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Thursday
Aug232012

Law Faculty Blogs and Disruptive Innovation: Law Reviews Fight Back (The Fading Promise of Online Companions)

Part of the evidence of the influence of faculty law blogs comes from the response of law reviews.  They have sought to address the concerns with timliness and relevancy by developing online companions. 

The contents of online law reviews range from full length articles to op ed pieces and blog style commentary.  Most online supplements seek “intermediate” scholarship that discusses current issues or responds to articles in the hard copy journal.  The pieces are expected to be “lightly footnoted” and shorter than traditional articles. Some specifically seek “op ed” or blog length pieces written in a “highly readable style.”  

Online companions have a number of advantages.  They are published more quickly than traditional reviews and offer some intermediation, including cite checking and editing by students, albeit at a reduced level.  Online publication can also benefit from the “good name” of the law school and the inclusion in legal data bases. 

They have not, however, succeeded in stemming the influence of faculty law blogs.  With respect to shorter, op ed or blog style pieces, the advantages of online companions in comparison to widely cited faculty law blogs is unclear.  The “good name” of the law school has some value, but for online publications, the value is subject to a significant discount.  Moreover, the value of the “good name” arises at least in part from the rigorous selection, editing and cite checking process that precedes publication.  For shorter, op ed and blog like pieces, these services will be less important.  

Moreover, the online companions have struggled to find sufficient current and topical issues.  Many online companions have largely abandoned this approach and mostly published responses to hard copy articles.  These are less time sensitive and often can be arranged with the assistance of the author of the hard copy piece.  In addition, attracting and publishing intermediate scholarship on a regular basis will tax the resources of many law reviews.   

For all of these reasons, online companions have not succeeded in replacing faculty law blogs as a source of timely scholarship on current developments. 

The full paper, Essay:  Law Faculty Blogs and Disruptive Innovation is here; the underlying data is posted here.

Wednesday
Aug222012

Law Faculty Blogs and Disruptive Innovation: Replacing Law Reviews

The law blogosphere is no longer a state of nature lacking in intermediation.  A cluster of faculty law blogs have emerged that are often cited by courts and legal publications.  A list of these blogs can be found here.

The reasons are not hard to see.  They fill a gap in the scholarship continuum largely left unaddressed by traditional law reviews. 

There has been plenty of criticism of law reviews.  They have been criticized for their length and questionable relevancy.  One of the most significant is that they take significant time to write and significant time to publish.  When they are out in hard copy, many legal debates are already over.  Many metrics show a decline in the influence of law reviews, whether Supreme Court citations or paid subscriptions.

Faculty law blogs, in contrast, represent a superior method for disseminating legal analysis in some cases.  Law blogs are often the first (and sometimes the only) source of analysis on current developments, whether new cases, proposed legislation, or pending rules.  They can quickly introduce ideas into an ongoing debate or apply existing ones to new developments.  Nor do these posts consist only of unsupported opinion.  They frequently refer to legal authority, although in a less dense, more flexible narrative.  As a result, the analysis is more accessible to those outside the academic community, including judges, practitioners, and regulators. 

In other words, blog posts not only can qualify as scholarship but they can qualify as better scholarship than law reviews, at least in some cases. 

Law reviews have tried to stem this influence through online companions.  We will address the success of this approach in the next post. 

The full paper, Essay:  Law Faculty Blogs and Disruptive Innovation is here; the underlying data is posted here.

Tuesday
Aug212012

Law Faculty Blogs and Disruptive Innovation: Blog Posts and Introduction of Intermediation on the Blogosphere

Faculty law blogs represent an almost classic case of disruptive innovation.  Disruptive innovation usually connotes the introduction of a new technology that eventually destabilizes an existing market.  Often, the technology, when introduced, is inferior and not perceived as a threat.  Over time, however, the technology improves and migrates from a market niche and becomes the reigning standard.

In legal education, faculty law blogs arose in a state of nature and were often perceived as inferior technology used by faculty to convey random, often personal, views.  Early criticism was that blogging allowed second rate scholars to elucidate second rate opinions to a mass audience.  The criticism was always overbroad.  The fact that there was second rate analysis ignored the fact that there was also first rate analysis.  Moreover, other forms of scholarship, whether law review articles or papers posted on SSRN, suffered from similar problems.

Nonetheless, the criticism did reflect one unquestionable reality.  Blogging by law faculty began in an undifferentiated state.  There was no structural method of separating the good from bad.  Anyone could start a blog and post.  The blogosphere lacked a system of content intermediation, a function provided by students on law reviews.    

That, however, has changed.  A class of widely recognized and often cited law faculty blogs has emerged.  They are regularly cited in court opinions and law review articles. At least nine have been cited by courts more than once (with one having been cited 45 times).  There are 18 faculty law blogs that have been cited by legal periodicals more than 100 times.  The full data is here.

These blogs have an incentive to maintain their reputation by ensuring quality.  Blogs in Empires (Law Prof Blog and Jurisdynamics) and Captives (those supported by a law school), quality can be promoted through uniform standards imposed as a condition of participation. 

With respect to Independent Blogs (those neither supported by a specific law school or part of an Empire), posts are mostly derived from a group of regular, although often shifting, commentators.  The members of the group have an incentive to ensure that their reputation is not harmed by substandard posts.   This can be most readily accomplished by avoiding contributions from faculty who do not meet minimum standards of quality.  Indeed, blogs often provide contributors with the right to post as a guest, giving permanent members an opportunity to assess quality. 

All of this suggests that law faculty blogs are no longer undifferentiated or devoid of intermediation.  While anyone can start a blog and post, not all law faculty can access the most widely recognized and cited law faculty blogs.  Moreover, content has evolved.  The most widely read for the most part eschew personal information in favor of substantive legal analysis, typically in a specific area of law. 

The full paper, Essay:  Law Faculty Blogs and Disruptive Innovation is here; the underlying data is posted here.

Monday
Aug202012

Law Faculty Blogs and Disruptive Innovation:  Introduction

We posted on this Blog a data set that provides the number of law faculty who are currently blogging (as of June 2012).  There were slightly more than 300 active bloggers on that date (a number that has been remarkably consistent over the last five or six years).  We also broke down the faculty by law school and showed that law blogging is dominated by faculty at schools outside the top 50.

The data set included a list of the top blogs by citations in court opinions and citations in legal publications.  The lists demonstrates that there are a cluster of law blogs that are widely cited as authority.  With respect to legal opinions, one faculty law blog has been cited 45 times.  For legal publications, one faculty law blog has been cited over 700 times, with another 17 blogs having more than 100 citations in legal publications.  

At one level, the data shows that the number of law faculty who blog has remained relatively consistent over the last five years (although the particular faculty and the list of active law faculty blogs has evolved considerably).  The increase in citations shows that faculty have become increasingly comfortable citing law blogs as authority.  Moreover, in rankings of faculty based upon law review citations, citations to posts count.  Thus, faculty who blog may obtain an increased citation count in these rankings.

But in fact, the raw data tells a much larger story, one that requires an additional set of data points.  The raw data also looks at the full time law faculty in the top 200 of SSRN downloads for the 12 month ending May 1, 2012 and identifies the faculty in the list who also blog and where they teach.  All of this data provides a basis for some intriguing conclusions.  

While we will explore the meaning of this data over the next two weeks, lets start with a conclusion.  Faculty law blogs have become a permanent part of the scholarship continuum.  They are, in certain circumstances, a better mechanism for articulating ideas and participating in legal debates than traditional law reviews.  Moreover, efforts by law reviews to fight back through online companions have largely failed. 

So let’s talk about what all of this data means.  The full paper, Essay:  Law Faculty Blogs and Disruptive Innovation is here; the underlying data is posted here.

Saturday
Aug182012

Can you be against corporate social responsibility but in favor of unbridled corporate political speech?

The “corporate social responsibility” (CSR) movement can be explained by contrasting it with Milton Friedman’s proposition (here) that:

[I]n a free society … there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.

This exclusive focus on profits makes adherents of CSR uncomfortable because it seemingly urges individuals to ignore issues like environmental impact and working conditions when dealing with corporations.   Fans of Friedman respond that if there are environmental and labor conditions that need to be dealt with, then they should be addressed via generally applicable laws that corporations will be subject to—but beyond that corporations should be judged solely on the basis of the wealth they create.  CSR proponents reply that modern corporations are too powerful to be dealt with solely via generally-applicable laws.  And so it goes.

The debate took center-stage in the blogosphere this week, spurred on by a post by Will Wilkinson (here), which noted that the uproar created by Chik-fill-A’s CEO’s anti-gay marriage comments raised some difficult questions for proponents of CSR.  As Erik Gerding noted in introducing a Masters Forum on the topic over at The Glom (here):

Is CSR viewpoint neutral?  When covering CSR in a Corporations course, I ask students whether social activists who are lobbying a corporation to change what they see as immoral employment practices, should be able to put their views to a shareholder vote?  Then I ask whether the answer would or should change based on whether the activists are looking to end racial or gender discrimination or whether they are lobbying a company to stop offering benefits to partners in same sex couples.

(Stephen Bainbridge also chimed in here.)

Wilkinson ultimately argues that:

CSR, when married to norms of ethical consumption, will inevitably incite bouts of culture-war strife. CSR with honest moral content, as opposed to anodyne public-relations campaigns about "values", is a recipe for the politicisation of production and sales…. I'd suggest the best arena for moral disagreement is not the marketplace, but our intellectual and democratic institutions.

In other words, if the sine qua non of capitalism is the free flow of capital to the actors who will use it most effectively, then CSR hurts us all by diverting the flow of capital from the best producers to those who simply share our views on particular social issues (at least in those instances where the two don’t overlap).

I won’t rehash all the interesting arguments made in the posts linked to above (they are all well worth reading--you can find all the Glom Masters' posts here), but I will note that it seems to me a similar objection can be raised to the post-Citizens United freedom of corporations to spend seemingly unlimited sums on political elections.  As just one recent possible example, I note that it seems at least some of the flow of capital to banks has been diverted on the basis of political leanings rather than banking efficiency (story here).  So, should opponents of CSR also oppose unbridled corporate political speech rights?

Friday
Aug172012

The Volcker Rule and the Curse of the Second Best Solution (Part 2)

The premise of the last post was that the Volcker Rule is a second best solution designed to reduce the risk that a bank too big to fail will in fact fail.  The alternative approach would be to make the banks smaller so that they were not too big to fail.  One way to do this would be to strengthen the Volcker Rule into something that more closely resembled the barriers imposed by Glass Steagall.  The effect would be to downsize the large banks through additional limitations on their activities.  In effect, it would result in smaller financial institutions without imposing specific size limitations.  

At the same time, the division would allow the development of a group of investment banks that could provide additional competition in the financial markets.  Recall that before the recent financial crisis, there were five large investment banks (Goldman, Morgan Stanley, Merrill, Bear Sterns, and Lehman).  They competed with commercial banks by offering capital raising expertise.  Two of the five were acquired (Bear and Merrill), one failed (Lehman) and two converted to commercial banks.  The large free standing investment banks have been eliminated. 

The idea of a reinstatement of Glass Steagall has been mentioned often but has generated little serious effort.  So it was quite interesting to hear an unexpected source call for the reinstatement of Glass Steagall, Sandy Weill.  Weill, probably more than any single industry titan, was responsible for the elimination of Glass Steagall.  He presided over the financial conglomerate that consisted of a combined Travelers and Citigroup. 

According to the WSJ, he was reported as saying: 

  • What we should probably do is go and split up investment banking from banking, have banks be deposit takers, have banks make commercial loans and real estate loans, have banks do something that’s not going to risk the taxpayer dollars, that’s not too big to fail

The statement is not unlike the about face taken by Alan Greenspan during the financial crisis.  It is a recognition that prudential limitations (Glass Steagall) may sometimes be better than piecemeal and complicated regulatory structures (the Volcker Rule).

For an article on the benefits to the capital markets of having a Glass Steagall type restriction in place, see The "Great Fall": The Consequences of Repealing the Glass-Steagall Act.

Thursday
Aug162012

The Volcker Rule and the Curse of the Second Best Solution (Part 1)

One of the key components to Dodd Frank was the so called Volcker Rule.  Sometimes characterized as a mini-Glass Steagall, this provision prohibited banks from engaging in short term proprietary trading or from operating hedge funds.  The Report issued by the Financial Stability Oversight Council in January 2011 about the requirement is here.  The final rule is here.

The Rule, consisting of hundreds of pages, has been criticized as excessively complex and full of potential loopholes.  Banks can still engage in certain hedging transactions, market making activities, transactions in government securities and transactions on behalf of clients. 

