ProfessorBainbridge.com

But would they have standing?

Investors should sue California over its corporate gender quotas right now https://t.co/c7IFW8Owwg via @LibertyUnyieldi I'm not a standing expert, but would be interested in those who are analyzing the argument.

— Professor Bainbridge (@ProfBainbridge) October 7, 2018

California SB 826--The Board Gender Quota Bill--Should Be Unconstitutional Under the Commerce Clause

Professor Bainbridge: California Corporate-Board Quota Law Unlikely to Survive a Constitutional Challenge https://t.co/0NTY2uNty6

— Professor Bainbridge (@ProfBainbridge) October 2, 2018

Francis Pileggi on Brett Kavanaugh on Delaware Corporate Law

Here

Can California Require Delaware Corporations to Comply with California's New Board of Director Gender Diversity Mandate? No.

Kim Krawiec reports:

Thanks to California, corporate board diversity or, more specifically, gender diversity, is in the news again. SB 826 which, according to news reports, Gov. Jerry Brown is expected to sign, passed the state Senate in a 23-9 vote and the Assembly in a 41-26 vote. The statute would require “publicly held domestic or foreign corporation[s] whose principal executive offices, according to the corporation’s SEC 10-K form, are located in California” to have a minimum of one female director on its board by the end of 2019. By the end of 2021, those numbers would increase for corporations with five directors, who would need to have a minimum of two female board members, and for corporations with six or more directors, who would need to have at least three female board members.

Kim goes on to review the policy arguments pro and con. Kevin Paul Bishop has a somewhat more detailed description of the bill.

In this post, I consider whether California can do this as a constitutional matter. 

Opponents of the legislation are mainly focusing on equal protection arguments, claiming that neither the U.S. nor the California constitutions prohibit the sort of quotas contemplated by the bill. I think there’s another issue raised by the statute, however.

Virtually all U.S. corporations are formed (“incorporated”) under the laws of a single state by filing articles of incorporation with the appropriate state official.[1]The state in which the articles of incorporation are filed is known as the “state of incorporation.” Selecting a state of incorporation has important consequences, because of the so-called “internal affairs doctrine”—a conflicts of law rule holding that corporate governance matters are controlled by the law of the state of incorporation.

Suppose, for example, that Acme, Inc., is incorporated in Delaware, but all of Acme’s assets are located in Illinois. All of Acme’s shareholders, directors, and employees reside in Illinois. Acme’s sole place of business is located in Illinois. An Acme shareholder brings suit against the board of directors, alleging that its members violated their fiduciary duty of care. The law suit is filed in an Illinois court. Despite all these Illinois ties, the Illinois court usually nevertheless will apply Delaware law.[2]

The internal affairs doctrine developed on the premise that, in order to prevent corporations from being subjected to inconsistent legal standards, the authority to regulate a corporation's internal affairs should not rest with multiple jurisdictions. … By providing certainty and predictability, the internal affairs doctrine protects the justified expectations of the parties with interests in the corporation.[3]

The internal affairs doctrine takes on particular transactional significance when considered in conjunction with the constitutional restrictions on a state’s ability to exclude foreign corporations. With rare exceptions, states have always allowed foreign and pseudo-foreign corporations to do business within their borders. As early as 1839, for example, the U.S. Supreme Court held that federal courts should presume a state would recognize foreign corporations in the absence of an express statement to the contrary by the legislature.[4]A subsequent Supreme Court decision implied that states could not exclude foreign corporations from doing business within the state provided that the business constituted interstate commerce under the Commerce Clause of the U.S. Constitution.[5]These decisions effectively created a common market for corporate charters. If Illinois, for example, adopts a restrictive corporation law, its businesses are free to incorporate in a less restrictive state, such as Delaware, while continuing to conduct business within Illinois.

Virtually all U.S. jurisdictions follow the internal affairs doctrine, even if the corporation in question has virtually no ties to the state of incorporation other than the mere fact of incorporation. A few states make a more general exception to the internal affairs doctrine for so-called pseudo-foreign corporations. A foreign corporation is one incorporated either by a state or nation other than the state in question. A pseudo-foreign corporation that has most of its ties to the state in question rather than to the state of incorporation. Many Delaware corporations are pseudo-foreign corporations. They are incorporated in Delaware, but most of their operations are located in one or more other states. In most states, there is no significant legal difference between a foreign and a pseudo-foreign corporation, and the internal affairs doctrine will be applied to invoke the law of the state of the incorporation with respect to both. California and New York are the principal exceptions to this rule. Both states purport to apply parts of their corporate laws to pseudo-foreign corporations formed in other states but having substantial contacts with California or New York.[6]SB 826 is the latest salvo in this struggle.

In 2005, the Delaware supreme court held that the general California statute was unconstitutional under the Due Process and Commerce Clauses of the U.S. Constitution.[7]

The internal affairs doctrine is not, however, only a conflicts of law principle. Pursuant to the Fourteenth Amendment Due Process Clause, directors and officers of corporations “have a significant right ... to know what law will be applied to their actions” and “[s]tockholders ... have a right to know by what standards of accountability they may hold those managing the corporation's business and affairs.” Under the Commerce Clause, a state “has no interest in regulating the internal affairs of foreign corporations.” Therefore, this Court has held that an “application of the internal affairs doctrine is mandated by constitutional principles, except in the ‘rarest situations,’ ” e.g., when “the law of the state of incorporation is inconsistent with a national policy on foreign or interstate commerce.”[8]

Ultimately, of course, the U.S. Supreme Court will have to decide the issue.

In my view, however, the Sureme Court will come down on Delaware’s side.

… application of local internal affairs law (here California's section 2115) to a foreign corporation (here Delaware) is “apt to produce inequalities, intolerable confusion, and uncertainty, and intrude into the domain of other states that have a superior claim to regulate the same subject matter....” Professor DeMott's review of the differences and conflicts between the Delaware and California corporate statutes with regard to internal affairs, illustrates why it is imperative that only the law of the state of incorporation regulate the relationships among a corporation and its officers, directors, and shareholders. To require a factual determination to decide which of two conflicting state laws governs the internal affairs of a corporation at any point in time, completely contravenes the importance of stability within inter-corporate relationships that the United States Supreme Court recognized in CTS.[9]

Unlike 2115, SB 826 tries to finesse that holding by limiting its application to quasi-foreign corporations “whose principal executive offices, according to the corporation’s SEC 10-K form.” I doubt whether that is sufficient, however. Let’s start with general principles. The Court has emphasized that “state regulation of corporate governance is regulation of entities whose very existence and attributes are a product of state law,”[10]from which the Court extrapolated the proposition that “it . . . is an accepted part of the business landscape in this country for States to create corporations, to prescribe their powers, and to define the rights that are acquired by purchasing their shares.” In keeping with that principle, the Court emphasized that state law governs the rights and duties of corporate directors: “As we have said in the past, the first place one must look to determine the powers of corporate directors is in the relevant State’s corporation law. . . . ‘Corporations are creatures of state law’ . . . and it is state law which is the font of corporate directors’ powers.”[11]Granted, none of these cases are directly on point, but taken together they suggest the Court will recognize the constitutional status of the internal affairs doctrine.

Now let’s drill down a bit. As Jack Jacobs (former Delaware Vice Chancellor and Supreme Court Justice) has noted, a problem with the California and New York statutes is that they “have extraterritorial reach because they legislatively overrule the internal affairs doctrine and impose their own, often different, internal governance requirements upon foreign corporations having a specified level of contact with the forum state.”[12]In Edgar v. Mite, a plurality of the Supreme Court held said that an Illinois statute violated the commerce clause of the U.S. Constitution because, inter alia, of the statute’s “sweeping extraterritorial effect.”[13]“The limits on a State's power to enact substantive legislation are similar to the limits on the jurisdiction of state courts. In either case, ‘any attempt “directly” to assert extraterritorial jurisdiction over persons or property would offend sister States and exceed the inherent limits of the State's power.’”[14]

SB 826 has similar extraterritorial effect. Imagine a Delaware corporation with operations in many countries around the world, as well as numerous U.S. states. While its principal executive offices are located in California, only about 3% of the company’s operations are located in California. A sizeable majority of the company’s board of directors are domiciles of other states (and even other countries). The board routinely holds conference calls linking directors at locations around the globe. The board’s regular meetings take place in various locations throughout the United States.

The Southern Agrarians' Opposition to Corporate Personhood

You could hardly call the Southern Agrarians leftists. Yet, as I recently learned while researching a project on populism and corporate governance, the Southern Agrarians shared with modern left-wing Occupy-style populists a disdain for the idea of corporate personhood. For example, in an essay entitled The Foundations of Democracy, Frank Owsley complained that the Supreme Court had erected the 5th and 14th Amendments "into bulwarks of human freedom, but into impregnable fortresses of corporate wealth."

The usual arguments in favor of corporate personhood apply, of course. One might also note that the New Deal, during which Owsley was writing, proved that corporations were, shall we say, pregnable. 

Anyway, I toss this out there for the benefit of anybody who wants to do a project of how both right of center and left of center populists both get corporate personhood wrong.

"What Do Judges Maximize?"

At Law & Liberty poll sci professor James Rogers tackles the titular question, pointing out:

Simple, or naïve, attitudinalism posits Supreme Court justices vote their policy preferences in each specific case they decide. Yet if justices indeed pursue policy outcomes in their decisions, the belief that justices vote their policy preferences in each specific case makes no sense. Justices who seek to maximize achievement of their substantive policy preferences in their judicial decisions will not necessarily vote for the substantive outcome they prefer in a particular case.

Here’s why.

In recent years the U.S. Supreme Court hears about 80 cases per term. The actual legal decision in these few cases binds only the specific parties to the dispute. While some cases are more significant than others, that’s still not necessarily a huge amount of political influence relative to the influence the precedent will have on scores, or even hundreds, of related cases that are not heard by the Supreme Court. Even thinking of actual cases ignores the policy impact Supreme Court precedents can have: Precedent influences not only actual cases, but affects behavior that never rises to the level of litigation. Competent legal counsel can advise clients in light of the precedent to behave in a way that leaves them without risk of litigation.

This broader policy impact of precedent can swamp the policy impact of resolving a legal dispute between the two litigants in a case actually before the Court.

As longtime readers may recall, Mitu Gulati and I did on this issue a while back. See Stephen M. Bainbridge & G. Mitu Gulati, How Do Judges Maximize? (The Same Way Everybody Else Does—Boundedly): Rules of Thumb in Securities Fraud Opinions, 51 Emory L.J. 83 (2002).

Our work suggests that Rogers' account of judicial incentives is incomplete because he makes two moves common to the debate over how judges decide cases. First, he focuses on the Supreme Court, despite the fact that that court decides an infinitesimally small amount of American law. In addition, he focuses on Supreme Court cases that have partisan policy implications, which make up an even smaller fraction of judicial work. In a typical Supreme Court term, "approximately 80 percent of votes are in support of the majority opinion, and only about 20 percent of cases are determined narrowly. The 5–4 cases that get national attention are in fact somewhat anomalous." A small sample of anomalous cases is not going to tell us much about how judges in general maximize. (And notice that Roger's post is titled :How Judges Maximize" not "How Supreme Court Justices maximize in the small percentage of their cases that have closely divided partisan policy implications." There is at least the suggestion that his analysis had broad application.)

Second, Rogers implicitly invokes the two basic modes of judicial decision making, which we identified as the Herculean model in which the judge has full information and full knowledge and, generally speaking, gets it right; and (b) the Wannabe model, in which the judge seeks to be Herculean, but errs because he or she is mortal. Two sub-variants of each model depend on what the scholar in question believes that judges seek to maximize: social welfare or personal policy preferences.

Gulati and I pointed out that these accounts fail to account for the fact that judges are agents with incentives to shirk in a variety of ways. We began "by assuming a nonexpert federal judge faced with an overwhelming caseload and limited time and resources with which to decide those cases. We add[ed] the assumption that most judges do not find securities law interesting. From these institutional characteristics, we infer[ed] an explanation for the development and popularity of the heuristics premised on limited cognitive capabilities, resource constraints, and a judicial desire to move cases off the docket in an acceptable fashion."

Instead of leaving [determinations of materiality and intent] for trial, as we show herein, judges are using substantive heuristics to dispose of securities cases at the motion to dismiss stage. In contrast to prior commentary, however, we argue this result reflects not a pro-defendant bias but rather institutional constraints that give judges incentives to eliminate securities cases from their dockets with minimal effort.

Second, our focus on substantive heuristics highlights a previously unobserved link between institutional constraints and the evolution of substantive doctrine. When judges invoke procedural heuristics that enable them to avoid tackling a substantive issue, there is no effect on the evolution of substantive law (except that no law is created). When judges invoke substantive heuristics, however, the use of such heuristics channels and even dominates the on-going evolutionary processes of the (quasi-common) law of securities regulation. As we demonstrate, for example, the development of substantive securities law heuristics has dramatically affected the evolution of the law on both materiality and scienter. At the same time, however, other issues, such as the scope of different duties to disclose, are largely ignored (except perhaps to say why they were not deserving of attention).

Importantly, this is true even at the Supreme Court level.

There is general agreement that the Supreme Court has not done a very good job in the securities area, especially in recent years. Scholars operating in a wide range of paradigms have criticized the court’s recent securities opinions.  Supreme Court securities law decisions typically lack a broad, consistent understanding of the relevant public policy considerations. Worse yet, they frequently lack such basics as doctrinal coherence and fidelity to prior opinions.

Why doesn’t the Supreme Court do a better job in securities cases? Our model offers an answer. When deciding securities cases, the Court is faced with hard, dry, and highly technical issues. Supreme Court justices and their clerks arrive on the court with little expertise in securities law. One reasonably assumes that neither the justices nor their clerks have much interest developing substantial institutional expertise in this area after they arrive. (Former Justice Powell being the exception that proves these rules.) Accordingly, it would be surprising if the Court’s securities opinions exhibited anything remotely resembling expert craftsmanship.

Under such conditions, we would expect the justices to take securities cases rarely, typically when there is a serious circuit split, which is in fact what we observe.  When obliged to take a securities issue, the Court will seek to minimize the amount of effort required to render a decision. This observation is not intended pejoratively. To the contrary, in terms of our model, the justices are acting rationally. …

Bounded rationality implies that Supreme Court justices (and their clerks) have a limited ability to master legal information, including the myriad complexities of doctrine and policy in the host of areas annually presented to the court. Specialization is a rational response to bounded rationality—the expert in a field makes the most of his limited capacity to absorb and master information by limiting the amount of information that must be processed by limiting the breadth of the field in which he develops expertise. Supreme Court justices will therefore need to specialize, just as experts in other fields must do. Specializing in securities law would not be rational. The psychic rewards of being a justice—present day celebrity and historical fame—are associated with decisions on great constitutional issues, not the minutiae of securities regulation.

The debate over judicial incentives is important. The overemphasis on 5-4 Supreme Court decisions in that debate, however, means that the vast majority of both the academic and public debate--including the colloquy between Rogers and McGinnis--grossly distorts the real picture of how (and what) judges maximize.

WLF: "Supreme Court to Hear Arguments in Case Involving SEC’s Alleged Improper Appointment of ALJs"

I received an email from the Washington legal Foundation re an important upcoming case:

“If the SEC’s constitutional violations have no consequence because the agency may simply ratify all acts taken by its improperly appointed agents, then there will be very little incentive to comply with the Appointments Clause in the future.”

—Richard Samp, WLF Chief Counsel

 

WASHINGTON, DC—The U.S. Supreme Court will hear oral arguments this coming Monday, April 23, at 10 a.m., in Lucia v. SEC, a case that will decide whether the Securities and Exchange Commission violated the U.S. Constitution’s Appointments Clause by the manner in which it appointed Administrative Law Judges (ALJs) to conduct trials of SEC enforcement actions. WLF Chief Counsel Richard Samp, who co-authored WLF’s brief in the case and will attend the arguments, will be available Monday afternoon to discuss what the oral arguments may have revealed about likely outcomes.

 

The Appointments Clause specifies procedures for appointing “Officers” of the United States. The SEC did not comply with those procedures in appointing ALJs, claiming that ALJs are not “Officers.” If the Supreme Court rules that ALJs are, in fact, “Officers,” the validity of many of the trials recently conducted by the SEC’s ALJ (i.e., all cases in which appeals from SEC enforcement orders are still pending) will be called into question.

 

WLF’s brief urged the Court to rule both that the SEC appointed its ALJs in an unconstitutional manner and that defendants (including Petitioner Raymond Lucia) whose enforcement proceedings were tried before an improperly appointed ALJ are entitled to a new trial. The United States argues that even if the Court rules that the ALJ appointments were unconstitutional, the SEC should be permitted to retroactively “ratify” all the proceedings conducted by those ALJs. 

California censorship takes another hit

From WLF Legal Pulse:

Occasionally, but not nearly often enough, courts reintroduce California’s censors to the First Amendment, as the U.S. Court of Appeals for the Ninth Circuit did last year in striking down San Francisco’s warning-label mandate for “sugary” drinks. On February 20, a Northern District of California judge handed the state its latest speech-regulation defeat, striking down a law designed to limit information that entertainment database company IMDb.com could publish (IMDb.com Inc. v. Becerra).

Go read whole thing.

The Washington Post's SCOTUS reporter's not even pretending to be objective anymore

Apparently he saw no incongruity in these consecutive posts:

Is a corporation's name expressive speech protected by Matal v. Tam?

Keith Paul Bishop discusses that issue

Kokesh Footnote 3 Notwithstanding: The Future of the Disgorgement Penalty in SEC Cases

New article on the recent Kokesh case by yours truly. I was limited to 5,000 words by the review, so it's short and very to the point:

Disgorgement of ill-gotten gains long has been a basic tool in the Securities and Exchange Commission’s (SEC) penalty toolkit, despite a paucity of statutory authorization. Because disgorgement lacked a statutory framework, courts have had to flesh out the sanction via interstitial rulemaking. In Kokesh v. SEC, the US Supreme Court took up the seemingly technical—but surprisingly important—question of what statute of limitations applies to SEC disgorgement actions. More important, at least for present purposes, the Court’s opinion cast into doubt the validity of the seemingly well-established disgorgement sanction.

Earlier cases based the SEC’s authority to seek and the courts’ power to impose disgorgement on the claim that it is a form of equitable ancillary relief. If disgorgement is a penalty, however, courts lack that power and the SEC lacks that authority. This conclusion follows necessarily from the basic premise that there are no penalties in equity and the complete absence of any statutory authority to impose disgorgement as a legal sanction. Now that the Supreme Court has made clear that disgorgement is, in fact, a penalty, the future of the disgorgement penalty looks bleak.

Bainbridge, Stephen M., Kokesh Footnote 3 Notwithstanding: The Future of the Disgorgement Penalty in SEC Cases (2017). UCLA School of Law, Law-Econ Research Paper No. 17-12. Available at SSRN: https://ssrn.com/abstract=2992719

Free speech victory

In Lee v Tam, SCOTUS affirms and holds that disparagement provision of the trademark laws is unconstitutional.

— SCOTUSblog (@SCOTUSblog) June 19, 2017

An unusually clear refutation from SCOTUS of the "hate speech is not free speech" nonsense: pic.twitter.com/Nxx4bl32Am

— PopehatWitchHunt (@Popehat) June 19, 2017

The media continue to overstate Kokesh

Bloomberg BNA is another case in point:

The U.S. Supreme Court put sharp new limits on a favorite tool used by securities regulators to recoup money from people found to have violated federal laws ( Kokesh v. SEC, U.S., No. 16-529, opinion 6/5/17).

The justices unanimously said the Securities and Exchange Commission is bound by a five-year statute of limitations when it seeks “disgorgement,” or the return of illegal profits.

For Pete's sake. It's a five YEAR statute of limitations, which BTW remains subject to the usual tolling rules. It scarcely requires the speed of a striking cobra. More like that of a tortoise. 

The Graphic Novel Version of Kokesh v SEC

My WLF Legal Pulse post on SCOTUS decision in Kokesh v. SEC is now up

Here.