Business Law Prof Blog

More Beliefs: Director Primacy and Public and Private Companies

Yesterday, Prof. Bainbridge annotated my "creed" on corporate governance, and I appreciated his take. In fact, many of his chosen sources would have been mine.

In a later footnote, he noted that he was not sure what I meant by my statement: "I believe that public companies should be able to plan like private companies . . . ." I thought I'd try to explain. 

My intent there was to address my perception that there is a prevailing view that private companies and public companies must be run differently.  Although there are different disclosure laws and other regulations for such entities that can impact operations, I'm speaking here about the relationship between shareholders and directors when I'm referencing how public and private companies plan. 

Public companies generally have far more shareholders than private companies, so the goals and expectations of those shareholders will likely be more diverse than in a private entity. Therefore, a public entity may need to keep multiple constituencies happy in a way many private companies do not.  However, that is still about shareholder wishes, and not the public or private nature of the entity itself.  A private company with twenty shareholders could crate similar tensions for a board of directors.

As an example, consider Investopedia's description of Advantages of Privatization in an article called "Why Public Companies Go Private" (emphasis added):

Private-equity firms have varying exit time lines for their investments depending on what they have conveyed to their investors, but holding periods are typically between four and eight years. This horizon frees up management's prioritization on meeting quarterly earnings expectations and allows them to focus on activities that can create and build long-term shareholder wealth. Management typically lays out its business plan to the prospective shareholders and agrees on a go-forward plan. 

This is often a practical reality, but I disagree (or at least believe it should not be the case) that a company must be private to "free up management's prioritization on meeting quarterly earnings expectations and allows them to focus on activities that can create and build long-term shareholder wealth."  

This, I think, connects with Prof. Bainbridge's point in his footnote annotation 4, where he says, "I think too many hedge funds are pressing too many boards to pursue short-term gains at the expense of sustainable long-run shareholder wealth maximization and, accordingly, that boards need more insulation from shareholder pressure." I agree completely with his point there, and that's the kind of issue facing public companies that I was intending to address in my assertion.  

Ultimately, director primacy means ensuring a large measure of director autonomy (or insulation). This works in both directions, whether it relates to short- versus long-term planning or providing workplace benefits (or not). Ensuring a robust business judgment rule as an abstention doctrine preserves director primacy, and in the long run, will benefit corporate governance and shareholder choice.  

The "Daily Fantasy Sports" Marketplace Is Booming, But Is It Legal?

Over the past few weeks I have posted extensively on how gambling laws treat commercial NCAA Tournament pools.  However, March Madness pools are not the only form of online sports gaming proliferating on the Internet.  Indeed, play-for-cash "daily fantasy sports" contests have recently become big business.  Even the National Basketball Association is now a shareholder in one of these ventures (FanDuel).

With the legal status of "daily fantasy sports" still relatively unsettled, it is my pleasure to announce the online publication of sections 1-4 of my newest law review article "Navigating the Legal Risks of Daily Fantasy Sports: A Detailed Primer in Federal and State Gambling Law."   This article explores the legal status of "daily fantasy sports" in light of both federal and state gambling laws, and explains why the legal status of such contests likely varies based on both contest format and states of operation.

The full version of this article will be published in the January 2016 edition of University of Illinois Law Review.  In the interim, I welcome any thoughts or comments.

Thanks to My Research Assistant

When I write a law review article, I usually include in the author’s footnote a brief note of thanks to the student research assistants who helped me on that article. When I write a book, I thank my research assistants in the preface.

My research assistant also helps me from time to time with research related to this blog. (Yes, I actually research some of the things I write on this blog. Hard to believe, isn’t it?) Blogs don’t have prefaces or author’s footnotes, so there’s no convenient way to acknowledge his help. I decided to give him his own blog post.

My thanks to Stephen Knudsen, University of Nebraska College of Law Class of 2015, for the assistance his has given me over the past year on this blog. (He is, of course, totally responsible for anything I wrote that you found objectionable or wrong.) The two or three people who read what I write here are now aware of his contribution and he can provide the link to his parents, almost doubling my usual readership.

The Supreme Court Building in Legos

I saw this in Utah over spring break and I just had to share it with our readers: the Supreme Court building made out of Legos.

This was part of an extensive Lego exhibit that also included the White House, the Capitol, and the Washington Monument, among other familiar D.C. monuments. If you have a child that likes Legos, a lot of time, and a lot of money for the Legos, feel free to try this at home. What better way for a lawyer or law student to teach a child about the Supreme Court?

