The Affordable Care Act, the DC Circuit, and the SEC

Yesterday, two circuit courts issued opposite decisions on the Affordable Care Act. The Fourth Circuit held that individuals could obtain subsidies through the federal healthcare site.

The D.C. Circuit, by a vote of 2-1 held the reverse. The D.C. Circuit opinion (Halbig v. Burwell) included on the panel judges Griffith, Edwards and Randolph. Edwards and Randolph are senior judges. The majority, Griffith and Randolph, were appointed by Republican presidents while the dissent, Edwards, was appointed by a Democratic president.

While it is difficult to attribute political leanings to judges (all are motivated by a desire to interpret the law fairly), the reality is, that until recently, the D.C. Circuit was made up of a majority of judges who showed very little deference towards administrative agencies. The SEC was a particularly common recipient of this lack of deference. The D.C. Circuit's decision in Business Roundtable v. SEC, the case that struck down the shareholder access rule, was a particularly egregious case of a lack of deference, and one hard to defend under existing case law.

When the Commission would lose (as in the shareholder access case), appeal to the full court (en banc) was mostly pointless. With a panel already uniting in opposition, the full court was not likely to produce enough votes to overturn the decision. Business Roundtable was not, therefore, appealed (although some argued that it should have been).  

The membership of the D.C. Circuit remained static (except for some retirements) during the current President's first term. He was the first president in memory to obtain no appointments to the D.C. Circuit. That changed, however, during his second term. The President has succeeded in obtaining approval for three judges on the court. There are now 7 non-retired judges appointed by Democratic presidents and four appointed by Republican presidents.  

The result, at least so it seem, is that deference has, to some degree, returned. Thus, the SEC's decision in National Association of Manufacturers v. SEC (the conflict minerals case) was an administrative law victory for the SEC. 

The NAM decision was not, however, a complete victory. The Commission saw a small portion of the rule struck down on questionable first amendment grounds. Unlike past cases, however, the Commission did not just take the shellacking. First, the SEC, showing verve, indicated its intent to implement the rule (staying only the portions held to have violated the first amendment) and denied a motion for a stay. For the statement from CorpFin on the issue, go here

The Commission then went even further. It contested the first amendment decision. In other words, the Agency declined to take 90% of a loaf (the portions of the rule not overturned) and opted for a strategy seeking the whole loaf. The Commission asked to have the case held. See Petition of the SEC for Rehearing or Rehearing En Banc Pending the Decision in American Meat Institute v. United States (May 29, 2014).

What has changed? Two things.  

First,  the constitutional question was already pending before the D.C. Circuit en banc, the issue having been raised in a different case. Second, given the shift in the make up of the court, there is a real chance that the law will shift to a place more in keeping with the SEC's view. If that happens, the Commission will likely ask the panel to alter its constitutional analysis and uphold the rule in its entirety.  

All of this brings us back to the Affordable Care Act. The DOJ has already announced (within hours) that it would take the case en banc in the D.C. Circuit. A victory for the United States (something highly probable) would confirm that, no matter what the individual panels do, the court en banc stands ready to change the reigning philosophy of the court.  

If the United States wins, it should embolden the SEC to appeal cases, to the full court en banc, that it loses where a panel was insufficiently deferential. In other words, the SEC would be in a position to no longer significantly fear legal challenges to rules (at least based on administrative law grounds). A loss like the one in Business Roundtable would no longer go unchallenged.  


The Supreme Court and Gender Neutrality

The Court came out with the opinion in Halliburton.  Fraud on the market survives.

The Supreme Court now has three women.  A majority of the country consists of women.  Most of our college students are women.  Isn't it time for opinions to be gender neutral?  Halliburton was not.  

The Chief Justice apparently thinks all plaintiffs and investors are men.  


  • "Halliburton urges us to overrule Basic’s presumption ofreliance and to instead require every securities fraud plaintiff to prove that he actually relied on the defendant’s misrepresentation in deciding to buy or sell a company’s stock"; 
  • "In either of those cases, a plaintiff would have to prove that he directly relied on the defendant’s misrepresentation in buying or selling the stock.");
  • "or that a plaintiff would have bought or sold the stock even had he been aware that the stock’s price was tainted by fraud"; 
  • "presumption of reliance with respect to an individual plaintiff by showing that he did not rely on the integrity of the market price in trading stock."
  • "And if the plaintiff did not buy or sell the stock after the misrepresentation was made but before the truth was revealed, then he could not be said to have acted
  • "if a plaintiff shows that the defendant’s misrepresentation was public and material and that the stock traded in a generally efficient market, he is entitled to a presumption that the misrepresentation affected the stock price. Second, if the plaintiff also shows that he purchased the stock at the market price during the relevant period, he is entitled to a further presumption that he purchased the stock in reliance on the defendant's misrepresentations."


  • "That is because, even assuming an investor could prove that he was aware of the misrepresentation, he would still"; 
  • "That provision requires an investor to prove that he bought or sold stock “in reliance upon” the defendant’s misrepresentation."

In some cases, the opinion also used quotes that were not gender neutral.  At least there, the lack of gender neutrality came from the quote.  In at least one instances, however, the majority opinion makes a gender neutral quote into a non-gender neutral quote.  See majority opinion, at 17 ("If it was not, then there is 'no grounding for any contention that [the] investor[] indirectly relied on th[at] misrepresentation[] through [his] reliance on the integrity of the market price." 

The same lack of gender neutrality was reflected in the concurring opinion by Justice Thomas.  There, in addition to investors (see concurring opinion at 11) and plaintiffs (see concurring opinion at 3), the opinion went for a hat trick and characterized defendants as men.  See concurring opinion, at 12 ("Thus, by its own terms, Basic entitles defend­ants to ask each class member whether he traded in reli­ance on the integrity of the market price.  Thus, by its own terms, Basic entitles defend­ants to ask each class member whether he traded in reli­ance on the integrity of the market price.").  

So were any of the opinions gender neutral?  Only the short opinion written by Justice Ginsburg.   


CSR—and other-- Disclosure as “Compelled Speech”: The US and the EU Consider Very Different Approaches

The fate of compelled commercial speech is the subject of great uncertainty in the US at the moment given two recent decisions by the U.S. Court of Appeals for the D.C. Circuit.  As many previous posts have discussed,  (herehere, here, and here) ,the conflict minerals rules issued by the SEC was subject to many legal challenges, including one based on the First Amendment.  It its decision of April 14th the Court of Appeals upheld many aspects of the conflicts minerals rule but struck down the requirement that issuers must disclose if it cannot determine that its products are “DRC conflict free.”   Under the rule, that disclosure must be made in the issuer’s filing with the SEC and made to the public on the company’s website.   In striking down this provision of the rule the Court of Appeals agreed with the National Association of Manufacturers that such a disclosure was not factual, but ideological in nature, and that it was not targeted at preventing consumer deception.

The critical issue in the First Amendment portion of the case turned on the appropriate level of review.  The U.S. Supreme Court held in Zauderer v. Office of Disciplinary Counsel that government can constitutionally require disclosures of a “purely factual” nature which are “reasonably related to the State’s interest in preventing deception of consumers.” The Court has repeatedly reaffirmed Zauderer, most recently in the 2010 case Milavetz, Gallop & Milavetz, P.A. v. U.S., where Justice Sotomayor wrote for a unanimous Court that a low level of scrutiny applies only in cases where the compelled speech is “directed at misleading commercial speech.”  Because the “conflict free” labeling requirement went beyond that, the rule was subject to heightened scrutiny of Central Hudson.

At the same time as issuing the opinion, the Clerk of the D.C. Circuit issued an order staying the mandate in NAM v. SEC until seven days after disposition of a request for rehearing or rehearing en banc. This means that the court’s decision has not yet taken legal effect. Because NAM’s Administrative Procedures Act challenge failed, it is possible that both parties could seek rehearing.  Each party has 45 days in which to file a rehearing petition.  So far, neither has.

As noted by the dissenting opinion in NAM v. SEC, another case currently pending the same circuit, American Meat Institute v. U.S. Dep’t of Agriculture, raises comparable issues.   In that case the AMI argued that Department of Agriculture rules requiring country of origin labeling compelled speech in violation of the First Amendment because the rules were not aimed at preventing the deception of consumers.   A three judge panel of the Court of Appeals found that Zauderer encompassed interests beyond preventing customer confusion and upheld law.  Thereafter the D.C. Circuit vacated the panel decision and ordered en banc review.  Oral argument is set for May j19th.  

The outcome of these cases will have significant impact on many types of disclosures including but not limited to labeling regarding genetically modified organisms, child labor practices and many others.

At the same time that is seems likely that at least the DC Circuit is willing to uphold some First Amendment challenges to compelled commercial speech, the European Union is taking steps in the opposite direction.  On April 15th the European Parliament adopted  the Directive on disclosure of non-financial and diversity information to require large companies and groups to disclose information on policies, risks and results as regards environmental matters, social and employee-related aspects, respect for human rights, anti-corruption and bribery issues, and diversity on boards of directors.

The new rules will only apply to large companies with more than 500 employees and should impact approximately 6 000 large companies and groups across the EU. Companies will be required to disclose “information necessary for an understanding of their development, performance, position and impact of their activity, rather than a fully-fledged and detailed report. Furthermore, disclosures may be provided at group level, rather than by each individual affiliate within a group.”  Under the Directive, companies may choose how best to make their disclosures and may use international, European or national guidelines which they consider appropriate (for instance, the UN Global Compact, ISO 26000, or the German Sustainability Code).

Large listed companies will be required to provide information on their board diversity policy, including, but not limited to, age, gender, educational and professional background. Disclosures will set out the objectives of the policy, how it has been implemented, and the results. Companies which do not have a diversity policy will have to explain why not.

In order to become law, the Commission's proposal needs to be adopted jointly by the European Parliament and by the EU Member States in the Council (Following today's adoption by the European Parliament, the Council is expected to formally adopt the proposal in the coming weeks.  Thereafter the EU member states will have two years to implement the requirements in their national legislation.  Each member state may grant exemptions from the reporting requirements.  Already efforts are underway in some member states to protest the legislation, notably in Germany where the BDI trade association for German businesses argues that the legislation is unnecessary, because more and more firms are already producing reports on corporate social responsibility (CSR) without being forced into it.  "In recent years, the number of companies in Germany who publish annual sustainability or CSR reports on a purely voluntary basis has steadily increased," said Holger Losch, a member of the BDI's executive board.

Thus the European Union may soon be a far cry away from the US position on compelled commercial speech—at least if American Meat Institute goes the way of the NAM v. SEC.  Even if American Meat is more nuanced it seems hard to imagine US disclosure regulations reaching as far as those proposed under the EU Directive especially given the statement in the NAM v SEC opinion that “Congress [could] not require issuers to disclose the labor conditions of their factories abroad or the political ideologies of their board members, as part of their annual reports? Those examples, obviously repugnant to the First Amendment, should not face relaxed review just because Congress used the “securities” label.

Much uncertainty remains in each of the US and EU as to the ultimate outcome of the divergent approaches to non-financial disclosure regulation.  The varying approaches will provide interesting opportunities for empirical comparisons—even as they lead to frustration for issuers.


Bank of America, Kenneth Lewis and the Financial Crisis

Bank of America settled a case with the Attorney General of NY, Eric Schneiderman over the acquisition of Merrill Lynch. The settlement included a $10 payment by Kenneth Lewis, the former CEO of BofA. A copy of the settlement is here. The case was heralded as a major victory. According to Schneiderman:
  • “Today’s settlement demonstrates a major victory in our continued commitment to applying the law equally to individuals, as well as corporations. I would hope this closes one chapter of our ongoing efforts to ensure the frauds that occurred in and around the financial crisis are not forgotten.” 

Perhaps this is the end of the matter. We take the moment though to say, one last time, that whatever the merits of the disclosure claim, the closing of the acquisition of Merrill by BofA probably saved the financial system from going into terminal meltdown. An earlier post is here.  

With Lehman having failed and the banks not lending, who knows what the shock of a Merrill failure would have had on the teetering financial system. Ken Lewis was head of the bank at the time of the acquisition. For those with a memory of these things, his decision to go through with the acquisition when there were legal grounds to walk away probably saved this country from descending into an even deeper and more brutal recession. Thus, Mr. Lewis should be, as his lawyer described, "proud of the role he played in helping the U.S. banking system survive. . ."


Diversity, the Board of Directors, and the Role of Women

As we have long discussed on this Blog, corporate boards are not diverse. In 2013, approximately 14% of directors were women and/or minorities. In the S&P 500, the average number of women on a board is two (although approximately 9% have no women). In the S&P 1500, the average is one.

The usual explanation for this is the dearth of qualified candidates. The idea that, among executives, professors, lawyers, politicians, non-profits, etc. there are not enough qualified women and minorities is inaccurate. Over time, however, the argument becomes harder to make with a straight face. This can be seen with particular clarity in connection with educational trends.

Recent figures put out by the Bureau of Labor Statistics shows a growing educational divide between men and women. As the Bureau provides: "By 27 years of age, 32 percent of women had received a bachelor's degree, compared with 24 percent of men." Of course, there are not likely to be very many 27 year olds on the board (although Chelsea Clinton was elected to a board of a public company at 31). Nonetheless, the statistics suggest that boards lacking in meaningful diversity are not projecting a particularly progressive image to what is increasingly the most educated segment of the U.S. population. 


Michael Lewis, Flash Boys and Some Observations: The Promise of IEX

The NYT article and the segment on 60 minutes emphasized the role of IEX in resolving some of the concerns raised by high frequency trading.

IEX effectively introduced into the process a "speed bump" designed to impose delay on high frequency traders, eliminating some of their advantage. This was largely billed as a possible solution to what Michael Lewis described as a "rigged" market.

Success of the approach remains to be seen. One suspects that technology will develop end runs around the model. The emphasis, however, fails to capture what is really the most radical thing about the IEX model: The avowed investor orientation of the venue. As Lewis explained in the NYT: 

  • To ensure that their own incentives remained as closely aligned as they could be with those of investors, the new exchange did not allow anyone who could trade directly on it to own any piece of it: Its owners were all ordinary investors who needed first to hand their orders to brokers.

Or, as IEX says: "IEX is unique in that it is a registered ATS owned by a consortium of investors: mutual funds, hedge funds, family offices, and individuals." In other words, unlike many of the other large players in the market that are owned by, or oriented towards the interests of, brokers, IEX is seeking to orient its operations towards the interests of investors.

In theory, this should translate into the rejection of practices that benefit brokers but are viewed by investors as problematic. This can be seen from the approach taken by IEX with respect to rebates. These involve payments to liquidity providers in the form of a rebate of a portion of the access fee. Some have criticized the payments because they create a potential conflict of interest by encouraging brokers to route trades to venues because of the rebate rather than the treatment of investors.  

Given the negative perception of the practice, an investor friendly ATS would presumably seek to avoid a model dependent upon the payment of rebates. In fact, that is what IEX is doing. As the NYT stated: 

  • They would pay no rebates to brokers or banks that sent orders; instead, they would charge both sides of any trade the same amount: nine one-hundredths of a cent per share (known as nine mils).

The model has other investor friendly possibilities. To the extent that it registered as an exchange with the SEC, the IEX could develop a model of listing standards that is investor friendly. This could result in more rigorous standards (both their substance and enforcement) than what is currently in place.  

The IEX model has a lot to offer, but it is not an eleemosynary organization operating in the name of the social good. While IEX may be owned by investors, it presumably wants to maximize profits. To the extent that it foregoes the use of rebates to generate order flow, IEX is counting on investors to instruct brokers to send orders to it (IEX lists on its web site the brokers that will send it orders). Thus, the real success of the model now shfts to the behavior of investors.  


Glass Steagall, Banks, and an Absence of Risk Taking: The Example of Ireland  

One consequence of Glass Steagall was that by walling off commercial and investment banking, the two segments of the industry could evolve separately.  In early 2008, as the financial crisis began, the U.S. had five world class investment banks:  Bear Sterns, Lehman, Merrill Lynch, Mogan Stanley and Goldman.  

When the smoke cleared a year later, they were gone, at least as independent investment banking firms. Two were acquired, one failed, and two converted to commercial banks.  This was no surprise but eminently predicable. See The "Great Fall": The Consequences of Repealing the Glass-Steagall Act.  Gone were a set of intermediaries with the capital markets as something approaching their exclusive focus.

The tasks of these investment banks have largely been absorbed by commercial banks.  Commercial banks also provide underwriting and other corporate finance related services.  They make money from the capital markets.  But because they are deposit taking entities, they are subject to much greater regulatory oversight than investment banks.  Part of that oversight entails a reduction in risk taking in order to protect those deposits.  By definition, therefore, commercial banks take less risk than investment banks.

An example of this was discussed in DealBook.  In Lending Where Banks Can’t, Blackstone Thrives in Ireland, DealBook discussed innovative financing techniques by Blackrock in Ireland.  Among other things, Blackrock was able to make loans to Ireland's phone company on favorable terms in return for an equity interest.  As the article noted: 

  • Outside its complexity and daring, the Eircom deal also underscores how European banks, crippled by bad loans and regulatory restraints, are ceding ground to firms like Blackstone and others that can lend money like a bank but are not scrutinized as such. 

Blackrock demonstrates the innovative approach that can be taken by entities that are less hampered by regulatory oversight designed to reduce risk taking.  Investment banks in the US used to play that role.  Not any longer.  The result may well be harm to companies unable to get financing or the capital markets, in part by refusing to take that marginal company public.  Glass Steagall was regulation but it was regulation that allowed the capital markets to function in a more competitive manner.   


Diversity, Apple and the Unofficial Quota

Apple's board of directors has eight people, including one woman and one Asian (who happen to be the same person).  The current list of directors is here.

Apple is susceptible to pressure to change because the new quota for companies in the S&P 500 is two women.  ISS data for 2013 of the 1500 companies in the S&P Index puts the percentage of women at 14% and 17% for companies in the S&P 500. For those companies, the average number of women is 2 (although slightly less than 10% of the companies have no women). 

This is not to say that all boards are so lacking in diversity. There are after all 30 companies in the top 500 that have (as of 2013) four or more women.  And, as an interesting fact about that, eight of the companies that currently have women as CEOs in the S&P 500 (there are 23) have four or more women on the board. 

But for the most part, diversity means the minimum number that will alleviate pressure from shareholders.  All of this brings us back to Apple.  With only one woman and minority, Apple has been under pressure to improve.  According to the LA Times, Trillium Asset Management and the Sustainability Group expressed "disappointment" about the number of women on the board and, as a result, Apple agreed to add this sentence to the charter of the nominating and corporate governance committee:  "The committee is committed to actively seeking out highly qualified women and individuals from minority groups to include in the pool from which Board nominees are chosen.” 

Will the addition of this language accomplish anything?  It hasn't so far.  That same language appeared in Apple's proxy statement back in 2009. So the Nominating Committee has been "actively seeking" highly qualified women and minorities at least since then.  In 2009, five of the eight directors were the same (Levinson, Campbell, Drexler, Jung, and Gore).  One of the slots went to the CEO, although that switched from Jobs to Cook.  Two directors, however, were replaced.  Eric Schmidt and Jerome York, who were on the board in 2009, but were gone by 2013, were replaced by Robert Iger and Ronald Sugar.  So there were openings but no "highly qualified women" or "individuals from minority groups" made the cut.

Perhaps this time around, Apple will do better.    


Retail Investors, Outflow from Capital Markets, and the Millennial Generation

We are discussing the possibility that retail investors are leaving the capital markets.

UBS conducted a study of the investment attitudes of the Millennial generation (defined as 21 to 36).  The survey, conducted during the last day of December and into early January 2014, involved slightly more than 1,000 Millennials. Surveyed participants age 21 to 29 had "at least $75,000 in household income or $50,000 in investable assets," and those age 30-36 had "at least $100,000 in household income or $100,000 in investable assets." Thus, the surveyed group was affluent and presumably more likely to be aware of investment alternatives than the general population. 

Compared with older generations, Millennials seem to have a greater tolerance for risk.  65% of those responding described their risk tolerance as moderate to aggressive.  That compared to 73% for Gen X (37-48), 59% for Boomers (49-67), and 51% for the WWII generation (above 68).  The difference between Gen X and Millennials was not in the aggressive/somewhat aggressive categories (31% and 29% respectively) but in the moderate category (47% and 36%).  

Whatever the risk tolerance levels, Millennials are mostly staying out of the stock market. According to the Report, the Millennials surveyed had "more than half of their assets in cash (52%), with less than one-third of their assets (28%) in equities."  The numbers are almost reversed for the other three generations which have 23% in cash and 46% in equities.    

The data may reflect a typical attitude common among a generation just beginning to enter the job market and amass wealth.  The Report suggested otherwise.  It noted that even the Millennials aged 30-36 with at least $100,000 in assets had a high cash allocation (42%) and concluded that the asset allocation reflected "wariness about financial markets."

The data suggests that Millennials have a decent tolerance for risk yet are staying out of the stock market.  Which raises an intriguing question.  If Millennials have a decent tolerance for risk what is keeping them out of the stock market?


The Increasing Importance of Sustainability Reporting

Sustainability is becoming an increasingly hot topic among corporate commentators--at the 2014 World Economic Forum in Davos, there were more than 20 sessions covering climate change, resource security and sustainability  The attention being paid to sustainability issues is in part due to the fact that activist investors and others pushing for corporate governance changes have, to a large extent, won their battles on issues such as majority voting, eliminating staggered boards, and super-majority voting, among others.  While those issues remain on the table, space has been cleared for other matters to garner increased attention and sustainability is moving into the gap.  There are many different definitions of “sustainability” but a common one holds that sustainability is a “tridimensional construct that includes environmental, economic, and social dimensions" of corporate activity.  This concept is commonly referred to involving triple-bottom line accounting, in which a sustainable firm considers the impact of its behavior as measured by economic growth and social and environmental impact.

Although no U.S. laws currently mandate sustainability reporting, the issue is of importance to investors. Both the New York Stock Exchange and NASDAQ are participating in the United Nations’ Sustainable Stock Exchanges initiative which aims to explore how exchanges can work together with investors, regulators, and listed companies to enhance corporate transparency on CSR issues and encourage responsible long-term approaches to investment.  State and local pension funds and union pension funds are actively encouraging the use of shareholder resolutions to push sustainability issues. Nearly 40 percent of all shareholder proposals filed in 2013 concerned sustainability issues and these proposals represented the largest category overall, according to a report by Ernst & Young.

Within the broad category of sustainability, climate change has been a frequent shareholder proposal topic.  In this area it is worth noting the SEC Staff's February 13, 2013 no-action letter to the PNC Financial Services Group, Inc.  PNC sought to exclude a shareholder proposal asking its board to report to shareholders on the company's assessment of greenhouse gas emissions resulting from its lending portfolio and its exposure to climate change risk in its lending, investing, and financing activities.  PNC argued that exclusion of the proposal was proper because the company’s “day-to-day business consists primarily of lending, investing, and financing activities." The SEC did not agree, instead stating “we note that the proposal focuses on the significant policy issue of climate change. Accordingly, we do not believe that PNC may omit the proposal from its proxy materials in reliance on rule 14a-8(i)(7).”

Despite the increased attention being paid to sustainability issues generally, and climate change specifically, most U.S. companies are remiss in reporting on such matters. According to The Conference Board’s report Sustainability Practices: 2013 Edition, fewer than 20 percent of S&P 500 companies disclose their performance across a broad range of environmental and social practices.  This lack persists despite the existence of a plethora of reporting mechanisms, including, among others, the GRI Framework for Reporting, the CDP’s (formerly the Carbon Disclosure Project) reporting process, Brandlogic’s Sustainability IQ Matrix, Bloomberg’s ESG Disclosure Scores, Newsweek’s Greenest Companies, and the EIRIS Global Sustainability Ratings.  With regard to climate change it also suggests that companies are ignoring the SEC’s Commission Guidance Regarding Disclosure Related to Climate Change, issued in 2010, in which the agency suggested specific places in publically filed reports where issuers should consider including climate change disclosures.

While some companies issue sustainability (or CSR) reports on an annual basis, many do not. This stance is becoming increasingly ill-advised as the calls for such disclosures continue to grow.  In 2013, the Center For Science and Democracy joined the legions pushing for climate change disclosure, pairing with CDP to quiz companies about whether they were members of trade groups and, if so, whether they agreed with these groups' climate policy positions.  The results can be found in the 2013 UCS report Assessing Trade and Business Groups' Positions on Climate Change, available at

Companies who are not currently engaging in sustainability reporting would be well-advised to reconsider their position.  Sustainability reporting is likely going to be inevitable and it would behoove issuers to be ahead of (or at least on) the curve, instead of playing catch-up.  That said, sustainability reports should not just be window-dressing.  While such an approach might satisfy simply “check-the-box” compliance concerns, investors are eager for real content and shirking the issue will likely lead to investor ire.

To be sure, there are some concerns that must be borne in mind when issuing sustainability reports. Among other matters, issuers should be careful not violate Regulation FD (Fair Disclosure) by releasing material nonpublic information in the report.  Further, any information contained in a sustainability report should be contained in other public documents (e.g., securities and other regulatory filings).

The bottom line is that sustainability reporting matters to investors.  Issuers who are proactive in this area will be able to address shareholder concerns more effectively, thereby lessening the potential for expensive and unnecessary proxy fights and increasing their corporate reputation.


Diversity and the Legal Profession

We spend a significant amount of time on this blog examining the issue of diversity.  Mostly it comes up in the context of boards of directors (although we also discuss it regularly with respect to the lack of women and people of color on the Delaware courts).  Nationally, women and people of color make up approximately 15% of boards.  For the most part, this means one person of color and one woman on each of the boards of the largest companies in the U.S.   

But this is not the only area that deserves criticism.  Recent data with respect to women in the legal profession is not good and, unfortunately, moving in the wrong direction.  According to the National Association of Legal Placement, women and minority partners increased slightly, minority associates increased somewhat, but the number of women associates fell for the fourth year in a row.    

  • Among associates, the percentage of women had increased from 38.99% in 1993 to 45.66% in 2009, before falling back each year since, to 44.79% in 2013. Over the same period, minority associate percentages have increased from 8.36% to 20.93%, more than recovering from a slight decline from 2009 to 2010. Representation of minority women among associates in the two most recent years just barely exceeded the 11.02% figure for 2009.

Moreover, while the numbers improved within the ranks of partners, they were still low.  As NALP reported:

  • In 2013 that slow upward trend continued for partners, with minorities accounting for 7.10% of partners in the nation’s major firms, and women accounting for 20.22% of the partners in these firms. In 2012, the figures were 6.71% and 19.91%, respectively. Nonetheless, the total change since 1993, the first year for which NALP has comparable aggregate information, has been only marginal. At that time minorities accounted for 2.55% of partners and women accounted for 12.27% of partners.

We've included a table at the end of this post with the statistics. 

The problem, however, starts at the front end. Since 2000 (and likely before) women have constituted less than half the students admitted to law school.  This is the case despite the fact that through much of the first decade of the new millennium, female applicants were equal to or outnumbered male applicants.  The number of women matriculants is also less than half of all law school graduates with 21,560 men and 19,700 women graduating in 2012.  Moreover, from 2011 to 2012, the decline in admitted students (down from 55,000 to 50,000) was almost entirely borne by non-Caucasian/white admittees (Caucasian students only fell from 35,920 to 35,620). So things aren't getting much better and there is reason to believe matters are backsliding. 

What is going on? It's not a lack of qualified candidates.  The only requirement (besides taking the LSAT) for admission to law school is an undergraduate degree.  And in that category, women are trouncing men. Of the population aged 25-34, 27.8% of the men and 35.6% of the women have a BA or higher.  So there is something about legal education and the legal profession that is discouraging women.  While the concern over the total decline in applications is catching most of the national news, perhaps this is a more important issue to address. 


Table 1. Women and Minorities at Law Firms — 2009-2013








% Minority Women



% Minority Women



% Minority Women



% Minority Women




































































Reese v. McGraw-Hill Companies: Rehash of Claim Not Enough to Set Aside Judgment

In Reese v. McGraw-Hill Cos., No. 08 Civ. 7202 (SHS), 2013 WL 5338328 (S.D.N.Y. Sept. 24, 2013), the United States District Court for the Southern District of New York (“S.D.N.Y”) denied a motion for relief from judgment from a previous dismissal of securities fraud claims against McGraw-Hill Companies, Inc. (“McGraw-Hill”).  The court found that the newly discovered information would not have changed the outcome of the case.

Plaintiff shareholders, including lead plaintiff Boca Raton Firefighters and Police Pension Fund (collectively “BRPF”), brought claims of securities fraud based upon statements made by Standard and Poor’s (“S&P”), at the time of the financial division of McGraw-Hill. Specifically, BRPF alleged that S&P defrauded investors through misstatements made in regard to the “stringency, independence, and integrity” of the company’s credit ratings of mortgage-backed securities and collateralized debt obligations, and in regards to misstatements about the ongoing surveillance of the reliability of its ratings.

The trial court originally dismissed the suit for failure to state a claim in March 2012, and the United States Court of Appeals for the Second Circuit affirmed. In the most recent action, BRPF contended that it discovered new evidence that warranted that the 2012 dismissal be set aside through Federal Rule of Civil Procedure (“FRCP”) 60(b)(2), or alternatively, that BRPF be given the ability to amend its complaint against S&P and McGraw-Hill.

The source of BRPF’s newly discovered evidence came from a February 2013 Department of Justice complaint against McGraw-Hill, and from the deposition of an unrelated suit involving McGraw-Hill given by Frank Raiter, the head of S&P’s mortgage-backed securities. BRPF contended that this new evidence supported its motion to set aside the 2012 judgment by showing that S&P’s ratings were not independent and objective, but rather that “profits were running the show.” BRPF pointed to statements made by Raiter that stated that S&P delayed the implementation of an upgraded ratings model because the company wanted to maintain its current market share.

A motion to set aside a final judgment under FRCP 60(b)(2) is a stringent standard and should only be granted when “substantial justice” requires it. The elements of a 60(b)(2) claim include: (1) newly obtained evidence existed during the trial, (2) the party seeking a 60(b)(2) motion was justified in not being aware of the facts, (3) the evidence is admissible and would have changed the outcome of the case, and (4) the evidence is not merely cumulative or impeaching.

The trial court found that BRPF’s new evidence was not such that it would change the outcome of the original dismissal against BRPF. Even with the new evidence, BRPF did not meet the particularized requirements for showing that S&P’s statements were materially false, and constituted securities fraud under its original 10b-5 claim. 

The court likewise dismissed BRPF’s motion to amend its complaint because the newly discovered evidence would not change the outcome of the case and was untimely.

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


Board Diversity and "Checking the Box"

Twitter represented one of the most publicized public offerings in 2013.  In going public, the Company filed a registration statement on Form S-1.  The Registration Statement disclosed that there were six executive officers, a group that included one woman (Vijaya Gadde, the general counsel).  She was appointed to the position shortly before the public offering. 



Jack Dorsey

  36   Chairman

Peter Chernin

  62   Director

Peter Currie

  57   Director

Peter Fenton

  41   Director

David Rosenblatt

  45   Director

Evan Williams

  41   Director


The filing of the registration statement generated significant commentary about the lack of diversity on the board.  In part, the criticism arose because of the response made by the CEO to calls for greater diversity.  In particular, he disavowed any interest in selecting board members to the extent doing so would amount to “just checking a box.”

Twitter did recently add Marjorie Scardino to the board.  As her bio posted on the Twitter site reveals:

  • Ms. Scardino, age 66, served as Chief Executive Officer and as a member of the board of directors of Pearson plc, a publishing and education company, from 1997 to 2012. From 1985 to 1997, Ms. Scardino served in several roles at The Economist Group, a media company, including as Chief Executive Officer. Ms. Scardino served on the board of directors of Nokia Corporation, a telecommunications company, from 2001 to April 2013. Ms. Scardino holds a B.A. in Psychology from Baylor University and a J.D. from the University of San Francisco School of Law.

The decision likely takes the heat off of Twitter for now (although the board continues to lack people of color).  The number of women directors in America is so anemic (around 15%) that the appointment of a single woman is generally sufficient to meet applicable standards for public companies.

Nonetheless, the incident raises important issues.  First, any high profile company that does an IPO will likely be criticized if it lacks gender diversity on the board.  Facebook is an example of where this occurred.  Presumably, this is known to the board of the company going public, either because directors have seen examples in the popular press or because they have been told by their lawyers and investment bankers assisting with the IPO.  As a result, it is somewhat inexplicable that the issue does not get corrected before the public offering occurs.

Second, public companies are, broadly speaking, operating under a "check the box" approach to diversity.  Public companies know that, for the most part, they can alleviate public pressure as long as they have a single woman or person of color on the board.  This suggests that the number of women, or people of color, are based not on a serious understanding of the benefits of diversity but upon the need to alleviate public pressure. 


Advising Candidates Entering the Market for Law Faculty

Every law faculty member has, at one time or another, had to sit down with someone interested in the teaching market and explain the criteria used by most law schools in selecting faculty.  Anyone who has participated in the appointments process at a law school knows that random factors always intervene. Moreover, since law schools only typically require a JD (and some not even that), every graduate meets this criteria.  As a result, law schools have to use other factors to reduce down the pool of candidates. 

In providing insight into this often Delphic process, the usual advice is likely to involved recommendations of a judicial clerkship, the publication of a law article (notes in law school for the most part do not count), and perhaps the teaching of a law class.

An empirical article about the market for law faculty titled The Labor Market for New Law Professors and written by two faculty members, Professors Tracey George at Vanderbilt Law School and Albert Yoon at the University of Toronto, provided some statistical analysis that may refine these answers.  The piece examined the factors that went into obtaining a short interview at the AALS conference, a callback interview, and a final offer.  The article used survey data from 2007-2008 and does not account for any shift in hiring market dynamics that have occurred since then.  The article also relied on survey data that was supplemented by "limited biographical information" from other sources. 

The article suggests that stage of career matters.  The optimal time to apply for law teaching is within a decade of graduation.  Judicial clerkships are a plus (not at the screening stage but at the job talk phase) as are published articles.  Notably, as one might suspect, the type of teaching experience matters.  Non-law teaching does not provide a plus in the hiring process.  Moreover, while writing is a plus, the publication needs to be in a top 100 journal. See Id.  ("A top-100 law journal continues to be an important plus: such candidates were 18-20% more likely to have job talks."). 

As the article describes:  

  • Candidates who graduated within the last ten years were 30-37% more likely to receive an offer than those who graduated outside of this window. A judicial clerkship improves the probability of being hired by roughly 9-19% (the effect diminishes sharply once controls are added for rank of law school attended). Prior experience in law teaching increases the probability by 25-27%. (But non-law teaching experience does not improve one’s chances.) An article in a top-100 journal increases the probability by 18%-20%.

Other factors matter in an uneven way.  Increasingly, candidates seem to come to the teaching market with JDs and PhDs. PhDs can help.  As the article notes:  "Non-law doctorates, regardless of subject, are statistically significantly related to the probability of being asked for a call-back". 

With respect to hiring, however, a PhD affects placement. Those with PhDs "who were no more likely to be hired, but conditioned on being hired, more likely to end up at a Tier-1 law school". As the article concluded: 

  • This means that conditioned on being hired, applicants with a PhD are less than half as likely to end up at Tier-3 or Tier-4 schools as applicants without PhDs, but more than twice as likely to end up at a Tier-1 school. In other words, having a PhD may not affect one’s chances of getting a tenure-track job, but appears to have a significant and positive effect on placement. 

Perhaps the most interesting factor is the importance of law school teaching or a fellowship position.  The statistics showed that this group had a 34-35% greater likelihood of obtaining a job talk.  See Id.  ("The largest factor came from professional employment: respondents from a law school teaching or fellowship position were 34-35% more likely to have job talk offers than the baseline group. In pair-wise comparisons, they were also at least 25% more likely to have job talk offers than respondents from any other employment."). 

There are any number of explanations for this "bump."  One is that teaching at a law school provides an indicia of how the candidate will succeed at one of the major tasks on any law faculty.  In short, the information to some degree reduces hiring risk.  More likely, however, the fellowship programs often try to set themselves up as a feeder for teaching positions, likely obtaining higher quality candidates.  To the extent this is true, the programs may provide assistance in the faculty job market, whether assistance in creating a strong record or in preparing for the rigors of the AALS interview process. 

Finally, what everyone also knows, is that the law school attended matters.  Id.  ("As expected, Tier-1 graduates and law teaching fellows fared better than other applicants").

So the advice today?  Mostly the same:  clerk, publish (even if not in the top 100, its important to show a culture of writing), and teach, with the proviso that a fellowship program is a good idea if it has  a strong record for faculty placement.  Finally, if you want a top law school teaching post to an elite law school get a PhD.  


Lackluster Law Reviews and the Changing Landscape of Legal Scholarship

Adam Liptak's article in the NYT about the decline in law review covers some familiar ground for anyone who has been teaching in a law school. Faculty are at the mercy of untrained students. Articles are often excessively long and too dense. Some faculty latch onto a good idea and then promptly repeat it over and over in successive articles.

But beyond rehashing old ground, the article really did a disservice to the universe of legal scholarship.  A description that empasized hard copy law review articles and law review placement may have been accurate 20 years ago. But today, the landscape has changed. For one thing, there are legal blogs that get ideas out quickly and efficiently. They are being cited more and more often. See Essay: Law Faculty Blogs and Disruptive Innovation (noting that as of June 2012, law blogs had been cited in at least 88 legal opinions and more than 6,340 citations in assorted law reviews and other legal publications).

Second, there are online supplements to law reviews that publish shorter and more timely pieces. Admittedly, many of these supplements are struggling to attract high quality submissions. Nonetheless, they provide a forum for shorter pieces designed to be published quickly and, often, to affect an ongoing debate. At the University of Denver, the law review published an entire edition on the JOBS Act, recent legislation adopted in the securities area. The papers were all written by students under very tight supervision (on my part). The scholarship was short, direct and useful.

Third, there is SSRN. Sometimes it seems as if the tyranny of the student selection process has only been replaced by the perfidy of the download count. Nonetheless, as a practical matter, the easy availability of papers on SSRN to some degree reduces the importance of the student selection process. Substitutes for quality such as the reputation of the particular review (often really the reputation of the particular law school) that published an article are less important when quality can be judged first hand by downloading the piece on SSRN.

Fourth, whatever the criticism, amicus brief writing by faculty seems to be far more common. Faculty are in a position to write something that less resembles a polemic and more resembles an explanation. Particularly in the business area, law clerks at the Supreme Court are often unversed in such areas as the federal securities laws.  An amicus brief from faculty has the ability to influence the outcome, either by convincing the justices or by preventing some interpretive mistakes in the final opinion, whatever the outcome.

A thousand flowers are blooming in the realm of legal scholarship, compensating for many of the problems associated with traditional law reviews. The real problem is that the reward system at law schools still functions as if the law review article and the law review placement process constituted the sole judge of a faculty member's intellectual contribution. It remains sage advice to any untenured faculty member to stay away from blogging (at least if it reduces the time available for traditional law review articles). Pieces published in online supplements of law reviews are subject to an "online discount." See Essay: Law Faculty Blogs and Disruptive Innovation at 541. As a result, some faculty who would be better off blogging or writing shorter online pieces are forced into the straitjacket of traditional articles.

The problem, therefore, is not legal scholarship. The problem is the hidebound views within the academy that act as if the Internet had never arrived and hard copy law review articles remained the only coin of the realm.


It’s Not Over Yet For Conflict Minerals or Debit Card Fees

Earlier posts have discussed the on-going legal battles over provisions contained in Dodd-Frank requiring the SEC to create a rule governing conflict minerals disclosure and the Federal Reserve to draft a regulations capping debit card fees.  In the first round (in the DC District Court), the SEC successfully defeated a challenge to the final conflict minerals rule it crafted, while the Fed (surprisingly) lost a challenge to its action with Judge Richard J. Leon striking down the Fed regulation.

Now we move on the round two.  On August 12th  a group led by the  National Association of Manufacturers, which lost in the DC District Court, filed a notice of intent to appeal the ruling upholding the SEC’s final conflict minerals rules, followed by a preliminary statement of issues filed on August 19th.  In that statement of issues NAM indicates that it will appeal, among other issues, the Commission’s refusal to adopt a de minimis exception to the conflict minerals rule, the SEC inclusion of non-manufacturers who contract for the manufacture of products within the scope of the rule, whether the SEC conducted an adequate economic analysis of the rule and whether the rule compels speech in violation of the First Amendment.  Initial documents related to the appeal are due by September 12th.

