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Emulex followup #2: Will it matter?

John Coffee thinks Emulex will prove to be much ado about nothing:

Defendants are hoping that the Supreme Court’s decision earlier this month to grant certiorari in Varjabedian v. Emulex Corp.[11] will produce a decision that slows the spread of merger objection cases. In that case, the Ninth Circuit panel held that because Section 14(e) of the Securities Exchange Act authorizes the SEC to prohibit acts not themselves fraudulent under the common law or Section 10(b) (at least if the prohibition was reasonably designed to prevent acts and practices that were fraudulent), the plaintiff in such a case need not allege scienter, but only negligence. Although this position is arguable, every other circuit that has ruled has decided to the contrary, and the Ninth Circuit has not done well in the Supreme Court when it is the lone dissenter among the circuits. More importantly, some hope that the Supreme Court will rule (as some amici have requested it to do) that there is no implied private cause of action under Section 14(e). Although this is possible, the issue was not discussed in any detail in Emulex. Thus, the court is more likely to insist on scienter, while noting in a parenthesis or footnote that “for purposes of this case we have assumed with the parties that a private cause of action exists under Section 14(e), which issue we reserve for a future day.”

Still, assume that the court either says that there is no private cause of action under Section 14(e) or mandates that scienter must be plead. What will the impact be? Either decision will, of course, provoke hundreds of law firm memos to clients, but the real world impact may be very modest. Plaintiffs could simply assert the same allegations under Section 10(b) and Rule 10b-5. Or, if a merger vote by a publicly listed corporation is involved, a cause of action might also be plead under the proxy rules and Section 14(a) (and such a suit in some circuits requires no allegation of scienter). The false premise in expecting Emulex to restrict the flood of merger objection cases is the assumption that plaintiffs want to take their cause of action to trial. In the vast majority of such cases, however, they do not. Rather, they are either (a) exploiting the lawsuit’s potential ability to disrupt the merger’s timetable or (b) selling preclusion to the defendant because settling the current frivolous suit may prevent other litigation with greater merit. Hence, the fact that plaintiffs must base their cause of action on Rule 10b-5 (where they cannot satisfy the pleading requirements) is not prohibitive because they plan to settle, not fight.

First, judges could solve that problem by smacking plaintiff lawyers who bring such cases with Rule 11 sanctions. But most federal judges lack the spine to do so. Second, somebody like Ted Frank or Sean Griffith could intervene in such settlements.

Emulex followup #1: Status of the implied right of action

As a followup to my previous post, I should note that some have argued that the case presents the Supreme Court with a broader issue than the scienter question on which my Legal Pulse column focused. Ann Lipton, for example, points out that:

When the defendants petitioned for certiorari, here’s how they phrased the Question Presented:

Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.

Note the precise wording here ....

It’s really two questions: first, what is the state of mind element under Section 14(e), and second is there a private right of action at all?  The implication of the defendants’ petition for cert is, well, no, there isn’t, and the amicus brief filed by the Chamber of Commerce makes that argument explicitly.

So what the defendants are really angling for is a declaration that plaintiffs cannot bring claims under 14(e) at all, with a fallback position of, if they can, they have to show intent. 

Ann points out that tossing the private right of action under Section 14(e) and Rule 14e-3 would lead to all sorts of odd results when you step back and look at how Delaware corporate and federal securities law interact in this context. (Go read it.)

As Ann points out, the modern Supreme Court is a lot less found of implied private right of action than it used to be, but as she also points out the Court is reluctant to outright overturn long established implied private actions. As I tell my students, the Court has gotten out of the business of creating or expanding implied private rights of action, but has grandfathered those that have been approved at some point by a one of at least 5 justices. If so, the section 14(e) implied right of action is safe.

In an interesting post Kevin LaCroix reaches the same conclusion:

Chamber’s counsel argued in its amicus brief that the courts of appeals have ignored the U.S. Supreme Court’s precedents on inferring statutory rights of action. The Chamber’s brief, in urging the Court to take up the case, contended that the case could provide the Court a chance to rule that the circuit courts improperly implied a right of action under Section 14(e) and could thereby eliminate a “complex, judicially-created liability scheme.”

In her November 14, 2018 post on her On the Case blog about the Chamber’s amicusbrief (here), Alison Frankel quotes Stanford Law Professor Joseph Grundfest as predicting not only that the Court would take up the Emulex case, but that it would conclude that there is no private right to sue under Section 14. Interestingly, in making his comments, Grundfest does not seem to be limiting his prediction just to the private right of action under Section 14(e); rather he seems to be suggesting that the Court will conclude there is no private right of action at all under any part of Section 14. Obviously, if the Court were to go so far, then the Emulex decision would indeed have a very significant impact on federal court merger objection litigation.

There may be grounds to be skeptical of the likelihood that the Court would in fact go so far as to eliminate the private right of action under Section 14 altogether, or even with respect just to Section 14(e). In her article about the Chamber’s amicus brief, Frankel quotes counsel for Emulex as saying, first, that Congress has amended the securities laws numerous times since the courts recognized the private right of action under Section 14(e), and yet did not address the issue. In addition, Emulex’s counsel notes that the issue of whether there is a private right of action under Section 14 arguably was not fully addressed in the courts below, which would seem to eliminate the possibility that the Supreme Court would take up the issue for the first time in the case now. Indeed, the plaintiff in the Emulex case argued in his brief in opposition to the cert petition (here) that Emulex itself conceded in the lower courts that there is a private right of action under Section 14(e).

Corban Rhodes and Anna Menkova further explain that:

... some have seen the case as an opportunity for the high court to go far beyond that question and deny investors any ability to bring claims under Section 14(e), declaring that no private right of action exists, regardless of the standard.

This effort is misguided for several reasons. First, the Emulex case is a poor vehicle to consider a question of this magnitude, especially after petitioners raised the issue only as a passing afterthought in the petition itself, and never briefed it below. Second, the question is not ripe for the Supreme Court’s review, given that there is no circuit split on this issue, despite private Section 14(e) claims having been recognized for decades. Third, even if the court were to take up this broader question, the court’s own reasoning in past Section 14(e) cases supports the existence of an implied private right of action. And finally, as a policy matter, while state court remedies provide some means of relief for investors defrauded in the context of a merger, federal courts should not abdicate their role in protecting investors and ensuring the integrity and transparency of tender offers.

They go on to elaborate on each of those points in some detail, concluding:

A case in which the issue was not even raised below, and where there is no circuit split, is hardly the correct vehicle to consider eradicating a long-recognized federal right.

All of which seems correct. As Ann Lipton points out, however:

... the Supreme Court doesn’t have to go all the way to holding that 14(e) provides no right of action to make an impact; all it has to do is say “We reserve for another day the question whether a private right of action exists under 14(e),” and we are off to the races.  Expect a bunch of test cases, and a concerted, coordinated build of precedent in the lower courts, now more populated with Republican judges inclined to be skeptical of private claims.  And that, I suspect, is really what the defendants, and the Chamber of Commerce, consider endgame.

Emulex: SCOTUS to decide if scienter is an element of the implied cause of action under Exchange Act Section 14(e) and Rule 14e-3

.@UCLA_Law's @ProfBainbridge explains importance of new #SCOTUS securities case at @WLF blog: https://t.co/5XTZqGcpym via @WLF

— Washington Legal Fdn (@WLF) January 22, 2019

Another state decides to take on Delaware. Reserve a space for Wyoming on Boot Hill.

In corporate law, Delaware is kind of like the movie gunslinger that "every piss-ant prairie punk who thought he could shoot a gun would ride into town to try out." And like that gunslinger, Delaware "must have killed more [states] than Cecil B. DeMille." (Bonus points for spotting the source of the quotations.) 

Most recently, North Dakota tried. I predicted that effort would fail. It did.

Bloomberg reports that now Wyoming's going to try:

Wyoming is looking to compete with Delaware as a corporate-friendly destination by creating a specialized court that offers lower fees and speedy dispute resolutions.

The proposals are part of a broader push by Wyoming lawmakers to make the state that invented the limited liability company (LLC) into a fintech friendly “Delaware of the West.”

Separate bills planned for the Wyoming state legislative session that started this week would use blockchain technology for commercial filings and business registrations and create a special purpose state-chartered depository bank intended to serve the blockchain industry.

Good luck with that.

A proponent of Wyoming's effort told Bloomberg that “when you go to other competing jurisdictions, a lot of times they have specialty courts that can deal with those specific issues.” It's true that the Delaware Chancery Court specializes in corporate law. But what that overlooks is that Delaware has a 100+ year head start. What matters is not having a specialized court, but having a huge volume of case law. What transactional lawyers (who advise their clients on where to incorporate) want is predictability and certainty. The vast volume of Delaware decisional law makes it possible, in most cases, to write an opinion letter with confidence. Wyoming's new court will be starting from scratch.

As for the much ballyhooed blockchain laws, Delaware's legislature is an expert at spotting new trends and incorporating them into its law. On the blockchain front, Delaware has already moved and doubtless will be evaluating what Wyoming does. If need be, Delaware will copy (and likely improve) the Wyoming laws. 

So I fully expect Wyoming to join North Dakota, Nevada, Pennsylvania, etc... who "finally found a home under the boot hill grave that bears [their] name."

Cato sues SEC over gag settlements

Alison Frankel reports:

Adding to mounting conservative criticism of a Securities and Exchange Commission rule that prohibits people who settle with the commission from thereafter denying the government’s allegations, the libertarian Cato Institute sued the SEC Wednesday in federal court in Washington, D.C., alleging that the SEC’s "gag rule" is unconstitutional.

“The government uses its extraordinary leverage in civil litigation to extract from settling defendants a promise to never tell their side of the story, no matter how outrageous the government’s conduct may have been and no matter how strong the public’s interest may be in knowing how the government conducts itself in high-stakes civil litigation,” the Cato suit said. “This civil-rights lawsuit seeks to end the federal government’s decades-long use of gag orders in violation of the First Amendment to the United States Constitution.”

Back in November, the WSJ opined that:

One of the strongest rules in free-speech law is that the government may not engage in “prior restraint” of speech except in extreme circumstances. Yet the Securities and Exchange Commission does so routinely. Under a rule adopted in 1972, the SEC demands that parties entering into settlements with the commission be silenced about the prosecution forever. If they question the merits of the case against them, the SEC reserves the authority to reopen it. ...

The SEC’s gag rule is a symptom of a broader problem: Administrative agency power tends to expand beyond its lawful scope. This is why the Founders were so obsessively concerned that the three branches of government operate publicly subject to carefully constructed checks and balances.

In October, the New Civil Liberties Alliance filed a petition asking the SEC "to amend its rule restricting speech that is set forth in 17 C.F.R. § 202.5(e) (“The Gag Rule”). ... The Rule is unconstitutional, without legal authority, and further is ill-conceived policy."

Scott Shackford has a blog post at Reason discussing the issue.

Another new book chapter by yours truly: "The Law and Economics of Insider Trading 2.0"

Bainbridge, Stephen Mark, The Law and Economics of Insider Trading 2.0. Forthcoming in Encyclopedia of Law and Economics (2nd edition 2020); UCLA School of Law, Law-Econ Research Paper No. 19-01. Available at SSRN: https://ssrn.com/abstract=3312406:

Insider trading is one of the most controversial aspects of securities regulation, even among the law and economics community. One set of scholars favors deregulation of insider trading, allowing corporations to set their own insider trading policies by contract. Another set of law and economics scholars, in contrast, contends that the property right to inside information should be assigned to the corporation and not subject to contractual reassignment. Deregulatory arguments are typically premised on the claims that insider trading promotes market efficiency or that assigning the property right to inside information to managers is an efficient compensation scheme. Public choice analysis is also a staple of the deregulatory literature, arguing that the insider trading prohibition benefits market professionals and managers rather than investors. The argument in favor of regulating insider trading traditionally was based on fairness issues, which predictably have had little traction in the law and economics community. Instead, the economic argument in favor of mandatory insider trading prohibitions has typically rested on some variant of the economics of property rights in information. This is a chapter from the forthcoming Encyclopedia of Law and Economics (2nd edition 2020).

Keywords: Insider trading

JEL Classification: K22, G30, G38

New book chapter by yours truly: "Insider Trading Compliance Programs"

Bainbridge, Stephen Mark, Insider Trading Compliance Programs (January 8, 2019). UCLA School of Law, Law-Econ Research Paper No. 19-02. Available at SSRN: https://ssrn.com/abstract=3312430:

This chapter in a forthcoming handbook on corporate compliance provides an overview of corporate insider trading compliance programs. It sets out the basic legal framework of the federal insider trading prohibition. It then reviews the reasons corporations adopt compliance programs. The chapter next reviews the basic elements of an insider trading compliance program. Finally, the chapter examines the special case of Rule 10b5-1 compliance programs.

Keywords: insider trading, compliance

JEL Classification: K22

Harold Demsetz, RIP

Oh no. I had the privilege of knowing Harold Demsetz for many years. Few economists had a better grasp of corporate law and governance. His work influenced mine and countless others. Plus, he was a kind and generous friend. https://t.co/cv1oaMJlhc

— Professor Bainbridge (@ProfBainbridge) January 8, 2019

I second that. Harold kindly read a number of my papers and always gave me great comments. https://t.co/Xy1WitcEKO

— Professor Bainbridge (@ProfBainbridge) January 8, 2019

Harold Demsetz was a 24-7 economist. An appreciation by @artcarden https://t.co/GFrtDrPJhz

— Alex Tabarrok (@ATabarrok) January 8, 2019

💯.

Here’s an old blog post of mine making the case for an Alchian, Demsetz and Klein Nobel Prize.https://t.co/qpJ8FFKhJY https://t.co/mRSBlk0zv6

— Joshua Wright (@ProfWrightGMU) January 8, 2019

Big tent religion versus perpetual schism

Rod Dreher passes along a note from a Catholic (whom I assume to be theologically and political right of center):

In the last couple of months I’ve returned to Catholicism with more faith and vigor, trying to recover my faith through regular parish life, small-scale involvement (K of C, etc.), and deeper faith experiences—and it has, by and large, worked. I feel more closely connected to Christ than ever, and it has been a real blessing to me to get more involved in my parish life. For the first time in a long time, I find that I’m glad to be a Catholic, excited to go to Mass, and optimistic about the laity.

Sadly, his correspondent then attended a retreat sponsored by a lay religious order, which turned out to be dominated by "hippy dippy" Catholics. The problem is that, at least in the correspondent's parish, the hippies are in charge:

... these are the most involved people in our parish. They are the leaders in the pews. They are the Eucharistic ministers and bulletin columnists and what we might call “the elite” in parish culture. They set the tone for everyone else, and I note with some alarm that the dinner table included no fewer than four teachers at the parish school. If the teachers and parish leaders and even the priests (!) of the parish can’t be counted on to defend the most basic teachings of the Church, then where are we? Seriously, I’m really asking. If we just tacitly agree as Catholics that we’re just going to smirk at what we don’t like, then what the hell are we doing every Sunday?

...I’m really trying hard to be a good Catholic, but you know who’s making it hard? Other Catholics. Even the priests themselves. It’s like we’re living in some bizarro world where we pretend to believe something even as we all mock it. There is no looming collapse of Christian culture—we’re there. We’re post-collapse.

I get it. I really do. But my background prior to my conversion was mainly Baptist. And I'm not talking the behemoth that is the Southern Baptist Convention. I'm talking the 200,000 strong Conservative Baptist Association and the General Association of Regular Baptist Churches.

The chief characteristic of these micro-denominations is schism at the slightest whiff of heresy. If I have my history right, the Southern Baptists split off from the Triennial Commission (definitely not to be confused with the Trilateral Commission). Northern baptist churches remained only loosely affiliated through the Commission and several other missionary associations until 1907 when the Northern Baptist Convention was formed. In 1947, the Conservative Baptists split off from the Northern Baptists. In the 1950s, the most conservative of the Conservative Baptist churches objected that the denomination leadership was cooperating with Billy Graham, who the conservative minority regarded as too liberal and too ecumenical. Unwilling to tolerate association with those who associated with Graham, some 200 churches left the association. So the schismatics underwent their own schism.

The GARBC story is similar. In 1923, a collection of evangelical and fundamentalist churches split off the increasingly mainline Northern Baptists and formed the Baptist Bible Union. In 1932, BBU went out of business (so to speak) and the GARBC rose from the ashes.

The GARBC is further relevant because they practice a doctrine known as second degree separation. First degree separation requires that Christians separate themselves from the world. Second degree separation requires that Christians also separate themselves from Christians who are not separated from the world. (In other words, those who practice second degree separation separate themselves from those who do not practice first degree separation.) For example, a lot of GARBC folks thought Billy Graham taught unsound doctrines and associated with apostates. Accordingly, they refused to associate with Graham (first degree) and also refused to associate with any Christians who did cooperate with Graham (second degree).

The logical of the separation doctrine, especially when taken to the second degree, inevitably leads to ecclesiastical separatism -- i.e., schism. The true believers (usually a small rump) quote 2 Cor. 6:17 ("Therefore, come forth from them and be separate,” says the Lord, “and touch nothing unclean; then I will receive you.") and march out to form their own new organization.

At the opposite extreme, of course, stands Roman Catholicism with its billion-odd believers. It is the ultimate big tent. You can't be a Roman Catholic and practice second degree separation, because even if you don't associate with the hippy-dippy Catholics, you're going to be rubbing shoulders with those who do. I doubt whether you can be a Roman Catholic and practice first degree separation (although I'd love to see how Rod Dreher relates the Benedict option to the doctrines of separation.)

I understand the folks who practice second degree separation. After all, I've got family members who were leaders of a group that left a GARBC church to form an independent church because they thought the GARBC was getting too liberal on separation. There is an appeal to purity (especially if you're a curmudgeonly Yankee).

But then I remember that Jesus said "I have not come to call the righteous to repentance but sinners." Instead of separating ourselves from those who do not share our beliefs, I suggest that we have a duty to witness to them. To live an orthodox life and expound (lower case o) orthodoxy. Maybe this is especially true if we look at our local parish and see disaster. After all God sent Jonah to Nineveh, not some city where everybody was already headed to heaven.

Pileggi's Annual Review of Key Delaware Corporate and Commercial Decisions

Francis Pileggi's invaluable Annual Review of Key Delaware Corporate and Commercial Decisions for 2018 is online. It's a must read for anybody working in corporate law.

Speaking of "principal executive office" under California corporation law, what exactly does it mean?

In the preceding post, I noted the centrality of the term "principal executive office" to the application of California's corporate board gender quota bill. Keith Paul Bishop notes California corporate law fails to define this key term despite its appearance I numerous provisions of California corporate law.

Similarly, SEC Form 10-K and 10-Q require that the corporation disclose its principal executive office without defining that term. Having said that, Rule 3b-7 defines “executive officer” as the company’s “president, any vice president ... in charge of a principal business unit” or any other “officer” or “person” who “performs similar policy making functions.” Logically, "principal executive office" would mean the place where the CEO and most other executive officers work most of the time.

In federal tax law, "principal executive office" is "generally understood to mean 'the head office, the place where the principal officers generally transact business, and the place to which reports are made and from which orders emanate.'” Dimmitt & Owens Fin., Inc. v. Unique Industries, Inc., 589 F. Supp. 14, 16 (N.D. Ill. 1983), aff'd sub nom. Dimmitt & Owens Fin., Inc. v. U.S., 787 F.2d 1186 (7th Cir. 1986).

 

 

The ambiguous application of California's Corporate Board Gender Quota Law (SB 826)

Keith Paul Bishop has spotted two key ambiguities:

SB 826 (Jackson) is reputably the first state law requiring publicly held corporations to have a minimum number of female directors.  It is generally assumed that the law applies only to those publicly held domestic and foreign corporations having their principal executive offices in California.  But is that what the new law actually provides?

The bill adds two sections to the California Corporations Code.  The first, Section 301.3, expressly imposes a quota on "a publicly held domestic or foreign corporation whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California".  This language is ambiguous as to domestic corporations.  Did the legislature intend to impose gender quotas on all publicly held domestic corporations or only those with principal executive offices in California?

The scope of law becomes even more muddied with respect to publicly held foreign corporations.  While Section 301.3 includes a requirement that the foreign corporation's principal executive offices be in California, SB 826 also added a new Section 2115.5 that provides:

"Section 301.3 shall apply to a foreign corporation that is a publicly held corporation to the exclusion of the law of the jurisdiction in which the foreign corporation is incorporated."

Noticeably absent from this section is any requirement that the foreign corporation's principal executive offices be in California. 

I hope Keith is right that "it is unlikely that the legislature believed that it could impose its will on foreign corporations with no connections to California." But then again the California legislature has done odder things than that. In any case, I definitely agree with Keith that the statute is probably unconstitutional even if we assume that the bill implicitly requires that the foreign corporation have its principal executive office in California.