ProfessorBainbridge.com

Fighting the SEC

Interesting post by Steve Bradford links to a fascinating story. (At least by securities lawyer standards.)

Brian Leiter: Top 50 Law Schools of 2014

As voted by readers of Leiter's blog. Some preposterous results:

1. UCLA below Cornell? Puhleeze.
2. UC Irvine in the top 20. Ridculous.
3. Duke at # 11? I don't think so.

Senator Richard Blumenthal (D-CT) is outraged by fee shifting bylaws

Apparently he thinks they are a major threat to the Republic. Silly man. Keith Paul Bishop has the details.

Footnote fetishism and other law review silliness

Joan Heminway vents on some law review absurdities to which she and a colleague have recently been subjected. I feel her pain.

Justice Scalia's shot across the SEC's bow re insider trading

A while back, I noted that I had filed an amicus brief with the Supreme Court in Whitman v. United States, a case raising serious questions about the current state of insider trading law.

I regret to report that the Supreme Court denied cert in Whitman, but intrigued by Justice Scalia's seprate statement with respect to the order. As the WSJ opined today:

Justice Scalia joined the rest of the High Court in refusing to hear hedge-fund manager Doug Whitman ’s appeal of his insider-trading conviction. But joined by Justice Clarence Thomas , Justice Scalia made clear he isn’t happy with the way the law is being interpreted.

“A court owes no deference to the prosecution’s interpretation of a criminal law,” wrote Justice Scalia, while raising the related question: “Does a court owe deference to an executive agency’s interpretation of a law that contemplates both criminal and administrative enforcement?”

The Second Circuit Court of Appeals thought a court does owe such deference, and so it sustained Whitman’s conviction based on the Securities and Exchange Commission’s interpretation of insider-trading law. Justice Scalia wrote that he doubts such “pretensions to deference,” and said “the rule of lenity requires interpreters to resolve ambiguity in criminal laws in favor of defendants.” 

Scalia's separate statement concludes:

Whitman does not seek review on the issue of deference, and the procedural history of the case in any event makes it a poor setting in which to reach the question. So I agree with the Court that we should deny the petition. But when a petition properly presenting the question comes before us, I will be receptive to granting it. 

If and when Scalia does find such a case, he might also encourage the Court to consider whether the incredible vagueness of the current insider trading prohibition violates due process (it does). The Court might also consider the serious federalism issues we raised in Whitman.

Hopefully the case will also give the Court an opportunity to consider the validity of SEC Rule 10b5-2, to which lower courts have unthinkingly, supinely, and asininely given Chevron deference.

Related articles

Scalia's Insider-Trading Invitation

With the Rule of Lenity, Do Justices Make The Statute Less "Severe"

SEC Commissioners Gallagher and Piwowar Dissent from SEC Gift to Trial Lawyers

In today's WSJ:

Earlier this month reports circulated that the Securities and Exchange Commission may set up a $600 million “fair fund” to distribute money collected from defendants to purportedly harmed investors in the insider-trading case SEC v. CR Intrinsic Investors. ...

The only guaranteed winners will be administrators who distribute the fair fund and class-action lawyers who will take a significant cut of any funds paid to their clients. Indeed, plaintiffs lawyers mounted an unprecedented lobbying campaign after the court directed the SEC to make a recommendation about whether to establish a fair fund. Before the vote, our offices received dozens of letters from purported victims urging the commission to petition for a fair fund.

The strikingly similar tone and content of the letters that came cascading into our offices made it clear that they had been sent at the behest of class-action lawyers in a parallel civil action. It was all part of a coordinated campaign by the plaintiffs bar to gain access to the pot of gold at the end of the government investigations rainbow. These lawyers played no part in the commission’s successful enforcement action, yet they may now receive tens of millions of dollars as a result of the majority’s vote.

We refuse to be a part of any commission decision that will create a cottage industry for class-action lawyers, piggybacking on government investigations and targeting the disgorgement—and, even worse, government-ordered penalties—collected from defendants in SEC enforcement actions.

Good for them. Kindly go read the whole thing.

Walter Olson on "An agenda for financial regulation"

Steve Bainbridge has a wish list for reforms to financial and securities law in the new Congress, especially the damaging Dodd-Frank and Sarbanes-Oxley laws. Included: repeal of conflicts minerals disclosure, “say on pay,” and pay ratio disclosure; more leeway for public companies to opt out of various regulatory obligations to shareholders that their own shareholders have not contractually seen fit to impose; and litigation reform.

Meanwhile, my Cato colleague Mark Calabria points out that there “are numerous protectors of the status quo in both major political parties,” which may frustrate the relatively free-market instincts of the responsible committee chairs, Sen. Richard Shelby and Rep. Jeb Hensarling. “But at least financial regulation is unlikely to get any worse.”

via overlawyered.com

John McGinnis on the effect of the election on public sector unions

We are not fans of public sector unions here at PB.com. Neither is Professor McGinnis, who opines:

One of the most notable consequences of this election was the setback it dealt to public sector unions. Importantly, the losses came at hands of both parties. Republican Scott Walker was reelected in Wisconsin after rolling back the power of public sector unions. Gina Raimondo gained the governorship of Rhode Island despite using her position as that state’s Treasurer to restructure public pensions and thereby earning the enmity of public sector unions. In my own home state of Illinois, Governor Pat Quinn lost in state where the most important mainstay of his party is public sector unions, whose pensions and other exactions have made Illinois the state with one of the lowest credit ratings and worst business climates in the nation.

The decline in political power and legal privileges of public sector unions would be the single most salutary structural improvement in the states where they enjoy such privileges. The right of public sector unions to check off dues, to mandate collective bargaining, and/or to strike gives them unaccountable power in the delivery of public services. As a result such public services are often more expensive and less efficient. Worst of all public sector unions exercise this leverage to gain above-market, unfunded pensions that need to be financed later—at a time when those who have negotiated those pensions have left government.

It is mistake to analogize unions in the public sector to those in the private sector. In the private sector, negotiations over wages are genuinely two sided with management vigorously representing the interests of shareholders. By contrast, in the public sector the real party in interest—the citizens of the city or state—are generally not well represented at the bargaining table. The elected officials cannot be counted on to negotiate effectively because they want the campaign contributions and political muscle that unions can bring.

The recurring dilemma of democratic politics is that politicians often benefit by giving away benefits to such concentrated groups at the expense of the rest of us. Privileges for public sector unions exacerbate this fundamental problem rather than diminish it.

Kindly go read the whle thing.

ISS adopts a new "holistic"--i.e., bogus--approach to independent chairman of the board proposals

ISS announced today that:

Calls for independent board chairs were the most prevalent type of shareholder proposal offered for consideration at U.S. companies’ annual meetings in 2014. As of Oct. 31, 63 of these proposals came to a shareholder vote, up from 59 resolutions over the same time period in 2013. ...

ISS' current policy is to generally recommend for independent chair shareholder proposals unless the company satisfies all of the following criteria:

• The company designates a lead director, who is elected by and from the independent board members with clearly delineated and comprehensive duties.

• The board is at least two-thirds independent.

• The key board committees are fully independent.

• The company has disclosed governance guidelines.

• The company has not exhibited sustained poor TSR performance (defined as one- and three-year TSR in the bottom half of the company's four digit industry group, unless there has been a change in the CEO position within that time).

• The company does not have any problematic governance issues. 

This "Generally For" policy is updated by adding new governance, board leadership, and performance factors to the analytical framework and to look at all of the factors in a holistic manner. New factors (not explicitly considered under the current policy) include the absence/presence of an executive chair, recent board and executive leadership transitions at the company, director/CEO tenure, and a longer (five-year) TSR performance period.

ISS believes that a more holistic review of each company's board leadership structure, governance practices, and financial performance will strengthen the application of this policy. Under the proposed revisions, any single factor that may have previously resulted in a "For" or "Against" recommendation may be mitigated by other positive or negative aspects, respectively. 

ISS did this despite the fact that the evidence clearly does not support any sort of presumption in favor of independent board chairmen:

Comment on the 2015 ISS Benchmark Policy Consultation re ... The solution is to adopt bylaws that allow the independent boardmembers to call special meetings, require them to meet periodically outside ...

 

Davis Polk on ISS Policy re Combined CEO and Chairman of the ... on the 2015 ISS Benchmark Policy Consultation re Independent Chair ... on what the board believes to be optimal under the circumstances.

 

The case for letting companies-not ISS-decide if they want separate ...   5 days ago ... Randi Val Morrison makes a good argument for "tolerance of multiple ... Academic bias against conservatives is so real even The New Yorker ...

ISS also did this despite having allowed only only seven business days to pass after comments are due before making the announcement. Clearly, ISS' comment period was a sham and fig leaf. There is no way they processed and gave serious consideration to comments ion one week. No way.

Finally, the new policy is especially pernicious. By definition "holistic" approaches to anything vests essentially unreviewable discretion in the decision maker. And therein lies the problem.

At the core of ISS' business model is a huge conflict of interest:

ISS advises institutional investors how to vote proxies and provides consulting services to corporations seeking to improve their corporate governance. Critics contend that corporations could feel obligated to retain ISS’s consulting services in order to obtain favorable vote recommendations. 

"Holistic" review thus could work like this: Acme Corp. receives a shareholder proposal for an independent board chairman. Most if not all of the factors ISS identifies as relevant point towards a "FOR" recommendation. But Acme suddenly hires ISS as a governance advisor. So ISS "holistically" decides on an "AGAINST" recommendation. 

Or it could be even worse: Ajax Inc. receives a shareholder proposal for an independent board chairman. Most if not all of the factors ISS identifies as relevant point towards an "AGAINST" recommendation. But because Ajax does not use ISS as a governance advisor, ISS "holistically" decides on a "FOR" recommendation. The proposal fails but narrowly. Ajax wises up and hires ISS as a governance advisor. The following year Ajax gets a similar proposal, but now ISS "holistically" decides on an "AGAINST" recommendation.

Put proxy advisory reform on the agenda of the new GOP majorities in Congress. Today.

Who was the first person the SEC found to have violated the insider trading laws?

The Green Bag posts the following question:

Let's start by being very clear about the phrasing of the question. It asks "who was the first person ever found by the" SEC to have violated the insider trading laws.

Found is being used here as the simple past tense of the verb find, of course, which in turn means "To determine a fact in dispute by verdict or decision < find guilty> <found that no duty existed>. Cf. HOLD (2)." Blacks Law Dictionary. Thus, we can eliminate cases in which the SEC charged someone with insider trading but the defendant was found to have violated the law (or not) by a court. Accordingly, we can eliminate the defendants in early cases such as Speed v. Transamerica Corp., 99 F. Supp. 808 (D.Del. 1951) (omissions in connection with what amounted to a tender offer); Kardon v. Nat'l Gypsum Co., 73 F. Supp. 798 (E.D. Pa. 1947) (sale of control negotiated face to face); In re Ward La France Truck Corp., 13 S.E.C. 373 (1943) (same). In addition, those cases uniformly involved face-to-face transactions and/or control transactions. As such, they do not really count as insider trading, which I take to refer in this context as the sort of modern insider trading violations on impersonal stock exchanges with which we are all familiar.

As such, we come inexorably to the SEC’s enforcement action In re Cady, Roberts & Co., 40 S.E.C. 907, 1961 WL 3743 (1961).

Curtiss-Wright Corporation’s board of directors decided to reduce the company’s quarterly dividend. One of the directors, J. Cheever Cowdin, was also a partner of Cady, Roberts & Co., a stock brokerage firm. Before the news was announced, Cowdin informed one of his partners, Robert M. Gintel, of the impending dividend cut. Gintel then sold several thousand shares of Curtiss-Wright stock held in customer accounts over which he had discretionary trading authority. When the dividend cut was announced, Curtiss-Wright’s stock price fell several dollars per share. Gintel’s customers thus avoided substantial losses.

Cady, Roberts involved what is now known as tipping: an insider who knows confidential information does not himself trade, but rather informs—tips—someone else, who does trade. It also involved trading on an impersonal stock exchange, instead of a face-to-face transaction. As the SEC acknowledged, this made it “a case of first impression.” Id. at *1. Although rule 10b-5 had sometimes been invoked prior to Cady, Roberts to deal with insider trading-like issues, as noted above, those cases typically had involved issues of tortious fraudulent concealment in face-to-face or control transactions. Notwithstanding, the SEC held that Gintel had violated Rule 10b-5. In so doing, it articulated what became known as the “disclose or abstain” rule: An insider in possession of material nonpublic information must disclose such information before trading or, if disclosure is impossible or improper, abstain from trading.

It was not immediately clear what precedential value Cady,Roberts would have. See, e.g., Recent Decision, 48 Va. L. Rev. 398, 403-04 (1962) (“in view of the limited resources of the Commission, the unfortunate existence of more positive and reprehensible forms of fraud, and the inherent problems concerning proof and evidence adhering to any controversy involving a breach of duty of disclosure, there is little prospect of excessive litigation evolving pursuant to [Cady, Roberts]”).

There were several reasons back in 1962 to doubt Cady, Roberts's precedential value. It was an administrative ruling by the SEC, not a judicial opinion. It involved a regulated industry closely supervised by the SEC. Neither the text of the statute nor its legislative history supported—let alone mandated—a broad insider trading prohibition. (Although the claim is somewhat controversial, I have argued elsewhere that Congress in 1934 did not intend for section 10(b) to prohibit insider trading as we know it today. Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189, 1228-34 (1995).)

Finally, there was a long line of state law precedent to the contrary. See id. at 1218-27 (analyzing cases).

In short order, however, Cady, Roberts became the law of the land, as it was embraced by the Second Circuit in SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir.), cert. denied, 394 U.S. 976 (1968).

With the Republicans controlling both houses of Congress, why not try fixing SOX and Dodd-Frank?

Here's my wish list of provisions in Sarbanes-Oxley and Dodd-Frank that I'd like to see the new Republican majority in Congress repeal or fix:

1. Repeal the conflict minerals disclosure rule. It's costly, hard to administer, and ineffectual.

2. Repeal say on pay. It doesn't work. It's counter productive. It's an unjustified intrusion on director discretion. 

3. Repeal the Volcker rule. It's too complex to be workable, as well as a bad idea from the get go.

4. Repeal pay ratio disclosure. It's a costly rule that was intended soly to make left0liberal Occupy Wall Street types happy.

5. Allow corporations to opt out of the shareholder proposal rule (14a-8). Doing so would provide both a check on shareholder interventions and, if widely adopted, it would also provide evidence that investors prefer such provisions.

6. Alternatively, 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.

7. Also, with respect to the shareholder proposal rule, 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.

8. Another change to the shareholder proposal rule that is needed is raising the eligibility threshold for using Rule 14a-8 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.

9. Shorten the 10 day reporting window under Section 13(d) to no more than 2 business days. The ten day window maybe made sense back in the old days when one filed everything on paper. But in these days of electronic filing, when the SEC has accelerated filing of a host of disclosures, it makes no sense to let 5% holders have 10 days of secrecy. Especially in an era of empty voting and other shenanigans by hedge funds.

10. Litigation reform.

11. I agree with the Chamber of Commerce: "Replace the single director leadership structure at the Consumer Financial Protection Bureau (CFPB) with a bipartisan commission to ensure continuity and a balanced approach to policymaking. Restore appropriate Congressional oversight by bringing the CFPB’s budget within the formal appropriations process, similar to most independent agencies.  Ensure more effective coordination with safety and soundness regulators to guarantee that CFPB regulations do not conflict with other regulations or otherwise undermine the diversity and soundness of the banking system."

12.  I also agree with the Chanber that Congress should "Hold proxy advisory firms, principally Institutional Shareholder Services and Glass Lewis, to standards that move the industry towards a more accountable, transparent, and evidence-based policymaking process while eliminating core conflicts of interest."

Matt Haley of Haley v Talcott has passed away

in the Klein, Ramseyer & Bainbridge Business Associations casebook we include the Delaware (Strine) decision in Haley v. Talcott on dissolution. 

Haley and Talcott each held a 50% interest in Matt and Greg Real Estate, LLC. The LLC owned the land on which a restaurant called the Redfin Seafood Grill was located. According to Chancellor Leo Strine, Talcott “owned” the restaurant and Haley managed it pursuant to an employment agreement between Talcott and Haley. The two had a falling out and Haley sued for judicial dissolution. Talcott claimed that Haley was limited to the exit provision in the LLC operating agreement.

The case presents a nice conflict between two bedrock principles of Delaware business association law: (1) Freedom of contract, which is especially strong in the LLC context. (2) The power of the Delaware courts to strike down as inequitable conduct authorized by statute (as most famously stated in Schnell v. Chris-Craft).

Then Chancellor Leo Strine nodded in passing to freedom of contract, but then granted a decree of dissolution despite the existence of an apparently exclusive contractual exit provision. His analysis proceeds as follows: (1) The barebones LLC dissolution provision may be interpreted by analogy to § 273 of the Delaware General Corporation Law. (2) Under § 273, a shareholder is entitled to dissolution on grounds of deadlock if three conditions are satisfied: (i) the corporation must have two 50% stockholders, (ii) those stockholders must be engaged in a joint venture, and (iii) they must be unable to agree upon whether to discontinue the business or how to dispose of its assets. (3) All three conditions are satisfied on these facts. (4) It would be inequitable to limit Haley to the contractual exit provision because doing so would leave him subject to the guarantee he had given on the mortgage on the property.

And now my friend Jayne Barnard sent along a footnote to the case:

Sussex County restaurateur Matt Haley may have been the only Delawarean to receive a prestigious James Beard Foundation Award, but he didn't care much about fancy foods. ...

Friends, colleagues and people whom Haley, 53, touched through his restaurants and much-honored global humanitarian work were stunned to hear of his death Tuesday night from injuries suffered in a motorcycle accident in India.

Haley was one of Delaware's most respected culinary ambassadors and philanthropists. He owned eight popular restaurants in the state's beach resort towns, had a total of 25 operations in at least four states, served on several boards and was a frequent speaker. ...

The Rehoboth Beach resident was recognized for his good deeds both in Delaware and across the world.

The article details Haley's many humanitarian and philanthropic efforts.

Rick Garnett on Justice Alito on St Thomas More

Speaking to the St. Thomas More Society of Maryland (HT:  The Catholic Review), Justice Alito said:

“It is important for us to remember that it is not only possible to be a very good lawyer and also a good person, but this is in fact what we are called to do,” he said. “St. Thomas More provides us with an example.”

Nice.

via mirrorofjustice.blogs.com

Very nice indeed.

Davis Polk on ISS Policy re Combined CEO and Chairman of the Board and ISS' lousy process

I previously commented on the 2015 ISS Benchmark Policy Consultation re Independent Chair Shareholder Proposals and praised Randi Val Morrison's argument for "tolerance of multiple views and alternative structures based on what the board believes to be optimal under the circumstances."

Now Randi has kindly referred me to Davis Polk's very detailed and thoughtful comment letter on the issue. In addition to making some excellent points about the substance of the policy proposals, Davis Polk makes some very telling comments about the seriously flawed process the ISS has followed in this case:

First, as the 2015 policy survey did not have any questions about independent chair shareholder proposals, market constituents were unprepared for the potential revision of that policy, and it took some time to review, understand and evaluate the possible impact of the policy for a broad range of constituents.

The proposals subject to comment were released on October 15, with a deadline for comments two weeks later. While the draft policy is fairly succinct, there is little specific information provided. There are only general references to a “holistic review” of new factors, citing several examples, without indicating whether the existing factors remain unchanged (other than the performance period), or would be adjusted as well. The draft mentions that any single factor could be mitigated by positive or negative aspects, but then there is no explanation of what factors would be considered positive or negative. The lack of detail makes it difficult to target comments meaningfully.

ISS indicates that the final policy will be issued on or around November 7, only seven business days after comments are due. This seems to be a fairly limited window to thoroughly review comments received and to properly take them into account in formulating final policies, which may discourage additional persons from commenting. 

Davis Polk has a point. The institutional investors ISS serves would be screaming bloody murder if the SEC or the exchanges adopted such a flawed comment process. 

Is a fish "a record, document, or tangible object"? Why the Supreme Court will decide.

The Washington Legal Foundation emailed me this press release:

On Wednesday, November 5, 2014, at 10:00 a.m., the U.S. Supreme Court will hear oral argument in a criminal case, Yates v. United States. The Court will decide whether to overturn the conviction, under the Sarbanes-Oxley Act, of John Yates, a commercial fisherman who allegedly directed his crew to throw undersized fish back into the sea after receiving a regulatory citation for catching them.

Washington Legal Foundation filed a brief in the case urging reversal of Yates’s conviction, arguing that the broadly worded statute failed to provide Yates with requisite “fair warning” of what conduct would run afoul of the law. WLF Senior Litigation Counsel Cory Andrews, who authored WLF’s amicus brief, will be available following oral argument to discuss the case and assess whether the justices’ questioning suggested any particular outcome.

The case raises important questions about the permissible scope of the Sarbanes-Oxley Act, a law passed in 2002 to restore integrity to and faith in public companies’ disclosure and accounting practices in the wake of corporate scandals at Enron and WorldCom. Yates was convicted for violating the Act’s so-called anti-shredding provision, 18 U.S.C. § 1519, which makes it a crime to destroy or cover up “any record, document, or tangible object” with the intent to obstruct an investigation. Treating fish as “tangible object[s],” federal prosecutors indicted Yates under § 1519. The U.S. Court of Appeals for the Eleventh Circuit affirmed his conviction.

Ahead of oral argument, WLF issued this statement by Senior Litigation Counsel Cory Andrews:

“Overcriminalization occurs when vague, ambiguous language in a criminal statute deprives citizens of the appropriate ‘fair warning’ needed to comply with the law. The Eleventh Circuit’s overbroad interpretation of the Sarbanes-Oxley Act’s ‘anti-shredding’ provision would radically transform that law into a trap for the unwary. It takes the investigation of a civil offense (catching fish that were too small) and converts it into a criminal matter without notice and for no good reason.”

I discuss the relevant provisions in my book The Complete Guide to Sarbanes-Oxley: