Saturday, October 31, 2020

Not All Heroes Wear Capes

Earlier this week, VC Laster issued his decision in United Food & Commercial Workers Union v. Zuckerberg.  Professor Stephen Bainbridge blogged about the decision here, with a lot more detailed discussion of the law than I’m going to provide, but I’m covering the same territory anyway because this case is an interesting example of the pathologies associated with the common law.

So, before stockholder plaintiffs are permitted to bring a derivative action on behalf of a corporation, they must first make a showing that the corporate board is too conflicted to be able to make the litigation decision themselves.  This may occur because board members are themselves at risk of liability regarding the underlying transaction being challenged, or because they are too close to someone who is.  The test was first articulated by the Delaware Supreme Court in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), but because this was a common law creation and the court was mostly focused on the dispute in front of it, the test it articulated conflated the general inquiry – is the board able to be objective about the litigation – with the specific application of that inquiry to the Aronson Board.  In other words, the Aronson test conflated the issue of objectivity with respect to bringing a lawsuit and liability on the underlying claim, and phrased the former in terms of the latter.

As time wore on, that conflation made the Aronson test difficult and confusing to apply, for two reasons: First, in many cases – unlike the situation in Aronson – board members change between the time of the alleged fiduciary breach and the time of the lawsuit, making liability on the underlying claim irrelevant.  And second, the legal standards for liability changed, making Aronson’s articulation – which was tied to the liability standards for that board at that time – increasingly disconnected from the actual liability risk.

The Delaware Supreme Court started to fix these problems in Rales v. Blasband, 634 A.2d 927 (Del. 1993), where it created a new test – one rooted solely in the objectivity of the board at the time of the lawsuit – but instead of overruling Aronson, it said that the Rales test would only apply when the board entertaining the possibility of a lawsuit had not made a decision being challenged by the plaintiffs.

That, naturally, led to decades of confusing caselaw about whether Rales or Aronson would apply in a particular matter, making the issue the bane of corporate law professors who tried to teach the distinction to their students (ahem, some of us don’t bother and just teach Rales). 

And here’s the part that’s interesting to me: Why would the law persist in this obviously maladaptive way?  Because, I believe, no litigant had any interest in arguing for a change.  At the end of the day, Rales and Aronson are asking the same question, and regardless of which is used, they come out the same way – a point that several Delaware courts have made.  Which means neither plaintiff nor defendant had much of an interest in briefing the distinction or arguing the law should be changed, and they didn’t.  Without any litigants to press for clarification, Delaware courts allowed this state of affairs to continue and torture corporate law professors and junior associates throughout the land.

This is the weakness of common law rulemaking, and the adversarial system in general; courts decide what litigants ask them to decide. And litigants don’t always ask the right questions.

Which is likely why earlier this week, VC Laster – sua sponte – seized the initiative and gave Aronson the boot, even though the parties had assumed Aronson would apply and briefed the matter that way.  In so doing, Laster painstakingly detailed the problems with the Aronson test, concluding, “Precedent thus calls for applying Aronson, but its analytical framework is not up to the task….This decision therefore applies Rales as the general demand futility test.”

Now all that remains is to see if Laster’s bid for a change takes hold.  Notably, litigants still don’t have any incentive to make a serious argument on this score, but if they – like the academy – are relieved to see the shift, they may make a perfunctory gesture towards Aronson in future cases, but then cite Zuckerberg for the idea that Aronson may be dead letter, and go from there.  Even if the plaintiffs appeal Laster’s specific ruling in Zuckerberg dismissing their complaint, I’d be surprised if they waste precious briefing space on the Aronson/Rales distinction, which means the Delaware Supreme Court would have to go affirmatively out of its way to question Laster’s reasoning if it wants to preserve Aronson’s vitality.  Let’s hope it doesn’t bother.

That said, when it comes to the underlying substantive dispute in Zuckerberg, I’m not sure I agree with Laster’s analysis.

The lawsuit arose out of Mark Zuckerberg’s ill-fated proposal to amend Facebook’s charter to create a class of no-vote shares, essentially to allow him to transfer much of his financial interest in the company while maintaining his hold on the high-vote B shares that give him control.  As many will recall, the Board recommended the charter amendment and the shareholders – dominated by Zuckerberg’s high vote shares – voted in favor, but in a subsequent lawsuit, stockholder-plaintiffs uncovered multiple irregularities that had occurred in the course of negotiating the proposal.  Zuckerberg dropped the plan, and that was that, until new plaintiffs brought a derivative lawsuit alleging that even though the plan was abandoned, all of the expenditures associated with it damaged the company.  Thus, the question before Laster was whether the Facebook Board was sufficiently disinterested and independent to decide whether to bring a lawsuit over the Board’s earlier approval of the charter amendments, namely, whether to sue many of its own members.  And that question turned, in part, on whether Reed Hastings and Peter Thiel, two of Facebook’s Board members, faced a substantial risk of liability for having voted in favor of the charter amendment in the first place.

So really, part of the underlying legal question here was whether Hastings and Thiel breached their duties of loyalty by recommending the charter amendment.  The plaintiffs argued, in part, that they did so because they were “biased” in favor of founder control – namely, they believed that corporate founders should be able to run their companies free from the meddling influence of public shareholders.

Laster held that even if this was their reasoning, it did not constitute a lack of loyalty:

A director could believe in good faith that it is generally optimal for companies to be controlled by their founders and that this governance structure is value-maximizing for the corporation and its stockholders over the long-term. Others might differ. As long as an otherwise independent and disinterested director has a rational basis for her belief, that director is entitled (indeed obligated) to make decisions in good faith based on what she subjectively believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants.  If a director believes that it will be better for the corporation to have the founder remain in control, then the director may make decisions to achieve that goal. As long as a director acts in good faith, exercises due care, and does not otherwise have any compromising interests, a director will not face liability for making a decision that she believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants,…

The belief that founder control benefits corporations and their stockholders over the long run is debatable, but it is not irrational.

To which I respond – what about Blasius?

In Blasius Industries v. Atlas, an incumbent board maneuvered to neuter the effects of shareholder consents that would otherwise have replaced it with a dissident slate.  VC Allen held that even if the Board sincerely and in good faith believed the dissident slate would harm the company and its own plans were better for shareholders, the incumbents would violate their fiduciary duties by taking the choice out of the shareholders’ hands.  As Allen put it:

As I find the facts … they present the question whether a board acts consistently with its fiduciary duty when it acts, in good faith and with appropriate care, for the primary purpose of preventing or impeding an unaffiliated majority of shareholders from expanding the board and electing a new majority. ...I conclude that, even though defendants here acted on their view of the corporation's interest and not selfishly, their December 31 action constituted an offense to the relationship between corporate directors and shareholders that has traditionally been protected in courts of equity. As a consequence, I conclude that the board action taken on December 31 was invalid and must be voided….

The real question the case presents, to my mind, is whether, in these circumstances, the board, even if it is acting with subjective good faith..., may validly act for the principal purpose of preventing the shareholders from electing a majority of new directors. The question thus posed is not one of intentional wrong (or even negligence), but one of authority as between the fiduciary and the beneficiary (not simply legal authority, i.e., as between the fiduciary and the world at large)....

I therefore conclude that, even finding the action taken was taken in good faith, it constituted an unintended violation of the duty of loyalty that the board owed to the shareholders.

Without, umm, weighing in on the overall merits of this particular lawsuit, might Blasius’s reasoning be transferred to the Facebook context?  Directors may believe it’s better if Zuckerberg remains in control of the company, but that doesn’t give them the right to unilaterally effectuate a recapitalization handing him that control even after he sells his shares.

