I posted about Lorenzo v. Securities & Exchange Commission when the SEC first granted certioriari; you can read my long thoughts about it here.  Now that the Court held oral argument, I’ll offer my quick comments (and I’ll probably say still more when the decision comes down; this is a bountiful source of blogging material).

Picking up where I left off in my earlier post (I’ll assume you’ve either read that or are otherwise familiar with the issues in this case):

Lorenzo poses a quandary because the Supreme Court backed itself into a corner in Janus Capital Group, Inc. v. First Derivative Traders, 564 U.S. 135 (2011).  There, the Court narrowly construed what it means to “make” a statement for the purposes of Rule 10b-5(b), but then went further and suggested – via its invocation of Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994) – that a wide range deceptive conduct falling outside of that definition not only would not involve making statements, but also would not be prohibited by Section 10(b) at all.

All of which has come back to bite the Court in Lorenzo.  There, Lorenzo – acting with scienter – sent a deceptive email drafted by and attributed to his boss.  And his argument is, he didn’t “make” a statement for Janus purposes, and if his conduct is considered otherwise deceptive or manipulative for Section 10(b) purposes, then Janus itself accomplishes nothing.  Certainly, he didn’t commit any more of a deceptive act than the Janus defendants, and if their conduct didn’t fall within Section 10(b)’s prohibitions, well, then, neither did Lorenzo’s.

Based on the transcript, I’d tentatively say the Court is not inclined to buy Lorenzo’s argument.  Counting heads is interesting here; the original Janus opinion was your typical 5-4 conservative/liberal split, but this time around one of the two new conservatives (Kavanaugh) is recused, because he was on the original panel that decided the case in the DC Circuit (where he sided with Lorenzo).  Which means, if the Court breaks the same way it did in Janus, it would create a 4-4 split and affirm the lower court, handing at least a temporary win to the SEC.

That said, most of the questions were highly critical of Lorenzo, but, then, most of the questions came from the liberals who dissented in Janus, making it tough to use them as a gauge.

From the conservative side of things, Gorsuch was the only justice to offer a full-throated defense of Lorenzo’s position – one that was more effective than Lorenzo’s counsel, I’d add – but even with Gorsuch, I couldn’t tell if he was genuinely convinced or simply trying to articulate Lorenzo’s argument.  Gorsuch basically laid out the claim that the only deceptive conduct here was the text of the email itself, and since Lorenzo was not the “maker” of that statement, he at best aided a deception, and did not himself engage in any deceptive conduct.

Roberts also defended Lorenzo, on the ground that the SEC’s position would render Janus a dead letter, but he didn’t talk much and, as with Gorsuch, he may have simply been offering the argument rather than stating his own position.

Alito, however – who was a member of the Janus majority – seemed convinced that Lorenzo’s act of knowingly sending a false email was sufficiently deceptive to violate Section 10(b).  Which suggests the Court will ultimately rule in favor of the SEC with at least a 5-3 split.

That, however, puts the Court in the awkward position of reconciling a holding against Lorenzo with its Janus holding.

If I’m right about where the Court is going, it seems to me like there are a few potential paths.  First, the Court can say that Janus was solely about interpreting 10b-5(b), and its references to Central Bank were irrelevant.  This would mean that other kinds of conduct beyond “making” a statement (including the defendant’s conduct in the Janus case itself) may well violate Section 10(b) via 10b-5(a) or (c).  If the Court goes that route, though, it is potentially broadening 10b-5 liability even for private plaintiffs, past what’s currently available now.

The second path would be to say that because Lorenzo included other verbiage in his email (like, directing clients to call him with questions), he functionally adopted the false statements and therefore became their “maker” even under Janus.  This isn’t the position taken by the SEC but would be the least disruptive course of action for the Court.

(The Court could, I suppose, distinguish between private plaintiffs and the SEC but no one seemed interested in that possibility.)

A final path, I guess, would be to duck everything, say that Lorenzo violated Section 17(a), and that there is somehow no need to reach the Section 10(b) question.  But no one offered that as a possibility, either, so I can’t tell if it’s something the Court is inclined to try.

