In Business Organizations, I am in the early part of teaching agency and partnership. In my last class, we discussed Cargill, which is a fairly typical case to open agency discussions.  I like Cargill, and I think it is a helpful teaching tool, but I think one needs to go beyond the case and facts to give a full picture of agency. 

Of note, the case deals only with “actual agency” — for whatever reason, the plaintiffs did not argue “apparent agency” or estoppel in the alternative.  A. Gay Jenson Farms Co. v. Cargill, Inc., 309 N.W.2d 285, 290 n.6 (Minn. 1981) (“At trial, plaintiffs sought to establish actual agency by Cargill’s course of dealing between 1973 and 1977 rather than ‘apparent’ agency or agency by estoppel, so that the only issue in this case is one of actual agency. ”). I think this explains a lot about how the case turns out.  That is, the court recognized that to find for the farmer, there had to be an actual agency relationship.  

I don’t love this outcome because one of the hallmarks of an agency relationship is its reciprocal nature. That is, once we find an agency relationship, the principal is bound to the third party and the third party is bound to the principal. In contrast, in a case of estoppel, the principal may be bound (estopped from claiming there is not an agency relationship), but that finding only runs one way. The principal still cannot bind the third party.  

This is a problem for me in Cargill. That is, I don’t see a scenario where a court would bind the farmers to Cargill on similar facts. (I know I am not the first to make this observation, but it seemed worth exploring a bit.) As such, I don’t think it can rightly be deemed an agency relationship.  

Assume the facts from the case to show agency, but suppose instead Cargill was suing the farmers because the grain prices had increased dramatically and that the farmers had a contract with Warren (the purported agent) to deliver grain at $5/bushel.  However, spot prices were now $15/bushel.  Warren had not paid the farmers for a prior shipment and did not have the ability to pay now. If the contract is with Warren, the farmers should be able to now sell that grain in the market and take the extra $10/bushel for themselves.  However, if Cargill were really the principal on that contract, Cargill would have a right to buy it at $5/bushel.  I just don’t see a court making such a ruling on these facts.  

For what it’s worth, I do think there is an estoppel argument here, and I think the Cargill court had ample facts to support finding Cargill a guarantor through other actions (promises to pay, name on checks, etc.), some of which might support an apparent authority argument, too. But because I don’t see this relationship as an agency relationship as a two-way street, I don’t think it can be an “actual agency” relationship. 

Incidentally, I see this reciprocal nature test as proper for partnerships, too.  That is, unless a court, on similar facts, would be willing to find a partnership where it works to the detriment of the plaintiffs, one cannot find a partnership.  Think, for example, of another classic case, Martin v. Peyton, 246 N.Y. 213 (N.Y. 1927).  There, creditors of the financial firm KNK sued KNK, as well as Peyton, Perkins, and Freeman (PPF) who had loaned KNK money. The claim was that PPF was not a mere lender, but had instead become partners of KNK because of the amount of control and profit sharing included in the loan arrangement.  If PPF were deemed partners of KNK, of course, PPF would be liable to the KNK creditors.  Here, the court determines that no partnership exists.  

While a reasonably close call,  I think this is right.  I don’t think, based on a similar set of facts, that a court would find for PPF if the dispute were such that finding a partnership between PPF and KNK would reduce the amount KNK would pay its investors. If it can’t run both ways, the partnership cannot exist.  I appreciate that in some cases, there simply is not a good analog to test the reciprocal nature of the relationship.  But where it’s possible, I think this is a good test to determine whether there really is an agency or partnership relationship or if, instead, what we really have is a sympathetic plaintiff.   

 

image from pixabay.com

As we celebrate Martin Luther King Day today, I am moved to write a bit about him as a teacher.  Preachers (along with coaches and others who interact with us in various capacities in our lives) are teachers, of course.  They struggle, as educators, with similar challenges in their teaching to those that we face in curricular, co-curricular, and extracurricular teaching in law schools.

So many parallels are obvious.  But I want to focus on one small (and perhaps less obvious) thread in this post: love.  The choice of this focus derives from a David Brooks op-ed that I read a few days ago in The New York Times.  The column included a number of helpful facts and ideas relating to the connection between emotions and intelligence.  Perhaps one of the most poignant messages it conveyed was this one: “children learn from people they love, and . . . love in this context means willing the good of another, and offering active care for the whole person.”  That rang true to me.  How, then, might love unite Dr. King with teaching and learning?

