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UCLAW's James Park's article Karmel’s Dissent: The SEC’s Use and Occasional Misuse of Section 21(A) Reports of Investigation

My friend and UCLA colleague Jim Park has just posted a new article that will be of interest to securities lawyers:

Section 21(a) of the Securities Exchange Act gives the SEC the option of publishing a report of its findings after conducting an investigation. Typically, the SEC issues such reports about once a year to highlight major compliance and enforcement issues. This Article examines the SEC’s use of Section 21(a) investigative reports with special attention to its 1979 report in Spartek, where Commissioner Roberta Karmel filed a famous dissent. In that opinion, she argued that the report effectively sanctioned conduct over which the SEC did not have jurisdiction and that Spartek did not have sufficient notice of its regulatory obligations. While such concerns have not been at issue in most Section 21(a) reports of investigation, they were recently raised by the SEC’s report in DAO, which analyzed whether a digital token was a security under the Howey test. While the SEC’s conclusion was reasonable, it was a close call, and the report did little to clarify the scope of the SEC’s jurisdiction over tokens. The SEC should be cautious in using reports of investigation to define its own jurisdiction and should actively seek adjudication to confirm the scope of its authority.

Karmel’s Dissent: The SEC’s Use and Occasional Misuse of Section 21(A) Reports of Investigation (January 13, 2022). Brooklyn Journal of Corporate, Financial & Commercial Law (forthcoming), UCLA School of Law, Law-Econ Research Paper No. 22-01, Available at SSRN: https://ssrn.com/abstract=4008573

University students can watch class videos at double normal speed without losing significant comprehension

News you can use from UCLA:

In one experiment, the researchers divided 231 UCLA undergraduates into four groups and had them watch two 13-to-15-minute lecture videos — one on the Roman Empire and another on real estate appraisals. One group watched at normal speed, one at 1.5 times normal speed, another at double speed and the final group at 2.5 times normal speed. They were instructed not to pause the videos or take notes.

Immediately after the viewings, they were given comprehension tests on the individual videos, each comprising 20 multiple-choice and true-or-false questions. The normal-speed group averaged 26 correct answers out of 40, while the double-time group scored 25 (about the same as the 1.5-speed group). The 2.5-speed group didn’t do as well, answering only about 22 questions correctly. ...

“Surprisingly, video speed had little effect on both immediate and delayed comprehension until learners exceeded twice the normal speed,” said lead author Dillon Murphy, a doctoral student in psychology at UCLA.

So could you go through law school in 18 months instead of three years.

The SEC is trying to revive the discredited equal access test and turn insider trading by tippers into a status crime

Keith Bishop alerts us to a troubling case:

In Dirks v. SEC, 463 U.S. 646 (1983), the United States Supreme Court found that a tippee may be liable for trading on the basis of material, nonpublic information if he or she knows that the tipper disclosed inside information in breach of a duty and for a personal benefit.  The Court stated that a personal benefit may be inferred when the tipper receives something of value in exchange for the tip or "makes a gift of confidential information to a trading relative or friend".   In Salman v. United States, 137 S. Ct. 420 (2016), the Supreme Court made it clear that the tipper need not receive something of pecuniary value from the tippee, it is enough that the tipper provided the information as a gift to a trading relative or friend.

Yesterday, the Securities and Exchange Commission filed a civil complaint alleging insider trading by two individuals - David Sargent and Christopher Klundt.  Mr. Klundt was employed by the issuer in question and is alleged to be the tipper.  Mr. Sargent is alleged to be the tippee.  The SEC alleges that "Klundt communicated material nonpublic information to Sargent in exchange for a personal benefit or with the expectation of receiving a benefit".  Noticeably lacking is any allegation as to what that benefit was.  The complaint does include several allegations concerning the two defendants' friendship.  It will be interesting to see whether these allegations of the defendants' amity will suffice under Salman and Dirks. 

In effect, what the SEC is trying to do is to turn trading by tippees into a status crime. It is enough in the SEC's view that tipper and tippee are friends. This an extremely aggressive reading of Salman and Dirks.

