Business Law Prof Blog

What a Week Yesterday Was

In blogging, it’s feast or famine.  Some weeks I strain to find something to say; other times I’m spoiled for choice.

This week, we kick off with the Supreme Court’s decision in Slack v. Pirani, which Ben Edwards flagged in his post yesterday.  I blogged extensively about the case previously here and here and here.

Not much to say about this one except that the unanimous reversal of the Ninth Circuit was probably the best outcome plaintiffs could reasonably have hoped for.  The Court held – as expected – that Section 11 claims require plaintiffs to show they purchased shares registered on the defective registration statement, but it also allowed for the possibility that plaintiffs would be able to do so and remanded to the Ninth Circuit to make that determination.  Plaintiffs, and their amici, raised arguments about statistical tracing and accounting methods; it’s not impossible those will stick.  And, the Supreme Court remanded to the Ninth Circuit for reconsideration of the Section 12 claims, which means plaintiffs may try to make some new law there as well.  These are all longshots, but the case survives to fight another day.

Next up, we have the Ninth Circuit’s en banc decision in Lee v. Fisher, upholding Gap’s forum selection bylaw requiring that all derivative claims – including Section 14(a) claims – be brought in Delaware Chancery, which has no jurisdiction to hear them.  I blogged about this issue here and here and here and here; the decision creates a split with the Seventh Circuit’s Seafarers Pension Plan ex rel. Boeing Co. v. Bradway, 23 F.4th 714 (7th Cir. 2022), and it was 6-5 to boot, so I’m pretty sure this is Supreme Court bound unless someone settles something.

The majority opinion kicks off with an incorrect history of forum selection clauses and their relationship to Section 14(a) claims.  None of that matters to the reasoning, really, it’s just annoying.

The court says:

Gap’s inclusion of a forum-selection clause in its bylaws is consistent with a modern corporate trend. … In the first decade of the 2000s, there was an increase in litigation, id., “brought by dispersed stockholders in different forums, directly or derivatively, to challenge a single corporate action,” … Because multiforum litigation could impose high costs and hurt investors, id., many corporations adopted forum-selection clauses in response…

That’s true as far as it goes, but multiforum litigation was an issue for state claims, not federal claims.  For federal claims, the big concern was not multiforum litigation, but state court litigation, specifically Securities Act claims in state court.  So, bylaws morphed from being a protection against state law multiforum litigation into being a protection against state court litigation of Section 11 claims.  In fact, I’m, like, 90% sure that Gap’s bylaw – requiring that derivative claims be brought in Delaware Chancery – was in fact never intended to apply to federal claims at all, but was enacted with state law claims in mind.  It was likely only after this particular derivative 14(a) claim was brought that Gap decided to apply its bylaw to federal Exchange Act claims.

Then the opinion says:

Lee’s complaint is consistent with another modern trend, in which plaintiffs frame corporate mismanagement claims that normally arise under state law (including challenges to corporate policies relating to “ESG [environmental, social, and governance] issues . . . such as environmentalism, racial and gender equity, and economic inequality”) as proxy nondisclosure claims under § 14(a), in order to invoke exclusive federal jurisdiction and avoid any forum-selection clause pointing to a state forum.

No, plaintiffs bring Section 14(a) claims because they are negligence-based and predicated on a simple material misstatement.  If they brought mismanagement claims, they’d have to get around the business judgment rule and need to show a loyalty violation; negligence would be exculpated under 102(b)(7).  That’s not a defense of the practice, or of this particular complaint; it’s just a correction of the Ninth Circuit’s history.

But onward to the main event.  My big thing here, as you all are aware by now, is the assumption that bylaws and charter provisions are in fact contracts.  Well, the Ninth Circuit just accepts that they are – and further that they are contracts governed by Delaware law – with no analysis at all.

In interpreting Gap’s forum-selection clause, we apply Delaware’s rules of contract interpretation, because “[c]orporate charters and bylaws are contracts among a corporation’s shareholders.” Airgas, Inc. v. Air Prods. & Chems., Inc., 8 A.3d 1182, 1188 (Del. 2010)….

The bylaws are not only a contract among stockholders, but are also considered “part of a binding broader contract among the directors, officers and stockholders formed within the statutory framework of the Delaware General Corporation Law,” Hill Int’l, 119 A.3d at 38, because “the certificate of incorporation may authorize the board to amend the bylaws’ terms and that stockholders who invest in such corporations assent to be bound by board-adopted bylaws when they buy stock in those corporations,” Boilermakers, 73 A.3d at 940…..

We also reject the dissent’s argument that the forum-selection clause is unenforceable because Gap’s shareholders —whether they are “sophisticated parties” or not, Dissent 66—did not “consent” to its inclusion in the corporate bylaws, Dissent 65, and had “no opportunity to negotiate the content of the bylaws or alter terms not to their liking.” Dissent 66. This argument fails as a matter of both federal and Delaware law. The Supreme Court has expressly rejected the “determination that a nonnegotiated forum-selection clause in a . . . contract is never enforceable simply because it is not the subject of bargaining.” Carnival Cruise Lines, Inc. v. Shute, 499 U.S. 585, 593 (1991). We have likewise held that “a differential in power or education on a non-negotiated contract will not vitiate a forum selection clause.” Murphy v. Schneider Nat’l, Inc., 362 F.3d 1133, 1141 (9th Cir. 2004). And because “state law governs the validity of a forum-selection clause just like any other contract clause,” DePuy Synthes Sales, Inc. v. Howmedica Osteonics Corp., 28 F.4th 956, 963–64 (9th Cir.), cert. denied, 143 S. Ct. 536 (2022), it is even more significant that Delaware courts have not agreed with the dissent’s reasoning. 

Obviously, I’m tearing my hair out over here, but rather than type it all out again, I’ll just direct y’all’s attention to my latest paper on the subject, Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine, the proofs of which are now actually at the printer and so thankfully I don’t have to update it to address this latest decision. 

Working off the premise that bylaws are contracts, the Ninth Circuit spends most of its time dealing with the question whether you can contract to bring a derivative Section 14(a) claim in a forum that has no jurisdiction to hear it.  Functionally, of course, such a contract is the equivalent of a waiver of the claim, so the real issue is whether such a waiver is prohibited under federal law.

The Exchange Act prohibits “[a]ny condition, stipulation, or provision binding any person to waive compliance with any provision of this chapter or of any rule or regulation thereunder, . . .” 15 U.S.C. § 78cc(a).  Courts, including the Ninth Circuit, have uniformly held that a predispute agreement not to bring a private claim under the securities laws is the equivalent of a prohibited waiver of Exchange Act compliance, see, e.g., Petro-Ventures v. Takessian, 967 F.2d 1337 (9th Cir. 1992), although there is some circuit disagreement about what exactly counts as a predispute agreement not to sue.

In this case, though, the Ninth Circuit held that Gap’s bylaw does not run afoul of the Exchange Act because it only eliminates derivative Section 14(a) claims, not direct claims.  And, the court further held, false proxy statements are really more injuries to shareholders’ individual voting rights than to the company generally, which means they are a poor fit for derivative claims, and the plaintiff in this case could have brought the same claims directly.  So, according to the Ninth Circuit, the company’s substantive obligations under the Act remain intact, and no prohibited waiver is effectuated:

The dissent has failed to identify any § 14(a) claim that cannot be brought as a direct action, and therefore has failed to show that the unavailability of a derivative § 14(a) action precludes enforcement of any substantive obligation arising under § 14(a). Accordingly, the dissent’s observation that “[d]irect and derivative suits are not interchangeable,” Dissent 60, is irrelevant here. Because § 29(a)’s antiwaiver provision is concerned only with waiver of the substantive obligations imposed by the Exchange Act, the availability of any particular method of enforcing those obligations is not material.

So. The bylaw did not run afoul of the Exchange Act antiwaiver provision.

The court then turned to the plaintiff’s argument that even if the bylaw did not count as a prohibited waiver of Exchange Act claims, it still ran afoul of the general policy of the federal securities laws, which intended to allow these claims to go forward.

At this point, relying a lot on Joseph Grundfest & Mohsen Manesh’s article, Abandoned and Split But Never Reversed: Borak and Federal Court Derivative Litigation, the court held that the derivative private right of action under Section 14(a) was kind of a judicial mistake – dicta in the case that recognized it, J.I. Case Co. v. Borak, 377 U.S. 426 (1964), and out of place in the securities laws generally.  The court did not purport to overrule Borak and eliminate the right; it simply held that given the right’s weak pedigree, preserving it did not qualify as a sufficiently important policy to override the forum selection provision.

A lot of the court’s reasoning here went back to the idea that false proxy statements are really more properly brought as direct claims, because they impair stockholders’ voting rights.  The court held there was no reason not to follow Delaware’s conception of the direct/derivative distinction in this case for the purpose of interpreting federal 14(a) rights, because Delaware’s conception makes sense and is not inconsistent with the federal policy underlying the Section 14(a) cause of action. 

So.

As a policy matter, my problem with the decision is that, contra the Ninth Circuit, in fact, direct claims do not function as a complete substitute for derivative claims.  Suppose an acquiring company needs a shareholder vote to complete a merger, and the proxy statement is misleading.  Suppose the merger is a bad deal for the company.  Under Delaware law, that’s an injury to the company, not the shareholder – and, in fact, in the very Delaware cases cited by the Ninth Circuit for the proposition that these should be brought as direct claims, Delaware also held that it could not identify any injury that would justify an award of damages directly to the stockholders, because the only harms were derivative.  In re J.P. Morgan Chase & Co. S’holder Litig., 906 A.2d 766 (Del. 2006); In re Tyson Foods, Inc., 919 A.2d 563 (Del. Ch. 2007).  Ironically, the Ninth Circuit cited Tyson Foods for the proposition that there must be a direct remedy available for false proxy statements, when that case itself dismissed the direct claims because there was no relief anyone could think of.

So there absolutely are false proxy situations that are more naturally brought as derivative claims.  And Delaware apparently won’t provide a remedy, or might only provide a nominal damages remedy – because the psychic harm is direct but the economic harm is derivative, which is not something Tooley really contemplated.  Plus, it’s necessary that federal law provide the cause of action, because Section 14(a) imposes liability for negligence.  Delaware state law does not; companies can exculpate claims for negligence under DGCL 102(b)(7). 