The darling model next to the building is my five-year-old granddaughter Payton, something of a Lego expert herself. Thanks to Sandy Placzek for the photography. (Grandpa has too much fun playing with the grandchildren to spend time taking pictures.)

ICYMI: Tweets From the Week (Mar. 29, 2015)

"paucity of ... instruction ... on broad conceptions of the purpose of the corporation has important ramifications" http://t.co/VKUyRUSf8D

— Stefan Padfield (@ProfPadfield) March 22, 2015

ICYMI: "S&P 500...companies referencing GRI guidelines in their sustainability reports increased...to 31% in 2014" http://t.co/foz5vZPjhr

— Stefan Padfield (@ProfPadfield) March 25, 2015

UK's Top Boardrooms Look Set To Hit 25% Women Target http://t.co/QPfe9JgRwJ via @forbeseurope #CorpGov #diversity

— Dina Medland (@dinamedland) March 25, 2015

the data, suggests "that compensation results from 'rent extraction' by CEOs" http://t.co/0jhdTVdcYR #corpgov

— Stefan Padfield (@ProfPadfield) March 26, 2015

Does the Trans-Pacific Partnership Agreement subordinate "national interests to those of multinational corporations"? http://t.co/WbpOxkYRzA

— Stefan Padfield (@ProfPadfield) March 28, 2015

Omnicare – It’s Still About Civil Procedure

On Tuesday, the Supreme Court finally issued its decision in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund (.pdf), concerning the definition of “opinion falsity” in the context of a lawsuit under Section 11 of the Securities Act.

Joan described the case in more detail here, but the basic issue was, what does it mean for a statement of opinion to be false?  Or, to ground it more in the facts of Omnicare, if the company files a registration statement - as Omnicare did - that claims that the company "believes" its contracts are in compliance with the law, is that statement false when the DoJ sues for Medicaid fraud?

The defendants argued that opinion statements - such as a "belief" in legal compliance - can only be false if they falsely represent the speaker’s belief, i.e., if the speaker did not really believe that Omnicare was in compliance.  If the speaker did believe in such compliance, then even if that belief was unfounded or turned out to be false, the statement itself would be literally true.  

The plaintiffs agreed that statements of opinion may be false if the speaker misrepresents his or her own opinion, but also argued that opinions may be false for other reasons.  For example, according to the plaintiffs, an opinion statement is false if the statement has no reasonable basis, regardless of the subjective beliefs of the speaker.  So in Omnicare's case, its statement about legal compliance would be false if it did not bother to investigate whether its contracts were in compliance with the law, or if it ignored information that suggested the contracts were not in compliance.

In general, the case was pitched as a dispute about the continuing viability of Section 11 as a strict liability statute.  Section 11, 15 U.S.C. §77k, provides that issuers are strictly liable for false statements in registration statements, and signatories of the registration statement are liable unless they demonstrate that they conducted a reasonable investigation of those statements.  So, if Omnicare prevailed in its argument that belief statements are only false if the speaker misstates his own belief, it would, as a practical matter, require the plaintiffs to demonstrate that the speaker intentionally misled investors, thus importing a scienter requirement into Section 11.  The effect would be particularly pronounced because there is a great deal of slipperiness regarding what counts as an opinion statement in the first place.

Ultimately, the Supreme Court adopted a standard that fit within the framework advocated by the plaintiffs, although the Court used a narrower formulation.  The Court agreed with the defendants that statements of opinion can only be false if disbelieved by the speaker – if the speaker misstates his or her own belief – but then went on to hold that such statements may be misleading if they omit material information.  Such as, if they omit the fact that the speaker had no basis for the belief he or she purported to hold and failed to conduct any investigation into the matter.  It depends on context and delicate inferences yadda yadda yadda, but a registration statement is a formal document and investors are likely to assume that statements of belief contained therein are the product of a reasonable investigation, etc.

But none of this is what the case was really about.

[More under the cut]

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Commissioner Dan Gallagher on Twitter

Plenty of valuable information was shared today at Vanderbilt's 17th annual law & business conference, including remarks from Elisse Walter (former-SEC Chairman), Jim Cox (Duke), Bob Thompson (Georgetown), Amanda Rose (Vanderbilt), and others.

The most immediately useful information, however, might be the fact that SEC Commissioner Dan Gallagher, our luncheon speaker, is on Twitter. In academic and other circles, Commissioner Gallagher garnered a great deal of attention due to his controversial article co-authored with Joseph Grundfest (Stanford) entitled "Did Harvard Violate Federal Securities Law? The Campaign Against Classified Boards of Directors."

Below is a recent Tweet from Commissioner Gallagher for those who would like to follow him.

My statement from this a.m.'s open mtg re Reg A+. I'm very excited about what this rule will do for small biz. http://t.co/C51EGq9oRR

— Dan Gallagher SEC (@DanGallagherSEC) March 25, 2015

Developing Areas of Capital Market and Federal Securities Regulation at Vanderbilt Law School

After teaching my early morning classes, I will spend the rest of the day at Vanderbilt Law School for their Developing Areas of Capital Market and Federal Securities Regulation Conference.

This is Vanderbilt's 17th Annual Law and Business Conference and they have quite the impressive lineup, including Commissioner Daniel Gallagher, Jr. of the U.S. Securities and Exchange Commission. 

I am grateful to the Vanderbilt faculty members who invited me to this event and others like it. Vanderbilt is only about 1 mile from Belmont and I have truly enjoyed getting to know some of the Vanderbilt faculty members and their guest speakers.

Corporations, the State, and the Rule of Law- Call for Papers

Below is a call for papers and description of a weeklong project on business and human rights. If you are interested, please contact one of the organizers below. I plan to participate and may also be able to answer some questions.

Lat Crit Study Space Project in Guatemala

Corporations, the State, and the Rule of Law

We are excited to invite you to participate in an exciting Study Space Project in Guatemala. Study Space, a LatCrit, Inc. initiative, is a series of intensive workshops, held at diverse locations around the world. This 2015 Study Space project involves a 7 working day field visit to Guatemala between Saturday June 27 (arrival date) and Saturday July 4, 2015 (departure date).  We are reaching out to you because we believe that your interests, scholarship, and service record align well with the proposed focus of our trip.

This call for papers proposes a trip to Guatemala to study more closely the phenomena of failed nations viewed from the perspective of the relationship of the state of Guatemala with corporations. With the recent surge of Central American unaccompanied minors and children fleeing with their mothers, the United States has had to confront the human face of children and women whose claim to asylum or other immigration relief is rooted in the dire reality that the countries from which they flee cannot or will not protect them. Largely, these fleeing migrants are escaping violence perpetuated by private actors, at times gang members or even their own parents or spouses. Their stories of flight cannot be disengaged from the broader context in which the violence occurs. Theirs is also the story of failed nations, characterized by ineptitude, weakness, and even worse, indifference or at times even complicity.

This story of failed nations applies beyond the reign of private “rogues” whom everyone agrees are bad actors (i.e., gangs, drug traffickers, violent criminals). The other side of the coin, invisible in this new wave of Central American refugees, is a more nuanced story about the failing role of some of these Central American nations in regulating the acts of corporations, whether owned by the oligarchy or operated by transnational actors. Corporations are entities with great potential to promote and further the public good, such as through job creation and economic development. Corporations, however, can also be the cause of social ills, particularly when left unregulated or at times even supported by the state to pursue private interests that conflict with the public good. In Guatemala, examples of deeply problematic unregulated arenas abound-- from the lack of antitrust legislation to the absence of meaningful environmental protections to protect even the most precious of natural resources, such as water. There is also the misuse of public institutions and laws to shield corporations from their public and fiscal responsibility or to aid them in capitalizing on public goods, including minerals or land. Ironically, here, the state apparatus functions quite effectively to exert its authority in the execution of laws. The failure, however, rests in the illegitimacy of law, not in its execution.

Guatemala is a nation that is experiencing tremendous social upheaval from the acts of corporations on issues that include mining, water uses, deforestation, genetically modified seeds, free-trade zones, and maquiladoras, to name a few. Caught between the state and corporations are the communities most deeply affected by both the absence and the presence of law in ways that appear to conflict with the public interest. The questions that arise include how law can and should restore the balance between the promotion of investment and economic development with the protection of the public interest and the preservation of the public good. These inquiries also involve issues related to the protection of rights, whether of individuals or communities in the collective, including the right to self-determination, the right to food and water, or the right to dignified work.

The purpose of this trip is not to single out Guatemala for scrutiny. The reality is that the bilateral and multilateral relations that Guatemala is forced to sustain with other more powerful nations aggravate many of its pressing problems. Questions about Guatemala’s regulation of corporations must also address the relationship between the powerful transnational forces of globalization and the domestic laws of Guatemala, including those related to trade liberalization and intellectual property. This inquiry must also acknowledge how the absence of accountability of transnational corporations operating in Guatemala in the corporation’s own nation-state – including the power these corporations have to influence law-making-- should lead us to a discussion of shared responsibility and a proposal for solutions that are transnational and international in character.

