Yesterday, the Supreme Court released its opinion in Collins v. Yellen.  As one observer predicted, the result followed from last year’s decision in Seila Law v. CFPB.  In Seila, the Supreme Court declared that the for-cause removal protection afforded to the head of the CFPB was unconstitutional.  In Collins, the Supreme Court reached the same conclusion, also finding that the for-cause removal protection was unconstitutional.  

Writing for ScotusBlog, Amy Howe succinctly described the facts:

The Supreme Court on Wednesday had mostly bad news for shareholders of mortgage giants Fannie Mae and Freddie Mac in their lawsuit seeking to unwind a 2012 agreement that required the companies to transfer profits to the federal government. The justices unanimously agreed that one of the shareholders’ claims could not go forward. And although the court agreed, by a vote of 7-2, that the structure of the federal agency that regulates Fannie and Freddie is at least in part unconstitutional, the court stopped short of ordering that the money be returned to the shareholders as a result of that constitutional defect. Instead, the case now goes back to the lower courts, which will determine whether the shareholders are entitled to any relief.

Beyond the shareholders’ lawsuit, the decision is the second time in the past year that the court has rejected congressional efforts to limit the president’s ability to remove the heads of federal agencies. Last June, the court struck down the removal limitations for the head of the Consumer Financial Protection Bureau. Wednesday’s decision did the same for the director of the Federal Housing Finance Agency, and a White House official indicated within an hour of the ruling that President Joe Biden intends to replace Mark Calabria, the Trump appointee currently heading the FHFA, “with an appointee who reflects the administration’s values.”

I’m interested in what that 7-2 vote on the structure of the federal agency may signal for future challenges.  While it’s going to take me a bit to digest the opinion and construct a scorecard for it, I expect that the reasoning holds significant implications for self-regulatory organizations.   Justice Alito’s opinion on the merits of the constitutional argument begins on page 26 in part III.B.  It’s divided into four parts.  I’ll take each in turn.

Alito first rejects the argument that the FHFA should be treated differently than the CFPB because of its narrower scope.  This may foreclose arguments that SROs should be treated differently simply because they regulate a narrow industry.  Alito also rejected a distinction related to the FHFA’s funding source.  While the CFPB obtains funds directly from Treasury, the FHFA raises a substantial portion of its funds from the companies it oversees.  This strikes me as similar to SROs which raise their funds from their “members.”

Alito’s second subsection rejects the argument that the FHFA sometimes acts as a private party and not as part of the government.  He explains:

Amicus next contends that Congress may restrict the removal of the FHFA Director because when the Agency steps into the shoes of a regulated entity as its conservator or receiver, it takes on the status of a private party and thus does not wield executive power. But the Agency does not always act in such a capacity, and even when it acts as conservator or receiver, its authority stems from a special statute, not the laws that generally govern conservators and receivers.

This may make it difficult for SROs enforcing federal statutes to argue that they should escape scrutiny.  Of course, the FHFA director is appointed by the President and SRO leadership (PCAOB aside) is generally not appointed by a public agency.  

The third subsection considers whether the FHFA should be treated differently because it oversees only special government-sponsored entities.  Alito rejects this contention as well, declaring that “the President’s removal power serves important purposes regardless of whether the agency in question affects ordinary Americans by directly regulating them or by taking actions that have a profound but indirect effect on their lives.”  This language seems to capture the reach of SROs indirectly and profoundly affecting Americans.

Alito’s fourth subsection rejects the argument that FHFA’s removal protection should be upheld because it only modestly restricts the executive’s removal power.  He finds that “the Constitution prohibits even ‘modest restrictions’ on the President’s power to remove the head of an agency with a single top officer.”  At present, the President often has no clear power to influence the composition of SRO leadership.  To be sure most have governing boards instead of single directors, but this distinction may not matter.

Section III.C. goes on to remand to lower courts to determine whether the unconstitutional removal protection for the FHFA director somehow harmed the plaintiffs.

Roberts, Kavanaugh, Thomas, and Barrett joined the opinion in full.  Gorsuch joined as to all except III.C.  Thomas concurred.  

Gorsuch concurred with all save Part III.C.  He would rather have declared the FHFA’s head’s action’s unconstitutional because of the unconstitutional removal restriction and awarded real relief.  He argued:

As strange as the Court’s remand instructions are, the more important question lower courts face isn’t how to resolve this suit but what to do with the next one. Today, the Court sounds the call to arms and declares a constitutional violation only to head for the hills as soon as it’s faced with a request for meaningful relief. But as we have seen, the Court has in the past consistently vindicated Article II both in reasoning and in remedy. E.g., Seila Law, 591 U. S., at ___ (opinion of ROBERTS, C. J.) (slip op., at 36); Lucia v. SEC, 585 U. S. ___, ___–___, n. 5 (2018) (slip op., at 12–13, n. 5); NLRB v. Noel Canning, 573 U. S. 513, 557 (2014); Ryder v. United States, 515 U. S. 177, 182–183 (1995); Bowsher, 478 U. S., at 736. These cases—involving appointment and removal defects alike—remain good law. So what are lower courts faced with future removal defect cases to make of all this? The only lesson I can divine is that the Court’s opinion today is a product of its unique context—a retreat prompted by the prospect that affording a more traditional remedy here could mean unwinding or disgorging hundreds of millions of dollars that have already changed hands. Ante, at 32–33. The Court may blanch at authorizing such relief today, but nothing it says undoes our prior guidance authorizing more meaningful relief in other situations.

For my part, rather than carve out some suit-specific, removal-only, money-in-the-bank exception to our normal rules for Article II violations, I would take a simpler and more familiar path. Whether unconstitutionally installed or improperly unsupervised, officials cannot wield executive power except as Article II provides. Attempts to do so are void; speculation about alternate universes is neither necessary nor appropriate. In the world we inhabit, where individuals are burdened by unconstitutional executive action, they are “entitled to relief.” Lucia, 585 U. S., at ___ (slip op., at 12).

The big question I’m left with is what will happen with this court when the constitutional status of some large financial SRO comes before the Supreme Court.  Will they be declared unconstitutional?  If they are, what will happen to the markets they regulate?

Well, the Supreme Court’s decision in Goldman Sachs v. Arkansas Teacher Retirement System is out and I suppose that makes me legally obligated to blog about it.

The result itself was … overdetermined.  As I posted after oral argument:

[Goldman] argued that “genericness” is a relevant fact to be considered at class certification in service of the price impact inquiry, along with any other evidence on the subject.  Goldman’s claim was not that courts should revisit the question of materiality at class cert – which tests what a hypothetical reasonable investor would have thought about the statements – but that in weighing whether the statements actually had an effect on prices, it is legitimate for courts to consider the generic nature of the statements at issue.  …

[T]he plaintiffs agreed with Goldman that genericness is a relevant fact to be considered by courts as part of the price impact inquiry, subject to appropriate expert evaluation.  …Which meant, the disagreement between the parties boiled down to whether [] the Second Circuit had erred by rejecting the notion that genericness is relevant if not dispositive…

So the parties are functionally reduced to fighting over what the Second Circuit meant, and whether the Supreme Court should vacate the Second Circuit’s opinion for a do-over, or whether the Supreme Court should affirm but clarify that it understands the Second Circuit to not have categorically barred the introduction of evidence of genericness at the class certification stage.

So, now we have the decision, and:

On the first question—whether the generic nature of a misrepresentation is relevant to price impact—the parties’ dispute has largely evaporated. Plaintiffs now concede that the generic nature of an alleged misrepresentation often will be important evidence of price impact … The parties further agree that courts may consider expert testimony and use their common sense in assessing whether a generic misrepresentation had a price impact.  And they likewise agree that courts may assess the generic nature of a misrepresentation at class certification even though it also may be relevant to materiality….

We share the parties’ view.

Anyhoo, 8 members of the Court decided to remand to the Second Circuit, while Justice Sotomayor wrote separately to argue that she thought the Second Circuit got it right the first time.  Goldman also had an argument that the burden of persuasion should have shifted back to the plaintiffs under Rule 301; it lost on that 6-3, so the law is pretty much where it’s always been.

Or is it?

Let’s take a step back and recall that the Supreme Court has been granting cert to decide what is basically the same exact issue for literally 10 years now.  The first time was Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. 804 (2011) (Halliburton I).  In that case, the Fifth Circuit had modified the presumption announced in Basic Inc. v. Levinson, 485 U. S. 224 (1988) – that material, false, public statements impact the prices of securities that trade efficiently – by placing the burden on plaintiffs to prove such an impact.  They could do this, the Fifth Circuit held, either by showing that stock prices had gone up in response to the initial false statement, or by establishing loss causation, which the Fifth Circuit defined to mean that stock prices had gone down in response to a corrective disclosure.

This was significant, as I explained in an earlier blog post, because it is unusual for plaintiffs to be able to show upward price movement upon an initial lie; it is far more common that frauds keep prices level when they otherwise would have fallen.  And there is always a price drop at the end of the class period, because otherwise, no plaintiff would bring a claim. Which means the fight is never about whether there was a disclosure and a price drop, but about whether the disclosure was the right kind of disclosure, and the Fifth Circuit was requiring a very tight linkage between the disclosure and the earlier lie.  Ultimately, the evidence that the Fifth Circuit was demanding would not have shed light on the price impact inquiry at all.

The Supreme Court (umm, sort of) understood all of this.  It rejected the Fifth Circuit’s attempt to shift the burdens first established in Basic.  It also rejected the defendants’ fallback position that even if the initial burden should not have been placed on plaintiffs, the defendants should have had a chance to rebut the presumption by disproving loss causation.  Why?  Because “[t]he fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory.”

And finally, it rejected the defendants’ further fallback position that while the Fifth Circuit had said “loss causation,” what it really meant was “price impact,” because, ahem, “We do not accept Halliburton’s wishful interpretation of the Court of Appeals’ opinion. As we have explained, loss causation is a familiar and distinct concept in securities law; it is not price impact…. Whatever Halliburton thinks the Court of Appeals meant to say, what it said was loss causation… We take the Court of Appeals at its word. Based on those words, the decision below cannot stand.”

That was step one.

 Step two was Amgen Inc. v. Connecticut Retirement Plans, 568 U.S. 455 (2013).  There, the defendants argued that at class certification, plaintiffs should have the burden of proving materiality – or that defendants should be able to prove lack of materiality – as a means of establishing that the lie had not impacted prices.  The Supreme Court said no.

Step three was Halliburton Co. v. Erica P. John Fund, Inc., 573 U. S. 258 (Halliburton II).  This time, the Court held that defendants do have the right to try to prove lack of price impact at class certification.

And now we have Goldman.  The Court rejected Goldman’s attempt to shift the burden to plaintiffs, again, writing, “the best reading of our precedents—as the Courts of Appeals to have considered the issue have recognized—is that the defendant bears the burden of persuasion to prove a lack of price impact.”

But it also accepted that the “generic” nature of a statement – a concept, incidentally, that is never actually defined – is relevant to the price impact inquiry.  And then it had this curious explanation for why:

The generic nature of a misrepresentation often will be important evidence of a lack of price impact, particularly incases proceeding under the inflation-maintenance theory.  Under that theory, price impact is the amount of price inflation maintained by an alleged misrepresentation—in other words, the amount that the stock’s price would have fallen “without the false statement.” Glickenhaus & Co. v. Household Int’l, Inc., 787 F. 3d 408, 415 (CA7 2020). Plaintiffs typically try to prove the amount of inflation indirectly: They point to a negative disclosure about a company and an associated drop in its stock price; allege that the disclosure corrected an earlier misrepresentation; and then claim that the price drop is equal to the amount of inflation maintained by the earlier misrepresentation. See, e.g., id., at 413–417; In re Vivendi, S. A. Securities Litig., 838 F. 3d 223, 233–237, 253–259 (CA2 2016).

