Saturday, May 25, 2019
A couple of weeks ago, I was lucky to participate in a panel on securities litigation at George Mason University Antonin Scalia Law School, along with Professor J.W. Verret, Jonathan Richman of Proskauer Rose, Steven Toll of Cohen Milstein, moderated by Judge Michelle Childs of the District of South Carolina. We had a lively discussion about current issues concerning these actions, including what I guess is now being branded as “event-driven” litigation, definitions of materiality, and arbitration clauses in charters and bylaws.
In my opening remarks, I discussed merger litigation and the shift from state to federal courts, covering much of the territory I previously described on this blog (of course, since that post, the Supreme Court dismissed the Emulex case as improvidently granted). I also drew from research by Matthew Cain, Steven Davidoff Solomon, Jill Fisch, and Randall Thomas, presented in April at the ILEP symposium on corporate accountability. (Their research is not yet public but I will link here as soon as it becomes available).
In the meantime, if you’re interested, you can watch a video of the panel here:
The other panels from the symposium are also available for viewing at this link.
Saturday, May 18, 2019
In 2014, the Supreme Court decided Burwell v. Hobby Lobby Stores, where it held that it is possible for a for-profit corporation to have a religious identity, derived from the religious commitments of “the humans who own and control those companies.” In so holding, the Court relied in part on state laws that permit even for-profit corporations to pursue purposes beyond stockholder wealth maximization. As the Court put it:
Not all corporations that decline to organize as nonprofits do so in order to maximize profit. For example, organizations with religious and charitable aims might organize as for-profit corporations because of the potential advantages of that corporate form, such as the freedom to participate in lobbying for legislation or campaigning for political candidates who promote their religious or charitable goals. In fact, recognizing the inherent compatibility between establishing a for-profit corporation and pursuing nonprofit goals, States have increasingly adopted laws formally recognizing hybrid corporate forms. Over half of the States, for instance, now recognize the “benefit corporation,” a dual-purpose entity that seeks to achieve both a benefit for the public and a profit for its owners.
In any event, the objectives that may properly be pursued by the companies in these cases are governed by the laws of the States in which they were incorporated—Pennsylvania and Oklahoma—and the laws of those States permit for-profit corporations to pursue “any lawful purpose” or “act,” including the pursuit of profit in conformity with the owners’ religious principles.
So it was a bit of an eyebrow-raiser to read this April Executive Order in which Trump declares:
The majority of financing in the United States is conducted through its capital markets. The United States capital markets are the deepest and most liquid in the world. They benefit from decades of sound regulation grounded in disclosure of information that, under an objective standard, is material to investors and owners seeking to make sound investment decisions or to understand current and projected business. As the Supreme Court held in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), information is “material” if “there is a substantial likelihood that a reasonable shareholder would consider it important.” Furthermore, the United States capital markets have thrived under the principle that companies owe a fiduciary duty to their shareholders to strive to maximize shareholder return, consistent with the long-term growth of a company.
As readers of this blog are likely aware, academics love to argue over whether existing law requires that corporations be run solely to maximize stockholder wealth, and of course over whether such law – if it exists – is a good idea or a bad idea. See generally Joan MacLeod Heminway, Shareholder Wealth Maximization as a Function of Statutes, Decisional Law, and Organic Documents, 74 Wash. & Lee L. Rev. 939 (2017). Usually, however, these battles occur in the context of state law. And while federal law – securities regulation, and so forth – often implies a corporate purpose of wealth maximization, I have to admit, I don’t recall seeing so blatant a statement about it before.
In any event, this section of the Executive Order directs the Department of Labor to review its existing guidance re: ERISA plans’ involvement in ESG matters. It’s a follow-up to last year’s Labor Department release – which I blogged about here – warning that ERISA plans may violate their duties to plan beneficiaries if they engage on ESG matters, or vote for ESG-related proxy proposals, for reasons other than plan wealth maximization.
As I’ve previously discussed, the SEC is currently reviewing rules governing the proxy process – including the role of proxy advisory services – to determine if additional regulation is needed. Much of this fight is, of course, about shareholder involvement in ESG matters and corporate governance more generally. I assume from this latest Executive Order that we’re about to see something of a two-pronged effort to limit shareholder power, with new guidance and/or regulations issuing from the SEC on one side and the Labor Department on the other. Anyone’s guess how successful this effort is likely to be, but I will highlight Andrew Tuch’s recent article, Why Do Proxy Advisors Wield So Much Influence? Insights From U.S.-U.K. Comparative Analysis, B.U. L. Rev. (forthcoming), pointing out that proxy advisory services have far less influence in the UK than in the United States, which he attributes to the fact that US shareholders have less power, and have reached less consensus on best practices in corporate governance, than shareholders in the UK. He concludes that many of the attempts to limit shareholder power – and the power of proxy advisors – in the US will not only be ineffective, but will actually strengthen proxy advisors’ hand.
Saturday, May 11, 2019
Vanguard recently announced that it will no longer centralize proxy voting across all of its funds; instead, its externally managed funds will set their own proxy voting policies. Although these represent only around 9% of Vanguard’s assets under management, they include almost all of Vanguard’s actively managed funds and actively managed equity assets.
I haven’t really seen much explanation for the shift from Vanguard itself – its own statement on the matter is quite vague – but I suspect they may have made the change for the same reason that Fidelity separates active and passive voting authority, namely, to avoid having the active funds grouped with the passive for the purposes of Section 13(d) of the Securities Exchange Act. Fidelity’s policy is longstanding because historically, it specializes in active funds. Vanguard, by contrast, is nearly synonymous with index funds, so my guess is that it reached a point where the active assets under management were becoming a regulatory risk, especially if those funds wanted to take positions with a view toward influencing – or supporting those who influence – management. As John Morley points out, Section 13(d) limits the ability of large fund providers to take activist stances; Vanguard, I think, just opened that door a crack. (If anyone else has more info on this or a different theory, please drop a comment or otherwise let me know.)
