Saturday, January 16, 2021

Corporations and Contracts: Continuing to Beat this Drum

I’ve previously lamented the blurring of the lines of corporate and contract law, usually arising in the context of forum selection provisions in bylaws or charters that are treated as indistinguishable from ordinary contracts.  My most recent post on this concerned the dismissal of a Section 11 case against Uber; shortly thereafter, another California court dismissed claims against Dropbox, in a decision which I may or may not discuss in more detail at a later date.

As Kyle Wagner Compton, author of the invaluable Chancery Daily, recently brought to my attention, in Mack v. Rev Worldwide, VC Zurn went in the opposite direction.  The plaintiff, John Mack (yes, that John Mack) argued that he was not bound to the forum selection clauses contained in certain Notes that he held because he had not assented to them.  Zurn held that he had agreed to provisions that allowed the Notes to be amended by a vote of a majority of the noteholders, and he was thus bound by clauses added through that process.  On that holding I express no opinion.  What does grab me, however, is that Zurn supported this decision by reference to the forum selection bylaw cases, including Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), finding them to be an appropriate analogy.

Except, as I keep pointing out, Boilermakers rested explicitly on the statutory scheme that details the conditions and limits on directors’ power to adopt bylaws, including directors’ fiduciary obligations.  See id. at 954, 956, 959.  That’s very different from a contractual agreement that details the mechanisms by which the contract can be amended.  And though Zurn did acknowledge that her analogy was not perfect, it represents a further erosion of judicial recognition of the differences between the two regimes.

Anyway, at least I’m not the only one concerned about this; here’s Mandatory Arbitration and the Boundaries of Corporate Law, by Asaf Raz, with further discussion of the distinction between the corporate legal framework and the contractual one.

January 16, 2021 in Ann Lipton | Permalink | Comments (0)

Saturday, January 9, 2021

Bad for Business

The past few days, I’ve been thinking a lot about the classic case of AP Smith Manufacturing Co. v. Barlow, 98 A.2d 581 (N.J. 1953).

Though it is often invoked as emblematic of the “stakeholder” theory of the corporation, large portions of Barlow read more like a particularly vigorous application of the business judgment rule.  So long as corporate altruism could conceivably benefit the corporation, it will not be second-guessed.  Thus, Barlow held that corporate donations to Princeton University were permissible because, among other things:

[Corporations] now recognize that we are faced with other, though nonetheless vicious, threats from abroad which must be withstood without impairing the vigor of our democratic institutions at home and that otherwise victory will be pyrrhic indeed. More and more they have come to recognize that their salvation rests upon sound economic and social environment which in turn rests in no insignificant part upon free and vigorous nongovernmental institutions of learning….[S]uch expenditures may likewise readily be justified as being for the benefit of the corporation; indeed, if need be the matter may be viewed strictly in terms of actual survival of the corporation in a free enterprise system….

[T]here is now widespread belief throughout the nation that free and vigorous non-governmental institutions of learning are vital to our democracy and the system of free enterprise and that withdrawal of corporate authority to make such contributions within reasonable limits would seriously threaten their continuance. Corporations have come to recognize this and with their enlightenment have sought in varying measures…to insure and strengthen the society which gives them existence and the means of aiding themselves and their fellow citizens. Clearly then, the appellants, as individual stockholders whose private interests rest entirely upon the well-being of the plaintiff corporation, ought not be permitted to close their eyes to present-day realities and thwart the long-visioned corporate action in recognizing and voluntarily discharging its high obligations as a constituent of our modern social structure.

Once you get past the anti-Communist rhetoric of the era, the point here is that corporations fundamentally rely on the stability of the nations in which they operate.  Civil unrest, weak legal institutions, are bad for business.  Or, as Matt Levine put it a few years ago:

If the president can, without consulting the courts or Congress, banish U.S. lawful permanent residents, then he can do anything. If there is no rule of law for some people, there is no rule of law for anyone. The reason the U.S. is a good place to do business is that, for the last 228 years, it has built a firm foundation on the rule of law. It almost undid that in a weekend. That’s bad for business.

So it isn’t surprising that business leaders have offered some forceful condemnation of recent efforts by some Republicans to subvert the results of the presidential election.  Before January 6, the US Chamber of Commerce stated, “Efforts by some members of Congress to disregard certified election results in an effort to change the election outcome or to try a make a long-term political point undermines our democracy and the rule of law and will only result in further division across our nation.”  Other business leaders signed a statement to the same effect.

After the President of the United States incited an attack on Congress in hopes of overturning election results, the Business Roundtable stated that “elected officials’ perpetuation of the fiction of a fraudulent 2020 presidential election is not only reprehensible, but also a danger to our democracy, our society and our economy.”  The National Association of Manufacturers called for Vice Pence and the Cabinet to invoke the 25th Amendment and remove Trump from office, and the President of the American Petroleum Institute was quoted in the Washington Post saying that Trump was “unworthy of the office of being president.”

Beyond mere rhetoric, there’s been chatter about withholding campaign contributions from politicians who continue to provoke political instability.  According to a director of Merck and Morgan Stanley, “Respect for the rule of law underlies our market economy.”

To be sure, there is some question as to how committed business leaders will remain to this stance.  Business leaders have supported Trump throughout his presidency, distancing themselves during controversies only to re-embrace him when he cut taxes or regulations

In a time when we debate whether corporations suffer from a “short-term” bias, trading social stability for favorable regulatory treatment may the ultimate expression of short-term thinking. Or, as David Gelles wrote in the New York Times, “[M]oney has a short memory.”

Meanwhile, Axe Body Spray would simply like to be removed from this narrative.


January 9, 2021 in Ann Lipton | Permalink | Comments (2)

Saturday, January 2, 2021

Dependence, Control, and ViacomCBS

I’ve previously written about Shari Redstone and the controversies surrounding Viacom and CBS; this week, VC Slights kindly gave me something new to blog about when he denied defendants’ motion to dismiss shareholder claims associated with the Viacom/CBS merger.

The CliffsNotes version is that due to a dual-class voting structure, Shari Redstone was the controlling shareholder of CBS and Viacom, and for several years fought to combine the two companies.  Her dreams were finally realized in 2019 when the two merged in a stock-for-stock deal.  Former Viacom shareholders sued, alleging that this was a transaction in which a controlling stockholder – Redstone – stood on both sides, and that the deal sold out the Viacom shareholders to benefit CBS and Redstone. 

Normally, of course, deals in which a controlling stockholder has an interest are subject to entire fairness scrutiny unless they are cleansed in the manner prescribed by Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014).  Notwithstanding the failure to employ those protections here, the defendants creatively claimed that business judgment review was appropriate – and moved to dismiss on that basis – arguing that mere presence on both sides does not trigger heightened scrutiny; instead, plaintiffs must additionally show that the controller received a nonratable benefit, which did not happen in the CBS/Viacom merger.

To me, that’s kind of redundant; by definition, standing on both sides of a transaction means that the controller received something not available to the minority stockholders.  In this case, Redstone was able to trade her CBS stock for shares in the combined entity – a benefit that Viacom stockholders did not share.  (Well, okay, probably some Viacom stockholders did, but that’s a whole ‘nother issue I’ve talked about pretty endlessly).   

VC Slights, however, was unsatisfied with leaving things there, perhaps because it begs the question why Redstone would have favored CBS over Viacom in the exchange ratio.  And the answer to that, according to the plaintiffs, was because Redstone wanted Robert Bakish at Viacom to head the combined entity, and a favorable-to-CBS exchange ratio was the price that the CBS board demanded for installing him.  Normally, it might be reasonable to trade merger consideration for a particular governance arrangement, so plaintiffs further argued that this arrangement was unfair to the Viacom stockholders because Bakish wasn’t worth the price.  Redstone wanted him in place for personal reasons (to cement her control by installing an ally).

In any event, all of this left Slights with the question whether (1) standing on both sides is enough to trigger fairness scrutiny absent a nonratable benefit to the controller, and (2) if not, did plaintiffs allege enough of one?

His answers, respectively, were (1) to reserve judgment and (2) yes.

What’s interesting here?

First, though Slights chose not to decide whether entire fairness must always apply when a controller stands on both sides, in discussing the question, he had something of an intriguing footnote.  He wrote:

I note that Viacom and CBS’s dual-class structures, whereby NAI possessed more than 80% of the voting power but faced only 10% of the economic risk in both companies, commends Plaintiffs’ “mere presence” argument for careful consideration in this case. See David T. White, Delaware’s Role in Handling the Rise of Dual-, Multi-, and Zero-Class Voting Structures, 45 Del. J. Corp. L. 141, 153–54 (2020) (positing that in dual-class structures, “the owners of the majority voting rights in these companies are less concerned when riskier moves fail as compared to their counterparts at ‘one share-one vote’ corporations”); Lucian A. Bebchuk & Kobi Kastiel, The Perils of Small-Minority Controllers, 107 Geo. L.J. 1453, 1466 (2019) (observing that “small-minority controllers are insulated from market disciplinary forces [in dual-class companies] and thus lack incentives generated by the threat of replacement, which would mitigate the risk that they will act in ways that are contrary to the interests of other public investors”); id. (“[D]ualclass structures with small-minority controllers generate significant governance risks because they feature a unique absence of incentive alignment.”).

As we all know, dual class share structures are increasingly popular, and concerns have been raised that they present a challenge to Delaware corporate doctrine, which assumes that stockholders have economic incentives proportional to their interests and that a functioning market for corporate control justifies a deferential judicial stance.  I could of course be overreading the footnote, but to me it suggests a hint of a step toward Delaware developing differential scrutiny for disputes involving dual-class shares, especially since the Note he cites by David White argues precisely that the business judgment rule is inapposite in dual-class cases.

Second, after concluding that Redstone’s personal interest in consolidating her control was a sufficient nonratable benefit justifying entire fairness scrutiny, he further held that plaintiffs had stated a claim against the controller for breach of fiduciary duty.  But that left the question whether plaintiffs had also stated a claim against the directors on Viacom’s special committee for breaching their duties by, essentially, bowing to Redstone’s demands.

Now the interesting thing here is that plaintiffs did not allege that the Viacom directors were interested in the transaction themselves; the entire basis for the allegations of disloyalty arose from their obedience to Redstone.

Thus the question: Assuming plaintiffs have alleged facts to suggest a transaction was unfair due to a conflict, can they state a non-exculpated claim for breach of fiduciary duty against disinterested directors who were involved with that transaction, solely due to their dependence on the person with the conflict?

To answer that question, Slights quoted In re Cornerstone Therapeutics, Inc. Stockholder Litigation, 115 A.3d 1173 (Del. 2015):

To state “a non-exculpated claim for breach of fiduciary duty against an independent director protected by an exculpatory charter provision,” Plaintiffs must allege “facts supporting a rational inference that the director harbored self-interest adverse to the stockholders’ interests, acted to advance the self-interest of an interested party from whom they could not be presumed to act independently, or acted in bad faith.”

Cornerstone did say that, ‘tis true, but it still begs the question whether mere lack of independence is enough, or whether something more is required.  (VC Glasscock asked that question in connection with a dispute over Oracle’s acquisition of NetSuite, and sought additional briefing on the matter.  Which was never filed; the plaintiffs voluntarily dismissed their claims against the relevant defendants.)

Because here’s the thing.  There’s dependence, and there’s dependence.  There’s director dependence that comes from essentially agreeing to work for the controller rather than to work for the corporation, and there’s director dependence that comes from, you know, being unconsciously biased to favor a friend.  That’s particularly true today, since Leo Strine worked so hard to expand the concept of director dependence to include “mutual affiliations” that would make it “difficult to assess [a person’s] conduct without pondering his own association with [that person],” In re Oracle Corp Deriv. Litig., 824 A.2d 917 (Del. Ch. 2003), and “relationships [that] give rise to human motivations compromising the participants’ ability to act impartially toward each other,” Sandys v. Pincus, 152 A.3d 124 (Del. 2016).  Acquiescing to a controller’s demands comes very close to a “conscious disregard” for the director’s duties, or an intent to “act[] with a purpose other than that of advancing the best interests of the corporation.” Stone v. Ritter, 911 A.2d 362 (Del. 2006).  Simple lack of objectivity, though, is much more like a good faith failure to recognize the flaws in one’s own judgment.

Which is why it is not obvious that there’s a blanket rule that dependence, alone, states a claim for disloyalty. 

That said, Slights elided this issue, which he could do successfully because, although he framed his analysis in terms of director “dependence,” he actually found that plaintiffs had alleged a more serious kind of dependence – a “controlled mindset,” whereby they simply worked to advance Redstone’s goals.  And that, coupled with other allegations about their relationship to Redstone, was enough to “plead reasonably conceivable breaches of the duty of loyalty.”

Third, the final interesting data point in Slights’s examination of director independence had to do with the legal significance of the directors’ fear that Redstone would fire them if they failed to do her bidding.  Now, the doctrine is sort of confused when it comes to directors’ fear of being removed by a controller – in the context of derivative lawsuits, it’s not grounds for a finding of dependence unless the directors have a personal need to remain on the job; in the context of cleansing a controller conflict, we assume generally that directors fear removal

Here, though, the question was whether fear of removal was enough to create dependence such that it suggested disloyalty on the directors’ part – which is a whole ‘nother question (one which, I would think, might actually raise the bar for a finding of dependence).  And to answer that, Slights said that while he would not generally assume directors are dependent simply because they serve at the pleasure of the controller, it was not necessary for the plaintiffs to allege that these directors had an especial need for their positions in light of Redstone’s specific history of threatening to remove board members at Viacom and CBS who bucked her authority.  The fact that they labored under that realized threat created an inference of dependence.

So takeaway here?  The definition of dependence and its legal significance shifts across contexts – and depending on how the dual-class case law shapes up, the same may turn out to be true of control.

January 2, 2021 in Ann Lipton | Permalink | Comments (2)

Saturday, December 26, 2020

The I in We

I am fascinated by Chancellor Bouchard’s opinions in the WeWork dispute, available here and here.

The backstory: In the wake of WeWork’s collapsed IPO, SoftBank – which was one of WeWork’s significant investors – agreed to buy additional equity from the company, to complete a tender offer for a large amount of WeWork’s outstanding equity, and to lend WeWork $5.05 billion.  It ended up buying the equity and the debt, but the tender offer fell through.  At that point, WeWork – on the authority of the 2-person Special Committee who had negotiated the SoftBank deal – filed suit against SoftBank for breaching its obligations under the contract.  The Board of WeWork – by then consisting of 8 people: the 2 members of the Special Committee, 4 others designated by and obligated to Softbank, and 2 more with SoftBank affiliations – appointed two new, ostensibly independent directors to serve as a new committee to investigate the litigation.  One of the Special Committee members objected to the appointment; the other abstained from the vote.

The new committee was charged with determining whether the Special Committee had authority to sue SoftBank.  To the utter shock of absolutely no one, they concluded that, in fact, the Special Committee had no such authority, that the Special Committee could not continue the lawsuit due to certain conflicts, and that in any event continuing the lawsuit was not in the best interests of the company.  Critically, one of the conclusions that the new committee reached was that WeWork – the company – had little to gain from the litigation because it was the tendering stockholders, and not the company, who would benefit from the completion of SoftBank’s tender offer.  Thus, the new committee sought to terminate the litigation. Bouchard was therefore confronted with warring committees, and had to decide whether the litigation against SoftBank would continue.

Probably the least interesting aspect of Bouchard’s decision was his determination that the test of Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981) – originally developed to determine the propriety of allowing a special committee to terminate derivative litigation – would be used to evaluate the new committee’s decision here.  That test requires that the court evaluate whether the new committee was independent acted in good faith, and conducted a reasonable investigation of the issues.  Assuming it did so, the court must evaluate whether in its own “business judgment” the motion to terminate the litigation should be granted.

Here, Bouchard held that assuming the new committee was independent and acted in good faith, its investigation was not reasonable, because it ignored several facts that suggested the Special Committee had the authority to litigate against SoftBank and did not properly weigh the benefits against the burdens of completing the litigation.  Bouchard also held that under Zapata’s second prong, in his judgment, the litigation should continue.  Thus, he refused to allow the new committee to terminate the lawsuit.

In a companion opinion, he evaluated SoftBank’s motion to dismiss the WeWork/Special Committee complaint against it.  Among other things, he held that WeWork had standing to sue over the failed tender offer, even though – as the new committee had also emphasized – the proceeds of the tender offer would go to tendering stockholders and not to the company itself.

What stands out here?

First, though Bouchard said he had “no reason to doubt” the good faith and independence of the new committee, I am not operating under such constraints.  The 2-man committee was appointed for a two month term, for which each was paid $250K, and the expected outcome of their investigation was undoubtedly known to each of them.  As Bouchard pointed out, they acted under significant constraints: not only were they on a clock, their limited mandate meant they could not, for example, take control of the litigation themselves and thus eliminate any purported conflicts under which the Special Committee acted.  Truly independent directors, who were acting in good faith, might have refused such a charge, but these directors had no such qualms, and they reached exactly the conclusions that their patrons expected of them.

The entire circumstances of their appointment should, I would think, raise questions about their good faith and independence, and honestly, I wonder how often courts are willing to take at face value the conclusions of directors who are appointed for a particular purpose in the expectation they will reach a particular result.  For example, I recall In re Oracle Corp. Derivative Litig., 824 A.2d 917 (Del. Ch. 2003), where two new ostensibly independent board members were appointed for the sole purpose of investigating claims against the incumbent board and concluded (again, shockingly) that the claims had no merit.  The court decided – controversially – that the new board members were not independent, but did so because of preexisting ties to the company, and not because of the circumstances of their appointment. 

There have previously been studies of how often board special committees conclude that derivative litigation against defendant board members has merit, and usually (but not always), they recommend dismissal.  But what has not been studied, as far as I know, is how often new directors are appointed to create a special committee, whether they are more likely to recommend dismissal than incumbent directors, and whether courts are more or less likely to take their recommendations seriously.  It’s possible sample sizes are just not big enough to draw conclusions, but I personally would be interested in an analysis of how new directors differ from incumbent directors in terms of their conclusions and/or the terms of their appointment.

I also note this: Delaware courts start with the presumption that corporate directors are so conscious of their fiduciary duties and so constrained by reputational concerns that they would not lightly betray their obligations for the crass material benefits that a board position can provide.  But if that’s going to work, reputations have to mean something, and once damaged, they should not lightly be rehabilitated.  Which is why I was so concerned by VC Zurn’s opinion in Rudd v. Brown.  There, the plaintiffs alleged that an activist shareholder appointed a compliant director to a company’s board in order to force a merger.  The plaintiffs claimed that this particular director lacked independence, because he had developed a sort of gun-for-hire reputation: activists had repeatedly appointed him, knowing he would champion acquisitions they favored.  Zurn rejected the argument in a footnote:

Plaintiff also asserts in briefing that Brown had “a long history of being appointed to companies’ boards to push a merger or acquisition for short-term profit, including other companies that Engaged had targeted for a sale in the past.” Pl.’s Answering Br. at 37. Insofar as Plaintiff asserts that this gives rise to conflict, that assertion fails. Plaintiff provides no support for the proposition that a director is conflicted purely by virtue of his track record, and I am aware of none.

With this kind of precedent in hand, the newly-appointed WeWork directors had no worries that they were accepting a quarter-million dollars at the expense of their reputations with respect to future opportunities.  But what if they had such concerns?  What if appointing stockholders, as well, had to worry about directors’ past history of compliance?  What if a past history of noncompliance helped burnish directors’ credentials as independent monitors?  Wouldn’t that create a better system, where courts and minority stockholders had more faith in the special committee process?

Second, there’s the standing/harm issue.  Both of Bouchard’s opinions – the one dealing with the new committee’s attempt at dismissal, and the one dealing with SoftBank’s dismissal motion – had to address the argument that WeWork the company was not harmed by SoftBank’s abandonment of the tender offer, since it was the individual stockholders, and not the company, who missed out.  And this interests me because, in a roundabout way, it touches on the issue I raised a couple of weeks ago – namely, when a merger agreement falls through, is the harm to selling stockholders direct or is it derivative?

In this case, the new committee and SoftBank argued that the tendering stockholders did not have a direct claim against SoftBank for breach of contract because they were not parties to SoftBank’s contract with WeWork, and the contract itself specified there were no third party beneficiaries.  They also argued that if the tendering stockholders had a problem with the termination of WeWork’s litigation, their remedy was a derivative action.  See Op. at fn 253.  And then they argued that WeWork was not in fact harmed by the termination of the tender offer because WeWork would not have collected the proceeds.

That is … quite the paradox.

Rather than fully engage this thorny question of who suffers a harm from a terminated stock sale, Bouchard concluded that WeWork as a company suffered a harm because if SoftBank increased its equity stake, it would have more of an interest in monitoring WeWork’s performance.

That is, I have to say, unsatisfying.  I mean, by that logic, SoftBank would have the greatest interest in monitoring WeWork’s performance if it was planning to buy the whole company.  But we know from Revlon that when there’s an offer to sell the whole company for cash, it’s an endgame transaction – we’re not worried about the company’s future after that point; instead, we’re worried about the selling stockholders. 

Anyway, all of this just highlights to me that it’s a blip in the law, and perhaps unresolvable.  At the end of the day, in a shareholder-wealth-maximization world, all harms to the company matter because they are harms to stockholders, and the direct/derivative distinction is not a fact of nature, but a policy judgment as to which types of claims should be handled by the board in the first instance and which should not.  So it stands to reason there wouldn’t be complete doctrinal coherence for the edge cases.

December 26, 2020 in Ann Lipton | Permalink | Comments (1)

Saturday, December 19, 2020

FTC, Common Ownership, and Investor Power

I’ve previously discussed the common ownership problem in this space, and it basically comes down to the fact that common ownership – institutional investors who own stock in a broad swath of companies, including competing companies – is a mixed bag.  On the one hand, it may incentivize investors to address systemic risks, like climate change.  On the other, it operates in tension with a corporate governance framework predicated on shareholder wealth maximization, and may incentivize anticompetitive behavior to the extent investors care less about competition within an industry than maximizing profits for the industry as a whole.  And on the third hand, the mere fact that this kind of vast power over our economic system is exercised by only a handful of private players – whether used for good or for ill – may represent a political/democracy problem.

As a result, there have been proposals to break up the power of the largest fund families.  For example, Lucian Bebchuk and Scott Hirst have proposed that fund families be limited to investing in 5% of any particular target company.

That’s not what’s on the table, however.

In two new releases, the FTC has proposed reinterpreting the Hart Scott Rodino Act.  That Act requires pre-review by the government whenever an acquirer proposes to obtain a significant amount of the voting securities of another company to ensure that the acquisition would not be anticompetitive.  How significant?  It’s a numerical test that varies every year.  For our purposes, though, what’s critical is that the requirements are softened when the investor is obtaining the securities “solely for the purpose of investment,” meaning, the acquirer “has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.”  Institutional investors like mutual fund companies are exempt from HSR reporting if they obtain securities “solely for the purpose of investment” and hold less than 15% of the target.

The FTC is looking into whether it should redefine what “solely for the purpose of investment” means.  Among other things, it is considering whether shareholders who participate in activities like “discussions of governance issues, discussions of executive compensation, or casting proxy votes” should no longer count as passive (and related rulemaking would ensure that holdings are considered at the family, rather than fund, level). 

What the FTC is looking into, then, is whether the ordinary engagement activities of index funds (or indeed, any shareholder) would make them active holders subject to the full range of HSR reporting.  They would not be prohibited from acquiring stock in companies that compete with each other.  They would simply be required to file paperwork with the government and await the outcome of a review before they could complete sizeable transactions.  Unless, of course, they agree to cease all attempts to engage with management.

Now, in general, I support the FTC’s attention to the problem of common ownership.  But I think the level on which we need to be thinking is consolidation in the asset management industry, and to some extent, the statutory framework may not be well-suited to deal with that problem.  I.e., from a consumer/retail investor standpoint, there are more mutual fund choices than ever, and fees are often quite low, so there may not be room for regulators to attack the problem by claiming asset management consolidation is itself anticompetitive.  Which means, regulators may be stuck with focusing on how asset managers deal with portfolio companies, and the HSR Act itself draws a distinction between acquisitions “solely for the purpose of investment” and acquisitions for other purposes, so it’s a natural avenue for the FTC to pursue.

That said, though much of the research into common ownership does not try to explain why or how common ownership results in anticompetitive behavior by portfolio companies, at least one explanation is that shareholders in such companies are passive – i.e., they don’t prod management to improve their competitive position, leading to a lack of competition.

If that’s right, narrowing the definition of “solely for the purpose of investment” could be the opposite of a solution.  It could reward the very disengagement that facilitates the antitrust problem, and disincentivize mutual funds from participating in the kind of oversight that might prod greater competition. 

Plus, I really cannot help but notice, it would also take mutual funds out of the business of policing executive pay, and ESG issues like climate change and diversity.  Which would be well in keeping with the general Trump Administration hostility to these kinds of shareholder interventions.

December 19, 2020 in Ann Lipton | Permalink | Comments (0)

Saturday, December 12, 2020

The Allergan Mess

In 2018, a securities class action was filed against Allergan, alleging that the company concealed risks associated with breast implants.  Boston Retirement System was appointed lead plaintiff, and the case survived a motion to dismiss.  The court refused to certify the class, however, because of perceived misconduct by lead counsel Pomerantz.  See In re Allergan PLC Sec. Litig., 2020 WL 5796763 (S.D.N.Y. Sept. 29, 2020).

Specifically, Judge McMahon held that Pomerantz had defied her original order appointing it as lead counsel by taking on another firm – Thornton – as a kind of shadow co-lead counsel.  When Pomerantz was appointed, McMahon specifically rejected its request to name FIRM as co-lead because, in her words, “the involvement of multiple firms tends to inflate legal fees.”  Despite her order, well:

Thornton has not only remained involved in this litigation, albeit under the rubric of “additional counsel,” but that it has effectively played the role of co-lead counsel – to the point that BRS’ corporate representative has testified under oath that Thornton’s responsibilities did not change at all in response to the lead plaintiff order. It is clear that Thornton has been fully involved in every aspect of this case to date. It has duplicated the efforts of Pomerantz by working on the CAC (it signed the pleading, so it has to have worked on it) and the motions to dismiss and for class certification (ditto), by joining in meet and confer sessions with defense counsel, participating in depositions, and by getting (and so obviously reviewing) all correspondence.

Moreover, I have learned, in connection with the prosecution of this motion, that the Pomerantz and Thornton firms have entered into an agreement to split any fee earned from the prosecution of this lawsuit almost down the middle. The agreement calls for the fee earned by lead counsel to be split with 55% going to Pomerantz and 45% to Thornton – a division that is so close to the firms’ original agreement of a 50-50 split, reached at a time when they anticipated being appointed co-lead counsel as to be a rather transparent substitute for co-lead counsel status.  This amended agreement between the two firms was dated six days after BRS designated Pomerantz as lead counsel.  The court was not informed about this arrangement, by BRS or anyone else.

This Court is not fooled by the rebranding of Thornton as “additional counsel.”

So, McMahon refused to allow Pomerantz and Boston Retirement System to continue to represent the class, and she reopened applications for lead plaintiff.

In response, one of the original movants – DeKalb County Pension Fund, represented by Faruqi & Faruqi – renewed its petition, along with several new movants, including Union Asset Management Holding AG represented by BLBG and the General Retirement System of Detroit represented by Abraham, Fruchter & Twersky. 

On December 7, McMahon granted the DeKalb petition – despite the fact that other movants had larger losses, which is the typical requirement for lead plaintiff status – because she believed it would be improper to appoint a plaintiff who had not moved for lead status when the case was originally filed.  And in her order, she specified:

DeKalb’s motion to have Faruqi and Faruqi appointed as lead class counsel is granted, on the condition that the Faruqi firm and none other serve as lead counsel and perform all services for which recompense may some day be sought.


Here’s the thing.

The way McMahon describes it, it does sound like Pomerantz and Thornton defied her original order, and that is certainly a legitimate grounds for refusing to appoint Pomerantz as class counsel.

But the fact is, in securities cases, plaintiffs’ firms always coordinate with other firms.  Not necessarily as co-lead, but to perform tasks like routine discovery, or depositions in other cities, or smaller motion practice.  Plaintiffs’ firms tend to have fewer attorneys than defense firms, and they often don’t have the staff to maximize the value of a large case without getting at least some additional assistance.  And while I won’t deny that these arrangements, like any billing arrangement, may be abused, that isn’t necessarily the case; much of the work is legitimate, and takes some of the burden off the lead firm.  When it comes to co-leads specifically, they may ultimately be valuable – I have no opinion on their general worth – but at least one way they may inflate fees is that every decision has to get approval from partners on both sides, which, while done in good faith, may add to the hours billed.  But that isn’t a concern if additional counsel are brought on to handle discrete tasks.

Point being, even among the best plaintiffs’ firms, a complete bar on enlisting other firms could be burdensome.

Faruqi & Faruqi is … not among the best plaintiffs’ firms.  In the merger context, they’ve been repeatedly accused of filing nuisance cases and settling for immaterial disclosures without engaging in meaningful discovery.  Their recoveries in securities class actions, specifically, are less than spectacular. 

That doesn’t mean they can’t prosecute the Allergan action effectively, but it does suggest they’d derive significant benefit from being able to obtain at least some assistance from other firms.

McMahon’s decision, in other words, may represent an appropriate rebuke to Pomerantz, but it is not in the best interests of the class.

And to me, it all highlights the fallacy of California Public Employees’ Retirement System v. ANZ Secs., Inc (which I blogged about here).  There, the Supreme Court held that the filing of a securities class action does not toll the repose period for subsequently filed individual actions.  Which means that any Allergan class member who trusted Pomerantz, but not Faruqi, to lead the litigation will have to worry about the clock if they want to file their own individual suit.  And down the line, if Faruqi ultimately seeks to settle the action on the class’s behalf, dissatisfied class members can object but by then, they may not have any realistic chance of opting out; they’ll be stuck with whatever deal the court approves – a fact that will be known to both Faruqi and to the Allergan defendants at the outset of negotiations.

December 12, 2020 in Ann Lipton | Permalink | Comments (0)

Friday, December 11, 2020

The Supreme Court issues a very important order!

That's right - it's the moment we've all been waiting for.  The Court has granted cert in Goldman Sachs v. Arkansas Teachers Retirement System.  (Oh, I think there was some other stuff about not throwing out 20 million presidential votes in four states).

In any event, here are the questions presented by the petition:

(1) Whether a defendant in a securities class action may rebut the presumption of classwide reliance recognized in Basic Inc. v. Levinson by pointing to the generic nature of the alleged misstatements in showing that the statements had no impact on the price of the security, even though that evidence is also relevant to the substantive element of materiality; and (2) whether a defendant seeking to rebut the Basic presumption has only a burden of production or also the ultimate burden of persuasion.

I may or may not have more to say later but for those interested, my blog post about the Second Circuit opinion is here, and you can read all of the cert briefing here.




December 11, 2020 in Ann Lipton | Permalink | Comments (0)

Tuesday, December 8, 2020

Still thinking about Anthem-Cigna

Several weeks ago, I posted about VC Laster’s opinion in the busted Anthem-Cigna merger.  Ever since then, I continued to mull the case and – in particular – I had questions about what might happen if the Cigna shareholders sued Cigna’s management over the deal’s failure.  I planned to post about it as a hypothetical thought experiment, but then – what ho! – the Cigna shareholders did in fact file such a lawsuit – though, as I explain below, not quite the one I was contemplating. 

Anyhoo, now I am finally getting around to posting my thoughts, though I’m almost hesitant to do so because I’m afraid the answer to my questions may be really obvious and I’m simply splattering my ignorance over the internet, but, well, that’s what blogging is for, so, here goes.

It all starts with Laster’s conclusions after the Anthem-Cigna trial. He found that Cigna’s CEO, David Cordani, intentionally tried to sink the deal by refusing to honor Cigna’s commitments under the merger agreement.  And Cordani did so not out of concern for Cigna’s stockholders, but because he was resentful of not being chosen to lead to the combined entity.  For example, after an agreement was struck – one that granted Anthem more board members and relegated Cordani to the COO role – Cigna’s chair congratulated Cordani on taking “the right step for our shareholders,” and Cordani responded, “Brain knows yes. Heart is heavy.”  Later, Cordani emailed that though the deal was the “correct” outcome, he was “still struggling to accept it all.”

Sadly, that struggle was lost, which – according to Laster’s findings – led Cordani to embark on a campaign of sabotage.  But Laster also concluded that the merger was doomed to fail for regulatory reasons regardless of Cordani’s behavior.  And that failure was very expensive to Cigna’s stockholders; it cost them a 35% premium over market price.

What I’ve been trying to imagine, then, is what would happen if Cigna’s shareholders tried to sue Cordani for breaching his duty of loyalty, thus costing them valuable merger consideration.  Leaving aside any issues about limitations periods, what result?

To begin, we have to determine whether this claim would be direct or derivative.  Because if it’s derivative, we next have to ask if the stockholders would be estopped from bringing their claim in the right of the corporation.  After all, Cigna litigated the case against Anthem, and took the position – on which it prevailed – that the merger was doomed to fail no matter what Cordani did.  So, would Cigna (and thus any derivative plaintiff) now be bound by that finding?  (Of course, the case is on appeal to the Delaware Supreme Court, so there could be a reversal, etc etc, but let’s assume the finding stands).

Preclusion would seem awfully unfair under these facts, because when Cigna litigated the Anthem case, its choices were made by its management – including Cordani – whose interests were not aligned with those of the stockholder-plaintiffs in my hypothetical loyalty action.  Which really only suggests that perhaps this kind of claim should be direct in nature, because the harm isn’t to the corporate entity, but to shareholders themselves, in that they were unable to collect the merger consideration that should have been their due.  But does that really state a direct claim?

In In re Coty Stockholder Litigation, 2020 WL 4743515 (Del. Ch. Aug. 17, 2020), a controlling shareholder increased its stake from 40% to 60% via tender offer, and when stockholders sued directly and derivatively (arguing certain process failures, and breach of a stockholders’ agreement regarding post-tender offer conduct), their claims were sustained.  Defendants argued that any non-tendering stockholders were not harmed, since they continued to hold stock in a company with a controlling stockholder both before and after the deal.  Chancellor Bouchard rejected that argument, recognizing as a direct harm the fact that the non-tendering stockholders – who held their shares throughout the transaction – “no longer have any expectation of receiving a control premium for their shares in a future buyout” (emphasis added).

Similarly, in Louisiana Municipal Police Employees’ Retirement System v. Fertitta, 2009 WL 2263406 (Del. Ch. July 28, 2009), stockholder plaintiffs were permitted to bring direct claims alleging that the company’s Chairman intentionally sank a merger with an entity that he controlled, which would have netted the shareholders a 41% premium over market price.

On the other hand, VC Zurn just decided Mark Gottlieb, et al., v. Jonathan Duskin, where shareholders alleged that the directors improperly rejected a merger offer with a 33% premium above the trading price.  That case was brought directly, but Zurn determined that it should have been filed as a derivative action.  See also In re NYMEX Shareholder Litigation, 2009 WL 3206051 (Del. Ch. Sept. 30, 2009) (“A breach of fiduciary duty that works to preclude or undermine the likelihood of an alternative, value-maximizing transaction is treated as a derivative claim because the company suffers the harm…”).

On the third hand, there’s the original Tooley v. Donaldson, Lufkin, & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), where an improper delay in receipt of merger consideration was held to state a direct claim – or would have, if the shareholders had a contractual right to payment, which they didn’t.  Is that relevant here?  Perhaps once the merger agreement was signed, Cigna shareholders had a contractual right – or something that would ripen into a contractual right – to consideration, which was personal to them, and Cordani interfered with that right by sabotaging the deal.

I don’t know how any of this would play out, and I’d be interested to hear any thoughts – especially if there’s some very obvious answer that I am missing.  That said, when it comes to the actually-filed case against Cigna’s management, the plaintiff sidestepped all of these contortions.  Instead of seeking damages in the form of lost merger consideration, the plaintiff claims that Cordani’s conduct caused the company to forfeit the reverse termination fee it otherwise would have obtained from Anthem due to the merger’s failure on regulatory grounds.  That’s pretty clearly a derivative harm, and the best part is, the plaintiff would presumably be quite happy for estoppel to apply – because it matches up with Laster’s findings in the original trial quite nicely.

December 8, 2020 in Ann Lipton | Permalink | Comments (4)

Monday, December 7, 2020

Spousal Misappropriation - A Special Breed of Insider Trading Action

In a recently published article just posted to SSRN, I examine spousal misappropriation as a basis for an insider trading claim.  The article, Women Should Not Need to Watch Their Husbands Like [a] Hawk: Misappropriation Insider Trading in Spousal Relationships, leverages the facts of a specific Securities and Exchange Commission enforcement action (SEC v. Hawk, No. 5:14-cv-01466 (N.D. Cal.)), to undertake an analysis of applicable statutory and regulatory principles, existing decisional law, and the realities of the legal and social context.  The SSRN abstract, derived from the text of the article, follows.

This article endeavors to sort through and begin to resolve key unanswered questions regarding spousal misappropriation as a basis for U.S. insider trading liability, some of which apply to insider trading more broadly. It identifies and describes misappropriation insider trading liability under U.S. law, recounts and analyzes probative doctrine and policy relevant to spousal misappropriation cases, and (before briefly concluding) offers related observations about the impact of that doctrine and policy on a specific motivating Securities and Exchange Commission ("SEC") enforcement action and other spousal misappropriation cases.

The analysis undertaken in the article supports enforcement actions based on a strong threshold presumption of a relationship of trust and confidence in spousal relations, as recognized by the SEC through its adoption of Rule 10b5-2(b)(3). This support derives from a focus on two fundamental building blocks of spousal misappropriation cases addressed in the article—a broad understanding of deception as it is relevant to these cases and longstanding accepted sociolegal wisdom on the nature of marital relationships as evidenced in the spousal communications privilege. Essentially, marriage is best seen as a relationship of trust and confidence. To the extent a spouse’s breach of that trust or confidence is deceptive and occurs in connection with the purchase or sale of securities, the breach should be deemed to provide a basis for insider trading enforcement (and liability). Market integrity is damaged through marital deception in the same way that it is damaged through the deception by an attorney of a client or the attorney’s law firm partners. Market actors depend on the confidentiality of information shared in marriages as well as information shared in attorney-client relationships and partnerships.

The article is one of a number that were written for a symposium on insider trading stories held at The University of Tennessee College of Law last fall.  They all occupy the same issue of the Tennessee Journal of Law & Policy, which hosted the symposium.  The other authors include (in the order of their respective article's appearance in the journal): Donna Nagy, BLPB co-editor John Anderson, Eric Chaffee, Mike Guttentag, Ellen Podgor, Kevin Douglas, and Jeremy Kidd.  The ideas for these articles were originally the subject of a discussion group convened by John Anderson and me at the 2019 Annual Conference of the Southeastern Association of Law Schools ("SEALS"). 

That reminds me to note for all that it is now time to submit proposals for the 2021 SEALS conference.  John Anderson and I will again convene an insider trading group for this meeting.  And I also will be proposing a discussion group (based in part on the colloquy between Ann Lipton and me here) on the treatment of business entity organic documents (including corporate charters and bylaws, limited liability company/operating agreements, and partnership agreements) as contracts and the application of contract law to their interpretation and enforcement.  If you have a desire to participate in either group or want to propose a program of your own (whether it be a panel or a discussion group), please let me know in the comments or by private message.

December 7, 2020 in Ann Lipton, Corporate Governance, Joan Heminway, Securities Regulation, White Collar Crime | Permalink | Comments (0)

Saturday, November 28, 2020

Litigation Limits in Corporate Constitutive Documents – the Uber Case

This holiday weekend, I continue my blog series on the March of Litigation Limits in Corporate Constitutive Documents (most recent prior posts here, here, and here – and those link back to earlier entries).

In Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020), the Delaware Supreme Court held that corporate charters may contain provisions selecting federal courts as the forum for Securities Act/Section 11 claims under the federal securities laws.  That, of course, raised the question whether non-Delaware courts would treat these provisions as enforceable.

We have two rulings on that so far: In September, there was Wong v. Restoration Robotics, Case No. 18CIV02609 (Cal. Sup. Ct. Sept. 1, 2020), and then, earlier this month, we got In re Uber Technologies Securities Litigation, Case No. CGC19579544 (Nov. 16, 2020) (more details on the Uber case available at Kevin LaCroix’s blog post).

Both courts, correctly in my view, recognized that the enforceability, or not, of these provisions is not a matter of internal affairs and is therefore not governed by Delaware law.  Instead, both applied California law.  After that, both courts examined California contract doctrine and concluded that the provisions were not unconscionable or otherwise unreasonable/void as against public policy, and therefore were enforceable against the plaintiffs. 

What both courts skimmed over, however, is whether corporate charters and bylaws should be treated as contracts in the first place.  As regular readers know, I have argued that there are major differences between the legal regime that governs corporations, and the legal regime that governs contracts.  See Manufactured Consent: The Problem of Arbitration Clauses in Corporate Charters and Bylaws, 104 Geo. L.J. 583 (2016).  Corporate law is entangled with state imposed fiduciary obligations that place limits on directors’ ability to propose, and enforce, forum provisions, and corporate law also places sharp limits on the ability of shareholders to act.  Both of these aspects of corporate doctrine render it a poor analogy to contract law.  For example, corporate law specifies the manner by which bylaws and charters may be amended; contract doctrine has no such strictures.  Corporate law cares about conflicts of interest; contract doctrine expects each party to act selfishly. So there are all kinds of questions raised when corporate provisions are treated as contractual, like: Do directors operate under a conflict of interest when they invoke a litigation limit against a plaintiff?  Should holders of nonvoting shares be treated as equally bound as holders of voting shares?  If the provision is in a director-enacted bylaw, does that affect the analysis of whether a binding contract has been formed?  What if there are supermajority voting requirements, or other limits on shareholder governance rights, which inhibit shareholders’ ability to  modify a forum provision imposed by directors?  What if those limits, while legal in the state of incorporation, would be prohibited under the corporate law of the state whose contract law is being applied? 

Crucially, neither the Wong nor the Uber courts tried to engage these questions.  Uber briefly cited to a California case for the proposition that “whether a set of bylaws constitutes a contract turns on whether the elements of a contract are present,” which is true as far as it goes, but (1) Uber’s forum provision was not in the bylaws – it was in the charter; (2) the case on which the Uber court relied – O'Byrne v. Santa Monica-UCLA Medical Center, 94 Cal. App. 4th 797 (2001) – involved associational bylaws, not corporate bylaws, a difference that apparently escaped the court; and (3) the court’s only examination of whether the “elements of a contract” were met involved a fleeting reference to consent, rather than a full-blown analysis of how the corporate legal framework differs from the contractual one.

All of which is to say, I’m afraid that courts’ failure to grapple with this issue is sleepwalking us into a regime where contract law and corporate law really will collapse, in a manner that will render the latter incoherent.

November 28, 2020 in Ann Lipton | Permalink | Comments (2)

Saturday, November 21, 2020

Case Western Reserve Symposium: "Equity Holdings in the Three Index Funds"

On November 6, I had the privilege of participating in Case Western Reserve Law School's George A. Leet Business Law Symposium, "Equity Holdings in the Three Index Funds: Anti-Competitive Effects, Fiduciary Duties and Environmental, Social and Governance Issues."  The agenda for the full symposium is here; I spoke on the first panel, "Fiduciary Obligations of Index Fund Managers," alongside Jill Fisch, Darren Rosenblum, and Bernard Sharfman (moderated by Anat Beck).  The entire symposium is now online at YouTube, so you can watch and, in particular, admire the care I took with my Zoom background:





November 21, 2020 in Ann Lipton | Permalink | Comments (2)

Saturday, November 14, 2020

DoorDash’s Forum Selection Clause and the Exercise of Some Restraint – For Now

Very quick post this week as I comment on DoorDash’s recently-publicized S-1, and the forum selection clause contained in its current certificate of incorporation:

Unless this corporation consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware (or, if the Court of Chancery does not have jurisdiction, the federal district court for the District of Delaware) shall, to the fullest extent permitted by law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of this corporation, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee of this corporation to this corporation or this corporation’s stockholders, (iii) any action arising pursuant to any provision of the General Corporation Law or this Restated Certificate of Incorporation or the Bylaws of this corporation (as either may be amended from time to time), or (iv) any action asserting a claim governed by the internal affairs doctrine, except for, as to each of (i) through (iv) above, any claim as to which the Court of Chancery determines that there is an indispensable party not subject to the jurisdiction of the Court of Chancery (and the indispensable party does not consent to the personal jurisdiction of the Court of Chancery within ten (10) days following such determination), which is vested in the exclusive jurisdiction of a court or forum other than the Court of Chancery, or for which the Court of Chancery does not have subject matter jurisdiction. Any person or entity purchasing or otherwise acquiring or holding any interest in shares of capital stock of this corporation shall be deemed to have notice of and consented to the provisions of this Article XIV. Unless this corporation consents in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act.

As I understand it, upon the completion of the offering, DoorDash will move this clause from the charter into the bylaws.  Though (as I’ve previously said) I have questions about the charter vs. bylaw issue, the substance of the clause will remain the same.

What’s notable here is how DoorDash could have – but did not – choose to go much further than it did.

As I previously blogged, Boeing has a forum selection bylaw that requires all “derivative” claims to be filed in Delaware Chancery.  I strongly suspect that Boeing only intended the clause to apply to traditional fiduciary claims, but after the Delaware Supreme Court’s decision in Salzberg v. Sciabacucchi – permitting corporate constitutive documents to limit claims brought under the federal Securities Act – Boeing sought to have its bylaw applied to a derivative claim alleging violations of Section 14 of the Exchange Act.  Because state courts do not have jurisdiction over Exchange Act claims, in practical effect, Boeing’s argument meant that the derivative Section 14 claim against it needed to be dismissed.  A district court bought that argument, and the case is now on appeal to the Seventh Circuit.  Separately, the plaintiffs have filed a declaratory judgment action in Delaware challenging the bylaw as contrary to Delaware law.

Facebook is currently making a similar argument.  Facebook, like several companies, was hit with a derivative lawsuit in California federal court challenging its lack of diversity (which Marcia blogged about here).  Among other claims, the plaintiff is alleging false proxy statements in violation of Section 14 that induced shareholders to vote in favor of Facebook’s directors and approve its executive pay packages.  But because Facebook has a charter provision requiring that “derivative” actions be filed in Chancery, Facebook is moving to have the case dismissed, using Boeing as precedent.

Thus, it is striking to me that DoorDash chose not to push the envelope here, and is explicitly permitting claims to be filed in federal court if Delaware Chancery does not have jurisdiction.  This is, by current standards, a remarkable show of restraint.

One thing that does occur to me, though: In general, plaintiffs cannot bring federal claims for damages from a false proxy statement if they cannot show that the proxy statement was an “essential link” in accomplishing the challenged transaction.  In practical effect, the proxy statement must have solicited necessary shareholder votes.  But DoorDash – and, for that matter, Facebook – have dual-class share structures that give one person a controlling stake. Under those circumstances, the votes of the minority shareholders will rarely be necessary to legally effect a transaction.  Thus, DoorDash may feel that allowing Section 14 claims (derivative or direct) to be filed in federal court presents a fairly minimal risk of liability, when weighed against the headaches associated with trying to bar them.

November 14, 2020 in Ann Lipton | Permalink | Comments (0)

Friday, November 6, 2020

Hu, Mitts, and Sylvester on Share Lending and Fund Stewardship

This week I want to call everyone’s attention to a fascinating new paper by Edwin Hu, Joshua Mitts, and Haley Sylvester, Index Fund Governance: An Empirical Study of the Lending-Voting Tradeoff.

As the authors explain, for a long time, the SEC prohibited mutual funds from lending their shares to short-sellers if doing so would interfere with the funds’ stewardship obligations.  As a result, funds typically would recall any loaned shares in time to vote them at the annual shareholder meeting.  However, in 2019, the SEC changed its rules to allow funds to loan their shares even if doing so would sacrifice their ability to vote, so long as it would be in the funds’ best interest.  Hu, Mitts, and Sylvester study the effects of the rule change and find that the number of shares available to borrow around the time of shareholder meetings jumped by 58% in companies with a high level of index fund ownership, and there are increases even when important matters, like proxy fights, are on the ballot.  The extra shares don’t result in greater short interest, but they do apparently take them out of the voting pool – or potentially make them available for activists to vote.

The really interesting question this raises is whether these managers really are acting in the funds’ best interest – trading the value of the vote against the value of the lending fees – or whether instead, perhaps due to a fee split between the fund and the adviser, the managers are sacrificing the interests of the fund in order to benefit the adviser.  It’s complicated; not every share that becomes available to borrow actually does get lent out, which, as I understand it, means no fees are earned but the vote is still lost.  On the other hand, for some votes, the fund may reasonably calculate that there is unlikely to be an impact on value, or that the fund’s votes are unlikely to be pivotal (on this, I direct interested readers to Fatima Zahra Filali Adib’s paper, previously highlighted in this space, observing that funds can determine when their votes are likely to matter to outcomes, and they allocate attention accordingly).  That said, the authors also tell the tale of a company called GameStop, where activists won a proxy contest, arguably because index fund holders – who would otherwise have voted with management – loaned their shares instead of voting them.

Relatedly, Joshua Mitts has just posted another paper on share lending, where he argues that passive funds that are part of large mutual fund complexes can use negative information about a stock gleaned from the active side of the business to raise the prices they charge to short sellers who borrow their shares.  Doing so allows passive funds to, in a way, earn profits from “active” participation in the market.  Mitts also claims that this activity helps make prices more efficient, which is ultimately to the long term benefit of passive investors.

November 6, 2020 in Ann Lipton | Permalink | Comments (0)

Saturday, October 31, 2020

Not All Heroes Wear Capes

Earlier this week, VC Laster issued his decision in United Food & Commercial Workers Union v. Zuckerberg.  Professor Stephen Bainbridge blogged about the decision here, with a lot more detailed discussion of the law than I’m going to provide, but I’m covering the same territory anyway because this case is an interesting example of the pathologies associated with the common law.

So, before stockholder plaintiffs are permitted to bring a derivative action on behalf of a corporation, they must first make a showing that the corporate board is too conflicted to be able to make the litigation decision themselves.  This may occur because board members are themselves at risk of liability regarding the underlying transaction being challenged, or because they are too close to someone who is.  The test was first articulated by the Delaware Supreme Court in Aronson v. Lewis, 473 A.2d 805 (Del. 1984), but because this was a common law creation and the court was mostly focused on the dispute in front of it, the test it articulated conflated the general inquiry – is the board able to be objective about the litigation – with the specific application of that inquiry to the Aronson Board.  In other words, the Aronson test conflated the issue of objectivity with respect to bringing a lawsuit with liability on the underlying claim, and phrased the former in terms of the latter.

As time wore on, that conflation made the Aronson test difficult and confusing to apply, for two reasons: First, in many cases – unlike the situation in Aronson – board members change between the time of the alleged fiduciary breach and the time of the lawsuit, making liability on the underlying claim irrelevant.  And second, the legal standards for liability changed, making Aronson’s articulation – which was tied to the liability standards for that board at that time – increasingly disconnected from the actual liability risk.

The Delaware Supreme Court started to fix these problems in Rales v. Blasband, 634 A.2d 927 (Del. 1993), where it created a new test – one rooted solely in the objectivity of the board at the time of the lawsuit – but instead of overruling Aronson, it said that the Rales test would only apply when the board entertaining the possibility of a lawsuit had not made a decision being challenged by the plaintiffs.

That, naturally, led to decades of confusing caselaw about whether Rales or Aronson would apply in a particular matter, making the issue the bane of corporate law professors who tried to teach the distinction to their students (ahem, some of us don’t bother and just teach Rales). 

And here’s the part that’s interesting to me: Why would the law persist in this obviously maladaptive way?  Because, I believe, no litigant had any interest in arguing for a change.  At the end of the day, Rales and Aronson are asking the same question, and regardless of which is used, they come out the same way – a point that several Delaware courts have made.  Which means neither plaintiff nor defendant had much of an interest in briefing the distinction or arguing the law should be changed, and they didn’t.  Without any litigants to press for clarification, Delaware courts allowed this state of affairs to continue and torture corporate law professors and junior associates throughout the land.


This is the weakness of common law rulemaking, and the adversarial system in general; courts decide what litigants ask them to decide. And litigants don’t always ask the right questions.

Which is likely why earlier this week, VC Laster – sua sponte – seized the initiative and gave Aronson the boot, even though the parties had assumed Aronson would apply and briefed the matter that way.  In so doing, Laster painstakingly detailed the problems with the Aronson test, concluding, “Precedent thus calls for applying Aronson, but its analytical framework is not up to the task….This decision therefore applies Rales as the general demand futility test.”

Now all that remains is to see if Laster’s bid for a change takes hold.  Notably, litigants still don’t have any incentive to make a serious argument on this score, but if they – like the academy – are relieved to see the shift, they may make a perfunctory gesture towards Aronson in future cases, but then cite Zuckerberg for the idea that Aronson may be dead letter, and go from there.  Even if the plaintiffs appeal Laster’s specific ruling in Zuckerberg dismissing their complaint, I’d be surprised if they waste precious briefing space on the Aronson/Rales distinction, which means the Delaware Supreme Court would have to go affirmatively out of its way to question Laster’s reasoning if it wants to preserve Aronson’s vitality.  Let’s hope it doesn’t bother.

That said, when it comes to the underlying substantive dispute in Zuckerberg, I’m not sure I agree with Laster’s analysis.

The lawsuit arose out of Mark Zuckerberg’s ill-fated proposal to amend Facebook’s charter to create a class of no-vote shares, essentially to allow him to transfer much of his financial interest in the company while maintaining his hold on the high-vote B shares that give him control.  As many will recall, the Board recommended the charter amendment and the shareholders – dominated by Zuckerberg’s high vote shares – voted in favor, but in a subsequent lawsuit, stockholder-plaintiffs uncovered multiple irregularities that had occurred in the course of negotiating the proposal.  Zuckerberg dropped the plan, and that was that, until new plaintiffs brought a derivative lawsuit alleging that even though the plan was abandoned, all of the expenditures associated with it damaged the company.  Thus, the question before Laster was whether the Facebook Board was sufficiently disinterested and independent to decide whether to bring a lawsuit over the Board’s earlier approval of the charter amendments, namely, whether to sue many of its own members.  And that question turned, in part, on whether Reed Hastings and Peter Thiel, two of Facebook’s Board members, faced a substantial risk of liability for having voted in favor of the charter amendment in the first place.

So really, part of the underlying legal question here was whether Hastings and Thiel breached their duties of loyalty by recommending the charter amendment.  The plaintiffs argued, in part, that they did so because they were “biased” in favor of founder control – namely, they believed that corporate founders should be able to run their companies free from the meddling influence of public shareholders.

Laster held that even if this was their reasoning, it did not constitute a lack of loyalty:

A director could believe in good faith that it is generally optimal for companies to be controlled by their founders and that this governance structure is value-maximizing for the corporation and its stockholders over the long-term. Others might differ. As long as an otherwise independent and disinterested director has a rational basis for her belief, that director is entitled (indeed obligated) to make decisions in good faith based on what she subjectively believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants.  If a director believes that it will be better for the corporation to have the founder remain in control, then the director may make decisions to achieve that goal. As long as a director acts in good faith, exercises due care, and does not otherwise have any compromising interests, a director will not face liability for making a decision that she believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants,…

The belief that founder control benefits corporations and their stockholders over the long run is debatable, but it is not irrational.

To which I respond – what about Blasius?

In Blasius Industries v. Atlas, an incumbent board maneuvered to neuter the effects of shareholder consents that would otherwise have replaced it with a dissident slate.  Chancellor Allen held that even if the Board sincerely and in good faith believed the dissident slate would harm the company and its own plans were better for shareholders, the incumbents would violate their fiduciary duties by taking the choice out of the shareholders’ hands.  As Allen put it:

As I find the facts … they present the question whether a board acts consistently with its fiduciary duty when it acts, in good faith and with appropriate care, for the primary purpose of preventing or impeding an unaffiliated majority of shareholders from expanding the board and electing a new majority. ...I conclude that, even though defendants here acted on their view of the corporation's interest and not selfishly, their December 31 action constituted an offense to the relationship between corporate directors and shareholders that has traditionally been protected in courts of equity. As a consequence, I conclude that the board action taken on December 31 was invalid and must be voided….

The real question the case presents, to my mind, is whether, in these circumstances, the board, even if it is acting with subjective good faith..., may validly act for the principal purpose of preventing the shareholders from electing a majority of new directors. The question thus posed is not one of intentional wrong (or even negligence), but one of authority as between the fiduciary and the beneficiary (not simply legal authority, i.e., as between the fiduciary and the world at large)....

I therefore conclude that, even finding the action taken was taken in good faith, it constituted an unintended violation of the duty of loyalty that the board owed to the shareholders.

Without, umm, weighing in on the overall merits of this particular lawsuit, might Blasius’s reasoning be transferred to the Facebook context?  Directors may believe it’s better if Zuckerberg remains in control of the company, but that doesn’t give them the right to unilaterally effectuate a recapitalization handing him that control even after he sells his shares.

This is not to say the proposed amendments were per se disloyal; just, as with any loss of control rights, you’d expect shareholders to get something in return.  A payment, for example, perhaps coupled with MFW-like protections (which Zuckerberg refused), rather than simply the dubious honor of having Zuckerberg control the company in perpetuity.

I suppose one might argue this isn’t a Blasius situation of interfering with the shareholder franchise so much as it as a Unocal/Unitrin situation of defending against a potentially damaging change in control (and yes, I realize some would argue they’re two sides of the same doctrinal coin).  But Blasius is used for entrenchment; Unocal is applied for mergers and hostile takeovers.  So it would be awfully strange to apply the Unocal framework when the whole issue arises because the existing controller (and the existing directors) are trying to entrench their positions by increasing the separation between control rights and financial rights.  And even if we were to apply Unocal, the maneuver would still fail on preclusiveness grounds; due to a lack of a majority-of-the-minority approval condition, it was mathematically impossible for the minority shareholders to maintain the existing capital structure.*

But that further raises the question whether an impermissible Unocal defense is necessarily a disloyal act (a critical issue here, since the question is being asked in the context of a claim for damages), and I am not certain the caselaw is entirely clear.

In any event, this is probably all old hat; I assume a lot of this territory was covered back during the Google case or during the briefing in the initial Facebook lawsuit.  Still, Laster’s opinion reopens those wounds, and we never got an answer the first time!

*One of the odd doctrinal blips here is that because the proposal was a conflicted-controller transaction, it was subject to entire fairness review, which should be a higher standard than Unocal/Unitrin scrutiny.  But if Unocal is the right framework, we know it fails due to preclusiveness; no further analysis required.  Assuming, of course, that we measure preclusiveness by the ability of the minority shareholders alone (rather than all the shareholders, including Zuckerberg) to reject the transaction.  Which I think we should do, since it was only the minority losing control, and that usurpation of control is what Unocal is concerned about.  But the fact that these kinds of contortions arise when the Unocal framework is used may simply demonstrate the impropriety of applying it in the first instance.

October 31, 2020 in Ann Lipton | Permalink | Comments (0)

Saturday, October 24, 2020

ESG Investing, or, If You Can’t Beat ‘Em, Join ‘Em

This week, I'm plugging a new piece I posted to SSRN, forthcoming as a chapter in Research Handbook on Corporate Purpose and Personhood (Elizabeth Pollman & Robert Thompson eds., Elgar). It actually includes a lot of the arguments/observations I've previously made in this space, but if you want them compiled in a handy chapter, here's the abstract:

ESG Investing, or, If You Can’t Beat ‘Em, Join ‘Em

If corporate purpose debates concern whether corporations should operate solely to benefit their shareholders, or if instead they should operate to benefit the community as a whole, “ESG” – or, investing based on “environmental, social, and governance” factors – occupies a middle ground. Its adherents welcome shareholder power within the corporate form and accept that shareholders are the central objects of corporate concern, but argue that shareholders themselves should encourage corporations to operate with due regard for the protection of nonshareholder constituencies. This Chapter, prepared for the Research Handbook on Corporate Purpose and Personhood, will explore the theory behind ESG, as well as the barriers to its implementation.

October 24, 2020 in Ann Lipton | Permalink | Comments (0)

Saturday, October 17, 2020

McClane on the Governance Effects of Securitization

Professor Jeremy McClane’s paper, Reconsidering Creditor Governance in a Time of Financial Alchemy, was just published by the Columbia Business Law Review and it’s a doozy.  His thesis is that lenders play an important role in corporate governance by imposing a degree of fiscal discipline on firms’ decisionmaking.  But when loans are securitized, lenders have fewer incentives to exercise control.  By analyzing SEC filings, he finds evidence to suggest that after firms violate financial covenants with lenders, the ones with nonsecuritized loans improve their performance and operate more conservatively, but the ones with securitized loans do not, implying that lenders intervened to force changes in the former category but not the latter.

The upshot: Lenders play an important role in corporate governance, with a view toward curbing the kind of short-term behavior that is often criticized from a stakeholder perspective (i.e., quick payouts that can make the firm more unstable and ultimately harm employees).  Securitization has therefore removed an important constraint on predatory behavior.

October 17, 2020 in Ann Lipton | Permalink | Comments (1)

Saturday, October 10, 2020

A Terrible Injustice Has Been Corrected

The Ninth Circuit just issued a loss causation opinion in In re BofI Securities Litigation, and it’s so beautiful, it gets so much right, it’s like staring at the sun, or the face of God. Birds sang, angels wept, my sinuses have been cleared, my freezer is defrosted, and all that’s left for me to do before I depart from this Earth is see Wonder Woman 1984 in theaters.

The background is a bit complex. BofI is the subject of two 10(b) securities class actions, covering different time periods.  The first alleges that the Bank lied about its lending practices, and the second alleges that the Bank lied about investigations into those lending practices.  Both cases were heard before the same district court judge, and the court dismissed both sets of claims on loss causation grounds, employing a particularly vigorous – nay, implausible – view of market efficiency. 

I blogged about second of those dismissals here, where I explained that the plaintiffs in that action had alleged that the fraud was revealed when a reporter for the New York Post filed a FOIA request and wrote an article about his findings.  The court rejected plaintiffs’ allegations of loss causation because anyone could have filed a FOIA request and obtained the relevant information; therefore, the court would assume that information obtained by the FOIA was already impounded in stock prices.

At the time, I called this “judicial magical thinking”:

Let’s take a moment to unpack the factual inferences here that the court is willing to draw at the 12(b)(6) stage: that unspecified investors made a FOIA request, that they got their response faster than the reporter’s own inquiry, and that they used that information to trade in sufficient quantities to completely offset the effects of the initial lie.  And that despite the fact that markets, apparently, can be expected to behave in this manner, these investors believed, ex ante, it would be cost-efficient to justify the time and expense of making the FOIA request in the first place so that they could exploit the information that the request – might! – reveal.

And, it should be noted, in drawing these inferences, the court remained untroubled by the fact that the stock did, in fact, drop upon publication of the Post article.

Forgive me if I have a little trouble accepting – without any additional evidence – that markets are imbued with this kind of near-mystical perfection. 

So I was not happy, in other words.

The district court pulled a similar move with respect to the other BofI class action.  There, the plaintiffs alleged the truth was revealed through a series of blog posts on Seeking Alpha, and through a whistleblower complaint filed by an ex employee named Erhart.  The district court reasoned that because the Seeking Alpha blog posts merely reanalyzed public data, they could not constitute corrective disclosures; further, the court held that because a whistleblower complaint only involves uncorroborated allegations, it, too, cannot reveal fraud and cause losses as a result.

Both cases were appealed to the Ninth Circuit, and this week, the Ninth Circuit issued its first opinion on the subject, holding that the whistleblower Erhart’s allegations were sufficient to establish loss causation. In so doing, the court used reasoning that, in my view, corrects the errors the district court made in both cases.

So, what’s good here?

First, the Ninth Circuit rejected the argument that the Seeking Alpha blog posts could not have revealed the fraud because they merely reanalyzed publicly available data.  Instead, the court held:

To rely on a corrective disclosure that is based on publicly available information, a plaintiff must plead with particularity facts plausibly explaining why the information was not yet reflected in the company’s stock price. The district court interpreted this requirement to mean that the shareholders had to allege facts explaining why “other market participants could not have done the same analysis and reached the same conclusion” as the authors of the blog posts. (Emphasis added.) We think that sets the bar too high. For pleading purposes, the shareholders needed to allege particular facts plausibly suggesting that other market participants had not done the same analysis, rather than “could not.” If other market participants had not done the same analysis, then it is plausible that the blog posts disclosed new information that the market had not yet incorporated into BofI’s stock price.

This reasoning implicitly rejects the district court’s holding in the case involving the NY Post article.  I.e., the mere fact that someone was able to do the analysis doesn’t create a presumption that someone else must have done the analysis earlier, let alone that these results were already reflected in the stock price.  Time is not a flat circle, things can happen at Time Two that haven’t already occurred at Time One.  The “modest” presumption that public information is reflected in market prices does not extend to all possible conclusions that could be drawn from that public information, let alone conclusions that require special effort, expertise, and investigation.

As for the whistleblower issue, the Ninth Circuit rejected the district court’s conclusion that an unconfirmed allegation cannot reveal fraud, and used particularly nice language in doing so:

To plead loss causation here, the shareholders did not have to establish that the allegations in Erhart’s lawsuit are in fact true. Falsity and loss causation are separate elements of a Rule 10b-5 claim. The shareholders adequately alleged that BofI’s misstatements were false through the allegations attributed to confidential witnesses. In analyzing loss causation, we therefore begin with the premise that BofI’s misstatements were false and ask whether the market at some point learned of their falsity—through whatever means. Viewed through that prism, the relevant question for loss causation purposes is whether the market reasonably perceived Erhart’s allegations as true and acted upon them accordingly. … If the market recalibrated BofI’s stock price on the assumption that Erhart’s allegations are true—and thus that BofI’s prior misstatements were false—then the drop in BofI’s stock price represented dissipation of inflation rather than a reaction to other non-fraud-related news.

This is a great quote; too often, courts allow concerns about the falsity of defendants’ statements to bleed into their analysis of the loss causation element.  I previously blogged about this problem, where I pointed out that courts (including, ahem, the Ninth Circuit in an earlier case) have sometimes held that mere allegations of fraud (or investigations, or what-have-you) cannot “reveal” the fraud to the market unless later events show those accusations to have been merited.  This does not make sense; it suggests a stock price drop occurring at Time One – upon publication of the allegations – is not a “real” loss unless there’s a corroboration of those allegations that emerges later at Time Two.  But the losses at Time One are the losses; shareholders will have experienced that pain regardless of whether subsequent revelations establish the reliability of the earlier disclosures.

Obviously, what’s going on with respect to these demands for corroboration at Time Two – long after the losses are felt – is that courts are suspicious that there was any falsity to be revealed in the first place.  Rather than say that, though, courts direct their skepticism toward loss causation, and demand especial proof that the corrective event really is revealing an underlying fraud.  But if a court is skeptical of the original falsity pleading, it should explain why the original falsity pleading was insufficient – and if the standard for pleading falsity was met, there shouldn’t be a second gamut where falsity is again tested with respect to the pleading of loss causation.

I further addressed this problem in my essay, Fact or Fiction: Flawed Approaches to Evaluating Market Behavior in Securities Litigation:

a number of courts have declared that announcements of investigations or lawsuits—whether instituted by the government, or internal inquiries—cannot, standing alone, cause losses for Section 10(b) purposes because an investigation or a complaint is merely an allegation rather than a confirmation of wrongdoing. This, of course, is a non sequitur; if a stock price represents traders’ view of the potential cash flows of the business, adjusted for risk, a credible possibility of fraud will cause them to reassess those risks and reprice the stock accordingly. Assuming the investigation was, in fact, caused by an underlying fraud—that is, if the plaintiffs are able to demonstrate the other elements of a Section 10(b) claim and show a causal chain between the investigation and the fraud they’ve alleged—there is no reason to treat stock price drops due to market distrust of the subject company as any less “caused” by the fraud as other kinds of price drops. An investigation is hardly an intervening event, and presumably, if there was fraud, and it is ultimately revealed—either with a full admission, or simply with disclosure of the underlying financial condition that it concealed—the stock will drop even further, to account for the fact that what was once an uncertainty has now become definite.

So I’m delighted with the Ninth Circuit’s analysis here.

I am, however, disappointed with Judge Lee, who dissented on this point.  Judge Lee put his concerns thusly:

But what if it turns out that Erhart’s allegations in his lawsuit are bunk? What if he is mistaken?

If that’s the case, per my Fact or Fiction piece, yes, it breaks the chain of causation between the underlying fraud and the public revelations, such that the losses were not proximately caused by the fraud.  Think of it this way: If the whistleblower is making it all up out of a dream he had, and by purest happenstance managed to identify a real fraud at the company, presumably that whistleblower would have lodged his allegations even if there had been no underlying fraud to be found.  If that is the case, the losses would have happened whether or not the firm was tainted, the losses were not caused by the fraud, and the case should be dismissed. QED.

But subsequent corroboration is not how we address that kind of causation problem.  Rather we ask — typically in discovery — whether there is reason to think the whistleblower allegations and the subsequent price drop were inspired by events entirely unrelated to the fraud.  At the pleading stage, there is no reason to think the whistleblower is an intervening cause; if a fraud is adequately alleged, and a whistle is blown by someone who appears to have knowledge of it, an inference is created that the two events are connected.  If later facts establish that not to be the case, fine, but the chain of causation hardly needs further examination on a motion to dismiss.

Anyway, that’s the good part of the Ninth Circuit’s opinion.  But every rose has its thorns, and, well, in this case, those appear in the Ninth Circuit’s analysis of the blog posts.  Though the court rejected the district court’s conclusion that analysis based on public information can never constitute a corrective disclosure, it also held that the blog posts here were not sufficiently credible for the market to have relied upon them, and thus they could not have revealed the fraud. As the Ninth Circuit put it:

The posts were authored by anonymous short-sellers who had a financial incentive to convince others to sell, and the posts included disclaimers from the authors stating that they made “no representation as to the accuracy or completeness of the information set forth in this article.” A reasonable investor reading these posts would likely have taken their contents with a healthy grain of salt.

Therefore, the shareholders have not plausibly alleged that any of the Seeking Alpha blog posts constituted a corrective disclosure.

That’s a helluva thing to conclude on the pleadings, especially since Joshua Mitts has demonstrated that traders do in fact rely on pseudonymous blog posts, and also make judgments about the posters’ credibility based on their track records.  Indeed, in this case, the plaintiffs alleged that the stock price dropped in reaction to the blog posts, which – for pleading purposes – suggests that traders did take them seriously, regardless of the Ninth Circuit’s post hoc assessments of what a reasonable investor would do.  It reminds me of that time the Ninth Circuit held that a statement was immaterial puffery despite the fact that the market moved in response to it.  See Police Ret. Sys. v. Intuitive Surgical, Inc., 759 F.3d 1051, 1060 (9th Cir. 2014).  Apparently, materiality judgments are for courts now, not traders.

Now, it’s true – as Judge Lee’s dissent notes, and as Joshua Mitts has documented – we have a short-trader market manipulation problem.  Sometimes, pseudonymous bloggers post false accusations in order to cash in on the resulting price drop.  But that issue is hardly solved by holding that analyses which really do identify underlying misconduct (which, again, we’re assuming for pleading purposes) cannot constitute corrective disclosures for the shareholders who bought at an earlier time point.  Indeed, the Ninth Circuit’s reasoning leads to the perverse conclusion that the blog posts of the bad actor manipulative short-sellers – the ones who manufacture accusations in order to force a stock price drop – are also immaterial, have no effect on stock prices, have caused no harm, and therefore the posters are immune from punishment.  That is the opposite of what we should be doing.

Well.  Nobody’s perfect.

October 10, 2020 in Ann Lipton | Permalink | Comments (1)

Monday, October 5, 2020

The Business Law Prof Blog Symposium Goes Virtual!


The fourth annual Business Law Prof Blog symposium, Connecting the Threads, is happening, despite the pandemic.  We are proceeding in a virtual format, hosted on Zoom on Friday, October 16.  More information is available here.

The line-up includes an impressive majority of our bloggers speaking on a wide range of topics from shareholder proposals to social enterprise, opting out of partnership, and much more.  Most papers will have a faculty and student discussant.  My submission, “Business Law and Lawyering in the Wake of COVID-19,” is coauthored with two students and carries one hour of Tennessee ethics credit.  While I wish we could host everyone in person in Knoxville, it always is an amazing day when we all get together.  I look forward to learning more about what everyone is working on and hearing what everyone has to say.

October 5, 2020 in Ann Lipton, Colleen Baker, Conferences, Haskell Murray, Joan Heminway, Joshua P. Fershee, Marcia Narine Weldon, Stefan J. Padfield | Permalink | Comments (0)

Saturday, October 3, 2020

In Which I Play a Contracts Professor Again

I usually leave the arcana of contract interpretation principles to the specialists, but every now and then I apparently dip my toe in, and this is another of those weeks.

VC Laster’s opinion in In re Anthem-Cigna Merger Litigation tells a truly wild tale.  In brief, Anthem and Cigna agreed to merge, but Cigna’s CEO, David Cordani, wanted to helm the combined entity. When it became clear he wouldn’t get the CEO spot, he began a campaign of sabotage, assisted by Cigna executives who supported his ambitions.  Thus, Cigna’s top leadership hired a PR firm to trash talk the merger while concealing the firm’s involvement from Cigna’s Board.  At one point, Cigna’s General Counsel personally leaked certain letters so they would be disclosed publicly, then tasked her head of litigation with conducting an internal investigation to discover the source of the leak.  Cigna’s foot-dragging with respect to integration planning and responding to regulators was so profoundly passive-aggressive that I felt my blood pressure rising – and this is despite the fact that Anthem was not exactly an angel: it lied in federal court proceedings, and the overall merger would certainly have reduced competition in an already-consolidated industry.

In any event, both sides sued, and Laster ultimately concluded that while Cigna’s breaches were many and varied, the merger would have failed anyway due to regulatory opposition.

But entertainment-value aside, a technical point caught my attention, and that’s the burden of proof framework that Laster adopted, and which is in some tension with the framework articulated by the Delaware Supreme Court in Williams v. ETE, 159 A.3d 264 (Del. 2017).  Notably, however, it’s not clear that the framework was outcome-determinative, and even if it was, the party harmed – Anthem – endorsed Laster’s interpretation in its post-trial briefing, so this couldn’t be grounds for an appeal.

The issue: Sometimes, a party’s obligation to perform on a contract may only be triggered if a particular condition occurs. In that case, if the condition does not occur, the obligation is not triggered.  But, if the party prevented the condition from occurring by breaching its own contractual responsibilities, the party is obliged to perform.

In this case, the performance obligation was the merger itself, subject to the condition that there be no regulatory injunction preventing consummation.  Such an injunction did issue, however, when federal courts held the merger would be anticompetitive.  Thus, the parties were nominally relieved of the obligation to close.  Anthem, however, claimed that Cigna’s lack of cooperation breached its obligations under the merger agreement, which was the cause of the regulatory failure.

Laster agreed that Cigna was flagrantly – nay, ostentatiously – in breach of its obligations to cooperate with regulators and to use its best efforts to close.  Thus, the only question was whether those breaches were responsible for the fatal injunction.  And here’s where the burden of proof issue comes up.

In Williams, the Delaware Supreme Court held, “once a breach of a covenant is established, the burden is on the breaching party to show that the breach did not materially contribute to the failure of the transaction.”  Words to that effect are repeated a couple of times in the opinion (e.g., “if a proper analysis of ETE’s covenants led to a conclusion that ETE breached those covenants, the burden would shift to ETE to prove that its breaches did not materially contribute to the failure of the closing condition”), and CJ Strine in dissent also wrote, “As the Majority notes, under our law if a party establishes a breach of a covenant to bring about a condition at closing, the burden is on the breaching party to show that the breach did not materially contribute to the failure of that closing condition.”

So these statements would suggest that all Anthem needed to do was show that Cigna breached its obligations.  After that, the burden would be on Cigna to show that the breaches did not materially contribute to the failure of the condition, i.e., were not responsible for the issuance of the injunction.

But Laster didn’t see it that way.  Both the Williams majority and the dissent cited in support Restatement § 245 comment b.  That section of the Restatement says:

Where a party’s breach by non-performance contributes materially to the non-occurrence of a condition of one of his duties, the non-occurrence is excused.

And the comment reads:

Although it is implicit in the rule that the condition has not occurred, it is not necessary to show that it would have occurred but for the lack of cooperation. It is only required that the breach have contributed materially to the non-occurrence. Nevertheless, if it can be shown that the condition would not have occurred regardless of the lack of cooperation, the failure of performance did not contribute materially to its non-occurrence and the rule does not apply. The burden of showing this is properly thrown on the party in breach.

To Laster, this suggested a more complex burden shifting framework.  First, Anthem would have to show that Cigna breached its obligations in a manner that contributed materially to the issuance of the injunction.  After establishing that, Cigna would have the opportunity to offer an affirmative defense that even if it had cooperated, the injunction still would have issued.  Laster found Williams unclear on this point, I believe, because despite the language I quoted above, it did not distinguish between proof that the breach contributed to the condition’s failure, and proof that lack of a breach would still have led to failure – inquiries that he believed were distinct. And there is precedent from other jurisdictions supporting Laster’s reading, for example, Cox v. Snap, 859 F.3d 304 (4th Cir. 2017) and Cogswell v. CitiFinancial Mortgage, 624 F.3d 395 (7th Cir. 2010).

And so, that’s how he proceeded.  Under this framework, Anthem was unable to make the initial showing that certain of Cigna’s breaches contributed to the injunction, but it did succeed in making that showing with respect to other breaches.  And at that point, the burden switched to Cigna which, Laster concluded, was able to establish that the outcome would have been the same regardless.

Now, all this might be angels-on-pinheads – after all, there were only two Delaware cases that anyone cited regarding this matter, Williams and WaveDivision Holdings, LLC v. Millennium Digital Media Systems, L.L.C., 2010 WL 3706624 (Del. Ch. Sept. 17, 2010) – so it apparently doesn’t come up all that often.  But it does come up.  The Restatement itself offers an illustration involving earn-outs (and, umm, also one involving a husband murdering his wife and then himself, which … okay, we’ll save that for a critical gender studies post), and those apparently have become more popular due to covid-related uncertainty (earnouts, I mean, not murder-suicides), so this is an issue that could have a subtle effect on outcomes in future cases.

October 3, 2020 in Ann Lipton | Permalink | Comments (0)

Saturday, September 26, 2020

Goodbye Iroquois Brands

The SEC made its long-awaited revisions to Rule 14a-8, which dramatically increase the dollar investment requirements, add a new prohibition on allowing shareholders to aggregate their holdings to meet those requirements, prohibit shareholder representatives from advancing proposals on behalf of more than one shareholder per meeting, and raise the resubmission thresholds, among other things.  In practical effect, these rules make it much more difficult for retail shareholders – who are unlikely to hold $15K or $25K of a single company’s stock in their portfolio – to advance proposals.  And, as Yaron Nili and Kobi Kastiel have documented, retail shareholders (and specific retail shareholders at that) have been the driving force behind a large number of proposals.  They find that – despite critics’ claims that these “gadflies” are advancing a personal agenda – their proposals frequently win majority support.  Thus, important corporate governance innovations have been driven, in part, by proposals advanced by retail investors.

Retail investors are not the only ones who advance proposals, though; pension funds do, as well.  That’s where the Department of Labor comes in.  As I previously blogged, the DoL has proposed new rules that would sharply limit ERISA plans’ ability to participate in corporate governance; assuming the rule goes into effect, that would knock out another source of proposals (and voting support for them). 

So who’s left?

ESG/sustainability-focused funds sometimes advance proposals, and that’s a growing field.  We know, however, that funds’ commitments to ESG – and their involvement in governance – varies tremendously, and so only a handful of funds may be participating in this space.

That leaves unusually wealthy/concentrated retail investors, and public pension funds, which are not subject to ERISA.

What about ordinary mutual funds?  Up until now, ordinary mutual funds never advance proposals, though they will vote in favor of them.  Nili and Kastiel argue that funds’ operate under various conflicts that make them uncomfortable taking the lead.  As I previously blogged, these funds actually supported the new restrictions (and even more draconian changes to the resubmission rules that were not enacted); this is because, I believe, they are not only subject to public scrutiny as to how they cast their votes, but they are also on the receiving end of proposals, and would like to relieve that pressure.  And when it comes to the Big Three and other large managers, it’s not as though they need a proposal to get management’s attention; they’re more than capable of quietly demanding operating changes if they want them.  Proposals are more likely to be a vehicle for shareholders who do not have that kind of influence individually.

Thus, one of the immediate effects of the rule change may be to take mutual funds out of the spotlight; their governance interventions (or lack thereof) will become immediately less transparent to investors and the public, and less easy to monitor.  Which is ironic, considering the Commission’s expressed concern about funds that sell a false narrative about their sustainability efforts.

Another irony is that many proposals seeks disclosure of more sustainability information – precisely the information the SEC has refused to require be disclosed because, the Commissioners have argued, relevant information varies from company to company.  Proposals are used to obtain company-specific information, and now that avenue will be narrowed, if not entirely closed.

I suspect, though, that ESG activists are a creative bunch, and we will see new proponents entering the space.  In a crowded ESG field, for example, some funds may find that advancing proposals can burnish their public reputations and attract new investment.  One possibility would be to proceed the way the proxy access project did, by advancing proposed bylaws that would lower the investment threshold at each company on a case-by-case basis.  Big Three opposition would be a serious stumbling block, but considering how much BlackRock and State Street, in particular, tried to hide their support for the new restrictions behind the Investment Company Institute, they might be persuaded to support at least limited, expanded access at specific companies.

September 26, 2020 in Ann Lipton | Permalink | Comments (0)