers & Acquisitions). Students love puzzling through the issues, asking, e.g.:
- Why do appraisal rights exist?
- Why do we not see many reported appraisal rights opinions?
- How do planners and drafter address the existence of appraisal rights in practice?
Based on a quick peek at the table of contents of Bill's and Keith's article, I sense their work will offer the reader some answers to these and other related questions.
Sunday, February 5, 2023
Emilie Kao on 303 Creative v. Elenis: "Can Stand-Alone Dignitary Harm Create A Right to Endorsement and Duty to Endorse?"
The following excerpt is from the introduction to a recent publication that may be of interest to BLPB readers. The publication is: Emilie Kao, 303 Creative v. Elenis: Can Stand-Alone Dignitary Harm Create A Right to Endorsement and Duty to Endorse?, 2023 Harv. J.L. & Pub. Pol'y Per Curiam 5, 2–5 (2023). Emilie Kao is Senior Counsel and Vice-President for Advocacy Strategy at Alliance Defending Freedom (ADF), which represents Lorie Smith.
All people have inherent dignity and should be treated with respect. However, whether and how courts should address legal claims surrounding dignity are notoriously complicated. Does the government have an interest in protecting citizens from “dignitary harm”--subjective feelings of emotional distress or stigma? If so, does the government's interest require it to compel or silence the expression of certain views? If so, does the dignity of the person compelled to speak or remain silent matter? Dignitary harm has played important roles in conflicts between religious freedom and anti-discrimination laws in Masterpiece Cakeshop v. Colorado Civil Rights Commission and Fulton v. Philadelphia. And they are at issue again in 303 Creative v. Elenis, a free-speech case that was recently argued at the U.S. Supreme Court.
In 303 Creative, Colorado's public accommodation law--the Colorado Anti-Discrimination Act (CADA)--requires graphic artist, Lorie Smith, to create websites celebrating same-sex marriage that violate her religious belief that marriage is between one man and one woman. Colorado stipulated that Ms. Smith serves all people, regardless of sexual orientation and that her websites are unique, custom, and expressive; in other words, that she is engaging in pure speech. Like many artists, Ms. Smith chooses each word, visual design, and artistic element to tell a unique story that is consistent with her beliefs, whether about animal rescue, homelessness, or marriage. She wants to design websites to “promote God's design for marriage.” Therefore, she cannot create websites that celebrate marriages contrary to God's design for any of her clients, regardless of sexual orientation. Her decisions are always based on the message, not the person.
Colorado claims that it has a compelling interest in ensuring that members of protected classes are shielded from “dignitary harm.” That dignitary harm, though, consists merely in a creative professional declining to endorse their desired message. The Tenth Circuit agreed with Colorado. But in his dissent, Chief Judge Tymkovich warned that, “[l]ike Nineteen Eighty-Four's Winston Smith, CADA wants Lorie Smith to not only accept government approved speech but also to endorse it.” The Supreme Court should refuse Colorado's attempt to create a right to endorsement and a corresponding duty to endorse that would compel Ms. Smith to speak messages that violate her conscience. A government interest in protecting citizens from the emotional and moral distress of disagreement is intrinsically distinct from the material and dignitary harms created by status-based denials. Therefore, courts should treat the claims arising from these distinct interests differently.
Saturday, February 4, 2023
Section 12 of the Securities Act gives a right of rescission to purchasers of illegally unregistered securities, and purchasers of securities sold by means of a false prospectus. See 15 U.S.C. § 77l. Although the right of action has existed since 1933, its exact contours have always been somewhat hazy. But now, in the age of social media – with the potential for widespread promotion of unregistered and/or fraudulent investments (lately, cryptocurrencies) – interpretations of Section 12 are getting a work out, and the legal ground may be shifting.
So, the background. Section 12 provides:
Any person who—
(1) offers or sells a security [without meeting registration requirements]
(2) offers or sells a security (… by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission,
shall be liable… to the person purchasing such security from him, who may sue either at law or in equity in any court of competent jurisdiction, to recover the consideration paid for such security with interest thereon, less the amount of any income received thereon, upon the tender of such security, or for damages if he no longer owns the security.
In Pinter v. Dahl, 486 U.S. 622 (1988), the Supreme Court addressed what it means to be a “seller” under Section 12, such that one can be held liable. First, one is a seller if one actually passes title to the subject security in a transaction with the plaintiff. Remote sellers, i.e., persons who passed title back in a chain of sales that led to the sale to the plaintiff, are not liable.
Second, one is a seller if one “solicits” the sale to the plaintiff, even if the soliciting person did not actually pass title. The Court explained that brokers, for example, or agents of the seller, can be held liable under Section 12, and the critical question is whether the soliciting person acted for his own financial gain, or the financial gain of the seller. If the soliciting person was merely offering gratuitous advice to the buyer, however, he would not come within the scope of Section 12. The Court rejected a test that would make liability turn on whether the defendant’s “participation in the buy-sell transaction is a substantial factor in causing the transaction to take place.” As the Court put it, “§ 12's failure to impose express liability for mere participation in unlawful sales transactions suggests that Congress did not intend that the section impose liability on participants' collateral to the offer or sale.” The Court further elaborated, “The ‘purchase from’ requirement of § 12 focuses on the defendant's relationship with the plaintiff-purchaser. The substantial-factor test, on the other hand, focuses on the defendant's degree of involvement in the securities transaction and its surrounding circumstances.”
This test for “seller” status under Section 12 is now known as the “statutory seller” requirement, and in the aftermath of Pinter, all courts agree that whether a plaintiff proceeds under Section 12(a)(1) – for unregistered securities – or 12(a)(2) – for false prospectuses, the seller requirement remains the same.
So, two routes to liability under Section 12. Transfer of title – which is usually easy to spot – or solicitation. But what is a solicitation? In a bunch of cases interpreting Pinter, courts latched on to the “defendant's relationship with the plaintiff-purchaser” language to hold that statutory sellers must have direct contact with the plaintiff, or at least some kind of active relationship with the plaintiff, to become liable. See, e.g., Holsworth v. BProtocol Foundation, 2021 WL 706549 (Feb. 22, 2021). This often came up in the context of registered offerings, where plaintiffs suing for false prospectuses were informed that participation in the preparation of offering materials is not “solicitation” for Section 12 purposes, unless there was some kind of direct relationship between the preparer and a particular purchaser. Shaw v. Digital Equipment Corp., 82 F.3d 1194 (1st Cir. 1996); Mass. Mut. Life Ins. Co. v. Residential Funding Co., LLC, 843 F. Supp. 2d 191 (D. Mass. 2012); Braun v. Ontrak, 2022 WL 5265052 (Cal. Super. Oct. 4, 2022); Citiline Holdings v. iStar Fin., 701 F. Supp. 2d 506 (S.D.N.Y. 2010); Rosenzweig v. Azurix Corp., 332 F.3d 854, 871 (5th Cir. 2003); Baker v. SeaWorld Entertainment, 2016 WL 2993481 (S.D. Cal. Mar. 31, 2016); In re Westinghouse Sec. Litig., 90 F.3d 696 (3d Cir. 1996); Freeland v. Iridium World Comms., 2006 WL 8427320 (D.D.C. Sept. 15, 2006); In re Deutsche Telekom AG Sec. Litig., 2002 WL 244597 (S.D.N.Y. Feb. 20, 2002).
But now we have social media! And more and more investment opportunities are being advertised through mass communications (sometimes, in Regulation A offerings, which are subject to Section 12 liability for false communications). A bunch of these are, of course, cryptocurrencies, where the issue isn’t just false prospectus communications, but unregistered sales. All of which makes a flat rule of personal communication somewhat unsatisfying.
Recently, the Ninth and Eleventh Circuit reversed district court rulings that direct communication was necessary. Both Circuits held that mass social media communications that urge particular investments can trigger Section 12 liability to all affected purchasers. See Wildes v. Bitconnect, 25 F.4th 1341 (11th Cir. 2022); Pino v. Cardone Capital, 55 F.4th 1253 (9th Cir. 2022); see also Owen v. Elastos Foundation, 2021 WL 5868171 (S.D.N.Y. Dec. 9, 2021); Balestra v. ATBCoin LLC, 380 F. Supp. 3d 340 (S.D.N.Y. 2019).
Notice the shift, then. For some courts, preparing a prospectus for a registered offering was not deemed to involve sufficient solicitation to trigger Section 12 liability - but now other courts are saying that urging purchases on social media is sufficient. Someone’s got to give.
And even on the internet, what kind of communications qualify? That part’s still not entirely clear. In the social media cases, the defendants created and sold particular investments and hawked them relentlessly, and that was found to be a solicitation. Which brings us to Underwood v. Coinbase Global, Inc., 2023 U.S. Dist. LEXIS 17201 (S.D.N.Y. Feb. 1, 2023).
There, a class of plaintiffs alleged that many of the cryptotokens available for sale on the Coinbase exchange were, in fact, unregistered securities, and brought a battery of claims against Coinbase, including claims under Section 12 for unregistered sales. The plaintiffs actually tried to establish liability under both of Pinter’s definitions of seller – they sued Coinbase for transferring title, and for soliciting sales.
So, let’s start with the title transfer allegations. As we all know, in securities class actions, the original complaints are filed, consolidated, and then a notice is issued alerting other potential plaintiffs of the case. Any plaintiffs (the original ones, or new ones) may then petition the court for “lead plaintiff” status. The court appoints a lead, and (usually) appoints that lead’s chosen counsel as lead counsel, and a new, consolidated complaint is filed. That consolidated complaint becomes the operative complaint for the case. And, because the original plaintiffs may not be appointed lead, the early pleadings tend to be very sparse placeholders, in anticipation of a more detailed pleading to come after the leads are selected.
In Coinbase, however, there was no battle for lead status – after the original complaint was filed, one other plaintiff and one other law firm joined with the original plaintiffs/counsel, and they were all appointed lead together, after which they filed the amended complaint.
As is typical in these situations, the amended complaint was much longer and more detailed than the original complaint. But, crucially, the original complaint had alleged that traders on the Coinbase exchange trade with each other, and Coinbase facilitates the exchange. The amended complaint alleged that Coinbase acts as a market maker, buying directly from one user to sell to another, and vice versa – which would make it a statutory seller for Section 12 purposes under Pinter’s first prong.
Judge Engelmayer refused to accept the amended complaint’s allegations. Citing circuit authority, he held that when an amended complaint contains factual allegations that contradict the facts alleged in earlier complaints, the new allegations may be rejected. And he buttressed that holding by pointing out that the user agreement cited in the original complaint – but not the amended version – described Coinbase as merely facilitating transactions between users without trading itself.
I mean … I have no idea how Coinbase arranges its transactions, but, considering how securities class actions are organized, Judge Engelmayer’s holding is a little concerning, because the whole point is that early complaints are not drafted with the same kind of care as the consolidated complaint. That’s not ideal, but it’s an inevitable byproduct of the lead plaintiff process, and the lead plaintiff process is – for its flaws – one of the best things to come out of the PSLRA. And, in this case, a new plaintiff and new firm joined the action. I don’t know the history there but it’s certainly possible neither had anything to do with the original complaint, and became part of the action because of the notice – precisely as the PSLRA intended. It’s troubling that these new parties might be bound by mistakes – perhaps flat out errors – made by the original filers.
But let’s move on to the second prong of Pinter, concerning solicitation liability. Plaintiffs alleged that Coinbase made money on trades – satisfying Pinter’s requirement that the solicitation be motivated by the defendant’s financial gain – and that Coinbase participated in “airdrops” of particular new token offerings, wrote news stories on price movements of particular tokens, and linked to news stories about them.
This, according to Judge Engelmayer, was not sufficient to qualify as solicitation under Pinter:
To hold a defendant liable under Section 12 as a seller, a purchaser such as plaintiffs must, therefore, demonstrate its direct and active participation in the solicitation of the immediate sale…. the AC's allegations regarding Coinbase's "solicitation" of the transactions involving the Tokens fail, because they do not describe conduct beyond the "collateral" participation that Pinter and its progeny exclude from Section 12 liability. … These activities of an exchange are of a piece with the marketing efforts, "materials," and "services" that courts, applying Pinter’s second prong, have held insufficient to establish active solicitation by a defendant.
I’m not even saying this decision is wrong, exactly, but the line between participating in promotional “airdrops” and linking to articles about price movements, and urging purchases through YouTube and Instagram (as occurred in some of the social media cases where plaintiffs were allowed to proceed), is a fuzzy one – and that’s exactly what the Supreme Court was trying to avoid in Pinter. See 486 U.S. at 652 (“the substantial-factor test introduces an element of uncertainty into an area that demands certainty and predictability”).
Anyway, it’s an area where the law is rapidly developing so … stay tuned.
Friday, February 3, 2023
My mind is still reeling from my trip to Lisbon last week to keynote at the Building The Future tech conference sponsored by Microsoft.
My premise was that those in the tech industry are arguably the most powerful people in the world and with great power comes great responsibility and a duty to protect human rights (which is not the global state of the law).
I challenged the audience to consider the financial price of implementing human rights by design and the societal cost of doing business as usual.
In 20 minutes, I covered AI bias and new EU regulations; the benefits and dangers of ChatGPT; the surveillance economy; the UNGPs and UN Global Compact; a new suit by Seattle’s school board against social media companies alleging harmful mental health impacts on students; potential corporate complicity with rogue governments; the upcoming Supreme Court case on Section 230 and content moderator responsibility for “radicalizing” users; and made recommendations for the governmental, business, civil society, and consumer members in the audience.
Thank goodness I talk quickly.
Here are some non-substantive observations and lessons. In a future post, I'll go in more depth about my substantive remarks.
1. Your network is critical. Claire Bright, a business and human rights rock star, recommended me based on a guest lecture I did for her class. My law students are in for a treat when she speaks with them about the EU Corporate Sustainability Reporting Directive (that she helped draft) next month.
