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Platinum Partners Value Arbitrage Fund LP v. Chicago Board Options Exchange: Regulatory Immunity Does Not Apply to Private Disclosure of a Regulatory Action

In Platinum Partners Value Arbitrage Fund LP v. Chicago Board Options Exchange, No. 1-11-2903 (Ill. App. Aug. 10, 2012), the appellate court reversed the trial court’s dismissal of the plaintiff’s securities and fraud claims, holding that the doctrine of regulatory immunity did not apply to the private disclosure of a stock option price adjustment by a self-regulatory organization (“SRO”).

The plaintiff, a hedge fund, alleged that an unnamed employee at one of the defendants Chicago Board Options Exchange (“CBOE”) or Options Clearing Corporation (“OCC”) disclosed a pending adjustment to the strike price of options in India Fund, Inc. (“IFN”) to insider market participants before making a public disclosure of that adjustment. The plaintiff further alleged that because it purchased 50,000 IFN put options after the private disclosure but before the public disclosure, it was harmed by the defendants’ private disclosure. The trial court dismissed the case, holding that the CBOE and OCC were absolutely immune from suit because the conduct at issue was undertaken as part of their regulatory duties as SROs.

Regulatory immunity applies to allegations concerning conduct “within the bounds of the government functions” delegated to an SRO. The test for whether conduct is within those bounds is objective and depends on whether “specific acts and forbearances were incident to the exercise of regulatory power.” The court reasoned that although the strike price adjustment was itself an exercise of regulatory power, the private disclosure, which served no regulatory purpose, was not. Thus, the private disclosure was not within the scope of regulatory immunity.

The defendants argued that, even absent regulatory immunity, the plaintiffs had failed to state a claim. The court, however, held that the plaintiffs had properly stated a claim of fraud under sections 12(F) and 12(I) of the Illinois Securities Law (which closely tracks federal securities law), the Illinois Consumer Fraud and Deceptive Business Practices Act, and common law. Section 12(F) claims require that “a complainant must allege that the defendant (1) made a misstatement or omission, (2) of material fact, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff reasonably relied and (5) that reliance proximately caused the plaintiff’s injuries.” Here, the defendants had a duty to disclose the strike price adjustment, and the plaintiffs adequately pleaded the requisite omission of that disclosure, materiality, reliance, and injury. In addition, the plaintiffs adequately pleaded the scienter element necessary for the other three claims.

Because the defendants’ private disclosure of the strike price adjustment was not within the scope of regulatory immunity, and because the plaintiffs adequately pleaded four fraud claims, the court reversed the trial court’s dismissal of the plaintiff’s claims. It also held that the plaintiff should be allowed to amend its complaint to include new facts and allegations discovered by its replacement counsel, because it was “in the best interests of justice.”

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


Richman v. Goldman Sachs Group: CDOs and Wells Notices

In Richman v. Goldman Sachs Group, Inc., WL 2362539 (S.D.N.Y. June 21, 2012), the court dismissed Plaintiffs' claim regarding Goldman Sachs Group, Inc.’s (“Goldman”) failure to disclose its receipt of Wells Notices but denied Defendants’ motion to dismiss claims pertaining to Goldman’s alleged conflicts of interest in several Collateralized Debt Obligation ("CDOs") placements.

Plaintiffs are purchasers of Goldman's common stock between February 5, 2007 and June 10, 2010 (“Plaintiffs”). Defendants are Goldman Sachs & Co (“Goldman”), Goldman Chairman and CEO Lloyd C. Blankfein, Goldman CFO David Viniar and Goldman COO Gary D. Cohn (“Individual Defendants.”) Plaintiffs claimed that Defendants made misstatements and omissions about Wells Notices the company received from the Securities and Exchange Commission (“SEC”), and about the conflicts of interest arising out of Goldman's role in structuring the CDOs known as Abacus, Hudson Mezzanine Funding ("Hudson"), Anderson Mezzanine Funding ("Anderson") and Timberwolf I.

In the Abacus transaction, for example, Goldman allegedly allowed one of its favored hedge fund clients, Paulson & Co., to select assets for inclusion in the CDO. At the same time, however, Goldman falsely identified ACA Management as the sole portfolio selection agent for the transaction.  Goldman also allegedly told investors that it had "aligned itself with the Hudson program by investing in a portion of equity," while at the same time it failed to disclose that it had the entire short position on the deal (in other words, Goldman did not disclose that its $6 million equity holding in the CDO was dwarfed by the $2 billion short position held in it). Plaintiffs also alleged other examples of undisclosed conflicts.  

The court found that Plaintiffs plausibly alleged that Goldman made material omissions regarding its arrangement with Paulson & Co. in the Abacus transaction because Defendants "knowingly allowed Paulson to select the assets for the Abacus CDO, and knew that Paulson was selecting assets that it believed would perform poorly or fail." Similarly, the court found that Plaintiffs plausibly alleged that in the Hudson, Anderson, and Timberwolf I CDO transactions, Goldman represented that it held a long position in the equity tranches and did not disclose its substantial short positions. As the court said:

 "having allegedly affirmatively represented [Goldman] had a particular investment interest in [these synthetic CDOs]—that it was long—in order to be both accurate and complete, Goldman ... had a duty to disclose [it] had a [greater] investment interest [from its] short [position] ... [because that was] a fact that, if disclosed, would significantly alter the ‘total mix’ of available information."

Finding that Plaintiffs established duty, the court turned to the scienter analysis. Scienter could be  inferred when defendants "knew facts or had access to information suggesting that their public statements were not accurate." Here, Defendants allegedly assured shareholders that Goldman complied with the law and that it had "procedures in place to address 'potential conflicts of interest.'" Alternately, Goldman allegedly fostered a conflict of interest in the Abacus CDO and acted against investor interest in Hudson, Anderson and Timberwolf I. The court found that "Goldman knew or should have known that its statements about complying with the letter and spirit of the law, and its disclaimers regarding ‘potential’ conflicts of interest were inaccurate and incomplete." The court agreed with Plaintiffs that a strong inference of scienter could be drawn from Goldman's actions in the four CDO deals.

The court also found that Plaintiffs had sufficiently alleged loss causation and claims against the Individual Defendants.  The Individual Defendants allegedly helped prepare the SEC filings at issue. Moreover, scienter was established through allegations that the Individual Defendants actively monitored the status of the relevant CDO assets and were intimately acquainted with the CDO operations.    

