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Quack Deregulation?

In case you missed it, some pretty salacious accusations were levied against the SEC this week by David Weber, the former chief investigator for the SEC Inspector General's office.  The allegations prompted Stephen Bainbridge to ask: “One wonders what the SEC apologists will say post-Weber?”  The question is an interesting one, at least in part because of how frequently Bainbridge and other like-minded laissez-faire apologists have argued that scandals don’t justify regulation.  However, it is certainly fair to say that those of us who argue for greater federalization of corporate law because we are concerned about a race to the bottom engendered by the competition for corporate charters among the states must acknowledge that there are obvious costs, including various forms of rent-seeking, associated with our proposals.  (As Richard Hasen puts it (here): “Rent-seeking occurs when resources are dedicated to capturing a government benefit, rather than being put to a productive use ….”)  Without having looked too deeply into Weber’s allegations, my initial reaction is that they fall into that category to the extent they are true.  All of which is to say that they certainly must be accounted for, but just as certainly don’t necessarily require throwing the baby out with the bath water.  With apologies to Winston Churchill, it may still be the case that despite these issues a strong SEC remains the worst corporate governance regulator except for all the others that have been tried.


Swanson v. Weil: Court Grants Motions to Dismiss due to an Absent Pre-Litigation Demand

In Swanson v. Weil, Civil Action No. 11-CV-02142-WYD-KLM, 2012 WL 4442795 (D. Colo. Sept. 26, 2012), the United States District Court for the District of Colorado granted the defendants’ motions to dismiss.  Plaintiff Charles D. Swanson, a shareholder of Janus Capital Group, Inc. (“Janus”), brought a derivative action against the company, as well as several of its directors and executive officers.  The plaintiff alleged the board approved an excessive compensation package and that the company included false and misleading statements in its proxy statement.  Both Janus and the individual defendants moved for dismissal on the grounds that the plaintiff did not make the required pre-litigation demand to the board and that the demand would not have been futile. 

A complainant must make a demand upon the board prior to initiating litigation.  However, courts excuse the demand requirement if a reasonable doubt is created that “(1) the directors are disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.”

Under the first prong, the court reasoned that all directors except for one were classified as independent directors, resulting in a disinterested board.  However, the plaintiff argued that despite being comprised of independent directors, the board was interested because a substantial likelihood of liability existed.  The court analyzed this argument in conjunction with the second prong. 

To satisfy the second prong, the facts must raise either “(1) a reason to doubt that the action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the decision.”  The court dismissed the latter because the complaint did not challenge that the board made an informed decision.  The plaintiff offered several arguments to support the former, including that the compensation package violated Janus’ pay for performance plan, the board made false statements in the proxy statement regarding compensation determinations, and the defendants should not be rewarded for poor performance.  However, the court failed to find sufficient facts in the complaint to show a substantial likelihood that liability existed. 

The plaintiff also sought to allege liability by claiming that the pay package increased compensation by 41% during a time of decreasing stock prices.  The court reasoned that allegations of increased compensation during years of poor performance alone could not sustain a claim.  The plaintiff also asserted that the shareholder vote against the compensation package, previously discussed here, was enough to create liability and show bad faith.  The court determined this was not enough to show bad faith because the vote was not binding on the board, and it took place after the board approved the package.  

Finally, the plaintiff pointed to an earlier demand by a different shareholder that the board ignored.  The court rejected this argument because a prior demand does not excuse a future demand by a different shareholder. 

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


Bennett v. Sprint Nextel: Court Expands “Privileged” Information Subject to PCAOB Inspection 

In Bennett v. Sprint Nextel Corp., Case No. 11-9014-MC-W-ODS, 2012 U.S. Dist. LEXIS 145902 (W.D. Mo. Oct. 10, 2012), the plaintiffs, shareholders of Sprint Nextel Corp. (“Sprint”), filed a motion to compel KPMG, Inc. (“KPMG”), a non-party to the suit, to release certain documents presumed to support allegations of securities fraud in connection with Sprint’s acquisition of Nextel. The court granted, in part, the plaintiffs’ motion to compel on the ground that some of the information intentionally withheld by KPMG was privileged pursuant to 105 U.S.C. § 7215(b)(5)(A) (“Section 105(b)(5)(A)”), which protects information involved with Public Company Accounting Oversight Board (“PCAOB” or “Board”) inspections of registered accounting firms.

To maintain its administrative oversight authorized by the Sarbanes-Oxley Act, the PCAOB conducts regular inspections of accounting firms that perform independent audits of publicly traded companies. From 2004 to 2009, KPMG performed independent audit work for Sprint, and assisted with the accounting for Sprint’s acquisition of Nextel in 2005. In 2006, the PCAOB initiated a customary inspection of KPMG’s auditing practices. Of particular interest to the plaintiffs were aspects of the inspection that involved KMPG’s Sprint audit.

Section 105(b)(5)(A) protects against discovery “all documents and information prepared or received by or specifically for the Board, and deliberations of the Board.” This excludes from discovery such information “directed to targets of the Board’s investigations.”

First, the plaintiffs contested KPMG’s claim of privilege for internal communications not necessarily transmitted to the PCAOB but created for the sole purpose of responding to inquiries made during the course of the inspection. The plaintiffs argued that the privilege should not apply to information not “specifically for the Board.” However, the court reasoned that the internal “communications that discuss confidential questions or comments made by the Board or reflect KPMG’s development of responses to Board inquiries are also protected.” The court held that the internal information was “specifically for the Board,” because “absent the inspection, these documents and communications would not exist.”

Second, the plaintiffs challenged KPMG’s assertion that the statutory privilege covered internal documentation that could potentially divulge information regarding the PCAOB’s deliberations. The plaintiffs maintained that the deliberations privilege should not apply since KPMG was not involved with the PCAOB’s actual deliberations. The court agreed that the deliberations privilege was intended to protect the PCAOB and its “consideration and analysis of the evidence,” not the evidence itself. As a result, the deliberative privilege did not extend to the documents submitted to the PCAOB.  

Finally, the plaintiffs contended that KPMG specifically waived its statutory privilege by informing Sprint’s CEO of the upcoming inspection and by sharing a presentation used to organize preparations for the inspection with Sprint personnel. Analogizing to other privileges, the court reasoned that the partial disclosure of privileged documents does not destroy the protection of other privileged documents. The court held that KPMG never revealed the “details or substance of the investigation,” and that the limited amount of detail disclosed was not enough to warrant a complete waiver of privileged information.

Accordingly, the court granted, in part, the plaintiffs’ motion to compel and denied the plaintiffs’ contentions of waiver. We have previously discussed the underlying suit here.

