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The Absurd Insider Trading Case Against Phil Mickelson

The SEC and US Department of Justice have often overreached in their efforts to police insider trading, especially when they think they can make a big bang by taking down a high profile person (see, e.g., the asinine case against Mark Cuban), but the purported case against Phil Mickelson is one of the most absurd yet.

The NY Times reports that:

In the summer of 2011, a series of winning stock trades raised immediate red flags for financial regulators.

The traders — a cross-section of investors including the championship golfer Phil Mickelson and the high-rolling gambler and golf course owner William T. Walters — collectively reaped several million dollars betting on the consumer products companyClorox and one other stock, according to people briefed on the matter who spoke anonymously because they were not authorized to discuss the investigation.

The trades, options contracts to buy Clorox stock, came just days before the billionaire investor Carl C. Icahn announced an unsolicited takeover bid for the company that drove up the stock price. And trading records indicated that the bets came not just from Mr. Mickelson but also from at least one other investor connected to Mr. Walters and the golfing world, one of the people briefed on the matter said. ...

As federal authorities examine whether Mr. Icahn leaked details of his Clorox bid to Mr. Walters, the people said, they are exploring a theory that Mr. Walters might have passed the information to Mr. Mickelson.

This case stinks. It seems to me that there are two possible theories of liability of here, neither of which stands up to close scrutiny. First, Rule 14e-3 prohibits persons who occupy a certain status such as the offering person, the subject company, or an officer, director, partner or employee or any other person acting on behalf of the offering person or the issuer from tipping off other persons about an impending tender offer. Further, it prohibits thise tippees from trading on the basis of such information. But Rule 14e-3 only applies if the offering person (i.e., the takeover bidder, which would be Icahn in this case) has taken substantial steps towards commencing a tender offer. According to the NY Times, however, "in the case of Clorox, Mr. Icahn never submitted a tender offer." In addition, even if Icahn had taken the requisite substantial steps towards commending a tender offer, Mickelson would have to know or have reason to know that the information was non-public and came indirectly from Icahn.

Second, case law under Rule 10b-5 says that tipping material nonpublic information can sometimes be illegal. None of the players in this case are insiders of Clorox, so the classic disclose or abstain rule would not apply. Instead, the SEC would have to proceed under a misappropriation theory. In order for that to work, the SEC at a minimum would have to prove that (1) Icahn tipped the information to Walters in breach of a fiduciary duty owed to the person or entity who owned the information, (2) that Icahn got a personal benefit for doing so, (3) that Walters passed the information to Mickelson, (4) Mickelson knew or should have known that the information came was material, nonpublic, and had been disclosed to him in violation of a fiduciary duty by the source. It should also be the case that the SEC will have to prove that Mickelson knew or should have known that Icahn got a personal benefit from making the tip, although that issue is currently pending before the Second Circuit. 

The SEC's case would break down at several points. First, does Icahn owe a duty to anyone (say the investors in his hedge funds) that was breached by his disclosure? After all, isn't Icahn really disclosing his own intentions? Indeed, Forbes reports that "Icahn himself owned more than 90% of his Icahn Enterprises and had already moved to return all the outside money in his hedge fund." Tipping or trading on the basis of your own intentions is not illegal under Rule 10b-5.

Second, what personal benefit did Icahn get from making the disclosure?

Third, what did Mickelson know and how did he learn it? Can they link his trade to Icahn and, if so, did Mickelson known that Icahn was breaching a fiduciary duty (assuming he was) by making the disclosure.

I am not unsympathetic to the argument that putative shareholder activists like Carl Icahn need watching. As the WSJ reports:

The investigation signals that the FBI and the SEC are concerned about a potential dark side of shareholder activism. Activist investors push for broad changes at companies or try to move stock prices with their arguments. Mr. Icahn, a 78-year-old billionaire, has come to epitomize such activism in U.S. boardrooms.

Investigators are focusing on potentially abusive practices among such activists, including whether they are leaking information about their stakes before making public disclosures—the subject of a Wall Street Journal page-one article in March.

But while abuses by activists should be policed, I just don't see how the SEC or DOJ can possibly make this case stick.

 

Related articles

Tipping chain liability: The Newman and Chiasson Appeal

Feds Investigate Carl Icahn, Phil Mickelson And William Walters For Insider Trading

Mickelson: 'Done absolutely nothing wrong'

Insider Trading Inquiry Includes Mickelson and Icahn

Mark Cuban Acquitted of Insider Trading

Guttentag sheds new light on corporate political spending disclosure: Today's "must read"

An essential corrective to the debate over corporate political spending disclosure has been posted by Michael Guttentag:

Mandatory disclosure is a central feature of securities regulation in the United States, yet there is little agreement regarding precisely how the Securities and Exchange Commission (“SEC”) should determine what public companies are required to disclose. The current debate about whether the SEC should require the disclosure of political spending by public companies is but one example of this lack of consensus.

In this Article I first answer the more general question of how to evaluate any proposed public company mandatory disclosure requirement. I then apply this new evaluation method to the specific question of whether public companies should be required to disclose political spending. This analysis shows, based, in part, on previously unpublished empirical findings, that the evidence does not support requiring public companies to disclose political spending.

Guttentag, Michael D., A New Light on Public Company Political Spending Disclosure (May 16, 2014). Columbia Business Law Review, 2014, Forthcoming; Loyola-LA Legal Studies Paper No. 2014-25. Available at SSRN: http://ssrn.com/abstract=2438078

It is a must read.

More on the Forces of Unanimity versus UVA Professor Douglas Laycock

From Walter Olson:

If the issue of FOIA-ing U.Va. professors rings a bell, it’s because it’s happened at least twice before. Around 2009 Greenpeace, the environmental activist group, FOIAed the university demanding correspondence and documents relating to former professor Patrick Michaels (now at Cato), who had espoused skeptical views on global warming. Then allies of former Virginia attorney general Ken Cuccinelli filed a FOIA request seeking similar documents for Michael Mann, a prominent advocate of global warming theories. [C-ville.com, WaPo]

No one could doubt that Laycock’s views on religious accommodation are part of a set of intellectually derived convictions that run through decades of his work. (In addition to opposing such forms of church-state entanglement as officially sponsored prayer, he supports the right of gays to marry.) It’s simply a matter of trying to arm-twist a tenured, well-recognized scholar who takes a position that the Forces of Unanimity consider wrong.

And from Rick Hasen:

I know something about these requests, and at this point I think it worth remembering what Indiana Professor Eric Rasmussen said: we should be equally outraged at these threats to academic freedom when they come from the left or the right.

I concur. Threats to academic freedom must be resisted by people of goodwill regardless of which side of the political aisle from which they come.

Director versus Shareholder Primacy in New Zealand Company Law as Compared to U.S.A. Corporate Law

The PowerPoint deck posted here was used in a lecture I gave last night at The University of Auckland. The talk was based on my paper, Director versus Shareholder Primacy in New Zealand Company Law as Compared to U.S.A. Corporate Law, which argues that:

Any model of corporate governance must answer two basic sets of questions: (1) Who decides? In other words, when push comes to shove, who has ultimate control? (2) Whose interests prevail? When the ultimate decision maker is presented with a zero sum game, in which it must prefer the interests of one constituency class over those of all others, whose interests prevail?

On the means question, prior scholarship has almost uniformly favored either shareholder primacy or managerialism. On the ends question, prior scholarship has tended to favor either shareholder primacy or various stakeholder theories. In contrast, this author has proposed a “director primacy” model in which the board of directors is the ultimate decision maker but is required to evaluate decisions using shareholder wealth maximization as the governing normative rule.

Shareholder primacy is widely assumed to be a defining characteristic of New Zealand company law. In assessing that assumption, it is essential to distinguish between the means and ends of corporate governance. As to the latter, New Zealand law does establish shareholder wealth maximization as the corporate objective. As to the former, despite assigning managerial authority to the board of directors, New Zealand company law gives shareholders significant control rights.

Comparing New Zealand company law to the considerably more board-centric regime of U.S. corporate law raises a critical policy issue. If the separation of ownership and control mandated by the latter has significant efficiency advantages, as this article has argued, why has New Zealand opted for a more shareholder-centric model? The most plausible explanation focuses on domain issues, which suggest that there are a small number of New Zealand firms for which director primacy would be optimal. The unitary nature of the New Zealand government may also be a factor, because the competitive federalism inherent in the U.S. system of government promotes a race to the top in which efficient corporate law rules are favored.

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Related articles

Managing Shareholder Interventions: An Updated Director Primacy Critique of Shareholder Empowerment

Webcast of the Conference on Competing Theories of Corporate Governance now online

Director Primacy at the Lowell Milken Institute

Shareholder Activism in the United States: Managing Shareholder Interventions

Director primacy in 5 minutes worth of bullet points

Tweets to Jeff Bezos, not that he's likely to do anything about them

These will piss some people off, but that was the intent, so no apologies:

It would be really nice if @amazon made it easier to separate real books from real publishers from the self-published e-dreck slush pile.

