Typically insightful analysis by Steven Davidoff of the "Faustian" bargain between Valeant Pharmaceuticals and William Ackman’s hedge fund to make a $45.6 billion unsolicited offer for Allergan.
One interesting point Davidoff makes is that:
Activists and corporations may team up on hostile takeovers, but the companies that join with activists may soon discover they are targets themselves.
Let's elaborate. There is a lot of evidence that, as Mark Mitchell and Kenneth Lehn put it, Bad Bidders Become Good Targets (98 J. Pol. Econ. 372 (1990)). This is so because studies of acquiring company stock performance report results ranging from no statistically significant stock price effect to statistically significant losses. In turn, poor performance by acquiring companies can be attributed to the fact that, by some estimates, bidders overpay in as many as half of all takeovers.
If a bidder/hedge fund team overpays, they thus will open themselves to attack by another bidder/hedge fund team. Ad infinitum.
Subject to the usual disclaimers about emirical work, Knighthoods, Damehoods, and CEO Behaviour (April 3, 2014), available at SSRN: http://ssrn.com/abstract=2420066, is a very interesting paper:
This paper studies theoretically and empirically whether and how governments can affect the behaviour of CEOs through the use of awards and honours. Our model predicts that government awards have a negative effect on firm performance. This effect is stronger in non-competitive industries. The empirical analysis uses two legal reforms in New Zealand: knighthoods and damehoods were abolished in April 2000 but reinstated in August 2009. The findings are consistent with the predictions of the model. Overall, our results indicate that governments can redirect firms towards a "stakeholder view"; through the use of government awards to the detriment of shareholders.
Although Congress has mandated extremely draconian civil and criminal sanctions for insider trading, it has never seen fit to define what constitutes insider trading. Admittedly, insider trading is difficult to define with precision, but Congress also was concerned that even if a clear statutory definition could be devised, inside traders would find ways of evading it. See generally Stephen M. Bainbridge, Note, A Critique of the Insider Trading Sanctions Act of 1984, 71 VA. L. REV. 455, 472-73 (1985).
Accordingly, Congress deliberately left the definition of insider trading as vague and unconstrained as possible. In light of the draconian penalties associated with insider trading, however, this decision raises troubling vagueness concerns. As Jonathan Macey bluntly put it, “opposition to a clear, fixed definition for the crime of insider trading constitutes nothing less than a naked power grab by the SEC, a move obviously at odds with the most elemental notions of justice and fair play.” JONATHAN R. MACEY, INSIDER TRADING: ECONOMICS, POLITICS, AND POLICY 64 (1991). Or as Ed Kitch put it, somewhat less bluntly, “[t]he fact that the agency finds it more comfortable to avoid the discipline of defining the offense before bringing the charge is no reason for eschewing the increased fairness and deterrent efficacy that would flow from the exercise.” Edmund W. Kitch, A Federal Vision of the Federal Securities Laws, 70 VA. L. REV. 857, 861 (1984).
According to the WSJ, however, oral argument in an insider trading case pending before the Secomd Circuit suggests that that court may finally be willing to do something about this fundamental unfairness:
In an hourlong hearing in Manhattan, judges of the U.S. Court of Appeals for the Second Circuit signaled that federal prosecutors may have taken too broad a view of insider trading, saying Wall Street needs more of a "bright line" about what constitutes a crime. ...
Two members of the Second Circuit panel in Manhattan expressed concern that the prosecutors' approach is too vague.
"We sit in the financial capital of the world, and the amorphous theory you have gives precious little guidance to all these financial institutions and all these hedge funds out there about a bright-line theory as to what they can and cannot do," Judge Barrington D. Parker said.
The broader federal judiciary is closely watching the appeal, in part, because the law on insider trading is ambiguous.
Daniel Richman, a professor at Columbia Law School, said that because of the statute's ambiguity, most of the law concerning insider trading had been set by the courts, calling the tolerance for this "remarkable."
Remarkable strikes me as valid, but too weak. Try intolerable. Or indefensible. Or appalling.
It is time for courts to finally draw some very bright lines. As for where those lines should be drawn, I direct the interested reader to my article Regulating Insider Trading in the Post-Fiduciary Duty Era: Equal Access or Property Rights? (May 8, 2012). Available at SSRN: http://ssrn.com/abstract=2054814
Dennis Berman has a must read column in today's WSJ:
"Shareholder value," was once a guiding principle for CEOs and directors. Now it has turned into a brittle orthodoxy.
Investor activists made this so. Using persistent menace and frequent success, their agenda—buybacks and dividends, cost-cutting and tax gambits—has hardened into the default boardroom agenda, too. ...
The answer is that the activism market, like any market, has begun to adapt. And this is where things will get very interesting for the future of business. Scarcity is forcing activists to become more than value stockpickers, but exotic and operational nit-pickers on capital structure, products, personnel and R&D costs. They're turning into self-imposed management consultants.
All of this could bring some fresh innovation into the way American companies are run.
Points of agreement: (1) At the moment, it seems like activist investors are ruling the corporate roost. (2) Activists are turning from investors into self-appointed management consultants.
Points of (apparent) disagreement: (1) This may not be a permanent shift. For a brief period back in the 1980s, it looked like corporate raiders and their academic allies (Frank Easterbrook & Daniel Fischel, Ronald Gilson, etc....) had prevailed over management. But they got rolled back by a combination of litigation successes by management and developments like the poison pill. It remains possible that today's activists and their academic allies (e.g., Lucian Bebchuk) can be rolled back by a determined campaign of litigation, activist poison pills, and regulatory reform.
(2) Activist shareholders as management consultants is a terrible idea.
Abstract ... Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders.
There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions.
This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.
This [essay] proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.
In this post, however, I want to focus on just one of those points; namely, the idea that activist investors are likely to be a positive force when it comes to operational decisions. In my essay, I wrote that:
Even if we grant Bebchuk (2013)’s claim that hedge funds have incentives to pursue what he calls “PP Action”—i.e., corporate courses of action that will have positive effects on both short- and long-term value—do we really think a hedge fund manager is systematically going to make better decisions on issues such as the size of widgets a company should make than are the company’s incumbent managers and directors? Of course, a hedge fund is more likely to intervene at a higher level of generality, such as by calling for the company to enter into or leave certain lines of business, demanding specific expense cuts, opposing specific asset acquisitions, and the like, but the argument still has traction. Because the hedge fund manager inevitably has less information than the incumbents and likely less relevant expertise (being a financier rather than an operational executive), his decisions on those sorts of issues are likely to be less sound than those of the incumbents. It was not a hedge fund manager who invented the iPhone, after all, but it was a hedge fund manager who ran TWA into the ground.
If Berman is right and operational interventions are going to become more likely because the activists have plucked all the low-hanging fruit, the need to roll back their gains becomes all the more urgent. The reforms that I and others have advocated are now essential if American business is to withstand the assault by the ilk of Ackman and Icahn, whose track record confirms they are not competent to run a business that actually makes goods and provides services.
In my new book, Insider Trading Law and Policy, I discuss liability in cases in which inside information is passed from one tipper to another in a so-called tipping chain:
Suppose, for example, that Tipper tells Tippee #1 who tells Tippee #2 who trades. Can Tippee #2 be held liable? If the preconditions of tipping liability are satisfied, there is nothing in Dirks to foreclose such liability. Donald Langevoort, for example, suggests that liability in tipping chain cases should require a three-part showing: “each person in the chain (1) was given the information expressly for the purpose of facilitating trading based on inside information, (2) knew that the information was material and nonpublic, and (3) knew or had reason to know that it came to him as a result of some breach of duty by an insider.” He goes on to note, however, that tipping chain cases—“albeit without any substantial judicial discussion of the underlying issue”—generally have imposed liability “simply on a showing that the person came into possession of information that he knew was material and nonpublic and which he knew or had reason to know was obtained via a breach of fiduciary duty by an insider.”
In Obus, for example, the Second Circuit opined that:
A tipper will be liable if he tips material non-public information, in breach of a fiduciary duty, to someone he knows will likely (1) trade on the information or (2) disseminate the information further for the first tippee’s own benefit. The first tippee must both know or have reason to know that the information was obtained and transmitted through a breach and intentionally or recklessly tip the information further for her own benefit. The final tippee must both know or have reason to know that the information was obtained through a breach and trade while in knowing possession of the information.[1]
[1]Obus, 693 F.3d at 288. The court further explained that the tippee could be held liable on the basis of “conscious avoidance,” citing SEC v. Musella, 678 F. Supp. 1060, 1063 (S.D.N.Y.1988), for the proposition that Dirks was “satisfied where the defendants, tippees at the end of a chain, ‘did not ask [about the source of information] because they did not want to know.’ ” Obus, 693 F.3d at 288–89.
As the WSJ reported on Monday, this issue is now on appeal before the Second Circuit:
The appeal is being pursued by Todd Newman and Anthony Chiasson, two portfolio managers whose 2012 insider-trading convictions were a significant victory for prosecutors. ...
The original trial judge told jurors that Messrs. Chiasson and Newman could be convicted of insider trading even if they hadn't known that the person who leaked the information had done so in return for a "personal benefit."
Lawyers for Messrs. Newman and Chiasson say prosecutors must show that their clients knew the tippers were somehow compensated for the tips and that the judge's instruction was erroneous. The inside tips on which the pair traded were conveyed through a network of analysts before reaching analysts who worked for Messrs. Chiasson and Newman, the lawyers said in court documents. Their clients didn't seek out or knowingly use inside information, they said.
Prosecutors have said they need only show that people who used the tips were aware the tipper disclosed the nonpublic information in breach of a fiduciary duty when they traded on it.
Even if the instruction was erroneous, the jury would have concluded the two men inferred the information was given in exchange for a reward, prosecutors said in court documents.
Given the phrasing of the Obus standard, the jury instruction may well hold up on appeal. On the other hand, the seminal Dirks v. SEC decision makes clear that the requisite breach of fiduciary duty is one in which the tipper gets a personal benefit in return for the tip, so shouldn't the personal benefit requirement be made explicit?
The problem here is that the Obus case erroneously phrased the Dirks standard. According to the Second Circuit:
The [Supreme] Court held that a tipper like the analyst in Dirks is liable if the tipper breached a fiduciary duty by tipping material non-public information, had the requisite scienter (to be discussed momentarily) when he gave the tip, and personally benefited from the tip. Id. at 660–62, 103 S.Ct. 3255. Personal benefit to the tipper is broadly defined: it includes not only “pecuniary gain,” such as a cut of the take or a gratuity from the tippee, but also a “reputational benefit” or the benefit one would obtain from simply “mak[ing] a gift of confidential information to a trading relative or friend.” Id. at 663–64, 103 S.Ct. 3255. When an unlawful tip occurs, the tippee is also liable if he knows or should know that the information was received from one who breached a fiduciary duty (such as an insider or a misappropriator) and the tippee trades or tips for personal benefit with the requisite scienter. See id. at 660, 103 S.Ct. 3255.
The highlighted text is the source of the problem. It suggested that the personal benefit and fiduciary duty requirements are separate. Under Dirks, however, they are one and the same:
In determining whether a tippee is under an obligation to disclose or abstain, it thus is necessary to determine whether the insider's “tip” constituted a breach of the insider's fiduciary duty. ... [The] test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.
463 U.S. at 661-62. In other words, no personal benefit, no breach. Therefore, it seems to me, the jury should have been instructed that the prosecution has to prove that the tippees knew of recklessly avoided knowing that the tipper got a personal benefit.
David Lynn points out that the Commission's loss could have been a lot worse given its recent track record before the DC Circuit:
... On the benefit side of the equation, the Court stated "we find it difficult to see what the Commission could have done better," noting that the SEC determined that Congress intended the rule to achieve "compelling social benefits" which the agency was "unable to readily quantify" due to a lack of data about the rule's effects. The Court noted that the SEC had to promulgate the rule based on the statute, and thus necessarily relied on Congress's determination that the costs were necessary for achieving the goals.
With this outcome, the rule writers at the SEC are no doubt breathing a sigh of relief, as they still have a relatively full plate of Dodd-Frank Act and JOBS Act mandated rulemakings that continue to percolate. After a string of high profile losses in this Court and the U.S. District Court for the District of Columbia, this outcome is probably the best that the SEC and the Staff could have hoped for and may serve to pave the way for moving forward with the rest of the rulemaking agenda.
A coalition of business groups--including the U.S. Chamber of Commerce, National Association of Corporate Directors, National Black Chamber of Commerce, American Petroleum Institute, American Insurance Association, The Latino Coalition, Financial Services Roundtable, Center on Executive Compensation, and Financial Services Forum--have filed a rulemaking petition with the SEC asking that the Commission amend Rule 14a-8 "to increase significantly the percentage of favorable votes required before the company is obligated to include in its proxy materials the substance of proposals shareholders previously rejected."
They make a good case for it, but this proposal is small beans compared to the much more sweeping changes the rule requires (about which I blogged recently).
In his homily, the leader of the world's 1.2 billion Roman Catholics recounted the Biblical story of how the faith of the apostles had been shaken after Jesus' death but confirmed by the women who found his tomb empty after his resurrection.
"Their faith had been utterly shaken, everything seemed over, all their certainties had crumbled and their hopes had died. But now that message of the women, incredible as it was, came to them like a ray of light in the darkness," he said.
The 77-year-old pope, wearing white vestments, urged his listeners to rediscover direction in their lives, in the same way the apostles had re-found their faith.
"Do I remember it? Have I forgotten it? Have I gone off on roads and paths that made me forget it?" he asked.
I have to give a talk next month on the state of legal education. As someone who falls in between the "law school is a scam" and the "law school is great" folks, I think the system doesn't need to be blown up but also that some reforms in legal education are essential. But what are the odds they're going to happen?
Here are my Big 10 reforms. My questions for readers are (a) have I left any out and (b) do I have them correctly ranked by order of probability they will actually happen (going from most to least likely). Please note that this list is NOT normative. It's not the order in which I think reforms ought to happen, but rather the order of the likelihood I think they might happen:
More transparency from law schools on employment data
More “experiential learning”
Clinics
Simulations
Externships
More online educational opportunities
Reduction in class sizes
Reduction in faculty size
Reduction in size of law school administrations
Law school closures
Third year apprenticeship
Two year J.D.
Making law an undergraduate major
Warning: Experience teaches that law school reform posts tend to bring out the trolls. So read the comment policy first.
Just as I have reservations about empirical scholarship in the law, I have different but equal reservations about economic modeling in the law. But, setting those aside, An Evaluation of Shareholder Activism is a very interesting paper:
We develop a method to evaluate shareholder activism when an activist targets firms whose shareholders are diversified portfolio holders of possibly correlated firms. Our method of evaluation takes the portfolios of all of the shareholders, including the activist, as its basis of analysis. We model the activist from the time of the acquisition of a foothold in the target firm through the moment when the activist divests the newly acquired shares. We assume that during this period, all exchanges of securities, and their corresponding prices, are achieved in Walrasian markets in which all participants, including the activist, are risk-averse price-takers. Using the derived series of price changes of all the firms in the market, as well as the derived series of changes in all the portfolio holdings over this period, we evaluate the impact of activism on the activist, on the group of other shareholders, and on the combined group. We show that when activism is beneficial to the activist, the group of other investors may not benefit; furthermore, even when the activist benefits from activism, the value of the market may decrease. When the activist benefits from activism, an increase in the value of the market is a necessary but not sufficient condition for the group of other investors to benefit also from activism. In addition, we show that the combined group, the activist plus the group of other investors, benefits if and only if the value of the market increases and, under this condition, either the activist or the group of other investors, but not necessarily both, benefits.
We explore the effect of religious piety on corporate social responsibility (CSR). Prior research links religion to honesty and risk aversion. Accordingly, religion induces managers to be more honest and likely view as opportunistic and unethical an exploitation of other stakeholders. Risk aversion also implies that managers are unlikely to take advantage of other stakeholders as stakeholders can take retaliatory actions against them. Religion therefore motivates managers to treat other stakeholders and the society at large more favorably, resulting in stronger CSR. Our evidence, based on over 17,000 observations across 16 years, shows that religious piety leads to stronger CSR. However, this is the case only when religious piety is sufficiently strong, i.e. when it is beyond a certain threshold. To draw a causal inference, we use as our instruments religious piety in the distant past, i.e. from 1971 and 1952. Religious piety from decades ago is unlikely correlated with current CSR, except through its impact on contemporaneous piety. Our instrumental-variable analysis shows that the effect of religion on CSR is likely causal.
In his recent speech, SEC Commissioner Daniel Gallagher also commented on the state of SEC Rule 14a-8--the so-called shareholder proposal rule.
First, he identified the problem:
The Commission’s rules have for decades permitted qualifying shareholders to require the company to publish certain proposals in the company’s proxy statement, which are then voted upon at the annual meeting.
Unfortunately, the Commission has never adequately assessed the costs and benefits of this process. Currently, a proponent can bring a shareholder proposal if he or she has owned $2,000 or 1% of the company’s stock for one year, so long as the proposal complies with a handful of substantive—but in some cases discretionary—requirements. Activist investors and corporate gadflies have used these loose rules to hijack the shareholder proposal system.
The data and statistics are striking. In 2013, the number of shareholder proposals rose ... [but] only 7% of shareholder proposals received majority support in 2013.
These proposals are not coming from ordinary shareholders concerned with promoting shareholder value for all investors. Rather, they are predominantly from organized labor, including union pension funds, which brought approximately 34% of last year’s shareholder proposals, as well as social or policy investors and religious institutions, which accounted for about 25% of 2013’s proposals. Approximately 40% were brought by an array of corporate gadflies, with a staggering 24% of those proposals brought by just two individuals.
He then turned to possible solutions:
First, the holding requirement to submit proxies should be updated. $2,000 is absurdly low, and was not subject to meaningful economic analysis when adopted. The threshold should be substantially more, by orders of magnitude: perhaps $200,000 or even better, $2 million. But I don’t believe that this is actually the right fix: a flat number is inherently over- or under-inclusive, depending on the company’s size. A percentage threshold by contrast is scalable, varies less over time, better aligns with the way that many companies manage their shareholder relations, and is more consistent with the Commission’s existing requirements. Therefore, I believe the flat dollar test should be dropped, leaving only a percentage test. ...
I also think we need to take another look at the length of the holding requirement. A one-year holding period is hardly a serious impediment to some activists, who can easily buy into a company solely for the purpose of bringing a proposal. All that’s needed is a bit of patience, and perhaps a hedge. A longer investment period could help curtail some of this gamesmanship. ...
He also recommends giving companies greater power to exclude shareholder proposals affecting ordinary business matters and capping the number of times a proposal can be repeated.
Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders.
There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions.
This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.
This [essay] proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.
In particular, I argued that:
An appropriate starting point would be the shareholder proposal rule, which figures in about a third of shareholder interventions. Under current law, companies may not opt out of Rule 14a-8. If the law were changed to permit companies to adopt provisions in their articles of incorporation–either in the initial pre-IPO articles or by charter amendment thereafter–that would provide both a check on shareholder interventions and, if widely adopted, it would also provide evidence that investors prefer such provisions.
A less sweeping opt out provision would allow corporations to opt out of the current exemption in Rule 14a-8(i)(1) for proposals that are not proper as a matter of state corporate law. Under present law, a corporation must include in its proxy statement a shareholder proposal that is not a proper subject of a shareholder action under the law of the state of incorporation provided that the proposal is framed as a recommendation. Allowing companies to exclude such proposals even if phrased in precatory terms would provide a rough first cut at effecting the proposed substance/procedure distinction.
In order to effect that distinction, the exemption under Rule 14a-8(i)(7) for proposals relating to ordinary business expenses needs to expanded and revitalized. Under current law, the ordinary business exclusion is essentially toothless. The SEC requires companies to include proposals relating to stock option repricing, sale of genetically modified foods and tobacco products by their manufacturers, disclosure of political activities and support to political entities and candidates, executive compensation, and environmental issues. Obviously, however, these sort of ordinary business decisions are core board prerogatives. Because deference to board authority remains the default presumption, this exemption therefore needs to be expanded and revitalized.
Activist shareholders who make use of Rule 14a-8 should be required to provide greater disclosures with respect to their motivations, goals, economic interests, and holdings of the issuer’s securities (including derivative positions), so that their fellow shareholders can assess whether the activist’s goals are consistent with the interests of all shareholders. Towards the same end, the eligibility threshold for using Rule 14a-8 should be increased to require that the proponent have held a net long position of 1 percent of the issuer’s voting stock for at least two years. In addition to decreasing the risk that the activist would be pursuing private rent seeking, by discouraging proposals from activists using an empty voting strategy, such a change will ensure that activists are long-term investors rather than short-term speculators.
The proxy rules also should be amended to prevent hedge funds from compensating those members of an issuer’s board of directors that were nominated by the fund. The recent trend toward such payments raises serious conflicts of interest, as the hedge fund’s nominees likely will be loyal to the fund rather than the issuer. In particular, such directors have financial incentives to acquiesce in—or even assist—private rent seeking by their fund sponsor.
, I discuss liability in cases in which inside information is passed from one tipper to another in a so-called tipping chain:
