Saturday, October 16, 2021

Yet Another Controlling Shareholder Opinion

This week, I continue in my series of posts about controlling shareholders (prior posts here, here, here, here, here, here, here, here, here, and here) to call your attention to Patel v. Duncan, decided September 30.

Talos was a company backed by two private equity sponsors: Apollo and Riverstone. Apollo had 35% of the shares; Riverstone had 27%; and the rest were publicly traded.  Talos had a 10 member board, and Apollo and Riverstone had a shareholder agreement that guaranteed each would appoint 2 members, a fifth member would be jointly agreed upon, and the sixth member would be Talos’s CEO.  Of course, because their combined voting power exceeded 50%, there was no doubt their nominees would be included on the board.  As a result, the company’s SEC filings identified Talos as a “controlled company” for the purposes of NYSE rules; as the company put it, “We are controlled by Apollo Funds and Riverstone Funds. The interests of Apollo Funds and Riverstone Funds may differ from the interests of our other stockholders…. Through their ownership of a majority of our voting power and the provisions set forth in our charter, bylaws and the Stockholders’ Agreement, the Apollo Funds and the Riverstone Funds have the ability to designate and elect a majority of our directors.”

In 2018, Talos bought a troubled company that was heavily indebted to Apollo; as a result of this purchase, Apollo was nearly made whole on an investment that might otherwise have failed.  Then, in 2019, Talos bought certain assets from Riverstone, and it was this purchase that was alleged by a derivative plaintiff to have been unfair to the public stockholders.

When the Riverstone transaction was arranged, Riverstone’s 2 board nominees, both of whom were also Riverstone affiliates, were recused from the negotiation process. Additionally, one of Apollo’s nominees was recused, because of her associations with Riverstone.  So that left 7 directors to arrange the transaction, including the joint Riverstone-Apollo nominee, one Apollo nominee who was also an Apollo affiliate, and the CEO.  A representative of Riverstone and one of Apollo observed all Board meetings on the subject, without apparently speaking.  Under the original terms of the deal, Talos was supposed to pay for the Riverstone assets partially in common stock, but that issuance would have required approval of the common stockholders; as a result, the terms of the deal were changed so that Talos paid in a new form of preferred stock that would automatically convert to common.  The change was approved by Apollo and Riverstone in a written consent, the result of which was to avoid a shareholder vote and allow the deal to close more quickly. Per the court, “There was no Board meeting discussing, or resolution approving, the changing of these terms.”

The derivative plaintiff claimed that Talos overpaid for the Riverstone assets.  He argued that Apollo and Riverstone were controlling shareholders of Talos and had a kind of quid pro quo arrangement whereby each one would approve the other’s tainted deal.  Because Apollo and Riverstone together were controllers, the argument went, the two had fiduciary duties to Talos and the Riverstone deal was subject to entire fairness review. 

Vice Chancellor Zurn, however, rejected the argument that Apollo and Riverstone were bound together in a manner that would constitute a control group.   First, she looked at general ties between the two.  She disagreed that there was any significant historical relationship between the parties as had been found in other cases involving putative joint controllers, like In re Hansen Medical Shareholders Litigation, 2018 WL 3025525 (Del. Ch. June 18, 2018), and Garfield v. BlackRock Mortgage Ventures, 2019 WL 7168004 (Del. Ch. Dec. 20, 2019), such as a pattern of joint investments.  She also felt that the admission of controlled status under NYSE rules was “not as strong” as self-designations of controller status in Hansen and Garfield; for example in Hansen, the two funds had admitted to working as a group in a 13D filing pertaining to a different company.

Second, she looked to transaction-specific ties.  She found no evidence for the purported quid pro quo other than the mere fact that the two transactions had taken place.  The shareholders’ agreement was no evidence of such an arrangement, because it only referred to director voting and did not make any promises regarding votes on other matters.  And the presence of Riverstone and Apollo representatives as observers in board meetings did not suggest any specific involvement in negotiations.

Thus, she concluded that Apollo and Riverstone were not sufficiently associated that their separate minority positions should be linked.  Given that, in their role as individual minority shareholders, they had no fiduciary duties to Talos that they could violate. The transaction with Riverstone was not subject to entire fairness review because Riverstone was not a controlling shareholder – or even a fiduciary – of Talos.

The problem I have with all of this starts with the standard announced by the Delaware Supreme Court in Sheldon v. Pinto Tech. Ventures, L.P., 220 A.3d 245 (Del. 2019).  According to that case, a controller exists “where the stockholder (1) owns more than 50% of the voting power of a corporation or (2) owns less than 50% of the voting power of the corporation but exercises control over the business affairs of the corporation.… [M]ultiple stockholders together can constitute a control group exercising majority or effective control, with each member subject to the fiduciary duties of a controller. To demonstrate that a group of stockholders exercises control collectively, the [plaintiffs] must establish that they are connected in some legally significant way—such as by contract, common ownership, agreement, or other arrangement—to work together toward a shared goal.” 

Relying on cases like Garfield and Hansen, VC Zurn looked to the factors those courts had examined (transaction-specific ties, historical ties) to conclude that the Sheldon standard was not met.  But in Garfield and Hansen, the courts were trying to determine whether an agreement actually existed in the first place.  Here, it was not necessary to try to suss out whether there was an agreement, because Apollo and Riverstone admitted they had one.  All that was necessary was to determine whether the agreement they had gave them “more than 50% of the voting power of a corporation...exercising majority or effective control.”

Under the agreement they admitted to having, Apollo and Riverstone jointly had more than 50% of the vote, and they jointly agreed that they would use that voting power to select 6 members of a 10 member board.  Sure, they divvied it up – you vote for my nominee, I’ll vote for yours – but the fact remains, they had a “legally significant connection” – an actual, for real, disclosed contract – for dictating 60% of the directors.  Four of whom actually worked for Riverstone or Apollo; one of whom was the Talos CEO.  (Not that those ties matter, necessarily; imagine a single stockholder, with more than 50% of the vote, who nonetheless chose to select only nominally independent board members. That entity would absolutely be a controller.[1]  Therefore, it shouldn’t matter who Apollo and Riverstone chose to place on the board – the relevant point is that with more than 50% of the vote, they had an agreement to jointly select more than half the board members). 

True, their agreement did not give them transactional control over the particular purchase in question, but usually transactional control is treated as an alternative test for controller status; controller status also exists when someone controls the corporation in general.  See, e.g., In re Rouse Props., Inc., 2018 WL 1226015 (Del. Ch. Mar. 9, 2018).  And when it came to the corporation in general, Apollo and Riverstone straightforwardly, together, had “more than 50% of the voting power of a corporation,” and therefore “constitute[d] a control group exercising majority or effective control,” with all the legal consequences that follow.  The rest of it – their history, their involvement with the negotiations, the existence (or not) of a quid pro quo – is beside the point.

(Also, for what it’s worth, if you’re looking for evidence that they jointly executed the transaction, the fact that Apollo and Riverstone somehow changed the deal terms all on their own without involving the Board seems pretty significant.)

Anyway, all of this matters because, as scholars are now documenting, shareholder agreements in public companies are increasingly common, usually involving PE firms like Apollo and Riverstone.  They often provide for board seats, observation rights, and positions on key committees, among other things.  So it’s really, really important that courts come to a coherent, consistent position on how these agreements will be addressed, and as relevant here, when transactional control is going to be a necessary aspect of the controlling shareholder inquiry.


[1] For example, ViacomCBS has a majority independent board but – well, you know. 

October 16, 2021 in Ann Lipton | Permalink | Comments (0)

Monday, October 4, 2021

Connecting the Threads 2021 - My Thread in the Tapestry . . . .

Screen Shot 2021-10-04 at 7.36.06 PM

With my bum shoulder and a lot of work on our dean search cramping my style over the past few weeks, I have been remiss in posting about the 2021 Business Law Prof Blog Symposium, Connecting the Threads V.  The idea behind the name (and Doug Moll likes to riff on it--so have at it, Doug!) is that our bloggers here at the BLPB connect the many threads of business law in what we do--here on the blog and elsewhere.

Anyhoo (as Ann would say), as always, my BLPB co-bloggers did not disappoint in their presentations.  I know our students look forward to publishing many of the articles and the related commentaries in the spring book of our business law journal, Transactions: The Tennessee Journal of Business Law.  I also am always so proud of, and interested to hear, the commentary of my colleagues and students.  This year was no exception.

In the future, I will post more about the article that I presented.  But I will offer a teaser here, accompanied by the above screen shot from the symposium.  (It was "Big Orange Friday" on our campus.  The orange had to be worn.  Go Vols!)

The title of my presentation and article is Choice of Entity: The Fiscal Sponsorship Alternative to Nonprofit Incorporation.  A brief excerpt from the continuing legal education handout for the symposium presentation is set forth below (footnotes omitted).

[T]his presentation urges that competent, complete legal counsel on choice-of-entity for nonprofit business undertakings should extend beyond advising clients on which form of business entity best fits their needs and wants, if any. For many small business ventures that qualify for federal income tax treatment under Section 501(a) of the U.S. Internal Revenue Code of 1986, as amended (“IRC”), as religious, charitable, scientific, literary, educational, or other eligible organizations under Section 501(c)(3) of the IRC . . . , the time and expense of organizing, qualifying, managing, and maintaining a tax-exempt nonprofit corporation under state law may be daunting (or even prohibitive). Moreover, the structures imposed by business entity law may not be needed or wanted by the founders or promoters of the venture. Yet, there may be distinct advantages to entity formation and federal tax qualification that are not available (or not as easily available) to unincorporated not-for-profit business projects. These may include, for example, exculpation for breaches of performative fiduciary duties and limitations on personal liability for business obligations available to participants in nonprofit corporations under state statutory law and easier clearance of or compliance with initial and ongoing requirements for tax-exempt status under federal income tax law.

The described conundrum—the prospect that founders or promoters of a nonprofit project or business may not have the time or financial capital to fully form and maintain a business entity that may offer substantial identifiable advantages—is real. Awareness of this challenge can be disheartening to lawyer and client alike. Fortunately, at least for some of these nonprofit ventures, there is a third option—fiscal sponsorship—that may have contextual benefits. This presentation offers food for thought on the benefits of fiscal sponsorship, especially for arts and humanities endeavors.

Again, I will have more to say about this later, once the article is fully crafted.  But your thoughts on fiscal sponsorship--and examples, stories, and the like--are welcomed in the interim as I continue to work through the article.

October 4, 2021 in Ann Lipton, Conferences, Joan Heminway, Lawyering, Nonprofits, Research/Scholarhip | Permalink | Comments (0)

Saturday, October 2, 2021

Private Really is the New Public

A while back, I posted about how there’s been some institutional investor support for the proposal that the SEC require not only public companies, but private companies, disclose climate change information.

Usually, of course, private companies aren’t required to disclose things – especially to institutional investors – on the theory that institutional investors can themselves bargain for the information that they need.  (Yes, yes, there are kind of exceptions, like Securities Act Section 4(a)(7), etc).  But the SEC and Congress have been gradually expanding which companies count as private, raising concerns that not only that they have assumed too much sophistication on the part of institutions (for example, institutional investors themselves have complained about opacity among the PE funds in which they invest), but also that the SEC and Congress have ignored the benefits of creating a body of public information across a wide swath of companies.

Which is why this article grabbed me

The California Public Employees’ Retirement System and Carlyle Group Inc. helped rally a group of more than a dozen investors to share and privately aggregate information related to emissions, diversity and the treatment of employees across closely held companies. More firms and institutions are expected to join.

“We need to start a common language across all these participants so we can actually, in a sustained way, make some progress,” Carlyle Chief Executive Officer Kewsong Lee said in an interview. “By honing in on a set of common standards and common metrics, we start to standardize the conversations so we can really track progress. It’s really hard to do that right now.”

Blackstone Group Inc. and the Canada Pension Plan Investment Board, the country’s largest pension fund, are also part of the effort. Boston Consulting Group was tapped to aggregate the data.

Private-equity firms will be seeking to standardize and share data on greenhouse-gas emissions, renewable energy, board diversity, work-related injuries, net new hires and employee engagement. Calpers CEO Marcie Frost said she would like to see these metrics expand to include data such as C-suite diversity and employee satisfaction.

The article is framed as further evidence of a trend toward ESG investing, but for me the more relevant point is that investors are trying to band together to create a common pool of information about private companies that have been excepted from the public disclosure regime.  You could, I suppose, call that a triumph of private ordering; I take it as evidence of a fundamental failure of the securities disclosure system.  I suppose you could also tell a story about the privatization of what was once public infrastructure more generally, or the unholy marriage of privatization and environmentalism.

October 2, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, September 25, 2021

An Embarrassment of Riches: Slack, Brookfield, Activision, and the Death of Aronson

Sometimes, there’s not a whole lot new to blog about – and other times you get the Slack decision, the Brookfield decision, an SEC investigation of Activision, and Aronson’s demise all in a single week.  So in this post, I am going to tackle the first three and save United Food and Commercial Workers Union v. Zuckerberg for maybe another time, but if you really want to know my immediate reaction to the Zuckerberg case, I tweeted a thread here.  Professor Bainbridge also has a long blog post on the Zuckerberg decision here.