Should you decide to participate, you would be encouraged and welcomed to suggest specific topics (and field visits) you would like to be included as part of this project. While we are still working on a precise itinerary (which you can help us shape), our projected goals right now are to visit with government officials, non-profits, community groups and the private sector with a special focus on labor and environment. The trip would include time in Guatemala City but also time in key rural sectors. For example, we are planning to visit a transnational mining site and the free-trade zone where maquiladoras are concentrated in Guatemala. As part of the trip, we will include orientations and debriefings with the group so we can share knowledge, impressions, and insights as the trip progresses. 

The cost of your participation (excluding flight) is $1,900.  This fee will cover housing, food, in-country transportation, conference space, and other fees that we will pay such as to translators, community groups assisting with logistics, and a modest fee to Luis Mogollón (a Guatemalan lawyer with significant law school academic program development experience in Guatemala) who will spend countless hours making this trip safe and enjoyable for all of us.  The flight to Guatemala from the United States should range between $600 to $800. 

Our aim is to publish essays from this project as a book in Spanish and English. We hope to have between 15-20 contributions. While ideally participants will speak Spanish, we can accommodate non-Spanish speakers (or those who only speak “un poquito”) and will hire interpreters to work with you during the trip to Guatemala.  Keep in mind that you may need to conduct some research in Spanish (at least for primary sources) depending on the focus on your project. We also hope to present papers about this project at several conferences upon the completion of our project, including at LatCrit, Inc. and ideally in Guatemala.

The organizing Committee is comprised of Raquel Aldana, Associate Dean for Faculty Scholarship at Pacific McGeorge School of Law; Steven Bender, Associate Dean for Research and Faculty Development at Seattle University School of Law; José R. Juárez, Professor of Law and Director of the Spanish for Lawyers Program at the University of Denver, Sturm College of Law; Beth Lyon, Director of the Farmworker Legal Aid Clinic and Professor of Law at Villanova University School of Law; Mario Mancilla, Technical Assistant of the Secretariat of Environmental Matters, CAFTA-DR; Luis Mogollón, Adjunct Professor and Consultant of the Inter-American Program from Pacific McGeorge; Rachael Salcido, Professor of Law at Pacific McGeorge School of Law; and Enrique Sánchez-Usera, Chair of the Inter-Disciplinary Studies at the University of Rafael Landívar Law School.

Please do not hesitate to contact any of us with questions. We do hope you decide to join us in this great project.

 

 

NCAA Claims To Put Education Ahead of Profit. Really?

Last week, NCAA lawyers went into court seeking to reverse the U.S. District Court for the Northern District of California’s ruling in O’Bannon v. National Collegiate Athletic Association.  In that case, the district court had held that the NCAA member colleges illegally restrained trade under Section 1 of the Sherman Act when they colluded among other things, to keep college athlete compensation below the full cost of college attendance. 

Among the NCAA’s many legal arguments in seeking reversal was their claim that college athletics is exempt from the Sherman Act because amateurism, according to the NCAA, is driven by economic motives and not commercialism.  Although previous court decisions from the Third and Sixth Circuit seem to side with the NCAA’s argument on that point, other circuits have long rejected this contention and analyzed NCAA conduct in labor markets under the traditional Sherman Act.

Nevertheless, even to the extent there exists a split in the circuits on this important issue, it seems extraordinarily disingenuous for the NCAA lawyers to even make the argument that it prioritizes education over economics when considering the economic realities of the ongoing NCAA men’s basketball tournament.  In the past ten days alone, the NCAA has pocketed upwards $1 Billion from media rights and other revenues related to this single tournament tournament.  And, not only are the athletes unpaid, they are also going uneducated based on the NCAA’s attempt to maximize their own television revenues through midweek tournament games.

Through the first week of the NCAA men’s basketball tournament, athletes on many college basketball teams have already missed upwards of three class days.  While the NCAA elects to schedule midweek games in the early rounds to maximize its television revenues, the NCAA could easily recast the tournament with all teams playing back-t0-back games on Friday night and Saturday night much as all Ivy League teams do during the Ivy League’s regular season.

Making matters worse, the NCAA has once again scheduled its men’s college basketball championship game on a Monday night – requiring athletes on the two finalist teams not only to miss late-week classes, but also to miss Monday and Tuesday classes in that last round.  Indeed, while NCAA member schools make substantial money from the NCAA men’s basketball tournament, the athletes’ main “compensation” -- a minimum of at least six missed class days – places them substantially behind in the classroom on their way home.

