SEC Regulatory Accountability Act of 2013: Whose Interests are Being Served?

On May 17^th the U.S. House of Representatives by a 235-161 vote (including 17 Democrat supporters) approved the SEC Regulatory Accountability Act of 2013 (the “Accountability Act”).  The Accountability Act directs the SEC to engage in mandatory cost benefit analysis of every proposed regulation.  Specifically, the Accountability Act requires the SEC to assess the significance of the problem the regulation is designed to address, determine if its estimated costs justify its estimated benefits, and identify available alternatives.  Additionally, the SEC would have to measure potential job creation, or losses, as the result of an issued rule.

If the Accountability Act becomes law, the SEC would also be required to review its regulations every five years to determine whether they are “outmoded, ineffective, or excessively burdensome” and to consider modifying or repealing regulations which are found to be so.

If a proposed regulation is expected to have an economic impact greater than $100 million annually the SEC is required to develop and publish a plan to assess whether the regulation has achieved its stated purposes.  The assessment must be published within two years after adoption of the regulation and must include consideration of costs, benefits, and consequences, using performance measures that were identified when the rule was adopted.

How important is this?  Not at all if the bill dies in the Senate (where govtrack.us gives it a 15% chance of passing) or if it is vetoed by the White House as President Obama has indicated is possible.  However, if it survives those hurdles, according to Accountability Act proponent Rep. Jeb Hensarling (R-TX) Chair of the Financial Services Committee its requirements “offer a “common sense” approach that forces government officials to assess the costs and consequences of its actions the same way families struggling to make ends meet tackle “kitchen-table economics.”  Further, proponents  argue that the Accountability Act does little more than reiterate an executive order issued by President Obama in 2011 calling for all regulatory agencies to commit to more comprehensive assessments of the costs and benefits inherent in any new rules, craft regulations in “plain language,” and review past actions in an effort to modify, or weed out, outdated and excessively burdensome regulations.  As an independent agency the SEC is not bound by this Executive Order but has promised to comply with it.

Dale Brown, president and CEO of the Financial Services Institute, believes the bill has “the potential to save Main Street investors and financial services providers significantly more," as "unclear and inefficient regulations drive up compliance costs and increase litigation expenses for those serving the financial and securities industry, and this in turn raises the cost of investment and retirement planning for investors.”

Business Roundtable weighs in “[r]egulation has provided substantial benefits to the country, but it has done so at a high cost. We believe the country can achieve its statutory objectives at less cost through a process we call “smarter regulation.” Smarter regulation is based on several principles, including early engagement of regulators with the public, the use of quality information, objective analysis of regulatory alternatives, consideration of costs and benefits, expert oversight, and legislative accountability.”

Sounds pretty convincing, right?  We are all for smart regulation that saves investors’ money.  Then why has President Obama threatened to veto the Accountability Act?  According to detractors, the bill is an underhanded attempt to give Wall Street veto power over any regulation it does not like. They argue that the bill would essentially cripple the SEC, diverting resources from rulemaking and enforcement.  They note that the SEC is already required to conduct economic analysis on every rule it passes, and to examine the effect of its rulemakings on capital formation, market efficiency, and competition and argue that the proposed legislation “would force the agency to measure costs and benefits of a new rule before that rule was even implemented or market data resulting from the rule was available. The bill also imposes enormously broad and vague mandates such as determining whether a regulation imposes the ‘least burden possible’ among all possible regulatory options. A court could overturn the SEC’s decision in any case where it found any one of the numerous analyses required here to be inadequate. The vagueness of mandates like the ‘least burden possible’ means that court challenges or court decisions could rest on claims that are essentially speculative and theoretical. These new mandates would not improve the quality of the regulatory process; they would stop it in its tracks.”

Also opposing the bill is SEC Chairwoman Mary Jo White who told members of the House Financial Services Committee that while she’s “a firm supporter of economic analysis," she has "concerns about this bill.” Not only would it add additional requirements but it would put the agency’s rules “under constant challenge.”

 “H.R. 1062 is a regulatory ‘accountability' act only if you believe that the SEC's primary accountability should be to the securities firms it is supposed to regulate rather than to the public it is supposed to protect,” says Barbara Roper, director of investor protection for the Consumer Federation of America. “This bill would further slow the already glacial regulatory process and further empower Wall Street interests to derail needed reforms.”  Roper adds that the bill fails its own cost-benefit test as “sponsors appear to have ignored its significant costs,” estimated by the Congressional Budget Office to be $23 million for implementation.

Yet another strong critique comes from former SEC Chairman Arthur Levitt who argues that the bill will “gut” the SEC given the increased costs it would impose on the SEC at a time when Congress is defunding the agency. 

Rep. Gwen Moore (D-WI) states bluntly that the while the bill is terrible for investors, it is also not good for industry.  “It would mean that rulemakings would take even longer, as the SEC struggled to meet the impossibly subjective economic cost-benefit standard to stave off the coming court battle over competing economic impact projections. The ink would not be dry on a SEC rule before the race to the courthouse door to challenge the regulations would begin. Presumably, the most powerful industry participants would challenge the rules in the way that achieves their narrow interest, which may be to the detriment of investors or other less-affluent market participants. In this way, the most powerful industry interests would be able to not only use the courts to undo consumer protections, but to also seek competitive advantage over competitors.

In Congress, I hear a lot from the financial industry about "uncertainty." There would never be certainty in securities markets if this bill were to ever become law. However, my primary concern is not for industry. It is for the People. The bill would eventually degrade consumer protection in financial markets until no investor could have faith in U.S. financial markets. The bill would allow firms and markets to operate unchecked. The industry with the best lawyers would reign, regardless of business model, practices, or any other market consideration. Congress would be powerless to help. This legislation rejects the lessons of the financial crisis and statutorily mandates the mistakes that led to it, with the taxpayers on the hook.”

Business Roundtable and others have already scored victories challenging SEC cost-benefit analysis in the courts.  If the Accountability Act becomes law their efforts to block and stall regulation will grow exponentially.  Even if the bill does not make it through this time around, sponsors can try again with a more amenable Congress and President.

Two Nominees for the SEC

The Administration has nominated two candidates to the SEC:  Kara Stein, an aide to Jack Reed, the Senator who until recently chaired the Senate Subcommittee on Securities, and Michael Piwowar, an aide to Sen. Mike Crapo (R., Idaho), the ranking Republican member of the Senate Banking Committee. Both have been under consideration for months.  A statement by Senator Crapo is here. 

When confirmed, Ms. Stein will take the seat currently occupied by Commissioner Walter and Mr. Piwowar will take the seat occupied by Commissioner Paredes.  Piwowar will be the only economist on the Commission.  Past practice suggests that when nominees from each party are considered together, the confirmation process proceeds relatively quickly and with few problems.

The Lack of Impartiality in the Proxy Process

The vote is in on the contest over whether position of chair and CEO should be divided at JP Morgan Chase.  But a fundamental shift in the traditional dynamics of a proxy contest occurred during the voting process.  Shareholders were denied an important piece of data.  Unlike management, shareholders were at least temporarily denied data on the running vote totals obtained by Broadridge.  As the WSJ noted:

• in the midst of one of the most closely watched investor votes in years — over whether to separate the roles of chairman and chief executive at JPMorgan Chase — that protocol has changed. The firm that is providing tabulations of the JPMorgan vote stopped giving voting snapshots to the proposal’s sponsors last week.

According to the article, Broadridge received a call from SIFMA, described as Wall Street's "main lobby group" and was told to "cut off access to organizations that are sponsoring proposals".  As the WSJ described: 

• Lyell Dampeer, a senior executive at Broadridge, said his firm was required to give real-time results to companies, and for years Broadridge gave that same information to proposal sponsors. But late last week, he received a call from an employee of the Securities Industry and Financial Markets Association, Wall Street’s main lobby group, requesting that Broadridge cut off access to organizations that are sponsoring proposals, he said. Sifma represents JPMorgan and other big banks and brokerage firms.

The tallies apparently resumed following pressure placed on JP Morgan.  As the Dealbook reported:  "After a series of conference calls on Saturday between lawyers for JPMorgan and the attorney general’s office, JPMorgan agreed to direct a firm that provides early tabulations to restart the tallies."

The information matters.  In the case of close tallies, proponents and opponents may want to increase the resources devoted to a proxy contest.  Significant shifts in the tallies may indicate the success or failure of a particular strategy.  The information also typically becomes public and can help publicize the context, something that may benefit the side with the fewest resources.  Thus, the practice by Broadridge denies shareholders information that may well be useful in a proxy contest. 

There are several observations to make about this new policy.  First, it is hard to understate the role played by Broadridge in the proxy process.  As the SEC recently noted:  "almost all proxy processing in the U.S. is handled by a single intermediary, Broadridge Financial Solutions, Inc. ("Broadridge").  Broadridge reported that during the year ended April 30, 2012 it processed over 12,000 proxy distribution jobs involving over 638 billion shares. Broadridge has estimated that in recent years it handles distributions to some 90 million beneficial owners with accounts at over 900 custodian banks and brokers."  Exchange Act Release No. 68936 (Feb. 15, 2013). 

Second, it is unlikely that SIFMA intervened only in the case of tallies involving JP Morgan Chase.  The article suggests that SIFMA sought an end to the disclosure of ongoing tallies more systematically.  Thus, while the practice was apparent in the context of JP Morgan Chase, it may well apply to future proxy contests involving other companies. 

Third, while issuers may have a desire to retain a monopoly on the running tallies, they are not the ones that hired Broadridge.  Broadridge is fulfilling the legal obligations of the brokers (and some banks).  Thus, the instruction to terminate came not from an issuer organization but one that represents broker dealers.  As SIFMA describes on its web site, the organization "brings together the shared interests of hundreds of securities firms, banks and asset managers."  In other words, it is brokers, not issuers, that are instructing Broadridge to cut off the tallies to shareholders. 

Fourth, the circumstances are complicated by the fact that issuers, not brokers, pay Broadridge.  See Id.  ("Since 1937 the NYSE has specified the level of reimbursement which, if provided to the member broker-dealers, would obligate them to effect the distribution of proxy materials to street name holders").  The fees are not insignificant.  Id.  ("Based on information from Broadridge, the PFAC estimated that issuers spend approximately $ 200 million in aggregate on fees for proxy distribution to street name shareholders during a year.").  Moreover, JP Morgan Chase is likely a member of SIFMA because of its role as an investment bank.  Nonetheless, Broadridge as a legal matters fulfills obligations of brokers.  It is an agent for those intermediaries. 

The bottom line is that brokers are effectively instructing Broadridge to provide information to one side but not the other in a proxy contest.  Yet the proxy system is designed to ensure that the intermediaries not directly involved in the contest remain impartial.  Thus, brokers are exempt from the proxy rules for forwarding materials to beneficial owners so long as they remain impartial in doing so.  See Rule 14a-2(a)(1), 17 CFR 240.14a-2(a)(1).  Similarly, brokers cannot vote uninstructed shares held by street name owners for controversial matters.  In other words, they are not allowed to use these shares to influence the outcome of the final tally of a controversial matters, something that includes the election of directors. 

Impartiality would mean that both sides (or neither side) received the data.  Although the flow of information to shareholders was resumed, The Council of Institutional Investors has raised the issue with the Commission.  To the extent the Securities and Exchange Commission views impartiality by intermediaries as an important element of the proxy process, this may be an instance where regulatory intervention is necessary.   

Public Benefit Corporations in Colorado: What Will A Public Benefit Corporation Accomplish?

Colorado has adopted, effective April 1, 2014, the public benefit corporation act of Colorado (the “PBCA”) that is similar to legislation being considered in Delaware, but completely different from the model benefit corporation act sponsored by B Lab Company (www.bcorporation.net) and adopted in a number of states.  The previous entries have described the background of the Colorado Bar Association’s efforts (led by a group of attorneys supported by the Business Law Section of the CBA, the “Drafting Group”) that led to the adoption of H.B. 13-1138 and discussed the nature of a public benefit corporation (a “PBC”) as well as material provisions of the PBCA.  This post will conclude the discussion of the PBCA.

Properly used, it can be expected that PBCs and benefit corporations will have limited utility.  Proponents of benefit corporations have predicted that “[f]or-profit social entrepreneurship, social investing and the sustainable business movement have reached a critical mass,” and similar sentiments were expressed in the Senate floor debate on H.B. 13-1138.  Whether this is fact or hyperbole remains to be seen.

On the other hand, reaction to the April 24, 2013 collapse of the garment factory building in Bangladesh where more than 900 people were killed shows that people care about social good.  That came on the heels of a fire at another factory in November 2012 that killed 112 low wage workers.  Factories like these in Bangladesh pump out what author Elizabeth Cline (author of Overdressed: The Shockingly High Cost of Cheap Fashion) calls “fast fashion” or clothes made for and sold inexpensively by big chain stores.  Whether these stores suffer any long-term repercussions for these incidents and the working conditions in their Asian garment factories generally remains to be seen.  Will the public care about how and where their clothes are made, or will price continue to be the driving factor?

Clearly retailers, large and small, have focused on “doing good” and making that known publicly for marketing purposes.  As discussed in a previous post, no company needs to be a PBC or a benefit corporation to do so.  Furthermore, the certification organizations, such as B Lab Company, have certified a number of corporations and other entities that are not benefit corporations or PBCs.   So, what corporation may want to be a PBC or a benefit corporation?

B Lab and others believe that simply being known as a benefit corporation or PBC has value.  We will have to see whether this does in fact have any value, or whether the value will be based on the entity’s performance – is it selling or using low cost merchandise made in inhumane conditions not withstanding its purported social mission? 

B Lab and its supporters also believe that the reporting provisions in the statute provide the needed transparency to ensure that the PBC or benefit corporation carries out the shareholders’ will.  But can any self-assessment not audited by an independent third party ever get to the bottom of that question?

There are undoubtedly businessmen and women who truly want to see their organization do better for the world or their community while making a profit.  They may want to see their vision ingrained in the fiber of the corporation so that the vision survives the individual.  It is for this purpose that a benefit corporation or a PBC may have value. 

• By being a “benefit corporation,” the corporation’s directors are obligated to pursue or create the “general public benefit” “to create a material positive impact on society and the environment” in addition to any specific public benefit identified in the benefit corporation’s articles of incorporation.

• By being a PBC, the corporation’s directors are obligated to balance the interests of those materially affected by the corporation's conduct with the pecuniary interests of the shareholders and the public benefits identified in the articles of incorporation.

• Being a PBC is not a permanent occupation, and two-thirds of the shareholders can vote to amend the articles of incorporation to terminate PBC status or to amend the public benefits identified.

While the articles of incorporation of a regular corporation can identify public benefits the shareholders believe to be important and can exonerate the directors for using profit to focus on these benefits, the directors of a regular corporation generally do not have to look beyond the corporation and its defined purposes as does a benefit corporation or PBC.  On the other hand, persons with a view toward maximizing short-term profit have a completely different perspective than persons with a long-term view.   For example, when selling the Nigerian barges to increase 1999 profits, Enron executives clearly were taking a short-term view which proved to be criminal.  On the other hand, modern corporate governance is focused on creating sufficient incentives that encourage corporate management to take a longer term view.  Colorado’s PBCA concurs, directing management to operate the PBC in a “responsible and sustainable manner” – goals applicable not only to PBCs but to all corporations and, in fact, all business entities.

In this light, is there a place for PBCs?  The answer is a cautious “yes.”  Successful businessmen and women may want to see their vision survive their tenure.  Where the balancing requirements of the PBCA (or the “general public benefit requirement of the B Lab model act and its progeny) fit the entrepreneur’s vision, the relevant act may form a reasonable basis for incorporation or adoption.   It must be done carefully and after a consideration of relevant factors and directors’ duties and in light of the shareholders’ needs and desires.  Finally, and perhaps most importantly, becoming a PBC or a benefit corporation is not an “out-of-the-box” activity.  It requires careful drafting of articles of incorporation and consideration of other factors, including designating priorities for the directors to consider and weight to the various factors to be balanced.

The PBCA enabling PBCs is the product of compromise and therefore is imperfect in the eyes of the Drafting Group as well as the proponents of the B Lab model act.  It is also the product of several years of work by the Drafting Group seeking to create a statute for Colorado that protected directors when following public benefit direction from the shareholders but which did not put the corporation and its shareholders in the inflexible handcuffs of the B Lab model act as adopted in a number of states.  It is unlikely that the PBC legislation or any benefit corporation legislation will provide a panacea for the socially responsible business movement. It will, however, put another arrow in its quiver.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Public Benefit Corporations in Colorado: Unanswered Questions

Colorado has adopted, effective April 1, 2014, the public benefit corporation act of Colorado (the “PBCA”) that is similar to legislation being considered in Delaware, but completely different from the model benefit corporation act sponsored by B Lab Company (www.bcorporation.net) and adopted in a number of states.  The previous entries have described the background of the Colorado Bar Association’s efforts (led by a group of attorneys supported by the Business Law Section of the CBA, the “Drafting Group”) that led to the adoption of H.B. 13-1138 and discussed the nature of a public benefit corporation (a “PBC”) as well as material provisions of the PBCA.  This post will discuss a number of other unresolved issues facing corporations that elect to become PBCs under Colorado law or benefit corporations under the laws of other states.

The PBCA does not address issues under the Colorado Securities Act (§ 11-51-101 et seq.) which regulates offers and sales of securities in Colorado.  Generally compliance will require disclosure to prospective investors of the public benefit purpose so that investors are not misled into believing that the PBC is a Colorado Business Corporation Act entity with a profit motive and the directors’ duty of care obligations under C.R.S. § 7-108-401(1) “for the best interests of the corporation.”  Other normal compliance with the exemption/registration requirements of the Colorado Securities Act and the licensing of broker-dealers is also required.  If a PBC (or a benefit corporation organized under the laws of another state) solicits funds from investors, it will need to consider the applicability of federal and state laws regulating the offer and sale of securities.

The PBCA also does not address issues that may arise for PBCs under the Colorado Charitable Solicitations Act (§ 6-16-101 et seq.).  The Colorado Charitable Solicitations Act was enacted “to protect the public’s interest in making informed choices as to which charitable causes should be supported” and “to help the secretary of state investigate allegations of wrongdoing in charities, without having a chilling effect on donors who wish to give anonymously or requiring public disclosure of confidential information about charities.”  The Charitable Solicitations Act requires that “charitable organizations” that solicit donations for “charitable purposes” file certain reports with the Colorado Secretary of State.  A PBC’s public benefit purpose may fit within the broad definition of a “charitable purpose” and, as a result, the PBC may be considered to be a “charitable organization.”  If soliciting funds for its public benefit purpose, each PBC should consider whether compliance with the Colorado Charitable Solicitations Act is required and how to accomplish such compliance.

Note that the potential application of the Charitable Solicitations Act is not a problem that was caused by the PBCA.  Limited liability companies can be formed in Colorado to conduct (as set forth in § 7-80-103) “any lawful business” whether or not for a profit.  It can have a hybrid (public benefit or charitable) purpose even if it also is engaged in a business for a profit.  As a result, there is a risk that the PBC (like a limited liability company formed for a public benefit purpose or a non-profit corporation) might solicit funds for “charitable purposes” and thereby be subject to the Charitable Solicitations Act.

The Colorado legislation, and legislation for benefit corporations generally, does not and cannot address the many issues that may arise under the Internal Revenue Code for a PBC pursuing its public benefit purpose. For example, § 162(a) of the Internal Revenue Code authorizes taxpayers to deduct from income their “ordinary and necessary business expenses.” Marketing expenses generally fall within this section, such as the expenses incurred in advertising “organically grown ingredients," "sustainably grown coffee," or "contributions to local schools or charities.” Will expenditures for a public benefit purpose that do not fit within the marketing rubric or which may be excessive when compared to normal marketing budgets be deductible?  That is a question to be answered.

The PBC may be a wholly unsuitable investment for an employee stock ownership plan (an “ESOP”) or other plan governed by the Employee Retirement Income Security Act of 1974 (“ERISA”).  As set forth in ERISA § 404 and the regulations thereunder, the primary responsibility of fiduciaries of an ERISA plan is to run the plan solely in the interests of the participants and beneficiaries, and for the exclusive purpose of providing benefits and paying plan expenses.  What fiduciary will be able to conclude that a PBC or benefit corporation which is not being operated solely for profit or the pecuniary benefit of its shareholders meets the mandated ERISA fiduciary standard of care?  Any decision by an ERISA fiduciary to invest in or hold securities of a PBC or a benefit corporation (or any corporation claiming a purpose other than profit) is likely to be a personally risky decision to the fiduciary under current law.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Public Benefit Corporations in Colorado: Why A Public Benefit Corporation Rather Than A Non-PBC?

Colorado has adopted, effective April 1, 2014, the public benefit corporation act of Colorado (the “PBCA”) that is similar to legislation being considered in Delaware, but completely different from the model benefit corporation act sponsored by B Lab Company (www.bcorporation.net) and adopted in a number of states.  The previous entries have described the background of the Colorado Bar Association’s efforts (led by a group of attorneys supported by the Business Law Section of the CBA, the “Drafting Group”) that led to the adoption of H.B. 13-1138 and discussed the nature of a public benefit corporation (a “PBC”) as well as material provisions of the PBCA.  This post will discuss some reasons a corporation may choose to become a PBC.

As noted above, there is a school of thought that a public benefit corporation is necessary because a regular corporation cannot protect its directors when making decisions that may intentionally reduce profit or positive cash flow, or otherwise have no direct correlation to the success of the corporation’s business.

Of course, the business judgment rule serves to protect directors when they make a bad business judgment provided the directors did so in good faith and after a reasonable investigation.  That is not the type of decision in question.  The decision for which the public benefit corporation is useful to protect directors is the intentional decision by the directors to divert some of the corporation’s profit or cash flow to purposes that may have a socially-beneficial purpose (at least in the opinion of the shareholders) which is not intended to have any demonstrable positive impact to the corporation itself.  In effect, the directors are intentionally diverting cash resources which could be used for the benefit of the business or as a distribution to the shareholders to a non-business purpose.  Such an action would likely not be protected by the customary interpretations of the business judgment rule.

It is, of course, possible that the articles of incorporation of a CBCA corporation can include, among its stated purposes, a non-business purpose.  The articles can also include an instruction to the directors that, in pursuing the purposes of the corporation they are to include in their decision-making this other non-business purpose even at the expense of business profit and business opportunities.  This is consistent with the view of Professor Celia Taylor, University of Denver Sturm College of Law who, has said in The Race to the Bottom here:

I continue to believe that special legal designation of benefit status is not necessary.  In time, empirical analysis may be able to establish whether the new legislation in Delaware and elsewhere makes any meaningful difference in corporate behavior or whether it simply provides another avenue for corporations to tout their ‘good’ behavior.

On the other hand, the law supporting that approach is uncertain.  Furthermore, it is important to note that the public benefit corporation and the benefit corporation are designed to do more than simply support a corporation’s view of social responsibility and beneficial causes.  Under the B Lab model act, every benefit corporation must create the general benefit purpose which is defined as follows:

A material positive impact on society and the environment, taken as a whole, assessed against a third-party standard, from the business and operations of a benefit corporation.

This requires that the directors of the benefit corporation look beyond any specific benefit purposes identified in the benefit corporation’s articles of incorporation.

This is similarly the case with the PBCA.  Unlike the B Lab model act, the PBCA does not require that the PBC create the general public benefit.  Also unlike the B Lab model act, the PBCA requires that the PBC pursue or create one or more specific public benefits which are to be described in its articles of incorporation.  However, the PBCA makes it clear that pursuing the identified specific public benefits at the expense of profit is not sufficient.  The PBCA provides that (in their decision-making) the directors must balance:

1. The pecuniary interests of the shareholders (usually defined as “profit”);
2. The specific public benefit identified by the PBC in its articles of incorporation; and
3. The best interests of those materially affected by the corporation's conduct.

The third factor requires the directors to look beyond the PBC itself in their decision-making and is the most significant distinction between a CBCA corporation that has added provisions to its articles of incorporation and a PBC. 

This third factor will require significant future interpretation and at present leads to significant potential uncertainty.  For example, competitors of the PBC are potentially “materially affected by the corporation’s conduct.”

• Must, then, the directors of a PBC consider the best interests of the PBC’s competitors?  As a part of the balancing process, the answer would be ‘yes.’ 

• How must the directors, in their decision making process, document their balancing?  May the Board minutes or consent simply state that the directors “approved the following resolutions after balancing the factors set forth in C.R.S. § 7-101-506(1).”  This is to be determined.

It should be noted that the PBCA does not require any specific decision as a result of the directors’ balancing or that the directors give greater weight to one factor over other factors.  Of course, the shareholders could draft the PBC’s articles of incorporation to be more specific or to give more weight to certain factors as compared to others.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Public Benefit Corporations in Colorado: PBCs As Compared to Benefit Corporations

Colorado has adopted, effective April 1, 2014, the public benefit corporation act of Colorado (the “PBCA”) that is similar to legislation being considered in Delaware, but completely different from the model benefit corporation act sponsored by B Lab Company (www.bcorporation.net) and adopted in a number of states.  The previous entries have described the background of the Colorado Bar Association’s efforts (led by a group of attorneys supported by the Business Law Section of the CBA, the “Drafting Group”) that led to the adoption of H.B. 13-1138 and discussed the nature of a public benefit corporation (a “PBC”) as well as material provisions of the PBCA.  This post will point out some differences between the B Lab model act and the PBCA.

Provisions In The B Lab Model Act Not Included In The PBCA.

Under Section 102 of the B Lab model act and the legislation previously introduced in Colorado, every benefit corporation had the obligation to create "the general public benefit," defined to be "a material positive impact on society and the environment, taken as a whole, assessed against" a third party standard.  The Drafting Group noted that, among other issues, things good for society (such as increased employment, availability of petroleum products and nuclear energy providing energy for houses, transportation, and factories) may not be good for the environment.  Matters that may be good for the environment (creating large roadless areas, closing down factories, and reducing the availability of energy from petroleum and nuclear sources) may not be good for society.

Under Section 301 of the B Lab model act and the legislation previously introduced in Colorado defined the standard of conduct for directors by requiring the directors, in making any decision for the benefit corporation, to consider the interests of the shareholders, the employees and workforce of the benefit corporation and its suppliers, the interests of the benefit corporation's customers, the community in which the benefit corporation operated and societal factors, the short- and long-term interests of the benefit corporation, and other relevant factors.   This raised a significant concern to the Drafting Group because these considerations were required for each decision made by the board, not merely decisions related to the benefit corporation's general or specific benefit purpose.  Furthermore, unless the directors carefully documented their consideration of each of the factors mandated by the B Lab model act in connection with each decision, the decisions could be questioned.

Section 102 of the B Lab model act as it existed at the time and the legislation previously introduced in Colorado mandated a third party assessment performed on an annual basis against a standard that was defined in the 2011 and 2012 bills introduced in Colorado with almost two full pages of text.  The definitions were in such strict terms that the Drafting Group was convinced that the standard did not yet exist and perhaps could not exist.  (Perhaps in recognition of this, the current version of the B Lab model act has a simpler definition of “third party standard.”)

The B Lab model act and the legislation as initially introduced in Colorado in 2011 did not provide a right for shareholders objecting to the conversion to a benefit corporation to dissent from the transaction.

Section 302 of the B Lab model act requires that benefit corporations that are publicly traded must, and other benefit corporations may, appoint a benefit director who has certain obligations that differ from the other directors.  In addition to being a member of the board, the benefit director must prepare an “annual compliance statement” that offers the benefit director’s opinion whether the benefit corporation “acted in accordance with its general public benefit purpose and any specific public benefit purpose in all material respects during the period covered by the report.”  The B Lab model act exonerates the benefit director from any personal liability unless the liability derives from self-dealing, willful misconduct, or a knowing violation of law.  The Drafting Group believed that including a director with a special constituency different from the other directors was inadvisable under and inconsistent with Colorado law.

Sections 303 and 304 of the B Lab model act contemplates the possibility that benefit corporations may appoint a “benefit officer” and establishes standards of conduct for officers generally.  The Drafting Group believed that the standards of conduct for officers with discretionary authority found in C.R.S. § 7-108-401(1) was sufficient and there did not need to be a special provision for officers of a PBC.

Section 305 of the B Lab model act provides that a “benefit enforcement action” may be brought against the board by the benefit corporation itself.  The Drafting Group did not see the value in this provision because it is the board of directors who would make the determination for the benefit corporation to bring the action.

Section 305 of the B Lab model act also contemplated that persons other than the shareholders of the benefit corporation could bring a derivative action, notwithstanding clear guidance in both the federal and Colorado Rules of Civil Procedure, Rule 23.1 to the contrary.  It is clear in s 7-107-402 of the CBCA and in Rule 23.1 that only equity owners can bring a derivative action, and the right to do so does not extend to directors, owners of an affiliated entity, and “other persons.”

Under § 301 of the B Lab model act and under the original H.B. 13-1138 as introduced in the House there was a clear exoneration of the corporation and its officers and directors of liability for monetary damages if they met the applicable standard of care.  There is no similar provision under the PBCA.  There is merely the provision discussed above that the PBC’s articles of incorporation may provide that a failure by any disinterested director to satisfy the requirements of C.R.S. § 7-101-506 “does not, for the purposes of section 7-108-401 or article 109 [of the Colorado Business Corporation Act] constitute an act or omission not in good faith or a breach [of the director's] duty of loyalty.”  The term “disinterested” is not defined and this leaves room for interpretation.  This, again, is a provision that may be looked at for further amendment.

One provision in the PBCA that is not included in either the Delaware legislation from which the PBCA was adapted or the B Lab model act is that the PBCA includes the right for certain cooperatives organized under Articles 55 or 56 of Title 7, C.R.S., to elect PBC status.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Public Benefit Corporations in Colorado: The Shareholder’s Right to Enforce

Colorado has adopted, effective April 1, 2014, the public benefit corporation act of Colorado (the “PBCA”) that is similar to legislation being considered in Delaware, but completely different from the model benefit corporation act sponsored by B Lab Company (www.bcorporation.net) and adopted in a number of states.  The previous entries have described the background of the Colorado Bar Association’s efforts (led by a group of attorneys supported by the Business Law Section of the CBA, the “Drafting Group”) that led to the adoption of H.B. 13-1138 and discussed the nature of a public benefit corporation (a “PBC”).  This post will continue the discussion of the material provisions of the PBCA.

Enforcement Issues.  Shareholders of a PBC may enforce the director's duties under C.R.S. § 7-101-506(1) through a derivative action if the shareholders (individually or collectively) own at least 2 percent of the PBC's outstanding shares or (if a public corporation listed on a national securities exchange) the lesser of 2 percent or shares with a value of at least $1,000,000.

This is the only right that the PBCA permits the shareholders to enforce by a derivative action.  There is nothing in the PBCA that takes away the right of any other shareholder in any Colorado corporation (including a PBC) to maintain a derivative action outside of the PBCA except to the extent that a shareholder of a PBC is demanding that the directors focus only on the shareholders’ pecuniary interests.  The right to bring such an action is limited because that is the focus of the PBCA.

Persons other than shareholders of a PBC do not have the right to bring a derivative action (or any other enforcement action) under the PBCA; similarly, persons other than shareholders of a Colorado corporation that is not a PBC do not have the right to bring a derivative action.

It should also be noted that the derivative action provision found in § 7-101-508 has an antecedent existing in the CBCA at § 7-107-402 (entitled Actions by Shareholders).  This applies to both PBCs and to corporations formed under the CBCA that are not PBCs and further defines the right of shareholders to bring derivative actions.  Nothing in the PBCA changes the application of that provision except to the extent that § 7-101-508 changes the standing issue for a derivative action brought against a PBC.

In balancing the different factors as required by the PBCA, the directors are protected from frivolous litigation in a couple of ways.  Section 7-101-506(2) provides that a director of a PBC does not have any duty to any beneficiary of the identified public benefit or other person because of an interest “materially affected by the [PBC’s] conduct.”   The PBCA goes on to say that, with respect to any decision implicating the balancing requirement, the directors’ will have satisfied their duties:

• to the shareholders and the corporation if the director’s decision is both informed and disinterested and not such that no person of ordinary, sound judgment, would approve.

This latter clause is interesting in two respects.  First of all, for the protection to be available, the director raising the defense must be disinterested with respect to the decision.  Second, the double negative in the last part of the clause raises the complaining shareholder’s burden of proof significantly unless the complaining shareholder can show that the director was not “disinterested” with respect to the decision.  Whether this disinterestedness requirement adversely impacts the willingness of directors to make decisions, or increases the disclosure of potential conflicts of interest, remains to be seen.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Concession Theory and Listeners’ Rights

Two weeks ago I posted the abstract from the most recent draft of my latest paper, Rehabilitating Concession Theory, ___ OKLA. L. REV. ___ (forthcoming).  Last week I highlighted one of the key arguments I make in the paper, which is a rebuttal of the proposition that the unconstitutional conditions doctrine somehow trumps concession theory.  This week, I’d like to review another key argument in the paper, which is a rebuttal of the proposition that listeners’ rights trump corporate theory.  Here is a relevant excerpt:

Even if one understands the Citizens United opinion to be fundamentally about listeners’ rights,  there remains the question whether there is something about corporations that would justify including them in the line of cases carving out exceptions for particular identity-based restrictions on speech.  For example, in United States Civil Service Commission v. Letter Carriers,  the Supreme Court upheld a federal statute that prohibited federal employees from taking “an active part in political management or in political campaigns.”   The Court upheld the statute despite the fact that its prohibitions clearly infringed upon the federal employees’ “right to speak, to propose, to publish, to petition Government, to assemble.”   The Supreme Court’s justifications for this identity-based restriction on speech included (1) the preservation of “the impartial execution of the laws” by making it illegal for federal employees “to play substantial roles in partisan political campaigns, and … run for office on partisan political tickets,”  (2) avoiding the appearance of “political justice,” which must be avoided if “confidence in the system of representative Government is not to be eroded to a disastrous extent,”  (3) ensuring that “the rapidly expanding Government work force should not be employed to build a powerful, invincible, and perhaps corrupt political machine,”  and (4) “to further serve the goal that employment and advancement in the Government service not depend on political performance.”   Anyone with even a passing familiarity with the Citizens United decision will likely recognize these justifications as surprisingly similar to those rejected as a basis for regulating corporate speech in that case. 

Nor is Letter Carriers the only case wherein the Court has upheld identity-based restrictions on speech on the basis of justifications so deferential to legislative determinations….

The Citizens United majority was well aware of this line of cases upholding identity-based speech restrictions, but dismissed them as irrelevant by baldly asserting that: “The corporate independent expenditures at issue in this case, however, would not interfere with governmental functions, so these cases are inapposite. These precedents stand only for the proposition that there are certain governmental functions that cannot operate without some restrictions on particular kinds of speech.”   The dissent, however, retorted that:

["]The majority's creative suggestion that these cases stand only for that one proposition is quite implausible. In any event, the proposition lies at the heart of this case, as Congress and half the state legislatures have concluded, over many decades, that their core functions of administering elections and passing legislation cannot operate effectively without some narrow restrictions on corporate electioneering paid for by general treasury funds.["]

However, in spite of the fact that the majority was aware of these cases and the dissent relied on them at least in part, and despite the fact that it would seem difficult to determine the applicability of these cases without coming to some express conclusions about what corporations are, the Citizens United majority avoided any express discussion of corporate theory and the dissent expressly disavowed any role therefore.   Nonetheless, commentators quickly identified an important role for corporate theory in the decision.   I have previously written about how this failure to expressly discuss corporate theory in relevant cases creates a legitimacy problem for the Court.   Accordingly, the mere existence of a listeners’ rights rationale for cases like Citizens United does not preclude a role for corporate theory in general, or concession theory in particular.  In fact, its viability as any sort of a trump card arguably requires an analysis of what corporations are.  

Public Benefit Corporations in Colorado: Transparency: The PBC’s Reporting Requirements

Colorado has adopted, effective April 1, 2014, the public benefit corporation act of Colorado (the “PBCA”) that is similar to legislation being considered in Delaware, but completely different from the model benefit corporation act sponsored by B Lab Company (www.bcorporation.net) and adopted in a number of states.  The previous entries have described the background of the Colorado Bar Association’s efforts (led by a group of attorneys supported by the Business Law Section of the CBA, the “Drafting Group”) that led to the adoption of H.B. 13-1138 and discussed the nature of a public benefit corporation (a “PBC”).  This post will continue the discussion of the material provisions of the PBCA.

Reporting Requirements.  The Delaware draft legislation from which the PBCA was derived required that the PBC deliver a biennial report to shareholders that permitted, but did not require, assessment against a third-party standard.  In negotiations that led to the finalization of the PBCA as adopted, the proponents of the B Lab asked that the reporting provisions included in the prior version of H.B. 13-1138 be carried forward in the new version.  As a result, there is no mandatory annual or biennial reporting period, but merely a requirement that the PBC “prepare a report” that includes certain information.  As described in § 7-101-507, the report (when prepared) must describe:

(a)                The ways in which the PBC promoted the public benefit identified in the PBC's articles of incorporation and the best interests of those materially affected by the PBC’s conduct;

(b)               Any circumstances that have hindered the PBC’s promotion of the public interest identified in its articles of incorporation or the best interests of those materially affected by the PBC’s conduct;

(c)                The process and rationale for selecting or changing any third party standard against which the PBC’s performance is assessed; and

(d)               An assessment of the overall social and environmental performance of the PBC against a third party standard, although the assessment can be a self-assessment and does not need to be audited or certified by any third party.

Each PBC must send a copy of the report (when prepared) to each shareholder and post it on the PBC’s website, if any.  The posted version of the report may omit financial or proprietary information included in the report sent to shareholders.  If the PBC does not maintain a website, it must provide the report (free of charge) to any person requesting a copy.

The Third Party Standard.  There is no mandate in the PBCA that any PBC actually select a third party standard.  The implication in the reporting section is clear that, when a report is prepared, the report should include an assessment against a third party standard.  The term “third-party standard” is defined in § 7-101-507 as a “standard for defining, reporting, and assessing the overall corporate social and environmental performance” that has been “developed by an organization that is not controlled by the [PBC] or any of its affiliates.”  The definition also requires that the publisher of the standard makes publicly available:

(I)                The criteria considered when measuring the social and environmental performance of a business, the relative weightings of those criteria, if any, and the process for development and revision of the standard; and

(II)             The “material owners” of the organization, the members of its governing body (and their selection process), and the sources of financial support for the organization “in sufficient detail to disclose any relationships that could reasonably be considered to compromise its independence.”

There is no penalty for failing to include an assessment, and in fact there is no temporal (annual as in § 401(a) of the B Lab model act, or biennial as in the draft Delaware legislation) requirement for the benefit report.  Since § 7-107-101 of the Colorado Business Corporation Act requires an annual meeting of its shareholders, that would be the appropriate time for the benefit report to be prepared.

 Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Public Benefit Corporations in Colorado: The Heart of a PBC – The Directors’ Standard of Conduct

Colorado has adopted, effective April 1, 2014, the public benefit corporation act of Colorado (the “PBCA”) that is similar to legislation being considered in Delaware, but completely different from the model benefit corporation act sponsored by B Lab Company (www.bcorporation.net) and adopted in a number of states.  The previous entries have described the background of the Colorado Bar Association’s efforts (led by a group of attorneys supported by the Business Law Section of the CBA, the “Drafting Group”) that led to the adoption of H.B. 13-1138 and discussed the nature of a public benefit corporation (a “PBC”).  This post will continue the discussion of the material provisions of the PBCA.

The Directors’ Standard of Conduct.  In § 7-101-506(1), the PBCA defines the “duties of directors” as follows:

• The Board of Directors shall manage or direct the business and affairs of a public benefit corporation in a manner that balances the pecuniary interests of the shareholders, the best interests of those materially affected by the corporation’s conduct, and the specific public benefit identified in its articles of incorporation.

Under this provision, the board of directors must balance the pecuniary interests of the shareholders and the specific public benefit the shareholders have defined with “the best interests of those materially affected by the corporation's conduct.”  This could include employees, suppliers, and customers, but could also include neighbors and even competitors. 

• This does not include the mandatory “consideration” of potentially conflicting factors as does the B Lab model bill, but does suggest careful drafting of board of directors’ minutes to reflect the “balancing” mandated by the statute.

• The PBCA does not provide for any prioritization of the balancing requirement, although the shareholders can do so in the articles of incorporation.

This provision expands the focus of the PBC beyond the “best interests of the corporation” as required by C.R.S. § 7-108-401(1).  Unlike the B Lab model act, this “balancing” does not mandate any conclusion, although the shareholders can provide further direction in the PBC’s articles of incorporation.

The PBCA provides that directors shall not have any duty to any person solely on account of any interest in the public benefit and that, where directors perform the balancing of interests described above, they will be deemed to have satisfied their fiduciary duties to shareholders and the corporation if (in the words of § 7-101-506(2)) their “decision is both informed and disinterested and not such that no person of ordinary, sound judgment would approve.”   This is an effort to establish a very high standard for plaintiff shareholders who wish to challenge directorial actions.  In addition, the PBC’s articles of incorporation may provide that a failure by any disinterested director to satisfy the requirements of C.R.S. § 7-101-506 “does not, for the purposes of section 7-108-401 or article 109 [of the Colorado Business Corporation Act] constitute an act or omission not in good faith or a breach [of the director's] duty of loyalty.”

This is similar to, but in addition to, the exoneration provision found in C.R.S. § 7-108-402 which eliminates a director's liability for monetary damages for breach of his or her duty of care, but not for a breach of the duty of loyalty, such as may be found with respect to a conflicting interest transaction in § 7-108-501.

In the end, this balancing requirement is the price that a PBC must pay for the statutory protections afforded to directors of a PBC.  If a corporation does not want to balance the interests of its shareholders against “the best interests of those materially affected by the corporation’s conduct,” choosing to be a PBC would be ill-advised.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Public Benefit Corporations in Colorado: The Crafting of H.B. 13-1138 as adopted

After dealing with proposed legislation following the model benefit corporation act promoted by B Lab Company (www.bcorporation.net) for three legislative sessions, a group of Colorado attorneys supported by the Business Law Section of the Colorado Bar Association (the “Drafting Group”) determined to draft a statute that more closely fit within the Colorado Business Corporation Act and that avoided the issues so clear in the B Lab model act.  H.B. 13-1138, as drafted by the Drafting Group, passed the Colorado House on February 19, 2013, but it ran into political difficulties in the Colorado Senate and was likely going to fail.

On about March 25, 2013, the Drafting Group became aware of a proposal drafted by the Delaware Bar for a Delaware statute permitting “public benefit corporations.”  (This has been discussed in The Race to the Bottom here.)  On the same day, B Lab issued a press release (included on its website) that praised the Delaware proposal.

In a careful review of the Delaware draft legislation, the Drafting Group determined that it was closer to H.B. 13-1138 and the prior Colorado efforts than anything that had been presented to Colorado in the past.  After adapting the Delaware draft legislation to the Colorado Business Corporation Act, the Drafting Group presented it to the sponsors of H.B. 13-1138.  Representative Lee and Senator Kefalas agreed to present the bill as a "strike below" to H.B. 13-1138.  Before doing so, the sponsors and representatives of the Drafting Group met with B Lab representatives and their supporters to determine if this revision could receive their support, thus assuring easy passage in the Senate and the House.  With some modifications, B Lab and its supporters agreed to support the “strike-below” H.B. 1138 which became the PBCA.  It was approved by the Senate on April 30, 2013, by the House on May 1, 2013, and signed by Governor Hickenlooper on May 15, 2013.

While not perfect, the Drafting Group believes that the PBCA enacted in Colorado is a significant step forward in the national dialogue regarding benefit corporations.  It provides a mechanism by which a business corporation organized under the Colorado Business Corporation Act or a cooperative organized under Articles 55 or 56 of Title 7, C.R.S., can elect to become a PBC by a two thirds vote.  The remaining one-third voting against the change to a PBC (or at least not voting for it) have the right to dissent under C.R.S. § 7-113-101 if they choose to exercise that right.  To make this right to dissent clear, amendments were adopted to § 7-113-102(1) by adding subsections (1)(e) (which incorporates the right to dissent found in C.R.S. § 7-101-504(3)) and (1)(f) (creating a right to dissent if a PBC completes a plan by which it terminates its status as a PBC).  Furthermore, § 7-101-504(5) provides that a nonprofit corporation cannot be a constituent entity in a conversion to PBC status.

A PBC Defined.  As set forth in § 7-101-503(1), a PBC is defined as one that “is intended to produce a public benefit or public benefits and to operate in a responsible and sustainable manner.”  The articles of incorporation will serve as the basis for disclosure by the PBC.  Section 7-101-503 and -505 require that the articles of a PBC must set forth:

(a)        One or more specific public benefits to be promoted by the PBC;

(b)        State at the beginning of the articles of incorporation that it is a PBC;

(c)        The entity’s name must include the words “public benefit corporation” or the abbreviations “P.B.C.” or “PBC”; and

(d)       Share certificates issued for a PBC, or the statement required under C.R.S. § 7-106-207 must clearly indicate that the entity is a PBC.

The term “Public Benefit” is defined in § 7-101-503(2) to mean:  “One or more positive effects or reduction of negative effects on one or more categories of persons, entities, communities, or interests other than shareholders in their capacities as shareholders, including effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, or technological nature.”

Importantly, the PBC legislation does not impose the potentially contradictory requirements of the “general public benefit purpose” mandated by the B Lab model act, but provides the flexibility to the shareholders to define the other-than-profit purpose or purposes of the PBC.

The PBCA, in § 7-101-509, makes it clear that the PBC statute does not create a negative implication against other Colorado Business Corporation Act corporations.  To the extent that that any Colorado corporation can elect in its articles (or by resolution or otherwise) to follow a beneficial purpose outside a pure profit motive and protect the business judgment of its directors before the enactment of the PBCA, a Colorado corporation can continue to do so without electing to be treated as a PBC.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

Public Benefit Corporations in Colorado: Background

In 2013, the Colorado General Assembly passed and Governor Hickenlooper has signed H.B 13-1138, the “Public Benefit Corporation Act of Colorado” (the “PBCA”) which will become effective on April 1, 2014.  The PBCA adds Part 5 to Article 101 of the Colorado Business Corporation Act in Title 7, C.R.S., to allow Colorado corporations desiring to do so to elect the status of being a “public benefit corporation.”  A public benefit corporation (or “PBC”) must identify a public benefit purpose in its articles of incorporation, and the directors, in managing the business and affairs of the PBC, must balance the pecuniary interests of the shareholders, the interests of those materially affected by the corporation's conduct, and the public benefits identified in the articles of incorporation. 

As will be explained in a future post, Colorado’s public benefit corporation statute has little similarity to the other “benefit corporation” statutes adopted or being considered in a number of other states or the “model benefit corporation act” proposed by B Lab Company of Berwyn, Pennsylvania (“B Lab” and the “B Lab model act,” available at www.bcorporation.net).

Colorado’s process toward the enactment of the PBCA began in September 2009 when representatives of B Lab approached a group of Colorado attorneys (the "Drafting Group") who (under the auspices of the Business Law Section of the Colorado Bar Association) were the working on updating the Colorado Business Corporation Act based on revisions made to the ABA's Model Business Corporation Act, Delaware law, and judicial guidance.  When presented with the concept of a benefit corporation - that directors should be protected in the exercise of their business judgment should the directors consider alternative constituencies in their decision-making (including employees, suppliers, customers, the local or regional economy, the local or global environment, or other similar (or dissimilar) factors) - the Drafting Group appreciated the concept and expressed their belief that such a concept should be considered in Colorado. 

The Drafting Group spent a considerable amount of time working with the proposed statute that B Lab provided and adapted it to the Colorado Business Corporation Act with a number of changes, all in time for submission to the 2010 Colorado General Assembly.  The changes reflected the Drafting Group's belief that the statute enacted in Colorado should be flexible as other Colorado entity statutes, and not prescriptive, while still providing meaningful protections against misuse of the benefit corporation form.  The changes to the B Lab proposal that the Drafting Group developed were rejected by B Lab and their Colorado supporters and no bill was introduced into the 2010 General Assembly.

B Lab and their supporters introduced S.B. 11-005 into the 2011 General Assembly.  S.B. 005 was a statute based on the inflexible B Lab model act poorly adapted to the Colorado Business Corporation Act.  For example, S.B. 11-005 proposed to add Article 138 to Title 7, making it appear that the benefit corporation was a subset of the Colorado Nonprofit Corporation Act which, of course, it was not intended to be.  The Drafting Group became involved in the legislative process and worked with the sponsor and B Lab’s Colorado supporters to redraft a bill that was a compromise from the 2010 draft but (in the Drafting Group’s opinion) more closely reflected Colorado's approach to entity statutes.  Apparently under pressure from B Lab and other B Lab supporters, the sponsor withdrew the bill immediately before the first Senate hearing.

Near the end of the 2012 General Assembly the 2011 sponsors again introduced substantially the same bill as S.B. 12-182.  Notwithstanding the Drafting Group’s opposition, S.B. 12-182 passed the Senate on bipartisan votes, only to die on the House floor for the lack of a vote on the last night of the session.

Governor Hickenlooper included benefit corporation legislation in his call for the 2012 special legislative session, and S.B. 12-182 was reintroduced as S.B. 12S-003.  Again members of the Drafting Group testified against the legislation in the Senate, but the Senate passed S.B. 12S-003.  The sponsors withdrew S.B. 12S-003 before being considered by the House committee to which it was assigned.  At the same time and with the assistance of the Drafting Group and the support of the Colorado Bar Association, Representative Claire Levy (D. Boulder) introduced a much more flexible bill into the House during the special session (H.B. 12S-1007).  This bill was heard by the House State, Veterans, & Military Affairs committee, but the committee voted to postpone the bill indefinitely.

During the regular session and in anticipation of the special session, the Drafting Group held discussions with various constituencies that supported the B Lab bill before the General Assembly to determine whether there was a middle road that could be adopted to facilitate the approval of the benefit corporation legislation.  In those meetings, it became clear that B Lab and its supporters had no interest in a flexible benefit corporation statute because it was concerned that the name B Lab itself had coined, “benefit corporation,” would be diluted if any legislation using that name deviated from the strict mandates of the B Lab model act.  In several meetings, the Drafting Group was told by B Lab representatives that it could use any name desired for the more flexible corporation the Drafting Group envisioned, but B Lab representatives would not allow the General Assembly to call it a “benefit corporation.”

Following the 2012 special session, the Drafting Group met and decided to be proactive in advance of the 2013 General Assembly.  In the general discussion that preceded any specific drafting, about one third of the Drafting Group suggested that corporations organized under the Colorado Business Corporation Act could direct their officers and directors to consider alternative constituencies and still receive the protection of the business judgment rule under current law, meaning that benefit corporation legislation was unnecessary.  Another third of the Drafting Group disagreed, based on the “for profit” motive of a corporation formed under the Colorado Business Corporation Act, although acknowledging that where corporate social responsibility formed a part of product or business marketing, it was justifiable under ordinary corporate law principles.  The final third accepted both arguments as indicative of the confusion in the issue that properly drafted legislation could clarify.  The Drafting Group also concluded that since benefit corporation statutes were likely to be enacted nationally and in Colorado, Colorado should strive to have the best benefit corporation act in the country.

Herrick K. Lidstone, Jr., Burns, Figa & Will, P.C.

The Public Benefit Corporation of Colorado: History and Analysis

This Blog has taken a number of innovative steps.  Unusually for most blogs, it involves a collaboration between faculty and students, with students regularly providing blog content.  The Blog has covered a number of important trials, with students attending every session and putting up a post after each. 

Today begins another innovation.  Colorado has just approved the use of Public Benefit Corporations (effective April 1, 2014).  We are privileged to have a series of posts by  Herrick K. Lidstone, Jr., a shareholder and managing director at Burns, Figa & Will, P.C.. 

Mr. Lidstone provides an overview of the process that lead to this legislative development.  In effect, The Race to the Bottom has become the repository for the history behind this important piece of business legislation.  In addition, however, he includes in his posts a concise overview of the new statute and some of the issues or concerns posed by the legislation.  It is likely to have been the first comprehensive overview of the legislation published in a readily available source.

The series contains nine separate posts.  They include:

Part 1 - Background

Part 2 – The Crafting of H.B. 13-1138 as adopted

Part 3 – The Heart of a PBC – The Directors’ Standard of Conduct

Part 4 – Transparency: The PBC’s Reporting Requirements

Part 5 – The Shareholder’s Right to Enforce

Part 6 – PBCs As Compared to Benefit Corporations

Part 7 – Why A Public Benefit Corporation Rather Than A Non-PBC?

Part 8 – Unanswered Questions

Part 9 – What Will A Public Benefit Corporation Accomplish?

We will publish two a day until the series is finished.

The discussion of Public Benefit Corporations is another example of the benefits that can be provided by law blogs:  Analysis on important subjects that is published in a timely manner.  See Essay: Law Faculty Blogs and Disruptive Innovation. 

U.S. v. Harris: Motion to Dismiss Granted Regarding Alleged 15 U.S.C. § 77q(a) Securities Fraud

In U.S. v. Harris, Michael F. Harris (“Harris”) was charged with four counts of securities fraud in violation of 15 U.S.C. § 77q(a), along with three counts of wire fraud and one count of mail fraud in October 2012.  2013 WL 325619 (E.D. Va. Jan. 29, 2013).  Harris moved to dismiss two of the four counts of securities fraud, asserting that the five-year statute of limitations had run; the motion was granted.

Harris was the President and majority shareholder of M.F. Harris Research, Inc., which was formed to develop a treatment for HIV and AIDS.  Over a six-year period, which ended in July 2011, Harris allegedly made misrepresentations in order to entice investors to purchase stock in his company.  Ultimately, Harris used these funds from investors for his own use.  This first count of securities fraud at issue involved a $200,000 wire transfer for the purchase of stock in October 2006.  The stock certificates were not issued until February 2010.  The second count of securities fraud at issue involved both a check written by an investor in June 2007 for the purchase of $10,000 in stock and a wire transfer made by the same investor in September 2007 for an additional $10,000 in stock.  The stock from the two purchases was not fully issued until October 2007. 

 Harris argued that the five-year statute of limitations had run on these two counts, and that the “criminal limitations statutes are to be liberally interpreted in favor of repose . . . .”  Harris further argued that the securities sale was complete at the time of payment, not at the time the stock certificates were issued.  The U.S. Government argued that the court should define “sale” broadly to include alleged post-sale conduct or, in the alternative, conclude that post-sale conduct is included in the offense listed in § 77q(a) as a continuing offense.   

 The court found that sales were completed at payment not when the certificates were issued.  The court found that a sale required “offer, acceptance, and promise of or actual payment.”  The court declined to adopt a broad definition of sale as urged by the U.S. Government for four reasons:  (1) other circuit courts had rejected the idea of delivery as required for a completed sale, (2) to do so would make the construction of the statute incoherent, (3) it is the opposite of how stocks are sold in the current market, and (4) it would be inconsistent with Congressional interpretation of the criminal statute of limitations.

The Government also argued that conduct prohibited by Section 17(a) of the Securities Act of 1933, 15 USC § 77q(a), constituted a continuing offense.  The plain language of the statute, however, did not contemplate “a prolonged course of conduct” or prohibit conduct that was “inherently continuous.”  Nor did the types of offenses prohibited by Section 17(a) support the Government’s position.  Although noting that “the law on this issue is not well-settled” the court found that the cases supported the conclusion that “the conduct prohibited by § 77q(a) is not by its nature a continuing offense.”     

For all of these reasons, the court granted Harris’s motion to dismiss.

The primary materials for this case may be found on the DU Corporate Governance Website.

Cagle v. Mathers Family Trust: Forum Selection Clauses in Investment Contracts

In Cagle v. Mathers Family Trust, 295 P.3d 460 (Colo. 2013), the Colorado Supreme Court held that the Colorado Securities Act (“CSA”) does not void, as a matter of public policy or pursuant to the CSA’s anti-waiver provision, a forum selection clause in a private contract.

According to the allegations, Plaintiffs, citizens of various states (“Plaintiffs”), all purchased investment interests in oil and gas joint ventures in Texas, Alabama, and Mississippi from defendant HEI Resources, Inc. (“Defendant”). Defendant is incorporated in Texas and based out of Colorado. Plaintiffs all signed application agreements and joint venture agreements that selected Texas as the choice of law and Texas courts as the exclusive forum.

After losing all or a significant portion of their investments, Plaintiffs brought suit in Colorado under the CSA, as well as several other states’ securities statutes, and common law doctrines alleging fraud, concealment, breach of fiduciary duty, negligence, and misrepresentation. Plaintiffs alleged that the forum selection clauses were unenforceable because, among other things, they contravened the public policy of the CSA. Additionally, Plaintiffs argued that the clauses violated the anti-waiver provision of the CSA, which barred agreements that waive compliance with the substantive provisions of the CSA.

Defendants filed a motion to dismiss the suit, arguing that Colorado did not have jurisdiction to hear the case under the forum selection clauses in the signed joint venture agreements.

 The court noted that the CSA required that its provisions “be coordinated with the federal acts and statutes to which references are made in this article . . . to the extent coordination is consistent with both the purposes and the provisions of this article." The federal securities laws included “an anti-waiver provision with nearly identical language” as the CSA.  Despite this language, federal courts have upheld forum selection clauses. As a result, the court concluded that “we must construe the CSA to coordinate with the federal securities acts, and we follow the reasoning of federal courts that have analyzed a forum selection clause in conjunction with the anti-waiver provision in the federal securities laws.”

The court also examined whether the forum selection clause violated a strong public policy.   The court reasoned that the CSA did not require that the action take place in Colorado. The statute provided that a party “may” bring an action.  As the court reasoned, the statute was “permissive, not mandatory, and allows but does not require that CSA violations be litigated in Colorado. As a result, the court concluded “that the language of the CSA does not show evidence of a strong public policy that would fall within the [public policy] exception and require voiding of the forum selection clauses here.”

The court also examined other statutes containing anti-waiver provisions, including  the Colorado Wage Claim Act (“CWCA”) or the Wrongful Withholding of Security Deposits Act (“WWSDA”).  Both, however, were found not to be comparable to the CSA.  As the court reasoned:

The CSA has a different purpose than the CWCA and the WWSDA. The CWCA and the WWSDA protect people domiciled in Colorado and concern matters—employment and landlord-tenant relationships—in which Colorado has a strong interest. The CSA, in contrast, protects both Colorado and out-of-state investors, like the plaintiffs here, and concerns the regulation of investments that include out-of-state investments. Because the language of the CSA anti-waiver provision is nearly identical to that of the federal securities anti-waiver provision and does not contain the language preventing waiver of "rights" and "benefits" that the CWCA and WWSDA contain, it only prohibits the waiver of substantive rights. Here, the plaintiffs did not waive their substantive rights under the CSA because they can pursue their CSA claims in a Texas court.

As a result, the cases interpreting these statutes did not compel a conclusion that the forum selection clause at issue was void. 

The court ordered that the case be returned to the district court and the order of dismissal be reinstated. 

The primary materials for this case can be found on the DU corporate governance website.

The Supreme Court, Business Cases, and the Chamber of Commerce

An earlier post here mentioned a law review article recently published in the Minnesota Law Review (written by Lee Epstein, William M. Landes, and Judge Posner) documenting the pro-business slant of the Supreme Court under Justice Roberts.  

While that finding does not come as a complete surprise as commentators have long noted the favor businesses receive under the current Court, less attention has been paid to why businesses are faring so well.  One important factor in the equation is the efforts of the United States Chamber of Commerce, a lobbying group representing the interests of businesses and other industry associations.  A new report by the Constitutional Accountability Center (CAC) finds that since the start of the Roberts Court in 2005, the Chamber has won more than two-thirds of the cases in which it has participated.

This term, the Chamber filed amicus briefs in 24% of cases, up from 10% during the latter part of the Rehnquist Court.  With Roberts as Chief Justice, the Chamber has won 69% of the cases in which ithas gotten involved, up from 56% during the latter part of the Rehnquist Court and just 43% during the last five years of the Burger Court, from 1981 to 1986.

The Chamber has also been influential at the certiorari stage, filing 54 amicus briefs at that point in the proceedings --far more than any other private organization as reported by SCOTUS earlier this month. And it succeeded in convincing the Justices to take the case in nearly a third of those instances—a better success rate than that of any other group that filed more than ten briefs.

According to Doug Kendall, CAC’s founder and president, “They are very much shaping the diet of cases that goes before the Supreme Court each term,” “And then once they get a case before the court they usually win it.”

This success does not come cheaply. In 2012, the Chamber spent $136,300,000 on lobbying making it number one in the ranking of lobbying expenditures done by Center for Responsive Politics. In the same year the Chamber contributed $3,168,924 to candidates, party committees like the RNC or the DSSC, other PACs, outside spending groups or 527s.  While it is possible that some of those monies went for purposes other than advancing the interests of businesses, given the stated mission of the Chamber it seems likely that the vast percentage of dollars spent went to that end.  There is also clear indication that the Chamber intends to continue and expand its efforts.   Chamber President and Chief Executive Officer Thomas Donohue said earlier this year that the group will "significantly expand the expertise" of its public policy law firm, the National Chamber Litigation Center, to fight regulations that hurt businesses. The Chamber is particularly concerned about regulations stemming from the Dodd-Frank financial reform as well as others.

It would be nice to know where the money to fund these significant efforts is coming from –but we can’t.  Because it is a nonprofit business association organized under section 501(c)6 of the Internal Revenue Code, the Chamber does not have to disclose its donors.  Of course, if efforts to have the SEC pass regulations requiring publicly traded corporations to reveal their political contributions to shareholders, the Chamber stands to take a hit.  It is not surprising then that it (along with other major trade industry groups) successfully persuaded Republicans in the House to introduce legislation that would make it illegal for the SEC to issue any political disclosure regulations applying to companies under its jurisdiction. It also joined in issuing a letter to the chief executives of Fortune 200 companies, encouraging them to stand against proxy resolutions and other proposals from shareholder activists demanding more disclosure of political spending and filed with the SEC a comment letter vehemently objecting to political disclosure spending regulation. (here). 

Opposing  the Chamber and other anti-disclosure stance are the  more than 500,000 Americans who have signed a petition asking the SEC to mandate the disclosure of political spending by corporations, including direct expenditures such as advertising campaigns and contributions to political committees, trade associations and nonprofit organizations, as well as many other proponents of disclosure.  If the SEC does act and the corporations are required to disclose their donations to the Chamber, it just might make a difference in the influence that organization currently yields—and the outcome of some important business cases.

Concession Theory and the Doctrine of Unconstitutional Conditions

Last week I posted the abstract from the most recent draft of my latest paper, Rehabilitating Concession Theory, ___ OKLA. L. REV. ___ (forthcoming).  This week I’d like to highlight one of the key arguments I make in the paper, which is a rebuttal of the proposition that the unconstitutional conditions doctrine somehow trumps concession theory.  Here is a relevant excerpt:

One of the challenges the Citizens United majority posed to those who would base regulation of corporate political speech on the unique state-granted privileges of corporate status is the concept of unconstitutional conditions.  Kathleen Sullivan describes the doctrine as follows:

"The doctrine of unconstitutional conditions holds that government may not grant a benefit on the condition that the beneficiary surrender a constitutional right, even if the government may withhold that benefit altogether. It reflects the triumph of the view that government may not do indirectly what it may not do directly over the view that the greater power to deny a benefit includes the lesser power to impose a condition on its receipt…. The Lochner Court first fashioned the doctrine." [Kathleen M. Sullivan, Unconstitutional Conditions, 102 Harv. L. Rev. 1413, 1415 (1991).]  ….

[However], it is unclear what exactly would be added to the relevant analysis by applying the unconstitutional conditions doctrine since, like the Free Speech clause of the First Amendment itself, it does not actually constitute a complete bar to government action but rather requires the government to satisfy some form of heightened scrutiny….

[Furthermore], the unconstitutional conditions analysis can turn on the germaneness of the condition to the purpose of the regulation…. Once we take concession theory as our starting point (which we must if we are analyzing unconstitutional conditions doctrine as a form of rebuttal to concession theory) we can view the purpose of conditioning corporate status on limited corporate political speech as having an “essential nexus” to the conceptualization of the corporation as a state concession since that conceptualization has from the beginning included a fear of undue political influence….

Finally, and perhaps most importantly, it is not even clear that an unconstitutional conditions analysis is applicable.  Certainly, the analysis would be applicable if a state government were to require incorporators to agree not to engage in corporate political speech as a condition of incorporating in the state, but it is less clear that using concession theory to justify the regulation of corporate political speech by the federal government similarly implicates the doctrine.  What benefit is the federal government conditioning on the waiver of First Amendment rights?  If the answer is “none,” then we are arguably simply back to the question whether understanding the corporation as a state concession as opposed to merely an association of individuals improves the ability of the federal government to satisfy its strict-scrutiny burden.  In other words, if the primary purpose of the unconstitutional conditions doctrine is to limit the ability of the government to do indirectly (via the conditioning of benefits) what it cannot do directly, then the doctrine is inapplicable here because the government is in fact directly regulating speech.

As an aside, the Supreme Court will hopefully provide some added clarity to our understanding of unconstitutional conditions soon (go here for more details).

UBS and Citigroup’s Appeal Denied; Nonprofit Considered Banks’ “Customer” for FINRA Arbitration Purposes

In UBS Fin. Servs., Inc. v. Carilion Clinic, the United States District Court for the Eastern District of Virginia affirmed a district court ruling that UBS Financial Services, Inc. (“UBS”) and Citigroup Global Markets, Inc. (“Citi”), as members of the Financial Industry Regulatory Authority, Inc. (“FINRA”), must arbitrate a securities dispute with the Carilion Corporation (“Carilion”) under FINRA Rule 12200. 706 F.3d 319 (4th Cir. 2013).

According to the allegations, Carilion in 2005 sought to finance renovation and expansion of one of its hospitals and to refinance existing debt by issuing municipal bonds.  To effectuate this, Carilion engaged UBS and Citi to advise a structure for and assist in implementing the bond issuance. UBS and Citi recommended a bond issuance composed of a majority of auction-rate bonds. Heeding UBS and Citi’s advice, Carilion issued $234,225,000 in auction-rate bonds and $74,240,000 in daily rate bonds. Throughout this process, UBS and Citi served as underwriters, broker-dealers, sellers of interest rate swaps, agents in dealing with rating agencies and in discussions with bond insurers, and provided monitoring and advisory services, all on Carilion’s behalf. The parties memorialized the various agreements in broker-dealer agreements and underwriting agreements. For their services, UBS and Citi were compensated with a management fee, including an underwriter’s discount, and annual broker-dealer fees.

In February 2008, UBS and Citi ceased submitting support bids for the bonds at auctions and the auction-rate bond market collapsed, forcing Carilion to refinance at a cost of millions. Carilion initiated arbitration proceedings, and UBS and Citi filed this action seeking an injunction of the arbitration proceedings.

FINRA Rule 12200 requires FINRA members to arbitrate disputes with customers when (1) the customer requests arbitration and (2) the dispute arises in connection with business activities of the member. UBS and Citi argued that the rule did not apply to Carilion because it was not a customer and that the parties’ contracts waived any right to arbitrate. The court disagreed on both counts.

First, UBS and Citi argued that Carilion was not a customer because the definition of customer should have been limited to “persons who received investment or brokerage services.” The court concluded that Carilion was a customer under Rue 12200 because it was not a broker or dealer, it purchased commodities or services related to investment banking and securities covered by FINRA, and it purchased them from FINRA members in the course of the members’ business activities. The court dismissed UBS and Citi’s contention that this definition would cause confusion with the definition of “customer” by the Municipal Securities Rulemaking Board, stating that any difference did not rise to the level of an irreconcilable conflict.

Second, the court reasoned that the parties’ agreements were not sufficiently specific to create a reasonable expectation that arbitration was being waived, displaced or superseded. The court noted that the language in question did not mention arbitration, and that it only created specific forum choice obligations that most logically applied to court and jury trials, as opposed to any tenuous type of proceeding, including arbitration; therefore, the court declined to impute what was not unequivocally there 

The court affirmed the district court ruling that Carilion was a customer of UBS and Citi, and could obligate them, as members of FINRA, to arbitrate the dispute.

The primary materials for this case may be found on the DU Corporate Governance website.

RMSC: JOBS Act

The final session of the conference focused on the JOBS Act – Emerging Growth Company Financing, Reg D General Solicitation and Crowd Funding.  Panelists included Mark Kronforst, Associate Director, Division of Corporation Finance, Securities and Exchange Commission; and Professor J. Robert Brown, Jr., Professor of Law, University of Denver, Sturm College of Law.  The panel was moderated by Reid Godbolt, Jones & Keller, PC. 

Professor Brown started the discussion with an overview of what has occurred with the JOBS Act since the last RMSC, essentially nothing as far as rules.  However, he shared his views on the important and hotly debated pieces of the Act and what difficulties the SEC is facing.  

Rule 506 allows general solicitations to the world at large, but the interests in the company may only be sold to accredited investors.  This creates a problem of unaccredited investors lying in order to become part of the investment.  The SEC has taken the position that the issuer must take reasonable steps to see if the investor is accredited.  A self-certification by the investor is not enough but the battle continues to determine just what verification is enough to satisfy the reasonableness standard.  

Another heavily debated piece is the process used for general solicitations.  There are opinion letters that indicate a general solicitation should be filed with the SEC by using Form D.  However, this is currently not mandatory and the SEC must determine the best process to follow. 

A third area that is contested is hedge funds.  Under the current rules, hedge funds are allowed to participate in general solicitations without the restrictions mutual funds must follow.  Hedge fund managers would like to keep it this way, but mutual fund managers would like to see this changed. 

Professor Brown then discussed crowd funding and explained how the SEC is in an impossible position.  Portals such as Kickstarter, where the money raised does not qualify as securities, feed off emotional spending.  The problem with making emotional spending into a security is the opportunity for fraud is magnified and the investments are very risky.  There are limits on the amount of investment a person can make within a 12-month period, but the portal is responsible for monitoring the limits.  Self-verification is not okay in this setting, but requiring further verification adds too much cost to the portal, making this an unattractive business.  The SEC has the unlucky responsibility of determining where the balance lies. 

Mr. Kronforst was unable to comment on most of what Professor Brown outlined since the SEC is currently deciding what to do about each of these issues.  However, Mr. Kronforst mentioned that the biggest surprise from the JOBS Act is that he thought the issues would be different from the typical securities issues, yet all of the issues now in front of the SEC are the same they face with other types of cases. 

The Race to the Bottom’s complete coverage regarding the JOBS Act can be found here, here, and here.