On August 21st, the Federal Reserve, which also lost in the District Court, notified the US Court of Appeals that it would appeal from the ruling striking down its regulation setting a 21 cent cap on debit card fees.  What is interesting in this action, in addition to the central test of the courts’ power to strike down financial regulations, is what will happen during the pendency of the appeal.  Judge Leon initially suspended the vacatur of the regulation so that the parties could determine their next action.  At the hearing on August 21st, the judge suggested that he could require the Fed to write an interim rule that would, in his view, comply with Dodd-Frank while pursuing an appeal.  The Fed objects to this idea, stating through its lawyer Scott Alverez that “doing so might undermine the Fed’s position during the appeal” and that “such a rule might create uncertainty for banks and others.”“The industry would not be aware of what to do.  Nor would the merchants.”  Judge Leon seemed unconvinced and asked the Fed to file briefs by Aug. 28 including arguments as to why the district court did not have the authority to direct the Fed to write a replacement debit fee rule. 

So now we wait and will see in the not too distant future if the US Court of Appeals brings any consistency to the as of now very inconsistent method by which the DC District Court has treated Dodd-Frank rule-making.






The Federal Reserve will appeal a judge's decision to throw out its limits on debit card fees.

The central bank told a U.S. District Court Wednesday it would challenge the ruling from Judge Richard Leon, who said in July the Fed misinterpreted Congress's intent when it originally set the hotly contested limits.

The decision to appeal comes as banks and retailers are yet again sparring over the so-called "interchange fees." Limits on those fees were mandated as part of the Dodd-Frank financial reform law, and the banking industry has fiercely tried to fight them back through Congress, regulators, and now the courts. Meanwhile, retailers have pushed right back, eager to save billions of dollars in revenue by paying smaller amounts to banks every time they process a debit card transaction.



Leaning Back: Corporate Culture and Fostering Creativity

The Economist (in the Schumpeter column) published a pithy piece titled "In Praise of Laziness."  The article asserted that "the biggest problem in the business world is not too little but too much—too many distractions and interruptions, too many things done for the sake of form, and altogether too much busy-ness."  Rather than lean in, there should be greater incentive to lean back.  In other words, do less, not more.  The main beneficiaries?

  • The most obvious beneficiaries of leaning back would be creative workers—the very people who are supposed to be at the heart of the modern economy. In the early 1990s Mihaly Csikszentmihalyi, a psychologist, asked 275 creative types if he could interview them for a book he was writing. A third did not bother to reply at all and another third refused to take part. Peter Drucker, a management guru, summed up the mood of the refuseniks: “One of the secrets of productivity is to have a very big waste-paper basket to take care of all invitations such as yours.” Creative people’s most important resource is their time—particularly big chunks of uninterrupted time—and their biggest enemies are those who try to nibble away at it with e-mails or meetings. Indeed, creative people may be at their most productive when, to the manager’s untutored eye, they appear to be doing nothing.

The piece essentially demonstrates the counterintuitive nature of a system that promotes creativity.  Employees are paid to do nothing (or at least to be less quantitatively productive), in the hope that they will come up with something innovative, even revolutionary.  In such a system, some will take advantage of the arrangement and daydream rather than innovate.  Others will think hard but produce nothing.  In other words, leaning back is, in the aggregate, a system that may well be extraordinarily inefficient and one, in a rigorous profit maximizing universe, that may be hard to justify.

Yet creativity is itself inefficient.  There are no logarithms that can predict creativity.  Indeed, it is the very unpredictability of the endeavor that provides the greatest promise for return.  As a result, building a system that deliberately includes some "leaning back" inefficiency may prove to be the most efficient of them all.

Leaning back is not limited to the corporate realm.  It can also benefit education.  Its tempting to judge success or failure of a system by the scores on a test (a form of leaning in).  The US is often judged globally, for example, based upon the poor showing in assorted math and science tests (11th in fourth-grade math for example).  Its not that the test scores are meaningless.  What they are is incomplete.  They don't assess the role of creativity in the learning process. 

Sometimes its better to lean back from the testing process.  In Denver, for example, one of the high schools is the Denver School of the Arts, an institution replete with actors and creative writers, flute layers and dancers.  Indeed a student who graduated from the school in 2005 recently won a Tony Award.  This does not come through in the math and science tests.  

In truth, any process that seeks to foster creativity must build in some opportunity for leaning back. The Economist praised laziness.  In reality, creativity is not a byproduct of laziness but a byproduct of inefficiency.  So lets praise creativity and the importance of inefficiency.   


The Future of Online Education for Law Schools

The NYT recently published a fascinating article about online education.  The core of the article was the decision of Georgia Tech to offer an online masters degree in computer science.  The cost will be $6600, "far less than the $45,000 on-campus price."  The degree will be awarded by Georgia Tech.  Georgia Tech will provide the content and the professors (in return for 60% of the revenue) and Udacity, a for profit corporation in the educational area, will provide the the computer platform (in return for 40% of the revenues).

The program raises a number of interesting questions.  This is not an example of someone offering free courses online.  It is an example of an academic institution offering advanced degrees. To the extent that the quality of the online program does not continuously match the quality of the on campus degree, there is a risk that the approach can water down the overall reputation and quality of the university.

Moreover, there are likely to be some students who opt for the $6600 degree rather than study for the degree on campus, depriving the University of almost $38,000.  That loss of revenue will be made up if enough students take the online program but that remains to be seen.

All of this means that the model chosen by Georgia Tech may or may not work.  But it represents an innovative approach and demonstrates an evolving approach of higher education.  For all of the criticism that is commonly heaped on higher education, the US still has the best system in the world. Moreover, as Georgia Tech shows, education takes place in an capitalist environment where there is room to profit from innovation. 

The approach by Georgia Tech also addresses some of the cost issues associated with higher education. While $6600 is not an insignificant amount, it certainly brings the Masters degree within the range of larger body of prospective students than those able to study on campus.  Moreover, it provides a mechanism to learn a new skill or enhance an existing one remotely.  

The approach and risk taken by Georgia Tech should, therefore, be lauded and followed closely but it is only a piece of the ongoing evolution in higher education, not an end result.  Online education will likely find a permanent role in the pantheon of higher education but will not replace the on campus experience (expensive though it is).

Note, first of all, that Georgia Tech is proposing an online masters, not an online BA.  In other words, the approach is not being marketed as a substitute for the four year degree.   

Moreover, the degree at Georgia Tech is in computer science.  With the growing importance of technology, this type of degree may be particularly suited to an online program.  To the extent that computer science teaches some objective content (the ability to use assorted computer programming languages for example), the degree may have value both because of the academic credential and because of the particular skills taught.      

For other degrees (whether BAs or advanced degrees), the on campus experience may have greater value. Many obtain MBAs not only for the knowledge but also for the particular contacts that are made during the program.  This presumably requires an on campus experience.  

In the law area, Concord Law School, an unaccredited law school based in California, has provided an online education since the late 1990s.  Those who complete the program can sit for the California Bar.  Moreover, law schools may also offer online classes.  See ABA Standard 306 (permitting up to 12 credit hours of online classes).  

Legal education does not appear to have been significantly impacted by online endeavors.  There may be a reason for that.  Legal education is not really meant to teach a specific content (notwithstanding the fact that almost every law school offers the same basic courses in the first year) but is more intended to teach students how to think like lawyers.  This is likely a more difficult skill set to teach in an entirely online fashion.  Similarly, personal contacts made in law school (whether with fellow students or among practitioners) have a value that may be difficult to duplicate online.  

But having said that, online learning in the area of legal education provides benefits.  It may be more cost effective.  It is convenient.  Classes taught remotely may be able to retain experts outside the law school's geographic area (courses on the EU taught by EU experts in Europe for example).  This suggests that there is a role for online learning that can be best used in conjunction with traditional legal teaching methods.

Of course, this may be a narrow perspective.  To the extent that it is, the approach (and risks) taken by Georgia Tech may provide additional insight into the role of online learning in the legal context.  


DC Circuit Court Upholds Conflict Minerals Rule

On July 23, the United States District Court for the District of Columbia in an opinion by Robert Wilkins, upheld the newly adopted Conflict Minerals Rule, granting the SEC summary judgment in a case brought by the National Association of Manufacturers and others.   While the decision is of course subject to appeal, for now issuers subject to the rule must work to ensure compliance with the Conflict Minerals Rule by May 31, 2014 when the first reports required by the Rule will be due. 