The SEC's efforts in this area also appear to be an attempt to revive the discredited equal access theory. Under the SEC's approach, if the friend of a tipper has unequal access to information that suffices to hold him/her liable. Which the Supreme Court precedents do not allow.

As I explained in Equal Access to Information: The Fraud at the Heart of Texas Gulf Sulphur, 71 SMU L. REV. 643 (2018), available at https://scholar.smu.edu/smulr/vol71/iss3/3, that test was invented out of whole cloth by the Second Circuit and decisively rejected by the Supreme Court. But the SEC has never accepted that loss and has consistently tried to bring back equal access as the basic test.

RIP, Lani Guinier: Recalling her Scholarship on Cumulative Voting and the Socratic Method

The WSJ reports that Harvard Law Professor Lani Guinier has passed away:

Ms. Guinier’s writings and studies focused on voting rights, race and gender.  ...

Before her appointment at Harvard Law School in 1998, she was a tenured professor at the University of Pennsylvania Law School; worked in the civil rights division at the Justice Department under President Jimmy Carter ; and headed the voting rights project at the NAACP Legal Defense Fund in the 1980s. She received her law degree from Yale Law School in 1974. ...

In 1993, President Bill Clinton nominated Ms. Guinier to be the assistant attorney general for civil rights. However, her writings on voting rights came under scrutiny and the administration withdrew her nomination.

“Her scholarship changed our understanding of democracy—of why and how the voices of the historically underrepresented must be heard and what it takes to have a meaningful right to vote,” said Mr. Manning.

Obviously, condolences go out to her friends and family. I never had the privilege of meeting her, but I was very interested in her work in two areas.

First, I was fascinated by her proposal to use cumulative voting in political elections so as to promote minority representation:

Cumulative voting is based on the principal of “one person one vote” because each voter gets the same total number of votes. Everyone's preferences are counted equally.

It's not a particularly radical idea. I learned about cumulative voting from my gentleman professor of corporations back at Yale Law School. Thirty states either require or permit corporations to use this election system to protect minority shareholders, and minority in that sense is not based on race, but is based on the number of shares that the person owns in the corporation.

Cumulative voting is certainly not anti-democratic because it emphasizes the importance of voter choice in selecting public or social policy, and it is neither liberal nor conservative.

Lani Guinier, Keynote Address, 25 U. Toledo L. Rev. 875, 881 (1995). In another work, she elaborated:

Many people, not all people, but many people think of their interests along racial lines. If that is true, and that is important to them, and they choose to vote along racial lines, then it is democratic, in my view, to allow them to participate as a racial group. But we must allow people to self-identify so that if they do not want to vote along racial lines, they don't have to. Nobody is forcing them. Cumulative voting or nondistricted elections provide exit opportunities for people who do not want to vote along with the majority of their particular racial-minority group. Cumulative voting provides racial “dissenters” the opportunity to form coalitions, biracial coalitions. But it also provides racial minority groups with a chance to reach out to other groups.Because it minimizes “wasted” votes, meaning votes cast for political losers, cumulative voting enables groups to reach out beyond their racial “cul-de-sac” and negotiate and bargain excess votes on particular issues or at particular elections.

Cumulative voting does not eliminate the need for compromise. It changes, however, the timing and the atmosphere of the compromise. Compromises are made in the open; compromises are made after open exchanges of views. Compromises are not hidden in order to confuse voters; compromises are not suppressed in order to pretend one is all things to all people.

Lani Guinier, More Democracy, 1995 U. Chi. Leg. Forum 1, 17–18 (1995). I'm not a huge fan of cumulative voting in the corporate law context. Boards elected by cumulative voting tend to fall into cliques, with the majority clique often meeting prior to the formal board meeting so as to work out a mutual position that is then imposed on the minority. 

But in a federal system in which, as Justice Brandeis famously observed, the states can serve as laboratories  of democracy, it strikes me as a worthy experiment for ensuring fairer elections.

In addition, as a critic of the Socratic method, I was interested to come across a pair of critiques of the method coauthored by Professor Guinier:

... many women are alienated by the way the Socratic method is used in large classroom instruction, which is the dominant pedagogy for almost all first-year instruction.Women self-report much lower rates of class participation than do men for all three years of law school.Our data suggest that many women do not “engage” pedagogically with a methodology that makes them feel strange, alienated, and “delegitimated.”

