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 - firstname.lastname@example.org
- 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.
Sunday, August 12, 2018
We’re a month away from our second annual Business Law Professor Blog CLE, hosted at the University of Tennessee on Friday, September 14, 2018. We’ll discuss our latest research and receive comments from UT faculty and students. I’ve entitled my talk Beyond Bitcoin: Leveraging Blockchain for Corporate Governance, Corporate Social Responsibility, and Enterprise Risk Management, and will blog more about that after I finish the article. This is a really long post, but it’s chock full of helpful links for novices and experts alike and highlights some really interesting work from our colleagues at other law schools.
Two weeks ago, I posted some resources to help familiarize you with blockchain. Here’s a relatively simple definition from John Giordani at Forbes:
Blockchain is a public register in which transactions between two users belonging to the same network are stored in a secure, verifiable and permanent way. The data relating to the exchanges are saved inside cryptographic blocks, connected in a hierarchical manner to each other. This creates an endless chain of data blocks -- hence the name blockchain -- that allows you to trace and verify all the transactions you have ever made. The primary function of a blockchain is, therefore, to certify transactions between people. In the case of Bitcoin, the blockchain serves to verify the exchange of cryptocurrency between two users, but it is only one of the many possible uses of this technological structure. In other sectors, the blockchain can certify the exchange of shares and stocks, operate as if it were a notary and "validate" a contract or make the votes cast in online voting secure and impossible to alter. One of the greatest advantages of the blockchain is the high degree of security it guarantees. In fact, once a transaction is certified and saved within one of the chain blocks, it can no longer be modified or tampered with. Each block consists of a pointer that connects it to the previous block, a timestamp that certifies the time at which the event actually took place and the transaction data.
These three elements ensure that each element of the blockchain is unique and immutable -- any request to modify the timestamp or the content of the block would change all subsequent blocks. This is because the pointer is created based on the data in the previous block, triggering a real chain reaction. In order for any alterations to happen, it would be necessary for the 50%-plus-one of the network to approve the change: a possible but hardly feasible operation since the blockchain is distributed worldwide between millions of users.
In case that wasn’t clear enough, here are links to a few of my favorite videos for novices. These will help you understand the rest of this blog post.
- Blockchain Expert Explains One Concept in 5 Levels of Difficulty
- 19 Industries That Blockchain Will Disrupt
- How Blockchain is Changing Money and Business
To help prepare for my own talk in Tennessee, I attended a fascinating discussion at SEALS on Thursday moderated by Dean Jon Garon of Nova Southeastern University Shepard Broad College of Law called Blockchain Technology and the Law.
For those of you who don’t know how blockchain technology can relate to your practice or teaching, I thought I would provide a few questions raised by some of the speakers. I’ve inserted some (oversimplified)links for definitions. The speakers did not include these links, so if I have used one that you believe is incomplete or inaccurate, do not attribute it to them.
Del started the session by talking about the legal issues in blockchain consensus models. He described consensus models as the backbones for users because they: 1) allow users to interact with each other in a trustless manner; 2) ensure the integrity of the ledger in both normal and adversarial situations; and 3) create a “novel variety of networks with extraordinary potential” if implemented correctly. He discussed both permissioned (e.g. Ripple) and permissionless (Bitcoin) systems and how they differ. He then explained Proof of Work blockchains supported by miners (who solve problems to add blocks to the blockchain) and masternodes (who provide the backbone support to the blockchain). He pointed out how blockchains can reduce agency costs and problems of asymmetrical information and then focused on their utility in financial markets, securities regulation, and corporate governance. Del compared the issues related to off-chain governance, where decisionmaking first takes place on a social level and is then actively encoded into the protocol by the developers (used by Bitcoin and Ethereum) to on-chain governance, where developers broadcast their improvement protocols on-chain and then, once approved, those improvements are implemented into the code. He closed by listing a number of “big unanswered issues” related to regulatory guidance, liability for the performance of the technology and choice of consensus, global issues, and GDPR and other data privacy issues.
Catherine wants to help judges think about smart contracts. She asked, among other things, how judges should address remedies, what counts as substantial performance, and how smart contract audits would work. She questioned whether judges should use a consumer protection approach or instead follow a draconian approach by embracing automation and enforcing smart contracts as drafted to discourage their adoption by those who are not sophisticated enough to understand how they work.
Tonya focuses on blockchain and intellectual property. Her talked raised the issues of non-fungible tokens generated through smart contracts and the internet of value. She used the example of cryptokitties, where players have the chance to collect and breed digital cats. She also raised the question of what kind of technology can avoid infringement. For more on how blockchain can disrupt copyright law, read her post here.
In case you didn’t have enough trust issues with blockchain and cryptocurrency, Rebecca’s presentation focused on the “halo of immutability” and asked a few central questions: 1) why should we trust the miners not to collude for a 51% attack 2) why should we trust wallets, which aren’t as secure as people think; and 3) why should we trust the consensus mechanism? In response, some members of the audience noted that blockchain appeals to a libertarian element because of the removal of the government from the conversation.
Professor Carla Reyes, Michigan State University College of Law- follow her on Twitter at Carla Reyes (@Prof_CarlaReyes);
Carla talked about crypto corporate governance and the potential fiduciary duties that come out of thinking of blockchains as public trusts or corporations. She explained that governance happens on and off of the blockchain mechanisms through social media outlets such as Redditt. She further noted that many of those who call themselves “passive economic participants” are actually involved in governance because they comment on improvement processes. She also noted the paradox that off chain governance doesn’t always work very well because participants don’t always agree, but when they do agree, it often leads to controversial results like hard forks. Her upcoming article will outline potential fiduciaries (miner and masternode operators for example), their duties, and when they apply. She also asked the provocative question of whether a hard fork is like a Revlon event.
As a former chief privacy officer, I have to confess a bias toward Charlotte’s presentation. She talked about blockchain in healthcare focusing on these questions: will gains in cybersecurity protection outweigh specific issues for privacy or other legal issues (data ownership); what are the practical implications of implementing a private blockchain (consortium, patient-initiated, regulatory-approved); can this apply to other needed uses, including medical device applications; how might this technology work over geographically diverse regulatory structures; and are there better applications for this technology (e.g. connected health devices)? She posited that blockchain could work in healthcare because it is decentralized, has increased security, improves access controls, is more impervious to unauthorized change, could support availability goals for ransomware attacks and other issues, is potentially interoperable, could be less expensive, and could be controlled by regulatory branch, consortium, and the patient. She closed by raising potential legal issues related to broad data sharing, unanswered questions about private implementations, privacy requirements relating to the obligation of data deletion and correction (GDPR in the EU, China’s cybersecurity law, etc); and questions of data ownership in a contract.
Eric closed by discussing the potential tax issue for hard forks. He explained that after a hard fork, a new coin is created, and asked whether that creates income because the owner had one entitlement and now has two pieces of ownership. He then asked whether hard forks are more like corporate reorganizations or spinoffs (which already have statutory taxation provisions) or rather analogous to a change of wealth. Finally, he asked whether we should think about these transactions like a contingent right to do something in the future and how that should be valued.
Stay tuned for more on these and other projects related to blockchain. I will be sure to post them when they are done. But, ignore blockchain at your peril. There’s a reason that IBM, Microsoft, and the State Department are spending money on this technology. If you come to UT on September 15th, I’ll explain how other companies, the UN, NASDAQ, and nation states are using blockchain beyond the cryptocurrency arena.
August 12, 2018 in Commercial Law, Compliance, Conferences, Contracts, Corporate Governance, Corporations, Current Affairs, Entrepreneurship, Human Rights, Law School, Lawyering, Legislation, Marcia Narine Weldon, Research/Scholarhip, Securities Regulation, Shareholders, Teaching, Technology, Writing | Permalink | Comments (0)
Monday, July 30, 2018
Hello to all from Tokyo, Japan (Honshu). I have been in Japan for almost a week to present at and attend the 20th General Congress of the International Academy of Comparative Law (IACL), which was held last week in Fukuoka, Japan (Kyushu). By the time you read this, I will be on my way home.
As it turns out, I was at the Congress with old business law friends Hannah Buxbaum (Indiana Maurer Law), Felix Chang (Cincinnati Law), and Frank Gevurtz (McGeorge Law), as well as erstwhile SEALS buddy Eugene Mazo (Rutgers Law). I also met super new academic friends from all over the world, including several from the United States. I attended all of the business law programs after my arrival (I missed the first day due to my travel schedule) and a number of sessions on general comparative and cross-border legal matters. All of that is too much to write about here, but I will give you a slice.
I spoke on the legal regulation of crowdfunding as the National Rapporteur for the United States. My written contribution to the project, which I am told will be part of a published volume, is on SSRN here. The entire project consists of eighteen papers from around the world, each of which responded to the same series of prompts conveyed to us by the General Rapporteur for the project (in our case, Caroline Kleiner from the University of Strasbourg). The General Rapporteur is charged with consolidating the information and observations from the national reports and synthesizing key take-aways. I do not envy her job! The importance of the U.S. law and market to the global phenomenon is well illustrated by this slide from Caroline's summary.
The Congress was different from other international crowdfunding events at which I have presented my work. The diversity of the audience--in terms of the number of countries and legal specialties represented--was significantly greater than in any other international academic forum at which I have presented. Our panel of National Rapporteurs also was a bit more diverse and different than what I have experienced elsewhere, including panelists hailing from from Argentina, Brazil, Canada, France, Germany, Poland, and Singapore (in addition to me). At international conferences focusing on the microfinance aspects of crowdfunding, participants from India and Africa are more prominent. I expect to say more about the individual national reports on crowdfunding in later posts, as the need or desire arises.
A few outtakes on other sessions follow.
July 30, 2018 in Conferences, Contracts, Corporate Finance, Corporate Governance, Crowdfunding, Current Affairs, International Business, International Law, Joan Heminway, Research/Scholarhip, Securities Regulation, Social Enterprise | Permalink | Comments (0)
Thursday, July 26, 2018
One of the business law academy's power couples, Amy and Bert Westbrook, recently posted an intriguing piece on SSRN that Bert and I have been communicating about a bit this summer. It is entitled Snapchat's Gift: Equity Culture in High-Tech Firms, and it is, indeed, a lovely gift--well conceived and packaged. It is a look at dual class common equity in technology firms--and equity more generally--that confronts and incorporates many perspectives from law, economics, and other social sciences.
Some of you, like me, teach basic corporate finance in a variety of courses. In those situations, it is important for instructors to have a handle on descriptions of the basic instruments of corporate finance--debt, equity, hybrid, and other. What is the package of rights each instrument represents that incentivizes investors to supply money or other valuable assets? In my classes, we ultimately discuss equity as a bundle of rights that includes potentials for financial gain and governance. Snapchat's Gift digs into the validity of these perceived rights in relevant part by focusing on recent changes in the primary public offering market for equity securities in the United States--in particular, the advent of highly publicized and fully subscribed initial public offerings of nonvoting common shares.
Monday, July 2, 2018
What would the world look like if a public company officer or director, recognizing the value of material nonpublic firm information in his possession and intending to benefit people of limited means, gave this valuable information to those less fortunate without the knowledge or consent of the firm and without any expectation of benefit in return? How, if at all, do we desire to regulate that behavior? The officer or director apparently would be in breach of his or her fiduciary duty absent a valid, binding, and enforceable agreement to the contrary. Does that conduct also, however, violate U.S. federal insider trading rules? Should it? This article, a relatively short piece that I wrote for a "virtual symposium" issue of the Washington University Journal of Law & Policy, offers answers to those questions.
Other symposium authors with insider trading pieces in this volume include:
Great reading on this topic, all around. As we await the next insider trading regulation volley after Salman v. United States, this collection of essays and articles fills a nice gap. Although the issue is not yet posted to the journal's website, it soon should be. In the mean time, here is a photo of the relevant page from the table of contents:
(Sorry for the faint image and the shadows! I took this in my office; no natural light was available, if you know what I mean . . . .)
Tuesday, June 12, 2018
Bernie Sharfman's paper, A Private Ordering Defense of a Company's Right to Use Dual Class Share Structures in IPOs, was just published, and I think he has a point. In fact, as I read his argument, I think it is consistent with arguments I have made about the difference between restrictions or unconventional terms or practices that exist at purchase versus such changes that are added after one becomes a member or shareholder. Here's the abstract:
The shareholder empowerment movement (movement) has renewed its effort to eliminate, restrict or at the very least discourage the use of dual class share structures in initial public offerings (IPOs). This renewed effort was triggered by the recent Snap Inc. IPO that utilized non-voting stock. Such advocacy, if successful, would not be trivial, as many of our most valuable and dynamic companies, including Alphabet (Google) and Facebook, have gone public by offering shares with unequal voting rights.
