ProfessorBainbridge.com

"The Time Is Now: Let's Stop Congressional Insider Trading"

So says the Motley Fool's Rich Smith in a roundup of developments.

STOCK Act passes Senate cloture vote. I call Bull Sh*t on Eric Cantor.

Great news: The Senate voted 93-2 in favor of a cloture motion on the STOCK Act, which bans Congressioal insider trading. Unfortunately, it looks like Eric Cantor still wants to kill the bill with kindness:

A House Republican leadership aide told CBS News that lawmakers will take up their version of the STOCK Act by the end of February. House Republicans plan to expand the legislation beyond the Senate bill to include non-stock investments and also include executive branch officials and employees.

"Building upon the Senate bill, this common-sense proposal will not only deal with insider trading of stocks, but also prevent all federal officials and employees from using insider information for profit in other areas in a constitutionally sound way," Laena Fallon, a spokesperson for House Majority Leader Eric Cantor, told CBS News. "As Leader Cantor has said, he strongly supports increased disclosure to prevent any sense of impropriety and ensure the public's confidence and trust in our elected officials."

I call bull shit. What Cantor wants to do is to broaden the bill so as to weigh it down with irrelevancies, many of which are legitiimately controversial (rumor has it he still will include a blind trust provision).

As one of those people who has written the history of insider trading law, and will continue to do so for the next 20 years or so (God willing), I intend to make damn sure that if Eric Cantor manages to kill the STOCK Act that he will go down in history as the man who defended Congress' right to commit insider trading with impunity.

Law and strategy

An interesting post by Gordon Smith concludes "the study of law and strategy views the world from the perspective of a business and asks: how can we use law to gain a competitive advantage?" 

It's a serious post and makes a very good point. But my immediate reaction was rather flippant; namely, "I've got to churn out a book on how lawyers can use Sun Tzu's The Art of War to win." 

But I probably won't. In the first place, it's probably been done. (It has.) In the second place, The Art of War is one of the most overused pieces of nonsense in the book business/business book field these days. as The Economist observed a while back:

The “Art of War” is widely used by after-dinner speakers short of ideas.  .... Sun Tzu beat the Christmas-cracker industry by two –and-a-half millennia. 

In the West Sun Tzu’s advice has been adapted for almost every aspect of human interaction from the boardroom to the bedroom. The publishing industry feeds on Sun Tzu spin-offs, churning out motivational works such as “Sun Tzu For Success: How to Use the Art of War to Master Challenges and Accomplish the Important Goals in Your Life” (by Gerald Michaelson and Steven Michaelson, 2003), management advice such as “Sun Tzu for Women: The Art of War for Winning in Business” (Becky Sheetz-Runkle, 2011) and sporting tips such as “Golf and the Art of War: How the Timeless Strategies of Sun Tzu Can Transform Your Game” (Don Wade, 2006). Amazon offers 1,500 titles in paperback alone. 

And they all suck.

But there's still a lot of bucks to be made with one of those books with a title like "How to be Super-Excellent and Greatly Achieve Great Super-Greatness Excellently while Clearing Up Your Cellulite and Winning Every Case Greatly." 

So I'll pass on the Sun Tzu angle. ... Think ... How about "Be a Nelson of the Law: How Mahan's The Influence of Sea Power upon History Provides Winning Legal Strategies"? ... Or "The Insurgent Lawyer: Using 'The U.S. Army/Marine Corps Counterinsurgency Field Manual' to Win Every Case"?

All I need is the right hook and I can make a mint. Suggestions welcome.

Why you're not a fancy con law prof and neither am I

Jack Balkin is a very fancy professor of constitutional law at a very fancy law school. One of his blog posts today is a classic example of why neither you nor I am a fancy professor of constitutional law at a fancy law school. You see, at the end of his post, Balkin makes a very simple (and I think correct) point:

If for-profit corporations have free speech rights, it is not because corporations are persons. It is because it makes sense to give the people that control them (who are not necessarily their owners) the power to use the corporate form to amplify their voices. Conversely, to the extent that it makes sense to limit the speech of for-profit corporations, it is not because constitutional rights of corporations are violated; it is because the rights of the people who control the corporations should not extend so far.

Well, duh. This is not new information. Nor would it justify an appointment as a fancy professor of constitutional law at a fancy law school. Even us corporate law professors get it.