With respect to the Wells Notices, Goldman, according to Plaintiffs, failed to disclose the receipt of the Wells Notices from the SEC in connection with the investigation of the Abacus transaction.  Plaintiffs asserted that Defendants' disclosures about governmental investigations triggered a duty to disclose receipt of Wells Notices, and that by failing to do so caused the public to mistakenly believe that “no significant developments had occurred which made the investigation more likely to result in formal charges." The court noted that the delivery of a Wells Notice, while reflecting the SEC Enforcement Division’s determination on bringing charges, did not necessarily mean that charges would be filed.  The court found that failure to disclose receipt of the Wells Notices did not render Goldman’s statement misleading and that Defendants' violation of FINRA's Wells Notice disclosure requirement was not grounds upon which a section 10(b) or Rule 10b-5 claim could be based.   The court also rejected the argument that a FINRA rule requiring disclosure of a wells notice triggered a duty to disclose under the antifraud provisions. 

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


How Women Can Change Corporate Boards: The Effects of Achieving a Critical Mass of Female Directors

This post was co-authored and submitted to The Race to the Bottom by Anna Catalano and Nick Slavin. Ms. Catalano serves on the boards of directors of Mead Johnson Nutrition, Willis Group Holdings, Chemtura, and Kraton Polymers. Her leadership blog can be found here. Mr. Slavin wrote this when he was a corporate attorney with Skadden, Arps, Slate, Meagher & Flom LLP.  

As the number of qualified women in the corporate director candidate pool grows, companies are reconsidering the business case for gender diversity on boards. The most familiar arguments involve the optical value of having a board’s members reflect the company’s diverse employees, customers, shareholders, and other stakeholders, and the strategic value of women’s diverse “perspective” in the boardroom. In recent years, however, the arguments have come into sharper focus as some commentators have made the controversial claim that women may have higher ethical standards in business than do men,[1] and studies have more precisely articulated the benefits women can provide in the boardroom and the circumstances in which such benefits occur. 


Although the causal mechanisms are difficult to pinpoint, the correlations between women directors and ethical governance are beginning to show a pattern. A 2009 study in Corporate Reputation Review found that Fortune 500 companies with higher percentages of women directors were more likely to be found on Ethisphere Magazine’s “World’s Most Ethical Companies” list.[2] Other studies identify a correlation between women directors and higher scores on measures of corporate social responsibility.[3] Data from the Journal of Financial Economics suggest that these positive effects might be due in part to the effects they have on the other board members, showing that a greater number of female directors is correlated with better attendance and engagement of male directors.[4]

Recent research analyzes how boardroom dynamics change as the number of female directors increases. Kramer, Konrad, and Erkut’s (2006) Critical Mass study observes that the benefits of a gender diverse board only fully appear upon reaching a “critical mass,” or tipping point, of women directors.[5] Their research shows that while one woman may have a potential impact in the boardroom, the presence of three or more substantially increases the magnitude of women’s influence. Reaching this threshold number gives women the support and validation they need to be the most effective directors.

In some European countries, reaching this threshold is now mandated. Required gender-based quotas for public company boards have been introduced in Norway, France, Iceland, and Spain, while countries such as Switzerland, Israel and South Africa have introduced quotas for government-owned companies.[6] Norway’s mandated quota, introduced in 2003, called for women to comprise at least 40% of public boards by 2008.[7] Proponents argue that Norway’s model has not adversely affected corporate valuations as some feared, and Norwegian board members interviewed about their experiences report that the markedly increased female presence has at a minimum made preparation material more comprehensive and processes more formal, both of which tend to be associated with good governance.

Solo female directors, however, remain common in the United States. Catalyst, a nonprofit organization that advocates women in business, reports that in 2005, 182 companies in the Fortune 500 had just one female director, while 53 companies still had no female representation on their boards.[8] While strong women can make a substantial difference as solo flyers, those who serve as the lone woman director often report feelings of isolation as fellow board members may view their competence cautiously. Though two women with different styles and areas of expertise can help dispel some feelings of tokenism (particularly if their backgrounds include significant profit-and-loss and financial experience), women who serve on boards with only two female directors say they dislike being stereotyped as the “women’s contingent.”[9] The Critical Mass study indicates that boards that follow the “rule of three” normalize women’s presence in the boardroom, where they are viewed more as contributing individuals rather than as representatives of their gender. In contrast to the Norwegian model, relatively few American companies benefit from this phenomenon: last year, just over one-fifth of companies in the Fortune 500, where average board size is over 11, had three or more women directors.[10]

Moving boards beyond the lone token woman requires companies to see the value of a gender-diverse board, and a number of recent studies have highlighted the benefits of gender diversity. They note that women more often consider multiple stakeholders, not just stockholders, when making decisions, and have a greater connection to the complex human context of the business. According to some, women are more likely to ask tough questions and demand comprehensive answers, and their collaborative leadership style and direct manner of communication can improve board dynamics as well. The Norwegian data also support previous studies observing that boards with more women tend to be more engaged, better prepared, and more observant of formalities.

Still, the subtle and often ambiguous benefits that female directors bring continue to be debated, with many arguing that women directors are not preferable to serve on boards than similarly qualified male candidates. A 2010 study surveying 400 male and female board members of primarily American companies concluded that while 90% of female directors believed women bring unique attributes and perspectives to the boardroom, only about half of male directors shared the sentiment.[11] The same study showed that male directors were less likely than female directors to support the SEC rule mandating an explanation of diversity’s role in board member selection (43% vs. 62%, respectively). Likewise, 25% of surveyed women supported diversity quotas and regulations, while just 1% of men reported so.

Perhaps these differences of opinion in part reflect the reality that with diversity comes potential risks: miscommunication, conflict, exclusion, and loss of camaraderie. Qualified directors must be chosen carefully and the chairman must have the ability to temper the wider range of opinions at the table with an overall sense of group cohesion.

While the benefits of gender diversity on boards remain controversial, recent research, as well as the effects of quotas in certain countries in Europe and elsewhere, have helped to articulate clearer rationales for boards adding strong female directors, at least until a “critical mass” is achieved.

[1] Lisa Yoon, “On Boards, Are Women the Fairer Sex?,”, April 10, 2003. Retrieved from

[2] Bernardi, Richard A., Susan M. Bosco, and Veronica L. Columb, “Does Female Representation of Boards of Directors Associate with the ‘Most Ethical Companies’ List?” Corporate Reputation Review 12.3 (2009): 270-280. Business Source Complete. Web. 13 June 2012.

[3] Bernardi, Richard A., and Veronica H. Threadgill, “Women Directors and Corporate Social Responsibility.” Electronic Journal of Business Ethics and Organization Studies 15.2 (2010): 15-21. Retrieved from

[4] Adams, Renée B., and Daniel Ferreira, “Women in the Boardroom and Their Impact on Governance and Performance.” Journal of Financial Economics 94.2 (2009): 291-309. Elsevier. Retrieved from

[5] Kramer, Vicki W., Alison M. Konrad, and Sumru Erkut, “Critical Mass on Corporate Boards: Why Three or More Women Enhance Governance.” Wellesley Centers for Women 11 (2006): 1-74.

[6] Wintrob, Suzanne, “Mandated Diversity Quotas Won’t Make Corporate Governance Any Better,” Financial Post Magazine, June 19, 2012. Retrieved from

[7] Ibid.

[8] Soares, Rachel, Baye Cobb, Ellen Lebow, Allyson Regis, Hannah Winsten, and Veronica Wojas, “2011 Catalyst Census: Fortune 500 Women Board Directors.” Catalyst (2011): 1-2. Retrieved from

[9] Kramer, Konrad, and Erkut, 30.

[10] Soares et al.

[11] Connor, Michael, “Men and Women Disagree Sharply on Governance.” Business Ethics, October 7, 2010. Retrieved from



Stock Exchanges and the Implications of Demutualization

The WSJ reported that the SEC was clamping down on the efforts by stock exchanges to "bolster profits by pumping out products that increasingly have catered to high-speed traders."  As the article noted:

  • Since the flash crash of May 2010, SEC Chairman Mary Schapiro has been personally involved in driving inquiries about whether exchanges are improperly favoring customers whose rivers of buy and sell orders drive exchange profits, according to a person familiar with her thinking.
  • The agency is investigating whether exchanges have provided such clients order-routing privileges that give them an edge over ordinary investors.

The article comes on the heels of the decision by the SEC to fine the NYSE $5 million for violations of Rule 603 (a)(1) of Regulation NMS.

The article suggests that the stock exchanges are motivated by profit maximization in the introduction of new products.  They should be.  Both have converted to for-profit companies with the accompanying obligation to profit maximize.  At the same time, however, they are self regulatory organizations with legal and regulatory responsibilities.  As the SEC described:

National securities exchanges, such as NYSE, are critical elements of the national market system.   Because of this central role, an exchange is required to satisfy among the most significant regulatory responsibilities of any market participant.  These regulatory responsibilities implicate both an exchange’s own operations and its role as a self-regulatory organization that acts as a co-regulator with the Commission and other authorities.

While the exchanges strive to profit maximize while protecting the regulatory function (the NYSE for example has created a separate nonprofit subsidiary with an independent board to perform regulatory functions), one has to wonder whether, in the end, the NYSE (and Nasdaq) would benefit from sheering off any remaining regulatory responsibilities.  That would not prevent the SEC from adopting rules (such as Rule 603) and bringing actions against companies that violated the rules.  But it would give the exchanges greater freedom to act as the "for profit" companies that they have become.  


Taneja v. Familymeds Group, Inc. and the Importance of Process

Delaware has a reputation for producing management-friendly decisions in the corporate governance area.  The evidence can be seen from the jurisprudence emanating from the state, but it also can be seen from the fact that plaintiffs increasingly seek to litigate governance issues in other jurisdictions.    The thinking, presumably, is that they will get a better result in other states, even when the courts are applying Delaware law.  

A possible example of this occurred in Taneja v. Familymeds Group, Inc., 2012 Conn. Super. LEXIS 2127 (Conn. Aug. 21, 2012).  Shareholders brought a derivative action against the board, essentially alleging mismanagement.  The business mostly operated in Connecticut but was incorporated in Nevada.  The court noted that Nevada, in the absence of controlling law, viewed Delaware as persuasive.  As a result, the court found itself interpreting Delaware law.   

In the derivative action, defendants were represented by a law firm ("Law Firm").  The original case was dismissed for failure to make demand.  Plaintiffs thereafter made demand.  The directors were represented by the same Law Firm.  The Law Firm conducted an investigation into the allegations and ultimately issued a report concluding that "the allegations of the plaintiffs' demand were not substantiated."  The report was approved by the two directors "not subject to a conflict because of the pending demand allegations."  

Plaintiffs challenged the board's decision to reject demand.  The court noted that, under Delaware law, it was limited to "an analysis of the board's good faith and the reasonableness of the board's investigation of the demand." The court concluded that the designation of the Law Firm to undertake the investigation had not been done in good faith.  

The court essentially found that the Law Firm wore two hats:  Independent investigator and advocate for defendants.  The two positions could not be reconclied. 

At the time of the delegation, the directors were not disinterested. The assumption and the expectation were that the investigation's conclusion was predetermined, and that it was to be in the board's favor. The obligation of [the Law Firm] was to defend their client first and foremost. The undertaking of the investigation commenced while this purpose was in mind. This "asks too much of human nature . . ."  

Nor did approval by the disinterested directors change the outcome.  "The two remaining directors who voted . . . 'controlled neither which facts they heard nor the legal guidance given to them to put the evidence into the proper context.'" So long as the decision was based upon "the report of a conflicted law firm, then their conclusions are not entitled to the presumption that they were reasonable."

In the area of demand refusal, courts primarily rely on process to protect shareholders.  In this case, the court did not really question the quality of the investigation.  It was enough that the integrity of the process was in doubt.  Would Delaware courts have agreed?  Plaintiffs avoided having to find out by maintaining the action in Connecticut. 


Central States Law Schools Association 2012 Scholarship Conference

The Central States Law Schools Association 2012 Scholarship Conference will be held October 19 and 20, 2012, at the Cleveland-Marshall College of Law, in Cleveland, Ohio.  I've attended the conference multiple times and highly recommend it for anyone interested in getting helpful feedback on a work-in-progress in a very supportive environment.  Abstracts are due September 22, 2012.  For more information, go here.


Independent Agency Regulatory Analysis Act of 2012: S 3468 (Part 3)

There is another critically important issue raised by the Independent Agency Regulatory Analysis Act that represents a significant and historical shift in the treatment of independent agencies.

The term "independent agency" has multiple definitions.  Sometimes it is used to mean a free standing agency.  Under that definition, the EPA is an independent agency because it is not buried in another department.  The IRS is not an independent agency because it is in the Department of Treasury.  This definition is mostly a matter of geography and says nothing about the powers of the particular agency.

The term also, however, has a constitutional significance.  There are agencies that are "independent" because they are "independent" of the President.  Independence can come from a variety of powers given to an agency that allow them to act without consulting those in the White House (Justice Breyer lists some of them in his dissent in the PCAOB case).

