Saturday, July 4, 2020
It seems we’re all talking about VC Laster’s recent opinion in In re Dell Technologies Class V Stockholder Litigation. Stefan posted about Laster’s taxonomy of coercion earlier this week; for me, I want to focus on another aspect of the case, the one that Stephen Bainbridge latched onto as indicative of his “director primacy” view.
The basic set up in Dell was that controlling shareholders – Michael Dell and Silver Lake – engineered a transaction whereby Dell would redeem Class V stock from its holders, and they wanted to cleanse the deal using Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) procedures to ensure it would receive business judgment review. To that end, they conditioned the transaction on special committee approval and unaffiliated shareholder approval. Dissatisfied stockholders sued, claiming that despite those efforts, the MFW conditions were not satisfied, and, for the purposes of a 12(b)(6) motion, Laster agreed.
Laster actually found that, as alleged, the departures from MFW were many and varied, but there’s one aspect in particular I want to focus on, namely, the curious role of the “stockholder volunteers.” After months of negotiation, the special committee reached a deal with the company that met with immediate objection from Class V stockholders. Rather than go back to the committee, Dell instead started negotiating directly with a selection of six large investors until a new deal was struck. At least according to the plaintiffs, the committee perfunctorily approved the revised deal, and it was that deal that was finally presented to the stockholders generally for their vote. When Class V shareholders sued, Dell argued that the committee-plus-stockholder negotiations were sufficient to satisfy MFW. In their view, this set up presented the best of all worlds: independent committee protection with direct input from sophisticated shareholders bargaining in their own interests.
Laster disagreed. He observed that corporate directors are the ones charged with protecting shareholder interests, and that task cannot be delegated to individual shareholders who have no fiduciary obligations to the company and do not have the information available to insiders. In so doing, he cited several academic articles (including, umm, one of mine, Shareholder Divorce Court) discussing how individual shareholders have private interests that may not match those of the shareholders collectively.
It was this portion of the opinion that Stephen Bainbridge highlighted as endorsing his “director primacy” theory, which posits that shareholders have a very subordinate role in corporate managerial decisionmaking, even in the context of large transactions.
The part that I’m interested in, however, is Laster’s attention to the varying incentives of even the “disinterested” stockholders. That’s what I was discussing in Shareholder Divorce Court, namely, how large institutional shareholders are likely to have cross-holdings that affect their preferences, and lead them to favor nonwealth maximizing actions at a particular company if they benefit the rest of the portfolio (after the article was published, I posted about additional empirical work in this area here). Laster has historically been especially sensitive to these kinds of conflicts. He authored In re CNX Gas Corp. S’holders Litig., 4 A.3d 397 (Del. Ch. 2010) (which I highlight in Shareholder Divorce Court), where T. Rowe Price was found to be “interested” for cleansing purposes because, across its mutual funds, it held stock in both a target and the acquiring company. Laster also wrote the opinion in In re PLX Tech. Stockholders Litigation, 2018 WL 5018535 (Del. Ch. Oct. 16, 2018), which I discussed here, where he concluded that a hedge fund’s “short-term” outlook caused its interests to differ from the other shareholders (even though those other shareholders had voted to put the hedge fund’s representatives on the company’s board). In his Dell opinion, Laster mentions another relevant type of cross-holding, namely, the distinction between investors who own both debt and equity, and investors who own equity alone.
The problem, though – as I discuss in Shareholder Divorce Court and What We Talk About When We Talk About Shareholder Primacy– is that if you’re going to recognize the heterogeneity of shareholder interest due to these different types of portfolio-wide investments, it’s unclear why a majority vote should be permitted to drag along the minority in a particular deal. Which conflicts will we recognize as generating bias, and which will we ignore? That’s the problem that cases like Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) and MFW are forcing Delaware to confront. Laster’s far more willing to engage here; so far, other judges have, umm, avoided the issue. For example, Laster cites In re AmTrust Financial Services, Inc. Shareholder Litigation, 2020 WL 914563 (Del. Ch. Feb. 26, 2020), where a controller negotiated directly with Carl Icahn when it seemed shareholders were unlikely to approve a deal endorsed by the special committee, but, as Laster notes, Chancellor Bouchard refused to decide whether such actions forfeited MFW protection. Similarly – as I wrote about in Shareholder Divorce Court – VC Slights, entertaining a stockholder challenge to Tesla’s acquisition of SolarCity, failed to reach the question whether institutions like BlackRock who owned shares in both entities counted as “disinterested” votes for Corwin purposes.
In practical effect, it seems, Laster is less about director primacy than judicial primacy, in a way that often puts him at odds with other members of the Delaware judiciary. (See, e.g., my discussion of Salzberg v. Sciabacucchi, and the differing views of the nature of the corporation expressed by Laster and the Delaware Supreme Court). Because once you hold that shareholders are too biased to make decisions, that doesn’t necessarily lead to director primacy; instead, it creates more space for the judiciary to step in to protect the interests of the abstract notion of shareholder, distinct from the ones who actually cast ballots. Or perhaps, we should call it state primacy. Which was the point of my post last week (as well as the thesis of my post about the PLX case and my What We Talk About When We Talk About Shareholder Primacy essay. I do have a theme).
And that segues nicely into - happy July 4th, and the birth of the American government!
Saturday, June 27, 2020
The Department of Labor has been a busy bee.
First, it approved the use of private equity investments in 401(k) plans. The idea would be that workers would be able to invest in funds that invest in private equity funds; apparently, some funds are already on offer, and they also hold a small amount of publicly traded stock to satisfy liquidity concerns. Jay Clayton at the SEC endorsed the move, saying it would “provide our long-term Main Street investors with a choice of professionally managed funds that more closely match the diversified public and private market asset allocation strategies pursued by many well-managed pension funds as well as the benefit of selection and monitoring by ERISA fiduciaries.”
Second, the DOL proposed new rules to discourage the use of ESG investing with respect to ERISA-regulated retirement plans (and because many state pension funds are not covered by ERISA but follow its lead, the rules could extend much further). The proposed rules are not exactly a surprise; they follow guidance that the Trump Administration put out in 2018, and which I blogged about at the time. And – as I also blogged– in 2019, the Administration warned the DOL was continuing to examine the issue with a view to more action on this front.
So what are the implications?
First, though the private equity rules are championed by those who argue they will allow retail investors access to higher profits, it’s ironic that they come just when a new study shows that private equity investments are no more profitable than public markets, and almost concurrently with a new SEC warning of pervasive conflicts in the private equity industry that lead to hidden fees and unequal allocation of investment opportunities. Institutional investors in private equity funds have long complained to the SEC of the lack disclosure of these matters, and rather than respond to that, we’re apparently … going to open the 401(k) spigot. That, I think, will make private equity managers less accountable to investors and the public (why bargain with a union pension fund when you’re getting billions from a bunch of different funds layered through so many intermediaries that no one’s able to monitor things?) and more opaque.
Second, as I’ve talked about before, ESG can have a bunch of different meanings. Some use it as a stockpicking technique like any other, on the theory that socially responsible companies are valuable companies. Others use it for moral/impact reasons; they are willing to sacrifice at least some returns in order to adhere to their ethical commitments. When it comes to ERISA plans, the past several presidential administrations have all agreed that fiduciaries must only use ESG to advance the economic interests of plan beneficiaries; they are not permitted to use beneficiaries’ money to advance unrelated social goals. What’s been different over the years, however, is the standard of proof that fiduciaries must meet in order to incorporate ESG factors into their decisionmaking. The new rule imposes a very high standard, by explicitly directing that fiduciaries using ESG analysis “examine the level of diversification, degree of liquidity, and the potential risk-return in comparison with other available alternative investments that would play a similar role in their plans’ portfolios.” That requirement, unique to ESG, betrays a deep distrust of ESG investing, and will very likely dissuade at least some fiduciaries from engaging in ESG activity at all for fear of being unable to adequately justify their decisionmaking. And, critically, the rule does not merely apply to buying and selling securities; it also applies to other types of plan administration, including voting and engagement decisions. Which means, among other things, it targets union involvement with shareholder proposals.
It’s worth pointing out that the US’s approach here is precisely the opposite of the European approach, where the default assumption is that ESG factors should be considered as a part of prudent asset management. Recently, the SEC Investor as Owner Subcommittee recommended that the SEC “begin in earnest an effort to update the reporting requirements of Issuers to include material, decision-useful, ESG factors,” and part of the rationale was that the US risks letting other jurisdictions set the pace on these issues. The DOL’s proposed rule, I believe, will only accelerate the process of ceding leadership to the European Union.
Notably, in recent years, several commenters have pushed institutional investors to look beyond simple financial returns and consider to the overall welfare of their human beneficiaries when making investment decisions. David Webber has argued that pension funds should be able to allocate dollars in a way that benefits labor and unionization, Nathan Atkinson has argued that institutional investors should be mindful of the overall interests of their clients (as consumers, employees, etc), and former Chief Justice Strine has argued that institutional investors should concern themselves with the health and welfare of their human beneficiaries when casting proxy votes (the latter piece with Antonio Weiss). The proposed DOL rule would put the kibosh on that, at least for ERISA plans, explicitly mandating that plan fiduciaries evaluate “investments and investment courses of action based solely on pecuniary factors that have a material effect on the return and risk of an investment based on appropriate investment horizons and the plan’s articulated funding and investment objectives…”
The new rule also discourages including ESG funds in 401(k) plan menus. If the rule takes effect, ERISA fiduciaries would only be permitted to include such funds if they are chosen for their financial returns, with a special requirement that they document their reasoning. Those special recordkeeping requirements, of course, will make it difficult to include ESG funds in 401(k) plans at all. According to the DOL release, there aren’t many 401(k) plans that offer ESG investments now – maybe 9% of them do – but ESG funds are a growing segment of the market and there has been a lot of advocacy to expand 401(k) ESG offerings. This rule, if enacted, will likely dampen that effort. More broadly, it could discourage the development of any ESG funds, because these funds would be functionally unavailable both to 401(k) plans and to ERISA-covered pension plans. Notably, the rule has a capacious definition of ESG – it encompasses any fund that includes “one or more environmental, social, and corporate governance-oriented assessments or judgments in their investment mandates … or that include these parameters in the fund name” – so the rule’s knock-on effect may be to dissuade mutual funds from considering these factors at all (or at least mentioning them in their prospectuses). Which is significant, given that Larry Fink has said that he plans to “mak[e] sustainability integral to portfolio construction” in BlackRock funds.