Lani Guinier, Michelle Fine, Jane Balin, Ann Bartow, and Deborah Lee Stachel, Becoming Gentlemen: Women's Experiences at One Ivy League Law School, 143 U. Pa. L. Rev. 1, 3–4 (1994).

The Socratic method in the large classroom, though valuable as a way to teach sharp analytic skills, is ill-suited to fostering “legal imagination,” which is what lawyers need most to become effective advocates, institutional designers, transaction engineers, and leaders. It also contributes to law student disengagement, particularly for women and people of color.

Susan Sturm & Lani Guinier, The Law School Matrix: Reforming Legal Education in A Culture of Competition and Conformity, 60 Vand. L. Rev. 515, 516 (2007). All of which tended to confirm that I was right to be a Socratic method skeptic.

In sum, I found Professor Guinier's scholarship to be provocative, thoughtful, and insightful. Based on what I saw of it, she was unfairly Borked. I'm sure we disagreed on many political issues, but I found her quite admirable in many ways.

Contrary to Ewan McGaughey, Dodge v. Ford Motor Co. is still good law in Michigan

As I work away at my new book The Profit Motive: Defending Shareholder Wealth Maximization, I've been researching the foundational American corporate law decision: Dodge v. Ford Motor Co., 170 N.W. 668(Mich. 1919).

As informed readers will know, Dodge held that:

A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the nondistribution of profits among stockholders in order to devote them to other purposes.

I'm specifically working on the chapter defending Dodge from the attacks that have been widely aimed at it by progressive corporate law scholars, one of which is a question posed by the late Lynn Stout: "Why rely on a case that is nearly one hundred years old if there is more modern authority available?” Her argument actually conflates two distinct claims. One is that there is modern authority that contradicts Dodge. As we shall see, however, modern authority supports Dodge. The other component claim is that old cases have minimal precedential weight." Lynn A. Stout, Why We Should Stop Teaching Dodge v. Ford, 3 Va. L. & Bus. Rev. 163, 166 (2008).

In researching the former component of Stout's argument, I ran across the following claim by Ewan McGaughey of King’s College, London and The London School of Economics and Political Science: 

... the claim that “shareholder primacy” is the “traditional paradigm” is absurd. The single case reference is predictably Dodge v. Ford Motor Co., 204 Mich. 459 (1919) which does not represent the law in the vast majority of states, including Michigan. See Lynn A. Stout, Why We Should Stop Teaching Dodge v. Ford (UCLA, Law-Econ Research Paper No. 07-11, 2007).

Ewan McGaughey, The Codetermination Bargains: The History of German Corporate and Labor Law, 23 Colum. J. Eur. L. 135, 176 n.71 (2016).

I took note of that claim because, as long time readers will recall, McGaughey was the fellow who subjected me to the Reductio ad Hitlerum a few years back.

I am unable to find any specific reference in the SSRN version of Lynn's article to Dodge's status as a matter of Michigan law. More generally, her discussion of the case law is more nuanced than McGaughey suggests. She thinks almost all of the cases on point are dicta and that the one non-dicta decision, Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., is "a dead letter." So I think Lynn's article provides very weak support for McGaughey's description of the law, at best.

Turning to the actual law, a 1935 Michigan Supreme Court decision cited Dodge with approval. Wagner Electric Corp. v. Hydraulic Brake Co., 257 N.W. 884, 887 (Mich. 1934). So did a 2006 Michigan Court of Appeals decision. Wojcik v. McNish, 2006 WL 2061499, at *5 (Mich. App. July 25, 2006). Most recently, a 2020 Michigan federal court decision concluded that it was still “well established under Michigan law that the primary purpose of a business corporation is to benefit and profit the stockholders.” Smith v. Smith, 2020 WL 2308683, at *8 (E.D. Mich. May 8, 2020) (emphasis supplied), citing Dodge for that proposition.

