Thursday, November 15, 2018
Facing looming retirement crises, some states have begun to do more. Notably, Nevada recently passed a state fiduciary statute. I cheered the legislation's passage because it mostly puts in place the legal protections that most savers now mistakenly believe that they already have. New Jersey also recently began to solicit comments on the issue as well. For the New Jersey process, written comments are due on December 14th.
As it moves forward, New Jersey will likely have to contend with the financial services industry doggedly lobbying to protect a stockbroker's right to sell clients the wrong products. Much of the campaign will likely be led by the Securities Industry and Financial Markets Association (SIFMA). SIFMA touts itself as "the voice of the nation's securities industry." It came up with some creative concerns about the Nevada fiduciary statute and will likely raise similar concerns with New Jersey.
One SIFMA argument struck me as particularly interesting in its implications:
We remain concerned that any new fiduciary duties under the Nevada law would impose additional recordkeeping requirements that would violate the National Securities Markets Improvement Act of 1996 (“NSMIA). As you well know, NSMIA precludes states from enacting regulations relating to the making and keeping of records “that differ from, or are in addition to, the requirements in those areas established under [the Exchange Act].” We are hard pressed to envision a scenario in which new duties do not require the creation of a new record.
For example, under the new law, broker-dealers and their agents are subject to NRS 628A.020. This provision states:
“A financial planner has the duty of a fiduciary toward a client. A financial planner shall disclose to a client, at the time advice is given, any gain the financial planner may receive, such as profit or commission, if the advice is followed. A financial planner shall make diligent inquiry of each client to ascertain initially, and keep currently informed concerning the client’s financial circumstances and obligations and the client’s present and anticipated obligations to and goals for his or her family.”
Both the disclosure and information collection requirements would need to be done in writing, or verbally followed by the creation of a written record to document compliance with and ensure adequate supervision of these obligations. In our view, even if the Division does not require that a new form be filled out, the broker-dealer would still have to create a new record to demonstrate compliance, which violates NSMIA. We encourage you to continue to explore options that do not create additional books and records issues.
In essence, SIFMA appears to be arguing that states cannot regulate conduct within state borders if it would require incidental paperwork. Curiously, SIFMA's testimony omitted the statute's next sentence which says that the "[SEC] shall consult periodically the securities commissions (or any agency or office performing like functions) of the States concerning the adequacy of such requirements as established under this chapter." If Congress intended to strip the states of the power to regulate conduct, it seems odd that the statute would direct the SEC to check with the states to make sure that its books and records rules were adequate. If a court read the statute the way SIFMA seems to, it would mean that a state could not require a financial adviser to inform the client about how much money she would make off selling a particular product. It would also mean that the states could not regulate conduct if it might ever require anyone to write something down.
The argument also seems to stretch too far because it would interfere with state authority to prohibit fraud. When Congress passed the NSMIA, it took pains to explicitly preserve the states' power to enforce their anti-fraud laws. If state law creates a disclosure duty to inform the customer about a conflict, it would likely be a fraudulent omission for a broker-dealer to make sales without disclosing the conflict.
It'll be interesting to watch this issue to see what happens.
Wednesday, November 14, 2018
Keith Klovers (FTC) & Douglas H. Ginsburg (U.S. Court of Appeals for the District of Columbia Circuit): "We believe the argument for antitrust enforcement against common ownership is misguided." https://t.co/SYN4aiskr5 #corpgov— Stefan Padfield (@ProfPadfield) November 13, 2018
"In resolving fraud claims brought against Tesla and Elon Musk ..., the SEC required that the company hire or designate 'an experienced securities lawyer' to review all social media communications made by senior officers." https://t.co/frldO3OtvH #corpgov— Stefan Padfield (@ProfPadfield) November 13, 2018
A friend quit his job as an investment adviser after the financial crisis, saying he could never again trust a word that came out of the mouths of corporate executives. Should that impact the puffery doctrine? https://t.co/zIQ0Z6JP7i #corpgov— Stefan Padfield (@ProfPadfield) November 13, 2018
"Say you can only teach two words from economics to a student or friend -- what would they be?" @tylercowen's answer? "Incentives Matter." (Including: Why does the employee divorce rate increase after a company goes public?) https://t.co/OCFApy9rWQ #corpgov— Stefan Padfield (@ProfPadfield) November 14, 2018
"Companies should anticipate ... that House Democrats will launch a number of investigations ... and should be prepared with a game plan for responding to a subpoena or other inquiry in the event they are impacted by one of these investigations." #corpgov https://t.co/fTzkCGHjK0— Stefan Padfield (@ProfPadfield) November 15, 2018
Tuesday, November 13, 2018
Back in May, I noted my dislike of the LLC diversity jurisdiction rule, which determines an LLC's citizenship “by the citizenship of each of its members” I noted,
I still hate this rule for diversity jurisdiction of LLCs. I know I am not the first to have issues with this rule.I get the idea that diversity jurisdiction was extended to LLCs in the same way that it was for partnerships, but in today's world, it's dumb. Under traditional general partnership law, partners were all fully liable for the partnership, so it makes sense to have all partners be used to determine diversity jurisdiction. But where any partner has limited liabilty, like members do for LLCs, it seems to me the entity should be the only consideration in determing citizenship for jurisdiction purposes. It works for corporations, even where a shareholder is also a manger (or CEO), so why not have the same for LLCs. If there are individuals whose control of the entity is an issue, treat and LLC just like a corporation. Name individuals, too, if you think there is direct liability, just as you would with a corporation. For a corporation, if there is a shareholder, director, or officer (or any other invididual) who is a guarantor or is otherwise personally liable, jurisdiction arises from that potential liability.
