ProfessorBainbridge.com

Manne on SEC Insider Trading Charges in Sanofi Deal

Steven Davidoff recently reported that:

Federal securities regulators charged eight people in Georgia with insider trading on Tuesday, saying they bought stock in a company ahead of a merger announcement after one of them learned about a pending deal.

The Securities and Exchange Commission said that Thomas D. Melvin Jr., an accountant from Griffin, Ga., learned from a client that the drug giant Sanofi-Aventis was planning to buy Chattem, a pharmaceutical-products company that was then publicly traded. The client, who was a director of Chattem, was seeking Mr. Melvin’s advice on the deal’s tax implications on his stock options and made it clear that the discussion was confidential, the S.E.C. said.

Nevertheless, Mr. Melvin leaked the news of the possible deal to four of his friends — C. Roan Berry, Michael S. Cain, Joel C. Jinks and R. Jeffrey Rooks — the commission charged. That set off another chain of illegal tips as Mr. Berry passed the news onto Ashley J. Coots, who, in turn, tipped his friend Casey D. Jackson, according to the complaint. The S.E.C. also said that Mr. Cain, a stockbroker, told Peter C. Doffing about the secret transaction.

This prompted an email from my friend and hero Henry Manne, which he has kindly permitted me to reprint below:

Do we really want to police all such personal conversations? Do we really want the day-to-day conversations of people like the ones involved here to be threatened by SEC monitoring?

This is a good illustration of the civil liberties danger our insider trading law enforcement threatens.

Perhaps I am simply obsessed with a topic I've been around for too long, but I do indeed feel like shouting from the rooftops "Hey, the SEC is fucking us over." Why isn't the liberal community even taking notice?

Do people really believe that this sort of investigation, conducted on a scale required to stop insider trading would be completely benign or is worth more than the implied costs? But there is a paradox in all this, since the best response to the kinds of concerns I've just mentioned is that there really is no threat to our civil liberties because the whole thing is just Kabuki theater. No one in his right mind would believe that the SEC scratches more than a very bare tip (the parts easily spotted) of a very large iceberg. (An interesting movie could be made out of the story line implied by this case focusing on interpersonal relationships not generally considered a danger to the community.)

That in turn bears out my old argument (as well as Dooley's) that effective enforcement of these laws is impossible, and, therefore, it is better not to try. For 46 years I have tried to get the army of commentators on this topic to consider the problems (and the economics) of enforcement. To date only Dooley and Bainbridge have taken up my challenge. These show prosecutions do have an effect: they drive the right people out of the market for information and put it more and more into the hands of those willing to take risks (e.g. the Al Capones of the stock market) or of naifs such as are involved in the instant case. 

Delaware Chancery Court Arbitration Process Closure to Public Violates First Amendment

So says a federal district court. Steven Davidoff has the details. Jim Hamilton comments. The WSJ explains:

Delaware's Court of Chancery two years ago began a program in which sitting judges can arbitrate business disputes behind closed doors, with no public record of the proceedings.

But U.S. District Judge Mary A. McLaughlin ruled Thursday that the so-called judicial-arbitration procedure is the equivalent of a civil trial, meaning the public is entitled to have access to the proceedings under the First Amendment. ...

The Chancery judges named as defendants in the challenge said they would appeal her ruling. "In an increasingly competitive global marketplace, the United States cannot afford to be at a competitive disadvantage in providing efficient ways for businesses to resolve their disputes. Otherwise, businesses will tend to move toward other nations that provide that advantage," the Chancery judges said in a written statement.

Delaware is not Holland

Earlier this week, the Delaware Supreme Court, in the case of Americas Mining Corp. v. Theriault in a 110-page opinion, upheld the Court of Chancery’s decision awarding over $2 billion in damages based on a breach of fiduciary duty claim in connection with the sale of a company. The Supreme Court also upheld an award of lawyers’ fees in the amount of $300 million!! See here for more discussion. Today I also read the Dutch headlines that the liquidators' fees in the Dutch DSB Bank bankruptcy case have almost reached 30 million. Conclusion: Amsterdam isn't Delaware.

via www.thedefiningtension.com

The titular pun, of course, is that Justice Randy Holland wrote the Delaware Supreme Court opinion.

