ProfessorBainbridge.com

The NOL Poison Pill Upheld

Much discussion in the corporate blawgosphere of Selectica, Inc. v. Versata Enterprises, Inc. VC Noble's opinion for the Delaware Chancery Court involved what Steven Davidoff calls "frankly odd" facts:

They arose out of Versata’s acquisition of 5.2 percent of Selectica and Versata’s accompanying offer to acquire Selectica. (Both companies produce business software.) In response, Selectica adopted a low-threshold, net-operating-loss poison pill that would be triggered when someone acquired 4.99 percent of its stock, rather than the more typical 15 percent trigger. Versata was exempted from this threshold to the extent that it did not subsequently acquire Selectica shares.

The net operating loss poison pill is a new development. The lower triggering threshold is adopted to conform with Section 382 of the Internal Revenue Code and protect the company’s net operating losses, which can be used to lower future taxes to the extent a company accrues profits. According to Factset Sharkrepellent, 41 companies including Citigroup and Pulte Homes adopted these types of pills last year. Selectica itself is a microcap survivor of the dot.com bubble with $160 million of net operating losses, a market capitalization of about $11 million, little revenue and no profits. It is uncertain whether Selectica will ever return to profitability in order to use these net operating losses, or N.O.L.s, as the court refers to them.

A post by Kevin Brady reviews the facts in much greater detail and also provides a through review of the legal analysis.

How does the NOL pill work? A Wachtell Lipton client memo explains that:

Lehman Bros.: Another Black Eye for the SEC and SOX

Megan Carpentier:

One of the major components of the post-Enron accounting reforms, and laughable so, was a provision requiring that all CEOs sign off on their company’s financial statements. It was supposed to prevent CEOs from willfully looking the other way while subordinates cooked the company books (i.e., deny them plausible deniability) and inculcate in American corporate culture a sense of responsibility. It was laughable then, and, as yesterday’s report on the book-cooking that went on at Lehman Brothers proves, it’s laughable today.

The provision was based on the assumption that when CEOs admitted they didn’t know about accounting “errors” that caused collapses and massive disruptions, that they were telling the truth and that, if they had to be personally responsible, they might look into accounting irregularities and stop mischievous underlings from ruining companies. It’s surprising now to think that Congress was that gullible, or thought the American people were.

In the case of Lehman CEO Richard Fuld, he’s been found “grossly negligent” for certifying accounting statements he made no effort to look into, just as you might think. According to Michael de la Merced and Andrew Sorkin, Lehman shifted $50 billion off its books with fraudulent accounting tricks in the months before its collapse. They’d been engaging in the transaction since 2001, and there wasn’t a thing that the post-Enron regulations did to stop it.

Relatedly, the Lehman Bros. episode is yet another triumph for the crack SEC enforcers who overlooked Madoff for so long.

Should I Pre-Order an iPad?

I can't remember the last time I was as consumed by "I gotta have it" fever as I am for the iPad. Maybe the GI Joe with Kung Fu grip? Anyway, I'm going to buy an iPad. Not the very first one, I'm going to wait for the 3G model to come out later in the month. But I can pre-order the 3G model for delivery upon release. What to do? The WSJ Smart Money blog says wait:

Price drops

Putting off your purchase a few months could cut your bill substantially. When Apple introduced the iPhone in 2007, it slashed the 8GB version’s $599 price tag to $399 just 10 weeks later. (Outraged early adopters received a $100 credit.) That swift of a drop on the iPad is unlikely, but the price could come down in as few as six months, says Michael Carnell, the founder of Charleston, S.C., information technology firm Palmettobug Digital. “The run-of-the-mill consumer can wait that long,” he says.

In particular, consumers could see prices drop on the Wi-Fi/3G version. “The extra charge for 3G in the device doesn’t make much sense,” Enderle says. Apple stands to profit from the $15 to $30 monthly 3G subscriptions.

Bugs

“This is version one — there’s a lot that has to be worked out,” says Aaron Ray-Crichton, an independent technology consultant and the founder of ARC Systems Consulting in Brooklyn, N.Y. Apple originally anticipated an iPad release in late March, and analyst reports have pointed to possible production problems.

App availability

Currently, the iPad has very few apps of its own. Most are iPhone apps, Carnell says. Displayed on a 9.7-inch screen instead of a 3.5-inch one, they may appear too jagged and low resolution to be useful, he says. If you’re looking at the iPad for the apps, hold off a month or two until developers can catch up.