No, what makes one eligible to be a fancy professor of constitutional law at a fancy law school is how one gets to the right answer. Getting there the obvious way won't cut it. Instead, you've got to have some really braniac way of getting there that no one else would have thought of. Using Icelandic blood feuds to explain class action suits or invoking Wittgenstein to explain the UCC, and so on. Ideally, it should be abstract, erudite, and so off the wall it never would have occurred to anybody who actually works in the field. (BTW, telling us what Rawls or Dworkin would think about your subject is now incredibly passe. Even student notes at bottom tier law schools can do that these days.) 

In Balkin's case, it's the Thirteenth amendment and "the (in)famous 1830 case of State v. Mann, the North Carolina Supreme Court, in an opinion by Judge Ruffin, held that the owner of a slave had complete authority to use violence against a slave, even to take the slave's life." All of which, to him, "suggests an interesting perspective on the First Amendment rights of for-profit corporations."

To which my immediate reaction was, "WTF?" Followed by, "no, it doesn't."

But it's precisely the sort of thing that passes as top notch legal scholarship these days. Blow that idea up into a 35,000 word article and you too could be a fancy professor of constitutional law at a fancy law school. Except that it never would have occurred to you in the first place. But don't feel bad. It never would have occurred to me either.

A remarkably narrow definition of religion

The current debate over the Obama administration's decision to require Catholic-affiliated social services to provide health insurance for employees that includes coverage for abortions has prompted both liberals and libertarians to take a remarkably narrow definition of what constitutes religion. Kevin Drum opines for example that:

I'm just a big ol' secular lefty, so I guess it's natural that I'd disagree. And I do. I guess I'm tired of religious groups operating secular enterprises (hospitals, schools), hiring people of multiple faiths, serving the general public, taking taxpayer dollars — and then claiming that deeply held religious beliefs should exempt them from public policy. 

Doug Mataconis likewise opines that:

I think Drum is correct here. Religious liberty is an important principle, one that I take very seriously, but it doesn’t mean what Dionne and the Catholic Bishops seems to think it means. Operating a hospital or a school or an adoption agency is not a religious undertaking in the same way that, well, operating a church is, and there’s simply no merit to the argument regulations regarding how you operate an institution that is essentially secular in nature are somehow a violation of religious liberty. More importantly, operating such institutions while taking government money (i.e., Medicare and Medicaid) means accepting at least some regulation about how that money is used. 

I agree that taking taxpayer money presents a problem. If the church could avoid this sort of intrusive government regulation simply by refusing taxpayer money, I'd prefer that the church do so. But a lot of these secular elites would prefer that the church be kicked out of the public square as a whole. Consider, for example, the recent debate over the so-called ministerial exception. Anti-church secularists have been trying for years to subject Church organizations like Mataconis' hospital, school, or adoption agency to the anti-discrimination laws so that the Church could not use adherence to its teachings as basis for hiring and firing employees. Fortunately, the Supreme Court upheld a broad (albeit incoherent) version of the ministerial exception. 

The basic problem is that to the extent secular elites are willing to begrudgingly tolerate religious liberty at all, they have come to define religion in remarkably narrow terms. Consider the distinction Mataconis draws between "a hospital or a school or an adoption agency" and "a church." I accept Mataconis claim that he values religious liberty, and am happy to exempt him from the secular elites who wish the Church ill, but even so the narrow definition of religion he adopts is precisely the technique by which others have sought to erode the religious liberty of the Catholic Church in particular.

The Catholic Church believes--as an article of faith--that both the Church as an institution and its members as individuals have a religious duty to tend to everyone, not just fellow Catholics. Indeed, the whole point of the Parable of the Good Samaritan is that there is a moral obligation to help those in need without regard to who they are. In response to this teaching, Catholics have run social services like hospitals since the earliest days of the Church's history:

Another characteristic of Christian charity was the obligation and practice of hospitality (Romans 12:13; Hebrews 13:2; 1 Peter 4:9; 3 John). The bishop in particular must be "given to hospitality" (1 Timothy 3:2). The Christian, therefore, in going from place to place, was welcomed in the houses of the brethren; but like hospitality was extended to the pagan visitoras well. Clement of Rome praises the Corinthians for their hospitality (Ep. ad. Cor., c. i) and Dionysius of Corinth for the same reason gives credit to the Romans (Eusebius, Church History IV.23). The bishop's house above all others was open to the traveller who not only found food and shelter there but was provided in case of need with the means to continue his journey. In some cases the bishop was also a physician so that medical attention was provided for those of his guests who needed it (Harnack, "Medicinisches aus d. ältestenKirchengesch." in "Texte u. Untersuchungen" VIII, Leipzig, 1892). The sick were also cared for in the valetudinaria of the wealthier Christians who in the spirit of charity extended hospitality to those who could not be accommodated in the bishop's house. There was thus from the earliest times a well organized system of providing for the various forms of suffering; but it was necessarily limited and dependent on private endeavour so long as the Christians were under the ban of a hostile State. Until persecution ceased, an institution of a public character such as our modern hospital was out of the question. it is certain that after the conversion of Constantine, the Christians profited by their larger liberty to provide for the sick by means of hospitals. But various motives and causes have been assigned to explain the development from private care of the sick to the institutional work of the hospital (Uhlhorn, I, 317 sq.). It was not, at any rate, due to a slackening of charity as has been asserted (Moreau-Christophe, "Du problème de la misère", II, 236; III, 527), but rather to the rapid increase in the number of Christians and to the spread of poverty under new economic conditions. To meet these demands, a different kind of organization was required, and this, in conformity with the prevalent tendency to give all work for the common weal an institutional character, led to the organization and founding of hospitals.

To force Catholics to differentiate between "a hospital or a school or an adoption agency" and "a church" is thus to deny us the right to practice our religion as we see fit. 

As Ross Douthat put it:

... it’s precisely the more universal services provided by Catholicism’s institutions that have left them vulnerable to the Obama White House’s current regulatory attack. If they were explicitly sectarian in their community service, they would be eligible for the narrow conscience exemption that the Department of Health and Human Services has afforded to religious bodies. But because they serve non-Catholics as well as Catholics, the government has decided (as Yuval Levin puts it in a fine post today) that they can be “fined for holding views regarding contraception, sterilization, and abortion that are different from the Obama administration’s views.”

In other words, contemporary liberalism offers religious groups a choice. They can try to serve the widest possible population, in which case a liberal administration will set rules that force them to violate their conscience. Or they can serve a narrower one, in which case liberal journalists will sneer at them (and their most generous benefactors) for only caring about their co-religionists.

Hence, as Justice O'Connor put it in her concurrence in McCreary County, Ky. v. American Civil Liberties Union of Ky., 545 U.S. 844 (2005):

There is no list of approved and disapproved beliefs appended to the First Amendment-and the Amendment's broad terms (“free exercise,” “establishment,” “religion”) do not admit of such a cramped reading.

The Amendment's broad terms likewise should not admit the cramped and narrow reading of religious belief reflected in the claim that we must differentiate between "a hospital or a school or an adoption agency" and "a church." 

Religious liberty does not equal democratic religions

The Washington Monthly's Political Animal blog has gone from good (Kevin Drum) to bad (Steven Benen) to much worse (Ed Kilgore). Case in point is Kilgore's argument that:

... it should be clear that given the vast opposition of U.S. Catholics to the Church’s teachings on contraception and (to a lesser extent) abortion, the Bishops do not exactly come to the table with clean hands when it comes to its demands for “religious liberty.” 

Huh? Religious liberty means freedom of religion from government. It has never required democratic religions. As such, hierarchical churches (like us Catholics) have the same rights to non-interference by the government as do whatever congregational churches Kilgore has in mind (if any).

Is the SEC Really Independent from Political Influence?

In theory, the SEC is supposed to be independent of politics. In practice, however, the SEC depends on the political process quite heavily. Appointment of the 5 commissioners requires a presidential nomination and Senate approval, both of which take political vetting. Selection of the Chairman is a Presidential perogative. And, of course, the SEC depends on Congress for its budget. One thus might expect that SEC Commissioners and top staff from time to time get signals--subtle or otherwise--from members of Congress or the incumbent administration that they would prefer that the SEC go easy on some favored constiuent.