Of course, as many may recall, Dr. King (like other Christian clerics) preached about loving one’s enemies.  But I somehow sensed there was a more palpable, direct, individual connection among Dr. King, love, teaching, and learning.  As I searched the web for specific references to substantiate and illustrate my hunch, I found online drafts of Dr. King’s papers, including “Draft of Chapter IV, ‘Love in Action.'”  In this draft, Dr. King focuses in on the simple words of Jesus spoken from the cross: “Father, forgive them, for they know not what they do.”  (Luke 23:34)  As I read Dr. King’s text, I understood that part of his message was that Jesus’s words expressed love, and through that love, Jesus taught his followers.  By repeating and parsing Jesus’s words and linking Jesus’s love-through-forgiveness with the ignorance (or intellectual blindness) of those who did not love Jesus, Dr. King can be seen as more subtly making the same point that George Will made in his column: love and learning are intertwined.  Specifically, Dr. King wrote:

One day we will learn that the heart can never be totally right if the head is totally wrong.  This is not to say that the head can be right if the heart is wrong. Only through the bringing together of head and heart—intelligence and goodness—can man rise to a filfillment [sp] of his true essence.

(emphasis in the original)

I am not in the classroom this semester.  Nevertheless, I will have some student interaction, including most prominently with my research assistants.  I intend to carry the messages from the op-ed and Dr. King’s writings in my heart and work to push them into practice.  George Will noted in his op-ed that “students have got to have a good relationship with teachers. . . . In good times and bad, good teachers and good students co-regulate each other.”  I have always endeavored to relate to my students as best as possible despite age and other differences.  But I know that is hard to do in a large-class setting.  I also know there always are students who resist the entreaty to engage.  “The call for intelligence,” Dr. King observed, “is a call for open-mindness, sound judgment, and love for truth.”  Both instructor and student must share these values and observe them in the teacher-student relationship for the learning proposition to optimally succeed.

My sense is (and my anecdotal experience bears this out) that the results are worth the effort if instructors and students collaboratively invest in the teaching and learning process in this way.  Do you agree?  I am interested in your thoughts, consistent or inconsistent with the observations made here.

Today, I’d planned to blog about what their early 2019 speeches suggest is on the minds of policymakers at U.S. financial regulatory agencies as the New Year begins.  I decided to wait a few weeks to collect more data.  However, my initial research included a visit to the Federal Reserve Bank of Minneapolis (FRBM) site and led me to the subject of today’s post.

Last week, Neel Kashkari, the President and CEO of the FRBM, participated in a live Intelligence Squared U.S. (IQ2US) debate (in partnership with Foreign Affairs) on whether Ten Years After the Global Financial Crisis, the System is Safer (Resolution).  According to its website, IQ2US has now held 160 debates with 500 debaters.  Before a debate, the audience votes “yes,” “no,” or “undecided” about a resolution.  After three rounds of debate (opening statements, responses and audience questions, and closing statements), the audience votes again.  Each debate team argues for or against the resolution of the day.  The team whose numbers have increased the most in the final vote wins. 

Kashkari, in addition to debate partner Jason Furman, a top economic adviser to President Obama and former Chairman of the Council of Economic Advisers, debated in support of the Resolution.  Kashkari – who oversaw TARP during the financial crisis – shared his perspective that although more needs to be done, the system is now safer than it was ten years ago.  Specifically, he and Furman focused in their opening remarks upon five dimensions of the financial system, arguing that three were safer (big banks have more capital and less short-term funding; activity levels have fallen in non-bank areas such as securitization and money market mutual funds; and certain positive international developments such as banking reforms in Europe, institutionalized central bank swap lines, and the U.S. now being the world’s biggest oil producer), and that two were about the same/neutral (the use of monetary or fiscal policy to respond to a crisis). Hence, overall, the system was safer even if there was room for improvement.

