After the Supreme Court decided Citizens United v. Federal Election Commission, 558 U.S. 310 (2010), there were a flurry of articles pointing out its flaws as a matter of corporate theory (and those are only a very limited sample). 

The problem is, the Supreme Court accepted a kind of simplistic view of the corporation as an association of citizen-shareholders, imbued with free speech rights by the transitive properties of the First Amendment.  But corporations are not spontaneously-formed groups of private citizens; corporations themselves are creatures of law, and law in the first instance sets the ground rules for their structure and powers, including who has authority to speak, the purposes for which they may speak (i.e., wealth maximization), and the procedures for deciding what speech will be made. 

In other words, the First Amendment can rationally be said to confer rights on natural persons, who exist outside of law; they are not constituted by law.  Corporations, however, must be created by law before they exist as entities for the First Amendment to act upon, and it’s not clear how much that law – the law that creates them – has to be informed by constitutional principles.

For example, there are lots of ways in which corporate and securities law use the structure of the corporate form to restrict speech.  Everything from limits on who may have access to the corporate proxy to offer shareholder proposals (or who may offer shareholder proposals at all), to recent claims that Target Corporation’s managers breached its fiduciary duties to shareholders by offering Pride Merchandise, can be viewed through a free speech lens.  Right now, the Attorney General of Florida – through its state pension fund – is suing Target, claiming that by marketing to an LGBTQ+ customer base, it misled shareholders about its management of ESG risks.  In any other context, we might call that retaliatory action by the State of Florida in response to Target’s exercise of its free speech rights (the Attorney General is even arguing that an Ohio fund, and its counsel, would be inadequate to lead a class action because they favor diversity initiatives, as Mike Levin and I discussed in a Shareholder Primacy podcast a while back).  But because it’s filtered through the securities laws, it isn’t viewed in First Amendment terms.  (Though, of course, that isn’t always true; hence, Glass Lewis and ISS are suing over Texas’s attempt to regulate ESG proxy advice, and one of their arguments is that Texas’s law unconstitutionally restricts speech, which is a claim that had success against a similar Missouri law).

Well, one group in Montana has decided to put all this to the test with what it calls the Transparent Election Initiative. They propose to amend Montana’s constitution to provide that corporations chartered by the state do not have the power to spend money to advance political causes. 

It’s a bold attempt to confront Citizens United’s theoretical challenges, although, to be honest, the Supreme Court has never had much use for corporate theory.

Of course, leaving aside how the Supreme Court might eventually rule, we still have the problem of charter competition.  Founders aren’t going to choose to organize in jurisdictions that restrain their political activities if they can help it, and right now, Delaware, Texas, and Nevada – running a full-on race to the bottom – will happily offer an expanded set of corporate rights as part of their efforts to lure incorporations.

And another thing.  In this week’s Shareholder Primacy podcast (the last one for a couple of weeks): Mike and I talk about the near-$30-billion worth of stock options that the Tesla board granted to Elon Musk, and about ESG and anti-ESG shareholder proposals.  Here at Apple, here at Spotify, and here at YouTube.

…in a nonprecedential opinion so don’t get too excited.

San Diego County Employees Retirement Association v. Johnson & Johnson represents the latest iteration of courts trying to figure out what the heck to do about fraud on the market class certification in the wake of the Supreme Court’s desperately confused Goldman Sachs Grp., Inc. v. Ark. Teacher Ret. Sys., 594 U.S. 113 (2021).

Plaintiffs alleged that J&J concealed asbestos in its talc products, resulting in multiple stock price drops as the truth dribbled out.  At class certification, J&J claimed it had rebutted the presumption of reliance by demonstrating that each allegedly corrective disclosure revealed no new information the market, and therefore could not have been responsible for the dissipation of artificial inflation.

I pause here to note that this is, I guess, the framework mandated by Goldman, but – as I have frequently screamed – it is both illogical and inconsistent with Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011) (Halliburton I). Specifically, even if J&J proves beyond a reasonable doubt that its fraudulent statements were never publicly corrected, that does not in any way shed light upon the question whether the fraud impacted stock prices to begin with – at best, it means J&J got away with it.  And that matters a lot for a merits determination, but not at all for class certification, as Halliburton I explains.

Moving on.  J&J’s argument wasn’t, in fact, that the truth was never disclosed; the argument was that the truth was disclosed to no effect, and that the disclosures identified by the plaintiffs only repackaged information that had previously been disclosed.  In a 2-1 decision, the Third Circuit concluded that, given the obscure and incomplete nature of prior disclosures, the district court had not abused its discretion in concluding that the disclosures at issue revealed new information to the market.

So, things that are notable in the majority opinion:

First, the majority held that simple republication of previously publicized facts may count as a “new” disclosure, if the second source is more credible and made to a broader audience.

Second, the majority noted that expert analysis of disparate bits of public data may qualify as new information.

Third, the majority held that if corporate management denies the truth of a disclosure, that denial mitigates any corrective effect.