Flipping Roles in the Securities Regulation Classroom

Today, part of the assignment for my Securities Regulation students was to read a chapter in our casebook and, as assigned by me, come to class prepared to teach in  a three-to-five-minute segment a part of the assigned reading.  The casebook is Securities Regulation: Cases and Materials by Jim Cox, Bob Hillman, and Don Langevoort.  The chapter (Chapter 7, entitled "Recapitalization, Reorganizations, and Acquisitions") covers the way in which various typical corporate finance transactions are, are not, or may be offers or sales of securities that trigger registration under Section 5 of the Securities Act of 1933, as amended (the "1933 Act").  I have used this technique for teaching this material before (and also use a student teaching method for part of my Corporate Finance course), and I really enjoy the class each time.

I find that the students understand the assigned material well (having already been through a lot of registration and exemption material in the preceding weeks) and embrace the responsibility of teaching me and each other.  I am convinced that they learn the material better and are more engaged with it because they have had to read it with a different intent driven by a distinct objective. For their brief teaching experience, each student needs to understand both the transaction at issue and the way in which it implicates, does not implicate, or may implicate 1933 Act registration requirements.  They do not disappoint in either respect, and I admit to being interested in their presentations and proud of them.

I also find that changing my role principally to that of a listener and questioner refreshes me.  I organize and orchestrate the general structure of the class meeting and come to class prepared with the knowledge of what needs to be brought out during the session.  But since I cannot control exactly what is said, I must listen and react and help create logical transitions and other links between the topics covered.  In addition, I can create visuals on the board to illustrate aspects of the "mini-lectures" (as I did today when a student was explaining a spin-off transaction).  I honestly have a lot of fun teaching this way.

There are, no doubt, many ways in which we can engage students in teaching course material in the classroom that may have similar benefits.  What are yours?  When and how do you use them to make them most effective?  Teach me!  :>)

Despite Low Oil and Gas Prices, the Energy Sector Is Relatively Healthy

The Economist has a helpful brief outline -- here -- of why oil prices are so low.  I continue to think that oil prices will stabilize in the $55-$65 range, but now that it's apparent that most Bakken oil is profitable around $42, I would not be surprised to see prices bounce around in that range periodically for a while, too. 

A few things to keep in perspective when you hear about how the energy sector is suffering: 

(1) It's not very often through the years that anyone would be upset by low energy prices.  That usually is a sign of good things to come in terms of markets because low energy prices can reduce costs of manufacturing, they tend to increase demand (in energy and beyond), and it tends to mean more money in consumers' pockets. Those are usually very good things. 

(2) Despite layoffs are some energy sector companies, and a dramatic slow down of drilling, if you looked back to 2005 0r 2006 (an even more recently) people would have been thrilled to see the sector with this many jobs. Even another 20-30% slow down represents a strong and viable industry.

(3) Legal work for the sector is likely to carry on at a strong pace. A slow down will mean a slower pace in many sectors, and mineral leasing and other title work will likely slow significantly, but slow downs can lead to increases in M&A, restructuring, and litigation. 

There are concerns, but it's always helpful to keep things in perspective. It's fair to raise questions and highlight the rapid changes, but it's not all gloom and doom.    

Macaroni & Cheers!

Today marks my return to blogging after a brief (3 weeks) respite, and what better way to be welcomed back than with news of a mega-merger?!?  Today, Kraft Foods, a publicly traded company, and H. J.Heinz, owned by Warren Buffett's Berkshire Hathaway and Brazilian private equity firm 3G, signed a multi-billion dollar merger agreement to create what will become the third largest food company in North America. 

Under the proposed merger Kraft shareholders will receive 49% of the stock in the newly merged company, plus a cash dividend of $16.50 per share, representing a reported 27% premium on Kraft's trading stock price as of Tuesday, March 24th which closed at around $61.33/share.  

The stock market reacted positively to the news with Kraft stock opening around $81/share and climbing up to $87 and settling down in the low $80's (it was trading at $82/share around 2:00 pm). You can track the stock price here.  The immediate bump in price casts some shadows on the Kraft stock premium agreed to in the deal.

Among the possible legal hurdles are antitrust concerns, but the deal doesn't raise red flags on its face given the little overlap between the two companies.

 

The bigger, and more interesting corporate governance question will be the Kraft shareholder approval process requiring a proxy statement.  Kraft Foods is a Virginia corporation (see Articles of Incorporation), and thus the merger and Kraft's shareholders' rights are governed by the Virginia Corporation Act.  Because Kraft is a public corporation, shareholders will not have appraisal rights under Va. Code Ann. § 13.1-730 (West) and those rights have not be altered in the Articles of Incorporation.  So the legal challenges, if any and given the size of the deal are likely, will have to assert that the transaction itself is flawed (either under duty of care or loyalty) or that the proxy process was defective in failing to disclose material information.  

-Anne Tucker

 

 

Faculty Lounge Mini-Symposium on Board Diversity

Over at the Faculty Lounge, Kim Krawiec (Duke) is hosting an interesting mini-symposium on board diversity entitled “What’s The Return On Equality?”

The posts to date are linked to at the bottom of this recent post.

The Illogic of Crowdfunding Resale Restrictions

The JOBS Act requires the SEC to create an exemption for small, crowdfunded offerings of securities. That exemption, if the SEC ever enacts it, will allow issuers to raise up to $1 million a year in sales of securities to the general public. (Don’t confuse this exemption with Rule 506(c) sales to accredited investors, which is sometimes called crowdfunding, but really isn’t.)

The crowdfunding exemption restricts resales of the crowdfunded securities. Crowdfunding purchasers may not, with limited exceptions, resell the securities they purchase for a year. Securities Act sec. 4A(e); Proposed Rule 501, in SEC, Crowdfunding, Securities Act Release No. 9470 (Oct. 23, 2013). Unlike the resale restrictions in some of the other federal registration exemptions, the crowdfunding resale restriction serves no useful purpose. All it does is to increase the risk of what is already a very risky investment by reducing the liquidity of that investment.

Enforcing the “Come to Rest” Idea

Some of the resale restrictions in other exemptions are designed to enforce the requirement that the securities sold “come to rest” in the hands of purchasers who qualify for the exemption.

Rule 147, the safe harbor for the intrastate offering exemption in section 3(a)(11) of the Securities Act, is a good example. To qualify for the intrastate offering exemption, the securities must be offered and sold only to purchasers who reside in the same state as the issuer. Securities Act sec. 3(a)(11); Rule 147(d). This requirement would be totally illusory if an issuer could sell to a resident of its state and that resident could immediately resell outside the state. Therefore, Rule 147(e) prohibits resales outside the state for nine months.

The resale restrictions applicable to the Rule 505 and 506 exemptions have a similar effect. Rule 506 only allows sales to accredited investors or, in the case of Rule 506(b), non-accredited, sophisticated investors. Rules 506(b)(2)(ii), 506(c)(2)(i). These requirements would be eviscerated if an accredited or sophisticated purchaser could immediately resell to someone who does not qualify.

Rule 505 does not limit who may purchase but, like Rule 506, it does limit the number of non-accredited investors to 35. Rules 505(b)(2)(ii), 501(e)(1)(iv). If an issuer could sell to a single purchaser who immediately resold to dozens of others, the 35-purchaser limitation would be meaningless.

To enforce the requirements of the Rule 505 and 506 exemptions, Rule 502(d) restricts resales in both types of offering.

Preventing an Information-less Resale Market

Rule 504 also includes a resale restriction, Rule 502(d), even though it does not impose any restrictions on the nature or number of purchasers. A resale would not, therefore, be inconsistent with any restrictions imposed on the issuer’s offering.

However, Rule 504 does not impose any disclosure requirements on issuers. See Rule 502(b)(1). Because of that, people purchasing in a resale market would not have ready access to information about the issuer. But the Rule 504 resale restriction does not apply if the offering is registered in states that require the public filing and delivery to investors of a disclosure document. Rules 502(d), 504(b)(1). In that case, information about the issuer is publicly available and there’s no need to restrict resales. People purchasing in the resale market would have access to information to inform their purchases.

The resale restrictions in Rule 505 and 506 offerings could also be justified in part on this basis. If issuers sell only to accredited investors in those offerings, there is no disclosure requirement. If they sell to non-accredited investors, disclosure is mandated, but even then there’s no obligation to make that disclosure public. See Rule 502(b). People purchasing in the resale market therefore would not have ready access to public information about the issuer.

This lack-of-information justification is consistent with the lack of resale restrictions in Regulation A. To use the Regulation A exemption, an issuer must file with the SEC and furnish to investors a detailed disclosure document. Rules 251(d), 252. Because of that, information about the issuer and the security will be publicly available to purchasers in the resale market.

The Crowdfunding Exemption

Neither of these justifications for resale restrictions applies to offerings pursuant to the forthcoming (some day?) crowdfunding exemption.

The come-to-rest rationale does not apply. The crowdfunding exemption does not limit the type or number of purchasers. An issuer may offer and sell to anyone, anywhere, so no resale restriction is necessary to avoid circumvention of the requirements of the exemption.

The information argument also does not apply. A crowdfunding issuer is required to provide a great deal of disclosure about the company and the offering—as I have argued elsewhere, probably too much to make the exemption viable. See Securities Act sec. 4A(b)(1); Proposed Rule 201 and Form C. The issuer is also obligated to file annual reports with updated information. Securities Act sec. 4A(b)(4); Proposed Rule 202. All of that information will be publicly available. Even if one contends that the information required to be disclosed is inadequate, it will be no more adequate a year after the offering, when crowdfunding purchasers are free to resell. Securities Act sec. 4A(e); Proposed Rule 501.

Some people, including Tom Hazen and my co-blogger Joan Heminway, have argued that resale restrictions may be necessary to avoid a repeat of the pump-and-dump frauds that occurred under Rule 504 when Rule 504 was not subject to any resale restrictions. As I have explained, Rule 504, which requires no public disclosure of information, fits within the information rationale. Such fraud is much less likely where detailed disclosure is required. There will undoubtedly be some fraud in the resale market no matter what the rules are, but public crowdfunding will be much less susceptible to such fraud than the private Rule 504 sales in which the pump-and-dump frauds occurred.

Conclusion

The resale restrictions are consistent with neither the come-to-rest rationale nor the information rationale for resale restrictions Forcing crowdfunding purchasers to wait a year before reselling therefore serves no real purpose. The only real effect of those resale restrictions is to make an already-risky investment even riskier by reducing liquidity.

ICYMI: Tweets From the Week (Mar. 22, 2015)

Mere puffery? "91% of the FTSE100 refer in their annual reports to their high standards of business ethics" http://t.co/qXqula2KdR #corpgov

— Stefan Padfield (@ProfPadfield) March 17, 2015

Under Newman, unless "the tippee is particularly loquacious, sub-tippees will never be liable" http://t.co/yr6Y0sGvIE

— Stefan Padfield (@ProfPadfield) March 18, 2015

"when a duty of care breach is not the exclusive claim, a court may not dismiss based upon an exculpatory provision" 2002WL31584292 #corpgov

— Stefan Padfield (@ProfPadfield) March 18, 2015

"securities fraud class actions should be litigated as derivative actions" http://t.co/rA0GHmZTW1 #CorpGov

— Stefan Padfield (@ProfPadfield) March 20, 2015

SEC Chair on "the current state of shareholder activism; the shareholder proposal process; and fee-shifting bylaws" http://t.co/TMQbyNaJDt

— Stefan Padfield (@ProfPadfield) March 21, 2015

Not exactly about the firm's wealth maximization

The UAW Retiree Medical Benefits Trust recently won a battle with Gilead and Vertex to have those companies include on their proxy statements proposals to require them to explain to shareholders the risks of their drug pricing decisions.

Basically, both Gilead and Vertex have come under fire recently for charging extremely high prices for new drugs.  There's an argument, of course, that this is simply a bad business decision - if your customers can't afford your drugs, they won't buy them.  And that's the official basis for the Trust's proposal.  The Trust describes, for example, how Sanofi was once forced to dramatically cut drug prices because the initial prices were set unrealistically high.

But I find it very hard to believe that the UAW Retiree Medical Benefits Trust is genuinely concerned about drug pricing in its capacity as a shareholder seeking maximum returns.  Instead, it seems far more likely that the Trust's concern is, you know, drug prices.  That it has to pay.  For its beneficiaries.  And it's using its status as shareholder of several pharmaceutical companies to try to influence policy in that regard.  The fact that the SEC is allowing the proposal to be included on the companies' proxies suggests that the SEC is not terribly concerned about that possibility (unlike Delaware, which does not want shareholders to pursue their own idiosyncratic agendas).

It reminds me of the AFL-CIO's earlier objection to Wall Street banks' practice of paying deferred compensation to executives to leave to go to government.  From a wealth max perspective, you'd think this would be an awesome thing for shareholders - which means the AFL-CIO's objections were not really rooted in concern about the banks' financial performance, but in its broader political concerns about the practice.   But the SEC didn't have a problem with that - it refused to allow Goldman to exclude the proposal.

Manufactured Consent

So, I repeatedly threatened that I’d eventually post a summary of my paper on arbitration clauses in corporate governance documents – and well, now you’re all finally being subjected to it.

This post was originally published at CLS Blue Sky blog, but I've made some minor edits and added a new introduction.

For many years, commenters have argued that at least some shareholder disputes can and should be arbitrated, rather than litigated, and that this could be accomplished by amending the corporate “contract” – namely, its charter and/or its bylaws – to require arbitration.  The possibility was raised in articles by John Coffee and Richard Shell in the late 1980s,[1] and the idea has resurfaced many times since then, including this year by Adam Pritchard.[2]  For almost as long as the idea has been kicked around, there have been warnings that if arbitration clauses are “contractually” binding by virtue of their presence in corporate governance documents, then they may be subject to the Federal Arbitration Act (FAA), which would preempt state attempts to regulate/oversee their use.  Coffee discussed that possibility in his 1988 piece on the subject[3]; more recently, Barbara Black[4] and Brian Fitzpatrick[5] have sounded further alarms.

For foes of shareholder litigation, this is a feature, not a bug; though they rarely say so explicitly, whenever anyone relies upon FAA cases to justify the insertion of arbitration clauses in corporate charters and bylaws, they are implicitly advocating the idea that not only are charters and bylaws “contracts” for FAA purposes, but that federal law requires their enforcement, regardless of the preferences of the chartering state.  After the Supreme Court decided AT&T Mobility LLC v. Concepcion,[6] the notion was particularly powerful, because it meant that corporations would be free to use arbitration clauses to require that shareholder claims be brought on an individual, rather than class, basis.  Given the economics of shareholder litigation, this would almost certainly mean the death of most shareholder lawsuits.

And that’s where my paper comes in.   

[More under the cut]

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Sports and Business

Last week, I wrote sports and the problems that could arise from a myopic focus on winning.

I promised to attempt to tie that post to business this week, but because I am running to a lunch meeting and then to the Belmont v. Virginia NCAA tournament basketball game viewing party, I am going to keep this short.

(Also, please indulge a little more bragging about my school. Before the game even begins, I am already incredibly proud of our basketball team. Belmont won the academic bracket for the NCAA tournament teams this year, which is based on academic measures like Academic Progress Rate (APR) and Graduation Success Rate (GSR)).

Anyway, I think there are a number of parallels between sports and business. Sports, done the right way, can teach many valuable lessons, such as the importance of teamwork, diligence, unselfishness, strategy, preparation, etc. In fact, team sport participation was one of the things I looked for when interviewing for law students when I was in practice and it is something I look for now when interviewing research assistants. 

As mentioned in last week's post, sports can lead participants off-track if there is a myopic focus on winning that trumps certain overriding principles. Similarly, a myopic focus on profits in business, without adherence to certain legal rules and ethical principles, can lead individuals and companies astray. What the overriding principles should be, and the appropriate level of focus on profits, are two difficult questions that all businesses should attempt to address.   

Wolf Packs, Corporate Cocaine, and Activist Hedge Funds- Sharfman adds his view

Bernard Sharfman has posted a new article entitled “Activist Hedge Funds in a World of Board Independence: Long-Term Value Creators or Destroyers?" In the paper he makes the argument that hedge fund activism contributes to long-term value creation if it can be assumed that the typical board of a public company has an adequate amount of independence to act as an arbitrator between executive management and the activist hedge fund. He also discusses these funds’ focus on disinvestment and attempts to challenge those in the Marty Lipton camp, who view these funds less charitably. In fact, Lipton recently called 2014 “the year of the wolf pack.” The debate on the merits of activist hedge funds has been heating up. Last month Forbes magazine outlined “The Seven Deadly Sins of Activist Hedge Funds,” including their promotion of share buybacks, aka “corporate cocaine.” Forbes was responding to a more favorable view of these funds by The Economist in its February 7, 2015 cover story.

Whether you agree with Sharfman or Lipton, the article is clearly timely and worth a read. The abstract is below:

Numerous empirical studies have shown that hedge fund activism has led to enhanced returns to investors and increased firm performance. Nevertheless, leading figures in the corporate governance world have taken issue with these studies and have argued that hedge fund activism leads to long-term value destruction.

In this article, it is argued that an activist hedge fund creates long-term value by sending affirming signals to the board of directors (Board) that its executive management team may be making inefficient decisions and providing recommendations on how the company should proceed in light of these inefficiencies. These recommendations require the Board to review and question the direction executive management is taking the company and then choosing which path the company should take, the one recommended by executive management, the one recommended by the activist hedge fund or a combination of both. Critical to this argument is the existence of a Board that can act as an independent arbitrator in deciding whose recommendations should be followed.

In addition, an explanation is given for why activist hedge funds do not provide recommendations that involve long-term investment. There are two reasons for this. First, the cognitive limitations and skill sets of those individuals who participate as activist hedge funds. Second, and most importantly, the stock market signals provided by value investors voting with their feet are telling the rest of the stock market that a particular public company is poorly managed and that it either needs to be replaced or given less assets to manage. These are the kind of signals and information that activist hedge funds are responding to when buying significant amounts of company stock and then making their recommendations for change. Therefore, it is not surprising that the recommendations of activist hedge funds will focus on trying to reduce the amount of assets under current management.