Cathy Hwang, Carliss Chatman, and I put together this statement recognizing that race and racism are important to the study of business law. The statement focuses on business law, but all law faculty are welcome to sign. If you agree, you can sign on here:  https://forms.gle/5rvj24XMs4xSBRTV9. Signatures will be published here on the Business Law Prof Blog on Tuesday, September 1, and periodically updated with additional signatures thereafter.

We are law professors, and many of us write and teach about business law.

 

We think race and racism are important to the study of business law, just as they are important to the study of any area of law. From slavery and redlining to lack of opportunity in the workplace and limited access to capital, race and racism have always been part of business and business law.

 

To our colleagues and our students: we welcome the opportunity to engage in these discussions and commit to thinking hard about how to incorporate them into our research and our teaching.

When the Delaware Supreme Court decided Marchand v. Barnhill, a lot people wondered – including, ahem, me – whether it heralded a new approach to Caremark claims.  Among other things, Caremark claims tend to be successful – if at all – upon a showing that the Board either participated in, or simply disregarded, illegality (in Elizabeth Pollman’s phrasing, were disobedient).  Claims that the Board simply did not monitor sufficiently tend to be more of a theoretical possibility than a lived reality, or at least, that was the case until Marchand.  Given the facts of Marchand, I speculated at the time that the choice to find potential liability on the basis of lack of monitoring was motivated by some desire to beef up the law in this area.

Which is why I found the decision in Teamsters Local 443 Health Services & Insurance Plan v. John G. Chou interesting, because to me, it reads like VC Glasscock, at least, plans to tread gingerly.

The plaintiffs alleged that AmerisourceBergen (“ABC”) violated the law in connection with its pharmaceutical business.  For those keeping score, I must clarify that the allegations do not involve ABC’s violations of law in connection with the distribution of opioids – that case is pending before the Delaware Supreme Court with respect to a Section 220 dispute.  Instead, this ABC case involves violations of law in connection with the distribution of cancer medication.  Apparently, one of ABC ‘s subsidiaries had an entire business model of skimming the excess “overfill” medication off of cancer med vials, and then repackaging and selling it – lucrative for the subsidiary, but also extraordinarily dangerous and quite illegal because of the potential for contamination.  Eventually, the whole thing ended in Specialty (one of ABC’s operating segments) pleading guilty to criminal charges and settling civil ones.

Glasscock began his analysis with a fun (for us law professors) summary of the theoretical issues surrounding Caremark claims:

The facts of Caremark claims … often invoke judicial sympathies. Frequently, the facts of the case involve corporate misconduct that has led to material suffering among customers, or to the public at large. A judge in the Caremark context must be careful to remember the issues before her. At issue is not whether specific or society-wide victims may themselves receive a remedy for corporate misconduct. Instead, the issue is whether the corporation, whose directors have allegedly allowed it to commit bad acts, should itself recover damages that ultimately inure to the benefit of the corporate owners, its stockholders. This unusual posture raises the question of whether Caremark liability is merely a branch of fiduciary liability designed to make the beneficiaries of that duty whole for breach, or whether it should be seen also as a blunt but useful tool to encourage good corporate citizenship. That question is for academic discussion, not judicial resolution; again, a judge in equity must be mindful that it is the corporation, not that corporation’s victims, to whom any recovery will flow.

He then distinguished between the two flavors of Caremark: failure to monitor, and actively ignoring evidence of illegality:

Caremark claims can take two forms. A so-called “prong one” claim arises where “the directors utterly failed to implement any reporting or information system or controls.”  Under “prong one,” “a director may be held liable if she acts in bad faith in the sense that she made no good faith effort to ensure that the company had in place any system of controls.” A “prong two” claim, on the other hand, arises where “having implemented such a system or controls, [the directors] consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.” To state a “prong two” Caremark claim, the Plaintiffs must “plead [particularized facts] that the board knew of evidence of corporate misconduct—the proverbial ‘red flag’—yet acted in bad faith by consciously disregarding its duty to address that misconduct.”

The Chou plaintiffs alleged both types of claims.  With respect to failure to monitor, they claimed that Specialty was entire outside of ABC’s board-level compliance program, and ABC’s Audit Committee – which was responsible for compliance – was aware of that fact.  Specifically, one of ABC’s officers commissioned a report from Davis Polk regarding ABC’s compliance, and Davis Polk reported its findings to the Audit Committee:

Important implications of Davis Polk’s findings were that Specialty was not integrated into ABC’s compliance and reporting function, and that oversight responsibilities were being left to officers and directors of the various ABC subsidiaries.

In the aftermath of the Davis Polk Report the Board and the Audit Committee did not follow through on Davis Polk’s recommendations. Indeed, [the relevant subsidiaries] were kept out of ABC’s compliance programs for the entire period of the [illegal program]….

This is the stuff that Marchand directly implicates, and therefore should be a slam dunk for liability, at least at the pleading stage, right?

Wrong.

Glasscock expressly declined to rule on whether the plaintiffs had stated a failure to monitor claim (though he did acknowledge a “lax approach (at best) to compliance,” slip op. at 70.  Instead, he sustained the complaint solely on the ground that ABC had ignored red flags of illegal activity.

The Davis Polk report, he pointed out, was not simply evidence of failure to monitor; it was its own kind of red flag, at least when combined with other evidence.  As he put it, the report put the Board on notice of “gaps in Specialty’s compliance, making the later red flags all the more consequential.”  Slip op. at 57. 

The other red flags?  There was a qui tam lawsuit regarding the illegal conduct, which the Board necessarily knew about because it was disclosed in ABC’s 10-Ks, which the Board signed.  The defendants claimed that the Board responded to those allegations – it did not consciously disregard them – but Glasscock concluded that the Board’s responses were in fact to a different qui tam case that potentially involved other drugs. Slip op. at 60-61. Board minutes showed some discussion of the relevant matter, but not necessarily any remedial action.  Therefore, it was reasonably conceivable that the Board took no action in response to the suit. 

And, there was a subpoena from federal prosecutors, which the Board necessarily knew about because it was also disclosed in the 10-Ks.  And though the 10-Ks said the Board was responding to the subpoena, that didn’t necessarily mean the Board was investigating the underlying conduct.  Slip op. at 67 (“[i]t is reasonably conceivable that ABC could respond to the subpoena, in the way of handing over the information requested, without taking any action with regard to the reason why the United States Attorney’s Office was asking for information…. I find that the absence of any discussion of the subpoena by the Board is sufficient to make reasonable the inference the Plaintiffs ask me to draw, that is, even after receiving the subpoena the Board did nothing to correct the underlying mission critical compliance shortcomings.”)

You know what was not a red flag though?   The fact that the FDA received and executed a search warrant of the subsidiary’s operations in 2012.  Why?  Because there was no evidence the Board was aware of it.  Unlike the other red flag allegations, the search was never mentioned in a 10-K.  See slip op. at 66 (“It is not reasonable to infer that the Board consciously ignored a red flag with regard to the search warrant, because there is no well-pled allegation that the Board had knowledge of the search warrant or the raid, and hence the scienter required to adequately plead bad faith is absent.”).  

In other words, just as Marchand seemed motivated to find potential Caremark liability based on a lack of monitoring, Glasscock seems pretty motivated to do the opposite. By sticking to the Board admissions of knowledge (while reading their actions extremely narrowly), Glasscock was able to cabin the case into well-trod Caremark ground, without the need to venture into the new territory explored in Marchand.

That said, Glasscock couldn’t quite escape one telling conclusion, which I imagine will be cited in many a future plaintiff’s brief going forward: “Calling attention to the hiring of law firms to review alleged illegality, without more, is insufficient to refute well-pled allegations that the Board failed to address mission critical compliance risks.”  I.e., asking for a legal review?  Does not satisfy Caremark.

