Saturday, March 23, 2019
A few months ago, I read John Carreyrou’s Bad Blood: Secrets and Lies in a Silicon Valley Startup about Elizabeth Holmes and the Theranos fraud, and I was very curious to see how the same story would play out in the new documentary The Inventor: Out for Blood in Silicon Valley. (Sidebar: I am truly on the edge of my seat for the forthcoming Adam McKay adaptation starring Jennifer Lawrence – but that’s a whole ‘nother thing). In general, I preferred the book: it has far more detail, and the documentary has little new information to contribute. That said, there was power in the immediacy of actually watching Elizabeth Holmes, hearing her speak, and seeing how people reacted to her. So, below are some of my general thoughts.
Friday, March 15, 2019
Tulane just held its 31st Annual Corporate Law Institute, and though I was not able to attend the full event, I was there for part of it. Though the panels were very interesting and I took copious notes, as a matter of personal satisfaction, the single most important thing I learned is that it is pronounced Shah-bah-cookie. You’re welcome.
That said, below are some takeaways from the Hot Topics in M&A Practice panel, and to be clear, this isn’t even remotely a comprehensive account of everything interesting; it’s just stuff that I personally hadn’t heard before. (And thus, the exact contours of my ignorance are revealed.)
Saturday, March 9, 2019
I am fascinated by the eyebrow-raising speech SEC Commissioner Hester Peirce delivered to the Council of Institutional Investors (CII) earlier this week. In it, she said:
I have concerns about CII’s position with respect to the Johnson & Johnson shareholder proposal. As you know, a Johnson & Johnson shareholder submitted a proposal that, if approved, would have started the process to shift shareholder disputes with the company to mandatory arbitration…. CII also submitted a letter stating that “shareholder arbitration clauses in public company governing documents reflect a potential threat to principles of sound governance.”…
CII argues that “shareowner arbitration clauses in public company governing documents represent a potential threat to principles of sound corporate governance that balance the rights of shareowners against the responsibility of corporate managers to run the business.” Among your worries is the non-public nature of arbitration and thus the absence of a “deterrent effect.”…
The problem is that these class actions are rarely decided on the merits. Instead, the cost of litigating is so great that companies often settle to be free of the cost and hassle of the lawsuit. Settlements are rarely public and certainly involve no publication of broadly applicable legal findings. Additionally, such suits can depress shareholder value since they often result in costly payouts to make the suit go away that do not inure to the benefit of shareholders. Indeed, the cost of defending and settling these suits is a substantial cost of being a public company. The result is that the company’s shareholders are ultimately harmed by the very option intended to protect them: first by the company’s diversion of resources to defend often meritless litigation, and second by the resulting decline in the value of their shares. Case law remains untouched, and the shareholders not involved in the process have no idea what happened. A big chunk of shareholder money typically goes to nice payouts for the lawyers involved.
As I understand it, in her view, institutional investors are not capable of judging the value of securities litigation relative to arbitration, may not be aware that securities lawsuits often settle without definitive factual findings, and also may have never head the criticism that such lawsuits are expensive for companies and enriching for attorneys.
She also appears to believe that institutional investors are unable to identify the types of corporate information that contribute to their understanding of firm value. As she put it:
My concerns are mainly ones of focus. I recently had a conversation with a boy who shares an obsession with many other children his age—the video game Fortnite. He described to me how much he enjoyed long stretches of playing the game ... How is it that this simulated environment can drown out the real distractions around him? Clearly, the designers of that game and others like it have figured out how to concentrate the mind on objects of their own making....
I see a parallel in today’s investment world. Many investors these days seem focused on non-investment matters at the expense of concentration on a sound allocation of resources to their highest and best use. Real dollars are being poured into adhering to an amorphous and shifting set of virtue markers. I do not want the SEC to become an enabler of this shift in focus. … We are being asked more and more to shift securities disclosure to focus more on matters that do not go to an assessment of how effectively companies are putting investor money to work….
Institutional investors  have been a strong voice in favor of regulation that supports the incorporation of environmental, social, and governance (“ESG”) in investing. The International Organization of Securities Commissions, or “IOSCO,” issued a statement on ESG investing in January. The statement directed issuers to consider whether ESG factors—which are not defined—should be included in their disclosures, …
I found the statement to be an objectionable attempt to focus issuers’ on a favored subset of matters, as defined by private creators of ESG metrics, rather than more generally on material matters. The U.S. securities laws already provide for material disclosures. Explicit consideration of ESG factors must therefore require something more than what is already contemplated by our laws …
When the SEC is asked to concentrate on issues other than protecting investors, facilitating capital formation, and fostering fair, orderly, and efficient markets, our focus shifts away from our mission. …
Yet despite this apparently low opinion of institutional investors’ ability to identify and advocate for their own interests, she also made the claim that:
If shareholders value the ability to bring class actions, they can divert their investments to companies that offer such options. I am sure that CII’s preferences will be well-attended by issuers seeking your investment money. I trust that shareholders like you are more than capable of handling the matter without our intervention.
I have to say, if institutional investors are distracted by nonmaterial ESG factors like a child playing Fortnite, I’m not sure how they’re supposed to go about pricing arbitration provisions in a publicly traded company.
In fact, we may want to begin rolling back all of those exemptions from registration for institutional and accredited investors. The premise of Regulation D, and Rule 144A, the “testing the waters” provision, and Section 4(a)(7) is that institutions are capable of bargaining for the information they need to make intelligent investment decisions, and they do not need the paternalistic protections of mandatory securities disclosure. But if it’s true that they are ignorant even of the phenomenon of the securities nuisance settlement, I don’t have much faith in their ability to engage in the more complex task of valuing an illiquid limited partnership interest in a 10-year private equity fund. (To be fair, that’s also how institutional investors themselves see it; they’ve just asked the SEC for greater oversight of the private equity industry.)
Okay, I’m snarking, of course, but this highlights a greater tension in the law that we see both at the federal and state level: regulators like to say they’re relying on institutional investors’ own judgments and wisdom (Regulation D, Corwin, etc) right up until the moment that these investors start to advocate for things the regulator doesn’t like (ESG disclosure, hedge fund activism, reliance on proxy advisors), at which point, investors are like children: better seen and not heard. It’s a way of making substantive regulatory choices while maintaining a pretense of deference to private ordering. The greater truth, in my view, is that institutional investors themselves are a product of regulation; they couldn’t exist without it, it’s written into their bones. They are so entangled with the regulatory state that the concept of private ordering becomes meaningless; there is simply one set of regulatory choices over another.
Saturday, March 2, 2019
I’ve previously posted that judges sometimes suggest that markets are efficient to a degree that borders on the mystical.* But on the opposite end of the spectrum, it often seems as though Congress does not believe in efficient markets at all. For example, the PSLRA’s “crash damages” provision contains the implicit assumption that when negative information comes to light, it will take 90 days for the stock to appropriately internalize it. 15 U.S.C. §78u-4(e)(1). Dodd Frank requires all public companies to disclose information on their compliance with the Federal Mine Safety & Health Act (I amuse myself by highlighting for my class the “mine safety disclosure” in the Starbucks 10-K, for example), even though that information is public via other channels. (Spoiler alert: the disclosures apparently make a difference, so Congress may be right!)
