You can read the full comment letter here.  For additional background on the proposed rule, go here.  An excerpt from the letter:

It is our position that social and political issues should not be considered by fiduciaries in employee retirement savings investment decisions. We are not opposed to any person or entity considering ESG or other social factors when investing their own money; individuals and companies may promote social causes through their investments to the extent they desire. But we are opposed to investment managers and employers being encouraged or mandated to consider ESG factors and protected from legal action when they do. Adopting this Proposed Rule and allowing employers and investment managers to consider ESG factors makes what should be a financial decision into a political one….

Under the Proposed Rule, plan fiduciaries will more often choose ESG investments, employers can serve their political agendas, and investment managers are protected from adverse consequences of their social investment decisions. Indeed, the government may also exert pressure on plan sponsors who do not offer ESG defaults as a way of driving capital to achieve desired social outcomes. But it is the employees and beneficiaries—whose retirement savings are affected—who will suffer. The Proposed Rule encourages fiduciaries to favor social causes to the potential detriment of employees’ retirement savings. Moreover, retirement plans that consider ESG factors will incur higher investment costs. As a result, less of each employee’s retirement savings is available for investment and the return may be much less. A fiduciary cannot sacrifice investment returns or assume greater investment risks as a means of promoting collateral social justice policy goals….

The consensus background on sub-regulatory guidance in this area across the political spectrum highlights one critical point of agreement: the longstanding view that the fiduciary duty under ERISA requires an objective assessment of an investment’s economic risk and return when evaluating whether it is appropriate for a plan. Fiduciaries remain bound by statute to manage investments with an ‘‘eye single’’ to maximizing the funds available to pay retirement benefits. Yet, the Proposed Rule promotes ERISA fiduciaries to subordinate those interests in favor of other objectives. The Proposed Rule does not protect employee retirement savings but increases the risk of loss and costs by encouraging investments that are often misleading, administratively costly, and historically untested. While it is never appropriate to encourage plan sponsors to take such risks, it is particularly indefensible in a time when Americans struggle with inflation and financial uncertainties. The Proposed Rule risks the economic security of retirees to further a political agenda. The Department should not adopt the Proposed Rule.

Julia Y. Lee has published Prosocial Fraud in 2 Seton Hall L. Rev. 199.  Here is an excerpt:

This Article identifies the concept of prosocial fraud–that is, fraud motivated by the desire to help others. The current incentive-based legal framework focuses on deterring rational bad actors who must be constrained from acting on their worst impulses. This overlooks a less sinister, but more endemic species of fraud that is not driven by greed or the desire to take advantage of others. Prosocial fraud is induced by prosocial motives and propagated through cooperative norms. This Article argues that prosocial fraud cannot be effectively deterred through increased sanctions because its moral ambiguity lends itself to self-deception and motivated blindness. The presence of a beneficiary other than the self allows individuals to supplant one source of morality (honesty), with another (benevolence), providing a powerful source of rationalization that weakens the deterrent impact of legal sanctions.

After examining the types of motives that typify prosocial fraud, this Article identifies structural and situational factors–definitional ambiguity, incrementalism, and third-party complicity–that increase its prevalence. Given the cognitive and psychological biases at play, this Article suggests that any efforts to curb prosocially motivated fraud focus less on adjusting sanctions and more on exploring alternative mechanisms of ex ante, private enforcement….

Empathy and altruism may … play a role in dishonest helping behavior motivated by the desire to restore equity. Whereas negative inequity produces feelings of envy, positive inequity induces feelings of guilt, which motivates individuals to dishonestly help others. Particularly where the risks of being caught are low, individuals are more prone to act on emotions such as envy, guilt, and empathy. Moreover, when individuals act dishonestly to restore equity, they subjectively “discount the immorality of their actions.”

Today I’m posting to call everyone’s attention to In re Kraft-Heinz Co. Derivative Litigation, decided by Vice Chancellor Will earlier this week.

This is a demand excusal case and there may be a lot that’s interesting about it but I’m focusing on one specific aspect.

Kraft-Heinz was 27% owned by Berkshire Hathaway, 24% owned by 3G (which had operational control), and 49% owned by public shareholders.  Berkshire and 3G each got to nominate 3 members of the 11 member board, and they had a shareholder agreement whereby they promised to vote for each other’s designees, and not take action to “to effect, encourage, or facilitate” the removal of the other’s designees.

Kraft-Heinz started to perform poorly and 3G sold 7% of its stake just before a disappointing earnings announcement.  Shareholders filed a derivative lawsuit alleging that 3G traded on nonpublic information, naming 3G and its board designees as defendants, and the critical question was whether the 11-person board was majority disinterested for demand purposes. That question, in turn, turned on whether Berkshire’s nominees – one of whom was a Berkshire director, one of whom was a director of several Berkshire subsidiaries and the CEO of one  – could objectively consider whether to bring a lawsuit against 3G. 

The plaintiffs alleged that Berkshire and 3G together formed a control group, but the court did not consider that relevant one way or another; i.e, whether they were or they weren’t, the critical question was the disinterestedness/independence of Berkshire’s board nominees vis a vis 3G, and that question did not turn on their control group status.

The court said the Berkshire members were disinterested and independent, notwithstanding the shareholder agreement.  Per the court, the agreement did not bind Berkshire not to sue 3G and its board nominees – only to refrain from removing them – and the Berkshire nominees were not themselves parties to that agreement anyway.   Plus, Berkshire Hathaway does not exactly need to rely on 3G to have access to investment opportunities.

Okay, so why is this interesting?

Conceptually, it’s not dissimilar from the problem that faced the court in Patel v. Duncan, which I blogged about here.  That case also involved a publicly traded company controlled by two private equity firms that had a shareholder agreement to select 60% of the board nominees.  One of the firms engaged in an interested transaction with the company, and the way the case was framed, the critical question was whether the firms jointly consisted a control group such that the transaction could only be cleansed via MFW procedures, but substantively what it came down to was whether the court believed that the first PE firm could be objective about transactions in which the second firm had a financial interest.  The court believed objectivity was possible, and though the plaintiff argued that the two firms had a tacit quid pro quo – where each would approve the other’s interested transactions – the court found no evidence of such an agreement other than the existence of an interested transaction with the first firm, approved a year earlier, and dismissed the case.

As I blogged at the time, shareholder agreements in publicly-traded firms are increasingly common, and one very popular structure involves agreements among PE firms with respect to a company that they take public but retain continuing control over.  Which means we can expect to see more questions arise concerning how disinterested one firm can truly be when it comes to matters involving its co-venturer.

I mean, sure, in one sense, each firm may have an incentive to police the behavior of the other (unless, as alleged in Patel, they have a joint agreement to loot the company), but if we take the more nuanced approach to dependence that the Delaware Supreme Court has recently pursued, it seems much more likely that one firm will try, within at least some limits, to placate  the other rather than allow disagreements to spill into litigation and boardroom friction, especially if they expect to do future deals together.

Vice Chancellor Will believed that Berkshire didn’t need 3G to do future deals – and so that would not be a factor in assessing Berkshire’s objectivity – but Berkshire’s brand is being a nondisruptive shareholder; the last thing it wants to do is get a reputation for public squabbles with co-investors.  Plus, 3G had substantive control of the company; Berkshire may have worried about its ability to find a replacement with whom it could also partner if 3G’s malfeasance were established.  And that doesn’t even get into the question whether VC Will correctly evaluated the effect of the shareholder agreement on the behavior of the Berkshire nominees (at least one of whom, as a Berkshire subsidiary CEO, is functionally a Berkshire employee).

Anyway, this is a problem that’s going to recur, which means Delaware needs to offer more considered guidance about the appearance of bias that may stem from shareholder agreements, and the legal consequences that follow.

Whenever I want to complain about my boredom with blogging the latest developments in Arkansas Teachers’ Retirement System v. Goldman, I think to myself, at least I’m not as bored as Judge Crotty of the SDNY.  And Judge Crotty made that clear this week in his opinion re-certifying the class (for a third time).

The history, as I’ve previously blogged, was that plaintiffs alleged Goldman violated Section 10(b) with anodyne statements about its ethics and ability to manage conflicts among its varied client base, and these were revealed to be false in a few financial-crisis-era scandals about conflict-ridden CDO sales.  The plaintiffs’ theory was that Goldman had a reputation for managing its conflicts well, which was baked into the stock price, and these statements maintained its stock price at those inflated levels, until the truth was disclosed and the stock price dropped.  Goldman’s main defense has been that the statements were too vague, generic, content-less, etc to matter to investors.  It tried that argument on a motion to dismiss, and then a motion for reconsideration of the motion to dismiss, and then on a motion for interlocutory appeal of the denial of the motion for reconsideration, and then at class cert, and then on an appeal of the class cert decision to the Second Circuit – where it finally won a remand! – and then at the remanded class cert hearing, and then before the Second Circuit again on an appeal of the second class cert opinion, and then before the Supreme Court – where it won again! – and then on remand back to the Second Circuit – score! – and then back to Judge Crotty where … this week, it lost again.

Throughout all of this, Goldman’s argument morphed.  At first, the argument was that its statements were so vague that they could not, as a matter of law, have impacted stock prices.  When that failed before Judge Crotty, Goldman instead offered factual evidence via expert reports that these particular statements were so generic that shareholders ignored them.  When Judge Crotty rejected the expert’s evidence as unpersuasive, Goldman went back to arguing before the Second Circuit that the statements were legally incapable of impacting stock prices.  By the time the case was actually before the Supreme Court, the argument was that the Second Circuit had erroneously held that genericness cannot be part of the factual inquiry when examining price impact, and therefore the Circuit had failed to take into account the generic nature of the statements, in addition to other factual evidence, when it reviewed Judge Crotty’s class cert decision.  The Supreme Court held that it was not clear whether the Second Circuit had so held – and if the Second Circuit had held that, it shouldn’t have have – and kicked it back down.

The Supreme Court’s decision was … maddening.  As I blogged at the time, it seemed to shift the burden of proof to plaintiffs in cases involving “price maintenance” theories, and introduced loss causation into the class certification decision – even though in Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011), the Court had held that loss causation should not be considered at class certification.

Which is what Judge Crotty had to deal with when the same evidence was before him, again, and his exasperation was clear.

First, he emphasized that nothing in any of the appellate opinions had overruled his prior factual determinations about the strength of the expert evidence, and he reiterated those findings: namely, that Goldman’s price drops were associated with revelations of the truth about its conflicts, that market commentary at the time reiterated the importance of Goldman’s ability to manage its conflicts, and that the revelations that caused the price drops were far more specific and credible than earlier purported disclosures that had not caused any price drops.  As he put it, “Since the updated direction from the Supreme Court and Second Circuit has no bearing on these factual findings, the Court here reiterates, and restates, its grounds only in brief.” Op. at 17.

Second, pace Vivendi, he held that to determine whether Goldman’s statements maintained the artificial inflation in its stock price, the proper comparator was not what would have happened if Goldman had remained silent, but what would have happened if it had told the truth.  If it had told the truth about its inability to manage conflicts, investors would have devalued the stock.

Third, he even looked to what would have happened if Goldman had remained silent, and found the statements still maintained the stock price because “in a marketplace where, according to Defendants, dozens of Goldman competitors and other blue-chip corporations routinely make statements ‘indistinguishable’ from some of the alleged misstatements, it seems unlikely that Goldman’s conspicuous failure to conform-…would be irrelevant to investors.”  Op. at 24-25.

I’ve made that argument before; in my paper, Reviving Reliance, I said:

The articulated rationale for many puffery holdings—that the statements are too similar to those offered by other companies to carry much weight in the minds of investors—is not only unpersuasive, but is something of a self-fulfilling prophecy. Corporations frequently make disclosures similar to those of other companies, from representations that their financial statements comply with Generally Accepted Accounting Principles to declarations that a merger price is “fair” to shareholders, and yet none of these statements are declared to be puffery on grounds of ubiquity. Moreover, in a world where computer programs analyze corporate SEC filings so as to instantly trade on even minute data changes, if a corporation did not, for example, proclaim itself to exhibit “financial discipline” when all of its competitors did, investors would likely take the absence seriously.  As
a result, when courts treat all such statements as equally meaningless, they provide no incentive for corporations to refrain from making them when they are no longer truthful.

Along these lines, as I pointed out in a previous post, Goldman was making statements about its integrity and conflicts management long before the class period – at a time when, by hypothesis, the statements were true.  Can you even imagine how the market would have reacted if those statements suddenly disappeared?

Judge Crotty went further, though.  Displaying extreme skepticism of the idea that corporations generally issue happy talk that has no effect on investors, he added: “This Court is hard-pressed to understand why statements such as those at issue here would have achieved such ubiquity in the first place were they incapable of influencing (including by maintaining) a company’s stock price.” Op. at 24.

And now I have to pause and note how radical Crotty’s holdings are, even if, ahem, they make perfect sense.  That’s because the inquiry into materiality/puffery/genericness what-have-you in securities cases is usually divorced from any honest attempt to assess the role these statements actually play in the market; as I’ve repeatedly blogged, materiality inquiries often seem more like backdoor attempts to distinguish claims based on poor governance from claims based on fraud than empirical evaluations of evidence. (Which is also a point I’ve also made in both Reviving Reliance and my paper Fact or Fiction: Flawed Approaches to Evaluating Market Behavior in Securities Litigation.)  Quoting, ahem, me, “what we call ‘harm’ and ‘damage’ for the purpose of private securities fraud lawsuits have become so artificial that it no longer seems as though we’re even trying to measure the actual real-world effects of fraud.”; see also Fact or Fiction (describing “the cavernous distance between judicial measures of harm and the underlying reality”).  So it is genuinely striking to see a judge examine actual market behavior instead of pursuing some broader policy regarding what Section 10(b) ought to be about.

Which is why I fully expect Goldman’s next 23(f) appeal to argue that Crotty’s analysis contradicts the Supreme Court because he treated genericness as a point in favor of price impact instead of against it.

Anyway, the final striking aspect of Judge Crotty’s opinion is this:  Even though technically, plaintiffs are meant to have a presumption of price impact, and defendants have the responsibility of rebutting that presumption, Crotty took the Supreme Court at its word and seemed to place an initial burden on plaintiffs to establish a connection between the final stock price drop and the earlier false statements in order to win that “presumption.”  To wit, he began his analysis with the heading “Plaintiffs’ Persuasive Evidence of Price Impact,” explained that evidence, and concluded, “The Court credits Dr. Finnerty’s conclusions, and finds that Plaintiffs have presented compelling evidence that the alleged misstatements in fact impacted Goldman’s stock price.”  Op. at 16-17.  Only after finding plaintiffs had established price impact did he turn to defendants’ evidence, concluding they had “failed to rebut the Basic presumption… Neither [of defendants’ experts] persuasively undermine these findings”  Op. at 17.

See what he did there?  He made the plaintiffs prove price inflation and only then turned to whether defendants’ had met their burden of rebuttal, all while paying lipservice to the idea that there was some kind of “presumption” in plaintiffs’ favor at work.  And I can’t say he’s wrong, precisely, because that was in fact the Supreme Court’s suggestion.

More than anything else, though, what offends me aesthetically about this case and makes me want to scream “IT’S NOT FAIR!!” at the top of my lungs – before I remember that we live in a cold, cruel world and fairness is a fairytale – is how Goldman was permitted to change its argument before the Supreme Court in order to revive a claim that it had made before the district judge, lost, and then abandoned on appeal – and instead of dismissing the writ as improvidently granted, the Court rewarded Goldman for that bait-and-switch with yet another bite at the apple. 

The other notable thing: The factual evidence, at least as Judge Crotty describes it, presents a pretty compelling case that yes Goldman’s statements mattered: Goldman did have a strong reputation, the truth did damage that reputation and make people worried for Goldman’s future, and the statements at the very least maintained that reputation because Goldman couldn’t suddenly have been silent on the topic without raising questions.  And that’s evidence we probably would never have seen but for Crotty’s denial of the original motion to dismiss, when another judge likely would have granted it.  Which you would think would make future courts hesitant to casually dismiss claims based on a seat-of-the-pants judgment that no reasonable investor would have taken certain statements seriously.

But it won’t.