Putting aside the legitimate concerns over implementation of the Volcker Rule, the real problem is more central.  The Volcker Rule represents a second best solution to a problem that is well known but intractable.  The central problem is that the largest financial institutions, no matter what regulators and politicians say, are too big to fail.  

With the four largest commercial banks in the US each having consolidated assets of over $1 trillion, the failure of any one of them would have profound effects on the economy.  The economic catastrophe that followed in the collapse of the much smaller Lehman set off (or greatly contributed to) a damaging recession that may have altered the outcome of a presidential race.  Given that risk, no politician, Democrat or Republican, will likely allow that to happen under his or her watch.

The obvious solution would be to make the financial institutions smaller and allow them greater freedom to operate.  If they took excessive risk and failed, they would suffer the consequences.  Breaking up the commercial banks, however, is not a viable solution.  There is no will.  Nor is there agreement on the method of doing so nor the ultimate size of a bank that would not be too big to fail.

The second best solution then is to reduce the risk that one of these behemoths will fail.  One way to do that is to have government regulators camp out at the various banks and prevent excessive risk taking.  They already do that.  See Testimony of Thomas J. Curry, June 19, 2012 before the House Committee on Financial Services ("The primary focus of examiners is to determine whether banks have sound risk control processes commensurate with the nature of their risk-taking activities, capital, reserves, and liquidity. Given the millions of transactions that large banks conduct daily across varied product lines and businesses, examiners do not review every transaction in a bank."). 

Indeed, the FDIC maintains a permanent staff at some or all of these large financial institutions.  So does the Office of the Comptroller of the Currency.  See Testimony of Thomas J. Curry, June 19, 2012 before the House Committee on Financial Services ("The foundation of the OCC’s supervisory efforts is our continuous, onsite presence of examiners at each of the 19 largest banking companies.").  

The losses at JP Morgan forced on regulators a reexamination of their oversight role, see   Testimony of Thomas J. Curry, June 19, 2012 before the House Committee on Financial Services ("We are also undertaking a two-pronged review of our supervisory activities and response. . . . The second component evaluates the lessons learned from this episode that could enhance risk control and risk management processes at this and other banks and improve OCC supervisory approaches."), and may result in more effective oversight. 

Nonetheless, the potential for excessive risk taking cannot be eliminated by government oversight.   Developments happen quickly.  In some circumstances, they are brought about by a single person (remember the collapse of Barings?).  They may also be covered up by the perpetrators.   

As a result, the Volcker Rule gets at the concern over excessive risk taking in a blunderbuss way.  It simply bans certain kinds of transactions. Doing so will take away profit making opportunities for the banks.  It will not necessarily result in greater stability for the entire financial system since other, less regulated investors, may engage in the transactions previously undertaken by banks.  But what it will do is reduce the likelihood that a bank will take a bet in the capital markets that threatens its solvency and triggers the problem of too big to fail.

For an article on the consequences of repealing Glass Steagall, see The "Great Fall": The Consequences of Repealing the Glass-Steagall Act.

Wednesday
Aug152012

The Jobs Act and the Interference with Capital Raising

The JOBS Act ostensibly had as a central purpose the elimination of restrictions on capital raising in order to facilitate job creation.  The Act raised a number of concerns about investor protection.  These concerns, in turn, threatened to generate less, not more, capital raising.   

An example may be the so called "On Ramp" provisions.  These were provisions designed to reduce the regulatory requirements for "emerging growth" companies.  For the most part, these are companies worth less than $1 billion that have been public for no more than five years.  They avoid certain disclosure obligations (fewer years of audited financial statements and a dispensation from new or revised accounting standards) and a pack of other requirements such as the need to submit executive compensation to shareholders ("say on pay"). 

Shareholders have fewer rights.  They will receive less disclosure.  In a rational environment, this could result in investors shunning the companies.  In fact, that is exactly the concern confronting companies eligible to be treated as an "emerging growth company."  According to CFO.com:

  • During one week last month, at least 13 companies, including HomeTrust Bancshares, Plesk, and LegalZoom.com, warned investors in their Securities and Exchange Commission prospectuses that the regulatory relief provided by the JOBS Act could actually be a turnoff.

What is an example of this disclosure?  As one company decribed in its risk factors

  • We are an "emerging growth company," as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies" including, but not limited to, not being required to comply with the auditor attestation requirements of section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We cannot predict if potential investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile or decrease.

Emerging growth companies may suffer harm through investor resistance.  Moreover, the harm may not be limited to them.  Section 107 of the JOBS Act allows companies to opt out of the On Ramp exemptions.  Yet investors without the time or inclination to figure out which is which may well have an incentive to simply avoid investing in any company that has recently gone public.

Tuesday
Aug142012

Finn v. Smith Barney: 10(b) Market Manipulation Suit Dismissed for Lack of Reliance

In Finn v. Smith Barney,  No. 11-1270-cv, 2012 WL 1003656 (2d Cir. Mar. 27, 2012), the Second Circuit affirmed the Southern District of New York’s dismissal of market manipulation claims brought under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The plaintiffs were investors who purchased auction rate securities (“ARS”), securities whose interest rates were reset periodically via a Dutch auction, from the defendants, various Citigroup, Inc. subsidiaries (collectively, “Citigroup”). The investors alleged that Citigroup’s frequent intervention in the ARS market was manipulative, and that the parent company, Citigroup Inc., was a 20(a) controlling person.

Section 10(b) forbids the use of a “manipulative or deceptive device” in contravention of the Security and Exchange Commission’s (“SEC”) rules and regulations. SEC Rule 10b-5 forbids any fraudulent practice in connection with the purchase or sale of securities. Manipulation occurs when a party intentionally or willfully controls or artificially affects security prices for fraudulent or deceptive purposes. Further, “[m]arket manipulation requires a plaintiff to allege (1) manipulative acts; (2) damage (3) caused by reliance on an assumption of an efficient market free of manipulation; (4) scienter; (5) in connection with the purchase or sale of securities; (6) furthered by the defendant’s use of the mails or any facility of a national securities exchange.”

The plaintiffs alleged that they purchased the ARS under the belief that the auction markets were driven solely by investor supply and demand, and that Citigroup’s increasing interventions, by placing bids for its own accounts, distorted that market. However, various documents--including prospectuses, confirmations, website disclosures, and media reports--had disclosed that Citigroup could, to prevent auction failure, “routinely place . . . bids . . . for its own account” that were “likely to affect” auction rates and allocations. In light of these disclosures, the court held that the plaintiffs could not plausibly claim reasonable reliance on the assumption of an efficient free market.

