A while back, I posted about an eyebrow-raising opinion out of the Second Circuit holding that clean audit opinions may not be material to investors because they use generic language.  Happily, the Second Circuit has agreed to take a second look at the issue, and invited the SEC to file an amicus brief, which it did.  (Alison Frankel has a column on the case here; the brief is linked here)

The brief is simple and makes the obvious point that the language of a clean audit opinion may be standardized, but its use reflects an industry understanding regarding the procedures used in the audit and the auditor’s conclusions.

One thing worth highlighting: As I explained in my original post, the way we seem to have gotten here is that the defendant auditor conducted a shoddy audit, but then argued that there was no link between its own audit deficiencies and the actual flaws in the underlying financial statements – i.e., even a proper audit would not have caught the problems.

The SEC argues that, even if true, that would not make the audit opinion immaterial; it might, however, affect the analysis of loss causation.  The distinction matters a lot to the SEC, because loss causation is only an element for private litigants; materiality, however, is an element that the SEC must prove in its own enforcement actions.

I agree with the SEC: a claim that the auditor would have issued a clean opinion – and missed the problems in the underlying financials – even if it had used proper procedures, is more properly characterized as a claim about loss causation, i.e, whether the false statement resulted in losses to the shareholders.

I like to use a little rule of thumb on the distinction between transaction causation (materiality) and loss causation.  Transaction causation asks, what would have happened if investors knew the truth?  Loss causation asks, what would have happened if the lie had been true? 

If investors would have done nothing differently, even had the truth been disclosed, the lie is immaterial. (This is, by the way, precisely what the Second Circuit has previously said about materiality). 

If the same losses would have occurred even if the allegedly false statements had been truthful – i.e., if there was some intervening cause that tanked the stock price – there is no loss causation.

In this case, it is impossible to believe that investors would have had no reaction had they been told the company was incapable of presenting a clean audit opinion.  Therefore, the Second Circuit should hold that the opinion was material.

And okay fine since I can’t resist…

As Ben Edwards blogged on Thursday, VC Laster came down with his long-awaited opinion in TripAdvisor.  The case was fascinating enough as it was – could it be a violation of fiduciary duty for a Delaware corporation to leave Delaware? – but in light of Elon Musk’s latest threats, it took on a heightened significance.

Most interestingly, VC Laster found, first, yes, a controller’s choice to relocate to a state that scrutinizes conflict transactions less closely than Delaware may itself be a conflict transaction.  And, second, damages rather than an injunction would almost certainly be the correct remedy.  Damages, he claimed, could be assessed by watching stock price movements; and not even necessarily at the moment of a shareholder vote, but even upon announcement of an intention to hold one.  (Which works for a public company, I guess; I assume we won’t see these disputes in private companies but that context would make a damages remedy much harder to fashion).

But here’s the thing.  To get there, he had to distinguish some prior cases that concluded that the elimination of litigation rights did not state a claim for breach of fiduciary duty.  This issue had come up, for example, in the context of charter amendments adding an exculpation clause under Section 102(b)(7), and in a reincorporation to California.  VC Laster was pretty clear that he simply thought some of them were wrongly decided, but his main point was that in those cases, the amendments were immaterial – i.e., it was not clear that the change conferred a non-ratable benefit on existing directors.  By contrast, he held, in this case, the differences between Nevada law and Delaware law are sufficiently plain – and the controller’s reasons for wanting the move sufficiently blatant – that the stockholder plaintiffs had at least, for pleading purposes, established they were losing a valuable right.

So … Texas?  As I previously wondered, Texas’s law might be different than Delaware’s but it is not obvious that it is so different – especially with respect to conflict transactions – that plaintiffs would be able to plead the same case.  And Musk may believe the Texas judges will less receptive to stockholder claims than Delaware judges, but, in TripAdvisor, VC Laster held that stockholders’ loss of access to any particular forum does not confer a material benefit on fiduciaries.

But!  If plaintiffs were able to plead that the move to Texas conferred a material benefit on Elon Musk, and then they had to prove damages via stock price movements – well, Musk gave them quite a boon by tweeting on January 30, in the middle of a dramatic slide in Tesla’s stock price due to the Tornetta verdict, that he hoped to reincorporate out of state.  That will sufficiently muddy the waters about price impact so as to give plaintiffs plenty of runway. 

Once again, foiled by bad tweets.

But finally, I think it will take quite a while to get that far, because if Tesla ever files a proxy statement for a shareholder vote, we will see some truly popcorn-worthy litigation over the completeness of the disclosures.  Will the proxy admit – or deny – the move was based on a Twitter poll?  How will the purposes of the move be characterized?  What was the board’s process for recommending the move, and how independent were the directors?  According to the WSJ, the directors intentionally keep concerns about Musk’s drug use out of the board minutes – can shareholder plaintiffs use §220 to get emails, then?  Etc, etc.