This is not to say the proposed amendments were per se disloyal; just, as with any loss of control rights, you’d expect shareholders to get something in return.  A payment, for example, perhaps coupled with MFW-like protections (which Zuckerberg refused), rather than simply the dubious honor of having Zuckerberg control the company in perpetuity.

I suppose one might argue this isn’t a Blasius situation of interfering with the shareholder franchise so much as it as a Unocal/Unitrin situation of defending against a potentially damaging change in control (and yes, I realize some would argue they’re two sides of the same doctrinal coin).  But Blasius is used for entrenchment; Unocal is applied for mergers and hostile takeovers.  So it would be awfully strange to apply the Unocal framework when the whole issue arises because the existing controller (and the existing directors) are trying to entrench their positions by increasing the separation between control rights and financial rights.  And even if we were to apply Unocal, the maneuver would still fail on preclusiveness grounds; due to a lack of a majority-of-the-minority approval condition, it was mathematically impossible for the minority shareholders to maintain the existing capital structure.*

But that further raises the question whether an impermissible Unocal defense is necessarily a disloyal act (a critical issue here, since the question is being asked in the context of a claim for damages), and I am not certain the caselaw is entirely clear.

In any event, this is probably all old hat; I assume a lot of this territory was covered back during the Google case or during the briefing in the initial Facebook lawsuit.  Still, Laster’s opinion reopens those wounds, and we never got an answer the first time!

*One of the odd doctrinal blips here is that because the proposal was a conflicted-controller transaction, it was subject to entire fairness review, which should be a higher standard than Unocal/Unitrin scrutiny.  But if Unocal is the right framework, we know it fails due to preclusiveness; no further analysis required.  Assuming, of course, that we measure preclusiveness by the ability of the minority shareholders alone (rather than all the shareholders, including Zuckerberg) to reject the transaction.  Which I think we should do, since it was only the minority losing control, and that usurpation of control is what Unocal is concerned about.  But the fact that these kinds of contortions arise when the Unocal framework is used may simply demonstrate the impropriety of applying it in the first instance.

October 31, 2020 in Ann Lipton | Permalink | Comments (0)

Friday, October 30, 2020

Verstein on Insider Trading and the "Use-versus-Possession" Controversy

The courts have interpreted Section 10b of the Securities and Exchange Act as prohibiting insiders from trading in their own company’s shares only if they do so “on the basis of” material nonpublic information. This element of scienter for insider trading liability is sometimes tricky for regulators and prosecutors to satisfy because insiders who possess material nonpublic information at the time of their trade will often claim they did not use that information. The insider may claim that her true motives for trading were entirely innocent (e.g., to diversify her portfolio, to pay a large tax bill, or to buy a new house or boat). Such lawful bases for trading can be easy for insiders to manufacture and are often difficult for regulators and prosecutors to disprove.

Historically, the SEC and prosecutors sought to overcome this challenge by taking the position that knowing possession of material nonpublic information while trading is sufficient to satisfy the "on the basis of" test. This strategy met mixed results before the courts, with some circuits holding that proof of scienter under Section 10b requires proof that the trader actually used the inside information in making the trade.

Facing a circuit split, the SEC attempted to settle the “use-versus-possession” debate by adopting Rule 10b5-1, which defines trading “on the basis of” material nonpublic information for purposes of insider trading liability as trading while “aware” of such information. A number of commentators, however, question the statutory authority for Rule 10b5-1, and some courts have simply “ignored” it. See Donald C. Langevoort, “Fine Distinctions” in the Contemporary Law of Insider Trading, 2013 Columbia Bus. L. Rev. 429, 439 (2013).

Professor Andrew Verstein’s forthcoming article, Mixed Motives Insider Trading, (Volume 106 of the Iowa Law Review) charts a “third way” to resolve the ongoing use-versus-possession controversy. Professor Verstein would impose liability for mixed-motives insider trading only where material nonpublic information provides the “primary motive” for the trading. While I have argued elsewhere that a strict “use” test best complies with Section 10b’s scienter requirement, Professor Verstein’s primary-motive test offers a significant improvement over the strict awareness test reflected in both SEC Rule 10b5-1 and the Insider Trading Prohibition Act recently passed by the House of Representatives. For these reasons, Professor Verstein’s proposal warrants serious consideration as regulators and legislators consider paths to reform.

The SSRN abstract to Professor Verstein’s article follows:

If you trade securities on the basis of careful research, then you are a brilliant and shrewd investor. If you trade on the basis of a hot tip from your brother-in-law, an investment banker, then you are a criminal. What if you trade for both reasons?

There is no single answer, thanks to a three-way circuit split. Some courts would forgive you according to your lawful trading motives, some would convict you in keeping with your bad motives, and some would hand the issue to the jury. Sometimes called the “awareness/use” debate or the “possession/use” debate, the proper treatment of mixed motive traders has occupied dozens of law review articles over the last thirty years.

This Article demonstrates that courts and scholars have so far followed the wrong reasons to the wrong answers. Instead, this Article takes trader motives seriously, drawing on insights and solutions from the broader jurisprudence of mixed motive. This analysis generates a new legal test and demonstrates the test’s superiority.

October 30, 2020 in Securities Regulation, White Collar Crime | Permalink | Comments (0)

Thursday, October 29, 2020

New Report on Regulation Best Interest

The North American Securities Administrators Association (NASAA) recently released a new report aimed at "identify a baseline of broker-dealer (“BD”) and investment adviser (“IA”) firm policies, procedures, and practices involving sales to retail investors, as those policies, procedures, and practices existed in 2018 prior to adoption and release of the final rule by the SEC (the “pre-BI period”)."  NASAA will do a second look later to see how Regulation Best Interest changes sales patterns.  My early prediction:  not much.

As it stands, some of the differences between the BD channel and the IA channel are shocking.  You're nine times as likely to get sold a non-traded REIT by a BD than by an IA.  Across the board, BDs load investors up with riskier, complex products:

Screen Shot 2020-10-29 at 11.42.11 AM

This doesn't surprise me.  Many of these complex products pay massive commissions to the brokers who sell them.  Unsurprisingly, they tend to get sold more often through that channel.  The IA channel compensates advisers differently and they lack the same incentive to get their clients into variable annuities and other complex, illiquid products.

Looking forward, if Regulation Best Interest has some meaningful effect, we would expect these numbers to change in some significant way.  I doubt that it will.


October 29, 2020 | Permalink | Comments (0)

Wednesday, October 28, 2020

Wisconsin Hiring Announcement

The University of Wisconsin Law School is looking to hire in the areas of Business/Corporate Law, among other closely related areas. We invite applications for faculty position at the rank of Assistant, Associate or Full Professor of Law beginning academic year 2021-2022. We seek entry-level and lateral candidates who show scholarly promise, as evidenced by publications, works in progress, or a research agenda. Applicants should have relevant experience such as teaching, legal practice, or a judicial clerkship. Hiring rank will be commensurate with years of relevant experience. All candidates must have proven success in conducting research or publishing papers in high-impact journals, and teaching appropriate to their stage of career. The University of Wisconsin is an Equal Opportunity and Affirmative Action Employer. We promote excellence through diversity and encourage all qualified individuals to apply. 


The complete PVL is available here:

October 28, 2020 | Permalink | Comments (0)

Tuesday, October 27, 2020

2020 American Bar Association LLC Institute - Free for Law Students!

I have written about the American Bar Association Limited Liability Institute in this space before.  See, e.g., here, here, here, here, and here.  The 2020 LLC Institute is being hosted virtually and begins next Friday--something to look forward to at the end of election week!  This ABA program is always a premier event, and it is the only national annual program that focuses in exclusively on LLCs and unincorporated business associations.

Importantly, this year's institute is free to law students.  I have recommended registration and attendance to mine.  Click here for more information, including the agenda, list of speakers (including yours truly!), and registration.

October 27, 2020 in Conferences, Joan Heminway, LLCs, Teaching, Unincorporated Entities | Permalink | Comments (1)

Is an LLC Member Labeled as a Partner Personally Liable for LLC Debts?

If one is going to ignore entity distinctions, I supposed one may as well go all in.  Following is from an opinion issued last week that involves Christeyns Laundry Technology, LLC (“Christeyns”), which is a limited liability company.  The opinion, though, asserts: 

Selective is a New Jersey corporation with its principal place of business in New Jersey. [Docket No. 1-1, ¶ 2.] Christeyns is a Limited Liability Corporation with two partners: Christeyns Holding, Inc., and Rudi Moors. [Docket No. 25, at 14, ¶ 7.] Christeyns Holding, Inc., is a Delaware corporation with its principal place of business in East Bridgewater, Massachusetts. [Id. at 14, ¶ 8.] Rudi Moors is a resident of South-Easton, Massachusetts. [Id. at 14, ¶ 9.] The remaining parties’ claims arise out of a common nucleus of operative fact.

SELECTIVE INSURANCE COMPANY OF AMERICA, Plaintiff, v. CHRISTEYNS LAUNDRY TECHNOLOGY, LLC, et al., Defendants. Additional Party Names: Clean Green Textile Servs., LLC, Lavatec Laundry Tech., Inc., Single Source Laundry Sol., No. CV1911723RMBAMD, 2020 WL 6194015, at *3 n.2 (D.N.J. Oct. 22, 2020) (emphasis added).

We have already established that an LLC is a limited liability company, and not a corporation. And while the opinion seems to track the diversity requirements of corporation and an LLC correctly, LLCs are not partnerships, and thus do not have partners, either.  LLCs are made up of members. Referring to them as members clearly connotes limited liability protections that are generally provide to members of an LLC, while the generic "partner" could imply that each "partner" faces unlimited liability for the debts and obligations of a "partnership." 

Similarly, another case from last week made the following observation about a witness:

"Ernest Thompson is listed as "GEN. PART" of M Nadlan LLC per DHPD records. The court takes this to mean General Partner of the Limited Liability Corporation."

 Yolanda Martinez, Petitioner, M Nadlan LLC, Respondent., No. 41219/2019, 2020 WL 6166864, at *3 n.3 (N.Y. Civ. Ct. Oct. 21, 2020) (emphasis added).

Again with the mixing of entities.  In fairness, the court did not label Mr. Thompson as "GEN. PART." Someone else did.  But the court did refer to the LLC as a corporation.  Once again, although I know LLCs sometimes adopt partnership terms, they should not.  And yet again, here, "general partner" could imply personal liability for entity debts on the part of Mr. Thompson, evening though it is more likely he is a managing member of the LLC.  If you are listed as a general partner, that holding out could be deemed to be a form or personal guarantee, at least where one could plausibly claim reliance.  Moreover, it's just bad form.  

Anyway, it's possible, and maybe even likely, that courts would uphold limited liability protections for these LLC members who are listed as partners. But why take the risk of having to find out?  

October 27, 2020 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (2)

Monday, October 26, 2020

Chiarella at 40: Upcoming Conference


The NYU Pollack Center for Law & Business, Indiana University Maurer School of Law, and Securities and Exchange Commission Historical Society invite you to a virtual program entitled "Insider Trading: Honoring the Past|A Program Commemorating the 40th Anniversary of Chiarella v. United States," which will take place on Thursday, November 5th from 10am-noon Eastern Time.

The program will explore the fascinating backstories of the Chiarella prosecution and the Supreme Court argument as well as the SEC’s and DOJ’s insider trading enforcement strategies in the wake of the Court’s ruling. The Chiarella case is also the subject of Donna Nagy’s recent essay, Chiarella v. United States and its Indelible Impact on Insider Trading Law.

A webinar link will be circulated to all those who RSVP, which you can do here. Conference details and schedule are below.

Conference Organizers:

Stephen Choi, Murray and Kathleen Bring Professor of Law, NYU School of Law, Co-Director Pollack Center for Law and Business
Donna M. Nagy, C. Ben Dutton Professor of Law, Indiana University Maurer School of Law
Jane Cobb, Executive Director, SEC Historical Society


10:00am Welcome by Stephen Choi, Murray and Kathleen Bring Professor of Law, NYU School of Law, Co-Director Pollack Center for Law and Business

10:10-11:10am    Session I: The Chiarella Prosecution and Supreme Court Litigation

John S. Siffert, Co-Founding Partner, Lankler Siffert Wohl; Adjunct Professor—NYU School of Law (Assistant US Attorney in the SDNY 1974-1979, prosecuted the Chiarella case and argued the 2nd Circuit appeal)
John “Rusty” Wing, Partner, Lankler Siffert Wohl (Chief of the Securities and Business Fraud Unit for the SDNY’s U.S. Attorney’s Office 1971-1978)
Hon. Judge Jed S. Rakoff, U.S. District Judge SDNY (Chief of the Securities and Business Fraud Unit for the SDNY’s U.S. Attorney’s Office 1978-1980)
Stanley S. Arkin, founding member of Arkin Solbakken (represented Vincent Chiarella at his criminal trial, 2nd Circuit appeal, and argument before the Supreme Court)
• Panel Moderator: Donna M. Nagy, C. Ben Dutton Professor of Law, Indiana University Maurer School of Law

11:10am-12:00pm    Session II: The SEC and DOJ’s Response to the Supreme Court’s Chiarella Decision

Donald C. Langevoort, Thomas Aquinas Reynolds Professor of Law, Georgetown University Law Center (SEC Special Counsel, Office of General Counsel, 1978-1981)
Lee S. Richards III, Co-Founding Partner, Richards Kibbe & Orbe (Assistant US Attorney in the SDNY 1977-1983, prosecuted US v. Newman based on the misappropriation theory advanced in, but left undecided by, the Court’s Chiarella ruling)
Hon. Judge Jed S. Rakoff, U.S. District Judge SDNY (SDNY Fraud Unit Chief during the Newman investigation, later served as defense counsel in Carpenter v. United States)
• Panel Moderator: Robert B. Thompson, Peter P. Weidenbruch, Jr. Professor of Business Law Georgetown University Law Center

October 26, 2020 in Conferences, Joan Heminway, Securities Regulation | Permalink | Comments (0)

The Sharing Economy, Autonomous Vehicles, and Such . . . .

Although my UT Law colleague Greg Stein is perhaps most well known for his work in the area of real estate law (development, finance, land use, etc.--see his SSRN page here), of late, he has been focusing increased attention on issues at the intersection of technological innovation and economic enterprise.  I have been interested in and engaged by this new twist to his research, thinking, and writing.  This post promotes two works he has completed that occupy this scholarly space, the first of which was recently published in the Brooklyn Law Review and the second of which is forthcoming in the Florida State University Law Review.

The Brooklyn Law Review piece is entitled "Inequality in the Sharing Economy."  The SSRN abstract follows.

The rise of the sharing economy benefits consumers and providers alike. Consumers can access a wider range of goods and services on an as-needed basis and no longer need to own a smaller number of costly assets that sit unused most of the time. Providers can engage in profitable short-term ventures, working on their own schedule and enjoying many new opportunities to supplement their income.

Sharing economy platforms often employ dynamic pricing, which means that the price of a good or service varies in real time as supply and demand change. Under dynamic pricing, the price of a good or service is highest when demand is high or supply is low. Just when a customer most needs a good or service – think bottled water after a hurricane – dynamic pricing may price that customer out of the market.