The plaintiffs further argued that the sheer frequency of Citigroup’s market interventions rendered any disclosures misleading. However, the court reasoned that at least one of Citigroup’s disclosures specifically included the word “routinely,” indicating the potential for such a high frequency of intervention.

The plaintiffs also argued that the district court had taken improper judicial notice of the disclosure documents in question. Under Federal Rule of Evidence 201(b)(2), such notice may be taken when a document can be readily and accurately determined “from sources whose accuracy cannot reasonably be questioned.” Because the district court took judicial notice for the sole purpose of establishing the public availability of the disclosure documents, and the documents were in fact publicly available before and during the class period, the judicial notice was not an abuse of discretion.

Because Citigroup’s disclosure negated the reliance element of the alleged 10(b) violations, there was no primary manipulation; without primary manipulation, there could be no 20(a) liability for the parent company, Citigroup, Inc. Therefore, the court affirmed the dismissal of all claims.

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

Monday
Aug132012

In re Optimal U.S. Litigation: Presumption against Extraterritoriality of Exchange Act Trumps Plaintiffs’ Claims in Madoff Feeder Case

In In re Optimal U.S. Litigation, 10-cv-04095-SAS, 2012 WL 1988713 (S.D.N.Y. June 4, 2012), the district court dismissed the plaintiffs’ securities claims, holding that, under Morrison, the Securities Exchange Act of 1934 (“Exchange Act”) did not reach those claims.

The plaintiffs were investors in Optimal U.S., an investment fund owned by Banco Santander, S.A., and managed by Optimal Investment Management Services, S.A. (collectively, “the defendants”). Optimal U.S. invested all of its assets in the infamous Bernard L. Madoff Investment Securities LLC. The plaintiffs alleged that the defendants violated Section 10(b) of the Exchange Act by “fail[ing] to conduct adequate due diligence, ignor[ing] red flags, and ma[king] misstatements and omissions in connection with the sale of Optimal U.S. shares . . . .” Although they conceded that the purchase and sale of the shares took place outside the United States, the plaintiffs alleged that the Exchange Act still reached their claims under two theories: 1) the purchase was “in connection with” trades made in the United States; and 2) the defendants’ investments constituted an “economic reality” of trades made in the United States.

The court rejected the first theory, noting that the presumption against extraterritorial application of the Exchange Act foreclosed a broad interpretation of the phrase “in connection with” in the context of extraterritoriality. In addition, although SEC v. Compania Internacional Financiera, S.A. established that certain foreign securities that were “functional equivalents” of United States securities could be considered “in connection with” those securities, the Optimal U.S. shares and the domestic shares subject to Madoff’s trades were not “functionally equivalent” because the relationship between the two was “much more attenuated.”  See SEC v. Compania Internacional Financiera, S.A., No. 11 Civ. 4904, 2011 WL 3251813 (S.D.N.Y. July 29, 2011).

The court rejected the second theory on two grounds. First, the concept of “economic reality” had been employed in a prior case to dismiss claims based on a United States swap agreement that was held to be “economically equivalent” to German shares; the same concept could not be used in the “reverse situation” in an attempt to expand the reach of the Exchange Act. See Elliott Associates v. Porsche Automobile Holding, 759 F. Supp. 2d 469 (S.D.N.Y. 2010). Second, Optimal U.S. shares were not economically equivalent to any U.S.-listed shares, because the former did not have a “direct, one-to-one relationship” with the latter.

Because the court held that the strong presumption against extraterritorial application of the Exchange Act was not overcome by the plaintiffs’ two legal theories, it dismissed the plaintiffs’ securities claims brought under the Exchange Act, leaving only claims of common law fraud, negligent misrepresentation, and aiding and abetting fraud.

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

 

Friday
Aug102012

When Does a Promissory Note Become a Security? Fletcher Int'l, Ltd. v. ION Geophysical Corp.

In Fletcher Int'l, Ltd. v. ION Geophysical Corp, Fletcher International Ltd (Fletcher), a preferred shareholder of ION Geophysical Corp. (ION), challenged the issuance of promissory notes by an ION subsidiary.  Fletcher asserted that the notes were securities and that under the rights and preferences of the preferred shares, it had a right to “consent” to the issuance of “any security.”  The Court of Chancery of Delaware granted in part and denied in part the parties’ cross-motions for partial summary judgment, concluding that one note ION issued was a security and its issuance violated Fletcher’s consent rights.  No. 5109-CS, 2012 WL 1883040 (Del. Ch. May 23, 2012).

The instant case concerned three promissory notes ION caused another subsidiary to issue in connection with ION’s acquisition of ARAM Systems Ltd. and its affiliate Canadian Seismic Rentals, Inc. (“ARAM”). The notes were issued to ARAM’s owner, Don Chamberlain and his family.  ION issued these notes as a condition of its agreement with ARAM to finance the purchase price through short-term bridge financing and to expedite the closing. This included a one-year, non-convertible $35 million “Escrow Note” and a one-year, $10 million “Tax Receivable Note.” After ION issued the first two notes, ION and ARAM amended the Senior Credit Facility of the purchase agreement that shortened the lives of both notes from one year to three months. 

The third note was issued as a result of Lehman Brothers’ collapse and the resulting credit market freeze.  Instead of going forward with its planned bond offering, ION issued the five-year, transferrable, $35 million “Final Note” with a quarterly interest rate of fifteen percent.  ION failed to consult with Fletcher before causing any of the three notes to be issued.  

The court had to determine whether the notes were securities under the Certificate of Rights and Preferences for the preferred shares.  As in an earlier decision involving the same parties, the court relied on the four-factor test set out in Reves v. Ernst & Young, 494 U.S. 56 (1990).  Reves set out a four-part “family resemblance” test for determining when, under the federal securities laws, a note constituted a security.  The test required consideration of: “(1) the motivations that would prompt a reasonable buyer and seller to enter into the transaction; (2) the plan of distribution of the note; (3) the reasonable expectations of the investing public; and (4) whether some factor, such as the existence of another regulatory scheme, significantly reduces the risk of the instrument, thereby rendering the application of the securities laws unnecessary.”

In applying the test, the court determined that two of the loans were not securities but short-term bridge loans. Factors that led the court to this conclusion were the notes’ short terms, the inherent difficulty in pricing or selling the notes, and their short-term nature, something that made the protection of the securities laws unnecessary. The court was not dissuaded by the fact that the notes contained securities act legends and contained references to securities laws.   