The DOL rules, then, are of a piece with new SEC proposals to limit shareholder use of 14a-8 and expand retail access to private offerings. The rules, collectively, favor minimizing corporate accountability to investors and the general public in favor of opacity and unfettered management discretion. And the Administration seems to be encouraging short-term business models – private equity – over the long-term risk mitigation strategy of ESG, which is odd, because as I previously blogged, the Administration, like a lot of Delaware caselaw, has explicitly stated that the purpose of the corporation is to maximize long-term shareholder welfare.
(That said, it appears the Chamber of Commerce objects to the ESG proposal, on the ground that the recordkeeping requirements may prove a tempting target for plaintiffs raising fiduciary duty claims, and with that kind of opposition, we may see some changes before a formal enactment.)
Stepping back, it should be obvious none of this has anything to do with investor choice. The true tell is the rule regarding ESG fund inclusion in 401(k) plans. As I said the first time I blogged about this issue:
It’s all well and good to require that ERISA fiduciaries act solely in the economic interests of beneficiaries, on the assumption that this is what beneficiaries would likely want, and on the assumption that wealth maximization functions as “least common denominator” for beneficiaries’ otherwise conflicting interests.
But this reductionistic approach to defining beneficiary interests, adopted for the purpose of making them more manageable, should not stifle opportunities to accommodate the actual preferences of beneficiaries, especially when it is feasible to allow beneficiaries to sort themselves – like, say, when ESG-focused funds can be made available to those beneficiaries who are willing to sacrifice some degree of financial return to advance social goals. Providing these opportunities to beneficiaries who choose them inflicts no damage on the interests of beneficiaries solely interested in financial return, and, in fact, the principle that investors should be able to control their own retirement planning is (supposedly) the reason these types of ERISA platforms are offered in the first place.
The new guidance, then, seems less about protecting beneficiaries from politically-motivated fiduciaries than it is about forcing beneficiaries to participate in the political goals of the Trump administration, namely, minimizing shareholder participation in corporate governance, particularly when those shareholders advance (what are usually) liberal policy priorities.
To be sure, we don’t have a whole lot of funds that openly advertise their plan to sacrifice returns in favor of social goals; it’s a real issue that funds billing themselves as “ESG-focused” are not clear about their strategies, and that’s something the SEC is legit investigating. But assuming we can get full disclosure, and there is a demand for such funds, the DOL is dictating the choices of millions of investors, many of whom will have no other exposure to the market.
Which brings me to my main point, which is, all of these proposed changes simply highlight that it is inaccurate to the point of absurdity to describe the American corporate governance system as “private law.” State choices dictate the build of the business form, its accessibility to the public, the structure of investors themselves, and their preferences when allocating capital. That’s the thesis of my latest Essay, Beyond Internal and External, which argues that corporate governance is subject to pervasive regulation in a manner that directly effectuates public policy. If we’re going to have the state make these kinds of choices, we should at least own them, rather than cloak them in the language of “private ordering.”
Saturday, June 20, 2020
I drafted this post before, well, the SEC got dragged into the middle of an SDNY meltdown and that’s obviously way more interesting than what I was going to say, but I have this whole post already here so... here goes.
One of the big business news stories of the past week has been Hertz and its failed stock offering. (N.B.: Well, it seemed like a big deal when this post was originally drafted)
During the pandemic, stock markets have gyrated wildly, apparently driven in part by retail traders who, left without the opportunity to bet on sports, have turned to trading as an alternative form of gambling. They’re apparently encouraged by free trading apps and especially Robinhood, which – unlike other platforms which treat trading as srs bzns– gameifies the experience. As one trader put it, “With sports, if I throw $1,000 at something, I lose the whole thing real quick, but here if things go south you can cut your losses.”
That particular theory was sort of tested when it came to Hertz, which is in bankruptcy. Despite that fact, its stock started to climb, in what has been described as the equivalent of a Jackass sketch. Everyone understood there was almost no chance of the company actually generating value for shareholders, but the coordinated attention acted as something of a combination dare, Ponzi scheme, market manipulation, and performance art.
Hertz tried to take advantage of it all by selling new stock, figuring hey, this might be an easy way to pay off its creditors, and that all by itself seems to have burst the bubble; traders weren’t expecting anyone to take them seriously. But the plan was scotched when the SEC raised questions about the sufficiency of Hertz’s prospectus disclosures.
We are in the process of a reorganization under chapter 11 of title 11, or Chapter 11, of the United States Code, or Bankruptcy Code, which has caused and may continue to cause our common stock to decrease in value, or may render our common stock worthless.
And also here:
The price of our common stock has been volatile following the commencement of the Chapter 11 Cases and may decrease in value or become worthless. Accordingly, any trading in our common stock during the pendency of our Chapter 11 Cases is highly speculative and poses substantial risks to purchasers of our common stock. As discussed below, recoveries in the Chapter 11 Cases for holders of common stock, if any, will depend upon our ability to negotiate and confirm a plan, the terms of such plan, the recovery of our business from the COVID-19 pandemic, if any, and the value of our assets. Although we cannot predict how our common stock will be treated under a plan, we expect that common stock holders would not receive a recovery through any plan unless the holders of more senior claims and interests, such as secured and unsecured indebtedness (which is currently trading at a significant discount), are paid in full, which would require a significant and rapid and currently unanticipated improvement in business conditions to pre-COVID-19 or close to pre-COVID-19 levels. We also expect our stockholders’ equity to decrease as we use cash on hand to support our operations in bankruptcy. Consequently, there is a significant risk that the holders of our common stock will receive no recovery under the Chapter 11 Cases and that our common stock will be worthless.
Note how these disclosures were reported in the media:
This does not, in short, seem like a disclosure problem at all. And that means there’s a lot to think about.
First, there have been a lot of comparisons to the dot com bubble, and I agree, but in a very specific way. The internet bubble featured anonymous commenters who’d engage in pump-and-dumps – recommend a stock, watch everyone pile in, and sell out – but it wasn’t necessarily the case that anyone was fooled. People used the comments as a coordinating mechanism – which stock they’d all buy now – and play musical chairs to see who could make money and cash out before the crash. That’s how Donald Langevoort viewed the SEC’s case against Jonathan Lebed, anyway, and it definitely is an element of what’s happening here. (See this article about a website devoted to tracking Robinhood trades). So all that raises the question of how much transparency markets can really bear. (Cf. Matt Levine, writing about a different kind of transparency, in Too Much Information Can Be Bad)
Beyond that, the SEC’s interference betrays a rather surprising lack of faith both in market efficiency and investor autonomy, and thereby illustrates the SEC’s Janus-faced (heh) approach to investor protection. Recently, the SEC has been fairly aggressive in its insistence that disclosure is a cure-all, that markets are efficient and no one needs to be told anything twice, and that retail investors should have more access to private capital. At the same time, the SEC has resisted and denigrated the demands of actual investors regarding the types of information they need to make intelligent decisions. And now, apparently, the SEC is willing to step in to save Hertz investors from themselves – even when they act with full disclosure on a widely traded, exchange-listed (for now), stock. It seems the SEC has complete faith in efficient markets and investor wisdom, except when it doesn’t.
Another aspect of this story has to do with market efficiency in – as William Fisher once put it – “a time of madness.” As I said, it wasn’t just Hertz; there have been reports of retail traders playing stocks like a roulette wheel and even manipulating prices for the lulz. There have also been several securities fraud lawsuits filed since the lockdowns, particularly ones pertaining to the coronavirus. These are fraud-on-the-market cases, and they depend at least on market informational efficiency, if not fundamental value efficiency, which implies some amount of rationality. Will the evident irrationality of markets at this time affect the plaintiffs’ ability to certify a class?
It’s not an entirely crazy question; there is some precedent for courts treating market irrationality as evidence of inefficiency. See In re Initial Public Offering Securities Litigation, 260 F.R.D. 81 (S.D.N.Y. 2009) (“there is insufficient evidence of efficiency to permit the use of the Basic presumption with respect to trading during the quiet periods. To the contrary, the evidence indicates that the quiet periods were marked by chaotic pricing, irrational purchases, and market inefficiencies. [Plaintiffs’] own evidence demonstrates that the markets for the focus case shares were inefficient during the first weeks of trading. A purchaser of these securities during the relevant quiet period could not reasonably rely on the market price to reflect the market’s judgment of the security’s value. Therefore, the Basic presumptions cannot apply to these periods.”)
That said, the Supreme Court’s Halliburton v. Erica P. John Fund, 573 US 258 (2014), may have established a more forgiving standard for evaluating market efficiency, so we shall see.
But my final observation is this: All of this is kind of hilarious until you read these kinds of stories, where some 20-year-old Robinhood trader may have killed himself because he – mistakenly – believed he’d lost $700K. Additionally, the Twitterati is ablaze with anecdotal reports of teens and even pre-teens trading stocks in Robinhood, treating it as an alternative to Fortnite – and I can’t wait to see what happens if those kids are trading on margin. Now, Robinhood purports to require that accountholders be at least 18, so we have a bunch of questions: (1) are there really a bunch of children trading, or are those isolated examples no matter what Twitter says?; (2) are parents are intentionally giving their kids access to brokerage accounts, or are children just lying their way in?; and (3) just how robust are Robinhood’s age and suitability checks? Robinhood has now promised to improve its interface regarding options trading, to consider “additional criteria and education for customers seeking level 3 options,” and to, umm, make a “$250,000 donation to the American Foundation for Suicide Prevention.” So, yay?
Monday, June 15, 2020
The full schedule for the 2020 National Business Law Scholars Conference, which is being hosted on Zoom Thursday and Friday of this week, is now available. You can find it here. If and as additional changes are necessary, we will re-post.
As is always the case, the conference includes folks presenting work in a variety of areas of business law. These traditional paper panels are the heart of the conference. In addition, as I noted in my post last week, we are including three plenary sessions--one on "Business Law in the COVID-19 Era," one reflecting on teaching business law in the current environment, and one on current bankruptcy law and practice issues. There is something for almost everyone in the business law space in the conference program.
I am pleased and proud to note that several of my fellow bloggers from the Business Law Prof Blog are participating in the conference this year. They include (in addition to me): Colleen Baker, Ben Edwards, Ann Lipton, and Marcia Narine Weldon. I hope many of you will join us for all or part of the program and offer comments to colleagues on and relating to their work.
Thursday, June 11, 2020
So, this week we’re back to litigation-limiting corporate constitutive documents.