2. Your social media profile is important. Organizers looked at videos that had nothing to do with this topic to see how I present on a stage. People are always watching.
3. Sometimes you can’t fake it until you make it. This is one of the few times where I didn’t know more than my audience about parts of my presentation. I prepared so that I could properly respect my audience’s expertise. For example, I watched 10 hours of video on a tech issue to prepare one slide just in case someone asked a question during the networking sessions.
4. Speak your truth. Going to a tech conference to tell tech people about their role in human rights and then going to a corporate headquarters to do the same isn’t easy, but it’s necessary and I had no filter or restrictions. I didn't hold back talking about Microsoft-backed ChatGPT even though they invited me to Lisbon for the conference. It was an honor to speak to Microsoft employees the day after the conference with Claire, Luis Amado, former head of B Lab Europe, and Susana Guedes to discuss sustainability, ESG, diversity, and incentivizing companies and employees to do the right thing, even when it's not popular.
5. Explore and leave the hotel even when you’re tired. I was feeling run down last Friday night and wanted to stay in bed with some room service. Manuela Doutel Haghighi (one of my new favorite people) organized a dinner at an Iranian restaurant owned by a former lawyer with 6 badass women, and I now have new colleagues and collaborators.
Stay tuned for my next post where I'll cover some of my remarks.
February 3, 2023 in Compliance, Conferences, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Human Rights, International Business, Lawyering, Marcia Narine Weldon | Permalink | Comments (0)
Thursday, February 2, 2023
The University of Arkansas School of Law seeks to fill a tenure-track clinical position starting in the 2023-2024 academic year with a focus on economic development, transactions, business, or entrepreneurship. Lateral applicants are encouraged to apply. Clinical professors are expected to teach 6 to 8 students during the fall and spring semesters.
A candidate must have a J.D. degree from an ABA accredited law school and a commitment to teaching in an environment dedicated to excellence in teaching and mentoring of students. The ideal candidate will have at least three (3) years of practice experience in the clinic subject. At least one (1) year of clinical teaching experience is strongly preferred. Must be a licensed attorney and be eligible to become a member of the Arkansas Bar.
We look for innovative faculty with a preference for both practice and teaching experience. Applicants must demonstrate a commitment to service to legal education and to the wider community as well as a desire to engage in the intellectual life of the University. The University of Arkansas School of Law is dedicated to the aims of diversity and strongly encourages applications from women and minorities.
The University of Arkansas-Fayetteville, located in the northwest corner of the state, is the flagship campus of the University of Arkansas. U.S. News & World Report has consistently ranked the city of Fayetteville as one of the "top five" places to live in America. The region is welcoming, forward-thinking, and full of opportunities for outdoor recreation. The University of Arkansas is an equal opportunity, affirmative action institution. The university welcomes applications without regard to age, race/color, gender (including pregnancy), national origin, disability, religion, marital or parental status, protected veteran status, military service, genetic information, sexual orientation, or gender identity. Persons must have proof of legal authority to work in the United States on the first day of employment.
All applicant information is subject to public disclosure under the Arkansas Freedom of Information Act. Questions and expressions of interest should be directed to Professor Carl Circo, Chair of the Faculty Appointments Committee, at firstname.lastname@example.org.
Please apply for this position at the link below:
Wednesday, February 1, 2023
ICYMI: "25-State Lawsuit on New Labor Rule Allowing Asset Managers to Direct Their Clients’ Retirement Money to ESG Investments"
From the Office of the Utah Attorney General (here):
Today, [January 26, 2023,] Utah Attorney General Sean D. Reyes led a 25-state coalition in a lawsuit over a Department of Labor rule which would affect the retirement accounts of millions of people. The rule would allow 401(k) managers to direct their clients’ money to ESG (Environmental Social Governance) investments and runs contrary to the laws outlined in the Employee Retirement Income Security Act of 1974 (ERISA). “The Biden Administration is promoting its climate change agenda by putting everyday people’s retirement money at risk,” Attorney General Reyes said. “Americans are already suffering from the current economic downturn. Permitting asset managers to direct hard-working Americans’ money to ESG investments puts trillions of dollars of retirement savings at risk in exchange for someone else’s political agenda.... From the complaint: “[T]he 2022 Investment Duties Rule makes changes that authorize fiduciaries to consider and promote “nonpecuniary benefits” when making investment decisions. Contrary to Congress’s clear intent, these changes make it easier for fiduciaries to act with mixed motives. They also make it harder for beneficiaries to police such conduct.” The 25 states joining Utah Attorney General Reyes in this lawsuit are: Alabama, Alaska, Arkansas, Florida, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Mississippi, Missouri, Montana, Nebraska, New Hampshire, Ohio, South Carolina, North Dakota, Tennessee, Texas, Virginia, West Virginia, and Wyoming.
Open Postdoc/fellowship position at Wharton Initiative on Financial Policy and Regulation in Bankruptcy/Restructuring
Dear BLPB Readers:
Here is some exciting news from the Wharton Initiative on Financial Policy and Regulation:
"The Wharton Initiative on Financial Policy and Regulation (WIFPR) is seeking a postdoctoral fellow to support its activities in the field of bankruptcy and restructuring. WIFPR sponsors research, organizes conferences and events, and supports faculty and students at the intersection of finance, law, and policy.
The postdoctoral fellow will be responsible for coordinating WIFPR’s work in bankruptcy/restructuring. More generally, responsibilities include: conducting original research on bankruptcy/restructuring, contributing to WIFPR’s academic programming, engaging with stakeholders, and assisting Faculty Directors and the Senior Fellow with WIFPR events and administration generally.
The postdoctoral fellow will receive a competitive salary and associated benefits. There is no teaching obligation.
The candidate must have a JD or PhD. The candidate should also have some experience with data analysis.
The term of appointment is two years, beginning July 1, 2023. The ideal candidate would have the intention of pursuing a research career in either law, economics, or finance."
Full details of this open position are here.
Monday, January 30, 2023
I have had the good fortune of talking to friend-of-the-BLPB Frank Gevurtz about some of his illuminating "takes" on Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, a decision we all wrestle with, it seems, in one way or another. I recently ran into Frank (at the AALS Annual Meeting), and he informed me that some of those thoughts have made their way into a full-length article. That article, Important Warning or Dangerous Misdirection: Rethinking Cautions Accompanying Investment Predictions, was recently posted to the Social Science Research Network (SSRN) and is available here. The abstract follows.
We are constantly bombarded with cautions warning us of dangers to our health or wellbeing. Sometimes, however, cautions increase the danger. This article addresses one example: cautions warning investors of the risks that predictions regarding corporate performance will not pan out.
Here, the danger is investors falling prey to trumped up predictions of corporate performance, the result of which is to misallocate resources, increase the cost of capital for honest businesses, and create a drag on the overall economy. This article shows how the typical cautions accompanying predictions of corporate performance facilitate rather than avoid this danger by misdirecting both investors and courts from looking at what they should: the credibility of the speaker in giving the prediction.