The court found that the third note was a security.  The note was issued to finance a substantial investment in lieu of the planned bond offering; it had a long, high-interest life, necessitating securities law protection; and it included a securities legend and securities law references.

As a result, the court granted Fletcher’s motion for summary judgment, finding that the issuance of the one note had violated the consent rights under the Certificates.  

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

Thursday
Aug092012

St. Clair Shores General Employees’ Retirement System v. Lender Processing Services: If at First You Don't Succeed…

In City of St. Clair Shores Gen. Emp. Ret. Sys. v. Lender Processing Serv., Inc., 3:10-CV-1073-J-32JBT, 2012 WL 1080953 (M.D. Fla. Mar. 30, 2012), the court granted Defendants' motion to dismiss, while also allowing Plaintiff leave to file another amended complaint.

According to the complaint, Defendant Lender Processing Services ("LPS") provides mortgage processing and settlement services and default and technology solutions to mortgage lenders; Defendant Lee A. Kennedy is an officer and chairman of LPS's board; and Defendants Jeffrey S. Carbiener, Francis K. Chan, and Michelle M. Kersch are officers of LPS (collectively, "Defendants"). Plaintiff City of St. Clair Shores General Employees' Retirement System, a municipal pension fund, and other possible class members, purchased or acquired LPS shares between August 2008 and October 2010. Plaintiff claimed that during that period, Defendants inflated LPS's revenue through the use of fraudulent business practices. Plaintiff alleged that as a direct result of this fraud, LPS shareholders lost millions of dollars.

In order to state a claim under section 10(b) and Rule 10b–5, a plaintiff must allege a material misrepresentation or omission, scienter, a connection with the purchase or sale of a security, reliance, economic loss, and loss causation. To avoid dismissal, a Rule 10b–5 claim must satisfy the fraud pleading requirements under Federal Rule of Civil Procedure Rule 9(b), as well as the heightened pleading requirements of the Private Securities Litigation Reform Act (“PSLRA”). The PSLRA requires plaintiffs to "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, the complaint shall state with particularity all facts on which that belief is formed." Furthermore, the plaintiff must state with particularity the facts that demonstrate the defendant acted with scienter.

Defendants alleged that Plaintiff failed to plead the following: "(1) that the individual defendants ‘made’ any of the alleged misstatements; (2) that any of the alleged misstatements were materially false or misleading; (3) loss causation; and (4) a strong inference of scienter."

Defendants sought dismissal of the claims under the Supreme Court's decision in Janus Capital Group, Inc. v. First Derivative Traders, 131 S. Ct. 2296, asserting that the individual defendants had not “made” the alleged misstatements.  The court, however, found that the allegations were sufficient to find that at least three defendants had “ultimate authority” over their statements.  This included statements made by the defendants in the press, statements made as agents for the company, and the execution by some of the defendants of the certification required for SEC fillings. 

The court also agreed that Plaintiff had sufficiently alleged the materiality of the misstatements.  This was the case "[e]ven if Defendants' statements were literally accurate, as argued by Defendants”.  Similarly, the allegations were sufficient to plead causation.  The court noted that

"loss causation is not subject to a heightened pleading requirement" and that "to sufficiently plead loss causation, a plaintiff must allege a disclosure or revelation of truth about a defendant's prior misstatement or omission that is in some way connected with a stock price drop.” Here, the court deemed that Plaintiff's Complaint establishes a connection between Defendant's misstatement and the drop in stock price and was therefore not subject to dismissal on a causation basis.

The court did find, however, that Plaintiff had not adequately allege  scienter. "Rule 9(b) does not allow a complaint to merely lump multiple defendants together, but requires plaintiffs to differentiate their allegations when suing more than one defendant and inform each defendant separately of the allegations surrounding his alleged participation in the fraud." Accordingly, the court dismissed Plaintiff's complaint without prejudice, but allowed Plaintiff to file a second amended complaint that would comply with the requirements of Rule 9(b).

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

Wednesday
Aug082012

The Director Compensation Project: Bank of America Corp.

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the Bank of America (NYSE:BAC) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:

  

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

Mukesh D. Ambani *

92,282

184,534

0

0

276,816

Susan S. Bies

80,000

160,000

0

0

240,000

William P. Boardman (retired)

0

0

0

0

0

Frank P. Bramble, Sr.

100,000

160,000

0

0

260,000

Virgis W. Colbert

80,000

160,000

0

0

240,000

Charles K. Gifford **

100,000

160,000

0

257,190

517,190

Charles O. Holliday, Jr.

167,000

333,000

0

0

500,000

D. Paul Jones, Jr.

80,000

160,000

0

0

240,000

Monica C. Lozano

80,000

160,000

0

0

240,000

Thomas J. May

100,000

160,000

0

0

260,000

Donald E. Powell ***

80,000

160,000

0

75,000

315,000

Charles O. Rossotti

110,000

160,000

0

0

270,000

Robert W. Scully

100,000

160,000

0

0

260,000

* Mr. Ambani was appointed in March, 2011 and the amounts provided reflect pro-rated awards for service prior to the 2011 annual meeting

** Mr. Gifford receives office space and secretarial support

*** Mr. Powell is a non-management director with an annual cash retainer of $75,000

 

Director Compensation.  During fiscal year 2011, Bank of America held 18 Board meetings and each of the current directors attended at least 75% of the meetings of the Board and Board Committee meetings collectively.  The five active (non-emergency) Committees met at least 9 times each and one Committee as many as 16 times during 2011.  Bank of America grants an annual restricted stock award to Directors.  After a one-year vesting period, dividends are paid simultaneously as those on common stock stares.  The shares awarded to each Director equals the dollar value of the award divided by the closing price of common stock as of the grant date and rounded down plus a cash payment for fractional shares.  Non-management directors are given the opportunity to defer these awards to a stock account. 

Director Tenure.  The two most senior members of the Board of Directors include Mr. May and Mr. Gifford, each holding his position since April 2004.  All directors currently serving are slated for re-election except for one, Mr. Jones.  Most directors sit on other boards.  Mr. Colbert, for example, sits on the boards of both Sara Lee Corporation and Stanley Black & Decker, Inc.  Ms. Lozano serves on the board for The Walt Disney Company and ImpreMedia. 

