Saturday, July 31, 2021
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.
Saturday, July 24, 2021
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. pcOrder.com, 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 won’t 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.
Saturday, July 17, 2021
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...
Saturday, July 10, 2021
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.
Saturday, July 3, 2021
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.
Wednesday, June 23, 2021
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.
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.
Saturday, June 19, 2021
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.
Saturday, June 12, 2021
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?
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.
Saturday, June 5, 2021
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 http://apply.interfolio.com/84001, 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 email@example.com.
Saturday, May 29, 2021
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.
Saturday, May 22, 2021
I’ve been fascinated by the battle over the Tribune Publishing Company, because it’s a fairly stark example of directors’ obligation to maximize shareholder wealth conflicting with the broader interests of society, and is a textbook case for M&A classes.
Tribune Publishing has a troubled history, but was managing to turn a profit; Alden Global, a hedge fund with a 32% stake in the company, offered to buy out the remaining shareholders at a premium of around 35% (compared to the stock price prior to the announcement of its offer). Alden, owner of several newspapers, is known to run them ruthlessly, selling real estate, making significant cuts to newsrooms, and causing local coverage to suffer. The macro consequences are significant: as local news declines, corruption grows and services to residents are reduced.
That said, Alden’s papers have profit margins of about 17%; by contrast, the New York Times’s profit margin is 1%. From a fiduciary duty standpoint, the Tribune Board’s obligation here was a no-brainer; it was unlikely that any kind of long term plan would give shareholders as much value as Alden’s offer.
Reporters at the Tribune papers, of course, protested, but that was Alden’s problem, not the Board’s: if reporters chose to revolt over the sale, maybe even to the point of damaging the properties, the Tribune shareholders would still be cashed out and laughing all the way to the bank. Delaware offered no space for the Tribune Board to worry about the broader impacts of the sale on newspaper quality.
Enter Stewart Bainum Jr, a wealthy hotel magnate who wanted to buy just the Baltimore Sun and run it as a nonprofit – I gather on a model similar to the Salt Lake Tribune. But he felt he had been betrayed in negotiations by Alden, and instead decided to make a bid for the whole company. He joined with another billionaire, Hansjorg Wyss, to tentatively top Alden’s bid, which allowed the Tribune Board to share confidential information under the merger agreement. However, Wyss was not as altruistically-minded as Bainum; once he saw the financials, he dropped out, apparently because he realized the Chicago Tribune would never be a national paper. Bainum was unable to put together a new bid, and shareholders voted in favor of the deal yesterday.
But there was one bit of last minute intrigue. Patrick Soon-Shiong, the billionaire owner of the Los Angeles Times, held a 24% stake in Tribune, and he alone could block the sale because the merger agreement required two-thirds approval by the non-Alden shares. If he voted against it, the deal would be sunk. A few days ago, he told the Washington Post – improbably – that he had forgotten the shareholder meeting was set for May 21, and hemmed and hawed over how he planned to vote .
The day of the vote, he released a statement that he would “abstain” because he was a “passive” investor in Tribune – as though anyone could be passively invested while owning 24% of a high profile public company.
More importantly, he didn’t really abstain – he simply submitted a blank proxy card, and the Board voted his shares in accord with its recommendation, i.e., in favor of the sale. This initially caused some confusion in the reporting, because the proxy statement instructions distinguished between blank proxy cards submitted by shareholders of record, and blank proxy cards submitted by beneficial owners (i.e., holders in street name):
If you are a stockholder of record and you return your signed proxy card but do not indicate your voting preferences, the persons named in the proxy card will vote the shares represented by that proxy as recommended by the Board of Directors. If you are a beneficial owner and you return your signed voting instruction form but do not indicate your voting preferences, please see “What are ‘broker non-votes’ and how do they affect the proposals?” regarding whether your broker, bank, or other holder of record may vote your uninstructed shares on a particular proposal.
The proxy statement later explained that broker non-votes were, functionally, votes against. Soon-Shiong, with his large stake, was a record stockholder, and so his blank card was a delegation of voting power to Tribune’s Board – a vote in favor – despite his claim of abstention.
Why, then, did he not simply vote for the deal?
I assume because reporters across the country have been concerned about this sale for months – including reporters at Soon-Shiong’s LA Times. If he voted in favor, he would potentially have sown distrust in his own newsroom, and he thought he could square that circle by appearing to take no position. But taking no position wasn’t really an option for him: given the two-thirds voting requirement, if he had truly abstained, so that his votes simply weren’t counted one way or another, that would have been enough to block the deal. Even choosing not to decide would have been a decision.
Or is that really true, though? Because there was a third option available. He could have chosen echo voting – voting his shares in exact proportion to the votes of the other non-Alden shareholders. That would not have had no effect – his mere presence would have made it possible for Alden’s bid to succeed – but he would have delegated his decisionmaking to the other shareholders, which would have been a much more “passive” move than delegating it to Tribune’s Board. We don’t have the exact vote count yet, but apparently around 81% of the non-Alden shares voted for the deal. If that’s right, it means with echo voting, the vote probably would still have favored the deal, but it would have been a squeaker. I look forward to seeing the final totals.
Saturday, May 15, 2021
Vice Chancellor Zurn just issued a monster, 213-page opinion sustaining a complaint alleging that the Board of Pattern Energy breached its fiduciary duties when selling the company. At 213 pages, there’s a lot to talk about, but I actually am going to focus on a couple of specific points that happen to intersect with a lot of what I blog about here.
The set up: Pattern Energy was created by a private equity firm, Riverstone, to operate energy projects owned by other Riverstone entities. At one time, Riverstone indirectly owned a controlling stake in Pattern, but by the time of the events of the complaint, it had shed its interest. It did continue to exert influence, though. First, Pattern had been formed to operate other Riverstone projects, and continued to do so, mainly though its relationship with another company called Developer 2, which was majority-owned by Riverstone. Second, Pattern owned a stake in Developer 2, but was prohibited from selling that stake – including through a merger – without Riverstone’s consent, which functionally gave Riverstone approval power over Pattern mergers. Third, most of Pattern’s officers, including its CEO, were Riverstone affiliates and partners in various ways, including by occupying present or past managerial roles with Developer 2. Fourth, two of Pattern’s directors were Riverstone people – its CEO, and a Riverstone manager who had been appointed to Pattern’s board back when Riverstone had hard control.
