Business Law Prof Blog

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

Exercise Caution: Why Cautionary Statements May Misdirect

I have had the good fortune of talking to friend-of-the-BLPB Frank Gevurtz about some of his illuminating "takes" on Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund, a decision we all wrestle with, it seems, in one way or another.  I recently ran into Frank (at the AALS Annual Meeting), and he informed me that some of those thoughts have made their way into a full-length article.  That article, Important Warning or Dangerous Misdirection: Rethinking Cautions Accompanying Investment Predictions, was recently posted to the Social Science Research Network (SSRN) and is available here.  The abstract follows.

We are constantly bombarded with cautions warning us of dangers to our health or wellbeing. Sometimes, however, cautions increase the danger. This article addresses one example: cautions warning investors of the risks that predictions regarding corporate performance will not pan out.

Here, the danger is investors falling prey to trumped up predictions of corporate performance, the result of which is to misallocate resources, increase the cost of capital for honest businesses, and create a drag on the overall economy. This article shows how the typical cautions accompanying predictions of corporate performance facilitate rather than avoid this danger by misdirecting both investors and courts from looking at what they should: the credibility of the speaker in giving the prediction.

To solve this problem, this article introduces a radically different approach to determining the legal impact of cautions accompanying predictions of corporate performance. This is to distinguish between cautions alerting investors to problems with the speaker’s credibility in giving the prediction versus those that simply list various risks that might lead the prediction to not pan out. The article thereby provides a roadmap for courts to replace their current misguided focus on the wrong type of cautions in the numerous cases raising the issue of when cautions serve as a defense to claims of securities fraud based upon a failed prediction.

Although Frank's draft article is ultimately directed at judicial decision-making, there is much in it for use by others.  I have been teaching materiality law and lore to my Securities Regulation students this past week.  So much of this article is relevant to our discussions.  In the article, Frank writes about (among other things) the bespeaks caution doctrine and the Private Securities Litigation Reform Act safe harbor for forward-looking statements, both of which are part of my materiality coverage.  I am finishing talking about these aspects of materiality litigation tomorrow.

While I am on the topic of materiality , I also want to thank BLPB co-editor Ann Lipton for her great post on Saturday on Tesla and Basic.  I use the Securities Regulation text coauthored by her, Jim Cox, Bob Hillman, and Don Langevoort (thanks for that, too, Ann!), which allows for a robust coverage of materiality.  The Tesla trial has been on our minds and in our classroom.  I am adding Ann's blog post to the mix.

Criminal Insider Trading in Personal Networks

Earlier today, friend-of-the-BLPB Andrew Jennings released a podcast in his Business Scholarship Podcast series featuring me talking about my forthcoming piece in the Stetson Business Law Review, "Criminal Insider Trading in Personal Networks."  You may recall me blogging about this piece as part of my report on the 2022 Law and Society Association's 7th Global Meeting on Law and Society this past summer.  The SSRN abstract is as follows:

This Article describes and comments on criminal insider trading prosecutions brought over an eleven-year period. The core common element among these cases is that they all involve alleged tipper/tippee insider trading or misappropriation insider trading implicating information transfers between or among friends or family members (rather than merely business connections). The ultimate objectives of the Article are to explain and comment on the nature of these criminal friends-and-family insider trading cases and to posit reasons why friends and family become involved in criminal tipping and misappropriation--conduct that puts both the individual friends and family members and the relationships between and among them at risk.

I am grateful to be in the position of publishing this work in the near future (after a number of years of work on the larger project that includes the featured criminal cases).  I enjoyed talking to Andrew about it.  His podcast series has been a welcomed and valuable contribution to our field.  You can find out a lot about current business law research by listening to even a few of his podcasts.

The podcast featuring me is available through any of the following links:

Apple Podcasts and other podcast apps: https://podcasts.apple.com/us/podcast/joan-macleod-heminway-on-friends-and-family-insider/id1470002641?i=1000587717188

YouTube: Business Scholarship Podcast - Ep.164 – Joan MacLeod Heminway on Friends-and-Family Insider Trading

Website url: https://andrewkjennings.com/2022/11/27/joan-macleod-heminway-on-friends-and-family-insider-trading/

Check it out.  Consider subscribing!