To solve this problem, this article introduces a radically different approach to determining the legal impact of cautions accompanying predictions of corporate performance. This is to distinguish between cautions alerting investors to problems with the speaker’s credibility in giving the prediction versus those that simply list various risks that might lead the prediction to not pan out. The article thereby provides a roadmap for courts to replace their current misguided focus on the wrong type of cautions in the numerous cases raising the issue of when cautions serve as a defense to claims of securities fraud based upon a failed prediction.
Although Frank's draft article is ultimately directed at judicial decision-making, there is much in it for use by others. I have been teaching materiality law and lore to my Securities Regulation students this past week. So much of this article is relevant to our discussions. In the article, Frank writes about (among other things) the bespeaks caution doctrine and the Private Securities Litigation Reform Act safe harbor for forward-looking statements, both of which are part of my materiality coverage. I am finishing talking about these aspects of materiality litigation tomorrow.
While I am on the topic of materiality , I also want to thank BLPB co-editor Ann Lipton for her great post on Saturday on Tesla and Basic. I use the Securities Regulation text coauthored by her, Jim Cox, Bob Hillman, and Don Langevoort (thanks for that, too, Ann!), which allows for a robust coverage of materiality. The Tesla trial has been on our minds and in our classroom. I am adding Ann's blog post to the mix.
Friday, January 27, 2023
One of the bigger securities stories these days is the “taking Tesla private at 420” trial going on right now, simply because it’s so rare to have a securities fraud class action trial at all. And this one is even more bizarre because the judge has already granted summary judgment to plaintiffs on two key elements: falsity and scienter.
As readers of this blog are no doubt aware, in August 2018, Musk tweeted “Am considering taking Tesla private at $420. Funding secured.” A couple of hours later he tweeted “Investor support is confirmed. Only reason why this is not certain is that it’s contingent on a shareholder vote,” linking to this blog post. The blog post elaborated that Musk “would like to structure this so that all shareholders have a choice. Either they can stay investors in a private Tesla or they can be bought out at $420 per share” – a merger structure that never made sense legally. Eventually Tesla backtracked with a blog post announcing that the company would remain public.
The plaintiffs now allege – and the jury is being asked to decide whether – those two tweets were fraudulent.
According to the jury instructions on file with the court, the jury will be told that in order to find Musk liable, they must find:
1) Elon Musk and/or Tesla made untrue statements of a material fact in connection with the purchase or sale of securities;
2) Elon Musk and/or Tesla acted with the necessary state of mind (i.e., knowingly or with reckless disregard for the truth or falsity of the statements);
3) Elon Musk and/or Tesla used an instrument of interstate commerce in connection with the sale and/or purchase of Tesla securities;
4) Plaintiff justifiably relied on Elon Musk and/or Tesla’s untrue statements of material fact in buying or selling Tesla securities during the Class Period; and
5) Elon Musk and/or Tesla’s misrepresentations caused Plaintiff to suffer damages.
And finally, the jury will be told to assume that both tweets were false, and that Musk acted with reckless disregard as to whether they were true.
That means one of the critical unresolved issues – and one that is central to Musk’s defense – is the element of materiality.
Now, that may seem odd, since the tweets were obviously material. The market reacted wildly to them, so much so that Tesla trading was briefly halted on the NASDAQ. (Although see my earlier post on that).
But that’s not the kind of materiality Musk means.
In fact, materiality as an element of a 10(b) claim has two different dimensions. First, was the false statement material? And second, were the undisclosed facts material – that is, was the difference between the true state of affairs, and the one portrayed by the defendant, material to investors?
To put it another way, these days, doctrines like puffery play an awfully big role in securities class actions, as many cases are brought based on undisclosed misconduct. A scandal emerges; there is no doubt that the facts of the scandal – previously hidden from the market – are material to investors. But silence about scandalous facts is not itself fraudulent; the plaintiffs need to show how the market was misled about these facts. So, plaintiffs argue that certain high-level statements about ethics and legal compliance were false; courts are then asked to evaluate whether those statements were likely to influence investors. These are disputes about whether the allegedly false statements themselves were material, in a situation where the undisclosed facts undoubtedly were.
But suppose a company overstates its quarterly earnings by $100. This is a situation where the statement – an earnings report – was undoubtedly material (and false); what is in question is whether the undisclosed fact – that the earnings were false by a mere $100 – was material. Investors likely would not see any material difference between the reported figure and the true figure.
That’s the essence of Musk’s argument in the Tesla trial. The judge has already ruled that funding was not secured, and investor support was not confirmed, so Musk claims that a handshake arrangement with the Saudi Public Investment Fund, and perhaps the availability of funding from other sources, ensured that funding was sufficiently far along that investors would not have drawn a distinction between “funding secured” and disclosure of the full truth.
That concept of “materiality” is, in fact, the heart of what was at issue in Basic v. Levison, 485 U.S. 224 (1988), the Supreme Court case that defined what materiality means for the purposes of Section 10(b). There, Basic had engaged in discussions regarding a possible merger with Combustion Engineering, but when asked about it, Basic’s President told investors that no negotiations were underway, and that he was unaware of any reason for the “abnormally heavy trading activity” in Basic stock. This was all, of course, false, and the question was whether the undisclosed facts – the true state of merger negotiations – were material to investors. Defendants argued for a bright-line rule, that until an agreement in principle is reached, any merger negotiations should be deemed automatically immaterial. The Supreme Court rejected that argument, holding instead that materiality exists where there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available.”
In the case of merger negotiations, this would require courts to evaluate how probable the transaction appeared to be at the time. Nascent discussions might be immaterial, but board level indicia of interest, such as active negotiations or instructions to investment bankers, might be very material to investors, even if there was no certainty that a deal would ultimately be reached.
What’s ironic, then, is that the Tesla trial is the literal mirror image of Basic. In Basic, a CEO denied merger negotiations, and the relevant question was whether those negotiations were far enough along to create a material distance between his denials and the true state of affairs. In In re Tesla, Inc. Securities Litigation, the CEO declared an imminent merger, and the question is whether the underlying negotiations were sufficiently embryonic to create a material distance between his tweets and the true state of affairs.
Wednesday, January 25, 2023
Dear BLPB Readers:
From Professor Wade Davis:
"Minnesota State University Mankato is hiring a tenure track Business Law professor position for fall 2023. Here is a link to the Job Posting.
The Business Law program is located in the College of Business and provides students the practical knowledge and skills needed to become impactful leaders, entrepreneurs, and professionals who make legally-informed, ethical, and strategic decisions. It offers a robust curriculum including courses in contract law, employment law, intellectual property, environmental law, negotiation, and international law.
The Business Law program has a stand-alone minor with approximately 40 declared students. It teaches core classes for the College of Business, the MBA program, and several departments across the university.
Applications will start to be reviewed on Feb. 28 and continue until the position is filled. Minnesota State University, Mankato is an Affirmative Action/Equal Opportunity University and a member of the Minnesota State System. Please contact Wade Davis at email@example.com if you have any questions."