According to the complaint, Pattern began contemplating a merger, and because of its close ties to Riverstone and especially Developer 2, Riverstone wanted to make sure that any merger would preserve Riverstone’s influence and Pattern’s relationship with Developer 2. Therefore, Riverstone preferred a financial buyer who would maintain Riverstone’s role with the companies, and was opposed to a strategic acquirer, Brookfield, who would pay more for Pattern but would either also absorb Developer 2 or disentangle it from Pattern. The plaintiff alleged, and Zurn accepted, that Pattern’s Board favored the financial buyer over Brookfield, largely to protect Riverstone, in violation of its duties to maximize wealth for Pattern’s stockholders. Zurn also sustained certain claims against Pattern’s officers, and aiding-and-abetting claims against Riverstone.
So here’s what I find most interesting....
(More under the jump)
Saturday, May 8, 2021
Margaret Blair just posted a new paper to SSRN, How Trustees of Dartmouth College v. Woodward Clarified Corporate Law. It’s a fun historical piece on how Trustees of Dartmouth College v. Woodward enshrined the concession theory of the corporation into law. She argues that although the case is often cited for the contractual theory of the corporation, it also stands for the proposition that corporations result from state-conferred privileges. She traces the history of business organizations in the United States in order to demonstrate that critical features of the corporate form – separate personhood, asset partitioning, limited liability – were not replicable absent official state recognition, leading up to Dartmouth College’s famous pronouncement that “A corporation is an artificial being, invisible, intangible, and existing only in contemplation of the law. Being the mere creature of the law, it possesses only those properties which the charter of its creation confers upon it either expressly or as incidental to its very existence.” The notion of a corporation as the product of state privilege was also articulated by Justice Washington in his concurrence, where he wrote, “A corporation is defined by Mr. Justice Blackstone to be a franchise….It amounts to an extinguishment of the King’s prerogative to bestow the same identical franchise on another corporate body….”
Along these lines, I also note that Paul Mahoney has an interesting piece where he doesn’t – exactly – disagree with Blair’s history, but does claim that private contracting mechanisms were not as bad at replicating the corporate form as Blair takes them to be, in part because of early limits on respondeat superior (so that tort liability risk was less of a thing) and because reputational concerns kept everyone out of the courts, so they resolved their differences privately. See Paul G. Mahoney, Contract or Concession? An Essay on the History of Corporate Law, 34 Ga. L. Rev. 873 (2000). In his telling, it was the interference of the legislature that arrested the development of privately-created corporations, in part so that the Crown could protect the monopoly rights of those who paid for charters.
Of course, being of the critical-legal-studies sort myself, I just have to add that there is something rather incongruous about arguing whether corporations can be formed “privately” or instead need a “state concession” when the only evidence one way or another comes from judicial recognition – or lack of recognition – of corporate personhood. Judges are, of course, state actors, so in that sense, one cannot have any of the benefits of the corporate form without the involvement of the state, because ultimately you need a judicial pronouncement to make it so.
Saturday, May 1, 2021
Last year, I blogged about the Boeing decision in the Northern District of Illinois. In sum, a district court ruled that Boeing’s forum selection bylaw – requiring that all derivative actions be filed in Delaware Chancery – applied even to federal securities claims brought under Section 14(a) of the Exchange Act. That matters because Delaware Chancery has no jurisdiction to hear Section 14(a) claims; dismissal in favor of the Delaware forum, as a practical matter, was a holding that the forum selection bylaw defeated plaintiffs’ ability to bring derivative Section 14(a) claims at all. Which would seem to be in tension with the anti-waiver provisions of the Exchange Act, which voids “[a]ny condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title.” 15 U.S.C. § 78cc(a).
The Boeing plaintiffs have appealed to the Seventh Circuit and while we all await the outcome of that case, another court has just reached a similar result – this time, a magistrate decision in Lee v. Fisher, N.D. Cal., No. 3:20-cv-06163. Section 14(a) claims were brought derivatively against The Gap and, just as in Boeing, the court dismissed the claims due to a forum selection bylaw designating Delaware Chancery as the forum for all derivative actions.
If you’ve been following this issue, you can guess what follows. First, the court assumed that a forum selection bylaw is enforceable as a contract in the first place, offering no analysis beyond a footnote that “the Delaware Supreme Court recently ruled that forum-selection clauses governing shareholder claims are valid and enforceable under Delaware’s General Corporation Law.” But Delaware law applies as a matter of corporate law and the internal affairs doctrine; the court made no attempt to determine whether Delaware law should apply as a matter of contract law when we’re outside the internal affairs doctrine.
Assuming the bylaw was a contractual provision, the court relied on Yei A. Sun v. Advanced China Healthcare, Inc., 901 F.3d 1081 (9th Cir. 2018) to hold that contractual forum selection provisions defeat anti-waiver provisions in the substantive governing law. Here is the court’s reasoning:
The Ninth Circuit has made clear that the strong federal policy in favor of enforcing forum-selection clauses supersedes the anti-waiver provisions in state and federal statutes… Because the anti-waiver provision standing alone does not supersede the forum-selection clause, “in order to prove that enforcement of such a clause would contravene a strong public policy of the forum in which suit is brought, . . . [P]laintiff must point to a statute or judicial decision that clearly states such a strong public policy.” …. Plaintiff does not point to any statute or judicial decision that clearly states that enforcing the forum selection clause would contravene a strong public policy.
(quoting Yei A. Sun, 901 F.3d at 1090).
In other words, the forum selection bylaw would be enforced because the plaintiff was unable to find evidence of a federal policy against enforcing it, other than the explicit anti-waiver provision in the Exchange Act itself. As the court put it:
[T]he Ninth Circuit has made clear that existence of an anti-waiver clause in a statute that the plaintiff intends to prosecute is insufficient to demonstrate the required strong public policy for purposes of overcoming a forum selection clause. Yei A. Sun, 901 F.3d at 1090 (“Because an antiwaiver provision by itself does not supersede a forum-selection clause, in order to prove that enforcement of such a clause would contravene a strong public policy of the forum in which suit is brought, . . . the plaintiff must point to a statute or judicial decision that clearly states such a strong public policy.”)