That said, I think this is a good move. I’ve long argued that mutual funds’ practice of centralizing their voting behavior is problematic both from the perspective of fund governance and from the perspective of corporate governance. On the fund governance side, vote centralization may fail to reflect the distinct interests of individual funds. On the corporate governance side, a diversified portfolio of funds may influence managerial decisionmaking in ways that conflict with the interests of less diversified shareholders. Given the concerns these days that mutual fund companies exercise too much power over corporate behavior, decentralizing voting authority seems like the most obvious - and appropriate - solution.
Saturday, May 4, 2019
I'm basically buried in exam-grading right now, and that leads me to the perennial question of how best to design a law school exam. Up until now, I've pretty much stuck to a single format: short essays (such as issue-spotters), in-class (3-3.5 hours), limited open book (they can use assigned materials and their own notes). I'm wondering whether next year I should mix that up a bit. For instance, Securities Regulation seems especially well-suited to multiple choice, at least partially; I also wonder whether a take-home exam would allow students to craft more thoughtful answers.
So, consider this a call for commentary: Especially if you teach in the business space, what kind of exam do you find works best, and why? Joan, I know, actually gives oral midterms - which I think is amazing, but I'm not quite ready for - so of the other options, in-class or take home? Open book or closed? Multiple choice or something else? Why do you choose what you choose?
Saturday, April 27, 2019
Last year, I had the privilege of participating in ILEP's 24th Annual Symposium, Deconstructing the Regulatory State, where I served as a discussant on papers presented by Jill Fisch and Hillary Sale regarding the role of disclosure in the securities regulatory landscape. Those papers, Making Sustainability Disclosure Sustainable and Disclosure's Purpose have now been published by the Georgetown Law Journal.
Georgetown has also published my remarks on the two papers as part of their online series. The title for my commentary is Mixed Company: The Audience for Sustainability Disclosure, and there's no formal abstract, but this is the introduction:
In their symposium articles, Professors Sale and Fisch offer mirror-image visions of the role of mandated disclosure. Professor Sale addresses information that is typically relevant to an investing audience and recognizes its importance to the wider public. Professor Fisch, by contrast, addresses information that is most relevant to a noninvestor audience but only contemplates its importance to corporate financial performance. The gulf between their approaches highlights one of the significant tensions in our system of securities regulation: the distance between its intended purpose and its current function.
Close readers of this blog will recognize that my comments follow a theme that I've frequently visited in this space, namely, the need for a corporate disclosure system that is not centered on investors. I'm actually working on a much longer article on this topic where I explore these ideas in depth, but for those who are interested, the elevator-pitch version is now available at Georgetown Law Journal Online.
Monday, April 22, 2019
Co-blogger Ann Lipton has posted a number of times on Elon Musk's Twitter disclosures and their potential legal significance. I chimed in once. Unless I am mistaken, her most recent post (citing to our prior posts) on this subject is here. Based on these posts, we both seem to understand that the Twitter Era has spawned some interesting disclosure-related legal questions.
I had these posts in the back of my mind when I got an email invitation yesterday from IPO Docs, a firm that sells "Regulation D Private Placement Memorandum Templates" to check into the firm's services. I have never been a fan of online templates or form documents as drafting precedent, especially for investment disclosure documents. In general, one-size-fits-all disclosure lawyering is just too far from my practice background (which involved reverse-engineering the work of my Skadden colleagues and others). But I do tell students they should be familiar with these kinds of form/exemplar resources and that, after determining the quality and suitability of a resource for their purposes, they may want to use form documents as a cross-check for contents or phrasing.
These two examples of Internet-related disclosures (online commentary and disclosure forms) are two pieces of a larger disclosure regulation puzzle. The puzzle? How best to address challenges to disclosure regulation posed by our increased use of and reliance on the Internet. Believe me; I am a fan of the Internet. But having been engaged with disclosure regulation pre-Internet and post-Internet, I do see challenges.
Social media and blog posts or commentary, for example, raise issues about the nature of the speech and the identity of the speaker. Are tweets made by firm managers disclosures of firm information or are they private statements? Who is the person behind a social media or weblog account commenting on business affairs? (I note that Ann's September 29, 2018 post on the Musk affair reports, based on information in the SEC's complaint, that analysts "privately contacted Tesla’s head of investor relations for more information and were assured that the tweet was legit." And many may remember the dust-up--almost twelve years ago--around John Mackey's "anonymous" online posts.)
To the extent that we come to accept, from a disclosure compliance standpoint, business disclosures that are made through fractured online posts and commentary, we lose the benefits of standardization--including easy comparability--that comes from the traditional periodic and transaction-based disclosure regimes built into the Securities Act of 1933 and Securities Exchange Act of 1934. While I understand the virtues of allowing for more customized business disclosures in certain circumstances (e.g., for Form S-8 registration statements, where a summary plan description geared to benefit-holders fulfills key prospectus disclosure requirements), should we be encouraging or mandating that investors of all kinds comb the Internet to find scraps of information to enable them to get comparable data? (Of course, many investors do perform Internet searches, regardless. But mandatory disclosure documents are the core elements of compliance, and they allow for relatively direct comparisons.)
What about disclosure challenges relating to Internet-available offering documents? I admit that I have less concern here if these documents are purchased and used by a competent lawyer. But I fear that will not be the dominant scenario.
In my view, a significant peril with disclosure templates is that people using them as drafting models may not be competent or skilled in their use. Specifically, form end-users may not understand (or even consult) the legal rules relating to disclosures required to be made by a firm seeking capital under applicable federal and state securities law registration exemption(s). The interpretation and interaction of some of these rules--and the preservation of arguments and remedies if an exemption is later found to be unavailable--can be complex. It is too easy to use template text without questioning it.
Moreover, Internet forms may lull businesses into thinking they have met all attendant legal requirements relating to a financing transaction for which a form document has been purchased. In a private placement, the existence of an accurate and complete disclosure document is but one of many legal compliance issues. Private placements exempt under Regulation D have a number of moving parts, disclosure being only one.