Harvard Professor Kenneth Rogoff and Robert Rosenkranz, Chairman of Delphi Capital Management and Founder and Chairman of IQ2US, debated against the Resolution.  Rogoff’s opening remarks emphasized unknowns in the system, that the next war (financial crisis) is likely to look different from those of the past, and that a critical aspect of the financial system is leadership (seemingly a combination of competent technocrats and political leaders who support them).  Rogoff has confidence in global central banks such as the U.S., U.K. and E.U., but expressed reservations about other leadership areas.  Rosenkranz’s opening comments focused on the complex web of interrelationships in the system (OTC derivatives being the most important source); the arguable continued vulnerability of the system to the failure of a single, large bank; an increase in the potential for herd behaviors by “accelerators of trouble” (such as the spread of algorithmic trading and potential rating agency decisions); international frictions; and, the diminished strength of system shock absorbers such as liquidity.                         

All four debaters did an excellent job and a short blog post is an insufficient space for a comprehensive summary (so, view it for yourself!).  However, I was previously unaware of IQ2US, intrigued by its mission, and am always interested in the financial system and past crises.  Now, I know you’re wondering…so I’ll go ahead and tell you…the initial/final audience vote was: For (29%/35%), Against (49%/57%), and Undecided (22%/8%).  Hence, Rogoff and Rosenkranz prevailed by a 2% margin. 

Finally, if you’re like me, you probably haven’t been thinking about how you’d vote for the resolution: Don’t Bring Extinct Creatures Back to Life.  Who knows, maybe I’ll tune in on January 31st, and then just maybe, I’ll let you know!   

Forgive me for yet another foray into the vagaries of Tesla, but the company provides your humble blogger with an endless supply of discussion material.  (My own prior posts on disparate Tesla-related subjects can be found here, here, and here; Joan Heminway also commented on Tesla here.)

Earlier this month, it was reported that Elon Musk retweeted a Forbes report that Tesla had outsold all other US luxury car makers, only to delete the tweet when it turned out the report was inaccurate (it had compared Tesla’s global sales with US sales by other car manufacturers).  Such was the creation of a classroom hypothetical if I ever saw one.

I have so many questions:

1.    Why did the Chief Executive Officer of Tesla not realize that the sales report was inaccurate, and if he did realize it, did he retweet anyway in hopes that no one would spot the error?

2.    If Musk was aware the report was false, could he be liable for having made a false statement in connection with a securities transaction in violation of Section 10(b)?

A.  We might ask whether Musk “made” a statement at all.  As I’ve previously posted here and here, the Supreme Court is set to decide in Lorenzo v. Securities & Exchange Commission whether merely passing on someone else’s false representation – attributed to that other person – constitutes a false statement or otherwise fraudulent action by the conduit.

At the same time, there is a long (pre-Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011)) history of courts holding that corporate executives are responsible for the content of analyst reports when they place their imprimatur upon them. See, e.g., In re Cabletron Sys. Inc., 311 F.3d 11 (1st Cir. 2002); Elkind v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir. 1980); Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353 (5th Cir. 2004).  Did Musk’s retweet qualify?  Was his authorship “implicit from surrounding circumstances” under Janus? 

We might say this is different from the Lorenzo case because in that instance, the conduit positioned himself as an employee, passing on information pursuant to his boss’s instruction; Musk, by contrast, apparently chose to single out this particular article; the curation itself may be interpreted as a kind of endorsement.

What if his profile said “retweets are not endorsements”? (At the time of this posting, by the way, it did not.)  And – continuing with the fancy that this is a classroom discussion – if you were corporate counsel, would you insist on such a disclaimer?

B. If Musk did make a false statement, was it material?  After all, the original false statement was already out there and presumably widely distributed.  Moreover, it concerned factual information that was easy to check.  In the past, courts have assumed that efficient markets have a heroic ability to self-correct under much more challenging circumstances (see my prior post; see also my forthcoming essay addressing the subject). If reporters’ synthesis of public raw data is not “material” for securities law purposes, see, e.g., In re Merck & Co. Securities Litigation, 432 F.3d 261 (3d Cir. 2005), it’s hard to see why Musk’s retweet of an easily-debunked false news report would be any more significant.