- Util Auditors, LLC v. Honeywell Int'l Inc., No. 17 CIV. 4673 (JFK), 2018 WL 5830977, at *1 (S.D.N.Y. Nov. 7, 2018) ("Plaintiff ... is a limited liability corporation with its principal place of business in Florida, where both of its members are domiciled.").
Thermoset Corp. v. Bldg. Materials Corp. of Am., No. 17-14887, 2018 WL 5733042, at *2 (11th Cir. Oct. 31, 2018) ("Well before Thermoset filed its amended complaint, this court ruled that the citizenship of a limited liability corporation depended in turn on the citizenship of its members.").ALLENBY & ASSOCIATES, INC. v. CROWN "ST. VINCENT" LTD., No. 07-61364-CIV, 2007 WL 9710726, at *2 (S.D. Fla. Dec. 3, 2007) ("[A] limited liability corporation is a citizen of every state in which a partner resides.").
Monday, November 12, 2018
Today, in honor of my Dad, my father-in-law, my cousin, my administrative assistant, many friends, and others who have honored us with their military service, I am posting a link to a recent episode of The Home Team with Jared Allen's Homes for Wounded Warriors. The episode features an interview by my former student, Betty Rhoades, of one of my new military buddies, Captain Chris Davis, USMC. Chris is a 3L at UT Law and a super guy. He founded a nonprofit last year, Vols for Vets, of which I (and others) are very proud.
Thanks to all who have served in our armed forces for helping to protect us from enemies far and near. Your service is to be honored and cherished. We thank you for our lives and our freedom.
Friend of the BLPB Josephine Nelson informs us of the following:
The second-annual ComplianceNet conference will take place on June 3-4, 2019. Villanova University Charles Widger School of Law and its Girard-diCarlo Center for Ethics, Integrity and Compliance will host the conference. Like the highly successful inaugural conference at UC Irvine in 2018, this conference will allow scholars from across disciplines and different legal and regulatory topics to exchange research and explore connections for collaboration.
The timing of this year’s conference is designed to follow on the heels of the Law & Society meeting in nearby Washington, D.C. If you are already headed to Law & Society, Villanova is a short train-ride away and easily accessible by public transportation. Regardless of whether you will be attending Law & Society, Villanova is in a beautiful location right outside Philadelphia, easily serviced by major international airports (Philadelphia (PHL), Newark (EWR), Baltimore (BWI), two more in NYC, and two more in DC); 90 minutes from NYC; and two hours from D.C.
The theme of this year's conference is Business Ethics, although we welcome additional papers discussing compliance across diverse settings. This year’s theme seeks to engage the question of how to run ethical companies, and how to encourage ethical behavior within organizations. The conference welcomes attempts to explore the strengths and limitations of various approaches, to identify how measurement strategies have shaped practices, and to understand how we can improve outcomes, for instance through new technology and combining methods. Submissions do not need to align with the meeting theme, but we encourage you to consider relating to it. The conference is also open to scholars and other experts who want to attend without presenting a paper.
The conference will host a business meeting of ComplianceNet, during which members may discuss future activities.
To register for the conference either as a presenter or attendee, please fill out the form by following this link. The URL is https://www.eventbrite.com/e/the-second-annual-compliancenet-conference-tickets-50784542935.