And that’s where we are.

The “expungement” process stockbrokers use to delete complaints from their records has been drawing more and more attention.  Colleen Honigsburg and Mathew Jacob found that brokers who win “expungements are 3.3 times as likely to engage in new misconduct as the average broker.”  As I wrote before, this result may indicate that the process suppresses the investor protection signals sent by customer complaints.  In a paper forthcoming in the Washington and Lee Law Review, I dug into why the purportedly adversarial process for expungements generates these results.  (Shameless plugs: the paper has also been covered by the Business Scholarship Podcast and Ipse Dixit.)  In essence, many of the arbitrations underlying expungements cannot be fairly characterized as approaching adversarial.  A report from the PIABA Foundation found that about 98% of the time, the brokerage firm respondents in these cases did not oppose the request.  This raises real questions about whether we have any reason to believe that the expungement hearings reliably surface information relevant to deciding whether to recommend that a customer complaint be expunged.

Many of these expungement proceedings follow a similar pattern now.  A stockbroker will sue a current or former employer alleging that a customer (who is not a party on these straight-in or expungement-only arbitrations) made a false complaint against them.  The parties will select their arbitrator from FINRA’s list, set all hearing times, and then (often with roughly thirty days or less notice) send a letter to some address where the complaining customer may or may not be advising them of their ability to participate in the hearing which will determine whether or not they submitted a “false” complaint.  There are many reasons why we should not have confidence that this process produces informed decisions by the arbitrators, and I detail many of them in my article.

But we should have other concerns about how this process may, over time, increasingly bias arbitrators against customers.  These expungement-only arbitrations have been rapidly increasing in volume.  The PIABA Foundation found an over 900% increase in these cases from 2015 to 2018.  While we have considered what this process now does to the reliability of BrokerCheck, and the public’s access to information, we have not considered how these unopposed expungement cases may affect arbitrator perceptions about investors.  Consider the information environment for an arbitrator who has consecutively served on five unopposed expungement-only cases.  In each instance, the arbitrator will be told that a complaining customer simply lied, didn’t have their facts straight, or otherwise filed an improper complaint. No one will rebut any of these claims. Most of time, the arbitrators agree and grant the expungement request.  What does this mean for the next investor to bring a customer claim before an arbitrator whose views about investors have been marinated in unopposed, expungement-only proceedings?  Investors may fear that these arbitrators will see investors as liars because they have been exposed to unopposed expungement hearing after unopposed expungement hearing.  Although I haven’t developed the data skills to figure this out on my own, outcome statistics could possibly help answer this question.  It may be that arbitrators who have been exposed to a good number of unopposed, expungement-0nly arbitrations become more hostile to investors over time.  It might also turn out that these prior hearings don’t seem to impact future rulings.  Without good data in hand, I wouldn’t want to blindly trust an arbitrator who had been told time and time again that people like me were liars.

Fortunately, there seems to be a growing consensus that we should retool the expungement process to increase overall confidence in it.  The North American Securities Administrators Association will be discussing it at their Annual Meeting in a few weeks.  These regulators have a real stake in a trustworthy process because expungements delete information from their record system.  If the deleted information would have been useful to spot developing trends, it hurts public enforcement and protection.  Hopefully we’ll see more reforms in the near future.

Submissions and nominations of articles are being accepted for the eleventh annual Fred C. Zacharias Memorial Prize for Scholarship in Professional Responsibility.  To honor Fred’s memory, the committee will select from among articles in the field of Professional Responsibility with a publication date of 2020.  The prize will be awarded at the 2021 AALS Annual Meeting.  Please send submissions and nominations to Professor Samuel Levine at Touro Law Center: slevine@tourolaw.edu.  The deadline for submissions and nominations is September 1, 2020.