And now we have evidence in the form of a study by April Knill and Sarah Fulmer of FSU:

Using data on political action committee (PAC) and chief executive officer (CEO) contributions combined with data on SEC enforcement actions from 1999 through 2010, we analyze how contributions to political campaigns affect the severity of SEC enforcement outcomes. We find that contributions made by either party have a significant impact on reducing the severity of SEC enforcement outcomes, both in terms of each outcome and across outcomes. Specifically, accused executives whose firms have contributed to political campaigns via a PAC are banned as an officer for three fewer years, serve probation for four fewer years, prison for five fewer years and are 78% less likely to be given both prison time and a monetary penalty. An analysis of the effect of campaign contributions on an index that accounts for the severity of the SEC enforcement outcome suggests that contributions lessen the severity of the enforcement verdict by the SEC. Executives from firms whose CEOs have contributed see similar effects. Results suggest that the amount contributed seems to be less important than the fact that they contributed, suggesting that perhaps there are other factors at play such as soft money contributions (i.e., before 2002) or other interactions correlated with campaign contributions that are not legally required to be disclosed.

One issue I have with their analysis is the decision to include criminal sanctions. The SEC has no power to undertake criminal prosecutions. Instead, that's purely a decision for the Justice Department and the relevant US Attorney's office. See Section 20(b) of the Securities Act of 1933, which provides that:

Whenever it shall appear to the Commission that any person is engaged or about to engage in any acts or practices which constitute or will constitute a violation of the provisions of this title, or of any rule or regulation prescribed under authority thereof, the Commission may, in its discretion, bring an action in any district court of the United States, or United States court of any Territory, to enjoin such acts or practices, and upon a proper showing, a permanent or temporary injunction or restraining order shall be granted without bond. The Commission may transmit such evidence as may be available concerning such acts or practices to the Attorney General who may, in his discretion, institute the necessary criminal proceedings under this title. Any such criminal proceeding may be brought either in the district wherein the transmittal of the prospectus or security complained of begins, or in the district wherein such prospectus or security is received.

Accordingly, the SEC has no power to conduct a criminal case, but rather only the power to refer a case to the DOJ, which then has discretion to bring a criminal case or not.

In practice, moreover, it's my impression that many (most?) criminal cases are initiated by the DOJ or relevant US Attorney a SEC referral is made and that many (most?) never even get a SEC referral.

In any case, assuming their data does reflect a real enforcement impact of political contributions, what's the mechanism by which contributions have that effect? The SEC presumably doesn't check Opensecrets. org to see which defendants have contributed. Instead, the most logical inference is that the SEC gets a signal from the Hill or the White House that this is a favored constituent. But how does the signal get sent?

Senator Gilibrand on the need for the STOCK Act

"Pay for Regulator Performance"

My friends and fellow corporate law profs Todd Henderson and Fred Tung have published a very provocative paper, in which they argue that:

Few doubt that executive compensation arrangements encouraged the excessive risk taking by banks that led to the recent Financial Crisis. Accordingly, academics and lawmakers have called for the reform of banker pay practices. In this Article, we argue that regulator pay is to blame as well, and that fixing it may be easier and more effective than reforming banker pay. Regulatory failures during the Financial Crisis resulted at least in part from a lack of sufficient incentives for examiners to act aggressively to prevent excessive risk. Bank regulators are rarely paid for performance, and in atypical cases involving performance bonus programs, the bonuses have been allocated in highly inefficient ways. We propose that regulators, specifically bank examiners, be compensated with a debt-heavy mix of phantom bank equity and debt, as well as a separate bonus linked to the timing of the decision to take over a bank. Our pay-for-performance approach for regulators would help reduce the incidence of future regulatory failures.

Study of Delaware Forum Selection in Charters and Bylaws

Corporate law attorney and expert Claudia Allen has publisjed the 2012 version of her annual study of exclusive jurisdiction provisions. She tells me that:

The number of companies analyzed has grown from 82 in April 2011 to 195 as of December 31, 2011.  While exclusive forum provisions are attractive to corporate America (as evidenced by the 27 S&P 500 constituents with such a provision), opposition has begun to appear in the form of policies from ISS, Glass Lewis and the Council of Institutional Investors, and non-binding shareholder proposals seeking the repeal of exclusive forum bylaws.