In addition, a 2003 Michigan appellate court decision, Churella v. Pioneer State Mut. Ins. Co., 671 N.W.2d 125 (Mich. App. 2003), explained that Michigan law draws an important distinction between business corporations and mutual insurance companies. While “the purpose of a business corporation is to provide profit to its shareholders . . . this is not the purpose of a mutual insurance company. The purpose of a mutual insurance company is to provide affordable insurance coverage to its members.” Id. at 132. The court specifically cited Dodge for its statement of the purpose of a business corporation. Id.

To repeat: Dodge is a “well established" proposition of Michigan law.

As for whether Dodge is good law in other states, while you wait to read my book (in about a year), I refer you to the relevant portion of my article Making Sense of the Business Roundtable's Reversal on Corporate Purpose, 46 J. Corp. L. 285, 289ff (2021).

Statement by SEC Commissioners Peirce and Roisman Slamming Chair Gensler’s Regulatory Agenda

Peirce and Roisman slam Gary Gensler's agenda:

While Chair Gary Gensler’s newly released regulatory agenda is ambitious in scope, we are disappointed with its content. It fails to include any items intended to facilitate capital formation and misses opportunities to foster fair, orderly, and efficient markets and further investor protection. Instead the agenda is brimming with plans to redo recently completed rules, add new regulatory obligations, and constrain investor choice. ...

The Agenda makes plenty of room for rulemakings to undo rulemakings that the Commission only recently completed.  These include proposals to further amend our rules on proxy solicitation and shareholder proposals; the Resource Extraction Payments Rule; the rules pertaining to the accredited investor definition and the private offering exemption integration framework; as well as our whistleblower rules. Not only are the Commission’s most recent amendments to each of these rules barely or less than a year old; none have been effective for more than a few months. As we said when we initially raised these concerns, we have not seen any new information that would warrant opening up any of these rules for further changes at this time.  So, why the rush to revisit them?

Why, indeed. The whole thing makes depressing reading.

Skadden speculates that Caremark is no longer the hardest corporate law claim to prove

A new post at CLS Blue Sky Blog reports on recent Caremark decisions suggesting "that directors may be more exposed to such claims than they have been in the past." The authors conclude that these cases "highlight the critical importance of establishing and monitoring company reporting systems for 'essential and mission critical' compliance risk."

All of which leads Skadden to speculate that:

Despite two and a half decades of Caremark decisions stressing the high bar for pleading a breach of the duty of loyalty premised on oversight liability, the recent decisions from the Delaware courts indicate a willingness to entertain well-pled oversight claims involving “essential and mission critical” issues for a company’s compliance risk. While these cases repeat the prior court statements about how difficult these claims are to plead, they suggest that, in practice, that may no longer be the case.

Regular readers, of course, will recall my article Don’t Compound the Caremark Mistake by Extending it to ESG Oversight (September 2021), forthcoming in Business Lawyer (2022). Available at SSRN: https://ssrn.com/abstract=3899528, in which I argue that:

Since the foundational decision in In re Caremark Intern. Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996), Delaware corporate law has required boards of directors to establish reasonable legal compliance programs. Although Caremark has been applied almost exclusively with respect to law and accounting compliance, the original Caremark decision contemplated applying the oversight duty to the corporation’s “business performance.” Accordingly, there is no doctrinal reason that Caremark claims should not lie in cases in which the corporation suffered losses, not due to a failure to comply with applicable laws, but rather due to lax risk management.

The question thus arises as to whether Caremark should be extended to board failures to exercise oversight with respect to environmental, social, and governance (ESG) factors. Obviously, where existing legislation or regulations impose compliance obligations in ESG-related areas, such as human resources, the environment, or worker safety, Caremark already applies. As such, boards must “ensure that compliance and monitoring systems are in place” to oversee corporate compliance with those laws.

Many ESG issues are not yet the subject to legal requirements, however. The question addressed in this Article is whether the board’s Caremark obligations should be extended to encompass oversight of corporate performance with such issues. In other words, should the board face potential liability not just for failing to ensure that the company has adequate reporting and monitoring systems in place to insure compliance with ESG-related legal requirements, but also to monitor ESG risks in areas where corporate compliance would be voluntary or aspirational.

Ideally, of course, I'd like to see Caremark reversed and for Delaware to return to the Graham v. Allis-Chalmers regime, but I'm not holding my breath. At the very least, however, we need to stop expanding it.