Anyhoo, we’ll know by June, I suppose – so watch this space for updates.

In January 2018, Larry Fink of Blackrock, the world’s largest asset manager, shocked skeptics like me when he told CEOs:

In the current environment, these stakeholders are demanding that companies exercise leadership on a broader range of issues. And they are right to: a company’s ability to manage environmental, social, and governance matters demonstrates the leadership and good governance that is so essential to sustainable growth, which is why we are increasingly integrating these issues into our investment process. Companies must ask themselves: What role do we play in the community? How are we managing our impact on the environment? Are we working to create a diverse workforce? Are we adapting to technological change? Are we providing the retraining and opportunities that our employees and our business will need to adjust to an increasingly automated world? Are we using behavioral finance and other tools to prepare workers for retirement, so that they invest in a way that will help them achieve their goals?

In October 2018, Blackrock declared, “sustainable investing is becoming mainstream investing.” The firm bundled six existing ESG EFT funds and launched six similar funds in Europe and looked like the model corporate citisen.

So does Blackrock actually divest from companies with human rights violations or that do not provide meaningful disclosures on human trafficking, child slavery, forced labor, or conflict minerals? The company did not publicly divest from gun manufacturers although it did “speak with” them in February after the Parkland school shooting; the company has stated that due to fiduciary concerns, it cannot divest from single companies in a portfolio. 

In theory, a behemoth like Blackrock could have a significant impact on a firm’s ESG practices, if it so chose. It could set an example for companies and for other institutional investors by seeking (1) additional information after reviewing disclosures and/or (2) demanding changes in management if companies did not in fact, show a true commitment to ESG.

But I shouldn’t pick on Blackrock. Based on what I heard last week in Geneva at the UN Forum on Business and Human Rights, other investors outside of the SRI arena aren’t pressuring companies either.  I attended the Forum for the fourth time with over 2,000 members from the business, NGO, civil society, academic, and governmental communities. There was a heavy focus this year on supply chain issues because 80% of the world’s goods travel through large, international companies.The Responsible Business Alliance and others stressed the importance of eradiating forced labor. Apple, Google, Microsoft, Intel, and Amnesty International focused on tech companies, artificial intelligence, and human rights implications. Rio Tinto and Nestle allowed an NGO to publicly criticize their disclosure reports in painstaking detail. An activist told the entire plenary that states needed to stop killing human rights defenders. In other words, business as usual at the Forum. Here are some of the takeaways from some of the sessions:

  1. NGO PODER warned that investors should not divest when companies are not living up to their responsibilities  but instead should engage companies on ESG factors and demand board seats.
  2. The UN Working Group on Business and Human Rights observed that rating agencies can and should be a fast track to the board on ESG issues. 
  3. A representative from the Sustainable Stock Exchanges Initiative, a joint initiative of UNCTAD, PRI, the UN Global Compact, and UNEP-FI, indicated that investors want to know if ESG information is material. It may be salient, but not material to some. 79 stock exchanges around the world have partnered with the SSEI. 39 have voluntary ESG disclosures and 16 have mandatory disclosures.
  4. The Business and Human Rights Resources Center noted that of 7,200 corporate statements mandated by the UK Modern Slavery Act, only 25% met the minimum requirements required by law. As they shocked the audience with this statistic, news alerts went out the Australia had finally passed its own anti slavery law.
  5. 40% of companies in apparel, agricultural, and extractive industries have a 0 (zero) score for human rights due diligence, indicating weak implementation of the UN Guiding Principles on Business and Human Rights. The average score in the benchmark was only 27%.
  6. French companies must respond to the French Duty of Vigilance Law and the EU Nonfinancial Disclosure regulations, which have different approached to identifying risks. It could take six months to do an audit to do the disclosure, but investors rarely question the companies directly or the data. 
  7. SAP Ariba found that 66% of consumers believe they have a duty to buy goods that are good for society and the environment and that sustainability is mostly driven by millennials and generation Z consumers. 
  8. Nestle, the biggest food and beverage company in the world, requires its 165,000 suppliers to follow responsible sourcing standard especially for child and forced labor. The conglomerate partners with NGOs to conduct human rights impact assessments for their upstream suppliers. 
  9. Apple has returned 30 million USD in recruitment fees to workers since 2008 to address forced labor and illegal practices. HP has also returned fees. The hotel industry has banded together to fight forced labor. Most responsible businesses have banned the use of recruitment fees but many workers still pay them to personnel agencies in the hopes of getting jobs with large companies. 
  10. Many companies are now looking at human rights and ESG issues throughout their own supply chains but also with their joint venture, merger, and other key business partners.
  11. Rae Lindsay of Clifford Chance noted that avoiding legal risk is not the main role of human rights due diligence but lawyers working across disciplines can make sure that clients don’t inadvertently add to legal risk in deals. She encourages deal lawyers to become familiar with the risks and law and business students to learn about these issues. 