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


Zelaya v. U.S.: SEC’s Discretionary and Nondiscretionary Actions in Regards to a Ponzi Scheme

In Zelaya v. U.S., No. 11-62644-Civ-SCOLA, 2012 WL 3887203 (S.D. Fla. Sept. 7, 2012), the district court granted in part and denied in part the defendant’s motion to dismiss. The United States argued in its motion to dismiss that the court lacked subject matter jurisdiction under the Federal Tort Claims Act (“FTCA”). Carlos Zelaya, George Glantz, and the Glantz Revocable Trust (collectively, “Plaintiffs”) claimed that the Securities and Exchange Commission (“SEC”) acted negligently under the FTCA in regards to an alleged Ponzi scheme.

Plaintiffs alleged that Robert Stanford (“Stanford”) operated a Ponzi scheme “selling fraudulent offshore certificates of deposit.” The complaint further alleged that Stanford formed the Stanford Group Company for the purpose of promoting investment in this scheme. The Stanford Group Company registered with the SEC in 1995 as a broker-dealer and investment adviser. According to Plaintiffs, the SEC received several complaints from 1997 to 2004 about Stanford, and the SEC concluded after each investigation that he was operating a Ponzi scheme. However, Plaintiffs allege that the SEC did not take action against Stanford until 2009.

Under the FTCA, a government agency does not waive sovereign immunity if it makes a discretionary decision; however, nondiscretionary acts are not protected by sovereign immunity. Accordingly, if an act is deemed discretionary, a court lacks subject matter jurisdiction. A discretionary decision “involve[s] an element of judgment or choice.” A nondiscretionary act exists if a “federal statute, regulation or policy specifically prescribes a course of action for an employee to follow.”

Plaintiffs first argued that the SEC was negligent in failing to inform the Securities Investor Protection Corporation (“SIPC”) about Stanford’s alleged Ponzi scheme. Under 15 U.S.C. §78eee(a)(1), “[i]f the [SEC] . . . is aware of facts which lead it to believe that any broker or dealer subject to its regulation is in or approaching financial difficulty, it shall immediately notify [SIPC]” (emphasis added). The court reasoned that a Ponzi scheme is inherently equivalent to “approaching financial difficulty, because Ponzi schemes by their very nature are insolvent at their inception.” It held that the SEC had concluded Stanford’s operation was a Ponzi scheme. Although the process in reaching that conclusion involved discretion, once the SEC made the decision that the operation was a Ponzi scheme, the SEC was required to report it to the SIPC. The “duty to report” did not involve discretion. Accordingly, the motion to dismiss was denied in regards to the reporting requirement.

Plaintiffs’ second argument was that because the SEC concluded that Stanford’s operation was a Ponzi scheme, it acted negligently in failing to deny Stanford’s annual amendment to its investment advisor registration. The SEC is statutorily mandated to grant or deny only the initial application of an investment advisor. There is no statute requiring the SEC to take a specific action regarding amendments to registration; therefore, “any action or inaction by the [SEC] regarding registration amendments was necessarily discretionary.” The court granted the motion to dismiss concerning the annual amendments.

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



Northern District of California Finds Securities Class Action Suit Can’t Get Past “Go” Without Pleading Sufficient Particularity in Kovtun v. Vivus, Inc.

In Kovtun v. Vivus, Inc., No. C 10-4957 PJH, 2012 WL 4477647 (N.D. Cal., Sep. 27, 2012) the United States District Court for the Northern District of California granted defendants’ motion to dismiss for failure to properly state a claim.  The court found that the claim failed to sufficiently allege falsity or scienter.

The plaintiffs, members of the proposed class who purchased or acquired Vivus securities during the class period (“Plaintiffs”), brought claims for violations of section 10(b) of the Securities Exchange Act (“Exchange Act”) and Rule 10b-5 promulgated thereunder, as well as violations of sections 20(a) and 20(b) of the Exchange Act.  Defendants included Vivus, Inc., a pharmaceutical company, its CEO, Leland Wilson, and its VP of Clinical Development, Wesley Day (“Defendants”).

Plaintiffs’ claims arose out of Defendants’ development of a new drug created to combat obesity called Qnexa.  The complaint focused on allegedly optimistic statements made after a third round of clinical trials and before the Food and Drug Administration (“FDA”) denied initial approval of the drug.  Plaintiffs’ claims were dismissed once before for lack of specificity and failure to state why statements were misleading.  As a result, Plaintiffs filed a second amended complaint. 

According to the second complaint, Defendants made a number of public statements during the class period, including press releases, conference calls, presentations and filings with the Securities and Exchange Commission (“SEC”), that omitted serious risks “revealed by the study data and the inadequacy of clinical data.”  Plaintiffs alleged that   investors were not informed about the “serious and life-threatening health risks, or the inadequacy of the clinical data” associated with Qnexa. 

To state a claim under Rule 10b-5, a plaintiff must plead: (1) a material misrepresentation or omission; (2) scienter; (3) in connection with the purchase or sale of a security; (4) economic loss; and (5) loss causation.  These claims must also satisfy the requirements of Federal Rule of Civil Procedure (“Fed. R. Civ. P.”) 9(b) and the Private Securities Litigation Reform Act (“PSLRA”). 

Fed. R. Civ. P. 9(b) requires that actions alleging fraud must be pled with specificity and particularity, “including an account of the time, place and specific content of the false representations as well as the identities of the parties.”  The PSLRA also imposes heightened standards at the pleading stage and requires that falsity and scienter be plead with particularity. 

The court limited its analysis to falsity, materiality, and scienter.  To claim falsity under the PSLRA, whether as a misrepresentation or omission, a “complaint must specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, must state with particularity all facts on which that belief is formed.”  Moreover, a misleading statement or omission must “give a reasonable investor the impression of a state of affairs that differs in a material way from the one that actually exists.”  

The court found that the Plaintiff had not sufficiently alleged that the Defendants’ statements were false.  The opinion determined that Plaintiffs:  failed to allege that different  statements were false rather than  opposing, but permissible, judgments and made  conclusory allegations.  In addition, the statements had to be examined “in context,” taking into account information “well-known and understood” by the markets.

The court also accepted Defendants’ arguments that some of the statements challenged by Plaintiffs were “vague assertions of corporate optimism” and therefore not actionable.    Others were forward-looking and protected by the PSLRA safe harbor or the “bespeaks caution” doctrine.  The court viewed statements about the likelihood of FDA approval as forward looking. Moreover, statements about FDA approval “included warnings about the uncertainties of forward-looking statements, and also referred investors to VIVUS' SEC filings. Those filings, in turn, were replete with discussion of risk factors.”  Nor were there sufficient allegations that the statements were false.  “In the absence of any facts indicating that defendants made statements about the trial results that were false at the time they were made, the statement that defendants expected that the FDA would approve Qnexa can at most be considered a reflection of a bad guess about an event that had not yet occurred.”

The court further agreed with Defendants that Plaintiffs failed to plead sufficient facts to show that Vivus’ statements were materially misleading.  The court held that Plaintiffs failed to show that any fact allegedly omitted would have had such an effect on the total mix of information available that a reasonable investor would have relied on it. 

Plaintiffs sought to show scienter through the use of the “core” products doctrine and statements from confidential witnesses.  Under the PSLRA, a plaintiff must plead with particularity facts giving rise to a strong inference that the defendants acted with scienter.  To give rise to a strong inference, a plaintiff’s assertions must be at least as compelling as opposing inferences introduced by the defendants.  Moreover, courts will consider assertions standing alone as well as holistically to determine whether a strong inference was pled.

The court conceded that an inference could arise as a result of presumed knowledge of the "core operations" of the company but that the allegation alone would “generally not support a strong inference of scienter absent ’additional detailed allegations about the defendants' actual exposure to information’", something not sufficiently alleged in this case.  The court also found that because the confidential witnesses predominantly worked in sales and their allegations did not provide facts contradicting Defendants’ statements, the confidential witnesses’ statements did not create a strong inference of scienter. 

The court dismissed as insufficient the allegations that Defendants were motivated to commit fraud as evidenced by the company’s need to raise capital, the relationship between executive compensation and capital raising and stock sales.  To be evidence of sceinter, the sale of shares by insiders must be “out of line” with prior sales.  In this case, the court found the given the insider’s “overall trading history,” the sales were not “dramatically out of line.”   

Finally, because Plaintiffs failed to properly claim a primary securities violation under section 10(b), the court dismissed Plaintiffs’ section 20 claims without further evaluation. 

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


Sivolella v. AXA Equitable Life Ins. Co.: Court Defines “Security Holder” Broadly Under the Investment Company Act of 1940

In Sivolella v. AXA Equitable Life Ins. Co., No. 11–4194 (PGS), 2012 WL 4464040 (D. N.J. Sept. 25, 2012), the U.S. District Court for the District of New Jersey denied the defendant-fund advisor’s motion to dismiss for lack of standing, holding that the plaintiff is a “security holder” under Section 36(b) of the Investment Company Act of 1940 (“ICA”).

Plaintiff, Mary Ann Sivolella, enrolled in a variable annuity provided by AXA Equitable Life Insurance Company (“AXA Equitable”) as part of a group plan through her employer. As a plan participant, Sivolella’s contributions were placed into an account registered as a unit investment trust and owned by the insurance company. Sivolella was, however, permitted to direct her contributions in the account towards a number of investment portfolios, eight of which were offered through trusts created by AXA Equitable (the “AXA Funds”).

Sivolella’s complaint alleged that: (i) AXA Equitable and AXA Equitable Funds Management Group, LLC (collectively “AXA”) acted as the investment advisor to the AXA Funds, which also have individual sub-advisors; (ii) AXA charged the AXA Funds an investment management fee for supervisory services that was deducted from the respective fund balances, reducing Sivolella’s investment; and (iii) AXA forwarded a small portion of the fees to the sub-advisors and retained the majority of the fees. Sivolella brought an action against AXA on behalf of the AXA Funds under both Section 36(b) of the ICA and an unjust enrichment theory alleging that AXA’s fees were excessive considering their limited function and advisory capacity.

AXA’s motion to dismiss did not attack the merits of the ICA claim; instead, AXA asserted that Sivolella lacked standing because she was not a “security holder” under the ICA. As such, AXA averred that the district court lacked the requisite subject matter jurisdiction to decide the merits of the case.

Section 36(b) of the ICA limits standing to “the [Securities and Exchange Commission], or [] a security holder on behalf” of a mutual fund. The ICA does not directly define a “security holder”; however, AXA asserted that the term, as used in Section 36(b), “refers to the legal or record owner of a security.” AXA proffered that Sivolella, as the owner of an annuity, was not the legal or record owner of the account that invested in the AXA Funds and, therefore, was not a security holder under the ICA. Furthermore, AXA asserted that Sivolella bore the burden of establishing standing and that the limited facts in Sivolella’s complaint—that she is a “security holder” —fell short of such burden.       

The court acknowledged AXA’s standing argument, describing the Defendants' position as an attempt to limit a security holder “to the legal or record owner of a security” while Plaintiff's asserted that the phrase encompassed the “equitable or beneficial owner of a security.”  The court agreed with the Plaintiffs, noting that the term “security holder” had to be broadly construed in order to protect the investing public. The court explained that a broad interpretation of the term was consistent with the U.S. Supreme Court’s analysis of a similar phrase under Securities Exchange Act: “The Court will consider instruments to be ‘securities’ on the basis of such public expectation, even where an economic analysis of the circumstances of the particular transaction might suggest that the instruments are not ‘securities.’”

The court considered Sivolella’s economic stake in the investment and the alleged excessive fees charged by AXA. The court explained that Sivolella: (1) was responsible for the advisory fees paid to AXA; (2) bore the risk of loss due to the investment’s poor performance; and (3) must pay taxes on any realized gains from the investment. Moreover, the court noted that the investment was immune from AXA creditors, but was subject to claims by Sivolella’s creditors. As such, the court held that Sivolella had the greater economic stake, and it would “make no sense to limit standing” to AXA or others that did not pay the alleged excessive fees. For the foregoing reasons, the court denied AXA’s motion to dismiss the Section 36(b) claim.

Lastly, the court granted AXA’s motion to dismiss Sivolella’s unjust enrichment claim. The court explained that common law causes of action are only necessary to fill voids left by statutory law. Accordingly, because Sivolella’s claim under Section 36(b) is valid, a parallel action under a common law doctrine is not necessary.

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


Hidalgo-Velez v. San Juan Asset Mgmt., Inc.: Case Removal to Federal Court Proper under the Securities Litigation Uniform Standards Act

In Hidalgo-Velez v. San Juan Asset Mgmt., Inc., No. 11-2175CCC, 2012 WL 4427077 (D.P.R. Sep. 27, 2012), the United States District Court for the District of Puerto Rico denied the plaintiffs’ motion to remand, finding that the defendants’ removal to federal court was proper under the Securities Litigation Uniform Standards Act (“SLUSA”).

The plaintiffs, investors in defendant Puerto Rico Global Income Target Maturity Fund Inc. (the “Fund”), brought a class action and derivative suit in Puerto Rican courts alleging fraudulent disclosures and omissions of material information against the respective officers and directors of the Fund; the Fund’s investment adviser, San Juan Asset Management, Inc.; the Fund’s sales agent, BBVA Securities Puerto Rico, Inc.; the Fund’s outside auditor, PricewaterhouseCoopers LLP (“PwC”); and various other individuals. PwC removed the action to the United States District Court according to the removal provision contained in the SLUSA, and the plaintiffs subsequently moved to remand.

The SLUSA removal provision is a three-prong test. The suit must (1) be “a ‘covered’ class action, (2) be based on state statutory or common law [, and] (3) allege[] that defendants made a ‘misrepresentation or omission of a material fact’ or ‘used or employed any manipulative device or contrivance in connection with the purchase or sale’ of a covered security.”

The district court found the first two prongs of the test were clearly met. The plaintiffs’ argued, however, that the case did not involve a “covered security.” Plaintiffs alleged that their investments were not used to purchase securities expressly listed in the definition of “covered securities.” The district court held, however, that SLUSA applied to investments in funds that acquired covered securities.

The district court pointed to prior United States Supreme Court cases which held that the “in connection with” language should be “interpreted broadly.” Furthermore, the court noted other decisions that applied SLUSA “to cases brought by investors of a fund that invests, or represents that it will invest, in a covered security, even when the shares of the fund in which the class invested are not covered securities.”

Financial statements included by PwC with its Notice of Removal showed that the Fund had purchased securities in companies traded on NASDAQ. The securities fell within the definition of a “covered security.” Finally, the district court rejected the plaintiffs’ claim-by-claim analysis because the statutory language of the SLUSA precluded actions, not claims. Therefore the district court denied the plaintiffs’ motion to remand.

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


SEPTA v. Volgenau: 8 Delaware Code § 124 Empowers and Protects Corporations But Does Not Prevent Direct Claims Against Corporations’ Directors

In Southeastern Pennsylvania Transportation Authority v. Volgenau, C.A. No. 6354-VCN, 2012 WL 4038509 (Del. Ch. August 31, 2012), SRA International, Inc. and several members of its board (“SRA” or “Defendants”) moved  for judgment on the pleadings with respect to Count IV of the Complaint, alleging that  Southeastern Pennsylvania Transportation Authority(“SEPTA” or “Plaintiff”) could not challenge an alleged violation of the article of incorporation. 

SEPTA, a former stockholder of SRA, filed a direct complaint against SRA and several members of the board of directors with the purpose of preventing a merger with Providence Equity Partners, LLC.  The Delaware Court of Chancery granted Defendants’ motion in part and denied it in part.  After the merger was consummated, SEPTA abandoned its claim for injunctive relief.

SEPTA brought its claim as a “purported direct class action on behalf of itself and all other similarly situated former common stockholders of SRA.”  Count IV of the Complaint alleged that SRA violated its Certificate of Incorporation when it merged and did not distribute equal per share payments to each class of Common Stock shareholders, specifically benefitting SRA’s controller, Ernst Volgenau.  SEPTA argued that this act invalidated the merger and that SRA and the individual defendants breached their fiduciary duty of loyalty.

Defendants argued that  Delaware Code § 124 (“§ 124”), the ultra vires statute, procedurally barred Plaintiff’s claims as a matter of law.  Delaware’s General Assembly enacted § 124 with the intent to “prevent challenges to a corporation’s power to act” [emphasis in original].  The statute only allows claims for injunctive relief, derivative claims, or suits by the Attorney General to be filed against a corporation.  Therefore, Defendants argued that Plaintiff’s non-injunctive direct claim must be dismissed.

SEPTA asserted that the claim did not seek recovery under § 124 but for claims based upon breach of contract and breach of fiduciary duty.   SEPTA argued that SRA’s Certificate of Incorporation was a contract with provisions for equal distribution to all common stockholders and that Volgenau’s additional compensation during the merger constituted a breach of that contract.  Additionally, the individual SRA board members allegedly breached their fiduciary duties of loyalty and care when they approved a merger that violated the articles of incorporation. 

The court upheld the Defendants’ § 124 argument regarding the action against SRA as a corporation.  Finding that Plaintiff’s suit did not qualify as one of the three instances allowed by § 124, the court ruled that the Plaintiff could not challenge the validity of SRA’s merger as an ultra vires act.  However, the court ruled that § 124 does not bar a direct claim against the “persons who caused such action to occur.”  Therefore, the court allowed SEPTA to maintain its breach of fiduciary duty claim against the fiduciaries that approved the merger.

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


2012 New England Securities Conference: SEC Chairman Mary L. Schapiro Discusses Evolution of SEC Enforcement Program, Calls on Congress to Provide SEC with Enhanced Power to Impose Monetary Penalties on Violators of Securities Laws

On October 11, 2012, Securities and Exchange Commission (“SEC”) Chairman Mary L. Schapiro gave a speech to the New England Securities Conference in which she discussed the evolution of the SEC’s Enforcement Division, highlighted recent activities and successes of the Enforcement Division, and called upon Congress to provide the Enforcement Division with more clout to punish those who violate federal securities laws, all with the overriding goal of protecting investors.

Chairman Schapiro said that she has worked to re-shape the Enforcement Division into a more proactive, technologically advanced, and collaborative organization that is able to “take on any wrongdoer, whoever they may be” and “allow the outgunned and vastly out-spent…Enforcement [Division] to go toe-to-toe with enormous financial institutions and to win.” 

Chairman Schapiro stated that the SEC’s encouragement of “aggressive and entrepreneurial” enforcement actions and elimination of bureaucratic hurdles has led to clear and definite results; specifically, the initiation of a record number of increasingly complex and varied actions “[resulting in] more than $2.2 billion in monetary relief…[and] dozens of orders barring individuals from the financial industry.”  Chairman Schapiro further highlighted the SEC’s re-structuring of its Enforcement Division into five specialized units in order to build “pools of expertise.”  One result of this re-structuring was the proactive identification by one of these units of “potentially massive fraud” by an Illinois-based investment advisor through the use of social media.  This proactive identification allowed the SEC to end the fraud “before any investors had lost a dime.”

Chairman Schapiro also emphasized the SEC’s implementation of more modernized technology systems such as its e-discovery and Tips, Complaints, and Referrals system, which allow SEC staff to better analyze, centralize, follow up on, and integrate data and tips into its enforcement and examination activities.  Chairman Schapiro highlighted the SEC’s Automated Bluesheet Analysis Project (“ABAP”), under which Enforcement Division personnel “[use] newly-developed analytics to identify suspicious trading patterns and relationships among multiple traders and across multiple securities, generating significant enforcement leads and investigative entry points.”  The ABAP has already paid dividends, allowing the SEC to take down an insider-trading scheme that had been running for 20 years.  This scheme had previously been undetected because the principals communicated with a middleman using public telephones and prepaid disposable mobile phones; ABAP allowed the SEC to conduct parallel analysis of Bluesheet trading data to identify and trace the scheme back to the principals.  Finally, Chairman Schapiro described the newly-created Aberrational Performance Inquiry team, which utilizes SEC- developed risk models and technology to analyze investment performance data of hedge funds to determine which funds warrant further review into their practices.

Chairman Schapiro noted the continuing need for cross-agency cooperation, particularly with regard to Dodd-Frank’s shifting of the oversight of smaller hedge fund advisers from federal to state agencies.  Chairman Schapiro stated:

[t]he coordination of state and federal action maximizes our reach, supports rapid and effective action, and helps to ensure that victims have a better opportunity to recover some of their funds.  And by presenting a coordinated front, we minimize the chances that a wrongdoer will be able to arbitrage different jurisdictions in an effort to minimize or escape liability.

Finally, Chairman Schapiro spoke to the issue of penalties, reminding her audience that the SEC’s ability to levy monetary penalties was nonexistent for quite some time.  While the SEC now has this ability, Chairman Schapiro stated that “the punishments [the SEC] can impose are not significant enough” to provide a real deterrent to securities laws violators because the SEC cannot base its penalties on investor loss.  Chairman Schapiro spoke of her hope for the passage of a bipartisan bill, currently in the Senate.  This would increase the SEC’s clout with regard to penalties, allowing the SEC to impose per-violation penalties of up to $1 million for individuals and $10 million for institutions.  It would also allow the SEC to penalize a violator up to “three times the size of the ill-gotten gain – or up to the full amount of investor losses.”

Chairman Schapiro concluded her speech by recapping the Enforcement Division’s evolution and stating that more change and improvement was still to come.

The primary materials for this speech may be found at the DU Corporate Governance website.


Securities and Exchange Commission v. Obus: The Misappropriation Theory of Insider Trading

On April 25, 2006, the Securities and Exchange Commission (“SEC”) filed an action for insider trading under Rule 10b-5 against the defendants, Nelson Obus, Peter Black, and Thomas Strickland.  The district court granted the defendants’ motion for summary judgment with regards to the misappropriation theory.  The Second Circuit, however, reversed, holding that the SEC had in fact presented adequate evidence to create a genuine issue of material fact as to the defendants’ liability.  SEC v. Obus, No. 10-4747-cv., 2012 WL 3854797 (2d Cir. Sept. 6, 2012).

According to the SEC’s allegations, Strickland worked as an underwriter at General Electric Capital Corporation (“GE”).  Allied Capital Corporation (“Allied”) approached GE to perform due diligence on SunSource, Inc. (“SunSource”), in anticipation of Allied’s possible acquisition of SunSource.  In the course of the due diligence process, Strickland learned about the acquisition.  Strickland also learned that Wynnefield Capital (“Wynnefield”), a hedge fund where his college friend, Black, worked, was a large shareholder of SunSource.

Strickland and Black, according to the SEC’s complaint, had a conversation regarding SunSource.  The SEC claimed that  Strickland tipped Black off about the acquisition, and then Black relayed the information to Obus, his boss at Wynnefield.  On June 8, 2001, two weeks after this conversation occurred, Wynnefield bought 50,000 shares of SunSource at $4.75 per share.  On June 19, 2001, Allied announced that it was acquiring SunSouce.  The same day, SunSource’s stock closed at $9.50 per share, which was nearly double what Wynnefield had paid earlier that month.  This resulted in a $1.3 million profit.

To be held liable under the misappropriation theory of insider trading, the tipper must “(1) tip (2) material non-public information (3) in breach of a fiduciary duty of confidentiality owed to […] the source of the information (4) for personal benefit to the tipper.”  A personal benefit is broadly defined and does not have to be a pecuniary benefit.  The tipper also must act with scienter.  Scienter is “a mental state embracing intent to deceive, manipulate, or defraud” and “may be established through a showing of reckless disregard for the truth.”  The requirement of scienter meant that an “accidental” tip of information was not a violation.   As the court described:

Assume two scenarios with similar facts. In the first, a commuter on a train calls an associate on his cellphone, and, speaking too loudly for the close quarters, discusses confidential information and is overheard by an eavesdropping passenger who then trades on the information. In the second, the commuter's conversation is conducted knowingly within earshot of a passenger who is the commuter's friend and whom he also knows to be a day trader, and the friend then trades on the information. In the first scenario, it is difficult to discern more than negligence and even more difficult to ascertain that the tipper could expect a personal benefit from the inadvertent disclosure. In the second, however, there would seem to be at least a factual question of whether the tipper knew his friend could make use of material non-public information and was reckless in discussing it in front of him. Similarly, there would be a question of whether the tipper benefited by making a gift of the non-public information to his friend, or received no benefit because the information was revealed inadvertently through his poor cellphone manner.

Liability for the tippee required proof that the tippee knew or should have known that the information received was in breach of a fiduciary duty and that he or she traded or tipped for personal benefit.

With regard to Strickland, the court held that, in the light most favorable to the non-moving party, the SEC provided sufficient evidence to survive a motion for summary judgment.  The SEC presented evidence that:  First, Strickland was an employee of GE and owed a fiduciary duty to his company.  Second, he testified that he knew the information was material and non-public.  Third, he called Black, an old college friend whose company had a stake in SunSource.  Fourth, Black immediately informed his boss, Obus, about his conversation with Strickland.  Fifth, Wynnefield purchased $50,000 shares of SunSource a few weeks before Allied acquired SunSource and made a significant profit.  Sixth, Obus told Daniel Russel, Allied’s CFO, that he had been “tipped off about the [SunSource] deal.”  Seventh, Strickland gave Black information he knew Black was in a position to use.  The court noted that “the defendants challenge[d] the credibility of much of this evidence and point[ed] to other facts that suggest a more innocent explanation.”  Nonetheless, the evidence was sufficient to withstand a motion for summary judgment. 

Based on Strickland’s liability as the original tipper, Black and Obus could also be found liable. Black allegedly knew that Strickland worked for GE and was performing due diligence.  He also knew possession of information about a non-public acquisition would preclude someone from buying stock.  As for the need for personal benefit, Black did not independently trade on the information, but he did allegedly tipp Obus, his boss.  The court determined that a jury could find that the tip was given in order to “curry favor with his boss” and that this was sufficient to meet the personal benefit requirement. 

With respect to Obus, he allegedly traded on the information.  Nonetheless, to be liable, he had to know that the information was provided in breach of a fiduciary duty.  According to the court, it was enough for Obus to believe that Black's information was “credible” and thus came from “someone entrusted with confidential information” and who “acted inappropriately.”  These facts together were “sufficient to allow a jury to infer that Obus was aware that Strickland's position with GE Capital exposed Strickland to information that Strickland should have kept confidential.”  Alternative interpretations raised by the defendants were matters to be resolved by the jury. 

Therefore, the court held that the SEC had provided adequate evidence to raise a genuine issue of material fact regarding the defendants’ liability under the misappropriation theory.

All primary materials for this case can be found on the DU Corporate Governance Website.



Villari v. Mozilo: When in Doubt, Go for the Double

In Villari v. Mozilo, 208 Cal. App. 4th 1470 (August 30, 2012), the court affirmed the dismissal of the plaintiff’s second amended complaint, holding that the trial court had correctly found the plaintiff to have lost standing to maintain shareholder derivative claims on behalf of Countrywide Financial Corporation (“Countrywide”) following the merger with Bank of America Corporation (“BofA”).

In January 2008, Countrywide announced that it was planning to merge with BofA. The plaintiff, Joseph Villari (“Plaintiff”) and others filed their first complaint the same day. BofA completed its acquisition of Countrywide in July 2008, and Countrywide was reorganized as Countrywide Financial Corporation, a BofA subsidiary (“New Countrywide”).  The Second Amended Complaint, filed after the merger, alleged that Countrywide and several former officers and directors engaged in mismanagement and fraud and alleged that the acquisition was “part of a single, inseparable fraud.”  Plaintiff also filed a double derivative action against BofA, New Countrywide, and several directors and officers of those corporations.

The trial court dismissed the claims. The court ruled that Plaintiff failed to meet the continuous ownership rule required for a derivative action as a result of the merger. Plaintiff brought the immediate appeal, claiming that he had adequately pled the fraud exception to the continuous ownership rule Plaintiff did not challenge the dismissal of the double derivative claims.

 Under Delaware law, shareholder derivative claims are subject to the continuous ownership rule. In order to bring a derivative action, a shareholder must have been an owner at the time of the alleged wrong, at the time the action was commenced and throughout the entire duration of the litigation. A plaintiff who loses shareholder status due to a merger also loses standing to continue the action. The fraud exception to this rule allows a plaintiff to retain standing if “(1) the merger itself is the subject of a claim of fraud; [or] (2) where the merger is in reality a reorganization which does not affect plaintiff’s ownership of the business enterprise.” In order for a plaintiff to maintain a suit under the first prong of the exception, the plaintiff must show that the merger was done solely to eliminate derivative claims.

 Plaintiff argued that the fraud exemption was not limited to mergers solely designed to deprive shareholders of standing, but also to situations “where the directors’ fraudulent conduct and breach of fiduciary duty prior to a merger impaired the corporation’s financial condition to such an extent that a merger became a practical necessity.” The court, however, rejected the argument, finding that there was “no compelling need to justify a broadening of the fraud exception to the continuous ownership rule” and that the “expansion of the fraud exception to the continuous ownership rule that would effectively swallow that rule.” The court noted that had Plaintiff pursued the double derivative claims that were brought in the second amended complaint, the continuous ownership rule would have been irrelevant and the case could have proceeded.

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




Lakeview Investment v. Schulman: Case Dismissed Pursuant to SLUSA

In Lakeview Investment v. Schulman, et al., Lakeview Investment (“Plaintiff”) filed a class action in California state court alleging that Tremont Partners, Tremont Group Holdings, Oppenheimer Acquisition Corporation, MassMutual Holding, Massachusetts Mutual Life Insurance Company, and various senior executives of the corporate defendants (collectively “Defendants”) violated the state’s securities laws by making false statements about the sale of limited partnership interests in two hedge funds.  2012 WL 4461762 (S.D.N.Y. Sept. 27, 2012).  Defendants removed the case to federal court, asserting that the Securities Litigation Uniform Standards Act (“SLUSA”) precluded Plaintiff from maintaining the state court action.  The court granted Defendants’ motions for judgment on the pleadings and for failure to state a claim, and dismissed the case.

Plaintiff invested approximately $25 million in two hedge funds, Rye Select Broad Market XL Fund, L.P. (“XL Fund”) and Rye Select Broad Market Fund, L.P. (“Market Fund”).  The Market Fund was a “feeder fund” that was subsequently invested into Bernard L. Madoff Investment Securities, which purported to use a “split-strike investment” method.  Though the XL Fund operated differently than the Market Fund and was not managed by Bernie Madoff, it was designed to mimic the returns of the Market Fund.  In late 2008, after Madoff revealed his massive Ponzi scheme, Plaintiff lost its entire $25 million investment.

SLUSA prohibits “covered class action” securities claims in any state or federal court by a private party.  A case that is removed from state court pursuant to SLUSA should be dismissed by the federal court.  To successfully remove a case from state court to federal court, the defendant must prove that the state court action is “(1) a covered class action (2) based on state statutory or common law that (3) alleges that defendants made a misrepresentation or omission of material fact or used or employed any manipulative device or contrivance (4) in connection with the purchase or sale of a covered security.”

The covered class action element is satisfied when the complaint is seeking damages for fifty or more plaintiffs.  The court found that this element was satisfied because the plaintiff did not argue that there were less than fifty plaintiffs.  The court found the state statutory or common law element was satisfied because all the claims were based on California state law.  Additionally, the court found the misrepresentation element satisfied because all the claims referred to Defendants’ “duty of ‘candor’ toward the plaintiff when ‘soliciting investments’” and Defendants’ breach of this duty.

Plaintiff argued that the fourth element, in connection with a covered security, was not satisfied because the XL Fund and the Market Fund did not trade in covered securities.  Nonetheless, the court found that it was sufficient that the Market Fund invested with Madoff and Madoff “purported to trade in covered securities using his fictional ‘split-strike conversion’ method.”  The court further found that since the XL Fund mimicked the Market Fund and that Madoff was trading in covered securities was a central portion of the compliant, that this element was also satisfied

Plaintiff tried to avoid dismissal of the entire complaint by arguing that SLUSA did not require the whole claim to be dismissed, just the class action portion.  Individual claims, therefore, were still permissible.  The court found that the plaintiff’s complaint did not distinguish between class action claims and individual claims, and thus dismissed the entire case. 

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


The Supreme Court and Enforcement of The Race to the Bottom: Gatz v. Auriga Capital (Part 2)

We are discussing the Supreme Court's decision in Gatz v. Auriga Capital, CA 4390, Del. S. Ct., Nov. 7, 2012, where the Court took issue with the Chancery Court for the use of dicta to express views on the fiduciary obligations of managers of LLCs. 

The decision is an example of the race to the bottom in action.  The lower court in effect found that as a rule of construction LLC operating agreements would be presumed to impose traditional fiduciary duties on managers unless the agreement specifically said otherwise.  In other words, in the face of silence, fiduciary obligations existed.    

The views of the Chancery Court were pro-investor.  The Supreme Court, however, struck down this pro-investor analysis, using an admonition against dicta to do so.  Id.  (the "court’s statutory pronouncements must be regarded as dictum without any precedential value.").  Nor is this the first time this type of thing has happened.  A recent example occurred when the Chancellor in Air Products interpreted staggered board provisions in a manner favorable to shareholders.  The Supreme Court, however, reversed in a poorly reasoned decision. 

Gatz is a reminder that when trial courts go too far in a pro-investor manner, the Supreme Court stands ready to reverse.  It of course explains why shareholders and other investors are increasingly seeking reform at the federal level. 


Gordon v. Goodyear: Court Grants Defendants’ Motion to Dismiss in Shareholder Derivative Suit

In Gordon v. Goodyear, No. 12 C 369, 2012 WL 2885695 (N.D. Ill. Jul. 13, 2012), the district court dismissed Natalie Gordon’s (“Plaintiff”) derivative suit against William M. Goodyear (“Goodyear”), CEO of Navigant Consulting, Inc. (“Navigant”); Navigant’s COO; Navigant’s CFO; Navigant’s General Counsel; and members of Navigant’s Board of Directors (“Board”) (collectively, the “Defendants”).

