Hundreds of men have resigned or been terminated after allegations of sexual misconduct or assault.  Just last week, celebrity chef/former TV star Mario Batali and the  founder of British retailer Ted Baker were forced to sell their interests or step down from their own companies. Plaintiffs lawyers have now found a new cause of action. Although there a hurdles to success, shareholders file derivative suits when these kinds of allegations become public claiming breach of fiduciary duty, unjust enrichment, or corporate waste among other things. Examples of alleged corporate governance missteps in the filings include: failure to establish and implement appropriate controls to prevent the misconduct; failure to appropriately monitor the business; allowing known or suspected wrongdoing to persist; settling lawsuits but not changing the corporate culture or terminating wrongdoers; and paying large severance packages to the accused. Google, for example, announced earlier this year that it had terminated 48 people with no severance for sexual misconduct, but until it became public, the company did not disclose a $90 million payment to a former executive, who had allegedly coerced sex from an employee. Earlier this week, Google acknowledged another $35 million payment to a search executive who had been accused of sexual assault. This second payment was revealed after lawyers filed a shareholder derivative suit in January. CBS, on the other hand, denied a $120 million severance package to its former head, Les Moonvies, who has demanded arbitration.

So what happens when a company knows that a prominent executive has engaged in misconduct? How does a company prevent the conduct and then react to it? Board members and rank and file employees are undergoing more training even as people talk of a #MeToo backlash. But is that enough? Should companies now discuss potential or alleged sexual harassment by executives as a material risk factor in SEC filings? One panelist speaking at the 37th Annual Federal Securities Institute last month suggested that board counsel needed to consider this as an option.

#MeToo has also affected M&A deals with over a dozen companies now inserting a “Weinstein clause” representing, for example that “To the knowledge of the company, no allegations of sexual harassment have been made against any current or former executive officer of the company or any of its subsidiaries” Other “#MeToo reps” require a target company to confirm that it “has not entered into any settlement agreements” with perpetrators of sexual misconduct. Clawbacks are also increasingly common both in M & A deals and executive compensation agreements. Some companies have even asked newly-hired executives to represent that they have not been accused of or engaged in sexual misconduct.

I expect these #MeToo reps, clawbacks, and other disclosures to become more mainstream for a few reasons. First, there’s a steady stream of news keeping these issues in the headlines, and many states have banned or are considering banning nondisclosure agreements in sexual harassment cases. Second, women leaders may now play a larger role in changing corporate culture. California requires that publicly held corporations whose “principal executive office” is located in California include at least one female board member by 2019 and even more depending on the size of the board. See here for some perspective on whether more female board members would lead to fewer sexual harassment scandals.  Third, proxy advisory firms sounded the alarm on #MeToo in early 2018 and both ISS and Glass Lewis have issued statements about what they plan to recommend when there are no women on boards. Finally, BlackRock, the world’s largest asset manager has made it clear that it expects to see women on boards.  Some people do not agree that these guidelines/laws will work or are even necessary. Indeed, it will take a few years for empirical evidence to reveal whether having more women on boards and in the C suite will make a meaningful difference.

Personally, I believe it will take a combination of new leadership, successful shareholder derivative suits, and a continuation of the social due diligence in the hiring and M & A context. Sexual misconduct is wrong but it’s also expensive. Companies are spending hundreds of thousands of dollars and sometimes more to investigate claims and prepare reports that they know will likely be made public at some time. Conduct won’t change unless there are real financial and social penalties for wrongdoers.  

The University of Richmond School of Law will host the Third Annual Junior Faculty Forum on Tuesday, May 21 and Wednesday, May 22, 2019 in Richmond, Virginia.  More information is available here.  This is Richmond’s description of the event:

This annual workshop brings together junior law scholars to present their scholarship in an informal collegial atmosphere. The workshop is timed to allow participants to incorporate feedback on early ideas or projects before the summer, and papers and works-in-progress are welcome at any stage of completion. To maximize discussion and feedback, the author will provide a brief introduction to the paper, but the majority of the individual sessions will be devoted to collective discussion of the papers. We will also have plenty of opportunities for networking and more casual discussions.  

Richmond Law will provide all meals for those attending the workshop, but attendees will cover their own travel and lodging costs.

 

It is Spring Break at WVU, so I am using this time to finish some paper edits and catch up on my email. Last week, I got an email about a recent case from the United States District Court for the Northern District of Illinois. It is a headache-inducing opinion that continues the trend of careless language related to limited liability companies (LLCs). 

The opinion is a civil procedure case (at this point) regarding whether service of process was effective for two defendants, one a corporation and the other an LLC.  The parties at issue, (collectively, “Defendants”) are: (1) Ditech Financial, LLC f/k/a Green Tree Servicing, LLC (“Ditech Financial”) and (2) Ditech Holding Corporation f/k/a Walter Investment Management Corp.’s (“Ditech Holding”). The court notes that it is unclear whether there is diversity jurisdiction, because

“the documents submitted by Defendants with their motion to dismiss suggest that there may be diversity of citizenship in this case. See [12-1, at 2 (stating Ditech Holding is a Maryland corporation with a principal office in Pennsylvania) ]; [12-1, at 2 (stating Ditech Financial is a Delaware limited liability corporation with a principal office in Pennsylvania) ].”

Clayborn v. Walter Investment Management Corp., No. 18-CV-3452, 2019 WL 1044331, at *8 (N.D. Ill. Mar. 5, 2019) (emphasis added).  

Why do courts insist on telling us the state of LLC formation and principal place of business, when that is irrelevant as to jurisdiction for an LLC?  Hmm. I supposed that fact that courts keeping calling LLCs “corporations” might have something to do with it.  The court does seem to know the rule for LLCs is different than the one for corporations, noting that “Plaintiff has not pled or provided the Court with any information regarding the citizenship of each member of Ditech Financial LLC. “ Id.

Despite this apparent knowledge, the court goes on to say:

Under Illinois law, “a private corporation may be served by (1) leaving a copy of the process with its registered agent or any officer or agent of the corporation found anywhere in the State; or (2) in any other manner now or hereafter permitted by law.” 75 ILCS 5/2-204. At least one court to consider the issue has concluded that Illinois state law does not allow service of a summons on a corporation via certified mail. Ward v. JP Morgan Chase Bank, 2013 WL 5676478, at *2 (S.D. Fla. Oct. 18, 2013); see also 24 Illinois Jurisprudence: Civil Procedure § 2:20; 13 Ill. Law and Prac. Corporations § 381. Plaintiff has not cited, nor has the Court located, any support for the proposition that a summons and complaint sent by certified mail constitutes one of the “other manner[s] now or hereafter permitted by law” to effectuate service. Consequently, the Court concludes that Plaintiff has not properly served Ditech Holding under Illinois law, and therefore cannot have served Ditech Financial.2 [see below]

Id. Now the case gets more confusing.  Note that last line above: the court implies that proper service of the corporate parent may have been sufficient to serve the LLC, too. Footnote 2 of the opinion properly clarifies this, though the court then provides another baffling tidbit.

Footnote 2 provides:

Even if Plaintiff had properly served Ditech Holding, it would not have properly effectuated service upon Ditech Financial. Ditech Financial appears to be a limited liability company.[1]; [12]. Under Illinois law, service on a limited liability company is governed by section 1–50 of the Limited Liability Company Act. 805 ILCS 180/1–50; John Isfan Construction, Inc. v. Longwood Towers, LLC, 2 N.E.3d 510, 517–18 (Ill. App. Ct. 2016). Under section 1–50 of the Limited Liability Company Act, a plaintiff may only serve process upon a limited liability company by serving “the registered agent appointed by the limited liability company or upon the Secretary of State.” Pickens v. Aahmes Temple #132, LLC, 104 N.E.3d 507, 514 (Ill. App. Ct. 2018) (quoting 805 ILCS 180/1–50(a)). To properly serve Ditech Financial, Plaintiff would have had to deliver a copy of the summons and complaint to Ditech Financial’s registered agent in Illinois: CT Corporation System. [12, at 5.]

The court had already stated the Ditech Financial was an LLC, though it had called it a “limited liability corporation.” Is the court unclear about the entity type?  If entity type is in question, it would seem worthy of note in the body of the opinion. The court properly cites to the LLC Act, but it inconclusive as to whether Ditech Financial is, in fact, an LLC.    

To make matters worse, the court repeats, in footnote 3, its earlier mistake as to  what an LLC really is:

Service on a limited liability corporation, such as Ditech Financial, must be effectuated in the same manner as service on a corporation such as Ditech Holding. See, e.g., Grieb v. JNP Foods, Inc., 2016 WL 8716262, at *3 (E.D. Pa. May 13, 2016) (evaluating the effectiveness of service of process on a limited liability company under Pa. R. Civ. P. 424).

The court ultimately dismisses the claim without prejudice, which seems proper.  But the rest of this? Sigh. If you need me, I’ll be the one in back banging his head on the table. image from media.giphy.com

This “just in” from BLPB friends Beate Sjåfjell and Afra Afsharipour:

We are thrilled to co-organise a workshop at UC Davis School of Law on 26 April 2019, with the aim of facilitating an in-depth comparative analysis of the relationship between takeovers and value creation.

We invite submissions on themes concerning takeovers and value creation from any jurisdiction around the world as well as comparative contributions. Themes include but are not limited to:

What are the implications of a takeover on sustainability efforts?

What is the scope for using sustainability arguments as a defense by the target board in a takeover?

What should be the role of the bidder board?

What are the implications of large M&A transactions for building/growing a culture of sustainability at a firm?

Is there a distinct difference between planned mergers and uninvited takeovers?

How could takeovers be regulated to promote sustainable value creation?

We especially encourage female scholars and scholars from diverse backgrounds to submit abstracts. Participation at the workshop will be limited to the presenters, to facilitate in-depth discussions. Deadline for submission of abstracts: 27 March 2019!

Please feel free to send this call for papers on to colleagues who may be interested, and don’t hesitate to get in touch if you have any questions!

This looks like a great opportunity for those of us who work in the M&A space.  But the deadline is fast upon us!  Another thing to consider as a Spring Break activity . . . . 

Jeremy Kress at the University of Michigan’s Ross School of Business recently posted on SSRN his new article, Solving Banking’s “Too Big To Manage” Problem, forthcoming in the Minnesota Law Review.  Here’s the abstract:

The United States’ banking system has a problem: many financial conglomerates are so vast and complex that their executives, directors, and shareholders cannot oversee them effectively. Recognizing this “too big to manage” (TBTM) dilemma, both major political parties have endorsed breaking up the banks, and bipartisan coalitions in Congress have introduced bills to shrink the largest firms. Despite this apparent consensus, however, policymakers have not agreed on a solution to the TBTM problem. Thus, a decade after the financial crisis, the biggest U.S. banks are significantly larger today than they were in 2008. 

This Article contends that the most prominent proposals to break up the banks—by reinstating the Glass-Steagall Act, capping banks’ size, or imposing onerous capital rules—each suffer from critical policy and political shortcomings. This Article then proposes a better way to solve the TBTM problem: using the Federal Reserve’s existing authority to compel divestitures when a financial conglomerate falls out of compliance with minimum regulatory requirements. In contrast to existing break-up proposals, this never-before-used approach would increase big banks’ incentives to comply with the law, reduce the systemic footprint of the riskiest firms, preserve economies of scale and scope for most financial institutions, and not require new legislation. This Article asserts that the Federal Reserve should use its divestiture authority in appropriate circumstances, and it proposes a novel framework to end the TBTM problem by putting this authority into practice.

In January, I had the honor of attending the Huber Hurst Seminar at the University of Florida’s Warrington College of Business, and participating in a lively discussion of this article with Kress and other seminar participants.  It’s an interesting, insightful paper, and the quality of its writing makes it accessible to all.  Definitely a worthwhile read!   

 

Yesterday was International Women’s Day and I was supposed to post but couldn’t think of what to write. I simply had too many choices based on this week’s news. It’s no coincidence that three months before the World Cup and on International Women’s Day, the U.S. Women’s Soccer Team sued U.S. Soccer for gender discrimination based on pay and working conditions, including medical treatment, travel arrangements, and coaching. On the one hand, some argue that the women should not receive the same amount as their male counterparts because they do not draw the same crowds or generate the same revenue. The plaintiffs argue that they cannot draw the same crowds in part because they do not get the same marketing and other financial support. In their defense, the U.S. women have won the World Cup three times and have won gold four times at the Olympics. The men’s team has never won either tournament and didn’t even qualify for the 2018 World Cup. I was in Brazil for the 2014 World Cup and when the men advanced, people were genuinely shocked. No one expected it and I was able to get a ticket to that match 15 minutes before start time for pennies on the dollar. Yet the men earn more.

If U.S. Soccer followed a pay for performance model, the women would and should clearly earn more. But, it’s more complicated than that. As the NY Times explained, “each team has its own collective bargaining agreement with U.S. Soccer, and among the major differences are pay structure: the men receive higher bonuses when they play for the United States, but are paid only when they make the team, while the women receive guaranteed salaries supplemented by smaller match bonuses.” Even so, the union for the U.S. Men’s team supports the lawsuit, stating “we are committed to the concept of a revenue-sharing model to address the US Soccer Federation’s “market realities” and find a way towards fair compensation. An equal division of revenue attributable to the MNT and WNT programs is our primary pursuit as we engage with the US Soccer Federation in collective bargaining. Our collective bargaining agreement expired at the end of 2018 and we have already raised an equal division of attributable revenue. We wait on US Soccer to respond to both players associations with a way to move forward with fair and equal compensation for all US soccer players.” I will follow the lawsuit filed by Winston & Strawn and report back. 

The other stories I considered writing about concerned the ouster Chef Mario Batali and resignation of the founder of UK retailer Ted Baker over sexual harassment allegations. I will save that for next week when I will discuss whether companies should consider listing sexual harassment/misconduct as a material risk factor in SEC filings.

 

  

I am fascinated by the eyebrow-raising speech SEC Commissioner Hester Peirce delivered to the Council of Institutional Investors (CII) earlier this week.  In it, she said:

I have concerns about CII’s position with respect to the Johnson & Johnson shareholder proposal. As you know, a Johnson & Johnson shareholder submitted a proposal that, if approved, would have started the process to shift shareholder disputes with the company to mandatory arbitration…. CII also submitted a letter stating that “shareholder arbitration clauses in public company governing documents reflect a potential threat to principles of sound governance.”…

CII argues that “shareowner arbitration clauses in public company governing documents represent a potential threat to principles of sound corporate governance that balance the rights of shareowners against the responsibility of corporate managers to run the business.” Among your worries is the non-public nature of arbitration and thus the absence of a “deterrent effect.”…

The problem is that these class actions are rarely decided on the merits. Instead, the cost of litigating is so great that companies often settle to be free of the cost and hassle of the lawsuit.  Settlements are rarely public and certainly involve no publication of broadly applicable legal findings. Additionally, such suits can depress shareholder value since they often result in costly payouts to make the suit go away that do not inure to the benefit of shareholders.  Indeed, the cost of defending and settling these suits is a substantial cost of being a public company. The result is that the company’s shareholders are ultimately harmed by the very option intended to protect them: first by the company’s diversion of resources to defend often meritless litigation, and second by the resulting decline in the value of their shares. Case law remains untouched, and the shareholders not involved in the process have no idea what happened. A big chunk of shareholder money typically goes to nice payouts for the lawyers involved.

As I understand it, in her view, institutional investors are not capable of judging the value of securities litigation relative to arbitration, may not be aware that securities lawsuits often settle without definitive factual findings, and also may have never head the criticism that such lawsuits are expensive for companies and enriching for attorneys. 

She also appears to believe that institutional investors are unable to identify the types of corporate information that contribute to their understanding of firm value.  As she put it:

My concerns are mainly ones of focus.  I recently had a conversation with a boy who shares an obsession with many other children his age—the video game Fortnite.  He described to me how much he enjoyed long stretches of playing the game … How is it that this simulated environment can drown out the real distractions around him? Clearly, the designers of that game and others like it have figured out how to concentrate the mind on objects of their own making….

I see a parallel in today’s investment world.  Many investors these days seem focused on non-investment matters at the expense of concentration on a sound allocation of resources to their highest and best use. Real dollars are being poured into adhering to an amorphous and shifting set of virtue markers. I do not want the SEC to become an enabler of this shift in focus. … We are being asked more and more to shift securities disclosure to focus more on matters that do not go to an assessment of how effectively companies are putting investor money to work….

Institutional investors [] have been a strong voice in favor of regulation that supports the incorporation of environmental, social, and governance (“ESG”) in investing. The International Organization of Securities Commissions, or “IOSCO,” issued a statement on ESG investing in January.  The statement directed issuers to consider whether ESG factors—which are not defined—should be included in their disclosures, …

I found the statement to be an objectionable attempt to focus issuers’ on a favored subset of matters, as defined by private creators of ESG metrics, rather than more generally on material matters. The U.S. securities laws already provide for material disclosures. Explicit consideration of ESG factors must therefore require something more than what is already contemplated by our laws …

When the SEC is asked to concentrate on issues other than protecting investors, facilitating capital formation, and fostering fair, orderly, and efficient markets, our focus shifts away from our mission. …

Yet despite this apparently low opinion of institutional investors’ ability to identify and advocate for their own interests, she also made the claim that:

If shareholders value the ability to bring class actions, they can divert their investments to companies that offer such options. I am sure that CII’s preferences will be well-attended by issuers seeking your investment money. I trust that shareholders like you are more than capable of handling the matter without our intervention.

I have to say, if institutional investors are distracted by nonmaterial ESG factors like a child playing Fortnite, I’m not sure how they’re supposed to go about pricing arbitration provisions in a publicly traded company. 

In fact, we may want to begin rolling back all of those exemptions from registration for institutional and accredited investors.  The premise of Regulation D, and Rule 144A, the “testing the waters” provision, and Section 4(a)(7) is that institutions are capable of bargaining for the information they need to make intelligent investment decisions, and they do not need the paternalistic protections of mandatory securities disclosure.  But if it’s true that they are ignorant even of the phenomenon of the securities nuisance settlement, I don’t have much faith in their ability to engage in the more complex task of valuing an illiquid limited partnership interest in a 10-year private equity fund. (To be fair, that’s also how institutional investors themselves see it; they’ve just asked the SEC for greater oversight of the private equity industry.)

Okay, I’m snarking, of course, but this highlights a greater tension in the law that we see both at the federal and state level: regulators like to say they’re relying on institutional investors’ own judgments and wisdom (Regulation D, Corwin, etc) right up until the moment that these investors start to advocate for things the regulator doesn’t like (ESG disclosure, hedge fund activism, reliance on proxy advisors), at which point, investors are like children: better seen and not heard.  It’s a way of making substantive regulatory choices while maintaining a pretense of deference to private ordering.  The greater truth, in my view, is that institutional investors themselves are a product of regulation; they couldn’t exist without it, it’s written into their bones.  They are so entangled with the regulatory state that the concept of private ordering becomes meaningless; there is simply one set of regulatory choices over another.

Received today from BLPB friends Beate Sjåfjell and María Jesús Muñoz Torres:

Happy International Women’s Day! We celebrate this day by issuing the call for papers for the 5th international workshop of Daughters of Themis: International Network of Female Business Scholars. The theme is Finance for Sustainability; a highly topical theme! The deadline is 26 March, and we hope that the brief window of opportunity will be large enough for all interested to respond.

We appreciate if you would circulate this call to any interested colleagues identifying as female business scholars, including junior scholars (PhD candidates) as well as colleagues in lower-income countries. Please note that we this year do have some, very limited, funds available so that we can contribute to the funding for one or two participants based on financial hardship.

For those unfamiliar with Daughters of Themis: our annual workshop is the heart of our network, and you can read more here, reporting back from our three last workshops here: 2018, 2017 and 2016.

Please feel free to contact Beate or María Jesús with any questions you might have.

Unfortunately, this workshop overlaps a bit with the Grunin Center’s annual conference (which focuses in on “Legal Issues in Social Entrepreneurship and Impact Investing”).  But if you are a business finance/law person who focuses on sustainability, you should be at one event or another!