Tuesday, January 24, 2023
The call for papers will be posted soon, but I wanted to let everyone know that The University of Tennessee College of Law will be hosting the National Business Law Scholars Conference in person (!) in Knoxville, Tennessee on June 15 and 16. As many will recall, Tennessee Law was scheduled to host the conference in 2020 and 2021, only to have to move the conference online late in the game both years because of COVID-19 infection rates. While we were happy to host our business law friends on Zoom those two years, we are truly excited to have folks come to our campus!
More coming soon. But go ahead and save those dates. Please reach out to me if you have any questions.
Saturday, January 21, 2023
As some of you may have heard, following on the success of the Yada Yada Law School, administered by friend-of-the-BLPB Greg Shill, a group of law faculty are getting together to teach classes in the waystar/ROYCO School of Law this semester. Classes start this week. Class meetings will be held weekly, on prescribed days, at 6pm-7pm Pacific/8pm-9pm Central/9pm-10pm Eastern. The first two sessions are as follows:
Tuesday, January 24:
Professor Diane Kemker
Introduction: Using “Succession” (And Scripted Entertainment) to Teach Law: How and Why
[Assignment: Required: any/all of “Succession,” Seasons 1-3; Optional/recommended: any/all of “Yellowstone,” Seasons 1-5]
Wednesday, February 1:
Professor Megan McDermott
Greg Needs a Lawyer. Is He Getting an Ethical One?
[Assignment: Season 3, Ep. 2]
I will be presenting on February 16 on What the Roys Should Learn from the Demoulas Family (But Probably Won't), a lesson on corporate law fiduciary duties.
General information is provided in the syllabus included below. A full schedule of class sessions will be available soon. I will publish that, too. I hope many of you will plan on attending.
“Succession and the Law”
About the course
This is a completely unofficial course for lawyers and law professor fans (or anti-fans!) of the HBO show, “Succession.” It has been organized for informal educational/entertainment purposes only! Over the course of the spring semester, as we await the premiere of Season 4, we will look back at past episodes from a legal point of view. Depending on when Season 4 begins, we may also schedule some additional group “watch parties” and real-time discussion groups.
We have assembled a terrific group of faculty from across the country and across a variety of disciplinary specialties.
We are Prof. Diane Kemker and Prof. Susan Bandes, the organizers of our fun course on “‘Succession’ and the Law.” Diane has a background in professional responsibility and wills and trusts, and Susan is one of the nation’s most-cited experts in criminal law and procedure. Both of us have a longstanding interest in the use of popular culture for legal pedagogy. In the spring of 2023, Diane will be a Visiting Professor of Law at DePaul University College of Law, from which Susan retired/took emeritus status in 2017.
Meeting time: 6pm-7pm Pacific/8pm-9pm Central/9pm-10pm Eastern
Meeting day: Our class will meet on a weekly basis by Zoom. Please note that we will meet on different nights of the week in different weeks, but always at the same time.
Meeting ID: 867 8356 0319
We have created a Facebook group, waystar/RoyCo School of Law, to support the class. It will be a place for ongoing discussion of the show, of our sessions, and related issues. To be added, please send a Direct Message to Diane Kemker.
Professor Diane Kemker (firstname.lastname@example.org)
Visiting Professor of Law, DePaul University College of Law and Southern University Law Center
Dean and Gerri Kellman Professor of Professional Responsibility, waystar/RoyCo School of Law
Professor Susan Bandes (email@example.com)
Centennial Distinguished Professor of Law, Emerita, DePaul University College of Law
Greg Hirsch Professor of Affectionate Litigation
Professor Anat Alon-Beck
Associate Professor of Law, Case Western Reserve University School of Law
Professor Karyn Bass-Ehler
Assistant Chief Deputy Attorney General, Illinois Attorney General's Office
Professor Gillian Calder
University of Victoria (Canada) Law
Professor Joan MacLeod Heminway
Interim Director of the the Institute for Professional Leadership, Rick Rose Distinguished Professor of Law
The University of Tennessee College of Law
Roy/Demoulas Distinguished Professor of Law and Business
Professor Lenese Herbert
Professor of Law
Howard University School of Law
Professor Rebecca Johnson
Associate Director, Indigenous Law Research Unit
Director, Graduate Program
University of Victoria (Canada) Law
Professor Richard McAdams
Bernard D. Meltzer Professor of Law
University of Chicago Law School
Professor Megan McDermott
Associate Teaching Professor
University of Wisconsin School of Law
Honorary Fellow at the Collingwood Centre for Ethics and Civility (Eastnor, England)
Professor Benjamin Means
Professor of Law and John T. Campbell Chair in Business and Professional Ethics
University of South Carolina School of Law
Professor Douglas Moll
Beirne, Maynard & Parsons, L.L.P. Professor of Law
University of Houston Law Center
Professor Robin Wagner
Pitt, McGehee, Palmer, Bonanni & Rivers
NRPI Adjunct Lecturer of Employment Law
All meetings are at 6pm-7pm Pacific/8pm-9pm Central/9pm-10pm Eastern
Friday, January 20, 2023
A couple of months ago, I blogged about Menora Mivtachem Insurance v. Frutarom, 54 F.4th 82 (2d Cir. 2022). There, a public company issued new stock in connection with a merger, and the S-4 contained false information about the target, supplied by the target. The truth came out, the stock price fell, and shareholders sued the target and some of its officers under 10(b). In that context, the Second Circuit held that the plaintiffs, who had purchased shares in the publicly-traded acquirer and not the target itself, did not have "standing" to pursue claims against the target defendants.
The original decision issued on September 30; on November 30, the Second Circuit issued some minor revisions to its ruling (deleting, as far as I can tell, language that suggested that the defendants in a 10(b) action must be agents of the subject company, i.e., that plaintiffs couldn't sue if a stranger to a company made false statements about it and caused plaintiffs to make a purchase of that company's stock).
The plaintiffs sought rehearing, and one of the arguments they made was that the Menora reasoning was so broad that purchasers of shares in a SPAC would be unable to sue managers of a target company for false statements made in connection with the de-SPAC transaction. The Second Circuit denied the petition, and so, right on cue, defendants in the Lucid SPAC case pending in the Northern District of California cited Menora to argue that the plaintiffs had no standing to pursue their claims. The court rejected Menora - and even its predecessor, Nortel - in an extensive analysis of Blue Chip and standing requirements for 10(b) actions:
Blue Chip focused on the unique problem that arises when a plaintiff’s claim is based on inaction and when it is likely that oral testimony will be the primary, or only, evidence. That problem does not exist here or in Nortel. The transactions of plaintiffs in both cases are anchored by the time of the transactions and the amount and value of securities bought or sold....
Based on this Court’s survey, Nortel’s holding regarding standing has been considered in seven decisions outside of the Second Circuit. All but one of these decisions apply Nortel with little or no commentary on the Second Circuit’s reasoning. The one case to address Nortel’s standing analysis (notably, the one court in the Ninth Circuit that has considered Nortel) concludes that the “Second Circuit’s rationale in that decision is problematic” and not supported by extensive reasoning.” Zelman, 376 F. Supp. 2d at 962.