I feel very "old school" in writing this post. What are your views on these and other issues relevant to business disclosures made on or facilitated by the Internet? As a person who has been known to describe herself as a "disclosure lawyer," I would appreciate any ideas you may have. And tell me where I am wrong in the observations I make here.
Saturday, April 20, 2019
It’s no secret to anyone paying attention to Delaware law that the Aruba decisions – both at the Chancery and Supreme Court levels – involved some apparently personal clashes, which have already been the subject of speculation from several quarters, and I can only assume there is more analysis to come.
I was going to weigh in on that as well but upon further reflection, I decided that it’s … boring. And I’d rather talk about the substance of the law, because what we’re seeing here is the inevitable breakdown in appraisal actions given that no one knows why we even have them.
As a warning, I’ll say that reading over what I wrote on this, I realize it’s probably pretty impenetrable unless you already are versed in Delaware appraisal jurisprudence. I’ve previously posted about recent developments in Delaware appraisal litigation here, here, here, and here, so that might provide some background, but otherwise - you know, read at your own risk:
[More below the jump]
Saturday, April 13, 2019
Every year, when we get to the section on shareholder voting in my Business Associations class, I assign this article about Netflix. As it describes, Netflix has a staggered board and plurality voting and it takes a two-thirds vote of the stockholders to amend the bylaws. Every year, shareholders submit proposals to change these matters; every year, a majority vote in favor, and every year, Netflix just ignores the vote and keeps on keeping on.
But now it seems there are some cracks in the wall.
Last year, Netflix went on what I can only interpret as something of a charm offensive, publicizing what it claimed was unusually strong board oversight and transparency between the board and the management team. I take this to mean that their shareholders had become sufficiently restive that the company felt it needed to respond.
But that apparently did not work as well as hoped. This year, shareholders again submitted a series of governance reform proposals, seeking the right to call meetings, proxy access, the ability to act by written consent, the ability to amend bylaws by majority vote, and a bylaw amendment that would provide for director elections by majority rather than plurality voting. All passed except the bylaw amendment, which did not reach the required two-thirds vote, but did get 57% of the vote of the outstanding shares and 72% of the voting shares.
But this time, instead of ignoring the vote, Netflix actually amended its bylaws to provide for proxy access.
It seems that even Netflix cannot resist the pressure from investors forever. And now I’ll have to give my students a different lesson.
Friday, April 5, 2019
Where we last left off in our saga, Professor Hal Scott of Harvard Law School, as trustee for the Doris Behr 2012 Irrevocable Trust, sought to introduce a shareholder proposal at Johnson & Johnson to amend the corporation’s bylaws to require arbitration of federal securities claims by any J&J stockholder, on an individual basis. (You can read a full accounting of all of this, with links, here)
J&J sought to exclude the proposal on two grounds. First, that the proposal would cause the company to violate federal law because an arbitration bylaw of this sort would act as a prohibited waiver of rights under the Exchange Act, and second, that the proposal would violate state law because – as Delaware Chancery’s decision in Sciabacucci v. Salzberg made clear – corporate bylaws and charters only govern claims pertaining to corporate internal affairs, and cannot impose limits on non-internal affairs claims, like federal securities claims. J&J was boosted in this latter effort by an opinion letter from the NJ Attorney General agreeing that NJ law would be in accordance with Delaware on this issue. In light of the NJ AG letter, the SEC granted J&J’s request for no-action relief.
Undaunted, the Trust has now filed a complaint in the District of New Jersey, alleging that J&J violated the federal securities laws by excluding the proposal, and seeking an injunction requiring that J&J circulate supplemental proxy materials before the April 25 shareholder meeting. J&J’s argument in response has mainly focused on what it claims is the Trust’s unreasonable delay in bringing the matter to court, which belies any claim of irreparable harm.
Without wading into that dispute, I want to talk a little about the Trust’s complaint and supporting briefing.
Starting with the proposal itself, it states that “The shareholders of Johnson & Johnson request the Board of Directors take all practicable steps to adopt a mandatory arbitration bylaw” governing disputes between shareholders and the company arising under the federal securities laws, and prohibits class claims or joinder. It then contains a supporting statement: “The United States is the only developed country in which stockholders of public companies can form a class and sue their own company for violations of securities laws. As a result, U.S. public companies are exposed to litigation risk that, in aggregate, can cost billions of dollars annually…”
I realize this isn’t the main issue, but I have to pause to observe that while I enjoy the United States/Canada rivalry as much as anyone, I’m not sure I’d go so far as to deny that Canada is a developed country. As a result, the proposal may run afoul of Rule 14a-8(i)(3), which prohibits proposals that contain false information. That strikes me as an alternative ground for exclusion. (I believe Japan and Australia also permit securities class actions, and the list could probably be broadened depending on how “class action” is defined).
Leaving that point aside, I have to engage in another bit of nitpicking. The complaint’s introductory statement says: “The Trust is seeking shareholder approval for a proposal that would amend Johnson & Johnson’s bylaws and require the company’s shareholders to resolve their federal securities law claims through arbitration rather than costly class-action litigation” This, of course, is inaccurate; the proposal does not amend the bylaws, but rather requests that the directors amend the bylaws. Even if it passed, the directors would be free to ignore it.
But moving on to the heart of the matter, the preliminary injunction brief has a few main arguments:
First, the Trust argues that under the Federal Arbitration Act, agreements to arbitrate federal securities claims must be enforced according to their terms. That statute provides that “[a] written provision in any … contract evidencing a transaction involving commerce to settle by arbitration a controversy thereafter arising out of such contract … shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” 9 U.S.C. § 2. Thus, it claims, it is impermissible to single out agreements to arbitrate federal securities claims and declare them unenforceable.
On this latter point, I’m inclined to agree; though there once was an argument that the securities laws themselves treat arbitration agreements and bars on class claims as an impermissible waiver of substantive rights, after American Express v. Italian Colors Restaurant, that argument has far less force.
That said, the unspoken assumption of the Trust’s argument is that a corporate bylaw constitutes an contract to arbitrate for FAA purposes, and that federal securities claims “aris[e] out of” state law corporate constitutive documents. These are both points that are very much in dispute, as I discuss in my Manufactured Consent paper.
Second, the Trust argues that a state law rule that would limit the enforceability of an arbitration bylaw is similarly preempted by the FAA.
In this case, the state law rule at issue is simply one that holds that corporate bylaws can only govern internal affairs claims – not a rule that singles out arbitration specifically. For that reason, it would seem that the FAA has little role to play, for that statute only “preempts any state rule discriminating on its face against arbitration…[and] also displaces any rule that covertly accomplishes the same objective by disfavoring contracts that (oh so coincidentally) have the defining features of arbitration agreements.” Kindred Nursing Centers v. Clark, 137 S.Ct. 1421 (2017).
The Trust has an answer to that, however: it claims that limiting the rule only to corporate bylaws and charters is itself an impermissible act of discrimination against arbitration agreements. The rule at issue here does not apply to all contracts, but only some contracts – namely, the corporate contract – and for that reason, it runs afoul of the FAA’s command that arbitration agreements may only be invalidated on the same grounds as would exist for “any contract.”
I admit, there’s some superficial textual appeal to that argument – one of the maddening aspects of this area of law is that it is impossible to tell what counts as “discrimination” against arbitration without a baseline for comparison, and that baseline can be elusive – but as I understand it, in the Trust’s reading, states have a choice: Either they can allow corporations to include arbitration agreements in their bylaws – which can then govern disputes that have nothing to do with the corporate form or the corporate constitutive documents themselves, or the laws that ordinarily govern them – or states can create a rule that all contracts formed under state law must pertain only to corporate internal affairs. That seems to me to go well-beyond a nondiscrimination principle for contracts to arbitrate, and would also seem to be in some tension with the Supreme Court’s recognition of the particular need for a choice-of-law principle unique to the corporate form, namely, the internal affairs doctrine. See CTS Corp. v. Dynamics Corp. of America, 481 U.S. 69 (1987).
Which just illustrates one of the problems with applying the FAA to corporations. The entire corporate form is structured by state law rules, from distinctions between what goes in the bylaws versus matters that must be in the charter, to how charters are amended versus how bylaws are amended, to what counts as a quorum, to who has the power to call meetings and under what circumstances, to when written consent can substitute for a shareholder vote, and so forth. If you say that rules specific to the corporate form cannot be applied to arbitration provisions, you undermine states’ ability to dictate corporate structure.
Third, the Trust argues that Sciabacucci was wrongly decided and does not in fact represent the law of Delaware – which, well, again, eventually it will be appealed and we’ll know one way or the other.
Fourth, the Trust claims that there is no reason to believe that NJ law follows Delaware law on this point. On this, I take no position, other than to note that in addition to the NJ AG’s opinion, Professor Jacob Hale Russell wrote an analysis of NJ law which is now available on SSRN.
Finally, the Trust argues that even if the proposed bylaw would be unenforceable, it still would not violate either state or federal law for J&J simply to enact it, recognizing that, if J&J chose to enforce it against a stockholder in court, the bylaw would be declared ineffective and nonbinding. Therefore, the proposal is not excludable on the grounds that it would cause J&J to violate the law.
This is also an intriguing point, which gives rise to the general question whether it would be a violation of a Board’s fiduciary duties to enact a bylaw that purported to bind stockholders, but that it knew would be unenforceable in a court of law. Would that be a misuse of the corporate machinery? Impermissibly deceptive? It would certainly seem to be beyond the scope of the Board’s powers to enact – that’s the whole basis of the Sciabacucci decision – which itself would be a violation of state law.
Anyhoo, that’s as far as my thinking takes me – but, as I said, the most immediate argument before the court right now is whether the Trust waited too long to seek a preliminary injunction, so we’ll see what happens from here.
Friday, March 29, 2019
Earlier this week, the Supreme Court issued its opinion in Lorenzo v. SEC, and the thing that strikes me the most about it is that the dissenters do more to undermine Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011), than the majority does.
I previously posted about Lorenzo here; the remainder of this post assumes you’re familiar with the problem posed by Lorenzo and its relationship to the earlier Janus decision.
[More under the jump]
Saturday, March 23, 2019
A few months ago, I read John Carreyrou’s Bad Blood: Secrets and Lies in a Silicon Valley Startup about Elizabeth Holmes and the Theranos fraud, and I was very curious to see how the same story would play out in the new documentary The Inventor: Out for Blood in Silicon Valley. (Sidebar: I am truly on the edge of my seat for the forthcoming Adam McKay adaptation starring Jennifer Lawrence – but that’s a whole ‘nother thing). In general, I preferred the book: it has far more detail, and the documentary has little new information to contribute. That said, there was power in the immediacy of actually watching Elizabeth Holmes, hearing her speak, and seeing how people reacted to her. So, below are some of my general thoughts.
Friday, March 15, 2019
Tulane just held its 31st Annual Corporate Law Institute, and though I was not able to attend the full event, I was there for part of it. Though the panels were very interesting and I took copious notes, as a matter of personal satisfaction, the single most important thing I learned is that it is pronounced Shah-bah-cookie. You’re welcome.
That said, below are some takeaways from the Hot Topics in M&A Practice panel, and to be clear, this isn’t even remotely a comprehensive account of everything interesting; it’s just stuff that I personally hadn’t heard before. (And thus, the exact contours of my ignorance are revealed.)
Saturday, March 9, 2019
I am fascinated by the eyebrow-raising speech SEC Commissioner Hester Peirce delivered to the Council of Institutional Investors (CII) earlier this week. In it, she said:
I have concerns about CII’s position with respect to the Johnson & Johnson shareholder proposal. As you know, a Johnson & Johnson shareholder submitted a proposal that, if approved, would have started the process to shift shareholder disputes with the company to mandatory arbitration…. CII also submitted a letter stating that “shareholder arbitration clauses in public company governing documents reflect a potential threat to principles of sound governance.”…
CII argues that “shareowner arbitration clauses in public company governing documents represent a potential threat to principles of sound corporate governance that balance the rights of shareowners against the responsibility of corporate managers to run the business.” Among your worries is the non-public nature of arbitration and thus the absence of a “deterrent effect.”…
The problem is that these class actions are rarely decided on the merits. Instead, the cost of litigating is so great that companies often settle to be free of the cost and hassle of the lawsuit. Settlements are rarely public and certainly involve no publication of broadly applicable legal findings. Additionally, such suits can depress shareholder value since they often result in costly payouts to make the suit go away that do not inure to the benefit of shareholders. Indeed, the cost of defending and settling these suits is a substantial cost of being a public company. The result is that the company’s shareholders are ultimately harmed by the very option intended to protect them: first by the company’s diversion of resources to defend often meritless litigation, and second by the resulting decline in the value of their shares. Case law remains untouched, and the shareholders not involved in the process have no idea what happened. A big chunk of shareholder money typically goes to nice payouts for the lawyers involved.
As I understand it, in her view, institutional investors are not capable of judging the value of securities litigation relative to arbitration, may not be aware that securities lawsuits often settle without definitive factual findings, and also may have never head the criticism that such lawsuits are expensive for companies and enriching for attorneys.
She also appears to believe that institutional investors are unable to identify the types of corporate information that contribute to their understanding of firm value. As she put it:
My concerns are mainly ones of focus. I recently had a conversation with a boy who shares an obsession with many other children his age—the video game Fortnite. He described to me how much he enjoyed long stretches of playing the game ... How is it that this simulated environment can drown out the real distractions around him? Clearly, the designers of that game and others like it have figured out how to concentrate the mind on objects of their own making....
I see a parallel in today’s investment world. Many investors these days seem focused on non-investment matters at the expense of concentration on a sound allocation of resources to their highest and best use. Real dollars are being poured into adhering to an amorphous and shifting set of virtue markers. I do not want the SEC to become an enabler of this shift in focus. … We are being asked more and more to shift securities disclosure to focus more on matters that do not go to an assessment of how effectively companies are putting investor money to work….
Institutional investors  have been a strong voice in favor of regulation that supports the incorporation of environmental, social, and governance (“ESG”) in investing. The International Organization of Securities Commissions, or “IOSCO,” issued a statement on ESG investing in January. The statement directed issuers to consider whether ESG factors—which are not defined—should be included in their disclosures, …
I found the statement to be an objectionable attempt to focus issuers’ on a favored subset of matters, as defined by private creators of ESG metrics, rather than more generally on material matters. The U.S. securities laws already provide for material disclosures. Explicit consideration of ESG factors must therefore require something more than what is already contemplated by our laws …
When the SEC is asked to concentrate on issues other than protecting investors, facilitating capital formation, and fostering fair, orderly, and efficient markets, our focus shifts away from our mission. …
Yet despite this apparently low opinion of institutional investors’ ability to identify and advocate for their own interests, she also made the claim that:
If shareholders value the ability to bring class actions, they can divert their investments to companies that offer such options. I am sure that CII’s preferences will be well-attended by issuers seeking your investment money. I trust that shareholders like you are more than capable of handling the matter without our intervention.
I have to say, if institutional investors are distracted by nonmaterial ESG factors like a child playing Fortnite, I’m not sure how they’re supposed to go about pricing arbitration provisions in a publicly traded company.
In fact, we may want to begin rolling back all of those exemptions from registration for institutional and accredited investors. The premise of Regulation D, and Rule 144A, the “testing the waters” provision, and Section 4(a)(7) is that institutions are capable of bargaining for the information they need to make intelligent investment decisions, and they do not need the paternalistic protections of mandatory securities disclosure. But if it’s true that they are ignorant even of the phenomenon of the securities nuisance settlement, I don’t have much faith in their ability to engage in the more complex task of valuing an illiquid limited partnership interest in a 10-year private equity fund. (To be fair, that’s also how institutional investors themselves see it; they’ve just asked the SEC for greater oversight of the private equity industry.)
Okay, I’m snarking, of course, but this highlights a greater tension in the law that we see both at the federal and state level: regulators like to say they’re relying on institutional investors’ own judgments and wisdom (Regulation D, Corwin, etc) right up until the moment that these investors start to advocate for things the regulator doesn’t like (ESG disclosure, hedge fund activism, reliance on proxy advisors), at which point, investors are like children: better seen and not heard. It’s a way of making substantive regulatory choices while maintaining a pretense of deference to private ordering. The greater truth, in my view, is that institutional investors themselves are a product of regulation; they couldn’t exist without it, it’s written into their bones. They are so entangled with the regulatory state that the concept of private ordering becomes meaningless; there is simply one set of regulatory choices over another.
Saturday, March 2, 2019
I’ve previously posted that judges sometimes suggest that markets are efficient to a degree that borders on the mystical.* But on the opposite end of the spectrum, it often seems as though Congress does not believe in efficient markets at all. For example, the PSLRA’s “crash damages” provision contains the implicit assumption that when negative information comes to light, it will take 90 days for the stock to appropriately internalize it. 15 U.S.C. §78u-4(e)(1). Dodd Frank requires all public companies to disclose information on their compliance with the Federal Mine Safety & Health Act (I amuse myself by highlighting for my class the “mine safety disclosure” in the Starbucks 10-K, for example), even though that information is public via other channels. (Spoiler alert: the disclosures apparently make a difference, so Congress may be right!)
These identical bills would require public companies to disclose “Data, based on voluntary self-identification, on the racial, ethnic, and gender composition of the board of directors of the issuer; nominees for the board of directors of the issuer; and the executive officers of the issuer.” The bills would also require disclosure of veteran status, and any policies for promoting diversity among boards of directors and corporate executive officers. And then, oddly, the bills would require the Commission’s Director of the Office of Minority and Women Inclusion to publish “best practices with respect to compliance with this subsection,” in consultation with a newly established advisory council of issuers and investors (I say “oddly” because – they want to publish best practices for disclosing diversity information? I’m guessing that’s not what they’re going for, but that’s how it’s drafted.)
In any event, these bills represent something of a challenge to the efficient markets hypothesis because in most (if not all) cases, the racial, gender, etc characteristics of board members, board nominees, and top officers is readily available to investors. What may not be available, of course, are policies for promoting diversity, absent a rule requiring disclosure – which it turns out, we already have, at least with respect to director nominations. See 17 CFR § 229.407(c)(2)(vi); see also Developments on Public Company Disclosures Regarding Board and Executive Diversity.
Of course, the reality is these “disclosure” rules are not about disclosure at all; they’re about substantively pressuring companies to diversify their management teams – which explains, I assume, the bit about “best practices”; the goal is to craft guidelines for best practices in hiring, not best practices in disclosure. (Relatedly, Congress has begun to express concern about diversity in finance more generally.) For this reason, it is not at all surprising that the Chamber of Commerce has firmly endorsed this legislation, viewing it (explicitly) as a less-intrusive alternative to mandated diversity requirements, such as the ones adopted by California.
And yeah, there’s nothing unusual about securities disclosure requirements functioning in this manner, it’s just that you’d usually expect those requirements to force disclosure of things investors don’t already know.
It seems to me that a much more helpful – and more radical – proposal would be to force disclosure of things investors don’t know, such as general information about diversity throughout the company (a proposal made most recently by Jamillah Williams). This kind of data is usually confidential, though it is reported to the EEOC. Interested parties can request it via FOIA for firms that contract with the government, and companies like Oracle and Palantir have fought fierce – and ultimately losing – battles to keep it secret, ostensibly because diversity data is a “trade secret,” but more likely because the true numbers are embarrassing. That’s information that is much more likely to enlighten.
*a critique, among others, that I elaborate upon in my forthcoming essay, Fact or Fiction: Flawed Approaches to Evaluating Market Behavior in Securities Litigation
Monday, February 25, 2019
A bunch of us sensed that it was coming. I raised the question in an October 8, 2018 post here. Now, it has actually happened.
Tesla Chief Executive Officer Elon Musk has finally caught the negative attention of the U.S. Securities and Exchange Commission (SEC) with yet another of his reckless tweets. The WaPo reported earlier tonight that "[t]he Securities and Exchange Commission . . . asked a federal judge to hold Tesla CEO Elon Musk in contempt for violating the terms of a recent settlement agreement . . . ." That settlement agreement, as readers will recall, relates to SEC allegations that Musk lied to investors when he posted on Twitter that he had secured the funding needed to take Tesla private. The settlement agreement provides for the review and pre-approval of Musk's market-moving public statements.
Ann Lipton and I, as BLPB's resident fraud mongers, have been following the Musk affaire de Twitter for a number of months now. (See, e.g., here, here, and here.) Based on our prior posts, it seems clear the world was destined for this moment--a moment in which the SEC not only catches Musk in a tweeted misstatement but also can prove that the tweet was not pre-approved, as required under the terms of the settlement agreement. The WaPo article notes evidence that breaches of the agreement may be the rule rather than the exception. (Why does that not surprise me?)
Let's see where this goes next . . . .
Saturday, February 23, 2019
I had a great time reading Guhan Subramanian & Annie Zhao’s new paper, Go-Shops Revisited. It follows up on Prof. Subramanian’s earlier study of their effects, Go-Shops vs. No-Shops in Private Equity Deals: Evidence & Implications, 63 Bus. Law. 729 (2008). In the original study, Prof. Subramanian found that go-shops generally had beneficial effects for target companies: bidders would pay a little bit more for the privilege of something like exclusivity in the original negotiations, and not infrequently, a superior proposal would materialize during the go-shop period. But in the new paper, the authors conclude that go-shops are no longer an effective tool for price discovery, in large part because changes in their design make it much less likely that a superior proposal will emerge.
There are a lot of interesting observations in the new paper, with the basic point being that deal attorneys – aware that Delaware courts focus a lot on things like the size of termination fees – instead manipulate aspects of the go-shop that tend to escape judicial notice, and that collectively function to make go-shops less effective. One particular point that stood out: The authors note that PE firms have changed how they compensate CEOs who remain with the company after the buyout. Today, they pay based on whether the firm achieves certain multiples of invested capital, a metric that CEOs might view as functionally guaranteeing them a healthy payout, and one that incentivizes them to keep the deal price as low as possible. (The authors contrast with earlier IRR-based payouts, which were so difficult to achieve as to render compensation speculative). And even if the CEO does not negotiate compensation with the PE firm until after a deal price is reached, the CEO will know the PE firm’s practices and past history. The authors got a kind of amazing quote from an unnamed PE investor who said his firm tries to “corrupt” management; the multiple-of-invested-capital compensation structure, argue the authors, contributes to that corruption.
Point being, there are a lot of wonderful nuggets in the paper, and I highly recommend it.
Saturday, February 16, 2019
Where we left things, Delaware Vice Chancellor Laster had just ruled in Sciabacucci v. Salzberg that Delaware corporate charters and bylaws may only govern matters of corporate internal affairs, including litigation related to internal affairs; they may not be used to govern external matters like securities litigation. For that reason, forum-selection provisions purporting to require that Section 11 claims be filed in federal court were invalid. The implication – though not part of his holding – was that a similar result would obtain for charter and bylaw provisions that purport to require individualized arbitration of securities claims.
After that, the defendants, predictably, appealed to the Delaware Supreme Court, and we were all waiting (im)patiently to see how that would unfold when – alas! – a panel consisting of Strine, Vaughn, and Seitz dismissed the appeal as prematurely filed due to a pending attorneys’ fee petition in Chancery.
Speaking as someone who once did in fact have to litigate the issue of whether a notice of appeal was prematurely filed, thus depriving the appellate court of jurisdiction, all I can say is – oof! Then again, in my case, the matter wasn’t raised until it was too late to file a corrected notice; if we’d lost, the entire appeal would have been lost. Happily for the Sciabacucci defendants, their situation is not nearly as dire; presumably they’ll just refile their notice once the fee petition is addressed. But it does mean it will be a little while longer before the Delaware Supreme Court weighs in on this issue.
But that’s not all!
Hal Scott, a law professor at Harvard, has long been an advocate for using corporate charters and bylaws to mandate individualized arbitration of federal securities claims, and in November, he submitted a 14a-8 proposal to Johnson & Johnson to have shareholders vote to request that its Board adopt such a bylaw.
In the past, the SEC has taken the position that bylaws of this sort would violate federal law, specifically, the anti-waiver provisions of the securities laws, but the Supreme Court’s recent jurisprudence on arbitration has weakened that argument. Professor Scott presumably figured the time was ripe to try again, especially since SEC Commissioners have been making noises about being more receptive to the idea. And indeed, when J&J first submitted a request for no-action relief to the SEC, its grounds for exclusion was simply that the proposal would violate federal law.
(You can find the correspondence at this link.)
But then Sciabacucci happened. Except, J&J is incorporated in New Jersey, not Delaware, raising the question whether the Sciabacucci decision would travel. (I previously posted about New Jersey’s law back when they amended their corporate code to permit forum selection provisions.)
J&J quickly submitted an attorney opinion letter expressing the view that NJ law maps to that of Delaware, and therefore the proposal was excludable as violative of state law. Professor Scott shot back with the argument that Sciabacucci was incorrectly decided (previewing, I assume, arguments we can expect to see in the Delaware Supreme Court).
And then J&J brought in a ringer: It submitted a letter by New Jersey’s Attorney General opining that Sciabacucci represents the law of New Jersey.
(There were some other documents submitted as well, not all of which are included with the No-Action materials on the SEC’s website - which raises a procedural question, btw, why some and not others? For example, NASAA submitted its own letter in support of J&J, and so did the Council of Institutional Investors.)
Since no-action relief is typically granted when there “appears to be some basis” for the company’s view that the proposal is excludable under 14a-8, you would think that that J&J had by now gone above and beyond.
But you would be wrong.
Because while the SEC did grant the no-action request, it did so with, shall we say, a reluctant air. The SEC’s letter said:
When parties in a rule 14a-8(i)(2) matter have differing views about the application of state law, we consider authoritative views expressed by state officials. Here, the Attorney General of the State of New Jersey, the state’s chief legal officer, wrote a letter to the Division stating that “the Proposal, if adopted, would cause Johnson & Johnson to violate New Jersey state law.” We view this submission as a legally authoritative statement that we are not in a position to question. In light of the submissions before us, including in particular the opinion of the Attorney General of the State of New Jersey that implementation of the Proposal would cause the Company to violate state law, we will not recommend enforcement action to the Commission if the Company omits the Proposal from its proxy materials in reliance on rule 14a-8(i)(2). To conclude otherwise would put the Company in a position of taking actions that the chief legal officer of its state of incorporation has determined to be illegal. In granting the no-action request, the staff is recognizing the legal authority of the Attorney General of the State of New Jersey; it is not expressing its own view on the correct interpretation of New Jersey law. The staff is not “approving” or “disapproving” the substance of the Proposal or opining on the legality of it. Parties could seek a more definitive determination from a court of competent jurisdiction.
We are also not expressing a view as to whether the Proposal, if implemented, would cause the Company to violate federal law. Chairman Clayton has stated that questions regarding the federal legality or regulatory implications of mandatory arbitration provisions relating to claims arising under the federal securities laws should be addressed by the Commission in a measured and deliberative manner.
That’s a lot of words! I mean, literally, it’s a lot of words, considering that usually no-action relief is granted in a short paragraph.
And it didn’t stop there. SEC Chair Jay Clayton actually issued a statement on the matter, reiterating the importance of the Attorney General’s letter in the Commission’s decisionmaking, and emphasizing that the SEC itself was taking no position on the question whether such provisions violate federal law. If anything, the statement went out of its way to signal that the SEC’s views on the federal legality of arbitration provisions have shifted; as Clayton put it, “Since 2012, when this issue was last presented to staff in the Division of Corporation Finance in the context of a shareholder proposal, federal case law regarding mandatory arbitration has continued to evolve.”
Such action is quite extraordinary as a matter of SEC procedure, especially the part where Clayton came close to inviting Professor Scott or a similarly-minded proponent to take the issue to court:
More generally, it is important to note that the staff’s Rule 14a-8 no-action responses reflect only informal views of the staff regarding whether it is appropriate for the Commission to take enforcement action. The views expressed in these responses are not binding on the Commission or other parties, and do not and cannot definitively adjudicate the merits of a company’s position with respect to the legality of a shareholder proposal. A court is a more appropriate venue to seek a binding determination of whether a shareholder proposal can be excluded.
It’s not clear where things go from here; the most obvious possibility would be to wait for the Delaware appeal (now, ahem, delayed) to shake out and/or find a state willing to break with Delaware on this issue (which then, I previously argued, might potentially tee up some constitutional questions about the scope of the internal affairs doctrine, though I think it also would depend a lot on how a case was brought.)
But according to news reports, Professor Scott may continue to pursue the matter at J&J, possibly by appealing to the full Commission (which seems unlikely to succeed, since we know where Clayton stands, and even Commissioner Peirce has said state law determines whether these bylaws are permissible).
Either way, I’m sure I’ll be blogging about it, so watch this space.
Update: Prof. Scott did, in fact, request that CorpFin seek full Commission review of J&J’s request for no-action relief, arguing, among other things, that the New Jersey Attorney General conceded that there was no settled law in New Jersey on the issue and therefore his letter should not be taken as an authoritative interpretation of state law. Prof. Scott also argued (as he did in his original correspondence) that if New Jersey law does prohibit his proposed bylaw, the Federal Arbitration Act would preempt it (an argument that I find quite unpersuasive, since the FAA only prohibits laws that disparately target arbitration; a rule that restricts charters and bylaws to matters of internal affairs does not single out arbitration, as the Sciabacucci case itself demonstrates). In a letter signed by the Director of CorpFin, the Division denied the request on the ground that, in light of the Attorney General’s letter, the issues presented were not “novel or highly complex” and therefore did not meet the standard for Commission resolution. Correspondence available here.