DLA Piper's John Reed on the Chancery Court decision in Americas Mining

Since Chancellor Strine's opinion in Americas Mining (a.k.a. the Southern Peru-Grupo Mexico case) was just affirmed by the Delaware Supreme Court, John Reed's analysis is still apt:

DLA Piper's Reed on Strine, Southern Peru-Grupo... by thedealvideo

I agree with him that we don't want judges second guessing a properly constituted and functioning special committee. Hence, I'm inclined to think that the decision of such a committee ought to get business judgment rule protection. Unfortunately, the coyrt did not go that route.

Americas Mining Corp. v. Theriault: Entire Fairness and Outcome Determination

The Delaware Supreme Court recently affirmed Chancellor Strine's opinion in Americas Mining Corp. v. Theriault (copy of opinion here). The headline news is that the Court thus upheld a $2 billion-plus judgment and a whopping $300 million-plus legal fee for plaintiff's counsel. I guess the welcome mat for plaintiff lawyers in Delaware is now a red carpet.

Edward McNally:

The Delaware Supreme Court has upheld the largest attorney fee award in Delaware history.  In doing so, the Court has squarely upheld the use of percentages to award fees out of the common fund created by the litigation and disclaimed the so-called "lodestar" approach.

The decision is also noteworthy for its upholding of the Court of Chancery's damages award, also probably the largest in Delaware history. 

Francis Pileggi:

The Delaware Supreme Court today, in the case of Americas Mining Corp. v. Theriault, No. 29, 2012 (Del. Aug. 27, 2012), read here, in a 110-page opinion, upheld the Court of Chancery’s 100-plus page decision awarding over $2 billion in damages based on a breach of fiduciary duty claim in connection with the sale of a company. Delaware’s High Court also upheld an award of attorneys’ fees in the amount of $300 million. The trial court decision, styled as In re Southern Peru Copper Corporation Shareholder Derivative Litigation, C.A. No. 961-CS (Del. Ch. Oct. 14, 2011), was highlighted on these pages here and here. 

I want to focus on the court's treatment of the burden of proof in cases governed by the entire fairness standard. Specifically, the Court's holding that, if the record does not permit a pretrial determination that the defendants are entitled to a burden shift, the burden of persuasion will remain with the defendants throughout the trial to demonstrate the entire fairness of the interested transaction.

As I explain in my book Mergers and Acquisitions, 3d:

... a freeze out merger must satisfy an "entire fairness" standard.  In turn, entire fairness has two components: fair price and fair dealing. …

If a freeze out merger is approved by a majority of the disinterested shareholders—the so called "majority of the minority," however, the burden of proof shifts to the plaintiff to show that the merger was unfair. The standard of review remains entire fairness, with its integral fair price and fair dealing components, but the burden is now on plaintiff to show lack of fairness on one or both grounds.

The deal in question here was not a freeze-out merger, but rather an acquisition of a company controlled by a majority shareholder of the acquirer. As such, the majority shareholder stood on both sides of the deal--as is the case in a freeze-out merger--and the entire fairness standard therefore applied, as the Court explained:

The Court of Chancery held that the defendants-appellants, Americas Mining Corporation (“AMC”), the subsidiary of Southern Copper Corporation’s (“Southern Peru”) controlling shareholder, and affiliate directors of Southern Peru (collectively, the “Defendants”), breached their fiduciary duty of loyalty to Southern Peru and its minority stockholders by causing Southern Peru to acquire the controller’s 99.15% interest in a Mexican mining company, Minera México, S.A. de C.V. (“Minera”), for much more than it was worth, i.e., at an unfair price. ...