Further, at least two of these decisions are no longer in line with the Second Circuit’s approach after Menora. Nortel had suggested in dicta that if two companies had a “direct relationship” such as that created during a merger, that plaintiffs who purchased one company may have standing to sue based on misrepresentations of the other party to the merger. Menora held that there is no such exception. Two cases outside of the Second Circuit had found plaintiffs had standing under the “direct relationship” exception. It is unclear if, faced with the issue again, these courts would follow the Second Circuit’s current approach....
The Court also sees no benefit from limiting standing as defendants suggest. The goal of such a limitation appears to be to ensure Section 10(b) actions are only brought where a defendant’s conduct is meaningfully related to the plaintiff’s harm. This is already accomplished by the elements of Section 10(b) claims, which include that a misrepresentation must be material and made “in connection with” the purchase or sale of a security. Not only would defendants’ standing rule be redundant, it would conflict with Section 10(b) materiality analysis, under which a misrepresentation is material and actionable where “a reasonable investor’s decision would conceivably have been affected” by it.
In re CCIV/Lucid Motors Securities Litigation, 4:21-cv-09323 (N.D. Cal. Jan. 11, 2023). The court did, however, grant the motion to dismiss on materiality grounds, because when the plaintiff purchased shares in the SPAC, neither the SPAC nor Lucid had acknowledged that a merger was likely. I can't find the decision on Westlaw or Lexis, but here's a Law360 article about it.
Anyhoo, as I've said before, I'm not sure how much longer SPACs will be a thing, but it seems we have a bit of a disagreement among courts that's likely to recur in different contexts.
Monday, January 16, 2023
I have given several talks on ESG (environmental, social, and governance) matters in the past few months. And, of course, it is a subject discussed in the classroom. As we celebrate the birthday of Dr. Martin Luther King Jr. today (and this week), I could not help but feel that his work provided a foundation for—somehow embraced—current ESG discussions and actions. So, I went poking around on the Internet.
I guess I am not the only one who noticed this connection.
On the environmental part of ESG, Los Padres ForestWatch offers that:
Dr. King’s actions and teachings led to many important acts being passed in congress including the Civil Rights Act of 1964 and the Voting Rights Act of 1965. It’s through this work that Dr. King created a movement that was meant for us to understand how we are mutually tied together and that all life is interrelated. It’s this structure of thinking that has led many to believe that his work was the early structure for the Environmental Justice Movement. We see after Dr. King’s passing that environmentalists were able to pass the Clean Air Act of 1970, the Clean Water Act of 1972 and the Endangered Species Act. All of which that had a direct effect on communities of color which are often marginalized and impacted heavily by climate change.
Yet, Dr. King's social issue impacts—including especially the social justice effects of his work—are far more central to communities and corporations. Jeff Hilimire notes in a piece published on the Hands on Atlanta's website, that "[a]fter fighting for human rights for all Americans, Dr. King began to focus on employment and corporations as the next evolution of equality. He believed that companies have a responsibility to be forces of good in the world, and that their influence could make powerful change." Finally, Natalie Runyon at Thomson Reuters Institute hints at governance accountability when she notes in an online article that, while Dr. King would view current ESG efforts favorably, "Dr. King . . . stated that words are not enough—action must follow, with measurement to demonstrate progress."
I will be giving Dr. King's connection to ESG more thought this week as we celebrate his legacy. But regardless of Dr. King's level of responsibility for ESG, his work resonates for me in ESG discussions and debates.
Saturday, January 14, 2023
An ambitious question, yes, but it was the title of the presentation I gave at the Society for Socio-Economists Annual Meeting, which closed yesterday. Thanks to Stefan Padfield for inviting me.
In addition to teaching Business Associations to 1Ls this semester and running our Transactional Skills program, I'm also teaching Business and Human Rights. I had originally planned the class for 25 students, but now have 60 students enrolled, which is a testament to the interest in the topic. My pre-course surveys show that the students fall into two distinct camps. Most are interested in corporate law but didn't know even know there was a connection to human rights. The minority are human rights die hards who haven't even taken business associations (and may only learn about it for bar prep), but are curious about the combination of the two topics. I fell in love with this relatively new legal field twelve years ago and it's my mission to ensure that future transactional lawyers have some exposure to it.
It's not just a feel-good way of looking at the world. Whether you love or hate ESG, business and human rights shows up in every factor and many firms have built practice areas around it. Just last week, the EU Corporate Sustainability Reporting Directive came into force. Like it or not, business lawyers must know something about human rights if they deal with any company that has or is part of a supply or value chain or has disclosure requirements.
At the beginning of the semester, we discuss the role of the corporation in society. In many classes, we conduct simulations where students serve as board members, government officials, institutional investors, NGO leaders, consumers, and others who may or may not believe that the role of business is business. Every year, I also require the class to examine the top 10 business and human rights topics as determined by the Institute of Human Rights and Business (IHRB). In 2022, the top issues focused on climate change:
- State Leadership-Placing people at the center of government strategies in confronting the climate crisis
- Accountable Finance- Scaling up efforts to hold financial actors to their human rights and environmental responsibilities
- Dissenting Voices- Ensuring developmental and environmental priorities do not silence land rights defenders and other critical voices
- Critical Commodities- Addressing human rights risks in mining to meet clean energy needs
- Purchasing Power- Using the leverage of renewable energy buyers to accelerate a just transition
- Responsible Exits- Constructing rights-based approaches to buildings and infrastructure mitigation and resilience
- Green Building- Building and construction industries must mitigate impacts while avoiding corruption, reducing inequality, preventing harm to communities, and providing economic opportunities
- Agricultural Transitions- Decarbonising the agriculture sector is critical to maintaining a path toward limiting global warming to 1.5 degrees
- Transforming Transport- The transport sector, including passenger and freight activity, remains largely carbon-based and currently accounts for approximately 23% total energy-related CO2 global greenhouse gas emissions
- Circular Economy- Ensure “green economy” is creating sustainable jobs and protecting workers
The 2023 list departs from the traditional type of list and looks at the people who influence the decisionmakers in business. That's the basis of the title of this post and yesterday's presentation. The 2023 Top Ten are:
- Strategic Enablers- Scrutinizing the role of management consultants in business decisions that harm communities and wider society. Many of our students work outside of the law as consultants or will work alongside consultants. With economic headwinds and recessionary fears dominating the headlines, companies and law firms are in full layoff season. What factors should advisors consider beyond financial ones, especially if the work force consists of primarily lower-paid, low-skilled labor, who may not be able to find new employment quickly? Or should financial considerations prevail?
- Capital Providers- Holding investors to account for adverse impacts on people- More than 220 investors collectively representing US$30 trillion in assets under management have signed a public statement acknowledging the importance of human rights impacts in investment and global prosperity. Many financial firms also abide by the Equator Principles, a benchmark that helps those involved in project finance to determine environmental and social impacts from financing. Our students will serve as counsel to banks, financial firms, private equity, and venture capitalists. Many financial institutions traditionally focus on shareholder maximization but this could be an important step in changing that narrative.