But in truth there is only one attribute that truly matters for purposes of independence and that is the limitation on the President's ability to remove agency heads "for cause."  To the extent that an agency head cannot be removed at will, the agency head has greater independence and at least sometimes can deflect political considerations in making policy. 

The Independent Agency Regulatory Analysis Act of 2012 provides that the President can, by executive order, regulate the rulemaking process of "independent" agencies.  Independent is defined as those agencies listed in 44 USC 3502(5). The agencies listed in this section include:

  • the Commodity Futures Trading Commission, the Consumer Product Safety Commission, the Federal Communications Commission, the Federal Deposit Insurance Corporation, the Federal Energy Regulatory Commission, the Federal Housing Finance Agency, the Federal Maritime Commission, the Federal Trade Commission, the Interstate Commerce Commission, the Mine Enforcement Safety and Health Review Commission, the National Labor Relations Board, the Nuclear Regulatory Commission, the Occupational Safety and Health Review Commission, the Postal Regulatory Commission, the Securities and Exchange Commission, the Bureau of Consumer Financial Protection, the Office of Financial Research, Office of the Comptroller of the Currency, and any other similar agency designated by statute as a Federal independent regulatory agency or commission;

The definition also includes the Federal Reserve Board but the legislation specifically exempts the Fed from its requirements. 

For the most part, these agencies have commissions or agency heads that can only be removed for cause, although there is considerable variation.  The OCC enabling act, for example, provides that the Comptroller may be removed "upon the reasons" communicated by the President to the Senate.  See 12 USC 2.  The SEC commissioners are treated as removable only for cause but the enabling statute does not actually say that (it does provide for five year terms).  See Section 4 of the Exchange Act, 15 USC 78d (also requiring that no more than three commissioners be from the same political party). 

As a result of this limitation on presidential removal authority, the general view is that these agencies are less subject to political influence.   Moreover, in the folklore of administrative law, there is a view that Congress has a greater proprietary interest in the independent agencies.  Commissions (like the SEC) must have representation from more than one political party.  And the parties in Congress are keen to make sure that, in appointing commissioners, their views are represented.  The presence of genuine representatives of both parties can reduce the influence of the President.   

The Independent Agency Regulatory Analysis Act of 2012, therefore, does two things.  First, it increases the potential for politicizing the rulemaking (and policy making) process of the listed agencies.  Whether the SEC and the securities markets, or the OCC/FDIC and banking policy, or the NRC and nuclear power policy, these matters will be susceptible to greater political intrusion.  OIRA and its so called "nonbinding" assessments will provide plenty of room for interference.  Moreover, the exception in the legislation for the Fed shows that the sponsors understood that this could occur and at least sometimes thought it a bad idea.  There is no explanation, however, why this exception was applied only to one agency. 

Second, it is, frankly, a give away of authority from Congress to the President.  In truth, the President can probably already subject independent agencies to rulemaking oversight.  The issue is constitutional.  In the past, the courts viewed the independent agencies as outside the executive branch (in the interstices between the branches if you can believe that). 

After Morrison v. Olson, 487 US 654 (1988), it is relatively clear that the independent agencies are in fact in the executive branch.  As a result, there is a very strong argument (but not one completely free from doubt) that the President can, absent affirmative prohibitions in the statute, subject all executive branch agencies to a common set of rulemaking policies, including those designated as independent.  

Indeed, past Presidents have concluded that they have the authority to do so.  See Richard H. Pildes & Cass R. Sunstein, Reinventing the Regulatory State, 62 U. Chi. L. Rev. 1, 28 (1995) ("Under President Reagan, the Department of Justice concluded that the President had the legal authority to extend the orders [imposing centralized control over the regulatory process of independent agencies]").  They have not done so, however, at least in part for political reasons.  See Id. ("President Reagan declined to include the independent agencies within the requirements of his two executive orders. In part, this appears to have been a political judgment. The Democratic Congress, skeptical of the executive orders in general, might well have been outraged by an assertion of presidential authority over the independent agencies, which Congress often considers 'its own.'").

This legislation will resolve the issue.  It is true that the legislation removes any remaining legal uncertainty about the President's authority to subject these agencies to rulemaking oversight.  But mostly what it does is give the President permission to exercise the same level of control over independent agencies that it does over traditional executive branch agencies.  In exercising the judgment, Presidents will not need to worry any more about legislative outrage in asserting increased control over these agencies. 


Independent Agency Regulatory Analysis Act of 2012: S 3468 (Part 2)

The Independent Agency Regulatory Analysis Act raises some significant concerns and reflects an effort to make even more difficult the rulemaking process for independent agencies like the SEC. 

The additional procedures that can be imposed on independent agencies under the legislation are triggered by executive orders issued by the President.  In other words, every time the presidency changes, a new president can effectively impose additional rulemaking procedures on independent agencies.  Moreover, the OIRA can be given 90 days to conduct an assessment of the independent agency's compliance with applicable "regulatory analysis requirements."   All of this allows for shifting standards and increased delay.  

What are the consequences of delay?  The SEC's proposal to repeal the ban on general solicitations was sharply criticized in some quarters because it was issued as a proposal rather than an interim final rule.  In other words, the SEC was criticized for delay.  Yet had this Act been in place and the SEC was required to submit the proposal to OIRA, there would have been additional delay.

The assessment by OIRA is described as "nonbinding."  To the extent that OIRA finds that the independent agency did not follow the required procedures, however, the head of the agency must provide "an explanation" for the noncompliance.  Rather than acknowledge noncompliance as part of the rulemaking process, an agency head is likely to "comply" with any issue raised by OIRA.  As a practical matter, therefore, the so called "nonbinding" review by OIRA will in fact be "binding."

Finally, the approach will simply discourage rulemaking, a trend already underway as a result of decisions like Business Roundtable v. SEC (see Shareholder Access and Uneconomic Economic Analysis: Business Roundtable v. SEC).  The consequence is not necessarily less regulation.  Agencies may not be willing to update their regulatory framework, leading to an ossified regulatory structure, or may rely on more informal methods of implementing regulations.  The SEC can use no action letters, enforcement proceedings, phone advice, and other informal mechanisms to set out regulatory positions.  The integration of the Internet into the private offering process (through password protected web sites) was, for example, done as part of an informal process mostly through the mechanism of no action letters. 

Informal positions are less transparent and do not have to go through notice and comment.  Nor do they necessarily result in better outcomes.  Nonetheless, informal positions will not need to go through OIRA. 


Independent Agency Regulatory Analysis Act of 2012: S 3468 (Part 1)

Legislation is being taken up in the Senate to further impose limits on rulemaking by the SEC (and other independent agencies).  The Independent Agency Regulatory Analysis Act of 2012 would subject "independent regulatory agencies" to the "regulatory analysis"  requirements applicable to executive agencies."  The legislation is sponsored by Senators Portman, Warner, and Collins.  

Under the provision, independent agencies can be subject to an executive order that requires the "regulatory analysis" otherwise imposed on traditional executive branch agencies.  In addition, the President can require that an independent agency submit a proposed or final rule to the Office of Information and Regulatory Affairs for "review."  OIRA can take up to 90 days to determine whether "the agency has complied with the regulatory analysis requirements made applicable by Executive order." 

To the extent OIRA determines that the independent agency has not met the requirements, the Agency head is obligated to address the findings in the rulemaking record.  The Agency must include a "clear statement" of the issues engendering agreement and disagreement with OIRA.  To the extent that the head of the agency determines that, in fact, the rule complies with the relevant executive order but must include "an explanation of that determination."  Alternatively, there must be an explanation "why the independent agency did not comply" with the relevant requirements.

The legislation has a number of implications.  We will discuss them in the next post. 


Proxy Statements: Part 1 & Part 2

One of the issues that has arisen in the corporate governance area is the concern over information overload.  The Proxy Statement has become increasingly crowded with disclosure that is relevant to shareholders but adds to the length and complexity of the document. 

Proxy statements are already long.  Take the one filed by Apple.  The document was 51 pages long.  Executive compensation took up 14 pages (pp. 21-35), with another page devoted to equity compensation plans. 

Each time the Commission proposes a new disclosure requirement for the proxy statement, one of the criticisms invariably involves the added length and complexity.  In adopting Rule 10C-1, for example, the Commission noted that commentators raised:  

concerns about extending already lengthy proxy statement discussions of executive compensation and expressing doubt that additional disclosure of the process for selecting advisers would provide any useful information to investors.

Exchange Act Release No. 67220  (June 20, 2012).  The concerns apparently had an effect on the final rule.  As the Commission concluded:  

Consistent with the proposed rule, the final rule does not require listed issuers to describe the compensation committee's process for selecting compensation advisers pursuant to the new listing standards. We are sensitive to the concerns of commentators that adding such disclosure would increase the length of proxy statement disclosures on executive compensation without necessarily providing additional material information to investors.

Pressure for additional disclosure in the proxy statement will only continue. The Commission has been called upon to require increased disclosure on a number of corporate governance issues, including political contributions, sustainability reporting, shareholder approval of auditors, and global warming.  Whatever the merits of each of these proposals, they will presumably add to the length and complexity of the proxy statement.

It is, therefore, time to consider a Part 1 and Part 2 of a proxy statement, much the way the Commission already divides registration statements.  Part 1 could be the material that had to be distributed directly to shareholders.  It could be formatted in XBRL and written in plain English. 

Part 2 could include some of the more complicated disclosure mandated by the proxy rules but of interest only to a small minority of investors.  Part 2 could then be posted on the Internet.  One suspects, for example, that much of the disclosure in the Apple Proxy Statement on executive compensation could be in the Part 2.    

The approach would allow for the distribution of a simpler proxy statement while making the full disclosure easily available to anyone interested.  A shorter proxy statement would entail costs savings, reducing the distribution expenses.  At the same time,  it would hold out the promise of a proxy statement that retail investors might actually read, potentially increasing the possibility that they would return their voting instructions.   


An Expanded Role in Governance for the SEC: Iran Threat Reduction and Syria Human Rights Act

In the realm of corporate governance, the SEC has traditionally been responsible for disclosure while substance fell to the states.  The basic separation forced the Commission to use disclosure in order to change substantive behavior, an approach that worked with varying levels of success (or lack of success).  See Essay: Corporate Governance, the Securities and Exchange Commission, and the Limits of Disclosure

The neat division, however, no longer exists.  Congress has increasingly given the SEC a much more substantive role in the corporate governance process.  The authority ranges from drafting listing standards for audit committees (see Rule 10a-3) and compensation committees (see Rule 10C-1) to seeking clawbacks of executive compensation.  It is the SEC, not the states, that oversees the advisory vote by shareholders on compensation (say on pay). 

Congress, however, has gone further and injected the Commission into the area of corporate social responsibility.  In Dodd-Frank, the SEC was assigned the task of implementing disclosure requirements for conflict minerals.  Some have described the information as important to investors but for the most part the disclosure requirements were designed to affect corporate behavior.  The approach likely would reduce the willingness of companies to purchase conflict minerals and reduce funding for military groups in and around the Democratic Republic of the Congo.  Disclosure imposed on resource extraction companies also has goals consonant with corporate social responsibility. 

The recent adoption of the Iran Threat Reduction and Syria Human Rights Act has pushed the SEC in yet another direction. The legislation was designed to, among other things, impose sanctions on Iran in order to stop the development of nuclear weapons.  Section 219 of the Act added a new subsection (r) to Section 13 to the Exchange Act and imposed disclosure requirements on public companies with respect to compliance with the Act.   Like the conflicts mineral requirements, the disclosure is less about investor information and more about ensuring substantive compliance. 

The provision went further, however, and required the Commission to post information about non-compliance on its web site.  Companies subject to the Act must provide the Commission with a separate notice whenever they report activity under the Act.  The Commission is then required to transmit the relevant report to the President and Congress.  In addition, however, the Commission must "make the information provided in the disclosure and the notice available to the public by posting the information on the Internet website of the Commission."

Presumably this means something other than disclosure through Edgar.  The SEC will likely have to set up a separate page that discloses reports filed pursuant to the Act.  The idea of disclosure on the SEC website has been tried before.  A number of problems arose.  Because circumstances changed, there were concerns over the timeliness of the information.  Moreover, it raised a fundamental question about the role of the SEC in publicizing these types of activities, particularly given the public nature of the disclosure.  Some of these issues may resurface in the implementation of this provision. 

The prior example was voluntary and, when confronted with all of the difficulties, abandoned.  This one, however, is mandated by Congress.  It puts the SEC into the job of disclosing on its web site certain types of corporate behavior.  Its not clear why the SEC needs to have this role but one suspects the instances of this type of requirement will increase. 


Barry, Hatfield & Kominers on Derivatives Markets and Social Welfare

Jordan M. Barry,  John William Hatfield, and Scott Duke Kominers have posted On Derivatives Markets and Social Welfare: A Theory of Empty Voting and Hidden Ownership on SSRN with the following abstract:

The prevailing view among many economists is that derivatives markets simply enable financial markets to incorporate information better and faster. Under this view, increasing the size of derivatives markets only increases the efficiency of financial markets. 