Saturday, February 9, 2019
I’ve previously blogged about the battle to muzzle proxy advisor services with new regulations, including posting a summary of the SEC’s roundtable on the subject, a discussion of the (lack of) existing regulation, comments on the SEC’s withdrawal of two no-action letters concerning the use of such services.
This week, we have a bit of new news. First, the SEC announced that Commisioner Elad Roisman will be spearheading efforts in this area. That matters because, as I previously observed, Commissioner Roisman seems particularly sympathetic to the idea that firms should have an opportunity to review and comment and/or correct proxy advisor recommendations. So I’m guessing that’s something the SEC is going to propose.
Second, NASDAQ, Inc. – along with many other public companies (not all of which are NASDAQ companies, btw) – submitted a letter to the SEC requesting various changes to the proxy rules, including more regulation of proxy advisors. And the first thing I’ll note about the NASDAQ letter is that it’s nine pages long – 1.5 pages of text, and the rest is just a list of signatories.
I also notice that NASDAQ’s proposals are quite similar to those that were included in the Republican Financial Choice Act, which passed the House in 2017. And it seems to me that, if adopted, they would pose a real threat to how proxy advisors function.
Among other things, NASDAQ claims it wants a process for companies to dispute “inaccurate” proxy recommendations, except it makes clear that it’s not just objecting to factual errors, but advisor opinions that the issuer feels are wrong. As NASDAQ puts it, “The SEC should require transparent processes and practices that allow ALL public companies, regardless of their market capitalization, to engage with proxy advisory firms on matters of mistakes, misstatements of fact and other significant disputes.” (emphasis added).
What NASDAQ is referencing here is the fact that ISS does send previews of its reports to the S&P 500, but not other companies. (Glass Lewis makes factual data, but not the analysis, available to all issuers in advance). I’m not sure I have much of an opinion on whether the reports should be distributed in advance to issuers, but if proxy advisors are required by law to resolve any disputes or even just entertain those disputes before distributing the report to clients – even disputes that are not about factual data but about substantive analysis – that could inhibit their efforts to make timely and unbiased recommendations to clients.
As I said above, this is also the proposal likely to gain the most traction with Commissioner Roisman, so we’ll see how things unfold.
NASDAQ also wants proxy advisor services to make its recommendation policies public, and go through a formal notice and comment system to change those policies. Obviously, this would not only inhibit proxy advisors’ flexibility, but would force them to reveal what may very well be trade secrets, thus potentially undermining their business models (a point John Coates made in his testimony before Congress).
Finally, I note that NASDAQ is also asking the SEC to repeal the NOBO/OBO rules so that companies have direct access to information about shareholder identity. I didn’t even know that was something that was on the table, and I rather suspect that was thrown in as a Hail Mary, as I gather there would be a lot of objection from institutional investors.
So, that’s the general scoop, and I have to say that while I’m not surprised to see a lot of issuers take these positions, I'm a little surprised to see them coming from NASDAQ itself; given its ownership of the NASDAQ exchange, I’d have thought it would be a little more circumspect. Is there a political economy story I’m missing, possibly some kind of competitive pressure for listings that’s playing a role here? Or am I overthinking it?
Saturday, February 2, 2019
It’s a crazy time for me right now, so this week I just offer five feature articles that I read last year, each of which did a business-related deep dive that, for one reason or another, had my jaw-dropping (and in more than one case, had me laughing out loud).
Josh Dzieza, Prime and Punishment: Dirty Dealing in the $175 Billion Amazon Marketplace. On the dirty tricks sellers use to sabotage their rivals and the quasi-court system Amazon has created to handle complaints. Compare, by the way, to Molly Roberts on Facebook’s proposal for its own Facebook court.
Taffy Brodesser-Akner, How Goop’s Haters Made Gwyneth Paltrow’s Company Worth $250 Million. One of the things that struck me here was where the author points out that women’s health concerns are often dismissed by doctors, which might drive them to seek help from nontraditional sources. I’ve heard a similar explanation for the anti-vaxx movement – pregnant women are objectified and ignored by the medical establishment, which drives them to reclaim some kind of agency by rejecting that establishment entirely.
Elizabeth Evitts Dickinson, A Dress for Everyone: Claire McCardell took on the fashion industry — and revolutionized what women wear. I know nothing about fashion but I still came away from this piece amazed that I’d never heard of Claire McCardell. It’s a wonderful deconstruction of the political dimensions to clothing. (For more on that, try The Politics of Pockets)
Zachary Mider, Zeke Faux, David Ingold & Dimitrios Pogkas, Sign Here to Lose Everything. This is actually a series of articles about abuse of New York’s “confessions of judgment,” and it’s prompted various political responses.
Saturday, January 26, 2019
Like everyone else, it seems, I decided to watch the dueling Fyre festival documentaries on Hulu and Netflix. (If you don’t know what I’m talking about, read this.) At first, I had moral qualms about it because they’re each a bit skeevy, in their own way: the Hulu one paid Fyre’s organizer, Billy McFarland, to sit for an interview – so he profits from it – and the Netflix one was produced by the same media team that promoted the Fyre festival.
Then I reminded myself that I don’t, ahem, actually pay for Netflix or Hulu, and I felt much better.
I’ve read a lot of reviews of the two films and most of them seem to prefer Hulu’s. I myself prefer Netflix’s. The Hulu documentary was a lot lighter on the specifics of how the disaster unfolded, and a lot heavier on trying to make a broad claim about “millennials” being in thrall to social media and influencers, a claim that I found facile.
My interest was more in the technicalities of how this kind of massive fraud is perpetuated, how people go along with it, and that’s what Netflix’s documentary is about. We get a lot of interviews with people who were involved with the project – including the residents of the Bahamian island where the festival occurred – and we get a clearer picture of what happened.
[More under the cut]