Where we last left things, the Delaware Supreme Court held in Salzberg v. Sciabacucchi, 2020 WL 1280785 (Del. Mar. 18, 2020), that Delaware law permits corporations to adopt charter provisions that would require plaintiffs bring Securities Act claims in a federal, rather than state, forum. I posted about that decision here, and argued that it left a number of unanswered questions about its application.
This week, we’re beginning to see the fallout.
In Seafarers Pension Plan v. Bradway, the plaintiff brought a derivative Section 14(a) action against the Boeing Company in the Northern District of Illinois. Plaintiff alleged that the company proxy statements contained false statements pertaining to the development of the 737 Max, and via these false proxy statements, defendants solicited shareholder votes in favor of their own reelection and compensation.
Boeing moved to dismiss on the ground that its bylaws provided that Delaware Chancery Court would be “the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation,” as well as the sole forum for “any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of the Corporation to the Corporation.”
Significantly, because Section 14(a) claims cannot be brought in Delaware Chancery – federal courts have exclusive jurisdiction – Boeing’s argument meant that the plaintiff would not be able to maintain its suit at all. As a result, the plaintiff argued that application of the bylaw to this lawsuit necessarily ran afoul of 15 U.S.C. § 78cc, which prohibits prospective waivers of 1934 Act obligations.
A parallel case, Chopp v. Bradway, 20-cv-00326-MN, involving derivative claims under Section 10(b), was filed in the District of Delaware. Boeing made the same arguments in favor of dismissal in that case as well. (Section 10(b) claims, like Section 14(a) claims, can only be brought in federal court). The plaintiff voluntarily dismissed that action before a decision could be reached, leaving only Seafarers.
On June 8, the Seafarers court agreed with Boeing and dismissed the derivative Section 14(a) claims. See Seafarers’ Pension Plan v. Bradway, No. 27, 19-cv-08095 (N.D. Ill. June 8, 2020). The decision is not currently available on Lexis or Westlaw though I assume it will turn up eventually.
[More under the jump]
Friday, June 5, 2020
This has not exactly been a week of great productivity on the subject of corporate governance theory
So instead, I’ll just say, like my co-blogger Stefan who posted yesterday, I’ve also been paying attention to corporate responses to protest movement. Because we’re both talking about that subject, I’ll just start by quickly reproducing the links that I gave Stefan in my comments on his post:
And one I forgot to add:
Anyhoo, as I said, I’ve been watching how corporations are responding, but unlike Stefan, I haven’t perceived silence at all - quite the opposite. But, what corporations are saying is interesting. These are the articles that captured my attention:
Corporate Voices Get Behind ‘Black Lives Matter’ Cause (“Some companies were more cautious in their approach. Target, which is based in Minneapolis and was hit by looting at a store there last week, described ‘a community in pain’ in a blog post but never mentioned the word ‘black.’”)
What CEOs Said About George Floyd’s Death (“Few companies talked about law enforcement or other forms of authority. Dell Technologies Inc. was the only company to use the words ‘police brutality.’”)
Adidas Voices Solidarity While Closing Its Stores (“Companies like Adidas and Nike have long paid black entertainers and athletes to pitch their products, and it is often black teenagers in the country’s largest cities who determine which brands are fashionable and subsequently sell big in the white suburbs. This is a particular bone of contention for black employees at Adidas…”)
#BlackoutTuesday: A Music Industry Protest Becomes a Social Media Moment (“Beyond the confluence of hashtags, some in the music industry questioned what was being done beyond promises for reflection and general statements of support.”)
‘Blackout Tuesday’ Prompts Debate About Activism and Entertainment (“Other celebrities voiced skepticism over the efforts and concern that it would dilute more urgent forms of activism.”)
Silent No More on Race, America's CEOs Fumble for Right Words (“Unlike syrupy messages in support of nurses and essential workers fighting the coronavirus pandemic or a call for unity after 9/11, there is no happy medium for a position on white privilege.”)
Brands Have Nothing Real to Say About Racism (“Facebook and Citibank weighed in, as did the gay dating app Grindr and even the cartoon cat Garfield.”)
Ben & Jerry’s pointed call to ‘dismantle white supremacy’ stands out among tepid corporate America statements (N.B.: take a moment to absorb that this article appears in the Washington Post Food section)
People On Nextdoor Say The Platform Censored Their "Black Lives Matter" Posts (“while the company may be officially saying that it supports the Black Lives Matter movement, this week, many of its volunteer moderators took a contrary position, stifling conversations about race, police, and protests while removing comments and postings with the very phrase the company had tweeted just three days ago.”)
Venture firms rush to find ways to support Black founders and investors (“Black entrepreneurs and investors are questioning the motivations of these firms, given the weight of evidence that shows inaction in the face of historic inequality in the technology and venture capital industry.”)
SoftBank launches $100M+ Opportunity Growth Fund to invest in founders of color (“Just a couple of weeks ago, the CEO and founder of one of its portfolio companies, Banjo, resigned after it was revealed that he once had ties to the KKK.”)
For more equitable startup funding, the ‘money behind the money’ needs to be accountable, too (“Consider that already, most VCs today sign away their rights to invest in firearms or alcohol or tobacco when managing capital on behalf of the pension funds, universities and hospital systems that fund them. What if they also had to agree to invest a certain percentage of that capital to founding teams with members from underrepresented groups?”)
A statement from [Brand]® pic.twitter.com/XT9tXF9hvz— Chris Franklin (@Campster) May 31, 2020
I’ll finish by noting that however tepid, many of the corporate statements do explicitly reference Black Lives Matter. And since even that sentiment was considered controversial a few years ago, we can safely conclude that the needle has moved.
Saturday, May 30, 2020
Sometimes I blog in ways that ignore the chaos of our current political moment. This is not one of those times.
Both as a corporate governance scholar and an American citizen, I’ve spent the last few days riveted by Twitter’s decision to go to war with the President of the United States.
And it was a decision; after Twitter posted its first fact-check of a Trump tweet, its VP of Global Communications said, “We knew from a comms perspective that all hell would break loose.”
All hell did. Trump responded with an executive order (whose legal effect is, ahem, questionable), and Twitter’s stock price plummeted. But Twitter doubled-down, hiding a Trump tweet for glorifying violence, and doing the same when the White House twitter account repeated the same quote.
We’ve talked a lot here about corporate political stances, and – especially in the context of Nike and Colin Kaepernick -- how despite appearances, they’re often justifiable on a theory of shareholder value maximization.
A similar argument could be made about Twitter’s conduct. It has come under increasing pressure to control its platform; trolls and bots and harassment by some users have driven away others. Trump’s tweets about Joe Scarborough specifically led to a torrent of criticism, essentially begging Twitter to hold Trump to the same standards as any other user. Twitter’s efforts to impose discipline – on any chaos agent, including the President – could easily be viewed as part of a larger strategy to ensure that the platform remained usable for everyone else. Merely choosing to join battle may attract users and attention, which is Twitter’s main asset.
At the same time, Twitter’s actions here feel different. They feel like an recognition of civic responsibility, to keep political discourse civil and truthful, regardless of whether that is the most profitable course for the company.
The Wall Street Journal recently reported that Facebook dropped its own initiative to minimize polarization and political falsehoods on its platform, in part because “some proposed changes would have disproportionately affected conservative users and publishers, at a time when the company faced accusations from the right of political bias.” Shira Ovide, commenting in the New York Times, wrote, “If Facebook made these decisions on the merits, that would be one thing. But if Facebook picked its paths based on which political actors would get angry, that should make people of all political beliefs cringe….there should be a line between understanding the political reality and letting politics dictate what happens on your site.”
That’s such an odd statement. Facebook isn’t a state actor, it’s a private company, and a private company exists to benefit shareholders, which, among other things, may mean placating politicians – right?
And yet when these things come up, I often see people offering takes like these:
They’re wrong, but also – they’re kind of right, in the popular sense that large corporations often have public responsibilities and therefore the public demands their decisionmaking reflect public values.
But then there’s Scott Rosenberg’s view that Facebook’s hands-off policy is analogous to a government neutrally facilitating free speech, while Twitter is behaving more like a property owner trying to maintain order in its mall.
The flaw in Rosenberg’s analogy is that Facebook is not a neutral platform; the point of the Wall Street Journal piece is that Facebook’s own algorithms privilege certain types of speech over others in order to maximize user engagement – much like a mall owner who makes sure there are plenty of amenities on the property so no one ever leaves.
That said, I often experience this kind of gestalt switch when I think about corporate social responsibility; categorizing the behavior as privately oriented or publicly oriented is often simply a matter of perspective. Large corporations are, in fact, a hybrid of the two, a product of both public systems and individual choices. Which is why it’s so hard to put the conflict here into a neat little box.
Saturday, May 23, 2020
So, this blog post about DoorDash and pizza arbitrage has been making the internet rounds; you’ve probably already seen it, but if not, it’s well worth a read. It highlights some of the irrationalities of the platform-food-delivery business – irrationalities that have resulted in losses despite the fact that the pandemic has caused business to boom. UberEats and GrubHub are now considering a merger, and I suppose their lack of profit might be interpreted as the result of predatory pricing, which would raise antitrust concerns, but honestly it looks more like they are just having trouble making the business model work.
So what struck me about the blog post was this:
You have insanely large pools of capital creating an incredibly inefficient money-losing business model. It's used to subsidize an untenable customer expectation. You leverage a broken workforce to minimize your genuine labor expenses. The companies unload their capital cannons on customer acquisition, while this week’s Uber-Grubhub news reminds us, the only viable endgame is a promise of monopoly concentration and increased prices. But is that even viable?
Third-party delivery platforms, as they’ve been built, just seem like the wrong model, but instead of testing, failing, and evolving, they’ve been subsidized into market dominance. Maybe the right model is a wholly-owned supply chain like Domino’s. Maybe it’s some ghost kitchen / delivery platform hybrid. Maybe it’s just small networks of restaurants with out-of-the-box software. Whatever it is, we’ve been delayed in finding out thanks to this bizarrely bankrolled competition that sometimes feels like financial engineering worthy of my own pizza trading efforts.
The more I learn about food delivery platforms, as they exist today, I wonder if we’ve managed to watch an entire industry evolve artificially and incorrectly.
That’s pretty much the argument I made in my earlier post, The Meaning of We. Loosening of the securities laws has, I think, resulted in a distorted and inefficient allocation of capital toward exploitative and ultimately unproductive businesses. Now, it’s true – GrubHub and Uber are both publicly traded companies today – but they got their start due to piles of private investment, and that momentum has carried them through into the public markets. From where I sit, the expanded ability of companies to raise capital privately has only facilitated particular kinds of biases and short-sightedness among a very small segment of the investor base, resulting in real, and damaging, effects in the broader economy. Perhaps this is a problem that will resolve itself - with the implosion of SoftBank, perhaps private markets will simply get smarter - but I suspect that this is more a problem of the people who make decisions in private markets, and their biases and incentives. Regulators are increasingly focusing their attention on investor sophistication with respect to individual transactions, and neglecting the broader macroeconomic purposes of the securities regulation regime.
Saturday, May 16, 2020
It’s long been blackletter law that a Section 10(b) claim can be rooted in statements that are not targeted to the company’s investors, and are not specifically about the health of the company, so long as investors rely on them, or the speaker should have expected such reliance. See, e.g., In re Carter-Wallace, Inc. Sec. Litig., 150 F.3d 153 (2d Cir. 1998); Semerenko v. Cendant Corp., 223 F.3d 165 (3d Cir. 2000). As a result, even product advertisements and other consumer-facing material can form the basis of a securities fraud claim. Notably, in the recent case of Roberts v. Zuora Inc. et al., 2020 WL 2042244 (N.D. Cal. Apr. 28, 2020), the plaintiffs based their 10(b) claims both on the company’s statements to investors and its general product advertisements, and the court – denying a motion to dismiss – drew no distinction between the two.
Which is why I thought Background Noise? TV Advertising Affects Real Time Investor Behavior by Jura Liaukonyte and Alminas Zaldokas was so interesting (you can read the paper at this SSRN link, and their summary at CLS Blue Sky Blog here). In the paper, the authors find that after a television advertisement for a product airs, searches for the manufacturer’s SEC filings increase, as does trading volume in the manufacturer’s stock. The findings validate the caselaw; it seems retail investors, at least, regularly consider product advertisements when deciding what stocks to buy.
The broader issue, though, arises when we’re not talking about an individual fraud claim, where a particular investor can attest that he or she relied on some specific piece of information, but a fraud on the market action, when the Carter-Wallace principle translates to the rule that just about any statement made by the defendant in any context to any audience may trigger securities fraud liability, so long as it was, in some sense, “public.” The plaintiffs generally do not prove that investors really did rely on the misstatements; rather, it becomes the defendants’ burden to prove the opposite (which may be, literally, impossible to do). As a result, when the statements are far removed from investment context, courts may grope for a limiting principle, and arrive at doctrinally inconsistent results to get there.
That’s always how I’ve always understood the result in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), anyway. There, mutual fund prospectuses contained false information about fund policies, but the plaintiffs brought their claims not on behalf of fund investors, but on behalf of investors in the publicly-traded fund sponsor, who – it was claimed – misled its own investors about how it administered its funds. Based on my experience as a plaintiffs’ attorney, I am quite confident that the reason the plaintiffs relied on mutual fund prospectuses to make an argument about the fund sponsor was that they looked, as hard as they could, for false statements made directly by the fund sponsor itself, and were unable to find any. So they were forced to make the argument that buyers of the sponsor’s stock made their investment decisions based on the policies identified in the fund prospectuses. And because that argument seems like a stretch but difficult to challenge factually, the Supreme Court took the easier route and simply said the fund sponsor was not responsible for the prospectuses. Would the Court have reached the same result if investors in the funds had brought the same claim? I suspect not – which is likely why the Court backtracked in Lorenzo v. SEC, 138 S.Ct. 2650 (2018).
Anyhoo, for those interested in more discussion along these lines, see Donald Langevoort’s papers Reading Stoneridge Carefully: A Duty-Based Approach to Reliance and Third Party Liability under Rule 10b-5 and Lies without Liars? Janus Capital and Conservative Securities Jurisprudence.
Saturday, May 9, 2020
I’ve blogged a lot about the complexities of Delaware’s controlling-stockholder jurisprudence (here, here, here, here, here, and here), and written an essay on the subject. The latest Chancery opinion on this issue, Gilbert v. Perlman, represents another, unusual, addition to the genre.
In Gilbert, Francisco Partners was the controlling stockholder of Connecture with a 56% stake. During its tenure, however, it worked closely with Chrysalis Ventures, a firm that it had coordinated with in prior ventures, and who was the next largest Connecture blockholder with an 11% interest. A Chrysalis partner, Jones, also served as Connecture’s Chair. Eventually, Francisco proposed to buy out the minority Connecture shareholders in a deal that was neither conditioned on the approval of an independent director committee nor a majority of the minority shareholder vote.
According to the proxy statement, the Connecture board, in the course of its internal deliberations, considered it important that Chrysalis support any proposed transaction. Chrysalis suggested that it be permitted to roll over its shares in the new entity, which would, it believed, allow Francisco to bump up the price for the remaining minority shareholders. A few days later, Jones asked for the same participation rights personally. A deal on these terms was struck. The unaffiliated shareholders, however, were unimpressed by the arrangement, voting only 9.9% in favor of the deal. But their votes were unnecessary and the merger closed.
Two minority shareholders of Connecture filed suit alleging that Francisco, as controller, breached its fiduciary obligations. Because Francisco had negotiated the deal with essentially no procedural protections for the minority, it was plain this was a transaction that would receive entire fairness review, and Francisco did not even bother moving to dismiss; instead, it simply answered the complaint. The more complex allegations concerned Chrysalis and Jones: plaintiffs alleged that they had formed a control group with Francisco and thereby shared its fiduciary obligations, and it was that question that Vice Chancellor Glasscock addressed on Chrysalis’s and Jones’s 12(b)(6) motion.
First, Glasscock articulated the basic landscape. As he put it:
Under Delaware law, “controlling stockholders are fiduciaries of their corporations’ minority stockholders.” That is, where a stockholder may control the corporate machinery to benefit itself, as by exercising voting control, it is a potential fiduciary. Where in fact it exerts such control, a controlling stockholder is bound by Delaware’s common law fiduciary duties of loyalty and care. Conversely, stockholders who control only their own shares, and cannot exert corporate control, are owed fiduciary duties; they themselves are not obligated to act in the corporate interest….
It is also possible under Delaware law for several minority stockholders to band together to form a “control group.” In this situation, though none are individually controllers, because they act in consort to exercise collective control, the stockholders in the group owe fiduciary duties. To demonstrate the existence of a control group, it is insufficient to identify a group of stockholders that merely shares parallel interests. To form a control group, the stockholders must be “connected in some legally significant way—e.g., by contract, common ownership, agreement, or other arrangement—to work together toward a shared goal.” By pooling resources in a plan by which they control the corporation, they become fiduciaries.
So, what if we have a controller who joins with minority shareholders? Do those minority shareholders inherit the same fiduciary obligations of a controller merely by virtue of their agreement, or is more required? Per Glasscock, we need more:
To create a control group, a controller must go beyond merely permitting participation by other stockholders in the transaction. Instead, the minority-holder’s participation must be material to the controller’s scheme to exercise control of the entity, leading to the controller ceding some of its control power to the minority-holders. In this way, the minority stockholders involved wield their own levers of power as part of the group; this control of the corporate machinery makes them fiduciaries. … [O]nly if the controlling stockholder shares or materially limits its own control power through an arrangement (such as a voting agreement) could a control group potentially be found….
In my view, where a controlling stockholder takes an action joined by minority stockholders, the latter can be deemed members of a control group, and thus fiduciaries, where two conditions exist. There must be an arrangement between the controller and the minority stockholders to act in consort to accomplish the corporate action, and the controller must perceive a need to include the minority holders to accomplish the goal, so that it has ceded some material attribute of its control to achieve their assistance. In order to survive a motion to dismiss, a plaintiff advancing this unusual theory must plead facts that permit a reasonable inference that these conditions exist.
Alas for the plaintiffs, they were unable to make such a showing. They definitely demonstrated the existence of an arrangement to act in concert – indeed, the parties disclosed in the proxy statement that they had entered into a voting agreement – and Chrysalis and Jones even received a nonratable benefit, namely, the right to rollover their stock. But the plaintiffs did not show that Francisco needed them in any way, or ceded its power, such that they shared fiduciary obligations with Francisco. As Glasscock put it:
if the Plaintiffs could have pled that Francisco Partners needed something material in way of its take-private scheme, and was accordingly willing to give up some material part of its control attributes to Chrysalis and Jones to get it, they may have adequately made the allegation that a control group existed here. The Complaint, however, points to neither quid nor quo—it describes nothing Francisco Partners needed or ceded to the Moving Defendants, other than the bare right to roll over shares.
The logic has a certain surface-level appeal. With great power comes great responsibility, and absent power, the responsibility does not follow. Therefore, gratuitous receipt of a controller’s largesse is not sufficient for the beneficiary to take on the controller’s responsibilities.
But beneath that simple maxim lies a raft of complexity.
First, as a practical matter, we may have trouble identifying which test applies. Recall, the rule is, in order to show that shareholders were working together – such that minority blockholders become controllers in the first instance – plaintiffs only need show the existence of an agreement. The enhanced test, requiring that the controller actually engage in a quid pro quo with someone else, only comes into play once the existence of a controlling shareholder is established. So imagine you have a large minority blockholder working with another, smaller blockholder. If the larger minority blockholder is incapable of exercising control on its own, the two together will owe fiduciary obligations if they reach an agreement; if, however, the larger blockholder does exercise control on its own, an agreement is not sufficient; the plaintiff will need to show that some of that power was ceded to the smaller in order to bring a claim against the two together. Given the inherent uncertainty associated with determining whether a minority blockholder exerts control in the first instance (see, ahem, my essay), you can already imagine the bizarre and conflicting set of incentives under which both plaintiffs and defendants will labor in order to make their cases at different stages of litigation.
Or, imagine you have three minority shareholders, any two of which are sufficient to control the entity. If the three shareholders combine, is only the third subject to the enhanced test? What if it’s not clear which are the “two” and which is the “third” – especially if the original two are alleged to have control from a minority (under 50%) position?
Maybe this is an angels-on-pinheads concern – after all, this scenario doesn’t come up much in general, and it probably doesn’t come up much with triad combinations – but we might further delve into what counts as a “benefit” to the controller that justifies a finding of a quid pro quo.
Here, there was not simply an agreement to act in concert: the minority shareholders received a unique benefit in the transaction, namely, Chrysalis and Jones were given the opportunity to roll over their shares, which was significant for a merger that, by hypothesis, undervalued the minority stake. (The fact that Jones immediately jumped on the deal personally is further evidence that this opportunity had real value, to the detriment of the minority shareholders being squeezed out).
But that was not enough for Glasscock: He required that Francisco have received something of value in exchange. What possibilities exist?
Here are some ideas. Apparently, because it was buying fewer minority shares, Francisco was willing to pay more for them (though the financial logic of that is not clear) – which would place it in a stronger legal position both in the (inevitable) fiduciary lawsuit or in an appraisal action. Plus, by maintaining good relations with Chrysalis, it avoided a lawsuit by Chrysalis itself - a significant threat, given that Jones was Chair of the Board and presumably knew where all the Francisco bodies were buried.
Also, Connecture was an unusual controlled company in that, as far as I can tell, Francisco had only put 2 nominees on a 7 member board (though plaintiffs alleged it had close ties to the remaining members). Chrysalis, of course, had the Chair. If Francisco wanted to force a merger through over board/Chrysalis objections, it would have had to go through the process of replacing the existing board members, including Jones. Could it have done so? Surely, but it would have taken time and placed it in an even more precarious legal position later. This is especially so given that, under federal law, Connecture was required to discuss the fairness of the proposed transaction in its proxy statement. Imagine the difficulty of doing so if the Chair of the board did not agree, or had been forced out in some kind of prolonged dispute.
The point is, even a cursory review of the facts reveals how Francisco benefitted by keeping matters amicable with Chrysalis. All of these possibilities suggest Chrysalis therefore had some control over the deal’s final shape; after all, the proxy statement itself stated that Chrysalis proposed higher minority shareholder consideration in exchange for its own participation.
So why aren’t these facts enough to meet Glasscock’s test?
One possibility is that this is simply a pleading matter. If plaintiffs had framed the case with these benefits made explicit, perhaps they’d have survived a motion to dismiss, with further factual development to come after discovery.
But if that’s the case, we might ask why this kind of pleading and proof are even necessary. If a controller grants a boon to a minority shareholder as part of a conflict transaction, why can’t we assume the controller is getting some kind of “soft” benefit in exchange? Why else would it ever agree to such an arrangement? Why can’t we view the specter of this kind of quid pro quo as sufficiently omnipresent to forego the necessity of proof? After all, we do that with controlling shareholder transactions generally; we assume that they are coercive to the minority even absent specific evidence that minority shareholders actually were coerced. We could similarly assume that if a controller confers a valuable benefit on a specific minority shareholder in connection with an self-interested deal, it’s not acting out of graciousness.
So the alternative possibility is that these soft benefits – which facilitated the transaction but were not, perhaps, legally necessary to complete it – were not, in Glasscock’s view, significant enough to rate. But if not, why not? Does Glasscock require actual proof of the control ceded by the controller (beyond, apparently, Chrysalis’s actual involvement in setting the price for the minority shares)? Or does Glasscock require different benefits to the controller? What would those benefits be?
I guess my thinking is, the whole reason we subject controlling shareholder transactions to heightened scrutiny is because we cannot trust the ordinary market mechanisms for disciplining predatory behavior. But that doesn’t mean controlling shareholders wield unconstrained power; as with anything else, their paths can be made rougher or smoother, and a smooth path may have value to the controller. As a result, even minority blockholders may wield influence. They can use that influence to ally themselves with the remaining minority, and thus make transactions more fair, or to ally themselves with controllers, in order to receive private benefits. To the extent Delaware law is designed to encourage “good” behavior that minimizes the need for judicial intervention, shouldn’t the rules in this area incentivize those blockholders to either maintain an alignment of interests with the minority shareholders, or bear legal responsibility for them?
Glasscock’s framing of the inquiry suggests some skepticism toward the notion that a controller would ever cede power to a minority blockholder, so that a plaintiff must allege an unusually explicit arrangement before the scenario will be contemplated. But, as I’ve repeatedly discussed in this space, control is not a simple on/off switch. Even a 56% stockholder may encounter obstacles in a take-private deal despite its legal ability to force it through. Delaware’s repeated insistence on viewing control through a black/white lens glosses over the practical realities of how control is often exercised, putting its doctrine at odds with the underlying reality.
Saturday, May 2, 2020
Much of the SEC’s disclosure regime is predicated on the idea of market efficiency: it’s not necessary that companies constantly repeat publicly available information, because that information is already known to, and absorbed by, market participants. The problem is, even the SEC is never quite sure how far to run with this.
Case in point: the SEC’s proposal to eliminate Item 303(a)(5), which requires that registrants provide a tabular disclosure of contractual obligations. As the SEC explains, “We do not believe that eliminating the requirement would result in a loss of material information to investors given the overlap with information required in the financial statements and our proposed expansion of the capital resources requirement, discussed above in Section II.C.2. As many commenters pointed out, much of the information presented in response to this requirement overlaps with U.S. GAAP and is therefore included in the notes to the financial statements…”
Both the SEC’s Investor-As-Owner subcommittee, and the Council of Institutional Investors, have objected to the proposal. For example, the Investor-As-Owner Subcommittee says:
Investors and analysts, however, have informed the subcommittee that the information in the current tabular format is useful and material. While much of the information can be derived from other places in a Form 10K, it is more complete and substantially less costly and less time-consuming for analysts to gather and analyze, and for investors to use, in its current presentation. It is not apparent to us that the cost savings from the company side from the proposed change would be greater than the increased costs that dispersed analysts and investors would have to bear from having to gather the information themselves.
Its potential materiality can be illustrated with a recent analyst report on the cruise line industry, which has been hit particularly hard by the coronavirus. The report relied on the tabular presentation of contract obligations to compare and contrast cruise lines’ exposures to a mismatch between revenue shortfalls and their near-term obligations. While a similar analysis could have been done by relying on information in financial footnotes, the substitute analysis would have been less complete and taken longer to execute. In the current environment, less timely disclosure of this analysis would have been less useful to investors.
Investors find these tabular presentations to be extremely useful, as they compile information that is often scattered throughout the filing into one central location. For example, in periods in which a company’s liquidity becomes of concern to investors, such as at the present moment, it is useful for investors to be able to turn to a particular section of the filing and readily see what a company’s future contractual obligations are, without having to hunt for each piece of information throughout the filing…
This is also, by the way, an ongoing issue with respect to non-GAAP financial metrics – as long as the GAAP numbers are there, what does it matter if the company releases non-GAAP financials as well? And yet it does matter, which is why Congress and the SEC regulate non-GAAP disclosures.
I’ll note that even as both Congress and the SEC demonstrate some ambivalence about market perfection – not only through non-GAAP regulation, by the way, but also via “crash” damages in the PSLRA context and proposed diversity disclosures - (some) courts continue to assume market perfection and make that the basis of their analysis of securities fraud lawsuits.
Leaving all of that aside, however, one of the more interesting observations is CII’s point that:
We would also note that the preparation of the contractual obligations table is a useful management exercise as it summarizes the obligations in one location and provides management with a picture of such obligations. We know that what gets measured and disclosed is what gets monitored by management. This is another reason to include the table and enhance as we describe elsewhere herein.
In other words, it’s not just about whether investors can glean and absorb types of information; the disclosure structure imposed by the SEC dictates board priorities and therefore indirectly polices corporate governance. This is not a new idea – commenters have long made similar observations – but CII is right that to the extent the SEC is attempting to move to a principles-based disclosure system, it is perhaps not fully recognizing the real governance tradeoffs that accompany more exacting disclosure requirements.
Saturday, April 25, 2020
All right, it’s probably a little premature to call it an “age of direct listings”; we’ve had Spotify and Slack and I guess some company called Watford Holdings and Airbnb was reportedly considering one, and in the Before Times a lot of VCs were making noises about preferring direct listings to traditional IPOs, but in the immediate future I don’t expect to see a lot of new firms going public either way (notwithstanding the occasional ambitious SPAC), so these issues may turn out to be nothing more than a curiosity.
BUT! In the meantime! We have Pirani v. Slack Technologies, 2020 WL 1929241 (N.D. Cal. Apr. 21, 2020), in which a district court refused to dismiss Section 11 claims brought by investors who purchased Slack shares after the company listed directly on the NYSE. And, it turns out, direct listings raise a lot of unsettled questions under Section 11.
Slack, like a lot of companies these days, never formally sold its stock to the public; instead, it distributed stock in exempt transactions, subject to various securities law rules that permit these kinds of distributions but generally require the investors to hold their stock for some period of time before reselling it. Eventually, Slack had distributed a lot of stock this way, and its investors were clamoring for liquidity, i.e., an easy way to sell their shares. So Slack decided to list its shares for trading on the New York Stock Exchange.
That was fine for shares that had been distributed so long ago that investors were now legally permitted to resell them, but a lot of shares were distributed more recently, and investors holding those shares were were not permitted to trade them yet. In order to allow these latecomers to sell immediately, Slack registered those shares – and only those shares – formally with the SEC. Normally, companies file registration statements when they sell new stock to the public, and the registration permits immediate trading. But registration statements can be used – as Slack’s was – to register previously-issued shares, so as to enable holders of those shares to trade right away. As a result, when Slack’s stock formally began trading on the NYSE, there were actually two groups of shares for sale: The shares that had been distributed so long ago that the legal holding period had expired, and the recently-issued shares that had just been registered. In total, 118,429,640 shares were registered, and an additional 164,932,646 shares traded with them. But, of course, it was all common stock, and therefore fungible; no specific share could be traced to one group or the other.
Which is how we get to Section 11.
Section 11 of the Securities Act of 1933 allows any investor to sue if they purchased a security issued pursuant to a false registration statement. Damages are calculated based on the extent to which the price of the security falls below “the price at which the security was offered to the public.”
Naturally, soon after Slack’s direct listing, some investors came to believe that the registration statement contained false information (specifically, concerning Slack’s ability to avoid service disruptions), and sought to bring Section 11 claims against the company. In the context of a direct listing like Slack’s, then, two questions were raised: First, what is the “price at which the security was offered to the public” if the issuer is not selling any new shares to the public? And second, how can a purchaser show that he or she bought shares tied to the registration statement?
These were the questions that confronted the court.
And first, let’s first talk about theory.
In general, the idea behind Section 11 is that when a company is selling securities to the public, it is functionally warranting that the securities are worth at least the price at which they’re being sold for, based on the information in the registration statement. If the registration statement turns out to be false and the securities drop below that offering price, disappointed investors are entitled to recoup the amount of their overpayment. In this scheme, the issuer is held liable to the extent it collected payments in excess of the securities’ value, as gauged by the registration statement information.
That said, the rules are not quite so simple. First, many persons other than the issuer may be liable for false registration statements (though these persons, like corporate directors, are generally those who are in a position to correct false registration statements). And second, registration statements are explicitly required even when persons other than the issuer are selling shares – like, control persons. In the end, then, Section 11 remedies are analogous to disgorgement but they are not quite so strict because even persons who do not collect monies from the sale of shares may end up paying damages.
