Thursday, April 9, 2020
Congressional securities trading has attracted a good bit of attention after controversial trades by Senators Burr and Loeffler. The scrutiny has even drawn more attention to another surprisingly well-timed trade by Senator Burr.
In his essay, Shill takes up the issue from a policy perspective, looking at how we ought to regulate Congressional Securities Trading. He draws from ordinary securities regulation and suggest pulling over the trading plan approach and short-swing profit prohibition we use for corporate executives. This approach should help manage ordinary securities transactions by members of Congress and their staff. He also advocates for limiting Congressional investing to U.S. index funds and treasuries. This would reduce the incentive to favor one market participant over another.
The proposed reforms would be a substantial improvement over the status quo. We should not have legislators with significant financial incentives to favor one company over another when making law and setting policy. We should also not subsidize public service by tolerating Congressional trading on Congressional information.
Of course, we'll still face some implementation challenges. When and how would we require newly-elected and currently-serving officials to liquidate existing portfolios? What kinds of exceptions would we make for private-company investments where no ready, liquid market exists? These implementation challenges strike me as mild compared to the benefits.
And Congressional adoption of the proposal would certainly yield substantial benefits. Although difficult to quantify, two broad benefits seem clear. First, adopting the proposal would generally increase confidence in government's integrity. As we're seeing with the pandemic, public trust in public officials can shift how society responds in times of collective crisis.
Allowing federal officials to trade securities generates real harm, confusion, and suspicion. Consider the hubbub over Trump's indirect ownership of a tiny stake in drug-maker Sanofi. Some have seized on the small, indirect interest to contend that he now hypes a particular drug for personal gain. A public-trust-focused regime limiting all elected officials to only broad index funds and U.S. Treasuries would likely cut down on the fear that officials recommend particular things to the public because of their economic interests. To be clear, it strikes me as extremely unlikely that the President now hypes the drug because of his minuscule ownership stake. The much likelier explanation is simply disordered magical thinking.
Many politicians have been targeted by similar attacks. This particular type of ill-informed charge has also been leveled at Senator Elizabeth Warren. One deeply misleading headline claimed she "invested in private prisons" before going on to explain that she owned a Vanguard index fund. It would be better to remove this line of attack entirely by sharply limiting the ways public officials invest.
Limiting Congressional ownership would also advance another vital national interest by increasing confidence in American securities markets. Our ability to attract capital and move it from investors to the real economy depends on confidence in the system. If investors fear that Congressional insiders have a leg up, they may not be as likely to participate in our markets.
As Congress considers how to regulate on these issues in the future, it should pay close attention to Shill's recommendations.
Friday, March 27, 2020
Although this is a little off-brand for the BLPB, I thought readers might appreciate a puppy break. This is Lucky, the newest addition to the family.
She's excellent at giving me so much to worry about that I stop thinking about the pandemic! But that does not mean that stuff stops happening!
Notably, FINRA has a rule proposal out to alter its exiting suitability standard in light of the SEC's new Regulation Best Interest. FINRA summarized the proposal as doing two things:
- amend the FINRA and CAB suitability rules to state that the rules do not apply to recommendations subject to Regulation Best Interest (“Reg BI”), and to remove the element of control from the quantitative suitability obligation; and
- conform the rules governing non-cash compensation to Reg BI’s limitations on sales contests, sales quotas, bonuses and non-cash compensation.
Because Reg BI so closely resembles the FINRA Suitability Rule, firms may not have to do too much to comply with the text of the rule. This leaves me wondering about guidance. FINRA has many notices to members and other explanations available to give context to the suitability rule. With regulation moving from the self-regulator to the regulator, will the guidance move as well and will it have the same force? This may be unknowable because so many customer issues get resolved in arbitrations without explained decisions.
What will happen in the future when FINRA has to manage compliance or enforcement for activity covered by Reg BI? In the past, FINRA could simply determine what its own rules meant. Now, new issues may need to be addressed by the SEC instead. FINRA may still simply opt to apply Rule 2110 for conduct it would have deemed over the line under the suitability standard. Essentially, it's a catch-all for requiring all members to "observe high standards of commercial honor and just and equitable principles of trade."
Regulation Best Interest is now set to go into effect this July. Whether the date will get bumped back remains uncertain. Financial Planning has reported that the SEC is now mulling whether to extend the deadline. My bet is that the SEC will probably extend the deadline event though there probably isn't much of a need to because it didn't seem as though Reg BI actually required any major changes to most firms' business practices.
Monday, March 9, 2020
Friend of the BLPB and fellow crowdfunding researcher Andrew Schwartz recently posted this article on SSRN: Mandatory Disclosure in Primary Markets, 2019 Utah L. Rev. 1069. I was provoked by the abstract, which reads as follows:
Mandatory disclosure—the idea that companies must be legally required to disclose certain, specified information to public investors—is the first principle of modern securities law. Despite the high costs it imposes, mandatory disclosure has been well defended by legal scholars on two theoretical grounds: ‘Agency costs’ and ‘information underproduction.’ While these two concepts are a good fit for secondary markets (where investors trade securities with one another), this Article shows that they are largely irrelevant in the context of primary markets (where companies offer securities directly to investors). The surprising result is that primary offerings—such as an IPO—may not require mandatory disclosure at all. This profound insight calls into question the fundamental premises of the Securities Act of 1933 and similar laws governing primary offerings around the world. Reform of these rules could lead to a new age of simplified, low-cost primary offerings to the public, something that is already happening in New Zealand through its equity crowdfunding market.
As someone who believes that federal law should provide an exemption for small crowdfunded offerings (although current rule-making proposals instead look to ratchet up the aggregate offering prices for the federal crowdfunding exemption) with lighter mandatory disclosure obligations than those provided for under Title III of the Jumpstart Our Business Startups Act and Regulation Crowdfunding, I found myself very curious about Andrew's paper. So, I skimmed it (since I do not have time to read it in full at the moment). I am glad to see that the article raises a distinction worth more exploration in the mandatory disclosure space--that between primary and secondary offerings. But I admit to some skepticism about the overall thesis as to the lack of value of mandatory disclosure in primary offerings. I hope a thorough review of the paper will provide important information and analyses.
As the abstract and a recent post on the article on The CLS Blue Sky Blog indicate, the paper highlights for attention two of the theoretical values of mandatory disclosure for examination: its positive effects on agency costs and on information underproduction. Given those ostensible focuses, here are a few things I will be looking for as I read:
- An articulation of the different types of agency costs associated with initial public offerings (IPOs) and other primary offerings (as evidenced in the literature) and their relationship to mandatory disclosure obligations, as well as observations on the effects of mandatory and voluntary disclosure on those agency costs;
- A rationale for why other theories supporting mandatory disclosure regulation are seemingly marginalized or omitted in the paper, including (1) standardization to facilitate investor comparisons and contrasts (which it seems is mentioned in a few footnotes) and (2) efficient capital market theory applications in the IPO disclosure context (including, perhaps, those impacting observed underpricing/overpricing market effects); and
- An explanation of the role, if any, of investor sophistication and information access (which, together with mandatory disclosure, have framed analyses of the value of mandatory disclosure since the Court's Ralston Purina decision more than 65 years ago) in the article's analyses and overall thesis.
By quick inspection, it appears that the agency costs addressed are restricted to those borne of a manager-shareholder relationship that relies on a somewhat legalistic, rather than economic, concept of agency that would arise only after investors in the market purchase shares of corporate stock in an offering and become shareholders. I wonder about the role of managers and others as promoters of the offering . . . . Standardization is at least mentioned in a few places. And as to the third bullet point, it looks like the answer the paper proffers is that institutional investors will drive significant voluntary disclosure to be made to all in a manner that gets information to the market efficiently. If that is the argument, I look forward to seeing the evidence.