I previously blogged about this case here, and the short version is that Slack went public via direct listing, and filed a Securities Act registration statement for slightly fewer than half of the shares that became available to trade on the opening day, because the rest of the shares did not need to be registered in order to trade under Rule 144.  Stock purchasers claimed that the registration statement contained false statements in violation of Section 11 of the Securities Act; the question was whether they’d need to establish that theirs were the registered shares before they’d be able to bring a claim – an impossible task, which would functionally prevent any shareholders from bringing any Section 11 claims at all.  The district court said no, they did not have to do that, and earlier this week, the Ninth Circuit affirmed by a 2-1 vote

The Ninth Circuit’s logic was unexpected, to say the least.  The Court interpreted NYSE Listed Company Manual, Section 102.01B Footnote E, to mean that NYSE direct listings are legally not possible unless a Securities Act registration statement is filed.  According to the court:

Per the NYSE rule, a company must file a registration statement in order to engage in a direct listing.  See NYSE, Section 102.01B, Footnote E (allowing a company to “list their common equity securities on the Exchange at the time of effectiveness of a registration statement filed solely for the purpose of allowing existing shareholders to sell their shares”) (emphasis added).... As indicated, in contrast to an IPO, in a direct listing there is no bank-imposed lock-up period during which unregistered shares are kept out of the market. Instead, at the time of the effectiveness of the registration statement, both registered and unregistered shares are immediately sold to the public on the exchange. See NYSE, Section 102.01B, Footnote E.  Thus, in a direct listing, the same registration statement makes it possible to sell both registered and unregistered shares to the public.

Slack’s unregistered shares sold in a direct listing are “such securities” within the meaning of Section 11 because their public sale cannot occur without the only operative registration in existence. Any person who acquired Slack shares through its direct listing could do so only because of the effectiveness of its registration statement….

Slack’s shares offered in its direct listing, whether registered or unregistered, were sold to the public when “the registration statement . . . became effective,” thereby making any purchaser of Slack’s shares in this direct listing a “person acquiring such security” under Section 11.

Now, the reason this is surprising is that the argument almost seems to have come out of nowhere.  It was not the basis for the district court’s decision, and though it was alluded to by the plaintiffs in their Ninth Circuit briefing, neither the defendants, nor their amici, seems to have addressed it, and the issue was only barely mentioned at oral argument.  And no one cited Section 102.01B Footnote E of the NYSE Listed Company Manual at all.

Plus, I gotta say, this is not the most convincing reading of the NYSE rules.  Here’s what the NYSE Listed Company Manual, Section 102.01B Footnote E, actually says:

Generally, the Exchange expects to list companies in connection with a firm commitment underwritten IPO, upon transfer from another market, or pursuant to a spinoff. However, the Exchange recognizes that some companies that have not previously had their common equity securities registered under the Exchange Act, but which have sold common equity securities in one or more private placements, may wish to list their common equity securities on the Exchange at the time of effectiveness of a registration statement filed solely for the purpose of allowing existing shareholders to sell their shares, where such company is listing without a related underwritten offering upon effectiveness of a registration statement registering only the resale of shares sold by the company in earlier private placements. …Consequently, the Exchange will, on a case by case basis, exercise discretion to list [such] companies …

That doesn’t sound like the NYSE is prohibiting direct listings in the absence of a Securities Act registration; it sounds more like the NYSE has not contemplated that an issuer might want to list without one.

Now, to be fair, maybe that doesn’t matter.  The NYSE, in creating its rules (which had to be approved by the SEC), only contemplated direct listings accompanied by a Securities Act registration statement, so that’s all that’s currently authorized.  Still, the legal effect of the registration statement was not, despite the Ninth Circuit’s holding, that it allowed the unregistered securities to trade publicly.  Rule 144 allowed them to trade publicly without any registration statement at all.  What the registration statement arguably allowed was for them to trade publicly on the Exchange, which is not the same thing.

Which gets to what I think was really the driving force behind the Ninth Circuit’s decision: policy.  As the Ninth Circuit explained:

interpreting Section 11 to apply only to registered shares in a direct listing context would essentially eliminate Section 11 liability for misleading or false statements made in a registration statement in a direct listing for both registered and unregistered shares. While there may be business-related reasons for why a company would choose to list using a traditional IPO (including having the IPO-related services of an investment bank), from a liability standpoint it is unclear why any company, even one acting in good faith, would choose to go public through a traditional IPO if it could avoid any risk of Section 11 liability by choosing a direct listing.  Moreover, companies would be incentivized to file overly optimistic registration statements accompanying their direct listings in order to increase their share price, knowing that they would face no shareholder liability under Section 11 for any arguably false or misleading statements.  This interpretation of Section 11 would create a loophole large enough to undermine the purpose of Section 11 as it has been understood since its inception.

And this is why the dissent is dissenting; in Judge Miller’s view, these policy considerations should not override the plain text of Section 11, which only permits claims by “any person acquiring such security,” meaning, “such security” as was registered on the faulty registration statement. 

Now, I suspect we’re not done here, because defendants will likely seek rehearing and/or certiorari, but if this is the final word, I note that the Ninth Circuit’s decision may have implications for ordinary IPOs, when issuers forego the traditional 180-day lockup and instead allow insiders to trade unregistered shares right away.  I previously blogged about this problem in connection with Robinhood’s IPO; per Law360, a lot of companies are now eliminating the traditional lockup.  Under prior law, one would expect the immediate trading of unregistered shares to bar, or at least inhibit, Section 11 claims, but by the Ninth Circuit’s logic, as I understand it, for these companies, the Securities Act registration statement is a necessary step to allow the unregistered shares to trade on the Exchange, and that might be enough to eliminate the tracing requirement.  The Ninth Circuit distinguished situations where shares were issued pursuant to more than one registration statement, see op. at 12, 14, but it also suggested – as other courts have held – that tracing is not an issue when the two registration statements contain identical misstatements, see op. at n.5; see also In re IPO Sec. Litig., 227 F.R.D. 65 (S.D.N.Y. 2004).  Point being, this decision, if it stands, could become the basis for eliminating the tracing requirement for exchange-traded shares so long as there has only been either one registration statement, or all registration statements contain identical misstatements.

What the Ninth Circuit decision does not resolve, though, is how losses/damages would be calculated in these kinds of situations, which – as I blogged in connection with Slack and Robinhood – remains an issue. 

My final observation is that the SEC could make most of this go away by refusing to accelerate the effectiveness of a registration statement for any issuer that does not agree to waive tracing defenses for shares purchased in the first 180 days.


Short version: Ordinarily, if a corporation issues new shares in exchange for inadequate consideration, this is a derivative harm to existing shareholders, but Gentile v. Rossette created an exception to that rule by holding that if the shares are issued to a controlling shareholder, who thereby increases his/her/its level of control, the harm is both direct and derivative.  Gentile sat uneasily amongst Delaware precedent for a long time, as Delaware courts increasingly narrowed its application, until finally, in Brookfield Asset Management v. Rosson, the Delaware Supreme Court eliminated it.  As the court put it:

Gentile is premised on the presence of a controlling stockholder that allegedly used its control to “expropriate” and extract value and voting power from the minority stockholders.  Controlling stockholders owe fiduciary duties to the minority stockholders, but they also owe fiduciary duties to the corporation.  The focus on the alleged wrongdoer deviates from Tooley’s determination, which turns solely on two central inquiries of who suffered the harm and who would receive the benefit of any recovery. That shift has led to doctrinal confusion in our law. The presence of a controller, absent more, should not alter the fact that such equity overpayment/dilution claims are normally exclusively derivative because the Tooley test does not turn on the identity of the alleged wrongdoer.

Still, this direct/derivative problem is not entirely settled because – as the Delaware Supreme Court pointed out – “To the extent the corporation’s issuance of equity does not result in a shift in control from a diversified group of public equity holders to a controlling interest, (a circumstance where our law, e.g., Revlon, already provides for a direct claim), holding Plaintiffs’ claims to be exclusively derivative under Tooley is logical and re-establishes a consistent rule that equity overpayment/dilution claims, absent more, are exclusively derivative …. we see no practical need for the ‘Gentile carve-out.’ Other legal theories, e.g., Revlon, provide a basis for a direct claim for stockholders to address fiduciary duty violations in a change of control context.”

In other words, if you’re a shareholder in a company without a controller, and directors sell enough of an interest to create a controller, then, even if there was no change in the character of the shares you personally hold, you can still bring a direct, Revlon-standard review challenge to that action.  Which to be honest I was not, until now, sure was a clear thing, though there have been some decisions that suggested as much.  See In re Coty Stockholder Litigation, 2020 WL 4743515 (Del. Ch. Aug. 17, 2020).  But I will say, given the malleability of the standard for what counts as control – see my numerous blog posts on the subject – any cases that arise will be hilarious to watch.  On the one hand, plaintiffs will want to argue that the party receiving the new stock was a controller already, so that the MFW standards for cleansing apply; on the other, plaintiffs will want to argue that the party receiving the new stock was not a controller already, in order to be able to bring claims directly.  And defendants will have the opposite incentives. 

I’ll also note that in Brookfield itself, plaintiffs offered the alternative argument that they had a direct claim because the company undersold shares to a 51% controller, in a manner that brought the controller’s holdings to 65%.  This was significant, claimed the plaintiffs, because certain charter provisions could only be amended upon a 2/3 vote, so increasing the controller’s power to that level gave the controller even more substantive control. 

And the Delaware Supreme Court did not reject the argument as a theoretical matter!  Meaning, it’s not only a direct claim if the company goes from no control to control; it’s a direct claim if the company goes from control to next-level control.  But, the Supreme Court said, the plaintiffs had not made their factual case here because 65% < 2/3. 

Which I have to say is pretty unconvincing; I mean, Delaware will accept that someone with 49% of the vote in a public company is a controller, because that additional 1% it needs will come from somewhere; I don’t see why the same argument couldn’t be used to say that 65% is functionally the same as 66% when it comes to public companies.  But that only highlights the problem here: once legal significance is attached to going from no control to control, or from control to next-level control, defining what we mean by control becomes very hard to do.

A final note on this: I previously blogged that in the Tesla trial, VC Slights could theoretically resolve the entire matter without ever deciding whether Elon Musk is, or is not, legally a controlling shareholder; as I said at the time, the only wrinkle that might force such a decision on him were the plaintiffs’ direct claims brought under a Gentile theory.  Now that that theory is kaput, it will be even easier for Slights to avoid the is-he-or-isn’t-he question, if the facts allow it and that’s something he wants to.


Activision Blizzard, according to reports, has a very serious sexual harassment/sex discrimination problem.  So serious that the California Department of Fair Employment and Housing filed a lawsuit after a 2-year investigation.  The EEOC has also been investigating the company since 2020.

Given all this, it’s no surprise that when the news broke, a shareholder lawsuit was filed against Activision, generally alleging that the company misrepresented its employment policies to investors.

What was more surprising, though, was the news that the SEC was investigating Activision, because usually that’s not the kind of fraud that the SEC gets involved with.  It’s hard to exactly articulate the difference, but the SEC tends to stay its hand when the allegation is that the company was doing non-financially bad things and did not disclose those bad things to investors.

What gives?

I have no special insight, of course, but if I had to guess, this is about the fact that the SEC only recently made the following addition to Item 101 of Regulation S-K:

(c) Description of business….

(2) Discuss the information specified in paragraphs …[(c)(2)(ii)] of this section with respect to, and to the extent material to an understanding of, the registrant's business taken as a whole, except that, if the information is material to a particular segment, you should additionally identify that segment….

(ii) A description of the registrant's human capital resources, including the number of persons employed by the registrant, and any human capital measures or objectives that the registrant focuses on in managing the business (such as, depending on the nature of the registrant's business and workforce, measures or objectives that address the development, attraction and retention of personnel).

And indeed, in its 2020 10-K, filed in February 2021, Activision included these statements under the heading “Human Capital”:

Activision Blizzard takes an active role in the entirety of the employee lifecycle, from candidates to alumni. Recognizing that ours is a rapidly changing industry with constant technological innovation, we remain focused on attracting, recruiting, enabling, developing, and retaining a diverse and innovative employee population.

Diversity, Equity, and Inclusion (“DE&I”): We believe that a culture of inclusion and diversity enables us to create, develop, and fully leverage the strengths of our workforce to exceed players' and fans' expectations and meet our growth objectives. We remain committed to building and sustaining a culture of belonging, built on equitable processes and systems, where everyone thrives. By embedding DE&I practices and programs in the full employee lifecycle, we work to recruit, attract, retain, and grow world-class talent. Our employee resource groups play an active role in our DE&I efforts by building community and awareness. We also offer leadership and management development opportunities on the topics of unconscious bias and inclusive leadership and train our recruiting workforce in diverse sourcing strategies….

Compensation and Benefits: The main objective of our compensation program is to provide a compensation package that attracts, retains, motivates, and rewards top-performing employees that operate in a highly competitive and technologically challenging environment. We seek to do this by linking compensation (including annual changes in compensation) to overall Company and business unit performance, as well as each individual’s contribution to the results achieved. The emphasis on overall Company performance is intended to align our employee’s financial interests with the interests of our shareholders. We also seek fairness in total compensation by reference to external comparisons, internal comparisons, and the relationship between development and non-development, as well as management and non-management, remuneration. We believe in equal pay for equal work, and we continue to make efforts across our global organization to promote equal pay practices….