On one hand the final ruling is not surprising given that during oral arguments Judge Wilkins suggested “[t]his is a circumstance where a court should really defer to Congress and the executive in an area of foreign policy where the court has no expertise." However, most commenters were still expecting a different outcome given the recent decision vacating the Resource Extractive Industries Rule.  As is appropriate in a grant of summary judgment, the Court considered each of the petitioners’ claims exhaustively.  The following summarizes the Court’s finding on each of the challenges raised.

The Court begins by noting that the case

presents two separate categories of claims for the Court’s review. First, Plaintiffs challenge the SEC’s promulgation of the Conflict Minerals Rule under the APA, claiming that the Commission ignored its statutory obligations under the Exchange Act in issuing the Rule and that the Commission’s rulemaking was arbitrary and capricious in several other respects. Second, Plaintiffs mount a constitutional attack against both the Final Rule and Section 1502 of Dodd-Frank, contending that the obligation for companies to publish their conflict minerals disclosures on their own websites compels speech in violation of the First Amendment.

The Court first considers the challenges made under the APA and begins by addressing the appropriate standard of review, noting that

Under the APA, agency action is unlawful if it is “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” 5 U.S.C. § 706(2). The “arbitrary and capricious” standard of review is a narrow one, and it is well settled that “a court is not to substitute its judgment for that of the agency.” Motor Vehicle Mfrs. Ass’n v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983).

Moreover, where a case turns on the agency’s interpretation of a statute it is charged with implementing, courts apply the well-worn, two-part Chevron test.  Under Chevron Step One, the court must first determine “whether Congress has directly spoken to the precise question at issue.” Pub. Citizen v. Nuclear Regulatory Comm’n, 901 F.2d 147, 154 (D.C. Cir. 1990). If so, then the court’s inquiry ends, and the clear and unambiguous statutory language controls.  If the statute is ambiguous, however, then the analysis shifts to Chevron Step Two, whereby the reviewing court must consider “whether the agency’s [interpretation] is based on a permissible construction of the statute.” Chevron, 467 U.S. at 843.


The SEC’s Statutory Obligations Under The Exchange Act

The petitioners raised a broad challenge to the Rule seemingly based on their understanding of Business Roundtable.   They claimed that the Commission failed to analyze properly the costs and benefits of the Rule as a whole and that this violated its statutory obligations under the Exchange Act.

Specifically, they argued:

  • The Commission had to conduct an adequate analysis of the overall costs and benefits of the rule, including the alternatives it adopted, in order to satisfy its statutory obligations and exercise its authority in a reasoned manner. …the Commission shirked its statutory obligations to consider “whether the action will promote efficiency, competition, and capital formation,” 15 U.S.C. § 78c(f), and to ensure that the Rule would not “impose a burden on competition not necessary or appropriate in furtherance of the purposes of” the Exchange Act id. § 78w(a)(2).

Further, the petitioners claimed that

  • the Commission abdicated this responsibility and improperly deferred to “Congress’s determination that conflict minerals disclosure will yield social benefits in the form of decreasing conflict and violence in the DRC” and “failed to even conclude that [its] choices will improve conditions in the DRC at all.”  

According to the petitioners, these failures rendered the Commission’s decision-making arbitrary and capricious, necessitating vacatur of the Conflict Minerals Rule.

In a strong rebuke, the Court disagreed.  It first rejected the notion that the Exchange Act requires mandatory cost-benefit analysis of every SEC rule, noting that Sections 3(f) and 23(a) (2) (the relevant provisions of the Exchange Act)

  • only obligate the SEC to “consider” the impact that a rule or regulation may have on various economic-related factors—efficiency, competition, and capital formation. In doing so, the Commission may deem it appropriate (or even necessary) to weigh the costs and benefits of its proposed action as related to these enumerated factors, but to suggest that the Exchange Act mandates that the SEC conduct some sort of broader, wide-ranging benefit analysis simply reads too much into this statutory language.

The Court distinguished Business Roundtable and other cases that found SEC rule-making to be arbitrary and capricious because it concluded that in those cases the SEC was statutorily required to consider the economic implications of its actions whereas nothing required the SEC to consider whether the Conflict Minerals Rule would actually achieve the humanitarian benefits identified.  The Court also pointed out “important distinction” between Business Roundtable and like cases, noting that those cases

  • involved rules or regulations that were proposed and adopted by the SEC of its own accord, with the Commission having independently perceived a problem within its purview and having exercised its own judgment to craft a rule or regulation aimed at that problem.

Here, by contrast, the Commission promulgated the Conflict Minerals Rule pursuant to an express, statutory directive from Congress, which was driven by Congress’s determination that the due diligence and disclosure requirements it enacted would help to promote peace and security in the DRC. As a result, the SEC rightly maintains that its role was not to “second-guess” Congress’s judgment as to the benefits of disclosure, but to, instead, promulgate a rule that would promote the benefits Congress identified and that would hew closely to that congressional command.

Because the Court did not believe that the SEC had an obligation to assess the impact the Rule would have on humanitarian conditions in the DRC, the Court assessed instead the SECs consideration of the impact the Rule would have on “efficiency, competition, and capital formation,” and on competition more generally.  Looking to the adopting release for the Rule, the court found that the SEC properly considered the each of the required elements and therefore did not act in an arbitrary and capricious fashion when adopting the Rule.

The Commission’s Estimation of Particular Costs

In addition to the argument that the SEC acted arbitrarily and capriciously because they failed to assess whether the Rule would achieve its stated goal of improving conditions in the DRC, the petitioners also argued that the SEC arbitrarily underestimated  the Rule’s costs. Again relying on Business Roundtable they claimed that the SEC “inconsistently and opportunistically framed the costs” of the Rule and “failed adequately to quantify the certain costs” pointing specifically to information technology (“IT”) costs and the estimated number of suppliers that will be impacted by the Rule.

The heart of these claims was a disagreement in cost assessment put forward by NAM and report issued by Tulane University to which the SEC gave more credence.  Refusing to engage in a battle of the experts, the Court noted that the SEC read and relied on comments and exercised its discretion in concluding which figures were most appropriate. Although there is room for dispute about which assessment is correct, for the Court, the fact that the SEC made a reasoned decision prevented the court from finding that the Commission acted arbitrarily or capriciously in reaching its particular estimate.


The De Minimis Threshold

The Court then considered the hotly contested issue of whether the Rule should have included a de minimis exception.  The arguments on this issue were complicated but essentially boil down to the petitioners claiming that the SEC wrongly believed it lacked discretion to adopt such an exemption due to Congressional mandate while the SEC claimed it believed it did have discretion and exercised it by choosing not to allow any de minimis exemption.  The Court found that while the SEC never stated explicitly that it considered Section 1502 ambiguous on the de minimis issue such an express assertion of ambiguity was not required, and found that the SEC had treated the statutory guidance as ambiguous.  Therefore, the analysis turned to the second prong of Chevron which the Court had little difficulty concluding the SEC had satisfied.  Because the SEC felt that allowing a de minimis exemption would undermine the purpose of the Rule, the Court found that

  • the Commission’s choice not to include a de minimis exception in the Final Rule was the product of reasoned decision-making, and the Court finds no basis under the APA to subjugate the Commission’s prerogative on this point.


Reasonable country of inquiry

In yet another challenge under the APA, the petitioners claimed that the “reasonable country of origin inquiry” standard contained in the Rule was too broad because it requires due diligence and reports whenever there is ‘reason to believe’ that the minerals ‘may have originated’ in the region.   They claimed that statutory language mandated disclosure only when there is ‘reason to believe’ that the minerals ‘did originate’ in the region.  They also argued that even if the statute is ambiguous, the SEC wrongly treated it as unambiguously requiring the standard specified by the Commission, a position that should be given no deference.  Finally, they claimed that even if the SEC did exercise discretion, it did so in an arbitrary and capricious fashion.