For individual papers, please submit the paper title and abstract (up to about 200 words). For panels (3 papers minimum with a maximum of 5 per panel), please submit an integrative statement explaining the panel (approximately 200 words), the titles of each paper and their authors, and an abstract for each paper (approximately 200 words). At our website, ComplianceNet.org, there is also a form to nominate papers for awards. Papers may be considered for awards whether they come through the nomination link or are presented at the conference.
The early registration discount deadline to submit papers and panels is January 25, 2019. The regular registration deadline for papers and panels is February 22, 2019. The registration deadline to attend without a paper or panel (as space available) is March 29, 2019. Registration for the conference includes the yearly membership in ComplianceNet. If you have questions regarding the call for proposals or about the conference, please contact Benjamin van Rooij (firstname.lastname@example.org).
. . .
---For conference updates, please refer to the ComplianceNet website at www.ComplianceNet.org---
Sounds like a great event. I note (and informed Josephine) that this conference overlaps with the Impact Investing Legal Working Group (IILWG)/Grunin Center for Law and Social Entrepreneurship’s 2019 Conference on “Legal Issues in Social Entrepreneurship and Impact Investing – in the US and Beyond,” scheduled for June 4-5 at the NYU Schools of Law in NYC. More on that conference later. In any event, it looks like there is a lot to do up North after the Law and Society Association conference! One could spend the whole week away presenting papers. . . .
Sunday, November 11, 2018
"Veterans Day and the role of volunteer lawyers"; "As we come together on Veterans Day to honor the sacrifices of our fellow Americans in their military service, we must not forget the many challenges that continue after their separation" https://t.co/6yv61uyxfk— Stefan Padfield (@ProfPadfield) November 9, 2018
"The U.S. securities regulator is set to review ... rules on corporate democracy, setting it up for a clash w/ investors who worry the agency will side w/ companies to diminish voting rights on charged issues like climate change and gun violence." https://t.co/KF81lR6Vsb #corpgov— Stefan Padfield (@ProfPadfield) November 9, 2018
"Wall Street ... celebrated after the ... election delivered divided government.... Investors ... figure Washington won't be able to mess things up ... traders even have a mantra for this thinking: gridlock is good. History generally backs it up." https://t.co/rrpRpSXFYM #corpgov— Stefan Padfield (@ProfPadfield) November 11, 2018
"critique of the alleged bias of efficient policies against the poor.... went into hibernation in part b/c a view took hold ... that distributional consequences ... were inconsequential b/c taxes and transfers ... address distributional concerns" 85 U. Chi. L. Rev. 1649 #corpgov— Stefan Padfield (@ProfPadfield) November 11, 2018
"moralizing managers ... impose serious costs, both on shareholders and on other members of the corporate group. These costs ... give us reason to question the legitimacy of managers using corporate resources to pursue their own moral agendas" 71 Vand. L. Rev. 1655 #corpgov— Stefan Padfield (@ProfPadfield) November 11, 2018
Saturday, November 10, 2018
Jonathan Macey and Joshua Mitts have just posted an intriguing new article, Asking the Right Question: The Statutory Right of Appraisal and Efficient Markets, regarding calculation of value for the purposes of an appraisal action.
As I’ve posted about previously (here and here), Delaware is in the midst of a judicial reinterpretation of its appraisal statute, placing new emphasis on market pricing for determining the value of publicly traded stock. Currently, one open question is whether “market” pricing refers to the deal price, assuming the process was relatively clean, or the unaffected trading price of the stock.
Macey & Mitts begin by agreeing with VC Laster’s opinion in Verition Partners Master Fund, Ltd., et al. v. Aruba Networks, Inc., that valuation should be based on the trading price, and not the deal price, and their discussion after is where things get interesting.
First, they point out that apparently, Delaware courts only will consider trading price relevant to an appraisal action if price is efficient. But they argue that even prices of stock that trades inefficiently would serve as a better indicator of value than more traditional calculations like discounted cash flow, in part because there are many different types of “inefficient” markets and some will process the most important information about the company and produce a reasonably accurate price – perhaps with the judge adjusting for any information that was not assimilated. The test for market efficiency in an appraisal action is, in their view, too demanding.
