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Delaware Merges Blasius and Unocal: Commentary on Coster v. UIP Cos., Inc.

In Coster v. UOP Cos., Inc., the Delaware Supreme Court finally addressed the longstanding debate over the validity of the Blasius doctrine. (The following is based in part on the discussion of Blasius and Unocal in my books Mergers and Acquisitions (Concepts and Insights) and Corporate Law (Concepts and Insights).)

In Unocal v. Mesa Petroleum,[1] the Delaware Supreme Court laid out what has been called an “intermediate” or “enhanced business judgment” standard of judicial review, but is perhaps best described as a “conditional business judgment rule,”[2] to govern target board of director actions taken in. response to an unsolicited takeover offer. In Unocal, the Delaware Supreme Court reaffirmed the target’s board general decision-making primacy, which includes an obligation to determine whether the offer is in the best interests of the shareholders. In light of the board’s potential conflict of interest vis-à-vis the shareholders, however, judicial review was to be somewhat more intrusive than under the traditional business judgment rule: “Because of the omnipresent specter that a board may be acting primarily in its own interests, rather than those of the corporation and its shareholders, there is an enhanced duty which calls for judicial examination at the threshold before the protections of the business judgment rule may be conferred.”

The initial burden of proof is on the directors, who must first show that they had reasonable grounds for believing that a danger to corporate policy or effectiveness existed. The directors satisfy this burden by showing good faith and reasonable investigation. The good faith element requires a showing that the directors acted in response to a perceived threat to the corporation and not for the purpose of entrenching themselves in office. The reasonable investigation element requires a demonstration that the board was adequately informed, with the relevant standard being one of gross negligence.[3] Assuming the directors carry their initial burden, they next must prove that the defense was reasonable in relationship to the threat posed by the hostile bid.

Because unsolicited takeover bids often end up involving a shareholder vote, such as when the acquirer conducts a proxy contest to elect a new board of directors for the target in hopes that the new board will remove any takeover defenses that may be impeding the offer, there long was a question about how Unocal applied when the target board’s actions allegedly disenfranchised target shareholders.

The problem was that in that context Unocal bumped up into another line of cases arising out of Blasius Industries, Inc. v. Atlas Corp.[4] In Blasius, the Delaware Chancery Court held that where the board of directors takes actions for the “primary purpose” of interfering with the free exercise of the shareholder franchise, the board must demonstrate that it had a “compelling justification” for doing so. Taken by itself, Blasius proved to be “an unworkable standard of review, as once a court triggers Blasius, it would seem impossible for the directors to provide a compelling justification for disenfranchising their shareholders.”[5]

When a board action affecting the shareholder franchise takes place in other contexts, such as a simultaneous tender offer and proxy contest, Unocal provide the basic standard of review for the board’s actions. In applying Unocal’s proportionality prong, however, the courts treated board action that purposefully disenfranchises the shareholders as “strongly suspect.”[6] Attempting to merge the two created an even more untenable standard.

I have never been a fan of Blasius.[7] (See my post Professor Lipton asks "What about Blasius?" Well, what about it?) So I pleased to learn that the Delaware Supreme Court has finally more or less killed off Blasius by essentially merging it into Unocal. See Coster v. UIP Cos. Inc.

I’m going to skip over the facts and the case’s convoluted procedural history, as Ann Lipton has a great post on the Chancery Court opinion and an excellent post on the Supreme Court decision.

The key passage is at 31-32:

First, the court should review whether the board faced a threat “to an important corporate interest or to the achievement of a significant corporate benefit.” The threat must be real and not pretextual, and the board’s motivations must be proper and not selfish or disloyal. As Chancellor Allen stated long ago, the threat cannot be justified on the grounds that the board knows what is in the best interests of the stockholders.

Second, the court should review whether the board’s response to the threat was reasonable in relation to the threat posed and was not preclusive or coercive to the stockholder franchise. To guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control, a board that is properly motivated and has identified a legitimate threat must tailor its response to only what is necessary to counter the threat. The board’s response to the threat cannot deprive the stockholders of a vote or coerce the stockholders to vote a particular way.

Critics of Unocal have long complained that it is an essentially toothless standard.[8] Assuming arguendo that they are correct, does this mean that judicial review of shareholder disenfranchisement will now be reviewed with a lenient eye?

There are suggestions in the opinion that Unocal is to be applied contextually. See Coster at 31 (stating that “the court’s review is situationally specific and is independent of other standards of review”). There are also suggestions that, as applied to shareholder disenfranchisement, the standard may not be Unocal but rather what might be called Unocal+. See Coster at 31 (“Unocal can also be applied with the sensitivity Blasius review brings to protect the fundamental interests at stake – the free exercise of the stockholder vote as an essential element of corporate democracy.”); id. at 33 (“Applying Unocal review in this case with sensitivity to the stockholder franchise is no stretch for our law.”). In other words, it is at least possible that Unocal will be applied in this context with a more skeptical eye than it is in other situations.[9]

There are also suggestions that the new Unocal/Blasius standard and the sensitivity it supposedly demands will be more limited in scope than early Blasius decisions suggested. Some 15 years ago, a New York court suggested that Blasius is now limited to proxy contests involving director elections:

Blasius has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office.”[10]

There are a few passages in the Supreme Court decision suggesting that the new standard is in fact limited to proxy contests over the election of directors and similar situations:

• Describing the standard as calling for “enhanced judicial scrutiny of board action that interferes with a corporate election or a stockholder’s voting rights in contests for control.” Coster at 30.
• “When a stockholder challenges board action that interferes with the election of directors or a stockholder vote in a contest for corporate control, the board bears the burden of proof.” at 31.
• Noting the need “[t]o guard against unwarranted interference with corporate elections or stockholder votes in contests for corporate control . . ..” at 32.