These identical bills would require public companies to disclose “Data, based on voluntary self-identification, on the racial, ethnic, and gender composition of the board of directors of the issuer; nominees for the board of directors of the issuer; and the executive officers of the issuer.” The bills would also require disclosure of veteran status, and any policies for promoting diversity among boards of directors and corporate executive officers. And then, oddly, the bills would require the Commission’s Director of the Office of Minority and Women Inclusion to publish “best practices with respect to compliance with this subsection,” in consultation with a newly established advisory council of issuers and investors (I say “oddly” because – they want to publish best practices for disclosing diversity information? I’m guessing that’s not what they’re going for, but that’s how it’s drafted.)
In any event, these bills represent something of a challenge to the efficient markets hypothesis because in most (if not all) cases, the racial, gender, etc characteristics of board members, board nominees, and top officers is readily available to investors. What may not be available, of course, are policies for promoting diversity, absent a rule requiring disclosure – which it turns out, we already have, at least with respect to director nominations. See 17 CFR § 229.407(c)(2)(vi); see also Developments on Public Company Disclosures Regarding Board and Executive Diversity.
Of course, the reality is these “disclosure” rules are not about disclosure at all; they’re about substantively pressuring companies to diversify their management teams – which explains, I assume, the bit about “best practices”; the goal is to craft guidelines for best practices in hiring, not best practices in disclosure. (Relatedly, Congress has begun to express concern about diversity in finance more generally.) For this reason, it is not at all surprising that the Chamber of Commerce has firmly endorsed this legislation, viewing it (explicitly) as a less-intrusive alternative to mandated diversity requirements, such as the ones adopted by California.
And yeah, there’s nothing unusual about securities disclosure requirements functioning in this manner, it’s just that you’d usually expect those requirements to force disclosure of things investors don’t already know.
It seems to me that a much more helpful – and more radical – proposal would be to force disclosure of things investors don’t know, such as general information about diversity throughout the company (a proposal made most recently by Jamillah Williams). This kind of data is usually confidential, though it is reported to the EEOC. Interested parties can request it via FOIA for firms that contract with the government, and companies like Oracle and Palantir have fought fierce – and ultimately losing – battles to keep it secret, ostensibly because diversity data is a “trade secret,” but more likely because the true numbers are embarrassing. That’s information that is much more likely to enlighten.
*a critique, among others, that I elaborate upon in my forthcoming essay, Fact or Fiction: Flawed Approaches to Evaluating Market Behavior in Securities Litigation
Monday, February 25, 2019
A bunch of us sensed that it was coming. I raised the question in an October 8, 2018 post here. Now, it has actually happened.
Tesla Chief Executive Officer Elon Musk has finally caught the negative attention of the U.S. Securities and Exchange Commission (SEC) with yet another of his reckless tweets. The WaPo reported earlier tonight that "[t]he Securities and Exchange Commission . . . asked a federal judge to hold Tesla CEO Elon Musk in contempt for violating the terms of a recent settlement agreement . . . ." That settlement agreement, as readers will recall, relates to SEC allegations that Musk lied to investors when he posted on Twitter that he had secured the funding needed to take Tesla private. The settlement agreement provides for the review and pre-approval of Musk's market-moving public statements.
Ann Lipton and I, as BLPB's resident fraud mongers, have been following the Musk affaire de Twitter for a number of months now. (See, e.g., here, here, and here.) Based on our prior posts, it seems clear the world was destined for this moment--a moment in which the SEC not only catches Musk in a tweeted misstatement but also can prove that the tweet was not pre-approved, as required under the terms of the settlement agreement. The WaPo article notes evidence that breaches of the agreement may be the rule rather than the exception. (Why does that not surprise me?)
Let's see where this goes next . . . .
Saturday, February 23, 2019
I had a great time reading Guhan Subramanian & Annie Zhao’s new paper, Go-Shops Revisited. It follows up on Prof. Subramanian’s earlier study of their effects, Go-Shops vs. No-Shops in Private Equity Deals: Evidence & Implications, 63 Bus. Law. 729 (2008). In the original study, Prof. Subramanian found that go-shops generally had beneficial effects for target companies: bidders would pay a little bit more for the privilege of something like exclusivity in the original negotiations, and not infrequently, a superior proposal would materialize during the go-shop period. But in the new paper, the authors conclude that go-shops are no longer an effective tool for price discovery, in large part because changes in their design make it much less likely that a superior proposal will emerge.
There are a lot of interesting observations in the new paper, with the basic point being that deal attorneys – aware that Delaware courts focus a lot on things like the size of termination fees – instead manipulate aspects of the go-shop that tend to escape judicial notice, and that collectively function to make go-shops less effective. One particular point that stood out: The authors note that PE firms have changed how they compensate CEOs who remain with the company after the buyout. Today, they pay based on whether the firm achieves certain multiples of invested capital, a metric that CEOs might view as functionally guaranteeing them a healthy payout, and one that incentivizes them to keep the deal price as low as possible. (The authors contrast with earlier IRR-based payouts, which were so difficult to achieve as to render compensation speculative). And even if the CEO does not negotiate compensation with the PE firm until after a deal price is reached, the CEO will know the PE firm’s practices and past history. The authors got a kind of amazing quote from an unnamed PE investor who said his firm tries to “corrupt” management; the multiple-of-invested-capital compensation structure, argue the authors, contributes to that corruption.
Point being, there are a lot of wonderful nuggets in the paper, and I highly recommend it.
Saturday, February 16, 2019
Where we left things, Delaware Vice Chancellor Laster had just ruled in Sciabacucci v. Salzberg that Delaware corporate charters and bylaws may only govern matters of corporate internal affairs, including litigation related to internal affairs; they may not be used to govern external matters like securities litigation. For that reason, forum-selection provisions purporting to require that Section 11 claims be filed in federal court were invalid. The implication – though not part of his holding – was that a similar result would obtain for charter and bylaw provisions that purport to require individualized arbitration of securities claims.
After that, the defendants, predictably, appealed to the Delaware Supreme Court, and we were all waiting (im)patiently to see how that would unfold when – alas! – a panel consisting of Strine, Vaughn, and Seitz dismissed the appeal as prematurely filed due to a pending attorneys’ fee petition in Chancery.
Speaking as someone who once did in fact have to litigate the issue of whether a notice of appeal was prematurely filed, thus depriving the appellate court of jurisdiction, all I can say is – oof! Then again, in my case, the matter wasn’t raised until it was too late to file a corrected notice; if we’d lost, the entire appeal would have been lost. Happily for the Sciabacucci defendants, their situation is not nearly as dire; presumably they’ll just refile their notice once the fee petition is addressed. But it does mean it will be a little while longer before the Delaware Supreme Court weighs in on this issue.
But that’s not all!
Hal Scott, a law professor at Harvard, has long been an advocate for using corporate charters and bylaws to mandate individualized arbitration of federal securities claims, and in November, he submitted a 14a-8 proposal to Johnson & Johnson to have shareholders vote to request that its Board adopt such a bylaw.
In the past, the SEC has taken the position that bylaws of this sort would violate federal law, specifically, the anti-waiver provisions of the securities laws, but the Supreme Court’s recent jurisprudence on arbitration has weakened that argument. Professor Scott presumably figured the time was ripe to try again, especially since SEC Commissioners have been making noises about being more receptive to the idea. And indeed, when J&J first submitted a request for no-action relief to the SEC, its grounds for exclusion was simply that the proposal would violate federal law.
(You can find the correspondence at this link.)
But then Sciabacucci happened. Except, J&J is incorporated in New Jersey, not Delaware, raising the question whether the Sciabacucci decision would travel. (I previously posted about New Jersey’s law back when they amended their corporate code to permit forum selection provisions.)