We present formal economic analysis that contradicts this view. Derivatives allow investors to hold economic interests in a corporation without owning voting rights, or vice versa. This leads to both empty voters — investors whose voting rights in a corporation exceed their economic interests — and hidden owners — investors whose economic interests exceed their voting rights. We show how, when financial markets are opaque, empty voting and hidden ownership can render financial markets unpredictable, unstable, and inefficient. By contrast, we show that when financial markets are transparent, empty voting and hidden ownership have dramatically different effects. They cause financial markets to follow predictable patterns, encourage stable outcomes, and can improve efficiency. Our analysis lends insight into the operation of securities markets in general and derivatives markets in particular. It provides a new justification for a robust mandatory disclosure regime and facilitates analysis of proposed substantive securities regulations.


AALS Section Transactional Law and Skills Call for Posters

Eric Gouvin from Western New England University School of Law sent me the following call for posters for the 2013 AALS meeting:

The AALS Section on Transactional Law and Skills invites faculty at AALS member law schools to submit poster presentation proposals for the 2013 AALS Annual Meeting in New Orleans (January 4-7, 2013).  The Section will consider all proposals relating to the teaching of, or scholarship focusing on, transactional law and skills.  Proposals consistent with this year’s Section panel on international transactions will be given a slight preference.

Posters are intended to provide authors an opportunity to present in clear and succinct fashion the thesis and conclusion of their research or to describe teaching innovations outside formal program presentations.  Because the focus should be on the content of the research and innovative teaching, posters that were primarily promoting a particular school program, project, book or materials are not eligible for poster display. Other advertising or fliers are not permitted with posters.

Please send your proposal by e-mail to by September 28, 2012. The proposal should state your name, the name of your law school, the Section for which you are submitting, the title of the poster, an actual electronic copy of the poster itself and a description of what you will be presenting. Your proposal and poster will be sent to the Section Chair and Chair-Elect who will form a Section review committee to determine what posters should be recommended to the AALS Committee on Sections and Annual Meeting, which will make the final selection of all posters.

This is an opportunity to share your work with the larger academic community.   If your Section is not sponsoring posters, you may still submit a poster proposal; the AALS Committee on Sections and Annual Meeting will review it. AALS will notify all posters proposers by November 9th, 2012 if the poster has been selected, and if so, the date, time and location of the poster presentation at the Annual Meeting.

If you have any questions about the Transactional Law and Skills Call for Posters, please contact either:

Joan MacLeod Heminway, Chair, University of Tennessee,

Eric Gouvin, Chair-elect, Western New England University,

All of the AALS details for submission can be found at the Section’s website:

The AALS Section on Transactional Law and Skills has been doing some wonderful work in promoting experiential learning and preparing students for practice.  Hopefully, some of our readers will consider submitting.


Another Crisis, Another Prophetic Woman Ignored

By now, most people are familiar with the story of Brooksley Born, who essentially predicted the financial crisis of 2008 while she was head of the Commodity Futures Trading Commission (CFTC)—only to be rebuffed by Alan Greenspan, Robert Rubin and Larry Summers.  Other women, like Sheila Bair and Susan Bies also apparently sounded alarms that were ignored.   Now we learn that another woman, Angela Knight, gave unheeded warnings related to the Libor scandal.  As the Wall Street Journal puts it (here):

At an April 25, 2008, meeting with officials at the Bank of England, Angela Knight, head of the British Bankers' Association, argued that the London interbank offered rate, or Libor, which serves as the basis for interest rates on trillions of dollars of loans and financial contracts, had become too big for her organization to manage, according to minutes of the meeting and a person who was there. Her suggestion went nowhere.

As I have noted previously, one may well ponder the gender implications of financial crisis in light of all of this.  The money quote from that post:

In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles.


Tomer on a More Human Economics

John F. Tomer has published “Brain Physiology, Egoistic and Empathic Motivation, and Brain Plasticity: Toward a More Human Economics” in the World Economic Review.  Here is the abstract:

The brain physiology research of leading evolutionary neuroscientist, Paul MacLean, has important implications for human economic motivation. Gerald Cory in his research has admirably utilized MacLean’s findings and has persuasively explained that humans have two dominant motivations: 1) ego or self-interest and 2) empathy or other-interest, which our brains attempt to balance. This view is clearly important and at odds with mainstream economics in which self-interest is the dominant motivation. The MacLean-Cory view, also known as Dual Motive Theory (DMT), represents a serious challenge to mainstream economics. However, the DMT leaves something to be desired. While understanding the promise of the perspective deriving from brain physiology, some scholars have expressed dissatisfaction with it. Accordingly, the purpose of this paper is to revise DMT utilizing the concept of brain plasticity and argue that the mainstream economic image of the brain is not supported by current knowledge of brain science. Brain plasticity refers to the ability of the brain to change structurally and functionally as a result of input from the environment. Some of this plasticity is no doubt genetically determined but some brain change is a product of individual effort and represents the individual’s investment in intangible capital (standard human capital, social capital, personal capital, and so on). In this revised view, the balance that individuals, groups, and societies strike between ego and empathy orientation is to a great extent determined by these intangible investments, not simply by brain physiology.


O'Kelley on the Evolution of the Modern Corporation

Charles R.T. O'Kelley has posted “The Evolution of the Modern Corporation: Corporate Governance Reform in Context” on SSRN. Here is the abstract:

This article traces the evolution of the modern corporation from the American Civil War to the present. I begin with a focus on the period from 1865 to the Great Depression. This was the era of the Great Tycoon, the time of the second industrial revolution and the transformation of America’s economy from small proprietorships and partnerships to the forerunner of the modern corporation. I then detail the transformational crisis of the Great Depression and Adolf Berle’s central role in shaping America’s changed understanding of the proper relationship between government and the modern corporation. It was Berle, both as a scholar and key advisor to Franklin Roosevelt, who recast America’s history so that the New Deal seemed a natural extension of individualism. The following part details the period encompassing the New Deal and the Second World War. It is this period in which the United States develop into a modern, Keynesian social democracy. It is this period when the United States, in partnership with the modern corporation, assumes the mantle of world hegemon. I then examine the modern corporation during heyday of American hegemony and the so-called “golden age of American capitalism;” the period runs roughly from 1950 to 1973 and is characterized by the Galbraithian corporation, with power devolved to the technocracy of the firm. I conclude with tentative intuitions as to the nature of the modern corporation and the CEO in recent times. The tentativeness of this final section is purposive. We are too close in time to the “present” to agree on what has transpired, much less what is about to transpire. Thus, my effort is to provide a common backdrop for understanding the slightly more distant past, in hopes that conversation about the near present and near future will be more fruitful.


Nation v. American Capital, Ltd.: Seventh Circuit Upholds Summary Judgment on Conditional Privilege Grounds

In Nation v. Am. Capital, Ltd., 2012 U.S. App. LEXIS 11214 (7th Cir., June 4, 2012), the Seventh Circuit Court of Appeals affirmed the district court’s grant of summary judgment against James Nation (“Plaintiff”) on his claim that American Capital, Ltd., (“Defendant”) tortiously interfered with a settlement contract between Plaintiff and his former employer, Spring Air.

Plaintiff had been Spring Air’s president and chief executive officer since 1995.  In 2007, Defendant helped finance Spring Air’s acquisition by HIG Capital (“HIG”) and, in the process, Defendant acquired a minority interest in Spring Air and a seat on the board of directors.  Shortly after acquiring Spring Air, HIG replaced Plaintiff as president and CEO and granted him a severance package of $1.2 million in return for his agreement not to work for any competitor through 2008.  Payments under this severance arrangement were spread over a period of fifteen months.  In 2008, Spring Air encountered severe financial difficulty, and Defendant agreed to provide additional cash to Spring Air in exchange for additional board seats.  By June 2008, Defendant “was the majority equity holder and controlled four of the seven seats on the Spring Air board.”

In August 2008, Spring Air stopped severance payments to Plaintiff and three other former employees.  In response, Plaintiff filed suit against Spring Air for the remaining severance payments.  When Spring Air filed for Chapter 7 bankruptcy in May 2009, Plaintiff brought a separate action against Defendant that alleged tortious interference with contract.  Plaintiff argued that Defendant, by virtue of its controlling position,  induced Spring Air to breach the severance agreement.

The district court granted summary judgment,  finding that Defendant “was conditionally privileged to interfere with [Plaintiff’s] contract based on [Defendant’s] status as Spring Air’s majority shareholder” and that Plaintiff had failed to present sufficient evidence to overcome this conditional privilege.

Under Illinois law, conditional privilege is an arm of the business judgment rule that allows a defendant “to protect an interest which the law deems to be of equal or greater value than the plaintiff’s contractual rights.”  The conditional privilege theory is based on the premise that the interests of a corporation and its officers, directors, and shareholders are sufficiently aligned such that officers, directors, and shareholders cannot be liable for tortious interference with the company’s contracts when that interference benefits the company.

In this case, the court held that Defendant’s position as Spring Air’s majority investor gave it the right to “lawfully influence the actions of the company in pursuit of the company’s affairs,” as well as a legitimate interest in protecting Spring Air’s value for shareholders.  The court also noted that Defendant likely had further privileges by virtue of its status as Spring Air’s major creditor; ultimately, the court rested its conditional privilege decision on Defendant’s status as Spring Air’s majority shareholder.

Finally, the court held that Plaintiff failed to overcome Defendant’s claim of conditional privilege because Plaintiff did not show that Defendant “induced the breach to further [its] personal goals or to injure [the plaintiff], and acted contrary to the best interests of the corporation.”  The court affirmed the trial court’s finding that Plaintiff offered no evidence indicating either that Defendant induced the breach of the severance agreement “for any reason other than to protect its investment and to preserve [shareholder value]” or to injure Plaintiff.  To the contrary, the court found Defendant’s interference with the severance agreement to be “amply justified” and warranting a grant of summary judgment in Defendant’s favor based upon the theory of conditional privilege.

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


Deborah G. Mallow IRA SEP Investment Plan v. McClendon: Failure to Disclose is not Irreparable Injury

In Deborah G. Mallow IRA SEP Investment Plan v. McClendon, No. 5:12-cv-00436-M, 2012 2012 WL 1985903 (W.D. Okla.)  Jun. 6, 2012), the United States District Court for the Western District of Oklahoma denied Deborah G. Mallow IRA SEP Investment Plan, Christopher Snyder, Dolezal Family Limited Partnership, Brian F. Leonard, David A. Kroll, Inc. Employees’ Profit-Sharing Plan and Trust, and Norman Spiegel’s (collectively “Plaintiff’s”) Motion for Preliminary Injunction. 

Defendant Aubrey K. McClendon (“McClendon” or “Defendant”) is the co-founder of Chesapeake Energy Corporation, one of the largest natural gas producers in the nation. Shareholders voted to give McClendon rights to purchase up to a 2.5% interest in each new well Chesapeake drilled. McClendon was required to invest in either all of the wells drilled in a calendar year or none at all and to pay his proportionate share of costs. In 2012, a Reuters article revealed that McClendon had borrowed upwards of $1.1 billion over a three-year period against his personal interests in the Chesapeake wells, and these loans were financed to pay McClendon’s obligations to Chesapeake. The company’s stock fell 5.5% after the publication appeared.

After the article was published, Chesapeake filed a preliminary proxy statement that provided additional information regarding McClendon’s well interests and transactions. The Securities and Exchange Commission (“SEC”) conducted a review of the proxy that Chesapeake then finalized. Plaintiffs asserted that Chesapeake failed to disclose material information necessary for shareholders to cast fully informed votes, and Plaintiffs asked the Court to enjoin the annual shareholders meeting.

For a party to succeed in seeking a preliminary injunction it must show: “(1) a substantial likelihood of success on the merits; (2) irreparable injury to the movant if the injunction is denied; (3) the threatened injury to the movant outweighs the injury to the party opposing the preliminary injunction; and (4) the injunction would not be adverse to the public interest.” The decision to grant a preliminary injunction is entirely discretionary.

To show an irreparable injury, a movant must show the injury to be both “certain and great,” and not merely “serious or substantial.” A showing of a material false solicitation is insufficient to prove irreparable harm. The court held that Plaintiffs did not show irreparable injury and that Plaintiffs had an adequate remedy if the injunction failed; the court could void the shareholders votes related to items of material information, and the items could be resubmitted to a shareholder’ vote if the court ultimately found a failure to disclose material information in the proxy statement.

The court also noted that this instance did not involve a merger or corporate activity that has a higher potential for irreparable injury. The court gave weight to the SEC’s review and clearance of the preliminary proxy.

Because the court found Plaintiffs failed to prove an irreparable injury, it did not reach the other elements of a preliminary injunction, and it denied Plaintiffs’ request for a preliminary injunction for the shareholder vote.

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


EMAK Worldwide, Inc. v. Kurz: Attorneys Receive $2.5 Million Award for Providing Benefits to a Delaware Corporation

In EMAK Worldwide, Inc. v. Kurz, No. 512, 2011, 2012 WL 1319771 (Del. Apr. 17, 2012), the Delaware Supreme Court affirmed the Court of Chancery’s judgment awarding $2.5 million in fees to Donald A. Kurz’s attorneys.  In Delaware, courts reward plaintiffs’ attorneys for providing “a benefit to a Delaware corporation, even if the benefit does not produce immediate monetary rewards.”  The Court of Chancery based the judgment on the finding that the voting rights preserved in Kurz v. Holbrook, 989 A.2d 140 (Del. Ch. 2010) and Crown EMAK Partners, LLC v. Kurz, 992 A.2d 377 (Del. 2010) were meaningful. 

Crown and Kurz, previously discussed here, involved a fight for control of EMAK’s board between the common and preferred shareholders.  Kurz was the largest common shareholder and Crown held all of the preferred shares.  Crown was able to unilaterally appoint two directors to the seven-director board.  When Kurz attempted to re-take control of EMAK in 2008, Crown began negotiations with EMAK to exchange its preferred shares for new preferred shares with voting power in director elections (“Exchange Transaction”).  Kurz filed a complaint seeking to enjoin the transaction, but Crown rescinded the transaction prior to court action.  Kurz subsequently amended the complaint to challenge the consent disclosures (“Ratification Consent”) of EMAK.  The court unsealed the record filings to correct the disclosures because of Kurz’s action.  Crown, in response to Kurz’s proxy contest in late 2009, then began gathering consents to shrink the board from seven to three directors (“Crown Consent”); however, the court found that the Crown Consent violated Delaware law. 

The long fight for control of EMAK ended in the $2.5 million judgment awarding Kurz’s attorneys “$1.7 million for rescinding the Exchange Transaction, $400,000 for correcting the Ratification Consent disclosures, and $400,000 for invalidating the Crown Consent.”  EMAK appealed and the court applied an abuse of discretion standard, meaning a judgment will not be vacated unless the lower court’s “factual findings…are clearly wrong and justice requires it, or they are not the product of an orderly and logical deductive process.” 

The court affirmed the award connected to the rescission of the Exchange Transaction based on the corporate benefit doctrine and the mootness rule.  The doctrine allows a court to reimburse plaintiffs for fees and expenses if “(1) the suit was meritorious when filed, (2) the defendants took an action that produced a corporate benefit before the plaintiffs obtained a judicial resolution, and (3) the suit and the corporate benefit were causally related.”  The appeal did not call into question the first element.  The court explained the second element was met because protecting shareholder rights is an enormous corporate benefit and the rescission of the Exchange Transaction achieved this.  In addition, the mootness rule satisfied the third requirement since the rule created a rebuttable presumption that a suit and corporate benefit were causally related in situations where the defendant’s actions after suit was filed make the claim moot.  

The court also affirmed the award for correcting the Ratification Consent disclosures.  The lower court used the following factors to determine the award:  “(1) the results achieved, (2) the time and effort of counsel, (3) the complexity of the issues, (4) whether counsel [worked] on a contingency fee basis, and (5) counsel’s standing and ability.”  Since the benefits were sizable, the case involved complex and novel legal issues, counsel worked on a contingency basis, and counsel had good standing and ability, the Delaware Supreme Court determined the award should stand. 

Finally, the Delaware Supreme Court affirmed the award for invalidating the Crown Consent because the finding that Crown’s control of EMAK was not inevitable is supported in the record.  Crown expressed concern that Kurz might win the proxy contest which indicates Crown was not the inevitable controller of EMAK. 

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


Paul v. Delaware Coastal Anesthesia: Silence of LLC Operating Agreement Activates Statutory Default Provision allowing Voting by Written Consent

In Paul v. Delaware Coastal Anesthesia, LLC, No. 7084-VCG, 2012 WL 1934469 (Del. Ch. May 29, 2012), the Court of Chancery of the State of Delaware granted defendants’ motion to dismiss plaintiff’s breach of contract claim, finding that there was “no conceivable set of facts under which [the plaintiff] could recover.” The court found that the LLC’s operating agreement was silent about the voting method used by members to terminate another member. As a result, section 18-302 of the Delaware Limited Liability Company Act (the “Act”) applied, and the vote by written consent to terminate the plaintiff’s membership was valid.

According to the complaint, the plaintiff, Dr. Leena Paul, held a 25 percent membership in Delaware Coastal Anesthesia, LLC (the “LLC”) while the three defendants each held 25 percent. The defendants agreed by written consent to terminate Plaintiff’s membership in the LLC, without holding a membership meeting or providing notice of the meeting to all the members. Plaintiff contended that the LLC’s operating agreement limited voting of shares to member meetings only, and therefore, the defendants’ vote was invalid. Plaintiff argued that two provisions of the operating agreement established the procedure that members must follow to schedule and provide notice of meetings. In contrast, the defendants asserted that the LLC’s operating agreement contained provisions allowing members to vote on company business through written consent.

The court began its analysis by establishing that the sole question in the case was whether the termination vote was effective under state contract law and the Act. The court acknowledged that the pleading standard for a motion to dismiss was minimal and, following Delaware case law, the court would consider all documents “‘integral to [the p]laintiff’s claim and incorporated into the complaint.’”

To assess the parties’ competing claims, the court evaluated the proper relationship between the Act and an LLC’s operating agreement. The relevant portion of section 18-302 stated that

unless otherwise provided in a limited liability company agreement, on any matter that is to be voted on, consented to or approved by members, the members may take such action without a meeting, without prior notice and without a vote.

The court noted that while Delaware law provided LLCs broad discretion in formulating their policies, the Act was intended to function as a default provision anywhere the agreement is silent or ambiguous. The court also recognized that should a conflict arise between the two, the LLC’s agreement generally prevailed.

Plaintiff’s termination occurred under a section of the operating agreement that allowed termination of an LLC member by a 75 percent vote of company shareholders for any reason. The provision merely required 90 days written notice to that member. Because this provision was silent about the voting method members could use, the statutory default was activated to fill this “gap” in the agreement. Applying section 18-302, the court held that voting by written consent was permissible, and thus, the vote to terminate Dr. Paul’s membership was valid.

The court concluded that the LLC’s operating agreement did not “otherwise provide” for a specific voting method and there was “no conceivable set of facts under which Dr. Paul could recover.” Therefore, the court granted the defendants’ motion to dismiss, upholding Dr. Paul’s termination.

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