So do investors care about ESG? Are these disclosure rules working? You wouldn’t think so by hearing the speakers at the Forum. On the other hand, proxy advisory firm ISS recently launched an Environmental and Social Quality Score to better evaluate the ESG risks in its portfolio companies. I’ll keep an eye out for any divestments or shareholder proposals. 

I’m not holding my breath for too much progress next year at the Forum. While I was encouraged by the good work of many of the companies that attended, I remain convinced that the disclosure regime is ineffective in effectuating meaningful change in the world’s most vulnerable communities. Unless governments, rating agencies, investors, or consumers act, too many companies will continue to pay lip service to their human rights commitments.  

 

 

 

In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715, 730 (Del. Ch. 2008) – a case I worked on as a judicial clerk – the court wrote, “[m]any commentators have noted that Delaware courts have never found a material adverse effect to have occurred in the context of a merger agreement.”

That statement is no longer true.

Today–in a 3 page opinion–the Delaware Supreme Court affirmed the 240+ page opinion by Vice Chancellor Travis Laster in Akorn, Inc. v. Fresenius Kabi, AG, et al., which held that Akorn triggered the Material Adverse Effect (“MAE”) clause of the merger agreement at issue.

As the Chancery Daily reports, and as is clear looking at the recent opinions, the Delaware Supreme Court opinion does not provide much reasoning for its decision to affirm, but the Court of Chancery opinion does provide plenty of guidance. In the first few pages, the Court of Chancery notes that Akorn experienced a “dramatic, unexpected, and company-specific downturn in…business that began in the quarter after signing.” The Court of Chancery also notes the importance of whistleblower letters and issues with Akron and the FDA. 

Also of interest, the court notes that this was an expedited case — a real benefit of the Delaware Court of Chancery. The parties only had 11 weeks leading up to the trial. At the five day trial, there were 54 depositions transcripts lodged, 1,892 exhibits introduced into evidence, and 16 live witnesses (including 7 experts). Those poor lawyers — and judicial clerks! 

Has an airline ever told you it wasn’t responsible for costs you would incur because of a flight initially delayed for “mechanical reasons” that was now delayed due to weather?  In thinking about how potential losses resulting from both a clearing member default and non-default issues (such as operational, investment, or custody problems) are likely to be allocated among a clearinghouse and clearing members, I think of such past travel experiences.  From my perspective, the issue of ownership is key to both.   

Hence, I’d like there to be an increased amount of discussion about clearinghouse ownership.  The word “ownership” was barely mentioned (maybe once) during the December 4th meeting of the Market Risk Advisory Committee, sponsored by CFTC Commissioner Rostin Behnam,  which largely focused on issues related to clearinghouses.  In contrast, participants frequently mentioned clearinghouse capital (“skin in the game”), and extensively discussed (Panel 2) the allocation of default versus non-default losses (which could occur nearly simultaneously).  Surprisingly, there is scant legal guidance on the allocation of non-default losses in the U.S. 

Clearinghouses, financial market infrastructure utilities, tend to be owned by their members or by investors (I’ve written extensively about clearinghouses for readers interested in learning more).  HOWEVER, in the case of both ownership structures, members bear the tail risk of a member’s default.  Hence, in investor-owned clearinghouses, there is an important misalignment of incentives.  Those receiving a clearinghouse’s profits (the investors) are not those primarily bearing the risk of a clearing member’s default (the clearing members).  Federal Reserve Bank of Chicago policymakers Robert Cox and Robert Steigerwald have referred to this separation of ownership from primary financial responsibility for default as “incomplete demutualization” (historically, clearinghouses were mutualized institutions, but many transitioned to investor ownership beginning in the early 1990s).    