— Stephen Bainbridge (@ProfBainbridge) May 27, 2014

It also would be really nice if @amazon separated the paranormal romance dreck from real science fiction and fantasy.

— Stephen Bainbridge (@ProfBainbridge) May 27, 2014

Let's use Rule 14a-8 to fight the Purge of Conservatives

SEC Rule 14a-8 (the shareholder proposal rule) allows shareholders to put proposals on their company's proxy statement and thereby force a shareholder vote on the proposal. As the SEC explains:

Rule 14a-8 provides an opportunity for a shareholder owning a relatively small amount of a company's securities to have his or her proposal placed alongside management's proposals in that company's proxy materials for presentation to a vote at an annual or special meeting of shareholders. It has become increasingly popular because it provides an avenue for communication between shareholders and companies, as well as among shareholders themselves. The rule generally requires the company to include the proposal unless the shareholder has not complied with the rule's procedural requirements or the proposal falls within one of the 13 substantive bases for exclusion described in the table below. ...

To be eligible to submit a proposal, rule 14a-8(b) requires the shareholder to have continuously held at least $2,000 in market value, or 1%, of the company's securities entitled to be voted on the proposal at the meeting for at least one year by the date of submitting the proposal. Also, the shareholder must continue to hold those securities through the date of the meeting.

The rule came to mind when I was reading a press release from the National Center for Public Policy Research:

At the annual Groupon shareholder meeting Tuesday in Chicago, The National Center for Public Policy Research requested and received a pledge from Groupon management that it will be "content neutral" in regard to the deals it offers to Groupon members.

The National Center's Free Enterprise Project Director Justin Danhofattended the meeting to request the content neutrality pledge after PETA announced it will attend Groupon's 2015 shareholder meeting to ask Groupon to adopt a content bias policy that would prohibit circuses from offering deals to Groupon members. ...

It seems that hardly a week goes by without a news story about left-wing organizations pressuring businesses to cave in and endorse some aspect of the left-wing agenda," said Amy Ridenour, chairman of the National Center. "We learned from a story by Ellen Jean Hurst in the April 22 Chicago Tribune that PETA plans to attend Groupon's 2015 shareholder meeting to pressure Groupon into becoming one of its activists. Unfortunately for PETA, it did not buy shares soon enough to attend this year's meeting, but we did. So we went first. We asked Groupon to be content-neutral; that is, equally fair to every point of view and every legal product. We are pleased to say that Groupon not only said 'yes,' but did so emphatically. We congratulate Groupon's management." ...

Justin Danhof, representing the National Center for Public Policy Research, will attend Amazon.com's annual shareholder meeting in Seattle. Like Groupon, Amazon.com is being pressured by left-wing activists to treat certain segments of the population differently, depending upon the activities of their legal businesses or their political or religious views. We will urge Amazon to be content neutral, as Groupon has pledged to be, always steadfast in its objectivity and treating everyone engaged in legal activities in an equal manner.

So here's my idea: We draft up a shareholder proposal requesting that the board of directors of various companies (target list to come) adopt a content neutral policy. We then identify conservatives who are shareholders of the target company and assist them in putting the proposal on the target company proxy.

Anybody with me?

The Purge Arrives at the University of Virginia: PC Thugs versus Douglas Laycock

The continuing effort by left-liberals to silence any dissent from their politically correct mandates is now taking on a famed legal scholar:

Douglas Laycock, School of Law faculty member and husband of UVA President Teresa Sullivan, is one of the country’s leading experts on religious liberty, and is well-known for a legal stance that often puts him on opposite sides of polarizing political issues: He supports individual religious rights, but also a total separation of church and state, and he’s argued several Supreme Court cases from that position, defending conservative Lutherans and Santería sect members alike. 

Some of his recent writings have been heavily cited by members of the religious right, and now he’s facing the ire of activists on the other end of the political spectrum.

“His work, whether he understands it or realizes it or not, is being used by folks who want to institute discrimination into law,” said Heather Cronk, co-director of Berkeley, California-based LGBT activist group GetEQUAL. ...