But that final inference—that the back-end price drop equals front-end inflation—starts to break down when there is a mismatch between the contents of the misrepresentation and the corrective disclosure. That may occur when the earlier misrepresentation is generic (e.g., “we have faith in our business model”) and the later corrective disclosure is specific (e.g., “our fourth quarter earnings did not meet expectations”). Under those circumstances, it is less likely that the specific disclosure actually corrected the generic misrepresentation, which means that there is less reason to infer front-end price inflation—that is, price impact—from the back-end price drop.

(emphasis added).

See what the Court did there?  Why is it talking about plaintiffs’ burdens?  Why is it citing two cases – Vivendi and Glickenhaus – that explained how to prove loss causation at trial? What relevance does the Court think this has for class certification and price impact?

I don’t know, but it almost suggests we could be right back where we started with the Fifth Circuit’s original rule.  And whatever it means, I am 100% certain it will cause additional, confused sparring in the lower courts.

Because at the end of the day, it’s very hard to get away from “what goes up must come down” as a heuristic.  Defendants routinely argue “look here that purported disclosure really didn’t disclose anything,” and from there claim that they have “disproved” price impact.  But that’s non sequitur.  If the purported end-of-class-period disclosure was not, in fact, a disclosure at all, that doesn’t actually answer the question whether the initial statements affected prices.  I blogged about how much this whole thing confused the Halliburton district court when it tried to implement the Supreme Court’s instructions in Halliburton II; I can only assume we’re about to see more of the same.

This coming Friday, June 25, at 1 PM EST, the Federalist Society is presenting Part 3 of its Freedom of Thought Six-Part Zoom Webinar Series.  This Part is entitled Limiting the Right to Exclude: Common Carrier and Market Dominance.  You can find additional details and register here (a recording of Part 1 can be found here; Part 2 here).  Below is a brief description of the focus of the program.

The recent concurrence by Justice Thomas in Biden v. Knight First Amendment Institute has raised new questions about how we might think about restrictions on speech and debate on social media. Where private, concentrated control over online content and platforms exists, can a solution be found in doctrines that limit the right of a private company to exclude? 

The SEC recently called for public comment on the issue of mandatory climate reporting, and the comments are in the process of being posted at the SEC’s site.  In the original request for information, Acting Chair Lee asked:

What climate-related information is available with respect to private companies, and how should the Commission’s rules address private companies’ climate disclosures, such as through exempt offerings, or its oversight of certain investment advisers and funds?

Not all of the commenters responded to this question, but here are some highlights:

The Institutional Limited Partners Association, which is a group of institutional investors in private equity, said:

If appropriate standards for minimum disclosures are established for SEC registrants, these standards will subsequently influence private markets. In anticipation of potentially listing private fund portfolio companies, GPs will seek to align to the SEC standard. LPs, particularly those looking to measure climate implications across their public and private investment portfolios, will benefit from this alignment. Furthermore, LPs that currently struggle to collect climate-related information will benefit from SEC requirements, which will serve as a framework to encourage GP reporting alignment

Private equity said:

From a regulatory perspective, the AIC believes that the existing private offering framework, under the federal securities laws, adequately facilitates disclosure by private equity and private credit firms. We look forward to working with the SEC on climate-related and other ESG disclosure topics as the SEC considers this framework.

Private issuers generally and, specifically, private equity and private credit firms and the funds they sponsor, are subject to a legal and regulatory framework that results in disclosure requirements appropriate for participants in private securities offerings.

Private issuers in the U.S. are customarily exempt from specific disclosure requirements in connection with private offerings of their securities, while public issuers are subject to a registration regime that, by design, is fundamentally different. This is because offerings exempt from registration under the Securities Act of 1933, as amended (the Securities Act) have long been recognized as precisely that – exempt – generally because the risk to the public is mitigated by the private nature of the offering and, very often, because of the sophistication of the investors in the offering.