Still, most of the time, the scheme is relatively coherent – an issuer sells securities for more than they are worth by including false information in the registration statement, therefore the issuer (and persons similarly responsible) must refund disappointed investors the amount of the overpayment.
So what to do about the Slack situation, then?
As to the first question – what counts as the “price at which the security was offered to the public” – Slack’s argument was of course that there was no such price, and therefore there could be no Section 11 damages. The court, however, ducked the issue, holding that damages are an affirmative defense and not an element of the plaintiffs’ claim, and therefore are an inappropriate basis for dismissal. At the same time, the court expressed some doubt as to the merit of Slack’s argument that a direct listing is entirely different from an IPO, pointing out that Slack itself admitted in its registration statement that the direct listing process would include a “pre-opening indication” that was “[s]imilar to how a security being offered in an underwritten initial public offering would open on the first day of trading.”
In my view, Section 11 is, at least for now, one important mechanism for enforcing the securities laws. If those laws contemplate that previously-issued shares will become freely-tradeable upon registration, then, it’s necessary that courts be able to identify some “offering price” that renders Section 11 meaningful. Slack should not be able to avoid liability simply by claiming there is no relevant price; something must count.
Which leaves us only to ask how that price should be determined.
As a formal matter, there are a few options. One is the “reference price” chosen by the NYSE to guide trading; another is the “opening price” determined by the market maker based on pre-opening buy and sell orders. Those buy and sell orders may use the reference price as a guide, but trades themselves are executed, to begin with, at the opening price set by supply and demand. In Slack’s case, the reference price was $26, but the opening price was $38.50.
This is sort of analogous to the IPO process. In a traditional IPO, the offering price is used to sell shares to initial allocants, but pre-opening bidding determines the actual opening price at which trading begins. For example, in Facebook’s IPO, its offering price was $38 per share, but due to pre-opening bidding, the stock actually began trading at $42.05 per share. For Section 11 purposes, $38 was the relevant price. In this analogy, the reference price in a direct listing is like a traditional IPO’s offering price and therefore the reference price should be the anchor for Section 11 claims.
But! Unlike a traditional IPO, no shares actually change hands at the reference price because there are no initial allocants. If we assume that the majority of Slack’s pre-listing shares were issued in sales that count as “private” under the securities laws, the first actual sales to the public were, in fact, at the opening price, and therefore $38.50 was the “price at which the security was offered to the public” for Section 11 purposes. Therefore, the opening price should control.
But on a third hand, we might look at the pre-open bidding history and see the very first price at which any seller offered to sell shares – likely NYSE’s reference, and possibly something else. That first price might technically be the first “price at which the security was offered to the public,” and therefore we might treat that as the appropriate anchor for Section 11 purposes.
All of that, though, is divorced from the functional purposes of Section 11 damages, namely, to force the issuer to “stand behind” a particular stated value for the security. Which is why I think this matter actually cannot be settled without discovery. Slack claimed in its briefing that it had no role in setting either the reference price or the opening price, but that likely overstates matters. Its bankers appear to have assisted both the NYSE and the designated market maker in setting both prices, and it may turn out that either price was driven by the preferences of selling insiders (the plaintiffs noted that several insiders sold at prices slightly above the open). If so, these participants’ involvement, along with their superior knowledge, may function as the same kind of “price warranty” that Section 11 ordinarily envisions, perhaps similar to when an issuer registers shares being sold by a controlling person (who necessarily must have a hand in setting the price to the public).
Which brings us to the next question, namely, how do we know that any open-market purchaser bought registered shares rather than unregistered ones?
This is actually not a problem unique to direct listings; it arises even in IPOs, when previously-issued shares become freely tradeable along with registered shares. In the typical IPO, some number of insiders hold unregistered shares at the time of the offering, but they are subject to a contractual lockup period that prevents them from trading (usually 180 days) after the registration statement becomes effective. After the lockup period expires, the unregistered shares commingle with the registered shares. Courts usually hold that a Section 11 plaintiff is required to prove that his or her shares are traceable to the registration statement, Krim v. pcOrder.com, 402 F.3d 489 (5th Cir. 2005), which is literally impossible to do for any open-market purchaser who buys after the expiration of the lockup period. As a result, the tracing requirement ends up cutting many a Section 11 claim off at the knees. To avoid neutering Section 11 entirely, advocates have argued that courts should award damages based on some kind of statistical formula, such as assuming that plaintiffs hold registered and unregistered shares in proportion to the number of registered and unregistered shares in the market generally, see Steinberg & Kirby, The Assault on Section 11 of the Securities Act: A Study in Judicial Activism, 63 Rutgers L. Rev. 1 (2010), but courts so far have not been receptive. Indeed, on more than one occasion, corporate attorneys have recommended that issuers intentionally shorten or eliminate the lockup period for some unregistered shares in order to defeat all Section 11 claims.
But now there’s Slack!
In Slack’s case, the court was sympathetic to the argument that because there is no lockup period in a direct listing – all shares become freely tradeable at once – a strict tracing requirement would mean no Section 11 claims are available to anyone. As a result, the court held that “in this unique circumstance—a direct listing in which shares registered under the Securities Act become available on the first day simultaneously with shares exempted from registration,” purchasers of all shares of the registered class would be eligible to bring Section 11 claims.
On the one hand, I am (again) sympathetic to the idea that Section 11 should not be so easily defeated. On the other hand, again, Section 11 was originally intended as a mechanism of disgorging ill-gotten gains from issuers, which is why there is so much fixation on offering prices and shares traceable to a registration statement. In a direct listing, the concerns are a bit different – there’s no disgorgement to be had – and there’s no precise functional way to figure out how the statute should apply.
That said, if we look back to the history of Section 11, we see that the expectation was something like a fraud-on-the-market theory, where trading prices for newly-registered shares were assumed to be set based on information in the registration statement, and open-market purchasers would therefore be injured if that information turned out to be false. See, e.g., Douglas & Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171 (1933) (“At that time the registration statement will be an important conditioner of the market. Plaintiff may be wholly ignorant of anything in the statement. But if he buys in the open market at the time he may be as much affected by the concealed untruths or the omissions as if he had read and understood the registration statement.”); 78 Cong. Rec. 10186 (1934) (“the market value is fixed by the false statement of the corporation. The individual investor relies upon the investigation made by the banker. It is fair to assume that this situation continues until such time as the corporation makes available a statement showing its earnings for 12 months. Then the market value is influenced by the statement of actual earnings and not by the statements contained in the registration statement”).
On that theory, it hardly matters whether the shares were technically those issued on the registration statement or not – all shares would be affected by the same false information, and thus all purchasers should have some remedy, even if the total damages are capped at the level traceable to the number of shares issued on the defective registration statement, and divided pro rata among all claimants.
My final thought is: Section 11 may serve an important disciplining function, not only for IPOs, but even for shelf registrations that incorporate SEC filings by reference. But, as I previously blogged, the statute has not been updated since 1933 and is not well-adapted to the realities of today’s offerings. The best solution isn't to have courts try to mold the statute to the current environment, but for Congress to work out a solution that best meets the needs of modern markets.
Saturday, April 18, 2020
New Essay: "Beyond Internal and External: A Taxonomy of Mechanisms for Regulating Corporate Conduct"
This week, I'm just plugging my new essay, forthcoming in the Wisconsin Law Review. It was written for the New Realism in Business Law and Economics symposium, hosted by the University of Minnesota Law School, and here is the abstract:
Corporate discourse often distinguishes between internal and external regulation of corporate behavior. The former refers to internal decisionmaking processes within corporations and the relationships between investors and corporate managers, and the latter refers to the substantive mandates and prohibitions that dictate how corporations must behave with respect to the rest of society. At the same time, most commenters would likely agree that these categories are too simplistic; relationships between investors and managers are often regulated with a view toward benefitting other stakeholders.
This Article, written for the New Realism in Business Law and Economics symposium, will seek to develop a taxonomy of tactics available to, and used by, regulators to influence corporate conduct, without regard to their nominal categorization of “external” or “internal” (or “corporate” and “non-corporate”) in order to shed light on how those categories both obscure and misdescribe the existing regulatory framework. By reframing the shareholder/stakeholder debate, we can identify underutilized avenues for encouraging prosocial, and discouraging antisocial, corporate action, and recognize areas of contradiction and incoherence in current regulatory policy. Finally, this exercise will demonstrate how corporations, far from being “privately” ordered, are in fact the product of an overarching set of choices made by state actors in the first instance.
Saturday, April 11, 2020
I first blogged about this case back when the Supreme Court’s Halliburton Co. v. Erica P. John Fund, Inc. (Halliburton II), 573 U.S. 258 (2014) decision was new, and now we finally have some answers.
In Halliburton II, the Court held that while securities class action plaintiffs get the benefit of a presumption that any material information – including false information – impacts the price of stock that trades in an efficient market, defendants may, at the class certification stage, attempt to rebut that presumption with evidence that there was no such price impact.
The complicating factor in all of this is that, per Amgen Inc. v. Connecticut Ret. Plans & Tr. Funds, 568 U.S. 455 (2013) and Erica P. John Fund v. Halliburton Co., 563 U.S. 804 (2011) (Halliburton I), defendants cannot rebut that evidence by demonstrating either a lack of materiality or a lack of loss causation. This, of course, severely ties defendants’ hands, because those are the usual proxies for price impact. (See prior blog posts for further discussion here and here and here and here.)
The Goldman case has an interesting twist, though. The basic allegation is that Goldman falsely represented that it behaved with honesty and integrity toward its clients, and its lies were revealed when the SEC filed an enforcement action alleging that Goldman’s transactions involving CDOs were riddled with undisclosed conflicts of interest. The SEC’s complaint triggered a price drop, and Goldman investors suffered as a result.
Goldman, however, argued it could rebut the presumption of price impact by demonstrating that at multiple times throughout the class period, the media reported on its conflicts, with no market reaction. Therefore, argued Goldman, it was clear that the initial lies did not impact prices, and the price drop at the end of the class period was not due to the revelation of the truth – all of which was known to the market – but simply due to the SEC’s enforcement action itself.
As I previously argued, much of this was really a disguised attempt to relitigate the materiality of the initial statements, but in a 2018 appeal, the Second Circuit remanded to the district court to give Goldman the opportunity to prove lack of price impact by a preponderance of evidence. See Ark. Teachers Ret. Sys. v. Goldman Sachs Grp., Inc., 879 F.3d 474 (2d Cir. 2018). The district court recertified the class, Goldman appealed again, and the Second Circuit’s affirmance, 2-1, issued earlier this week, engages more closely with the substance of Goldman’s argument.
Okay, that sets the stage. What actually happened here?
(More under the jump)
Saturday, April 4, 2020
One of the things that’s fascinated me about this strange time we’re living in is how it’s altered our buying habits.
For sure, some alterations were pretty predictable: more demand for work-from-home tools, computers, sanitizers, and protective gear (certainly, some people seem to have made very accurate forecasts.)
But some of the reports are less intuitive. For example, lots of people have turned to home baking – either because they have more time or because they don’t/can’t buy in stores – leading to a yeast shortage. (Except, as this Twitterer explains, you can always make your own, a philosophy that many have apparently extended to eggs).
You’ve all heard about the toilet paper shortages, but I appreciated this explanation for them.
And then, we have handy lists of the things that even in times of desperation, no one seems to want.
Saturday, March 28, 2020
We just reached the part of my M&A class where I teach The Williams Companies v. Energy Transfer Equity LP, 159 A.3d 264 (Del. 2017). It’s a difficult case – I try to explain the tax aspects which makes part of it a slog – but I do it anyway because I find both the facts and the opinions endlessly fascinating.
The basic set up is that Energy Transfer Equity (“ETE”) and The Williams Companies (“Williams”) had agreed that Williams would be acquired by ETE for a combination of cash and ETE partnership units. One condition of closing, however, was that ETE’s tax counsel at Latham would issue an opinion to the effect that the second leg of the deal should be non-taxable under IRS regulations. The Latham Tax Lawyer did not issue the opinion, ETE refused to close, and Williams sued, alleging that ETE breached the merger agreement by failing to use its best efforts to obtain the opinion. After a trial in Chancery, VC Glasscock ruled for ETE, and the Delaware Supreme Court affirmed, Strine dissenting.
So, the deal itself is complicated but it’s worth explaining. The actual transaction was to proceed in two steps. First, Williams merged into a shell company, ETC, and former Williams shareholders received 81% of ETC’s stock. ETE purchased the remaining 19% of ETC’s stock for $6.05 billion cash, which was immediately distributed to the former Williams shareholders, so now they would have cash plus an 81% interest in a company that was essentially just a reorganized version of Williams itself.
In the next step, ETC planned to sell all of the Williams assets to ETE, in exchange for ETE partnership units, leaving ETC a shell company whose only assets were ETE partnership units, 81% owned by the former Williams shareholders.
Originally, ETE’s tax counsel at Latham had opined that the transaction was not taxable, but that changed after the energy industry took a downturn. The deal suddenly became very unfavorable to ETE, and ETE was looking for an exit ramp.
At that point, ETE’s in-house tax lawyer, Whitehurst, purportedly noticed that the first leg of the transaction required ETE to pay $6.05 billion for a fixed amount of ETC stock – 19% - rather than a floating percent. This meant, thought Whitehurst, that ETE would now be massively overpaying for ETC stock given the industry downturn, and the overpayment would trigger IRS scrutiny. He conveyed his concerns to Latham, and a Latham Tax Lawyer (discreetly never identified by name in the Delaware Supreme Court opinion although he is named in Chancery) decided he could not issue the opinion, and the deal collapsed.
There’s a lot to talk about here, and first is the doubtfulness ETE’s claim that Whitehurst, experienced tax guy, suddenly just “noticed” that the deal called for a fixed rather than floating exchange rate, or that the Latham counsel just “noticed” the same.
It all starts with asking why a simple acquisition – ETE buys Williams shares in exchange for cash and equity interest in its partnership – was accomplished through such a convoluted set of maneuvers. And the reason for that is, Williams was a publicly traded corporation with a lot of mutual fund shareholders who could not hold ETE partnership units. Why? Because partnership units have a complex tax structure that mutual funds can’t handle. If ETE simply issued cash and partnership units in exchange for Williams shares, the mutual funds would have been forced to sell those units immediately, and they would have paid tax on that sale for a merger that would have otherwise had a tax-free equity component. And if Williams simply sold assets to ETE, then that sale itself would have been taxable.
So the whole point of the deal was to transfer ETE partnership units to a shell entity that was taxable as a corporation, and distribute stock in that entity to the former Williams shareholders, so that mutual funds could hold a financial interest in ETE without holding ETE directly and dealing with its tax structure, without making anything seem like an asset sale.
In other words, every single thing about this deal, down to its bones, was designed to avoid taxes.
I’m not saying that as a criticism, I’m saying that to highlight how carefully the tax aspects were integrated into the structure from the get-go, making it extremely unlikely that anyone would be “surprised” by any tax aspects of the deal without an intervening change in the law.
But there’s more.
Notice that in that first leg, Williams shareholders end up with 81% of ETC while ETE ends up with 19%. Those are very odd numbers; they suggest that someone is trying to avoid a regulatory cut-off at 80/20. And that seems to be the case; because as I understand it – and I am not a tax person so I genuinely welcome comments from anyone who understands the tax aspects better than I do – 80/20 is a common cut off needed to make deals nontaxable, according to this document drafted by – oh look, Latham.
Thus, to my uninformed eye, if it was previously doubtful, it now becomes actually incredible that Whitehurst suddenly noticed, several months in, that the deal called for a fixed rather than floating exchange rate. The fixed rate – 19% - seems to have been necessary to avoid taxes. If it was floating – if ETE acquired more of ETC as ETC’s value dropped – the deal would have been taxable in the first leg. So the fixed rate was a fundamental aspect of the deal’s design.
But that’s not actually the most interesting part of the opinion. No one believed Whitehurst was truly surprised by the fixed rather than floating structure; indeed, Glasscock was openly skeptical of Whitehurst’s testimony. But Glasscock’s view – and also the view of the Delaware Supreme Court – was that Whitehurst’s good faith or lack thereof was irrelevant. Yes, said the Delaware Supreme Court, ETE breached its covenant to use its best efforts to obtain the tax opinion, but Williams could only succeed if ETE’s breach was proximately related to the failure of the condition itself. And, whatever machinations it took to get there, the Latham Tax Lawyer acted in good faith when he said he could not issue the opinion. Therefore, ETE’s breach was not the cause of the failure. The Latham Tax Lawyer’s good faith functioned as an intervening event that broke the chain of causation from ETE’s lack of enthusiasm to the failure of the closing condition.
What’s critical, then, to both Delaware courts’ analyses, is their implicit belief that the Latham Tax Lawyer’s good faith was independent of his client’s behavior or obvious desire to escape a newly-disfavored deal.
Strine, dissenting, saw the matter differently. In his view, lawyers strive to please their clients, and their good faith on complex legal issues is therefore somewhat malleable. If ETE had used its best efforts to obtain the opinion – if it had not suggested to Latham that it wanted out of the deal, and pressured it in that direction – the Latham Tax Lawyer’s “good faith” may have led him to a different conclusion.
So what intrigues me about all of this are the fundamentally different views of law that are reflected in the majority and the dissenting opinions. The majority endorses classical legal theory: in its view, the law is a fixed point, perhaps reflected – like the shadows in the cave – in an attorney’s good faith, but still existing as a universal truth to which the lawyer aspires. As a result, despite any client bullying or cajoling, in the end, if the lawyer acts in good faith with all available facts, his or her position is immutable – it is a function of The Law itself.
Strine, however, appears to view the law itself as something either manipulable or at the very least unknowable, and thus any particular opinion is as subject to motivated reasoning as any other opinion might be. In true Legal Realist fashion, Strine’s view is that “law” is inherently indeterminate, constructed out of the policy preferences and incentives of the decisionmaker, which is why something as banal as a client’s preferred outcome will affect even the good faith judgments of the advocate.
So yeah, what I am saying is: Williams v. ETE is ultimately a battle about the nature of law itself, miniaturized in a dispute about commercially reasonable efforts to obtain a tax opinion.
Saturday, March 21, 2020
(All right, in my heart, I still believe I was right in my account of existing law, and Salzberg v. Sciabacucchi actually changed the law. But, if law is just a prediction of what judges will do, then okay, fine, yes, I was wrong.)
As you all know by now, I’ve been blogging about this case, and the issue of litigation-limiting bylaw and charter provisions, for a while, and I’ve written an article, and a book chapter, on the subject. In this post, I’ll assume the reader’s familiarity with the issue and my prior argument.
Anyway, the basic logic of the decision is illustrated by this figure from the opinion:
In other words, in the Delaware Supreme Court’s view, there are matters of internal affairs that are governed by the state of incorporation, and then there is a slightly larger category of matters that are still “intra-corporate” but not “internal affairs,” and can be governed by a corporation’s charter, and then there are truly external claims that cannot be the subject of a charter provision. Federal forum provisions for Section 11 claims, at least facially, count as intra-corporate claims because “FFPs involve a type of securities claim related to the management of litigation arising out of the Board’s disclosures to current and prospective stockholders in connection with an IPO or secondary offering. The drafting, reviewing, and filing of registration statements by a corporation and its directors is an important aspect of a corporation’s management of its business and affairs and of its relationship with its stockholders.” Op. at 11.
I’d love to do a full analysis of the decision but to be terribly honest, I’m just a wee bit distracted right now and also I found the opinion itself kind of … elliptical in its reasoning. Point being, I’ll give it a more thorough read at a later date but for now I’ve only got a series of quick points:
As I understand it, those matters that are sufficiently intracorporate to be the subject of a charter provisions, but not within the category of internal affairs, are to be determined case by case. But, per the Court’s earlier decision in ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), even provisions related to antitrust lawsuits are at least facially permissible, so it’s going to be really interesting to find out what the court does, and does not, believe can be governed by corporate charters – and even more interesting to see if any other states (hello, California) push back. I’ll note that simply as a matter of terminology, I find the logic puzzling because the court quotes its own decision in McDermott v. Lewis, 531 A.2d 206 (Del. 1987), where the phrase “intracorporate” is treated as coextensive with “internal affairs.” Op. at 37. Moreover, apparently because the court couldn’t find better precedent, in explaining how external matters would be distinguished from intracorporate-but-not-internal-affairs matters, the court cited – well, Mohsen Manesh on the definition of the internal affairs doctrine. Op. at 47-48. Suffice to say, for those of us trying to figure out what falls into this middle category of “intracorporate” matters, a definition that distinguishes only between internal affairs and external affairs is not helpful.
As Larry Hamermesh says of the decision, “I thought we were in a predictable room, but the door has opened up into very uncertain challenges and positions.”
The case largely focuses on charter provisions, even going so far as to mention charter provisions specifically in its discussion of why forum selection clauses do not violate federal policy. Op. at 45. But occasionally, the decision cites to DGCL 109, regarding the bylaw power. I … do not know how to interpret this. And this is not a minor issue: Part of the reason I have been arguing that corporate constitutive documents cannot govern “external” claims is precisely because there’s no vocabulary outside the corporate law context to discuss whether a waiver, say, of a jury right, or an agreement to pay litigation expenses, should be in bylaws, charters, or both, or subject to supermajority voting provisions, or what happens if someone has dual-class stock or is a controller, etc. We know how to answer those questions when they concern matters of corporate law; we don’t when we step outside that realm.
The opinion very much hangs the NJAG out to dry. As I previously blogged here, here, and here, Professor Hal Scott has been pushing for bylaw at J&J which would mandate arbitration of all federal securities claims, including ones brought under Section 10(b)/10b-5. J&J is chartered in New Jersey. As part of the dispute over whether the proposal could be included on J&J’s proxy under Rule 14a-8, NJ’s Attorney General argued that such provisions violate NJ law, relying on Chancery’s Sciabacucchi decision. Now, that decision has been reversed. Professor Scott’s lawsuit will go forward and New Jersey will … I don’t know.
I think? there’s a basis for distinguishing Section 11 and 10b-5 in the opinion. The court emphasizes that Section 11 necessarily involves directors (“Section 11 claims are ‘internal’ in the sense that they arise from internal corporate conduct on the part of the Board and, therefore, fall within Section 102(b)(1)”), but 10b-5 does not. The court also says that tort claims are “external,” and 10b-5 is akin to common law fraud. But, umm … then there’s the antitrust thing so I really don’t know.
Further to this, the decision opens with a description of how both Section 11 and Section 12 claims operate. Section 12, like 10(b), also does not necessarily involve directors. But the opinion doesn’t discuss whether such claims count as intracorporate, even though the forum provisions at issue in the case cover both types of claims.
So, yeah. I got nothing.
I note that since the decision permits charters to govern securities claims, there is now apparently no barrier to inserting a loser-pays provision in corporate constitutive documents for federal securities claims. After all, the DGCL only bars loser-pays for internal claims. So, Professor Bainbridge’s preferred policy may yet (mostly) prevail. Which again highlights why I think this is a problem. If a corporation adopts such a provision, Delaware will have to decide if it’s permissible, if it violates public policy, whether the provision must be in the charter or the bylaws, what to do if there are nonvoting shares, etc, and that’s just way outside of its area of expertise. What happens when a director invokes a loser-pays provision and a shareholder argues that, under the circumstances, doing so was a breach of the director’s fiduciary duty? How will Delaware make the call? The Supreme Court has not, umm, demonstrated much savvy with respect to the difference between Section 11 and Section 12 claims (or, if you read some decisions, even the difference between a Schedule 14D-9 filing and a Schedule 14A), so I’m not confident of its ability make these judgments.
The Delaware Supreme Court should maybe start boning up on PSLRA pleading standards now, is what I’m saying.
Which brings us to arbitration. At the very end of the opinion, in Footnote 169, the court mentions that even though this case only involved forum selection provisions, many commenters – and I’d fall into this category, naturally – are concerned about using charters and bylaws to force individualized arbitration of shareholder claims. The court dismisses this concern on the grounds that DGCL 115 would prohibit mandatory arbitration for internal affairs claims. The problem here is twofold: First, the court opens the door to corporations adopting arbitration provisions for federal securities claims – precisely as Prof. Scott is currently arguing – but secondly, there looms the possibility that DGCL 115 is invalid under the Federal Arbitration Act.
Now, I wrote a whole long paper explaining why I believe the Federal Arbitration Act does not apply to corporate constitutive documents, but the basis for that article is that corporations are not ordinary contracts within the meaning of the FAA. Every decision – like this one – that expands the boundaries of the corporate “contract” and applies ordinary contract law principles to define its scope not only, ahem, renders my article less relevant, but also undermines the basis for excluding corporations from FAA’s purview. This is not an abstract issue; Professor Scott’s lawsuit, for example, argues that the FAA renders arbitration bylaws valid, regardless of any New Jersey law to the contrary. Again, his lawsuit only deals with a bylaw mandating arbitration of federal claims, but there is no reason the logic would not extend to bylaws purporting to mandate arbitration of internal affairs claims.
In other words, this decision hands corporations the keys to challenging the viability of DGCL 115, and in that respect, I have a sinking fear that it signs Delaware’s death warrant.
But people have made that prediction before, so who knows.
My final observation is this: I think the contrast between the Supreme Court and Chancery decisions as a matter of corporate theory are quite striking. The Chancery decision is a fairly stark example of the concession theory of the corporation: Laster makes very clear that Delaware, as sovereign, is intimately involved in establishing corporations, designing their operations, and articulating their limits. The Supreme Court, by contrast, is a model of contracts theory; it treats the corporation as simply a private arrangement among its constituents, with few prohibitions on what that arrangement may entail. I have been thinking about designing a corporate theory seminar; if it comes to fruition, I’ll likely include excerpts of both opinions.
Saturday, March 14, 2020
For the last several weeks, Xerox has been pursuing a takeover over HP. At first, its overtures were friendly, and more recently it turned hostile (well, sort of hostile). It has put the campaign on hold in light of the pandemic – it says, because it is unsafe to travel and conduct meetings with shareholders – but before that, it filed a Schedule TO and an S-4 with the details of the offer. As relevant here, the S-4 explains that Xerox is proposing a tender offer followed by a second-step merger under DGCL 251(h). Shareholders who do not tender their shares, and thus are merged out, will receive the same consideration as shareholders who tender. Which is:
That said, Xerox plans to pay a total of $27,326,000,706 in cash. Therefore, if shareholders’ elections would result in a different figure, these elections are capped:
In other words, shareholders have a choice of whether they receive stock, cash, or a combination of both, but only up to a point; if too many shareholders select one or the other, Xerox will rebalance.
Which brings us to the right of appraisal. According to the S-4:
So, what’s the law on this? Delaware provides that public company shareholders who lose their shares in the second-step of a 251(h) merger are entitled to appraisal if they are “required by the terms of an agreement of merger or consolidation… to accept for such stock anything except” public company shares. See DGCL 262. In other words, cash consideration gets you appraisal; public company stock consideration does not. And, per Delaware caselaw, a combination of the two entitles shareholders to appraisal. See Louisiana Municipal Police Employees’ Retirement System v. Crawford, 918 A.2d 1172 (Del. Ch. 2007).
Where does Xerox’s offer fit?
On first glance, it doesn’t require anyone to accept anything; HP shareholders can choose stock, cash, or a combination of the two. Thus, according to at least once Delaware decision, appraisal should be unavailable. See Krieger v. Wesco Financial Corp., 30 A.3d 54 (Del. Ch. 2011).
But wait! Xerox contemplates that some shareholders might be required to accept cash, if it turns out that too many elect stock. We don’t know yet whether that will happen, and so Xerox is assuming that there will be appraisal rights. Which could mean that even if everyone makes the exact right election, no one is forced to accept any particular combination of cash or stock, second-step shareholders could still seek appraisal no matter what they elected, simply because of the ex ante possibility that some shareholders might have been required to accept cash. Cf. Krieger (appraisal is unavailable where “[t]he merger agreement did not contemplate proration or impose any cap on the number of shares available for individual stockholders or the class as a whole.”)
Is that the law? Maybe. Or maybe appraisal is only available if Xerox pulls the trigger and actually does force some shareholders to accept cash. Or maybe appraisal is only available to those particular shareholders who elected stock and were forced to accept cash, but not to shareholders who elected cash and received it. But cf. Krieger (“The General Corporation Law in fact makes appraisal rights available on a transactional and class-wide (or series-wide) basis. Stockholders can choose individually whether to perfect and pursue their appraisal rights, but the underlying statutory availability of appraisal rights is not a function of individual choice.”)
We don’t know!
Now, that in itself is not shocking; lots of times you have a statute and it covers some scenarios but not others and caselaw fills in the gaps. And when there’s a question of first impression, lawyers step in and use a combination of arguments based on statutory language, precedent, and policy to persuade the court to go their way.
But here’s where Delaware law fails us. As I’ve previously argued, there is no policy. The appraisal statute is a mess; there is no clear reason why Delaware permits appraisal in the first place, let alone why it distinguishes between public company stock and cash. To quote, ahem, me:
[Appraisal] can’t just be about liquidity because it applies to publicly-traded stock, it can’t just be about conflict transactions because it’s available in nonconflict transactions – even if it’s more available in 90% controller squeezeouts – and the distinction Delaware draws between receipt of cash versus receipt of publicly traded stock is incoherent. See Charles Korsmo & Minor Myers, Reforming Modern Appraisal Litigation, 41 Del. J. Corp. L. 279 (2017). It’s a Frankenstein’s monster of different impulses that act at cross-purposes.
That’s why we’ll never see agreement on how to reform the current system, and it’s also why it’s unclear how the Xerox/HP merger should be treated under existing law. One of the critical tools we use to make these kinds of predictions – a functional analysis of the purposes behind the statutory scheme – is entirely absent; it’s a crap shoot.
My point is, this is no way to run a railroad. I know Delaware has contemplated reforms to its appraisal statute and methodology but before we can see movement on that score, Delaware needs to answer the fundamental question of why we have appraisal in the first place. From that, everything else will (mostly) follow.
Saturday, March 7, 2020
On Thursday and Friday, Tulane hosted its 32nd Annual Corporate Law Institute. The CLI is a major conference focused on the latest developments in M&A and related topics, and features a variety of speakers drawn from the bench, the bar, and the SEC.
Now, obviously, it’s a tough time to host a large conference – the big question was whether we’d see cancelations – and I’m not in charge of administration so I can’t say what the final numbers were, but from what I could see, attendance looked just fine.
That said, I personally was not able to attend the whole event, but I did go to a few of the panels, and below are my notes from Hot Topics in M&A Practice and Chancellor William T. Allen and His Impact on Delaware Jurisprudence.
Saturday, February 29, 2020
I often skim through recent opinions issued in private securities class actions, just to see what the latest issues are and how courts are addressing them. So this week, I’ll talk about a few that caught my eye. As the subject line indicates, most of this discussion concerns materiality, but there are some extra issues tossed in.
And yes, this is a very long one, so behind a cut it goes: