Business Law Prof Blog

Virtual ESG and Compliance Conference- November 7

 The Society of Corporate Compliance and Ethics is hosting a virtual ESG and Compliance Conference on November 7.  I love to hear academics talk about these issues at conferences but because I still engage in the practice of law and I teach about compliance, governance, and sustainability, I find the conversations are very different when listening to practitioners.

My panel is titled ESG Due Diligence Across the Corporate Lifecycle From Start-Up to Maturity: The Roles of Compliance, Ethics, Legal, and the Board. My co-panelists, Ahpaly Coradin, Partner, Pierson Ferdinand, and Eugenia di Marco, a startup founder and international legal advisor, and I will focus on:

•  how to measure and prioritize ESG factors at different stages of a company's life cycle, according to a company's industry, and technology use.
•  how ESG creates value in M&A  beyond risk mitigation and learn the impact of ESG on target selection, valuation, and integration.
• board and management responsibilities in overseeing and managing ESG-related risks, particularly in light of Caremark duties and Marchand.

Date & Time: Thursday, November 7 from 12:45 PM – 1:45 PM central time

Other topics that speakers will discuss include:

• Supply chains and European due diligence 
• Global regulatory and legislative developments
• Sustainable governance in a global landscape
• Materiality assessments
• The intersection of governance and ESG
• OECD Guidelines

Who should attend?  (from the brochure)

• Compliance officers
• ESG, sustainability, and CSR professionals
• Audit professionals
• CFOs
• General counsel
• Corporate secretaries
• Risk managers
• Investment managers
• Supply chain and due diligence professionals
• Outside advisors

Although the official brochure clearly doesn't target academics, I strongly recommend that my peers attend. It may help inform your research and teaching, and I know that my students are very interested in these issues. 

Are you teaching on any of these areas? And what do you think practitioners should be focusing on that they aren't?

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Guest Post: Shareholder Proposals and the Next Step in Overboarding Disclosures

I am please to be able to publish this post authored by our former BLPB editor/co-blogger Stefan Padfield.  We miss his voice here, but he is doing good work in his current role, as this post shows!  Thanks for contributing this, Stefan.

+++++

On November 14, 2023, the National Center for Public Policy Research (NCPPR) – where I work – submitted a shareholder proposal to Johnson & Johnson that sought disclosures related to overboarding. (For the uninitiated, overboarding refers to the issue of corporate directors sitting on too many boards but can also be extended, as it is here, to other commitments.) On March 1, 2024, the SEC staff informed J&J that no action would be recommended against the company by the staff if J&J excluded NCPPR’s proposal. This no-action relief arguably represents a change in the long-standing SEC practice of supporting proposals related to overboarding and is thus worthy of further examination. (The underlying documents can be accessed here; the SEC staff also granted no-action relief to Verizon and Lowe’s on the same proposal.)

By way of background, the SEC staff is on record as saying that an overboarding proposal “relates to director qualifications.” Accordingly, the SEC staff has stated in the past that it does “not believe that [a company] may omit [such a] proposal from its proxy materials in reliance on rule 14a-8(i)(7)” as improperly relating to the ordinary business of the company.

Admittedly, our proposal was unique in that it asked directors to “disclose their expected allocation of hours among all formal commitments set forth in the director’s official bio, with allocation being permissible “on a weekly, monthly, or annual basis.” And perhaps this is sufficient for some to categorize our proposal as excludable micromanagement, as the SEC staff did. However, there is a good argument to be made that “the SEC has incorrectly applied the micromanagement rule to exclude disclosure proposals.” More generally, the active shareholder proponent just quoted also noted in the same piece the SEC’s heavy and arguably excessive reliance on the micromanagement exclusion this season:

In reality, the most significant substantive development in the Rule 14a-8 process in the last two seasons has been largely ignored in the anti-shareholder furor. Far from representing a system unfairly tilted toward proponents, the SEC is more readily concurring with issuers’ increasingly aggressive use of the micromanagement exclusion…. According to preliminary calculations by the Shareholder Rights Group, in 2023, micromanagement arguments accounted for 8 out of 27, or 30%, of successful Rule 14a-8(i)(7) requests. In 2024 so far, micromanagement arguments have accounted for 25 of 56, or 44.6%, of winning requests based on the ordinary business/micromanagement rule.

Regardless, in addition to prior no-action decisions that deemed overboarding proposals nonexcludable, we later submitted a similar proposal to Verizon and added the following stakeholder perspectives to urge the SEC staff to reconsider its conclusion in Johnson & Johnson:

• Weil, Gotshal & Manges LLP: “The board should assess whether directors that may be overcommitted have sufficient time and ability to take on the significant tasks relating to public company directorship.” (Emphasis added.)
• Wachtell, Lipton, Rosen & Katz: “As board responsibilities grow, so has the focus on director bandwidth; directors should be realistic about their bandwidth when considering new opportunities for board service.”
• Vanguard: “The role of public company directors is complex and time-consuming, and the funds believe that directors should maintain sufficient capacity to effectively carry out their responsibilities to shareholders. For this reason, the funds look for directors to appropriately limit their board and other commitments to ensure that they are accessible and responsive to both routine and unexpected board matters …. The funds look for boards to have in place policies regarding director commitments and capacity and to disclose such policies (and any potential exceptions) to shareholders ….” (Emphasis added.)
• The Conference Board: “[W]hile adopting an overboarding policy can be useful, it is more important for boards to have candid conversations about their evolving time requirements and the ability of directors to devote the time necessary to the role.... In light of expanding workloads, boards should take a fresh look at the time commitments expected of directors …. Overboarding policies are now a predominant practice, embraced by three-quarters of the S&P 500 and over half the Russell 3000 and supported by the proxy advisory firms. But policies alone are insufficient. As part of the annual evaluation process, directors should assess their ability, both on an individual and collective level, to dedicate the necessary time to fulfill their responsibilities effectively and make informed decisions.” (Emphasis added.)
• State Street: “[I]n its Summary of Material Changes to State Street Global Advisors’ 2023 Proxy Voting and Engagement Guidelines, State Street[i] indicates that starting in 2024 for companies in the S&P 500, it will no longer use numerical limits to identify overcommitted directors and instead ‘require that companies themselves address this issue in their internal policy on director time commitments and that the policy be publicly disclosed.’” (Emphasis added.)

Furthermore, the need for the requested disclosure can be demonstrated by looking at the bio of a director at CVS, where our proposal was unopposed: J. Scott Kirby. Doing so reveals the following nine commitments.

1. Director, CVS
2. CEO, United Airlines
3. Director, United Airlines
4. Executive Committee, United Airlines Board
5. Finance Committee, United Airlines Board
6. Director, SONIFI Solutions
7. Chairman, Star Alliance Chief Executive Board
8. Member, Board of Governors of the International Air Transport Association
9. Director, U.S. Air Force Academy Foundation

Suffice it to say, many would presume that Mr. Kirby would more than have his hands full simply as CEO of United Airlines. Accordingly, it seems a small thing for CVS shareholders to ask for an estimate of how exactly there will be enough hours in the day for Mr. Kirby to juggle these nine commitments without depriving CVS of the critical attention he is being nominated to provide as director. And to the extent some might argue that listing committee assignments as discrete commitments improperly inflates the perceived workload, we say: (1) either the discrete commitment is material or the disclosure of that commitment in the official bio is misleading; (2) a company is free to attribute zero hours to any disclosed commitment, and is thereby free to clarify for shareholders that, for example, membership on the finance committee is a nominal position.

Given the ever-increasing responsibilities of corporate directors, as well as generally increasing demands on their time, limiting oversight of overboarding to counting board seats and CEO spots is unsustainable. Accordingly, we will likely be submitting a similar proposal next season and urging the SEC staff to reconsider its conclusion in Johnson & Johnson. Asking prospective directors how they intend to allocate their hours among their often numerous commitments should not be viewed as improper micromanagement but rather basic accountability fully within the ambit of shareholders to request.

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[i] Our overboarding proposal at CVS was apparently defeated by a vote of 97% against. In light of the comments here by State Street and the preceding comments by Vanguard, it would be interesting to see how those asset managers voted (assuming they hold shares in CVS).

Texas Tech Law Hiring - Business Law

The School of Law at Texas Tech University invites applications for a full-time, 9-month tenure-track Professor of Law position to begin in August of 2025.  The position is open to both entry-level candidates and candidates who are on the tenure-track or tenured at another school.  Candidates who satisfy Texas Tech University’s requirements to be hired with tenure will also be eligible to hold the Frank McDonald Endowed Professorship in business law.

Required Qualifications

In line with TTU’s strategic priorities to engage and empower a diverse student body, enable innovative research and creative activities, and transform lives and communities through outreach and engaged scholarship, applicants should have experience or demonstrated potential for working with diverse student populations at the undergraduate and/or graduate levels within individual or across the areas of teaching, research/creative activity, and service.

Specific required qualifications are:

1. Candidates should have a J.D.;
2. Candidates should have a demonstrated potential for excellence in research, teaching, and service; and
3. Candidates should have demonstrated potential for excellence in the areas of Contracts and in corporate/business law, such as Business Entities, Securities Regulation, Mergers & Acquisitions, and related courses.

Preferred Qualifications

In addition to the required qualifications, individuals with the following preferred qualifications are strongly encouraged to apply:  Experience teaching corporate/business law courses and scholarly publications in corporate/business law areas.

About the University and School of Law

Established in 1923, Texas Tech University is a Carnegie R1 (very high research activity) Doctoral/Research-Extensive, Hispanic Serving, and state-assisted institution. Located on a beautiful 1,850-acre campus in Lubbock, a city in West Texas with a growing metropolitan-area population of over 300,000, the university enrolls over 40,000 students with 33,000 undergraduate and 7,000 graduate students.  As the primary research institution in the western two-thirds of the state, Texas Tech University is home to 10 colleges, the Schools of Law and Veterinary Medicine, and the Graduate School.  The flagship of the Texas Tech University System, Texas Tech is dedicated to student success by preparing learners to be ethical leaders for a diverse and globally competitive workforce.  It is committed to enhancing the cultural and economic development of the state, nation, and world.

The School of Law has approximately 440 students and 38 full-time faculty members.  The School of Law is an integral part of the University and offers 10 dual-degree programs with other Texas Tech schools and colleges. The School of Law has a strong focus on students and is committed to a practical education to produce practice-ready graduates.

About Lubbock

Referred to as the “Hub City” because it serves as the educational, cultural, economic, and health care hub of the South Plains region, Lubbock boasts a diverse population and a strong connection to community, history, and land.  With a mild climate, highly rated public schools, and a low cost of living, Lubbock is a family-friendly community that is ranked as one of the best places to live in Texas.  Lubbock is home to a celebrated and ever-evolving music scene, a vibrant arts community, and is within driving distance of Dallas, Austin, Santa Fe, and other major metropolitan cities.  Lubbock’s Convention & Visitors Bureau provides a comprehensive overview of the Lubbock community and its resources, programs, events, and histories.

Equal Opportunity Statement

All qualified applicants will receive consideration for employment without regard to race, color, religion, sex, sexual orientation, gender identity, gender expression, national origin, age, disability, genetic information or status as a protected veteran.

To Apply for this Position

Please include the following documents in your application at the Texas Tech Jobs website  https://www.depts.ttu.edu/hr/workattexastech/

• Curriculum Vitae
• Cover Letter
• List of references

Questions about this position should be directed to Jarod Gonzalez, J. Hadley and Helen Edgar Professor of Law and Chair, Faculty Appointments Committee at [email protected]. For your application to be considered, you must submit it at the Texas Tech Jobs website. If you need assistance with the application process, contact Human Resources, Talent Acquisition at [email protected] or 806-742-3851.