- Legal Advisors- Establishing norms and responsible performance standards for lawyers and others who advise companies. ABA Model Rule 2.1 guides lawyers to have candid conversations that "may refer not only to law but to other considerations such as moral, economic, social and political factors, that may be relevant to the client's situation." Business and human rights falls squarely in that category. Additionally, the ABA endorsed the United Nations Guiding Principles on Business and Human Rights ten years ago and released model supply chain contractual clauses related to human rights in 2021. Last Fall, the International Bar Association's Annual Meeting had a whole track directed to business and human rights issues. Our students advise on sanctions, bribery, money laundering, labor relations, and a host of other issues that directly impact human rights. I'm glad to see this item on the Top 10 list.
- Risk Evaluators- Reforming the role of credit rating agencies and those who determine investment worthiness of states and companies. Our students may have heard of S&P, Moody's, & Fitch but may not know of the role those entities played in the 2008 financial crisis and the role they play now when looking at sovereign debt. If the analysis from those entities are flawed or laden with conflicts of interest or lack of accountability, those ratings can indirectly impact the government's ability to provide goods and services for the most vulnerable citizens.
- Systems Builders- Embedding human rights considerations in all stages of computer technology. If our students work in house or for governments, how can they advise tech companies working with AI, surveillance, social media, search engines and the spread of (mis)nformation? What ethical responsibilities do tech companies have and how can lawyers help them wrestle with these difficult issues?
- City Shapers- Strengthening accountability and transformation in real estate finance and construction. Real estate constitutes 60% of global assets. Our students need to learn about green finance, infrastructure spending, and affordable housing and to speak up when there could be human rights impacts in the projects they are advising on.
- Public Persuaders- Upholding standards so that advertising and PR companies do not undermine human rights. There are several legal issues related to advertising and marketing. Our students can also play a role in advising companies, in accordance with ethical rule 2.1, about persuaders presenting human rights issues and portraying controversial topics related to gender, race, indigenous peoples, climate change in a respectful and honest manner.
- Corporate Givers- Aligning philanthropic priorities with international standards and the realities of the most vulnerable. Many large philanthropists look at charitable giving as investments (which they are) and as a way to tackle intractable social problems. Our students can add a human rights perspective as advisors, counsel, and board members to ensure that organizations give to lesser known organizations that help some of the forgotten members of society. Additionally, Michael Porter and Mark Kramer note that a shared-value approach, "generat[es] economic value in a way that also produces value for society by addressing its challenges. A shared value approach reconnects company success with social progress. Firms can do this in three distinct ways: by reconceiving products and markets, redefining productivity in the value chain, and building supportive industry clusters at the company's locations." Lawyers can and should play a role in this.
- Business Educators- Mainstreaming human rights due diligence into management, legal, and other areas of academic training. Our readers teaching in business and law schools and focusing on ESG can discuss business and human rights under any of the ESG factors. If you don't know where to start, the ILO has begun signing MOUs with business schools around the world to increase the inclusion of labor rights in business school curricula. If you're worried that it's too touchy feely to discuss or that these topics put you in the middle of the ESG/anti-woke debate, remember that many of these issues relate directly to enterprise risk management- a more palatable topic for most business and legal leaders.
- Information Disseminators- Ensuring that journalists, media, and social media uphold truth and public interest. A couple of years ago, "fake news" was on the Top 10 and with all that's going on in the world with lack of trust in the media and political institutions, lawyers can play a role in representing reporters and media outlets. Similarly, lawyers can explain the news objectively and help serve as fact checkers when appearing in news outlets.
If you've made it to the end of this post, you're either nodding in agreement or shaking your head violently in disagreement. I expect many of my students will feel the same, and I encourage that disagreement. But it's my job to expose students to these issues. As they learn about ESG from me and the press, it's critical that they disagree armed with information from all sides.
So can the next generation of lawyers save the world? Absolutely yes, if they choose to.
January 14, 2023 in Business Associations, Business School, Compliance, Conferences, Consulting, Contracts, Corporate Finance, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Human Rights, International Business, International Law, Law Firms, Law School, Lawyering, Management, Marcia Narine Weldon, Private Equity, Shareholders, Stefan J. Padfield, Teaching, Technology, Venture Capital | Permalink | Comments (0)
Friday, January 13, 2023
This is sort of arcane, but I am fascinated by two decisions that came out of Delaware this week from VC Laster and VC Glasscock. They are remarkably similar in facts and result, but travel slightly different paths to get there.
The first case, Harris v. Harris, concerned a family corporation. The mother was alleged to have systematically looted the company and – aware that a books-and-records action was likely to be filed by her children – forced through a merger with a shell New Jersey entity. After the merger, all of the former shareholders of the old corporation now held identical interests in the new corporation, which was the same in every respect, except for the new state of organization.
The second case, In re Orbit/FR Stockholders Litigation, concerned a corporation with private equity investors. The controller, a French corporation, was alleged to have systematically looted the company, and then effectuated a cash squeeze out merger in order to avoid any potential claims for breach of fiduciary duty.
Because in both cases, the minority stockholders no longer held shares in the looted entity – they held shares in the reorganized entity in Harris, and cash in Orbit/FR – the controller argued they had lost standing to pursue fiduciary claims based on pre-merger conduct.
Now, as background, in In re Primedia, Inc. Shareholders Litigation, 67 A.3d 455 (Del. Ch. 2013), VC Laster held that when derivative claims are extinguished in a merger, the shareholders of the old corporation may be able to bring direct claims arguing that the merger consideration was unfair due to failure to value the derivative claims and include them in the merger consideration. To succeed on a Primedia claim, the plaintiff must plead the existence of viable pre-merger derivative claims, that were material in the context of the merger, and that the buyer would not pursue the claims therefore no value was received for them. The Delaware Supreme Court adopted the Primedia framework in Morris v. Spectra Energy P’rs (DE) GP, LP, 246 A.3d 121 (Del. 2021).
In Orbit/FR, the controlling shareholder argued that the plaintiffs could not meet the pleading requirements of Primedia, in large part because any derivative claims that could have been brought against the controller were time-barred – shareholders should have brought the claims earlier and did not, therefore, they had no value, therefore, they did not need to be valued in the merger. The shareholder-plaintiffs argued that what shareholders did or didn’t do was beside the point; the claims belonged to the company, and a controlling shareholder can’t time-bar claims against itself by having the controlled board refuse to bring them.
All of that is in the briefing, but isn’t addressed by VC Glasscock, who side-stepped it by concluding that Primedia is the wrong framework. (He did address a laches argument but – this is confusing – it was a different laches argument, one concerning the fact that the plaintiffs had actually substituted in for earlier plaintiffs who filed a suit in 2018 and then attempted to settle for amounts that the new plaintiffs deemed inadequate).
In Glasscock’s view, Primedia is reserved for cases where a third party buys the company, has no interest in pursuing the old derivative claims, and therefore does not pay for them. He noted there are “stringent” requirements for pleading such a claim, “in light of the general rule that the derivative asset had transferred to the acquiror, and was not retained by the former stockholders.”