Unless there are significant sunset provisions, a dual class share structure allows insiders to maintain voting control over a company even when, over time, there is both an ebbing of superior leadership skills and a significant decline in the insiders’ ownership of the company’s common stock. Yet, investors are willing to take that risk even to the point of investing in dual class shares where the shares have no voting rights and barely any sunset provisions, such as in the recent Snap Inc. IPO. Why they are willing to do so is a result of the wealth maximizing efficiency that results from the private ordering of corporate governance arrangements and the understanding that agency costs are not the only costs of governance that need to be minimized.
In this essay, Zohar Goshen and Richard Squire’s newly proposed “principal-cost theory,” “each firm’s optimal governance structure minimizes the sum of principal costs, produced when investors exercise control, and agent costs, produced when managers exercise control,” is used to argue that the use of dual class shares in IPOs is a value enhancing result of private ordering, making the movement’s renewed advocacy unwarranted.
The recommended citation is Bernard S. Sharfman, A Private Ordering Defense of a Company's Right to Use Dual Class Share Structures in IPOs, 63 Vill. L. Rev. 1 (2018).
I find his argument compelling, as I lean toward allowing contracting parties to enter into agreements as they so choose. I find this especially compelling at start-up or the IPO stage. I might take a more skeptical view of changes made after start-up. That is, if dual-class shares are voted created after an IPO by the majority insiders, there is a stronger bait-and-switch argument. Even in that case, if the ability to create dual-class shares by majority vote was allowed by the charter/bylaws, it might be reasonable to allow such a change, but I also see a self-dealing argument to do such a thing post-IPO. At the outset, though, if insiders make clear that, to the extent that a dual-class share structure is self-dealing, the offer to potential purchasers is, essentially, "if you want in on this company, these are our terms." I can work with that.
This is consistent with my view of other types of disclosure. For example, in my post: Embracing Freedom of Contract in the LLC: Linking the Lack of Duty of Loyalty to a Duty of Disclosure, I discussed the ability to waive the duty of loyalty in Delaware LLCs:
At formation . . . those creating an LLC would be allowed to do whatever they want to set their fiduciary duties, up to and including eliminating the consequences for breaches of the duty of loyalty. This is part of the bargain, and any member who does not agree to the terms need not become a member. Any member who joins the LLC after formation is then on notice (perhaps even with an affirmative disclosure requirement) that the duty of loyalty has been modified or eliminated.
It was my view, and remains my view, that there some concerns about such changes after one becomes a member that warrant either restrictions or at least some level of clear disclosures of the possibility of such a change after the fact, though even in that case, perhaps self-dealing protections in the form of the obligations of good faith and fair dealing would be sufficient.
Similarly, in my 2010 post, Philanthropy as a Business Model: Comparing Ford to craigslist, I explained:
I see the problem for Henry Ford to say, in essence, that his shareholders should be happy with what they get and that workers and others are more his important to him than the shareholders. However, it would have been quite another thing for Ford to say, “I, along with my board, run this company the way I always have: with an eye toward long-term growth and stability. That means we reinvest many of our profits and take a cautious approach to dividends because the health of the company comes first. It is our belief that is in the best interest of Ford and of Ford’s shareholders.”
For Ford, there seemed to be something of a change in the business model (and how the business was operated with regard to dividends) once the Dodge Brothers started thinking about competing. All of a sudden, Ford became concerned about community first. For craigslist, at least with regard to the concept of serving the community, the company changed nothing. And, in fact, it seems apparent that craiglist’s view of community is one reason, if not the reason, it still has its “perch atop the pile.”
Thus, while it is true craigslist never needed to accept eBay’s money, eBay also knew exactly how craigslist was operated when they invested. If they wanted to ensure they could change that, it seems to me they should have made sure they bought a majority share.
I understand some of the concern about dual-class shares and other mechanisms that facilitate insider control, but as long as the structure of the company is clear when the buyer is making the purchase decision, I'm okay with letting the market decide whether the structure is acceptable.
Monday, April 2, 2018
This timely post comes to us from Jeremy R. McClane, Associate Professor of Law and Cornelius J. Scanlon Research Scholar at the University of Connecticut School of Law. Jeremy can be reached at email@example.com.
Spotify, the Swedish music streaming company known for disrupting the music market might do the same thing this week to the equity capital markets. On April 3, Spotify plans to go public but in an unusual way. Instead of issuing new stock and enlisting an underwriter to build a book of orders and provide liquidity, Spotify plans to cut out the middleman and list stock held by existing shareholders directly on the New York Stock Exchange.
This will be an interesting experiment that will test some prevailing assumptions that about how firms must raise capital from the public.
The Importance of Bookbuilding. First, we will see just how important bookbuilding is to ensuring a successful IPO. When most companies go public, they hire an underwriter to market the shares in what is known as a “firm commitment” underwriting. The investment banks commit to finding buyers for all of the shares, or purchasing any unsold shares themselves if they cannot find buyers (an occurrence which never happens in practice). The process involves visiting institutional investors and building a book of orders, which are then used to gauge demand and set a price at which to float the stock. The benefit of this process is risk management – the issuing company and its underwriters try to ensure that the offering will be a success (and the price won’t plummet or experience volatile ups and downs) by setting a price at a level that they know market demand will bear, and ensuring that there are orders for all of the shares even before they are sold into the market.
Without underwriters or bookbuilding, Spotify is taking a risk that its share price will be set at the wrong level and become unstable. In Spotify’s case, however there is already relatively active trading of shares in private transactions, which gives the company some indication of what the right price should be. Nonetheless, that indication of price is volatile, in part because the securities laws limit the market for its shares by restricting the number of pre-IPO shareholders to 2,000, at least in the US. In 2017 for example, the price of Spotify’s shares traded in private transactions ranging from $37.50 to $125.00, according to the company’s Form F-1 registration statement.
Monday, March 26, 2018
Brent Horton of Fordham University's Gabelli School of Business recently posted his American Business Law Journal article on pre-Securities Act prospectuses.
For interested readers, the abstract is below and the article can be downloaded here.
Some legal scholars—skeptics—question the conventional wisdom that corporations failed to provide adequate information to prospective investors before the passage of the Securities Act of 1933 (Securities Act). These skeptics argue that the Securities Act’s disclosure requirements were largely unnecessary. For example, Paul G. Mahoney in his 2015 book, Wasting A Crisis: Why Securities Regulation Fails, relied on the fact that the New York Stock Exchange (NYSE) imposed disclosure requirements in the 1920s to conclude that stories about poor pre-Act disclosure are “demonstrably wrong”. (Likewise, Roberta Romano argued in Empowering Investors that “there is little tangible proof” that disclosure was inadequate pre-Securities Act.)
This Article sets out to determine who is correct, those that accept the conventional wisdom that pre-Securities Act disclosure was inadequate, or the skeptics?
The Author examined twenty-five stock prospectuses (the key piece of disclosure provided to prospective investors) that predate the Securities Act. This primary-source documentation strongly suggests that—contrary to the assertions of skeptics—pre-Act prospectuses did fail to provide potential investors with financial statements, as well as information about capitalization and voting rights, and executive compensation.
Friday, March 16, 2018
Matt Kelly of Radical Compliance has posted on the costs and benefits of regulation. His post is timely considering this week's rollback of certain Dodd-Frank banking provisions by the Senate. Among other things, Kelly notes that according to a draft OMB report, "across 133 major rules, the average annualized cost (in 2015 dollars) was $92.8 billion, average annualized benefit $554.8 billion. Benefits were six times larger than costs." He further writes, with some skepticism, that the OMB is seeking comment from "peer reviewers with expertise... in regulatory policy" on its cost-benefit analysis as it finalizes its report.
He also cited GW public policy professors who looked at over two hundred major rules adopted between 2007-2010 and found that "The design of the rulemaking process can both increase the pace with which rules are promulgated and reduce the level of detail in which they are presented, but only when care is taken to ensure the individuals intimately involved have greater breadth – relative to depth – in the competencies they bring to the endeavor." As Kelly, observed, " Teams with more “breadth of competencies” (one subject matter expert, one lawyer, one economic analyst, one regulatory affairs specialist, and so forth) tended to write rules more quickly and keep them simpler. In contrast, teams with depth of competency (a whole bunch of lawyers, or policy analysts, or subject matter experts) tended to take more time and, as the authors wonderfully phrased it, “elongated the resulting rules.”'
Although Kelly looks at these issues through the lens of a compliance expert, his post is worth a read as Congress and the SEC look at regulatory reform. He correctly focuses on the need to look at the quality rather than the quantity of regulation.
Monday, March 12, 2018
As I read recent news reports (starting a bit over a week ago and exemplified by stories here, here, here, and here--with the original story featured here) about Carl Icahn's well-timed sale of Manitowoc Company, Inc. stock, I could not help but associate the Icahn/Manitowoc intrigue with the Stewart/ImClone affair from back in the early days of the new millennium--more than 15 years ago. As many of you know, I spent a fair bit of time researching and writing on Martha Stewart's legal troubles relating to her December 2001 sale of ImClone Systems, Inc. stock. Eventually, I coauthored and edited a law teaching text focusing on some of the key issues. A bit of my Martha Stewart work is featured in that book; much of the rest can be found on my SSRN author page. For those who may not recall or know about the Stewart/ImClone matter, the SEC's press release relating to its insider trading enforcement action against Stewart is here, and it supplies some relevant background. (Btw, ImClone apparently is now a privately held subsidiary of Eli Lilly and Company organized as an LLC.)
In reading about Icahn's Manitowoc stock sale, my thoughts drifted back to Stewart's ImClone stock sale because of salient parallels in the early public revelations. Just as Icahn had personal and professional connections with U.S. government officials who were aware of material nonpublic information regarding the later-announced imposition of steel tariffs, Martha Stewart had personal and professional connections with at least one member of ImClone management who was aware of impending negative news from the U.S. Food and Drug Administration regarding ImClone's flagship product. We know from the law itself and Stewart/ImClone fiasco not to jump to conclusions about insider trading liability from such scant facts. Stewart's insider trading case ended up being settled. (No, that's not why she went to jail . . . .) And I have argued in a book chapter (Chapter 4 of this book) that the facts associated with Stewart's stock sale may well have revealed that she did not violate U.S. insider trading prohibitions under Section 10(b) of, and Rule 10b-5 under, the Securities Exchange Act of 1934, as amended.
The Supreme Court's decisions in Dirks v. SEC and Salman v. United States advise us that a tippee trading while in possession of material nonpublic information only violates U.S. insider trading prohibitions under Section 10(b) and Rule 10b-5 if:
- disclosure of the material nonpublic information in the tippee's possession breached a duty of trust and confidence because it was shared (directly or indirectly) with the tippee improperly--typically (although perhaps not always--as I note and argue in a forthcoming essay) because the duty-bearing tipper benefitted in some way from disclosure of the information; and
- the tippee knew or should have known that the tipper breached his or her duty of trust and confidence.
See, e.g., Dirks v. SEC, 463 U.S. 646, 660 (1983).
Thus, there is much more to tease out in terms of the facts of the Icahn/Manitowoc scenario before we can even begin to assert potential insider trading liability. Among the unanswered questions:
- what Icahn knew and when he knew it;
- whether any information disclosed to Icahn was material and nonpublic;
- who disclosed the information to Icahn and whether anyone directly or indirectly making disclosures to him had a fiduciary or fiduciary-like duty of trust and confidence;
- whether any disclosures directly or indirectly made to Icahn were inappropriate and, therefore, breached the tipper's fiduciary or fiduciary-like duty of trust and confidence; and
- whether Icahn knew or should have known that the information he received was disclosed in breach of a fiduciary or fiduciary-like duty of trust and confidence.
Icahn denies having any information about the Trump administration's imposition of tariffs on the steel industry. (See, e.g., here.) And the nature of the duties of trust and confidence owed by government officials is somewhat contended (although Donna Nagy's work in this area holds great sway with me). Regardless, it is simply too soon to tell whether Icahn has any U.S. insider trading liability exposure based on current news reports. I assume ongoing inquiries will result in more facts being adduced and made public. This post may serve as a guide for the digestion of those additoonal facts as they are revealed. In the mean time, feel free to leave your observations and questions in the comments.