Plaintiff alleged that the “Board awarded excessive executive compensation” despite the fact that Navigant’s share price had declined from $21 per share in January 2006 to $9.20 per share in December 2010.  According to Plaintiff, Defendants breached their fiduciary duties of trust, loyalty, good faith, and due care to Navigant and its shareholders by approving this compensation package in the face of Navigant’s dismal financial performance.

Plaintiff relied on Navigant’s March 16, 2011 proxy statement, which recommended that Navigant shareholders approve the performance-based pay package proposed by the Board.  The proxy statement expressly stated that this vote was non-binding on the Board and on Navigant.  Further, on March 31, 2011, a leading proxy advisory service recommended that shareholders vote against the pay package; over fifty-five percent of Navigant shareholders took this advice. 

Plaintiff made no pre-suit demand on the Board, arguing that such a demand would have been futile because “the majority of the Board are also members of the Compensation Committee and . . . incapable of [dispassionately] evaluating a pre-suit demand.”  Defendants moved to dismiss the suit under Federal Rule of Civil Procedure 23.1(b)(3), which requires a plaintiff to plead with particularity its efforts at a pre-suit demand or its reasons for not making a pre-suit demand.  Courts apply the substantive law of the state of the corporation’s incorporation in pre-suit demand cases.  Navigant is a Delaware corporation, so the court applied Delaware law.

Under Delaware’s test for demand futility, a pre-suit demand on a board of directors is futile where a plaintiff can show “under the particularized facts alleged, a reasonable doubt is created that (1) the directors are disinterested and independent [or] (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.”

As to the first prong, the court found Plaintiff had not alleged that any of the executives who personally benefited from the pay package served on the committee that recommended the pay package.  The court also found that Plaintiff failed to show that Goodyear dominated or otherwise influenced the Board, or that any board member was double dealing or acting in bad faith with respect to the Board’s executive pay package decision.

As to the second prong, the court held that Plaintiff failed to provide particularized allegations to raise “(1) a reason to doubt that the [compensation] action was taken honestly and in good faith or (2) a reason to doubt that the board was adequately informed in making the [compensation] decision.”  Plaintiff’s argument that that the shareholders’ vote against the executive compensation package was evidence that the Board either acted in bad faith or was inadequately informed was not found by  the court to be persuasive.  The court noted that the Dodd-Frank Act specifically provided that shareholder votes on executive compensation were non-binding on a company and its board. 

The court also found that the board did not violate Navigant policies in approving the compensation and the decline in Navigant’s stock price did not justify demand excusal.

Because Plaintiff’s claim failed to satisfy either prong, the court held that Plaintiff had failed to show the futility of a pre-suit demand on the Board.  On this basis, the court dismissed Plaintiff’s claims against all Defendants.

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


The Supreme Court and Enforcement of The Race to the Bottom: Gatz v. Auriga Capital (Part 1)

There has been a fair amount of attention given to the opinion by the Delaware Supreme Court in Gatz v. Auriga Capital, CA 4390, Del. S. Ct., Nov. 7, 2012.  The opinion contained some sharp language criticizing the use of dicta in the Chancery Court opinion.  Gordon Smith discussed the case at The Conglomerate; likewise Steve Bainbridge did so in his blog.  Steve called the Supreme Court opinion a "smackdown" and noted that it entailed the "airing of dirty laundry that doesn't make the Supreme Court look good." 

The Supreme Court took issue with the trial court's decision to use dicta to opine on legal issues not before the court.  As the Supreme Court stated:   

the court’s excursus on this issue strayed beyond the proper purview and function of a judicial opinion. “Delaware law requires that a justiciable controversy exist before a court can adjudicate properly a dispute brought before it.”  We remind Delaware judges that the obligation to write judicial opinions on the issues presented is not a license to use those opinions as a platform from which to propagate their individual world views on issues not presented. A judge’s duty is to resolve the issues that the parties present in a clear and concise manner. 

The admonition was not designed to prevent judges from speaking out about legal issues that might come before them.  Judges could do so but only if in speeches, law review articles, or other non-judicial forums.  Again, in the words of the Supreme Court: 

To the extent Delaware judges wish to stray beyond those issues and, without making any definitive pronouncements, ruminate on what the proper direction of Delaware law should be, there are appropriate platforms, such as law review articles, the classroom, continuing legal education presentations, and keynote speeches.

The odd thing about the criticism is that the practice of using dicta to speak on issues not before the court has been encouraged by the Chief Justice.  Indeed, he co-authored an article that amounted to an apology for the practice, something labeled the "Guidance Function."  As the article stated:

the Delaware judges have frequently crafted dicta to give valuable guidance to deal lawyers on unanswered questions. The Delaware courts recognize the need to wait for a live controversy to resolve an issue definitively, but fortunately they also recognize that this does not mean that they cannot, or should not, use the attention paid to a published opinion to offer guidance on uncertain but vital areas of corporate law.

The Gatz opinion even cited the article despite the criticims of the practice. 

Challenging the use of dicta while authorizing similar views in speeches and articles is not an easy distinction to make.  First, all judges occasionally use dicta.  Somehow a blanket prohibition on the practice seems impractical. 

Second, Delaware courts regularly cite articles written by their bretheren as authority.  See Keyser v. Curtis, 2012 Del. Ch. LEXIS 175 n. 129 (Del. Ch. July 31, 2012) ("A similar application of the entire fairness doctrine has been advocated by a member of this Court, although not in a judicial opinion. See Leo E. Strine, Jr., et al, Loyalty's Core Demand: The Defining Role of Good Faith in Corporation Law").  Thus, articles and dicta can have essentially the same legal effect.

The Supreme Court opinion, therefore, is far more confusing than clarifying in its instructions to lower courts. 