When a transaction involving self-dealing by a controlling shareholder is challenged, the applicable standard of judicial review is entire fairness, with the defendants having the burden of persuasion. 

Jim Hamilton explains that :

Applying the entire fairness doctrine, the Delaware Supreme Court upheld the Chancellor’s ruling that a board special committee formed to evaluate a proposition by the company’s controlling shareholder engaged in a deal that was unfair to the company and breached its fiduciary duty of loyalty. Chancellor Strine found that the cramped perspective of the special committee put it in a position where there was only one strategic option to consider, the one proposed by the controlling shareholder. This resulted in a strange deal dynamic in which a majority stockholder kept its eye on the ball, actual value benchmarked to cash, and a special committee lost sight of market reality in an attempt to rationalize doing a deal of the kind the majority stockholder wanted, which was for the company to buy its non-public company for approx $3.1 million of the company’s stock. ...

The special committee was trapped in a controlled mindset where the only options to be considered were those proposed by the controlling stockholder. This mindset took off the table other options that would have generated a real market check, noted the Chancellor, and also deprived the special committee of negotiating leverage to extract better terms. In fact, said the court, the negotiations were stilted and influenced by the committee’s uncertainty about whether it was actually empowered to negotiate.

When a special committee confines itself to this world, reasoned the Chancellor, it engages in the self-defeating practice of negotiating with itself, perhaps without even realizing it, through which it nixes certain options before even putting them on the table. Although the special committee members were competent businessmen and may have had the best intentions, said the court, they allowed themselves to be hemmed in by the controlling stockholder’s demands. Throughout the negotiation process, the special committee and its outside advisor only focused on finding a way to get the terms of the merger structure proposed by the controlling shareholder to make sense, rather than aggressively testing the assumption that the merger was a good idea in the first place.

One question presented on appeal was whether the Chancellor should have shifted the burden of proof to the plaintiffs in light of the existence of the special committee. As the Supreme Court explained: 

In Kahn v. Lynch Communication Systems, Inc., this Court held that when the entire fairness standard applies, the defendants may shift the burden of persuasion by one of two means: first, they may show that the transaction was approved by a well-functioning committee of independent directors; or second, they may show that the transaction was approved by an informed vote of a majority of the minority shareholders. 

Unfortunately for defendants, their special committee failed to meet the required standards. Again, to quote the Supreme Court:

... “[t]o obtain the benefit of a burden shifting, the controlling shareholder must do more than establish a perfunctory special committee of outside directors.” Rather, the special committee must “function in a manner which indicates that the controlling shareholder did not dictate the terms of the transaction and that the committee exercised real bargaining power ‘at an arms-length.’” 

The failures by the committee noted by Hamilton thus precluded a shift in the burden of proof.

Now is when things get interesting (at least to me). The Court held that:

The failure to shift the burden is not outcome determinative under the entire fairness standard of review. We have concluded that, because the only “modest” effect of the burden shift is to make the plaintiff prove unfairness under a preponderance of the evidence standard, the benefits of clarity in terms of trial presentation outweigh the costs of continuing to decide either during or after trial whether the burden has shifted. Accordingly, we hold prospectively that, if the record does not permit a pretrial determination that the defendants are entitled to a burden shift, the burden of persuasion will remain with the defendants throughout the trial to demonstrate the entire fairness of the interested transaction. 

Some observations:

1. I suppose one outcome of this case will be the need for a mini-trial/evidentiary hearing pre-trial to determine whether the burden shifts to plaintiffs. After all, as Alison Frankel observes, "unless there's a pretrial ruling to the contrary, defendants must show the transaction was fair to minority shareholders, regardless of whether an independent committee oversaw the deal." The justification offered for this development is that there are "benefits of clarity in terms of trial presentation." But Chancery is not a jury court. Cases are tried to the bench. Surely, the expert members of the Chancery Court could handle a trial in which the issue of burden of proof was one of the issues to be litigated.