The key question here is whether by “corporate elections” the court meant all proxy contests or only proxy contests involving election of directors. If Unocal/Blasius is in fact now so limited, it will have important implications for cases like the current litigation involving the AMC APES shares, in which the AMC board allegedly interfered with the shareholder vote but not in the context of a proxy contest for electing directors. If so, is the standard of review now applicable to such matters the business judgment rule?

Finally, on a personal note, let me vigorously object to the Supreme Court’s claim that there are “fundamental interests at stake”; i.e., “the free exercise of the stockholder vote as an essential element of corporate democracy.” As regular readers know, much of my scholarly output over the last several decades has been devoted to the proposition that corporations are not democracies.[11] And I am not alone in saying that corporations are not democracies.[12]

Kalbi (Beef) Tacos Sous Vide with Ridge Vineyards Buchignani Ranch (Alexander Valley) Zinfandel 2017

• ¾ cup soy sauce
• 1 tablespoon Worcestershire sauce
• 1 tablespoon mirin
• 1 tablespoon honey
• 2 tablespoons toasted sesame oil
• Several grinds black pepper
• ½ medium pear, peeled and diced
• ½ cup canned diced pineapple
• 2 cloves garlic, diced

Combine marinade ingredients in bowl of a food processor and pulse until fairly smooth.

Brush both sides of 1-¾ pounds flanken style beef short ribs with marinade. Reserve remaining marinade in a small jar in the refrigerator. Place in a 1 gallon vacuum seal bag. Using the pulse setting on your vacuum sealer get as much air out of the bag as possible without pulling the marinade into the sealer. Use the seal setting to seal the bag. Note: this is not a recipe with which I would use the immersion method to get the air out of the bag. I worry about leakage and the zip-loc bag holding up for such a long sous vide session.

Around breakfast a day before you want eat the tacos, place bag in a very large pot (it just fit in my 12 quart stockpot). Put your sous vide machine in the pot. Set the temperature to 130° and the timer to 36 hours.

About an hour before you want to serve dinner, put reserved marinade in a small saucepan over high heat. Bring to a boil and reduce heat to low. Allow to reduce to a glaze. Remove from heat and set aside.

When marinade has cooled add 1 tablespoon to ¾ cup Sriracha Aioli and mix well. 

Heat a grill pan over high heat. Remove ribs from water bath. Open bag. Transfer ribs to a paper towel lined cutting board and pat dry. Brush both sides of the ribs with marinade glaze. Sear ribs on both sides in the grill pan and transfer back to the cutting board (sans paper towels). Allow to rest briefly. If the meat fails to fall of the bones, cut meat from them. Chop meat roughly. 

Serve with warmed taco size soft flour tortillas, the aioli, steamed rice, and my Asian Slaw or my Asian slaw with pears. 

I assemble my tacos by smearing some aioli on the tortilla, topping it with rice, beef, and slaw in that order. Helen goes beef, rice, slaw, drizzle of aioli.

We drank a Ridge Vineyards Buchignani Ranch (Alexander Valley) Zinfandel 2017, which was a great match. Medium strength bouquet. Good depth with medium finish. Dark red and black fruits. Blackberry, raspberry, and spice and dill (American oak). A dash of pepper on the finish. Very very good. In prime drinking form now and probably will last another 3-4 years.

Multicooker Beef Stew with Smith-Madrone (Napa Valley--Spring Mountain District) Cabernet Sauvignon 2019

• 1 pound beef chuck cut into 1-inch pieces
• ½ medium onion, diced
• 2 cloves garlic, minced
• 1 tablespoon tomato paste
• 1 tablespoon flour
• ¾ cup red wine
• 1 ½ cup water
• 2 teaspoons Better than Bouillon reduced sodium Beef Base
• 1 tablespoon Worcestershire sauce
• 1 tablespoon soy sauce
• 1 ounce dried porcini mushrooms, rinsed and cut into small pieces
• 1 bay leaf
• ½ teaspoon dried Italian parsley
• ½ teaspoon garlic powder
• ½ teaspoon onion powder
• 1 large Yukon Gold potato, diced
• 2 medium carrots, sliced into ¼-inch rounds
• ¾ cup frozen peas
• 1 package Better Than Gravy Beef flavor

Set multicooker on brown setting. Season beef with salt and pepper. Add drizzle of olive oil to multicooker pot. When it starts to shimmer, add half of the beef. Brown on both sides. Remove to a paper towel lined plate. Repeat with other half of the beef. Add onion to pot and sauté until translucent (about 7-8 minutes). Add garlic and tomato paste. Sauté for a minute. Add wine and bring to a boil. Boil 3 minutes. Add water. beef base, Worcestershire sauce, soy sauce, mushrooms, parsley, onion and garlic powders, and a grind or two of black pepper to pot. Return beef to pot.