Her firm website reports that:

In response to concerns that the plaintiffs' bar is suing Delaware corporations "anywhere but Delaware," an increasingly large number of Delaware corporations (including Chevron, DIRECTV, Life Technologies and 24 other members of the S&P 500) have adopted charter or bylaw provisions requiring that derivative actions, fiduciary duty claims and other intra-corporate disputes be litigated exclusively in the Delaware Court of Chancery. These concerns are particularly acute in connection with the announcement of M&A transactions. Claudia H. Allen, chair of the Corporate Governance Practice Group, has published a January 2012 update of her Study of Delaware Forum Selection in Charters and Bylaws. TheStudy, which is based upon exclusive forum provisions adopted or proposed by 195 Delaware corporations, includes: a Trend Update, Key Findings and Recommendations, Charts illustrating Key Findings and a List of Companies Analyzed. The Study also discusses the 2012 policies adopted by ISS and Glass Lewis on forum selection and the first non-binding shareholder proposals seeking repeal of board-adopted forum selection provisions.

This is a tremendously useful resource. Download the study here.

The Changing World of Shareholder Litigation

Kevin LaCroix has a great post on how the plaintiff's securities/corporate bar is changing in the post-Milberg Weiss era. A must read for corporate law jocks.

STOCK Act to come up for cloture vote?

I heard from Senate sources that the STOCK Act to ban Congressional insider trading will come up for a cloture vote next week. This is great news. As regular readers know, I'm a strong advocate of the bill in general and, in particular, of the version that was passed out of the Senate Committee on Homeland Security and Governmental Affairs. Coupled with the fact that President Obama asked Congress in his State of the Union address Tuesday to pass this legislation and send it to his desk for signature, a positive Senate vote might light a sufficient fire under Eric Cantor to get the bill moving in the House. We might actually finally win this thing.

Speaking of Cantor, I'm still trying to get a Twitter campaign going to send the message to Eric Cantor that it's time for Congress to ban insider trading by its members by passing the Senate version of the STOCK Act. If you want to help, tweet the hash tag #PassTheSenateSTOCKAct to both his accounts:  @EricCantor @GOPLeader

For prior PB.com coverage, go to the archive. 

For extended analysis, see my article Insider Trading Inside the Beltway, which argues that:

A 2004 study of the results of stock trading by United States Senators during the 1990s found that that Senators on average beat the market by 12% a year. In sharp contrast, U.S. households on average underperformed the market by 1.4% a year and even corporate insiders on average beat the market by only about 6% a year during that period. A reasonable inference is that some Senators had access to – and were using – material nonpublic information about the companies in whose stock they trade. 

Under current law, it is unlikely that Members of Congress can be held liable for insider trading. The proposed Stop Trading on Congressional Knowledge Act addresses that problem by instructing the Securities and Exchange Commission to adopt rules intended to prohibit such trading.

This article analyzes present law to determine whether Members of Congress, Congressional employees, and other federal government employees can be held liable for trading on the basis of material nonpublic information. It argues that there is no public policy rationale for permitting such trading and that doing so creates perverse legislative incentives and opens the door to corruption. The article explains that the Speech or Debate Clause of the U.S. Constitution is no barrier to legislative and regulatory restrictions on Congressional insider trading. Finally, the article critiques the current version of the STOCK Act, proposing several improvements.

Also, don't forget that you can buy a personally signed copy of my book on insider trading at  eBay. Other eBay sellers charging up to $20. I'm selling it at $4.99 plus S&H

Yours truly quoted on Carlyle's IPO

Miles Weiss has a very thorough and careful article on Carlyle's planned IPO, which includes provisions limiting fiduciary duties of the controlling persons, mandating arbitration of investor claims, and so on. He quoted a number of prominent lawyers and law makers opposed to what Carlyle's doing, but he also quoted yours truly at some length:

The U.S. Supreme Court held in the late 1980s that brokerages could require arbitration of customer disputes. The justices have never ruled on whether public companies can extend the concept to shareholders, said Stephen Bainbridge, a corporate and securities law professor at the UCLA School of Law in Los Angeles. That could change should Carlyle meet opposition from the SEC and respond by suing the agency, Bainbridge said.

The high court would be “almost certain” to strike down SEC policy if Carlyle were to push the issue, Bainbridge said. “Carlyle is admittedly taking an extremely aggressive position, but it’s a position I believe is fully consistent” with U.S. and Delaware law, he said.