J&J quickly submitted an attorney opinion letter expressing the view that NJ law maps to that of Delaware, and therefore the proposal was excludable as violative of state law. Professor Scott shot back with the argument that Sciabacucci was incorrectly decided (previewing, I assume, arguments we can expect to see in the Delaware Supreme Court).
And then J&J brought in a ringer: It submitted a letter by New Jersey’s Attorney General opining that Sciabacucci represents the law of New Jersey.
(There were some other documents submitted as well, not all of which are included with the No-Action materials on the SEC’s website - which raises a procedural question, btw, why some and not others? For example, NASAA submitted its own letter in support of J&J, and so did the Council of Institutional Investors.)
Since no-action relief is typically granted when there “appears to be some basis” for the company’s view that the proposal is excludable under 14a-8, you would think that that J&J had by now gone above and beyond.
But you would be wrong.
Because while the SEC did grant the no-action request, it did so with, shall we say, a reluctant air. The SEC’s letter said:
When parties in a rule 14a-8(i)(2) matter have differing views about the application of state law, we consider authoritative views expressed by state officials. Here, the Attorney General of the State of New Jersey, the state’s chief legal officer, wrote a letter to the Division stating that “the Proposal, if adopted, would cause Johnson & Johnson to violate New Jersey state law.” We view this submission as a legally authoritative statement that we are not in a position to question. In light of the submissions before us, including in particular the opinion of the Attorney General of the State of New Jersey that implementation of the Proposal would cause the Company to violate state law, we will not recommend enforcement action to the Commission if the Company omits the Proposal from its proxy materials in reliance on rule 14a-8(i)(2). To conclude otherwise would put the Company in a position of taking actions that the chief legal officer of its state of incorporation has determined to be illegal. In granting the no-action request, the staff is recognizing the legal authority of the Attorney General of the State of New Jersey; it is not expressing its own view on the correct interpretation of New Jersey law. The staff is not “approving” or “disapproving” the substance of the Proposal or opining on the legality of it. Parties could seek a more definitive determination from a court of competent jurisdiction.
We are also not expressing a view as to whether the Proposal, if implemented, would cause the Company to violate federal law. Chairman Clayton has stated that questions regarding the federal legality or regulatory implications of mandatory arbitration provisions relating to claims arising under the federal securities laws should be addressed by the Commission in a measured and deliberative manner.
That’s a lot of words! I mean, literally, it’s a lot of words, considering that usually no-action relief is granted in a short paragraph.
And it didn’t stop there. SEC Chair Jay Clayton actually issued a statement on the matter, reiterating the importance of the Attorney General’s letter in the Commission’s decisionmaking, and emphasizing that the SEC itself was taking no position on the question whether such provisions violate federal law. If anything, the statement went out of its way to signal that the SEC’s views on the federal legality of arbitration provisions have shifted; as Clayton put it, “Since 2012, when this issue was last presented to staff in the Division of Corporation Finance in the context of a shareholder proposal, federal case law regarding mandatory arbitration has continued to evolve.”
Such action is quite extraordinary as a matter of SEC procedure, especially the part where Clayton came close to inviting Professor Scott or a similarly-minded proponent to take the issue to court:
More generally, it is important to note that the staff’s Rule 14a-8 no-action responses reflect only informal views of the staff regarding whether it is appropriate for the Commission to take enforcement action. The views expressed in these responses are not binding on the Commission or other parties, and do not and cannot definitively adjudicate the merits of a company’s position with respect to the legality of a shareholder proposal. A court is a more appropriate venue to seek a binding determination of whether a shareholder proposal can be excluded.
It’s not clear where things go from here; the most obvious possibility would be to wait for the Delaware appeal (now, ahem, delayed) to shake out and/or find a state willing to break with Delaware on this issue (which then, I previously argued, might potentially tee up some constitutional questions about the scope of the internal affairs doctrine, though I think it also would depend a lot on how a case was brought.)
But according to news reports, Professor Scott may continue to pursue the matter at J&J, possibly by appealing to the full Commission (which seems unlikely to succeed, since we know where Clayton stands, and even Commissioner Peirce has said state law determines whether these bylaws are permissible).
Either way, I’m sure I’ll be blogging about it, so watch this space.
Update: Prof. Scott did, in fact, request that CorpFin seek full Commission review of J&J’s request for no-action relief, arguing, among other things, that the New Jersey Attorney General conceded that there was no settled law in New Jersey on the issue and therefore his letter should not be taken as an authoritative interpretation of state law. Prof. Scott also argued (as he did in his original correspondence) that if New Jersey law does prohibit his proposed bylaw, the Federal Arbitration Act would preempt it (an argument that I find quite unpersuasive, since the FAA only prohibits laws that disparately target arbitration; a rule that restricts charters and bylaws to matters of internal affairs does not single out arbitration, as the Sciabacucci case itself demonstrates). In a letter signed by the Director of CorpFin, the Division denied the request on the ground that, in light of the Attorney General’s letter, the issues presented were not “novel or highly complex” and therefore did not meet the standard for Commission resolution. Correspondence available here.
Saturday, February 9, 2019
I’ve previously blogged about the battle to muzzle proxy advisor services with new regulations, including posting a summary of the SEC’s roundtable on the subject, a discussion of the (lack of) existing regulation, comments on the SEC’s withdrawal of two no-action letters concerning the use of such services.
This week, we have a bit of new news. First, the SEC announced that Commisioner Elad Roisman will be spearheading efforts in this area. That matters because, as I previously observed, Commissioner Roisman seems particularly sympathetic to the idea that firms should have an opportunity to review and comment and/or correct proxy advisor recommendations. So I’m guessing that’s something the SEC is going to propose.
Second, NASDAQ, Inc. – along with many other public companies (not all of which are NASDAQ companies, btw) – submitted a letter to the SEC requesting various changes to the proxy rules, including more regulation of proxy advisors. And the first thing I’ll note about the NASDAQ letter is that it’s nine pages long – 1.5 pages of text, and the rest is just a list of signatories.
I also notice that NASDAQ’s proposals are quite similar to those that were included in the Republican Financial Choice Act, which passed the House in 2017. And it seems to me that, if adopted, they would pose a real threat to how proxy advisors function.
Among other things, NASDAQ claims it wants a process for companies to dispute “inaccurate” proxy recommendations, except it makes clear that it’s not just objecting to factual errors, but advisor opinions that the issuer feels are wrong. As NASDAQ puts it, “The SEC should require transparent processes and practices that allow ALL public companies, regardless of their market capitalization, to engage with proxy advisory firms on matters of mistakes, misstatements of fact and other significant disputes.” (emphasis added).
What NASDAQ is referencing here is the fact that ISS does send previews of its reports to the S&P 500, but not other companies. (Glass Lewis makes factual data, but not the analysis, available to all issuers in advance). I’m not sure I have much of an opinion on whether the reports should be distributed in advance to issuers, but if proxy advisors are required by law to resolve any disputes or even just entertain those disputes before distributing the report to clients – even disputes that are not about factual data but about substantive analysis – that could inhibit their efforts to make timely and unbiased recommendations to clients.
As I said above, this is also the proposal likely to gain the most traction with Commissioner Roisman, so we’ll see how things unfold.
