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SEC Chairman Gary Gensler to Finally Tackle Rule 10b5-1 Reform: I Offer a Few Suggestions

The WSJ reports:

Speaking Monday at The Wall Street Journal’s CFO Network event, SEC Chairman Gary Gensler said he is seeking to revise rules that govern the arrangements, known as 10b5-1 plans. Insiders set up plans ahead of time and use them to schedule future trades. The arrangement gives executives a defense against insider-trading claims that would stem from having undisclosed material nonpublic information at the time of a trade.

I suspect that I will be opposing most of Chairman Gensler's proposals over the next few years, but on this issue I am in complete accord. I discuss Rule 10b5-1 planes in my book Insider Trading Law and Policy (Concepts and Insights). As I explain therein, Rule 10b5-1 plans are widely abused:

There is growing evidence that many executives are abusing Rule 10b5–1 by establishing or amending trading plans while in possession of material nonpublic information on the basis of which they proceeded to trade while using the plan for cover.

I also discuss a number of best practices that could be mandated so as to reduce the current ease with which Rule 10b5-1 plans are abused:

• Corporate insiders should have only one Rule 10b5-1 plan in effect at any given time. Insiders with multiple Rule 10b5–1 plans with overlapping execution terms, can game the choice of plans to take advantage of material non-public information.
• Plans should have a term of at least one year, because short-term plans are more likely to be have been motivated by inside knowledge.
• Require the issuer's board of directors' Compensation Committee take responsibility for overseeing Rule 10b5-1 plans by the Named Executive Officers.
  
  • Adoption by an NEO of new Rule 10b5–1 plans, plan amendments and plan terminations should be pre-cleared by the committee.
• Adoption by an NEO of new Rule 10b5–1 plans, plan amendments and plan terminations should be pre-cleared by the issuer's internal audit function or its compliance office.
• Rule 10b5–1 plans should be adopted, modified, or terminated only at times when the corporate insider can buy or sell securities under the company’s insider-trading policy, such as during an open trading window or soon after an earnings announcement (when material non-public information will be communicated to the public).
• Bar corporate insiders from adopting new Rule 10b5–1 plans for six months or a year after a plan termination.
• Bar insiders from taking in the issuer's stock outside of a Rule 10b5-1 plan.
• A Form 8-K should be filed whenever an NEO adopts, modifies, or terminates a Rule 10b5-1 plan.
• With respect to Section 16 officers, their Form 4 disclosures should specify whether the trade was made pursuant to a Rule 10b5-1 plan.
• There should be a waiting period of 30 trading days between adoption of a plan and execution of the first trade pursuant to the plan.

Recommended Reading: Carney & Sharfman on Judicial Appraisal (Let's Just Call the Whole Thing Off)

Important new article from Bill Carney and Keith Sharfman:

Abstract For many years, we and other commentators have observed the problem with allowing judges wide discretion to fashion appraisal awards to dissenting shareholders on the basis of widely divergent, expert valuation evidence submitted by the litigating parties. The results of this discretionary approach to valuation have been to make appraisal litigation less predictable and therefore more costly and likely. While this has been beneficial to professionals who profit from corporate valuation litigation, it has been harmful to shareholders, making deals costlier and less likely to complete.

In this Article, we propose to end the problem of discretionary judicial valuation by tracing the origins of the appraisal remedy and demonstrate that its true purpose has always been to protect the exit rights of minority shareholders when a cash exit is otherwise unavailable, and not to judge the value of the deal.

While such reform would be costly to valuation litigation professionals, their loss would be more than offset by the benefit of such reforms to shareholders involved in future corporate transactions. Shareholders presently have adequate protections, both from private arrangements and legal doctrines involving fiduciary duties.

Their "thesis is simple: Whenever a dissenter can exit for cash or its equivalent, there is no need for appraisal."

I concur. In 2010, I wrote: 

I see no useful purpose in the modern appraisal proceeding. As Thompson notes, it has become a vehicle for dealing with some--but not all--instances of majority shareholder oppression in connection with some--but not all--freezeout transactions. Better to abolish appraisal and let shareholders pursue a class action for damages.

At the end of a long 2012 post on valuation in appraisal, I threw up my hands in disgust and wrote:

this issue presents yet another area in which the law governing appraisal rights appears to be broken. Once again, the student comes away from the cases with the unavoidable impression that the Delaware courts are just sort of making this stuff up as they go along. Accordingly, one again comes to the conclusion that the best thing to do would be to toss out current law in its entirety and start over with a blank sheet of paper.