Put lid on pot. Set mode control to pressure cook (high) and set timer to 25 minutes.

When timer expires, unplug the multicooker and allow to sit for about 10 minutes. Release any remaining pressure and remove lid. Add potatoes and carrots. Plug the multicooker back in and replace lid. Set mode control to pressure cook (high) and set timer to 15 minutes.

When timer expires, unplug the multicooker and allow to sit for about 10 minutes. Release any remaining pressure and remove lid. Plug the multicooker back in. Set mode control to brown and bring liquid to the boil. Add peas and cook for 3 minutes. Add gravy mix and stir thoroughly. Cook 1 minute.

Serve. I made some biscuits to go with the stew. I made some honey butter for the biscuits by mixing 3 tablespoons of salted butter with 1 tablespoon of local Malibu raw honey and 1 teaspoon of New Zealand Honey Co. Raw Manuka Honey.  

I still use my trusty Fagor multicooker. Sadly, you can't get them anymore, but the Zavor LUX 4 Quart Multi-Cooker is a good substitute.

We drank a 2019 Cabernet Sauvignon from our good friends at Smith-Madrone Winery. Deep purple. Powerful bouquet. Intense flavors with a long finish. Drinkable now with smooth tannins, but there's plenty of structure to support cellaring. If I drink another bottle in the near future, as I'm very likely to do, I would loosen it up a little by double decanting and allowing it to breath for about 30 minutes. Plenty of rich, dark fruits. Black currant, blackberry, and black cherry. There's also a green element that I associate more with left bank Bordeaux than Napa cabernets. Herbs and green bell pepper. Complex. Tasty. Excellent.

Some recent wine tasting notes

Had a @ThreeSticksWine 2019 Sonoma Coast Pinot Noir with beef stroganoff. Great match. Bright cherry and raspberry. Floral notes on the nose. Smooth tannins. Good acidity. Balanced. Accessible but drink young. Good food wine. Well done. pic.twitter.com/XqMZgXWkiV

— Steve Bainbridge (@PrawfBainbridge) June 25, 2023

Had a @RidgeVineyards 2013 Rousten Cabernet Franc with pork loin chops in a Marsala mushroom sauce. Lovely wine. Black cherry, blackberry, spice. Great depth. Complex. Long finish. Exceptional. #wine #winetasting pic.twitter.com/uEkCaAWi9h

— Steve Bainbridge (@PrawfBainbridge) June 25, 2023

High "social" scores on ESG measures are "positively correlated with the likelihood of corporate scandals"

If you believe the ESG hype, high scores on ESG metrics indicates high levels of corporate social responsibility. There has been a lot of work discrediting that proposition (much of which is discussed in my book The Profit Motive). And now there is more evidence:

In this paper, we study the impact of environmental, social and governance (ESG) ratings on the likelihood of subsequent corporate scandals. We find that the ‘S’ score (social responsibility) has a predictive power on scandals, while the overall ESG ratings has not. This finding holds for all our specifications. The underlying question that we want to address with this paper is whether the ratings reflect firms’ real efforts to act responsibly towards the society, or whether it constitutes deception. Our work contributes to the ongoing ‘aggregate confusion’ discussion amongst ESG scholars, showing that there is little informational content in an aggregate score (as it measures very diverse dimensions). Contrary to our expectation, the ‘S’ score is positively correlated with the likelihood of corporate scandals, suggesting that the ‘S’ score does not live up to measuring a company’s social responsibility, including the ‘commitment to being a good corporate citizen’ (Refinitiv, 2022). Our analysis is based on a hand-collected matched sample of 113 global corporate scandals.

Kjaer, Christina and Kirchmaier, Tom, Deceived by ‘S’: Corporate Scandals and ESG (April 25, 2023). Available at SSRN: https://ssrn.com/abstract=4428468 or http://dx.doi.org/10.2139/ssrn.4428468

Anti-ESG Backlash Comes for Pension Plans that Force Beneficiaries into ESG Investments: Could Somebody Sue UCRP?

Kevin LaCroix reports that:

On June 2, 2023, an American Airlines pilot filed an ERISA class action lawsuit in the Northern District of Texas against American Airlines; the American Airlines Employee Benefits Committee; the company’s benefits plan administrator; and the company’s benefits plan advisor. The lawsuit purports to be filed on behalf of participants in the company’s employee benefits plan. A copy of the complaint can be found here.

The gist of the complaint is that the defendants “breached their fiduciary duties in violation of ERISA by investing millions of dollars of American Airlines employees’ retirement savings with investment managers and investment funds that pursue leftist political agendas through environmental, social and governance (‘ESG’) strategies, proxy voting, and shareholder activism—activities which fail to satisfy these fiduciaries’ statutory duties to maximize financial benefits in the sole interest of the Plan participants.” ...

He also reports that a similar lawsuit is pending against Delta.

Which leads me to a point of personal privilege. By virtue of my job I am obliged to participate in the University of California Retirement Plan. In pension plan terms, the rules under which my pension operates is an involuntary defined benefit plan. I cannot opt out and I have zero control over how my money is invested.

So what is UCRP doing with my money? UCRP's investment policy states that:

The Office of the Chief Investment Officer (“OCIO”) shall incorporate environmental sustainability, social responsibility, and governance (ESG) into the investment evaluation process as part of its overall risk assessment in its investments decision making. ESG factors are considered with the same weight as other material risk factors influencing investment decision making.

The policy statement further states that the plan must not hold tobacco stocks. UCRP is also in the process of divesting from fossil fuel companies.

So the answer to the question, "what is UCRP doing with my pension plan," is going big on ESG. 

Not only is the basic UCRP pension plan gone whole hog on ESG, but so have the voluntary 403(b) retirement saving plan options. Almost all of the choices are fossil fuel free because they are subject to the UCRP's ESG investment policies.

Eli Lehrer and Robert Eccles recently argued that employers should offer employees a choice between ESG and non-ESG funds. Specifically, they argue for legislation ensuring that "state employees in defined contribution plans can select non-ESG options."

Laws passed in decidedly red North Dakota and Idaho offer good models in this regard. North Dakota’s law defines “social investment” as “consideration of socially responsible criteria…for the purpose of obtaining an effect other than a maximized return” and requires the State Investment Board to “demonstrate a social investment would provide an equivalent or superior rate of return compared to a similar investment that is not a social investment and has a similar time horizon and risk” before making it. The Idaho law contains language with similar effect and allows that state-defined contribution plans offer employees socially-oriented investment funds only so long as they offer alternatives as well. Both policies are worthy of emulation.

I don't expect a deep blue state like California to consider mandating that state pensions offer non-ESG alternatives, especially with virtue signaller in chief Gavin Newsom as governor, but maybe we can get there by litigation? I understand that state university pension plans are exempt from ERISA. But surely a conservative public interest law firm could come up with a theory that relies on other fiduciary duty theories.

Are the SEC’s Climate Change Disclosure Rules Really in Double Constitutional Trouble

Donald Kochan (George Mason) offers an affirmative answer to the titular question:

The first administrative and constitutional law infirmity in the SEC’s proposed climate disclosure rule rests on an application of the “major questions doctrine,” which the U.S. Supreme Court recently gave increased recognition through its 2022 decision in West Virginia v. EPA. ...

The second administrative and constitutional law infirmity derives from an application of the nondelegation doctrine.  For the SEC rules, this doctrine has received little attention.  Indeed, the inattention likely results from the emergence of a stronger major questions doctrine.  Many seem to hold a confused belief that the major questions doctrine is either the same as the nondelegation doctrine or a replacement for it.  Neither is true.  Seeing how each independently operate in a legal challenge to the expected SEC climate disclosure rule is a perfect way to correct these erroneous perceptions.

Go read the whole thing.

 

In re Match Group, Inc.: Do All Controlling Shareholder Transactions Require Cleansing, whether MFW or Ordinary?

Ann Lipton reports on an interesting new development:

Putting aside the question of how control is defined, we still have the issue of how conflict transactions are cleansed.  As I said, Chancery has settled on the proposition that all conflicted controller transactions are cleansed exclusively through MFW.  ...

at the end of May, the Delaware Supreme Court ordered the parties in In re Match Group Derivative Litigation, No. 368, 2022, to brief the issue whether MFW cleansing is required for all interested controller transactions, or whether ordinary cleansing is permissible outside the freezeout context.  The case involved a series of transactions by which the old Match Group reorganized its assets, in a manner that public shareholders claimed benefitted the controller at the expense of the minority.  VC Zurn held that MFW cleansing was satisfied and the public shareholders appealed, arguing that the stringent MFW requirements were not met – leading to the question whether MFW was even necessary to trigger business judgment review.

Significantly, this issue was waived by the Match Group defendants before the Court of Chancery; the Delaware Supreme Court said that notwithstanding that waiver, “the Court finds that resolving the issue raised by the IAC Defendants is in the interests of justice to provide certainty to boards and their advisors who look to Delaware law to manage their business affairs.”

Please go read Ann's post for her take on this important question. As for me, however, I'm going to take a dive into my archives to bring you my long-held view of the matter:

My own view is that not all controlling shareholder transactions need cleansing. I start with the Delaware Supreme Court's decision in

Sinclair Oil. v. Levien, 280 A.2d (Del. 1971). Under Sinclair Oil, the initial question is whether the controlling shareholder “has received a benefit to the exclusion and at the expense of the subsidiary.” (To be sure, Sinclair Oil involved a parent-subsidiary relationship, but the parent by definition is a controlling shareholder and the principles are the same.)