Aren’t incentive problems almost always at the heart of financial crises?  If clearinghouses are member-owned, the issue of whose capital, its placement, and the appropriate amount in the clearinghouse’s default waterfall should be mitigated.  Likewise, responsibility for default and non-default losses should be simplified: the members would be responsible.  Member ownership should also simplify many other issues participants noted: the misalignment between investors’ commercial incentives and members’ risk-management incentives in investor-owned clearinghouses; the amount of transparency to members of margin risk models; the amount of transparency to members surrounding stress testing; members’ role in governance and risk management; members’ good faith participation in auctions of a defaulted member’s portfolio; and a clearinghouse’s need for flexibility in a crisis. 

As I’ve written about, the rulebooks of many clearinghouses – for example, ICE Clear Credit – include breathtakingly expansive emergency provisions (see Rule 601) allowing the clearinghouse to take almost any action necessary to resolve an emergency.  In a sense, such provisions enable the clearinghouse to become a private-market “resolution” authority empowered to resolve the crisis at hand (indeed, clearinghouses in the U.S. are self-regulatory organizations).  Such flexibility could be tremendously beneficial to a clearinghouse in a crisis.  Importantly, as some participants noted, future crises aren’t likely to be carbon copies of those in the past.  I would think, however, that the members of an investor-owned clearinghouse are likely to be less enthused about the flexibility offered by such emergency provisions.

In sum, many issues related to clearinghouse recovery and resolution (the problem of what to do with a distressed/insolvent clearinghouse) currently being discussed could be simplified by increased consideration of a more bedrock issue: clearinghouse ownership.  Indeed, it’s baffling that this foundational issue has received such scant attention (a notable exception is a paper by Professor Paolo Saguato).  I’m not suggesting that member ownership of clearinghouses would solve all issues, especially that which I regard as the most important: emergency liquidity in a crisis.  And, certainly, remutualization of clearinghouses would have its own non-trivial set of problems.  I am suggesting, however, that at a minimum, there should be increased amount of discussion about clearinghouse ownership, and that member ownership could ameliorate many tensions between clearinghouses and clearing members.

In the remainder of this post, I highlight and comment upon additional items from the MRAC meeting. 

Participants flagged a finding from an August 2018 report by several global standard-setting bodies, Incentives to centrally clear over-the counter (OTC derivatives): a mere 5 – yes, 5 – bank-affiliated clearing member firms hold 80% plus of cleared client margin for the US, UK, and Japan.  That’s problematic. 

However, I personally consider another August 2018 report by the same authors, Analysis of Central Clearing Interdependencies, more worrisome (just check out its figures).  It details interconnections among global clearinghouses, clearing members, and service providers (often clearing members or their affiliates).  Some examples: 2 clearinghouses hold 40% of the amount of global prefunded financial resources at clearinghouses, and another 8 hold 50%; the 11 largest clearing members of those surveyed (a total of 306) have connections to 16-25 clearinghouses, hence a default at one risks triggering defaults of that clearing member (or its affiliates) at 24 additional clearinghouses because of cross-default clauses; and many large clearing members (or their affiliates) provide 3+ services (in one case, 6) to the clearinghouse.  Check out the figures in the report.              

Participants alluded to the August 2018 default by an individual power trader clearing member at a NASDAQ clearinghouse.  While research into the cause of this event appears ongoing, some commentators have suggested that the clearinghouse’s margin model could have played a role.  Both clearing members and the clearinghouse suffered losses, and 2/3 of the default fund was exhausted.  Hence, the clearinghouse required members to make additional capital contributions to recapitalize the default fund.  During the meeting, a participant suggested that as NASDAQ is a publicly-traded company ($14 billion dollar market capitalization), it would be reasonable to suggest that it increase its contribution to the default waterfall (it reportedly contributed 7 million Euros prior to the default). 

A participant briefly remarked that clearinghouse default funds for crypto assets should be kept separate from default funds for other assets.  From my perspective, this makes complete sense, at least for the near future.  However, the CME explains: “Bitcoin futures will fall into CME’s Base Guaranty Fund for futures and options on futures, as any newly listed futures.”  The CME, Inc. (because of its division, CME Clearing) is a designated, systemically significant financial market utility under Title VIII of Dodd-Frank.  This issue of crypto asset clearing is itself worthy of its own post!     

At least one participant noted that some clearinghouses (those designated by FSOC as systemically significant FMUs), but not all, now have access to accounts and services at a Federal Reserve bank.  As I’ve written about, this significant change to historical practice (traditionally, only depository institutions had access to Fed accounts and services) was enabled by Dodd-Frank’s Title VIII.  It has financial stability, competition, and a host of other implications and concerns.  Past WSJ reports (here and here) suggest that the Fed may also provide accounts for the clearing-related cash collateral of pension plans, asset managers, and hedge funds.  Indeed, who wouldn’t want an account at the Fed?  In fact, why not have A Public Option for Bank Accounts (Or Central Banking for All) as some legal academics have recently suggested?  To be clear, I’m not taking a position on such issues in this post.  I am, however, arguing that although esoteric, such issues as who has access to an account at the Fed are critical social policy choices with real world implications that merit broad-based public debate.        

A final item, also related to competition concerns, is that, as a participant noted, significant clearinghouses are essentially monopolies.  While clearinghouses might be natural monopolies, I’ve always also been baffled that there isn’t more discussion of anti-trust concerns in the global clearing ecosystem (one exception being a paper by Professor Felix Chang).

Today, I was heartened to read about how some airlines seem to be learning from past oversights.  Let’s not wait for a catastrophe to intensify public debate about critical issues currently receiving little discussion in the clearinghouse space.  

   

               

I just don’t get the fascination that courts have with calling LLCs (limited liability companies) limited liability corporations. Yes, at this point, I can no longer claim to be surprised, but I can remain appalled/disappointed/frustrated/etc. Today I happened upon a U.S. District Court case from Florida that made just such an error.  This one bugs me, in part, because the court’s reference immediately precedes a quotation of the related LLC statute, which repeatedly refers to the “limited liability company.”  It’s right there! 
 
That said, the court assesses the situation appropriately, and (I think) gets the law and outcome right.  The court explains: 
In this case, Commerce and Industry served the summons on Southern Construction by serving the wife of the manager of Southern Construction. Doc. No. 10. Because Southern Construction is a limited liability corporation, service is proper under Fla. Stat. § 48.062 . . . .
*2 (1) Process against a limited liability company, domestic or foreign, may be served on the registered agent designated by the limited liability company under chapter 605. A person attempting to serve process pursuant to this subsection may serve the process on any employee of the registered agent during the first attempt at service even if the registered agent is a natural person and is temporarily absent from his or her office.
(2) If service cannot be made on a registered agent of the limited liability company because of failure to comply with chapter 605 or because the limited liability company does not have a registered agent, or if its registered agent cannot with reasonable diligence be served, process against the limited liability company, domestic or foreign, may be served:
 
(a) On a member of a member-managed limited liability company;
(b) On a manager of a manager-managed limited liability company; or
(c) If a member or manager is not available during regular business hours to accept service on behalf of the limited liability company, he, she, or it may designate an employee of the limited liability company to accept such service. After one attempt to serve a member, manager, or designated employee has been made, process may be served on the person in charge of the limited liability company during regular business hours.
 