Connectivity

A Wi-Fi-only device is fine if you plan to use it at home or other areas with Wi-Fi hotspots. But 3G connectivity – available in iPad models set to launch later this spring — is basic for consumers who want their iPad to work while traveling in the car or in other locations where Wi-Fi is scarce. “Otherwise, you’re going to have limited access to that rich Internet content,” Ray-Crichton says. 3G subscription costs will set you back an extra $180 to $360 a year. Given that cost, an iPhone may be a more cost-effective choice for some users, he says.

All of which makes total sense, but for one thing. I really, really suck at waiting.

A Second Case Comment on Pfeiffer v. Toll: Did Chancery Get Federal Insider Trading Law Right?

Eight (out of 11) members of Toll Brothers board of directors sold significant amounts of the company’s stock between December 2004 and September 2005. Plaintiff sued derivatively on behalf of the corporation, claiming that the defendants had sold “while in possession of material, non-public information about Toll Brothers’ future prospects.” Pfeiffer v. Toll, C.A. No. 4140-VCL, slip op. (Del. Ch. Mar. 3, 2010).

I’ve discussed the state law aspects of the case here.

In the course of its opinion, however, the Delaware Chancery Court (per Laster, VC) touched on a couple of aspects of the federal insider trading prohibition that deserve further attention.

A Case Comment on Pfeiffer v. Toll: State Corporate Law Derivative Suits Against Inside Traders

Eight (out of 11) members of Toll Brothers board of directors sold significant amounts of the company’s stock between December 2004 and September 2005. Plaintiff sued derivatively on behalf of the corporation, claiming that the defendants had sold “while in possession of material, non-public information about Toll Brothers’ future prospects.” Pfeiffer v. Toll, C.A. No. 4140-VCL, slip op. (Del. Ch. Mar. 3, 2010).

We normally think of insider trading as being a matter of federal securities law. The insider trading prohibition originated in state corporate law, however, and the state rules remain on the books. See generally Stephen M. Bainbridge, Securities Law: Insider Trading 15-16 (2d ed. 2007), cited in Pfeiffer v. Toll, C.A. No. 4140-VCL, slip op. at 35, 36, 41 (Del. Ch. Mar. 3, 2010).

Toll Brothers is a leading home builder. During the relevant period, Toll Brothers was putting out lots of positive investor statements. In particular, Toll Brothers repeatedly sought to assure investors that there was no housing bubble and, even if there was, that Toll Brothers was sufficiently different from its competitors that it would be unaffected by the bursting of a bubble.

Allegedly, the defendants knew that this information was false, which was why they were selling their holdings of Toll Brothers stock. (Note that there’s federal securities fraud claims all over the statement of facts. Indeed, a federal suit is pending in parallel to the state suit.) Certainly, the defendants seemed to have been in a hurry to get out of Toll Brothers stock. “The eight defendants collectively sold 14 million shares for proceeds of over $615 million.” Some sold as much as 90% or more of their holdings.

The Court explained:

The Complaint sets forth two counts. Count I asserts a claim for breach of fiduciary duty under Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949), which recognized the right of a Delaware corporation to recover from its fiduciaries for harm caused by insider trading. Count II asserts a generalized claim for contribution and indemnification. The defendants (including Toll Brothers as nominal defendant) have moved to dismiss these claims. First, all defendants contend that the Complaint fails to plead demand futility for purposes of Court of Chancery Rule 23.1. Second, all defendants contend that the statute of limitations bars any claims based on the individual defendants’ stock sales. Third, the Outside Director Defendants argue that a claim for breach of fiduciary duty has not been pled as to them. Finally, and most boldly, the defendants argue that Delaware should abandon its traditional role of policing against breaches of the duty of loyalty by fiduciaries of Delaware corporations, at least where the underlying wrong involves insider trading, and that Brophy is an outdated precedent that should be rejected.

Toll, slip op. at 11.

I propose to focus on count I and the last two defenses raised thereto.

Nanny State Run Amok in NY

At first I thought this had to be an Onion headline. Sadly it is not.

Some New York City chefs and restaurant owners are taking aim at a bill introduced in the New York Legislature that, if passed, would ban the use of salt in restaurant cooking.

"No owner or operator of a restaurant in this state shall use salt in any form in the preparation of any food for consumption by customers of such restaurant, including food prepared to be consumed on the premises of such restaurant or off of such premises," the bill, A. 10129 , states in part.

The legislation, which Assemblyman Felix Ortiz, D-Brooklyn, introduced on March 5, would fine restaurants $1,000 for each violation.