NASDAQ also wants proxy advisor services to make its recommendation policies public, and go through a formal notice and comment system to change those policies. Obviously, this would not only inhibit proxy advisors’ flexibility, but would force them to reveal what may very well be trade secrets, thus potentially undermining their business models (a point John Coates made in his testimony before Congress).
Finally, I note that NASDAQ is also asking the SEC to repeal the NOBO/OBO rules so that companies have direct access to information about shareholder identity. I didn’t even know that was something that was on the table, and I rather suspect that was thrown in as a Hail Mary, as I gather there would be a lot of objection from institutional investors.
So, that’s the general scoop, and I have to say that while I’m not surprised to see a lot of issuers take these positions, I'm a little surprised to see them coming from NASDAQ itself; given its ownership of the NASDAQ exchange, I’d have thought it would be a little more circumspect. Is there a political economy story I’m missing, possibly some kind of competitive pressure for listings that’s playing a role here? Or am I overthinking it?
Saturday, February 2, 2019
It’s a crazy time for me right now, so this week I just offer five feature articles that I read last year, each of which did a business-related deep dive that, for one reason or another, had my jaw-dropping (and in more than one case, had me laughing out loud).
Josh Dzieza, Prime and Punishment: Dirty Dealing in the $175 Billion Amazon Marketplace. On the dirty tricks sellers use to sabotage their rivals and the quasi-court system Amazon has created to handle complaints. Compare, by the way, to Molly Roberts on Facebook’s proposal for its own Facebook court.
Taffy Brodesser-Akner, How Goop’s Haters Made Gwyneth Paltrow’s Company Worth $250 Million. One of the things that struck me here was where the author points out that women’s health concerns are often dismissed by doctors, which might drive them to seek help from nontraditional sources. I’ve heard a similar explanation for the anti-vaxx movement – pregnant women are objectified and ignored by the medical establishment, which drives them to reclaim some kind of agency by rejecting that establishment entirely.
Elizabeth Evitts Dickinson, A Dress for Everyone: Claire McCardell took on the fashion industry — and revolutionized what women wear. I know nothing about fashion but I still came away from this piece amazed that I’d never heard of Claire McCardell. It’s a wonderful deconstruction of the political dimensions to clothing. (For more on that, try The Politics of Pockets)
Zachary Mider, Zeke Faux, David Ingold & Dimitrios Pogkas, Sign Here to Lose Everything. This is actually a series of articles about abuse of New York’s “confessions of judgment,” and it’s prompted various political responses.
Saturday, January 26, 2019
Like everyone else, it seems, I decided to watch the dueling Fyre festival documentaries on Hulu and Netflix. (If you don’t know what I’m talking about, read this.) At first, I had moral qualms about it because they’re each a bit skeevy, in their own way: the Hulu one paid Fyre’s organizer, Billy McFarland, to sit for an interview – so he profits from it – and the Netflix one was produced by the same media team that promoted the Fyre festival.
Then I reminded myself that I don’t, ahem, actually pay for Netflix or Hulu, and I felt much better.
I’ve read a lot of reviews of the two films and most of them seem to prefer Hulu’s. I myself prefer Netflix’s. The Hulu documentary was a lot lighter on the specifics of how the disaster unfolded, and a lot heavier on trying to make a broad claim about “millennials” being in thrall to social media and influencers, a claim that I found facile.
My interest was more in the technicalities of how this kind of massive fraud is perpetuated, how people go along with it, and that’s what Netflix’s documentary is about. We get a lot of interviews with people who were involved with the project – including the residents of the Bahamian island where the festival occurred – and we get a clearer picture of what happened.
[More under the cut]
Saturday, January 19, 2019
Forgive me for yet another foray into the vagaries of Tesla, but the company provides your humble blogger with an endless supply of discussion material. (My own prior posts on disparate Tesla-related subjects can be found here, here, and here; Joan Heminway also commented on Tesla here.)
Earlier this month, it was reported that Elon Musk retweeted a Forbes report that Tesla had outsold all other US luxury car makers, only to delete the tweet when it turned out the report was inaccurate (it had compared Tesla’s global sales with US sales by other car manufacturers). Such was the creation of a classroom hypothetical if I ever saw one.
I have so many questions:
1. Why did the Chief Executive Officer of Tesla not realize that the sales report was inaccurate, and if he did realize it, did he retweet anyway in hopes that no one would spot the error?
2. If Musk was aware the report was false, could he be liable for having made a false statement in connection with a securities transaction in violation of Section 10(b)?
A. We might ask whether Musk “made” a statement at all. As I’ve previously posted here and here, the Supreme Court is set to decide in Lorenzo v. Securities & Exchange Commission whether merely passing on someone else’s false representation – attributed to that other person – constitutes a false statement or otherwise fraudulent action by the conduit.
At the same time, there is a long (pre-Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011)) history of courts holding that corporate executives are responsible for the content of analyst reports when they place their imprimatur upon them. See, e.g., In re Cabletron Sys. Inc., 311 F.3d 11 (1st Cir. 2002); Elkind v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir. 1980); Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353 (5th Cir. 2004). Did Musk’s retweet qualify? Was his authorship “implicit from surrounding circumstances” under Janus?
We might say this is different from the Lorenzo case because in that instance, the conduit positioned himself as an employee, passing on information pursuant to his boss’s instruction; Musk, by contrast, apparently chose to single out this particular article; the curation itself may be interpreted as a kind of endorsement.
What if his profile said “retweets are not endorsements”? (At the time of this posting, by the way, it did not.) And – continuing with the fancy that this is a classroom discussion – if you were corporate counsel, would you insist on such a disclaimer?
B. If Musk did make a false statement, was it material? After all, the original false statement was already out there and presumably widely distributed. Moreover, it concerned factual information that was easy to check. In the past, courts have assumed that efficient markets have a heroic ability to self-correct under much more challenging circumstances (see my prior post; see also my forthcoming essay addressing the subject). If reporters’ synthesis of public raw data is not “material” for securities law purposes, see, e.g., In re Merck & Co. Securities Litigation, 432 F.3d 261 (3d Cir. 2005), it’s hard to see why Musk’s retweet of an easily-debunked false news report would be any more significant.
3. Where was the monitor? Pursuant to Musk’s settlement with the SEC over earlier ill-considered tweets, Musk agreed to:
comply with all mandatory procedures implemented by Tesla, Inc. (the “Company”) regarding (i) the oversight of communications relating to the Company made in any format, including, but not limited to, posts on social media (e.g. Twitter), the Company’s website (e.g. the Company’s blog), press releases, and investor calls, and (ii) the pre-approval of any such written communications that contain, or reasonably could contain, information material to the Company or its shareholders.
Now, to some extent, Musk has already indicated that he does not intend to hew to the terms of the settlement with religious fervor, but leaving that point aside, does the existence of the tweet in this instance suggest that there really is no monitor? That the monitor did not consider the retweet material? Other?
In any event, whatever else may come of Musk’s stewardship of Tesla, it’s nice to know I’ll have things to blog about so long as he remains at the helm.
Saturday, January 12, 2019
The Supreme Court just agreed to hear Emulex Corp. v. Varjabedian, which presents something of a puzzle for merger law and policy.
In brief, Emulex agreed to be acquired by Avago in a friendly tender offer under DGCL 251(h). When Emulex issued its Schedule 14D-9 recommending that shareholders tender their shares, it failed to mention that its bankers found the premium was on the low side as compared to similar deals. The plaintiffs sued, alleging that the omission rendered Emulex’s recommendations misleading in violation of Exchange Act Section 14(e), which prohibits false statements in connection with tender offers. In the courts below, the defendants argued, among other things, that the plaintiffs failed to plead that any misleading statements were made with scienter. On appeal, the Ninth Circuit broke with other circuits and held that scienter is not a required element of a Section 14(e) violation.