2. How do you now keep the pre-trial proceedings on the burden of proof from duplicating much of what would have happened at trial? Presumably, the Chancery Court will have to undertake an extensive evidentiary hearing, which will cover much the same ground as will later be covered at trial. It seems duplicative and burdensome.


3. The court also justifies its holding by stating that a shift in the burden of proof is not outcome determinative. I find this hard to square with both other cases and aspects of this opinion. As to the former, have we not been told elsewhere that the burden of entire fairness review is so “onerous” that its application “frequently is determinative of the outcome of the litigation.” AC Acquisition Corp. v. Anderson, Clayton & Co., 519 A.2d 103, 111 (Del. Ch. 1986). Granted, that was in the context of a choice between the entire fairness and business judgment rule as a standard of review. Even so, it suggests that the burden of proof matters. Elsewhere in the present opinion, moreover, we are told that "This Court has repeatedly held that any board process is materially enhanced when the decision is attributable to independent directors. Accordingly, judicial review for entire fairness of how the transaction was structured, negotiated, disclosed to the directors, and approved by the directors will be significantly influenced by the work product of a properly functioning special committee of independent directors." If the defendant's case is "materially enhanced" by use of a special committee and the existence of such a committee "significantly" influences the court's analysis, why is the benefit of the burden shift modest? I find those statements hard to square.


4. If the effect of the shift in the burden of proof were more than "modest," a pre-trial determination would make sense because it would encourage settlements. The party with the burden of proof would be more willing to settle--conserving judicial resources--if that burden were truly onerous. But if the effect is modest, however, one might as well roll the dice at trial.


5. What will be the impact of this case on transaction planning? Here, I agree with Paul Regan, who observes that "the Supreme Court’s ruling is likely in keeping with the advice of counsel to controlling stockholders in such cases already, i.e., establish a special committee process that is unassailable but prepare for trial as if the burden of proof remains on the defendants.  For transaction planners and litigation counsel alike, Southern Peru appropriately reinforces the practical reality that defendants in these cases need to protect the transaction with good process irrespective of whether they get the burden shift before, at or after trial."


6. As Paul Weiss notes, "The Supreme Court did not directly address the viability of the so- called “unified standard” that has gained some currency in the Court of Chancery. Under that standard, entire fairness is not at issue and defendants may rely instead on the protection of the business judgment rule, provided that both an independent special committee and a majority of the minority stockholders approves the transaction after full disclosure."

Humanitarian Effort in Congo Puts S.E.C. in Unintended Role

... having your capital markets regulator engage in foreign policy may not be the best solution to ending a war.

via dealbook.nytimes.com

You think? Davidoff continues: "The S.E.C. estimates the initial compliance cost to be $3 billion to $4 billion, with continuing costs of $207 million to $609 million a year. Industry-sponsored estimates go higher, pinning the cost at $8 billion to $16 billion. ... These new rules could lead to manufacturers simply refusing to buy any of these minerals from Congo and surrounding area. This would be a de facto boycott that could harm the populace more than it would help. The rules could also have little benefit as smugglers simply circumvent them. Or the new rules could allow foreign companies to step in and buy these minerals at a lower cost, hurting American businesses while doing nothing to stop the fighting. As the S.E.C. has acknowledged, these rules “may provide significant advantage to foreign companies that are not reporting in the United States.” "

Partisan Politics in the Classroom

ABUSE OF POWER: Partisan Politics in the Classroom. “As faculty members at Ohio State last week double-checked their syllabi, glanced at their rosters, and ran through the usual routines for the start of fall courses, some of them found a surprise in their e-mail in boxes. A senior English professor invited his colleagues to open their classrooms in the weeks ahead to organizers in the Obama campaign. They would first encourage students to register to vote and then, if the instructors were willing, encourage students to volunteer for the Obama campaign.”

via pjmedia.com

The Professor's name is Brian McHale. He ought to be ashamed of this gross violation of professional norms.

Revised version of The Geography of Revlon-Land posted to SSRN

I have posted a substantially revised and expanded version of my article The Geography of Revlon-land to SSRN. 

Abstract: In Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), the Delaware Supreme Court explained that when a target board of directors enters Revlon-land, the board’s role changes from that of “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”

Unfortunately, the Court’s colorful metaphor obfuscated some serious doctrinal problems. What standards of judicial review applied to director conduct outside the borders of Revlon-land? What standard applied to director conduct falling inside Revlon-land’s borders? And when did one enter that mysterious country?

By the mid-1990s, the Delaware Supreme Court had worked out a credible set of answers to those questions. The seemingly settled rules made doctrinal sense and were sound from a policy perspective.

Indeed, my thesis herein is that Revlon and its progeny should be praised for having grappled — mostly successfully — with the core problem of corporation law: the tension between authority and accountability. A fully specified account of corporate law must incorporate both values. On the one hand, corporate law must implement the value of authority in developing a set of rules and procedures providing efficient decision making. U.S. corporate law does so by adopting a system of director primacy.

In the director primacy (a.k.a. board-centric) form of corporate governance, control is vested not in the hands of the firm’s so-called owners, the shareholders, who exercise virtually no control over either day-to-day operations or long-term policy, but in the hands of the board of directors and their subordinate professional managers. On the other hand, the separation of ownership and control in modern public corporations obviously implicates important accountability concerns, which corporate law must also address.

Academic critics of Delaware’s jurisprudence typically err because they are preoccupied with accountability at the expense of authority. In contrast, or so I will argue, Delaware’s takeover jurisprudence correctly recognizes that both authority and accountability have value. Achieving the proper mix between these competing values is a daunting — but necessary — task. Ultimately, authority and accountability cannot be reconciled. At some point, greater accountability necessarily makes the decision-making process less efficient. Making corporate law therefore requires a careful balancing of these competing values. Striking such a balance is the peculiar genius of Unocal and its progeny.

In recent years, however, the Delaware Chancery Court has gotten lost in Revlon-land. A number of Chancery decisions have drifted away from the doctrinal parameters laid down by the Supreme Court. In this article, I argue that they have done so because the Chancellors have misidentified the policy basis on which Revlon rests. Accordingly, I argue that Chancery should adopt a conflict of interest-based approach to invoking Revlon, which focuses on where control of the resulting corporate entity rests when the transaction is complete.

This is a revised version of the article, with an expanded discussion of the relevant Chancery Court cases.

Keywords: corporate governance, mergers, takeovers, takeover defenses

JEL Classification: K22

Accepted Paper Series 

Bainbridge, Stephen M., The Geography of Revlon-Land (July 23, 2012). 81 Fordham Law Review, (2013) Forthcoming; UCLA School of Law, Law-Econ Research Paper No. 12-13. Available at SSRN: http://ssrn.com/abstract=2115769

Dodd-Frank "conflict mineral" regulations: Ted Frank's view

The "conflict mineral" regulations of Dodd-Frank, requiring expensive investigation and disclosure of the sourcing of tin, tantalum, tungsten and gold used in the products of 6,000 publicly traded companies, were approved by a 3-2 vote of the SEC, despite lack of evidence that the benefits of such disclosure outweigh the billions of dollars of burden to American industry—and that cost figure is before the inevitable rent-seeking strike-suit securities litigation over alleged technical violations of disclosure. [WSJ]

As Professor Bainbridge points out, the Commissioner Paredes dissent foreshadows a D.C. Circuit reversal for failure to assess economic consequences, a la Business Roundtable.

The underlying law is foolish. Even if I refuse to buy tungsten from the Congolese because of concerns that the sale will directly fund evildoing, when I buy tungsten from the Chinese instead (who are no human-rights angels), Congolese warlords still indirectly benefit because they can sell their tungsten for more money to other buyers who do not purchase from the Chinese. Moreover, the law has had devastating, if predictable, unintended consequences for innocent Congolese.

via www.pointoflaw.com

Ditto.