Keith Bishop asks "Could The SEC Have Made A Weaker Case For Mandating Enhanced Repurchase Disclosures?"

It's a great question:

As I read the SEC's 102-page rule proposal, I was struck by the SEC's repeated use of "could".   According to my count, the word appears 90 times in the proposing release.   

"Could" is the past participle of "can".  When used as a substitute for "can", "could" implies a greater degree of uncertainty.   When we say that something "could happen" we mean that it might or might not happen.   Essentially, it means that something is possible, not that it necessarily will occur.  Thus, the proposing release's constant use of the word conveys a notable incertitude on the part of the SEC. 

I wonder if one could use that as a challenge to the eventual rule. After all, the SEC's seen a lot of high profile rules go down in flames due to lousy cost-benefit analyses.

23 states file comment opposing DOL's proposed rule that "promotes a social activist agenda over the interests of employees, retirees, and other retirement fund beneficiaries"

H/T: Stefan Padfield:

You can read the full comment letter here.  For additional background on the proposed rule, go here.  An excerpt from the letter:

It is our position that social and political issues should not be considered by fiduciaries in employee retirement savings investment decisions. We are not opposed to any person or entity considering ESG or other social factors when investing their own money; individuals and companies may promote social causes through their investments to the extent they desire. But we are opposed to investment managers and employers being encouraged or mandated to consider ESG factors and protected from legal action when they do. Adopting this Proposed Rule and allowing employers and investment managers to consider ESG factors makes what should be a financial decision into a political one....

Reform Rule 10b5-1 by making executives trade the same amount every day (or week or whatever)

My friend and sometime coauthor Todd Henderson recognizes that SEC Rule 10b5-1 has not prevented use of inside information by corporate executives and has come up with a unique and sensible reform proposal:

The typical big-company CEO makes enough money—more than $24 million in 2020—that he shouldn’t need to sell shares urgently. A CEO can set a goal for the year in dollar or percentage terms and then have those sales spread out evenly over every trading day to diversify his portfolio. No surprises, no allegations of trading in advance of information disclosure, no timing the market and no big risk of front-running.

I think this is an excellent idea, but I would offer what I hope is a friendly amendment: Why not allow CEOs to trade once a week or once a month. For example, the CEO could be obliged to sell the same number of shares on the same day of the week every week of the year. It's not clear to me why allowing the CEO to sell 1000 shares every Wednesday the exchange is open, for example, would not achieve essentially the same result.

Introducing The Profit Motive

2/ Since the title of the book is "The Profit Motive: : Defending Shareholder Wealth Maximization," there doesn't seem to be much point in hiding the ball behind a pretense of academic objectivity. So here's what I've got. Thoughts? #lawtwitter #academictwitter #corpgov pic.twitter.com/5mMk0UVA1h

— Steve Bainbridge (@PrawfBainbridge) December 23, 2021

More on whether Fliegler v. Lawrence was wrongly decided and whether the votes of interested stockholders should count under DGCL 144(a)(2)

About a week ago, I opined that Fliegler v. Lawrence was wrongly decided. 

The court’s reading of § 144 is inconsistent with a plain-meaning approach to statutory construction. Section 144(a)(1) requires approval by “a majority of the disinterested directors,” but § 144(a)(2) requires only approval by a “vote of the shareholders.” The statute’s drafters thus inserted a requirement of disinterest in (a)(1) but not in (a)(2). Presumably, they did not forget the word disinterested in the presumably brief interval between writing (a)(1) and (a)(2). Accordingly, on the face of the statute, shareholder approval ought to be effective even if the shareholders are not disinterested.

Keith Paul Bishop finds support for my argument in an odd place:

Like Section 144(a)(1) of the DGCL, California Corporations Code Section 310(a)(2) requires approval of the board by a vote "sufficient without counting the vote of the interested directors".  Unlike Section 144(a)(2), however, Section 310(a)(1) requires approval of the shareholders with the shares "owned by the interested director or directors not being entitled to vote thereon".    Thus, the California statute illustrates Professor Bainbridge's point - the Delaware legislature could have, but did not, include "disinterested" in Section 144(a)(2).   I agree - haec omissio non praetermitterenda est.