Employee Experience: We capture and act on the voice of our employees through regular company-wide pulse surveys. We emphasize to employees that this is their chance to “provide honest, candid feedback about their experience working for the company.” Our survey participation rates (regularly 75% or higher) demonstrate our collective commitment that Activision Blizzard remains a great place to work. The survey—and other forms of employee feedback—result in actionable steps that lead to positive improvements to the employee experience at the company-wide, business unit, and team levels. Our employee feedback is dynamic and relevant to our employees’ immediate needs. …

That … sounds rather at odds with a company that is alleged to have tolerated extreme levels of sexual harassment, discriminated against women in pay and promotion opportunities, and actively discouraged women from reporting their complaints to HR.  Notably, the California DFEH and EEOC investigations were well underway when this 10-K was filed, but I can’t find mention of either.

So if I had to guess, the SEC views this situation as potentially a way of communicating that no, it’s actually not kidding when it says that human capital disclosure is a required line item under Item 101 of Regulation S-K.

Assuming my speculations are correct, this is not about the SEC demanding that companies preemptively accuse themselves of uncharged wrongdoing; it’s not even about whether Activision’s practices ultimately turn out to be legal or illegal under California or federal law.  This is about the SEC, having recognized that in the knowledge economy, workforce management is an important contributor to corporate wealth, responded to investor demand by requiring a new level of transparency surrounding it.  And in the very first year after those requirements took effect, one digital company – exactly the type of knowledge/skills-based company that inspired the new requirements – may have blatantly misdescribed to investors the facts surrounding its internal policies.  And that possibility is what the SEC is looking into.

And - that’s as much as I can handle this week!

September 25, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, September 18, 2021

Rodrigues and Stegemoller on SPACs

There’s been so much interest in SPACs recently, I figured everyone should be aware of this new paper by Usha R. Rodrigues and Michael Stegemoller, SPACs: Insider IPOs.  One of the main points the authors make is that de-SPAC transactions represent a kind of “empty voting” scenario, where you can both vote in favor of the deal and redeem your shares for $10 – which is in fact what overwhelmingly occurs; the actual funds for the merger typically come from the simultaneous PIPEs.  As the authors point out, the regulations and practice governing SPACs did not always allow this; when SPACs first began to list on the NYSE, only shareholders who voted against the deal could redeem, and if redemptions exceeded a certain threshold, the deal would not close.  Shortly thereafter, however, regulations and practice evolved to allow all shareholders to redeem and to eliminate the conversion threshold.  The authors argue that the new practices are damaging to markets by allowing companies to go public on major exchanges before they are ready to do so.

Anyhoo, here is the abstract:

Proponents have hailed special purpose acquisition companies (SPACs) as the democratization of capitalism. In a SPAC, a publicly traded shell corporation acquires a private target, thereby taking it public in a manner that circumvents the rigors of a traditional initial public offering (IPO). Known as the “poor man’s private equity,” SPACs have been touted for giving the masses an otherwise rare chance to invest in private companies, and thereby reap the high returns usually reserved for the wealthy. Our original hand-collected data tell a different story.

We focus on two harms that SPACs present. First, they are singularly illiquid investments—even when nominally public, SPACs are generally owned and traded by the very few. Second, SPACs evolved to eliminate meaningful shareholder voice on the acquisition of a private target, using instead a species of “empty voting,” meaning that any such vote had no economic impact. By rendering the shareholder vote a nullity, SPACs can now virtually guarantee that a target will go public. This laxity of process creates the risk that subpar firms will trade side by side with quality public companies, tarnishing the market as a whole.

We are the first to examine this absence of liquidity and shareholder power, both of which are products of SPACs’ domination by insiders. This Article’s original data on SPACs’ empty voting, delinquent public filings, and thin-to-nonexistent trading provide empirical evidence that a small group of insiders use SPACs to manipulate the merger process, free of traditional IPO safeguards. We conclude with a reform proposal to reunite shareholders’ economic interest with voting power. This potential reform addresses the concerns of liquidity and lack of selectivity, while also providing a viable alternative to the traditional IPO.

September 18, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, September 11, 2021

Howey, Reves, and a Common Law Comedy of Error

So, Coinbase has made a lot of noise recently about the SEC’s warning that its “Lend” product may be a security and thus subject to registration under the securities laws.

Its wounded blog post, not to mention the complaints from the CEO on Twitter, have attracted a good deal of mockery, but I actually want to use this as a jumping off point for a different discussion.

The Lend product, as I understand it, would allow Coinbase to lend certain cryptocurrency held by its clients to other actors; the borrowers will pay an interest rate to Coinbase, which Coinbase will share with clients, resulting in a guaranteed minimum 4% interest payment to the client.  Essentially, Coinbase wants to be a bank, and to treat its clients as depositors, without the bother of banking regulation.  Per Coinbase’s blog post, the SEC is “assessing our Lend product through the prism of decades-old Supreme Court cases called Howey and Reves....  These two cases are from 1946 and 1990.”  Leaving aside the baffled tone (Howey? Reves? What is this sorcery?), and the language designed to make me feel old (I still wear clothes I bought in 1990), what is interesting to me is that the SEC is using both tests

This is an unsettled area when it comes to the definition of a security.  Howey is used to determine whether an instrument is an “investment contract” as that term is used in the definition of a security contained in the Securities Act of 1933 and the Exchange Act of 1934; Reves is used to determine whether a “note” is a security as defined in those Acts.  And it’s not always clear which test applies when.  Technically, a “note” is a definite promise to pay a particular sum.  But in SEC v. Edwards, 540 U.S. 389 (2004), the Supreme Court used the Howey test for a sale-and-leaseback arrangement that included a promise to pay $82 per month, rather than the Reves test.  That leaves a fair degree of uncertainty as to how to determine whether new instruments count as “notes” in the first place so that the Reves test is appropriate.  Are the two tests alternatives?  Is one preferable to the other in some situations?  The answer isn’t clear.

And it matters because the tests themselves are similar but not identical.  Both consider whether the product is sold to many people or to a single person; both consider the purposes of the transaction, but Reves is a fuzzy multifactored balancing test whereas Howey requires that all elements be met.

Why is the law like this? 

It’s actually, as far as I can tell, the product of the sometimes dysfunctional development of the common law.  (Something I previously discussed in the context of United Food and Commercial Workers Union v. Zuckerberg.  In that blog post, I talked about a different example of the common law creating an unnecessary multiplicity of tests: Aronson and Rales.  I should add, though, that in that post, I was wrong in predicting what the plaintiffs would do; Zuckerberg is currently pending before the Delaware Supreme Court and the plaintiffs are arguing for a reinterpretation of Aronson that would distinguish it from Rales.).

So, back to securities: In 1946, the Supreme Court had to decide if interests in an orange grove constituted an investment contract/security, and it came up with the four-factored Howey test: investment of money, in a common enterprise, with the expectation of profit, due to the managerial efforts of others. See SEC v. W.J. Howey Co., 328 U.S. 293 (1946).

Nearly 30 years later, in 1975, the Supreme Court decided United Housing Foundation, Inc. v. Forman, 421 U.S. 837 (1975).  In Forman, a New York City co-op was created as part of a program of low income housing.  To get an apartment in the co-op, you had to buy a share of “stock” in the corporation, but the stock itself had none of the features of traditional stock and mainly was used as a security payment for the apartment.  When the residents/stockholders sued, claiming they had been sold securities, the Supreme Court held that the stock was not “stock” as that term was meant in the securities laws, and then further held that it was not even an investment contract under the Howey test.  Why? Among other things, there was no expectation of profit as Howey envisioned.  As the Supreme Court put it:

By profits, the Court has meant either capital appreciation resulting from the development of the initial investment . . . or a participation in earnings resulting from the use of investors’ funds. . . .

Lower courts did two things with this.  First, they decided that all instruments allegedly subject to the securities laws – stock, notes, anything else – would get the Howey test.  Second, they read Forman’s concept of profit narrowly, to mean that the expectation of profit had to be something like profits generated specifically from the success of the enterprise.  Fixed rates of return, especially at a market rate, would not count as “profit” because those amounts would be due to the investor regardless of whether the enterprise was a success or failure. 

And then came Reves v. Ernst & Young, 494 U.S. 56 (1990), with the question whether a demand note was a security.  The Eighth Circuit applied Howey and concluded that the fixed rate of return excluded it from the security definition. See Arthur Young & Co. v. Reves, 856 F.2d 52 (8th Cir. 1988) (“the interest rate was fixed by an established market rate. The demand noteholders did not participate in the Co-op's earnings by virtue of their ownership of the demand notes, nor was there any prospect of capital appreciation. Therefore, the demand noteholders did not expect a ‘profit’ as that term is defined in Howey.”)

But debt instruments often have fixed rates of return!!  It’s kind of the point!  If you do this, you end up with a lot of debt instruments being entirely uncovered by the securities laws!

So, off it goes to the Supreme Court.  And the Court – rather than interrogate the lower courts’ interpretation of Forman, see Reves, 494 U.S. at 68 n.4 – decides that notes should have an entirely different test.

Now there are two tests. Howey and Reves.  (Okay, three, if you think of Forman, and subsequently Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985), as setting forth a definition of whether something is “stock”).

But we’re not done.  Because in SEC v. Edwards, the Court finally did confront the narrow definition of “profit” that courts were using for Howey. And there, applying Howey, it held that fixed rates of return can in fact be “profits.” 

But if the instrument has a fixed rate of return, there’s going to be a specific payment due at a particular time, and that might make it a note!

The whole point of Reves, I submit, was to get around an unduly narrow interpretation of Howey.  Once that interpretation changed, we’re left with two tests, no clear reason for them, and no clear guidance when one should apply and when it should be the other.

And that’s why the SEC is testing Coinbase’s Lend product – which involves a fixed rate of return – under both Reves and Howey.    

Anyway, here’s Adam Levitin on how Lend comes out under Howey and Reves.

September 11, 2021 in Ann Lipton | Permalink | Comments (2)

Saturday, August 28, 2021

Still Talking About Corporate Scienter

A couple of weeks ago, I posted about how courts are not terribly precise when evaluating allegations of corporate scienter in Section 10(b) claims.  Since then, a couple of cases were decided that provide some useful examples of the problem.

First up, there’s the Second Circuit’s Plumbers & Steamfitters Local v. Danske Bank, decided earlier this week.  Apparently, the Estonia subsidiary of Danse Bank got into trouble for money laundering, and the plaintiffs alleged this resulted in a number of false statements by Danse Bank itself.  The court dismissed all of the statement claims on various grounds, and then turned to the final allegations that, due to Estonia’s conduct, Danse Bank had engaged in a scheme to defraud.  The court rejected the claim in a few brief sentences:

At no point do [the plaintiffs] articulate with precision the contours of an alleged scheme to defraud investors, or which specific acts were conducted in furtherance of it. Instead, the claim rests upon the incorporation of the previous 140 pages of the pleading paired with the conclusory assertion that “Defendants carried out a common plan, scheme, and unlawful course of conduct that was intended to . . . deceive the investing public” and “artificially inflate the market price of Danske Bank ADRs.” App’x at 160. Money-laundering at a single branch in Estonia cannot alone establish that Danske Bank itself carried out a deceptive scheme to defraud investors. Absent some sort of enumeration of which specific acts constituted an alleged scheme in connection with the purchase or sale of securities, the Funds’ claim does not comply with the applicable heightened pleading standard and cannot go forward.

(emphasis added).

The court did not explain why a Danse Bank subsidiary is being treated as distinct from Danse Bank itself, or how one should assess Danse Bank’s actions and intent distinct from the behavior of its subsidiaries.  I can’t even say the decision was wrong, because I don’t know what standards the court used to reach it.

Next up, there’s Hurst v. Enphase Energy, 2021 WL 3633837 (N.D. Cal. Aug. 17, 2021), where, as relevant here, plaintiffs tried to demonstrate scienter by pointing out that several insiders made unusual sales prior to the end of class period disclosure.  The court rejected the argument by saying:

Defendants correctly highlight that seven of the eight identified insiders are not named in this action, and such sales are irrelevant to scienter.

No further analysis was provided; the court simply cited two other cases, Wozniak v. Align Tech., Inc., 2011 WL 2269418 (N.D. Cal. June 8, 2011) and In re Splash Tech. Holdings, Inc. Sec. Litig., 160 F.Supp.2d 1059 (N.D. Cal. 2001).  Wozniak, like the Enphase court, did not discuss the matter further. 

But let’s unpack this.

Insider trading is often described in 10(b) opinions as a “motive” to commit fraud – for example, in Splash, the court didn’t exactly say that nondefendants’ trades were never relevant, but it did suggest they’d only be relevant if there was evidence the trades were intended to manipulate the stock to assist their colleagues’ fraud.  But that is too broad brush. Insider trading may also be a result rather than a cause.  I.e., imagine a corporation where insiders are committing fraud for some reason – they feel pressure from stockholders or their bosses to get results, they have bonuses on the line, they’re afraid of losing their jobs, whatever it is.  Now they, and possibly other people in the organization, have inside information that the company is not in fact as successful as it pretends to be.  Anyone with this knowledge may decide to sell stock and cash in while they can; the sales, in this scenario, are not the reason for the fraud, but they do evidence someone’s knowledge that something in corporate reporting was amiss.  That knowledge may contribute to an inference of scienter, in the sense that information was known to someone demonstrating that the defendants’ public statements were false and would mislead investors.