Teaching Corporate Finance: Public & Exempt Offerings

 

Yesterday, I taught my Corporate Finance students about public offerings (focusing on initial public offerings--IPOs) and exempt offerings of securities.  The front end of this course focuses on the instruments of corporate finance and the back end focuses on a number of different corporate finance transactional contexts.  Although Business Associations is a prerequisite for the course, Securities Regulation is not.  As a result, the 75 minutes I spend on public and exempt offerings is less doctrinally focused and more practically driven (unsurprising, perhaps, given the fact that my Corporate Finance course is a practical applied experiential offering).

Students prepare for the class session by reading parts of the SEC's website on going public and exempt offerings and reviewing an IPO checklist created and modified by me from a timetable/checklist I generated while I was in full-time law practice.  Each student also must bring to class and be prepared to discuss a news article or blog post on public securities offerings.  I share general knowledge and we dialogue about insights gained from the discussion items they bring to class.  It usually turns out to be a fun and engaged class day, and yesterday's class meeting proved to be no exception.

I captured the board work on my phone and have pasted the photos in below.  (I should note that I use a much more detailed public offering timeline in Securities Regulation, which I have memorialized in a series of PowerPoint slides.  But the whiteboard version depicted below seems to be at about the right level of detail for the students in this course.)  I am curious about how my coverage of public and exempt securities offerings might compare to what others give to this material in similar courses.  Feel free to share in the comments.

 

SEALS 2023 - Congressional Insider Trading Discussion Group

Co-blogger John Anderson and I are considering submitting a late proposal for the inclusion of a discussion group in the Business Law Workshop for the 2023 annual meeting of the Southeastern Association of Law Schools (SEALS). The 2023 conference is scheduled to be held from July 23 - July 29 at the Boca Raton Resort and Club. A draft title and description for the possible discussion group follow.

Stock Ownership and Trading by Government Officials - Time for Reform?

Allegations of unlawful insider trading by government officials have again been making headlines. Multiple Senators were investigated for suspiciously timed trades in advance of the COVID-19 market collapse. A February 2022 Business Insider article identified members of both houses of Congress hailing from both major political parties who have failed to comply with applicable federal legislation. And a recent poll found that more than three-quarters of American voters think members of Congress have an “unfair advantage” in trading stocks. This discussion group focuses on insider trading by government officials and the need for and nature of possible responses.

Please contact me as soon as possible if you are interested in participating. We need to assemble a group of at least ten folks in total, at least half of whom are from SEALS member schools.  And the program is filling up fast!

Griffin on the Index Fund Voting Process

Professor Caleb Griffin (University of Arkansas School of Law) offered testimony before the Senate Committee on Banking, Housing, and Urban Affairs in June of 2022 on problems associated with the fact that the “Big Three” index fund managers (Vanguard, BlackRock, and State Street) cast almost a quarter of the votes at S&P 500 companies. As a result, enormous power is concentrated in the hands of just a few index fund managers, whose interests and values may not align with those whose shares they are voting. Professor Griffin proposed two solutions to this problem: (1) “categorical” pass-through voting, and (2) vote outsourcing. Professor Griffin’s remarks were recently posted here, and here’s the abstract:

In recent years, index funds have assumed a new and unprecedented role as the most influential players in corporate governance. In particular, the “Big Three” index fund managers—Vanguard, BlackRock, and State Street—occupy a pivotal role. The Big Three currently cast nearly a quarter of the votes at S&P 500 companies, and that figure is expected to grow to 34% by 2028 and over 40% in the following decade.

The best solution to the current problem—where we have virtually powerless index investors and enormous, concentrated power in the hands of index fund management—is to transfer some of that power to individual investors.

There are two primary ways to do so. The first is to allow individual investors to set their own voting instructions with “categorical” pass-through voting, where investors are able to give semi-specific instructions on common categories of topics. The second approach is vote outsourcing, where investors could instruct management to vote their shares in alignment with a third party representative.

Pass-through voting preserves the economies of scale at the Big Three while addressing the root of the problem: concentrated voting power in the hands of a small, unaccountable group. Ultimately, index funds occupy a unique and important role in financial markets, not least because they're disproportionately owned by smaller, middle-income investors. These investors have a valuable voice, and pass-through voting would help us hear it.

The Wit and Wisdom of Tom N.

It was so wonderful to be able to host an in-person version of our "Connecting the Threads" Business Law Prof Blog symposium on Friday.  Connecting the Threads VI was, for me, a major victory in the continuing battle against COVID-19--five healthy bloggers and a live audience!  Being in the same room with fellow bloggers John Anderson, Colleen Baker, Doug Moll (presenting with South Carolina Law friend-of-the-BLPB Ben Means), and Stefan Padfield was truly joyful.  And the topics on which they presented--shadow insider trading, exchange trading in the cloud, family business succession, and anti-ESG legislation--were all so salient.  (I offered the abstract for my own talk on fiduciary duties in unincorporated business associations in last week's post.)  For a number of us, the topic of our presentations arose from work we have done here on the BLPB.

This year, as I noted in my post last week, we had a special guest as our luncheon speaker.  That guest would be known to many of you who are regular readers as "Tom N."  Tom has commented on our blog posts here on the BLPB for at least eight years.  (I rooted around and found a comment from him as far back as 2014.)  And Tom lives right here in Tennessee--in middle Tennessee, to be exact (closer to Haskell Murray than to me).  You can check out his bio here.  I am delighted that we were able to coerce Tom to give up a day of law practice to come join us at the symposium.

The title/topic for Tom's talk was "A Country Boy Busines Lawyer's View from Down in the Weeds."  The talk was, by design, a series of reflections on Tom's wide-ranging business law practice here in the state of Tennessee.  He tries to stay out of the courtroom, but by his own recounting, he has been in court in every county in the state--and Tennessee has 95 counties!  

In the end, Tom ended up offering a bunch of tips for law students and lawyers (both of whom were in attendance at the symposium).  I took notes during Tom's talk.  I have assembled them into a list below.  The key points are almost in the order in which they were delivered.  The stories that led to a number of these snippets of practical advice were priceless.  You had to be there.  Anyway, here is my list, together with a few editorial comments of my own.  Tom can feel free to add, correct, or dispute my notes in the comments!

• Take tax courses; if you fear they may hurt your GPA, audit them.
• Use all available resources to get more knowledge.  (Tom indicated that he bought Westlaw/used Practical Law as a solo practitioner for many years but recently gave it up.  he also noted that he regularly reads a number of the law prof blogs.)
• Be a bar association member and access the resources bar associations provide.  (Tom noted the excellent written materials published by the American Bar Association and the superior continuing legal education programs produced by the Tennessee Bar Association.)
• “You are going to learn to write in law school.”  (Tom advised focusing on clear, efficient writing—something I just emphasized with my Business Associations students last week.)
• Publish in the law.  (Tom shared his view that writing in the law improves both knowledge and analysis.)
• Expect the unexpected, especially in court (e.g., confronting in court transactions in pot-bellied pigs involving a Tennessee nonprofit).  And as a Corollary: "You can't make this stuff up."  The truth often is stranger than anything you could make up . . . .)
• In business disputes, never assume that an attorney was there on the front end.  (And yes, there was mention of the use by many unknowledgeable consumers of online entity formation services.)
• As a lawyer, be careful not to insert your own business judgment.  The business decision is the client's to make.
• Relatedly, let the business people hand you the framework of the deal.
• Along the same lines: "I am not paying people to tell me I can’t do it; I am paying people to tell me how to do it.”  (As heard by Tom from his father, a business owner-manager.  I think many of us have heard this or learned this—sometimes the hard way . . . .  I do try to prevent my students from learning that lesson the hard way by telling them outright.)
• And further: “You want to screw up a deal, put the lawyers in the center of it.”
• As a courtroom lawyer, know the judges and—perhaps more importantly—court clerks!
• Introduce yourself to everyone; they may be in a position to help you now or later (referencing the time he introduced himself, unknowingly, to John Wilder, the former Lt. Governor of Tennessee, who proceeded to introduce him to the local judges).
• Preparation for the bar exam is a curriculum of its own.  (That's close to a quote.)
• “A lot of things go more smoothly of you can get people talking.”  (Tom is more of a fan of mediation than arbitration.)
• Local rules of court may not be even published; sometimes, you just need to pick up the phone and call the court clerk.  (Another reason to get to know local court clerks!)
• Developing rapport with a judge is incredibly important to successful courtroom lawyering.
• Saying "I don’t know" does not hurt anything; in fact, it may help judges/others develop confidence in you and your integrity.
• Your law school grades will not matter after your first or second job.  Employers will be looking at you and your professional record, not your grades.

I am sure I missed something along the way.  Maybe my fellow bloggers in attendance will have something to add.  But this list alone is, imv, pure gold for students and starting lawyers.

2022 Law and Society Association - 7th Global Meeting on Law and Society

Last night, I happily found myself sitting at a café table above the River Douro in Porto, Portugal (see photo below) as part of a two-day hiatus before the Global Meeting on Law and Society in Lisbon.  I look forward to the conference and the rest of my time in this beautiful country.  Viva Portugal!

I am participating in a number of programs over the course of the conference as part of CRN 46 (Corporate and Securities Law in Society), a Law and Society Association collaborative research network that started as a female business law prof group that routinely organized programs at the annual conferences of the Law and Society Association.  I am very proud of this heritage.  The group continues to promote and support the scholarship of women and other underrepresented populations in the business law scholarly realm.

I no doubt will have more to say about the meeting once it has ended and I am back in the United States.  (I also am taking a personal trip to the Catalonia region of Spain before I return to Knoxville.)  But for today, I will offer information about my academic paper presentation at the conference.

On Saturday, July 16, I will present my paper entitled "Criminal Insider Trading in Personal Networks."  This piece was written for the 2022 Stetson Business Law Review symposium, held back in February, and will be published in a forthcoming issue of this new student-edited business law  journal.  (Readers may recall that I posted a call-for-papers almost a year ago for the symposium.) The abstract I posted for the Global Meeting on Law and Society is set forth below.

This article describes and makes observations about a proprietary data set comprising criminal insider trading prosecutions brought between 2008 and 2018. The core common element among these cases is that they all involve tipper-tippee insider trading or misappropriation insider trading involving friends or family members (rather than business connections). The ultimate objectives of the article are (1) to understand and comment on the nature of the friends-and-family criminal insider trading cases that are prosecuted and (2) to posit reasons why friends and family become involved in criminal tipping and misappropriation. Observations will include insights founded in legal doctrine, theory, and policy as well as psychology and sociology. The article is part of a larger project on friends-and-family insider trading cases.

As I work on finishing a paper on my larger project describing the entirety of the data set that I have been working on for the past few years (with several cohorts of students, who deserve massive credit), it seemed interesting--and potentially important--to share this piece of the puzzle with the Stetson Business Law Review symposium attendees and the audience at the Global Meeting on Law and Society.  I hope to get new insights on the article as well as the larger project from the audience at this international presentation.  Of course, if anyone who is not attending the meeting or this particular session has relevant thoughts on the article or the overall project, I welcome them.  Feel free to ask for a draft.

Saúde! (Toasting to your health, in Portuguese, with some vinho verde, also pictured below.)

 

Rethinking Insider Trading Compliance Policies in Light of the SEC's New "Shadow Trading" Theory of Insider Trading Liability

In August 2021, the SEC announced that it had charged Matthew Panuwat with insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934. Panuwat was the head of business development at Medivation, a mid-sized biopharmaceutical company when he learned that his company was set to be acquired by Pfizer at a significant premium.

If Panuwat had purchased Medivation stock in advance of the announcement of the acquisition, it is likely he would have been liable for insider trading under the classical theory. Liability for insider trading under the classical theory arises when a firm issuing stock, its employees, or its other agents strive to benefit from trading (or tipping others who then trade) that firm’s stock based on material nonpublic information. Here the insider (or constructive insider) violates a fiduciary duty to the counterparty to the transaction (the firm’s current or prospective shareholders) by not disclosing the information advantage drawn from the firm’s material nonpublic information in advance of the trade.

If Panuwat had purchased shares of Pfizer in advance of the announcement, then it is likely he would have been liable under the misappropriation theory. Liability for insider trading under the misappropriation theory arises when one misappropriates material nonpublic information and trades (or tips another who trades) on it without first disclosing the intent to trade to the information’s source. As the Supreme Court held in United States v. O’Hagan, 521 U.S. 642, 652 (1997), the “misappropriation theory premises liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information” by duping them out of “the exclusive use of that information.”

But Panuwat did not trade in either Medivation or Pfizer. Instead, he purchased stock options in Incyte, another pharmaceutical company that was similar in size and market focus to Medivation. According to the SEC’s litigation release, “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.” Panuwat’s gamble paid off. Incyte’s stock price increased 8% when Pfizer’s acquisition of Medivation was announced. Panuwat earned $107,066 from his trade.

Panuwat moved to dismiss the SEC’s insider trading charges, arguing that his trading in the shares of an unrelated third-party issuer did not violate any recognized theory of insider trading liability.  While the district court acknowledged this was a case of first impression, it denied Panuwat’s motion and permitted the SEC to proceed with its first enforcement action under the "shadow trading" theory of insider trading liability.

The principal basis for the court’s decision seems to be that Panuwat’s trading arguably violated the misappropriation theory by breaching the broad terms of Medivation’s insider trading policy, which includes the following language:

During the course of your employment…with the Company, you may receive important information that is not yet publicly disseminated…about the Company. … Because of your access to this information, you may be in a position to profit financially by buying or selling or in some other way dealing in the Company’s securities…or the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company. … For anyone to use such information to gain personal benefit is illegal.

To me, the most interesting question raised by the Panuwat case, and the problem of shadow trading more generally, is why would Medivation (or any company) adopt such a broadly worded insider trading policy? How did this broad proscription on employee trading benefit Medivation’s shareholders?

Medivation’s shareholders could not have been harmed by Panuawat’s trading. Such trading could not affect Medivation’s stock price, nor could it put the acquisition in jeopardy. So why is the blanket proscription against trading in “another publicly traded company” in the policy at all? The final sentence of the policy as quoted above suggests that the drafters were under the impression that such trading would be illegal under the securities laws. This may be true under the misappropriation theory, but only because Medivation chose to make it so by including the language in the policy. What if Medivation’s policy had instead provided something like the following language:

Because of your access to this information, you may be in a position to profit financially by trading in the Company’s securities, or the securities of its customers and suppliers. Such trading is strictly prohibited. Nothing in this policy should, however, be read as prohibiting your trading or dealing in any other issuers’ securities unless expressly restricted by the Company.

Under this policy, the SEC would have had no basis for the charge that Panuwat’s trading violated the misappropriation theory. In other words, it is entirely up to issuers whether they want to expose themselves and their employees to “shadow trading” liability. But if such exposure to liability does not benefit an issuer’s own shareholders, it can only hurt them (by needlessly exposing the company’s employees and the company itself to direct or derivative insider trading liability). So what business justification is there for issuers to include the broader language in their insider trading compliance policies? I hope readers will offer their thoughts in the comments below.

More Commentary on the SEC's ESG Proposal - Sharfman and Copland

Courtesy of friend-of-the-BLPB Bernie Sharfman, I am linking to his coauthored (with James Copland) comment letter to the Securities and Exchange Commission (SEC) on the climate change rule-making proposal.  The letter includes copious footnotes.  As with other comment letters that have been written on the substance of the SEC proposal, there are some interesting definitional questions on which intelligent folks disagree.  E.g., what is included under the umbrella of investor protection?  What regulation promotes "efficiency, competition, and capital formation"?  These all are among the big picture issues on which the SEC has the opportunity to speak.  I expect thoughtful responses.

Sean Griffith on Whether the SEC's Proposed ESG Disclosure Regime Violates the First Amendment

There have been number of recent BLPB posts representing a diversity of viewpoints concerning the SEC's proposed rule to "Enhance and Standardize Climate-Related Disclosures for Investors". For example, co-blogger Joan MacLeod Heminway recently posted on a comment letter drafted by  Jill E. FIsch, George S. Georgiev, Donna Nagy, and Cynthia A. WIlliams (and signed by Joan and 24 others) that affirms the proposed rule is within the SEC's rulemaking authority. I have offered a couple posts raising concerns about the proposed rule from the standpoint of utility and legal authority (see here and here). One of the concerns I have raised is that the SEC's proposed disclosure regime may compel corporate speech in a manner that runs afoul of the First Amendment. SEC Commissioner Hester Pierce raised this same concern, and now Professor Sean J. Griffith has posted a new article, "What's 'Controversial' About ESG? A Theory of Compelled Commercial Speech under the First Amendment", which offers a more comprehensive treatment of this problem. Professor Griffith has also submitted a comment letter to the SEC raising this issue. Here's the abstract for Professor Griffith's article:

This Article uses the SEC’s recent foray into ESG to illuminate ambiguities in First Amendment doctrine. Situating mandatory disclosure regulations within the compelled commercial speech paradigm, it identifies the doctrinal hinge as “controversy.” Rules compelling commercial speech receive deferential judicial review provided they are purely factual and uncontroversial. The Article argues that this requirement operates as a pretext check, preventing regulators from exceeding the plausible limits of the consumer protection rationale.

Applied to securities regulation, the compelled commercial speech paradigm requires the SEC to justify disclosure mandates as a form of investor protection. The Article argues that investor protection must be conceived on a class basis—the interests of investors qua investors rather than focusing on the idiosyncratic preferences of individuals or groups of investors. Disclosure mandates that are uncontroversially motivated to protect investors are eligible for deferential judicial review. Disclosure mandates failing this test must survive a form of heightened scrutiny.

The SEC’s recently proposed climate disclosure rules fail to satisfy these requirements. Instead, the proposed climate rules create controversy by imposing a political viewpoint, by advancing an interest group agenda at the expense of investors generally, and by redefining concepts at the core of securities regulation. Having created controversy, the proposed rules are ineligible for deferential judicial review. Instead, a form of heightened scrutiny applies, under which they will likely be invalidated. Much of the ESG agenda would suffer the same fate, as would a small number of existing regulations, such as shareholder proposals under Rule 14a-8. However, the vast majority of the SEC’s disclosure mandates, which aim at eliciting only financially relevant information, would survive.

Comment Letter of Securities Law Scholars on the SEC’s Authority to Pursue Climate-Related Disclosure

This post alerts everyone to a comment letter, drafted by Jill Fisch, George Georgiev, Donna Nagy, and Cindy Williams (signed by the four of them and 26 other securities law scholars, including yours truly and Ann Lipton), affirming that the Securities and Exchange Commission’s recent proposal related to the enhancement and standardization of climate-related disclosures for investors is within its rulemaking authority.  The letter was filed with the Commission yesterday and has been posted to SSRN.  The SSRN abstract is included below.

This Comment Letter, signed by 30 securities law scholars, responds to the SEC’s request for comment on its March 2022 proposed rules for the “Enhancement and Standardization of Climate-Related Disclosures for Investors” (the “Proposal”). The letter focuses on a single question—whether the Proposal is within the SEC’s rulemaking authority—and answers this question in the affirmative.