So, I am curious, but I remain skeptical. I am reserving judgment until I read the article in its entirety! Regardless, this work has my attention, for sure. Let me know if you have read it and, if so, what your reactions are. Andrew also may want to comment.
Independent of the mandatory disclosure arguments, I know that I will enjoy reading about New Zealand's crowdfunding experience. I do find comparative regulatory work like this very enlightening. I appreciate Andrew adding that to the mix, too.
Wednesday, January 15, 2020
The following comes to us from Bernard S. Sharfman. It is a copy of the comment letter (without footnotes) that he recently sent to the SEC in support of the Amendments to Exemptions from the Proxy Rules for Proxy Voting Advice. (The comment letter with footnotes can be found here.) An introductory excerpt is followed, after the break, by the full letter. Please excuse any formatting errors generated by my poor copy-and-paste skills.
Part I of this letter will describe the collective action problem that is at the heart of shareholder voting. Part II will discuss the problems that this collective action causes for the voting recommendations of proxy advisors, including the creation of a resource constrained business environment. Part III discusses how proxy advisors deal with such a business environment. Part IV will discuss how the market for voting recommendations is an example of a market failure, requiring the SEC to pursue regulatory action to mitigate the harm caused by two significant negative externalities. Part V will discuss how the collective action problem of shareholder voting and the market failure impacts corporate governance. Part VI will discuss the value of the proposed amendments.
Tuesday, December 24, 2019
Happy holidays! Billions of people around the world are celebrating Christmas or Hanukah right now. Perhaps you’re even reading this post on a brand new Apple Ipad, a Microsoft Surface, or a Dell Computer. Maybe you found this post via a Google search. If you use a product manufactured by any of those companies or drive a Tesla, then this post is for you. Last week, a nonprofit organization filed the first lawsuit against the world’s biggest tech companies alleging that they are complicit in child trafficking and deaths in the cobalt mines of the Democratic Republic of Congo. Dodd-Frank §1502 and the upcoming EU Conflict Minerals Regulation, which goes into effect in 2021, both require companies to disclose the efforts they have made to track and trace "conflict minerals" -- tin, tungsten, tantalum, and gold from the DRC and surrounding countries. DRC is one of the poorest nations in the world per capita but has an estimated $25 trillion in mineral reserves (including 65% of the world's cobalt). Armed militia use rape and violence as a weapon of war in part so that they control the mineral wealth. The EU and US regulators believe that consumers might make different purchasing decisions if they knew whether companies source their minerals ethically. The EU legislation, notably, does not limit the geography to the DRC, but instead focuses on conflict zones around the world.
If you’ve read my posts before, then you know that I have written repeatedly about the DRC and conflict minerals. After visiting DRC for a research trip in 2011, I wrote a law review article and co-filed an amicus brief during the §1502 litigation arguing that the law would not help people on the ground. I have also blogged here about legislation to end the rule, here about the EU's version of the rule, and here about the differences between the EU and US rule. Because of the law and pressure from activists and socially-responsible investors, companies, including the defendants, have filed disclosures, joined voluntary task forces to clean up supply chains, and responded to shareholder proposals regarding conflict minerals for years. I will have more on those initiatives in my next post. Interestingly, cobalt, the subject of the new litigation, is not a “conflict mineral” under either the U.S. or E.U. regulation, although, based on the rationale behind enacting Dodd-Frank §1502, perhaps it should have been. Nonetheless, in all of my research, I never came across any legislative history or materials discussing why cobalt was excluded.
The litigation makes some startling claims, but having been to the DRC, I’m not surprised. I’ve seen children who should have been in school, but could not afford to attend, digging for minerals with shovels and panning for gold in rivers. Although I was not allowed in the mines during my visit because of a massacre in the village the night before, I could still see child laborers on the side of the road mining. If you think mining is dangerous here in the U.S., imagine what it’s like in a poor country with a corrupt government dependent on income from multinationals.
The seventy-nine page class action Complaint was filed filed in federal court in the District of Columbia on behalf of thirteen children claiming: (1) a violation of the Trafficking Victims Protection Reauthorization Act of 2008; (2) unjust enrichment; (3) negligent supervision; and (4) intentional infliction of emotional distress. I’ve listed some excerpts from the Complaint below (hyperlinks added):
Defendants Apple, Alphabet, Dell, Microsoft, and Tesla are knowingly benefiting from and providing substantial support to this “artisanal” mining system in the DRC. Defendants know and have known for a significant period of time the reality that DRC’s cobalt mining sector is dependent upon children, with males performing the most hazardous work in the primitive cobalt mines, including tunnel digging. These boys are working under stone age conditions for paltry wages and at immense personal risk to provide cobalt that is essential to the so-called “high tech” sector, dominated by Defendants and other companies. For the avoidance of doubt, every smartphone, tablet, laptop, electric vehicle, or other device containing a lithium-ion rechargeable battery requires cobalt in order to recharge. Put simply, the hundreds of billions of dollars generated by the Defendants each year would not be possible without cobalt mined in the DRC….
Plaintiffs herein are representative of the child cobalt miners, some as young as six years of age, who work in exceedingly harsh, hazardous, and toxic conditions that are on the extreme end of “the worst forms of child labor” prohibited by ILO Convention No. 182. Some of the child miners are also trafficked. Plaintiffs and the other child miners producing cobalt for Defendants Apple, Alphabet, Dell, Microsoft, and Tesla typically earn 2-3 U.S. dollars per day and, remarkably, in many cases even less than that, as they perform backbreaking and hazardous work that will likely kill or maim them. Based on indisputable research, cobalt mined in the DRC is listed on the U.S. Department of Labor’s International Labor Affairs Bureau’s List of Goods Produced with Forced and Child Labor.
When I mentioned above that I wasn’t surprised about the allegations, I mean that I wasn’t surprised that the injuries and deaths occur based on what I saw during my visit to DRC. I am surprised that companies that must perform due diligence in their supply chains for conflict minerals don’t perform the same kind of due diligence in the cobalt mines. But maybe I shouldn't be surprised at all, given how many companies have stated that they cannot be sure of the origins of their minerals. In my next post, I will discuss what the companies say they are doing, what they are actually doing, and how the market has reacted to the litigation. What I do know for sure is that the Apple store at the mall nearest to me was so crowded that people could not get in. The mall also has a Tesla showroom and people were gearing up for test drives. Does that mean that consumers are not aware of the allegations? Or does that mean that they don’t care? I’ll discuss that in the next post as well.
Wishing you all a happy and healthy holiday season.
December 24, 2019 in Compliance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Human Rights, Litigation, Marcia Narine Weldon, Securities Regulation, Shareholders | Permalink | Comments (0)
Monday, November 18, 2019
I was thrilled to be with so many wonderful colleagues and students (pictured above) at the Tennessee Journal of Law and Policy's symposium at UT Law last Friday. The symposium, "Insider Trading: Stories from the Attorneys," featured presentations about famous and not-so-famous insider trading cases. Presenters included Michael Guttentag (Loyola, Los Angeles), me, Jeremy Kidd (Mercer), Ellen Podgor (Stetson), John Anderson (Mississippi College), Eric Chaffee (Toledo), Kevin Douglas (Scalia), and Donna Nagy (Maurer). The papers presented highlight a variety of salient issues (including observations about the impact of gender and sexual orientation in specific cases or types of cases) involving or touching insider trading regulation. They are being published in 2020 by the Tennessee Journal of Law & Policy.
The idea for the symposium came from a Southeastern Association of Law Schools (SEALS) discussion session convened last summer by John and me. I described it in this post. Let me or John know if you are working in the insider trading area and would like to join us for our 2020 SEALS discussion group, "Insider Trading: Is It All about the Money?" The SEALS conference is scheduled to be held July 30 - August 5, 2020. The discussion is always lively!
Monday, November 4, 2019
I approached with some curiosity the Securities and Exchange Commission's recent shareholder proposal guidance in Staff Legal Bulletin No. 14J ("SLB 14J"). My interest in this topic stems from my past life as a full-time lawyer in private practice. During that time, I both wrote shareholder proposals and wrote no-action letters to the Securities and Exchange Commission ("SEC") to keep shareholder proposals out of corporate proxy statements.
In SLB 14J, the SEC clarifies its application of the "ordinary business" exception to the inclusion of a shareholder proposal under Rule 14a-8. Specifically, "[t]he Commission has stated that the policy underlying the 'ordinary business' exception rests on two central considerations. The first relates to the proposal’s subject matter; the second relates to the degree to which the proposal 'micromanages' the company." I want to share the SEC's guidance with you on the latter.
The idea of shareholders micromanaging most public firms is almost laughable. Yet, certain shareholder proposals do get somewhat specific in their direction of the firm and its resources.
In considering arguments for exclusion based on micromanagement, . . . we look to whether the proposal seeks intricate detail or imposes a specific strategy, method, action, outcome or timeline for addressing an issue, thereby supplanting the judgment of management and the board. [A] proposal, regardless of its precatory nature, that prescribes specific timeframes or methods for implementing complex policies, consistent with the Commission’s guidance, may run afoul of micromanagement. In our view, the precatory nature of a proposal does not bear on the degree to which a proposal micromanages. . . .
This makes some sense to me, yet this guidance may not be as easy to apply as the SEC may think. Here is the SEC's example of an excludable proposal:
For example, this past season we agreed that a proposal seeking annual reporting on “short-, medium- and long-term greenhouse gas targets aligned with the greenhouse gas reduction goals established by the Paris Climate Agreement to keep the increase in global average temperature to well below 2 degrees Celsius and to pursue efforts to limit the increase to 1.5 degrees Celsius” was excludable on the basis of micromanagement. In our view, the proposal micromanaged the company by prescribing the method for addressing reduction of greenhouse gas emissions. We viewed the proposal as effectively requiring the adoption of time-bound targets (short, medium and long) that the company would measure itself against and changes in operations to meet those goals, thereby imposing a specific method for implementing a complex policy.
I am note sure how I feel about the characterization of this proposal as excludable. Is the described proposal about reporting or about "prescribing the method for addressing the reduction of addressing reduction of greenhouse gas emissions"? Well, maybe a little of each . . . . What do you think?
During my time in active, full-time law practice, the format and content of Rule 14a-8 changed a number of times. It appears that the SEC may be poised to make another change--one more fundamental than enhanced guidance. According to one recent report, the SEC may announce as early as tomorrow "changes . . . to make it harder for shareholders to file proposals, and harder for proposals to be eligible for re-filing in subsequent years." Stay tuned for that possible announcement.
[Note: All footnote references in the quotations used in this post have been omitted.]
Saturday, September 7, 2019
Have you ever wanted to learn the basics about blockchain? Do you think it's all hype and a passing fad? Whatever your view, take a look at my new article, Beyond Bitcoin: Leveraging Blockchain to Benefit Business and Society, co-authored with Rachel Epstein, counsel at Hedera Hashgraph. I became interested in blockchain a year ago because I immediately saw potential use cases in supply chain, compliance, and corporate governance. I met Rachel at a Humanitarian Blockchain Summit and although I had already started the article, her practical experience in the field added balance, perspective, and nuance.
The abstract is below:
Although many people equate blockchain with bitcoin, cryptocurrency, and smart contracts, the technology also has the potential to transform the way companies look at governance and enterprise risk management, and to assist governments and businesses in mitigating human rights impacts. This Article will discuss how state and non-state actors use the technology outside of the realm of cryptocurrency. Part I will provide an overview of blockchain technology. Part II will briefly describe how public and private actors use blockchain today to track food, address land grabs, protect refugee identity rights, combat bribery and corruption, eliminate voter fraud, and facilitate financial transactions for those without access to banks. Part III will discuss key corporate governance, compliance, and social responsibility initiatives that currently utilize blockchain or are exploring the possibilities for shareholder communications, internal audit, and cyber security. Part IV will delve into the business and human rights landscape and examine how blockchain can facilitate compliance. Specifically, we will focus on one of the more promising uses of distributed ledger technology -- eliminating barriers to transparency in the human rights arena thereby satisfying various mandatory disclosure regimes and shareholder requests. Part V will pose questions that board members should ask when considering adopting the technology and will recommend that governments, rating agencies, sustainable stock exchanges, and institutional investors provide incentives for companies to invest in the technology, when appropriate. Given the increasing widespread use of the technology by both state and non-state actors and the potential disruptive capabilities, we conclude that firms that do not explore blockchain’s impact risk obsolescence or increased regulation.
Things change so quickly in this space. Some of the information in the article is already outdated and some of the initiatives have expanded. To keep up, you may want to subscribe to newsletters such as Hunton, Andrews, Kurth's Blockchain Legal Resource. For more general information on blockchain, see my post from last year, where I list some of the videos that I watched to become literate on the topic. For additional resources, see here and here.
If you are interested specifically in government use cases, consider joining the Government Blockchain Association. On September 14th and 15th, the GBA is holding its Fall 2019 Symposium, “The Future of Money, Governance and the Law,” in Arlington, Virginia. Speakers will include a chief economist from the World Bank and banking, political, legal, regulatory, defense, intelligence, and law enforcement professionals from around the world. This event is sponsored by the George Mason University Schar School of Policy and Government, Criminal Investigations and Network Analysis (CINA) Center, and the Government Blockchain Association (GBA). Organizers expect over 300 government, industry and academic leaders on the Arlington Campus of George Mason University, either in person or virtually. To find out more about the event go to: http://bit.ly/FoMGL-914.
Blockchain is complex and it's easy to get overwhelmed. It's not the answer to everything, but I will continue my focus on the compliance, governance, and human rights implications, particularly for Dodd-Frank and EU conflict minerals due diligence and disclosure. As lawyers, judges, and law students, we need to educate ourselves so that we can provide solid advice to legislators and business people who can easily make things worse by, for example, drafting laws that do not make sense and developing smart contracts with so many loopholes that they cause jurisdictional and enforcement nightmares.
Notwithstanding the controversy surrounding blockchain, I'm particularly proud of this article and would not have been able to do it without my co-author, Rachel, my fantastic research assistants Jordan Suarez, Natalia Jaramillo, and Lauren Miller from the University of Miami School of Law, and the student editors at the Tennessee Journal of Business Law. If you have questions or please post them below or reach out to me at firstname.lastname@example.org.
September 7, 2019 in Compliance, Conferences, Contracts, Corporate Governance, Corporations, CSR, Current Affairs, Financial Markets, Human Rights, Law Reviews, Lawyering, Legislation, Marcia Narine Weldon, Securities Regulation, Shareholders, Technology | Permalink | Comments (0)
Tuesday, August 13, 2019
Call for Papers
AALS Section on Securities Regulation—2020 AALS Annual Meeting
Emerging Voices in Securities Regulation
January 2-5, 2020
The AALS Securities Regulation section invites proposals for its "Emerging Voices in Securities Regulation” works-in-progress workshop at the 2020 AALS Annual Meeting. The workshop will bring together junior and senior securities regulation scholars for the purpose of giving junior scholars feedback on their scholarship and helping them prepare their work for the spring law review submission cycle. A junior scholar is any untenured full-time faculty member as of January 2, 2020.
FORMAT: The program will involve multiple simultaneous roundtables, with one junior scholar, one or two senior scholars, and interested observers at each table. Junior scholars’ presentations of their drafts will be followed by oral comments from senior scholars and further discussion, as time permits.
SUBMISSION PROCEDURE: Junior scholars who are interested in participating in the program should send an abstract (or longer summary) or draft-in-progress to Professor Eric C. Chaffee, Chair of the AALS Securities Regulation Section, at Eric.Chaffee@utoledo.edu, on or before September 16, 2019. The cover email should state the junior scholar’s institution, tenure status, number of years in his or her current position, and any previous positions in academia. The subject line of the email should read: “Submission—Sec Reg WIP Program.”
Junior scholars whose papers are selected for the program will need to submit their presentation drafts to Professor Chaffee by December 13, 2019, in order that the assigned commenters will have sufficient time to read the drafts prior to the Annual Meeting.
ELIGIBILITY: Junior scholars at AALS member law schools are eligible to submit proposals. Pursuant to AALS rules, faculty at fee-paid law schools, foreign faculty, adjunct and visiting faculty (without a full-time position at an AALS member law school), graduate students, fellows, and non-law school faculty are not eligible to submit. Please note that all presenters at the program are responsible for paying their own annual meeting registration fees and travel expenses.
Monday, May 13, 2019
Today, I have been attending and presenting at the Midwest Symposium on Social Entrepreneurship in Kansas City, Missouri. This is the Seventh Annual installment of this event, which engages entrepreneurs, lawyers, government actors, and others in education, networking, and discussions around various issues (which differ from year to year) relating to social enterprise structure, governance, finance, and operations. I love attending this symposium. The people are socially and intellectually stimulating. I appreciate Tony Luppino inviting me to participate.
There is much I could write about the programs today. However, I will focus in one one small thing for now: Opportunity Zones and more particularly the funds that invest in them. A quick description of Opportunity Zones and a cautionary message on related investment funds follow.
The U.S. Internal Revenue Service has defined Opportunity Zones as follows in a Q&A posted on its website:
An Opportunity Zone is an economically-distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment. Localities qualify as Opportunity Zones if they have been nominated for that designation by the state and that nomination has been certified by the Secretary of the U.S. Treasury via his delegation of authority to the Internal Revenue Service.
The main point is to encourage investment in businesses or real estate in distressed areas of the United States through federal tax incentives.
Unsurprisingly, investment funds have been established to make these tax-advantaged financings. From that state of affairs stems my public service announcement. As I listened to folks talking about this form of funding real estate and businesses, the securities lawyer in me became uncomfortable. The presenters appeared to be ignoring the seemingly obvious conclusion that the process of seeking investors to participate in these investment funds is a securities offering that must be registered under federal or state securities laws, unless an exemption is available. So, I raised that point from the audience . . . .
Sure enough, if one looks or resources on the Internet, one learns that promoters of these funds seem to have reached the same legal conclusion about the potential application of securities offering registration/exemptions. (See, e.g., here and here.) Federal registration exemptions in or under the Securities Act of 1933, as amended, that might work in this context include those for private placements (Section 4(a)(2) or Rule 506(b)) and intrastate offerings (Section 3(a)(11) and Rules 147 and 147A).
Bottom line word to the wise? Find an exemption for the offer or sale of investment interests in a Qualified Opportunity Fund or register the offering with the Securities and Exchange Commission and any applicable state securities commission. Otherwise, proceed at your regulatory peril . . . .
Monday, April 22, 2019
Co-blogger Ann Lipton has posted a number of times on Elon Musk's Twitter disclosures and their potential legal significance. I chimed in once. Unless I am mistaken, her most recent post (citing to our prior posts) on this subject is here. Based on these posts, we both seem to understand that the Twitter Era has spawned some interesting disclosure-related legal questions.
I had these posts in the back of my mind when I got an email invitation yesterday from IPO Docs, a firm that sells "Regulation D Private Placement Memorandum Templates" to check into the firm's services. I have never been a fan of online templates or form documents as drafting precedent, especially for investment disclosure documents. In general, one-size-fits-all disclosure lawyering is just too far from my practice background (which involved reverse-engineering the work of my Skadden colleagues and others). But I do tell students they should be familiar with these kinds of form/exemplar resources and that, after determining the quality and suitability of a resource for their purposes, they may want to use form documents as a cross-check for contents or phrasing.
These two examples of Internet-related disclosures (online commentary and disclosure forms) are two pieces of a larger disclosure regulation puzzle. The puzzle? How best to address challenges to disclosure regulation posed by our increased use of and reliance on the Internet. Believe me; I am a fan of the Internet. But having been engaged with disclosure regulation pre-Internet and post-Internet, I do see challenges.
Social media and blog posts or commentary, for example, raise issues about the nature of the speech and the identity of the speaker. Are tweets made by firm managers disclosures of firm information or are they private statements? Who is the person behind a social media or weblog account commenting on business affairs? (I note that Ann's September 29, 2018 post on the Musk affair reports, based on information in the SEC's complaint, that analysts "privately contacted Tesla’s head of investor relations for more information and were assured that the tweet was legit." And many may remember the dust-up--almost twelve years ago--around John Mackey's "anonymous" online posts.)
To the extent that we come to accept, from a disclosure compliance standpoint, business disclosures that are made through fractured online posts and commentary, we lose the benefits of standardization--including easy comparability--that comes from the traditional periodic and transaction-based disclosure regimes built into the Securities Act of 1933 and Securities Exchange Act of 1934. While I understand the virtues of allowing for more customized business disclosures in certain circumstances (e.g., for Form S-8 registration statements, where a summary plan description geared to benefit-holders fulfills key prospectus disclosure requirements), should we be encouraging or mandating that investors of all kinds comb the Internet to find scraps of information to enable them to get comparable data? (Of course, many investors do perform Internet searches, regardless. But mandatory disclosure documents are the core elements of compliance, and they allow for relatively direct comparisons.)
What about disclosure challenges relating to Internet-available offering documents? I admit that I have less concern here if these documents are purchased and used by a competent lawyer. But I fear that will not be the dominant scenario.
In my view, a significant peril with disclosure templates is that people using them as drafting models may not be competent or skilled in their use. Specifically, form end-users may not understand (or even consult) the legal rules relating to disclosures required to be made by a firm seeking capital under applicable federal and state securities law registration exemption(s). The interpretation and interaction of some of these rules--and the preservation of arguments and remedies if an exemption is later found to be unavailable--can be complex. It is too easy to use template text without questioning it.
Moreover, Internet forms may lull businesses into thinking they have met all attendant legal requirements relating to a financing transaction for which a form document has been purchased. In a private placement, the existence of an accurate and complete disclosure document is but one of many legal compliance issues. Private placements exempt under Regulation D have a number of moving parts, disclosure being only one.
I feel very "old school" in writing this post. What are your views on these and other issues relevant to business disclosures made on or facilitated by the Internet? As a person who has been known to describe herself as a "disclosure lawyer," I would appreciate any ideas you may have. And tell me where I am wrong in the observations I make here.
Monday, February 25, 2019
A bunch of us sensed that it was coming. I raised the question in an October 8, 2018 post here. Now, it has actually happened.
Tesla Chief Executive Officer Elon Musk has finally caught the negative attention of the U.S. Securities and Exchange Commission (SEC) with yet another of his reckless tweets. The WaPo reported earlier tonight that "[t]he Securities and Exchange Commission . . . asked a federal judge to hold Tesla CEO Elon Musk in contempt for violating the terms of a recent settlement agreement . . . ." That settlement agreement, as readers will recall, relates to SEC allegations that Musk lied to investors when he posted on Twitter that he had secured the funding needed to take Tesla private. The settlement agreement provides for the review and pre-approval of Musk's market-moving public statements.
Ann Lipton and I, as BLPB's resident fraud mongers, have been following the Musk affaire de Twitter for a number of months now. (See, e.g., here, here, and here.) Based on our prior posts, it seems clear the world was destined for this moment--a moment in which the SEC not only catches Musk in a tweeted misstatement but also can prove that the tweet was not pre-approved, as required under the terms of the settlement agreement. The WaPo article notes evidence that breaches of the agreement may be the rule rather than the exception. (Why does that not surprise me?)
Let's see where this goes next . . . .
Monday, December 24, 2018
A few weeks ago, I posted on the SEC Roundtable on the Proxy Process (here). I noted in a postscript to that post that friend-of-the-BLPB Bernie Sharfman had an additional comment letter (his fourth) relating to this regulatory project up his sleeve (so to speak). That comment letter, dated December 17, 2018, was recently filed (see here) and focuses on voting recommendations. The nub?
Investment advisers should not be in fear of breaching their fiduciary duties if they use board voting recommendations. . . . The SEC needs to go further than just approving the use of board voting recommendations as long as the investment adviser has an agreement with the client to use them. . . . [T]he SEC needs to explicitly state in some way that an investment adviser will not be in breach of its fiduciary duties under the Advisers Act if it uses board voting recommendations when voting its proxies.
To implement such a policy, this comment letter requests the SEC to provide investment advisers with a liability safe harbor under the Advisers Act when using board voting recommendations in voting their proxies as long as their clients do not prohibit their use and no significant business relationship exists between the investment adviser and the company whose shares are being voted. This will help ensure that the value inherent in board voting recommendations is reflected in the voting of proxies by investment advisers.
The entire letter is well worth a good read--and only 11 pages, at that.
But that's not all.
Bernie has taken thoughts from two of his four comment letters and combined and enhanced them in a recently posted article, Enhancing the Value of Shareholder Voting Recommendations. The abstract of the article is set forth below.
This writing addresses a fundamental issue in corporate governance. If institutional investors such as investment advisers to mutual funds have a fiduciary duty to vote the shares of stock that they owned on behalf of their investors, then how do we practically achieve informing them on how to vote their proxies without requiring each institutional investor to read massive amounts of information on the hundreds or thousands of companies they have invested in for the thousands, tens of thousands, or even hundreds of thousands of votes they are confronted with each year?
A critical step in resolving this issue is maximizing the ability of institutional investors to avail themselves of voting recommendations that are made on an informed basis and with the expectation that they will lead to shareholder wealth maximization. One way to achieve this maximization is to make sure that the voting recommendations provided by proxy advisors are truly informed ones. This leads to the recommendation that the proxy advisor should be held to the standard of an information trader. Another way is for the SEC to recognize the value of board recommendations and explicitly state that their use will allow investment advisers to meet their fiduciary duties when voting their proxies.
As Bernie noted on LinkedIn when he posted a link to the article a few days ago, it is a present "[f]or those of you who are looking forward to reading articles on corporate governance during the Christmas break." I, for one, am still focused on grading (we ended late this semester, and my exam was given on the last possible day--with one student taking it late because of illness) and on my daughter's birthday (today) and Christmas (tomorrow). But I did take a peek at the article anyway. It makes many nice points on relevant embedded legal issues and does draw together well Bernie's ideas on the interaction of the duties of proxy advisors and investment advisers.
Bernie is inviting comments. I am sure he would appreciate yours.
Monday, December 3, 2018
On November 15, the Securities and Exchange Commission (SEC) convened a Roundtable on the Proxy Process. (See also here.) I have not been following this as closely as co-blogger Ann Lipton has (see recent posts here and here), but friend-of-the-BLPB, Bernie Sharfman (Chairman of the Main Street Investors Coalition Advisory Council) has been active as a comment source. Both contribute valuable ideas that I want to highlight here as the SEC continues to chew on the information it amassed in the roundtable process.
Ann, as you may recall, has been focusing attention on the uncertain status of proxy advisors when it comes to liability for securities fraud. In her most recent post, she observes that
There’s a real ambiguity about where, if it all, proxy advisors fit within the existing regulatory framework, and while I am not convinced there is a specific problem with how they operate or even necessarily a need for regulation, I think it can only be for the good if the SEC were to at least clarify the law, if for no other reason than that these entities play an important role in the securities ecosystem, and if we expect market pressure to discipline them, potential new entrants should have an idea of the regime to which they will be subject.
I remember having similar questions as to the possible fiduciary duties and securities fraud liability of funding portals under the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (a/k/a the CROWDFUND Act)--Title III of the Jumpstart Our Business Startups Act (a/k/a/, the JOBS Act). I wrote about these ambiguities (and other concerns) in this paper, published before the SEC adopted Regulation CF. I know Ann's right that we have clean-up to do when it comes to the status of securities intermediaries in various liability contexts (a topic co-blogger Ben Edwards also is passionate about--see, e.g., here and here).
Bernie has honed in on voting process issues relating to both proxy advisors (the standard for making voting recommendations and the use/rejection of the same) and mutual fund investment advisers (the disclosure of mutual fund adviser voting procedures and SEC's enforcement of the Proxy Voting Rule). Specifically, in an October 12 letter to the SEC, Bernie sets forth three proposals on proxy advisor voting recommendations. His bottom line?
Institutional investors have a fiduciary duty to vote. However, the use of uninformed and imprecise voting recommendations as provided by proxy advisors should not be their only option. They should always be in a position of making an informed vote, whether or not a proxy advisor can help in making them informed.
Earlier, in an October 8 letter to the SEC (Revised as of October 23, 2018), Bernie recommends mutual adviser disclosure of "the procedures they will use to deal with the temptation to use their voting power to retain or acquire more assets under management and to appease activists in their own shareholder base" and "the procedures they will use to identify the link between support for a shareholder proposal at a particular company and the enhancement of that company’s shareholder value." He also recommends that the SEC "should clarify that voting inconsistent with these new policies and procedures or omission of such policies and procedures will be considered a breach of the Proxy Voting Rule" and engage in "diligent" enforcement of the Proxy Voting Rule. I commend both letters to you.
Ann's and Bernie's proxy disclosure and voting commentary also reminds me of the importance of co-blogger Anne Tucker's work on the citizen shareholder (e.g., here). It will be interesting to see what the SEC does with the information obtained through the proxy process roundtable and the related comment letters. There certainly is much here to be explored and digested.
[Postscript, 12/4/2018: Bernie Sharfman notified me this morning of a third comment letter he has filed--on proxy advisor fiduciary duties. It seems he may have a fourth letter in the works, too. Look out for that. - JMH]
Monday, November 26, 2018
Entrepreneurship in the Sharing Economy: P2P Strategies, Models, and Innovation Paradigms - Call for Papers
From our friend and colleague, Djamchid Assadi at the Burgundy School of Business in Dijon, France:
SIG 03 - ENT - Entrepreneurship
With our theme Exploring the Future of Management: Facts, Fashion and Fado, we invite you to participate in the debate about how to explore the future of management.
We look forward to receiving your submissions.
T03_08 - Entrepreneurship in the sharing economy: P2P strategies, models, and innovation paradigms
Djamchid Assadi, Burgundy School of Business BSB; Asmae DIANI, Sidi Mohamed Ben Abdellah University, Fez, Morocco; Urvashi Makkar, G.L. Bajaj Institute of Management and Research (GLBIMR), Greater Noida; Julienne Brabet, Université Paris-Est Créteil (UPEC); Arvind ASHTA, Arvind, CEREN, EA 7477, Burgundy School of Business - Université Bourgogne Franche-Comté, France
Sharing of funds, files, accommodations, and other utilities and properties has become a vital part of the emerging social life and economy.
The traditional dyadic firm-to-customer transactions has given place to the depositional triadic of P2P platforms game changers which facilitate exchange between peer providers and peer recipients. As these P2P platforms disrupt conventional transactions, for example, P2P home exchange platforms like Airbnb thoroughly disorder the hotel industry, it is crucial that researchers consider conceptual refinement and empirical grounding for providing insights.
This track aims to bring together researchers with an interest in the sharing economy and, specifically, in P2P platforms.
While direct interactions among individuals have always existed, P2P sharing platforms have considerably facilitated and lowered transaction costs for P2P exchanges. The P2P platforms do not supply nor demand. They do not divide a fortune to distribute its portions among peers. The P2P platforms simplify, accelerate and facilitate interactions among peers on the two-sided markets without the intermediation of central hubs. They enable individuals to unlock their unused and underused assets and skills for non or for-profit exchanges among peers.
They have transformed the way individuals consume and generate income and make use of their disposable resources and time. Numerous P2P platforms have sprung up for enterprising (Kickstarter, Indiegogo), working (Carpooling, Airbnb), dating (eHarmony, Match), innovating (Mindmixer), funding (Kiva, Zopa, Prosper), searching (CrowdSearching), etc. Airbnb and Uber are currently valued at $30 and $72 billion respectively.
This track aims to bring together researchers to provide insights and actionable visions to the emerging social and economic paradigms of spontaneous interactions and transaction among peers. It welcomes contributions that examine how P2P platforms transform market, entrepreneurship, competition, strategy, government-industry relations, supply chains, innovation, and other processes.
The following is a non-comprehensive list of leading issues in the sharing economy area.
How does entrepreneurship change in the sphere of sharing resources and utilities?
How do paradigms change in the case of open innovation?
Are the strategies and business models of sharing and collaborative online platforms peculiar?
Why do peers collaborate, share and circulate?
How does the sharing economy impact customer behavior?
What are the relations between social ties and ecosystem on the two-sided markets of the sharing economy?
How do conventional businesses react and develop business models to compete and/or coexist with the increasing trend of sharing economy?
How is value created (income steams) and distributed (value appropriation) among stakeholders in the sharing economy? Who are winners and losers?
What is the role of institutions in the sharing economy?
How do technologies such as artificial intelligence, machine learning, augmented and virtual reality, and blockchains affect the functioning of sharing economy?
What are the effects of collaborative consumption on sustainability?
Is the possibility of evading ante-P2P regulations the dark side of the sharing economy?
Sharing and collaborative economy
Peer-to-peer and Two-sided market
Spontaneous order of P2P interactions and exchanges
Carpooling and Home-exchange
Optimization: Journal of Research in Management (Urvashi Makkar, proponent 2, is founding Editor-in-Chief of this journal. Djamchid Assadi, proponent 1, is member of the Editorial Board).
Innovative Marketing (Djamchid Assadi, proponent 1, is member of the Academic Advisory Board. He has exchanged for specific issues with Tatyana Kozmenko, Editorial Assistant).
The corresponding proponent, Djamchid Assadi, has exchanged with the individuals in charge within the books publishing companies. They have shown interest in considering proposals for collective books on the topic of sharing economy.
For more information contact:
Djamchid Assadi - email@example.com
- Conference: 26-28 June 2019
- Authors registration deadline: 25 April 2019 // Early birds registration deadline: 18 April 2019
- Notification of acceptance: 20 March 2019
- Deadline for paper submission: 15 January 2019 (2 pm Belgian time)
Tuesday, October 23, 2018
Employee Stock Options in Unicorns: Scholarship At the Intersection of Securities Law and Employee Benefits
Friend of the Business Law Prof Blog Anat Beck recently posted a draft of her article entitled Unicorn Stock Options - Golden Goose or Trojan Horse? on SSRN. I heard presentations on earlier versions of this piece, which I personally find quite intricate and interesting. An excerpt fro the SSRN abstract follows:
This article examines a contemporary puzzle in Silicon Valley – is there a shift in unicorn employees expectations that results in labor contracting renegotiations? It explores the challenges faced by unicorn firms as repeat players in competitive technology markets. It offers the following possible solutions. First, new equity-based compensation contracts, and critiques them. Second, alternatives to the traditional liquidity mechanisms, and critiques them.
It concludes with proposals to remove legal barriers to private ordering, and new mandatory disclosure requirements.
The article has been picked up by the Harvard Law School Forum on Corporate Governance and Financial Regulation and linked to in a Matt Levine column for Bloomberg. This is a good read, especially for those of you interested in entrepreneurial business law (which is Anat's speciality).
Saturday, October 13, 2018
Last week Dr. Denis Mukwege won the Nobel Peace Prize for his work on gender-based violence in the Democratic Republic of Congo (DRC). This short video interview describes what I saw when I went to DRC in 2011 to research the newly-enacted Dodd-Frank disclosure rule and to do the legwork for a non-profit that teaches midwives ways to deliver babies safely. For those unfamiliar with the legislation, U.S. issuers must disclose the efforts they have made to track and trace tin, tungsten, tantalum, and gold from the DRC and nine surrounding countries. Rebels and warlords control many of the mines by controlling the villages. DRC is one of the poorest nations in the world per capita but has an estimated $25 trillion in mineral reserves (including 65% of the world's cobalt). Armed militia use rape and violence as a weapon of war in part so that they control the mineral wealth.
The stated purpose of the Dodd-Frank rule was to help end the violence in DRC and to name and shame companies that do not disclose or that cannot certify that their goods are DRC-conflict free (although that labeling portion of the law was struck down on First Amendment grounds). I wrote a law review article in 2013 and co-filed an amicus brief during the litigation arguing that the law would not help people on the ground. I have also blogged here about legislation to end the rule, here about the EU's version of the rule, here about the differences between the EU and US rule, and half a dozen times since 2013.
I had the honor of meeting Dr. Mukwege in 2011, who at the time did not support the conflict minerals legislation. He has since endorsed such legislation for the EU. During our trip, we met dozens of women who had been raped, often by gangs. On our way to meet midwives and survivors of a massacre, I saw five corpses of villagers lying in the street. They were slain by rebels the night before. I saw children mining gold from a river with armed soldiers only a few feet away. That trip is the reason that I study, write, and teach about business and human rights. I had only been in academia for three weeks when I went to DRC, and I decided that my understanding of supply chains and corporate governance from my past in-house life could help others develop more practical solutions to intractable problems. I believed then and I believe now that using a corporate governance disclosure to solve a human rights crisis is a flawed and incomplete solution. It depends on the belief that large numbers of consumers will boycott companies that do not do enough for human rights.
What does the data say about compliance with the rule? The General Accounting Office puts out a mandatory report annually on the legislation and the state of disclosures. According to the 2018 report:
Similar to the prior 2 years, almost all companies required to conduct due diligence, as a result of their country-of-origin inquiries, reported doing so. After conducting due diligence to determine the source and chain of custody of any conflict minerals used, an estimated 37 percent of these companies reported in 2017 that they were able to determine that their conflict minerals came from covered countries or from scrap or recycled sources, compared with 39 and 23 percent in 2016 and 2015, respectively. Four companies in GAO’s sample declared their products “DRC conflict-free,” and of those, three included the required Independent Private Sector Audit report (IPSA), and one did not. In 2017, 16 companies filed an IPSA; 19 did so in 2016. (emphasis added).
But what about the effect on forced labor and rape? The 2017 GAO Report indicated that in 2016, a study in DRC estimated that 32 percent of women and 33 percent of men in these areas had been exposed to some form of sexual and gender-based violence in their lifetime. Notably, just last month, a coalition of Congolese civil society organizations wrote the following to the United Nations seeking a country-wide monitoring system:
... Armed groups and security forces have attacked civilians in many parts of the country...Today, some 4.5 million Congolese are displaced from their homes. More than 100,000 Congolese have fled abroad since January 2018, raising the risk of increased regional instability... Since early this year, violence intensified in various parts of northeastern Congo’s Ituri province, with terrifying incidents of massacres, rapes, and decapitation. Armed groups launched deadly attacks on villages, killing scores of civilians, torching hundreds of homes, and displacing an estimated 350,000 people. Armed groups and security forces in the Kivu provinces also continue to attack civilians. According to the Kivu Security Tracker, assailants, including state security forces, killed more than 580 civilians and abducted at least 940 others in North and South Kivu since January 2018. (emphasis added)
The U.S. government provides $500 million in aid to the DRC and runs an app called Sweat and Toil for people who are interested in avoiding goods produced by exploited labor. As of today, DRC has seven goods produced with exploitative labor: cobalt (used in electric cars and cell phones), copper, diamonds, and, not surprisingly, tin, tungsten, tantalum, and gold- the four minerals regulated by Dodd-Frank. The app notes that "for the second year in a row, labor inspectors have failed to conduct any worksite inspections... and [the] government also separated as many as 2,360 children from armed groups...[t]here were numerous reports of ongoing collaboration between members of the [DRC] Armed Forces and non-state armed groups known for recruiting children... The Armed Forces carried out extrajudicial killings of civilians including children, due to their perceived support or affiliation with non-state armed groups. .."
For these reasons, I continue to ask whether the conflict minerals legislation has made a difference in the lives of the people on the ground. The EU, learning from Dodd-Frank's flaws, has passed its own legislation, which goes into effect in 2021. The EU law applies beyond the Democratic Republic of Congo and defines conflict areas as those in a state of armed conflict, or fragile post-conflict area, areas with weak or nonexistent governance and security such as failed states, and any state with a widespread or systematic violation of international law including human rights abuses. Certain European Union importers will have to identify and address the actual potential risks linked to conflict-affected areas or high-risk areas during the due diligence of their supply chains.
Notwithstanding the statistics above, many investors, NGOs, and other advocates believe the Dodd-Frank rule makes sense. A coalition of investors with 50 trillion worth of assets under management has pushed to keep the law in place. It's no surprise then that many issuers have said that they would continue the due diligence even if the law were repealed. I doubt that will help people in these countries, but the due diligence does help drive out inefficiencies and optimize supply chains.
Stay tuned for my upcoming article in UT's business law journal, Transactions, where I will discuss how companies and state actors are using blockchain technology for due diligence related to human rights. Blockchain will minimize expenses and time for these disclosure requirements, but it probably won't stop the forced labor, exploitation, rapes, and massacres that continue in the Democratic Republic of Congo. (See here for a Fortune magazine article with a great video discussing how and why companies are exploring blockchain's uses in DRC). The blockchain technology won't be the problem-- it's already being used for tracing conflict diamonds. The problem is using the technology in a state with such lawlessness. This means that blockchain will probably help companies, but not the people the laws are meant to protect.
October 13, 2018 in Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Human Rights, International Business, International Law, Legislation, Marcia Narine Weldon, Securities Regulation | Permalink | Comments (1)
Monday, October 8, 2018
BLPB reader Tom N. sent me a link to this article last week by email. The article covers Elon Musk's taunting of the U.S Securities and Exchange Commission (SEC) in a post on Twitter. The post followed on the SEC's settlement with Musk and Tesla, Inc. of a legal action relating to a prior Twitter post. The title of Tom N.'s message? "Musk Pokes the Bear in the Eye." Exactly what I was thinking (and I told him so) when I had read the same article earlier that day! This post is dedicated to Tom N. (and the rest of you who have been following the Musk affair).
Last week, I wrote about scienter issues in the securities fraud allegations against Elon Musk, following on Ann Lipton's earlier post on materiality in the same context. This week, I want to focus on state corporate law--specifically, fiduciary duty law. The idea for this post arises from a quotation in the article Tom N. and I read last week. The quotation relates to an order from the judge in the SEC's action against Musk and Tesla, Alison Nathan, that the parties jointly explain and justify the fairness and reasonableness of their settlement and why the settlement would not hurt the public interest. Friend and Michigan Law colleague Adam Pritchard offered (as quoted in the article): “She may want to know why Tesla is paying a fine because the CEO doesn’t know when to shut up.” Yes, Adam. I agree.
What about that? According to the article, the SEC settlement with Musk and Tesla "prevents Musk from denying wrongdoing or suggesting that the regulator’s allegations were untrue." The taunting tweet does not exactly deny wrongdoing or suggest that the SEC's allegations against him were untrue. Yet, it comes close by mocking the SEC's enforcement activities against Musk and Tesla. Musk's action in tweeting negatively about the SEC is seemingly--in the eyes of a reasonable observer--an intentional action that may have the propensity to damage Tesla.
At the very least, the tweet appears to be contrary to the best interests of the firm. But is it a manifestation of bad faith that constitutes a breach of the duty of loyalty under Delaware law? As most of us well know,
[b]ad faith has been defined as authorizing a transaction "for some purpose other than a genuine attempt to advance corporate welfare or [when the transaction] is known to constitute a violation of applicable positive law." In other words, an action taken with the intent to harm the corporation is a disloyal act in bad faith. . . . [B]ad faith (or lack of good faith) is when a director acts in a manner "unrelated to a pursuit of the corporation's best interests." It makes no difference the reason why the director intentionally fails to pursue the best interests of the corporation.
Bad faith can be the result of "any emotion [that] may cause a director to [intentionally] place his own interests, preferences or appetites before the welfare of the corporation," including greed, "hatred, lust, envy, revenge, . . . shame or pride."
In Re Walt Disney Co. Derivative Litigation, 907 A.2d 693, 753-54 (Del. Ch. 2005). Of course, Musk was not authorizing a transaction--or even clearly acting for or on behalf of Tesla--in making his taunting tweet. But he is identified strongly with Tesla, and his tweet was intentional and inconsistent with the best interests of the firm. Did he intend to harm Tesla in posting his tweet? Perhaps not. Did he act in a manner "unrelated to a pursuit of the corporation's best interests?" Perhaps. The tweet is certainly an imprudent (and likely grossly negligent or reckless) action that appears to result from Musk intentionally placing his own hatred or revenge ahead of the interests of Tesla.
"To act in good faith, a director must act at all times with an honesty of purpose and in the best interests and welfare of the corporation." Id. at 755. Yet, it is unclear how far that goes in a Twitter-happy world in which the personal blends into the professional. Musk was (in all likelihood) not taking action as a director or officer of Tesla when he tweeted his taunt. Yet, he was undoubtedly cognizant that he occupied those roles and that his actions likely had an effect on the firm. Should his fiduciary duties extend to this type of conduct?
And what about the Tesla board's duty to monitor? Does it extend to monitoring Musk's personal tweeting? E.g., the argument made in the Chancery Court's opinion in Beam Ex Rel. Martha Stewart Living Omnimedia, Inc. v. Stewart. Even of not mandated by fiduciary duty law, the SEC clearly wants the board to have that monitoring responsibility. The settlement with the SEC reportedly provides for "Tesla’s board to implement procedures for reviewing Musk’s communications with investors, which include tweets." More for us all to think about when we think about Elon Musk and Tesla . . . . It's always best not to poke the bear.
Monday, October 1, 2018
I have been so grateful for Ann Lipton's blog posts (see here and here) and tweets about Elon Musk's going-private-funding-is-secure tweet affair. Her post on materiality on Saturday--just before the SEC settlement was announced--was especially interesting (but, of course, that's one of my favorite areas to work in . . .). She tweeted about the settlement here:
[Note: this is a screenshot.] Ann may have more to say about that in another post; she did add a postscript to her Saturday post reporting the settlement . . . .
But I also find myself wondering about another of the contentious issues in Section 10(b)/Rule 10b-5 litigation: scienter. This New York Times article made me think a bit on the point. It tells a tale--apparently relayed to the U.S. Securities and Exchange Commission (SEC) in connection with its inquiry into the tweet incident--of fairly typical back-room discussions between/among business principals. This part of the article especially stuck with me in that regard:
On an evening in March 2017, . . . Mr. Musk and Tesla’s chief financial officer dined at the Tesla factory in Fremont, Calif., with Larry Ellison, the chairman of Oracle, and Yasir Al Rumayyan, the managing director of the Saudi Public Investment Fund. During the meal, . . . Mr. Rumayyan raised the idea of taking Tesla private and increasing the Saudi fund’s stake in it.
More than a year later, . . . Mr. Musk and Mr. Rumayyan met at the Tesla factory on July 31. When Mr. Rumayyan spoke again of taking the company private, Mr. Musk asked him whether anyone else at the fund needed to approve of such a significant deal. Mr. Rumayyan said no . . . .
Could Musk have actually believed that a handshake was all that was needed here? We all know a handshake can be significant. (See here and here for the key facts relating to the now infamous Texaco/Getty/Pennzoil case.) But should Musk have taken (or at least should he have known that he should take) more care to verify before tweeting? In other words, can Musk and his legal counsel actually believe they can prove that Musk (1) had no knowledge that his tweet was false and (2) was merely negligent--not reckless--in relying on the oral assurance of a business principal to commit to a $70+ billion transaction?
Don Langevoort has written cogently and passionately about the law governing scienter. One of my favorite articles he has written on scienter is republished in my Martha Stewart book. What he urges in that piece is that the motive and purpose of a potentially fraudulent disclosure are not the relevant considerations in determining the existence of scienter. Rather, the key question is whether the disclosing party (here, Musk) knew or recklessly disregarded the fact that what he was saying was false. Join this, Don notes, with the securities fraud requirement that manipulation or deception be in connection with the purchase or sale of a security, and the test becomes not merely whether Musk misrepresented material fact or misleadingly omitted to state material fact, but also whether he could reasonably foresee the likely impact of his misrepresentation on the market for Tesla's securities.
On the one hand, as Ann points out in her post on Saturday, a number of investors in the market thought the tweet was a joke. Given that, might we assume that Musk--a person perhaps similarly experienced in finance--knew or should have known that his tweet was false? On the other hand, as Ann notes in her post, the SEC's complaint states that "market analysts - sophisticated people - privately contacted Tesla’s head of investor relations for more information and were assured that the tweet was legit. So that’s evidence the market took it seriously." Yet, Musk might just be presumptuous enough to believe he could reasonably rely on an oral promise by a person who is in control of executing on that promise--thinking it represented a deal (although, of course, not one that experienced legal counsel would understand to be legally, or even morally, binding or enforceable). Too wealthy men jawing about a deal . . . .Puffery, or the way business actually is done in this crowd?
Based on what I know today (which is not terribly much), my sense is that a court should find that Musk acted in reckless disregard of the falsity of his words and understood the likely impact those words would have on the trading of his firm's stock. To find otherwise based on the specific facts alleged to have occurred here would inject too much subjectivity into the (admittedly subjective) determination of scienter. But we shall see. As Ann noted in Saturday's post, a private class action also has been brought against Musk and Tesla based on the tweet affair. So, we may yet see the materiality and scienter issues play themselves out in court (although I somehow doubt it).
Tuesday, August 14, 2018
According to its website,
The U. S. Securities and Exchange Commission (SEC) has a three-part mission:
Maintain fair, orderly, and efficient markets
Facilitate capital formation
I think it needs to add: "Ensure proper entity identification."
Examples abound. Take this recent 10-Q:
On June 27, 2018, the Company formed a joint venture with Downtown Television, Inc., for the purpose of developing, producing and marketing entertainment content relating to deep-sea exploration, historical shipwreck search, artifact recovery, and expounding upon the history of these shipwrecks. The joint venture is being formed as a new limited liability corporation that will be 50% owned each by EXPL and Downtown, and has been named Megalodon Entertainment, LLC. (“Megalodon”), as is further described in Note B.
Endurance Exploration Group, Inc., SEC 10-Q, for the quarterly period ended: June 30, 2018 (emphasis added).
Side note: That 10-Q, I will note, raised some other questionable decisionmaking, as it goes on to report:
NOTE B – JOINT VENTURE
EXPL Swordfish, LLC
Effective January 9, 2017, the Company, through a newly formed, wholly owned subsidiary, EXPL Swordfish, LLC (“EXPL Swordfish”), entered into a joint-venture agreement (“Agreement”) with Deep Blue Exploration, LLC, d/b/a Marex (“Marex”). The joint venture between EXPL Swordfish and Marex is referred to as Swordfish Partners.
As near as I can tell, Swordfish Partners is what it says it is, a partnership formed as a joint venture for a unique purpose. This is fascinating to me. Why would a company filing quarterly reports with the SEC not choose to take the time to create an LLC for the joint venture? I'm not a maritime expert, though I did participate in Tulane Law School's program with the Aegean Institute of the Law of the Sea and Maritime Law many years ago. I simply cannot come up with a good reason not to create a limited liability entity for the joint venture. I know there are times when it makes sense (or is not a concern), but this doesn't seem like one of those times.
I did a quick look for some other entity issues in SEC filings. There are many more, but this is what the Google machine provided in a quick search:
- From Core Moldings Technologies, Inc. Schedule 13D (Aug. 8, S018): "GGCP Holdings is a Delaware limited liability corporation having its principal business office at 140 Greenwich Avenue, Greenwich, CT 06830."
- From Financial Engines, Inc. Form 8-K, Jan. 28, 2016: "On February 1, 2016, Financial Engines, Inc. (“Financial Engines”) completed the previously announced acquisition of Kansas City 727 Acquisition LLC, a Delaware limited liability corporation ...."
- Limited Liability Company Agreement of Artist Arena International, LLC, Exhibit 3.206: "This Limited Liability Company Agreement (this “Agreement”) of Artist Arena International, LLC, a New York limited liability company (the “Company”), dated as of January 4, 2011, is adopted and entered into by Artist Arena LLC., a New York limited liability corporation (the “Member” or “AA”), pursuant to and in accordance with the Limited Liability Company Law of the State of New York, Article 2, §§ 201-214, et seq., as amended from time to time (the “Act”)."
- CloudCommerce, Inc., Form 8-K, October 1, 2015: "Certificate of Merger of Domestic Corporation and Foreign Limited Liability Corporation between Warp 9, Inc., a Delaware corporation, and Indaba Group, LLC, a Colorado limited liability company."
I swear we can do better. Really.