Why, then, would nondefendants’ trades be relevant here?

There are a number of possibilities, and they depend on your theory of scienter.

In the simplest example, suppose the selling shareholders worked closely with the individual defendants who spoke publicly.  Or suppose they sat in the surrounding offices.  It might very well be a reasonable inference that if they knew something was amiss, the individual defendants – who worked with them – knew it as well.  Maybe it’s not a strong inference, maybe it doesn’t carry the day, but it’s not an irrational one and it hardly makes sense to dismiss the possibility with a bright line declaration that nondefendants’ sales are irrelevant.

But let’s say we’re talking about corporate scienter rather than individual scienter.  Now, again, nondefendant individual sales may be relevant here, but how they are relevant depends on your theory of how to attribute scienter to a corporation.

Suppose corporate scienter is gleaned from the overall functioning of the organization.  The fact that there is evidence that at least some insiders (maybe highly placed ones) had knowledge of the truth, and yet the company issued false statements despite that knowledge, may give rise to an inference of exactly the kind of communication breakdown that justifies treating the entity as though it behaved recklessly.

Or, suppose corporate scienter is based on the scienter of someone who – as some circuits have held – approved the false statement, or furnished information for inclusion.  These insiders may very well have done that.  Maybe they approved false statements, or supplied false information to someone else.  Their sales indicate knowledge of the truth; their actions permit their own scienter to be attributed to the entity.

Why not just name them as defendants, then?  Simple: Their internal involvement with corporate information flow may not be enough to constitute a false statement under Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), and though they may have participated in a scheme to defraud under Lorenzo v. SEC, 139 S. Ct. 1094 (2019), given how narrowly the Supreme Court has read reliance in the 10(b) context, see Stoneridge Inv. Partners LLC v. Scientific- Atlanta Inc., 552 U.S. 148 (2008), it’s not clear plaintiffs would be able to state a claim against them individually.  Thus, evidence of their knowledge contributes to an inference of scienter against the entity, but they are not proper defendants individually.

And, indeed, in Splash – which was cited by the Enphase court and held that the trades of nondefendants were irrelevant – the actual individuals who traded had been defendants earlier in the case, and were dismissed because plaintiffs could not show they had personally made any false statements.

Or! There is another possibility.  As I discussed in my post two weeks ago, some circuits have held that if truthful information was available to persons who played a role in approving or furnishing false information, etc, plaintiffs may be able to create a pleading stage inference that someone who approved or furnished false information acted with scienter, even if they cannot identify who that person is in their complaint.  And those allegations might create a strong inference of corporate liability for 12(b)(6) purposes, with the specific guilty agent to be identified later.

Insider sales by nondefendants may help contribute to that inference.  Maybe plaintiffs can’t show they were personally involved with generating the false statements, but there may be enough of them – highly placed – that you can infer at least one of them probably was.  Or, going back to the proximity issue, if they are adjacent to power, their knowledge may contribute to an inference that the truth was widely known at least among higher level people, so that, again, it is likely that at least one such person contributed to the false statements while knowing the truth.

I am not saying that any of these inferences were appropriate in Enphase – maybe not.  And how strong they are likely to be is necessarily going to vary case by case.  But the issue deserves more unpacking than a simple maxim that nondefendant sales are irrelevant to to scienter.

August 28, 2021 in Ann Lipton | Permalink | Comments (1)

Saturday, August 21, 2021

An Unusual Insider Trading Case

Insider trading isn’t really my specialty – that’s John’s area – but everyone’s talking about SEC v. Panuwat, which means I feel like I need to weigh in.

In short: Company insider (Panuwat) obtains confidential information from his employer that the firm is to be acquired.  He immediately trades in the stock of a similar but unrelated company – recognizing, correctly, that news of the acquisition will lift the stocks of comparable firms.  Has he violated Section 10(b) and Rule 10b-5 by misappropriating confidential information from his employer?

First, I note that Panuwat’s trades took place on August 18, 2016 and the SEC filed its complaint on August 17, 2021.  Which, you know, tells you something about the SEC’s ambivalence and risk assessment for this case. (The statute of limitations for imposing a penalty is 5 years).

Second, this problem has been considered before.  Here’s Ian Ayres and Joe Bankman on the subject (h/t to the Twitter birdie who called this to my attention), and here’s a recent empirical paper by Mihir N. Mehta, David M. Reeb, and Wanli Zhao concluding that these kinds of trades are relatively common (discussed in this Law360 article).

There’s probably a lot that can be said about the policies regarding the prohibition on insider trading and whether they should be extended to this scenario – Ayres and Bankman cover that, and John’s recent posts are all about different justifications for prohibiting inside trading – but I actually want to make a small doctrinal analogy to something that I know more about, namely, misstatement cases under Section 10(b).

In that context, courts have occasionally addressed the issue of what to do when a false statement about one company artificially inflates the stock price of a different company.  For example, in Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir.2000), Cendant falsified its financials, and then proposed a stock-for-stock takeover of ABI.  In response, ABI’s stock price rose, only to fall when the fraud at Cendant was revealed and the merger called off.  Were statements about Cendant’s financials made in connection with ABI’s stock?  The Third Circuit said maybe, and remanded for further inquiry (offering somewhat contradictory standards as to how the inquiry would be conducted for the Cendant defendants versus the auditor defendants).

Then there’s Ontario Public Service Employees Union Pension Trust Fund v. Nortel Networks Inc., 369 F.3d 27 (2d Cir. 2004).  In that case, Nortel made false statements about its financial condition, and when the truth was revealed, the stock price of JDS Uniphase fell, because Nortel was its largest customer.  When JDS Uniphase shareholders sued Nortel, the Second Circuit said that JDS shareholders had no standing to pursue claims against Nortel.

And recently, Juul – which is a private company – made false statements about its marketing tactics – which, when the truth was revealed, ultimately caused Altria’s stock price to fall because of Altria’s 35% investment in Juul.  A district court allowed Altria’s investors to sue Juul and certain of its managers, because “the connection between JUUL’s allegedly false statements and Plaintiffs purchase of Altria’s stock lacks the remoteness found in Nortel Networks.” Klein v Altria Group, 2021 WL 955992 (E.D. Va. Mar. 12, 2021)

What does all of this have to do with SEC v. Panuwat?  I guess that’s in the eye of the beholder.

On the one hand, you could say the situations are entirely distinct.  Section 10(b) prohibits fraud in connection with a securities transaction.  And when someone makes false statements about a particular company, there are limits to whether that fraud is related to securities transactions in other companies.

When it comes to misappropriative insider trading, though, the question is whether confidential information was used (in violation of a relationship of trust and confidence) for the purpose of a securities trade.   See U.S. v. O’Hagan, 521 U.S. 642 (1997) (“The ‘misappropriation theory’ holds that a person commits fraud ‘in connection with’ a securities transaction, and thereby violates § 10(b) and Rule 10b–5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. Under this theory, a fiduciary's undisclosed, self-serving use of a principal's information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information.”).  One might argue that, unlike in the misstatement context, there’s nothing in that standard that requires the securities trade to be of the same, or even a related, company; indeed, the whole reason we have a “misappropriation” theory of insider trading in the first place is to address what happens when an insider of one company – in O’Hagan, a fiduciary of an acquirer planning to launch a tender offer – uses confidential information to trade in the securities of a different company – in O’Hagan, the target.

Plus, I mean, as a practical matter, courts don’t like securities plaintiffs, but they also don’t like employees who trade on confidential information, so you can anticipate outcomes through that realist lens.

But!  I think there’s another wrinkle here.  When the Nortel court rejected the plaintiffs’ claim, it explicitly expressed concern about a slippery slope. Everything in markets affects everything else; that’s why quants develop whole strategies based on minute market correlations.  If traders could sue for losses experienced by one company due to statements by a different company, that could dramatically expand 10(b) liability – which, many argue, already should not extend as far as it does.  It would mean, for example, that if a drug company lies about the efficacy of a new treatment, traders who short its competitors could sue.  If a company lowballs its earnings (not uncommon when they’re trying to cram through a merger), traders who go long on its competitors could sue.  And on and on.

You could argue that these concerns are not present when we’re talking about insider trading, because there’s a limiting principle: The trader must have misappropriated inside information.  If that’s proved, then we may be less concerned about which securities he or she traded.

But is that true, though?

Because here’s the thing.  There’s a longstanding debate within insider trading doctrine about whether liability turns on the trader using the confidential information to trade, or whether liability is triggered whenever someone trades while in possession of confidential information, or whether – splitting the baby – trading while in possession gives rise to an inference of “use” which can then be rebutted.  See, e.g., footnote 2 of Zachary Gubler’s A Unified Theory of Insider Trading Law.  The SEC’s longstanding position is that trading in possession is sufficient to trigger liability in most circumstances.  See Rule 10b5-1 (“a purchase or sale of a security of an issuer is ‘on the basis of’ material nonpublic information about that security or issuer if the person making the purchase or sale was aware of the material nonpublic information when the person made the purchase or sale”).  And the proposed Insider Trading Prohibition Act that recently passed the House also prohibits trading “while aware of material, nonpublic information relating to such security …or any nonpublic information, from whatever source, that has, or would reasonably be expected to have, a material effect on the market price of any such security.”

So now imagine an employee who has confidential information about his or her employer.  Under the SEC’s rule, trading in any public company stock that might be affected by the information is prohibited under 10b-5 – regardless of whether the employee used the information, or not.  The door is blown wide open.

Now, in the complaint against Panuwat, the SEC doesn’t merely rest on a “trading while in possession” theory.  Instead, the SEC explicitly alleges that Panuwat used the confidential information he acquired from his employer:

within minutes of receiving the Medivation CEO’s email on August 18, 2016, and while knowing or being reckless in not knowing that such entrusted information was material and nonpublic, Panuwat used this information concerning the Medivation acquisition to trade. Specifically, Panuwat logged on to his personal brokerage account from his work computer and purchased 578 Incyte call option contracts with strike prices of $80, $82.50, and $85 per share—significantly above Incyte’s stock price of $76 to $77 per share at the time—and the soonest possible expiration date, September 16, 2016. Panuwat was aware that Incyte was not expected to make any significant announcement, such as issuing a quarterly earnings report, before the options expiration date. Rather, Panuwat anticipated that Incyte’s stock price would jump within less than a month on public disclosure of the upcoming Medivation acquisition announcement. Panuwat had never traded Incyte stock or options before.

(emphasis added)

Which may cover this case specifically but unless the SEC is planning to tweak its own rules on this more generally, I think here’s where the problem arises.

August 21, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, August 14, 2021

Let’s Talk About Corporate Scienter

A plaintiff alleging claims under Section 10(b) of the Securities Exchange Act must show that the defendant acted with “scienter,” which usually means either an intent to mislead investors, or reckless indifference to whether investors would be misled.

Since corporations, as well as natural persons, can be Section 10(b) defendants, there is often a question as to how a corporation’s “state of mind” can be determined for Section 10(b) purposes.  For example, the Third Circuit brushed up against this issue in Pamcah-UA Local 675 Pension Fund v. BT Group PLC, 2021 WL 3415060 (Aug. 5, 2021), and in In re Cognizant Tech. Solutions Corp. Securities Litigation, 2020 WL 3026564 (D.N.J. June 5, 2020), the court tried to develop a Section 10(b) corporate-scienter taxonomy.  My very first article, Slouching Towards Monell: The Disappearance of Vicarious Liability Under Section 10(b), was about how courts identify corporate scienter.  But I’m still finding that a lot of judicial opinions demonstrate confusion on this subject, which inspires me to post about it now.  To be sure, this is not an issue unique to 10(b) actions – it comes up in other areas of law – but Section 10(b) has some specific challenges, so I’m focusing on 10(b) here.

[More under the jump]

Continue reading

August 14, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, August 7, 2021

Another SPAC legal development

Very quick post this week just to call to your attention the recent complaint filed in Delaware Chancery by Grant & Eisenhofer, Delman v. GigAcquisitions3 LLC , No. 2021-0679.  (Bloomberg article on the case here, with links to the docket and complaint).

The complaint challenges the Lightning eMotors de-SPAC transaction on behalf of a class of investors in the SPAC shell company.  Rather than bring federal fraud claims, though – as many prior SPAC plaintiffs have – this plaintiff is alleging that the acquisition was a poor deal for the SPAC, initiated to benefit the SPAC sponsor, who had a limited time to complete a deal before liquidating.  Therefore, the directors and the SPAC’s sponsor breached their fiduciary duties to the SPAC.

Two things of note:

First, G&E seems to be self-consciously pitching the case as a bellwether challenge to the SPAC trend generally.  In the complaint, it alleges:

Gig3’s history is part of a disturbing trend of SPAC transactions in which financial conflicts of interest of sponsors and insiders override good corporate governance and the interests of SPAC stockholders….

This Court should take this opportunity to affirm that the boards and controllers of SPACs incorporated in Delaware owe the same fiduciary duties to their stockholders as do the boards and controllers of any Delaware corporation, and thus put an end to the money-grabbing SPAC bonanza that has been burgeoning in recent years at the expense of the investing public

Second, obviously, the shareholders needed to vote in favor of the merger, which raises the specter of Corwin cleansing.  So G&E argues that the vote was not fully informed but, more interestingly, also argues that the SPAC sponsor and its principal were minority controlling shareholders by virtue of their roughly 20% stockholdings, their chummy relationships with several directors, and the compensation of the “independent” directors which included financial interests in the sponsor.

Yadda yadda yadda me on the malleable definition of a controlling shareholder, which means – it’ll be interesting to see whether Delaware is willing to take this bait.  If it is, then, like the SEC’s recent scrutiny, this could represent another significant speedbump in the SPAC boom.

One other point about this: retail SPAC shareholders are speculators and often do not vote their shares in favor of the de-SPAC transactions; on at least two occasions, this has led to SPACs openly encouraging anyone to vote who held as of the record date even if they have since sold their shares.  If we see more suits like G&E’s, I look forward to the Corwin cleansing arguments in those cases.

August 7, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, July 31, 2021

ScarJo, SPACs, and LexisNexis

In the 1990s, newspapers had a problem.  They wanted their articles to be included in electronic databases like LexisNexis, but such databases being a relatively new technology, the newspapers had not bothered to include database republication rights in their agreements with freelance reporters.  Some publishers argued that their existing contracts covered database inclusion, but the Second Circuit wasn’t having it.  See Tasini v. New York Times Co., 206 F.3d 161 (2d Cir. 2000).  After the Supreme Court held that the articles could not be included in databases without the reporters’ permission, news organizations updated their contracts to cover electronic database republication.

Scarlett Johansson and Disney are now embroiled in their own dispute over a contract impacted by new technology.  Johansson’s contract for the Black Widow movie included a fairly standard provision (at least for big name actors) that she be entitled to a cut of the box office, and to ensure that the box office receipts would be worth her while, she extracted a promise that the movie would receive a “wide theatrical release of the Picture i.e., no less than 1,500 screens.”  In the wake of Covid-19, however, Disney chose to simultaneously release the film in theaters and on its streaming platform, which likely reduced the box office take and Johansson’s cut.  She’s now suing the company for $50 million, but however the case comes out, I think we can safely say that box office sharing contracts going forward will explicitly account for streaming.

And now it seems that shareholder agreements are also being affected by a new “technology” of a sort, namely, SPACs.  In two cases pending in Delaware Chancery, investors in private companies slated for a SPAC merger are arguing that their shareholder agreements impose certain obligations on them in the event of a traditional IPO, but impose no obligations in the event that a company goes public via SPAC.

In the first, Brown v. Matterport et al., 2021-0595, the plaintiff is the former CEO.  He claims that he agreed to a lockup for his shares in the event of an underwritten IPO, but that no such restriction attaches for a de-SPAC transaction – and that Matterport is improperly trying to bind him to a lockup via the merged company’s bylaws.

In the second, Pine Brook Capital Partners v. Better Holdco et al., 2021-0649, a venture capital firm claims that its shareholder agreement only gives the company redemption rights for some of its shares in the event of an underwritten IPO – not a de-SPAC transaction.  (The firm also claims that the company is improperly requiring that larger shareholders – including itself – agree to a lockup as a condition to receiving merger consideration; the complaint does not specify whether its shareholder agreement provides for a lockup in the event of an IPO.)

SPACs have recently become an attractive alternative to IPOs, at least in part because of regulatory arbitrage.  Specifically, the common wisdom has been that projections issued in connection with a SPAC IPO are protected by the PSLRA’s safe harbor while projections issued in connection with a traditional IPO are not.  Also, it seems that while underwriter compensation must be fully disclosed in connection with a traditional IPO, SPAC IPOs may give more leeway for underwriters/investment banks to play multiple roles and leave some fees undisclosed.  But with the Matterport and Better cases, we’re seeing the downside: shareholder agreements were not drafted with SPACs in mind.  I assume that will change for shareholder agreements going forward, but it creates something of a holdup problem right now.

July 31, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, July 24, 2021

Robinhood and the Section 11 Defense

Robinhood is gearing up for its IPO, and one of its gimmicks is to allot 20-35% of its newly issued shares to its own customers, who trade on its platform.  This unusual allocation is being billed, in part, as evidence of its commitment to “democratize finance,” and it’s not the first time a company has used its IPO allocations as, essentially, a branding mechanism.

But this New York Times piece also points out that Robinhood is allowing its own employees to trade up to 15% of their shares right away, which is pitched as being of a piece with Robinhood’s nontraditional stock allocations.  And, in fact, Robinhood’s S-1 says:

up to 15% of the shares of our outstanding Class A common stock and securities directly or indirectly convertible into or exchangeable or exercisable for our Class A common stock held, as of the date of this prospectus, by our directors, officers and current and former employees and consultants (other than our founders and our Chief Financial Officer, who are discussed above) …, with such 15% calculated after excluding any shares withheld for taxes associated with IPO-Vesting Time-Based RSUs, may be sold beginning at the commencement of trading on the first trading day on which our Class A common stock is traded on Nasdaq

The registration statement says that another 15% of employee shares can be sold after 90 days.

Now, I’m not going to speculate as to Robinhood’s actual motives for permitting its employees and directors to trade 15% of their stock immediately, but I will note that if these shares – which were presumably issued pursuant to a Rule 701 plan and are not registered – become immediately tradeable, that will make it much more difficult for open-market purchasers in the future to bring any Section 11 claims.

Section 11, of course, permits purchasers of registered securities to sue when the security’s price drops below the offering price, if the registration statement contains false or omitted information.  Section 11 claims don’t require a showing of scienter, but there’s a catch: the plaintiff must be able to show that his or her shares were, in fact, issued pursuant to the defective registration statement; unregistered shares, or shares issued pursuant to some other registration statement, won’t qualify.  Which means, if there’s a “mixed” pool of shares trading – some of which were issued on the defective registration statement, and some of which were not – an open-market purchaser will have trouble establishing that his or her shares were part of the registered group, which could bar Section 11 claims no matter how deceptive the registration statement may turn out to have been.

As I previously posted, this requirement has already created some havoc in the context of direct listings – and the Slack case, described in my blog post, has been pending before the Ninth Circuit basically forever – but most traditional IPOs require that pre-IPO shares be locked up at least for 180 days after the offering.  The lockup means that at least for the first 180 days, all shares available to trade are registered shares, and anyone who buys in that period will be able to show that their shares were traceable to the registration statement.  If there’s a problem with that registration statement, those early purchasers will be able to advance Section 11 claims.

Attorneys have in the past proposed that lockups be made less strict, essentially as a method of stymieing Section 11 claims; if unregistered shares are mixed in with the registered shares as soon as trading begins, the theory goes, no open-market purchaser will be able to trace their shares to the registration statement.  Robinhood (whatever its actual motivation) seems to be adopting that strategy. 

Now, I’m going to do something very dangerous: I’m going to try to read the S-1 and do math, and I’m not at all certain I’m getting this right, so everything I’m about to say should be taken with a pillar of salt. 

But, if I’m reading the S-1 correctly, Robinhood is registering and selling 60.5 million shares (including the greenshoe, and registered insider sales).  And it looks like the additional employee shares that will be available to trade right away number a little over 7 million.  Plus, as I understand it, there’s an additional 45 million shares or so that may be free to trade soon after the IPO as a result of certain note conversions, but these additional shares will be registered on a separate registration statement soon after the IPO.  Let’s assume that this new registration statement contains the same information as in the IPO registration statement.  And after 30 days ish, I believe another 45 million shares can be converted, and will also be free to trade, but these will also be registered on the second registration statement.

(Again, I really need to emphasize I am not at all certain I’m catching everything, so really just take this as a vague sort of ballpark thing)

My point – however inexact my calculations may be – is this: if it turns out that the registration statement(s) contain false information, or omit required information, we’re looking at an open-market pool of (at various times) as many as 105 to 150 million registered shares, and maybe 7 million unregistered ones, for at least the first 90 days of trading.  Of course, not all holders will trade; that’s just an approximation of the shares available.

Which means any open-market purchaser is very likely to have bought registered shares; but is not certain to have done so. 

Will that be enough to bar Section 11 claims?

Well, the law’s not exactly clear on this.  The Fifth Circuit famously held that even if there was over a 90% probability that shares purchased by the plaintiffs were registered, they would not be able to bring Section 11 claims.  See Krim v., Inc., 402 F.3d 489 (5th Cir. 2005); see also Doherty v. Pivotal Software, 2019 WL 5864581 (N.D. Cal. Nov. 8, 2019) (following Krim).  But in In re Snap Securities Litigation, 334 F.R.D. 209 (C.D. Cal. Nov. 20, 2019), the court held that 100,000 unregistered shares mixed in with 200 million registered shares would not be enough to bar Section 11 claims.  In so doing, the court noted, “As a policy matter, barring use of statistical tracing in litigation following a major IPO would mean that waiving the lock-up period for even nominal number of pre-IPO investors would effectively inoculate a corporation against nearly all potential Section 11 liability it might face for misstatements or omissions in its registration statement.”

Which means – I don’t know what happens with a pool that’s maybe 4.5% unregistered, and I really don’t know whether a court is likely to split the baby and distinguish between pleading Section 11 standing and actually proving it later in the case, either on the merits or at class certification.

Now, obviously, maybe there won’t be any Section 11 claims!  Maybe the shares will never trade below their IPO price; maybe there won’t be any false statements in the registration statement.  But considering the overwhelming regulatory risks that Robinhood’s business model poses (and of course its S-1 describes these), I think there’s a nonzero chance all this is going to be tested.  And I’d assume Robinhood’s lawyers are gearing up for that possibility.*


*Another problem might concern the issue of multiple registration statements.  Now, if the two registration statements contain identical misstatements and omissions, it isn’t necessary that a plaintiff trace her shares to either one simply to show that she purchased shares pursuant to a defective registration statement.  But – and this is an issue I discuss in my Slack blog post – Section 11 damages are tied to the “the price at which the security was offered to the public,” and for shares issued pursuant to note conversions, that price, I assume, is likely to be the conversion price.  But the note conversion price is a different, and lower, price than the offering price for the IPO shares.  That would mean that a damages calculation might require an open-market purchaser to identify whether her shares originally are traceable to a note conversion, or to the IPO (which, of course, will be impossible once trading in both begins, and since there are a lot of note-conversion shares, the probabilities will work less in plaintiffs’ favor than the issue of registered vs. unregistered shares).  But the Slack court held that the issue of damages did not have to be decided at the pleading stage, and if Robinhood’s share price were to fall even below the note conversion price, a plaintiff class might be willing to just agree that the note conversion price will be treated as the offering price for the entire class.

Edit: See comments; the converted stock may be registered only for resale at the market price.  Which means, the converted stock wont have a specific offering price, creating a similar issue as occurred in the Slack case, i.e., figuring out how to define an offering price when shares are registered only for resale by someone other than the issuer.  A court might decide the offering price for Section 11 purposes should be defined as the conversion price, but might decide the offering price should be defined as something else, or even that there is no offering price at all.

July 24, 2021 in Ann Lipton | Permalink | Comments (2)

Saturday, July 17, 2021

Will He or Won’t He?

The business news this week was just lousy with reports on the Tesla trial currently ongoing in Delaware, and in particular, with reports on the testimony of Elon Musk (which, disappointingly, appears to have been less inflammatory than his depositions).  

The basic set up, of course – as I previously blogged – is that Musk championed Tesla’s acquisition of SolarCity, a company he founded with his cousins, chaired, and in which he held a substantial stake.  The unaffiliated Tesla shareholders voted in favor of the deal, which would be enough to cleanse it and restore business judgment review if Musk was not a controlling shareholder, but if he was, entire fairness review would follow.  So one of the burning questions at trial – and the one which most of the news reports focus on – is whether Musk, with something like a 22% stake in Tesla at the time, could be considered a controlling shareholder.  And that question, in turn, focuses not just on his voting power, but on his practical control over the company and the board. 

Y’all know that the question of who is a controller is one that has dominated a lot of my thinking recently (my most recent blog post on the subject is here; earlier posts are here, and here, and here, and here, and here, and here, and here), so I do have to observe that in In re Pattern Energy Group Stockholders Litigation, VC Zurn spent a lot of time explaining how one can be a controller – with fiduciary duties that follow – even without any stock ownership at all.  As she put it:

Fiduciary duties arise from the separation of ownership and control.  The essential quality of a fiduciary is that she controls something she does not own.  A trustee need not (and does not) own the assets held in trust; directors need not own stock. Even a third party lender that influences extraordinary influence over a company may be liable for acting negligently or in bad faith.  If a stockholder, as one co-owner, can owe fiduciary duties to fellow co-owners because the stockholder controls the thing collectively owned, surely an “outsider[]” that controls something it does not own owes duties to the owner.  “[I]t is a maxim of equity that ‘equity regards substance rather than form,’” and “the application of equitable principles depends on the substance of control rather than the form[;] it does not matter whether the control is exercised directly or indirectly.”  “[T]he level of stock ownership is not the predominant factor, and an inability to exert influence through voting power does not foreclose a finding of control.”  Thus, “Delaware corporate decisions consistently have looked to who wields control in substance and have imposed the risk of fiduciary liability on that person,” and “[l]iability for breach of fiduciary duty therefore extends to outsiders who effectively controlled the corporation.”

With this foundation, and considering evolving market realities and corporate structures affording effective control, Delaware law may countenance extending controller status and fiduciary duties to a nonstockholder that holds and exercises soft power that displaces the will of the board with respect to a particular decision or transaction.

That’s a point I made in my essay, After Corwin: Down the Controlling Shareholder Rabbit Hole; as I wrote there:

[O]ne of the first things a business law student learns is that even without a formal equity stake, contractual control can be exerted to the point where fiduciary obligations follow.  But all of this just raises the question whether the shareholder aspect of the controlling shareholder inquiry is necessarily doing any work.

Point being, the fact that Musk’s power does not come from his stock holdings alone is not dispositive of this question.  Musk is the kind of figure that boards, and shareholders, might be afraid to buck because he can’t be dislodged – Musk himself testified that Tesla would “die” without him – and he can send Tesla’s stock price tanking with a single tweet.  Imperial CEOs present a difficult case, but those factors are pretty much the basis for treating controlling shareholders differently from just ordinary conflicted boards. 

Or, with apologies to Guth v. Loft, 5 A.2d 503 (Del. 1939), “Musk was Tesla, and Musk was SolarCity.”  

That said, it must be observed that: (1) Plaintiffs can win this case even if Musk is deemed not to be a controlling shareholder, and (2) it’s possible VC Slights won’t have to decide whether Musk is or isn’t.

More under the cut...

Continue reading

July 17, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, July 10, 2021

New Paper: Capital Discrimination

Hey all.  For your reading enjoyment, I've posted my new paper, Capital Discrimination, forthcoming in the Houston Law Review, to SSRN.  Here is the abstract:

The law of business associations does not recognize gender.  The rights and responsibilities imposed by states on business owners, directors, and officers do not vary based on whether the actors are male or female, and there is no explicit recognition of the influence of gender in the doctrine. 

Sex and gender nonetheless may pervade business disputes.  One co-owner may harass another co-owner; women equity holders may be forced out of the company; men may refuse to pay dividends to women shareholders.

In some contexts, courts do account for these dynamics, such as when married co-owners file for divorce.  But business law itself has no vocabulary to engage the influence of sex and gender, or to correct for unfairness traceable to discrimination.  Instead, these types of disputes are resolved using the generic language of fiduciary duty and business judgment, with the issue of discrimination left, at best, as subtext.  The failure of business law doctrine to confront how gender influences decisionmaking has broad implications for everything from the allocation of capital throughout the financing ecosystem to the lessons that young lawyers are taught regarding how to counsel their clients.

This Article will explore how courts address – or fail to address – the problem of discrimination against women as owners and investors.  Ultimately, the Article proposes new mechanisms, both via statute and through a reconceptualization of fiduciary duty, that would allow courts to recognize, and account for, gender-based oppression in business.

The paper explores the topic through several case studies including, but not limited to, Shari Redstone’s battle with the boards of Viacom and CBS.

July 10, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, July 3, 2021

Meland v. Weber and board diversity

In June, the Ninth Circuit handed down its opinion in Meland v. Weber, holding that an individual shareholder of OSI Systems had standing to challenge California’s board diversity law, which mandates that publicly-traded companies with headquarters in the state appoint a certain number of women directors.

The shareholder is claiming that the mandate violates the 14th Amendment, and the Meland opinion naturally doesn’t engage that; the question before the Ninth Circuit was simply whether the shareholder can sue.

To find standing, the court had to make two necessary findings: first, that the law actually operated on the shareholder, i.e., it demanded some kind of action or behavior from the shareholder despite being targeted to corporate boards (what the Ninth Circuit called being the “object” of the law); and second, that there was a cognizable injury to the shareholder, i.e., some kind of threat to the shareholder personally if OSI Systems did not comply.

With respect to both findings, the connections that the court found between the law and the shareholder’s injury were, shall we say, attenuated.

As for the first finding, that the law operates on the shareholder, the essence of the plaintiff’s claim is that California is forcing him to discriminate in favor of women and against men by mandating that he cast his ballot in favor of women directors.  The Ninth Circuit agreed with this summary of the law’s operation, writing:

As a general rule, shareholders are responsible for electing directors at their annual meetings. E.g., Cal. Corp. Code §§ 301(a), 600(b). OSI is no exception. Thus, the only way a person can be elected to OSI’s board is if a plurality of shareholders vote in favor of the nominee at an annual shareholder meeting. OSI itself has no authority to elect its own board members. For SB 826 to hasten the achievement of gender parity—or indeed, for SB 826 to have any effect at all—it must therefore compel shareholders to act. Accordingly, the California Legislature necessarily intended for SB 826 to require (or at least encourage) shareholders to vote in a manner that would achieve this goal….

SB 826 necessarily requires or encourages individual shareholders to vote for female board members. A reasonable shareholder deciding how to vote could not assume that other shareholders would vote to elect the requisite number of female board members. Therefore, each shareholder would understand that a failure to vote for a female would contribute to the risk of putting the corporation in violation of state law and exposing it to sanctions. At a minimum, therefore, SB 826 would encourage a reasonable shareholder to vote in a way that would support corporate compliance with legal requirements. Indeed, the California Legislature must have concluded that SB 826 would have such an effect on individual shareholders; otherwise, if each individual shareholder felt free to vote for a male board member, SB 826 could not achieve its goal of reaching gender parity.

A couple of things about this reasoning.  Theoretically, yes, in a plurality voting system, in an uncontested election, if every single shareholder voted against whoever the female nominee was, she’d lose.  But the possibility of that outcome – well, let’s just say “hypothetical” does not begin to cover it.  The reasoning also makes the standing determination dependent on treating shareholders as a group rather than focusing on them as individuals, even though the harm alleged operates on the shareholder individually.  Which matters because I assume that some shareholders will enthusiastically – even joyfully – vote for whoever the female nominee is (if she’s a shareholder, she’ll vote for herself), and they are not experiencing any harm or compulsion at all.

Most importantly, though, it’s an entirely unrealistic look at how shareholder voting actually operates.  In an uncontested, plurality election, the corporate nominating committee decides who goes on the ballot and ultimately who ends up as a director.  And it’s far more likely that SB826 was intended to operate on the nominating committee – to make the committee its “object” – than the shareholder.  The Ninth Circuit dealt with this objection in a footnote:

California also suggests that SB 826 does not require Meland to make a discriminatory decision because board candidates are typically nominated by OSI’s nominating committee, and the committee will ensure that the slate of candidates complies with SB 826. At this juncture, however, we “must accept as true all material allegations of the complaint, and must construe the complaint in favor of the complaining party.” The complaint does not allege that OSI’s nominating committee has exclusive control over the slate of board candidates or that the number of candidates included in the slate always matches the number of available board seats. To the contrary, Meland alleges that shareholders, or groups of shareholders, may submit names of candidates for election to the board, an allegation that undermines California’s suggestion. Accordingly, we do not consider California’s argument, which is unsupported by the pleadings, at this stage of the proceedings.

That’s the first finding.

The second finding concerned how the shareholder would actually suffer if he defied the law, and on this, the Ninth Circuit recognized two injuries.  First, the corporation will be fined, and second, the corporation will be “sham[ed]” by the state of California via the publication of lists of noncompliant companies.  These outcomes will damage the value of the shareholder’s investment, which is sufficient for Article III purposes. 

Now, we’d call these derivative harms for corporate law purposes but that’s not really the issue for constitutional ones; the Article III question is whether there is an injury-in-fact.  Still, OSI reported $19 million of income last quarter, and California’s fines are at most $300,000 per violation (there aren’t rules yet but I assume that means annually).  I don’t know how many shares Meland owes but it does seem like the monetary harm to him individually is microscopic, and the “shaming” harm can only be described as speculative.

Where am I going with all of this?

Well, my general assumption with respect to California’s law has always been that since it applies exclusively to publicly-traded companies, there were few avenues to challenge it legally because most public company boards won’t want to declare themselves opposed to diversity.  But the Meland ruling allows boards to use shareholders as a cat’s paw for positions they don’t want to take openly.

And if the Meland ruling stands and/or is followed by other circuits, I wonder just how far it could go.  For example, could it be applied to less onerous diversity mandates, like the disclosure requirements some states have adopted, and possibly even the Nasdaq comply-or-explain proposal?  (Though Nasdaq’s a condition rather than a mandate, which might get different treatment on the merits, and Nasdaq likes to pretend it’s a private actor when it would legally benefit Nasdaq to do so.)  The Ninth Circuit found injury in shaming, not just fines, which I think might open the door for shareholders of, say, Illinois-headquartered public companies to sue claiming that Illinois’s diversity scoring system shames nondiverse companies.

(I highlight: Meland would not extend shareholder standing to matters that do not involve shareholder votes, like diversity in hiring; the voting aspect was necessary to the court’s ruling.)

Which brings me to my next point, which is, the plaintiff’s claim in Meland is rooted in equal protection, but there’s also the lurking issue of whether California’s law violates the internal affairs doctrine to the extent it operates on companies that are organized in other jurisdictions.  Not sure if this gets tested in court, but on this, I think California really shot itself in the foot when it passed SB826.  In the preamble, it said:

The Legislature finds and declares as follows:

(a) More women directors serving on boards of directors of publicly held corporations will boost the California economy, improve opportunities for women in the workplace, and protect California taxpayers, shareholders, and retirees, including retired California state employees and teachers whose pensions are managed by CalPERS and CalSTRS. Yet studies predict that it will take 40 or 50 years to achieve gender parity, if something is not done proactively…

(c) Numerous independent studies have concluded that publicly held companies perform better when women serve on their boards of directors, including:

(1) A 2017 study by MSCI found that United States’ companies that began the five-year period from 2011 to 2016 with three or more female directors reported earnings per share that were 45 percent higher than those companies with no female directors at the beginning of the period.

(2) In 2014, Credit Suisse found that companies with at least one woman on the board had an average return on equity (ROE) of 12.2 percent, compared to 10.1 percent for companies with no female directors. Additionally, the price-to-book value of these firms was greater for those with women on their boards: 2.4 times the value in comparison to 1.8 times the value for zero-women boards.

(3) A 2012 University of California, Berkeley study called “Women Create a Sustainable Future” found that companies with more women on their boards are more likely to “create a sustainable future” by, among other things, instituting strong governance structures with a high level of transparency.

(4) Credit Suisse conducted a six-year global research study from 2006 to 2012, with more than 2,000 companies worldwide, showing that women on boards improve business performance for key metrics, including stock performance. For companies with a market capitalization of more than $10 billion, those with women directors on boards outperformed shares of comparable businesses with all-male boards by 26 percent.

(5) The Credit Suisse report included the following findings:

(A) There has been a greater correlation between stock performance and the presence of women on a board since the financial crisis in 2008.

(B) Companies with women on their boards of directors significantly outperformed others when the recession occurred.

(C) Companies with women on their boards tend to be somewhat risk averse and carry less debt, on average.

(D) Net income growth for companies with women on their boards averaged 14 percent over a six-year period, compared with 10 percent for companies with no women directors….

(g) Further, several studies have concluded that having three women on the board, rather than just one or none, increases the effectiveness of boards….

Note that almost all of these justifications are rooted in the benefit to companies, rather than the benefits to women.  Now, the evidence of actual corporate benefit from gender diverse boards is mixed, but, as relevant here, internal arrangements that are intended to protect shareholders kind of fall into the core of what the internal affairs doctrine covers.  Employment law, however, which is about protecting employees as employees, does not.  If California had justified its law as a type of employment protection for women, it would be on much stronger ground here.  True, directors are not usually considered corporate “employees” in the traditional Restatement-of-Agency sense but there’s no reason that would matter for the purposes of assessing the contours of the internal affairs doctrine – California is free to define “employee” however it likes.

So why didn’t California just do that?

I think because there’s this persistent legal myth that somehow it’s only appropriate to regulate corporate internal governance arrangements for the benefit of investors; any regulation intended to benefit other groups should not operate via corporate governance.  That’s wrong, both descriptively and normatively, as I argue in my Beyond Internal and External essay, but it’s a default mindset.  California would have no trouble – and has had no trouble – enacting various antidiscrimination laws in the context of employment, public accommodations, and other areas, all to protect oppressed groups – but when it comes to corporate governance, suddenly the law is only legitimate, in lawmakers’ minds, if there’s an investor-oriented hook.

I’ll also note that Jens Dammann and Horst Eidenmueller make the same point in a pair of papers: they argue that co-determination (whereby employees, as well as shareholders, get to vote for corporate directors) may not be better for companies, but it is better for democracy, and that’s a legitimate reason to do it.  (And yes, I name-checked those papers before, for the same reason, in my earlier post: Doyle, Watson, and the Purpose of the Corporation).

Anyhoo, that said, I wonder if the easiest way for California and other states, or the Nasdaq, to deal with this is to require not that companies have diverse boards, but that their nominating committee present a diverse slate.  If I’m right that nominating committees won’t want to be the face of a legal challenge to the law, that leaves fewer people with any kind of standing – not shareholders under Meland’s logic, maybe not even disappointed board candidates, and it won’t create problems in situations where there may be majority-voting or a proxy contest, which are scenarios that would give the Meland shareholder a heftier claim to standing.

July 3, 2021 in Ann Lipton | Permalink | Comments (2)

Wednesday, June 23, 2021

Goldman *bangs head on desk*

Well, the Supreme Court’s decision in Goldman Sachs v. Arkansas Teacher Retirement System is out and I suppose that makes me legally obligated to blog about it.

The result itself was … overdetermined.  As I posted after oral argument:

[Goldman] argued that “genericness” is a relevant fact to be considered at class certification in service of the price impact inquiry, along with any other evidence on the subject.  Goldman’s claim was not that courts should revisit the question of materiality at class cert – which tests what a hypothetical reasonable investor would have thought about the statements – but that in weighing whether the statements actually had an effect on prices, it is legitimate for courts to consider the generic nature of the statements at issue.  …

[T]he plaintiffs agreed with Goldman that genericness is a relevant fact to be considered by courts as part of the price impact inquiry, subject to appropriate expert evaluation.  …Which meant, the disagreement between the parties boiled down to whether [] the Second Circuit had erred by rejecting the notion that genericness is relevant if not dispositive…

So the parties are functionally reduced to fighting over what the Second Circuit meant, and whether the Supreme Court should vacate the Second Circuit’s opinion for a do-over, or whether the Supreme Court should affirm but clarify that it understands the Second Circuit to not have categorically barred the introduction of evidence of genericness at the class certification stage.

So, now we have the decision, and:

On the first question—whether the generic nature of a misrepresentation is relevant to price impact—the parties’ dispute has largely evaporated. Plaintiffs now concede that the generic nature of an alleged misrepresentation often will be important evidence of price impact ... The parties further agree that courts may consider expert testimony and use their common sense in assessing whether a generic misrepresentation had a price impact.  And they likewise agree that courts may assess the generic nature of a misrepresentation at class certification even though it also may be relevant to materiality....

We share the parties’ view. 

Anyhoo, 8 members of the Court decided to remand to the Second Circuit, while Justice Sotomayor wrote separately to argue that she thought the Second Circuit got it right the first time.  Goldman also had an argument that the burden of persuasion should have shifted back to the plaintiffs under Rule 301; it lost on that 6-3, so the law is pretty much where it’s always been.

Or is it?

Let’s take a step back and recall that the Supreme Court has been granting cert to decide what is basically the same exact issue for literally 10 years now.  The first time was Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011) (Halliburton I).  In that case, the Fifth Circuit had modified the presumption announced in Basic Inc. v. Levinson, 485 U. S. 224 (1988) – that material, false, public statements impact the prices of securities that trade efficiently – by placing the burden on plaintiffs to prove such an impact.  They could do this, the Fifth Circuit held, either by showing that stock prices had gone up in response to the initial false statement, or by establishing loss causation, which the Fifth Circuit defined to mean that stock prices had gone down in response to a corrective disclosure.

This was significant, as I explained in an earlier blog post, because it is unusual for plaintiffs to be able to show upward price movement upon an initial lie; it is far more common that frauds keep prices level when they otherwise would have fallen.  And there is always a price drop at the end of the class period, because otherwise, no plaintiff would bring a claim. Which means the fight is never about whether there was a disclosure and a price drop, but about whether the disclosure was the right kind of disclosure, and the Fifth Circuit was requiring a very tight linkage between the disclosure and the earlier lie.  Ultimately, the evidence that the Fifth Circuit was demanding would not have shed light on the price impact inquiry at all.

The Supreme Court (umm, sort of) understood all of this.  It rejected the Fifth Circuit’s attempt to shift the burdens first established in Basic.  It also rejected the defendants’ fallback position that even if the initial burden should not have been placed on plaintiffs, the defendants should have had a chance to rebut the presumption by disproving loss causation.  Why?  Because “[t]he fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory.” 

And finally, it rejected the defendants’ further fallback position that while the Fifth Circuit had said “loss causation,” what it really meant was “price impact,” because, ahem, “We do not accept Halliburton’s wishful interpretation of the Court of Appeals’ opinion. As we have explained, loss causation is a familiar and distinct concept in securities law; it is not price impact…. Whatever Halliburton thinks the Court of Appeals meant to say, what it said was loss causation… We take the Court of Appeals at its word. Based on those words, the decision below cannot stand.”

That was step one. 

 Step two was Amgen Inc. v. Connecticut Retirement Plans, 568 U.S. 455 (2013).  There, the defendants argued that at class certification, plaintiffs should have the burden of proving materiality – or that defendants should be able to prove lack of materiality – as a means of establishing that the lie had not impacted prices.  The Supreme Court said no.

Step three was Halliburton Co. v. Erica P. John Fund, Inc., 573 U. S. 258 (Halliburton II).  This time, the Court held that defendants do have the right to try to prove lack of price impact at class certification.

And now we have Goldman.  The Court rejected Goldman’s attempt to shift the burden to plaintiffs, again, writing, “the best reading of our precedents—as the Courts of Appeals to have considered the issue have recognized—is that the defendant bears the burden of persuasion to prove a lack of price impact.”

But it also accepted that the “generic” nature of a statement – a concept, incidentally, that is never actually defined – is relevant to the price impact inquiry.  And then it had this curious explanation for why:

The generic nature of a misrepresentation often will be important evidence of a lack of price impact, particularly incases proceeding under the inflation-maintenance theory.  Under that theory, price impact is the amount of price inflation maintained by an alleged misrepresentation—in other words, the amount that the stock’s price would have fallen “without the false statement.” Glickenhaus & Co. v. Household Int’l, Inc., 787 F. 3d 408, 415 (CA7 2020). Plaintiffs typically try to prove the amount of inflation indirectly: They point to a negative disclosure about a company and an associated drop in its stock price; allege that the disclosure corrected an earlier misrepresentation; and then claim that the price drop is equal to the amount of inflation maintained by the earlier misrepresentation. See, e.g., id., at 413–417; In re Vivendi, S. A. Securities Litig., 838 F. 3d 223, 233–237, 253–259 (CA2 2016).

But that final inference—that the back-end price drop equals front-end inflation—starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure. That may occur when the earlier misrepresentation is generic (e.g., “we have faith in our business model”) and the later corrective disclosure is specific (e.g., “our fourth quarter earnings did not meet expectations”). Under those circumstances, it is less likely that the specific disclosure actually corrected the generic misrepresentation, which means that there is less reason to infer front-end price inflation—that is, price impact—from the back-end price drop.

(emphasis added).

See what the Court did there?  Why is it talking about plaintiffs’ burdens?  Why is it citing two cases – Vivendi and Glickenhaus – that explained how to prove loss causation at trial? What relevance does the Court think this has for class certification and price impact

I don’t know, but it almost suggests we could be right back where we started with the Fifth Circuit’s original rule.  And whatever it means, I am 100% certain it will cause additional, confused sparring in the lower courts. 

Because at the end of the day, it’s very hard to get away from “what goes up must come down” as a heuristic.  Defendants routinely argue “look here that purported disclosure really didn’t disclose anything,” and from there claim that they have “disproved” price impact.  But that’s non sequitur.  If the purported end-of-class-period disclosure was not, in fact, a disclosure at all, that doesn’t actually answer the question whether the initial statements affected prices.  I blogged about how much this whole thing confused the Halliburton district court when it tried to implement the Supreme Court’s instructions in Halliburton II; I can only assume we’re about to see more of the same.

June 23, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, June 19, 2021

Climate Change Disclosures and Private Companies

The SEC recently called for public comment on the issue of mandatory climate reporting, and the comments are in the process of being posted at the SEC’s site.  In the original request for information, Acting Chair Lee asked:

What climate-related information is available with respect to private companies, and how should the Commission’s rules address private companies’ climate disclosures, such as through exempt offerings, or its oversight of certain investment advisers and funds?

Not all of the commenters responded to this question, but here are some highlights:

The Institutional Limited Partners Association, which is a group of institutional investors in private equity, said:

If appropriate standards for minimum disclosures are established for SEC registrants, these standards will subsequently influence private markets. In anticipation of potentially listing private fund portfolio companies, GPs will seek to align to the SEC standard. LPs, particularly those looking to measure climate implications across their public and private investment portfolios, will benefit from this alignment. Furthermore, LPs that currently struggle to collect climate-related information will benefit from SEC requirements, which will serve as a framework to encourage GP reporting alignment

Private equity said:

From a regulatory perspective, the AIC believes that the existing private offering framework, under the federal securities laws, adequately facilitates disclosure by private equity and private credit firms. We look forward to working with the SEC on climate-related and other ESG disclosure topics as the SEC considers this framework.

Private issuers generally and, specifically, private equity and private credit firms and the funds they sponsor, are subject to a legal and regulatory framework that results in disclosure requirements appropriate for participants in private securities offerings.

Private issuers in the U.S. are customarily exempt from specific disclosure requirements in connection with private offerings of their securities, while public issuers are subject to a registration regime that, by design, is fundamentally different. This is because offerings exempt from registration under the Securities Act of 1933, as amended (the Securities Act) have long been recognized as precisely that – exempt – generally because the risk to the public is mitigated by the private nature of the offering and, very often, because of the sophistication of the investors in the offering.

Neither of these is very surprising; things get a little more interesting when we turn to the Democratic AGs, whose letter was not up at the SEC’s site as of the time of this posting, but was reported on by Law360:

[E]xempt offerings under Regulation Crowdfunding (“Reg CF”) and Regulation A (“Reg A”) must include certain offering information that is filed with the SEC and made available to potential and current investors. The SEC should add climate-related information to these exempt offering disclosures. Given the potential disparity in the sizes of publicly traded companies and firms that undertake Reg A and

Reg CF offerings, the SEC could base the type and extent of climate-related disclosures on the size of the firm and the industry in which the firm operates, with larger firms and firms in riskier and more heavily impacted industries required to make more extensive disclosures.

The SEC should also address climate-related disclosures as part of a broader review of and amendments to Regulation D (“Reg D”). Reg D, which permits companies to make exempt offerings to “accredited investors” and a limited number of unaccredited investors, exposes millions of retail investors to exempt offerings that currently have no disclosure requirements so long as those investors meet the wealth or income thresholds the SEC set in 1982. The SEC should extend Reg D’s disclosure requirements for unaccredited investors to all individual investors, whether accredited or unaccredited.  Because those disclosure requirements in turn refer to Form 1-A (as used in Reg A filings) and to Regulation S-K, the SEC’s addition of climate-related disclosures to Reg A/Form 1-A and to Reg S-K/Form S-1 would provide a pathway for that requirement to apply to disclosures for individual investors.

So, first thing: on the issue of climate change disclosures, are they seriously arguing that the kind of tiny local businesses that are hard-pressed even to provide an accurate balance sheet should now be disclosing greenhouse gas emissions?

Second and more broadly, though, the Regulation D proposal is less about climate change than about protecting individual investors.  There’s long been a debate about whether individuals can adequately vet private offerings, and whether the accredited investor definition provides them with sufficient protection (here’s a recent New York Times article about the perils of what was apparently a Reg D offering marketed to wealthy individuals).  If all Reg D sales to individuals included mandated disclosures, we’d probably see a lot fewer of those sales.  Not a criticism; that is, I assume, the point of the recommendation.

That said, it’s not entirely clear to me whether the AG’s are advocating for climate disclosures for other exempt offerings, i.e., exempt offerings under Regulation D that are marketed solely to institutions. The letter does say:

In response to the SEC’s inquiry regarding climate-related disclosures for private companies (Question 14), the SEC should also direct firms that undertake exempt securities offerings to provide climate-related disclosures. Based on currently available (albeit likely incomplete) data, the private offerings market dwarfs the public market, with exempt offerings totaling $3 trillion in 2017, as compared to $1.5 trillion in registered offerings.  Failure by the SEC to impose any requirements on companies issuing exempt securities—especially large companies with many investors—could undermine the benefits of mandatory disclosures made by publicly-traded companies by not affording investors with critical information necessary to bring about efficient capital allocation.

But since the only specific discussions concern Reg CF, Reg A, and individual investors under Reg D – well, let’s just say motes, beams, and eyes come to mind.

Things start to get more interesting when we move to T. Rowe Price’s letter:

In order to level the playing field for sustainability-related disclosures, reduce data gaps for investors, and mitigate the potential for public-private company arbitrage of so-called “dirty” assets, the SEC’s disclosure framework should apply to certain private companies as well as public companies. We encourage the Commission to consider using the same threshold that applies to private company 10-K reporting.  This would avoid creating incentives to transfer businesses with high carbon intensity from public markets to private, which would perversely result in equal or greater greenhouse gas emissions with less transparency to investors.

Which is actually less shocking than it seems on first blush, because the “same threshold that applies to private company 10-K reporting” requires at least 2,000 shareholders of record (with some exceptions), and the way that’s calculated means that very few companies meet the standard.  In other words, T. Rowe Price is acknowledging the possibility of arbitrage by public companies who move ownership of dirty assets to private companies, but its proposed solution is a mirage: in practice, if the assets are going to be sold, they’ll be sold to a company with only a handful of shareholders that doesn’t meet the reporting threshold. 