The SEC’s authority for the Proposal is grounded in the text, legislative history, and judicial interpretation of the federal securities laws. The letter explains the objectives of federal regulation and demonstrates that the Proposal’s requirements are properly understood as core capital markets disclosure in the service of those objectives. The statutory framework requires the SEC to adjust and update the content of the federal securities disclosure regime in response to the evolution of the economy and markets, and, in recent decades, the SEC has done so to require disclosures on a variety of subjects from Y2K readiness, to cybersecurity, to human capital management, to the effects of the Covid-19 pandemic. Rules mandating climate-related disclosure fit with this pattern of iterative modernization. Such rules do not represent a foray into new and uncharted territory, since the SEC has a long history of requiring disclosure on environmental and climate-related topics dating back more than 50 years. Finally, the federal securities laws do not impose a materiality constraint on the SEC’s authority to promulgate climate-related disclosure requirements.

The Comment Letter therefore concludes that the SEC has the statutory authority to promulgate the Proposal, and that the climate-related disclosure rules under consideration are consistent with close to nine decades of regulatory practice at the federal level and with statutory authority dating back to 1933 that has been repeatedly reaffirmed by Congress and the courts.

There is more that has been, can, and will be said about the Commission's rulemaking proposal as a matter of process and substance.  But I will leave that for another day.  For now, we just wanted you to know about the filing of the letter and offer you an easy way to find it and review it.

Colin Marks: Total Return Swaps ≡ Secured Transactions?!

I am excited to be promoting here an inventive and interesting paper, Total Return Meltdown: The Case for Treating Total Return Swaps as Disguised Secured Transactions, written by friend-of-the-BLPB Colin Marks (St. Mary's School of Law).   The SSRN abstract follows.

Archegos Capital Management, at its height, had $20 billion in assets. But in the spring of 2021, in part through its use of total return swaps, Archegos sparked a $30 billion dollar sell-off that left many of the world’s largest banks footing the bill. Mitsubishi UFJ Group estimated a loss of $300 million; UBS, Switzerland’s biggest bank, lost $861 million; Morgan Stanley lost $911 million; Japan’s Nomura, lost $2.85 billion; but the biggest hit came to Credit Suisse Group AG which lost $5.5 billion. Archegos, itself lost $20 billion over two days. These losses were made possible due to the unique characteristics of total return swaps and Archegos’ formation as a family office, both of which permitted Archegos to skirt trading regulations and reporting requirements. Archegos essentially purchased beneficial ownership in large amounts of stocks, particularly ViacomCBS Inc. and Discovery Inc., on credit. Under Regulation T of the Federal Reserve Board, up to 50 percent of the purchase price of securities can be borrowed on margin. However, to avoid these rules, Archegos instead entered into total return swaps with the banks whereby the bank is the actual owner of the stock, but Archegos would bear the risk of loss should the price of the stock fall and reap the benefits if the stock were to go up or were to make a distribution. Archegos would still pay the transaction fees, but the device permitted Archegos to buy massive amounts of stock without having the initial margin requirements, thus making Archegos heavily leveraged. This article argues that the total return swap contracts are analogous to and should be re-characterized as what they really are – disguised secured transactions. Essentially the banks are lending money to enable the Archegoses of the world to buy stocks, and are simply retaining a security interest in the stocks. Such a re-characterization should place such transactions back into Regulation T and the margin limits. But re-characterization also offers another contract law approach that is more draconian. If the structure of the contract violates a regulation, then total return swaps could be declared void as against public policy. This raises the specter that a court could apply the doctrine of in pari delicto and leave the parties where they found them in any subsequent suits to recover outstanding debts.

I do not teach, research, or write in the secured transactions space, but this work engages corporate finance and contract law as well.  (I am grateful that Colin, among others, has encouraged my forays into contract law research over the years.)  I was privileged to have the opportunity to preview Colin's arguments and offer some feedback during his research and writing of this paper, which is forthcoming in the Pepperdine Law Review.  I find his argument creative and intriguing.  I think you may, too.