All of which is to say: There is no remedy under Delaware law for negligent proxy statements whether the claim is brought directly or derivatively (with an asterisk), and if federal law is following Delaware, there’s no remedy for shareholders suing directly under federal law for transactions that harm the company, at least not unless shareholders manage to act quickly enough to halt the transaction entirely.  That’s the hole that derivative Section 14(a) claims can fill.

(Now, some courts have held that 102(b)(7) provisions can even exculpate negligence claims under federal law, as I discuss in Inside Out; let’s just say that I think these decisions are wrong and pretty clearly violate the Exchange Act’s antiwaiver provisions.)

But let’s go further.  As I said, unless someone backs down or settles, this case is Supreme Court bait.  Once it gets there, I would be surprised if we did not see an argument that predispute claim waivers simply do not run afoul of the antiwaiver provisions of the Exchange Act at all.  I.e., even though federal courts are in agreement that predispute waivers are unenforceable – and the Ninth Circuit agreed they are here, if there is no alternative federal claim preserved – I expect defendants or their amici to argue that the Exchange Act only prohibits waiver of substantive compliance with the Act; that does not necessarily translate into prohibiting private contracts not to sue.  After all, the SEC can still sue for Exchange Act violations, so the company is still bound to its substantive obligations.

I would also not be surprised if the Supreme Court were to find that argument compelling, and endorse it, or come very close (there must be some sliver of a private right remaining, or something; maybe you can waive fraud on the market claims so long as direct reliance claims remain, that kind of thing; there is already a circuit split about just how much of a private securities claim you can waive by contract).  In fact, after the Ninth Circuit’s decision, some version of that argument – you can eliminate claims this far but no farther – will probably be shopped with or without Supreme Court involvement.

If that happens, then, leaving aside what the effect might be on private contracts, the whole mess is dumped back into Delaware’s lap.  Delaware will have to decide how far companies can go in charters and bylaws to waive private securities fraud claims.  Delaware will have to decide when enforcing such waivers is a violation of directors’ fiduciary duties, and when directors are conflicted in enforcing such waivers, and whether enforcement of a waiver is a conflict transaction that needs to be reviewed under entire fairness. It will add a whole separate layer of state litigation on top of the federal, where Delaware will decide the contours of the federal right.  And it will be doing so in the shadow of jurisdictions like Nevada, which may very well adopt permissive rules.  We might even start with whether Delaware does, in fact, agree that directors may, consistent with their fiduciary duties, completely bar derivative Section 14(a) claims, especially if a situation comes up where, whether due to 102(b)(7) or Delaware’s vision of the direct/derivative distinction, Delaware would not provide any remedy but federal law would provide a derivative one.  And of course, arbitration provisions may make a comeback - even apart from the FAA, Delaware then gets to decide whether and to what extent invoking arbitration for securities claims is consistent with Delaware-imposed fiduciary duties.  This is the race to the bottom on the Autobahn.  

And that is exactly my point in Inside Out (or, One State to Rule them All): New Challenges to the Internal Affairs Doctrine.

And ... we aren’t even done with interesting business law developments this week, but this post is long enough so, more later.

Supreme Court Upholds "Tracing" Requirement for Section 11 Cases

Earlier today the Supreme Court released its opinion in Slack Technologies LLC v. Pirani.  It ruled that a plaintiff seeking to bring a Section 11 claim must trace their stock to a registration statement.  Of course, companies today now go public through direct listings or other methods where the pool of publicly traded stock includes some issued pursuant to registration statement and some from other prior holders.  Functionally, this often makes it impossible to for anyone buying shares in the open market to trace whether their shares were issued pursuant to a registration statement or simply sold by someone else.

The unanimous decision follows the vast majority of circuit courts to consider the issue.  It pointed out that the issue was previously addressed by Judge Friendly in Barnes v. Osofsky, 373 F. 2d 269, 272 (CA2 1967).  

 

In Memory; Harvey Pitt

The following message was received by me earlier this evening from the SEC Historical Society.  I thought many of you would want the information.  I interviewed with Harvey Pitt back at Fried Frank in 1984.  He then was already a securities regulation icon.  I was impressed (even though I did not end up working at Fried Frank--but together with Skadden's Washington, DC office, it was at the top of my list if I had decided to go to DC instead of Boston).  May he rest in peace and may his memory be for a blessing.

+++++

Dear Friends,

I write to pass along the very sad news that former SEC Chairman and one of the Society's founders, Harvey Pitt, passed away today.

There will be a service on Monday, JUNE 5th at 1:00 PM at the Washington Hebrew Congregation at 3935 Macomb Street, NW, Washington, DC 20016.

I understand that for anyone who would like to reach out to his wife, Saree, it was recommended by his family to give her a day or two before doing so.

I will pass along any additional helpful information that I may receive.

Sincerely,
Jane

 

Jane Cobb
Executive Director
[email protected]
202-756-5015

 

 

I’m Moving to the Free Enterprise Project

It’s not quite as dramatic as LeBron James taking his talents to South Beach, but I’m nevertheless excited to announce my upcoming move to the Free Enterprise Project (FEP), a DC-based think tank that “focuses on shareholder activism and the confluence of big government and big business.” The FEP is part of the National Center for Public Policy Research, which is “a communications and research foundation supportive of a strong national defense and dedicated to providing free market solutions to today’s public policy problems.” The NCPPR was founded in 1982, and readers of this blog may be interested to know that among its many activities it is the plaintiff in a recently filed lawsuit accusing the SEC of viewpoint discrimination in connection with its oversight of shareholder proposals (co-blogger Ann Lipton recently discussed an aspect of that lawsuit here).

In addition to the FEP, the National Center includes: (1) the Environment and Enterprise Institute, (2) Project 21, (3) Able Americans, and (4) The Political Forum Institute. For those interested, I’ve included a brief summary of each of these projects below.

• The Environment and Enterprise Institute seeks to “counter misinformation being spread to the public and policymakers by the environmental left.”
• Project 21 seeks to “promote the views of African-Americans whose entrepreneurial spirit, dedication to family and commitment to individual responsibility have not traditionally been echoed by the nation’s civil rights establishment.”
• Able Americans seeks to “support Americans living with intellectual, developmental and physical disabilities.”
• The Political Forum Institute seeks “to build a powerful and enduring community dedicated to the values and beliefs of the American founding: free peoples, free minds, and free markets.”

While I am looking forward to this new opportunity to advance the principles of “a free market, individual liberty and personal responsibility” – I must also express my gratitude for the opportunities I’ve been given by Akron Law to be of service to that institution and its students. If you aren’t familiar with all the great things going on at Akron Law, please visit their web page (here). There is much I could brag about when it comes to Akron Law, but perhaps the best thing I can say about the school is that everyone I ever worked with there – from the Dean’s suite to the administrative offices and throughout the school – was and is passionately committed to the success of our students. Unsurprisingly, we have not always agreed on the best path forward for the school, but I never once questioned the commitment of my colleagues to the institution and our students.

Finally, I want to express my gratitude to my past and present co-bloggers at the BLPB. I believe I can rightfully claim to be the founding member of this 2013 re-boot of the BLPB, but at this point I merely bask in the brilliance of my co-bloggers. When I was younger, I typically preferred to be a big fish in a small pond – but now the advice I almost always give is to dive into the pond with the biggest/best fish you can surround yourself with, and my experience here confirms that this is the better road travelled.

I’ve also decided to jump back on Twitter and LinkedIn, so feel free to connect with me there (at least until I’m cancelled).

Onwards and upwards!

Closing Out An Annual Day Of Reflection . . . .

Each year on and around Memorial Day, in addition to all the promotional sales that hit my email in box and text messaging apps, I read many grateful testimonials to those whose lives were lost in national military service.  The personal reflections are touching and inspire in me both sorrow for the loss and pride in the United States of America.  As many before me have said, there is no greater sacrifice for one's country.

Although family members alive during my lifetime have served in the armed services, none of those family members died in the line of service.  I have been lucky to not suffer that kind of loss.  It would be heartbreaking.

Today, my brother (who researches our family history) asked his Facebook friends--me included--to honor "all of those who have lost their lives in the struggle for freedom."  That request followed a brief recitation of the story of one of our family members who lost his life as a civilian working in what became enemy territory in World War II.  Here is what my brother wrote:

1st cousin 1 generation removed Donald MacLeod Williams (14 May 1921, San Francisco, California - 9 Mar 1943, Sasebo, Nagasaki, Japan) was a civilian POW who died while imprisoned during WWII at Sasebo POW Camp # 18. He was my grandfather’s sister’s son.

He was working for the Morrison-Knudsen Company on Wake Island when it was overtaken. Along with 250 other men, he was captured and transported by an oil tanker to Yokohoma. The men were marched through the streets and then put on a train to Sasebo Camp #18. While in the camp he became ill, developed pneumonia and died of both the pneumonia and malnutrition.

He was originally buried in Unoki near Sasebo in a mass grave. The American military recovered the bodies after the war and the family was given the ability to bury him properly. He had spent some of his childhood with his family in Hawaii and the decision was made to bury him there. He is buried in the National Memorial Cemetery of the Pacific in Honolulu, Hawaii.

I had never heard this story.  It made me think.  Specifically, it forced me to consider the risks of working abroad--something diplomats, journalists, and multinational businessmen must be keenly aware of when they are stationed or accept a position located overseas.  I offer the story to you so that you may be similarly enlightened.

To all of those who honored the lives of family, friends, or others today, "a day of prayer for permanent peace," I send sympathy and hopes for peace.

We haven’t even gotten climate change disclosure rules yet

But the First Amendment challenges to the securities laws seem to be piling up – in the Fifth Circuit Court of Appeals, specifically.

The Chamber of Commerce recently petitioned that court to overturn the SEC’s new rules requiring disclosure of stock buybacks.  Though the briefing hasn’t been filed yet, the press release on the subject announces that the Chamber plans to argue that the new rules unconstitutionally compel corporate speech.

Next up, the National Center for Public Policy Research – a conservative organization that has been filing a lot of anti-ESG shareholder proposals under 14a-8 – just petitioned the Fifth Circuit regarding the SEC’s no-action letter permitting Kroger to exclude an NCPPR proposal requesting a report on the “risks associated with omitting ‘viewpoint’ and ‘ideology’ from [Kroger’s] written equal employment opportunity (EEO) policy.”  The NCPPR argues, among other things, that the SEC has denied exclusion of similar proposals with a liberal bent, and is therefore engaging in viewpoint discrimination by allowing Kroger to exclude the NCPPR proposal.  (The SEC’s response, so far, mainly focuses on whether a no-action letter counts as a final order).

Finally, the National Association of Manufacturers (NAM) just intervened in NCPPR’s case to argue that 14a-8 itself is a violation of corporate First Amendment rights, as well as a violation of the major questions doctrine and unauthorized by the text of Section 78n. 

With respect to the statutory interpretation piece, awkwardly for NAM, Rule 14a-8, in one form or another, has been around since 1942.  NAM elides that point by focusing on the modern version of the rule and the current SEC’s interpretations of it (particularly with respect to social proposals), but NAM’s textual argument rests on the proposition that Section 78n “does not grant the SEC power to compel corporations to publicize or discuss shareholder-submitted proposals,” Mot. at 19, and therefore we’ve all been misinterpreting the statute since World War II.

For the First Amendment piece, NAM’s motion to intervene states:

[NAM]… moves to intervene to raise a fundamental threshold issue addressed by neither party but affecting every publicly traded company in the United States: Whether the First Amendment and federal securities laws allow the SEC, through its Rule 14a-8, to compel a corporation to use its proxy statement to speak about abortion, climate change, diversity, gun control, immigration, or other contentious issues unrelated to its core business or the creation of shareholder value.

The answer is “No.” It is “firmly established” that the States have the authority “to regulate domestic corporations.” CTS Corp. v. Dynamics Corp. of Am., 481 U.S. 69, 89 (1987). And state corporate law typically empowers corporate management, subject to oversight by the board of directors, to determine whether and how the corporation will speak or act. See, e.g., In re Franchise Servs. of N. Am., Inc., 891 F.3d 198, 210 (5th Cir. 2018).

But the SEC’s Rule 14a-8 asserts federal governmental power to override management and compel a corporation to publicize dissenting shareholders’ proposals on divisive issues in its own proxy solicitation. The SEC’s claimed power to dictate the contents of corporate proxy statements has no basis in federal securities law, and it violates the First Amendment’s prohibition against government-compelled speech.

Now, to be honest, First Amendment doctrine is way outside my lane, but I can’t help but make a couple of observations.

First, CTS was not about federal power to regulate; it was about conflicts among the powers of different states.  In fact, CTS was very explicit that federal law could preempt state law in this area, if there was federal law on point.  See 481 U.S. at 79.

More generally, state governments are … you know, governments.  If it is, in fact, a violation of the First Amendment for the federal government to require that shareholder proposals be included on corporate proxies, it would also be a violation of the First Amendment for states to do the same thing.  After all, in Citizens United v. FEC, 558 U.S. 310 (2010) – which involved federal campaign finance regulation – the Supreme Court held that states “cannot exact as the price” for the privilege of incorporation the forfeiture of First Amendment rights.  Id. at 351.

But that leads to the more interesting First Amendment question here.  Shareholder proposals don’t come from government regulators; they come from, well, shareholders.  Regulators may impose conditions for their inclusion on corporate proxies, but regulators are not the source – shareholders are.  And shareholders are, in the Supreme Court’s view, the company owners.  See Burwell v. Hobby Lobby, 573 U.S. 682 (2014).  (I include the cite to avoid debates about whether shareholders are in fact owners or simply residual claimants).  So when NAM argues that it violates the First Amendment to force companies to include shareholder proposals on proxies, what it’s really saying is that there is a constitutional principle requiring that corporate speech decisions be made exclusively by directors and officers, free from the influence of the corporation’s owners.

And that really gets to the heart of the problem with corporations and First Amendment rights; because the corporation is itself a creature of law, the law also determines who has authority to act on its behalf, and there is no obvious constitutional principle for excluding shareholders from that decision – indeed, Citizens United explicitly held that corporations are associations of citizens in corporate form, 558 U.S. at 349, and that shareholders could have a say in corporate speech via the “procedures of corporate democracy.” Id. at 370.  Those procedures are not preexisting natural forms to be found in the shape of a flower or the beat of a hummingbird’s wing; they are themselves created by law.  State or federal.

I’m hardly the first person to make that observation; academics have been arguing that point for years.

So I have to admit, I am very curious to find out if the Constitution mandates a particular theory of shareholder involvement in corporate governance, especially considering that we didn’t even have business corporations at the Founding and they only barely existed when the 14^th Amendment was adopted.  After Citizens United, we know that the Constitution distinguishes between corporations and their associated political action committees, so obviously there is some constitutional … minimum … regarding the corporate form, but apparently there is more to be unearthed.

But mainly, does all this mean that the Fifth Circuit is now the new “mother court” of securities law?

SEC Changes Introductory Disclaimer - Likely In Response to Discovery Dispute

If you regularly read speeches given by SEC Commissioners and staff, you may have noticed a change in the standard opening.  For most of my career, the remarks always began with something to this effect:

Before I begin, I must give the customary disclaimer that the views I express today are my own and do not necessarily reflect the views of my fellow commissioners or the staff.

That standard disclaimer came from Commissioner Crenshaw on March 30, 2023 in the opening to her remarks to the Fixed Income Forum.  And about a month ago, Chair Gensler's standard disclaimer on April 24, 2023 to the Annual Small Business Forum came out as:

As is customary, I would like to note that my views are my own, and I’m not speaking on behalf of the Commission or SEC staff.

But something has changed.  Chair Gensler gave the disclaimer this way on May 10, 2023 in remarks to the Municipal Securities Disclosure Conference:

My views are my own as Chair of the SEC, and I am not speaking on behalf of my fellow Commissioners or the staff (emphasis added)

This change continues forward to Chair Gensler's remarks today to to the Investment Company Institute:

As is customary, I’d like to note that my views are my own as Chair of the Securities and Exchange Commission, and I’m not speaking on behalf of my fellow Commissioners or the SEC staff (emphasis added)

It appears that the custom has changed and the introductory disclaimer now includes a note that remarks are in an official's capacity.  You can also see this in Commissioner Udeya's remarks at the MFA Global Summit on May 16.  He put it this way:

I would like to share remarks that reflect my views as an individual Commissioner of the SEC and do not necessarily reflect the views of the full Commission or my fellow Commissioners. (emphasis added)

The changed language likely results from discovery disputes in SEC vs. Ripple Labs.  Some news reports have covered the SEC being forced to turn over documents related to a 2018 Speech by William Hinman, then the SEC's Director for the Division of Corporation Finance.  

I poked around the docket in that case and found an order finding that internal discussions about the Hinman speech were discoverable and not protected by the Deliberative Process Privilege (DPP) because Hinman was communicating his own opinions and they did not "relate to some form of agency position, decision, or policy".  This is some relevant language from the opinion:

The DPP “is a form of executive privilege” that “shields from disclosure documents reflecting advisory opinions, recommendations and deliberations comprising part of a process by which governmental decisions and policies are formulated.” U.S. Fish & Wildlife Serv. v. Sierra Club, Inc., 141 S. Ct. 777, 785 (2021) (quotation marks and citation omitted).

The DPP applies to documents that are “predecisional” and “deliberative.” Id. at 785–86. Documents are “predecisional if they were generated before the agency’s final decision on the matter, and they are deliberative if they were prepared to help the agency formulate its position.” Id. at 786 (quotation marks omitted). Judge Netburn determined that the DPP does not apply to the Internal Speech Documents because those documents were intended to facilitate the communication of Hinman’s own opinions regarding the application of the securities laws to digital asset offerings and not the opinions of the SEC. Order I at 14; Order II at 5–7. The SEC argues that Judge Netburn’s conclusion constitutes an error of law because Second Circuit precedent states that “subjective documents which reflect the personal opinions of the writer rather than the policy of the agency” are protected by the DPP. See SEC Objs. at 13 (quoting Tigue v. U.S. Dep’t of Just., 312 F.3d 70, 80 (2d Cir. 2002)) (emphasis omitted). But this argument fails to recognize that documents reflecting such personal opinions are protected only when they relate to some form of agency position, decision, or policy. Cf. Sierra Club, Inc., 141 S. Ct. at 785. Because Judge Netburn determined that the Internal Speech Documents did not relate to an agency position, decision, or policy, Order I at 14; Order II at 5–6, her conclusion is not contrary to law.

To bring this full circle, this is probably the reason why the language in the disclaimer has changed to include some statement that the remarks are in their official capacity.  I don't know if other litigants will have the same success as Ripple did in getting access to internal documents, but I would expect defendants to try if they can find some hook to argue that the documents should be provided in discovery.

 

 

New Paper - Flight to Safety in the Regional Bank Crisis of 2023

Yesterday, a new paper by Cecilia Caglio, Jennifer Dlugosz, and Marcelo Rezende - all affiliated with the Board of Governors of the Federal Reserve System - posted on SSRN, Flight to Safety in the Regional Bank Crisis of 2023.  It's obviously an incredibly timely piece.  Here's the Abstract:

"Using weekly confidential data from U.S. banks, we document an unprecedented flight to safety of deposits from regional banks towards large banks in the early 2023. We show that large banks experienced large deposit inflows relative to small and regional banks and that these differences remain substantial if we account for bank characteristics associated with bank failures over this crisis, including liquidation values and shares of uninsured deposits. Large banks lowered deposit rates relative to other banks during the crisis, supporting the hypothesis that deposits flew to these banks because they are considered safer."   

C. Warren Neel - Celebrating Corporate Governance Research and an Accidental Mentor

Earlier today, I had the honor of making a brief presentation at a luncheon honoring both the 20th anniversary of the Corporate Governance Center at The University of Tennessee, Knoxville, and a dear colleague and mentor, C. Warren Neel, who passed away at the end of March.  Set forth below are the reflections I shared at the luncheon--in relevant part.   These are my prepared remarks, but I often comment extemporaneously, rather than read.  So, please understand that I did not exactly say what is set forth below, although it accurately captures the content I delivered.

+     +     +

Lawyers must be lawyers, and so I start with law.

On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002—the most broad-based federalization of corporate governance since the adoption of the federal securities law regime itself in the 1930s. It was in the shadow of that landmark legislation that The University of Tennessee’s Corporate Governance Center—now appropriately named the Neel Corporate Governance Center—was born. Like the legislation itself, the Corporate Governance Center cast a wide net. As an interdisciplinary research program that includes the College of Law and the College of Business Administration, the Corporate Governance Center brought to the campus (and I am using Warren Neel’s own words here, from an email message he wrote in support of my tenure) “an interdisciplinary approach to the critical issues of corporate governance.”

I remember the first all-hands meeting to solidify the structure and build-out of the Corporate Governance Center. We met next door (Stokely Management Center) in a classroom. After introductions, Warren kicked things off, as I recall, and then Joe Carcello led us by sharing the vision for the center and soliciting information about our research agendas that could be used to construct research collaborations and build out the center’s website and other promotional materials.

Back then, Warren and Joe envisioned categorizing the work of each of us into one of three substantive “buckets” mirroring the three key committees of a public company’s board of directors (other than the executive committee): audit, compensation, and nominating. I was the unpopular kid at the party when I noted that my work intersected all three buckets. That was the beginning of a recognition that working across departments might not be as simple as it initially seemed. We spent years together untangling that mess—a mess we still revisit with new Ph.D. students and (sometimes) faculty who join our merry band.

Little did I know then all that we would go through so much together.
Little did I know then that both Warren and Joe would become such dear friends and scholarly sparring partners.

Little did I know then that Warren, the accidental dean, would become my accidental mentor.

There is not enough time here today to unpack all of that. But suffice it to say that, after many Corporate Governance Center research forums and lectures and, more importantly, my periodic breakfasts with Warren and Tracie Woidtke (during which we entertained Corporate Governance Center distinguished speakers—maybe no one else was willing to get up that early?), Warren rubbed off on me more than a bit. I never could agree with him on a legal rule to separate the CEO and board chair functions or on mandatory term limits for corporate directors. But I deeply appreciated the analogies he could draw between and among political, academic, and corporate governance. And his insights on audit committee process and documentation from his many years as a board member were so well taken. He especially loved to talk about his board memberships at Saks, Inc. and Healthways, Inc. (now Tivity Health, Inc.) at our breakfasts.

Also, I admired the strong position he took on the need for more transparency in the disclosure of Public Company Accounting Oversight Board (PCAOB) inspection reports. In particular, Warren favored disclosure of the quality control criticisms included in Part II of those inspection reports. Some of you, like me and Tracie, may have heard him argue forcefully on that topic more than once.

Since Warren’s death, I have reflected often on these memories and Warren’s elemental place in my career here at UTK. As I earlier indicated, like Warren’s deanship at the College of Business, his role as my mentor was largely unplanned. But i had good fortune in a number of things that turned out to be the perfect storm that has created a satisfying academic career here at UTK over the past 23 years.   They included:

• leaving law practice to become an academic:
• settling here in Knoxville, at UTK, during the dot-com bust and just as fraud at many of our country’s largest public companies was becoming apparent;
• being contacted by Warren and Joe to join the Corporate Governance Center as a research fellow; and
• as a result, spending quality time with Warren.

“Those accidents would not have resulted in my career if, perhaps, I were at some university other than the University of Tennessee.” Those words are Warren’s—not mine—taken from the Epilogue of his 2010 book, The Accidental Dean.  I cannot think of a better way of capturing my own thoughts, honoring Warren, and celebrating the 20th anniversary of the Corporate Governance Center than by quoting Warren's own wise words.

I do appreciate the opportunity to be before you today to talk about the Neel Corporate Governance Center and my accidental mentor, Warren Neel.  Thank you.

Retail Corporate Governance

There’s been a lot of thinking recently about retail shareholder power.  The meme stock phenomenon, and the popularity of platforms like Robinhood, showed that retail shareholders can in sufficient numbers have a real influence over corporate behavior.   This had led authors like Sergio Alberto Gramitto Ricci and Christina Sautter to argue that we may be witnessing a revolution as retail shareholders assert themselves, bringing perhaps concerns about ESG and sustainability the fore.

A while back, Jill Fisch proposed that retail shareholders be given access to the type of electronic tools available to institutional shareholders so that they could create standing voting instructions, allowing them to cast ballots in corporate elections automatically according to predefined preferences.  That vision appears to close to realization; today, there are new programs that make it easier for retail shareholders to cast ballots, including in accordance with preset preferences.  As I understand the Iconik service, for a monthly fee, you can set your preferences and have the app automatically vote them – or you elect to follow the instructions provided by a third party provider like As You Sow or Third Act.  If you do that, it’s free.

And of course, we know that mutual fund companies are proposing to give more voice to retail shareholders through various kinds of pass-through voting experiments.  There are now voting platforms being developed that allow automatic voting in this context, as well.

Which is why it’s really interesting to watch what happening right now in In re AMC Entertainment Holdings Stockholder Litigation pending in Delaware.  As you probably know, AMC became a meme stock; AMC wanted to take advantage of the enthusiasm by selling more stock; its charter did not authorize any new stock issuances; retail shareholders either did not want to vote to amend the charter or simply did not pay attention to the vote; AMC found a workaround by using the blank check provision in its charter to issue new voting preferred stock; AMC held another shareholder vote, and – with the preferreds voting – the charter was amended to authorize the issuance of more common, which the preferred could then convert into.

A class of AMC common stockholders sued, arguing that this violated their rights, and now the parties have agreed to a settlement that VC Zurn will consider.

Now, because AMC stock is held by a particularly online set of investors, retail holders began writing to the court with their views of the settlement (usually negative).   (I also wonder whether Chancery’s moment in the spotlight during Twitter v. Musk contributed to retail shareholders’ participation.)  In response, VC Zurn formally set up a procedure for them to submit their comments, and boy, have they.  You can read the letters on the docket; some have taken further action, like moving to intervene, seeking access to discovery, and objecting to the special master.  Interestingly, last night the special master recommended that discovery access be granted, and there may be a telephonic hearing on any objections to be held later this morning.

But here’s the thing.  While some of the letters inspire a lot of sympathy – many investors appear to have endured significant losses – a lot of the comments are, well, uninformed, to put it mildly.  There are some fairly odd conspiracy theories floating around regarding AMC shares, and, in particular, something about an inflated share count and “synthetic” shares that are improperly voting.  Many of the objecting shareholders buy into those theories.  For example, in a report filed on May 17, the special master recommended against one shareholder’s attempt to intervene, which was predicated on the “synthetic share” theory.

So this is the elephant in the room:  What does this tell us about the wisdom of encouraging greater retail involvement in corporate governance?  While no doubt some retail shareholders are highly informed, many are not, and if AMC demonstrates anything, it’s that in some cases, the technological tools that enable retail shareholders to coordinate and share information may also cause the rapid spread of misinformation.

You can actually see that in the Netflix documentary Eat the Rich: The GameStop Saga.  The retail shareholders profiled had a sense of mission in attacking short sellers, but they also seemed to be very unclear as to what short sellers actually do. For example, they were under the misimpression that short sellers – rather than private equity firms – had bankrupted Toys R Us.

To be fair, Ricci and Sautter anticipate this, and in other work they propose various forms of investor education.  And Jill Fisch, in her paper on GameStop, argued that while misinformation was possible, in general, concerns might be exaggerated and investors generally tended to place greater weight on more reliable sources.

The investors who have filed letters in the AMC case may therefore be outliers; after all these are the ones who object to the settlement, and may not be representative of the ones who do not object.

Then again, Dhruv Aggarwal, Albert Choi, and Yoon-Ho Alex Lee have found that meme stock traders are, well, traders – not voters, which suggests their rise does not herald a corporate governance revolution.  Of course, these authors also recognize that meme stock traders may not be representative of retail investors generally, but if meme stock investors are not representative of retail investors as a whole, then the meme stock phenomenon itself may not tell us much about potential retail participation in corporate governance in the first place, and we’re back where we started.

University of Miami Law School Seeks Law & Technology Resident Fellow: Apply by July 1, 2023

I'm excited to announce this new position. It's particularly timely as just this morning, I had breakfast with venture capitalists, founders, and others in the tech ecosystem nurtured and propelled by the founders of Emerge Americas. This is a great time to be in Miami. Here are the details.

The University of Miami School of Law seeks to appoint an Inaugural Law & Technology Resident Fellow.  

This will be an exciting opportunity as the Fellow will join a vibrant community of scholars and practitioners working at the intersection of law and technology. Miami-Dade County and the surrounding Tech Hub is enjoying a dramatic expansion in technology-related startups and finance.  MiamiLaw has an established J.D. degree concentration in Business of Innovation, Law, and Technology (BILT). Faculty have set up numerous technology-related programs including Law Without Walls (LWOW) and the We Robot conference.

MiamiLaw currently offers courses in: AI and Robot Law; Blockchain Technology and Business Strategies; Digital Asset and Blockchain Regulation; Digital Transformation Services: Business & Legal Considerations; Dispute Resolution; Technology and The Digital Economy; E-Sports; Electronic Discovery; Genomic Medicine, Ethics and the Law; Intellectual Property in Digital Media; Introduction to Programming For Lawyers; NFTs: Legal and Business Considerations; Scientific Evidence; Tax Issues Relating to Movement of Foreign Tech Founders Into Miami in the 21St Century; Space Law: Regulating and Incentivizing Private Commercial Activities in Outer Space; a Startup Clinic and a class in Startup Law and Entrepreneurship; The Digital Economy and International Taxation--National and International Responses; Law, Technology, and Practice; Law, Policy & Technology; and Tiktok, Twitter and Youtube: The Legal Framework Governing Social Media.

We aim to enhance these substantial and growing technology-related activities by hiring a Law & Technology Resident Fellow. We seek a recent law graduate interested in studying and teaching about the impact artificial intelligence (AI) will have on the legal field, from the impact on legal education to the impact on legal practice and legislative reform.  We are specifically interested in candidates who would connect our students and our faculty both with new technologies and with tech startups in Miami.

In order to provide a space for training of and experimentation by the law school community, the initial Fellow also will be responsible for designing and then setting up an Artificial Intelligence Technology Lab—which could be real or virtual—that will, among other things, support faculty in their courses and research. The Fellow would be expected to teach one technology-related course, subject to approval by the Vice Dean and the law school’s Curriculum Committee, once the Lab is functional.

Applicants must have completed their J.D. degree prior to the beginning of the fellowship. Experience with Artificial Intelligence as it pertains to law and law practice, or optionally a degree in Computer Science or a related field, would also be helpful. The fellowship begins on August 1 and lasts for one year; a Fellow in residence may apply for a second year of support.

The University of Miami offers competitive salaries and a comprehensive benefits package including medical and dental benefits, vacation, paid holidays and much more.

Applications should include the following:

• A cover letter indicating your interest in the Resident Fellowship
• A resume or CV
• A law/graduate school transcript
• Two letters of recommendation

Applications for the Law & Tech Resident Fellowship must be received no later than July 1, 2023.

Please apply online and submit an application in electronic form to Carolina Morris ([email protected]).

The University of Miami is an Equal Opportunity Employer - Females/Minorities/Protected Veterans/Individuals with Disabilities are encouraged to apply. Applicants and employees are protected from discrimination based on certain categories protected by Federal law. Click here for additional information.

If you have any questions about what it's like to work at UM or live in Miami, please reach out at [email protected]

American Business Law Journal Accepting Editorial Board Applications

Dear BLPB Readers:

"The American Business Law Journal invites ALSB members who are interested in serving on the Editorial Board of the ABLJ to apply for the position of Articles Editor. The ABLJ is widely regarded, nationally and internationally, as a premier peer-reviewed journal. Serving as an Articles Editor provides an opportunity to serve the Academy of Legal Studies in Business and broader academic discipline at the highest levels of service. 

The incoming Articles Editor will begin to serve on the Board in August 2023. Board members commit to serve for three years: two years as Articles Editor and one year as Senior Articles Editor. After that, Articles Editors have the option of continuing to serve two more years—one as Managing Editor and another as Editor-in-Chief. Articles Editors supervise the review of articles that have been submitted to the ABLJ to determine which manuscripts to recommend for publication. If a manuscript is accepted, the Articles Editor is responsible for working with the author to oversee changes in both style and substance. If a manuscript is believed to be publishable but in need of further work, the Articles Editor outlines specific revisions and further lines of research that the author should pursue. The Articles Editor’s recommendations for works-in-progress are perhaps the most important and creative aspect of the job because they provide the guidance necessary for works to blossom into publishable manuscripts. 

An applicant for the position of Articles Editor should have an established track record of publications. We prefer applicants who have previously published with the ABLJ and have familiarity with our peer review process. However, we also welcome applicants, including international applicants, who have published in high quality law journals and/or peer reviewed law journals that adhere to the Harvard Bluebook style. Experience serving as a Reviewer for the ABLJ or as a Staff Editor is helpful. The ABLJ is committed to ensuring that financial resources, including the support of a research assistant, are not an obstacle to service on the Board.

Before applying, please contact us to learn more about the position and financial assistance that may be available, either through your institution or from the ALSB.

Please send a resume and letter of interest to Susan Park, ABLJ Editor-in-Chief, at [email protected] by May 31, 2023, for full consideration."

Leadership Opportunity - The University of Tennessee College of Law

As many of you know, I have had the honor and privilege of being the Interim Director of the Institute for Professional Leadership (IPL) at The University of Tennessee College of Law for the past three academic years.  The IPL is a special part of UT Law.  As the home of an academic program that ties various parts of the traditional law curriculum together, the IPL benefits students with a wide variety of post-graduation goals--helping them to prepare themselves for the inevitable leadership spaces they will occupy in their professional and personal lives.

I have served as Interim Director at the IPL while continuing with a full teaching schedule, scholarship agenda, and service load.  It now is time for me to step back and allow someone else to lead the IPL--someone who will devote full time to carrying out its mission.  Accordingly, we are looking for a permanent Director for the IPL.  The position announcement can be found here.  

As you can see from the position announcement, the permanent Director will be a member of the law faculty, either tenure-track or non-tenure-track.  The qualifications section of the announcement is copied in below, for your ease of reference.

Qualifications

Required Experience and Abilities

• Law degree from an ABA-accredited law school.
• Minimum of five years in law practice and/or substantial comparable experience in a law-related professional or educational setting.
• Tenure-track candidates should have a record of scholarship, teaching, and service at an ABA-accredited law school or a record that suggests the ability to achieve tenure at the University of Tennessee.
• Experience in significant leadership roles, particularly related to the legal profession.
• Prior teaching experience in a law school or other higher education setting.

Preferred Abilities and Experience

• Experience with strategic planning and execution.
• Experience assessing programmatic needs and successfully implementing new initiatives.
• Supervisory experience or demonstration of skills that exhibit the ability to carry out supervisory responsibilities with regard to staff and students.
• Proven ability to prioritize multiple projects and work well with diverse constituents, including faculty, staff, students, alumni, and practicing lawyers.
• Experience with online learning pedagogy and course development.
• Strong communication and interpersonal skills.Reputation for professionalism, integrity, and honesty.

The position announcement also includes valuable information about the IPL and the responsibilities of its Director.  I am happy to answer questions, as is my colleague, Brad Morgan ([email protected]), who is chairing the search committee.  Please pass along word of this opening to anyone you know who may be interested in this position.

Possibly the easiest theory in corporation law

This week, VC Laster upheld Caremark claims against Facebook’s board in a telephonic ruling.  The nub of the allegations was that the board allowed Facebook to violate an FTC consent decree, resulting in a massive $5 billion fine.

The transcript is not yet available so I don’t have the details, but I believe this is the legal theory I blogged about long ago here and here.  Namely, in addition to traditional oversight claims, the plaintiffs alleged that this was actually a conflicted controller transaction, in that the company agreed to accept a larger penalty in order to spare Zuckerberg personally.  Because the company did not use MFW procedures to cleanse that arrangement, the argument goes, the settlement is subject to entire fairness review.  And VC Laster upheld those claims, as well as the more traditional oversight claims.

Edit: I've now seen the transcript, and VC Laster does treat the settlement as an uncleansed-conflict transaction, but he does not invoke Zuckerberg's controlling shareholder status; he just says the approving directors were not disinterested/independent.

So, this is obviously a fascinating new extension of the definition of a conflict transaction – and, to be clear, I don’t think anyone is saying that it’s unreasonable for a company to protect its officers this way; it’s simply that, you know, when the officer is also the controlling shareholder, there’s the possibility the settlement did not have a legitimate business rationale.

But let’s get back to the Caremark thing.  We’ve seen a lot of these cases recently, and though many have been dismissed on the pleadings, I think it’s safe to say that ever since Marchand v. Barnhill, more have survived motions to dismiss.  My understanding is that Marchand also encouraged so many new Section 220 requests that Chancery is now delegating them to the Masters, because the Chancellor/Vice Chancellors can’t handle the workload.

I am not among those who object to the concept of Caremark on a theoretical basis, so my next comments are intended as descriptive rather than normative, but – I don’t think this situation is sustainable.  Not in terms of the administrative burden on Delaware courts, but because Delaware really can’t be in the business of functioning as a backup regulator for the entire United States. 

This is something I touch on in my new paper, Every Billionaire is a Policy Failure, which I posted about earlier this week (yes this is me plugging my paper. I’m plugging).  Delaware is going to have a legitimacy problem the more it departs from traditional shareholder wealth maximization concerns, and Caremark is not, or at least not entirely, about wealth maximization. 

So I rather suspect that the Delaware Supreme Court will be tempted to find a way to cabin it.

Now, it would be difficult for Delaware to suddenly do a volte-face and declare that it does, in fact, charter law breakers after all – Caremark itself is intended to confer legitimacy on the corporate form – but what the courts can do is crack down on these cases procedurally, and one easy way to do that might be to dial back 220 access (even though the Delaware Supreme Court recently liberalized the law here in AmerisourceBergen v. Lebanon County Employees’ Retirement Fund).  So I kind of expect to see something along those lines eventually.

Or, you know.  Corporations could stop openly breaking the law.  That works too.

I did the thing

Regular readers may have noticed that I was, perhaps, intrigued by the Twitter v. Musk dispute.  Obviously, I could not allow all that time spent studying a single case to go to waste, so I finally managed to get a paper out of it (which, I will confess, borrows in major parts from earlier blog posts on the subject, so some of you will find it old hat).

The paper, Every Billionaire is a Policy Failure, is now available on SSRN.  Here is the abstract:

(No, for real, that's the abstract; SSRN doesn't currently allow me to insert images in the abstract field, but I'm committed to the bit.)

So. For anyone who's not Twitter v. Musk'ed out, here's more.

 

Well-Being in Law Week: A Good Thing, Except Maybe for the Timing . . . .

In 2021 and again in 2022, I blogged about Well-Being Week in Law.  The first week in May bears this title, offering a chance for all of us to focus on how to best ensure that those involved in legal service work can flourish in our work and in the rest of our lives.  As the website notes:

When our professional and organizational cultures support our well-being, we are better able to make good choices that allow us to thrive and be our best for our clients, colleagues, organizations, families, and communities. It is up to all of us to cultivate new professional norms and cultures that enable and encourage well-being.

I agree with all of that.  And as an instructor and researcher and public servant who dedicates significant time to lawyer leadership, I focus a lot of attention on the legal profession and developing the whole lawyer.  So, count me in as a fan.

But this year, I did not post on Well-Being Week in Law, which was last week.  I carry a small amount of guilt for that (and for not getting this post up yesterday, too, when I had originally planned to publish it), since I did want to post last week to promote the mission.  But this week is just as good!

The Well-Being Week in Law initiative focuses us on five components of our well-being over five days.  They are: staying strong, aligning, engaging and growing, connecting, and feeling well.  As you may recognize, these five components line up with physical, spiritual, occupational and intellectual, social, and emotional well-being.  Of course, while one can highlight each in a specific weekday, we should ideally practice all five on all days!  But we all know how that goes . . . .  The important thing is the repetition of the themes and the sharing of practices and guidance on how to keep these realms of wellness in a positive range as we move forward in our professional and personal lives.  I hope that all of us can focus efforts on teaching and researching and serving with all five areas of well-being in mind all 52 weeks in the year.

Having said that, in reflection on my own circumstances, it does not seem very healthy to schedule the annual focus week on well-being in law during law school exams.  That is where most of us and our students are during the first week in May.  Although the well-being in law world should not revolve around law schools, they are the places in which the future of the profession is developed.  It sends a funky message, in my view, to ask students (and professors) to focus on holistic well-being at a time when we all understand that is not possible. 

Still, in addressing the concerns of appropriately needy students last week as they prepared to take my exam in Securities Regulation--a task that we all know both offers us a window on student well-being and impacts law professor well-being--I tried to mindfully focus attention on what I could control about the process of competitive assessment that law school entails.  I advised my students to exercise, eat, hydrate, and try to get some real sleep.  We talked about the purpose of the course (and their other academic work) in their career plans.  We engaged in ongoing, progressive teaching and learning--processing and synthesizing.  We talked about summer plans (including bar preparation, for some) and getting together for coffee or lunch or the like after exams conclude.  I encouraged them to engage in the personal practices that contribute to their mental health.  In other words, we worked through it together, and in the process, we naturally emphasized target areas of our well-being.

Law schools are where we build thriving lawyers.  If, as instructors in that setting, we do not start the process where we are, it is much harder for lawyers to develop the practices they will need to be productive and healthy professionals over the long haul.  Well-being is not a froofy add-on to the law curriculum.  Rather, it is an essential component to professionally responsible legal education and the practice of law.

Ten Questions Lawyers Should Ask Themselves about AI

A few months ago, I asked whether people in the tech industry were the most powerful people in the world. This is part II of that post.

I posed that question after speaking at a tech conference in Lisbon sponsored by Microsoft. They asked me to touch on business and human rights and I presented the day after the company announced a ten billion dollar investment in OpenAI, the creator of ChatGPT. Back then, we were amazed at what ChatGPT 3.5 could do. Members of the audience were excited and terrified- and these were tech people. 

And that was before the explosion of ChatGPT4. 

I've since made a similar presentation about AI, surveillance, social media companies to law students, engineering students, and business people. In the last few weeks, over 10,000 people including Elon Musk, have called for a 6-month pause in AI training systems. If you don't trust Musk's judgment (and the other scientists and futurists), trust the "Godfather of AI," who recently quit Google so he could speak out on the dangers, even though Google has put out its own whitepaper on AI development. Watch the 60 Minutes interview with the CEO of Google.

Just yesterday, the White House held a summit with key AI stakeholders to talk about AI governance. 

Between AI-generated photos winning competitions, musicians creating songs simulating real artists' voices, students using generative AI to turn in essays that fool professors, and generative AI's ability to hallucinate (come up with completely wrong answers that look correct), what can we as lawyers do? Are our jobs at risk? Barrons has put out a list.  IBM has paused hiring because it believes it can gain efficiencies though AI.  Goldman Sachs has said that 300 million jobs might be affected by this technology. I'm at a conference for entrepreneurs and the CEO of a 100-million dollar company said that he has reassigned and is re-skilling 90% of his marketing team because he can use AI for most of what they do. 

Should we be excited or terrified? I've been stressing to lawyers and my students that we need to understand this technology to help develop the regulations around it as well to wrestle with the thorny legal and ethical issues that arise. Here are ten questions, courtesy of ChatGPT4, that lawyers should ask themselves:

1. Do I understand the basic principles and mechanics of AI, including machine learning, deep learning, and natural language processing, to make informed decisions about its use in my legal practice?
2. How can AI tools be used effectively and ethically to enhance my practice, whether in legal research, document review, contract drafting, or litigation support, while maintaining high professional standards?
3. Are the AI tools and technologies I use compliant with relevant data protection and privacy regulations, such as GDPR and CCPA, and do they adequately protect client confidentiality and sensitive information?
4. How can I ensure that the AI-driven tools I utilize are unbiased, transparent, and fair, and what steps can I take to mitigate potential algorithmic biases that may compromise the objectivity and fairness of my legal work?
5. How can I obtain and document informed consent from clients when using AI tools in my practice, ensuring that they understand the risks, benefits, and alternatives associated with these technologies?
6. What are the intellectual property implications of using AI, particularly concerning AI-generated content, inventions, and potential copyright or trademark issues that may arise?
7. How can I assess and manage potential liability and accountability issues stemming from the use of AI tools, including understanding the legal and ethical ramifications of AI-generated outputs in my practice?
8. How can I effectively explain and defend the use of AI-generated evidence, analysis, or insights in court, demonstrating the validity and reliability of the methods and results to judges and opposing counsel?
9. What measures should I implement to supervise and train my staff, including paralegals and support personnel, in the responsible use of AI tools, ensuring that ethical and professional standards are maintained throughout the practice?
10. How can I stay up-to-date with the latest advancements in AI technology and best practices, ensuring that I continue to adapt and evolve as a legal professional in an increasingly technology-driven world?

Do you use ChatGPT or any other other generative AI in your work? Can you answer these questions? I'll be talking about many of these issues at the Connecting the Threads symposium and would love to get your insights as I develop my paper. 

Corwin Cleansing, Continued

In re Edgio, Inc. Stockholders Litigation, decided by VC Zurn this week, presented the unsettled question whether Corwin cleansing would apply to post-closing shareholder actions seeking injunctive relief for defensive/entrenchment measures.  Interestingly, she held it would not.

The set up: A company was in distress and its stock price was tumbling.  It became afraid that it might be targeted by activist investors.  It also had the opportunity for a very favorable deal: It could buy a business unit owned by Apollo for a large number of newly-issued shares.  The contract specified that Apollo would get one-third of the board seats, but would be required to vote its shares in favor of existing board members.  It would also be prohibited from selling for two years, and after that, it would not be able to sell to “any investor on the most recently published ‘SharkWatch 50’ list for twelve months.”

This was not a transaction that required shareholder approval under Delaware law, but the share issuance did require shareholder approval under NASDAQ rules, and the shareholders voted overwhelmingly in favor.

Post-closing, shareholders brought an action seeking to enjoin the entrenchment measures – not the deal itself – arguing that they violated Unocal.  Defendants, naturally, argued that the whole thing had been cleansed under Corwin by means of the shareholder vote.

VC Zurn began by noting that Corwin itself distinguished between injunctive relief and damages relief; in that case, the Delaware Supreme Court held that “Unocal and Revlon are primarily designed to give stockholders and the Court of Chancery the tool of injunctive relief to address important M & A decisions in real time, before closing. They were not tools designed with post-closing money damages claims in mind.”

In light of that language, VC Zurn held:

Corwin explains that conduct supporting a post-closing claim for damages can be cleansed by stockholders who were satisfied with the economic value they received in a transaction. Inequities in a transaction’s price or process are compensable by monetary damages, and therefore able to be cleansed by stockholders satisfied with the consideration they already received.  But Unocal scrutiny is inspired by concerns that directors may act to “thwart the essence of corporate democracy by disenfranchising shareholders,” which prototypically causes irreparable injury.  Because a dollar value cannot be affixed to the harm caused by unjustifiably entrenching actions, it cannot be said that a stockholder can consider wrongfully entrenching actions as part of the “economic merits” of a transaction.

Similar language about Corwin’s scope, she noted, was used in Morrison v. Berry, 191 A.3d 268 (Del. 2018).

But then she had to reconcile three different pre-Corwin Delaware precedents.

The first, In re Santa Fe Pacific Corporation Shareholder Litigation, 669 A.2d 59 (Del. 1995), involved a pre-closing, post-vote challenge to a merger agreement that contained various lockups that had prevented the company from striking a deal with a competing bidder.  In that context, the court held that the shareholder vote had not restored business judgment review, reasoning:

Permitting the vote of a majority of stockholders on a merger to remove from judicial scrutiny unilateral Board action in a contest for corporate control would frustrate the purposes underlying Revlon and Unocal. Board action which coerces stockholders to accede to a transaction to which they otherwise would not agree is problematic. ...Thus, enhanced judicial scrutiny of Board action is designed to assure that stockholders vote or decide to tender in an atmosphere free from undue coercion...

In voting to approve the Santa Fe–Burlington merger, the Santa Fe stockholders were not asked to ratify the Board's unilateral decision to erect defensive measures against the Union Pacific offer. The stockholders were merely offered a choice between the Burlington Merger and doing nothing. The Santa Fe stockholders did not vote in favor of the precise measures under challenge in the complaint. Here, the defensive measures had allegedly already worked their effect before the stockholders had a chance to vote.  In voting on the merger, the Santa Fe stockholders did not specifically vote in favor of the Rights Plan, the Joint Tender or the Termination Fee.

Since the stockholders of Santa Fe merely voted in favor of the merger and not the defensive measures, we decline to find ratification in this instance.

But, in two other decisions, Stroud v. Grace, 606 A.2d 75 (Del. 1992) and Williams v. Geier, 671 A.2d 1368 (Del. 1996), corporations had adopted various changes to their articles of incorporation that had the effect of entrenching existing management.  When these changes were subsequently challenged by dissenting minority shareholders, the Delaware Supreme Court held that the shareholder votes in favor ratified the amendments.

Faced with this somewhat conflicting set of cases, VC Zurn held:

Stroud and Williams are inconsistent with my reading of Corwin, and, unlike Santa Fe, neither was acknowledged in relevant part by the Corwin Court. Corwin cites Stroud as an example of a vote required by statute or charter that affected the standard of review, indicating the Supreme Court thought the Stroud vote properly had that effect.  Corwin also cites Williams, albeit for the pedestrian principle that a vote will not have a cleansing effect if it is coerced and for the general principle that an informed statutory vote is “the highest and best form of corporate democracy.” Corwin did not explicitly resolve the apparent tension between Santa Fe on one hand, and Stroud and Williams on the other.

I believe I am duty-bound to follow the most recent and specific Delaware Supreme Court authority. Notwithstanding Stroud and Williams, I read Corwin’s plain text as reiterated in Morrison v. Berry, together with Santa Fe’s instructions that Corwin implicitly preserved, to take a claim to enjoin defensive measures under Unocal enhanced scrutiny out of Corwin’s reach. I read that to compel the conclusion that a claim for injunctive relief under Unocal enhanced scrutiny is not susceptible to restoration of the business judgment rule under Corwin.

After that, it was just a question of actually applying Unocal to this particular deal.  And since there was evidence that these moves were intended as a takeover defense – and since the defendants did not even argue that they would pass the Unocal test (only that Unocal did not apply) – she sustained the complaint and ordered the parties to confer further.

So.

It’s actually fairly difficult to imagine that shareholder votes can’t cleanse entrenchment measures.  For example, proxy advisors like ISS generally oppose poison pills that last for over a year unless they are put to a shareholder vote; see also The Williams Cos. Stockholder Litigation, 2021 WL 754593 (Del. Ch. Feb. 26, 2021) (explaining that both ISS and Fidelity had recommended the board put a pill up for a shareholder vote).  Which makes perfect sense: Poison pills, as originally conceived, operated to solve a shareholder collective action problem – two-tier tender offers, for example, put shareholders in a prisoners’ dilemma that requires a cooperative response. 

Further, Corwin did distinguish between injunctive and damages relief in the Unocal context, ‘tis true, but it also distinguished between pre-closing and post-closing.

Moreover, VC Zurn’s pronouncement that “a dollar value cannot be affixed to the harm caused by unjustifiably entrenching actions” is curious; I mean, leave out the “unjustifiably” piece and it seems clear that control rights can be priced.  After all, in Brookfield Asset Mgmt., Inc. v. Rosson, 261 A.3d 1251 (Del. 2021), the Delaware Supreme Court, quoting Paramount Communications, Inc. v. QVC Network, Inc., 637 A.2d 34 (Del. 1994), held:

“the acquisition of majority status and the consequent privilege of exerting the powers of majority ownership come at a price,” and that price “is usually a control premium which recognizes not only the value of a control block of shares, but also compensates the minority stockholders for their resulting loss of voting power.”

That said, there is a very real distinction between Stroud and Geier on the one hand, and Santa Fe on the other, and it comes from the language of Santa Fe itself.  In that case, shareholders were presented with a deal – a full package of items, including a buyout at a premium; there was no opportunity to vote separately on the deal protections.  By contrast, in Stroud and Geier, shareholders were presented with an opportunity for a clean up-or-down vote on the entrenchment measures alone.

What immediately springs to mind, then, is the possibility – again, suggested in Santa Fe – that the shareholder vote in that case was not in fact free and fair, but was coerced.  Shareholders had to accept the deal protections if they wanted the premium, and there was certainly no way to know whether another deal would come through if they rejected the package outright.

That is what’s known as a “bundling” problem, i.e., when shareholders are not permitted to vote separately on particular items, and it’s actually something the SEC (theoretically) regulates, although of course the SEC hasn’t changed the requirements of Delaware law.

Not long ago, in Sciabacucchi v. Liberty Broadband Corp., 2017 WL 2352152 (Del. Ch. May 31, 2017), VC Glasscock held that a shareholder vote in favor of a share issuance to an existing blockholder was coerced – and thus not subject to Corwin – because it was “bundled” with certain transactions that would be beneficial to shareholders.  As VC Glasscock put it, the issuance was plausibly “extrinsic, and tacked to the Acquisitions to strong-arm a favorable vote.”

One could say something similar about the facts of Edgio: a favorable transaction was conditioned on acceptance of the entrenching measures, and therefore the shareholder vote was not free and fair, as Corwin requires.

But that argument perhaps proves too much.  Is it “bundling” if there is a premium-generating deal that comes with the loss of control rights, or is that merely a bargained-for exchange?  Commenters have repeatedly attacked Corwin itself for creating a “bundling” problem, in that shareholders voting on a deal are deemed to also be voting to absolve fiduciaries of any liability, but the Delaware Supreme Court obviously didn’t have a problem with that.

In other words, what is needed is some kind of theory as to what counts as an “extrinsic” condition versus what counts as intrinsic to the deal.  (Obligatory plug: I previously likened this issue to the unconstitutional conditions doctrine in my essay, The Three Faces of Control.)

One other point I’ll make on this, though.  Corwin itself, as well as Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014), are implicitly predicated on the recognition that today’s shareholder base is concentrated and institutionalized, and therefore presumably capable of protecting its own interests; indeed, many of the Chancery court decisions that paved the way said so explicitly.  See, e.g., In re MFW S’holders Litig., 67 A.3d 496 (Del. Ch. 2013); In re Cox Commc’ns, Inc. S’holders Litig., 879 A.2d 604 (Del. Ch. 2005); In re Netsmart Techs. S’holder Litig., 924 A.2d 171 (Del. Ch. 2007).  Which is why it is striking that Delaware is proposing to amend its law to make it easier to pass certain charter amendments (pertaining to increasing or decreasing shares outstanding), in recognition of the meme stock era and the re-retailization of the shareholder base.   It remains to be seen whether Delaware takes any steps to soften its standards of review as well.

The Fiscal Sponsorship Alternative

A great joy in my law practice over the years has been to work on a pro bono basis with creative and social enterprises.  For the 2021 Business Law Prof Blog symposium, Connecting the Threads, I offered some wisdom from my work with creatives in legally organizing and funding their projects.  I wrote briefly about that presentation here.

I recently posted the article that I presented back then, Choice of Entity: The Fiscal Sponsorship Alternative to Nonprofit Incorporation, 23 Transactions: Tenn. J. Bus. L. 526 (2022), on SSRN.  The associated abstract follows.

For many small business ventures that qualify for federal income tax treatment under Section 501(a) of the U.S. Internal Revenue Code of 1986, as amended, the time and expense of organizing, qualifying, managing, and maintaining a tax-exempt nonprofit corporation under state law may be daunting (or even prohibitive). Moreover, the formal legal structures imposed by business entity law may not be needed or wanted by the founders or promoters of the venture. Yet, there may be distinct advantages to entity formation and federal tax qualification that are not available (or not as easily available) to unincorporated not-for-profit business projects. These advantages may include, for example, exculpation for breaches of performative fiduciary duties by nonprofit corporate directors and other personal liability limitations applicable to various participants in nonprofit corporations under state statutory law.

The described conundrum—the prospect that founders or promoters of a charitable or other federal income tax-exempt nonprofit business or undertaking (often simply denominated as a “nonprofit project”) may not have the time or financial capital to fully form and maintain a business entity that may offer substantial identifiable advantages—is real. Awareness of this challenge can be disheartening to lawyer and client alike. Fortunately, at least for some of these nonprofit projects, there is a third option—fiscal sponsorship—that may have contextual benefits. Fiscal sponsorships allow for projects to receive tax advantaged funding and operating support without the need for time-consuming, costly legal entity formation.

This brief article offers food for thought on the uses for and benefits of fiscal sponsorship, especially (but not exclusively) for creative endeavors. First, fiscal sponsorships are defined and described in more detail. Then, the attributes of fiscal sponsorships are compared with the attributes of nonprofit § 501(c)(3) corporations to identify important bases for advice and decision making. Finally, before briefly concluding, the article synthesizes this information for use in applied legal advising and offers an example of a nonprofit project that found fiscal sponsorship both desirable and efficacious.

The article is available here.  Even though I do not teach a course on nonprofit organization, governance, or finance, I do occasionally raise the idea of fiscal sponsorship and other nontraditional organizational possibilities with students outside the classroom.  Had it not been for my pro bono work at Skadden, Arps, Slate, Meagher & Flom LLP in Boston in the 1980s and 1990s, I would not have known about fiscal sponsorships and could not have had those teaching moments with my students.  By publishing this piece, I hope to offer that same "aha moment" to others who may find themselves working with artists or musicians or others in the nonprofit space. 

#payitforward

VC Laster Goes to War

In Amalgamated Bank v. Yahoo!, 132 A.3d 752 (Del. Ch. 2016), VC Laster allowed a corporation to condition production of documents sought under Section 220 on the stipulation that if the plaintiff filed a lawsuit that relied on any of the documents, the entire production set would be deemed incorporated by reference into the complaint.  VC Laster considered this to be a reasonable stipulation to protect the defendant against the plaintiffs’ strategic cherry picking of documents in order to create a misleading impression of the facts.

Since then, such stipulations have become common, and the practice has evolved for defendants to certify that they have produced all responsive documents to the plaintiffs in order to get the benefit of incorporation-by-reference.  See, e.g., In re Vaxart S’holder Litig., 2022 WL 1837452 (Del. Ch. June 3, 2022).  The predictable result is that motions to dismiss are accompanied by ever-more-lengthy lists of exhibits.  Delaware Chancery has repeatedly warned that these “incorporation by reference” stipulations do not change the standard of review, and that it has the option either to disregard excess submissions or use them as a basis for transforming the dismissal motion into a motion for summary judgment.  See, e.g., In re Match Group Deriv. Litig., 2022 WL 3970159 (Del. Ch. Sept. 1, 2022).

In Oklahoma Firefighters Pension & Ret. Sys. v. Amazon.com, Inc., 2022 WL 1760618 (Del. Ch. June 1, 2022), VC Will permitted a defendant to redact documents produced in response to Section 220 demands to remove material that was nonresponsive to the plaintiffs’ request.  As VC Will put it, “In my view, redactions to material unrelated to the subject matter of a demand are proper because Section 220 only entitles a stockholder to information essential to accomplishing its stated purposes for inspection. The redactions appropriately cabin Section 220 inspections to their intended scope.”

From VC Laster’s opinion this week in Ontario Provincial Council of Carpenters’ Pension Trust Fund et al. v. Walton, 2023 WL 3093500 (Del. Ch. Apr. 26, 2023), one gets the distinct impression that he believes these two developments – singly and in combination – have been abused by defendants, and he’s fighting back. 

In Walton, the plaintiffs sued the Walmart board for violations of its Caremark duties with respect to opioid prescriptions, and relied on the heavily-redacted documents that Walmart produced in a prior 220 action.  Walmart, of course, submitted its own documents in support of its motion to dismiss.  Given the procedural posture (reasonable inferences drawn in the plaintiffs’ favor), VC Laster held that the certification of completeness, coupled with an incorporation-by-reference provision, allowed for the inference that “if the record lacks documentation relating to a particular event, and if it is reasonable to expect that documentation would exist if the event took place, … [then] the event did not occur.” Id. at *2.  With respect to redactions, which he often found “dubious” because “a partial-sentence redaction … depends on the premise that the author incoherently injected an unrelated topic into an otherwise responsive sentence,” id. at 3 – he either gave them a plaintiff-friendly inference or also treated them as evidence of the absence of discussion.  The net effect was a near weaponization of the lack of record evidence on various topics in order to conclude that the Walmart board failed to conduct proper oversight of the company. 

Prior cases have drawn inferences from the lack of 220 documents on a subject, e.g., In re Boeing Co. Deriv. Litig., 2021 WL 4059934 (Del. Ch. Sept. 7, 2021); Teamsters Local 443 Health Servs. & Ins. Plan v. Chou, 2020 WL 5028065 (Del. Ch. Aug. 24, 2020), but I’ve never seen anything quite like this.  To wit:

Walmart did not produce a final budget for the Health and Wellness Division as part of its Section 220 document production, entitling the plaintiffs to an inference that a budget sufficient to fund the projects necessary to comply with the DEA Settlement did not exist.

 ....

The memo identified two significant challenges. The first challenge, identified in a single sentence, was redacted. The redaction was marked “NR/ACP/AWP,” for non-responsive, attorney-client privilege, attorney work product. Because the single sentence redaction appears in an otherwise responsive paragraph, the redaction is dubious, and with three possibilities provided, the basis for it is unclear. At the pleading stage, the plaintiffs are entitled to an inference that the redacted text referenced a compliance failure that Walmart was not addressing.

....

An appendix to the slide deck identified a list of items that Walmart had completed during fiscal years 2011 and 2012. …Significant portions of the appendix are redacted. … The list of completed activities conspicuously omits significant items identified in the DEA Settlement, such as testing for doctor shopping, flagging requests for early refills, or checking for altered or forged prescriptions.

Read together, the 2012 Memo and accompanying materials support a pleading-stage inference that the Health and Wellness Division had created a summary of what a nice compliance program would look like, then never did the work to implement one.

He goes further.  He recognizes that he cannot draw negative inferences from redactions specifically for attorney-client privilege, but he also holds that a conscientious board, appropriately overseeing the company, would be expected to have at least some discussions of legal compliance that did not involve privileged conversations, and thus the absence of evidence of nonprivileged discussions would also be treated as evidence of absence.  As he put it:

Although this decision does not draw inferences from any of the passages or documents for which Walmart has asserted privilege, it does draw inferences from an absence of non-privileged documents containing discussions or decisions about the business issues necessarily involved in (i) taking the steps necessary to comply with the DEA Settlement and the Controlled Substances Act, (ii) responding to red flags of noncompliance, and (iii) assessing the effectiveness of the compliance efforts. Legal advice undoubtedly is an input into those discussions and decisions, but if directors and officers are doing their jobs, then there will be non-privileged discussions and decisions about what are inherently and ultimately business decisions (which the business judgment rule generally will protect). Walmart represented that its Section 220 production was complete, so when there are no indications of non-privileged discussions, the plaintiffs are entitled to an inference that the discussions and decisions did not occur.

The result was:

Walmart produced a copy of the meeting minutes, which comprise seven pages. All of the substantive portions of the minutes were redacted for non-responsiveness and attorney-client privilege with the exception of the following sentence: “Ms. Harris then provided an update to the Committee on the overall status of Health and Wellness Compliance projects.” … There are no non-privileged documents reflecting the Employee Compliance Committee making any business decisions or taking any action. At the pleading stage, the absence of evidence about action by the Employee Compliance Committee supports a plaintiff-friendly inference that the Employee Compliance Committee failed to take action to promote compliance with the DEA Settlement.

 ....

Walmart's privilege log contains entries suggesting that the Employee Compliance Committee met on twenty other occasions from 2016 through 2020. Walmart withheld all of the relevant meeting minutes, noting on its privilege log only that the discussions involved “controlled substances,” “opioids,” or Walmart's “Health & Wellness compliance program.” There are no indications that the committee had any business discussions, made any business decisions, or took any type of action. If Walmart's assertions of privilege are to be believed, then as the opioid epidemic raged, Walmart's senior compliance employees did nothing except receive and consider legal advice. They knew about the problem and took no action whatsoever. Although that seems highly unlikely, that is the record that Walmart created through its highly redacted Section 220 production.

The fact that so many meetings took place supports an inference that the officers and employees on the Employee Compliance Committee closely monitored Walmart's compliance with its obligations under the Controlled Substances Act. At the same time, the allegations in the complaint, together with other documents in the record, support an inference that Walmart was failing to comply with its obligations as a dispenser of prescription opioids and, in particular, was undermining its pharmacists’ ability to fulfill the Refusal-To-Fill Obligation. The court therefore must infer that the Employee Compliance Committee knew about Walmart's failure to fulfill its obligations as a dispenser of prescription opioids. The absence of any indication that the Employee Compliance Committee did anything except gather to receive and discuss legal advice, supports a pleading-stage inference that the members of the committee consciously ignored Walmart's compliance failures.

....

The Board also met in November 2017, and the minutes of that meeting span sixty-eight pages. Ex. 61. Only three sentences of substantive text survived the redaction tool. The first reads: “Timothy P. Flynn, Chair of the Audit Committee, then provided the Audit Committee report.” The following partially redacted text appears on the next page: “He concluded his report by stating that the Audit Committee had received updates from management regarding various other matters including ... [REDACTED] ... enhanced processes and training for pharmacists regarding filling prescriptions of controlled substances.” The redactions were marked for non-responsiveness, attorney-client privilege, and attorney work product. The unredacted text provides no basis to infer that the Board or Audit Committee had any business-oriented discussion about compliance issues or made any business decisions about compliance issues.

And my personal favorite:

Walmart redacted the entire director education presentation on the basis of the attorney-client privilege and work product doctrine. Because of those redactions, the only possible inference is that during a meeting specifically called to address the opioid crisis, Walmart's directors and senior executives and unidentified members of the Walton family did not discuss any business issues, consider any business initiatives, or make any business decisions. All they did was receive and consider legal advice. Although that is hard to believe, Walmart's redactions necessarily lead to that inference.

In more sorrow than anger, he writes:

Reinemund served on the Board during the full term of the DEA Settlement. …He therefore also faces a substantial risk of liability, and there is reason to doubt whether Reinemund could consider a demand.

The court reaches this conclusion reluctantly, because Reinemund is a person of stature who has had an impressive career. He graduated from the United States Naval Academy and served in the Marine Corps, rising to the rank of Captain. After leaving the military, Reinemund enjoyed success in the business world, culminating in the position of Chairman and CEO of PepsiCo from 2001 to 2003. From 2008 to 2014, he served as Dean of the Wake Forest University Business School. In addition to serving as a director at Walmart, he has served on the boards of other major public companies.

Why would an outside director like Reinemund ignore red flags about noncompliance with the DEA Settlement, much less make a conscious decision not to achieve compliance with the DEA Settlement? The answers likely lie in the redacted portions of the documents in Walmart's Section 220 production. 

See also id. at *41 (“As with Reinemund, it is hard to believe that an outside director like Flynn would ignore red flags about noncompliance with the DEA Settlement, much less make a decision not to comply with it. Once again, the answers likely lie in the redacted portions of the documents in Walmart's Section 220 production. Unfortunately, because of Walmart's compulsive redacting of documents, the pleading-stage record supports an inference that Flynn knew that Walmart was not in compliance with the DEA Settlement, knew that Walmart could not achieve compliance by the time the DEA Settlement terminated, and did nothing to bring the company into compliance.”).

That’s the headline, but it’s not all that’s of interest here.

I earlier blogged about Caremark and the distinction between taking legal risks and business risks.  In Walton, VC Laster articulates the distinction between legal risk and business risk thusly:

• In one hypothetical scenario, the lawyers say: “Although there is some room for doubt and hence some risk that our regulator may disagree, we believe the company is complying with its legal obligations and will remain in compliance if you make the business decision to pursue this project.”

• In the other hypothetical scenario, the lawyers say: “The company is not currently in compliance with its legal obligations and faces the risk of enforcement action, and if you make the business decision to pursue this project, the company is likely to remain out of compliance and to continue to face the risk of an enforcement action. But the regulators are so understaffed and overworked that the likelihood of an enforcement action is quite low, and we can probably settle anything that comes at minimal cost and with no admission of wrongdoing.”

In the former case, the directors can make a business judgment to pursue the project. In the latter case, the decision to pursue the project would constitute a conscious decision to violate the law, the business judgment rule would not apply, and the directors would be acting in bad faith.

Critically, I note that his assessment of good faith in these scenarios permits reliance on legal advice.  See also id. at *40.  That’s interesting, because – as I blogged when discussing the case of The Williams Companies v. Energy Transfer Equity LP, 159 A.3d 264 (Del. 2017) – there’s been some disagreement at the Delaware Supreme Court over approaches to legal advice.  In Williams, then-Chief Justice Strine in dissent recognized that even “good faith” legal advice is malleable, and may be adjusted depending on the desire of the client.  The majority, by contrast, treated “good faith” legal advice as something akin to an unwavering North Star, unresponsive to the client’s needs.  As recently as Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, 2021 WL 5267734 (Del. Ch. Dec. 19, 2022), Laster seemed to take more of Strine’s view of the matter, but his opinion was reversed on appeal in Boardwalk Pipeline Partners, LP v. Bandera Master Fund LP, 288 A.3d 1083 (Del. 2022), with a concurrence specifically warning that a great deal of deference ought to be given to good faith legal opinions.

The upshot of which is, going forward, I worry about how easy it will be for boards to satisfy Caremark obligations, despite red flags of illegal conduct, by relying good-faith-but-under-duress legal opinions.  And it is particularly ironic to see such a sentiment expressed in an opinion that does not, in the main, evince much confidence in counsel’s good faith advocacy.