Which is why the Investment Company Institute (ie., the advocacy organization for mutual funds) plays a similar shell game:

Our members support requiring private companies of the size that must provide periodic reports, or Rule 12g-1 reporting companies, to disclose the same sustainability-related information as public companies.

Beyond that, their main position is, “not it.”

We would strongly object to the Commission addressing private companies' climate change-related disclosures through its oversight of investment advisers and funds. If the Commission determines that this information should be mandated, it should require the information directly from private companies, not indirectly by imposing disclosure requirements on funds and advisers. Proper sequencing is critical to avoid creating the regulatory conundrum of requiring funds to disclose information about companies that the companies themselves are not required to provide to the funds.

But here’s the punchline – BlackRock:

At present, climate-related information with respect to private issuers is lacking in comparison to what is increasingly available from public issuers. To avoid regulatory arbitrage between public and private market climate-related disclosures, we believe that climate-related disclosure mandates should not be limited to public issuers.

Therefore, we encourage the SEC to explore its existing regulatory authority to mandate climate-related disclosures with respect to large private market issuers.  Improving and standardizing climate disclosures across public and private issuers would benefit institutional investors (by increasing information for climate-related assessments), issuers (by avoiding multiple nuanced requests for information from various investors) and asset owners (by expanding transparency and reporting).  As an investor in both public and private issuers, this equalized transparency would help us make more informed investment decisions with respect to climate-related issues in both markets.

With no qualifications at all that I can see. That’s a serious eyebrow-raiser, and one that particularly hits home because a few days ago, the Commission announced that Boston College Professor Renee Jones is the new head of Corporate Finance.  As has been widely reported, Jones recently published an article about the distortive effect that expansive offering/reporting exemptions have on corporate governance – regular readers may recall that I actually blogged my comments on that article when it was first published.  Jones also testified before Congress to make the same arguments.

So, this is a sleeper issue I’m keeping my eye on.

Update: State Street’s letter is now available and, in footnote 5, it indicates it’s also in favor of private company disclosure.

June 19, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, June 12, 2021

Emulex, redux

Everyone remembers Emulex Corp. v. Varjabedian, right?  The Ninth Circuit held that plaintiffs could sue under Section 14(e) for negligent, as well as intentional, false statements in connection with a tender offer – breaking with circuits that had read 14(e) to require scienter – and the Supreme Court granted certiorari to resolve the split.  The problem was, the defendants were sort of arguing that 14(e) only prohibits intentional conduct, and sort of arguing that there’s no private right of action under 14(e) at all.  As a result, the whole thing ended with the Court dismissing the writ as improvidently granted

Fast forward to Brown v. Papa Murphy’s Holdings Incorporated, 3:19-cv-05514-BHS-JRC, pending in the Western District of Washington.  The plaintiffs there also alleged that defendants negligently made false statements in connection with a tender offer; the claims survived a motion to dismiss; but the magistrate handling the case just recommended that the district court certify for interlocutory appeal under Section 1292.  What issue is being certified?  Well, that depends on which page of the opinion you read.  Here are some quotes from the magistrate’s order, from June 9, 2021, Dkt. 62:

the Court finds that defendants have shown that this matter should be certified for interlocutory appeal to determine whether there is a private right of action for claims under Section 14(e) of the Securities Exchange Act of 1934.

Defendants previously requested that the Court dismiss plaintiff’s second amended complaint on the ground that there is no private right of action for violations of Section 14(e) of the Exchange Act based on allegations of defendants’ negligence.  In recommending denial of defendants’ motion to dismiss, this Court found, in part, that Ninth Circuit precedent establishes an implied private right of action under Section 14(e).

The District Court adopted this Court’s Report and Recommendation (Dkt. 47) over defendants’ objections (Dkt. 51) and found that “[a]bsent a directive from the Ninth Circuit or the Supreme Court [. . .], the Court will not overturn precedent in holding that no private right of action for negligence-based claims exists.”

Here, defendants assert that the existence of a private right of action under Section 14(e) is a controlling question of law.  The Court agrees. If the Ninth Circuit were to rule that there is no Section 14(e) private right of action for claims premised on negligence, the outcome of the Ninth Circuit’s ruling could materially affect the outcome of this litigation.

Here, defendants argue that whether there is a private right of action under Section 14(e) for claims premised on negligence is a novel legal issue on which there is a substantial ground for difference of opinion.

You see the issue.  Most of the opinion is about the uncertainty of a private right of action based on negligence, but some of the phrasing concerns whether there is a private right of action at all.

In fact, here are the crucial grafs of the magistrate’s opinion:

Defendants assert that current Ninth Circuit precedent under Plaine v. McCabe, 797 F.2d 713, 718 (9th Cir. 1986) permits only a private right of action under Section 14(e) based on “fraudulent activity” in connection with a tender offer. Dkt. 58, at 8. Therefore, defendants conclude that the Ninth Circuit’s opinion in Plaine does not control plaintiff’s Section 14(e) claim premised on negligence. See id. Indeed, the Ninth Circuit in Plaine only addressed whether there was a private right of action under Section 14(e) based on claims of fraud—not negligence. See Plaine, 797 F.2d at 717–18….

[A]lthough the Ninth Circuit later held that claims under Section 14(e) require only a showing of negligence (rather than scienter), the issue of whether there is a private right of action for Section 14(e) claims based on negligence was not before the court. See Varjabedian v. Emulex Corp., 888 F.3d 399, 403–408 (9th Cir. 2018). 

But is that really an accurate characterization of Ninth Circuit precedent?

Not exactly.

Defendants – and the magistrate – interpreted Plaine v. McCabe, 797 F.2d 713 (9th Cir. 1986) to squarely hold that there is a private right of action under 14(e).  But in that case, the actual question presented was whether a nontendering shareholder could sue under 14(e), given the buyer/seller limits for 10(b) claims.  No one was arguing against a private right of action; the defendants merely argued that the plaintiff was uninjured because she did not tender.  In that context, the Ninth Circuit said:

Initially, we address the defendants’ argument that Plaine lacks standing to bring a section 14(e) claim. The defendants allege that because Plaine did not voluntarily tender her shares pursuant to the amended tender offer, she must not have relied on the alleged misstatements and was not injured by them.

To state a violation of section 14(e), a shareholder need not be a purchaser or seller of any securities as is required under other anti-fraud provisions of the Act...  Although Plaine did not tender her shares, she alleged injury occurring as a result of fraudulent activity in connection with a tender offer. In light of the Act's goal of protecting investors and the specific harm Plaine alleges, we follow the lead of the Fifth and Second Circuits and hold that in these circumstances even a non-tendering shareholder may bring suit for violation of section 14(e).

Then along came Varjabedian v. Emulex Corp.  There, private plaintiffs brought a 14(e) claim based in negligence, and the district court dismissed on the ground that a showing of scienter is required.  On appeal, the Ninth Circuit held that negligence is sufficient:

[F]or the reasons discussed above, we are persuaded that intervening guidance from the Supreme Court compels the conclusion that Section 14(e) of the Exchange Act imposes a negligence standard. Accordingly, we REVERSE the district court's decision as to the Section 14(e) claim because the district court employed a scienter standard in analyzing the Section 14(e) claim. We also REMAND for the district court to reconsider Defendant's motion to dismiss under a negligence standard. On remand, the district court shall also consider whether the Premium Analysis was material, an argument that Defendants raised but that the district court did not reach. In addition, the district court shall consider Plaintiff's Section 20(a) claim since the Section 14(e) claim survives.

This, the Papa Murphy defendants and magistrate held, meant that the Ninth Circuit assumed in Emulex –  but never squarely held – that the private right of action extends to negligence-based claims. 

By my read, though, you could make the same argument about Plaine, i.e., that the question of a private right of action was never squarely presented, the Ninth Circuit just assumed there was a private right of action, and its legal analysis was limited to whether that right extended to nontendering shareholders.  I mean, that’s at least as plausible as treating a private right of action for negligence as unsettled after Emulex, seeing as how in Emulex, the Ninth Circuit was facing a private claim and squarely told the district court to consider the motion to dismiss under a negligence standard.  

Given all of this, why did the Papa Murphy defendants argue, and the magistrate accept, that it was settled law in the Ninth Circuit that there exists some private right of action, and that it was only unsettled as to the state of mind requirement?

I assume it’s because of the standards for certification under Section 1292.  You can only get an interlocutory appeal if you show “substantial grounds for difference of opinion.”    No court has ever questioned that there is a private right of action under 14(e); therefore, the defendants would have trouble getting an interlocutory appeal for that question, even if they argued that Plaine never squarely so held.  The Ninth Circuit has, however, broken with other circuits on the issue of scienter versus negligence under 14(e), creating an avenue for argument on that score.  But the Ninth Circuit was also very clear that negligence, rather than scienter, is the standard in that circuit.  So, the only place where the defendants could find some uncertainty that would justify interlocutory review was by threading the needle between a negligence based standard and a private right of action – in effect, suggesting that while maybe 14(e) prohibits both negligent and intentional conduct, different levels of fault matter depending on whether an action is brought by private plaintiffs or the government.

Of course, the magistrate’s opinion here is not final.  It would have to be adopted by the district court, and then the Ninth Circuit would have to grant the appeal, before it would be heard.  But the muddling of issues may present the same problem in any Supreme Court petition as in the original Emulex case.

June 12, 2021 in Ann Lipton | Permalink | Comments (2)

Saturday, June 5, 2021

Tulane Seeks Applicants for Visiting Assistant Professor

Tulane Law School is currently accepting applications for a two-year position of visiting assistant professor.  The position is being supported by the Murphy Institute at Tulane, an interdisciplinary unit specializing in political economy and ethics that draws faculty from the university’s departments of economics, philosophy, history, and political science. The position is designed for scholars focusing on regulation of economic activity very broadly construed (including, for example, research with a methodological or analytical focus relevant to scholars of regulation).  It is also designed for individuals who plan to apply for tenure-track law school positions during the second year of the professorship.  The law school will provide significant informal support for such. Tulane is an equal opportunity employer and candidates who will enhance the diversity of the law faculty are especially invited to apply.  The position will start fall 2021; the precise start date is flexible.

Candidates should apply through Interfolio, at, providing a CV identifying at least three references, post-graduate transcripts, electronic copies of any scholarship completed or in-progress, and a letter explaining your teaching interests and your research agenda. If you have any questions, please contact Adam Feibelman at

June 5, 2021 in Ann Lipton, Jobs | Permalink | Comments (0)

Saturday, May 29, 2021

Back to Back They Faced Each Other

The biggest corporate news this week is about sustainability.  A Dutch court ordered Shell Oil to reduce its carbon emissions by 45% by 2030; 61% of Chevron shareholders voted to ask the company to substantially reduce its Scope 3 greenhouse gas emissions, while 48% voted in favor of greater lobbying disclosure, and disclosure of the effect of net zero by 2050 on its business and finances, and, of course, at Exxon, not only did an activist win at least 2 board seats over sustainability demands, but shareholders also supported proposals calling for greater lobbying disclosure.  And, earlier this month, shareholders at ConocoPhillips and Phillips 66 voted in favor of proposals to set emissions targets.

Unsurprisingly given the outcomes, BlackRock and Vanguard supported some of the Exxon dissident nominees, and also supported the successful Exxon shareholder proposals.  State Street supported some of the Exxon dissidents as well, though I don’t know if it’s reported its stance on the shareholder proposals.  BlackRock also voted in favor of the successful Chevron proposal.

Given the stunning success of shareholder environmental activism at the oil giants, then, it comes as a disappointment that it appears the deadline has passed for Congress to undo the SEC’s recent amendments to Rule 14a-8.  Senator Sherrod Brown introduced a resolution to revoke the changes, but no further action was taken.  These amendments to 14a-8 make it much harder for shareholders – especially smaller shareholders – to submit proposals, which is an issue because, though proposals are often supported by institutional investors, it’s retail shareholders who have traditionally taken the laboring oar of introducing and promoting them (although, when it comes to social/environmental proposals, a lot of specialty investors like religious organizations and SRI funds also introduce them).

On this, I have to point out that the Big Three – BlackRock, Vanguard, and State Street – were supporters of the new Rule 14a-8 restrictions.  Vanguard did so openly; BlackRock and State Street tried to play it close to the vest, but, as I explained in my draft chapter on ESG investing (see note 49), the Investment Company Institute supported the amendments, and it’s highly unlikely it would have done so without BlackRock and State Street’s buy-in.  In other words, BlackRock and State Street apparently sought to maintain their “sustainability” bona fides without publicly admitting they wanted to neuter shareholder ESG activism.  And it wouldn’t surprise me if the preferences of BlackRock, Vanguard, and State Street had something to do with Congress’s failure to act on Senator Brown’s resolution calling for the 14a-8 amendments’ repeal.

Point being, despite the headlines about the Big Three’s newfound support for sustainability, their commitments are fragile, and more than anything else, they seem to want to avoid being forced to take public positions on these matters in the first place.

May 29, 2021 in Ann Lipton | Permalink | Comments (2)