Orbit/FR, however, was more like a straightforward entire fairness case, in which a controller stood on both sides of the transaction. The shareholders had never filed a breach of fiduciary duty claim against the controller for its premerger conduct; instead, the only claim was that the controller looted the company and then effectuated an unfair merger, in part because it bought out its own liability for no value. Per Glasscock, “to the extent the existence of a pre-merger litigation asset, held by Orbit, contributes to a finding of the unfairness of the merger, that unfairness is not extinguished via the merger; it is created by the merger.” The plaintiff had adequately pled an unfair merger, and therefore it would be appropriate for the court to assess fairness in light of all of the assets of the acquired company, including its choses in action.
So. Primedia did not apply; plaintiffs’ claims survived the motion to dismiss.
Harris was bit more complex, in that the minority-shareholder-plaintiffs really did plead premerger fiduciary breaches against their mother, the controlling shareholder, in addition to other claims. In that context, VC Laster also invoked Primedia, but, in his view, though Primedia itself involved a third party buyer, its logic was descended from the squeeze-out case of Merritt v. Colonial Foods, Inc., 505 A.2d 757 (Del. Ch. 1986), where a controller effectuated a merger for the purpose of eliminating derivative claims, and the minority shareholders were permitted to use those claims to demonstrate the unfairness of the merger price. In Laster’s view, then, Primedia is simply a specific instance of a general rule that when a merger eliminates derivative claims, those claims are treated as assets of the target company and the fairness of the merger is assessed accordingly. And, further demonstrating that he believed Primedia simply to be an extension of earlier caselaw, Laster noted that the plaintiffs might not need to show that the value of the claims was material in light of the overall merger consideration – as Primedia suggests – if the unfairness of the merger can be pled by other means:
In Parnes, the Delaware Supreme Court did not hold that a stockholder only could assert a direct claim challenging a merger by pleading facts indicating that the value of the diverted proceeds were so large as to render the price unfair. The Delaware Supreme Court instead recognized more broadly that a stockholder could assert a direct claim challenging a merger if the facts giving rise to what otherwise would constitute a derivative claim led either to the price or to the process being unfair. In Primedia, the court identified this dimension of Parnes and explained that “[t]here is a strong argument that under Parnes, standing would exist if the complaint challenging the merger contained adequate allegations to support a pleadings-stage inference that the merger resulted from an unfair process due at least in part to improper treatment of the derivative claim.”
Using the Primedia framework, Laster, like Glasscock in Orbit/FR, went on to find that the minority stockholders in Harris could pursue their claims as a direct attack on the fairness of the merger.
So the cases reached the same result, but differed on the applicability of Primedia. Do these divergent approaches make much of a difference? Possibly. Glasscock seemed to think Primedia requires the pleading of very specific elements, so categorizing a claim as “Primedia” or “not Primedia” really matters for whether a complaint is sufficient; the Primedia pleading burden was avoided in Orbit/FR by viewing the case through the simple lens of whether the plaintiffs had alleged facts that made it reasonably conceivable that a controlling shareholder freezeout merger was unfair. Laster, by contrast, did not view Primedia so narrowly; though he found the formal elements met in Harris, he also went out of his way to note that Primedia’s test is really just a mechanism for assessing whether unfairness has been pled.
Conceptually, I do agree with Laster that there is really one unified concept here, namely, the extent to which a derivative claim is an asset of the target and whether its treatment renders the merger unfair to the selling stockholders. The facts necessary to plead such a claim should be a separate issue that is adjusted as the circumstances warrant.
Another interesting point of note, though: In Harris, Laster also held that the minority plaintiffs satisfied the two exceptions that exist to the continuous holding rule for derivative standing. As Laster pointed out, the continuous holding rule is waived if the merger is effectuated solely for the purpose of eliminating the derivative claims (known as the “fraud exception,” Ark. Tchr. Ret. Sys. v. Countrywide Fin. Corp., 75 A.3d 888 (Del. 2013)), and it is also waived if the merger is a mere reorganization of the old corporation with no substantive changes. Here, that’s exactly what happened on both counts, but Laster concluded that it would be administratively simpler to treat this as a direct claim, and that’s what he did.
Which means, among other things, we now have at least one example of a case where the fraud exception to the continuous holding rule was in fact met, which I think is – new? If there others, I don’t know what they are – feel free to let me know in the comments if it’s been done before.
Thursday, January 12, 2023
Last year, I covered a lawsuit challenging FINRA's constitutional status and the top-notch lawyers FINRA hired to defend it. Since then, FINRA has filed its motion to dismiss. You can read it yourself here if you're interested. The plaintiffs have until January 30th to respond.
My sense after reading it is that FINRA would prefer to shift the focus off itself and keep the court's attention on the plaintiffs' tattered regulatory history. The initial robust defense argues that the case should be dismissed for purported jurisdictional, venue, and standing flaws. The first seventeen and a half pages of the motion to dismiss focus on these arguments and a review of the plaintiffs. As a matter of litigation strategy, taking these shots early makes sense to me. If the arguments succeed, they'll knock the case out entirely.
The final seven pages make the case for FINRA's constitutional status. It argues that: (1) FINRA is a private entity exempt from separation of powers or appointments clause issues; and (2) that no non-delegation doctrine violation has occurred because the SEC supervises FINRA.
It'll be interesting to see how these arguments hold up, if Judge Scriven ever reaches them. On the whole, the arguments so far seem to center around the issues I highlighted in my article warning about the possibility of these kinds of challenges for SROs.
For example, FINRA argues that it shouldn't be deemed a part of government because FINRA wasn't created by the government. It relies in part on the Amtrak case, Lebron v. NationalRailroad Passenger Corp., 513 U.S. 374 (1995), for the proposition that only corporations “create[d]” by the government “for the furtherance of government objectives” will qualify as arms of the government.
I discussed this issue in my article, and took the view that:
Drawing a constitutional line between whether these entities are government-created entities or government-authorized entities does not relate to the core concern animating Free Enterprise Fund. Whether an entity is chartered under state law or is federally created has no bearing on whether the President is “stripped of the power . . . and his ability to execute the laws—by holding his subordinates accountable for their conduct.” The precise method of creation of an SRO does not relate to the underlying separation of powers concerns.
The brief also argues that FINRA's power is a permissible delegation. I'm less confident about the scope of appropriate delegation with the post-Trump era Supreme Court. My point here isn't to say that one side or the other is right, but that there is real uncertainty about how far the Supreme Court will push on non-delegation issues. It's going to be an interesting case to follow.
Wednesday, January 11, 2023
For those readers interested in exchanges and clearing, I wanted to highlight that Oliver Wyman's "Independent Review of Events in the Nickel Market in March 2022" was released yesterday. As I noted in an earlier post (here), in March 2022, the price of nickel on the LME rose over 270%, and the exchange not only halted nickel trading, but also canceled trades. Additionally, the LME, who engaged Oliver Wyman to produce this Review, released "LME Group Response to Oliver Wyman Independent Review." The Executive Summary - which is all I've had time to read thus far - notes that:
"The primary objectives of the review were to identify the factors that contributed to market conditions in the
nickel market in the period leading up to, and including, March 8, 2022, and make recommendations for how the
LME Group could reduce the likelihood of similar events occurring again"