Felix Ortiz is a officious prig and an ass. Not surprisingly, he's also a Democrat. 

My Insider Trading Text Cited by Delaware Chancery Court

Edward McNallay spotted a new Delaware Chancery Court case dealing with insider trading by corporate officers:

Pfeiffer v. Toll, C.A. 4140-VCL (March 3, 2010)

The by now ancient Brophy decision upheld a claim against insiders for trading on confidential corporate information. This decision affirms that Brophy is still good law in Delaware.  That is no real surprise, given the Court's strict enforcement of the duty of loyalty. The Court's discussion of possible damages that might be recovered also is very expansive.

On a different level, the opinion is revealing on how the Court goes about the task of deciding what is the law of Delaware. It is apparent that the Court is willing to consider a wide range of sources in a detailed  analysis. This raises the bar for brief writers as well.

One of those sources to which McNally refers is my book Securities Law: Insider Trading (Turning Point Series):

Credit Default Swaps Under Fire

The WSJ reports that:

International momentum is building for stricter oversight of derivatives trading, as a top U.S. regulator recommended new limits on credit-default swaps and European leaders pushed for a ban on speculative bets against government debt following recent financial turmoil in Greece. ...

German Chancellor Angela Merkel said Tuesday that her government is backing an initiative to curb the credit-default swaps market, together with France, Greece and Luxembourg, and she suggested Europe would forge ahead on its own even if the U.S. didn't go along.

José Manuel Barroso, president of the European Commission, the European Union's executive arm, said the commission would examine closely the possibility of banning outright "purely speculative" trading of the swaps. ...

As financial problems mounted for Greece and other euro-zone countries in recent months, prices of swaps insuring against debt default by those nations soared, drawing attention to the troubles and raising questions about whether speculation was worsening them.‬‪

This is just absurd.

More on owning the corporation

Josh Fersee continues the discussion of whether shareholder own the corporation with this observation:

I view shareholders as having “an ownership interest” in the corporation, an interest that is, I admit, often quite limited. I think comparing shareholders to those who own homes (or condos) with a restrictive homeowners’ association (HOA) as an apt analogy. When owning a home governed by an HOA, the homeowner gives up a number of rights often attributed to ownership — such as limits on exterior modifications or choice of color. However, just because those rights (and the related decision-making ability) were ceded to the HOA board, we don’t tend to think that means there is a lack of ownership.

Well, yes, but. A home is a thing. It is capable of being owned. But when we speak of the corporation, what is the res; i.e., the thing capable of being owned? I contend that there is no such thing:

In order for shareholders to own the corporation, the corporation would have to be a thing capable of being owned. It is not. The corporation is just a legal fiction, albeit a highly useful one, for the nexus of explicit and implicit contracts between a wide array of stakeholders, of whom shareholders are but one among many. [FN8] Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm's inputs. The corporation is a legal fiction representing the complex set of contractual relationships between these inputs.

[To be sure,] traditionalists reify the corporation: They treat the firm as an entity separate from its various constituents. Nexus of contracts theory rejects this basic proposition. Because shareholders are simply one of the many stakeholders bound together by this web of voluntary agreements, ownership is not a meaningful concept in contractarian theory. Someone owns each input, but no one owns the totality. Instead, the corporation is an aggregation of people bound together by a complex web of contractual relationships. (The validity of this insight becomes apparent when one recognizes that buying a few shares of IBM stock does not entitle me to trespass on IBM's property--I do not own the land or even have any ownership-like right to enter.)

Proxy Access in Canada

Lisa Fairfax:

Canadian shareholders have proxy access. As we know, US shareholders have sought proxy access for years. And while the SEC has proposed such access, it has been met with serious opposition, and as one Canadian commentator noted, the US opposition seems to suggest that they sky would fall if proxy access is granted. Obviously that has not occurred in Canada. So what has occurred? In essence, nothing. That is, apparently shareholder activists do not use make use of the corporation's proxy materials when seeking to unseat directors or otherwise elect their own slate of directors. One Canadian lawyer (admitting that his views were anecdotal) suggested that the reason for the lack of use relates primarily to the feeling that proxy access would put shareholder activists at a tactical disadvantage. This is because if such activists rely on proxy access, it generally means that they cannot engage in their own separate proxy solicitation without incurring the very costs that proxy access sought to avoid. In other words, by relying on proxy access, shareholder activists also would have to rely on the corporation's proxy machinery as the sole means for seeking to persuade shareholders to displace current management. In the Canadian lawyer’s view, shareholder activists see the inability to engage in their own separate proxy solicitation, and thereby control the solicitation process, as a non-starter. As a result, they believe the tactical advantages they gain by waging their own proxy contests outweigh any cost-savings inherent in proxy access.