This Article examines the extent to which the rise of the sharing economy may exacerbate existing inequality. It describes the sharing economy and its frequent use of dynamic pricing as a means of allocating scarce resources. It then focuses on three types of commodities – necessities, inelastic goods and services, and public goods and services – and discusses why the dynamic pricing of these three types of commodities raises the greatest inequality concerns. The Article concludes by asking whether some type of intervention is warranted and examining the advantages and drawbacks of government action, action by the private sector, or no action at all.

The title of the article that is forthcoming in the Florida State University Law Review is "The Impact of Autonomous Vehicles on Urban Land Use Patterns."  The SSRN abstract for this article is set forth below.

Autonomous vehicles are coming. The only questions are how quickly they will arrive, how we will manage the years when they share the road with conventional vehicles, and how the legal system will address the issues they raise. This Article examines the impact the autonomous vehicle revolution will have on urban land use patterns.

Autonomous vehicles will transform the use of land and the law governing that valuable land. Automobiles will drop passengers off and then drive themselves to remote parking areas, reducing the need for downtown parking. These vehicles will create the need for substantial changes in roadway design. Driverless cars are more likely to be shared, and fleets may supplant individual ownership. At the same time, people may be willing to endure longer commutes, working while their car transports them.

These dramatic changes will require corresponding adaptations in real estate and land use law. Zoning laws, building codes, and homeowners’ association rules will have to be updated to reflect shifting needs for parking. Longer commutes may create a need for stricter environmental controls. Moreover, jurisdictions will have to address these changes while operating under considerable uncertainty, as we all wait to see which technologies catch on, which fall by the wayside, and how quickly this revolution arrives. This Article examines the legal changes that are likely to be needed in the near future. It concludes by recommending that government bodies engage in scenario planning so they can act under conditions of ambiguity while reducing the risk of poor decisions.

These articles offer interesting perspectives on the need for and desirability of legal or regulatory change as a response to existing and inevitable ripple effects of the new ways we engage with technology and use it in our lives--in commerce and in the more personal aspects of our existence--whether those effects are felt in the socio-economic landscape or the land use realm.  Many business law academics have been researching and writing about these relationships between and among legal and regulatory rules, technological innovation, and shifts in commercial and personal behavioral patterns.  Greg's contributions to this body of work are both compelling and thoughtful.  I appreciate his insights.

October 26, 2020 in Commercial Law, Joan Heminway, Law and Economics, Real Property, Technology | Permalink | Comments (0)

Saturday, October 24, 2020

ESG Investing, or, If You Can’t Beat ‘Em, Join ‘Em

This week, I'm plugging a new piece I posted to SSRN, forthcoming as a chapter in Research Handbook on Corporate Purpose and Personhood (Elizabeth Pollman & Robert Thompson eds., Elgar). It actually includes a lot of the arguments/observations I've previously made in this space, but if you want them compiled in a handy chapter, here's the abstract:

ESG Investing, or, If You Can’t Beat ‘Em, Join ‘Em

If corporate purpose debates concern whether corporations should operate solely to benefit their shareholders, or if instead they should operate to benefit the community as a whole, “ESG” – or, investing based on “environmental, social, and governance” factors – occupies a middle ground. Its adherents welcome shareholder power within the corporate form and accept that shareholders are the central objects of corporate concern, but argue that shareholders themselves should encourage corporations to operate with due regard for the protection of nonshareholder constituencies. This Chapter, prepared for the Research Handbook on Corporate Purpose and Personhood, will explore the theory behind ESG, as well as the barriers to its implementation.

October 24, 2020 in Ann Lipton | Permalink | Comments (0)

The Limited Effect of "Maximum Effect"

Professor Dan Kleinberger and I have recently published a short article in the Business Law Today entitled "The Limited Effect of 'Maximum Effect.'" The executive summary of the piece is that more than 20 jurisdictions have followed Delaware rather than the Uniform Law Commission in giving “maximum effect” to the principle of freedom of contract in LLC arrangements.  You may wonder, "Exactly how effective has the construct of 'maximum effect' been?"  Our answer is "not very."

If you're interested in reading beyond the executive summary, you can find the article here:


October 24, 2020 | Permalink | Comments (0)

Friday, October 23, 2020

When Wall Street Talks, Does Washington Listen?

It’s hard to believe that the US will have an election in less than two weeks. Three years ago, a month after President Trump took office, I posted about CEOs commenting on his executive order barring people from certain countries from entering the United States. Some branded the executive order a “Muslim travel ban” and others questioned whether the CEOs should have entered into the political fray at all. Some opined that speaking out on these issues detracted from the CEOs’ mission of maximizing shareholder value. But I saw it as a business decision - - these CEOs, particularly in the tech sector, depended on the skills and expertise of foreign workers.

That was 2017. In 2018, Larry Fink, CEO of BlackRock, told the largest companies in the world that “to prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society…Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders.” Fink’s annual letter to CEOs carries weight; BlackRock had almost six trillion dollars in assets under management in 2018, and when Fink talks, Wall Street listens. Perhaps emboldened by the BlackRock letter, one year later, 181 CEOs signed on to the Business Roundtable's Statement on the Purpose of a Corporation, which “modernized” its position on the shareholder maximization norm. The BRT CEOs promised to invest in employees, deal ethically and fairly with suppliers, and embrace sustainable business practices. Many observers, however, believed that the Business Roundtable statement was all talk and no action. To see how some of the signatories have done on their commitments as of last week, see here.

Then came 2020, a year like no other. The United States is now facing a global pandemic, mass unemployment, a climate change crisis, social unrest, and of course an election. During the Summer of 2020, several CEOs made public statements on behalf of themselves and their companies about racial unrest, with some going as far as to proclaim, “Black Lives Matter.” I questioned these motives in a post I called “"Wokewashing and the Board." While I admired companies that made a sincere public statement about racial justice and had a real commitment to look inward, I was skeptical about firms that merely made statements for publicity points. I wondered, in that post, about companies rushing to implement diversity training, retain consultants, and appoint board members to either curry favor with the public or avoid the shareholder derivative suits facing Oracle, Facebook, and Qualcomm. How well had they thought it out? Meanwhile, I noted that my colleagues who have conducted diversity training and employee engagement projects for years were so busy that they were farming out work to each other. Now the phones aren’t ringing as much, and when they are ringing, it’s often to cancel or postpone training.

Why? Last month, President Trump issued the Executive Order on Combatting Race and Sex Stereotyping. As the President explained:

today . . .  many people are pushing a different vision of America that is grounded in hierarchies based on collective social and political identities rather than in the inherent and equal dignity of every person as an individual. This ideology is rooted in the pernicious and false belief that America is an irredeemably racist and sexist country; that some people, simply on account of their race or sex, are oppressors; and that racial and sexual identities are more important than our common status as human beings and Americans ... Therefore, it shall be the policy of the United States not to promote race or sex stereotyping or scapegoating in the Federal workforce or in the Uniformed Services, and not to allow grant funds to be used for these purposes. In addition, Federal contractors will not be permitted to inculcate such views in their employees.

The Order then provides a hotline process for employees to raise concerns about their training. Whether you agree with the statements in the Order or not -- and I recommend that you read it -- it had a huge and immediate effect. The federal government is the largest procurer of goods and services in the world. This Order applies to federal contractors and subcontractors. Some of those same companies have mandates from state law to actually conduct training on sexual harassment. Often companies need to show proof of policies and training to mount an affirmative defense to discrimination claims. More important, while reasonable people can disagree about the types and content of diversity training, there is no doubt that employees often need training on how to deal with each other respectfully in the workplace. (For a thought-provoking take on a board’s duty to monitor diversity  training by co-blogger Stefan Padfield, click here.)

Perhaps because of the federal government’s buying power, the U.S. Chamber of Commerce felt compelled to act. On October 15th, the Chamber and 150 organizations wrote a letter to the President stating:

As currently written, we believe the E.O. will create confusion and uncertainty, lead to non-meritorious investigations, and hinder the ability of employers to implement critical programs to promote diversity and combat discrimination in the workplace. We urge you to withdraw the Executive Order and work with the business and nonprofit communities on an approach that would support appropriate workplace training programs ...  there is a great deal of subjectivity around how certain content would be perceived by different individuals. For example, the definition of “divisive concepts” creates many gray areas and will likely result in multiple different interpretations. Because the ultimate threat of debarment is a possible consequence, we have heard from some companies that they are suspending all D&I training.  This outcome is contrary to the E.O.’s stated purpose, but an understandable reaction given companies’ lack of clear guidance. Thus, the E.O. is already having a broadly chilling effect on legitimate and valuable D&I training companies use to foster inclusive workplaces, help with talent recruitment, and remain competitive in a country with a wide range of different cultures. … Such an approach effectively creates two sets of rules, one for those companies that do business with the government and another for those that do not. Federal contractors should be left to manage their workforces and workplaces with a minimum amount of interference so long as they are compliant with the law.

It’s rare for the Chamber to make such a statement, but it was bold and appropriate. Many of the Business Roundtable signatories are also members of the U.S. Chamber, and on the same day, the BRT issued its own statement committing to programs to advance racial equity and justice. BRT Chair and WalMart CEO Doug McMillon observed,  “the racial inequities that exist for many Black Americans and people of color are real and deeply rooted . .  These longstanding systemic challenges have too often prevented access to the benefits of economic growth and mobility for too many, and a broad and diverse group of Americans is demanding change. It is our employees, customers and communities who are calling for change, and we are listening – and most importantly – we are taking action.” Now that's a stakeholder maximization statement if I ever heard one.

Those who thought that some CEOs went too far in protesting the Muslim ban, may be even more shocked by the BRT’s statements about the police. The BRT also has a subcommittee to address racial justice issues and noted that “For Business Roundtable CEOs, this agenda is an important step in addressing barriers to equity and justice . . . This summer we took on the urgent need for policing reform. We called on Congress to adopt higher federal standards for policing, to track whether police departments and officers have histories of misconduct, and to adopt measures to hold abusive officers accountable. Now, with announcement of this broader agenda, CEOs are supporting policies and undertaking initiatives to address several other systems that contribute to large and growing disparities.”

Now that stakeholders have seen so many of these social statements, they have asked for more. Last week, a group of executives from the Leadership Now Project issued a statement supporting free and fair elections. However, as Bennett Freeman, former Calvert executive and Clinton cabinet member noted, no Fortune 500 CEOs have signed on to that statement. Yesterday, the Interfaith Center on Corporate Responsibility (ICCR) sent a letter to 200 CEOs, including some members of the BRT asking for their support. ICCR asked that they endorse:

  1. Active support for free and fair elections
  2. A call for a thorough and complete counting of all ballots
  3. A call for all states to ensure a fair election
  4. A condemnation of any tactics that could be construed as voter intimidation
  5. Assurance that, should the incumbent Administration lose the election, there will be a peaceful transfer of power
  6. Ensure that lobbying activities and political donations support the above

Is this a pipe dream? Do CEOs really want to stick their necks out in a tacit criticism of the current president’s equivocal statements about his post-election plans? Now that JPMorgan Chase CEO Jamie Dimon has spoken about the importance of respect for the democratic process and the peaceful transfer of power, perhaps more executives will make public statements. But should they? On the one hand, the markets need stability. Perhaps Dimon was actually really focused on shareholder maximization after all. Nonetheless, Freeman and others have called for a Twitter campaign to urge more CEOs to speak out. My next post will be up on the Friday after the election and I’ll report back about the success of the hashtag activism effort. In the meantime, stay tuned and stay safe.

October 23, 2020 in Contracts, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Employment Law, Ethics, Financial Markets, Human Rights, Legislation, Management, Marcia Narine Weldon, Nonprofits, Stefan J. Padfield | Permalink | Comments (1)

Thursday, October 22, 2020

Nibbling Around the Edges With Minor Expungement Changes

With the comment period closing today, the SEC will consider a FINRA proposal to make some relatively minor changes to how the current process for expunging public records works.  In my comment letter, I explained that changes simply don't do anywhere near enough to address the core problem underlying the current, fundamentally broken expungement process. In essence, the Proposal’s expungement process improperly relies on an adversarial system to surface information relevant to whether customer dispute information should be expunged.  This adversarial system fails to function in any reliable way because expungement hearings generally proceed as one-sided affairs which are functionally ex parte proceedings.  In these functionally ex parte proceedings, arguments and evidence submitted by brokers seeking expungement never receive any real scrutiny by anyone well-situated to carefully consider these expungement requests.  When arbitrators recommend expungement, courts—which are generally precluded from closely reviewing the underlying arbitration absent the rarest of circumstances—then confirm the arbitration awards.  Judicial review under these circumstances provides no meaningful check on this process and only serves as a dubious veneer. 

To help the Commission see that these expungement hearings often have little resemblance to the sort of adversarial proceeding one would expect in arbitration, I pointed out that in expungement-only arbitrations, law firms often sue their own clients to obtain expungements for brokers employed by their brokerage firm clients.  State ethics rules generally prohibit lawyers from suing their own clients unless all clients involved specifically consent to the conflict.  And even then, the ethics rules prohibit a lawyer from representing both the claimant and the respondent at the same time in an adversarial proceeding.  (But that hasn't prevented it from happening within the FINRA arbitration forum.  One arbitration award reveals that a lawyer represented both the claimant and the respondent in the same proceeding.) As a practical matter, clients are only likely consent to being sued by their own lawyers when lawsuit somehow benefits them.

Expungement-only or "straight-in" arbitrations deviate from how we ordinarily expect adversarial proceedings to go.  Consider a typical fact pattern.  A customer loses a large amount of money after following a broker's investment advice.   The customer, believing that the commission-compensated broker gave unsuitable advice, complains about it or files an arbitration claim against the brokerage firm.  The brokerage firm may even settle the suit for a significant amount of money.  The rough allegations in the complaint and any settlement amount or arbitration outcome go into a public database so that other investors and regulators can know that another investor complained and whether any settlement ensued.

Later, the broker decides to seek an expungement.  The broker will file an arbitration claim against the brokerage and allege that the customer's claim was "false," that the broker had nothing to do with the complaint, or that the complaint was simply factually impossible.  In essence, the broker files an arbitration calling the customer a liar and names the brokerage employer as the respondent.  Together, the broker and the brokerage will select the arbitrator who will hear the case.  Each of them may strike up to four arbitrators off the ten arbitrator list FINRA provides and rank the remaining arbitrators.  If they cooperate, they can effectively control which arbitrator will be selected to hear the case.  (Surprise, arbitrators who grant expungements hear many, many expungement cases.). 

Under current FINRA guidance, the parties will send the customer some kind of notice about the expungement proceeding and letting the customer know that the customer can participate if they want, but that they have no obligation at all to participate.  This will be the first time the customer might learn that his former financial adviser has called him or her a liar.  My review of some of these letters left me with the distinct impression that the lawyers drafting these notice letters would prefer it if customers didn't participate.  (Surprise, customers only participate in about 1 out of 7 expungement hearings).  The letter often does not plainly state that the broker plans to convince an arbitrator that the customer is a liar.  It doesn't say anything outright false, but figuring out that the broker will call the customer a liar generally takes some reading.  After all, most people would not know that they were being called liars if they received a letter saying that "a broker has filed an arbitration proceeding under the industry arbitration code and now seeks to modify or remove certain information from the Central Registration Depository pursuant to FINRA Rule 2080."

The new changes will make some difference, but it's mostly just nibbling around the edges.  FINRA won't allow the parties to strike and rank arbitrators for expungement hearings any more.  It will require the broker to actually show the arbitrator the letter it used to notify the customer.  It'll require a majority vote by a three-arbitrator panel.  It'll put some time limits in place so that brokers can't wait years and years before seeking an expungement.  It'll make some other changes.

But there are many things the proposal won't do.  It won't address common customer barriers to participation.  It won't provide a lengthy notice period so customers can figure out what is going on and get legal help. It won't even guarantee customers can receive all of the documents filed in these arbitrations.  It won't make it clear that these proceedings are really ex-parte proceedings and that all advocates must be held to higher standards in them.  It won't change the system in any truly significant way.  It burdens the customer with protecting the public record at the customer's expense.

Ultimately, what this does is simply continue the problem.  It will likely allow FINRA to politely kick the can down the road for another five years and say that it has made changes in response to criticism and that it will continue to monitor the process and make further changes if they become necessary.  Fixing this problem has not been an urgent priority.  FINRA's proposals were filed about a month ago after taking a lengthy period to digest the comments FINRA received after putting out a notice in 2017.

As it stands, we know that the current expungement system is not set up in a way that is likely to surface information necessary for an arbitrator to make an informed recommendation on expungement.  These changes do not significantly alter that reality.  You should not trust BrokerCheck alone when looking up a financial professional.  You'll need to also check the arbitration award database to see if there have been expungements.  Even then, you won't learn everything you should have been able to see.  But at least you'll know that you should be more cautious.  After all, one study found that brokers receiving expungements were more than three times as likely to engage in future misconduct as the average broker.

October 22, 2020 | Permalink | Comments (0)

Wednesday, October 21, 2020

New MOU Between the CFTC and BoE Related to Derivatives Clearing

Yesterday, the CFTC and the Bank of England signed a Memorandum of Understanding on the Cooperation and the Exchange of Information Related to the Supervision of Cross-Border Clearing Organizations. Heath Tarbert, the Chairman of the CFTC, and Jon Cunliffe, deputy governor for financial stability at the Bank of England, also authored an opinion piece published in Risk.  It notes that the UK is “the single largest investor in the US,” and that the US “is the largest investor in the UK.”  The two jurisdictions account for about 80% of the global market activity for interest rate derivatives. 

The global clearing mandates that followed the financial crisis of 2007-09 have increased the importance of cross-border financial market infrastructures such as clearinghouses and also the potential for these infrastructures to propagate risks throughout global financial markets.  The opinion notes that “The long-lasting significance of these reforms was seen when the Covid-19 pandemic sent shockwaves through the world’s financial markets earlier this year.  The largest dollar moves in history were recorded for the S&P 500, Dow Industrial Average and Nasdaq-100.  The FTSE All-Share index fell more than 10% on March 12.  Despite this market turmoil and a transition to a work-from-home model, the central counterparties at the heart of this activity remained resilient.” 

That’s great news.  Ideally, this will be indicative of the future performance of these global, cross-border infrastructures.  However, should a clearinghouse become distressed or insolvent in either jurisdiction and taxpayer funds required, I think it would be helpful to have a better understanding of how any taxpayer losses would be shared not only between the U.S. and the U.K., but also with any other relevant jurisdictions.  Recall that “[t]he largest recipients of AIG bailout funds were European banks, Wall Street firms and, to a lesser degree, municipal governments,” and it was AIG’s near collapse that largely motivated the clearinghouse mandates.               

October 21, 2020 | Permalink | Comments (0)

Tuesday, October 20, 2020

More Misidentified LLCs, Plus Lagniappe

I was today years old when I learned that the California courts have a group of cases captioned the "Franchise Tax Board Limited Liability Corporation Tax Refund Cases."  This is distressing.  

In that case, the court explains: "This coordinated litigation involves the remedies available to certain limited liability companies (LLCs) that paid a levy pursuant to section 17942 of the Revenue and Taxation Code which was later determined by this District to be unconstitutional."  Fran. Tax Bd. Ltd. Liab. Corp. Tax Refund Cases, 235 Cal. Rptr. 3d 692, 697 (Cal. App. 1st Dist. 2018), reh'g denied (Aug. 6, 2018), review denied (Oct. 31, 2018) (emphasis added).  We can see clearly that rhe courts knows these are limited liability companies, and not limited liability corporations. Nonetheless, for eternity, when citied, these cases will refer to limited liability corporations. See, e..g, Union Band Wage & Hour Case v. Union Bank, B295835, 2020 WL 6018545, at *18 (Cal. App. 2d Dist. Oct. 9, 2020) ("Their reliance on Franchise Tax Board Limited Liability Corp. Tax Refund Cases (2018) 25 Cal.App.5th 369, 395-396 does not support their position."). 

Another recent case makes a similar mistake, thought it seems to have gotten a lot of other things right.  A Louisiana court explained: 

Robinson argues that, pursuant to La. R.S. 12:1320(B), as the manager of HLN, a limited liability corporation, Robinson is not liable, in solido, with HLN. Moreover, Robinson argues that Appellant mischaracterized the claim in an attempt to “resurrect” a prescribed tort claim. This Court, in Streiffer v. Deltatech Constr., LLC, explained that “[a] limited liability company is a business entity separate from its members and its members’ liability is governed solely and exclusively by the law of limited liability companies. ‘The fact that a person is the managing member of a limited liability company and/or has a significant ownership interest therein does not in itself make that person liable for its debts.’ ” 2018-0155, pp. 7-8 (La. App. 4 Cir. 10/10/18), ––– So.3d ––––, 2018 WL 4923559, writ denied, 2018-2107 (La. 2/18/19), 263 So.3d 1154 (internal citations omitted). Pursuant to La. C.C. Art. 24, limited liability companies, such as HLN, and its members, such as Robinson, are considered wholly separate entities. Ogea v. Merritt, 2013-1085, p. 6 (La. 12/10/13), 130 So.3d 888, 894-95. Further, pursuant to La. R.S. 12:1320(B), “no **11 member, manager, employee, or agent of a limited liability company is liable in such capacity for a debt, obligation, or liability of the limited liability company.” Further, pursuant to La. R.S. 12:1320(C), “[a] member, manager, employee, or agent of a limited liability company is not a proper party to a proceeding by or against a limited liability company, except when the object is to enforce such a person's rights against or liability to the limited liability company.” Based on the record before us, Robinson, as a manager of the limited liability company, cannot be liable, in solido; Appellant offered no evidence to rebut the general rule of limited liability.

Thomas v. Hous. Louisiana Now, L.L.C., 2020-0183 (La. App. 4 Cir. 9/30/20) (emphasis added). Other than the limited liability corporation thing, this is about right.  An individual who is a member of an LLC may have some independent liability (respondent inferior) by his or her actions in tort or through veil piercing, but they are not liable for the torts of the entity merely by being a member or manager.  Here the court notes that no evidence was offered to suggest otherwise.  Thus, the rest of the assessment is spot on.  

One other interesting note for those not familiar with Louisiana's civil law origins: the reference to a "prescribed tort claim" is a reference to an attempt to a cause of action for which the statute of limitations had run.  My first job as a law clerk was with a New Orleans law firm, and while I had went to Tulane, I took the common law curriculum. My first assignment was related to a "prescription issue," which sounded like a property law claim to me. Fortunately, the assigning attorney quickly clarified that for me. 
 I figured I'd add a little some extra -- lagniappe -- beyond a mere rant about people not accurately describing LLCs. 

October 20, 2020 in Corporations, Joshua P. Fershee, LLCs | Permalink | Comments (1)

Monday, October 19, 2020

The Federalist Society's National Lawyers Convention will be November 9-13, 2020.

Lots of virtual events that should be of interest to our readers, including the "Showcase Discussion" on Thursday 11/12 from 11:00 a.m. – 12:15 p.m.: A Discussion with Professors Robert George and Cornel West on Freedom of Speech, Freedom of Thought, the Black Lives Matter Movement, and the Cancel Culture. You can find the full schedule and register here.

October 19, 2020 in Stefan J. Padfield | Permalink | Comments (0)

Padfield on the Duty to Monitor Diversity Training

I have posted an essay over at Law & Liberty (here) that uses the Marchand case as a jumping off point for inquiring into a duty to monitor diversity training. The essay is an early summary of an on-going project. Comments are welcome.

October 19, 2020 in Stefan J. Padfield | Permalink | Comments (0)

Saturday, October 17, 2020

McClane on the Governance Effects of Securitization

Professor Jeremy McClane’s paper, Reconsidering Creditor Governance in a Time of Financial Alchemy, was just published by the Columbia Business Law Review and it’s a doozy.  His thesis is that lenders play an important role in corporate governance by imposing a degree of fiscal discipline on firms’ decisionmaking.  But when loans are securitized, lenders have fewer incentives to exercise control.  By analyzing SEC filings, he finds evidence to suggest that after firms violate financial covenants with lenders, the ones with nonsecuritized loans improve their performance and operate more conservatively, but the ones with securitized loans do not, implying that lenders intervened to force changes in the former category but not the latter.

The upshot: Lenders play an important role in corporate governance, with a view toward curbing the kind of short-term behavior that is often criticized from a stakeholder perspective (i.e., quick payouts that can make the firm more unstable and ultimately harm employees).  Securitization has therefore removed an important constraint on predatory behavior.

October 17, 2020 in Ann Lipton | Permalink | Comments (1)

Wednesday, October 14, 2020

Professors Shaner and Nili on Reclaiming Shareholder Democracy Through Virtual Annual Meetings

I recently had the pleasure of hearing my OU colleague Professor Megan Shaner present her interesting and timely new article, Back to the Future? Reclaiming Shareholder Democracy Through Virtual Annual Meetings (with Professor Yaron Nili).  What an important topic, especially in these unusual times!  An abstract is below:

From demanding greater executive accountability to lobbying for social and environmental policies, shareholders today influence how managers run American corporations. In theory, shareholders exert that influence through the annual meeting: a forum where any shareholder, large or small, can speak their mind, engage with the corporation’s directors and managers, and influence each other. But today’s annual meetings, where a widely diffused group of owners often vote by proxy, are largely pro forma: only handful of shareholders attend the meeting and voting results are largely determined prior to the meeting. In many cases, this leaves Main Street investors’ voice unspoken for.

But modern technology has the potential to resurrect the annual meeting as the deliberative convocation and touchstone of shareholder democracy it once was. COVID-19 has forced most American corporations to hold their annual meetings virtually. Virtual meetings allow shareholders to attend meetings at a low cost, holding the promise of re-engaging retail shareholders in corporate governance. If structured properly, virtual meetings can reinvigorate the annual meeting, reviving shareholder democracy while maintaining the efficiency benefits of proxy voting.

The Article makes three key contributions to the existing literature. First, using a comprehensive hand collected dataset of state reactions to COVID-19 and of all annual meetings held between March 11 and June 30, 2020, it offers a detailed empirical account of the impact that COVID-19 and the move to virtual annual meetings had on shareholder voting. Second, it uses the context of COVID-19 to show how modern-day annual meetings have drifted away from its democratic function. Finally, the Article argues that technology can revive the shareholder democracy goals of annual meetings, and underscores how virtual meetings can meet that important goal.

October 14, 2020 | Permalink | Comments (1)

Roe & Shapira on the stories we tell ourselves to insulate corporate executives from stock-market accountability.

Mark Roe & Roy Shapira have posted The Power of the Narrative in Corporate Lawmaking on SSRN (here).  Here is the abstract:

The notion of stock-market-driven short-termism relentlessly whittling away at the American economy’s foundations is widely accepted and highly salient. Presidential candidates state as much. Senators introduce bills assuming as much. Corporate interests argue as much to the Securities and Exchange Commission and the corporate law courts. Yet the academic evidence as to the problem’s severity is no more than mixed. What explains this gap between widespread belief and weak evidence?

This Article explores the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation — the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion — disparate types of corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as being truly and primarily short-termism phenomena emanating from truncated corporate time horizons (when they in fact emanate from other misalignments), thereby making us view short-termism as even more rampant and pernicious than it is; and (3) confirmation — the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters who benefit from its repetition.

The Article then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray. For example, a favorite remedy for stock-market-driven short-termism is to insulate executives from stock market pressure. If lawmakers believe that short-termism is a primary cause of environmental degradation, anemic research and development, employee mistreatment, and financial crises — as many do — then they are likely to focus on further insulating corporate executives from stock-market accountability. Doing so may, however, do little to alleviate the underlying problems, which would be better handled by, say, stronger environmental regulation and more astute financial regulation. Powerful narratives can drive out good policymaking.

October 14, 2020 in Stefan J. Padfield | Permalink | Comments (0)

Defining the Closely Held Corporation for Purposes of Oppression-Related Relief

       Hope everyone is doing ok these days.  I have found that by lowering my expectations for myself, I manage to feel a great deal of accomplishment.  For example, so long as I shower 15 minutes before my 2:30 pm class (yes, pm), I give myself a hearty pat on the back.

       (Just kidding by the way.  I am almost always showered by 2:00 pm.  [Winky-face emoji if I could do it.])

       In working on some presentations with Professor Daniel Kleinberger, I spent some time looking at how statutes and judicial decisions have defined the closely held corporation for purposes of offering oppression-related relief.  I wrote up some of my preliminary findings below, which you may (or may not) find interesting.  This is just a draft, so please excuse any errors:

      The cause of action for oppression is designed to provide relief to minority shareholders in closely held corporations. That said, jurisdictions differ in how they define the corporations that are subject to the oppression action, which in turn creates differences in the shareholders who are eligible for oppression-related protection.

      In jurisdictions with dissolution-for-oppression statutes, some provide no limitation on the types of corporations that fall within the statutory coverage. As literally written, in other words, these statutes extend the protection of the oppression doctrine to shareholders in any corporation—whether closely held or not.[1] In other jurisdictions, the statutory coverage is limited to corporations with shares that are not publicly traded.[2] These statutes seem more directly tailored to the shareholders that the oppression doctrine was designed to protect—i.e., shareholders in corporations that lack a market exit at a fair price.

      Some statutes focus more on the number of shareholders in the company. New Jersey, for example, provides an oppression action only for corporations with 25 or fewer shareholders.[3] Others set forth a more generally applicable oppression action, but then provide additional oppression-related grounds to corporations with less than a specified number of owners.[4] Still other statutes link the oppression action to “statutory close corporations”—i.e., corporations that qualify and elect to use the jurisdiction’s supplemental statutory provisions for closely held corporations.[5] Georgia, for example, provides an oppression action only for statutory close corporations.[6] In other states, the statutes set forth a more generally applicable oppression action, but then provide additional oppression-related grounds (or remedies) for statutory close corporations.[7]

      In jurisdictions following a fiduciary duty approach, there are relatively few decisions that attempt to define a closely held corporation for the purpose of determining whether the oppression doctrine should apply. In Donahue v. Rodd Electrotype Co., the Supreme Judicial Court of Massachusetts imposed a fiduciary duty between shareholders of a “close corporation.”[8] The court also defined “close corporation” as follows:

      In previous opinions, we have alluded to the distinctive nature of the close corporation, but have never defined precisely what is meant by a close corporation. There is no single, generally accepted definition. Some commentators emphasize an “integration of ownership and management,” in which the stockholders occupy most management positions. Others focus on the number of stockholders and the nature of the market for the stock. In this view, close corporations have few stockholders; there is little market for corporate stock. The Supreme Court of Illinois adopted this latter view in Galler v. Galler, 32 Ill.2d 16, 203 N.E.2d 577 (1965): “For our purposes, a close corporation is one in which the stock is held in a few hands, or in a few families, and wherein it is not at all, or only rarely, dealt in by buying or selling.” We accept aspects of both definitions. We deem a close corporation to the typified by: (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation.[9]

      While it is true that closely held corporations typically have a small number of shareholders and substantial shareholder participation in management, it is widely believed that the lack of exit rights is the primary cause of the oppression problem and the need for judicial oversight.[10] Thus, most courts that use a shareholder-to-shareholder fiduciary duty to police oppressive conduct would likely consider the lack of a market for the corporation’s shares to be the determinative factor in whether the corporation is subject to the oppression doctrine. As one authority observed:

            . . . [T]he term “close corporation” means a corporation whose shares are not generally traded in the securities markets even if ownership and management do not completely coalesce. This definition seems to be most nearly in accord with the linguistic usages of the legal profession. For instance, lawyers do not commonly exclude a corporation from the category of close corporations solely because some of its shareholders are not active in management.[11]


[1] The Arkansas dissolution-for-oppression statute, for example, states simply that a court “may dissolve a corporation . . . [i]n a proceeding by a shareholder, if it is established that . . . the directors or those in control of the corporation have acted, are acting, or will act in a manner that is . . . oppressive . . . .” Ark. Code § 4-27-1430(2)(ii). The statute does not limit the term “corporation” in any manner. Accord Haw. Rev. Stat. § 414-411(2)(B); Tenn. Code § 48-24-301(2)(B); Utah Code § 16-10a-1430(2)(b).

[2] See, e.g., Mich. Comp. Laws § 450.1489 (providing that “[a] shareholder may bring an action . . . to establish that the acts of the directors or those in control of the corporation are . . . willfully unfair and oppressive to the corporation or to the shareholder,” but stating that “[n]o action under this section shall be brought by a shareholder whose shares are listed on a national securities exchange or regularly traded in a market maintained by 1 or more members of a national or affiliated securities association”); N.Y. Bus. Corp. Law § 1104-a (allowing shareholders who own twenty percent or more of the company and who are entitled to vote for directors to petition for dissolution on the grounds of “oppressive actions” so long as the corporation is not “registered as an investment company” and has “no shares . . . listed on a national securities exchange or regularly quoted in an over-the-counter market by one or more members of a national or an affiliated securities association”); see also La. Rev. Stat. § 12:1-1435 (providing that “[i]f a corporation engages in oppression of a shareholder, the shareholder may withdraw from the corporation and require the corporation to buy all of the shareholder's shares at their fair value,” but stating that “[t]his Section shall not apply in the case of a corporation that, on the effective date of the withdrawal notice . . . has shares that are covered securities under Section 18(b)(1)(A) or (B) of the Securities Act of 1933, as amended.”).

Before 2006, the dissolution-for-oppression provision of the Model Business Corporation Act provided no limitation on the types of corporations that fell within its statutory coverage. See Model Bus. Corp. Act § 14.30(a)(2) (2005). In 2006, however, the provision was made unavailable to corporations with shares that are:

(i) a covered security under section 18(b)(1)(A) or (B) of the Securities Act of 1933; or

(ii) not a covered security, but are held by at least 300 shareholders and the shares outstanding have a market value of at least $20 million (exclusive of the value of such shares held by the corporation’s subsidiaries, senior executives, directors and beneficial shareholders and voting trust beneficial owners owning more than 10% of such shares).

Id. § 14.30(b) (2006). This 2006 amendment seems designed to limit the oppression action to corporations lacking a market exit at a fair price. Indeed, comment 2 to the present § 14.30 states that “[s]hareholders of corporations that meet the tests of section 14.30(b) may often have the ability to sell their shares if they are dissatisfied with current management.” See also Miss. Code § 79-4-14.30 (substantially the same as the Model Act).

[3] See N.J. Stat. § 14A:12-7(1)(c).

[4] See, e.g., Alaska Stat. § 10.06.628 (allowing “a shareholder or shareholders who hold shares representing not less than 33 ⅓ percent of the total number of outstanding shares” to petition for dissolution on various grounds, including “persistent unfairness toward shareholders” and “liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder,” but stating that the latter ground is only available in corporations with 35 or fewer shareholders); Cal. Corp. Code §§ 158, 1800 (substantially the same). 

The Minnesota dissolution-for-oppression statute allows a shareholder to bring an action when “the directors or those in control of the corporation have acted in a manner unfairly prejudicial toward one or more shareholders in their capacities as shareholders or directors of a corporation that is not a publicly held corporation, or as officers or employees of a closely held corporation.” Minn. Stat. § 302A.751. “Publicly held corporation” is defined as “a corporation that has a class of equity securities registered pursuant to section 12, or is subject to section 15(d), of the Securities Exchange Act of 1934.” Id. § 302A.011 subd. 40. Closely held corporation is defined as “a corporation which does not have more than 35 shareholders.” Id. § 302A.011 subd. 6a. Thus, allegations of oppressive conduct against a shareholder in his capacity as a shareholder or director may be asserted in any Minnesota corporation that lacks publicly traded shares. If the allegations of oppressive conduct are against a shareholder in his capacity as an officer or employee, however, the corporation cannot have more than 35 shareholders.

[5] To “qualify,” a corporation generally must have less than the maximum number of shareholders prescribed by the statute, and to “elect,” a corporation typically must include a statement in its articles that designates itself as a close corporation. See, e.g., Del. Code tit. 8, §§ 342-344 (30 or fewer shareholders); Ga. Code § 14-2-902 (failing to provide a limit on the number of shareholders for new companies electing to be statutory close corporations, but providing a 50-shareholder maximum for existing companies electing this status).

[6] See, e.g., Ga. Code § 14-2-940(a)(1).

[7] See, e.g., Wyo. Stat. § 17-16-1430(b) (stating that any corporation may be dissolved on the grounds that “[t]he directors or those in control of the corporation have acted, are acting, or will act in a manner that is . . . oppressive . . .”); id. § 17-17-140(a) (stating that a shareholder of a statutory close corporation may petition the court for dissolution or alternative relief on the grounds that “[t]he directors or those in control of the corporation have acted, are acting, or will act in a manner that is . . . oppressive . . . or unfairly prejudicial to the petitioner, whether in his capacity as shareholder, director or officer of the corporation”). Other states following this pattern include Missouri, Montana, and Wisconsin. See Mo. Stat. §§ 351.494(2)(b), 351.850-.865; Mont. Code §§ 35-1-938(2)(b), 35-9-501 to -504; Wis. Stat. §§ 180.1430(2)(b), 180.1833.

[8] See supra notes XX and accompanying text.

[9] Donahue v. Rodd Electrotype Co., 328 N.E.2d 505, 511 (Mass. 1975) (citations omitted).

[10] See supra note XX.

[11] 1 Close Corporations, supra note XX, § 1:3.

October 14, 2020 | Permalink | Comments (0)