The Court found that the statutory language was ambiguous because “Congress did not directly speak to the precise circumstances triggering disclosure obligations (and, by implication, due diligence and reporting requirements) in enacting Section 1502.”  It further found that the SEC did exercise discretion in adopting the reasonable country of origin inquiry standard.  Because the SEC exercised discretion, its actions were entitled to deference under the second prong of Chevron.  Finding that the SEC exercised reasoned judgment because, among other factors, it modeled the standard after the  “red flag” framework that triggers due diligence obligations under OECD guidance and that it recognized and rejected alternative interpretations it believed would have been permissible under the statute, the Court concluded “ that the Commission’s adoption of the reasonable country of origin inquiry is based on a reasonable and permissible construction of Section 1502, and is not otherwise arbitrary or capricious in contravention of the APA.”


The Rule’s Coverage Of Issuers That “Contract to Manufacture” Products

The petitioners made similar arguments with regard to the Rule’s inclusion of all issuers who “contract to manufacture” products with necessary conflict minerals.  They argued that the statute covered only issuers who themselves “manufacture” such products and that because “the SEC erroneously felt itself bound to adopt the contrary conclusion, the SEC’s interpretation is entitled to no deference.”  The SEC countered that Section 1502 as ambiguous as to whether issuers that “contract to manufacture” should be covered by its Rule, and in its view, the SEC reasonably and appropriately answered that question in the affirmative.         

The Court concluded that the statute was ambiguous, noting specifically that precedent clearly established the word “manufacture” is “an inherently ambiguous term.” Because of statutory ambiguity, the SEC’s interpretation of the term was entitled to deference and the Court found that the Rule’s application to issuers that “contract to manufacture” is “an amply reasonable construction of Section 1502. This is particularly true given the guidance supplied by the SEC in the Adopting Release, wherein the Commission emphasized its focus on the degree of influence and control that an issuer exercises over the manufacturing process, effectively excluding “pure retailers” from the scope of the Rule.”  One more APA challenge vanquished.


The Commission’s Adoption Of Different Phase-In Periods

The final APA challenge raised by petitioners was concerning the decision of the SEC to allow four-year phase-in period for small companies, while only allowing for a two-year phase-in period for large companies. They argued that “many smaller companies are part of larger companies’ supply chains” and that “[i]f small companies cannot comply with the rule for four years, and large companies will have to rely on small companies to comply,” it is unreasonable to expect larger companies to be able to comply within two years. The SEC explained its decision to grant different phase in periods as stemming from its belief that such “issuers may lack the leverage to obtain detailed information regarding the source of a particular conflict mineral.”  The Court agreed and while noting that it would have been “equally reasonable” to adopt one phase in period, stated that it would not “substitute its judgment on this question for the Commission’s.”


Plaintiffs’ First Amendment Challenge

Having rejected all of the petitioners’ APA challenges, the Court next considered their argument that the disclosure requirements (both the content requirements and the requirement to make the disclosure publicly available on an issuer’s website) under the Conflict Minerals Rule and Dodd-Frank § 1502 improperly compel “burdensome and stigmatizing speech” in violation of the First Amendment.  Specifically, they claimed that the rule and statute “infringe upon the First Amendment “by compelling companies to publicly state on their own websites, as well as in SEC filings, that certain of their products are ‘not DRC conflict free.”   After noting some procedural irregularities with petitioners challenge, the court concluded that the appropriate standard of review was that established by Central Hudson Gas & Elec.. (a more stringent standard than would have applied to a challenge concerning disclosure only to the SEC because this challenge involved public posting.)

Under Central Hudson,  a challenged regulation survives First Amendment scrutiny if: (1) the asserted “government interest is substantial,” (2) the regulation “directly advances the government interest asserted,” and (3) “the fit between the ends and the means chosen to accomplish those ends is not necessarily perfect, but reasonable.” Spirit Airlines, 687 F.3d at 415 (quoting Cent. Hudson, 447 U.S. at 566 (1980), and Pearson v. Shalala, 164 F.3d 650, 656 (D.C. Cir. 1999)).  Having identified the relevant government interest as promoting peace and security in and around the DRC, the Court readily concluded that the Rule passes First Amendment muster. It rejected the petitioners claim that there was a lack of sufficient empirical support to show that the Rule would achieve its goals, stating that the fact that the Section 1502 was enacted in a foreign relations context mattered.

As the Supreme Court recently made clear, “[i]n this context, conclusions must often be based on informed judgment rather than concrete evidence, and that reality affects what we may reasonably insist on from the Government.” Holder v. Humanitarian Law Project, --- U.S. ---, 130 S. Ct. 2705, 2727-28 (2010). Put another way, “because of the changeable and explosive nature of contemporary international relations, . . . Congress . . . must of necessity paint with a brush broader than that it customarily wields in domestic areas.” Id. (quoting Zemel v. Rusk, 381 U.S. 1, 17 Further, while “concerns of national security and foreign relations do not warrant abdication of the judicial role,” and while the Court does “not defer to the Government’s reading of the First Amendment, even when such interests are at stake,” the Court must nevertheless recognize that “when it comes to collecting evidence and drawing factual inferences in this area, ‘the lack of competence on the part of courts is marked.’” Id. at 2727 (quoting Rostker v. Goldberg, 453 U.S. 57, 65 (1981)). Indeed, judicial review is particularly deferential in areas “at the intersection of national security, foreign policy, and administrative law.” Islamic Am. Relief Agency v. Gonzales, 477 F.3d 728, 734 (D.C. Cir. 2007).”

Because Congress based its conclusion on the efficacy of Section 1502 and the Rule on reports from experts and on prior experience with other legislation, the Court found that “Congress’s passage of Section 1502 was not based on “mere speculation or conjecture,” but derived from its “informed judgment” and, to some degree, “history, consensus, and simple common sense.” (cites omitted).  The Court also rejected the argument that the public disclosure element of the Rule violated the third prong of Central Hudson.  Noting that “[n]either Section 1502 nor the Final Rule requires companies to separately or conspicuously publish on their website a list of products that have not been found to be “DRC conflict free,” …nor must companies physically label their products as such on the packaging itself.. Rather, companies can comply with these disclosure requirements simply by making their conflict minerals disclosures available on the same webpage that houses other required SEC filings, such as annual reports, proxy statements, and other investor-related information.”  This, coupled with the fact that during the rule-making process the SEC softened what issuers had to disclose if they could not determine the source of their materials, led the Court to conclude that the method selected by the SEC qualifies as a “reasonable fit” under the Central Hudson standard, and that the petitioners’ claim under the First Amendment fails.

Where does this leave us?  The case may well be appealed (and seems to present ample grounds for challenge which may be discussed in a future post).  As things stand now, we have two rulings from the DC District Court that stand in marked contrast to each other.  One decision vacated and remanded the Resource Extractive Industries Rule, while the decision discussed above took the opposite position.  Because the Conflict Minerals decision was a grant of summary judgment, it was more exhaustive than the Resource Extractive Industries decision.  We have no way of knowing what that court might have said about the First Amendment challenge raised in the case.  Unless and until the DC Circuit sorts out its position on these matters more legal challenges to SEC rule-making are likely.  Yet another unresolved issue is the impact of Rule 12b-21 which entitles an issuer to omit required information if it is”unknown and not reasonably available to the registrant, either because the obtaining thereof would involve unreasonable effort or expense.”  If numerous issuers rely on this rule to justify non-compliance with the Conflict Minerals Rule a whole new can of worms would be opened.


A Couple of Interesting SSRN Postings

Armstrong & Jacquart on Executive Pay

J. Scott Armstrong & Philippe Jacquart have posted, “Is the Evidence Sufficient to Take Action on Executive Pay? Reply to Commentators,” on SSRN.  Here is the abstract:

The experimental evidence in this collection of papers is sufficient for organizations to take action — at least with respect to investigating or testing alternative pay schemes. Some organizations have already implemented a number of these procedures. The failure of an organization’s directors to follow evidence-based procedures for executive pay might be used as a basis for legal action by shareholders when results are detrimental to a firm.

Hu & Marcus on Market Efficiency

Gang Hu & Mark Marcus have posted, “Emerging Issues in Evaluating Market Efficiency: Part I -- Serial Correlation,” on SSRN.  Here is the abstract:

The presence of serial correlation, properly analyzed, does not necessarily impact a security's ability to appropriately assimilate new information into its price. As long as information, when it is released, is incorporated into the price of a security, then misrepresentations and omissions, too, are incorporated. As a result, investors who relied on the integrity of the security’s price would necessarily have relied on the misrepresentations and omissions, satisfying the reliance condition for class certification.