Last week, I posted about the SEC’s Proxy Roundtable, and in particular, the panel regarding proxy advisors.

As I mentioned at the time, one of the big issuer complaints about proxy advisors is that their recommendations may be erroneous – though of course, the definition of “error” is somewhat expansive and may include differences of interpretation.  Issuer advocates have long sought some regulatory/statutory ability to review and, if possible, force revisions to proxy advisor reports before they are published, a proposal that – as I previously noted – apparently has found some sympathy with at least Commissioner Roisman.

From my perspective, though, the most interesting aspect to all of this is that if proxy advisors do, in fact, include false statements (however defined) in their recommendations, it is not entirely clear whether and to what extent they are subject to federal sanction.

The most obvious place to begin is Rule 14a-9, which prohibits false or misleading statements in proxy solicitations, and has generally been interpreted to apply to negligent, as well as intentional, false statements.

The problem here is that it is not entirely clear that the voting recommendations of proxy advisors are proxy solicitations.  Glass Lewis, in its letter to the Senate Banking Committee, functionally concedes that they are; but ISS’s letter disputes that interpretation, and argues that voting recommendations by proxy advisors are not proxy solicitations.

If ISS is right, is there any prohibition on false statements?

Well, ISS says yes, at least for its own recommendations, because ISS is a registered investment advisor.  As such, it is subject to the antifraud provisions of the Investment Advisers Act, and is subject under that Act to a duty of care, including a duty to ensure the accuracy of its recommendations.

That’s fine as far as it goes, but Glass Lewis is not a registered investment advisor, because it disputes that proxy advice counts as investment advice.

What if they’re both right: voting recommendations are neither proxy solicitations nor investment advice?  Then neither 14a-9, nor the Investment Advisers Act, would apply to false statements in recommendations.*

We might then look to general prohibitions on false statements, articulated in Section 10(b) of the Exchange Act and Section 17 of the Securities Act.  The problem is, both of these statutes only apply to statements made in connection with securities transactions.  Proxy advisors, by definition, only provide voting advice, not advice regarding purchases and sales.  Now, that may not matter: Section 10(b), for example, has been broadly extended to situations where the speaker might reasonably anticipate its statements would be used in connection with securities transactions, even if they weren’t specifically intended for that purpose.  But then any legal action would focus on buying and selling rather than voting behavior.  So it’s an unsettling gap: If proxy advisors are only providing voting advice, and their statements are not proxy solicitations, is there any clear legal prohibition on falsity?

My point is this: 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.

So this is where I do think some action by the SEC would be helpful.  Certainly, the SEC can decide whether proxy advisors’ voting recommendations qualify as proxy solicitations, and whether their conduct qualifies as investment advice (which might render unnecessary the proposed Senate Bill that would require proxy advisors to register as investment advisors).  And if neither of these categories applies, the SEC might weigh in on whether and to what extent proxy advisors may be liable privately or subject to regulatory sanction for distributing false information in advance of an upcoming vote.  And that alone, leaving aside other issuer complaints, would probably be useful going forward.

*Why the divergence in views as to whether proxy advice counts as investment advice?  I assume the default is no one wants to claim a regulated status if they don’t have to, but ISS is particularly vulnerable to charges of conflict due to its consulting business; it may therefore feel that RIA status lends it an air of legitimacy that its clients find reassuring and that staves off additional regulatory pressure.

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Greetings from Panama. Are you one of the people who look for products labeled “organic,” “non-GMO,” or “fair trade”? According to the official Fairtrade site:

Fairtrade is a simple way to make a difference to the lives of the people who grow the things we love. We do this by making trade fair.
Fairtrade is unique. We work with businesses, consumers and campaigners. Farmers and workers have an equal say in everything we do. Empowerment is at the core of who we are. We have a vision: a world in which all producers can enjoy secure and sustainable livelihoods, fulfill their potential and decide on their future. Our mission is to connect disadvantaged farmers and workers with consumers, promote fairer trading conditions and empower farmers and workers to combat poverty, strengthen their position and take more control over their lives….

Over and above the Fairtrade price, the Fairtrade Premium is an additional sum of money which goes into a communal fund for workers and farmers to use – as they see fit – to improve their social, economic and environmental conditions…

Fairtrade is about better prices, decent working conditions, local sustainability, and fair terms of trade for farmers and workers in the developing world. By requiring companies to pay sustainable prices (which must never fall lower than the market price), Fairtrade addresses the injustices of conventional trade, which traditionally discriminates against the poorest, weakest producers. It enables them to improve their position and have more control over their lives..

With Fairtrade you have the power to change the world every day. With simple shopping choices you can get farmers a better deal. And that means they can make their own decisions, control their future and lead the dignified life everyone deserves. 

In 2016, farmers received 158 million euros in Fairtrade premiums. 

This sounds great in theory, but according to a cacao farmer I spent time with in Panama, fair trade is not fair to the farmers. He and others in his indigenous tribe earn so little from the cacao exported to Switzerland for fine Swiss chocolate that he must resort to giving tours of his plantation in order to maintain the village school and pay for medical expenses for his tribe. His farm earns only 85 cents per half kilo of cacao (or 12 pods). This .85 cents is only for the exceptional cacao. Sometimes they earn even less. The Swiss tout the organic, non-GMO product and inspect the farms annually, which means that the farmers cannot use any fertilizers to combat the fungus that kills 85% of the crop every year. This also means that the farmers do everything by hand, including cutting, fermenting, roasting, and shelling the beans. The farmer/tour guide explained that they treat the cacao plants like a woman– they love, cherish, and protect them every day. They use the same harvesting process that they have used for over 1,000 years. IMG_1375

Just like coffee farmers I met in Guatemala, the cacao farmer I met in Panama calls “fair trade” a marketing scheme for the Americans and Europeans. I assume the farmers I met represent the view of some portion of the 1.65 million farmers involved in the Fairtrade program.  For more on the Fair Trade debate, see here.

I will have more on this and other sustainability issues next week. I’ll be at UN Forum on Business and Human Rights with 2500 companies, NGOs, academics, and state representative in Geneva. In the meantime, if you’re buying someone Fairtrade chocolate for the holidays, do it for the taste because you’re not really doing much to help the farmer.

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Tom Rutledge posts the following over at the Kentucky Business Entity Law Blog:

LLC Members Are Not the LLC’s Employees

There is now pending before the Eighth Circuit Court of Appeals of a suit that may turn on whether the relevant question, namely whether an LLC member is an employee of the LLC, has already been determined by a state court. In that underlying judgment, the Circuit Court of Cole County, Missouri, issued a judgment dated October 9 18, 2017 in the case Joseph S. Vaughn Kaenel v. Warren, Case No.: 15 AC-CC 00472. That judgment provided in part:

As an equity partner of Armstrong Teasdale, LLP, [Kaenel] is not a covered employee protected by the Missouri Human Rights Act.

I am curious as to which case this is that is pending.  Tom knows his stuff and knows (and respects) the differences between entities, so I assume there is more to than appears here.  

For example, the fact that a state court determined that an LLP equity partner is not an employee does not inherently answer the question of whether an LLC member is an employee. It could, but it does not have to do so.  

In addition, I’d want to know more about the relationship between the LLC member and the entity.  I am inclined to agree that an LLC member is not generally an employee merely by virtue of being a member.  But I am also of the mind that an LLC member could also be an employee.  In fact, there are times when counsel would be wise to advise a client who is an LLC member to also get an employment contract is she wishes to get paid.  I am assuming there is not an employment contract here for the Eighth Circuit case. 

However, suppose in the operating agreement all the members agree to pay one member for certain services. Or perhaps the compensated member gets priority payouts because of her agreement to do certain work for the entity.  That would, as far as I am concerned, at least muddy the waters.

I’ll be interested to see where this one goes (and, perhaps, what I have missed). But as far as I am concerned, LLC members can also be LLCs employees, even though the general answer is that they are not.  

Even after 19 years or so of teaching Business Associations courses, I still marvel at how hard it is to teach corporate fiduciary duty doctrine to my students.  A lot of my frustration comes from the amount of (perhaps not-so-useful) judicially instigated labeling involved under Delaware law, as the leading state in the area.  In particular, there is the narrowing of the duty of care to exclude both substantive duty of care claims and Caremark claims.  And then there is the matter of how to best describe the nature of the business judgment rule and how to describe the interaction of disclosure (candor) with the fiduciary duties of care and loyalty. And finally there is a lingering doctrinal question as to whether, in other jurisdictions, good faith, classified as a subsidiary component of the duty of loyalty in Delaware, may be a free-standing fiduciary duty or, in the alternative, foundational, penumbral, etc. to the fiduciary duties of loyalty and care  . . . .  Tough stuff.

Is anyone else out there suffering in the same way I do in teaching fiduciary duties in a Business Associations or Corporations class?  How do you handle the legal complexity/labeling questions?  I continue to want to improve in teaching this material.  I am all ears.

[Postscript:  I failed to note in the original post the helpful comments that I received on a longer-form, less specific post on this issue two years ago.  Feel free to look there for more and for some ideas folks shared about their teaching then.]

The SEC held its Roundtable on the Proxy Process on Thursday, and I was able to watch the live webcast of the last panel on proxy advisory firms.  (In a prior post, I discussed how, in advance of the Roundtable, the SEC withdrew two no-action letters that facilitated investment advisors’ reliance on proxy advisory services.) 

One thing I’ll note about the Roundtable is that it felt a lot like oral argument in an appellate court, in that everyone had fun expounding their positions but it’s not where the real policymaking gets done; that’s going to take place in back offices based on private meetings and written submissions, not in a public theater.

Still, I was interested in what everyone had to say.  The webcast just went online here, but I’ll offer a summary of what stood out to me. 

(More under the jump)

Continue Reading SEC Roundtable and Proxy Advisory Firms

     Greetings from Florida, the land of the endless voting snafus. As I continue my research on blockchain use cases, I’m particularly fascinated with the potential to make voting more streamlined and secure. West Virgina just used blockchain-protected voting in a general election for 144 voters in 30 different countries who were able to cast their ballots anonymously using a blockchain-enabled  app. Military personnel and overseas voters from 24 of the state’s 55 counties used the app from Voatz.. Under  the Uniformed and Overseas Citizens Act, personnel verify their identities by providing a photo of their driver’s license, state ID or passport that is matched to a selfie. After confirmation of the identity, the voter receives a mobile ballot based on the one that s/hewould receive in the local precinct. 

     Although the technology is supposed to be tamper proof, some argue that blockchain voting can’t protect against server problems, internet outages, or hacks on the mobile devices. Nonetheless, many governments are exploring the technology for voting and other citizen services. The tiny nation of Estonia has led the way in using digital ledger technology for citizen services since 2008. Through its E-Estonia initiative, the government facilitates voting, education, the justice system, legislation and other services. Not to be outdone, Dubai plans to become the first blockchain-powered government by 2020. Visas, permits, licenses, and bill payments require 100 million documents annually, and  the government believes that it can save 1.5 billion dollars through a paperless system.

     Of course, blockchain isn’t a cure all for our voting woes, but as a Floridian who is still waiting to find out who actually won our gubernatorial and senatorial races, I’m willing to try anything. 

Facing looming retirement crises, some states have begun to do more.  Notably, Nevada recently passed a state fiduciary statute.  I cheered the legislation’s passage because it mostly puts in place the legal protections that most savers now mistakenly believe that they already have.  New Jersey also recently began to solicit comments on the issue as well.  For the New Jersey process, written comments are due on December 14th.

As it moves forward, New Jersey will likely have to contend with the financial services industry doggedly lobbying to protect a stockbroker’s right to sell clients the wrong products.  Much of the campaign will likely be led by the Securities Industry and Financial Markets Association (SIFMA).  SIFMA touts itself as “the voice of the nation’s securities industry.”  It came up with some creative concerns about the Nevada fiduciary statute and will likely raise similar concerns with New Jersey. 

One SIFMA argument struck me as particularly interesting in its implications:

We remain concerned that any new fiduciary duties under the Nevada law would impose additional recordkeeping requirements that would violate the National Securities Markets Improvement Act of 1996 (“NSMIA). As you well know, NSMIA precludes states from enacting regulations relating to the making and keeping of records “that differ from, or are in addition to, the requirements in those areas established under [the Exchange Act].” We are hard pressed to envision a scenario in which new duties do not require the creation of a new record.

For example, under the new law, broker-dealers and their agents are subject to NRS 628A.020. This provision states:

“A financial planner has the duty of a fiduciary toward a client. A financial planner shall disclose to a client, at the time advice is given, any gain the financial planner may receive, such as profit or commission, if the advice is followed. A financial planner shall make diligent inquiry of each client to ascertain initially, and keep currently informed concerning the client’s financial circumstances and obligations and the client’s present and anticipated obligations to and goals for his or her family.” 

Both the disclosure and information collection requirements would need to be done in writing, or verbally followed by the creation of a written record to document compliance with and ensure adequate supervision of these obligations. In our view, even if the Division does not require that a new form be filled out, the broker-dealer would still have to create a new record to demonstrate compliance, which violates NSMIA. We encourage you to continue to explore options that do not create additional books and records issues.

In essence, SIFMA appears to be arguing that states cannot regulate conduct within state borders if it would require incidental paperwork.  Curiously, SIFMA’s testimony omitted the statute’s next sentence which says that the “[SEC] shall consult periodically the securities commissions (or any agency or office performing like functions) of the States concerning the adequacy of such requirements as established under this chapter.”  If Congress intended to strip the states of the power to regulate conduct, it seems odd that the statute would direct the SEC to check with the states to make sure that its books and records rules were adequate.  If a court read the statute the way SIFMA seems to, it would mean that a state could not require a financial adviser to inform the client about how much money she would make off selling a particular product.  It would also mean that the states could not regulate conduct if it might ever require anyone to write something down.

The argument also seems to stretch too far because it would interfere with state authority to prohibit fraud.  When Congress passed the NSMIA, it took pains to explicitly preserve the states’ power to enforce their anti-fraud laws.  If state law creates a disclosure duty to inform the customer about a conflict, it would likely be a fraudulent omission for a broker-dealer to make sales without disclosing the conflict.  

It’ll be interesting to watch this issue to see what happens.