Carlyle’s structure as a limited partnership, rather than a corporation, is critical to the legality of its arbitration provision, Bainbridge said. That’s because Delaware, the state in which most companies are incorporated, gives partnerships more leeway than corporations to restrict their fiduciary duties to shareholders.

Many closely held firms that manage hedge and buyout funds are also structured as limited partnerships, meaning they too could go public with mandatory-arbitration clauses if Carlyle succeeds, Bainbridge said. Technology and industrial firms that are set up as corporations might consider converting into limited partnerships, weighing the huge tax liabilities they would incur, the UCLA professor said.

“If Carlyle can get away with this, you are going to have a bunch of CEOs telling their tax accountants, ‘Price out what it would cost me’” to convert from a corporation to a partnership, Bainbridge said in a telephone interview.

Convert was a poorly chosen word, of course. You'd have to do it via a merger. Anyway, it's a great article. Go read the whole thing.

Tyler Cowen on my Corporate Governance After the Financial Crisis

Tyler Cowen at his Marginal Revolution blog:

I am learning a good deal from Stephen Bainbridge’s Corporate Governance After the Financial Crisis:

There seems little doubt that the monitoring model has influenced board behavior.  In 1995, only one in eight CEOs [of those stepping down] was fired or resigned under board pressure.  By 2006, however, almost a third of CEOs were terminated involuntarily.  Over the last several decades, the average CEO tenure has decreased, which also has been attributed to more active board oversight.

Thanks!

"Insider" Trading by the Representative Plaintiff in Shareholder Litigation

If a plaintiff's class action or derivative lawyer tells the representative shareholder material nonpublic information about the status of the litigation, on the basis of which the shareholder then trades in the issuer's stock, there's doubtless some sort of state law violation. As Peter Ladig reports, the Delaware Chancery Court's newly issued guidelines for practicing before it make clear that "litigants who engage in this type of behavior should expect to be subject to "intensive scrutiny" and face a host of possible penalties." (See also Francis Pileggi's summary of the case.)

Ladig further reports that a recent Delaware case imposed sanctions in just such a case:

... in Steinhardt v. Howard-Anderson, ... the court ordered the plaintiffs it had found to have traded while in possession of confidential, nonpublic information to (i) self-report to the Securities Exchange Commission; (ii) disclose their improper trading in any future application to serve as lead plaintiff; and (iii) disgorge any profits made from the trades. The court then dismissed the trading plaintiffs from the case with prejudice and barred them from receiving any recovery from the litigation.

Query, however, whether the trading representative shareholder violated the federal insider trading prohibition. The Supreme Court has consistently made clear that insider trading liability is premised on breach of a duty to disclose rising out of a fiduciary relationship. 

Outside the traditional categories of Rule 10b-5 defendants—insiders, constructive insiders, and their tippees—things become quite complicated. As the Second Circuit observed in United States v. Chestman:

[F]iduciary duties are circumscribed with some clarity in the context of shareholder relations but lack definition in other contexts. Tethered to the field of shareholder relations, fiduciary obligations arise within a narrow, principled sphere. The existence of fiduciary duties in other common law settings, however, is anything but clear. Our Rule 10b-5 precedents . . ., moreover, provide little guidance with respect to the question of fiduciary breach, because they involved egregious fiduciary breaches arising solely in the context of employer/employee associations.[1]

In Chestman, the question was whether the relationship between spouses was fiduciary in nature. In answering that question, the court laid out a general framework for dealing with nontraditional relationships. First, unilaterally entrusting someone with confidential information does not by itself create a fiduciary relationship.[2] This is true even if the disclosure is accompanied by an admonition such as “don’t tell.” Second, familial relationships are not fiduciary in nature without some additional element.

Turning to factors that could justify finding a fiduciary relationship on these facts, the court first identified a list of “inherently fiduciary” associations. "Counted among these hornbook fiduciary relations are those existing between attorney and client, executor and heir, guardian and ward, principal and agent, trustee and trust beneficiary, and senior corporate official and shareholder."

Once one moves beyond this class of “hornbook” fiduciary relationships, the requisite relationship exists solely where one party acts on the other’s behalf and “great trust and confidence” exists between the parties:

A fiduciary relationship involves discretionary authority and dependency: One person depends on another—the fiduciary—to serve his interests. In relying on a fiduciary to act for his benefit, the beneficiary of the relation may entrust the fiduciary with custody over property of one sort or another. Because the fiduciary obtains access to this property to serve the ends of the fiduciary relationship, he becomes duty-bound not to appropriate the property for his own use.