When the defendants petitioned for certiorari, here’s how they phrased the Question Presented:
Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.
Note the precise wording here – because we’re going to come back to that.
The dispute begins with the language of Section 14(e):
It shall be unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation.
The basic difficulty is that the phrase “make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading” is very similar to that used in Section 11 of the Securities Act, which prohibits misstatements in registration statements, and does not require a showing of scienter. It’s also nearly identical to that used in Rule 14a-9 of the Exchange Act, which prohibits misstatements in proxy materials, and also has generally been interpreted not to require scienter. And it’s pretty much word-for-word the language in Section 17(a)(2) of the Securities Act, which is enforceable only by the SEC and prohibits obtaining money or property by means of untrue statements about securities, and also - you guessed it - does not require a showing of scienter.*
But the phrase “fraudulent, deceptive, or manipulative acts or practices” is very similar to the prohibitions in Section 10(b) of the Exchange Act, which does require a showing of scienter.
14(e) has both! Oh no! Which is it?
Now the interesting thing is, until now, it wasn’t that much of an issue. But then the situation changed.
First, in around 2009 or 2010, you had the great merger litigation explosion; suddenly almost every sizeable merger was being challenged under state law, at least partly (most say) because the collapse of Milberg Weiss left a lot of plaintiffs’ firms hungry for work. Delaware eventually got sick of it and started making it harder to bring state law claims with cases like Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) and In re Trulia, 129 A.3d 884 (Del. Ch. 2016). Plaintiffs responded by bringing claims under federal law instead. (The stats are documented in The Shifting Tides of Merger Litigation, by Matthew Cain, Jill Fisch, Steven Davidoff Solomon, and Randall Thomas).
Second, in 2013, Delaware enacted 251(h), which created the so-called “intermediate form” merger by making it much easier to structure a friendly acquisition as a tender offer without holding a shareholder vote (a few other states followed suit). Suddenly, the number of deals structured as tender offers spiked.
All of which means that Section 14(e) has been getting more of a workout than it has in the past, leading to new questions about the proper interpretation of the statute.
But here’s where we get back to that Question Presented. It’s really two questions: first, what is the state of mind element under Section 14(e), and second is there a private right of action at all? The implication of the defendants’ petition for cert is, well, no, there isn’t, and the amicus brief filed by the Chamber of Commerce makes that argument explicitly.
So what the defendants are really angling for is a declaration that plaintiffs cannot bring claims under 14(e) at all, with a fallback position of, if they can, they have to show intent. (Well, actually, I think the defendants are after something else - but we’ll get there.) And here’s where the rubber meets the road:
When an acquisition is structured as a merger, it will require a shareholder vote, which means the target corporation must circulate a proxy statement. And it was established way back in 1964 that private plaintiffs can bring actions for false statements in corporate proxy materials under Rule 14a-9. See J.I. Case Co. v. Borak, 377 U.S. 426 (1964). As I mentioned, at this point it’s reasonably well established that 14a-9 does not require a showing of scienter.
Meanwhile, acquisitions structured as friendly tender offers (easy to do now under 251(h)) do not require shareholder votes, and thus do not involve proxy statements; the only federal prohibition on false statements comes from 14(e). (And, well, Section 10(b)).
So if the defendants prevail in Emulex - and depending on how they prevail - it could create very different liability schemes for deals structured as mergers rather than tender offers – a difference that is just now mattering a whole lot because of the changes in Delaware law.
Now, the defendants are correct that these days, the Supreme Court finds implied rights of action far less easily than it used to, and when the Court interpreted 14a-9 in 1964, implied rights of action were at their heyday. But unless we’re going to revisit Borak – and literally a 50-plus year understanding of the liability scheme for proxies – it makes no sense to say that plaintiffs are prohibited from suing for misrepresentations in tender offers under 14(e) while still permitting claims for false proxy statements under 14a-9. There are enough artificial distinctions between mergers and tender offers without adding more incentives for deal planners to game out a kind of regulatory arbitrage; indeed, Delaware recently amended the DGCL to create more, not less, similarity between long form and intermediate form mergers. And reaffirming that 14(e) requires scienter while 14a-9 does not may not be as dramatic a move, but it still creates an unnecessary discontinuity.
In any event, if Emulex prevails, I can totally see all kinds of weird results. Like, there are many states that don’t allow intermediate-form mergers, meaning that if you acquire a majority of shares via tender offer, unless you manage to get all the way to 90% or so, you’ll either have to get some kind of top-up or – if you can’t – you’ll have to hold a shareholder vote anyway to complete the deal. In those states, it may make more sense to simply hold a shareholder vote from the outset and skip the tender offer. But if there’s more liability for proxy materials than tender offer materials, acquirers may be tempted to choose a two-step structure anyway: they’ll make the tender offer, obtain enough shares to swing the merger vote, and hold a vote on the back end. That way, they may be insulated from liability for the initial tender offer materials, and – after Virginia Bankshares, Inc. v. Sandberg (1991) – there’s no cause of action for false statements in proxy materials where the outcome is fait accompli.
Or say you need a shareholder vote on the acquirer side – like, to issue more shares. It’s common to just distribute a joint proxy and have both target and acquirer shareholders vote. But if there’s a greater liability risk for proxy materials than tender offer materials, acquirers could intentionally break up the steps and hold a vote of their own shareholders, and then commence the tender offer.
Obviously, all this would be unwieldy and expensive, and if there isn’t another business justification, the choice to avoid issuing proxy statements might function as a confession of intent to commit fraud, but my broader point is simply this: Whatever the rule is going to be, it shouldn’t turn on whether the deal is structured as a merger or a tender offer.
Now, true, we haven’t seen a rash of gaming under the current regime, which - until the Ninth Circuit’s decision - already had different scienter requirements for 14(e) and 14a-9. That said, it must be recalled that Delaware didn’t start pushing these cases into federal court until 2015-ish; we may not have fully experienced the effects of divergent standards. In that sense, then, what Emulex is really doing is making the distinction more salient.
And what about this issue of private rights of action? Kevin LaCroix doubts the Court will eliminate the private right of action under 14(e) entirely, especially since no circuit court has even hinted at that possibility. But here’s the payoff: the Supreme Court doesn’t have to go all the way to holding that 14(e) provides no right of action to make an impact; all it has to do is say “We reserve for another day the question whether a private right of action exists under 14(e),” and we are off to the races. Expect a bunch of test cases, and a concerted, coordinated build of precedent in the lower courts, now more populated with Republican judges inclined to be skeptical of private claims. And that, I suspect, is really what the defendants, and the Chamber of Commerce, consider endgame.
*yes, yes, the phrase about “mak[ing] any untrue statement[s]” is also similar to the language of Rule 10b-5(b), which requires a showing of scienter, but that interpretation of 10b-5(b) is entirely due to the fact that 10b-5’s authorizing statute, Section 10(b), requires scienter; it’s not a standalone interpretation of the language of the rule.
Saturday, December 29, 2018
Chief Justice Leo Strine of the Delaware Supreme Court just posted a fascinating article/speech to SSRN, which was apparently delivered to the Institute for Corporate Governance & Finance in November.
The subject of the speech is the fiduciary obligation that mutual funds owe fund beneficiaries when voting their shares, and in particular, the funds’ failure – in Strine’s view – to adequately police portfolio companies’ political spending.
The general thesis is that investors in mutual funds benefit most when the economy does well by generating long-term, sustainable jobs, and he lauds the current trend of mutual funds’ willingness to second-guess corporate managers and vote for measures that promote long-term sustainability, including their increasing willingness to back shareholder-sponsored proposals on ESG measures. As he puts it:
[I]nstitutional investors are not just getting involved in boardroom battles. … [S]ome prominent mutual funds have now expressed the view that their portfolio companies should act with sufficient regard for the law and general social responsibility. That is, in the area of corporate social responsibility, the largest institutional investors seem to be evolving in a positive direction.
He laments, however, that funds’ willingness to buck management appears to stop when it comes to political spending:
In the key area of corporate political spending, the Big 4 have opted for a policy of total deference to management…. [T]he Big 4 generally will not even vote to require corporations to disclose what they spend on politics, leaving the Big 4 and others largely blind to what is going on… [T]o be fair, State Street has done far better, supporting a majority of these proposals over the years….
In his view, political spending indicates that the corporation is seeking to profit by short-term regulatory arbitrage rather than by long-term investment in better products and services that will pay off more over time:
If a business has to try to make money by influencing the political process, that suggests that its prospects for growth by developing improved products and services are not strong. Instead, the business apparently has to seek special favors to gain access to subsidies or government contracts, not on the basis of the merits alone, but by currying favor…
He calls upon mutual funds to vote in favor of transparency regarding political spending, and even in favor of supermajority shareholder approval of political spending.
So, this intrigues me for several reasons.
First, there is currently a fierce political battle being waged over the value of ESG proposals and whether mutual funds should vote in favor of them. As I previously mentioned, this was a topic of discussion during the SEC’s recent proxy roundtable, and Phil Gramm in particular spoke emphatically against such proposals. (He has also written, with Mike Solon, an op-ed against them). Main Street Investors is, despite the name, a corporate group that has also been lobbying against such proposals and against mutual funds’ increasing tendency to support them. Thus, it is surprising to see the Chief Justice stake out such a firm position in favor of ESG proposals.
But that’s not all.
The usual argument in favor of these proposals is that they are in fact long-term wealth maximizing, as Strine acknowledges. But he also goes further and suggests that mutual funds should favor these proposals – and restrictions on political spending – even if they are not wealth maximizing in the corporate sense, out of respect for fund beneficiaries’ presumed shared interest in the safety of their jobs and the health of the environment. As he puts it:
Worker Investors derive most of their income and most of their ability to accumulate wealth, from their status as laborers, not as capitalists. ….Unless American public companies generate well-paying jobs for Worker Investors to hold, Worker Investors will not prosper and be economically secure….
[F]or diversified investors any increased profitability by particular corporations that results from externalities is suffered by them both as Worker Investors and as human citizens who pay taxes, breathe air, and have values not synonymous with lucre.
The colder economic term externalities can be put in the more human terms of dirtier water and air, workers who suffer death or harm at an unsafe workplace, employees whose health care needs to be covered by the government or a spouse’s more responsible employer, or defrauded or injured consumers. All of them are costs that Worker Investors bear as taxpayers, human victims, and as diversified investors. In other words, Worker Investors are not in on the swindle that results when an industry, think big tobacco, is able to make profits by shifting its costs of harm to others….
This is an extraordinary claim. He is placing workers’ shared desire for certain basic living standards on par with the hypothetical shared desire of all investors to maximize returns, and claiming that mutual funds have a duty to advance those interests.
First, there is the issue of the factual basis for the argument. Some of those workers presumably are employed with big tobacco, or big oil, or coal, or any of the other industries where the desire for good jobs (or even the desire for affordable transportation) and environmental sustainability conflict. Shall we gloss over these distinctions (in the same way we do regarding the somewhat fictionalized concept of wealth maximization)?
Second, assuming he is correct, why is this a duty imposed on mutual funds and not the corporations directly? Strine has been a vocal champion of directors’ duties of wealth maximization; is he saying that mutual funds should be voting for policies that directors’ own duties prohibit them from advancing? I mean, obviously, the business judgment rule would prevent any kind of judicial second-guessing one way or another, but if we can talk theoretically about what mutual funds’ fiduciary duties require we can do the same for corporate directors.
Now, Strine (with co-author Nicholas Walter) has written before that if corporate political spending cannot constitutionally be constrained by regulation after Citizens United, then that suggests the shareholder wealth maximization norm must give way to a stakeholder theory of corporate obligation. (An argument that has also been made by others, including David Yosifon). Previously, though, I took him to mean that Citizens United should be overruled; should we now take him to be inching toward a reformed view of corporate law?
I obviously do not know whether anything more will come of this, but I look forward to future developments.
Wednesday, December 19, 2018
The holy grail, for those who are in favor of these things, has been to insert clauses in corporate governance documents that would require all securities claims to be arbitrated on an individualized basis. The expectation has been that, given the Supreme Court’s recent jurisprudence, such provisions would pass muster under federal law.
In 2015, Delaware amended the DGCL to prohibit the insertion of arbitration clauses in corporate governance documents. But that statute explicitly applies only to “internal corporate claims,” Del. Code tit. 8, § 115, leaving open the possibility that it would not prohibit arbitration clauses that only govern federal securities claims.
The other stumbling block has been the possibility – which I’ve discussed repeatedly in blog posts, a law review article, and a book chapter (abstract only on SSRN; you have to buy the book for the rest!) – is that charters and bylaws can only govern internal affairs claims, and not external claims, including claims created by federal law.
The latter argument was finally tested in Delaware Chancery, but not in the context of arbitration. Rather, several companies went public with charter or bylaw provisions requiring that all Section 11 claims be litigated in a federal forum. That’s not arbitration, naturally, but it raises the same question whether charters and bylaws can govern federal securities claims.
The answer, according to Vice Chancellor Laster, is no.
I won’t quote the whole decision here, but I’ll just say, he has a lot of the same reasoning that I’ve previously laid out (and yes, he cited me, so, you know, yay! And it’s possible when the decision came down the first thing I did was a word search for my name LIKE YOU WOULDN’T DON’T JUDGE).
He also inferred – citing a blog post by Lawrence A. Hamermesh and Norman M. Monhait – that when Delaware enacted Section 115, the reason it limited the statute to “internal corporate claims” was because no one thought charters and bylaws could possibly extend any further.
I am assuming there will be an appeal (Laster also seemed to assume so at oral argument), but if his decision is affirmed, what next?
I’ve been thinking a lot about what a determined corporate advocate would do, and it seems to me there are two possibilities.
First, I could see an effort to persuade other states – Nevada being the most obvious candidate – that corporations organized in that state may limit federal securities claims in their governance documents. My perspective, however, is that states can’t; any effort to do so would extend beyond the boundaries of internal affairs and the authority of chartering states. Now, as many readers may be aware, California is already testing the boundaries of the internal affairs doctrine with its new statute requiring public companies with their principal place of business in that state to include women on their boards; it would be the height of irony if the constitutional limits of the internal affairs doctrine were tested not in that context, but in the context of litigation limits on federal securities claims.
