Saturday, July 13, 2019
I just recently came across the Ninth Circuit’s decision in In re Atossa Genetics Inc Securities Litigation, 868 F.3d 78 (9th Cir. 2017), and it struck me because it highlights an ongoing tension between the reliance/materiality distinction in fraud-on-the-market cases in general, and in the Supreme Court’s jurisprudence in particular.
And I’ll say up front that a lot of what I’m about to discuss in this post is stuff I’ve laid out in more detail in my essay, Halliburton and the Dog that Didn’t Bark. The Atossa case is just a nice demonstration of the issue.
And hey, this got long, so – more after the jump.
Saturday, July 6, 2019
When I was in practice, I worked on a number of cases alleging violations of Section 11 of the Securities Act, but none that had been filed in state court. (For which I was profoundly grateful; I was always bemused by the fact that I needed to get pro hac’d into federal courts around the country but I was vastly more familiar with their rules and practices than with those of the New York State courts, notwithstanding my admission to the New York State bar).
So, to be honest, I never had any strong feelings about whether plaintiffs should have the right to pursue Section 11 class actions in state court, or whether the Securities Litigation Uniform Standards Act should be interpreted to permit defendants to remove such cases. And I didn’t spare much attention when the Supreme Court recently held in Cyan, Inc. v. Beaver County Employees Retirement Fund that defendants cannot remove them.
But Michael Klausner, Jason Hegland, Carin LeVine, and Sarah Leonard just posted a short empirical analysis of state Section 11 class actions, and the results have captured my interest. First, they find – unsurprisingly – there has been an increase in state Section 11 filings since Cyan was decided, and very often, state litigation is accompanied by a parallel federal case filed by a competing set of plaintiffs. Second, they conclude that the state cases are dismissed on the pleadings at far lower rates than federal cases (though the data is a bit muddy; they exclude from analysis any federal cases with a simultaneous Section 10(b) component, which means they may be excluding cases that appear more fraudulent and thus are - perhaps - stronger). They also analyze settlement sizes and find little difference between federal and state cases, with the caveat that Cyan may have effects further down the road (they also exclude cases filed prior to 2014 to avoid the effects of the financial crisis, which may also distort results).
So this is definitely a fruitful area to keep an eye on – especially with the looming battle over whether the PSLRA discovery stay applies in state court proceedings. See Wendy Gerwick Couture, Cyan, Reverse-Erie, and the PSLRA Discovery Stay in State Court, 47 Sec. Reg. L.J. 21 (2019); see also Post-Cyan Ruling on Discovery Stay.
Saturday, June 29, 2019
Greetings from sunny Portugal. I am enjoying some vacation time here after attending and presenting at the European Academy of Management conference in Lisbon this past week. I will have more to say about that conference in a later post. But for today, I offer some light thoughts and an Internet "treasure hunt" relating to mergers and acquisitions.
I arrived at my hotel in Sintra earlier today to find a notice in the room stating that "[o]n the 30th June 2019, the Hotel Tivoli Sintra will be changing the legal business entity which will be reflected in future invoices." The notice went on to ask that, "to avoid possible delays relating to the billing" each guest pay up his or her bill to date on June 30th "in a partial invoice," noting that "[t]he remaining services will be invoiced at the departure time with the new entity." Apologies were made for "the inconvenience" and thanks were offered for "the understanding."
Of course, as an M&A practitioner and instructor, I wanted to know what led to this change in "legal business entity." I suspected a merger or acquisition transaction. Was it an asset transaction in which the hotel brand was being changed? That's what I suspected. Since I ask my advanced business law students to try to identify the nature of business combination transactions from news reports and public filings, I thought I would see what I could find out by doing a bot of Internet research. Here's what I learned.
Minor Hotels "completed the acquisition of the entire Tivoli portfolio in early 2016." I read this in the Minor International Public Company Limited 2016 Annual Report. See also here. The Tivoli Hotel Sintra was part of this final stage in acquiring the Tivoli hotels. See here. Minor International (known as MINT) is registered under the laws of the Kingdom of Thailand.
In the fall of 2018, MINT launched a compulsory tender offer for shares of NH Hotel Group SA. The tender offer was commenced as a result of MINT's acquisition of a >30% equity stake in NH Hotel Group in a series of transactions earlier in the year. A news report reveals that MINT's significant stock acquisitions were part of an initial unsolicited bid for NH Hotel Group, which Hyatt Hotels & Resorts also desired to acquire. (Spain has a compulsory tender offer law that kicks in when control of a public company--which includes the direct or indirect acquisition of 30% or more of the public company's voting rights--changes. See here.) By the end of October, MINT had acquired sufficient additional shares of NH Hotel Group's common stock to bring its equity stake in NH Hotel Group to over 94%. See here and here and here. A subsequent news report indicates that "NH Hotels and Minor Hotels are seeking to further integrate their brands." The same posting noted that "[p]lans are already underway in Brazil and Portugal to rebrand some Minor Hotels as NH Hotels, with 15 hotels in the two countries undergoing the transformation."
Accordingly, it seems that I may be among the last hotel guests to stay at the Tivoli Hotel Sintra as a Tivoli branded hotel. At least that's my guess based on what I have read. Although I was not correct in my original guess as to the nature of the transaction that led to the change in "legal business entity" of my Sintra hotel, if my assessment is correct, I wasn't far off. An asset acquisition was involved at the outset, but the posited rebranding happened later and was more the result of a series of stock acquisitions in a hostile, competitive takeover environment. Not a bad day's work in M&A sleuthing. Just call me Nancy Drew, right, Ann?
Friday, June 28, 2019
Last week, the Delaware Supreme Court issued an opinion, Marchand v. Barnhill, which is notable for two reasons. First, it furthers the Court’s project of reinvigorating director independence standards, and second, it is one of the very few decisions to find that the plaintiffs properly pled a claim for Caremark violations.
The facts are these. Blue Bell Creameries suffered a listeria outbreak in 2015 that killed three people and nearly bankrupted the company, and shareholders brought a derivative lawsuit alleging that the directors failed to oversee corporate compliance with FDA and other requirements. First, they alleged that the CEO Paul Kruse, and the VP of Operations Greg Bridges, actually received notification from various agencies of the company’s lack of compliance and took no remedial action. In so doing, Kruse and Bridges violated their fiduciary duties to the company, and a litigation demand on the board would be futile because of their close ties to the board members.
Second, plaintiffs alleged that the Board violated its Caremark duties by failing to institute a system for monitoring the company’s compliance.
Chancery dismissed both claims, and the Delaware Supreme Court reversed.
Starting with the issue of director independence, as Delaware-watchers are well-aware, in the past few years, the law has undergone something of a revolution. Once upon a time, only clear financial ties or the equivalent of blood relations would be sufficient to show that one director lacked independence from another, but more recently, Delaware has begun to recognize how less concrete social and business ties, traveling in similar circles, ongoing professional and personal contacts, and so forth, can collectively create feelings of obligation that prevent one director from making an objective decision about whether to sue another.
Thus, in Marchand, the Court held that a particular director was likely biased in favor of Kruse because the Kruse family – not Paul Kruse personally – had mentored him throughout his business career, going so far as to make a sizeable donation to a local college that somehow ended up with the director in question getting a facility named after him. Significantly, the Court emphasized that “independence” may vary depending on the type of decision at issue – directors may be willing to vote against close friends on some matters, but that’s a far cry from being willing to sue the friend for breach of duty, and judges need to be sensitive to the difference.
This entire line of caselaw might be described as Strine’s revenge: it’s a direction he recommended with In re Oracle Corp. Derivative Litig., 824 A.2d 917 (Del. Ch. 2003) when he was on the Chancery court, and that the Delaware Supreme Court rejected in Beam v. Stewart, 845 A.2d 1040 (Del. 2004). Now in the Chief Justice spot, Strine has apparently persuaded his colleagues as to the correctness of his views and is moving full steam ahead, going so far in Marchand as to cite his Oracle decision, thus retroactively making it authoritative.
As to the Caremark issue, what’s striking here is not only the rarity with which Caremark claims make it past a motion to dismiss, but the fact that the Court accepted the plaintiffs’ claim that no monitoring system at all had been put into place. The Court highlighted that despite various compliance problems that arose over the years, the Board had no committee in place to address these matters and Board minutes did not indicate any discussion of them.
By contrast, in the few cases where Caremark claims have had some success – think something like In re Massey Energy Co., 2011 WL 2176479 (Del. Ch. May 31, 2011), where the claim was properly pled but lost in a merger – plaintiffs demonstrated that the Board didn’t simply fail to monitor, but was actually complicit in the legal violations. They knew of the red flags and either ignored them or directly encouraged the misbehavior. They were, in Elizabeth Pollman’s framework, actually disobedient regarding their legal obligations. (And to give credit where credit is due, I’ll say that Elizabeth Pollman is the one who has observed that successful Caremark complaints tend to plead willful violations of the law, and the paper she eventually releases on the subject is something to stay tuned for). But notwithstanding that general tendency, in Marchand, the Delaware Supreme Court did not hold that the Board was complicit, or that it had actual knowledge of potential legal violations; instead, it held that the Board simply had no monitoring system in place at all – a much harder claim since just about any monitoring system will do, and its design is within the directors’ business judgment. The Marchand Court went so far as to point out that monitoring systems in place at the management level were insufficient to absolve the Board, because there was no indication that the Board was monitoring at all – even to make sure that management did its job.
The thing to note about this aspect of Marchand is that the Court did not have to go that way, because Paul Kruse and Greg Bridges – who actually knew about the various problems – were both directors themselves, and Kruse later became Chair of the Board. That is, the Court could have said that the Board, via Kruse and Bridges, did have a monitoring system, and that, via Kruse and Bridges, the Board was aware of problems but refused to take action to remedy them. Yet the Court chose not to go this route – it didn’t even mention that Kruse was a director throughout the period and Bridges was a director for most of it (you have to look at the Chancery decision for those tidbits), and only grudgingly indicated that Kruse eventually became Chair of the Board – a fact to which the Court attaches no significance (and indeed, he only became Chair just before the problem reached crisis point). Instead, ignoring the fact that at least two members of the Board were part of management and directly received notice of compliance issues, the Court simply declared that no monitoring system was in place.
So the opinion seems, in a way, motivated.
That impression is reinforced by the types of compliance problems that the Court identifies to establish that that Blue Bell had longstanding sanitation issues. The Court lists regulatory citations that Blue Bell factories received dating back to 2009, but – to my untutored eye – they all read like, well, flyspecking. You know, periodically an agency inspects, and they always find a problem to write up, and it’s quickly resolved. Now, just to be clear, I am not an expert in the regulation of food safety and I may very well be misreading this, but a handful of problems like “equipment left on the floor and a ceiling in disrepair in the container forming room” just don’t strike me as the kind of thing to suggest systemic noncompliance. Matters only get serious when listeria is first detected in 2013, and after that, though listeria is identified several other times, nothing in the opinion indicates that the company was ignoring regulatory complaints or failing to attempt to remediate the problem before it issued a general recall in early 2015.
The point being, it almost seems as though the Court is going out of its way to justify a “failure to monitor” theory and seizes upon (again, to my untrained eye) fairly minor problems as evidence that the Board was not paying sufficient attention.
That said, I do have to highlight this aspect of the Court’s reasoning:
In answering the plaintiff’s argument, the Blue Bell directors also stress that management regularly reported to them on “operational issues.” This response is telling. In decisions dismissing Caremark claims, the plaintiffs usually lose because they must concede the existence of board-level systems of monitoring and oversight such as a relevant committee, a regular protocol requiring board-level reports about the relevant risks, or the board’s use of third-party monitors, auditors, or consultants…Here, the Blue Bell directors just argue that because Blue Bell management, in its discretion, discussed general operations with the board, a Caremark claim is not stated.
But if that were the case, then Caremark would be a chimera. At every board meeting of any company, it is likely that management will touch on some operational issue….
I admit, if defendants just argued that the Board discussed “operational issues,” that’s pretty damning.
Okay, so what do we make of all of this?
Well, I have to go back to an argument I’ve previously made in this space, namely, that with decisions like Corwin, Delaware has transformed itself into something like a mini-SEC. Suddenly, instead of emphasizing a Board’s substantive obligations, courts are scouring disclosures to determine if a shareholder vote was fully informed. Except, of course, we already have an SEC – we don’t need Delaware to do that job. (But see Reza Dibadj, Disclosure as Delaware’s New Frontier, 70 Hastings L.J. 689 (2019)). A contextual, nuanced take on independence carves out a space for Delaware that the SEC can’t replicate – and perhaps the same might be said of a more muscular approach to Caremark.
Saturday, June 22, 2019
If only there were an agency tasked with developing uniform standards for reporting material information
SEC Commissioner Peirce recently delivered a speech to the American Enterprise Institute and there's a lot going on here.
First, though this wasn't the nominal topic of the speech, Commissioner Peirce took the opportunity to take some shots at proxy advisors, complaining that:
Proxy advisor Glass Lewis, for example, has only 360 employees, only about half of whom perform research, who cover more than 20,000 meetings per year in more than 100 countries. Companies may not get an opportunity to correct underlying errors. According to one recent survey, companies’ requests for a meeting with a proxy advisory firm were denied 57 percent of the time. Companies submitted over 130 supplemental proxy filings between 2016 and 2018 claiming that proxy advisors had made substantive mistakes, including dozens of factual errors. Proxy advisors ISS and Glass Lewis provide companies some opportunity to contest such errors, but access is not uniform for all issuers, and the process may not provide adequate opportunity for issuers to respond before proxies are voted. The ramifications for the affected companies can be dramatic, as investment advisers, unaware of the error, vote their proxies in accord with the recommendation.
I've previously posted about the SEC's new interest in regulating proxy advisors; the writing on the wall appears to be that whatever else the SEC does, it's likely to create some kind of formal process by which companies can contest proxy advisor recommendations - potentially before the recommendations are distributed to investors, which, depending on how the regulations are drafted, could wind up impeding proxy advisors' ability to distribute recommendations at all. Glass Lewis recently began a pilot program to circulate companies' rebuttals to Glass Lewis's analyses; Glass Lewis says this is not about staving off regulation, which. Sure, let's go with that.
But the real topic of the speech was ESG investing, which she likened to a scarlet letter used to shame companies based on dubious metrics with little connection to financial value. As she put it:
It is true that ESG issues may well be relevant to a company’s long-term financial value. At a recent hearing before the Senate Banking Committee, John Streur of Calvert Research and Management testified that it is a “misconception” that using ESG investment strategies results in the investor sacrificing returns. In fact, he said, research has found that “firms in the top quintile of performance on financially material ESG issues significantly outperformed those in the bottom quintile.” Why, then, must the word “ESG” must be used at all? Of course, firms in the top quintile of performance on financially material issues outperform those on the bottom. If ESG disclosures mean disclosing what is financially material, there is little controversy, but the ESG tent seems to house a shifting set of trendy issues of the day...
There is, for example, a growing group of self-identified ESG experts that produce ESG ratings. ESG scorers come in many varieties, but it is a lucrative business for the successful ones. The business is a good one because the nature of ESG is so amorphous and the demand for metrics is so strong. ESG is broad enough to mean just about anything to anyone. The ambiguity and breadth of ESG allows ESG experts great latitude to impose their own judgments, which may be rooted in nothing at all other than their own preferences. Not surprisingly then, there are many different scorecards and standards out there, each of which embodies the maker’s judgments about any issues it chooses to classify as ESG. The analysis can appear arbitrary as it may treat similarly situated companies differently and may even treat the same company differently over time for no clear reason. Putting aside the analysis that produces the final score, some ESG scores are grounded in inaccurate information....
Even if the rating is not wrong on its own terms, the different ratings available can vary so widely, and provide such bizarre results that it is difficult to see how they can effectively guide investment decisions....
People are free to invest their money as they wish, but they can only do so if the peddlers of ESG products and philosophies are honest about the limitations of those products. The collection of issues that gets dropped into the ESG bucket is diverse, but many of them simply cannot be reduced to a single, standardizable score. ... We ought to be wary of shrill cries from a crowd of self-appointed, self-righteous authorities, even when all they are crying for is a label.
Now, I completely agree that often the call for ESG investing conflates the idea of investing based on moral/ethical considerations, and the idea of investing based on nonfinancial metrics which have a moral cast but are in fact part of financial analysis. And I agree that there is a proliferation of untested, vague standards, as well as a wide variety of funds that market themselves as "ESG" without being anything of the sort.
Which probably explains why Cynthia Williams and Jill Fisch petitioned the SEC for formal rulemaking on the disclosure of ESG information. It also explains why the SEC's Investor Advisory Committee asked the SEC to consider modernizing the framework for reporting on human capital management. So, maybe if there's a demonstrated investor demand for reliable, consistent, comparable information about public companies, there's something the SEC could do to help them out besides warning them to "be wary"?
Saturday, June 15, 2019
It’s no secret that Tesla has weathered some … ahem … criticism of its governance structure, and in particular, the (lack of) board supervision over Elon Musk. After Musk’s antics landed him in trouble with the SEC, the company proposed two charter amendments that would make the board more responsive to shareholders: first, to amend the charter so that future charter amendments will require only majority rather than 2/3 vote of the outstanding stock, and second, to amend the charter to reduce director terms from 3 years to 2.
Management sponsored proposals – especially those that hand more power to shareholders – are usually kind of a done deal. But this week, Tesla announced that even though the vast majority of voting shareholders favored the proposals, the proposals had failed to pass. Now, to be sure, the proposals needed a 2/3 vote of the outstanding stock – that was, after all, one of the things sought to be amended! – but it was still a bit of a surprise to see that the threshold hadn’t been met, given the amendments’ popularity.
I know that I wasn’t the only one who suspected some kind of Musk-related shenanigans, like perhaps Musk got cold feet about relinquishing power at the last minute, and withheld votes on his approximately 21% stake. The Wall Street Journal article reporting on the vote pointedly highlighted Musk’s ability to block changes he disliked. Plus, when it was originally posted online, the article reported that a spokeswoman for Tesla did not answer a question about how Musk voted, though later the article was revised to say that the company claimed Musk did not withhold his votes.
But still, I was suspicious about how exactly the proposals managed to fail, so I tried to do some back of the envelope calculations once Tesla filed its 8-K disclosing the tally.
And here’s what I figure. First, based on proxy disclosures and the 8-K, about 80% of the total voting shares made some kind of appearance at the meeting (in many cases, via broker non-votes). That compares to about 83% last year, when there were about 4 million fewer shares eligible to vote.
Second, broker non-votes this year exceeded last year’s tally by 11 million – but even if all of those shares had voted in favor of the proposals, it wouldn’t have been enough to change the outcome given the 20% of shares that never made an appearance.
Why so many non-votes/nonappearances as compared to last year? Well, I’m not sure if this means anything, but it also seems there was a lot higher volume of trading after the record date this year as compared to last year. Now, Tesla sold 3 million new shares in early May, so I only looked at the first two weeks after the record date of 2018 as compared to 2019, but it seems there was double the amount of trading in 2019. So, if I’m thinking about this correctly – and someone please feel free to weigh in if I’m getting this wrong, and disclaimer: I did not actually do a statistical analysis so I might be overstating the differences, but – it seems (1) the disparity in trading is not surprising given Tesla’s scandals this year and (2) the increased volume could potentially mean that otherwise-eligible voters sold their shares after the record date; so they didn’t bother to vote, and the new buyers weren’t able to do so.
So it’s definitely possible that all of this is just what it looks like: Tesla’s charter requires a high threshold to amend and the vagaries of public company voting made that threshold difficult to meet, even if most voting shareholders would prefer the amendment. But what we we don’t have is rock solid certainty that there wasn’t some kind of last-minute management change-of-heart.
And that takes me back to my post last year about the need for disclosure of how insiders vote (holders of high vote shares, high ranking officers, directors). We don’t have that now; absent actual class voting, the votes are just disclosed as an undifferentiated block. Which is what sent me on my bout of amateur sleuthing.
Now, not every company is Tesla and most of the time you can probably look at the vote total and, using other disclosures, figure out how insiders voted relative to other shareholders. But my point is, I shouldn’t have to open my creaky copy of Excel and consult multiple SEC filings to suss this information out. A clear statement, and separate totals, matter. They matter in terms of how the public understands the vote – reporting like this is downright misleading – and I think they probably matter in terms of how (some) shareholders understand their votes. Voting isn’t like efficient markets; whether or not information is “priced in,” actual votes have to be cast with knowledge in mind. Voters either understand the dynamics, or they don’t, and not everyone is going to do the math. Shareholders should be able to clearly understand the impact of their votes before and after the ballots are cast. Plus, I believe for certain kinds of close votes, insiders will be sensitive to how their ballots will be reported publicly, and that will affect their behavior.
Bottom line: Insider votes (and votes cast by high vote shares) should be broken out and reported separately.
Tuesday, June 4, 2019
New papers: On shareholder primacy, controlling shareholders, and mootness fees (they're different papers)
Several months ago, I posted about a symposium I attended at Case Western Reserve Law School titled Fiduciary Duty, Corporate Goals, and Shareholder Activism. The Case Western Reserve Law Review will be publishing a volume of papers from the symposium, and my contribution, What We Talk About When We Talk About Shareholder Primacy, is now available on SSRN. The essay (well, they're calling it an article but I think of it more as an essay) is about how shareholder primacy can be defined either as a wealth maximization norm or as obedience to shareholders, and what that means for corporate organization and theory.
In April, I attended the Corporate Accountability symposium sponsored by the Institute for Law & Economic Policy and the Vanderbilt Law Review. The Vanderbilt Law Review will be publishing those papers, and my contribution, After Corwin: Down the Controlling Shareholder Rabbit Hole, is now available on SSRN. The essay addresses the inconsistencies in how Delaware treats controlling shareholder transactions, and the new pressure that Corwin, as well as changes to corporate financing, have placed on the definition of what a controlling shareholder is.
(Regular readers of this blog will note that both of these essays draw heavily from my posts here. Waste not, want not.)
Finally, I previously posted about a panel on securities litigation that I attended at George Mason. At that time, I mentioned that my remarks drew from research that Matthew Cain, Steven Davidoff Solomon, Jill Fisch, and Randall Thomas presented at the April ILEP conference, and I promised to link to their paper when it was finally made public. Well, that paper, Mootness Fees (also forthcoming in Vanderbilt's ILEP symposium volume), is now available on SSRN (so hot off the presses that as of this posting, it's still in SSRN jail). It's an empirical examination of mootness fees paid out in the wake of Delaware's crackdown on merger litigation.
Saturday, June 1, 2019
Jeremy McClane at Illinois recently posted to SSRN a truly fascinating study of boilerplate in IPO prospectuses (okay, I gather it may have been out for a while but it was only posted to SSRN recently and that’s how I learn anything these days). In Boilerplate and the Impact of Disclosure in Securities Dealmaking, he concludes that while the inclusion of “boilerplate” – namely, generic disclosures that copy from similar deals – contributes to lower legal fees (though not lower underwriter and audit fees), it ultimately costs firms in terms of greater IPO underpricing and greater litigation risk. (It should be noted that he does not analyze litigation outcomes - compare to the risk factor paper, described below). Boilerplate is also associated with greater divergence in analyst opinion, and greater (upward) price revision in the pre-IPO period. All of this, he concludes, demonstrates that boilerplate contributes to greater information asymmetry.
In a previous post, I described a working paper, Are Lengthy and Boilerplate Risk Factor Disclosures Inadequate? An Examination of Judicial and Regulatory Assessments of Risk Factor Language, that examines boilerplate in SEC risk factors. The authors of that study concluded that – perversely – boilerplate is rewarded by judges in litigation and, crucially, by the SEC, where it is associated with fewer comment letters.
McClaine’s findings are in a similar vein. Despite the SEC’s (purported) efforts to stamp out boilerplate, he discovers that excess levels of boilerplate are not associated with more pre-offering prospectus amendments or with more SEC commentary. (Caveat: His study period includes post-JOBS Act filings but I’m not entirely clear how he treats draft registration statements for the purposes of this analysis).
A final note: McClane speculates on how boilerplate could impact investor assessments, given the common expectation that few investors actually, you know, read SEC filings to begin with. He points out that professional investors and analysts do the reading, and their determinations may ultimately drive pricing. He also notes that lawyers and underwriters draft IPO disclosures and that process may prompt them to ask questions, which ultimately generates more information. I’d add to the mix that these days, computers do a lot of the reading (especially once trading begins), which raises the possibility that subtle variations are more detectable than they were in days’ past. I’d love to see more analysis along these lines that divide filings by time period.
Saturday, May 25, 2019
A couple of weeks ago, I was lucky to participate in a panel on securities litigation at George Mason University Antonin Scalia Law School, along with Professor J.W. Verret, Jonathan Richman of Proskauer Rose, Steven Toll of Cohen Milstein, moderated by Judge Michelle Childs of the District of South Carolina. We had a lively discussion about current issues concerning these actions, including what I guess is now being branded as “event-driven” litigation, definitions of materiality, and arbitration clauses in charters and bylaws.
In my opening remarks, I discussed merger litigation and the shift from state to federal courts, covering much of the territory I previously described on this blog (of course, since that post, the Supreme Court dismissed the Emulex case as improvidently granted). I also drew from research by Matthew Cain, Steven Davidoff Solomon, Jill Fisch, and Randall Thomas, presented in April at the ILEP symposium on corporate accountability. (Their research is not yet public but I will link here as soon as it becomes available).
In the meantime, if you’re interested, you can watch a video of the panel here:
The other panels from the symposium are also available for viewing at this link.
Saturday, May 18, 2019
In 2014, the Supreme Court decided Burwell v. Hobby Lobby Stores, where it held that it is possible for a for-profit corporation to have a religious identity, derived from the religious commitments of “the humans who own and control those companies.” In so holding, the Court relied in part on state laws that permit even for-profit corporations to pursue purposes beyond stockholder wealth maximization. As the Court put it:
Not all corporations that decline to organize as nonprofits do so in order to maximize profit. For example, organizations with religious and charitable aims might organize as for-profit corporations because of the potential advantages of that corporate form, such as the freedom to participate in lobbying for legislation or campaigning for political candidates who promote their religious or charitable goals. In fact, recognizing the inherent compatibility between establishing a for-profit corporation and pursuing nonprofit goals, States have increasingly adopted laws formally recognizing hybrid corporate forms. Over half of the States, for instance, now recognize the “benefit corporation,” a dual-purpose entity that seeks to achieve both a benefit for the public and a profit for its owners.
In any event, the objectives that may properly be pursued by the companies in these cases are governed by the laws of the States in which they were incorporated—Pennsylvania and Oklahoma—and the laws of those States permit for-profit corporations to pursue “any lawful purpose” or “act,” including the pursuit of profit in conformity with the owners’ religious principles.
So it was a bit of an eyebrow-raiser to read this April Executive Order in which Trump declares:
The majority of financing in the United States is conducted through its capital markets. The United States capital markets are the deepest and most liquid in the world. They benefit from decades of sound regulation grounded in disclosure of information that, under an objective standard, is material to investors and owners seeking to make sound investment decisions or to understand current and projected business. As the Supreme Court held in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), information is “material” if “there is a substantial likelihood that a reasonable shareholder would consider it important.” Furthermore, the United States capital markets have thrived under the principle that companies owe a fiduciary duty to their shareholders to strive to maximize shareholder return, consistent with the long-term growth of a company.
As readers of this blog are likely aware, academics love to argue over whether existing law requires that corporations be run solely to maximize stockholder wealth, and of course over whether such law – if it exists – is a good idea or a bad idea. See generally Joan MacLeod Heminway, Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents, 74 Wash. & Lee L. Rev. 939 (2017). Usually, however, these battles occur in the context of state law. And while federal law – securities regulation, and so forth – often implies a corporate purpose of wealth maximization, I have to admit, I don’t recall seeing so blatant a statement about it before.
In any event, this section of the Executive Order directs the Department of Labor to review its existing guidance re: ERISA plans’ involvement in ESG matters. It’s a follow-up to last year’s Labor Department release – which I blogged about here – warning that ERISA plans may violate their duties to plan beneficiaries if they engage on ESG matters, or vote for ESG-related proxy proposals, for reasons other than plan wealth maximization.
As I’ve previously discussed, the SEC is currently reviewing rules governing the proxy process – including the role of proxy advisory services – to determine if additional regulation is needed. Much of this fight is, of course, about shareholder involvement in ESG matters and corporate governance more generally. I assume from this latest Executive Order that we’re about to see something of a two-pronged effort to limit shareholder power, with new guidance and/or regulations issuing from the SEC on one side and the Labor Department on the other. Anyone’s guess how successful this effort is likely to be, but I will highlight Andrew Tuch’s recent article, Why Do Proxy Advisors Wield So Much Influence? Insights From U.S.-U.K. Comparative Analysis, B.U. L. Rev. (forthcoming), pointing out that proxy advisory services have far less influence in the UK than in the United States, which he attributes to the fact that US shareholders have less power, and have reached less consensus on best practices in corporate governance, than shareholders in the UK. He concludes that many of the attempts to limit shareholder power – and the power of proxy advisors – in the US will not only be ineffective, but will actually strengthen proxy advisors’ hand.
Saturday, May 11, 2019
Vanguard recently announced that it will no longer centralize proxy voting across all of its funds; instead, its externally managed funds will set their own proxy voting policies. Although these represent only around 9% of Vanguard’s assets under management, they include almost all of Vanguard’s actively managed funds and actively managed equity assets.
I haven’t really seen much explanation for the shift from Vanguard itself – its own statement on the matter is quite vague – but I suspect they may have made the change for the same reason that Fidelity separates active and passive voting authority, namely, to avoid having the active funds grouped with the passive for the purposes of Section 13(d) of the Securities Exchange Act. Fidelity’s policy is longstanding because historically, it specializes in active funds. Vanguard, by contrast, is nearly synonymous with index funds, so my guess is that it reached a point where the active assets under management were becoming a regulatory risk, especially if those funds wanted to take positions with a view toward influencing – or supporting those who influence – management. As John Morley points out, Section 13(d) limits the ability of large fund providers to take activist stances; Vanguard, I think, just opened that door a crack. (If anyone else has more info on this or a different theory, please drop a comment or otherwise let me know.)
That said, I think this is a good move. I’ve long argued that mutual funds’ practice of centralizing their voting behavior is problematic both from the perspective of fund governance and from the perspective of corporate governance. On the fund governance side, vote centralization may fail to reflect the distinct interests of individual funds. On the corporate governance side, a diversified portfolio of funds may influence managerial decisionmaking in ways that conflict with the interests of less diversified shareholders. Given the concerns these days that mutual fund companies exercise too much power over corporate behavior, decentralizing voting authority seems like the most obvious - and appropriate - solution.
Saturday, May 4, 2019
I'm basically buried in exam-grading right now, and that leads me to the perennial question of how best to design a law school exam. Up until now, I've pretty much stuck to a single format: short essays (such as issue-spotters), in-class (3-3.5 hours), limited open book (they can use assigned materials and their own notes). I'm wondering whether next year I should mix that up a bit. For instance, Securities Regulation seems especially well-suited to multiple choice, at least partially; I also wonder whether a take-home exam would allow students to craft more thoughtful answers.
So, consider this a call for commentary: Especially if you teach in the business space, what kind of exam do you find works best, and why? Joan, I know, actually gives oral midterms - which I think is amazing, but I'm not quite ready for - so of the other options, in-class or take home? Open book or closed? Multiple choice or something else? Why do you choose what you choose?
Saturday, April 27, 2019
Last year, I had the privilege of participating in ILEP's 24th Annual Symposium, Deconstructing the Regulatory State, where I served as a discussant on papers presented by Jill Fisch and Hillary Sale regarding the role of disclosure in the securities regulatory landscape. Those papers, Making Sustainability Disclosure Sustainable and Disclosure's Purpose have now been published by the Georgetown Law Journal.
Georgetown has also published my remarks on the two papers as part of their online series. The title for my commentary is Mixed Company: The Audience for Sustainability Disclosure, and there's no formal abstract, but this is the introduction:
In their symposium articles, Professors Sale and Fisch offer mirror-image visions of the role of mandated disclosure. Professor Sale addresses information that is typically relevant to an investing audience and recognizes its importance to the wider public. Professor Fisch, by contrast, addresses information that is most relevant to a noninvestor audience but only contemplates its importance to corporate financial performance. The gulf between their approaches highlights one of the significant tensions in our system of securities regulation: the distance between its intended purpose and its current function.
Close readers of this blog will recognize that my comments follow a theme that I've frequently visited in this space, namely, the need for a corporate disclosure system that is not centered on investors. I'm actually working on a much longer article on this topic where I explore these ideas in depth, but for those who are interested, the elevator-pitch version is now available at Georgetown Law Journal Online.
Monday, April 22, 2019
Co-blogger Ann Lipton has posted a number of times on Elon Musk's Twitter disclosures and their potential legal significance. I chimed in once. Unless I am mistaken, her most recent post (citing to our prior posts) on this subject is here. Based on these posts, we both seem to understand that the Twitter Era has spawned some interesting disclosure-related legal questions.
I had these posts in the back of my mind when I got an email invitation yesterday from IPO Docs, a firm that sells "Regulation D Private Placement Memorandum Templates" to check into the firm's services. I have never been a fan of online templates or form documents as drafting precedent, especially for investment disclosure documents. In general, one-size-fits-all disclosure lawyering is just too far from my practice background (which involved reverse-engineering the work of my Skadden colleagues and others). But I do tell students they should be familiar with these kinds of form/exemplar resources and that, after determining the quality and suitability of a resource for their purposes, they may want to use form documents as a cross-check for contents or phrasing.
These two examples of Internet-related disclosures (online commentary and disclosure forms) are two pieces of a larger disclosure regulation puzzle. The puzzle? How best to address challenges to disclosure regulation posed by our increased use of and reliance on the Internet. Believe me; I am a fan of the Internet. But having been engaged with disclosure regulation pre-Internet and post-Internet, I do see challenges.
Social media and blog posts or commentary, for example, raise issues about the nature of the speech and the identity of the speaker. Are tweets made by firm managers disclosures of firm information or are they private statements? Who is the person behind a social media or weblog account commenting on business affairs? (I note that Ann's September 29, 2018 post on the Musk affair reports, based on information in the SEC's complaint, that analysts "privately contacted Tesla’s head of investor relations for more information and were assured that the tweet was legit." And many may remember the dust-up--almost twelve years ago--around John Mackey's "anonymous" online posts.)
To the extent that we come to accept, from a disclosure compliance standpoint, business disclosures that are made through fractured online posts and commentary, we lose the benefits of standardization--including easy comparability--that comes from the traditional periodic and transaction-based disclosure regimes built into the Securities Act of 1933 and Securities Exchange Act of 1934. While I understand the virtues of allowing for more customized business disclosures in certain circumstances (e.g., for Form S-8 registration statements, where a summary plan description geared to benefit-holders fulfills key prospectus disclosure requirements), should we be encouraging or mandating that investors of all kinds comb the Internet to find scraps of information to enable them to get comparable data? (Of course, many investors do perform Internet searches, regardless. But mandatory disclosure documents are the core elements of compliance, and they allow for relatively direct comparisons.)
What about disclosure challenges relating to Internet-available offering documents? I admit that I have less concern here if these documents are purchased and used by a competent lawyer. But I fear that will not be the dominant scenario.
In my view, a significant peril with disclosure templates is that people using them as drafting models may not be competent or skilled in their use. Specifically, form end-users may not understand (or even consult) the legal rules relating to disclosures required to be made by a firm seeking capital under applicable federal and state securities law registration exemption(s). The interpretation and interaction of some of these rules--and the preservation of arguments and remedies if an exemption is later found to be unavailable--can be complex. It is too easy to use template text without questioning it.
Moreover, Internet forms may lull businesses into thinking they have met all attendant legal requirements relating to a financing transaction for which a form document has been purchased. In a private placement, the existence of an accurate and complete disclosure document is but one of many legal compliance issues. Private placements exempt under Regulation D have a number of moving parts, disclosure being only one.
I feel very "old school" in writing this post. What are your views on these and other issues relevant to business disclosures made on or facilitated by the Internet? As a person who has been known to describe herself as a "disclosure lawyer," I would appreciate any ideas you may have. And tell me where I am wrong in the observations I make here.
Saturday, April 20, 2019
It’s no secret to anyone paying attention to Delaware law that the Aruba decisions – both at the Chancery and Supreme Court levels – involved some apparently personal clashes, which have already been the subject of speculation from several quarters, and I can only assume there is more analysis to come.
I was going to weigh in on that as well but upon further reflection, I decided that it’s … boring. And I’d rather talk about the substance of the law, because what we’re seeing here is the inevitable breakdown in appraisal actions given that no one knows why we even have them.
As a warning, I’ll say that reading over what I wrote on this, I realize it’s probably pretty impenetrable unless you already are versed in Delaware appraisal jurisprudence. I’ve previously posted about recent developments in Delaware appraisal litigation here, here, here, and here, so that might provide some background, but otherwise - you know, read at your own risk:
[More below the jump]
Saturday, April 13, 2019
Every year, when we get to the section on shareholder voting in my Business Associations class, I assign this article about Netflix. As it describes, Netflix has a staggered board and plurality voting and it takes a two-thirds vote of the stockholders to amend the bylaws. Every year, shareholders submit proposals to change these matters; every year, a majority vote in favor, and every year, Netflix just ignores the vote and keeps on keeping on.
But now it seems there are some cracks in the wall.
Last year, Netflix went on what I can only interpret as something of a charm offensive, publicizing what it claimed was unusually strong board oversight and transparency between the board and the management team. I take this to mean that their shareholders had become sufficiently restive that the company felt it needed to respond.
But that apparently did not work as well as hoped. This year, shareholders again submitted a series of governance reform proposals, seeking the right to call meetings, proxy access, the ability to act by written consent, the ability to amend bylaws by majority vote, and a bylaw amendment that would provide for director elections by majority rather than plurality voting. All passed except the bylaw amendment, which did not reach the required two-thirds vote, but did get 57% of the vote of the outstanding shares and 72% of the voting shares.
But this time, instead of ignoring the vote, Netflix actually amended its bylaws to provide for proxy access.
It seems that even Netflix cannot resist the pressure from investors forever. And now I’ll have to give my students a different lesson.
Friday, April 5, 2019
Where we last left off in our saga, Professor Hal Scott of Harvard Law School, as trustee for the Doris Behr 2012 Irrevocable Trust, sought to introduce a shareholder proposal at Johnson & Johnson to amend the corporation’s bylaws to require arbitration of federal securities claims by any J&J stockholder, on an individual basis. (You can read a full accounting of all of this, with links, here)
J&J sought to exclude the proposal on two grounds. First, that the proposal would cause the company to violate federal law because an arbitration bylaw of this sort would act as a prohibited waiver of rights under the Exchange Act, and second, that the proposal would violate state law because – as Delaware Chancery’s decision in Sciabacucci v. Salzberg made clear – corporate bylaws and charters only govern claims pertaining to corporate internal affairs, and cannot impose limits on non-internal affairs claims, like federal securities claims. J&J was boosted in this latter effort by an opinion letter from the NJ Attorney General agreeing that NJ law would be in accordance with Delaware on this issue. In light of the NJ AG letter, the SEC granted J&J’s request for no-action relief.
Undaunted, the Trust has now filed a complaint in the District of New Jersey, alleging that J&J violated the federal securities laws by excluding the proposal, and seeking an injunction requiring that J&J circulate supplemental proxy materials before the April 25 shareholder meeting. J&J’s argument in response has mainly focused on what it claims is the Trust’s unreasonable delay in bringing the matter to court, which belies any claim of irreparable harm.
Without wading into that dispute, I want to talk a little about the Trust’s complaint and supporting briefing.
Starting with the proposal itself, it states that “The shareholders of Johnson & Johnson request the Board of Directors take all practicable steps to adopt a mandatory arbitration bylaw” governing disputes between shareholders and the company arising under the federal securities laws, and prohibits class claims or joinder. It then contains a supporting statement: “The United States is the only developed country in which stockholders of public companies can form a class and sue their own company for violations of securities laws. As a result, U.S. public companies are exposed to litigation risk that, in aggregate, can cost billions of dollars annually…”
I realize this isn’t the main issue, but I have to pause to observe that while I enjoy the United States/Canada rivalry as much as anyone, I’m not sure I’d go so far as to deny that Canada is a developed country. As a result, the proposal may run afoul of Rule 14a-8(i)(3), which prohibits proposals that contain false information. That strikes me as an alternative ground for exclusion. (I believe Japan and Australia also permit securities class actions, and the list could probably be broadened depending on how “class action” is defined).
Leaving that point aside, I have to engage in another bit of nitpicking. The complaint’s introductory statement says: “The Trust is seeking shareholder approval for a proposal that would amend Johnson & Johnson’s bylaws and require the company’s shareholders to resolve their federal securities law claims through arbitration rather than costly class-action litigation” This, of course, is inaccurate; the proposal does not amend the bylaws, but rather requests that the directors amend the bylaws. Even if it passed, the directors would be free to ignore it.
But moving on to the heart of the matter, the preliminary injunction brief has a few main arguments:
First, the Trust argues that under the Federal Arbitration Act, agreements to arbitrate federal securities claims must be enforced according to their terms. That statute provides that “[a] written provision in any … contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract … shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2. Thus, it claims, it is impermissible to single out agreements to arbitrate federal securities claims and declare them unenforceable.
On this latter point, I’m inclined to agree; though there once was an argument that the securities laws themselves treat arbitration agreements and bars on class claims as an impermissible waiver of substantive rights, after American Express v. Italian Colors Restaurant, that argument has far less force.
That said, the unspoken assumption of the Trust’s argument is that a corporate bylaw constitutes an contract to arbitrate for FAA purposes, and that federal securities claims “aris[e] out of” state law corporate constitutive documents. These are both points that are very much in dispute, as I discuss in my Manufactured Consent paper.
Second, the Trust argues that a state law rule that would limit the enforceability of an arbitration bylaw is similarly preempted by the FAA.
In this case, the state law rule at issue is simply one that holds that corporate bylaws can only govern internal affairs claims – not a rule that singles out arbitration specifically. For that reason, it would seem that the FAA has little role to play, for that statute only “preempts any state rule discriminating on its face against arbitration…[and] also displaces any rule that covertly accomplishes the same objective by disfavoring contracts that (oh so coincidentally) have the defining features of arbitration agreements.” Kindred Nursing Centers v. Clark, 137 S.Ct. 1421 (2017).
The Trust has an answer to that, however: it claims that limiting the rule only to corporate bylaws and charters is itself an impermissible act of discrimination against arbitration agreements. The rule at issue here does not apply to all contracts, but only some contracts – namely, the corporate contract – and for that reason, it runs afoul of the FAA’s command that arbitration agreements may only be invalidated on the same grounds as would exist for “any contract.”
I admit, there’s some superficial textual appeal to that argument – one of the maddening aspects of this area of law is that it is impossible to tell what counts as “discrimination” against arbitration without a baseline for comparison, and that baseline can be elusive – but as I understand it, in the Trust’s reading, states have a choice: Either they can allow corporations to include arbitration agreements in their bylaws – which can then govern disputes that have nothing to do with the corporate form or the corporate constitutive documents themselves, or the laws that ordinarily govern them – or states can create a rule that all contracts formed under state law must pertain only to corporate internal affairs. That seems to me to go well-beyond a nondiscrimination principle for contracts to arbitrate, and would also seem to be in some tension with the Supreme Court’s recognition of the particular need for a choice-of-law principle unique to the corporate form, namely, the internal affairs doctrine. See CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69 (1987).
Which just illustrates one of the problems with applying the FAA to corporations. The entire corporate form is structured by state law rules, from distinctions between what goes in the bylaws versus matters that must be in the charter, to how charters are amended versus how bylaws are amended, to what counts as a quorum, to who has the power to call meetings and under what circumstances, to when written consent can substitute for a shareholder vote, and so forth. If you say that rules specific to the corporate form cannot be applied to arbitration provisions, you undermine states’ ability to dictate corporate structure.
Third, the Trust argues that Sciabacucci was wrongly decided and does not in fact represent the law of Delaware – which, well, again, eventually it will be appealed and we’ll know one way or the other.
Fourth, the Trust claims that there is no reason to believe that NJ law follows Delaware law on this point. On this, I take no position, other than to note that in addition to the NJ AG’s opinion, Professor Jacob Hale Russell wrote an analysis of NJ law which is now available on SSRN.
Finally, the Trust argues that even if the proposed bylaw would be unenforceable, it still would not violate either state or federal law for J&J simply to enact it, recognizing that, if J&J chose to enforce it against a stockholder in court, the bylaw would be declared ineffective and nonbinding. Therefore, the proposal is not excludable on the grounds that it would cause J&J to violate the law.
This is also an intriguing point, which gives rise to the general question whether it would be a violation of a Board’s fiduciary duties to enact a bylaw that purported to bind stockholders, but that it knew would be unenforceable in a court of law. Would that be a misuse of the corporate machinery? Impermissibly deceptive? It would certainly seem to be beyond the scope of the Board’s powers to enact – that’s the whole basis of the Sciabacucci decision – which itself would be a violation of state law.
Anyhoo, that’s as far as my thinking takes me – but, as I said, the most immediate argument before the court right now is whether the Trust waited too long to seek a preliminary injunction, so we’ll see what happens from here.
Friday, March 29, 2019
Earlier this week, the Supreme Court issued its opinion in Lorenzo v. SEC, and the thing that strikes me the most about it is that the dissenters do more to undermine Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), than the majority does.
I previously posted about Lorenzo here; the remainder of this post assumes you’re familiar with the problem posed by Lorenzo and its relationship to the earlier Janus decision.
[More under the jump]
Saturday, March 23, 2019
A few months ago, I read John Carreyrou’s Bad Blood: Secrets and Lies in a Silicon Valley Startup about Elizabeth Holmes and the Theranos fraud, and I was very curious to see how the same story would play out in the new documentary The Inventor: Out for Blood in Silicon Valley. (Sidebar: I am truly on the edge of my seat for the forthcoming Adam McKay adaptation starring Jennifer Lawrence – but that’s a whole ‘nother thing). In general, I preferred the book: it has far more detail, and the documentary has little new information to contribute. That said, there was power in the immediacy of actually watching Elizabeth Holmes, hearing her speak, and seeing how people reacted to her. So, below are some of my general thoughts.
Friday, March 15, 2019
Tulane just held its 31st Annual Corporate Law Institute, and though I was not able to attend the full event, I was there for part of it. Though the panels were very interesting and I took copious notes, as a matter of personal satisfaction, the single most important thing I learned is that it is pronounced Shah-bah-cookie. You’re welcome.
That said, below are some takeaways from the Hot Topics in M&A Practice panel, and to be clear, this isn’t even remotely a comprehensive account of everything interesting; it’s just stuff that I personally hadn’t heard before. (And thus, the exact contours of my ignorance are revealed.)