Part of the reason I find this argument so interesting is that it mirrors the same kind of arguments we’ve been having in the fraud on the market space for over a decade, namely, how efficiently must the stock trade before plaintiffs are entitled to the fraud on the market presumption? In that context, just like Mitts and Macey, Donald Langevoort (among others) has argued that courts have demanded too high a standard of efficiency when a lesser one would do for the purposes of the inquiry – a point that the Supreme Court seems to have found persuasive. Of course, in the Section 10(b) context, we’re talking about informational efficiency; Mitts and Macey's argument depends on markets being efficient for fundamental value, or at least more accurate than other types of analysis.
The second argument that Macey and Mitts make is that the stock price reaction of the acquirer may indicate whether the deal price was too high, in which case, any appraised value should be lower. I.e., if the acquirer’s stock price drops in response to announcement of the deal, that would suggest that the market believes the target was overvalued. That’s a really clever suggestion, though I do wonder about their argument that the analysis holds even for private targets – we might legitimately ask whether the market knows enough about private targets to make an informed assessment of the appropriateness of the deal price and the target’s effect on the acquirer’s value.
Of course, overall, their argument would push Delaware’s law even further toward eliminating appraisal for all but the most egregious cases; in recent years, many scholars have argued that appraisal can be used as a kind of substitute for a broken system of fiduciary duty litigation. Macey and Mitts believe that if fiduciary litigation is broken, it should be fixed, rather than substituting in a different cause of action to do that work.
Friday, November 9, 2018
My fellow BLPB editor Joan Heminway and I both have chapters in the book, along with many others.
The introduction is posted on SSRN, for those who are interested. Also, editor Ben Means has many talents, as he did the cover artwork below as well.
Thursday, November 8, 2018
The Theranos collapse and Elizabeth Holmes' indictment makes me wonder about what investor biases may have played a role in allowing Theranos to operate as long as it did. In an op-ed in The Hill, Ann McGinley and I point out that it might have been her seemingly deliberate projection of an idealized masculinity:
Presenting the right identity may unlock millions in funding and bypass close, critical reviews. Consider Elizabeth Holmes, the recently indicted founder of Theranos. Flanked by a board sporting retired military officers, she presented herself as a masculinized take on the Steve Jobsian ideal — aping his wardrobe choices with a black turtleneck sweater.
Her costume was often complimented by a blazer’s broad shoulders, and she spoke with a startlingly deep voice. The presentation exuded a hard-charging masculinity, allowing backers to see her as a Jungian fantasy of Jobs’ second coming.
The op-ed ties back to the bigger law review article discussing the ways in which a bias toward favored identities causes founders to perform their and their entities' identities to please sources of capital.
Gender bias (and other forms of implicit bias) likely does more than just raise capital costs for founders. It also seems to saddle venture capital funds with risks. The same techniques legitimate founders may embrace to raise capital might also be used by fraudsters looking to increase their odds on a con. In essence, uncorrected implicit biases may make it easier to dupe VCs into buying into frauds.
There may be ways to mitigate this risk. Implementing some blind or purely paper-based screening process to vet initial ideas without in-person presentations may provide a check similar to the techniques used in orchestral auditions. After all, research has led Cass Sunstein and others to conclude that job interviews do more harm than good. Getting a diverse committee to consider and approve investments might also also provide another check because a diverse group might not share the same biases. Of course, some biases are strong and widely shared. For example, investors generally tend to prefer investments pitched by masculine voices.
Ultimately, I don't know how to perfectly solve the problem. At the least, being aware of it and proceeding deliberately may allow some funds to reduce the role bias plays in their decisions.
Wednesday, November 7, 2018
"Throughout the last decades, the ... by no means obvious recognition of corporations as independent right holders has become a salient discursive element in two fields of international law; international human rights ... and ... investment law" https://t.co/1Phb6TdBkD #corpgov— Stefan Padfield (@ProfPadfield) November 5, 2018
"The two major proxy advisory firms, Institutional Shareholder Services Inc. (ISS) and Glass Lewis & Co. (GL), expect companies to respond to a “low” SOP vote (i.e., below 70% for ISS and below 80% for GL) in a particular manner" https://t.co/ON9di2pi5j— Stefan Padfield (@ProfPadfield) November 5, 2018
"San Francisco voters approve homeless tax on businesses"; "An estimated 7,000 people are homeless in San Francisco — a city in the middle of a housing crisis that some say is made worse by the influx technology workers with high salaries." https://t.co/nqmv66NfSo #corpgov— Stefan Padfield (@ProfPadfield) November 7, 2018
Tuesday, November 6, 2018
With just a few hours left to vote, I am taking this opportunity to ask you, if you have not already, to vote. Please. It is our opportunity to be heard.