Second, I can imagine an effort to bypass charters and bylaws entirely, and simply to insert into a registration statement some kind of declaration to the effect that “all purchasers agree that federal securities claims/Section 11 claims are subject to such-and-such limits.” But that, of course, might be a bridge too far for the SEC, and even if it isn’t, I personally am unaware of any precedent for treating the registration statement as a “contract,” and thus there would be serious questions about whether purchasers could be bound in this manner.
Anything else I’m not thinking of? Feel free to speculate in the comments.
In any event, this is clearly my beat, so stay tuned for further developments.
Saturday, December 15, 2018
(Photo from Sharing Christmas)
What strikes me about the genre is how business-centric it seems to be. Though there are other types of plots (riffs on Cinderella/Roman Holiday/Sound of Music are always popular), a fairly common storyline is that there is some business that revolves around Christmas and is enjoyable for the townsfolk but relatively unprofitable. The characters have to find a way to make the business viable without turning it over to a soulless corporate operator who will lay everyone off and destroy its essential character. Typically, this involves teaching someone the true meaning of Christmas and the special value added to a company by longtime employees who put their hearts into their work.
It’s not that this is new, exactly; Christmas stories about profit-motive versus philanthropy trace back at least as far as Miracle on 34th Street (if not A Christmas Carol). But viewed through a business lens, Miracle on 34th Street is a tale of shareholder primacy. Of course, Santa didn’t care about profits; he only wanted to make children happy. But Macy’s managers discovered that they would generate more wealth if they adopted a pretense of generosity, which is why they embraced Santa’s strategy.
The world looks a little different in Hallmark/Lifetime land. It might, in fact, maximize profits to automate the bakery or relocate the bakery or renovate the community theater or renovate the ski lodge or sell the Christmas tree farm or sell the reindeer farm or evict the Christmas shop or close the toy store or close the toy store or close the toy store, but the characters find a way to generate some minimum profit that’s enough to keep things running while providing steady jobs for devoted employees and special memories for consumers. And that’s the happy ending.
In other words, the goal is to create a sustainable business model that meets the needs of all stakeholders without conferring a fortune on anyone. I suppose we might call this the It’s a Wonderful Life view of business.
To be sure, some of the movies are more in the Miracle on 34th Street vein: the perfect advertising campaign is the one that captures the Christmas spirit because that’s what moves the product, but the notion of business as an anchor for a community seems to be the overwhelming favorite.
That said, almost all of these businesses are privately owned, so there are no public shareholders – or activists – to interfere with the mission. And maybe that’s the Miracle on 34th Street difference:
Saturday, December 8, 2018
I posted about Lorenzo v. Securities & Exchange Commission when the SEC first granted certioriari; you can read my long thoughts about it here. Now that the Court held oral argument, I’ll offer my quick comments (and I’ll probably say still more when the decision comes down; this is a bountiful source of blogging material).
Picking up where I left off in my earlier post (I’ll assume you’ve either read that or are otherwise familiar with the issues in this case):
Lorenzo poses a quandary because the Supreme Court backed itself into a corner in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011). There, the Court narrowly construed what it means to “make” a statement for the purposes of Rule 10b-5(b), but then went further and suggested – via its invocation of Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994) – that a wide range deceptive conduct falling outside of that definition not only would not involve making statements, but also would not be prohibited by Section 10(b) at all.
All of which has come back to bite the Court in Lorenzo. There, Lorenzo – acting with scienter – sent a deceptive email drafted by and attributed to his boss. And his argument is, he didn’t “make” a statement for Janus purposes, and if his conduct is considered otherwise deceptive or manipulative for Section 10(b) purposes, then Janus itself accomplishes nothing. Certainly, he didn’t commit any more of a deceptive act than the Janus defendants, and if their conduct didn’t fall within Section 10(b)’s prohibitions, well, then, neither did Lorenzo’s.
Based on the transcript, I’d tentatively say the Court is not inclined to buy Lorenzo’s argument. Counting heads is interesting here; the original Janus opinion was your typical 5-4 conservative/liberal split, but this time around one of the two new conservatives (Kavanaugh) is recused, because he was on the original panel that decided the case in the DC Circuit (where he sided with Lorenzo). Which means, if the Court breaks the same way it did in Janus, it would create a 4-4 split and affirm the lower court, handing at least a temporary win to the SEC.
That said, most of the questions were highly critical of Lorenzo, but, then, most of the questions came from the liberals who dissented in Janus, making it tough to use them as a gauge.
From the conservative side of things, Gorsuch was the only justice to offer a full-throated defense of Lorenzo’s position – one that was more effective than Lorenzo’s counsel, I’d add – but even with Gorsuch, I couldn’t tell if he was genuinely convinced or simply trying to articulate Lorenzo’s argument. Gorsuch basically laid out the claim that the only deceptive conduct here was the text of the email itself, and since Lorenzo was not the “maker” of that statement, he at best aided a deception, and did not himself engage in any deceptive conduct.
Roberts also defended Lorenzo, on the ground that the SEC’s position would render Janus a dead letter, but he didn’t talk much and, as with Gorsuch, he may have simply been offering the argument rather than stating his own position.
Alito, however – who was a member of the Janus majority – seemed convinced that Lorenzo’s act of knowingly sending a false email was sufficiently deceptive to violate Section 10(b). Which suggests the Court will ultimately rule in favor of the SEC with at least a 5-3 split.
That, however, puts the Court in the awkward position of reconciling a holding against Lorenzo with its Janus holding.
If I’m right about where the Court is going, it seems to me like there are a few potential paths. First, the Court can say that Janus was solely about interpreting 10b-5(b), and its references to Central Bank were irrelevant. This would mean that other kinds of conduct beyond “making” a statement (including the defendant’s conduct in the Janus case itself) may well violate Section 10(b) via 10b-5(a) or (c). If the Court goes that route, though, it is potentially broadening 10b-5 liability even for private plaintiffs, past what’s currently available now.
The second path would be to say that because Lorenzo included other verbiage in his email (like, directing clients to call him with questions), he functionally adopted the false statements and therefore became their “maker” even under Janus. This isn’t the position taken by the SEC but would be the least disruptive course of action for the Court.
(The Court could, I suppose, distinguish between private plaintiffs and the SEC but no one seemed interested in that possibility.)
A final path, I guess, would be to duck everything, say that Lorenzo violated Section 17(a), and that there is somehow no need to reach the Section 10(b) question. But no one offered that as a possibility, either, so I can’t tell if it’s something the Court is inclined to try.
Anyhoo, we’ll know by June, I suppose – so watch this space for updates.
Monday, December 3, 2018
On November 15, the Securities and Exchange Commission (SEC) convened a Roundtable on the Proxy Process. (See also here.) I have not been following this as closely as co-blogger Ann Lipton has (see recent posts here and here), but friend-of-the-BLPB, Bernie Sharfman (Chairman of the Main Street Investors Coalition Advisory Council) has been active as a comment source. Both contribute valuable ideas that I want to highlight here as the SEC continues to chew on the information it amassed in the roundtable process.
Ann, as you may recall, has been focusing attention on the uncertain status of proxy advisors when it comes to liability for securities fraud. In her most recent post, she observes that
There’s a real ambiguity about where, if it all, proxy advisors fit within the existing regulatory framework, and while I am not convinced there is a specific problem with how they operate or even necessarily a need for regulation, I think it can only be for the good if the SEC were to at least clarify the law, if for no other reason than that these entities play an important role in the securities ecosystem, and if we expect market pressure to discipline them, potential new entrants should have an idea of the regime to which they will be subject.