3.     Where was the monitor? Pursuant to Musk’s settlement with the SEC over earlier ill-considered tweets, Musk agreed to:

comply with all mandatory procedures implemented by Tesla, Inc. (the “Company”) regarding (i) the oversight of communications relating to the Company made in any format, including, but not limited to, posts on social media (e.g. Twitter), the Company’s website (e.g. the Company’s blog), press releases, and investor calls, and (ii) the pre-approval of any such written communications that contain, or reasonably could contain, information material to the Company or its shareholders.

Now, to some extent, Musk has already indicated that he does not intend to hew to the terms of the settlement with religious fervor, but leaving that point aside, does the existence of the tweet in this instance suggest that there really is no monitor?  That the monitor did not consider the retweet material? Other?

In any event, whatever else may come of Musk’s stewardship of Tesla, it’s nice to know I’ll have things to blog about so long as he remains at the helm.

By now, almost everyone has seen the new Gillette ad criticizing toxic masculinity and urging men to be better men:

Reactions range from offense at Gillette’s corporate moralizing to genuine appreciation and celebration.  Slate captured the corporate logic effectively:

The wide range of reactions was, of course, the point: to create a conversation starter. To rile people and get them talking about Gillette. To increase brand recognition amid Gillette’s declining market share and, ultimately, make Procter & Gamble more money. Much of the criticism of the ad has revolved around the company’s motives.

Yet P&G can have financial incentives and still make an ad worth lauding. These two things are not mutually exclusive. And this ad is a step in the right direction, because the more we collectively hear the message that sexual harassment is unacceptable, that bullying is wrong, and that helping victims is noble, the more this message will shape our—and our children’s—everyday choices. We need to get messages like this from our leaders, teachers, parents—andfrom television shows, movies, books, songs, and advertisements. Cultural shifts happen when every aspect of culture embraces and normalizes a change.

Some business law professors commenting on Twitter took the same position.  Iowa Law’s Greg Shill immediately saw the play:

Nicole Iannarone also saw the brand boosting implications and how the business judgment rule will protect the Gillette (P&G) board from any second guessing by disgruntled investors:

As Joshua Fershee pointed out after the Nike ad, the business judgment rule protects a board for its marketing decisions.  Even if others dislike it or they think it was a poor decision.

And Gillette certainly has its detractors.  New York’s Josh Barro panned the ad after celebrating the Nike ad, seeing it as more accusatory than uplifting:

This is important: Instead of offering the man something, the slogan now asks him to do something. Gillette has spent decades making him the best razors it could; now it’s the man’s turn to deliver.

Whatever this is, it isn’t marketing.

Gillette’s message — that something has too often gone wrong in masculinity, and that men ought to evaluate whether they are doing enough to combat bullying and mistreatment of women — is correct. But the viewer is likely to ask: Who is Gillette to tell me this? I just came here for razors. And razors barely even feature in Gillette’s new campaign.

From a business perspective, I see it differently.  Let’s face it:  Razors are essentially commodities.  Unlike Barro, I’m skeptical that there are any real differences between Harry’s, Dollar Shave Club, or Gillette.  It’s blades on a stick folks.  Consumers will either be drawn to a brand or they’ll just buy the cheapest readily available option.  (Confession:  I get my razors at Costco.  It’s blades on a stick.)  Gillette doesn’t want to compete on price against the new entrants so it needs to offer a brand razor buyers want. 

Barro felt as though Gillette shouldn’t be taking this approach because of the way it called men out, perhaps offending its customer base.  I suspect Barro may have assumed that the users are almost always the buyers.  Although many men do buy their own razors, many women also buy razors and other products for families.  By one count, women drive 70-80% of all consumer purchasing.  From this angle, it’s not surprising that women known for making ads for, among other things, feminine hygiene products created the ad.  If you want a man in your life to be his best self or if you’re a woman fed up with toxic masculinity, a Gillette razor might appeal to you.  

Even though some may see this as a cynical marketing move, Gillette has been remarkably consistent on these issues.  They ran a similar campaign a few years ago in India.  This Forbes piece captures it well:

If Gillette were purpose-washing—where it uses the optics of “doing good” in a malevolent way to make a buck—the company wouldn’t possess a prior track record. There are scores of companies who claim to be purpose-driven when in fact they are purpose-washing. They use the concept of “purpose” not to change society, but solely to make a buck.

I don’t see this as the case with Gillette. They possess a track record of being purpose-driven.

Six years ago the company launched a campaign in India titled “Gillette Soldier for Women.” Its goal was not about men turning women into soldiers; rather the company was pushing men to stand up for women. “Because when you respect women,” as the advert insisted, “you respect your nation.” 

Presumably, Gillette had a good experience with that campaign before unveiling this one in the American market.

Over the long term, it also helps that Gillette is absolutely right on the issue.  The American Psychological Association recently released guidelines for treating boys and men.  They found that traditional masculinity has real downsides for men:

Although boys and men, as a group, tend to hold privilege and power based on gender, they also demonstrate disproportionate rates of receiving harsh discipline (e.g., suspension and expulsion), academic challenges (e.g., dropping out of high school, particularly among African American and Latino boys), mental health issues (e.g., completed suicide), physical health problems (e.g., cardiovascular problems), public health concerns (e.g., violence, substance abuse, incarceration, and early mortality), and a wide variety of otheWhor quality-of-life issues (e.g., relational problems, family well-being; for comprehensive reviews, see Levant & Richmond, 2007; Moore & Stuart, 2005; O’Neil, 2015). Additionally, many men do not seek help when they need it, and many report distinctive barriers to receiving gender-sensitive psychological treatment (Mahalik, Good, Tager, Levant, & Mackowiak, 2012).

Looking at my own life, I don’t think an overly stoic, traditional masculinity has served me particularly well.  One of the APA’s identified markers is the rejection of help.  I’d probably have been happier and healthier if I had sought help when I needed it.  Instead, men often suffer needlessly for fear of showing weakness.  This likely contributes to the negative outcomes that fall on men–early deaths, suicides, mental health problems, and lower graduation rates.  To remind myself of that, I might grab the Gillette brand razors the next time I’m stocking up at Costco.  After all, even people that don’t shave with razors are buying them:

 

I am wading back into a jurisdiction case because when it to LLCs (limited liability companies), I need to. A new case from the United States Court of Appeals for the Sixth Circuit showed up on Westlaw.  Here’s how the analysis section begins:

Jurisdiction in this case is found under the diversity statute 28 U.S.C. § 1332. John Kendle is a citizen of Ohio; defendant WHIG Enterprises, LLC is a Florida corporation with its principal place of business in Mississippi; defendant Rx Pro Mississippi is a Mississippi corporation with its principal place of business in Mississippi; defendant Mitchell Chad Barrett is a citizen of Mississippi; defendant Jason Rutland is a citizen of Mississippi. R. 114 (Second Am. Compl. at ¶¶ 3, 5) (Page ID #981–82). Kendle is seeking damages in excess of $75,000. Id. at ¶¶ 50, 54, 58, 64, 71 (Page ID #992–95). The district court issued an order under Rule 54(b) of the Federal Rules of Civil Procedure that granted final judgment in favor of Mitchell Chad Barrett, and so appellate jurisdiction is proper. R. 170 (Rule 54(b) Order) (Page ID #3021).

Kendle v. Whig Enterprises, LLC, No. 18-3574, 2019 WL 148420, at *3 (6th Cir. Jan. 9, 2019).

No. No. No. An LLC is not a corporation, for starters.  And for purposes of diversity jurisdiction, “a limited liability company is a citizen of any state of which a member of the company is a citizen.” Rolling Greens MHP, L.P. v. Comcast SCH Holdings L.L.C., 374 F.3d 1020, 1022 (11th Cir. 2004).  As such the where the LLC is formed doesn’t matter and the LLC’s principal place of business doesn’t matter. All that matters is the citizenship of each LLC member.  

In this case, I can tell from the opinion that Kendle and Rutland are “co-owners” of WHIG Enterprises. The opinion suggests there may be other owners (i.e., members).  The opinion refers to the plaintiff suing “WHIG Enterprises, LLC, two of its co-owners, and another affiliated entity.” Kendle v. Whig Enterprises, LLC, No. 18-3574, 2019 WL 148420, at *1. The opinion later refers to Rutland as “another WHIG co-owner.”  If we want to know whether diversity jurisdiction is proper, though, we’ll need to know ALL of WHIG’s members.  