Neither of these is very surprising; things get a little more interesting when we turn to the Democratic AGs, whose letter was not up at the SEC’s site as of the time of this posting, but was reported on by Law360:

[E]xempt offerings under Regulation Crowdfunding (“Reg CF”) and Regulation A (“Reg A”) must include certain offering information that is filed with the SEC and made available to potential and current investors. The SEC should add climate-related information to these exempt offering disclosures. Given the potential disparity in the sizes of publicly traded companies and firms that undertake Reg A and

Reg CF offerings, the SEC could base the type and extent of climate-related disclosures on the size of the firm and the industry in which the firm operates, with larger firms and firms in riskier and more heavily impacted industries required to make more extensive disclosures.

The SEC should also address climate-related disclosures as part of a broader review of and amendments to Regulation D (“Reg D”). Reg D, which permits companies to make exempt offerings to “accredited investors” and a limited number of unaccredited investors, exposes millions of retail investors to exempt offerings that currently have no disclosure requirements so long as those investors meet the wealth or income thresholds the SEC set in 1982. The SEC should extend Reg D’s disclosure requirements for unaccredited investors to all individual investors, whether accredited or unaccredited.  Because those disclosure requirements in turn refer to Form 1-A (as used in Reg A filings) and to Regulation S-K, the SEC’s addition of climate-related disclosures to Reg A/Form 1-A and to Reg S-K/Form S-1 would provide a pathway for that requirement to apply to disclosures for individual investors.

So, first thing: on the issue of climate change disclosures, are they seriously arguing that the kind of tiny local businesses that are hard-pressed even to provide an accurate balance sheet should now be disclosing greenhouse gas emissions?

Second and more broadly, though, the Regulation D proposal is less about climate change than about protecting individual investors.  There’s long been a debate about whether individuals can adequately vet private offerings, and whether the accredited investor definition provides them with sufficient protection (here’s a recent New York Times article about the perils of what was apparently a Reg D offering marketed to wealthy individuals).  If all Reg D sales to individuals included mandated disclosures, we’d probably see a lot fewer of those sales.  Not a criticism; that is, I assume, the point of the recommendation.

That said, it’s not entirely clear to me whether the AG’s are advocating for climate disclosures for other exempt offerings, i.e., exempt offerings under Regulation D that are marketed solely to institutions. The letter does say:

In response to the SEC’s inquiry regarding climate-related disclosures for private companies (Question 14), the SEC should also direct firms that undertake exempt securities offerings to provide climate-related disclosures. Based on currently available (albeit likely incomplete) data, the private offerings market dwarfs the public market, with exempt offerings totaling $3 trillion in 2017, as compared to $1.5 trillion in registered offerings.  Failure by the SEC to impose any requirements on companies issuing exempt securities—especially large companies with many investors—could undermine the benefits of mandatory disclosures made by publicly-traded companies by not affording investors with critical information necessary to bring about efficient capital allocation.

But since the only specific discussions concern Reg CF, Reg A, and individual investors under Reg D – well, let’s just say motes, beams, and eyes come to mind.

Things start to get more interesting when we move to T. Rowe Price’s letter:

In order to level the playing field for sustainability-related disclosures, reduce data gaps for investors, and mitigate the potential for public-private company arbitrage of so-called “dirty” assets, the SEC’s disclosure framework should apply to certain private companies as well as public companies. We encourage the Commission to consider using the same threshold that applies to private company 10-K reporting.  This would avoid creating incentives to transfer businesses with high carbon intensity from public markets to private, which would perversely result in equal or greater greenhouse gas emissions with less transparency to investors.

Which is actually less shocking than it seems on first blush, because the “same threshold that applies to private company 10-K reporting” requires at least 2,000 shareholders of record (with some exceptions), and the way that’s calculated means that very few companies meet the standard.  In other words, T. Rowe Price is acknowledging the possibility of arbitrage by public companies who move ownership of dirty assets to private companies, but its proposed solution is a mirage: in practice, if the assets are going to be sold, they’ll be sold to a company with only a handful of shareholders that doesn’t meet the reporting threshold. 