The fact that the controlling shareholder is a party to the transaction is not enough. The controlling shareholder must have gotten a benefit that is both at the expense of and to the exclusion of the minority shareholders.

This is made clear by the court’s treatment of the minority’s objection to the subsidiary’s dividend policy. Sinven (the subsidiary) had adopted at Sinclair Oil’s behest a policy of paying out the maximum lawful dividend. This benefited Sinclair Oil but did not constitute self-dealing by Sinclair Oil because Sinclair received nothing from Sinven to the exclusion of its minority stockholders.” Id. at 772.

Unlike Restatement subsection (3), moreover, it is not enough that the controlling shareholder get a benefit or even that the benefit is not shared. The controlling shareholder must get a benefit not only that excludes the minority but comes at their expense. This is made clear by the court’s treatment of the minority’s complaint that Sinclair Oil had denied Sinven opportunities to develop oil properties outside of Venezuela. “From 1960 to 1966 Sinclair purchased or developed oil fields in Alaska, Canada, Paraguay, and other places around the world. The plaintiff contends that these were all opportunities which could have been taken by Sinven.” Id. But the court rejected that claim: “Sinclair usurped no business opportunity belonging to Sinven. Since Sinclair received nothing from Sinven to the exclusion of and detriment to Sinven's minority stockholders, there was no self-dealing.” Id. Again, you must have both exclusion AND detriment.

I will grant you that some recent Chancery Court cases appear to assume that

any “interested” transaction involving a controller is subject to intrinsic fairness analysis (unless cleansed as per below). But that is not the law, at least in Delaware. Under Sinclair Oil, there are two standards of review. If the plaintiff can carry the burden of proof of showing that the controlling shareholder benefited itself at the expense and exclusion of the minority, then entire fairness is the standard. But if the plaintiff cannot, the business judgment rule is the standard of review.

The rule thus is not: Controlling shareholder > was controlling shareholder connected to transaction > fairness unless cleansing.

The rule is: Controlling shareholder > did controlling shareholder benefited at the expense of and to the exclusion of minority shareholders > if yes, fairness unless cleansed; if no, business judgment rule.

In other words, If the plaintiff can't carry the burden of proof of showing that the controlling shareholder benefited itself at the expense and exclusion of the minority, then no cleansing--whether ordinary Kahn v. Lynch or MFW--is required.

As a policy matter, it is certainly the case that cleansing is necessary when the controlling shareholder benefited at the expense of and to the exclusion of minority shareholders, such as in the freezeout merger context. The potential conflict of interest is especially pronounced in this context. After all, “a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death . . ..” SEC v. Geon Industries, Inc., 531 F.2d 39, 47 (1976). In a freeze out merger, the transaction takes on even greater significance than in the ordinary case because the controlling shareholder is buying the company and thus has a strong incentive to minimize the prize at the expense of the minority. Freeze out mergers thus have long been the subject of especially close review.

Yet, as been ably said by a court otherwise quite protective of minority shareholder rights, “The majority . . . have certain rights to what has been termed ‘selfish ownership’ in the corporation which should be balanced against the concept of their fiduciary obligation to the minority.” Wilkes v. Springside Nursing Home, Inc., 353 N.E.2d 657, 663 (Mass. 1976). This seems to be the principle animating Sinclair Oil, which allows some controlling shareholder transactions the protection of the business judgment rule even without the sort of cleansing envisioned by either Kahn v. Lynch or MFW.

If I can get all the other stuff on my desk cleared by summer's end, I'm planning on turning the above into a law review article.

Is insider trading illegal if you're drunk when you trade?

in yesterday's Money Stuff newsletter, Matt Levine relates an interesting insider trading case:

A former Barclays Plc trader said he got an insider tip from an ex-Goldman Sachs Group Inc. vice president at a squash court after having too many drinks.

Apparently the trader had been drinking at the time he received the tip, but was sober at the time he executed the trade.

But suppose somebody with material nonpublic information traded on the basis of that information while he was intoxicated. What result?

Scienter is an element of the Rule 10b-5 insider trading violation, as Donald Langevoort explains:

"... liability for insider trading under Rule 10b-5 requires a showing that the insider or tippee acted with scienter. Once fiduciary status giving rise to a duty to disclose is determined as a matter of law, scienter is established if the defendant knew that the information was material and nonpublic, or recklessly disregarded facts that would indicate that the information in his possession was material and nonpublic." Donald Langevoort, 18 Insider Trading Regulation, Enforcement and Prevention § 5:5 (2023).

I've been unable to find any cases on whether being intoxicated at the time one commits the alleged violation negates scienter either for purposes of Rule 10b-5, the federal securities fraud laws generally, os common law fraud.

Turning to the general criminal law, a number of federal courts of appeal have held that voluntary intoxication is not a defense to a to a general intent crime. See, e.g., United States v. Gracidas-Ulibarry, 231 F.3d 1188, 1196 (9th Cir.2000) (en banc); United States v. Oakie, 12 F.3d 1436, 1442 (8th Cir.1993); United States v. Fazzini, 871 F.2d 635, 641 (7th Cir.1989); United States v. Lewis, 780 F.2d 1140, 1143 (4th Cir.1986). On the other hand, some courts have held that "voluntary intoxication is a defense to ... specific intent crimes." U.S. v. Sewell, 252 F.3d 647, 650 (2d Cir. 2001).

The Sewell court drew the following distinction between general and specific intent crimes:

"With the exception of strict liability crimes, crimes require general intent, which ordinarily is “at least an intention to make the bodily movement which constitutes the act which the crime requires,” in order for criminal liability to attach. 1 W. LaFave & A. Scott, Substantive Criminal Law, § 3.5, p. 315 (1986). In addition to general intent, some crimes require specific intent, which is “a special mental element” particular to the crime with which defendant is charged. Id. For example, common law larceny requires not only the general mental state for the act of “taking and carrying away the property of another” but also the specific mental state that defendant possessed an “intent to steal the property.” Id. (quotation marks omitted)." Id.

So, is insider trading a general or specific intent crime? The answer is that "violation of Rule 10b–5 requires 'specific intent,'” which requires the Government "to prove, inter alia, that the defendant 'acted knowingly, willfully, and with an intent to defraud,' and that 'an intent to defraud' [in the context of a tipping case] meant 'an intent to deprive the company in question of the confidentiality of its information.'” U.S. v. Whitman, 904 F. Supp. 2d 363, 372 (S.D.N.Y. 2012), aff'd, 555 Fed. Appx. 98 (2d Cir. 2014)(unpublished).

In sum, it looks like voluntary intoxication might well be a viable defense to an insider trading charge.

Companies aren't talking as much about ESG, DEI, and their other woke efforts

I have a sneaking suspicion that corporate support for woke initiatives is a mile wide and and an inch deep. That suspicion gets some confirmation from a report in today's WSJ:

Companies’ mentions of green and social initiatives during earnings calls have fallen off sharply in recent quarters, reversing a more boastful approach taken over the past few years amid intensifying pressure from some investors and conservative activists.  ...

Executives at U.S.-listed companies mentioned “environmental, social and governance,” “ESG,” “diversity, equity and inclusion,” “DEI” or “sustainability” on 575 earnings calls from April 1 to June 5, down 31% from the same period last year, according to data from financial-research platform AlphaSense. That is the largest such year-over-year decline and the fifth consecutive quarter of year-over-year drops, following a pickup in these discussions and corporate social efforts in the wake of the police killing of George Floyd in May 2020. 

Of course, it's possible that companies are continuing to pursue ESG and DEI agendas, while not advertising it.

Do we really want to encourage more retail investor participation in corporate governance?

Ann Lipton posted a couple of weeks ago about proposals to encourage retail investor participation in corporate governance (I'm a little behind).

A while back, Jill Fisch proposed that retail shareholders be given access to the type of electronic tools available to institutional shareholders so that they could create standing voting instructions, allowing them to cast ballots in corporate elections automatically according to predefined preferences.  That vision appears to close to realization; today, there are new programs that make it easier for retail shareholders to cast ballots, including in accordance with preset preferences.  As I understand the Iconik service, for a monthly fee, you can set your preferences and have the app automatically vote them – or you elect to follow the instructions provided by a third party provider like As You Sow or Third Act.  If you do that, it’s free.

And of course, we know that mutual fund companies are proposing to give more voice to retail shareholders through various kinds of pass-through voting experiments.  There are now voting platforms being developed that allow automatic voting in this context, as well.

I am deeply skeptical. In the first place, there are lots of sound theoretical reasons to limit participation by all shareholders--retail or institutional--in corporate governance. See my article The Case for Limited Shareholder Voting Rights: https://ssrn.com/abstract=887789.

Second, retail investors have strong incentives to be rationally apathetic--i.e., to refrain from exercising their voting rights:

1. Lack of Information: Retail investors may not always have access to comprehensive and timely information about the companies they invest in. This can make it challenging to make informed voting decisions. Additionally, the sheer number of companies in which retail investors may hold shares can make it difficult to keep up with all the voting matters.

2. Limited Influence: Individual retail investors often own a relatively small percentage of a company's shares, which can lead to a perception that their votes may not significantly impact the outcome. As a result, some may feel that their vote will not make a meaningful difference.

3. Time and Effort: Voting requires time and effort, especially for retail investors who hold shares in multiple companies. Researching the issues, reviewing the proxy statements, and casting votes can be time-consuming, and some investors may prioritize other aspects of their investment activities.

4. Trust in Management: Some retail investors may trust the management and board of directors of the companies they invest in to make decisions in their best interest. They may believe that voting is unnecessary or that management will act in accordance with shareholder interests without their active participation.

Historically, retail investors have been apathetic. In 2017, for example, the NY Times reported that " 91 percent of the shares owned by institutional investors — but only 29 percent of those held by individuals — were voted." 

There are several reasons why we might want to let there sleeping dogs lie. First, as Ann points out, we are currently observing in real time retail investors in action--i.e., the objections being filed in connection with the proposed settlement of the AMC Entertainment litigation. (For background on that litigation see my posts AMC APEs, Retail Investor Rational Apathy, Blank Check Preferred Stock, Class Voting, and Blasius and Chancery Daily, AMC, DGCL 242, and the Delaware Legislature.) As Ann delicately puts it:

a lot of the comments are, well, uninformed, to put it mildly.  There are some fairly odd conspiracy theories floating around regarding AMC shares, and, in particular, something about an inflated share count and “synthetic” shares that are improperly voting.  Many of the objecting shareholders buy into those theories.  

I've read a lot of these objections and the vast majority do not inspire confidence in the knowledge or judgment of the objectors.

Second, as Ann also pointed out, many retail investors are now day traders and meme stock traders who are very different from the traditional perception of retail investors who are long-term shareholders. Research examining "how the influx of retail shareholders has directly affected the governance outcomes at the meme stock companies" concluded that "meme stock companies have experienced a significant decrease in participation by their shareholders with respect to voting. Shareholder proposals under Rule 14a-8 have also been extremely limited, with most meme firms seeing no proposals brought after the rapid increase in retail ownership." 

The same research also concluded that meme stock companies' "ESG scores have gotten worse subsequent to the meme surge.

Predictions that retail investors will "revolutionize corporate governance and make public companies more responsive to social concerns" thus seem unfounded.

Third, many retail investors are deeply engaged with social media and increasingly exhibit the pathologies associated with social media. In the AMC Entertainment litigation, for example, one of the two lawsuits challenging the plan was filed by an individual Usbaldo Munoz. The AMC Apes have been viciously attacking Munoz. Things apparently got so bad that Munoz has now ghosted his own lawyers, leaving them without guidance as to how to proceed.

Today, the WSJ reported that:

... the ticker MMTLP has become a rallying cry for people angry at the Financial Industry Regulatory Authority and, by extension, the entire financial system. Market veterans say the investors’ rage is misguided.

The episode is the latest example of how social media is a double-edged sword in today’s stock market. Online communities allow individual investors to connect and share trading tips, but they can also fan conspiracy theories and lead to disastrous investing decisions.

...

Some Finra employees and market veterans caught up in debate around MMTLP have received death threats. In one anonymous message to a market veteran seen by The Wall Street Journal, the sender alluded to mass shootings and vowed to come “piss on your casket.”

In sum, maybe it'd be best to leave things alone.

Guest Post by U Oregon Law Professor Mohsen Manesh on Lee v. Fisher

Last week, in Lee v. Fisher [1], the Ninth Circuit en banc issued a consequential decision calling into question the scope of the implied right of action recognized by J.I. Case Co. v. Borak [2] and creating a stark split with the Seventh Circuit. Prof. Ann Lipton has blogged extensively about the case. Readers of this blog will recall that Prof. Bainbridge has also discussed Lee, commending the amici brief submitted by Joe Grundfest and I for its “audacity,” but expressing some skepticism the Ninth Circuit would agree with us.

Ultimately, the Ninth Circuit did agree with us, and Prof. Bainbridge kindly invited me to provide this update.

The Rise of Derivative Borak Suits

In 1964, the Supreme Court in Borak held that, under Section 14(a) of the Exchange Act, shareholders enjoy an implied private right of action to bring claims for false or misleading proxy statements. Importantly, Borak explained that a shareholder lawsuit under Section 14(a) may be brought as either a direct action, on behalf of individual shareholders, or a derivative action, on behalf of the corporation.  As the Borak Court stridently asserted,

The injury which a stockholder suffers from corporate action pursuant to a deceptive proxy solicitation ordinarily flows from the damage done to the corporation, rather than from the damage inflicted directly upon the stockholder. The damage suffered results not from the deceit practiced on him alone but rather from the deceit practiced on the stockholders as a group. To hold that derivative actions are not within the sweep of the section would therefore be tantamount to a denial of private relief. [3]

As Grundfest and I have explained, in recent years, as Delaware courts have cracked down on meritless shareholder litigation, the plaintiff’s bar has sought refuge in federal courts by bringing derivative Borak claims. These federal derivative suits allege corporate harm arising from the board’s mismanagement of matters ranging from executive compensation, to oversight of regulatory compliance, to corporate policies concerning diversity, equity and inclusion. Stated differently, these derivative suits concern internal corporate affairs—matters that are traditionally governed by state corporate law and, therefore, more sensibly litigated in the Delaware Chancery. But rather than bringing a state law claim for breach of fiduciary duty in Delaware courts, these federal derivative suits make the more tortured argument that the alleged corporate harm was a result of the shareholders being misled by the company’s proxy statement. In doing so, derivative Borak lawsuits transparently aim to establish federal court jurisdiction and, thereby, avoid the likely fate that such suits would face before a skeptical Delaware judge.

Lee v. Fisher

The suit in Lee exemplified this trend. In Lee, the plaintiff-shareholder brought a derivative Borak claim in federal court against the directors and officers of The Gap, alleging failures in the management’s efforts to promote racial diversity within the company’s leadership ranks.  As a derivative suit, the Lee plaintiff alleged that The Gap’s proxy statements had included materially false or misleading statements about the company’s efforts to pursue diversity, which in turn harmed The Gap by enabling the re-election of the company’s incumbent directors and approval of the officers’ compensation packages.

The Gap sought to dismiss the derivative suit by invoking a forum provision in its corporate bylaws that required all derivative suits to be litigated in the Delaware Chancery Court. Because federal courts have sole jurisdiction to hear Exchange Act lawsuits, directing all derivative claims to the Delaware Chancery would effectively preclude the plaintiff’s derivative Borak suit. Nevertheless, the Ninth Circuit en banc ruled that the forum bylaw is enforceable against the plaintiff, both as a matter of Delaware law and federal law, and dismissed the plaintiff’s federal derivative lawsuit.

Practical Implications

Lee has immediate practical implications. In the Ninth Circuit, corporations may now use a forum bylaw to force all derivative claims into the Delaware Chancery and, thus, eliminate federal derivative Borak suits altogether. Shareholders remain free to bring (i) the same Borak claim as a direct or class action to recover any damage they suffered personally and (ii) a derivative action under state corporate law to recover any damage suffered by the corporation. But duplicative federal derivative suits brought under Borak can be quashed by a corporate forum provision that requires all derivative suits to be filed in Delaware. As Alison Frankel observes, “If [Lee] is right, a whole category of shareholder suits can be erased.”

Doctrinal Implications

Beyond the immediate practical implications, Lee has doctrinal significance. Citing our forthcoming Business Lawyer article, Lee ruled that Borak’s recognition of an implied derivative right under Section 14(a) is dicta and not binding precedent. [4] In doing so, Lee wholeheartedly embraces our article’s argument that, under the Supreme Court’s post-Borak precedents, the implied right of action under Section 14(a) is limited to direct claims only.  

As we explain in the article, ever since Borak was decided, the Court has repeatedly criticized the 1964 precedent [5] and told us that it must be narrowly interpreted. [6] Moreover, the Court has said, and reiterated, that state law—not federal common law—defines what a derivative action is. [7]

Looking to state law, Delaware is unambiguous. “[W]here it is claimed that a duty of disclosure violation impaired the stockholders' right to cast an informed vote, that claim is direct.” [8] The claim is direct, not derivative,  because “where a shareholder has been denied one of the most critical rights he or she possesses—the right to a fully informed vote—the harm suffered is almost always an individual, not corporate, harm.” [9]

Any lower court that spends time examining the Court’s post-Borak precedents would conclude that Borak’s implied derivative right of action is nonbinding dicta, as the Ninth Circuit has now done, and that private Borak suits are limited to direct claims only. Even in the absence of a corporate forum bylaw directing all derivative suits to Delaware, there is no cognizable federal derivative cause of action under Section 14(a) to begin with.

The Circuit Split

Significantly, the Ninth Circuit’s decision in Lee squarely conflicts with an earlier Seventh Circuit ruling in Seafarers v. Bradway. [10] In Seafarers, a bare majority of a three-judge panel ruled, over the dissent of Judge Easterbrook, that a corporate forum bylaw, identical to the one at issue in Lee, is unenforceable against a derivative Borak suit, both as a matter of Delaware law and under the Exchange Act’s anti-waiver provision.

The Ninth Circuit en banc in Lee concluded that Seafarers was wrong as to both Delaware and federal law. On the former, as we explain in our paper, Seafarers was clearly wrong, a belief that is supported by a venerable cadre of former Delaware Chief Justices, Justices, Chancellors, and Vice Chancellors who submitted a separate letter to the Ninth Circuit. The Delaware Supreme Courts’ landmark 2020 decision in Salzberg v. Sciabaccuchi [11] plainly establishes that a corporate forum provision may regulate shareholder rights arising under federal securities law.

Borak is in Jeopardy

Given the stark split now opened between Seafarers and Lee, and the fact that both decisions generated pointed dissents, it seems likely that the Supreme Court will be revisiting Borak at some point. Even if the plaintiffs in Lee don’t seek cert, perhaps because they fear the Supreme Court precedent that might result, we now have a consequential circuit split on the meaning of Borak. This issue is certain to come up in other circuits.

In 2019, when the Supreme Court took cert in Emulex v. Varjabedian, involving the implied right of action under Exchange Act Section 14(e), much of the Court’s attention was focused on Borak and what it meant for implied rights of action under Section 14. During oral arguments, the Chief Justice remarked that “we now know that [Borak] was not the right approach,” that “Borak would not be decided the same way today,” and that, “from today’s perspective, what we did back then [in Borak] was a mistake.” Ultimately, the Court dismissed cert in Emulex as improvidently granted because that case dealt with Section 14(e), rather than Section 14(a). But it was clear at that time that the Court was really interested in revisiting Borak. Lee, or another case like it, squarely presents the Court with that opportunity. At that point, the whole entirety of Borak may be in jeopardy.