Certainly, all of these holdings have their origins in prior caselaw, but Johnson & Johnson offered a particularly stark application.  Evidence about J&J’s talc and asbestos had been made public in various fora, including as trial exhibits in lawsuits, without much market reaction – until it was distilled into a jury verdict against J&J, an announcement of further lawsuits, and blog posts and press releases publicizing trial evidence.  The Third Circuit reasoned that scattershot evidence introduced in prolonged public trials might not have been understood and acted upon by investors until clearer signals gave it credibility and informed the market of the kind of liability that J&J faced.  The dissent, for the most part, objected only on the ground that the district court had not made these findings; they were the invention of the majority.

Anyway, all I can say is, this opinion is a gift to plaintiffs – not just for class cert but also for motions to dismiss, where arguments similar to J&J’s succeed in getting complaints dismissed on loss causation and materiality grounds – so it’s a shame it’s not for publication.

There is a flashing danger sign for plaintiffs, though, and this is an issue I discussed when the Second Circuit managed to make the Supreme Court’s Goldman decision even worse. In J&J, the dissent especially focused on the need for subsequent disclosures to correct earlier misstatements in order to give rise to the inference that the initial lies impacted prices.  That’s a problem because – as has frequently come up in the context of loss causation – very often the effects of a fraud are felt long before the market realizes it’s been fooled.  Like, in an extreme case, a company might suddenly declare bankruptcy, and no one realizes it was due to anything except mismanagement, until months later a fraud is revealed – by which time, of course, there’s no price movement.  It’s precisely because of that scenario that (most) courts (usually) hold that loss causation can be established without proof that the market was actually informed that the defendants lied to them.  But if courts are just going to demand that kind of evidence at class certification, well, an awful lot of defendants are going to skate by so long as they can attribute fraud losses to other factors for a long enough time period.

And another thing.  No new Shareholder Primacy podcast this week; Mike and I are on a light schedule until the end of August.  But I jotted!  Here you can read my Jotwell review of Bridget Read’s book, Little Bosses Everywhere: How the Pyramid Scheme Shaped America.

Yesterday, the Delaware Supreme Court released its opinion in Wong v. Amazon. A copy of the decision is here.

A stockholder sent a letter to Amazon, demanding to inspect books and records under Delaware’s Section 220. The stockholder’s stated purpose was to investigate Amazon’s possible wrongdoing and mismanagement by engaging in anticompetitive activities.

The request kicked of an extended legal battle. A Magistrate conducted a one-day trial that led to a report siding with Amazon that the the stockholder had not alleged a “credible basis” to infer possible wrongdoing by Amazon. The stockholder took exception. A Vice Chancellor also sided with Amazon, but on a different basis–finding that the stockholder’s purposes was overbroad, “facially improper,” and not lucid. The stockholder appealed and the Delaware Supreme Court reversed.

Under Delaware law, investigating corporate wrongdoing is a legitimate purpose, but stockholders must present “some evidence to suggest a credible basis from which a court can infer that mismanagement, waste or wrongdoing may have occurred.” The Supreme Court found that the Vice Chancellor had erred in its interpretation of the scope of the stockholder’s purpose and should have engaged “with the evidence presented by the [stockholder].”

On the evidentiary front, the stockholder pointed to a history of investigations, lawsuits, fines, and one Federal Trade Commission action against Amazon that survived a motion to dismiss. The Delaware Supreme Court stressed that the credible basis standard is the “lowest possible burden of proof under Delaware law.” It requires more than a “mere untested allegation of wrongdoing but does not require that the underlying litigation result in a full victory on the merits against the company.” Collectively, these predicates sufficed to “establish a credible basis from which a court can infer that Amazon has engaged in possible wrongdoing through its purported anticompetitive activities.” Now the matter heads back to Chancery to “determine the scope and conditions of production.”

Stockholder inspection rights meaningfully differ between states. And it’s an open issue as to whether the internal affairs doctrine will always cover inspection rights.

This would have turned out differently if Amazon were a Nevada corporation. Nevada’s statute does not authorize books and records actions for public companies. In Nevada, inspection rights “do not apply to any corporation that furnishes to its stockholders a detailed, annual financial statement or any corporation that has filed during the preceding 12 months all reports required to be filed pursuant to section 13 or section 15(d) of the Securities Exchange Act, 15 U.S.C. §§ 78m or 78o(d).” Instead of having courts gatekeep inspection demands for public companies, Nevada tells stockholders to read the securities filings.

Delaware takes a more judicial approach and carefully considers requests. To resolve this issue, Delaware courts and magistrates issued three opinions/reports over a span of time, likely generating millions in legal fees. Whatever one thinks of how Nevada answers this question, it’s cheap, clear, and straightforward. In Delaware, Amazon was represented by Ross Aronstam & Moritz and Wachtell Lipton. They are not cheap.

Amazon’s expenses seem likely to grow. These firms will likely continue to defend Amazon through the production and in some future stockholder action using the materials procured as the basis for a complaint. That action may be righteous. It may generate net benefits for stockholders. Or it may drive costs and distract management.