Now, it may well be that there is diversity among the parties, but we don’t know, and neither, apparently, does the court. That may not be an issue in this case, but if people start modeling their bases for jurisdiction on the Kendle excerpt above, things could get ugly. The Eleventh Circuit, as noted above. A more recent case further reminds us to check diversity for all members in an LLC.  Thermoset Corporation v. Building Materials Corp. of America et al, 2017 WL 816224 (11th Cir., March 2, 2017).

I figured that I should give a shout out to folks getting right, given all my criticism of those getting it wrong.  Come, Sixth Circuit, let’s get it together. 

My frequent academic partner and friend John Anderson and I organized and moderated a discussion session on insider trading in the blockchain transactional environment at this year’s AALS annual meeting. The session, entitled “Insider Trading and Cryptoassests: The Future of Regulation in the Blockchain Era,” featured teacher-scholar participants from academic backgrounds in white collar crime, corporate law, securities regulation, intellectual property, cyberlaw, and ethics/compliance. The program description is as follows:

As the cryptoasset ecosystem shows signs of emerging from its “Wild West” phase, insider trading has become a principal concern for trading platforms, investors, and regulators. Insider trading cases concerning cryptoassets present challenges, however, because the legal understanding of both cryptoassets and the markets in which they are generated, bought, and sold has been significantly outpaced by their development, expansion, and innovation. In the United States, market professionals, the Securities and Exchange Commission (SEC), the Commodities Futures Trading Commission (CFTC), and others debate whether virtual currencies are securities, contracts, currencies, commodities, or something else. Both the SEC and CFTC assert jurisdiction over cryptoassets, but (at this writing) neither has precisely defined the scope or nature of its purported regulatory oversight. This commercial and regulatory uncertainty leaves a number of questions about insider trading in cryptoassets unanswered. This Discussion Group considers these and other related concerns regarding insider trading in cryptoassets.

The short papers submitted by the participants and the related commentary reflected the diverse areas of expertise of the participants and were engaging and thoughtful.  Constructive audience participation also was a highlight of the program.

We focused the discussion initially on whether, and if so how, insider trading in cryptoassets currently is regulated.  We also discussed whether regulation of that activity should be undertaken.  Then, assuming regulation, we considered whether existing regulatory tools could and should be used.  Finally, as part of that discussion, we began to assess who and exactly what should be regulated.  The dialogue was energizing, even if inconclusive.

Marcia Narine Weldon has written here at the BLPB at various times in the past six months on blockchain technology and its intersection with business and business law, including here, here, and here. In the first of those linked posts, she advises us that we ignore the blockchain at our peril. I agree.

But I also want to note that whether you believe that the blockchain is an awesome and promising new technology or a pernicious computer-based contrivance, its interactions with business law provide us all with opportunity: the chance to use our expertise to identify and resolve new legal and regulatory issues. As I learned from my experience in studying the regulatory context of crowdfunding in its early days, once the innovation train has left the station and is rolling down the tracks, it compels study and benefits from open, enlightened debate. Business lawyers are uniquely qualified to provide the necessary examination, dialogue, and guidance.  Let’s get to it!

As the New Year begins, are you thinking about the conferences you’ll attend in 2019?   

The Academy of Legal Studies in Business has a great annual conference in early August.  This year it’s in Montreal, Quebec, August 6-10.  I’ve never been to Montreal and can’t wait! 

The Academy also has a number of regional conferences.  Check out all the options (if I missed one, send me an email)!

Canadian ALSB Annual Conference May 2-4, 2019 (Halifax, Nova Scotia)

Great Lakes ALSB, October 11-12, 2019 (Frankenmuth, Michigan)

Mid-Atlantic Academy of Legal Studies in Business, March 29-30, 2019 (Reading, Pennsylvania)

Mid-West Academy of Legal Studies in Business, March 27-29, 2019 (Chicago, Illinois)

North Atlantic Regional Business Law Association Annual Conference, April 6, 2019 (Boston, Massachusetts)

North East Academy of Legal Studies in Business, May 3-5, 2019 (Cape May, New Jersey)

