The following is a guest post by Itai Fiegenbaum, Visiting Assistant Professor of Law at Willamette University College of Law:

Minority expropriation by a controlling shareholder manifests in a variety of forms. Controllers can cause the corporation to sell them an asset at a steep discount. Or purchase from them an asset for an inflated price. These self-dealing transactions share a common thread: Unfair pricing transfers value away from the corporation, and, by extension, from its minority shareholders, to the controller. An additional complication arises when the corporation’s stock is issued to the controller. In this case, a sweetheart deal dilutes the value of their relative voting and dividend rights.  

Shareholder litigation is designed to keep transaction planners honest. Not all manner of minority expropriation, however, is subject to the same enforcement procedure. Long-standing corporate law principles distinguish between transactions that harm shareholders directly and transactions that harm them derivatively, through a reduction in their share price. Challenges against the former can proceed directly; challenges against the latter, by contrast, must overcome several procedural hurdles before a court will adjudicate a claim on its merits.

An unmodified application of the bifurcation framework would filter most self-dealing transactions between the corporation and its controller to the derivative enforcement procedure. Until two weeks ago, the rule had one noticeable exception. Under Gentile v. Rossette, equity issuances to a controlling shareholder were deemed to engender both a direct and a derivative cause of action, thus allowing shareholder challenges to circumvent the cumbersome derivative mechanism. This exception was emphatically wiped out in Brookfield Asset Management v. Rosson.

The Delaware Supreme Court provided two justifications for this shift. First, a single streamlined approach through which to evaluate shareholder claims restores doctrinal certainty. Second, even without the Gentile carve-out, other legal theories provide shareholders with a direct claim in change of control scenarios. A closer look finds both explanations unpersuasive.

An outsized emphasis on doctrinal certainty gives short thrift to the underlying concerns that likely prompted the Gentile exception in the first place. Self-dealing transactions are not required to undergo internal approval procedures as a condition to their validity. While corporate fiduciaries are expected to faithfully bargain on behalf of the shareholders, external factors influence their willingness to steadfastly confront the controller. The benefits of continued incumbency and the allure of additional posts are weighed against the harm of potential personal liability and the embarrassment of a public airing of their shortcomings. The result of this assessment hinges on the prospect of a shareholder lawsuit.

The two enforcement procedures are hardly equivalent in that regard. A direct claim affords plaintiffs an unobstructed path to the courthouse. Plaintiffs that wish to vindicate a derivative harm, by contrast, are required to first navigate a procedural gauntlet. These differences impact the likelihood that a plaintiff steps forward and, consequently, the bargaining agents’ cost-benefits analysis in their negotiations with the controller. Effective independent director committees and attendant best practices were forged in the crucible of near-ubiquitous litigation based on a direct shareholder claim. An unaltered application of their teachings in the derivative context ignores the factors that encourage directors’ unflinching loyalty. Gentile provided a pathway around the cumbersome derivative procedure and made it more likely that a plaintiff step forward. Its elimination widens the enforcement gap for a large segment of self-dealing transactions.

The context-specific direct claims alluded to in Brookfield are incapable of satisfactorily covering this gap. Revlon grants plaintiffs a direct claim for equity issuances that transfer control. Ann Lipton has astutely observed the malleability of the control threshold and its impact on the parties’ incentives. My contribution is in highlighting Revlon’s gradual diminishment in the corporate governance ecosystem. Moreover, current doctrine allows a positive shareholder vote to extinguish Revlon claims. Shareholders’ near-certain approval of these transaction call into question the vote’s effectiveness at promoting accountability. In sum, eliminating the Gentile exception reduces the likelihood of a shareholder lawsuit, without ensuring that an alternative accountability mechanism picks up the slack.     

Outcomes-header
Apply to be my (across-campus) colleague.

Belmont University is hiring for a tenure track professor position in our Mike Curb College of Entertainment & Music Business. One of the main courses taught would be Entertainment Law and Licensing. I’ve lived in a half-dozen different cities and Nashville is my favorite by far. And Belmont has been a fabulous place to work. I am on the hiring committee, so feel free to reach out to me with questions.  

Details here. 

The following comes to us from one of our devoted readers (and fellow business law blogger), Walter Effross. He writes to inform us about a new initiative that he suggested to the American University Law Review, in which faculty, practitioners, judges, regulators, and others discuss “My Favorite Law Review Article.” The inaugural video (in which Walter recommends an Elizabeth Warren article) is here.

The guidelines for submissions are as follows:

1. Select the law review article that you wish to discuss. (Please choose an article that you did not write or co-author.)
2. All forms of video recording (Zoom, Photo Booth, phone camera, etc.) are acceptable; our team will edit appropriately.
3. Please try to keep your review between five and seven minutes long.
4. At the beginning of the video, please introduce (1) yourself and (2) the title and author of the Article. [including the citation, or at least the year of publication?]
5. Please provide a brief synopsis of the piece, read one or more pertinent passages, and/or discuss a particularly moving/interesting segment.
6. Most importantly, explain why this article is your favorite. You might consider discussing: when and how you first read it; what makes it special to you—the topic itself, the writing style, and/or something else; why others should read it; and/or how it contributed to your understanding of, or passion for, specific areas of the law.
7. Email your recording to Emily Thomas, at thomasemilyjane@gmail.com. 

I am intrigued by this initiative.  I admitted to Walter that it is making me think about what my favorite might be . . . .  The website notes that the law review hopes “that this collaborative project brings legal thinkers together and initiates productive conversation about the legal community and how we can better understand each other’s points of view.” I will be interested to see where this goes.  Let me know if you contribute!

[Editor’s Note: Most of this post comes directly from an email I received from Walter.  So, I tip my hat to him and thank him for the text of this post!]

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With my bum shoulder and a lot of work on our dean search cramping my style over the past few weeks, I have been remiss in posting about the 2021 Business Law Prof Blog Symposium, Connecting the Threads V.  The idea behind the name (and Doug Moll likes to riff on it–so have at it, Doug!) is that our bloggers here at the BLPB connect the many threads of business law in what we do–here on the blog and elsewhere.

Anyhoo (as Ann would say), as always, my BLPB co-bloggers did not disappoint in their presentations.  I know our students look forward to publishing many of the articles and the related commentaries in the spring book of our business law journal, Transactions: The Tennessee Journal of Business Law.  I also am always so proud of, and interested to hear, the commentary of my colleagues and students.  This year was no exception.

In the future, I will post more about the article that I presented.  But I will offer a teaser here, accompanied by the above screen shot from the symposium.  (It was “Big Orange Friday” on our campus.  The orange had to be worn.  Go Vols!)

The title of my presentation and article is Choice of Entity: The Fiscal Sponsorship Alternative to Nonprofit Incorporation.  A brief excerpt from the continuing legal education handout for the symposium presentation is set forth below (footnotes omitted).

[T]his presentation urges that competent, complete legal counsel on choice-of-entity for nonprofit business undertakings should extend beyond advising clients on which form of business entity best fits their needs and wants, if any. For many small business ventures that qualify for federal income tax treatment under Section 501(a) of the U.S. Internal Revenue Code of 1986, as amended (“IRC”), as religious, charitable, scientific, literary, educational, or other eligible organizations under Section 501(c)(3) of the IRC . . . , the time and expense of organizing, qualifying, managing, and maintaining a tax-exempt nonprofit corporation under state law may be daunting (or even prohibitive). Moreover, the structures imposed by business entity law may not be needed or wanted by the founders or promoters of the venture. Yet, there may be distinct advantages to entity formation and federal tax qualification that are not available (or not as easily available) to unincorporated not-for-profit business projects. These may include, for example, exculpation for breaches of performative fiduciary duties and limitations on personal liability for business obligations available to participants in nonprofit corporations under state statutory law and easier clearance of or compliance with initial and ongoing requirements for tax-exempt status under federal income tax law.

The described conundrum—the prospect that founders or promoters of a nonprofit project or business may not have the time or financial capital to fully form and maintain a business entity that may offer substantial identifiable advantages—is real. Awareness of this challenge can be disheartening to lawyer and client alike. Fortunately, at least for some of these nonprofit ventures, there is a third option—fiscal sponsorship—that may have contextual benefits. This presentation offers food for thought on the benefits of fiscal sponsorship, especially for arts and humanities endeavors.

Again, I will have more to say about this later, once the article is fully crafted.  But your thoughts on fiscal sponsorship–and examples, stories, and the like–are welcomed in the interim as I continue to work through the article.

Northwestern Pritzker School of Law invites applications for tenured or tenure-track faculty positions with an expected start date of September 1, 2022. This is part of a multi-year strategic hiring plan, and we will consider entry-level, junior, and senior lateral candidates.

Northwestern seeks applicants with distinguished academic credentials and a record of or potential for high scholarly achievement and excellence in teaching. Specialties of particular interest include: tax, anti-discrimination law, international law (joint search with the Buffett Institute for Global Affairs), health law (joint search with the Feinberg School of Medicine), and business law. Northwestern welcomes applications from candidates who would contribute to the diversity of our faculty and community. Positions are full-time appointments with tenure or on a tenure-track.

Candidates must have a J.D., Ph.D., or equivalent degree, a distinguished academic record, and demonstrated potential to produce outstanding scholarship. Northwestern Pritzker School of Law will consider the entry level candidates in the AALS Faculty Appointments Register, as well as through application directly to our law school. Candidates applying directly should submit a cover letter, C.V., and draft work-in-progress through our online application system: https://facultyrecruiting.northwestern.edu/apply/MTE3Mw. Specific inquiries should be addressed to the chair of the Appointments Committee, Zach Clopton, zclopton@law.northwestern.edu.

Northwestern University is an Equal Opportunity, Affirmative Action Employer of all protected classes, including veterans and individuals with disabilities. Women, racial and ethnic minorities, individuals with disabilities, and veterans are encouraged to apply. Click for information on EEO is the Law.

Western State College of Law (WSCL) at Westcliff University invites applications from entry-level and lateral candidates for up to two tenure-track faculty positions beginning August 1, 2022. We have particular interest in persons interested in teaching Business Organizations, Contracts, Sales, Evidence, Professional Responsibility, and Remedies. Candidates should have strong academic backgrounds, commitment to teaching excellence, and demonstrated potential for productive scholarship. 

WSCL is located in the city of Irvine, California – close to miles of famous beaches, parks, recreation facilities and outdoor activities as well as the many museums, music venues, and diverse cultural and social experiences of greater Los Angeles.

Founded in 1966, WSCL is the oldest law school in Orange County, California, and is a fully ABA approved for-profit, private law school. Noted for small classes and personal attention from an accessible faculty focused on student success, WSCL is proud that our student body is among the most diverse in the nation. Our 11,000+ alumni are well represented across public and private sector legal practice areas, including 150 California judges and about 15% of Orange County’s Deputy Public Defenders and District Attorneys.

WSCL is committed to providing workplaces and learning environments free from discrimination on the basis of any protected classification including, but not limited to race, sex, gender, color, religion, sexual orientation, gender identity or expression, age, national origin, disability, medical condition, marital status, veteran status, genetic marker or on any other basis protected by law.

Confidential review of applications will begin immediately. Applications (including a cover letter, complete CV, teaching evaluations (if available), a diversity statement addressing your contributions to our goal of creating a diverse faculty, and names/email addresses of three references) should be emailed to Professor Elizabeth Jones, Chair, Faculty Appointments Committee: enjones@wsulaw.edu For more information about WSCL, visit wsulaw.edu. 

A while back, I posted about how there’s been some institutional investor support for the proposal that the SEC require not only public companies, but private companies, disclose climate change information.

Usually, of course, private companies aren’t required to disclose things – especially to institutional investors – on the theory that institutional investors can themselves bargain for the information that they need.  (Yes, yes, there are kind of exceptions, like Securities Act Section 4(a)(7), etc).  But the SEC and Congress have been gradually expanding which companies count as private, raising concerns that not only that they have assumed too much sophistication on the part of institutions (for example, institutional investors themselves have complained about opacity among the PE funds in which they invest), but also that the SEC and Congress have ignored the benefits of creating a body of public information across a wide swath of companies.

Which is why this article grabbed me: 

The California Public Employees’ Retirement System and Carlyle Group Inc. helped rally a group of more than a dozen investors to share and privately aggregate information related to emissions, diversity and the treatment of employees across closely held companies. More firms and institutions are expected to join.

“We need to start a common language across all these participants so we can actually, in a sustained way, make some progress,” Carlyle Chief Executive Officer Kewsong Lee said in an interview. “By honing in on a set of common standards and common metrics, we start to standardize the conversations so we can really track progress. It’s really hard to do that right now.”

Blackstone Group Inc. and the Canada Pension Plan Investment Board, the country’s largest pension fund, are also part of the effort. Boston Consulting Group was tapped to aggregate the data.

Private-equity firms will be seeking to standardize and share data on greenhouse-gas emissions, renewable energy, board diversity, work-related injuries, net new hires and employee engagement. Calpers CEO Marcie Frost said she would like to see these metrics expand to include data such as C-suite diversity and employee satisfaction.

The article is framed as further evidence of a trend toward ESG investing, but for me the more relevant point is that investors are trying to band together to create a common pool of information about private companies that have been excepted from the public disclosure regime.  You could, I suppose, call that a triumph of private ordering; I take it as evidence of a fundamental failure of the securities disclosure system.  I suppose you could also tell a story about the privatization of what was once public infrastructure more generally, or the unholy marriage of privatization and environmentalism.

Insider trading reform has been a consistent theme in my last few posts (see, e.g., here, here, here, and here). In keeping with this theme, I’d like to highlight a new article, How Creepy Concepts Undermine Effective Insider Trading Reform, which was posted just yesterday by Professor Kevin R. Douglas (Michigan State College of Law). Professor Douglas is an important new voice in the areas of securities regulation, corporate finance, and business law more generally. Here’s the abstract:

Lawmakers are building momentum towards codifying our insider trading laws to clarify which kind of trading is illegal. In May 2021, the US House of Representatives passed the Insider Trading Prohibition Act for the second time in two years. In January 2020, a Securities and Exchange Commission sponsored task force on insider trading released a report containing proposed legislation. Both the House Bill and the task force proposal would prohibit trading while in possession of “wrongfully obtained” information and prohibit trades that involve a “wrongful use” of information. This article explains why the concept of “wrongful” trading is too ambiguous to improve insider trading law and explores the requirements of effective legislative reform.

For decades, scholars have described insider trading doctrine as mystifying and called for reform. Many explain the confusion by pointing to the stark difference in how enforcement officials and federal courts apply insider trading law. Others argue that the confusion is caused by policymakers failing to choose between fostering efficient markets and fostering fair or equitable markets. This article argues that the conflict between courts and enforcement officials is a symptom of two deeper conceptual problems—one at the doctrinal level and one at the policy level. The doctrinal confusion is more precisely caused by the attempt to simultaneously invoke two conflicting concepts of “fairness.” Fairness meaning consensual transactions, versus fairness meaning transactions in which all parties enjoy equal access to all material information and other economic values. Attempting to simultaneously apply these mutually exclusive notions of fairness has caused a slow and inconsistent conceptual creep, resulting in an incoherent doctrine.

The policy confusion is caused by officials relying on economic models that use misidentified theories of “economic efficiency.” Officials describe the policy goal of our insider trading regime as encouraging capital formation in US securities markets and economic growth in general. These goals imply an exclusive commitment to promoting “allocational efficiency”—or maximizing wealth. However, scholars usually rely on the concept of “market efficiency” when evaluating the law and practice of insider trading. The definition of market efficiency relies on assumptions that embody an unacknowledged focus on economic distribution—equalizing wealth. This includes the assumptions that all investors (1) trade at the same price (the correct price) and (2) have equal access to all available information. Conflating these forms of efficiency causes officials to unintentionally oscillate between promoting opaque distribution goals and promoting economic growth.

This article recommends clarifying insider trading law by prioritizing one of the two conflicting fairness doctrines and a compatible policy goal. Clarity requires specifying whether consent is a defense against insider trading liability. Enforcing only one fairness doctrine gives everyone the option of attempting to privately adhere to both principles while successfully applying one of the principles through law.

Through today and tomorrow, UNLV Law is cohosting a Corporate Governance Summit with Greenberg Traurig.  Many thanks to Robert Jackson for giving our keynote talk over lunch today.  His talk covered the waterfront, touching on ESG, corporate governance, broker misconduct, and SPACs.

Featured panel discussions include:

  • All about the green: Developments of environmental, social, and governance (ESG) issues in the boardroom
  • Buy, sell, or hold: What’s a board to do in today’s M&A environment?
  • Diversity, inclusion, and refreshment: The hidden ingredients of successful boardroom governance 
  • Carrots and sticks: Unlocking the power of effective incentive structures in executive and board compensation
  • If you don’t know, now you know: A guide to a board’s role in managing (unexpected) risk in the aftermath of the COVID-19 pandemic
  • Let’s talk!: Maximizing the shareholder relationship and the benefits of shareholder engagement

It’s been great to get together and talk about these issues in person.  Hopefully we’ll be in an even better position next year.

I had a chance to read Chapter 7 on Clearinghouses [CCPs] in a recent report by the Task Force on Financial Stability and look forward to reading more of the report soon.  It’s a short chapter with a lot of excellent information.  I particularly appreciated its focus on the issue of clearinghouse ownership (too often left out of clearinghouse discussions), incentive misalignments, and tensions between shareholders and clearing members when CCPs are for-profit, public companies.  There is an especially helpful discussion on externalities in the current clearing ecosystem and a summary table of them accompanied by related recommendations (p.99).  I agreed with several of the chapter’s recommendations (starting on p.96) and with the statement that “Pervasive reforms of derivatives markets following 2008 are, in effect, unfinished business; the systemic risk of CCPs has been exacerbated and left unaddressed” (p.96). 

On p.94, the report mentions that clearing members “complained when, in December 2017, the CBOE and CME listed bitcoin contracts (which have extremely high volatility and which many members were not authorized to transact) and then commingled the contracts with the default fund for other instruments.”  I think the complaints are understandable and pointed out this issue in a previous post (here).

I did have feedback about a few items in the chapter and will share two points:  

First, on p.93, the report states “Were a CCP to fail, something that has not yet occurred, the disruption to the financial system could be enormous.”  It’s certainly true that a failed, significant CCP would likely cause enormous disruptions in financial markets.  However, as I note in my 2016 report for the Volcker Alliance (p.52), CCPs have failed in other countries and some have argued that certain CCPs in the U.S. risked failure in the October 1987 crash. 

Second, I’d like to see a lot more discussion of recommendation #3 (p.97):

“Make sure that systemically important CCPs outside the United States have access to a lender of last resort who can provide dollar funding. This might be provided through a foreign central bank that is willing and able to lend and has access to a Fed swap line. If such funding is not available, and conditioned on a Fed finding that a non-U.S. CCP is adequately supervised, the Fed should consider extending access to the discount window to systemic non-U.S. CCPs. (Currently access is restricted to FSOC-designated systemically important financial market utilities.) It is in the United States’ interest to prevent the failure of systemic CCPs around the world. If a properly supervised entity needs access to dollar funding, and satisfactory information sharing is in place to limit risk, discount window access would strengthen the system.”

In The Federal Reserve’s Use of International Swap Lines, I noted that from my perspective, certain provisions in Dodd-Frank appeared to anticipate the possibility of Fed swap lines with CCPs outside the U.S. (p.648).  The risk of potentially having to provide emergency euro funding to clearinghouses outside the Eurozone has been an important aspect of the longstanding tensions between the U.K. and the E.U. surrounding clearing (a few stories on this are here, here, and here).  The E.U. has argued that because of this financial stability risk, such clearing should be relocated to the Eurozone.  Hence, the issue of a major central bank having to provide emergency funding to a foreign clearinghouse is a highly significant concern and merits extensive discussion.