Through the activist group Virginia Student Power Network, GetEQUAL found two UVA students willing to take up the cause of calling out Laycock: rising fourth-year Greg Lewis and now-alum Stephanie Montenegro. Last week, the pair sent an open letter to Laycock asking him to consider the “real-world consequences that [his] work is having.” They also submitted a Freedom of Information Act request seeking e-mails between Laycock and various right-wing and religious liberty groups.

Lewis said they’re not trying to smear Laycock, and they’re not trying to undermine academic freedom. They just want a dialogue, he said.

Bullshit. You don't start a dialogue with FOIA requests. This is a blatant effort at deterring public participation by anyone who does not hew 100% to the most radical version of the gay rights movement.

“I think it would be really constructive for him to hear how his work is being used to hurt the LGBTQ community,” said Lewis. “I don’t think he has any ill intent. I think he’s very thoughtful and moderate, and willing to hear both sides. But I think that everyone really has a lot to learn.”

My God. The pomposity and arrogance of these children (of the corn?) is just amazing.

It's time to start fighting back. There have to be consequences for people like Heather Cronk, Greg lewis, and Stephanie Montenegro or the day will come when they and their ilk will have successfully silenced the rest of us.

 

Related articles

As the purge continues, thank God for tenure

Sullivan's law professor husband criticized by gay rights group

Dear UVA students: in prying into Prof. Laycock's e-mails you are attacking his academic freedom

The Virginia Mess

Contra Professor Leahy, Corporate Political Contributions do not Constitute Bad Faith

In a new article, Joseph Kieran Leahy argues that "essentially all corporate political contributions made by large, public corporations today constitute bad faith because they reflect management's conscious disregard for shareholders' political views."

I find his argument unpersuasive. After all, as Chancellor Allen observed many years ago:

The corporation law does not operate on the theory that directors, in exercising their powers to manage the firm, are obligated to follow the wishes of a majority of shares. In fact, directors, not shareholders, are charged with the duty to manage the firm.... That many, presumably most, shareholders would prefer the board to do otherwise than it has done does not... afford a basis to interfere with the effectuation of the board's business judgment.

Paramount Communications Inc. v. Time Inc., Nos. 10866, 10670, 10935, 1989 WL 79880, at *30 (Del. Ch. July 14, 1989), aff'd, 571 A.2d 1140 (Del. 1990).

I see no reason that principle would not extend to political contributions.

Update: Leahy responds here.

Meese and Oman on Hobby Lobby is a "Must Read"

I've just finished reading Alan Meese and Nathan Oman's article, Hobby Lobby, Corporate Law, and the Theory of the Firm, which somehow slipped passed the secular liberals at the Harvard Law Review. It is an excellent argument in favor of the proposition that for profit corporations are persons for purposes of the Religious Freedom Restoration Act. It's also a devastating demolition of the absurd corporate law professors brief in that case (about which I have also written).

Meese and Oman "make three basic claims":

First, corporate law does not discourage for-profit corporations from advancing religion. Second, such businesses do not undermine the goals of corporate law, nor would it undermine such goals to grant these firms religious exemptions from otherwise neutral laws in appropriate cases. Third, given the plausible reasons for protecting religious exercise by for-profit corporations, there is no reason to reject the most natural reading of RFRA’s text, namely that “person” includes private corporations of all kinds. This does not mean, of course, that every RFRA claim by a for-profit corporation should be successful. In some cases there will be no substantial burden on religious practices, and in other cases the government may have a compelling reason for regulating corporations. RFRA, however, does not assign the task of weeding out such undesirable religious exemptions to the definition of “person.” Rather, other statutory provisions do that work.

I find all three claims fully convincing. You will too.

The New Zealand Takeovers Code versus US Law: An Overview

I was privileged to guest lecture the Takeovers course at the University of Auckland Faculty of Law on May 22, 2014. This presentation provides an overview of some key differences between the New Zealand Takeovers Code and US law.

"The Board’s Duty to Keep Its Options Open"

Stephen Lubben has a concise but (should that be "and"?) valuable treatment of how corporate law's antipathy to precommitments drives "big chapter 11 cases" to be "done by way of a quick 363 sale."

I argue that the roots of the issue are corporate governance, and not bankruptcy. That is, if the tendency for debtors to show up in chapter 11 with no option but to engage in a quick sale process is a problem, that problem has its roots in non-bankruptcy corporate law. 

I then begin the process of explaining how the decision to lock a company into an all-encompassing secured loan, and thus a likely quick 363 sale, should be regulated. Namely, I argue that ultimately this is a question of state law fiduciary duties, and that the foundation for this duty already exists in the Delaware Supreme Court’s oft maligned Omnicare, Inc. v. NCS Healthcare, Inc. 

In short, state corporate law imposes a duty on the board to carefully consider any decision that will foreclose a future board’s choices. In times of financial distress, this duty includes an obligation to carefully consider the effects of a particular decision on future restructuring options.

I addressed the relevant corporate law in my article Dead Hand and No Hand Pills: Precommitment Strategies in Corporate Law (October 30, 2002), available at SSRN:http://ssrn.com/abstract=347089:

Corporations frequently make use of precommitment strategies. Examples include such widely used devices as negative pledge covenants and change of control clauses in bond indentures, fair price shark repellents, no shop and other exclusivity provisions in merger agreements, mandatory indemnification bylaws, and so on. This paper argues that poison pills also can be understood as a form of precommitment, by which the board of directors commits to a policy intended either to negotiate a high acquisition price or to maintain the corporation's independence. 

In Quickturn Design Sys., Inc. v. Mentor Graphics Corp., the Delaware supreme court invalidated a no hand poison pill on grounds that a board of directors lacks authority to adopt such devices. In doing so, the court misinterpreted relevant Delaware law. It unjustifiably called into question the validity of a host of corporate precommitment strategies. Finally, and perhaps most troublingly, it called into question the central tenet of Delaware corporate law; namely, the plenary authority of the board of directors. 

This article argues that the Delaware supreme court's decision was wrong both as a doctrinal and a policy matter. There simply is no firebreak between the sorts of board self-disablement deemed invalid by Quickturn and the host of other precommitment strategies routinely used by corporate boards of directors. The Delaware supreme court's conclusion that the former are invalid for lack of statutory authority thus threatens to invalidate all of the latter. The article concludes by arguing that the Delaware supreme court should have analyzed the no hand pill under standard fiduciary duty principles rather than creating a new prophylactic ban on precommitment strategies.

The Delaware courts' continuing hostility to precommitments remains a mystery, at least to me.

Related articles

Precommitment Strategies in Corporate Law

A precis of The Geography of Revlon-Land

The Essential Business Judgment Rule

We get cited all over the place

Managing Social Media Risk: The #SaveJosh Case Study

Enterprise risk management has become a key issue for corporate boards, with both liability and business exposure for unprepared boards. There's a very valuable case study from the Stanford Rock Center for Corporate Governance that explores this issue in more detail:

On March 5, biotechnology company Chimerix refused to provide a potentially life-saving drug to 7-year old Josh Hardy who was battling cancer. The drug had not yet received FDA approval, and the company had discontinued its "compassionate use" program to dedicate resources to Phase 3 testing of the drug. 

Five days later, following a massive social media onslaught that captured national attention, the company relented. 

In this Closer Look, we dissect the powerful force of social media and examine its potential impact on corporate reputation. We ask: 

1. Why aren’t more companies prepared to deal with the reputational risks that emerge through online channels? 

2. How should information gathered from social media outlets be used to supplement a comprehensive risk management program? 

3. Are stories such as this one a board-level issue? If so, at what point do they become one? 

4. If Chimerix were your company, what would you do differently?

Larcker, David F. and Larcker, Sarah M. and Tayan, Brian, Josh Hardy and the #SaveJosh Army: How Corporate Risk Escalates and Accelerates Through Social Media (April 14, 2014). Available at SSRN: http://ssrn.com/abstract=2424451

The State of Legal Education in the USA

This is a presentation I gave to the University of Auckland Faculty of Law on May 19, 2014, on the state of legal education in the United States.

Shareholder Activism in the United States: Managing Shareholder Interventions

This is a presentation I gave at the University of Auckland Faculty of Law on May 19, 2014. It is based on my paper Preserving Director Primacy by Managing Shareholder Interventions (August 27, 2013), which is available at SSRN: http://ssrn.com/abstract=2298415.

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 paper 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.

Related articles

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Managing Shareholder Interventions: An Updated Director Primacy Critique of Shareholder Empowerment

"Are activist shareholders good for investors?"

Everything The Economist says about shareholder activism is wrong

The Economist is ineducable on shareholder activism

A Quick Comparison of USA Corporate Law and New Zealand Company Law

I gave this presentation to a group of company law students at the University of Auckland on May 19, 2014. It offers a quick comparison of USA corporate law and New Zealand company law, focusing on the role of the board of directors and its powers as compared to the role and powers of the shareholders.