CEO Compensation.  Thomas K. Montag, the Co-Chief Operating Officer, received the highest executive compensation during the 2011 fiscal year, totaling $14,298,604.  The Chief Financial Officer, Bruce R. Thomson, received the next highest compensation at $11,114,046.  Bank of America advocates a “pay for performance” policy that limits executive fringe benefits but does provide home security systems and secure parking.  Furthermore, use of corporate aircraft when conducting business on behalf of the Company is permitted and personal use is also allowed so long as the officer reimburses the Company for operating costs. 

Wednesday
Aug082012

The Director Compensation Project: Berkshire Hathaway Inc.

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements.

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the Berkshire Hathaway (NYSE: BRKB) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:

  

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Option Awards
($)

All Other Compensation
($)

Total
($)

Stephen B. Burke

3,300

0

0

0

3,300

Susan L. Decker

5,300

0

0

0

5,300

William H. Gates III

3,000

0

0

0

3,000

David S. Gottesman

3,300

0

0

0

3,300

Charlotte Guyman

7,300

0

0

0

7,300

Donald R. Keough

7,300

0

0

0

7,300

Thomas S. Murphy

7,300

0

0

0

7,300

Walter Scott, Jr.

3,000

0

0

0

3,000

 

Director Compensation.  During the 2011 fiscal year, Berkshire Hathaway held one annual meeting of the directors and four special meetings.  Every director attended all meetings except for Mr. Gates and Mr. Scott, who each missed one special meeting.  Directors received $900 for each meeting they attended in person and $300 for each meeting they attended by phone.  In addition, any director who served as an Audit Committee member received a $1,000 quarterly payment. 

Director Tenure.  Mr. Buffett has presided on the board of directors since 1965 and has served as Berkshire Hathaway’s Chairman and Chief Executive Officer since 1970, holding the longest tenure.  Several directors sit on other boards.  For instance, Mr. Burke sits on the boards of JPMorgan Chase & Co., as well as the Children’s Hospital of Philadelphia.  Mr. Munger currently serves as the Chairman of the Board of Daily Journal Corporation and as a director of Costco Wholesale Corporation. 

CEO Compensation.  During the 2011 fiscal year, Chief Executive Officer and Senior Vice President Mark D. Hamburg earned a total of $974,750 for his service.  Mr. Buffett, the Chief Executive Officer and Chairman of the Board, received a $100,000 base salary and a total compensation package of $491,925.  Mr. Buffet’s base salary has remained unchanged for 25 years, and he has advised the committee that he does not expect or wish it to be altered.  Berkshire Hathaway provided personal and home security services to Mr. Buffet, which amounted to $346,925 of his total compensation.  Mr. Buffet is the largest shareholder of Berkshire Hathaway, owning shares that amounted to a 34% voting interest and a 22% economic interest.

Tuesday
Aug072012

The Director Compensation Project: CVS Caremark Corporation

This post is part of an ongoing series that examines the way stock exchange independence rules relate to director compensation.  We are for the most part including companies from 2011’s Fortune 500 and using information found in their 2011 proxy statements. 

Nasdaq and the NYSE have similar rules with respect to director independence.  NYSE Rule 303A.01 requires that each listed company’s board of directors be comprised of a majority of independent directors.  A director does not qualify as “independent” if he or she has a “material relationship with the company.”  NYSE Rule 303A.02(a).  In addition, the director is not considered independent under NYSE Rule 303A.02(b)(ii) if the director received more than $120,000 in direct compensation, other than director’s fees, during any of the previous three years.  NYSE Rule 303A.06 imposes a higher independence standard for directors serving on the company’s audit committee by requiring them to comport with Rule 10A-3 (C.F.R. §240.10A-3).

Independent directors are compensated for their service on the board.  The amount of compensation can be seen from examining the director compensation table from the CVS Caremark (NYSE: CVS) 2011 proxy statement.  According to the proxy statement, the company paid the directors the following amounts:

 

Name

Fees Earned or Paid in Cash
($)

Stock Awards
($)

Cash Fees Elected to be Paid in Stock
($)

All Other Compensation**
($)

Total
($)

Edwin M. Banks

6,500

195,000

0

2,324

262,324

C. David Brown II

40

202,500

67,460

1,627

271,627

David W. Dorman*

47

345,000

114,953

0

460,000

Anne M. Finucane

37,952

259,965

48,750

0

346,667

Kristen Gibney Williams

65,027

194,973

0

1,415

261,415

Marian L. Heard

65,000

195,000

0

1,627

261,627

Jean-Pierre Millon

65,027

194,973

0

946

260,946

Terrence Murray

37

195,000

64,963

0

260,000

C.A. Lance Piccolo

65,027

194,973

0

5,475

265,475

Richard J. Swift

70,024

209,976

0

1,627

281,627

Tony L. White

75,891

227,442

0

322

303,655

*       Mr. David W. Dorman became the independent Chairman of the Board on May 11, 2011.

*       Other Compensation reflects an additional retainer received by directors serving on subcommittees.

 

Director Compensation.  During the 2011 fiscal year, CVS Caremark held eight meetings of the board of directors.  Each director attended at least 75% of these meetings.  Directors received an annual retainer worth $260,000; seventy-five percent was paid in shares of the company’s stock, and the other 25% was paid in cash or stock, at the option of the individual director.  Several directors also served on subcommittees.  This service qualified each to receive an additional retainer of either $10,000 or $20,000.  These retainers were paid semi-annually and at least 75% were paid in shares of Caremark common stock.  

Director Tenure.  Ms. Heard has been a director since 1999, making her the longest-serving member.  Directors serving on other boards include Mr. Richard J. Swift, who currently serves as a director of Public Service Enterprise Group Inc.; Hubbell Inc.; and Ingersoll-Rand PLC, and Mr. Dorman, who serves as director of Yum! Brands, Inc. 

CEO Compensation.  During the 2011 fiscal year, CVS Caremark’s President and Chief Executive Officer, Larry J. Merlo, received a compensation package totaling $14,074,790.  Mr. Merlo was appointed as Chief Executive Officer in March 2011.  Mark S. Cosby, the Executive Vice President, earned $9,594,923 in salary, stock options, and other compensation.  The company has implemented a long-term incentive compensation program to reinforce strategic objectives and continued employment at CVS.  This component represents a significant portion of total compensation earned by executive officers, and a total of $3,834,020 for Mr. Merlo.  CVS Caremark provided a financial planning allowance so that each executive officer could hire a financial planner.  The company also required the CEO to use its corporate aircraft for business and personal travel.

Monday
Aug062012

Medafor v. CryoLife: Section 12(g) of the Exchange Act does not Provide a Private Right of Action

In Medafor, Inc. v. CryoLife, Inc., the United States District Court for the District of Minnesota ruled that Section 12(g) of the Securities Exchange Act of 1934 (“Section 12(g)”) does not provide a private right of action.  2012 WL 1072340 (D. Minn., Mar. 30, 2012). 

CryoLife markets and distributes medical products, including Medafor's product, a substance that facilitates blood clotting. CryoLife also owned approximately 10% of the outstanding common shares of Medafor.

In 2010, Medafor had about 550 shareholders and was approaching $10 million in assets.  Section 12(g) requires any corporation with 500 or more shareholders of record and more than $10 million in assets to register with the Securities and Exchange Commission (“SEC”).  To reduce its number of shareholders, thereby avoiding Section 12(g) registration and its administrative burdens, Medafor initiated a reverse stock split in which shareholders owning less than 5,000 shares were given cash value for their shares.

After Medafor executed the reverse stock split, CryoLife sent a letter to Medafor threatening to sue and report Medafor to the SEC, unless Medafor complied with the registration requirements of Section 12(g).  In response, Medafor filed suit under the Declaratory Judgment Act seeking a judicial declaration that it was not required to register under Section 12(g).  CryoLife then moved to dismiss, arguing that Medafor lacked standing to bring the suit because was no case or controversy. 

To have standing under the Declaratory Judgment Act, a plaintiff must show the existence of a case or controversy by demonstrating a “substantial likelihood that he will suffer injury in the future.”  Thus, for the threat of a lawsuit to establish standing, the suit must be substantially likely to occur.  To determine the likelihood that Cryolife could bring suit against Medafor under Section 12(g), the district court examined the threshold question of whether Section 12(g) provided a private right of action that would allow a shareholder to sue a corporation for failing to register.  The language of Section 12(g) does not explicitly provide such a right, but Medafor argued that the right was implied. 

To determine whether Section 12(g) provided an implied private right of action to shareholders, the district court considered the language of Section 12(g), its legislative history, and the Supreme Court’s analysis of Section 17(a) in Touche Ross.  After finding that neither Section 12(g) nor its legislative history showed any congressional intent to create a private right of action, the district court focused on the Touche Ross decision. In Touche Ross, the Supreme Court held that Section 17(a) of the Exchange Act did not provide a private right of action because Congress had not clearly manifested its intent to include that right.  As the district court explained, the test under Touche Ross “focuses on whether Congress intended to include a private right of action, rather than on whether Congress intended to preclude that right.”  The district court applied the Touche Ross test to Section 12(g) and ruled that the section does not provide a private right of action because Congress had not intended to include that right.

The district court ruled that because Section 12(g) does not provide a private right of action for CryoLife to sue Medafor, there was no case or controversy.  Therefore, the court granted CryoLife’s motion to dismiss because Medafor lacked standing to pursue a declaratory judgment.

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

Saturday
Aug042012

Finding the Latest "Hot" Corporate and Securities Law Scholarship

Many readers of this blog are likely very familiar with the Social Science Research Network (SSRN), which "is devoted to the rapid worldwide dissemination of social science research."  One of the neat things you can do on SSRN, which may be news to at least some interested readers, is see the top downloaded papers in a particular subject area for all papers posted in the last 60 days.  You get there via the "Browse" page on SSRN.  From there you can see the top downloads for any subject heading by clicking on the accompanying "info" icon where available.  For example, you can find the list for "Corporate Governance U.S." here (the list on the left is for all-time downloads) and the list for "Securities Law: U.S." here (there will be some overlap).  Happy hunting!

PS--For some analysis of the “Top 5 Corporate & Securities Blog Posts” you can check out the Securities Law Practice Center, which posts a “bi-weekly installment shining a light on the best of the corporate and securities blogosphere.”  The authors were kind enough to select my last post for inclusion here.

Thursday
Aug022012

Barker v. UBS AG: Motion for Summary Judgment Denied

In Barker v. UBS AG, Mary Barker brought a case alleging that UBS AG (UBS) ended her employment in violation of the whistleblower provision of the Sarbanes-Oxley Act (“SOX”) under 18 U.S.C. § 1514A.  3:09-CV-2084, (D. Conn. May 22, 2012).  UBS moved for summary judgment, and the court denied the motion. 

Traditionally, a firm must own a minimum number of “seats” to be able to trade on that exchange.  According to the complaint, UBS in 2006 began investing in additional seats on the exchanges.  Barker was assigned to reconcile these holdings on a uniform, consolidated basis.  In the course of doing so, Barker discovered reporting discrepancies regarding firm-wide holdings. 

Barker reported the discrepancies to her supervisor, Gerald Hees.  Hees allegedly discussed how to “spin” these discrepancies to senior management with other co-workers, forbade Barker from discussing these discrepancies with anyone outside the Equities department, and reprimanded her for informing Operational Risk about the project.  At the conclusion of the reconciliation project, management rewarded Barker for her work.  Barker, however, noticed that she was passed over for projects and removed from the promotion consideration list.  Subsequently, UBS conducted a large-scale employee reduction and terminated Barker. 

A motion for summary judgment may be granted only when there is no dispute regarding the material facts to be tried.  The court must draw all inferences in favor of the non-moving party.  If there is evidence that a reasonable jury would decide in the non-moving party's favor, then a dispute about a genuine issue of fact exists and the motion must be denied.  The plaintiff bears the initial burden of showing a violation of 18 U.S.C. § 1514A by setting forth a prima facie case.  The plaintiff must allege that: (1) a protected activity was engaged in; (2) “the employer knew of the protected activity”; (3) an unfavorable action was suffered; and (4) “circumstances exist to suggest that the protected activity was a contributing factor to the unfavorable action.”

To demonstrate a protected activity, the plaintiff must “provide factually specific information regarding the conduct she believes to be illegal” and plead that the protected activity she engaged in contributed to her termination.  The court defines a contributing factor as “any factor, which alone or in combination with other factors, tends to affect in any way the outcome of the decision.”

UBS argued that Barker could not establish a protected activity because management requested, supported, and concluded the project.  Additionally, UBS praised Barker and her team for their work.  Finally, UBS alleged that Barker did not know she was blowing the whistle on securities fraud and that senior management did not have knowledge of Barker’s protected activity when they made the decision to terminate her.

Barker asserted that senior management did not know about the project until months after she started.  She further asserted that she went beyond the scope of her job in completing the project and she was reprimanded for discussing the project with the Operational Risk department.  Barker argued that she met with a member of senior management to discuss her findings and, shortly thereafter, was removed from consideration for promotion. 

The court found that material issues of fact existed as to whether Barker participated in protected activities.  The court held that a reasonable jury could find that senior management knew of Barker’s protected activity when they chose to terminate her.  Furthermore, the court concluded that a reasonable jury could find that Barker’s expressed concerns regarding the inaccurate reporting created a reasonable belief that UBS violated federal law and that the close proximity of events leading to Barker’s termination satisfied the causation requirement.

Nor had UBS rebutted this prima facie case by showing that Barker had been terminated irrespective of the protected activity.  UBS had asserted that Barker had been terminated due to its financial hardships and her performance evaluations.  The performance evaluations discussed some performance issues, but they also complimented Barker.  Thus, the court found that UBS did not provide clear and convincing evidence that Barker would have been terminated regardless of any protected activity.

For all of these reasons, the court denied UBS’s motion for summary judgment.

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

Wednesday
Aug012012

In re Answers Corporation: Court Denies Defendants’ Motion to Dismiss Shareholder Claims 

On April 11, 2012, the Court of Chancery of Delaware denied defendants’ motion to dismiss plaintiffs’ claims. The plaintiffs consisted of the shareholders of the Answers Corporation (“the company”), who alleged that the board breached its fiduciary duties of care, loyalty, and good faith in connection with the merger of the company with AFCV Holdings, LLC (“AFCV”). The plaintiffs further alleged that A-Team, a wholly owned subsidiary of AFCV, which is a portfolio company of Summit Partners, L.P. (collectively, “the Buyout Group”), aided and abetted the company’s breach of its fiduciary duties.   In re Answers Corp. Shareholders Litig., C.A. No. 6170-VCN (Del. Ch. Apr. 11, 2012).

The plaintiffs specifically asserted that three conflicted board members conducted the sales process in accordance with their own interests and accepted an unfair price for the company. With respect to the other board members, the plaintiffs claimed they knowingly allowed this flawed sales process to occur and therefore breached their duty of loyalty. The plaintiffs alleged that the board locked up the merger with unreasonable deal protection measures, used the merger to gain benefits for itself, and issued materially misleading proxy materials.

According to the complaint, Redpoint Ventures (“Redpoint”) owned 30% of the stock at the time of the merger, was the largest shareholder of the company, and wanted to sell its interest.   The plaintiffs asserted that Redpoint threatened Mr. Rosenchein, the company’s CEO, that the entire management team would be replaced if it did not find a way to sell the company. Further, two other board members appointed by Redpoint, W. Allen Beasley and R. Thomas Dyal, steered the sale to benefit Redpoint’s goal.

The plaintiffs’ complaint alleged that in November 2010, AFCV offered to buy the company for $10.25 per share, which was more than the trading price at the time. However, negotiations continued and by December, the board became concerned that the company stock was going to rise above ACFV’s offer price unless the sale occurred quickly.   The plaintiffs alleged that the board was aware of Redpoint’s goal and approved a quick sales process to guarantee that the company stock would not rise above $10.25 per share before the sale.

The plaintiffs’ complaint further alleged that the Buyout Group insisted that the board do a quick “market check.”  In response,  the board asked UBS, its financial advisor, to do a two-week market check, which UBS stated was not a “real” market check. It coincided with the holidays and was not an accurate representation of the interest in the company. In April of 2011, the board received an offer from Brad. D. Greenspan to buy a controlling interest in the company at $13.50 per share. The board rejected the offer, stating that it was not superior to the ACFV offer.

The defendants denied the allegations and moved to dismiss the claims. The board argued that the plaintiffs had failed to state a claim for any breach of fiduciary duty.  The Buyout Group alleged that since the plaintiffs failed to state the underlying claim, they also failed to state a claim for aiding and abetting, among other arguments.

When a board decides to sell a company, “the board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise.” There is no one specific way to meet this requirement, but the process the directors follow must be reasonable. The board must consider the option of keeping the company independent, it cannot manipulate the sales process in any way to benefit a particular bidder, and it must seek the highest reasonable value available for its shareholders in the case it decides to sell.

To plead that a board breached its duty of loyalty, the plaintiff must allege facts that “the majority of the board either was interested in the sales process or acted in bad faith in conducting the sales process.” An interested director is one who receives a personal financial benefit that the other directors do not. Further, to show a director acted in bad faith, the plaintiff must show the director “intentionally fail[ed] to act in the face of a known duty to act, demonstrating a conscious disregard for his or her duties.”

The court held that the plaintiffs adequately pled the board breached its fiduciary duty for the following reasons: (1) the CEO knew his job was on the line if the sale did not go through and actively attempted to sell the company before the stock price went up; (2) two other directors manipulated the sale “to achieve liquidity for Redpoint”; and (3) the rest of the board was aware of the reasoning behind the sale and allowed the flawed sales process to proceed.  In addition, the court held that while there was nothing inherently unreasonable about the deal protection measures and the board extracting certain benefits like accelerated stock options, these issues were tag-along claims to the breach of fiduciary duty, and therefore should not be dismissed at this time.

To plead aiding and abetting of a breach of fiduciary duty, the plaintiffs must show (1) that a fiduciary relationship existed, (2) there was a breach of that duty, (3) the defendants knowingly participated in the breach, and (4) the plaintiff suffered damages caused by the breach.

Since the plaintiffs sufficiently pled breach of fiduciary duty, the court held that they satisfied elements 1, 2, and 4.  The court decided that the plaintiffs had satisfied element 3 as well, because the Buyout Group had non-public information about the company that it used to push the board to do a quick market check and close the sales process before the stock price could rise above ACFV’s offer price. 

Therefore, because the plaintiffs adequately pled breach of fiduciary duty and aiding and abetting of that breach, the court denied both motions to dismiss. However, the court did dismiss the plaintiffs’ proxy claim because the plaintiffs had abandoned that claim.

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

Tuesday
Jul312012

Faculty Law Blogs and Referrals

In the world of Internet trivia, another way to determine the influence of a blog is to show its ability to send traffic to another blog.  The Race to the Bottom has been posting on faculty who blog.  There have been a number of posts that have referenced the discussion.  Squarespace, the platform used by The Race to the Bottom got these referrals as a result of the other articles:

148   www.volokh.com  


76   www.thefacultylounge.org


28   www.theconglomerate.org

 

17

 

 

opiniojuris.org




8   lawprofessors.typepad.com (TaxProf Blog)
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