Application Process

Submission of applications is preferred by September 16, 2024. To ensure full consideration, please complete an online application at https://www.depts.ttu.edu/hr/workattexastech/ Requisition # 38114BR.

ESG Greenwashing

ESG greenwashing has been getting attention among legal academics.  In Rainbow-Washing, 15 Ne. U. L. Rev. 285 (2023), LMU Law's John Rice explores the

increasingly common, but destructive, practice in which corporations make public-facing statements espousing their support of the LGBTQIA+ community . . . to draw in and retain consumers, investors, employees, and public support, but then either fail to fulfill the promises implicit in those statements or act in contravention to them. 

My own forthcoming article in the University of Pennsylvania Journal of Business Law, presented at the November 2023 ILEP-Penn Carey Law symposium honoring Jill Fisch, mentions the increasing notoriety of ESG greenwashing and cites to John's article.

Last week, UVA Law Professor Naomi Cahn called out ESG greenwashing in Forbes, citing to a study to be published in the Journal of Accounting Research that finds "firms’ ESG rhetoric may not match their reality."  She suggests that "a meaningful analysis of a firm’s ESG commitment requires much further digging, and ultimately it requires meaningful oversight from outside the ESG community on what should be disclosed and the accuracy of the reports."  The article references a forthcoming book coauthored by Cahn, June Carbone (Minnesota Law) ,and Nancy Levit (UMKC Law) and quotes Minnesota Law Professor Claire Hill.  (Hat tip to Claire for leading me to this Forbes piece.)  It's a solidly good read.  I added a citation to it in my forthcoming article.

I suspect more will be done in this space academically and practically as ESG continues to occupy the minds of legal academics, lawyers, and business principals.  I will be continuing to work in this area, focusing next on corporate compliance issues.  Stay tuned for news on that project (and for a notification about the publication of my forthcoming University of Pennsylvania Journal of Business Law article referenced above).

2024 Corporate & Securities Litigation Workshop

Corporate & Securities Litigation Workshop: 

Call for Papers 

UCLA School of Law, in partnership with the University of Illinois College of Law, University of Richmond School of Law, and Vanderbilt Law School invites submissions for the Eleventh Annual Workshop for Corporate & Securities Litigation. This workshop will be held on September 20-21, 2024 in Los Angeles, California. 

Overview 

This annual workshop brings together scholars focused on corporate and securities litigation to present their scholarly works. Papers addressing any aspect of corporate and securities litigation or enforcement are eligible, including securities class actions, fiduciary duty litigation, and SEC enforcement actions. We welcome scholars working in a variety of methodologies, as well as both completed papers and works-in-progress at any stage. Authors whose papers are selected will be invited to present their work at a workshop hosted by UCLA School of Law. Participants will pay for their own travel, lodging, and other expenses. 

Submissions 

If you are interested in participating, please send the paper you would like to present, or an abstract of the paper, to [email protected] by Friday, June 7, 2024 Please include your name, current position, and contact information in the e-mail accompanying the submission. Authors of accepted papers will be notified in early July. 

Questions 

Any questions concerning the workshop should be directed to the organizers: Jim Park ([email protected]), Jessica Erickson ([email protected]), Amanda Rose ([email protected]), and Verity Winship ([email protected]). 

I Still Think My Disclosure Advice to Clients is the Same After Macquarie

I appreciate Ann's super helpful post on omissions liability after the U.S. Supreme Court's decision in Macquarie Infrastructure Corp. et al. v. Moab Partners, L. P., et al.  The hair splitting in that opinion is, in my view, dubious at best.  The Court's creation of a legally significant concept of "pure omissions" in a public company disclosure context is doctrinally counterfactual.  The omission to state a fact required to be disclosed under a mandatory disclosure rule like Item 303 of Regulation S-K necessarily occurs in a veritable river of disclosures in SEC filings and more generally and has the potential of making those disclosures misleading.  If material, such an omission should be actionable as deceptive or manipulative conduct under Section 10(b) of and Rule 10b-5 under the Securities Exchange Act of 1934, as amended.  Period.

Of course. civil liability would require proof of all elements of the claim, including (even for public enforcement officials) the requisite state of mind or scienter.  Private class action plaintiffs also would have heightened pleading burdens.  And a criminal prosecution can only be sustained if the predicate conduct is willful, as provided in Section 32(a) of the Exchange Act.

The point is that there is no such thing as a "pure omission."  Investors logically rely on the interplay between and among public statements made in filings and elsewhere.  If X exists for Public Company A, and Public Company A is required to disclose X in a public filing but does not do so, investors will view and assess all of the relevant public information about Public Company A assuming X does not exist for Public Company A.  If the omission makes existing disclosures misleading, is material, is made withe the action-appropriate state of mind, and deceives or manipulates, the basis for a Rule 10b-5 cause of action against Public Company A plainly exists based on the language of Section 10(b) and Rule 10b-5.  Back in January, wben I first wrote about Macquarie and an amicus brief I coauthored for the case (which you can fined here), I stated as much.  It seems Ann agrees when she says that "whatever the language of 10b-5(b), it seems entirely unobjectionable that it should be considered a “manipulative or deceptive device or contrivance” within the broader meaning of Section 10(b) to intentionally withhold information you have a duty to disclose – from some other source – in order to mislead someone else."  (Her further analysis follows.)

As Ann's post notes, much remains to be seen and said about the impact of Macquarie, and the Court has signaled that the true wisdom we can gain from its opinion in Macquarie may be constrained to actions brought under Rule 10b-5(b) and to certain factual contexts.  As a result, I have determined it is still appropriate--and wise--to caution public company clients that their failure to comply with mandatory disclosure requirements may make them subject to, among other things, Section 10(b)/Rule 10b-5 litigation.  One should, of course, note (among other things) that the omission would have to be material, make other disclosed facts misleading, and be made recklessly or willfully in order for liability to attach. 

Do you disagree?  Do you believe there are "pure omissions" in a public company disclosure context? Let me know.

 

Trial Court Blesses Shadow Insider Trading

A federal jury found Matthew Panuwat liable for insider trading late last week.  As you may recall, the U.S. Securities and Exchange Commission (SEC) brought an enforcement action against Mr. Panuwat in the U.S. District Court for the Northern District of California back in August 2021.  In that legal action, the SEC alleged that Mr Panuwat violated Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5, seeking a permanent injunction, a civil penalty, and an officer and director bar. The theory of the case, as described by the SEC in a litigation release, was founded on Mr. Panuwat's deception of his employer, Medivation, Inc., by using information obtained through his employment to trade in the securities of another firm in the same industry.

Matthew Panuwat, the then-head of business development at Medivation, a mid-sized, oncology-focused biopharmaceutical company, purchased short-term, out-of-the-money stock options in Incyte Corporation, another mid-cap oncology-focused biopharmaceutical company, just days before the August 22, 2016 announcement that Pfizer would acquire Medivation at a significant premium. Panuwat allegedly purchased the options within minutes of learning highly confidential information concerning the merger. According to the complaint, Panuwat knew that investment bankers had cited Incyte as a comparable company in discussions with Medivation and he anticipated that the acquisition of Medivation would likely lead to an increase in Incyte's stock price. The complaint alleges that Medivation's insider trading policy expressly forbade Panuwat from using confidential information he acquired at Medivation to trade in the securities of any other publicly-traded company. Following the announcement of Medivation's acquisition, Incyte's stock price increased by approximately 8%. The complaint alleges that, by trading ahead of the announcement, Panuwat generated illicit profits of $107,066.

The SEC's theory of liability, an application of insider trading's misappropriation doctrine as endorsed by the U.S. Supreme Court in U.S. v. O'Hagan, has been labeled "shadow trading."

The Director of the SEC's Division of Enforcement, Gurbir S. Grewal, put it plainly in responding to the jury verdict in the Panuwat case on Friday:

As we’ve said all along, there was nothing novel about this matter, and the jury agreed: this was insider trading, pure and simple. Defendant used highly confidential information about an impending announcement of the acquisition of biopharmaceutical company Medivation, Inc., the company where he worked, by Pfizer Inc. to trade ahead of the news for his own enrichment. Rather than buying the securities of Medivation, however, Panuwat used his employer’s confidential information to acquire a large stake in call options of another comparable public company, Incyte Corporation, whose share price increased materially on the important news.

Yet, many assert that the SEC's theory in Panuwat broadens the potential for SEC insider trading violations and enforcement.  See, e.g., here, here, and here. They include:

• a wide class of nonpublic information that may be determined to be material and give rise to an insider trading claim;
• the expansive scope of insider trading's requisite duty of trust and confidence (and the potential importance of language in an insider trading compliance policy or confidentiality agreement in defining that duty); and
• the potentially large number of circumstances in which employees may be exposed to confidential information about their employer that represents a value proposition in another firm's securities.

Three of us on the BLPB have held some fascination regarding the Panuwat case over the past three years.  Ann put the case on the blog's radar screen; John later offered perspectives based on the language of Medivation's insider trading compliance policy; and I offered comments on John's post (and now offer this post of my own).  I am thinking we all may have more to say on shadow trading as additional cases are brought or as this case further develops on appeal (should there be one).  But in the interim, we at least know that one jury has agreed with the SEC's shadow trading theory of liability.

Finfluencers and the Reasonable Retail Investor

Calling attention today to Sue Guan's paper, Finfluencers and the Reasonable Retail Investor, posted on SSRN and forthcoming to the University of Pennsylvania Law Review Online.  The abstract is copied in below.

Much recent commentary has focused on the dangers of finfluencers. Finfluencers are persons or entities that have outsize impact on investor decisions through social media influence. These finfluencers increasingly drive investing and trading trends in a wide range of asset markets, from stocks to cryptocurrency. They do so because they can provide powerful coordination mechanisms across otherwise diffuse investor and trader populations. Of course, the more influence wielded over their followers, the easier it is for finfluencers to perpetrate fraud and manipulation.

The increase in finfluencing has highlighted a gray area in the securities laws: a finfluencer's statements may not be factually untrue or clearly deceptive, but they can be interpreted as misleading depending on the context and the particular beliefs held by the finfluencer’s social media followers. Moreover, such statements can harm investors who buy or sell based on their interpretation of the finfluencer's activity. In other words, finfluencers can easily profit off of their followers' trading activity while steering clear of the securities laws.

A recent case has narrowed finfluencers' ability to do so. This Piece argues that In re Bed Bath and Beyond provides a path to holding finfluencers accountable even when they have not made clearly untrue statements. In considering materiality, In re Bed Bath and Beyond focuses on the reasonable retail investor. This places primacy on retail investors’ interpretation of social media activity and narrows a gap in securities oversight, demonstrating that existing securities laws can be flexible enough to deter and punish a significant portion of problematic finfluencer behavior. In doing so, it opens a path forward for harmed retail investors to seek redress from careless finfluencers.

Sue offers a video summary here. 

In this work, Sue takes on one of my favorite topics: materiality.  She sees the potential for courts to use the reasonable retail investor--as opposed to the reasonable investor--as the reference point for materiality analysis in securities fraud actions.  Truly interesting.

Social media does move markets.  Investors, retail investors, act on what they read in social media.  They may even act based on interpretations of emojis, as  Sue suggests.  I appreciate her taking on the legal aspects of market behavior in this context.  I am confident more will be said about this as additional cases are brought.

Remembering Roberta Karmel

I learned earlier this week of the death of Brooklyn Law Professor Roberta Karmel.  Roberta was extraordinary, and I miss her already.  Much has been written about her role in our profession--including her service as the first female commissioner at the Securities and Exchange Commission.  I will only add a few personal reflections here.

Roberta was both exacting and compassionate--traits that we sometimes think of as being mutually exclusive.  Small in stature, she somehow was still formidable.  When I first met her in a setting where she was commenting on academic work, I was impressed and intimidated.  Despite my extroversion, I was hesitant to introduce myself and reach out to her in friendship.  When I later admitted that to her, she laughed and (in that inimitable voice we all know and will remember) let me know how silly that was.

Roberta was the honored keynote speaker at our 2009 law graduation (hooding) ceremony at The University of Tennessee College of Law.  She was invited by a student committee that understood well her significance to the law and legal education communities.  She shared details of her life and career with us.  It was inspirational for me, even though I knew parts of the story.  Hearing that history in her own voice was priceless.

I was blessed to be part of a symposium held back in May 2021 to honor Roberta's career.  My paper from that symposium reflects on and extends an earlier published piece of her work.  I offered a post on that paper here.  As I note in that post, having the opportunity to review and dissect Roberta's work helped me in my own.

Thinking about all of this today does make me sad. Roberta's wisdom and voice will no longer add new ideas to the mix.  However, there also is cause for gratitude and hope.  She has left a strong legacy--one that we all can continue to reflect on and use in our work for many years to come.

David Rosenfeld on Insider Trading and Rule 10b5-1 Plans

The University of Chicago Business Law Review recently published an interesting and engaging article written by David Rosenfeld.  The article is entitled "Insider Abstention and Rule 10b5-1 Plans" and is available on SSRN.  The SSRN abstract for David's article follows.

Company insiders will typically be in possession of material non-public information (MNPI) about their companies. In order to allow insiders the opportunity to trade, the SEC adopted Rule 10b5-1, which provides an affirmative defense to insider trading liability if the trades are made pursuant to a written plan or trading instruction entered into when the trader was not aware of MNPI. Over the years, there has been considerable concern that insiders were abusing Rule 10b5-1 plans by adopting plans just prior to trading, adopting multiple plans, or even terminating plans when they turned out to be unprofitable. The SEC recently adopted new rules designed to curb some of the more abusive practices, but one significant problem remains: while Rule 10b5-1 plans are supposed to be irrevocable, insiders who back out of plans have so far escaped liability under the central anti-fraud provision of the federal securities laws, principally because a violation of that provision requires an actual trade.

The issue of “insider abstention”—insiders who decide not to trade based on MNPI—has long bedeviled insider trading law and policy. Insider abstention is typically undetectable and unknowable, raising insurmountable issues of proof, while the general requirement that fraud be “in connection with the purchase or sale of a security” imposes a rigid legal barrier. But Rule 10b5-1 plans stand on a different evidentiary footing: they are written plans, communicated to third parties, creating a clear record of intent. The only real question is whether legal liability can attach in the absence of an actual purchase or sale of a security.

Traditionally, the answer to this question has been no. The SEC staff has stated on a few occasions that cancellation of a Rule 10b5-1 plan would not in itself lead to liability under Rule 10b-5 because terminating a plan would not meet the “in connection with” requirement. However, Rule 10b-5 is not the only statutory provision that has been used to prosecute insider trading. The SEC has frequently prosecuted insider trading under Section 17(a) of the Securities Act, a provision that applies not only to the “sale” of securities but extends more broadly to “offers” to sell securities. And criminal authorities have increasingly been prosecuting in sider trading under mail and wire fraud statutes that do not have an “in connection with” requirement at all. These other statutory provisions could provide a basis for insider trading liability in the context of a cancelled or terminated Rule 10b5-1 plan.

I had the opportunity to review this paper in an earlier draft and found it illuminating and helpful.  I was interested in the piece in part because of recurrent concerns about insider trading abuses and reforms relating to Rule 10b5-1 plans.  As readers may recognize, the BLPB has featured posts in this regard, including this one by John Anderson. 

In this article, as in other aspects of David's work, David brings the keen eye of a former U.S. Securities and Exchange Commission enforcement professional to the question--an undoubtedly valuable lens.  Moreover, insider trading discussion groups in which I have participated at conferences in recent years have increasingly focused on the creative enforcement of insider trading under legal theories outside Section 10(b) of and Rule 10b-5 under the Securities Exchange Act of 1934, as amended.  David's article acknowledges and extends the reach of this trend.  Overall, the article is a fun and insightful read.

 

Supreme Court to Hear Important Securities Fraud Case - Tomorrow!

Tomorrow morning, the U.S. Supreme Court will be hearing oral arguments on a securities fraud case for which I am an amicus brief coauthor.  The case is: Macquarie Infrastructure Corporation, et al. v. Moab Partners, L.P., et al. (No. 22–1165, Certiorari to the C. A. 2nd Circuit).  The Court convenes at 10 am and has allotted one hour for oral argument: 30 minutes for the petitioners, 20 minutes for the respondent, Moab Partners, and 10 minutes for the U.S. Securities and Exchange Commission (“SEC”), as amicus supporting the respondents.  An audio feed of the argument is live-streamed on the Court's website, and the Court posts the audio later in the day.

The question presented to the Court is: "May a failure to make a disclosure required under Item 303 of SEC Regulation S-K support a private claim under Section 10(b) of the Securities Exchange Act of 1934, even in the absence of an otherwise misleading statement?"  The issue in the case, in essence, is whether a mandatory disclosure rule properly adopted by the SEC gives rise to a duty to disclose that can be the basis of a securities fraud claim under Section 10(b) of and Rule 10b-5 under the Securities Exchange Act of 1934, as amended.  There is a circuit split on this issue.  As most of you know, in 1988, in Basic v. Levinson, the Supreme Court offered that “[s]ilence, absent a duty to disclose, is not misleading under Rule 10b-5.”  A duty to disclose is therefore a foundational element in a Section 10(b)/Rule 10b-5 claim.  Of course, the elements of proof extend beyond this essential disclosure duty element—including by incorporating the requirement that there be a misstatement or misleading omission of a material fact).

The Macquarie case involves a corporation’s alleged failure to comply with an SEC mandatory disclosure rule.  The corporation and other original defendants are the petitioners.  Our brief argues in favor of the respondents.  In sum, we argue that the SEC disclosure requirement creates a judicially cognizable duty to disclose for purposes of a claim under Section 10(b)/Rule 10b-5.  Accordingly, we contend that the omission of the required disclosure provides a basis for a Section 10(b)/Rule 10b-5 claim.  An omission to state material fact required to be disclosed under an SEC mandatory disclosure rule may mislead investors who expect that any required disclosure is made or inapplicable.

Many of us teach in this space.  If you have time to listen in, the argument may illuminate some new things.  And it is bound to be interesting, regardless.

Rotten Eggs and Congressional Insider Trading

In June, at the National Business Law Scholars Conference in Knoxville, I sat in on a paper panel featuring Sarah Williams's work in process, Regulating Congressional Insider Trading: The Rotten Egg Approach.  A draft of the resulting paper, forthcoming in the Cardozo Law Review, has been made available on SSRN.  The abstract is copied in below.  

A 2004 study revealed that the stock portfolios of members of Congress were consistently outperforming those of the investing public. The financial success of federal lawmakers was statistically correlated to the use of nonpublic information obtained in connection with the performance of legislative responsibilities – reasonably characterizable as insider trading. Cries of dismay over such profiteering by lawmakers have been echoing in the public domain since Samuel Chase, Maryland’s representative in the Continental Congress, cornered the flour market in 1788 after learning that copious quantities of the product would be purchased by the government to support the Continental Army. Notwithstanding efforts to apply insider trading law to curb this behavior and the enactment of the Stop Trading on Congressional Knowledge (“STOCK”) Act, fortuitous securities transactions by members of Congress continue to occur in connection with headlining national events; it was recently observed with respect to news of the financial collapse of certain regional banks.

While there is scholarly and political support for laws that would effectively ban such rotten egg behavior, this Article proposes that the conduct be regulated under the statute created with rotten eggs in mind – the Securities Act of 1933. The Securities Act creates speedbumps for persons in a control relationship with issuers who want to sell the issuer’s securities in the secondary market. The speedbumps require both public disclosure and broker inquiry. This article asserts that senators and house representatives are in a control relationship with issuers such that they transcend the status of ordinary investor in the securities law regime and must navigate the obstacles established under the Securities Act for such persons before selling their securities in the secondary market. This approach eliminates the legal and evidentiary challenges of insider trading theory, provides a disclosure mechanism that is vastly more effective than that provided by the STOCK Act, and deploys broker-dealers as gatekeepers to ensure that such trades do not undermine the maintenance of fair markets.

As you can see, she takes a novel, creative approach to a tough, longstanding issue.  I look forward to reading the draft.

Materiality and the SEC's Rulemaking Authority

Over the summer, friend-of-the-BLPB Bernie Sharfman posted a draft paper to SSRN that was the subject of a short colloquy between us.  The paper, The Ascertainable Standards that Define the Boundaries of the SEC's Rulemaking Authority, asserts, among other things, that materiality is one of three "ascertainable policy standards that Congress has placed in the Acts to guide the SEC’s rulemaking discretion."  The reasoning? 

• "[T]here are multiple references to materiality in the Acts."
• The SEC's 1972 annual report avers that "[a] basic purpose of the Federal securities laws is to provide disclosure of material financial and other information on companies seeking to raise capital through the public offering of their securities, as well as companies whose securities are already publicly held."
• "As observed by Professor Ruth Jebe, it is fair to say that materiality 'constitutes the primary framing mechanism for financial reporting.'"

Bernie acknowledges that "there is no explicit statutory language in the Acts that forbids the SEC from promulgating rules requiring non-material disclosures."  I might add that nothing in either the Securities Act of 1933, as amended ("1933 Act"), or the Securities Exchange Act of 1934, as amended ("1934 Act"), explicitly limits the SEC's rulemaking authority to rules qualified by materiality.

Since the U.S. Congress knew to use materiality to qualify some disclosure, enforcement, and other responsibilities under the 1933 Act and the 1934 Act and not others, it easily could have provided an express constraint on the SEC's overall rulemaking authority in that regard.  Arguably, since Congress did not qualify all of the disclosure mandates in the 1933 Act or 1934 Act by materiality, SEC rulemaking that introduces a materiality qualification may be subject to unfavorable scrutiny.  (Congress could then take the view that, if it had meant to restrict the statutory disclosure or other mandates to only those items that are material, it would have said so.)  Yet, overall, Congress has delegated relatively broad authority to the SEC to engage in rule making that serves the investor protection, market integrity maintenance, and capital formation policies underlying the various provisions of the 1933 Act and the 1934 Act.

For example, Schedule A to the 1933 Act sets forth the initial disclosure mandates provided for by Congress for registration statements. See §7(a)(1) of the 1933 Act.  Congress then notes that the SEC "may by rules or regulations provide that any such information or document need not be included in respect of any class of issuers or securities if it finds that the requirement of such information or document is inapplicable to such class and that disclosure fully adequate for the protection of investors is otherwise required to be included within the registration statement."  Id. The disclosure requirements for registration statements are now executed primarily through registration forms adopted by the SEC under the 1933 Act.  In both Schedule A and in the forms of registration statement adopted by the SEC under the 1933 Act, disclosures were or are required that are not expressly qualified by materiality.  In fact, few of the mandatory disclosures in Schedule A are limited only to supplying material information.  The same is true for the initial disclosure mandates applicable to 1934 Act registration statements.  See § 12(b) of the 1934 Act.

There's more I could say, but I will leave it there for now.  As you might guess from the above, I am skeptical, at best, about the argument that materiality is a required constraint on SEC rule making.  I consider Congress's words and actions to be most important in this matter (absent any issues identified under the U.S Constitution).  Your thoughts on the asserted materiality constraint are welcomed.

Teaching the Core of the Securities Act of 1933

It was so much find to have our business law prof colleague Erik Gerding and two fabulous key members of his staff here in Knoxville yesterday.  I had posted on this visit last week.  Our visitors regaled us on the role of the U.S. Securities and Exchange Commission ("SEC") Division of Corporation Finance, the registration requirements and exemptions under the Securities Act of 1933, as amended ("1933 Act"), and the rule-making part of the Division's (and SEC's) mission.

Erik explained how, when he is teaching Securities Regulation, he spends two classes at the beginning of the semester putting the "fear of God" into his students about the registration requirement in Section 5 of the 1933 Act.  (His point is to make the dangers clear up front, since students tend to drop the class who should take it, given that they plan to practice business law in one way or another.)  Erik's colleague, Jennifer Zepralka, Chief of the SEC's Office of Small Business Policy, similarly noted in her remarks that there are only three kinds of securities offerings: registered, exempt from registration, and illegal.  Erik's Counsel, Jeb Byrne, echoed this.  And in the session at lunch time, one of my students (bless him!) was able to articulate my way of teaching this concept, through what I call the commandment of Section 5: "Thou shalt not offer or sell securities with out registration absent an exemption."  I used forced repetition of that commandment in teaching my Securities regulation course to refocus students as we move through the material.

Teachers of Business Associations and Securities Regulation all must contend with this central premise of the 1933 Act.  Its importance truly cannot be overstated.  So, how do you teach it to your students and make it stick?  And if you do not teach, what made the core value of Section 5 salient for you?  Share your wisdom in the comments.

Tennessee Law Welcomes the SEC Division of Corporation Finance!

We are excited to welcome our colleague Erik Gerding, the Director of the U.S. Securities and Exchange Commission Division of Corporation Finance, together with members of his staff, to The University of Tennessee College of Law a week from today. Information about the visit is included below.  If you are in the neighborhood, stop by!

Ripple and Forman

Thanks to Ann for her great "So, Ripple" post last week.  I have been waiting for a case like this—one that engages a court in the details of how the Howey test applies to the way different types of  cryptoassets work.  I was especially interested in how the court in the SEC v. Ripple Labs opinion would handle the different ways in which cryptoassets are sold and traded.  Well, now we have an opinion to work with.

I especially appreciate Ann setting the stage so well with the doctrinal legal background of the case.  Well done, friend!  Like Ann, I teach Securities Regulation every year.  Unlike Ann, I am gleeful about teaching definitional content in the federal securities laws, including the definition of the term "security."  It is amazing how, as financial investment instruments have evolved, significant numbers of practitioners and their clients have paid insufficient attention to the niceties of that definition and the definition of the embedded term "investment contract."

Like Ann, I am comfortable that a single financial instrument can be a security in some contexts and not in others.  And, like Ann, I have questions about the court's analysis in Ripple.  Specifically, I am disappointed in the way the Ripple court fails to take on the profit expectations element of the Howey test head-on—especially as to the "Programmatic Sales" made by Ripple—sales made into the XRP market after Ripple's initial "Institutional Sales" were made.  Instead, the court’s opinion joins the concept profit expectations to the efforts of others in its analysis in ways that I find perplexing.  Undertaking an analysis of the profit expectations piece of the Howey test independently may be hard work.  But it may have been worth the court's while to dig in more on whether the purchasers of XRP expect profits before assessing whether those profits are generated through the efforts of others. 

For this profit expectations part of the Howey analysis, I reflect on the U.S. Supreme Court's opinion in United Housing Foundation v. Forman.  Leaving aside the fact that Forman was really a case about whether stock—not an investment contract—is a security, the Forman Court defines financial instrument profits in three distinct ways:

• "capital appreciation resulting from the development of the initial investment" (421 U.S. at 852)
• "a participation in earnings resulting from the use of investors' funds" (421 U.S. at 852)
• the ability to resell at a price that exceeds the cost of purchase (421 U.S. at 854)

The Ripple opinion somewhat addresses each of these potential types of profit, but not always directly, distinctly, or completely.  The court focuses significantly on the first of the three, noting that "the Institutional Buyers reasonably expected that Ripple would use the capital it received from its sales to improve the XRP ecosystem and thereby increase the price of XRP," but that "Programmatic Buyers could not reasonably expect the same." (And I am not sure about that latter piece, by the way.)

Considerations relating to the third profit type, however, may be the most interesting—and challenging in application.  After reading the court's analysis, I still had many questions about whether those who bought the XRP that Ripple was selling in the Programmatic sales were buying because of anticipated market appreciation—appreciation that may be generated in part by the activities of Ripple in establishing and promoting (not to mention selling) XRP—or for more instrumental reasons.  The court finds that "each Institutional Buyer’s ability to profit was tied to Ripple’s fortunes and the fortunes of other Institutional Buyers because all Institutional Buyers received the same fungible XRP."  Yet, those who purchased XRP in Programmatic Sales also receive that same fungible XRP.  In general, I wonder how the Programmatic Sales made by Ripple are different from sales of stock made by, e.g., a founder into a preexisting trading market—an analogy worth considering.

The Ripple court's analysis of profit expectations under Howey in its opinion is, however, combined with its inquiry as to the "efforts of others."  In my teaching, I separate Howey into five prongs: (1) contract, transaction, or scheme; (2) investment of money; (3) common enterprise; (4) expectation of profits; (5) efforts of others.  Overall in my work (as exemplified in this article, in which I apply the Howey test to early crowdfunding interests), I have found it helpful to engage each of these five prongs of Howey independently, then follow with a synthesis that looks at the overall context in which the security determination is being made (including the related "economic realities" of the instrument in the circumstances).  That analysis of context is, of course, invited by the lead-in to Section 2(a) of the Securities Act of 1933, as amended (the “1933 Act”), which qualifies the definitions offered in Section 2(a) by an assessment of whether "the context otherwise requires."

The Ripple court’s failure to keep the two prongs—expectation of profits and efforts of others—analytically separate handicaps the court from addressing the Forman Court's core argument relating to the connection between the investment of money prong and the expectation of profits prong: that an instrument may represent a consumption or other interest, rather than an investment or profit-making interest.  Those who invest do so with the goal of achieving financial gain or another element of value.  The Forman Court's reasoning as applied in Ripple logically would result in a judicial determination of the nature of the XRP interest purchased by those acquiring XRP in the Programmatic Sales, which may well be different from the nature of the XRP interest acquired in the Institutional Sales.  Why were purchasers of XRP acquiring it at the time Ripple was selling in the Programmatic Sales?  What was at the heart of their acquisitions of XRP? The Ripple court fails to grapple with these questions.

The Ripple court does acknowledge in its opinion that some of those purchasers may have acquired XRP because they expected profits—even profits generated through Ripple’s efforts.  The court offers: “Of course, some Programmatic Buyers may have purchased XRP with the expectation of profits to be derived from Ripple’s efforts.”  But it discounts this rationale without offering an alternative.  Instead, the court points out that Ripple never made any promises to the purchasers of XRP who bought in Programmatic Sales.  Yet, explicit promises between a seller and a buyer are not the only conduct that can lead purchasers of financial instruments to expect profits . . . .

In that regard, the Ripple opinion somewhat conflates its Howey analysis of the "efforts of others" with an assessment of whether (and if so, how) Ripple offered to sell XRP to those who bought it (which may be irrelevant since Ripple did sell XRP into the market).  Section 5 of the 1933 Act—the legal provision that the Securities and Exchange Commission asserts Ripple violated—only applies to offers and sales of securities.  Consequently, it would seem logical to determine first whether what was offered or sold is a security and only then to address whether that security was offered or sold by the defendant. 

Instead, in analyzing whether there was an expectation of profits (and whether Ripple's efforts were sufficiently connected with profit generation) under the Howey test, the Ripple court focuses on whether the XRP purchasers knew from whom they were buying and where their money was going, alluding to a privity or tracing requirement of sorts.  Specifically, the Ripple opinion avers that “with respect to Programmatic Sales, Ripple did not make any promises or offers because Ripple did not know who was buying the XRP, and the purchasers did not know who was selling it,” noting that "a Programmatic Buyer stood in the same shoes as a secondary market purchaser who did not know to whom or what it was paying its money."  These considerations are more applicable to a determination of whether Ripple was offering or selling securities to a particular purchaser—a consideration relevant in a private action under Section 12(a)(1) of the 1933 Act—than to the determination of whether XRP is a security when it is sold by Ripple into a pre-existing market.

There’s more I could say on all of this, but this post already has gotten quite long.  So, I will leave it here.  Suffice it to say, in addition to the profit expectations analysis in the Ripple opinion, I have questions about the Ripple court’s analysis of the investment of money and expectation of others prongs of the Howey test.  Perhaps some of that will be a good topic for another post . . . .

Time for an Italian Symposium!

Ciao, from Italy.

Tomorrow, I have the privilege of sharing my work in an international symposium at the University of Genoa at the invitation of Vanessa Villanueva Collao.  This symposium offers a unique opportunity for transnational collaboration among corporate governance scholars.  We also are celebrating Vanessa's completion of her J.S.D. degree (University of Illinois 2023).  

I am presenting my paper, forthcoming in the Michigan State Law Review, on civil insider trading in personal networks.  This is the companion paper to my article on criminal insider trading in personal networks, recently published in the Stetson Business Law Review and part of my larger, long-term project on U.S. insider trading in friendships and family situations.  As many readers may know, this project has fascinated me for a number of years now.  Each phase of the project offers new insights.  And each audience helps provide valuable food for thought. I am confident that the participants in and audience members at tomorrow's symposium will be no exception.  I look forward to the interchanges on my work and the work of others being featured.

The program for the symposium is included below.  You will see more than a few fascinating members of the U.S. corporate governance law academic community (and friends of the BLPB) on the program for this event!  It is always good to reconnect with colleagues, especially our contributors and readers.

 

In Memory; Harvey Pitt

The following message was received by me earlier this evening from the SEC Historical Society.  I thought many of you would want the information.  I interviewed with Harvey Pitt back at Fried Frank in 1984.  He then was already a securities regulation icon.  I was impressed (even though I did not end up working at Fried Frank--but together with Skadden's Washington, DC office, it was at the top of my list if I had decided to go to DC instead of Boston).  May he rest in peace and may his memory be for a blessing.

+++++

Dear Friends,

I write to pass along the very sad news that former SEC Chairman and one of the Society's founders, Harvey Pitt, passed away today.

There will be a service on Monday, JUNE 5th at 1:00 PM at the Washington Hebrew Congregation at 3935 Macomb Street, NW, Washington, DC 20016.

I understand that for anyone who would like to reach out to his wife, Saree, it was recommended by his family to give her a day or two before doing so.

I will pass along any additional helpful information that I may receive.

Sincerely,
Jane

 

Jane Cobb
Executive Director
[email protected]
202-756-5015

 

 

Recording of the Inaugural Peter J. Henning Lecture

For those of you interested in watching or listening to the inaugural Peter J. Henning lecture (the subject of my blog post last Monday), you can find the recording here.  Friend-of-the-BLPB Chris Lund was kind enough to send the link along.  As you'll note, Judge Rakoff's remarks (which were introduced by Chris) begin with comments about Peter, his contributions to our field, and his service to the general public.  Judge Rakoff's thoughts in that regard are so well taken.  The whole presentation was such a fitting tribute.

I hope you all enjoy the lecture as much as I did!

This Friday - Wilkinson Family Speaker Series at OU College of Law

Dear BLPB Readers:

My colleague Professor Joseph Thai  at OU College of Law shared the following:

"Do you have an interest in securities fraud and investor protection? Want to ask national experts about the current banking crisis and its implications for regulators, investors, and the general public?

On behalf of OU College of Law, please join us for the Wilkinson Family Speaker Series (WFSS) in the Bell Courtroom at OU College of Law on Friday, March 24, 2023, from 9:15 a.m. – 1:15 p.m. The event is free, breakfast and lunch are included, and you are welcome to come and go if you cannot stay the entire duration.

Please see the flyer and attached program, and RSVP at the link below. Thank you!"

Program flyer is here: Download WSS Program

RSVP here