I remember having similar questions as to the possible fiduciary duties and securities fraud liability of funding portals under the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (a/k/a the CROWDFUND Act)--Title III of the Jumpstart Our Business Startups Act (a/k/a/, the JOBS Act). I wrote about these ambiguities (and other concerns) in this paper, published before the SEC adopted Regulation CF. I know Ann's right that we have clean-up to do when it comes to the status of securities intermediaries in various liability contexts (a topic co-blogger Ben Edwards also is passionate about--see, e.g., here and here).
Bernie has honed in on voting process issues relating to both proxy advisors (the standard for making voting recommendations and the use/rejection of the same) and mutual fund investment advisers (the disclosure of mutual fund adviser voting procedures and SEC's enforcement of the Proxy Voting Rule). Specifically, in an October 12 letter to the SEC, Bernie sets forth three proposals on proxy advisor voting recommendations. His bottom line?
Institutional investors have a fiduciary duty to vote. However, the use of uninformed and imprecise voting recommendations as provided by proxy advisors should not be their only option. They should always be in a position of making an informed vote, whether or not a proxy advisor can help in making them informed.
Earlier, in an October 8 letter to the SEC (Revised as of October 23, 2018), Bernie recommends mutual adviser disclosure of "the procedures they will use to deal with the temptation to use their voting power to retain or acquire more assets under management and to appease activists in their own shareholder base" and "the procedures they will use to identify the link between support for a shareholder proposal at a particular company and the enhancement of that company’s shareholder value." He also recommends that the SEC "should clarify that voting inconsistent with these new policies and procedures or omission of such policies and procedures will be considered a breach of the Proxy Voting Rule" and engage in "diligent" enforcement of the Proxy Voting Rule. I commend both letters to you.
Ann's and Bernie's proxy disclosure and voting commentary also reminds me of the importance of co-blogger Anne Tucker's work on the citizen shareholder (e.g., here). It will be interesting to see what the SEC does with the information obtained through the proxy process roundtable and the related comment letters. There certainly is much here to be explored and digested.
[Postscript, 12/4/2018: Bernie Sharfman notified me this morning of a third comment letter he has filed--on proxy advisor fiduciary duties. It seems he may have a fourth letter in the works, too. Look out for that. - JMH]
Saturday, December 1, 2018
On Wednesday, I had the great pleasure of delivering an address at the North American Securities Administrators Association’s annual training conference for its corporate finance division. I spoke about equity compensation for employees in private companies (you may recall that Joan linked to Anat Alon-Beck’s paper on that subject a couple of weeks ago). Equity compensation to employees is exempt from federal registration under Rule 701 – and the SEC is currently deciding whether to broaden that exemption – but is still subject to state regulation. Most states, however, simply follow the federal rules. The purpose of my talk was to discuss some of the risks posed to employee-investors when companies stay private for prolonged periods, and to suggest that state securities regulators may want to consider if there is a need for additional oversight.
Under the cut, I offer the (massively) abridged (but still probably too long) version of my remarks. For those interested in further reading on the subject, in addition to Anat’s paper highlighted by Joan, I recommend Abraham Cable’s excellent breakdown of the issues in Fool’s Gold? Equity Compensation and the Mature Startup.
[More under the jump]
Saturday, November 24, 2018
As I mentioned at the time, one of the big issuer complaints about proxy advisors is that their recommendations may be erroneous – though of course, the definition of “error” is somewhat expansive and may include differences of interpretation. Issuer advocates have long sought some regulatory/statutory ability to review and, if possible, force revisions to proxy advisor reports before they are published, a proposal that – as I previously noted - apparently has found some sympathy with at least Commissioner Roisman.
From my perspective, though, the most interesting aspect to all of this is that if proxy advisors do, in fact, include false statements (however defined) in their recommendations, it is not entirely clear whether and to what extent they are subject to federal sanction.
The most obvious place to begin is Rule 14a-9, which prohibits false or misleading statements in proxy solicitations, and has generally been interpreted to apply to negligent, as well as intentional, false statements.
The problem here is that it is not entirely clear that the voting recommendations of proxy advisors are proxy solicitations. Glass Lewis, in its letter to the Senate Banking Committee, functionally concedes that they are; but ISS’s letter disputes that interpretation, and argues that voting recommendations by proxy advisors are not proxy solicitations.
If ISS is right, is there any prohibition on false statements?
Well, ISS says yes, at least for its own recommendations, because ISS is a registered investment advisor. As such, it is subject to the antifraud provisions of the Investment Advisers Act, and is subject under that Act to a duty of care, including a duty to ensure the accuracy of its recommendations.
That’s fine as far as it goes, but Glass Lewis is not a registered investment advisor, because it disputes that proxy advice counts as investment advice.
What if they’re both right: voting recommendations are neither proxy solicitations nor investment advice? Then neither 14a-9, nor the Investment Advisers Act, would apply to false statements in recommendations.*
We might then look to general prohibitions on false statements, articulated in Section 10(b) of the Exchange Act and Section 17 of the Securities Act. The problem is, both of these statutes only apply to statements made in connection with securities transactions. Proxy advisors, by definition, only provide voting advice, not advice regarding purchases and sales. Now, that may not matter: Section 10(b), for example, has been broadly extended to situations where the speaker might reasonably anticipate its statements would be used in connection with securities transactions, even if they weren’t specifically intended for that purpose. But then any legal action would focus on buying and selling rather than voting behavior. So it’s an unsettling gap: If proxy advisors are only providing voting advice, and their statements are not proxy solicitations, is there any clear legal prohibition on falsity?
My point is this: There’s a real ambiguity about where, if it all, proxy advisors fit within the existing regulatory framework, and while I am not convinced there is a specific problem with how they operate or even necessarily a need for regulation, I think it can only be for the good if the SEC were to at least clarify the law, if for no other reason than that these entities play an important role in the securities ecosystem, and if we expect market pressure to discipline them, potential new entrants should have an idea of the regime to which they will be subject.
So this is where I do think some action by the SEC would be helpful. Certainly, the SEC can decide whether proxy advisors’ voting recommendations qualify as proxy solicitations, and whether their conduct qualifies as investment advice (which might render unnecessary the proposed Senate Bill that would require proxy advisors to register as investment advisors). And if neither of these categories applies, the SEC might weigh in on whether and to what extent proxy advisors may be liable privately or subject to regulatory sanction for distributing false information in advance of an upcoming vote. And that alone, leaving aside other issuer complaints, would probably be useful going forward.
*Why the divergence in views as to whether proxy advice counts as investment advice? I assume the default is no one wants to claim a regulated status if they don’t have to, but ISS is particularly vulnerable to charges of conflict due to its consulting business; it may therefore feel that RIA status lends it an air of legitimacy that its clients find reassuring and that staves off additional regulatory pressure.
Saturday, November 17, 2018
The SEC held its Roundtable on the Proxy Process on Thursday, and I was able to watch the live webcast of the last panel on proxy advisory firms. (In a prior post, I discussed how, in advance of the Roundtable, the SEC withdrew two no-action letters that facilitated investment advisors’ reliance on proxy advisory services.)
One thing I’ll note about the Roundtable is that it felt a lot like oral argument in an appellate court, in that everyone had fun expounding their positions but it’s not where the real policymaking gets done; that’s going to take place in back offices based on private meetings and written submissions, not in a public theater.
Still, I was interested in what everyone had to say. The webcast just went online here, but I’ll offer a summary of what stood out to me.
(More under the jump)