I’ve got to say, the logic – which originates in Yei A. Sun – baffles me. As I understand it, the federal policy in favor of forum selection clauses is so great that even if the statute says ‘’you may not waive this claim,” waivers that occur via the operation of a forum selection clause will still be respected unless there’s an additional statute or judicial decision that says “no, seriously, we weren’t kidding about the anti-waiver thing.” Why should the additional affirmation on top of the explicit anti-waiver provision be necessary? And if we’re talking about a federal rather than state anti-waiver provision (the original Yei A. Sun case dealt with a state law anti-waiver provision), aren’t the federal courts – in this case, the very federal court in which the plaintiff brought her claims – equipped to make a substantive determination as to what federal policy requires, which is evidenced by the anti-waiver provision in the federal statute? Why is it necessary for another court to do that first before the anti-waiver provision can be enforced, and which court should it be, if every federal court is waiting for another one to be the first mover? It’s one thing if you’re interpreting a state law rule so you need a state court to make clear how the state interprets its own policy, but if it’s a federal cause of action, isn’t a federal court competent to make a determination on its own?
Plus, all of this reasoning – about forum selection provisions trumping anti-waiver provisions – descends from the Lloyd’s of London cases, which I discussed in my prior post. You can go back and read that one if you’re interested, but my argument is they arose in a very different context and are quite distinguishable.
Anyway, yes, I do feel a bit like Don Quixote at this point – or perhaps the analogy should be more along the lines of Sisyphus – but I’m left kind of dumbstruck as I watch federal courts slowly develop a new rule that you can contractually waive securities law claims – despite literal decades of precedent holding that you can’t – if you’re clever enough to designate the waiver as a forum selection clause. Even arbitration law doesn’t go that far, and there actually is a federal statute that has been interpreted to represent a federal policy in favor of arbitration, unlike this “policy” in favor of forum selection which is entirely based on federal common law.
Finally, I just have to reiterate my concern about Delaware eating the world. Delaware decides how charters get amended, how bylaws get amended, what counts as an interested-party transaction, and how it will or will not be cleansed, whether it gets business judgment review or entire fairness or enhanced scrutiny, which means, so long as this line of cases continues, Delaware will be deciding critical questions regarding the validity of these bylaws and thus how federal securities law is administered. And since part of the federal courts’ reasoning is that it’s okay if shareholders waive federal claims so long as Delaware provides some similar state law remedy, they’re functionally delegating to Delaware the power to delineate the substantive contours of what federal securities law requires. I previously blogged about Omari Simmons’s article arguing that Delaware functions as a de facto federal agency, but this is a whole ’nother ballgame.
Saturday, April 17, 2021
I previously blogged about benefit corporations going public, with my main point being that the legal requirements in the benefit corporation statute are so weak that they do not, as a practical matter, bind companies to adhere to their social purpose. As a result, publicly traded benefit corporations are vulnerable to market pressures to favor shareholders over other stakeholders. The newly-public benefit corporations have therefore chosen to adopt more mundane devices to insulate them from the market for corporate control – high inside ownership, staggered boards, etc – to stay on mission. The drawback, however, is the same as exists for all antitakeover devices: managers may use their power to advance social purposes, but they may also use it to seek personal rents.
Anyway, I mention all of this because I noticed that another company recently went public as a benefit corporation, namely, Coursera, a provider of online education. Coursera is in some ways following the path charted by Laureate Education, which is a for-profit university system that is also organized as a benefit corporation. Both are also certified B-Corps (which provides a bit more reassurance of staying on mission; B-Corp status does not impose legal obligations but it functions as an independent monitor of corporate social performance), and both use inside ownership to insulate the company from public shareholder pressure. Laureate has dual-class stock, and Coursera, well:
Our directors, executive officers and principal stockholders beneficially own a substantial percentage of our stock and will be able to exert significant control over matters subject to stockholder approval.
Upon completion of this offering, our existing directors, executive officers, greater than 5% stockholders and their respective affiliates will beneficially own in the aggregate approximately 56.3% of our outstanding common stock, assuming no exercise of the underwriters’ option to purchase additional shares of our common stock. Therefore, these stockholders will continue to have the ability to influence us through their ownership position, even after this offering
Additionally, Coursera does not allow shareholders to call special meetings or act by written consent, has a staggered board, an advance notice bylaw, and a supermajority voting requirement for certain bylaw and charter amendments.
One thing I find interesting – and I remarked on this in my earlier post – companies are still figuring out how they talk about benefit corporation status in their prospectuses. That is, they can’t quite decide whether they want to say that benefitting stakeholders is itself a way of maximizing value to stockholders, so that benefit corporations are really just no different than any other corporation, or whether they want to say that they may sacrifice shareholder wealth to benefit other constituencies. In my prior post, I pointed out that Lemonade goes more in the shareholder wealth maximization direction, while Vital Farms focuses on stakeholders.
Coursera seems to be in the former category, which makes sense to the extent that, as an educational institution in particular, creating at least the appearance of a stakeholder focus might really be necessary for profit maximization. Anyway, this is what Coursera says in its prospectus:
There is no assurance that we will achieve our public benefit purpose or that the expected positive impact from being a PBC will be realized, which could have a material adverse effect on our reputation, which in turn may have a material adverse effect on our business, results of operations and financial condition…
As a PBC, we are required to publicly disclose at least biennially on our overall public benefit performance and on our assessment of our success in achieving our specific public benefit purpose. If we are not timely or are unable to provide this report, or if the report is not viewed favorably by parties doing business with us or by regulators or others reviewing our credentials, our reputation and status as a PBC may be harmed.
If our publicly reported B Corp score declines, our reputation could be harmed and our business could suffer
We believe that our B Corp status enables us to strengthen our credibility and trust among our customers and partners. Whether due to our choice or our failure to meet B Lab’s certification requirements, any change in our status could create a perception that we are more focused on financial performance and no longer as committed to the values shared by B Corps. Likewise, our reputation could be harmed if our publicly reported B Corp score declines and there is a perception that we are no longer committed to the B Corp standards. Similarly, our reputation could be harmed if we take actions that are perceived to be misaligned with B Corp values. …
[W]e may take actions that we believe will be in the best interests of those stakeholders materially affected by our specific benefit purpose, even if those actions do not maximize our financial results. While we intend for this public benefit designation and obligation to provide an overall net benefit to us and our partners and learners, it could instead cause us to make decisions and take actions without seeking to maximize the income generated from our business, and hence available for distribution to our stockholders. Our pursuit of longer-term or non-pecuniary benefits may not materialize within the timeframe we expect or at all and may have an immediate negative effect on any amounts available for distribution to our stockholders. Accordingly, being a PBC and complying with our related obligations could harm our business, results of operations, and financial condition, which in turn could cause our stock price to decline….
Our focus on the long-term best interests of our company as a PBC and our consideration of all of our stakeholders, including our shareholders, learners, partners, employees, the communities in which we operate, and other stakeholders that we may identify from time to time, may conflict with short- or medium-term financial interests and business performance, which may negatively impact the value of our common stock.
We believe that focusing on the long-term best interests of our company as a public benefit corporation and our consideration of all of our stakeholders, including our shareholders, learners, partners, employees, the communities in which we operate, and other stakeholders we may identify from time to time, is essential to the long-term success of our company and to long-term shareholder value. Therefore, we have, and may in the future, make decisions that we believe are in the long-term best interests of our company and our shareholders, even if such decisions may negatively impact the short- or medium-term performance of our business, results of operations, and financial condition or the short- or medium-term performance of our common stock. Our commitment to pursuing long-term value for the company and its shareholders, potentially at the expense of short- or medium-term performance, may materially adversely affect the trading price of our common stock…
This is not to say it entirely ignores the possibility that it may favor nonshareholder constituencies – it’s more like, Coursera emphasizes the shareholder-centric view of PBC status while also warning shareholders that Coursera’s Board is, you know, unaccountable:
[B]y requiring the boards of directors of PBCs consider additional constituencies other than maximizing stockholder value, Delaware public benefit corporation law could potentially make it easier for a board to reject a hostile bid, even where the takeover would provide the greatest short-term financial yield to investors.
Our directors have a fiduciary duty to consider not only our shareholders’ interests, but also our specific public benefit and the interests of other stakeholders affected by our actions. If a conflict between such interests arises, there is no guarantee such a conflict would be resolved in favor of our shareholders.
I also note that under its “Description of Capital Stock,” Coursera says:
We believe that an investment in the stock of a public benefit corporation does not differ materially from an investment in a corporation that is not designated as a public benefit corporation. Further, we believe that our commitment to achieving our public benefit goals will not materially affect the financial interests of our stockholders.
That’s almost word-for-word what Lemonade says as well:
We do not believe that an investment in the stock of a public benefit corporation differs materially from an investment in a corporation that is not designated as a public benefit corporation. We believe that our ongoing efforts to achieve our public benefit goals will not materially affect the financial interests of our stockholders.
But not Vital Farms, which doesn’t say anything like that in its Description of Capital Stock; instead, it simply redescribes what was then the existing legal regime for public benefit corporations, and adds “We believe that our public benefit corporation status will make it more difficult for another party to obtain control of us without maintaining our public benefit corporation status and purpose.”
Saturday, April 10, 2021
The Eastern District of Pennsylvania recently issued a lengthy opinion, largely refusing to dismiss a Section 10(b) complaint alleging that Energy Transfer LP made a series of misstatements about certain pipelines that were under construction. See Allegheny County Employees’ Ret. Sys. v. Energy Transfer LP, 2021 WL 1264027 (E.D. Pa. Apr. 6, 2021). There’s probably a lot worth examining here but I’m actually just going to use it as a jumping off point to talk about the PSLRA safe harbor.
The safe harbor insulates forward-looking statements from private securities fraud liability if:
(A) the forward-looking statement is—
(i) identified as a forward-looking statement, and is accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement; or…
(B) the plaintiff fails to prove that the forward-looking statement--
(i) if made by a natural person, was made with actual knowledge by that person that the statement was false or misleading; …
(2) Oral forward-looking statements
In the case of an oral forward-looking statement …the requirement set forth in paragraph (1)(A) shall be deemed to be satisfied--
(A) if the oral forward-looking statement is accompanied by a cautionary statement—
…(ii) that the actual results might differ materially from those projected in the forward-looking statement; and
(i) the oral forward-looking statement is accompanied by an oral statement that additional information concerning factors that could cause actual results to materially differ from those in the forward-looking statement is contained in a readily available written document, or portion thereof;
(ii) the accompanying oral statement referred to in clause (i) identifies the document, or portion thereof, that contains the additional information about those factors relating to the forward-looking statement; and
(iii) the information contained in that written document is a cautionary statement that satisfies the standard established in paragraph (1)(A).
15 U.S.C 78u-5.
There are certain preconditions, then, for safe harbor protection based on cautionary language: first, that the statements be identified as forward-looking explicitly, and second, that the cautionary language be included in a written document, or incorporated by reference if made orally.
In Energy Transfer, the court concluded that while some of defendants’ forward-looking statements qualified for safe harbor protection based on cautionary language, some did not meet the preconditions, see 2021 WL 1264027, at *5, *9, and went on to conclude that the plaintiffs had adequately alleged claims based on some of the unprotected ones.
The reason this intrigues me is that, as far as I know, courts have been rather free with allowing defendants to claim the protection of the safe harbor even if they fail to meet the preconditions (for example, if they fail to incorporate the warnings by reference in an oral statement, or try to incorporate by reference for a written one), so long as the cautionary language appears somewhere in a public document. The Seventh Circuit laid out the rationale in Asher v. Baxter Int’l, 377 F.3d 727 (7th Cir. 2004). (Disclosure: I was one of the attorneys representing the plaintiffs in Asher v. Baxter). In that case, the Seventh Circuit said:
When speaking with analysts Baxter’s executives did not provide them with …directions to look in the 10–K report for the full cautionary statement. It follows, plaintiffs maintain, that this suit must proceed with respect to the press releases and oral statements even if the cautionary language filed with the SEC in registration statements and other documents meets the statutory standard.
…[T]his is not a traditional securities claim. It is a fraud-on-the-market claim. None of the plaintiffs asserts that he read any of Baxter's press releases or listened to an executive's oral statement. Instead the theory is that other people (professional traders, mutual fund managers, securities analysts) did the reading, and that they made trades or recommendations that influenced the price. In an efficient capital market, all information known to the public affects the price and thus affects every investor. …
When markets are informationally efficient, it is impossible to segment information as plaintiffs propose. They ask us to say that they received (through the price) the false oral statements but not the cautionary disclosures. That can’t be; only if the market is inefficient is partial transmission likely, and if the market for Baxter's stock is inefficient then this suit collapses because a fraud-on-the-market claim won't fly.
The problem with that logic, though, is that PSLRA safe harbor protection is not predicated on the idea that cautionary statements will impact prices in the same way as the initial false statement and thereby nullify the effects of the lie. True, the common law bespeaks caution doctrine insulates all forward looking statements if cautionary language renders them immaterial, Harden v. Raffensperger, Hughes & Co., 65 F.3d 1392 (7th Cir. 1995), but the PSLRA standards are more forgiving. Defendants need only identify “important factors that could cause actual results to differ materially from those in the forward-looking statement,” 15 U.S.C. § 78u-5(c)(1)(A)(i), and “[f]ailure to include the particular factor that ultimately causes the forward-looking statement not to come true will not mean that the statement is not protected by the safe harbor.” H.R. Conf. Rep. No. 104-369, at 44 (1995).
Under the PSLRA, then, courts rarely, if ever, test whether the cautionary language was sufficient to offset the misleading effects of the projection. This is precisely why some courts have described the safe harbor as a “license to defraud,” In re Stone & Webster, Inc., Sec. Litig., 414 F.3d 187 (1st Cir. 2005) – because even if the cautionary language is insufficient to nullify the effects of the false statement – so that, by hypothesis, markets were actually misled by the projection – defendants may still be protected.
Given that, the Seventh Circuit’s invocation of the fraud-on-the-market doctrine seems inapposite, because the cautionary language that suffices to trigger safe harbor protection isn’t really about ensuring that prices fully incorporate the risks associated with false projections, or at least, that’s not its primary function. Plus, Congress enacted the PSLRA in response to what it perceived as abusive class actions - if it wanted to distinguish between the preconditions for fraud-on-the-market actions and other actions, it certainly could have done so.
If all that’s right, then what does the safe harbor do?
Well, I’m not a fan of the safe harbor but if I am going to justify it, I’d say the formalities associated with the safe harbor could prompt mindfulness on the part of corporate actors. They have extra protection for projections – so they’ll be more inclined to make them – but they also know they can’t simply speak off-the-cuff; they must take care to include the warnings. That enforced thoughtfulness may itself serve as some kind of protection against statements that aren’t rooted in reality, and it’s why the Seventh Circuit, in my view, was wrong to ditch the formalities. Also, if defendants were truly held to the requirement that they identify which exact statements they believed to be forward-looking as a precondition of claiming protection via cautionary language, I think that would spare everyone a lot of litigation and force corporate speakers to be clearer about their claims.
Anyway, in related news, Acting Corp Fin Director John Coates recently delivered a speech on the safe harbor and SPACs. Going public via SPAC, rather than traditional IPO, is all the rage right now, apparently at least in part because while traditional IPOs are excluded from safe harbor protection entirely, the de-SPAC merger is not. Specifically, the safe harbor says:
this section shall not apply to a forward-looking statement… that is… made in connection with an initial public offering...
15 U.S.C. 78u-5(b)(2)(D).
That regulatory distinction has led to some companies to offer wildly optimistic projections about SPAC acquisitions, a lot of which do not, ahem, come true.
Coates’s speech was notable in that he not only objected to the differential regulatory treatment on policy grounds – as he explained, companies going public for the first time pose particular risks to investors no matter what method they use to do so – but he also suggested that, read broadly, the existing safe harbor exclusion for initial public offerings might also be read to exclude de-SPAC transactions. Full quote:
[T]he PSLRA’s exclusion for “initial public offering” does not refer to any definition of “initial public offering.” No definition can be found in the PSLRA, nor (for purposes of the PSLRA) in any SEC rule. I am unaware of any relevant case law on the application of the “IPO” exclusion. The legislative history includes statements that the safe harbor was meant for “seasoned issuers” with an “established track-record.”…
The economic essence of an initial public offering is the introduction of a new company to the public. It is the first time that public investors see the business and financial information about a company….
If these facts about economic and information substance drive our understanding of what an “IPO” is, they point toward a conclusion that the PSLRA safe harbor should not be available for any unknown private company introducing itself to the public markets. Such a conclusion should hold regardless of what structure or method it used to do so. The reason is simple: the public knows nothing about this private company. Appropriate liability should attach to whatever claims it is making, or others are making on its behalf...
[A]ll involved in promoting, advising, processing, and investing in SPACs should understand the limits on any alleged liability difference between SPACs and conventional IPOs. Simply put, any such asserted difference seems uncertain at best.
It should be noted that Commissioner Hester Peirce tweeted her (tentative) disagreement with his reading of the statute, but if he’s right, it would mean that all these companies who thought their cautionary language insulated them from liability … were, you know, wrong.
Saturday, April 3, 2021
When Goldman Sachs petitioned the Supreme Court to grant certiorari from the Second Circuit’s affirmance of a class certification grant, it described the case as having “enormous legal and practical importance,” and later reiterated that it would be “hard to overstate the legal and practical importance of this case.”
By the time we got to oral argument, though … not so much.
I blogged about Goldman Sachs v. Arkansas Teacher Retirement System when it was before the Second Circuit (see here and here), but I only minimally discussed the Supreme Court iteration, in part because I couldn’t figure out what the legal issue was, other than that Goldman thought Amgen Inc. v. Connecticut Ret. Plans & Tr. Funds, 568 U.S. 455 (2013) was wrongly decided.
Well, that was my mistake, because it’s clear now that in fact, Goldman does not think that Amgen was wrongly decided, and the legal issue is that it doesn’t like the fact that it lost in the Second Circuit Court of Appeals.
That was evident in the briefing, in which it invited the Supreme Court to review the expert evidence submitted to the district court and reweigh it in its favor. (Seriously. Check out the Reply Brief at 8-9, 19-21)
Goldman does have a whole separate argument about Federal Rule of Evidence 301 and who has the burden of production/persuasion when it comes to the issue of reliance at class certification. This idea was first proposed, as far as I can tell, in an article by Wendy Couture, but was rejected by the Second Circuit in Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017). I won’t weigh in on that piece except to say that most Justices – with Alito and Gorsuch as exceptions – did not seem interested, but then, it’s hard to say with remote arguments because there isn’t room for the kind of back and forth you get with in-person presentations. So it’s possible the Rule 301 argument here is a wild card, but I don’t know anything about it and will therefore skip it.
So, all that aside, what’s going on here?
The plaintiffs alleged that Goldman falsely claimed to adhere to high ethical standards when managing its conflicts of interest, and that these statements were revealed to be false when various governmental entities filed enforcement actions. Goldman argued that its statements were immaterial as a matter of law, and when it lost on that argument, it argued at class certification that these statements were too generic to have had any impact on the price of its securities. The district court found that Goldman had not rebutted the presumption of price impact and certified the class. Goldman appealed to the Second Circuit, where it argued that the “generic” nature of the statements defeated class certification as a matter of law in any case where the plaintiffs argued that the false statements maintained stock prices rather than initially inflating them. The Second Circuit, by a 2-1 vote, rejected that claim as inconsistent with Amgen.
Before the Supreme Court, Goldman’s argument underwent a makeover. As you can see from the transcript, it abandoned any claim that, at the class certification stage, courts should determine whether statements are too generic to impact price as a matter of law, whether in the price maintenance context or anywhere else. Instead, it 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. And it further argued that the Second Circuit erred by rejecting the notion that genericness can ever be considered as relevant to the price impact inquiry.
In other words, Goldman drew a distinction between materiality, which concerns whether there is a “substantial likelihood” that a “reasonable investor” would have traded on the information, and price impact, which concerns whether there actually was an effect on stock prices. See Petitioners’ Brief at 32. All relevant facts, said Goldman, should be part of the impact inquiry, and genericness is a relevant fact even if it is also relevant to materiality.
At this point, the 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. And, the plaintiffs pointed out, Goldman actually submitted evidence in this case to the district court that the genericness of the statements meant that there was no price impact – there was a whole expert report on the subject. But the district court certified the class despite that report. See Resp. Brief at 11-12.
Which meant, the disagreement between the parties boiled down to whether (1) the Second Circuit had erred by rejecting the notion that genericness is relevant if not dispositive and (2) whether the Supreme Court should itself reweigh the evidence and determine that Goldman’s carried the day.
Let’s assume (2) is off the table. Come on.
The question then is whether the Second Circuit, considering Goldman’s appeal from the district court’s class cert decision, improperly refused to allow the generic nature of the statements to play any role in the price impact inquiry.
And that depends on how you read the Second Circuit’s opinion.
On the one hand, the Second Circuit held: “Whether alleged misstatements are too general to demonstrate price impact has nothing to do with the issue of whether common questions predominate over individual ones.” Ark. Teachers Ret. Sys. v. Goldman Sachs, 955 F.3d 254 (2d Cir. 2020).
Sounds pretty definitive, right? The Second Circuit seems here to be clearly rejecting the notion that genericness should even be part of the evidence.
On the other hand, the Second Circuit made those statements in response to arguments by Goldman that genericness should be determinative of the price impact inquiry.
Which is why the Solicitor General admitted that the Second Circuit could be read either way – maybe it meant that genericness is categorically irrelevant, but maybe it meant only to reject Goldman’s argument at the time that genericness was dispositive. See Brief of U.S. at 26; see also Transcript at 45-46.
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.
Let’s just say that on this question, I’m with Justice Breyer: “this seems like an area that the more that I read about it, the less that we write, the better….”
Saturday, March 27, 2021
This week, I offer brief comments on a couple of different things:
1. I’ve previously blogged about courts that stretch the definition of “forward-looking statement” in order to preclude defendants from claiming the protections of the PSLRA safe harbor. But probably the more common scenario runs in the other direction. Behold Police and Fire Retirement System of Detroit v. Axogen, 2021 WL 1060182 (M.D. Fla. Mar. 19, 2021), where the plaintiffs alleged that Axogen claimed that the potential demand for its medical products was very large because of the sheer number of nerve repair surgeries performed every year in the U.S. As it turned out, far fewer surgeries were performed annually; in effect, the plaintiffs argued that Axogen overstated the size of its market. Here’s what the court said in its dismissal order:
Plaintiff … [focuses] in particular on statements made in Axogen’s offering materials and elsewhere that a certain number of people in the United States “each year...suffer” traumatic PNI [peripheral nerve injuries], which “result in over 700,000 extremity nerve repair procedures,” and that “[t]here are more than 900,000 nerve repair surgeries annually in the U.S.” Plaintiff argues these statements refer to “present existing conditions.” But the number of injuries occurring “each year” reflects an ongoing state of affairs extending from the present into the future, rather than an observable state of affairs in existence at the specific point in time when the statement is made. Such a statement cannot be determined to be true or false by reference to “present existing conditions,” and is therefore analogous to other present tense statements the Eleventh Circuit has held to be forward-looking.
Thus is a representation about ongoing conditions - the number of nerve repair surgeries performed annually - transformed into a projection about future nerve repair surgeries. The court did not even appear to consider whether a reader would interpret Axogen’s statements as implying recent past annual figures in this range (a range that, according to the plaintiffs, was wildly inflated).
The problem here is that, in the Seventh Circuit’s words, “Investors value securities because of beliefs about how firms will do tomorrow, not because of how they did yesterday.” Wielgos v. Commonwealth Edison Co., 892 F.2d 509 (7th Cir. 1989); see also Glassman v. Computervision Corp., 90 F.3d 617 (1st Cir. 1996). Any representation of current conditions is relevant to investors because they will extrapolate from that to predict future conditions, but if that were enough to make the statement “forward-looking,” well, everything would be protected by the safe harbor.
2. Tesla is being sued again, this time by a stockholder who claims that Elon Musk’s … colorful … behavior on Twitter violates his settlement with the SEC, is a threat to corporate value, and that the Board’s failure to rein him in represents a violation of its duty of good faith (and hey, as I was drafting this very post Musk did it again). While I’m sure there are many things one could say about the lawsuit, the part that struck me was where the plaintiff alleged that the Board is dependent on Musk, in part, because Musk is indemnifying its members for any legal liability. As the plaintiff puts it:
the Board is insured, and thus indemnified, by Musk personally for a majority of the harm caused by Musk alleged herein. The Board cannot be considered independent in any way from Musk in these circumstances. Musk could refuse to pay out the ‘insurance policy’ if the Board elected to proceed with an investigation of him, and the Board would have every incentive to abandon that investigation.
It is my understanding from Tesla’s SEC filings that the personal indemnification arrangement ended in 2020 and the Board now has an ordinary insurance policy, but the plaintiff is, as I read it, claiming that Musk still provides the coverage for certain acts that occurred in 2020. The insurance arrangement raised a lot of eyebrows when it was first disclosed, and at the time I wondered what its legal significance would be for Board dependence. I now look forward to finding out.
(I should note that when the indemnification agreement was first disclosed, Tesla claimed that Musk’s performance was nondiscretionary, but that still raises questions about what Musk can and can’t dispute - and how interested the Board is in ensuring his solvency).
3. WeWork! In addition to the news that the plans to go public are back on – this time via SPAC – it’s the subject of another lawsuit, this time by the former shareholders of a private company that WeWork acquired, using its own stock as currency. Unsurprisingly, the former shareholders argue that various WeWork officers, including Adam Neumann, overstated the value of WeWork shares when negotiating the deal. What is surprising, to me anyway, is that the claims are solely brought under Section 10(b) of the Exchange Act. Section 10(b) claims are very difficult to bring – apart from the higher pleading standards of the PSLRA, they are also relatively narrow in terms of the type of conduct that is deemed prohibited. Their only real advantage over state claims – whether common law or even blue sky – is their availability for secondary market purchases, and the fraud-on-the-market presumption of reliance. So I’m wondering why the plaintiffs elected to bring claims solely under Section 10(b), in a case where neither of these advantages are relevant.
4. Insider trading! A guy named Jason Peltz was recently indicted for insider trading and related offenses, arising out of trades in companies rumored to be the subject of takeover interest. What makes this indictment unusual, however, is that it claims that an unnamed Reporter for a “financial news organization” was one of Peltz’s sources, providing Peltz with information about upcoming news stories. (The indictment tactfully declines to name the Reporter or the news organization, but the stories are identified with sufficient particularity that deducing his identity is a relatively simple task). So here’s the thing: Though Peltz is charged under 10b-5 for “misappropriating” confidential information, the indictment makes no reference to fiduciary obligations or the duty of trust and confidence. Meaning, it’s unclear whether the claim is that Peltz misappropriated information from the Reporter, or whether the claim is that the Reporter misappropriated from his publication and intentionally tipped Peltz (echoing the dispute at the heart of United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986)). On this point, I note that nothing in the indictment suggests any kind of longstanding close friendship between the Reporter and Peltz, but the indictment does mention that the scheme began when Peltz obtained inside information about a takeover bid, purchased the target’s stock, and then tipped the Reporter, who was able to publish a scoop (causing the target’s stock price to rise, and allowing Peltz to cash out).
And ... that’s all!
Saturday, March 20, 2021
A speculative frenzy appears to have taken hold of markets, extending to everything from GameStop shares to sports cards and anything blockchain (again). Caught up in the mania are SPACs – specifically the blank-check firms trading before an acquisition target has been identified.
The difficulty, as the Financial Times recently reported, is that retail shareholders caught up in the SPAC craze aren’t necessarily interested in voting their shares when it comes time to consummate a merger. Worse, a large number of them may have sold their shares after the record date, leaving no one to actually cast the ballot.
Which is why Switchback Energy Acquisition Corporation recently issued the most extraordinary press release:
- Stockholders as of the Close of Business on December 16, 2020 Should Vote Their Shares Even if They No Longer Own Them
Switchback Energy Acquisition Corporation (NYSE: SBE) (“Switchback”) today announced that it convened and then adjourned, without conducting any other business, its virtual Special Meeting of Stockholders to February 25, 2021 at 10:00 a.m., Eastern time (the “Special Meeting”), to allow for more time for stockholders to vote their shares to reach the required quorum and approve the required proposals….
Switchback has received overwhelming support for the Business Combination. At the time the Special Meeting was convened, approximately 99.9% of the proxies received had been voted in favor of the transaction. However, since holders of approximately 45% of the outstanding shares submitted proxies to vote, the necessary quorum of a majority of the outstanding shares was not present. Switchback requests that any investor who held shares of stock in Switchback as of the close of business on December 16, 2020 and has not yet voted do so as soon as possible in order to avoid additional delays….
Can I still vote if I no longer own my shares?
Yes, if you owned shares as of the close of business on December 16, 2020, the record date for the Special Meeting, you can still vote your shares even if you no longer own them.
This is, I must say, quite remarkable. I mean, there have long been concerns about “empty voting,” i.e., casting ballots for shares in which you have no economic interest, including casting ballots for shares that have since been sold. See, e.g., Henry T.C. Hu & Bernard Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S. Cal. L. Rev. 811, 835 (2006). Here, everyone’s assuming that the vote was a mere formality and the reason the shares were not voted was that retail shareholders are indifferent, but what if some shareholders disfavored the merger? Pushing the deal through with the ballots of former shareholders would hardly be fair to them.
Which gets to the legal question of whether this is even okay. Delaware has vaguely suggested, you know, maybe not. For example, in In re Appraisal of Dell, 2015 WL 4313206 (Del. Ch. July 13, 2015), VC Laster held:
even the right to control how shares vote transfers with the shares, notwithstanding the legal expedient of the record date, because the subsequent holder can compel the seller to issue him a proxy (assuming the seller can be identified)
In support, he cited Commonwealth Assocs. v. Providence Health Care, Inc., 641 A.2d 155 (Del. Ch. 1993), where Chancellor Allen expressed “doubt” that a contract for the sale of shares that allowed the seller to retain the right to vote would be “be a legal, valid and enforceable provision, unless the seller maintained an interest sufficient to support the granting of an irrevocable proxy with respect to the shares.” See also In re Canal Construction Co., 182 A. 545 (Del. Ch. 1936) (“As between a transferror who has parted with all beneficial interest in stock and his transferee, the broad equities are all in favor of the latter in the matter of its voting. While the transferee may not himself be qualified to vote because he had not caused the stock to be registered in his name …, it does not necessarily follow that the transferror may exercise the voting right in defiance of the transferee's wishes. So far have courts recognized the equity of the true owner of stock to control its voting power as against the registered holder, that the latter has been required to deliver a proxy to the former.”); In re Giant Portland Cement Co., 21 A.2d 697 (Del. Ch. 1941) (“A mere nominal owner naturally owes some duties to the real beneficial or equitable owner of the stock; and even if the right to demand a proxy is not exercised, if the vendor exercises his legal right to vote in such a manner as to materially and injuriously affect the rights of the vendee, he is, perhaps, answerable in damages in some cases.”)
Those cases were about disputes between the transferor and the transferee regarding the manner in which shares would be voted, but it should also be noted that in the context of “vote-buying” allegations, Delaware has suggested that it is illegitimate to divorce economic interest in shares from the voting rights attached to them. See Crown EMAK Partners, LLC v. Kurz, 992 A.2d 377 (Del. 2010).
Anyhoo, we can add this to the growing list of “concerns about SPACs,” which is why the SEC is reportedly taking a closer look. Of course, if the world is finally opening up post-covid, speculative trading may also subside, and the problem may take care of itself.
Saturday, March 13, 2021
By now, you’ve probably seen that the SEC filed a lawsuit against AT&T for, allegedly, violating Regulation FD by selectively leaking information about an upcoming earnings announcement in 2016. According to the complaint, in previous quarters, AT&T had disappointed the market by announcing earnings below analysts’ consensus expectations; when it realized it was going to do so again, its Investor Relations department began contacting the analysts with high expectations in order to dampen their optimism. The result was a lowered consensus estimate, and when AT&T did announce its 1Q2016 results, they actually came in slightly above expectations.
AT&T disputed the charges with a curious statement:
The evidence could not be clearer – and the lack of any market reaction to AT&T's first quarter 2016 results confirms – there was no disclosure of material nonpublic information and no violation of Regulation FD.
Well, yeah, genius, because the point of the scheme was to prevent a market reaction to AT&T’s first quarter 2016 results.
But what really strikes me about the whole situation is that it’s as clear an example as you can imagine of a company apparently violating the securities laws for the explicit purpose of trying to avoid a negative market reaction rather than to induce a positive one.
That’s important because in recent years, defendants in Section 10(b) actions have tried to cast doubt on the viability of the “price maintenance” theory of fraud, i.e., the theory that some fraudulent actions are designed not to push prices upward, but to withhold negative information so that prices can be maintained at existing levels. Defendants have argued that statements that merely maintain prices are not material to investors and/or have no impact on prices, and therefore cannot form the basis of a fraud claim. Happily, most courts have rejected that argument, but it’s getting a new workout now before the Supreme Court in Goldman Sachs v. Arkansas Teachers’ Retirement System (my most recent blog post on that case is here; it links to earlier ones). There, the defendants are not explicitly arguing that price maintenance theory is illegitimate, but they are suggesting there is something suspicious about it that warrants extra scrutiny:
Critically, respondents conceded that the challenged statements did not increase Goldman Sachs’ stock price when made. Instead, respondents relied on the increasingly popular “inflation-maintenance” theory—a theory this Court has never endorsed—to assert that the statements maintained the stock price at a previously inflated level….
The inflation-maintenance theory already seriously impedes a defendant’s ability to rebut the Basic presumption. The theory allows plaintiffs to rely on the presumption even if there is no evidence that a misstatement increased the stock price when it was made. Nor do plaintiffs need to identify what statement (if any) inflated the price in the first place.
Some of Goldman’s amici are attacking the theory more directly. To wit.
Happily, a group of former SEC officials have filed a brief in support of the plaintiffs that is almost entirely devoted to defending the inflation-maintenance theory, and highlighting how important it’s been to SEC enforcement actions.
(In case anyone cares, I also signed on to a law professors’ brief in support of the plaintiffs, here).
To bring this back to AT&T, obviously, AT&T is not accused of fraud, or doing anything to mislead the market, but its alleged conduct demonstrates the lengths to which companies will go in order to avoid negative market shocks; it should be utterly unsurprising that many frauds are designed precisely to minimize market reaction, and defendants in those cases shouldn’t be rewarded for success.
That said, as Matt Levine points out, in AT&T’s case specifically, the whole kerfuffle raises interesting questions about what kinds of information move the market or are material to it. If AT&T’s stock price stayed flat after its earnings announcement because the company had already lowered analysts’ expectations, you would expect to see a downward drift in the stock price before the announcement, when AT&T was quietly walking it down. I eyeballed its stock prices during that period and - without running a statistical analysis or comparing it to peer companies or anything - it doesn’t seem like the revisions to analyst estimates was having much of an effect. That could be for any number of reasons - my eyeballs may not be sensitive enough to the detect the pattern, or maybe these analysts were already known to get things wrong and their estimates weren’t baked into the stock price - but it’s amusing that (AT&T thought, at least) the difference between a negative market reaction and no reaction was not the earnings themselves, but what analysts had said about them the day before. In fact, the market appears to have been a lot more sanguine about analyst commentary than AT&T was.
Which, ahem, doesn’t mean that nonpublic information AT&T’s upcoming earnings was not material; just that it confirmed market expectations, no matter what analysts said. If anything wasn’t material here, it was the analysts.
The Goldman case is set for oral argument on March 29.