Saturday, February 16, 2019

Limiting securities claims in the corporate governance documents - no, we're not done with this yet

Where we left things, Delaware Vice Chancellor Laster had just ruled in Sciabacucci v. Salzberg that Delaware corporate charters and bylaws may only govern matters of corporate internal affairs, including litigation related to internal affairs; they may not be used to govern external matters like securities litigation.  For that reason, forum-selection provisions purporting to require that Section 11 claims be filed in federal court were invalid.  The implication – though not part of his holding – was that a similar result would obtain for charter and bylaw provisions that purport to require individualized arbitration of securities claims

After that, the defendants, predictably, appealed to the Delaware Supreme Court, and we were all waiting (im)patiently to see how that would unfold when – alas! – a panel consisting of Strine, Vaughn, and Seitz dismissed the appeal as prematurely filed due to a pending attorneys’ fee petition in Chancery. 

Speaking as someone who once did in fact have to litigate the issue of whether a notice of appeal was prematurely filed, thus depriving the appellate court of jurisdiction, all I can say is – oof!  Then again, in my case, the matter wasn’t raised until it was too late to file a corrected notice; if we’d lost, the entire appeal would have been lost.  Happily for the Sciabacucci defendants, their situation is not nearly as dire; presumably they’ll just refile their notice once the fee petition is addressed.  But it does mean it will be a little while longer before the Delaware Supreme Court weighs in on this issue.

But that’s not all!

Hal Scott, a law professor at Harvard, has long been an advocate for using corporate charters and bylaws to mandate individualized arbitration of federal securities claims, and in November, he submitted a 14a-8 proposal to Johnson & Johnson to have shareholders vote to request that its Board adopt such a bylaw.

In the past, the SEC has taken the position that bylaws of this sort would violate federal law, specifically, the anti-waiver provisions of the securities laws, but the Supreme Court’s recent jurisprudence on arbitration has weakened that argument.  Professor Scott presumably figured the time was ripe to try again, especially since SEC Commissioners have been making noises about being more receptive to the idea.  And indeed, when J&J first submitted a request for no-action relief to the SEC, its grounds for exclusion was simply that the proposal would violate federal law.

(You can find the correspondence at this link.)

But then Sciabacucci happened.  Except, J&J is incorporated in New Jersey, not Delaware, raising the question whether the Sciabacucci decision would travel.  (I previously posted about New Jersey’s law back when they amended their corporate code to permit forum selection provisions.)

J&J quickly submitted an attorney opinion letter expressing the view that NJ law maps to that of Delaware, and therefore the proposal was excludable as violative of state law.   Professor Scott shot back with the argument that Sciabacucci was incorrectly decided (previewing, I assume, arguments we can expect to see in the Delaware Supreme Court).

And then J&J brought in a ringer: It submitted a letter by New Jersey’s Attorney General opining that Sciabacucci represents the law of New Jersey.

(There were some other documents submitted as well, not all of which are included with the No-Action materials on the SEC’s website - which raises a procedural question, btw, why some and not others?  For example, NASAA submitted its own letter in support of J&J, and so did the Council of Institutional Investors.)

Since no-action relief is typically granted when there “appears to be some basis” for the company’s view that the proposal is excludable under 14a-8, you would think that that J&J had by now gone above and beyond.

But you would be wrong.

Because while the SEC did grant the no-action request, it did so with, shall we say, a reluctant air.  The SEC’s letter said:

When parties in a rule 14a-8(i)(2) matter have differing views about the application of state law, we consider authoritative views expressed by state officials. Here, the Attorney General of the State of New Jersey, the state’s chief legal officer, wrote a letter to the Division stating that “the Proposal, if adopted, would cause Johnson & Johnson to violate New Jersey state law.” We view this submission as a legally authoritative statement that we are not in a position to question. In light of the submissions before us, including in particular the opinion of the Attorney General of the State of New Jersey that implementation of the Proposal would cause the Company to violate state law, we will not recommend enforcement action to the Commission if the Company omits the Proposal from its proxy materials in reliance on rule 14a-8(i)(2). To conclude otherwise would put the Company in a position of taking actions that the chief legal officer of its state of incorporation has determined to be illegal.  In granting the no-action request, the staff is recognizing the legal authority of the Attorney General of the State of New Jersey; it is not expressing its own view on the correct interpretation of New Jersey law. The staff is not “approving” or “disapproving” the substance of the Proposal or opining on the legality of it. Parties could seek a more definitive determination from a court of competent jurisdiction.

We are also not expressing a view as to whether the Proposal, if implemented, would cause the Company to violate federal law. Chairman Clayton has stated that questions regarding the federal legality or regulatory implications of mandatory arbitration provisions relating to claims arising under the federal securities laws should be addressed by the Commission in a measured and deliberative manner.

That’s a lot of words!  I mean, literally, it’s a lot of words, considering that usually no-action relief is granted in a short paragraph. 

And it didn’t stop there.  SEC Chair Jay Clayton actually issued a statement on the matter, reiterating the importance of the Attorney General’s letter in the Commission’s decisionmaking, and emphasizing that the SEC itself was taking no position on the question whether such provisions violate federal law.  If anything, the statement went out of its way to signal that the SEC’s views on the federal legality of arbitration provisions have shifted; as Clayton put it, “Since 2012, when this issue was last presented to staff in the Division of Corporation Finance in the context of a shareholder proposal, federal case law regarding mandatory arbitration has continued to evolve.”

Such action is quite extraordinary as a matter of SEC procedure, especially the part where Clayton came close to inviting Professor Scott or a similarly-minded proponent to take the issue to court:

More generally, it is important to note that the staff’s Rule 14a-8 no-action responses reflect only informal views of the staff regarding whether it is appropriate for the Commission to take enforcement action.  The views expressed in these responses are not binding on the Commission or other parties, and do not and cannot definitively adjudicate the merits of a company’s position with respect to the legality of a shareholder proposal.  A court is a more appropriate venue to seek a binding determination of whether a shareholder proposal can be excluded.


It’s not clear where things go from here; the most obvious possibility would be to wait for the Delaware appeal (now, ahem, delayed) to shake out and/or find a state willing to break with Delaware on this issue (which then, I previously argued, might potentially tee up some constitutional questions about the scope of the internal affairs doctrine, though I think it also would depend a lot on how a case was brought.)

But according to news reports, Professor Scott may continue to pursue the matter at J&J, possibly by appealing to the full Commission (which seems unlikely to succeed, since we know where Clayton stands, and even Commissioner Peirce has said state law determines whether these bylaws are permissible). 

Either way, I’m sure I’ll be blogging about it, so watch this space.

Update: Prof. Scott did, in fact, request that CorpFin seek full Commission review of J&J’s request for no-action relief, arguing, among other things, that the New Jersey Attorney General conceded that there was no settled law in New Jersey on the issue and therefore his letter should not be taken as an authoritative interpretation of state law.  Prof. Scott also argued (as he did in his original correspondence) that if New Jersey law does prohibit his proposed bylaw, the Federal Arbitration Act would preempt it (an argument that I find quite unpersuasive, since the FAA only prohibits laws that disparately target arbitration; a rule that restricts charters and bylaws to matters of internal affairs does not single out arbitration, as the Sciabacucci case itself demonstrates). In a letter signed by the Director of CorpFin, the Division denied the request on the ground that, in light of the Attorney General’s letter, the issues presented were not “novel or highly complex” and therefore did not meet the standard for Commission resolution.  Correspondence available here.

Ann Lipton | Permalink


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