When I begin teaching my Business students about corporations, I always start with a little information about Delaware.  I tell them that Delaware has less than 0.3% of the U.S. population, it’s physically the second smallest state in the country, and it has more registered businesses than people, among other facts.

Which is why I very much enjoyed reading Omari Simmons’s paper, Chancery’s Greatest Decision: Historical Insights on Civil Rights and the Future of Shareholder Activism, which gave me a new appreciation for Delaware and its history.  I was entirely unaware that one of the cases involved in the Supreme Court’s famous Brown v. Board of Education decision was a ruling from Delaware Chancery.  The paper gives a fascinating background of racial relations in the state and the events that led to Chancellor Seitz’s ruling that Delaware’s racially-segregated school system impermissibly discriminated against African-Americans.  I’d had no idea of Delaware’s involvement in the civil rights movement and I was delighted to learn of it.  Here is the abstract:

This essay offers a historical account of the Delaware Court of Chancery’s greatest case, Belton v. Gebhart, a seminal civil rights decision. The circumstances surrounding the Belton case illuminate the limits and potential of shareholder activism to bolster civil rights in the modern context. They vividly illustrate how advancing civil rights requires a range of tactics that leverage public, private, and philanthropic resources. Shareholder activism works best as part of a multipronged activist strategy, not as a substitute for other types of activism. Examining a historical civil rights example is instructive for thinking about how shareholder activism might advance the modern civil rights agenda. Recognizing the complex challenges associated with advancing civil rights, this essay raises key questions about the nascent environmental, social, and governance (ESG) framework with which scholars, practitioners, and other observers must contend.

I guess the only thing I’ll add is that, due to Chief Justice Strine’s retirement, Governor Carney will be called upon to pick a successor, and many legal groups are urging that he consider a woman or person of color, given Delaware’s heavily male, heavily white bench.  I have no idea who the candidates are or the various considerations that will go into Governor Carney’s decision; all I can say is that Delaware’s judiciary is of unique national importance, and it would be gratifying to see it better reflect our country as a whole.

Texas Senator Phil Gramm and his former aide-de-camp recently took to the Wall Street Journal’s opinion page to attack Senator Warren’s plan for accountable capitalism.  At base, her plan offers governance reforms that only the federal government may be able to deliver.  The reforms may increase the odds that corporations will behave responsibly in our society and limit the risk that they will use their enormous capital and clout to manipulate our political system for their own ends.

Senator Warren’s plan sounds similar to rhetoric coming from business leaders.  The Business Roundtable recently released its view on the purpose of a corporation.  These leading executives declared a shared, fundamental commitment to balancing important stakeholder interests.  Page after page of CEO signatories agree that corporations should deliver value to customers, invest in employees by providing fair compensation and benefits, deal fairly and ethically with suppliers, support communities, respect the environment, and generate long-term value for shareholders. 

Warren’s legislation offers a plan for putting the Business Roundtable’s vision into practice.  The Accountable Capitalism Act calls for federal charters for America’s largest corporations. It would allow employees to vote for a minority of corporate directors and require a supermajority of directors to authorize corporate political spending.  Shareholders need not fear they will lose all influence over corporate decisions.  Shareholders will still elect the majority of corporate directors.

The Gramm and Solon op-ed gets some things wrong about corporate law.  Many state corporation laws already allow directors to consider other stakeholder interests.  Nevada, for example, authorizes a significant number of corporations.  Nevada corporate law includes a constituency statute, expressly allowing corporate directors to balance stakeholder interests, including the interests of employees, suppliers, creditors, the community, and the state or national economy.   Under Nevada law, corporate directors do not need to limit themselves simply to the narrow, short-term interests of some shareholders.  Gramm and Solon are simply wrong when they say that corporations now have a “duty to serve investors exclusively.”  That just is not true in many states.  Of course, directors who ignore shareholders will likely lose their seats.

In fact, many corporations without an exclusive duty to serve investors thrive.  Consider noted conservative billionaire Sheldon Adelson. He runs Las Vegas Sands Corp., a Nevada corporation.  Nevada’s corporate law grants the Las Vegas Sands’ board of directors the freedom to balance stakeholder interests.  They have still delivered enormous profits to shareholders. If Gramm and Solon were right that the law requires exclusive fidelity to shareholders, which they are not, investors could not have done so well over the years by buying and holding Las Vegas Sands’ stock.

Chief Justice Strine has also called for reforms to corporate law.  Although his plan differs from Warren’s, they both recognize the need for significant changes. Warren’s legislation would create a heavyweight division in American corporate law—putting in place rules for the largest and most powerful corporate entities. Something like this would likely need to be a federal reform because states probably cannot do this on their own. If just one state created a heavyweight division, corporations could simply dodge rules by jumping to a different jurisdiction. 

Ultimately, as corporations grow ever-larger, we must keep working to ensure that our corporate entities operate responsibly within our economy.  Corporations only exist because our laws authorize their formation.  We give corporate entities powers and privileges.  They offer their owners a way to do business without accepting any personal liability should things go wrong.  This is generally a very good thing because it spurs economic growth and investment.  Yet our Supreme Court has also begun to imbue state-chartered corporations with constitutional rights to political speech and religious freedom.

These powers must come with responsibilities, checks, and balances. Corporations do good by creating ways for people to work together to invest and operate businesses.  This creates enormous value for society. Purely profit-maximizing corporate actors may make sense in economic theory when they simply operate within the rules society sets up for fair and equitable business practices. Yet as corporations grow ever larger, they gain political power and the ability to shape the law in their favor. The Warren and Strine proposals should help frame a debate around how to deliver reforms. 

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“Directors who become associated with pill adoption experience significant decreases in vote margins and increases in termination rates …. Firms have positive abnormal stock price reactions when pill-associated directors die or depart ….” https://t.co/IjSDbUTU9T #corpgov

— Stefan Padfield (@ProfPadfield) October 7, 2019

“On average since 1980, the stock price of IPO firms has popped about 18 percent over the offering price on the first day of trading. Snapchat and its selling stockholders, to take one example, left almost $1.75 billion on the table in the company’s IPO.” #corpgov https://t.co/Rv9snrpy9Z

— Stefan Padfield (@ProfPadfield) October 9, 2019

The English East India Company began its life “as a cross between a guild (a form of member corporation) and a joint-stock company (a form of partnership)…. its stockholders inherited the moniker[] of … ‘owner’” https://t.co/9PYx1ZlOKB #corpgov

— Stefan Padfield (@ProfPadfield) October 8, 2019

“Companies based in the European Union … are subject to a continuous disclosure regime…. Disclosure rules in the U.S. are different.” https://t.co/SW2Z4jXzwO #corpgov

— Stefan Padfield (@ProfPadfield) October 5, 2019

“legislative approaches to CSR adopted in the United Kingdom, Canada, India and the European Union are analysed” https://t.co/4l0W1rN6f9 #corpgov

— Stefan Padfield (@ProfPadfield) October 3, 2019

BLPB readers, the deadline (Oct 18, 2019) is fast approaching for what looks to be a very interesting conference on Fintech Startups and Incumbent Players: Policy Challenges and Opportunities, organized by the Oxford Business Law Blog and the Law, Finance & Technology project at the University of Hamburg. 

A brief description is below. Call for papers is here: Download Call-for-Papers-Fintech-Workshop-in-Oxford-27-03-2020

The potential of financial technology for innovation and growth is well-established by now. Yet startups often face many regulatory challenges in the early years, obstructing market access. Technology firms and incumbent financial institutions are experimenting with new solutions to this problem, often establishing co-operative linkages one with the other. At the same time, governments and regulators have introduced special frameworks that may facilitate the newcomers’ market entry. Among these are regulatory ‘sandboxes’, which provide for a safe experimentation space allowing new market participants to test their services in the real market with a reduced regulatory burden, but under close scrutiny of the supervisor. Governments are continuing to experiment with other formats to help new market entrants with the regulatory complexity, including through incubators and mentorship programmes.

The 4th Oxford Business Law Blog Conference, co-organized by the University of Oxford, the University of Hamburg and the European Banking Institute, will put together high-level academics, regulators and practitioners involved with these issues, with the objective of evaluating these different initiatives.

When the news came out that Volkswagen had used defeat devices in order to fool regulators into thinking that its cars complied with environmental standards, massive amounts of litigation followed, eventually consolidated into an MDL so sprawling that it literally took me over an hour – plus two calls to Bloomberg – just to get the docket sheet loaded on my computer.

One set of claimants are the bondholders who purchased in an unregistered 144A offering just before the scandal broke.  These bondholders contend that the offering memoranda failed to disclose critical information about the regulatory risks Volkswagen faced, in violation of Rule 10b-5.  They’ve just got one problem: They’d like to bring their claims as a class, but because the bonds did not trade in anything like an efficient market, they cannot make use of the fraud-on-the-market presumption of reliance.  Instead, they’ve turned to Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972), which holds that when a fraud consists of omissions rather than misstatements, reliance may be presumed.

Now, the first issue is, what counts as an omissions-based fraud?  The fraud here included affirmative misstatements, and usually that would be enough prevent the use of Affiliated Ute.  See, e.g., Waggoner v. Barclays PLC, 875 F.3d 79 (2d Cir. 2017).  However, in a recent opinion denying summary judgment to defendants, Judge Breyer of the Northern District of California ruled that in the Ninth Circuit, plaintiffs may invoke the Affiliated Ute presumption even when affirmative misstatements are in the mix, so long as the center of gravity of the case concerns an omission.  See In re Volkswagen “Clean Diesel” Mktg., Sales Practices, & Prods. Liab. Litig., 2019 U.S. Dist. LEXIS 166832 (N.D. Cal. Sept. 26, 2019).

That’s intriguing enough on its own, because when I think of what kinds of cases are likely to be primarily about omissions, they’re likely to be what the defense bar is now calling “event driven litigation,” namely, the company did a bad bad thing, and concealed that fact, and the only misstatements are things like “we acted ethically” and “we’re in compliance with the law.”  Treating those as Affiliated Ute cases could conceivably make them easier to bring, which, well, aside from annoying the defense bar, further blurs the line between cases based on mismanagement (not permitted under Rule 10b-5), and cases based on deception (which are).  See Santa Fe Indus. v. Green, 430 U.S. 462 (1977).  This is especially so because Judge Breyer does not explain exactly what was deceptive here if we’re focusing on the omissions rather than the misstatements.  If failure to disclose really important bad things counts as deception, well, we may as well give up on Santa Fe* altogether.  (These are issues I talk about a lot in my articles; if you’re interested, you can find discussions in Reviving Reliance, Slouching Towards Monell: The Disappearance of Vicarious Liability Under Section 10(b), and Searching for Market Efficiency).

But that’s actually not the part of the opinion I want to focus on.  Because the Affiliated Ute presumption of reliance is rebuttable.  If defendants can show that even if they had disclosed the relevant information, the plaintiff would still have invested, then the presumption of reliance falls away.  And courts have held that when plaintiffs don’t even read the relevant documents, then, necessarily, disclosure would not have affected the plaintiffs’ behavior, so reliance is per se rebutted.  QED.  See Eckstein v. Balcor Film Investors, 58 F.3d 1162 (7th Cir. 1995); Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981).

Way back in my very first blog post here – I remember it like it was yesterday – we were all wondering whether the Supreme Court was going to overrule Basic and jettison the fraud-on-the-market doctrine entirely, and I was thinking about whether Affiliated Ute could work as a substitute.  At the time, I asked:

I can’t help but wonder whether defendants have the right to rebut Affiliated Ute in situations where they would not or could not have disclosed the truth, such that the disclosure hypothetical is off the table. This could occur, for example, if the “truth” was that the defendants had engaged in antitrust violations, or other forms of illegal behavior….

If those cases came up in a world where fraud on the market is off the table, would courts accept Affiliated Ute in situations where disclosure was not an option, because it would be too devastating to the company or its managers?

And that is sort of what just happened in Volkswagen.  Because the plaintiffs invoked Affiliated Ute, but naturally, the lead plaintiff couldn’t show its investment manager actually read the offering memoranda – because that never happens, and even if it had, an inquiry into the reading habits of all the investment managers in the class would make class certification impossible – and so the defendants claimed they had rebutted the Affiliated Ute presumption of reliance.  At which point, Judge Breyer said:

In the run-of-the-mill omissions case, an investor’s failure to read the relevant disclosure documents could indeed be fatal. Having not read those documents, any additional disclosures in them would have been unlikely to come to the investor’s attention. As a result, it would be difficult for the investor to prove that he would have acted differently—and avoided the investment—if additional disclosures were made in those documents.

This is not a run-of-the-mill omissions case, however. The omitted facts detailed Volkswagen’s large-scale and long-running defeat-device scheme. When that scheme was disclosed to the public, in September 2015, it was front-page news and prompted congressional hearings, video apologies by Volkswagen executives, and hundreds of lawsuits. The disclosure also prompted Plaintiff’s investment manager to reevaluate Plaintiff’s investment in Volkswagen bonds and to sell those bonds for a loss within a month’s time.

If Volkswagen had disclosed its defeat-device scheme in its 2014 bond offering memorandum, instead of waiting until September 2015, the same publicity, and the same response by Plaintiff’s investment manager, would likely have followed. The scheme was so substantial and blatant that it is hard to fathom that its disclosure would have gone unnoticed by the investing public, and that Plaintiff’s investment manager would not have been made aware of it.

Assuming, then, that Volkswagen’s evidence demonstrates that Plaintiff’s investment manager did not read the offering memorandum prior to purchasing the bonds, that evidence alone is insufficient to establish beyond controversy that Plaintiff’s investment manager would not have attached significance to the omitted facts about Volkswagen’s emissions fraud if those facts had been disclosed in the offering memorandum. As a result, Volkswagen has not rebutted Affiliated Ute’s presumption of reliance.

In other words, the plaintiff “relied” on the omissions in the documents, in the sense that the plaintiff could assume from the absence of scandal surrounding Volkswagen at the time of purchase that there was nothing scandalous disclosed in the memoranda.  And that’s enough to satisfy Affiliated Ute.

To be honest – and this is something I talk about in that original blog post, as well as in Searching for Market Efficiency – I actually think this is the correct interpretation of the original Affiliated Ute case.  The distinction between omissions-based frauds and affirmative-frauds is an odd one until you remember the full context of Affiliated Ute.  The Court was trying to get at the idea that some omissions are so huge that they go to the heart of the deal – of course you would assume those facts were not present, merely by the regularity of the transaction – and that’s when it would be absurd to make the plaintiffs bear the affirmative burden to prove reliance.

And in Judge Breyer’s view, a huge scandal that dominates headlines has that same kind of quality. 

*Oh why not:

Wrapping up the Mass Tort Deals series, we have suggestions for possible reforms.  (If you want links to the prior reviews, the Mass Torts Litigation Blog has a consolidated list here.)

Burch recognizes that getting real reforms here will be a challenge and that we are not likely to simply scrap the existing structure and start with something new for these cases.  In light of that, she focuses on empowering current and potential stakeholders who will have appropriate incentives to improve how the system functions.

Let’s start with financiers.  Burch’s scholarship has suggested empowering financiers to serve as monitors in this kind of litigation.  She continues that thread here and proposes a system where “plaintiffs could assign a financier a stake in their lawsuit as the contingent fee does now.  In exchange the financier funds the suit on a nonrecourse basis and pays attorneys a billable-hour rate plus some small percentage of the recovery as a bonus.”  In my view, this seems likely to generate much more effective and sophisticated oversight of attorney conduct.  A financier without in-house expertise in the area could simply hire sophisticated counsel to oversee the litigation.  Corporate defendants do this all the time and generally manage to select more sophisticated and competent counsel for themselves.  We cannot expect ordinary people to have the necessary expertise to competently oversee their counsel in these complex cases.  Reducing the sophistication gap between counsel will likely do much good for plaintiffs.

Securities law attempted something similar with the lead plaintiff provision for securities class action suits.  Although allowing larger institutional stakeholders to play a larger role in securities class actions has yielded some benefits, it doesn’t seem nearly as effective as Burch’s proposal here.  Even a larger institutional shareholder isn’t likely to have the same intensely concentrated interest in the action as a financier would.

Burch also focuses on how to better surface relevant information and inform courts about the true state of play.  She suggests a range of reforms to improve outcomes.  Actually conducting more trials, granting more remands, and appropriately calibrating lawyer groups will all likely generate more useful information.  She suggests a more competitive application process to crack open the cartel and allow other lawyers access to court.  One interesting possibility is to solicit objections in leadership contests and allow attorneys provide objections confidentially.  Without a protection like this, many important objections will never be made.  Consider the calculus for a repeat player.  If you know about problems and speak up, you paint a target on yourself for retaliation in the action, or other ongoing actions.  Leadership groups dole out work, rewards, and access.  Offending a well-connected player could cost an attorney millions.

She also suggests independent organizing by plaintiffs.  Social media and modern technology now enable communication and coordination between plaintiffs.  Having been the victim by a particular drug or product can create a type of shared identity.  We now have sites dedicated to “pelvic-mesh victims, Vioxx users, Essure plaintiffs, and retired NFL players.”  More reforms and oversight might emerge if group members coordinate and coordinate with each other.  It may makes sense for groups to encourage members to refuse to assent to lowball or uncertain, contingent settlement offers.  With defendants including walkaway thresholds, groups of plaintiffs could hold out together instead of settling after one-to-one conversations with an attorney facing enormous pressure to get them to settle.  Burch closes the book by with something both true and obvious, yet often forgotten.  “Plaintiffs aren’t commodities on an assembly line or inventory in a lawyer’s filing cabinet–they’re people like us.”

Burch’s work appears increasingly relevant as momentum builds toward reforming mass torts.  Ultimately, this review can only do rough justice to the complex and compellingly presented ideas.  This series has only scratched the surface.  If you’re interested in mass torts or complex civil litigation, go get the book!