So often people complain about money in politics, and I agree that raises concerns. But we always have the power to choose. We, the voters, always have the final say. We can impose term limits any time we want, by voting people out. If it is really a concern for us, we can overcome money in politics by choosing those who reject corporate interests. Either way, it is up to us. So, if you haven't already, please, please vote.
And if you already voted, thank you. Good work.
Monday, November 5, 2018
By the time many of you read this, Election Day 2018 will be upon us (or even over). I have had elections on my mind for some time now--elections of the political and corporate kind. As a result of an invitation to participate in last week's symposium on women and corporate governance hosted by the George Washington Law Review ("Women and Corporate Governance: A Conference Exploring the Role and Impact of Women in the Governance of Public Corporations"), my election-oriented thoughts somehow became infused with gender reflections . . . .
1992 was dubbed the political “Year of the Woman.” The appointment of Clarence Thomas to the U.S. Supreme Court in 1991 after hearings focused on sexual harassment allegations and revelations of Bill Clinton’s extramarital sexual conduct during his first campaign for election as U.S. President were and are credited with the record number of women elected to federal legislative positions in 1992. “When the ballots were counted, America had elected a record-breaking four women as senators and 24 women as representatives to Congress.” Li Zhou, The striking parallels between 1992’s “Year of the Woman” and 2018, explained by a historian, VOX, Nov 2, 2018, https://www.vox.com/2018/11/2/17983746/year-of-the-woman-1992 (interview with Georgetown University professor Michele Swers).
2018 has again been a hallmark year for women in politics—and in the public company boardroom. The #MeToo movement (and along with it yet another U.S. Supreme Court appointment tinged with allegations of sexual misconduct and a U.S President with a history of philandering and lechery) undoubtedly has been a factor in both the record-breaking number of women seeking political office in 2018 and a simultaneous renewed interest in gender diversity on corporate boards of directors. Perhaps this is not surprising. #MeToo largely emanates from the abuse of gendered power in government and business firms (which together are responsible for the fundamental regulation of our economic and social lives).
Given these parallels, there may be some value to looking at both the political and business management reactions to #MeToo. Specifically, I am interested in comparing, contrasting, and reflecting on the gender effects of the #MeToo movement on public company board composition in relation to the gender effects of the #MeToo movement on the composition of legislative bodies. I have determined to write a symposium essay along those lines for the George Washington Law Review. Your reflections and ideas on content are welcomed.
Sunday, November 4, 2018
"qualifiers like 'best efforts', 'reasonable best efforts', 'commercially reasonable efforts'": "recent cases ... view these standards—even when they appear in the same agreement—as largely interchangeable" #corpgov https://t.co/drCWbxNpOD— Stefan Padfield (@ProfPadfield) November 1, 2018
Modern Monetary Theory provides "different answers to when ... governments should print money, as well as the why of taxation. First let us consider the printing of money. Whether or not it is inflationary depends on how the printed money is used" https://t.co/yL6z5yLA0V #corpgov— Stefan Padfield (@ProfPadfield) November 2, 2018
"Google e'ees ... are walking out ... to protest handling of sexual misconduct .... demanding that Google make five concrete changes to its company policy: 1. An end to forced arbitration in cases of harassment and discrimination...." https://t.co/0SDIB6MIQr #corpgov— Stefan Padfield (@ProfPadfield) November 2, 2018
ICYMI: "U.S. Supreme Court justices signaled on Monday they may issue more pro-business rulings giving companies wide latitude to use arbitration to resolve disputes with employees, customers or other businesses rather than the courts." https://t.co/bLoTKtSjD9 #corpgov— Stefan Padfield (@ProfPadfield) November 2, 2018
Saturday, November 3, 2018
Yesterday, I had the pleasure of participating in Case Western Reserve Law Review Conference and Leet Symposium, Fiduciary Duty, Corporate Goals, and Shareholder Activism. It was a fun and lively set of discussions with some interesting themes that hit right in my sweet spot of interests, so I had a wonderful time. I’ll give a brief synopsis of the topics under the cut, but the entire thing will soon be available as a webcast online at the above link, and next year the law review will publish a special symposium issue.
Also, I just apologize in advance if I misdescribe anyone’s remarks – if you see this post and want to correct me, feel free to send an email.
[More under the jump]
Friday, November 2, 2018
The SEC's influential Investor Advisory Committee has just released new recommendations for the SEC as it continues to move forward with its effort to raise the standard for investment advice given to retail customers. Although the entire recommendation is worth reading, it highlights the special importance of making sure that account-type recommendations fall within the rule. As it currently stands, the proposed regulation does not apply to initial recommendations about what kind of account a customer should select.
The Committee described the issue's critical importance:
Some of the most important decisions investors make arise at the outset of the relationship, before they receive recommendations regarding specific transactions. These include decisions about whether to roll money out of a retirement account and into an IRA, what type of account to open (where the firm has more than one account type available), and the scope of services to be provided. Those central decisions, generally made at the beginning of a brokerage or advisory relationship, set up the contours of the relationship. They will often have a far greater impact on the investor than subsequent recommendations regarding which specific securities to invest in.
Rollover recommendations, for example, are frequently provided at a critical juncture in an investor’s life – retirement – and are often irrevocable decisions. Similarly, while some investors (including those who trade frequently) may be best served by paying an asset-based fee, others (including buy-and-hold investors who rarely trade) may be better served by paying transaction fees. Decisions about which type of account to open have the potential to greatly affect their costs. Moreover, both rollover and account type recommendations are recommendations of an “investment strategy involving securities” that can have substantial potential long-term impacts on investors. And both types of recommendations inherently involve potential conflicts of interest, making it critical that advisers and brokers put their clients’ interests ahead of their own in making such recommendations.
Early account-type decisions will likely have significant impacts on the range of options available later. The risk is that advisers eager to gather assets to manage will cause investors to pay higher fees and experience lower returns by drawing them into the wrong account type for their situation. Consider a choice facing a retiree with a buyout offer for a defined-benefit pension. If the retiree asks a financial adviser for advice, the advice should be in the best interest of the retiree--not the financial adviser. The right advice might be for the retiree to keep the pension and not move assets to the financial adviser. It's hardly acting in a person's best interest to draw them into a decision that isn't in their best interest and then act in their best interest once bad advice has caused them to surrender a stable pension.
Wednesday, October 31, 2018
"Marginal productivity theory states that each factor of production will be rewarded in line w/ its .. contribution to production. But although presented as .. objective .. It says nothing about the rules .. that govern .. which are .. political" https://t.co/b31l31ulJd #corpgov— Stefan Padfield (@ProfPadfield) October 28, 2018
"fiduciary problems via networks of joint venture connections across corporations in an industry" Sarath Sanga, A Theory of Corporate Joint Ventures, 106 Cal. L. Rev. 1437, 1438 (2018) #corpgov— Stefan Padfield (@ProfPadfield) October 30, 2018
"Is this the future for defendants accused of securities fraud: facing a multitude of far-flung suits by well-counseled, well-capitalized investment funds? If so, the business lobby has only itself to blame." #corpgov https://t.co/qjmspyj7ir— Stefan Padfield (@ProfPadfield) October 30, 2018
Study: Increasing environmental & CSR disclosures imposes processing costs on analysts, & "when processing costs are high, analysts will provide less information or less timely information, resulting in more gradual price discovery." https://t.co/Dx6QKSom5A #corpgov— Stefan Padfield (@ProfPadfield) October 30, 2018
“We can fly a health plan member to San Diego, have them picked up by private transport, receive the same drug ... from a hospital in Tijuana that meets US standards, give them ... $500, and still save between 40% to 60% for the employer,” https://t.co/gA7MEQw20o #corpgov— Stefan Padfield (@ProfPadfield) October 31, 2018
Tuesday, October 30, 2018
Tom Rutledge, at Kentucky Business Entity Law Blog, writes about a curious recent decision in which the Kentucky Court of Appeals overrule a trial court, holding that the law of piercing the veil required the LLC veil to be pierced. Tavadia v. Mitchell, No. 2017-CA-001358-MR, 2018 WL 5091048 (Ky. App. Oct. 19, 2018).
Here are the basics (Tom provides an even more detailed description):
Sheri Mitchell formed One Sustainable Method Recycling, LLC (OSM) in 2013. Mitchell initially a 99% owner and the acting CEO with one other member holding 1%. Mitchell soon asked Behram Tavadia to invest in the company, which he did.
He loaned OSM $40K at 6% interest from his business Tavadia Enterprises, Inc. (to be repaid $1,000 per month, plus 5% of annual OSM profits). There was no personal guarantee from Mitchell. OSM then received a $150,000 a business development from METCO, which Tavadia personally guaranteed and pledged certain bonds as security.
Two years (and no loan payments) later under the original $40,000 loan, Tavadia agreed to delay repayment. OSM and Tavadia the created a second loan for $250,000, refinancing the original $40,000 and a subsequent Tavadia $12,000 loan. This loan provided Tavadia a 25% ownership interest in OSM, but there was still no personal guarantee on the loan. Mitchell claimed this loan was needed to purchase essential equipment (no equipment was purchased). OSM then received a $20,000 loan from Fundworks, LLC, which was secured by Mitchell, who signed Tavadia’s name for OSM and she signed a personal guarantee in Tavadia’s name (both without permission).
Not surprisingly, in October 2015, OSM stopped operations, the equipment was sold, and more than half of the sale proceeds were deposited in Mitchell’s personal bank account, with the rest going to OSM’s account. OSM (naturally) defaulted on the Fundworks’ loan, which Tavadia learned about when Fundworks demanded repayment. The METCO loan also defaulted, and Tavadia was asked to provide funds from the bonds he provided as collateral.
Okay, so it sounds like Mitchell took advantage of Tavadia and engaged in some elements of fraud. What I can’t figure out from this case is why we’re talking about veil piercing.
First, the court states: “The evidence presented at trial demonstrated that Mitchell diverted OSM assets into her own account.” Tavadia v. Mitchell, No. 2017-CA-001358-MR, 2018 WL 5091048, at *5 (Ky. Ct. App. Oct. 19, 2018). So that money Mitchell owes to OSM, which owes money to Tavadia. The court noted that at least half the funds from the sale of OSM equipment went into Mitchell’s personal account. That needs to go back to OSM, and if veil piercing has value, then a simple order of repayment should be, too.
Second, the Fundworks loan, which Mitchell signed for, is really her loan, not Tavadia’s. He did not know about it until they sought payment, so it wasn’t ratified, and there is no other indication she has authority to enter into the contract.
At a minimum, these funds are owed Tavadia (or OSM) and should be itemized as such. Presumably, that is not enough money to make Tavadia whole. And I don’t know he should be. To the extent there were legitimate (if poorly executed) business attempts, he is on the hook for those losses. As such, I don’t see this as a veil-piercing case.
Instead, Tavadia should be able to sue Mitchell for her fraudulent actions that harmed him directly. And Tavadia should be able to make OSM sue Mitchell for improper transfers and fraud.
Maybe there are other theories for recovery, too, but veil piercing should not be one. Mitchell did not use the entity to commit fraud. She committed fraud directly. Just because there is an entity, plus an unpaid loan, it does not make this a veil-piercing case. In fact, because Tavadia is a member of the LLC, I think there is a reasonable argument that (absent truly unique circumstances) veil piercing cannot apply.
I am sympathetic that Tavadia was taken advantage of, and I think that Mitchell should have a significant repayment obligation to him, but I just don’t think this claim should be rooted in veil piercing. At a minimum, like in administrative law, one should have to exhaust his or her remedies before proceeding to a veil-piercing theory.
Monday, October 29, 2018
Last Friday, I had the honor of being the keynote speaker for the 64th annual conference of the Southeastern Academy of Legal Studies in Business (SEALSB). The invitation for this appearance was extended to me months ago by BLPB contributing editor Haskell Murray. It was a treat to have the opportunity to mingle and talk shop with the attendees (some of whom I already knew).
The participants in SEALSB are largely business law faculty members teaching at business schools. Having never before attended one of their meetings and as a bit of a "foreigner" in their midst, I wondered for quite a bit about what I should talk about. Should I take the conservative route and present some of my work, hoping to dazzle the group with my legal knowledge (lol), or should I take a riskier approach and tell them what was really on my heart when I accepted Haskell's kind invitation?
I chose the latter. I spoke for 15-20 minutes on "Valuing and Visioning Collaboration" between business law faculties in business and law schools and then took about 10 minutes of questions. I started with the stories of two of my students--who could have been the students of anyone in the room. Sarah took a business (accounting) major as an undergraduate and then came to law school; Ryan completed law school and went on to an MBA. Both achieved lofty learning objectives and engaged in productive scholarship. Both landed the jobs they wanted--ironically at the same firm (but years apart). For me, the stories of these two students--what they did and how they became successful--illustrates both the power of business school law faculty and law school business law faculty working together and the high value in that relationship as to both teaching and scholarship.
