Following is an announcement for an upcoming symposium that will tackle some challenging topics, including those related to the role corporate law plays in addressing poverty.  I, of course, would probably talk about the role of “entity law,” rather than “corporate law,” but that’s just me.  Regardless, this should be an interesting and enlightening discussion, and I look forward to seeing the papers that come from it.  

On Thursday, October 25, 2018, The University of Tennessee Law School and the Tennessee Journal of Race, Gender, & Social Justice will be hosting a Symposium titled The Urgency of Poverty. The Symposium reflects on the Poor People’s Campaign of 1968 and the continued injustices which have led to the current revival. The Symposium further explores the important role transactional lawyers and scholars must play in advocating for economic justice in modern America.

The Symposium will include panels on (1) Environmental Justice, (2) Intersection of Civil Rights and Economic Justice, (3) Solidarity Economies, and (4) Reforming Corporate Law. Professor Philip Alston, the U.N. Special Rapporteur on Extreme Poverty, and Human Rights, will deliver the keynote. The Symposium is accompanied by a dedicated publication featuring essays and articles from Transactional Professors of Color.

More information is available here: https://law.utk.edu/alumni/get-involved/cle/the-urgency-of-poverty/

 

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I have been so grateful for Ann Lipton’s blog posts (see here and here) and tweets about Elon Musk’s going-private-funding-is-secure tweet affair.  Her post on materiality on Saturday–just before the SEC settlement was announced–was especially interesting (but, of course, that’s one of my favorite areas to work in . . .).  She tweeted about the settlement here:

Screenshot 2018-10-01 10.12.17

[Note: this is a screenshot.]  Ann may have more to say about that in another post; she did add a postscript to her Saturday post reporting the settlement . . . .

But I also find myself wondering about another of the contentious issues in Section 10(b)/Rule 10b-5 litigation: scienter.  This New York Times article made me think a bit on the point.  It tells a tale–apparently relayed to the U.S. Securities and Exchange Commission (SEC) in connection with its inquiry into the tweet incident–of fairly typical back-room discussions between/among business principals.  This part of the article especially stuck with me in that regard:

On an evening in March 2017, . . . Mr. Musk and Tesla’s chief financial officer dined at the Tesla factory in Fremont, Calif., with Larry Ellison, the chairman of Oracle, and Yasir Al Rumayyan, the managing director of the Saudi Public Investment Fund. During the meal, . . . Mr. Rumayyan raised the idea of taking Tesla private and increasing the Saudi fund’s stake in it.

More than a year later, . . . Mr. Musk and Mr. Rumayyan met at the Tesla factory on July 31.  When Mr. Rumayyan spoke again of taking the company private, Mr. Musk asked him whether anyone else at the fund needed to approve of such a significant deal. Mr. Rumayyan said no . . . .

Could Musk have actually believed that a handshake was all that was needed here?  We all know a handshake can be significant.  (See here and here for the key facts relating to the now infamous Texaco/Getty/Pennzoil case.)  But should Musk have taken (or at least should he have known that he should take) more care to verify before tweeting?  In other words, can Musk and his legal counsel actually believe they can prove that Musk (1) had no knowledge that his tweet was false and (2) was merely negligent–not reckless–in relying on the oral assurance of a business principal to commit to a $70+ billion transaction?

Don Langevoort has written cogently and passionately about the law governing scienter.  One of my favorite articles he has written on scienter is republished in my Martha Stewart book.  What he urges in that piece is that the motive and purpose of a potentially fraudulent disclosure are not the relevant considerations in determining the existence of scienter.  Rather, the key question is whether the disclosing party (here, Musk) knew or recklessly disregarded the fact that what he was saying was false.  Join this, Don notes, with the securities fraud requirement that manipulation or deception be in connection with the purchase or sale of a security, and the test becomes not merely whether Musk misrepresented material fact or misleadingly omitted to state material fact, but also whether he could reasonably foresee the likely impact of his misrepresentation on the market for Tesla’s securities.

On the one hand, as Ann points out in her post on Saturday, a number of investors in the market thought the tweet was a joke.  Given that, might we assume that Musk–a person perhaps similarly experienced in finance–knew or should have known that his tweet was false?  On the other hand, as Ann notes in her post, the SEC’s complaint states that “market analysts – sophisticated people – privately contacted Tesla’s head of investor relations for more information and were assured that the tweet was legit. So that’s evidence the market took it seriously.”  Yet, Musk might just be presumptuous enough to believe he could reasonably rely on an oral promise by a person who is in control of executing on that promise–thinking it represented a deal (although, of course, not one that experienced legal counsel would understand to be legally, or even morally, binding or enforceable).  Too wealthy men jawing about a deal . . . .Puffery, or the way business actually is done in this crowd?  

Based on what I know today (which is not terribly much), my sense is that a court should find that Musk acted in reckless disregard of the falsity of his words and understood the likely impact those words would have on the trading of his firm’s stock.  To find otherwise based on the specific facts alleged to have occurred here would inject too much subjectivity into the (admittedly subjective) determination of scienter.  But we shall see.  As Ann noted in Saturday’s post, a private class action also has been brought against Musk and Tesla based on the tweet affair.  So, we may yet see the materiality and scienter issues play themselves out in court (although I somehow doubt it).

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By now, I’m sure everyone’s seen the eyebrow-raising SEC complaint filed against Elon Musk for his fateful tweet announcing “funding secured” for his plan to take Tesla private at $420/share – while keeping all the old shareholders.  There are a lot of juicy details here, including an allegation that the $420 price was – as many suspected – a reference to marijuana; he ballparked a 20% premium, which would bring the price to $419, and then rounded up to impress his girlfriend.

Well, as we all know by now, funding was not secure, there was no plan, and – as I previously posted – there was no way the plan was ever going to work in the first place, because you can’t go private while keeping a massive retail shareholder base.

That said, the thing I keep wondering is, if anyone but the SEC had brought this case, would there be a serious question of materiality?

For starters, there has been a private complaint.  A short-seller, apparently injured when Tesla’s price shot up in the wake of Musk’s initial tweet, filed a class action complaint alleging securities fraud.  Now, this case is in the early stages so there’s no way to tell exactly where it will go, but I first note that even though a short-seller filed the complaint, the class appears to consist of people who went long – who bought in on the tweet, and lost money when it became clear that no take-private deal would be forthcoming.

Why?

Well, short-sellers occupy a kind of weird position in Section 10(b) cases, especially for a scenario like this.  They borrow shares, sell them, and lose money if they have to return the borrowed shares by repurchasing at a higher price.  If the allegation is that the company’s lies forced them to cover at a higher price than they otherwise would have – i.e., if the lies happened after the initial sale – there may not be any reliance in the traditional sense.  That is, the seller may not have necessarily believed the lie, but might have been forced to cover anyway.  Courts have been a bit inconsistent in how these claims are treated, see Rocker Management, LLC v. Lernout & Hauspie Speech Products N.V., 2007 WL 2814653 (D.N.J. 2007) (discussing cases), and Basic v. Levinson, 485 U.S. 224 (1988) suggests that forced transactions made while knowing the truth are not in reliance on the fraud – so it is not clear that under existing doctrine, a short-seller who saw through the lie almost immediately, but was injured because other people didn’t, has a Section 10(b) claim.  (It’s not impossible that Halliburton Co. v. Erica P. John Fund, Inc., 134 S.Ct. 2398 (2014) will change how courts think about these things; in that case, the Supreme Court was explicit that reliance exists for traders who disbelieve the market price but expect it to eventually correct; the Court was not talking about short-sellers, but the logic might extend that far).

But anyway!  Leaving aside the short-seller bit for a moment, the problem from a materiality standpoint is that the market saw through the lie almost immediately. 

We start with the definition of materiality: a fact is material if there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” Basic, 485 U.S. at 231-32.  Well, would a reasonable shareholder have taken Musk’s statement seriously?  Musk has a history of bizarre tweets, so on the day the fatal tweet issued, people were speculating it was a joke.  For example:

To be sure, with respect to this argument, one of the best points in the class’s favor is a nugget in the SEC complaint that market analysts – sophisticated people – privately contacted Tesla’s head of investor relations for more information and were assured that the tweet was legit.  So that’s evidence the market took it seriously.

That said, as I explained in my prior post, the structure Musk proposed was legally impossible – indeed, his failure even to investigate the legality is a central factor in the SEC’s complaint.  But those legal standards are publicly known, and thus are part of the “total mix of information made available.”  See, e.g., Wielgos v. Commonwealth Edison Co., 892 F.2d 509 (7th Cir. 1989) (“Issuers needn’t print the Code of Federal Regulations…”). So, one might argue – especially in the fraud-on-the-market context, where truths might have an offsetting impact on market price – that the truth about the impossibility of Musk’s plan was necessarily known to investors and could not have impacted the stock’s price.

Aha, you might say – but the tweet did impact the stock’s price – it closed up nearly 11%!  Market reaction was so volatile that the NASDAQ had to temporarily suspend trading!  Isn’t that proof of materiality?

Well, you would think, but it turns out courts aren’t really eager to relinquish their authority over materiality determinations to market evidence, and frequently reject stock price reaction as proof of materiality.  See, e.g, Police Ret. Sys. v. Intuitive Surgical, Inc., 759 F.3d 1051, 1060 (9th Cir. 2014); Greenhouse v. MCG Capital Corp., 392 F.3d 650 (4th Cir. 2004).

That said, whatever challenges these issues might pose for private plaintiffs, it’s not clear they’ll get much traction in the context of a governmental action, where, rightly or wrongly, courts often treat materiality differently than they do in the private-litigation context.  Cf. Margaret V. Sachs, Materiality and Social Change: The Case for Replacing “the Reasonable Investor” with “the Least Sophisticated Investor” in Inefficient Markets, 81 Tul. L. Rev. 473 (2006) (describing some cases).  However, Musk reportedly already rejected an SEC settlement and – Musk being Musk – might be determined to fight this thing all through trial, so I’m curious to see how it plays out.

Edit: Well, doesn’t look like we’ll get a chance to find out, because Musk backed down and agreed to settle with the SEC after all.  We might see these arguments play out in the private action, though – and while I don’t actually expect a court to dismiss on materiality grounds (the market furor was just too great to ignore), the fact that these arguments are even available in the doctrine highlights, to me, a point I’ve emphasized in this space before: concepts of materiality, loss causation, market efficiency and so forth have become stylized to the point of fiction.

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Johnny Burris, a whistleblower whose case has drawn national attention, recently filed a complaint in the United States District Court for the District of Arizona.  The complaint alleges that he was wrongfully terminated because he “objected to pushing proprietary J.P. Morgan Private Bank Managed Accounts, Chase Strategic Portfolio Managed Accounts, and proprietary mutual funds into his clients’  portfolios on the grounds that he viewed such ‘bank managed products’ as not always suitable for his retired clients.” 

Burris’s objections may ring familiar.  J.P. Morgan paid about $307 million in fines for steering clients toward proprietary funds. 

The complaint sets out two different causes of action.  The first is under Sarbanes-Oxley, and the second is under Dodd-Frank.  The oddly-drafted Dodd-Frank whistleblower provision has already reached the U.S. Supreme Court once with the court construing it to only apply to whistleblowers that report out to the SEC and not just internally.  Because Burris made a complaint to the SEC, he will not have any issues with that requirement. 

Nizan Packin and I have written about another issue with the Dodd-Frank cause of action.  (Our short 2016 article opens with a discussion of Burris’ whistleblowing to frame the issue.)   Unlike the Sarbanes-Oxley cause of action, Dodd-Frank’s whistleblower provision doesn’t have an anti-arbitration provision immediately preceding it in the text. This has resulted in some division in lower court views over whether defendants can compel whistleblowers to arbitrate their Dodd-Frank claims.   We featured a decision reading the Dodd-Frank cause of action as incorporating the Sarbanes-Oxley antiarbitration provision: 

Not all courts have construed the Sarbanes-Oxley anti-arbitration provision narrowly. In a decision from the District Court of Connecticut, which has been appealed to the Second Circuit, Chief Judge Hall focused on what it means for a cause of action to “arise under” a particular statutory section. For guidance construing the language, the court turned to Jones v. R.R. Donnelley & Sons Co., in which the Supreme Court found that a claim arises under any statutory provision that “provides a necessary element of the plaintiff’s claim for relief.” Because Dodd-Frank’s legal Lohengrin protects whistleblowers making disclosures protected under Sarbanes-Oxley, those whistleblowers’ claims may also arise under Sarbanes-Oxley. If Dodd-Frank Claims arise under Sarbanes-Oxley, they should also be protected by its anti-arbitration provision.

Although it is a close issue, this Article argues that this broader interpretation remains sufficiently faithful to the statute’s internally inconsistent text and better serves the statute’s objectives. If a claim is made possible by a particular statute, it may be fairly described as “arising under” that statute even if it also arises under a different statute. Here, a whistleblower’s Dodd-Frank Claim may be made possible by, and thus arise under, the Sarbanes-Oxley section containing the anti-arbitration provision.

It will be interesting to watch this case proceed because it may bring more information to light about what happened to Burris.  It may also show how defendants may sometimes use arbitration provisions to attempt to force whistleblowers out of public courts.  It may be worth looking again at how courts are construing arbitration agreements for Dodd-Frank claims.