(3) If, after reasonable diligence, service of process cannot be completed under subsection (1) or subsection (2), service of process may be effected by service upon the Secretary of State as agent of the limited liability company as provided for in s. 48.181.
In the proof of service, the process server attests that he served Kenneth W. Jordan, the manager of Southern Construction, by serving Kimberly Jordan, Kenneth Jordan’s wife, at an address in Midway, Georgia. Doc. No. 10. Neither the process server nor counsel for Commerce and Industry provided any evidence that Southern Construction did not have a registered agent or, if it did, that service could not be made on the registered agent. There is also no evidence that Kimberly Jordan is a member, a manager or an employee of Southern Construction designated to accept service. Finally, there is no evidence regarding the address at which service was made, i.e., at the office of the registered agent, at the office of Southern Construction or at a residence. Therefore, based on the present record, the Court cannot conclude that service of process has been properly perfected.
COMMERCE & INDUSTRY INSURANCE COMPANY, Plaintiff, v. SOUTHERN CONSTRUCTION LABOR SERVICES, LLC, Defendant., No. 617CV965ORL31KRS, 2017 WL 10058577, at *1–2 (M.D. Fla. July 26, 2017) (emphasis added). 
 
The court here gets this right by both following the procedures (e.g., the presumption is to serve the LLC’s agent) and the also does not make any assumptions that a spouse is a member or employee, so that’s a good one.  This case led me to take a look at my home state’s process rules for LLCs. 
 
West Virginia’s process is less clear.  For example, West Virginia’s rules for service of process do not include a mention of LLCs specifically. The rules provide for service to a “domestic private corporations” and “unincorporated associations” (among others). For a domestic private corporation, service can be completed by serving “an officer, director, or trustee thereof; or, if no such officer, director, or trustee be found, by delivering a copy thereof to any agent of the corporation . . . .” or by serving an authorized agent or attorney.  

Service of unincorporated associations is much more complicated.  Service is made 

Upon an unincorporated association which is subject to suit under a common name, by delivering a copy of the summons and complaint to any officer, director, or governor thereof, or by delivering or mailing in accordance with paragraph (1) above a copy of the summons and complaint to any agent or attorney in fact authorized by appointment or by statute to receive or accept service in its behalf; or, if no such officer, director, governor, or appointed or statutory agent or attorney in fact be found, then by delivering or mailing in accordance with paragraph (1) above a copy of the summons and complaint to any member of such association and publishing notice of the pendency of such action once a week for two successive weeks in the newspaper of general circulation in the county wherein such action is pending. Proof of publication of such notice is made by filing the publisher’s certificate of publication with the court.

Does a manager count as an officer or director? A quick look at cases did not answer that question, but it would seem to me the answer should be “no.” Obviously, the easiest way to do complete service would be to serve an LLC’s agent or attorney, if either can be found.  But if you have to serve a “member,” one must deliver the summons and complaint to the member AND “publish[] notice of the pendency of such action once a week for two successive weeks in the newspaper of general circulation in the county wherein such action is pending.” Old school. Anyway, it seems to me that it is high time for West Virginia to specifically recognize LLCs and other entity forms in the Rules of Civil Procedure.   

I posted about my summer reading here, and I have decided to write this sort of post each semester, at least for a few semesters. 

This semester was incredibly busy, and I didn’t read as much as I would have liked, but I am glad I finished at least a few books. Nearly all of these books were pretty light

Always looking for interesting books to read – and I am open to reading in most areas – so feel free to leave a comment with suggestions or e-mail me. 

The Honest Truth About Dishonesty – Dan Ariely (Non-Fiction – Ethics/Behavioral Economics, 2013). Duke University behavioral economist examines the environs/structures that encourage or discourage honesty.

Hannah Coulter – Wendell Berry (Fiction-Novel, 2005). Elderly lady, twice widowed, reflects on her life and the lives of her family members as the world changes after World War II, and as the modern world diverts from rural, farming communities like Port William, KY. Berry’s first novel with a female narrator.

The Most Important Year – Suzanne Bouffard (Non-Fiction – Education, 2017). Discusses the importance of the year before kindergarten. (My oldest child starts kindergarten this coming fall). Biggest takeaway was to engage in Q&A with my children while reading to them; engage them.

Bad Blood – John Carreyrou (Non-Fiction – Business and Ethics, 2018). Discusses the Theranos scandal. The executives governed with fear and NDAs. Raised hundreds of millions of dollars (eventually at a $9B valuation), signed big healthcare deals, and recruited board members by appeal to ego, fear of missing out, vague grandiose claims, and name-dropping. No board members or major investors truly understood the science and were unable to uncover the fraud.

Everybody Always – Bob Goff (Non-Fiction – Religion, 2018). Lawyer, Consul to Uganda, Pepperdine Adjunct Law Professor discusses unconditional and unbounded Christian love.

Small Teaching – James Lang (Non-Fiction – Pedagogy, 2016). Read with a group of fellow Belmont professors. Encouraged me to start classes with a few questions about the previous class and/or low-stakes assessments (in the same form as the exams). Break tasks into component pieces and practice; just like football players practice steps and do drills focused on a piece of the whole. Suggests coming to class 10-15 minutes early and trying to engage each student in conversation over the course of the semester.

Your Mind Matters – John Stott (Non-Fiction – Religion, 1972). Lecture turned into a short book, encouraging Christians to engage their minds. Speaks out against anti-intellectualism.

On November 15, the Securities and Exchange Commission (SEC) convened a Roundtable on the Proxy Process.  (See also here.)  I have not been following this as closely as co-blogger Ann Lipton has (see recent posts here and here), but friend-of-the-BLPB, Bernie Sharfman (Chairman of the Main Street Investors Coalition Advisory Council) has been active as a comment source.  Both contribute valuable ideas that I want to highlight here as the SEC continues to chew on the information it amassed in the roundtable process. 

Ann, as you may recall, has been focusing attention on the uncertain status of proxy advisors when it comes to liability for securities fraud.  In her most recent post, she observes that

There’s a real ambiguity about where, if it all, proxy advisors fit within the existing regulatory framework, and while I am not convinced there is a specific problem with how they operate or even necessarily a need for regulation, I think it can only be for the good if the SEC were to at least clarify the law, if for no other reason than that these entities play an important role in the securities ecosystem, and if we expect market pressure to discipline them, potential new entrants should have an idea of the regime to which they will be subject.

I remember having similar questions as to the possible fiduciary duties and securities fraud liability of funding portals under the Capital Raising Online While Deterring Fraud and Unethical Non-Disclosure Act of 2012 (a/k/a the CROWDFUND Act)–Title III of the Jumpstart Our Business Startups Act (a/k/a/, the JOBS Act).  I wrote about these ambiguities (and other concerns) in this paper, published before the SEC adopted Regulation CF.  I know Ann’s right that we have clean-up to do when it comes to the status of securities intermediaries in various liability contexts (a topic co-blogger Ben Edwards also is passionate about–see, e.g., here and here).

Bernie has honed in on voting process issues relating to both proxy advisors (the standard for making voting recommendations and the use/rejection of the same) and mutual fund investment advisers (the disclosure of mutual fund adviser voting procedures and SEC’s enforcement of the Proxy Voting Rule).  Specifically, in an October 12 letter to the SEC, Bernie sets forth three proposals on proxy advisor voting recommendations.  His bottom line?

Institutional investors have a fiduciary duty to vote. However, the use of uninformed and imprecise voting recommendations as provided by proxy advisors should not be their only option. They should always be in a position of making an informed vote, whether or not a proxy advisor can help in making them informed.

Earlier, in an October 8 letter to the SEC (Revised as of October 23, 2018), Bernie recommends mutual adviser disclosure of “the procedures they will use to deal with the temptation to use their voting power to retain or acquire more assets under management and to appease activists in their own shareholder base” and “the procedures they will use to identify the link between support for a shareholder proposal at a particular company and the enhancement of that company’s shareholder value.”  He also recommends that the SEC “should clarify that voting inconsistent with these new policies and procedures or omission of such policies and procedures will be considered a breach of the Proxy Voting Rule” and engage in “diligent” enforcement of the Proxy Voting Rule.  I commend both letters to you.

Ann’s and Bernie’s proxy disclosure and voting commentary also reminds me of the importance of co-blogger Anne Tucker’s work on the citizen shareholder (e.g., here).  It will be interesting to see what the SEC does with the information obtained through the proxy process roundtable and the related comment letters.  There certainly is much here to be explored and digested.

[Postscript, 12/4/2018: Bernie Sharfman notified me this morning of a third comment letter he has filed–on proxy advisor fiduciary duties.  It seems he may have a fourth letter in the works, too.  Look out for that. – JMH]