Padfield on The Silent Role of Corporate Theory in the Supreme Court’s Campaign Finance Cases (Updated Draft)

I've posted an updated draft of my article, The Silent Role of Corporate Theory in the Supreme Court’s Campaign Finance Cases, 15 U. Pa. J. Const. L. __ (forthcoming), on SSRN (here).  The abstract reads as follows:

In Citizens United v. Federal Election Commission, a 5-4 majority of the Supreme Court held that corporate political speech could not be regulated on the basis of corporate status alone. In support of that conclusion, the majority characterized corporations as mere “associations of citizens.” The dissent, meanwhile, viewed corporations as state-created entities that “differ from natural persons in fundamental ways” and “have been effectively delegated responsibility for ensuring society’s economic welfare." I have argued previously that these two competing conceptions of the corporation implicate corporate theory, with the majority adopting an aggregate/contractarian view, and the dissent an artificial entity/concession view. Even if one understands Citizens United to be primarily about listeners’ rights, this stark contrast of competing theories of the corporation is difficult to ignore. At the very least, what the majority and dissent thought about corporate speakers was relevant to the question whether the campaign finance restrictions challenged in Citizens United should fall within that narrow class of speech restrictions justified on the basis of the speaker’s identity due to “an interest in allowing governmental entities to perform their functions.” Somewhat surprisingly, however, the majority was silent, and the dissent expressly disavowed, any role for corporate theory. I have previously offered some explanations for this apparent inconsistency, and concluded that an active “silent corporate theory debate” was indeed integral to the outcome of Citizens United - despite protestations to the contrary. In this project, I examine the key Supreme Court cases leading up to Citizens United to see whether a similar silent corporate theory debate is evident in those cases. I find that there is indeed such an on-going debate, and proceed to argue that in future cases involving the rights of corporations the justices should make their views regarding the proper theory of the corporation express. This will allow for a more meaningful discussion of the merits of those decisions, and impose an additional layer of intellectual accountability on the jurists.


The Election and Corporate Governance: Political Contributions and the Role of the SEC

In the aftermath of the election, attention is likely to return to the need to impose greater transparency on corporate campaign contributions.  While Citizens United ruled out most types of substantive regulation, the case specifically approved an approach  premised around greater disclosure. 

The DISCLOSURE (‘‘Disclosure of Information on Spending on Campaigns Leads to Open and Secure Elections Act of 2012’’) Act, HR 4010, seeks to do this.  The premise of the legislation is that corporations (and other organizations such as unions) must file a report with the Federal Election Commission that discloses campaign contributions. Presumably, in the aftermath of the election, this provision will again return to the forefront. 

The SEC presumably has the regulatory authority to require disclosure of this information.  Moreover, there is a strong regulatory reason for the SEC to do so.  The DISCLOSURE 2012 ACT leaves execution of these requirements to the FEC, not the SEC.  In other words, congressional intervention would largely give control over the disclosure process to another agency.  This is not an appropriate outcome and perhaps explains stories floating around that the SEC is prepared to act in this area.   


The Election and Corporate Governance: The Pressure on Dodd Frank Eased

After the election, the press noted statements by one prominent Republican that Obamacare is the law of the land.  So, in the aftermath of the election, is Dodd Frank. 

A victory for Governor Romney would likely have put pressure on Congress to repeal significant portions of Dodd Frank.  As the WSJ reports, this hope has largely evaporated.  The article noted the possibility of "small changes . . . in the next couple of years."  In other words, Dodd Frank is going nowhere and at most there may be some modest fixes, something always possible with such a long and complex piece of legislation. 

The election cycle also provided some evidence that opposition to Dodd Frank was costly at the ballot box.  One of the people defeated in this cycle was Nan Hayworth from New York.  Hayworth sponsored a number of efforts to repeal portions of Dodd Frank, including the disclosure of pay ratios.  Arguments were made that Scott Brown in Massachusetts acted to undercut provisions in Dodd Frank

With Dodd Frank no longer in doubt, certain provisions in the governance area will need to be implemented.  One is Section 952(b) and the requirement that companies disclose compensation ratios.  In addition, the Commission ought to reconsider shareholder access, the provision struck down by the DC Circuit.  With Congress having affirmed the SEC's authority to adopt a shareholder access rule, the post election cycle may be the right time to consider another effort at implementing the requirement. 


The Election and Corporate Governance: The Impact on the Courts

One place where there may be a change in the legal regime associated with corporate governance is the role played by the federal courts.  As this Blog has often discussed, the federal courts have not been particularly friendly toward corporate governance related issues. 

The Supreme Court has embarked on a deliberate policy to restrict the use of Rule 10b-5 in the context of private actions.  Janus is an example; so is Morrison.

The DC Circuit has been striking down SEC and other administrative rules while evidencing little concern with the requirement of agency deference.  Shareholder access is the obvious example.  Moreover, the trend has the potential to continue with industry challenges to the Conflict Minerals and Resource Extraction Rules.  The use of cost-benefit analysis as a basis for striking down rules such as the access rule has effectively forced agencies to direct resources away from rule writing and enforcement to economic analysis.  There is no evidence that this is the best use of agency resources and in any event it is not for a court to determine.

How important is the DC Circuit?  According to an editorial in the WSJ, the DC Circuit:

provides the only check on the burgeoning regulatory state. Congress tends increasingly to write ambiguous laws, precisely to give regulators the discretion to impose far-reaching costs on the economy without the legislators having to take responsibility for the vote.

There are currently no vacancies on the Supreme Court but some could come open in the next four years.  There are three vacancies on the DC circuit, with eight active judges.  The Obama Administration has nominated two judges to fill some of the vacancies.

Four more years of the Obama Administration means four more years of judicial appointments.  No one can predict with certainty what judges appointed for life will do.  But new appointees will change the mix of views and opinions and, in the area of corporate governance, may result in more investor friendly decisions. 


The Election and Corporate Governance: A Lesson in Demographics

If there has been a single common subject in the analysis of the 2012 presidential election, it has been the role of demographics.  Apparently something like 45% of President Obama's votes came from people of color.  He rolled up huge margins with Latinos, African Americans and, less discussed, Asians (Asians favored the President 73% to 26%). 

Then there were women, with the President chalking up a double digit lead (12%) with that group as well.  As one study noted:  "Since 1964 women have comprised a majority of the eligible electorate, but it was not until 1980 that the percentage of eligible women who actually voted surpassed the percentage of qualified men casting ballots . . . "

These demographics caused Politico to ask whether the Republican Party was Too old, too white, too male and whether this amounted to a "glaring structural weaknesses in the GOP".  See also Vote Data Show Changing Nation.

In the area of corporate governance, the exact same question can be asked about corporate boards and about the judiciary in Delaware.  Corporate boards of public companies consist of about 15% women (one study of the 1500 largest public companies put it at 12.7%) and 10% people of color.  For the most part, this means one woman and one person of color on a corporate board.

Similarly, Delaware determines the corporate law for an entire nation.  Yet, as we have noted, it is a remarkably undiverse group of judges.  There is, among the 10 jurists on the Chancery Court and the State Supreme Court, a single woman.  They often have similar backgrounds and attend similar law schools.  Moreover, as we have also noted, this lack of diversity can increasingly be contrasted with a more diverse federal judiciary. 

Corporate boards and the Delaware courts should consider whether they also have a "glaring structural weakness" that should be seriously considered.  For the Delaware courts, the lack of diversity provides another argument for preempting state statutes and transferring matters to the federal government. 

For public companies, the lack of diversity raises concerns over the quality of the board.  Companies that figure out the importance of diversity before the others may well obtain a competitive advantage in the market place.  See Essay: Neutralizing the Board of Directors and the Impact on Diversity