Saturday, November 16, 2019
I've frequently been asked to express a view on the spectacular decline of WeWork. Is there a broader lesson here? Or is this just a bizarre one-off?
I actually think there are a few lessons, and for this week’s post, I’ll start with the one about securities regulation and capital allocation.
One of the primary purposes of securities regulation is to ensure the efficient allocation of capital. See, e.g., John C. Coffee, Jr., Market Failure and the Economic Case for a Mandatory Disclosure System, 70 Va. L. Rev. 717 (1984); see also Benjamin Edwards, Conflicts and Capital Allocation, 78 Ohio St. L. J. 181 (2017). SEC Chair Jay Clayton recently gave a speech in which he emphasized that the SEC is “not in the business of dictating a company’s strategic capital allocation decisions,” which is true – the SEC’s job is not to tell market actors where or how to invest – but the SEC is responsible for creating a disclosure regime that facilitates efficient capital allocation via investors’ choices. And by that measure, the securities laws are failing.
As we all know, the securities laws – both through statutory revisions (JOBS Act) and regulatory interpretation – have made it easier for companies to raise capital without public disclosure. The theory is that wealthy, institutional investors can bargain for the information they need to make an intelligent investment decision. But – as others have pointed out – when capital is raised privately, optimistic sentiment can be expressed but negative sentiment cannot. I’ll go further: Because private-market investors are a small group, they have strong incentives to keep their negative opinions to themselves lest they be shut out of future deals. Meanwhile, mutual funds have made a deep dive into the private markets, and agency costs infect those decisions: active managers, hoping to improve their market relative to competitors, may well think it would be worse to miss out on a great deal than to make a bad bet that puts their fund on par with everyone else’s.
The result is a bubble of private company valuations that meets reality only when it comes time to go public, as recent experience has demonstrated. But the injuries are not experienced by these sophisticated investors alone; they’re experienced by all of the other actors whose lives are affected by the allocation of capital to doomed business models.
The New York Times just published an expose on the havoc SoftBank has wreaked internationally by dumping cash into unprofitable startups, which have then gone on to persuade small business owners and independent contractors around the world to upend their plans in hopes of opportunities that never materialize. Violent and/or fire-laden protests have resulted in Indonesia, India, and Colombia. Obviously, many of these investments were outside of the scope of American securities regulation, but not all of them, and they serve as a cautionary tale of the consequences when capital is allocated to poorly-designed businesses. In this, SoftBank is not alone; American venture capital firms have been pouring money into U.S. startups, well beyond amounts that the companies themselves have requested; some founders apparently feel that if they don’t accept venture capital money they don’t need, the VCs will simply invest in a competitor and drive them out of business. See also Sheelah Kolhatkar, WeWork’s Downfall and a Reckoning for SoftBank (“The fact that the Vision Fund flooded its companies with capital made it difficult for other startups or traditional companies with even a modicum of fiscal discipline to compete.”)
It’s not just the investors or even the founders who suffer; the effects are felt throughout the economy. SoftBank’s ill-considered bet on WeWork has upended real estate markets on two continents and that doesn’t even get into the effects on employees; even WeWork’s janitorial staff was paid in stock.
Now, I’ve argued that the securities disclosure regime should not be broadly interpreted to encompass the interests of all actors in society; securities disclosure is, at its core, for investors, and if we’re worried about other corporate constituencies – and we should be – we should design a disclosure system for their needs. But even within the confines of securities disclosure, efficient allocation of capital should be one of the central goals. And the overwhelming evidence is that, wherever the appropriate line between privatization and “publicization,” the American system has gone too far in the direction of the private.
Saturday, November 9, 2019
In recent years, there has been a lot of discussion over the problem of “common ownership,” namely, the fact that the giant institutional investors who dominate today’s markets tend to own stock in everything, and this may be a good thing but can also be bad if it encourages collusive behavior among competing firms linked by the same set of shareholders.
What has received less attention is the effect of common ownership on shareholder voting and corporate transactions. When a handful of large shareholders own stock in two merging partners – say, Tesla and SolarCity (not a hypothetical, incidentally) – they may vote for less-than-optimal deals on one side in order to benefit their holdings on the other side.
There are two implications to this: First, these cross-holdings may incentivize corporate managers to pursue nonwealth maximizing transactions when cross-holders are a significant part of the shareholder base (and may call into question the disinterestedness of large shareholders for Corwin cleansing purposes). And second, very often, these institutional shareholders are actually mutual funds, with cross-holdings not in a single fund, but in multiple funds across a fund family. Yet their voting patterns (or the actions of their portfolio firms) suggest that their influence is geared towards maximizing wealth across the family as though the investments were all part of a single portfolio, which is a potential violation of their duties to each individual fund.
I’ve written about both of these issues: the former in Shareholder Divorce Court (where I describe the Tesla situation) and the latter in Family Loyalty: Mutual Fund Voting and Fiduciary Obligation, but at the time, I only had a limited set of empirical studies to draw upon.
All of which is a long way of saying that two new studies were recently posted to SSRN, and they reach conclusions similar to those of the earlier studies.
First, there’s Dual-Ownership and Risk-Taking Incentives in Managerial Compensation, by Tao Chen, Li Zhang, and Qifei Zhu. They find that institutional investors who own stock and bonds in the same firm are more likely to favor managerial compensation policies that minimize incentives for risk-taking, as compared to institutional investors who own stock alone. Significantly, they find this effect at the mutual fund family level, suggesting that mutual funds are setting voting policy to maximize wealth at their funds collectively, without differentiating policies that might benefit some funds more than others.
Second, there’s Common Ownership and Competition in Mergers and Acquisitions, by Mohammad (Vahid) Irani, Wenhao Yang, and Feng Zhang. Similar to those who find that firms with common owners compete less in their product markets, the authors find that firms with common owners compete less in the takeover market, so that common ownership across potential acquirers of a target firm reduces the likelihood that the target will receive a competing bid, and increases returns to acquirers upon announcement of a bid (though the cross-ownership does not seem to effect target bid premiums or target returns). And, at least as I understand their methodology, these results are identified at the fund family level.
Anyhoo, this is a fascinating area and I very much hope we see more empirical work along these lines.
Saturday, November 2, 2019
It wasn’t terribly long ago (okay, fine, it was 23 years ago, I’m dating myself) when Friends aired this:
I’m guessing that depiction of stock trading was accurate for most people; it wasn’t that it was necessarily hard to open a brokerage account and trade, it was simply that most people didn’t quite understand the mechanics of how to go about it. Even with online trading, you still have to go out of your way to seek opportunities to trade. But what happens if stock trading is one of several simple options presented when people open up an app that they use every day?
That question is apparently about to be answered: Square, the payments app, recently announced that it will begin permitting free stock trades on its platform, setting itself up as a competitor to Robinhood. And the part that interests me isn’t simply the prospect of free trading, but the prospect of easy trading, accomplished with all the forethought of a candy bar purchase in the grocery check out aisle.