In 2019, referring to an earlier Carney and Sharfman article on appraisal, I wrote:

Do go read the whole thing. And then answer me this question: Why not just abolish appraisal?

I'm Puzzled: Board Diversity Lawsuit Against Oracle Tossed on Motion to Dismiss But Not on Failure to State a Claim

Kevin LaCroix reports:

Regular readers will recall that last year and earlier this year, plaintiffs’ lawyers filed a series of shareholder derivative lawsuits against the directors of several companies alleging that the lack of diversity on the companies’ boards breached the directors’ fiduciary duties. ...

The Oracle complaint asserts that the company’s board is “one of the few remaining publicly-traded companies without a single African American director.” The complaint alleges further that the directors “repeatedly made gross misrepresentations in the Company’s public statements by claiming to have a multitude of policies, internal controls, and processes designed to ensure diversity both at the management level and the Board itself.” ...

The complaint asserts claims for breach of fiduciary duty; aiding and abetting breach of fiduciary duty; abuse of control; unjust enrichment; and violation of Section 14(a) of the Securities Exchange Act of 1934.

The defendants filed a motion to dismiss, contending that the plaintiffs had not sufficiently pleaded demand futility and, in light of the forum selection clause in the company’s by-laws, that the plaintiffs’ state law claims must be asserted in the Delaware Court of Chancery. ...

On May 21, 2021, Northern District of California Magistrate Judge Jacqueline Scott Corley granted the defendants’ motion. A copy of Magistrate Judge Corley’s order can be found here.

The court agreed that the state law claims could only be brought in Delaware Chancery Court, reinforcing the power of forum selection clauses. It severed the federal Securities Exchange Act Section 14(a) claims and held they could be dismissed for failure to plead demand futility.

For discussion of the implications of this dismissal and two earlier dismissals in similar cases, go read the whole thing. As usual, it's a detailed and very cogent analysis.

Here's my question: I don't understand why plaintiff framed his Section 14(a) claims as derivative. Since the Section 14(a) implied private right of action was created by the Supreme Court, the law has been that "a right of action exists [under that statute] as to both derivative and direct causes. J. I. Case Co. v. Borak, 377 U.S. 426, 431 (1964). "It is well settled law that a Section 14(a) claim may be brought directly or derivatively." In re Trump Hotels Shareholder Derivative Litig., 96 CIV. 7820 DAB, 2000 WL 1371317, at *10 n.5 (S.D.N.Y. Sept. 21, 2000).

In the Trump case, the plaintiff's suit was dismissed for failure to make demand solely because the plaintiffs were “[p]roceeding in a purely derivative capacity in the right and for the benefit of the Company." Id. Which is what also happened here.

So why didn't the plaintiff in either case bring a direct cause of action under Section 14(a)?

 

Recommended Reading: Russell Powell's new paper Spirit of the Corporation

I read with great interest Russell Powell's new paper Spirit of the Corporation (May 4, 2021). Seattle University Law Review, Vol. 44, No. 2, 2021, Available at SSRN: https://ssrn.com/abstract=3839820.

Abstract: Christian theologians have analyzed the productive and destructive qualities of institutions, sometimes attributing to them human virtues and vices. In City of God, Saint Augustine describes a utopian vision of human community within a Christian context as an alternative to the flawed “City of Man.” Contemporary theologians and sociologists have described collective structures of human behavior in institutions as having a kind of “spirit” analogous to the individual human “spirit.” Institutions are then assumed to take on an existence separate from the individuals within them, and in fact, the “spirit” of an institution influences the behavior of individuals. In The 20th Century Capitalist Revolution, Adolf A. Berle Jr. considers the tradition of religious utopianism and whether corporate capitalism has a spiritual character that impacts communities and individuals for good or ill and whether this might have implications for corporate managers. This Article provides a contemporary theoretical framework for Berle’s insight as a basis for considering its legal and ethical implications for corporate governance. It attempts to unpack contemporary understandings of spirit in order to provide a helpful working definition. It also considers the origins and essential traits of the modern business corporation in the United States, and discusses the question posed by Berle—whether corporations can or ought to have a sort of moral orientation. The Article ponders potential policy shifts that might tilt the orientation of the “spirit of the corporation” toward the common good and considers the limits of legal reform and the role of individuals and subgroups in changing corporate paradigms.

As longtime readers know, I am deeply skeptical of efforts to invest the corporation with a real personality or soul. My primary statement of this view is in my post Is the corporation an entity? With application to the SCOTUS. It elaborates on my favorite quote of all time, from Edward, First Baron Thurlow: "Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?"

On close examination, however, it seems to me that what Professor Powell is really talking about is not some metaphysical spirit but rather what others might call corporate culture.

Powell states, for example, that "If the spirit of a corporation is formed in part by the institutions that support and constrain them (such as law), then legal change may result in a change in the essence of a corporation beyond isolated behaviors" (389). Compare that statement to these:

• "This corporate culture [of retaliating against whistleblowers] must change, and the law can lead the way." Carnero v. Boston Sci. Corp., 433 F.3d 1, 12 (1st Cir. 2006).
• "If we truly want to inspire long term changes in corporate culture, then we need to think carefully about how we might overhaul corporate and securities laws." Miriam H. Baer, Organizational Liability and the Tension Between Corporate and Criminal Law, 19 J.L. & Policy 1, 14 (2010).

Powell elsewhere quotes Walter Wink's observation that "the spirituality that we encounter in institutions is not always benign. It is just as likely to be pathological." (382) Compare that to:

• "This is not to deny that one might understand calamities like Enron in other ways. Clearly this was a pathological corporate culture ...." David A. Westbrook, Corporation Law After Enron: The Possibility of A Capitalist Reimagination, 92 Geo. L.J. 61, 127 (2003).

Interestingly, in Part V, Professor Powell shifts gears and discusses a number of case studies involving positive or negative corporate cultures using the word culture.

The question then is what do we gain by invoking the concept of a spirit? Powell's conclusion states:

There are strong theological arguments from a variety of traditions attributing a spiritual character to human institutions if not an individual spirit. A purely secular approach could conclude that such institutions have identifiable characteristics and cultures which, though created by human persons and other structures, take on an identity separate from those shaping them that may persist. I assert that both views may be identified as something we may understand as “spirit.”

Professor Powell deploys the concept of spirit to discuss a set of corporations whose "spirit" is oriented towards the common good and those who have a "negative impact" because their "essence has been 'corrupted.'"

I am--as most of you know--a big fan of law & religion scholarship. In this case, however, I'm not convinced invoking the concept of a corporate spirt does any useful work that could not be accomplished by invoking corporate cultures. 

Say on Pay Remains a Toothless Tiger: So What's the Point?

From Semler Brossy comes a report on say on pay votes to date in the 2021 proxy season:

22 Russell 3000 companies (3.3%) failed Say on Pay thus far in 2021.

If there was ever going to be a year in which one might have expected say on pay votes to show real teeth, surely 2021 was the year. As The Guardian reported:

The millionaire chief executives of some of the American companies with the lowest-paid workers saw an average pay raise of 29% last year while their workers saw a 2% decrease, according to a report released Tuesday. ...

The compensation hike came as companies gave their top leaders hefty bonuses and forgiving performance benchmarks during the pandemic, allowing the top executives to cash in while their low-wage employees were essential workers.

The WSJ likewise reported that:

CEO pay surged in 2020, a year of historic business upheaval, a wrenching labor market for many workers and unprecedented challenges for many leaders.

Median pay for the chief executives of more than 300 of the biggest U.S. public companies reached $13.7 million last year, up from $12.8 million for the same companies a year earlier and on track for a record, according to a Wall Street Journal analysis.

Pay kept climbing in 2020 as some companies moved performance targets or modified pay structures in response to the Covid-19 pandemic and accompanying economic pain. Salary cuts CEOs took at the depths of the crisis had little effect. The stock market’s rebound boosted what top executives took home because much of their compensation comes in the form of equity.

Yet, say on pay votes remain within the historic pattern of shareholder rubber-stamping CEO pay. So what's the point?

Collins v. Lewis cafeteria eventually opened but finally closed in 2014

Collins v. Lewis was a staple of Klein, Ramseyer & Bainbridge Business Associations casebook for many years. A friend sent along this article that tells something of the backstory.

Best judicial smackdown of the year (maybe ever)

#appellatetwitter Also, the Ninth Circuit makes it official, holding that, as a matter of law, Disney’s THE LAST JEDI was “mediocre and schlocky.” https://t.co/G0RE56hPXP pic.twitter.com/Cxkstoy6Ji

— tedfrank 💉 (@tedfrank) June 1, 2021