Pacific Northwest Academy of Legal Studies in Business, April 11-13, 2019 (Seattle, Washington)

Pacific Southwest Academy of Legal Studies in Business, February 14-17, 2019 (Palm Springs, California)

Rocky Mountain Academy of Legal Studies in Business [check for 2019 updates]

Southern Academy of Legal Studies in Business, February 28 – March2, 2019 (San Antonio, Texas)

Southeastern Academy of Legal Studies in Business [check for 2019 updates]

Western Academy of Legal Studies in Business, March 8-10, 2019 (Monterey, California)

The Supreme Court just agreed to hear Emulex Corp. v. Varjabedian, which presents something of a puzzle for merger law and policy.

In brief, Emulex agreed to be acquired by Avago in a friendly tender offer under DGCL 251(h).  When Emulex issued its Schedule 14D-9 recommending that shareholders tender their shares, it failed to mention that its bankers found the premium was on the low side as compared to similar deals.  The plaintiffs sued, alleging that the omission rendered Emulex’s recommendations misleading in violation of Exchange Act Section 14(e), which prohibits false statements in connection with tender offers.  In the courts below, the defendants argued, among other things, that the plaintiffs failed to plead that any misleading statements were made with scienter.  On appeal, the Ninth Circuit broke with other circuits and held that scienter is not a required element of a Section 14(e) violation. 

When the defendants petitioned for certiorari, here’s how they phrased the Question Presented:

Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.

Note the precise wording here – because we’re going to come back to that.

The dispute begins with the language of Section 14(e):

It shall be unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation.

The basic difficulty is that the phrase “make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading” is very similar to that used in Section 11 of the Securities Act, which prohibits misstatements in registration statements, and does not require a showing of scienter.  It’s also nearly identical to that used in Rule 14a-9 of the Exchange Act, which prohibits misstatements in proxy materials, and also has generally been interpreted not to require scienter.  And it’s pretty much word-for-word the language in Section 17(a)(2) of the Securities Act, which is enforceable only by the SEC and prohibits obtaining money or property by means of untrue statements about securities, and also – you guessed it – does not require a showing of scienter.*

But the phrase “fraudulent, deceptive, or manipulative acts or practices” is very similar to the prohibitions in Section 10(b) of the Exchange Act, which does require a showing of scienter. 

14(e) has both!  Oh no!  Which is it?

Now the interesting thing is, until now, it wasn’t that much of an issue.  But then the situation changed.

First, in around 2009 or 2010, you had the great merger litigation explosion; suddenly almost every sizeable merger was being challenged under state law, at least partly (most say) because the collapse of Milberg Weiss left a lot of plaintiffs’ firms hungry for work.  Delaware eventually got sick of it and started making it harder to bring state law claims with cases like Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015) and In re Trulia, 129 A.3d 884 (Del. Ch. 2016).  Plaintiffs responded by bringing claims under federal law instead. (The stats are documented in The Shifting Tides of Merger Litigation, by Matthew Cain, Jill Fisch, Steven Davidoff Solomon, and Randall Thomas).

Second, in 2013, Delaware enacted 251(h), which created the so-called “intermediate form” merger by making it much easier to structure a friendly acquisition as a tender offer without holding a shareholder vote (a few other states followed suit).  Suddenly, the number of deals structured as tender offers spiked.

All of which means that Section 14(e) has been getting more of a workout than it has in the past, leading to new questions about the proper interpretation of the statute.

But here’s where we get back to that Question Presented.  It’s really two questions: first, what is the state of mind element under Section 14(e), and second is there a private right of action at all?  The implication of the defendants’ petition for cert is, well, no, there isn’t, and the amicus brief filed by the Chamber of Commerce makes that argument explicitly.

So what the defendants are really angling for is a declaration that plaintiffs cannot bring claims under 14(e) at all, with a fallback position of, if they can, they have to show intent.  (Well, actually, I think the defendants are after something else – but we’ll get there.)  And here’s where the rubber meets the road:

When an acquisition is structured as a merger, it will require a shareholder vote, which means the target corporation must circulate a proxy statement.  And it was established way back in 1964 that private plaintiffs can bring actions for false statements in corporate proxy materials under Rule 14a-9.  See J.I. Case Co. v. Borak, 377 U.S. 426 (1964).  As I mentioned, at this point it’s reasonably well established that 14a-9 does not require a showing of scienter.  

Meanwhile, acquisitions structured as friendly tender offers (easy to do now under 251(h)) do not require shareholder votes, and thus do not involve proxy statements; the only federal prohibition on false statements comes from 14(e).  (And, well, Section 10(b)).

So if the defendants prevail in Emulex – and depending on how they prevail – it could create very different liability schemes for deals structured as mergers rather than tender offers – a difference that is just now mattering a whole lot because of the changes in Delaware law.

Now, the defendants are correct that these days, the Supreme Court finds implied rights of action far less easily than it used to, and when the Court interpreted 14a-9 in 1964, implied rights of action were at their heyday.  But unless we’re going to revisit Borak – and literally a 50-plus year understanding of the liability scheme for proxies – it makes no sense to say that plaintiffs are prohibited from suing for misrepresentations in tender offers under 14(e) while still permitting claims for false proxy statements under 14a-9.  There are enough artificial distinctions between mergers and tender offers without adding more incentives for deal planners to game out a kind of regulatory arbitrage; indeed, Delaware recently amended the DGCL to create more, not less, similarity between long form and intermediate form mergers.  And reaffirming that 14(e) requires scienter while 14a-9 does not may not be as dramatic a move, but it still creates an unnecessary discontinuity.

In any event, if Emulex prevails, I can totally see all kinds of weird results.  Like, there are many states that don’t allow intermediate-form mergers, meaning that if you acquire a majority of shares via tender offer, unless you manage to get all the way to 90% or so, you’ll either have to get some kind of top-up or – if you can’t – you’ll have to hold a shareholder vote anyway to complete the deal.  In those states, it may make more sense to simply hold a shareholder vote from the outset and skip the tender offer.  But if there’s more liability for proxy materials than tender offer materials, acquirers may be tempted to choose a two-step structure anyway: they’ll make the tender offer, obtain enough shares to swing the merger vote, and hold a vote on the back end.  That way, they may be insulated from liability for the initial tender offer materials, and – after Virginia Bankshares, Inc. v. Sandberg (1991) – there’s no cause of action for false statements in proxy materials where the outcome is fait accompli.

Or say you need a shareholder vote on the acquirer side – like, to issue more shares.  It’s common to just distribute a joint proxy and have both target and acquirer shareholders vote.  But if there’s a greater liability risk for proxy materials than tender offer materials, acquirers could intentionally break up the steps and hold a vote of their own shareholders, and then commence the tender offer.

Obviously, all this would be unwieldy and expensive, and if there isn’t another business justification, the choice to avoid issuing proxy statements might function as a confession of intent to commit fraud, but my broader point is simply this: Whatever the rule is going to be, it shouldn’t turn on whether the deal is structured as a merger or a tender offer. 

Now, true, we haven’t seen a rash of gaming under the current regime, which – until the Ninth Circuit’s decision – already had different scienter requirements for 14(e) and 14a-9.  That said, it must be recalled that Delaware didn’t start pushing these cases into federal court until 2015-ish; we may not have fully experienced the effects of divergent standards.  In that sense, then, what Emulex is really doing is making the distinction more salient.

And what about this issue of private rights of action?  Kevin LaCroix doubts the Court will eliminate the private right of action under 14(e) entirely, especially since no circuit court has even hinted at that possibility.  But here’s the payoff: the Supreme Court doesn’t have to go all the way to holding that 14(e) provides no right of action to make an impact; all it has to do is say “We reserve for another day the question whether a private right of action exists under 14(e),” and we are off to the races.  Expect a bunch of test cases, and a concerted, coordinated build of precedent in the lower courts, now more populated with Republican judges inclined to be skeptical of private claims.  And that, I suspect, is really what the defendants, and the Chamber of Commerce, consider endgame.

*yes, yes, the phrase about “mak[ing] any untrue statement[s]” is also similar to the language of Rule 10b-5(b), which requires a showing of scienter, but that interpretation of 10b-5(b) is entirely due to the fact that 10b-5’s authorizing statute, Section 10(b), requires scienter; it’s not a standalone interpretation of the language of the rule.