To be sure, there are differences between the two countries, their markets, and their shareholder class that may make any comparisons difficult. Then too, perhaps there are shareholders for whom cost savings would be more important than tactical advantage. Moreover, it could be that there are indirect benefits to proxy access even if shareholders do not directly use such a mechanism. However, the Canadian experience with proxy access at least raises the specter that the proxy access right may not be as beneficial as US shareholders believe. And instead, like e-proxy, proxy access may generate consequences that may undermine its effectiveness in enhancing shareholders' voice.

As someone who opposes proxy access but sees its inevitability given the current lineup at the SEC, I can but hope that Fairfax is right. But suppose the SEC's version of proxy access allows proponents to conduct a proxy solicitation in support of their nominee. After all, shareholders who wish to conduct a proxy solicitation in support of a Rule 14a-8 proposal are free to do so.

Religious Lingua Franca

David Skeel relates his experience visiting an Italian language service while in Milan:

I ended up in the Italian language service because of the timing of the services—certainly not because of proficiency in Italian, which is still years away. ...

The wonderfully lively service made me see contemporary worship songs projected on a screen in a new light. The general familiarity of praise songs, and the simplicity of the words, enabled me to join in the worship to an extent that wouldn’t have been possible otherwise. Even I understood lines like “Cantero del tuo amor/per sempre” (I will sing of your love always). It reminded me of the argument that the Catholic church has always made for paintings and other art in the church—that it made it possible for ordinary people to understand the richness of the Bible in an era when few could read.

It also reminds me of the arguments made by traditional Catholics for the Tridentine Mass. Having attended for many years a mass in which the  Alleluia, Kyrie, Gloria, Credo, Sanctus, Benedictus, and Agnus Dei are chanted (Gregorian) in Latin, I could attend a Tridentine Mass anywhere in the world and fully participate in key sections of the Mass, which I can't do when the entire Mass is conducted in the vernacular. A mix of Latin and the vernacular thus strikes me as ideal, providing a sort of leingua franca that binds all Catholics together.

As for "praise songs," however, don't get me started. Praise songs, worship rock bands, and PowerPoint sing along screens are all part of what drove me across the Tiber. (Of course, then I found about guitar masses. Shudder.) But YMMV.

I Like Soldier's Dogs too

Some happy dogs whose masters came home, respectively, from deployments in Afghanistan and Iraq. This'll put a smile on your face.

I like old dogs too

A touching essay on the merits of old dogs. It made me think of my beloved Sam. I still miss her.

(HT: Tom Smith)

Fiduciary Duties for Brokers

Mark Kleiman:

Does the current system of legalized bribery through campaign contributions matter?

Consider the case of a provision in the financial products regulation bill that would impose on stockbrokers the same sort of fiduciary duty lawyers have: to act in the interests of their clients when that conflicts with their own interests. It’s not a hard question, it seems to me, though I’d be willing to settle for a system where each brokerage house had to choose whether to be subject to such a standard or not, and disclose its choice to its clients.

The provision was in the original Obama Administration proposal and in Sen. Dodd’s version of the bill, but Tim Johnson of South Dakota wants to replace it with a “study,” and may get his way.

Campaign contributions aside, a fight over the fiduciary standard is a huge political winner for the Democrats. This is exactly the kind of issue we want to take into November. Go ahead, Goopers: explain why it’s “big government” and “the nanny state” and “socialism” to ask brokers not to cheat their clients. Good luck with that.

I don't think anyone disputes that brokers should have fiduciary duties to their clients. indeed, brokers already owe such duties.

As Justice Felix Frankfurter explained, however:

Once more with feeling: Shareholders Don't Own the Corporation

One of the new bloggers at Business Law prof opines that:

A shareholder move seeking a greater voice in corporate governance seems proper to me because it is about the exercise of ownership rights. 

For the umpteenth time, shareholders do not own the corporation. Shareholders are one of many constituencies that contract with the corporation, which itself is a legal fiction. There is no entity or thing capable of being owned. Granted, because the shareholders hold the residual claim on the corporation's assets, their deal with the corporation has certain ownership-like rights. But they have only those rights specified by their contract, as that contract is embodied in state corporate law and the firm's organic documents. More here and, especially, here.