I noted that, in these two (of the three principal) aspects of our common academic existence, teaching and scholarship, there are a number of ways that we can collaborate, offering examples of each:
- conference organization and attendance;
- work in interdisciplinary centers;
- scholarship co-authorships;
- co-teaching and teaching for each other;
- co-currocular and extra-curricular programs (e.g., competitions and journals);
- curriculum development; and
I bet you can guess what blog I mentioned as an example in addressing that last collaborative method . . . .
I also noted, however, that there are barriers to these collaborations--or at least to some of them in certain contexts. Those barriers may include: the fact that reaching across the aisle may be, for the relevant institutions and faculty members, new--that there is no history--and that it may therefore be more of a challenge to scope out and implement collaboration; differences in methodology, norms, and terminology; potential disagreements about institutional or personal credit allocation (including because of ego); questions about the necessary sources of funding and human capital; and overall, a lack of institutional or departmental incentives and rewards for collaboration (including credit in tenure and promotion deliberations at many schools).
Nevertheless, I offered that, even if institutions do not act to support collaborative efforts, we should strike out to overcome the barriers and engage with each other because the benefits are worth the costs. To do so, however, we must both understand and truly appreciate the benefits of collaboration. We also must be willing to take some attendant risk (or pick collaborative methods that avoid or limit risk). I indicated that I plan to head down the collaborative path with increased focus.
To conclude my remarks, in the spirit of my invitation from Haskell to attend and speak at SEALSB, I encouraged the assembled crowd to join me on that collaborative journey, quoting from Patrick Lencioni's book The Five Dysfunctions of a Team: A Leadership Fable. In that book, he wrote: "Remember teamwork begins by building trust. And the only way to do that is to overcome our need for invulnerability." [p. 58; emphasis added] Here, I invite all of you who teach business law in a business or law school setting to embrace vulnerability and reach across the aisle to work with your business law colleagues. And if you already have done so, please leave a comment on the outcome--positive or negative.
Sunday, October 28, 2018
"NY alleges Exxon Mobil defrauded investors about risks of climate change"— Stefan Padfield (@ProfPadfield) October 24, 2018
1st CAUSE OF ACTION (Martin Act Securities Fraud – GBL §§ 352 et seq.)
2d (Persistent Fraud and Illegality – EL § 63(12))
3d (Actual Fraud)
4th (Equitable Fraud)https://t.co/fDRiV5X5N6 #corpgov
"nine out of 10 startups will end up failing .... From analyzing just 12 startups that failed this year, PitchBook found that around $1.4 billion in VC funding wasn't enough to save these businesses." https://t.co/yoiGs9SFTk #corpgov— Stefan Padfield (@ProfPadfield) October 25, 2018
'On Wednesday's earnings call, Musk touted the quality health service his employees receive.— Stefan Padfield (@ProfPadfield) October 25, 2018
Amazon and Apple are among other tech companies investing in their own employee health clinics." https://t.co/kMQDWKUqKK #corpgov
"Understanding what injures a corporation can help us better understand corporate personality. Traditional corporate injury is ... to ... assets or profits.... recent expansions of what constitutes corporate injury ... seem at first to fit poorly ...." 73 Bus. Law. 1031 #corpgov— Stefan Padfield (@ProfPadfield) October 28, 2018
Saturday, October 27, 2018
Next Friday, the George Washington Law Review will host a symposium on Women and Corporate Governance. Co-sponsored by Lisa Fairfax, the symposium features an impressive lineup--three former SEC Commissioners, regulators, professors, partners at leading law firms, and the BLPB's own Joan Heminway. The panels include discussions about women and corporate boards, women as regulators, women in the C-Suite, and women as gatekeepers. This is the quick overview:
The Symposium will explore the role of women in a changing corporate environment, particularly in light of the 2008 financial crisis and its aftermath. Recent social, political, and economic events have brought renewed attention to the ways in which the corporate environment is impacted by, and responsive to, women. It is especially vital to further this discussion today, as corporations grapple with the under-representation of women on their boards, in their C-suites, and in a host of other managerial positions.
In place of the traditional individual keynote, we have the privilege of hosting a fireside chat featuring the three women who have served as Chair of the U.S. Securities and Exchange Commission – Mary Schapiro, Elisse Walter, and Mary Jo White, moderated by Professor Lisa Fairfax.
Congratulations to Professor Fairfax and the George Washington Law Review for getting so many leading lights together on such an important topic.