Because the spousal relationship at issue in Chestman did not involve either discretionary authority or dependency of this sort, it was not fiduciary in character.

According to Ladig, the Delaware Chancery Court characterized the relationship between the representative shareholder and the class s/he represents as a fiduciary one:

"Trading by plaintiff-fiduciaries on the basis of information obtained through discovery undermines the integrity of the representative litigation process. Consequently, it is unacceptable for a plaintiff-fiduciary to trade on the basis of nonpublic information obtained through litigation."

In theory, I suppose the representative plaintiff has discretionary authority over the litigation. Also, in theory, I suppose that the other shareholders depend the representative shareholder to serve their interests. In theory, it's therefore hard to quibble with Vice Chancellor Lasker's statement that:

When a stockholder of a Delaware corporation files suit as a representative plaintiff for a class of similarly situated stockholders, the plaintiff voluntarily assumes the role of fiduciary for the class. See Emerald P'rs v. Berlin, 564 A.2d 670, 673 (Del. Ch.1989); Youngman v. Tahmoush, 457 A.2d 376, 379 (Del. Ch.1983). As a fiduciary, the representative plaintiff “owes to those whose cause he advocates a duty of the finest loyalty.” Barbieri v. Swing–N–Slide Corp., 1996 WL 255907, at *5 (Del. Ch. May 7, 1996) (internal quotation marks omitted). [2012 WL 29340 at *8]

In practice, however, the real party in interest in shareholder litigation is the class counsel. It is the class counsell who really runs the show and upon whomn the class members really depend. In practice, the representative shareholder is simply the name on the lawsuit's title. See Bell Atlantic Corp. v. Bolger
2 F.3d 1304, 1309 n.8 (3d Cir 1993):

See Ralph K. Winter, Paying Lawyers, Empowering Prosecutors, and Protecting Managers: Raising the Cost of Capital in America, 42 Duke L.J. 945, 948 (1993) (in derivative actions, “plaintiffs are generally figureheads”); Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs' Attorney's Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U.Chi.L.Rev. 1, 3 (1991) (plaintiffs' class and derivative action attorneys “subject to only minimal monitoring by their ostensible ‘clients' who are either dispersed and disorganized (in the case of class litigation) or under the control of hostile forces (in the case of derivative litigation).”); Geoffrey P. Miller, Some Agency Problems in Settlement, 16 J.Legal Stud. 189, 190 (1987) (“the interests of plaintiff and attorney are never perfectly aligned”); John C. Coffee Jr., Understanding The Plaintiff's Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 Col.L.Rev. 669, 677-78 (1986) (in derivative and class actions client “generally has only a nominal stake in the outcome of litigation” and cannot closely monitor and control plaintiff's attorney's conduct); Daniel R. Fischel & Michael Bradley, The Role of Liability Rules and the Derivative Suit in Corporate Law: A Theoretical and Empirical Analysis, 71 Corn.L.Rev. 261, 271 & n. 26 (1986) (“real party in interest is the attorney”); Deborah L. Rhode, Class Conflicts in Class Actions, 34 Stan.L.Rev. 1183, 1203 (1982) (“as a practical matter, once a class is certified, named plaintiffs generally are neither highly motivated nor well situated to monitor the congruence between counsel's conduct and class preferences”) ....

Which suggests that the representative shareholder's discretionary authority may not rise to the level Chestman requires or that the other shareholders' dependency on the representative plaintiff rises to that level either.

I'm not saying that representative plainitffs ought to be allowed to trade on the basis of nonpublic information about the lawsuit. I'm just saying we don't need to make a federal case out of it. Before we do so there ought to be a meaningful showing under the Chestman standard, rather than just a label casually slapped on the relationship without a realistic examination of the relationship as it exists in the real world.

---

[1] 947 F.2d 551, 567 (2d Cir. 1991) (citations omitted), cert. denied 503 U.S. 1004 (1992).

[2] Repeated disclosures of business secrets, however, could substitute for a factual finding of dependence and influence and, accordingly, sustain a finding that a fiduciary relationship existed in the case at bar. Chestman, 947 F.2d at 569.