Which is why the Investment Company Institute (ie., the advocacy organization for mutual funds) plays a similar shell game:

Our members support requiring private companies of the size that must provide periodic reports, or Rule 12g-1 reporting companies, to disclose the same sustainability-related information as public companies.

Beyond that, their main position is, “not it.”

We would strongly object to the Commission addressing private companies’ climate change-related disclosures through its oversight of investment advisers and funds. If the Commission determines that this information should be mandated, it should require the information directly from private companies, not indirectly by imposing disclosure requirements on funds and advisers. Proper sequencing is critical to avoid creating the regulatory conundrum of requiring funds to disclose information about companies that the companies themselves are not required to provide to the funds.

But here’s the punchline – BlackRock:

At present, climate-related information with respect to private issuers is lacking in comparison to what is increasingly available from public issuers. To avoid regulatory arbitrage between public and private market climate-related disclosures, we believe that climate-related disclosure mandates should not be limited to public issuers.

Therefore, we encourage the SEC to explore its existing regulatory authority to mandate climate-related disclosures with respect to large private market issuers.  Improving and standardizing climate disclosures across public and private issuers would benefit institutional investors (by increasing information for climate-related assessments), issuers (by avoiding multiple nuanced requests for information from various investors) and asset owners (by expanding transparency and reporting).  As an investor in both public and private issuers, this equalized transparency would help us make more informed investment decisions with respect to climate-related issues in both markets.

With no qualifications at all that I can see. That’s a serious eyebrow-raiser, and one that particularly hits home because a few days ago, the Commission announced that Boston College Professor Renee Jones is the new head of Corporate Finance.  As has been widely reported, Jones recently published an article about the distortive effect that expansive offering/reporting exemptions have on corporate governance – regular readers may recall that I actually blogged my comments on that article when it was first published.  Jones also testified before Congress to make the same arguments.

So, this is a sleeper issue I’m keeping my eye on.

Update: State Street’s letter is now available and, in footnote 5, it indicates it’s also in favor of private company disclosure.

In my business organizations course, I usually highlight the difference between Nevada and Delaware law on fiduciary duties for LLCs.  My reading of changes to the Nevada statute in 2019 meant that Nevada LLCs do not come with default fiduciary duties.  This is the current statutory language:  

NRS 86.298  Duties of manager or managing member.  The duties of a manager or managing member of a limited-liability company to the limited-liability company, to any series of the limited-liability company, to any member or to another person that is a party to or otherwise bound by the operating agreement are only:

      1.  The implied contractual covenant of good faith and fair dealing; and

      2.  Such other duties, including, without limitation, fiduciary duties, if any, as are expressly prescribed by the articles of organization or the operating agreement.

What about Nevada LLCs formed prior to 2019?  There’s one relatively recent unpublished decision from the Nevada Supreme Court– Israyelyan v. Chavez, 466 P.3d 939 (Nev. 2020).  It involved an LLC formed prior to 2019.  The Supreme Court read the 2019 amendment as a clarification, meaning that Nevada LLCs did not have default fiduciary duties prior to 2019.  This is the language:

We note that in 2019 the Legislature added NRS 86.298, which expressly states that the LLC’s members’ duties are limited to those contracted to in the articles of organization and operating agreement, aside from the implied contractual covenant of good faith and fair dealing. That statute further suggests the Legislature did not intend for NRS Chapter 86 to impose implied fiduciary duties upon LLCs. See 2B Norman J. Singer & J.D. Shambie Singer, Sutherland Statutory Construction § 49:9, at 129 (7th ed. 2012) (“Where a legislature amends a former state, or clarifies a doubtful meaning by subsequent legislation, such amendment or subsequent legislation is strong evidence of the legislative intent of the first statute.”); see also Pub. Emp.s’ Benefits Program v. LVMPD, 124 Nev. 138, 157, 179 P.3d 542, 554-55 (2008) (holding that when the Legislature clarifies a statute “through subsequent legislation, we may consider the subsequent legislation persuasive evidence of what the Legislature originally intended”).