I suppose retail shareholders will never replace institutions for sheer size, but enough could enter the market to make some difference. Will their uninformed trades create new opportunities for hedge funds to profit – perhaps by reducing some of the distortions introduced by indexing? Will we see something like a “consumer premium,” whereby retail traders favor household names, companies they prefer because they patronize?
Will corporations try to cultivate retail shareholder bases? It is generally believed retail shareholders are more passive about voting, and more likely to vote with management when they do cast a proxy ballot; if the retail market surges, I can imagine corporations reaching out to these shareholders. Stock splits might come back in vogue, to attract retail investors who are disinclined toward impulse purchases of stocks priced in the $2000 range (even with the possibility of fractional trading).
Will we see a more vigorous effort to involve retail shareholders in the voting process? Will there be special mechanisms to enable retail shareholders to ask questions of executives on conference calls? Will we see more proxy solicitations like this one?
If we do, will retail shareholders use default voting arrangements and technological tools to oppose ESG related proposals? Or will an influx of casual retail shareholders result in greater ESG support? Will a cottage industry of retail proxy advisors sprout up – especially nonprofits with an agenda (i.e., “download the Sierra Club’s default voting instructions, compatible with the Square app!”)
If there are more retail shareholders in the market, will Delaware reconsider cases like Corwin, which are predicated on the existence of a highly institutionalized shareholder base?
I suppose it’s all a thought experiment for now but I do wonder how technological ease of stock trading has the potential to reshape the market.
Saturday, October 26, 2019
The Laundromat is Steven Soderbergh’s (and Netflix’s) loose adaptation of James Bernstein’s nonfiction book, Secrecy World: Inside the Panama Papers, illustrating the conduct facilitated by shell companies and the lawyers who supply the paperwork. Both in style and substance, it echoes Adam McKay’s The Big Short – which is why every. single. review. draws that comparison, and so will I – but sadly, I found it neither as entertaining nor as coherent.
The Laundromat takes the form of multiple vignettes regarding people whose lives are touched by the shell entities facilitated by the lawyers at Mossack Fonseca, with Gary Oldman and Antonio Banderas narrating as Mossack and Fonseca, respectively. They break the fourth wall as they offer tuxedo-clad, cynical descriptions of the services the firm provides.
Despite shoutouts to 1209 North Orange and its 285,000 companies – as well as the confession, I assume truthful, that Soderbergh has companies at that location – the film never really offers an explanation of precisely what shell companies do for their owners. That was one of the things I thought The Big Short attempted reasonably well: It took the complexity of the financial crisis and made a decent stab of explaining it in an entertaining way (my prior review here). The Laundromat tells us that these companies are stuffed with (illict) assets and that they offer privacy, but never goes further than that.
In fact, what explanations the film does offer are somewhat contradictory. We’re told that shell companies facilitate legal tax evasion, but the vignettes have nothing to do with tax evasion; they have to do with fraud, bribery, and other crimes. Moreover, multiple characters – including Mossack and Fonseca – end up in jail, so it’s clear that somebody did something illegal and the shell companies couldn’t protect them.
The truth, of course, is that shell entities have a variety of purposes, and can be used for both legal and illegal purposes, but that’s far too complex a story to portray on film, leaving The Laundromat’s explanations muddled and – from a pedagogical point of view – deeply disappointing.
At the same time, the movie doesn’t really stand on its own simply as a movie, divorced from the intricacies of the scandal that inspired it. The vignettes are half-finished, because they exist only as vehicles to illustrate the broader point about how wealthy people shield themselves from liability to the masses, which means that the failure to effectively so illustrate dooms the entire project.
Friday, October 18, 2019
I watched the Netflix documentary American Factory, about the labor relationships at a Chinese-owned auto glass factory in Dayton, Ohio. (For anyone unaware, the movie was produced by the Obamas). It’s a fascinating film for anyone interested either in business or labor issues.
The movie begins when the old GM plant is closed in the midst of the financial crisis, throwing thousands of people out of work. The plant is later purchased by Fuyao, a Chinese company. They’re hiring, but at much lower wages than the old factory, and they openly state they do not want any unionization. They are also sending over Chinese workers to work alongside the Americans. Despite the pay cut, American workers in this economically-depressed area are happy for the job; we can see the transformation made in people’s lives.
At first, the American workers and the Chinese workers bond; the Americans invite the Chinese over to parties, enjoy introducing them to American culture, and so forth. But the film then depicts something of a culture clash between the Americans and the Chinese.
The Chinese expect far more obedience from their workforce, longer working hours, and they seem baffled by American regulations – everything from environmental/safety to labor regulation. They openly state they want to hire younger workers (age discrimination!) and plan to fire labor organizers (labor violation!). Americans complain about unsafe working conditions and pollution, and obviously feel as that the Chinese supervisors – unfamiliar with American standards – are unsympathetic to their concerns. At one amusing/painful moment, the Chinese receive instructions from their supervisors about how American workers have unusually delicate sensibilities and need to be flattered into performing.
Later, in a jarring sequence, the American factory supervisors visit China. Among other things, workers regularly perform dangerous tasks without any safety equipment, and put on demonstrations of obedience and satisfaction, in sharp contrast to the increasing dissatisfaction of the American workers. Which isn’t to say the Chinese are necessarily any happier than the Americans – some Chinese workers talk about how they almost never get to see their families because of their long hours – but they are expected to put on a display of unity.
So there certainly are these cultural differences, which the film illustrates.
It does not actually strike me that in substance the Chinese-owned American factory is, in fact, run very differently than an American factory. Which is to say, the Chinese clearly are not sensitive to American laws, which is why they admit to extraordinarily illegal actions on camera; an American factory owner would be more savvy. But American bosses fire labor organizers, and violate safety laws, and demand unpaid overtime, and offer non-union laborers low wages, and replace workers with automation, all the time. In fact, to fight the labor agitation, the Chinese bring in an American consultant. Someone snuck a microphone into the meeting that the consultant held with the workers, and we hear all the standard lines from the anti-union playbook; none of this is unique to Chinese factory owners.
So while the framing device here is one of culture clash – and certainly the Americans and the Chinese experience it that way – it’s not clear that the substantive sources of disagreement would be any different no matter who owned the factory.
And that’s ultimately quite sad. Because we know from the start that the unionization effort is doomed, and the overall picture is one of an economic and legal system that simply is not designed to encourage that every single person be valued, and every single person be given a chance to flourish. Instead, the assumption underlying the system – in both countries – is that many human beings, perhaps most human beings, will be cogs in a larger machine, mere instruments to allow other people to thrive. On the American side, though, the rhetoric is at odds with that tragic reality.
Friday, October 11, 2019
When I begin teaching my Business students about corporations, I always start with a little information about Delaware. I tell them that Delaware has less than 0.3% of the U.S. population, it's physically the second smallest state in the country, and it has more registered businesses than people, among other facts.
Which is why I very much enjoyed reading Omari Simmons's paper, Chancery’s Greatest Decision: Historical Insights on Civil Rights and the Future of Shareholder Activism, which gave me a new appreciation for Delaware and its history. I was entirely unaware that one of the cases involved in the Supreme Court's famous Brown v. Board of Education decision was a ruling from Delaware Chancery. The paper gives a fascinating background of racial relations in the state and the events that led to Chancellor Seitz's ruling that Delaware's racially-segregated school system impermissibly discriminated against African-Americans. I'd had no idea of Delaware's involvement in the civil rights movement and I was delighted to learn of it. Here is the abstract:
This essay offers a historical account of the Delaware Court of Chancery’s greatest case, Belton v. Gebhart, a seminal civil rights decision. The circumstances surrounding the Belton case illuminate the limits and potential of shareholder activism to bolster civil rights in the modern context. They vividly illustrate how advancing civil rights requires a range of tactics that leverage public, private, and philanthropic resources. Shareholder activism works best as part of a multipronged activist strategy, not as a substitute for other types of activism. Examining a historical civil rights example is instructive for thinking about how shareholder activism might advance the modern civil rights agenda. Recognizing the complex challenges associated with advancing civil rights, this essay raises key questions about the nascent environmental, social, and governance (ESG) framework with which scholars, practitioners, and other observers must contend.
I guess the only thing I'll add is that, due to Chief Justice Strine's retirement, Governor Carney will be called upon to pick a successor, and many legal groups are urging that he consider a woman or person of color, given Delaware's heavily male, heavily white bench. I have no idea who the candidates are or the various considerations that will go into Governor Carney's decision; all I can say is that Delaware's judiciary is of unique national importance, and it would be gratifying to see it better reflect our country as a whole.
Friday, October 4, 2019
When the news came out that Volkswagen had used defeat devices in order to fool regulators into thinking that its cars complied with environmental standards, massive amounts of litigation followed, eventually consolidated into an MDL so sprawling that it literally took me over an hour – plus two calls to Bloomberg – just to get the docket sheet loaded on my computer.
One set of claimants are the bondholders who purchased in an unregistered 144A offering just before the scandal broke. These bondholders contend that the offering memoranda failed to disclose critical information about the regulatory risks Volkswagen faced, in violation of Rule 10b-5. They’ve just got one problem: They’d like to bring their claims as a class, but because the bonds did not trade in anything like an efficient market, they cannot make use of the fraud-on-the-market presumption of reliance. Instead, they’ve turned to Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972), which holds that when a fraud consists of omissions rather than misstatements, reliance may be presumed.
Now, the first issue is, what counts as an omissions-based fraud? The fraud here included affirmative misstatements, and usually that would be enough prevent the use of Affiliated Ute. See, e.g., Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017). However, in a recent opinion denying summary judgment to defendants, Judge Breyer of the Northern District of California ruled that in the Ninth Circuit, plaintiffs may invoke the Affiliated Ute presumption even when affirmative misstatements are in the mix, so long as the center of gravity of the case concerns an omission. See In re Volkswagen "Clean Diesel" Mktg., Sales Practices, & Prods. Liab. Litig., 2019 U.S. Dist. LEXIS 166832 (N.D. Cal. Sept. 26, 2019).
That’s intriguing enough on its own, because when I think of what kinds of cases are likely to be primarily about omissions, they’re likely to be what the defense bar is now calling “event driven litigation,” namely, the company did a bad bad thing, and concealed that fact, and the only misstatements are things like “we acted ethically” and “we’re in compliance with the law.” Treating those as Affiliated Ute cases could conceivably make them easier to bring, which, well, aside from annoying the defense bar, further blurs the line between cases based on mismanagement (not permitted under Rule 10b-5), and cases based on deception (which are). See Santa Fe Indus. v. Green, 430 U.S. 462 (1977). This is especially so because Judge Breyer does not explain exactly what was deceptive here if we’re focusing on the omissions rather than the misstatements. If failure to disclose really important bad things counts as deception, well, we may as well give up on Santa Fe* altogether. (These are issues I talk about a lot in my articles; if you’re interested, you can find discussions in Reviving Reliance, Slouching Towards Monell: The Disappearance of Vicarious Liability Under Section 10(b), and Searching for Market Efficiency).
But that’s actually not the part of the opinion I want to focus on. Because the Affiliated Ute presumption of reliance is rebuttable. If defendants can show that even if they had disclosed the relevant information, the plaintiff would still have invested, then the presumption of reliance falls away. And courts have held that when plaintiffs don’t even read the relevant documents, then, necessarily, disclosure would not have affected the plaintiffs’ behavior, so reliance is per se rebutted. QED. See Eckstein v. Balcor Film Investors, 58 F.3d 1162 (7th Cir. 1995); Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981).
Way back in my very first blog post here – I remember it like it was yesterday – we were all wondering whether the Supreme Court was going to overrule Basic and jettison the fraud-on-the-market doctrine entirely, and I was thinking about whether Affiliated Ute could work as a substitute. At the time, I asked:
I can’t help but wonder whether defendants have the right to rebut Affiliated Ute in situations where they would not or could not have disclosed the truth, such that the disclosure hypothetical is off the table. This could occur, for example, if the “truth” was that the defendants had engaged in antitrust violations, or other forms of illegal behavior….
If those cases came up in a world where fraud on the market is off the table, would courts accept Affiliated Ute in situations where disclosure was not an option, because it would be too devastating to the company or its managers?
And that is sort of what just happened in Volkswagen. Because the plaintiffs invoked Affiliated Ute, but naturally, the lead plaintiff couldn’t show its investment manager actually read the offering memoranda – because that never happens, and even if it had, an inquiry into the reading habits of all the investment managers in the class would make class certification impossible – and so the defendants claimed they had rebutted the Affiliated Ute presumption of reliance. At which point, Judge Breyer said:
In the run-of-the-mill omissions case, an investor’s failure to read the relevant disclosure documents could indeed be fatal. Having not read those documents, any additional disclosures in them would have been unlikely to come to the investor’s attention. As a result, it would be difficult for the investor to prove that he would have acted differently—and avoided the investment—if additional disclosures were made in those documents.
This is not a run-of-the-mill omissions case, however. The omitted facts detailed Volkswagen’s large-scale and long-running defeat-device scheme. When that scheme was disclosed to the public, in September 2015, it was front-page news and prompted congressional hearings, video apologies by Volkswagen executives, and hundreds of lawsuits. The disclosure also prompted Plaintiff’s investment manager to reevaluate Plaintiff’s investment in Volkswagen bonds and to sell those bonds for a loss within a month’s time.
If Volkswagen had disclosed its defeat-device scheme in its 2014 bond offering memorandum, instead of waiting until September 2015, the same publicity, and the same response by Plaintiff’s investment manager, would likely have followed. The scheme was so substantial and blatant that it is hard to fathom that its disclosure would have gone unnoticed by the investing public, and that Plaintiff’s investment manager would not have been made aware of it.
Assuming, then, that Volkswagen’s evidence demonstrates that Plaintiff’s investment manager did not read the offering memorandum prior to purchasing the bonds, that evidence alone is insufficient to establish beyond controversy that Plaintiff’s investment manager would not have attached significance to the omitted facts about Volkswagen’s emissions fraud if those facts had been disclosed in the offering memorandum. As a result, Volkswagen has not rebutted Affiliated Ute’s presumption of reliance.
In other words, the plaintiff “relied” on the omissions in the documents, in the sense that the plaintiff could assume from the absence of scandal surrounding Volkswagen at the time of purchase that there was nothing scandalous disclosed in the memoranda. And that’s enough to satisfy Affiliated Ute.
To be honest – and this is something I talk about in that original blog post, as well as in Searching for Market Efficiency – I actually think this is the correct interpretation of the original Affiliated Ute case. The distinction between omissions-based frauds and affirmative-frauds is an odd one until you remember the full context of Affiliated Ute. The Court was trying to get at the idea that some omissions are so huge that they go to the heart of the deal – of course you would assume those facts were not present, merely by the regularity of the transaction – and that’s when it would be absurd to make the plaintiffs bear the affirmative burden to prove reliance.
And in Judge Breyer’s view, a huge scandal that dominates headlines has that same kind of quality.
*Oh why not:
Friday, September 27, 2019
There is a lot going on in VC Slights’s new opinion in Tornetta v. Musk, refusing to dismiss a shareholder suit challenging Elon Musk’s eye-popping compensation package.
In Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), the Delaware Supreme Court held that, in the context of a squeeze-out merger, controlling shareholders can obtain business judgment review – rather than entire fairness – if they employ the dual protections of requiring the affirmative vote of a majority of the disinterested shares, and requiring that the deal be negotiated at the outset by a fully-empowered independent board committee.
Since then, there have been a lot of questions about MFW’s application, including whether MFW can/should be employed beyond the context of squeeze outs, which brings us to Tornetta.
Last year, Tesla granted Elon Musk a new compensation package that would award him as much as $55 billion in Tesla stock options, conditioned on achieving certain milestones. The package was approved by a vote of the unaffiliated Tesla stockholders, but did not satisfy the full set of MFW preconditions (i.e., it was not negotiated by an independent committee, etc). Thus, Tornetta filed a lawsuit challenging the award on the ground that (1) Musk is a Tesla controlling shareholder (2) the award is therefore an interested transaction subject to review for fairness and (3) the award was unfair. The claims were brought both directly and derivatively.
Now, the first interesting thing about this case is the number of issues that could have been raised on the motion to dismiss, but were not (though defendants may still raise them later).
Defendants could have, but did not, dispute that Musk was a controlling shareholder (likely because VC Slights previously concluded he was in a case challenging the Tesla/SolarCity merger – I’ll come back to that).
Defendants could have, but did not, dispute that the directors who approved the package were dependent on Musk.
Directors could have, but did not, move to dismiss for failure to make a demand on the board (more on that below).
Directors could have, but did not, move to dismiss on the ground that the claim could not be maintained as a direct action (again, more below).
As a result, the narrow question before Slights was simply whether stockholder approval alone can cleanse a compensation award to a controller, or whether instead MFW procedures are required. And he held that MFW procedures are always required when a controller’s interests conflict with those of the minority.
[More under the jump]
Friday, September 20, 2019
By now, regular readers of this blog are aware that I’ve been especially forceful in arguing that litigation limits in corporate charters and bylaws can only address matters of corporate internal affairs, and that federal securities claims are beyond their scope. Vice Chancellor Laster adopted a similar view in his Sciabacucchi v. Salzberg decision, where he invalidated charter provisions that purport to require that all Section 11 claims against the company be brought in federal court. Now that the matter is on appeal to the Delaware Supreme Court (Docket No. 346,2019) – and the opening brief is due today – a lot of articles about the scope of the internal affairs doctrine are dropping.
First up, we have Daniel B. Listwa & Bradley Polivka’s First Principles for Forum Provisions (Cardozo Law Review, forthcoming), in which the authors argue that Laster’s opinion erroneously focused on “territoriality” rather than “comity,” and that the suit should have been dismissed for lack of ripeness.
Next, there’s Mohsen Manesh with The Contested Edges of Internal Affairs (Tennessee Law Review, forthcoming), which explores the uncertainties surrounding the scope of the internal affairs doctrine, spotlighted both by the Sciabacucchi v. Salzberg decision and by California’s new board gender diversity mandate.
And then there’s The Limits of Delaware Corporate Law: Internal Affairs, Federal Forum Provisions, and Sciabacucchi, by Joseph Grundfest, which argues that Laster adopted a “novel” view of the internal affairs doctrine, inconsistent with both Delaware and U.S. Supreme Court precedent. This is interesting because his previous article, The Brouhaha Over Intra-Corporate Forum Selection Provisions: A Legal, Economic, and Political Analysis, 68 BUS. LAW. 370 (2013), co-authored with Kristen Savelle, stated that forum selection provisions “do not purport to regulate a stockholder’s ability to bring a securities fraud claim or any other claim that is not an intra-corporate matter” and that if they attempted to do so, courts could prevent it. That passage was relied upon by then-Vice Chancellor Strine in his decision upholding forum selection provisions that apply to state-law internal affairs claims in Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), and of course, Laster’s decision relied heavily on Boilermakers. In the new article, Grundfest acknowledges the tension and explains how his language has been taken out of context. See manuscript at n.345.
There’s also an interesting new empirical paper by Dhruv Aggarwal, Albert Choi, & Ofer Eldar, Federal Forum Provisions and the Internal Affairs Doctrine, which finds that after the Sciabacucchi v. Salzberg, firms with similar forum selection clauses in their constitutive documents experienced a stock price drop, suggesting that the market values such clauses. In light of these results, the authors argue that the internal affairs doctrine should be interpreted to permit them.
Point being, the Delaware Supreme Court has a lot of reading to do.
Saturday, September 14, 2019
Emily Strauss at Duke has posted a fascinating new paper, Crisis Construction in Contract Boilerplate (Law & Contemp. Probs., forthcoming). She examines how judges interpreted the boilerplate in RMBS contracts during the financial crisis, and finds that they relaxed their reading of certain provisions in order to enable injured investors to recover their losses, and then reverted to more strict readings when the crisis had passed.
Specifically, the RMBS contracts provided that the “sole remedy” available for loans that did not conform with quality specifications was for trust sponsors to repurchase the noncompliant loan. Of course, during the crisis, investors alleged that huge percentages of loans backing the trusts were noncompliant, and a loan-by-loan repurchase requirement would have been, as a practical matter, impossible to pursue. Strauss finds that judges interpreted the clause to permit investors to use sampling to identify noncompliant loans and claim damages, but only in the years following the crisis. By 2015, they reverted to a stricter reading of the contracts. She cites this an example of “crisis construction,” namely, the way that courts alter their readings of contracts during times of calamity in order to further some economic policy. (Strauss discusses that phenomenon in her paper, and Mitu Galati also describes it in this blog post spotlighting Strauss’s work ).
The part that really fascinates me, though, is how this trend strikes me as the opposite of what I experienced when I litigated these cases not as a matter of contract construction, but as a matter of securities law violations. As I posted a few years ago (with additional discussion here and here), I believe that courts adopted a narrow – and nonsensical – approach to class action standing when investors started suing en masse after the crisis, and they did so as a way of managing what would otherwise be incomprehensibly large liabilities for Wall Street’s major players. So I’m intrigued that when it came to securities liability, courts shut the door to plaintiffs, but when it came to contract liability, they opened it.
Saturday, September 7, 2019
A few weeks ago, we had an interesting opinion out of the 10th Circuit interpreting the scope of primary liability under Section 10(b) in the wake of the Supreme Court’s Lorenzo v. SEC decision. The short version is that in Malouf v. SEC, the Tenth Circuit found that scheme liability under Section 10(b) (and parallel provisions of Section 17(a) and the Investment Advisers Act) may be incurred when a defendant knowingly fails to correct someone else’s false statement. But matters are actually a bit more complicated.
More under the jump; warning, this post assumes basic familiarity with Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011) and Lorenzo. If you want that backstory, see this post on Janus and the Lorenzo cert grant and my discussion of the actual Lorenzo decision.
Saturday, August 31, 2019
Delaware Chancery court is apparently being dragged into the presidential race, via a new attack ad against Joe Biden. As reported by Shane Goldmacher, well:
NEW: Joe Biden about to get whacked on the Iowa and New Hampshire airwaves with an ad that also features Elizabeth Warren.— Shane Goldmacher (@ShaneGoldmacher) August 28, 2019
Spot paid for by an individual, Shirley Shawe, and is about the obscure Delaware Chancery Court.
There is so much to talk about here.
First, there’s the fact that the advertisement is misleading; Biden and Warren were apparently sparring about bankruptcy courts, not Chancery.
Second, there’s the fact that Biden – as a federal legislator – has no authority over Delaware Chancery.
Third, there’s the fact that while I won’t dispute that Delaware courts are too white, Delaware Chancery, at least, now has 3 women and 4 men. I’d be delighted to see more women on Chancery – and certainly the Delaware Supreme Court – but criticizing Chancery as too male is so last year.
Fourth, there’s the shifting numbers about the size of the ad buy; original reports said $500K, then the number was upped to $1 million, with print as well, and to be honest, I suspect that by blogging it I’m probably giving it the free attention that was the real aim.
But really the salient point is the identity of the buyer: Shirley Shawe, one of the litigants involved in the long-running TransPerfect dispute, tried before Chancellor Bouchard (which is why he is singled out for criticism in the advertisement).
TransPerfect was formed by Shirley Shawe’s son, Philip Shawe, and his one time-fiancee, Elizabeth Elting. They ended their romantic relationship but continued with the business. Elting had a 50% interest, and Philip Shawe a 49% interest, with 1% going to his mother so that the business as a whole could qualify as women-owned. Since Shirley always voted with her son, this meant that authority was split 50/50.
The business was successful but the working relationship was not, leading to prolonged and acrimonious litigation. Frankly, the Delaware opinions describing the fights between Shawe and Elting read more like a stalking complaint or domestic abuse than a business falling-out; among other things, Shawe was found to have hacked into Elting’s personal email, and – on two! occasions – hidden under her bed.
Ultimately, Chancellor Bouchard ordered that the company be sold, and Philip Shawe purchased it. The matter was not settled, though, because after that, the Shawes claimed that the Skadden partner who ran the auction “looted” the company.
Even today, the Shawes can’t let the matter go. From what I can glean, Shirley Shawe is involved with this nonprofit, formed in the wake of the TransPerfect dispute and devoted to criticizing the Delaware Chancery court (the group is not officially connected to Shawe, but this article describes her as a “driving force” behind it, and reports that she funded and starred in its advertisements). And now, of course, there’s this bizarrely irrelevant advertisement in the presidential race.
What the whole thing highlights, I think, is how business disputes that are tangled with family disputes don’t unfold like ordinary business matters, because the issues are far more personal. And business courts don’t really know how to address the family dynamics. That’s very much on display in TransPerfect, and it’s also the point of Allison Tait’s article, Corporate Family Law, 112 Nw. U. L. Rev. 1 (2017). Though she doesn’t talk about TransPerfect specifically, the situation really illustrates her point.
Saturday, August 24, 2019
Just after I posted my paper, Not Everything is About Investors: The Case for Mandatory Stakeholder Disclosure, arguing for a stakeholder-focused corporate disclosure system, the conversation about corporate obligations to noninvestor interests exploded. That’s because the Business Roundtable released a new “statement on the purpose of a corporation” which Marie Kondo-ed the traditional focus on shareholder interests, in favor of, well:
While each of our individual companies serves its own corporate purpose, we share a fundamental commitment to all of our stakeholders. We commit to:
- Delivering value to our customers. We will further the tradition of American companies leading the way in meeting or exceeding customer expectations.
- Investing in our employees. This starts with compensating them fairly and providing important benefits. It also includes supporting them through training and education that help develop new skills for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
- Dealing fairly and ethically with our suppliers. We are dedicated to serving as good partners to the other companies, large and small, that help us meet our missions. - Supporting the communities in which we work. We respect the people in our communities and protect the environment by embracing sustainable practices across our businesses.
- Generating long-term value for shareholders, who provide the capital that allows companies to invest, grow and innovate. We are committed to transparency and effective engagement with shareholders.
The reception has been … mixed.
There are two basic schools of thought. The first is that the BR’s statement represents a real change going forward, either because it will drive business decisionmaking or, more subtly, because the fact that the BR felt it necessary to issue the statement at all illustrates a societal shift that has already occurred.
The second is that this is a public relations ploy to stave off more onerous business regulation.
I posted about “stakeholder capitalism” a few weeks ago and how it often translates into a fairly naked attempt to avoid accountability to shareholders or anyone else. Which is why the Council of Institutional Investors (CII) immediately issued its own statement decrying the BR’s attempt to disclaim any responsibility to shareholders as a unique constituency.
Right on cue, Martin Lipton* – who, as I discussed in my prior post on the subject, has a very long history of using appeals to stakeholders as a mechanism for shielding management decisions from scrutiny – posted a statement in support of the BR, in which he warned that failure to embrace its vision would bring about calamity:
The failure of the Council of Institutional Investors to join the Business Roundtable in rejecting shareholder primacy and embracing stakeholder corporate governance is misguided. The argument that protection of stakeholders other than shareholders should be left to government regulation is an even more serious mistake. It would lead to state corporatism or socialism.
The failure to recognize the existential threats of inequality and climate change, not only to business corporations but also to asset managers, institutional investors and all shareholders, will invariably lead to legislation that will regulate not only corporations but also investors and take from them the ability to use their voting power to influence the corporations in which they invest.
In other words, corporations have to appear to be good citizens to avoid being forced to be good citizens. At least he’s honest.
Meanwhile, the Wall Street Journal published its own view in which it agreed this is all fine for PR purposes but if anyone really means to pursue profits with anything less than religious devotion, that would be bad.
Let’s just say it’s an odd day when Martin Lipton is fighting both the CII and the WSJ editorial page. Usually, the alignment would be more CII versus Lipton and the WSJ, because the reality is, CII members are all about protecting corporate stakeholders – after all, the CII is an organization of employee pension plans – they just, you know, want shareholders to be the ones making those decisions, not corporate managers. And the WSJ and Lipton are very much in the opposite camp. Indeed, the BR is currently fighting to make it harder for shareholders to introduce proposals that would force corporations to focus on – you guessed it – stakeholder interests, so this looks a lot less like an issue of what is best for society than about who should be the decisionmaker.
But there’s more. First, not everyone’s on board with the BR’s statement; there are some notable absences from BR’s list of signatories. Second, the BR’s statement puts it at odds with the Trump Administration, which seems to have formally declared shareholder wealth maximization as the only appropriate corporate purpose. It also puts the BR at odds with SEC Commissioner Hester Peirce, who has done the same.
So, what do we make of all of this?
Well, first and most obviously, abstract notions of corporate purpose – and the near-unenforceable fiduciary duties that follow – are likely to have very little direct influence on corporate behavior. But that doesn’t mean they’re entirely irrelevant, because they can impact the legal regime in which corporations operate. As I discuss in What We Talk About When We Talk About Shareholder Primacy, it matters if the Trump Administration and the SEC think corporate purpose = shareholder wealth maximization, because that means they’ll develop legal rules to make it so, including defining “materiality” for securities law purposes to mean only matters relevant only to financial return, and prohibiting shareholders from pushing for greater accommodation of stakeholders. And so far, the BR is fully on board with that agenda.
That said, the true drivers of corporate decisionmaking are real-world incentives that corporate managers have to favor one constituency or the other. And because shareholders are the only constituency who get a vote, managers are particularly likely to attend to their concerns. Which brings me to this op-ed by Chief Justice Strine and Antonio Weiss, published in Friday’s New York Times. In it, they make an argument that Strine has often advanced, namely, that large mutual fund investors should vote for policies that protect the worker-beneficiaries of those funds, and thus force managers to accommodate their interests as employees and consumers. (For recent academic commentary in that vein, see Nathan Atkinson here and Michal Barzuza, Quinn Curtis, & David Webber here.)
Now, Strine has made this argument before – I posted about one iteration here – and as I pointed out at the time, Strine has also long argued that managers have fiduciary duties to shareholders alone. So there’s some tension in his argument that mutual funds should advocate for corporate policies that, at least according to formal (if not practical) Delaware law, cannot be advanced to the extent they favor employee interests over those of investors. The op-ed, though, squares that circle by equating protections for workers and the environment with the long-term best interests of the corporation itself (and thus, by extension, its investors).
(The op-ed also makes the odd argument that there are too many meaningless items on the corporate ballot. Which is unexpected because most of the non-critical items are, like, proposals that deal with corporate social responsibility, which is what the op-ed just said funds should advocate for, so, I’m confused.)
Now, the claim that long-term corporate interests are identical to those of society as a whole is an ancient way of papering over the very real conflicting interests of different stakeholders. As an example, Larry Fink’s famed letter about corporate purpose gets a lot of attention as advancing a stakeholder-primacy view, but the letter actually said that accommodating stakeholders was in the long-term interest of business, and therefore is better for investors.
That’s the (purported) thinking behind the new Long-Term Stock Exchange (LTSE), which just received SEC approval of its listing standards. Among other things, the standards require that listed companies have policies that are “consistent with” the notion that they should “consider a broader group of stakeholders and the critical role they play in one another’s success,” and requires listed companies to “adopt and publish a Long-Term Stakeholder policy explaining how the issuer operates its business to consider all of the stakeholders critical to its long-term success.”
Now, I say “purported” here because – going back to where all this began – arguments about managers accommodating corporate stakeholders are frequently code for “activist shareholders leave us alone,” which has little to do with corporate well-being and everything to do with management entrenchment. Still, we’ll see how the LTSE works out – whether it attracts listings, investors, and (most critically) whether LTSE-listed companies insist their long-term policies were merely puffery as soon as they find themselves in the crosshairs of a securities fraud lawsuit.
Where does that leave us?
In my view, the hypothesized alignment between shareholder and stakeholder interests is ... complicated. This is my argument in Not Everything is About Investors: corporate profit-seeking is only aligned with the interests of society writ large if corporations pay a price for inflicting harms on non-shareholder constituencies. Which is why I think disclosure for non-shareholder audiences, while not a cure-all, is important: it helps society extract that price so that corporate managers are incentivized to act in society’s best interest as an inherent aspect of profit-seeking.
That was a lot.
In closing, I’ll just describe one particular colloquy that occurred at Tulane’s Corporate Law Institute earlier this year. One panel was devoted to corporate social responsibility, and the panelists included Strine and Myron Steele, former chief justice of the Delaware Supreme Court.
The moderator of the panel turned to Steele and asked him directly, is it ever permissible for a board of directors to decide that they will prioritize the needs of employees over earning a higher profit? And Steele said, well, if the board sits down, and carefully studies the issue, and decides that prioritizing employees is in the best interests of the company’s long-term profitability, then yes, the board can make that decision.
And the moderator asked again, okay, but what if there’s a tradeoff between prioritizing employees and earning profits? Can the board choose to favor employees?
And Steele said, if the board studies the issue, documents its process, and comes to a reasoned determination that it’s better for the corporation’s long-term prosperity if benefits are conferred on employees, then yes, that’s permissible.
So. There you have it.
*yeah, I have to keep saying – no relation
Wednesday, August 14, 2019
In a previous post, I plugged a short piece that was published in the Georgetown Online Journal, and at that time, I explained it was a preview of a longer, in-progress article about the need for a corporate disclosure system intended for non-investor audiences. I have now posted a draft of that longer paper to SSRN. Here is the abstract:
Corporations are constantly required to disclose information, but only the federal securities laws impose generalized public disclosure obligations that offer a holistic overview of corporate operations. Though these disclosures are intended to benefit investors, they are accessible by anyone, and thus have long been relied upon by regulators, competitors, employees, and local communities to provide a working portrait of the country’s economic life.
Today, that system is breaking down. Congress and the SEC have made it easier for companies to raise capital without becoming subject to the securities disclosure system, allowing modern businesses to grow to enormous proportions while leaving the public in the dark about their operations. Meanwhile, the governmentally-conferred informational advantage of large investors allows them to tilt managers’ behavior in their favor, at the expense of consumers, employees, and other corporate stakeholders. As a result, securities disclosures do not provide the comprehensive picture necessary to maintain social control over corporate behavior.
This Article recommends that we explicitly acknowledge the importance of disclosure for noninvestor audiences, and discuss the feasibility of designing a disclosure system geared to their interests. In so doing, this Article excavates the historical pedigree of proposals for stakeholder-oriented disclosure. Both in the Progressive Era, and again during the 1970s, efforts to create generalized corporate disclosure obligations were commonplace. In each era, however, they were redirected towards investor audiences, in the expectation that investors would serve as a proxy for the broader society. As this Article establishes, that compromise is no longer tenable.
As you can see, this one is a work in progress, so I’m very much interested in hearing everyone’s thoughts.
Saturday, August 10, 2019
Milton Friedman, shareholder primacy’s true north, wrote:
In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. He has direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to their basic rules of the society, both those embodied in law and those embodied in ethical custom.
Much judicial, political, and academic ink has been spilled over the first part of this pronouncement, but the second part has always baffled. What ethics? Whose ethics? How do we identify ethical customs that are not instrumental in generating higher profits (because if they were, there would be no need for the qualification; we would simply recognize that pursuit of profits may include pursuit of community goodwill because in its absence it may be hard to sell one’s product).
The recent tragedies in El Paso and Dayton have raised these questions anew. Cloudflare, which provides various website and internet security services, dropped 8chan (a breeding ground for violent white supremacist content and the site where the El Paso shooter posted a racist screed) as a client, thus knocking 8chan offline. In so doing, its CEO, Matthew Prince, explained:
We continue to feel incredibly uncomfortable about playing the role of content arbiter and do not plan to exercise it often. Some have wrongly speculated this is due to some conception of the United States' First Amendment. That is incorrect. First, we are a private company and not bound by the First Amendment. Second, the vast majority of our customers, and more than 50% of our revenue, comes from outside the United States where the First Amendment and similarly libertarian freedom of speech protections do not apply. The only relevance of the First Amendment in this case and others is that it allows us to choose who we do and do not do business with; it does not obligate us to do business with everyone.
Instead our concern has centered around another much more universal idea: the Rule of Law. The Rule of Law requires policies be transparent and consistent. While it has been articulated as a framework for how governments ensure their legitimacy, we have used it as a touchstone when we think about our own policies….
Cloudflare is not a government. While we've been successful as a company, that does not give us the political legitimacy to make determinations on what content is good and bad.
Two years ago, Cloudflare discontinued service to the Nazi site Daily Stormer. At that time, Prince said:
Now, having made that decision, let me explain why it's so dangerous…. Without a clear framework as a guide for content regulation, a small number of companies will largely determine what can and cannot be online. … Law enforcement, legislators, and courts have the political legitimacy and predictability to make decisions on what content should be restricted. Companies should not…
In an internal email to Cloudflare employees at that time, he was more blunt:
[T]his was an arbitrary decision. It was different than what I’d talked talked with our senior team about yesterday. I woke up this morning in a bad mood and decided to kick them off the Internet. … It was a decision I could make because I’m the CEO of a major Internet infrastructure company…. Literally, I woke up in a bad mood and decided someone shouldn’t be allowed on the Internet. No one should have that power.
Prince depicts himself as a man caught between conflicting ethical principles. Which apply?
After El Paso and Dayton, Andrew Ross Sorkin penned an open letter to Walmart’s CEO, the country’s largest seller of guns:
It is clear that this country is suffering from an epidemic that law enforcement and politicians are unable or unwilling to manage.
In the depths of this crisis lies an opportunity: for you to help end this violence….
You could threaten gun makers that you will stop selling any of their weapons unless they begin incorporating fingerprint technology to unlock guns, for example. You could develop enhanced background checks and sales processes and pressure gun makers to sell only to retailers that follow those measures.
You have leverage over the financial institutions that offer banking and financing services to gun makers and gun retailers as well as those that lend money to gun buyers….
It would be easy for you, and other chief executives, to argue that controlling the gun violence epidemic is Washington’s responsibility, not yours. But in an era of epic political dysfunction, corporate executives have a chance to fill that leadership vacuum.
All of this just begs the question of how much we should expect public-style regulation from the private companies that dominate our lives. Here’s Kara Swisher on Cloudflare’s decision:
It’s long past time for the digital giants to build safety into the DNA of products from their conception. The next crop of tech companies should think about safety from the get-go….
[W]hat we have today, as I have written before, are giant digital cities that were built without adequate police, fire, medical or safety personnel, decent street signs or any kind of rules that would make them work smoothly.
Amazon’s dominant position in commerce had led it to create its own private court system for adjudicating disputes, which has given rise to an industry of Amazon-court “lawyers” to help merchants navigate it. Facebook, as well, has proposed creating something like an internal court system for handling content disputes.
All of these examples strike me as peak “publicness,” in Hillary Sale’s terminology. When companies take on public responsibilities, the public demands that they act with the transparency and concern for public values that we ordinarily expect of governments. Or, to put it another way, Matthew Prince is right: His company does not have legitimacy to make these decisions, but made they must be - which is why greater public demands will be placed on Cloudflare to anticipate them, prepare for them, and avert the next El Paso rather than simply react to it. (Check out Matt Levine’s description of the terms of Facebook’s privacy settlement.)
How successful is that effort likely to be? Well, with both apologies and nods to Friedman, if corporations are like governments, an appeal to ethics alone isn’t going to cut it. As FDR reportedly once told a group of labor activists, “I agree with you; I want to do it; now, make me do it.” In the context of government, that means constituent anger and threatened disruption; companies may not be so different. So the real question is whether public outrage can become sufficiently expensive to force change. And that has yet to be seen.
Saturday, August 3, 2019
I often think about this Wall Street Journal article from 2015 about Mylan and its reincorporation to the Netherlands:
At a heated meeting with Mylan NV’s executive team in a Manhattan conference room in May, several investors complained about the drug maker’s resistance to a $40 billion takeover proposal from Teva Pharmaceutical Industries Ltd.
Executive Chairman Robert Coury leaned across the table and retorted, in language laced with expletives, “This is a stakeholder company, not a shareholder company,” according to multiple attendees, meaning his constituents went beyond investors and he wasn’t obligated to agree to a tie-up. Mr. Coury got his way….
Mylan’s resistance to Teva’s proposal was aided by an acquisition that moved the company’s legal home in February from Pennsylvania to the Netherlands—part of the wave of tax-trimming “inversion” transactions that swept American business last year. Mylan, whose senior management remain based in Pennsylvania, gained not just tax savings, but a Dutch corporate rule book that gives companies more levers to resist takeovers….
Dutch policy makers have spent the past decade touting the benefits of Dutch law to global corporations as part of an effort to turn the Netherlands into a management-friendly bastion.
The article’s a bit circumspect about it, but I have always imagined Coury saying something like, “It’s stakeholder, b---,” as he refused to consider Teva’s offer. This, of course, it a lot like Martin Lipton’s longstanding advocacy for a “stakeholder” orientation, from the days of Unocal – when, at his urging, the Delaware Supreme Court held that employee welfare was an appropriate consideration in a takeover battle (before it retconned its own holding the next year in Revlon) – extending to today’s exhortations that corporate managers should protect stakeholder interests. All the right buzzwords of corporate social responsibility and ESG are there, but the fairly transparent endgame is to make boards less accountable to shareholders, not more accountable to other constituencies.
Anyhoo, I mention all of this because it’s the first thing that occurred to me when the news broke about Pfizer’s new combination with Mylan. Pfizer will spinoff its Upjohn unit to combine it with Mylan, and shareholders of both Mylan and Pfizer will receive stock in the new company. Significantly, the combined entity will incorporate in Delaware, thus removing some of the insulation that Coury has enjoyed over the past few years (despite his intention, described in the above-linked article, to maintain his role as Executive Chair).
Given Mylan’s poor performance recently – and associated shareholder restiveness – perhaps this move was inevitable. As I previously noted in the case of Netflix, it seems like public companies can only wall off their shareholders for so long, especially as performance declines – which is exactly when shareholders are going to want to flex their muscles.
Saturday, July 27, 2019
I’m intrigued by this unusual Section 11 decision out of the Third Circuit, Obasi Investment LTD v. Tibet Pharmaceuticals, Inc, 2019 WL 3294888 (3d Cir. 2019). A company called Tibet held an IPO, but the registration statement failed to identify financial troubles at its operating subsidiary. Eventually the subsidiary’s assets were seized, Tibet’s stock price plunged, and trading was halted.
A class of plaintiffs brought a Section 11 claim against, you know, everyone they could get their hands on, including two individual defendants: Hayden Zou and L. McCarthy Downs. Zou was a Tibet shareholder who had come up with the idea for an IPO in the first place, and approached Downs, who was a managing director for an investment bank called Anderson & Strudwick (“A&S”). A&S ended up underwriting the offering, and for reasons that are not explained, A&S agreed with Tibet that after the IPO, two A&S designees would serve as nonvoting Board observers for the foreseeable future. Those designees were Zou and Downs, and the registration statement explained that even without votes “they may nevertheless significantly influence the outcome of matters submitted to the Board of Directors for approval.”
When the plaintiffs sued, they argued that Zou and Downs were proper Section 11 defendants, because that statute imposes liability on “every person who, with his consent, is named in the registration statement as being or about to become a director, person performing similar functions, or partner.” 15 U.S.C. §77k(a)(3).
The Third Circuit, in a 2-1 split, held that Zou and Downs were not named in the registration statement as performing functions similar to those of directors.
And honestly this is sort of a stream of consciousness about the decision, which got very very long, so behind a cut it goes:
[More under the jump]
Saturday, July 20, 2019
I’ve previously blogged in this space about Shari Redstone and her conflicts with the CBS board. Last week, New York Magazine published this fascinating article about Shari Redstone’s corporate battles and her relationship with her father, Sumner Redstone. Shari Redstone refused to participate and thus much of it appears to have been drawn from other sources, but it was all new to me, and the anecdotes make for a fascinating – and eyebrow raising – read. Here’s a taste:
In retrospect, it took some chutzpah for Moonves to take Redstone to court, when as reporting would later show, he was busily covering up the sexual-assault allegations against him. Less than six months later, he was gone. So were Gifford and most of the other elder men on the board who’d backed Moonves. .... CBS and Viacom are once again talking about merging, though Redstone cannot be officially involved until negotiations are further along. If the merger goes through, as it well may this summer, she will have cemented her control of a $30 billion media kingdom.
And Moonves’s stunning downfall has given Redstone, for all her wealth, something she’s never had before: a narrative that justifies her own rise. The #MeToo movement has hardly had a richer target than CBS, with its board of mostly old white men who protected Moonves and shrugged off the company’s treatment of women. ...The new board of CBS is, like Viacom’s, majority female for the first time — and increasingly stacked with her allies. Women are being put in charge and on the air at CBS. And the face of the family controlling these companies was once the patriarch whose embarrasing sexual exploits were aired in court; now it’s his daughter.
As the excerpt indicates, the main theme of the article is that Shari Redstone - though an unlikely candidate for feminist hero - has battled a cadre of older men, many of whom disparaged or dismissed her apparently on the basis of gender, and has come out on top. She’s now firmly in control of both CBS and Viacom, and likely will fulfill her ambition to combine the two companies. A great piece to mull over.
Saturday, July 13, 2019
I just recently came across the Ninth Circuit’s decision in In re Atossa Genetics Inc Securities Litigation, 868 F.3d 78 (9th Cir. 2017), and it struck me because it highlights an ongoing tension between the reliance/materiality distinction in fraud-on-the-market cases in general, and in the Supreme Court’s jurisprudence in particular.
And I’ll say up front that a lot of what I’m about to discuss in this post is stuff I’ve laid out in more detail in my essay, Halliburton and the Dog that Didn’t Bark. The Atossa case is just a nice demonstration of the issue.
And hey, this got long, so – more after the jump.
Saturday, July 6, 2019
When I was in practice, I worked on a number of cases alleging violations of Section 11 of the Securities Act, but none that had been filed in state court. (For which I was profoundly grateful; I was always bemused by the fact that I needed to get pro hac’d into federal courts around the country but I was vastly more familiar with their rules and practices than with those of the New York State courts, notwithstanding my admission to the New York State bar).
So, to be honest, I never had any strong feelings about whether plaintiffs should have the right to pursue Section 11 class actions in state court, or whether the Securities Litigation Uniform Standards Act should be interpreted to permit defendants to remove such cases. And I didn’t spare much attention when the Supreme Court recently held in Cyan, Inc. v. Beaver County Employees Retirement Fund that defendants cannot remove them.
But Michael Klausner, Jason Hegland, Carin LeVine, and Sarah Leonard just posted a short empirical analysis of state Section 11 class actions, and the results have captured my interest. First, they find – unsurprisingly – there has been an increase in state Section 11 filings since Cyan was decided, and very often, state litigation is accompanied by a parallel federal case filed by a competing set of plaintiffs. Second, they conclude that the state cases are dismissed on the pleadings at far lower rates than federal cases (though the data is a bit muddy; they exclude from analysis any federal cases with a simultaneous Section 10(b) component, which means they may be excluding cases that appear more fraudulent and thus are - perhaps - stronger). They also analyze settlement sizes and find little difference between federal and state cases, with the caveat that Cyan may have effects further down the road (they also exclude cases filed prior to 2014 to avoid the effects of the financial crisis, which may also distort results).
So this is definitely a fruitful area to keep an eye on – especially with the looming battle over whether the PSLRA discovery stay applies in state court proceedings. See Wendy Gerwick Couture, Cyan, Reverse-Erie, and the PSLRA Discovery Stay in State Court, 47 Sec. Reg. L.J. 21 (2019); see also Post-Cyan Ruling on Discovery Stay.