Stymied SEC Chairman Shapiro has hissy fit

Because three of the 5 SEC Commissioners have announced that they will not support the SEC's highly flawed proposal to regulate money market funds (on those flaws, see here), Chairman Mary Shapiro has issued a highly petulant statement announcing that she will not bring the proposal up to a vote. It's a remarkable display of whinging by somebody who's supposed to be a professional.

But, then again, Shapiro has been one of the least impressive SEC chairs during my professional career. So perhaps I should not be surprised.

SEC Commissioner Aguilar Responds to Chairman’s Statement on Money Market Fund Reform

SEC Commissioner Luis A. Aguilar yesterday responded to Chairman Mary L. Schapiro’s statement regarding the apparent lack of votes for the Commission to issue a proposal on a new round of structural money market mutual fund reforms. Commissioner Aguilar expressed support for a concept release on further money fund reforms, but raised questions about the potential impact a proposal focused on just one segment of the money markets may have given current economic conditions.

via jimhamiltonblog.blogspot.com

Hamilton goes on to detail the key points of Aguilar's statement.

Hamilton on Synthes

Jim Hamilton has a detailed analysis of Chancellor Leo Strine's recent decision in the Synthes shareholder litigation:

In a wide-ranging opinion, the Delaware Chancery Court ruled that minority shareholders did not state facts supporting an inference that a controlling shareholder’s interest in obtaining liquidity in a sale of the company constituted a conflict of interest justifying the invocation of the entire fairness standard and supporting a non-exculpated duty of loyalty claim.  The facts demonstrated that the controlling shareholder received equal treatment in the merger and that the business judgment rule applied to the decision of the board of directors to approve the merger. The facts did not support an inference that there was any breach of fiduciary duty on the part of the controlling stockholder or members of the board of directors. (In re Synthes, Inc. Shareholder Litigation, Del Chan Ct, Civil Action No. 6452, August 17, 2012)

In addition, the court held that Revlon duties did not apply where shareholders received mixed consideration of 65 percent stock and 35 percent cash for their stock. 

The analysis continues at length. For my take on the case, which focuses on the Revlon aspects, go here.

GM Goes From Bad to Worse Despite Obama Bailout

The UAW got their political payoff. And GM, according to Forbes writer Louis Woodhill, is headed to bankruptcy again.

Is this really what Obama wants to do for all manufacturing across America? Let's hope not. 

via www.realclearpolitics.com

It's an unbelievable mess of politically motivated autos that people don't want to buy because they're inferior. Perfect example of industrial policy at work. --TS

via rightcoast.typepad.com

The Institute of Delaware Corporate & Business Law » Blog Archive » Synthes-is: Strine on Pro Rata Treatment in a Sale of a Company with a Controlling Stockholder

Should courts permit deal litigation to go forward when there’s no evidence that the sale process was rushed, or was tainted by an interest on the part of those influencing the process in favoring themselves at the expense of public shareholders generally?

In his typically colorful opinion in In re Synthes, Inc. Litigation (Aug. 17, 2012), Chancellor Strine says no, because facts matter.

via blogs.law.widener.edu

A very interesting analysis of the "the question of dismissing deal litigation at the pleading stage."

I can't believe Romney just blessed Obama's heart

Growing up in a Baptist home located for the most part on Army bases in the South, I early learned the "bless their heart" rule:

Jokes.com
Henry Cho: Insults
comedians.comedycentral.com
Jokes Joke of the Day Funny Jokes

Which makes me appreciate this tweet all the more:

Romney in Iowa: "President Obama, bless his heart, has tried to substitute government for free people, and it has not worked.”

That's pretty mild for a "bless his heart" line. But maybe Romney's just getting warmed up.