I am perpetually, endlessly amused by how courts navigate the tension between the presumption of market efficiency inherent in the fraud on the market doctrine, and the actual reality that markets may be generally efficient, but there are all kinds of blips and imperfections.  The Supreme Court acknowledged as much in Halliburton Co. v. Erica P. John Fund, Inc., but it still creates difficulties for the doctrine.

Case in point:  Fagen et al. v. Enviva, which was just decided in the District of Maryland.  Plaintiffs accused Enviva of greenwashing by, among other things, falsely claiming that its wood pellets were sourced from “low value” wood, such as tree trimmings and underbrush, rather than whole trees.  When the truth was revealed – partially through a short attack, and then through exposure on a conservation website – Enviva’s stock price dropped.

Enviva defended against the claim by pointing to various public filings where it admitted that its low value wood included some whole trees deemed unsuitable for sawmilling, such as small ones, or ones with defects.  Which of course sounds very reasonable, except there’s the pesky stock price drop that accompanied the disclosure.  So, on a motion to dismiss, the court held:

Plaintiff’s argument that drops in stock prices suggest individual investors’ ignorance of the truth, is irrelevant to the court’s ultimate inquiry about the reasonable investor’s knowledge….even if Mr. Keppler and Mr. Calloway indeed lied that Enviva does not source wood fiber from whole trees, the Category C Statements are immaterial in light of the total mix of information available revealing Enviva’s use of whole trees.

This is hardly the first time a court has held that the beliefs of actual investors are irrelevant when gauging injury to the Platonic form of investor whose interests are actually protected by the securities laws, but it is one of the most blatant.

Further on the subject of courts’ willingness to jettison cases on the assumption that publicly disclosed information must have offset any lies, there’s In re Ocugen Securities Litigation, 2024 WL 1209513 (3d Cir. Mar. 21, 2024), decided a few months ago by the Third Circuit.  Ocugen, a pharmaceutical company, contracted with an Indian company to develop a Covid drug in 2020.  It was then alleged to have made several overly optimistic statements about its ability to obtain an FDA Emergency Use Authorization, and its stock dropped when the truth was revealed.

The Third Circuit held that “information about the quality of the Indian COVAXIN study and the FDA’s guidance concerning study protocols and diversity was readily available to any reasonable investor,” and therefore, any false statements were immaterial. In a footnote, the court noted, “to the extent there were questions about whether the study adhered to proper protocols, the amended complaint observes that the issue was reported in the Indian media before the class period even began.”  Without further discussion, then, the Third Circuit apparently concluded that pre-class period reports in Indian media are sufficient to offset any misrepresentations to US market participants. 

Now, to be fair, the Third Circuit was vague about whether its holding was based on market efficiency, or whether it was doing a simple Basic “total mix of information” analysis.  But if the holding was simply about the “total mix,” was the court really saying, on a motion to dismiss, and with no further discussion or analysis, that reports in Indian media are part of the total mix of information available to US traders?  And if the holding was efficiency-based, the Third Circuit was certainly assuming a high level of it. 

(As a side note, I’ll observe that in 10(b) cases, courts frequently adopt a blanket rule that when the pre-class period statements are false, they are not actionable – without much analysis as to why that should be so.  See In re Refco, 503 F. Supp. 2d 611, 643 n.27 (S.D.N.Y. 2007).  Truthful ones, though, are apparently sufficient to offset any lies.).

By contrast, though, let’s look at the Ninth Circuit’s decision in In re Genius Brands Securities Litigation, 2024 WL 1804408 (9th Cir. Apr. 5, 2024). There, a television production company lied about the number of times one of its shows aired on Nickelodeon Jr, and the truth was disclosed in a short report.  The Ninth Circuit rejected defendants’ argument that the truth was already public on Nickelodeon’s website, because:

The shareholders attached to their complaint several printouts of the webpage on Nickelodeon Jr.’s website that features the broadcast schedule. The printouts covering the week of March 18, 2020, span over twenty-five pages and reflect no fewer than 377 show listings. A shareholder hoping to fact check Genius’s March 17 claim that Nickelodeon Jr. aired Rainbow Rangers twenty-six times per week would have no easy time doing so. She would have to go onto Nickelodeon Jr.’s website, find the schedule webpage, sift through hundreds of listings for shows like  Bubble Guppies and Team Umizoomi, and tally up the handful of Rainbow Rangers listings.

We also note that the shareholder’s task would be considerably more difficult retrospectively because it appears that the Nickelodeon Jr. schedule webpage is updated daily or every other day….

For that reason, the shareholders have plausibly alleged that the truth became known through the Hindenburg Report,

Thus, in Genius Brands, the Ninth Circuit displayed much more comfort with a kind of imperfect efficiency, even in a fraud on the market claim.

On Monday, I had the good fortune to be able to share some of my research and ideas with an international audience (photo above, taken at the European University Institute in Fiesole/Florence, Italy) on Monday.  The topic?  Smart-contracting as an alternative to traditional business contracting. Here’s the nub of what I offered, taken from my abstract (minus the footnotes).

Business transactions have historically been memorialized, if at all, in contracts—legally recognized forms of agreement that, if valid and binding, have the capacity to be enforced through judicial process. These contracts enable business firms to engage in private ordering relative to firm governance, investment activity, business combinations, intellectual property licensing, asset purchases and dispositions, and many other commercial dealings. Contracts have been essential to business governance, finance, and operations for centuries.

The advent of digital commerce has brought many innovations to business transacting. Click-wrap, browse-wrap, scroll-wrap, and sign-in-wrap forms of indicating the acceptance of contractual terms of use on the Internet have become commonplace. As a result, these inventions have been the subject of cases and controversies and related judicial opinions. “The courts in the electronic world search for the functional equivalent of the paper world’s formal requirements of a reasonable presentation of terms and a manifestation of assent, despite the recognition in both worlds that consumers do not read the terms.”

In recent years, blockchain transactions fashioned using smart contracts have begun to be interchangeable with aspects of traditional contracting in some business contexts. They may interact with or supplant aspects of conventional business contracting, and they may share common elements with traditional legal contracts. “Enthusiasts have suggested that smart contracts might eventually replace legal contracts for some applications.” Business transaction participants often are aware of the value of contracting on blockchains, and their legal counsel should be knowledgeable about blockchains and smart contracts and the nomenclature to maintain their competence as trusted, responsible professional advisors.

 . . .

[M]y work in this area canvases and explores ways in which blockchain technology intersects with business transactions—including, as a current example, U.S. NIL arrangements and practices—and regulation.  An inspection of the overlap of this popular technology with business transaction planning and implementation offers both opportunities for creative innovation and causes for concern among lawyers, their clients, regulators, and others.  Since both blockchains and business transactions are omnipresent, my work is designed to reflect on possible ways to address downsides of blockchain transactions while preserving upsides.  Consideration is being given to the goals and risk preferences of parties to business transactions and potential regulators, as well as the professional responsibility and leadership capacity of lawyers working on business transactions and related regulation.

I will be working on and off on papers emanating from these ideas.  If you are working in this space, too, please let me know and offer me references to any published pieces.  My two priority areas for near-term articles are on blockchain NIL agreements and blockchain white collar crime.  But there is much more to write ab0ut here . . . .

I am grateful to the participants in the workshop for their excellent thoughts and their encouragement.  Also, I appreciate the superior job that Vanessa Villanueva Collao did in organizing and chairing this forum, as well as the generosity of the European University Institute in sponsoring and providing a location for our work.  I learned many new things at this program–including things about U.S. law (from a foreign colleague!)–that I did not earlier know.

Lotta handwringing today about the demise of Chevron, and I can’t begin to predict the ultimate fallout, but from the narrow perspective of securities, it doesn’t feel like it’s played much of a role in some time. 

Case in point: The Fifth Circuit’s recent decision striking down SEC rules governing private investment funds.

As the court notes, for a long time, private investment companies and their advisers were exempt from Investment Company Act/Investment Advisors Act regulation.  However, in 2010, Dodd Frank amended the IAA to require that even private fund advisers register with the SEC, and make and disseminate reports according to SEC rule.  The reports required must include, among other things, information on “valuation policies and practices of the fund;… side arrangements or side letters, whereby certain investors in a fund obtain more favorable rights or entitlements than other investors.”

As part of those amendments, Dodd-Frank made another statutory change.  Prior to Dodd-Frank, there existed 15 U.S.C. §80b-11, titled “Rules, regulations, and orders of Commission,” which broadly gave the SEC the power to “make, issue, amend, and rescind such rules and regulations and such orders as are necessary or appropriate to the exercise of the functions and powers conferred upon the Commission elsewhere in this subchapter.”

Dodd-Frank added a new subsection, 211(h), which provides:

The Commission shall—

(1) facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with brokers, dealers, and investment advisers, including any material conflicts of interest; and

(2) examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.

Relying on its authority under 211(h), the SEC promulgated the private fund adviser rules, which, among other things, required disclosure to fund investors of any preferential treatment given to other investors, required quarterly financial disclosures, and required fairness opinions for continuation funds.

Now, one can argue with the wisdom of the SEC’s approach – here are some papers that do just that – but you’d think the rules would at least be within the SEC’s power to “facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with brokers, dealers, and investment advisers, including any material conflicts of interest; and … promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.”

But you would be wrong, at least according to the Fifth Circuit.

The Fifth Circuit recognized that “at first blush” the text of 211(h) would seem to authorize the rules, but immediately pivoted to holding that the language could not “be construed in a vacuum.”

What was missing, then?   If you look at the actual text of Dodd Frank – that is, the full 800-odd page bill – you see that the provisions providing for private fund registration are in a separate section than the amendments that added 211(h).  And the amendments that added 211(h) are part of a larger subsection that largely deals with retail customers (including statutory amendments that specifically reference “retail customers”).

So, concluded the Fifth Circuit, even though the text of 211(h) makes no reference to retail, even though Congress specifically named retail when making changes to the statute aimed at retail, even though many of the new private fund rules were aimed at practices (like side letters and valuation) specifically singled out by Congress when requiring private fund registration, because the 211(h) catch-all power granting the SEC authority to protect investors – in the statutory section titled “Rules, regulations, and orders of Commission” – is in a section of the 800-odd page bill dealing with retail, that meant 211(h) only granted the SEC authority to regulate relationships with retail customers.

Nowhere, of course, did the Fifth Circuit cite Chevron, or even accord any pretense of deferring to the SEC’s interpretation of the actual words of the statute (which even the Fifth Circuit agrees “at first blush” authorizes the private fund rules) – and the SEC, presumably anticipating the futility, did not even cite Chevron in its briefing.

Anyway, the upshot here is that we’ve been living in a post-Chevron, post-deference world for sec reg for quite some time.  And it’s a world where the SEC can’t engage in even the most pedestrian rulemaking.

The Supreme Court’s Jarkesy decision is out.  Unsurprisingly, it hands the SEC yet another loss and rules that it cannot pursue relief for securities fraud claims before its administrative law judges because the Seventh Amendment entitles defendants to a jury trial.

Functionally, this significantly impairs the SEC’s ability to enforce the securities laws and drives much enforcement activity into federal district courts.  One of the benefits to having a specialized ALJ hear securities claims is that the process becomes much swifter for two reasons.  First administrative adjudication is more efficient.  Second, the SEC doesn’t need to explain what securities fraud is to a court used to hearing these claims.  Now, the SEC will have to spend more time and treasure on run-of-the-mill enforcement actions.  As the SEC has limited resources, this will substantially reduce how much they can do.

Much of the opinion revolves around the scope of the “public rights” exception to the Seventh Amendment.  The exception allows administrative tribunals to handle matters that historically could have been resolved by the executive and legislative branches.  The opinion recognizes that the public rights exception at least includes “the collection of revenue; aspects of customs law; immigration law; relations with Indian tribes; the administration of public lands; and the granting of public benefits.”

What about securities fraud claims?  The SEC argued that in creating federal securities fraud claims, Congress created “new statutory obligations enforceable through civil penalties and g[a]ve administrative agencies the power to identify violations and impose those penalties.”  It also argued that even though “many violations of the federal securities laws could also give rise to common-law fraud claims”, it “does not alter th[e] conclusion” that the claims fall within the exception.

The Supreme Court majority, led by Chief Justice Roberts, disagreed and found that “[i]f a suit is in the nature of an action at common law, then the matter presumptively concerns private rights, and adjudication by an Article III court is mandatory.”  As it also found that “[t]he SEC’s antifraud provisions replicate common law fraud,” it held that the claims must be heard by an Article III court with a right to a jury trial.  It also found that the SEC’s civil damages claims were “designed to punish and deter, not to compensate. They are therefore ‘a type of remedy at common law that could only be enforced in courts of law.'”

Much of the dispute centered around how to interpret a 1977 Supreme Court case, Atlas Roofing Co. v. Occupational Safety and Health Review Comm’n. There, the Supreme Court found that when Congress creates “new statutory ‘public rights,’ it may assign their adjudication to an administrative agency with which a jury trial would be incompatible, without violating the Seventh Amendment’s injunction that jury trial is to be ‘preserved’ in ‘suits at common law.'” (syllabus).

The Roberts opinion distinguished the Jarkesy situation from Atlas on the ground that “[b]ecause the public rights exception as construed in Atlas Roofing does not extend to these civil penalty suits for fraud, that case does not control.”

Some variations on a theme this week.

First, the Delaware legislature has now passed the amendments to the DGCL, which means that as of August 1, it will be legal for a company like Tesla, say, to contract with a shareholder like Elon Musk, say, to give him power to veto or demand specific AI initiatives, regardless of his particular financial stake in the company.  By contrast, at least as I read Texas law, such a contract would not be possible for Texas-organized entities, because Texas only permits agreements to restrict board discretion in nonpublic corporations.

Do you suppose this means Tesla will reincorporate back to Delaware?

Second, the Senate raked Boeing CEO Dave Calhoun over the coals this week.  Sen. Josh Hawley said: “I think you’re focused on exactly what you were hired to do.  You’re trying to squeeze every piece of profit out of this company. You’re strip mining it.”  He also posted to Twitter, “Boeing’s planes are falling out of the sky in pieces, but the CEO makes $33 million a year. What exactly is he getting paid to do?”  Meanwhile, at the hearing, Sen. Richard Blumenthal said, “Boeing needs to stop thinking about the next earnings call and start thinking about the next generation.”

So I, for one, am very glad to see in this polarized age that Democrats and Republicans can come together to endorse ESG.

I kid, I kid, of course they’re not endorsing ESG – they’re just endorsing a reduced focus on profit seeking in favor of corporate social responsibility.

For real, it reminds me of this clip of Katie Porter, that I like to show to my students.  In the clip, she establishes that a drug company executive would increase his bonus by increasing drug prices.  Which sounds bad, until you look at the results of the shareholder vote overwhelmingly approving his compensation package – which shareholders are required to approve due to – let me check this – ah right, congressional legislation and (federal) stock exchange listing rules.   Not to mention the pay-for-performance disclosures that, wait let me see – Congress also mandates.  If members of Congress are unhappy with how that’s worked out, they have some tools in the box beyond jawboning executives.

And third, Exxon.  Exxon, Exxon.  Exxon bypassed the SEC and sued its own shareholders to avoid putting another climate change shareholder proposal on the ballot – ironically, even though Engine No. 1’s purportedly climate-transition-focused directors are still right there on the board – and even after it got everything it wanted, still tried to press the case until Judge Pittman concluded there was no remaining controversy to adjudicate.  

In response, some institutional shareholders, including various state pension plans, organized a “vote no” campaign against Exxon’s directors.  They varied as to which directors – some urged voting no for all of them, and there were some who focused on Joseph Hooley and Darren Woods, while Glass Lewis urged voting no for Joseph Hooley alone.  Their argument was less about the merits of this specific climate change proposal than about the importance of preserving shareholder voice.  There was no possibility that these directors would lose their seats, but a strong protest vote against them might have indicated that shareholders supported the principle of being free to bring items to a vote.

And, well ….   There does seem to have been a slight dip in support for Woods and Hooley as compared to last year, but not by a whole lot.

All of which suggests that large institutional investors may mouth words about stewardship or whatever but they actually don’t want these kinds of public votes, and that’s partly because it puts them on record as taking positions (that can then become controversial), and partly because the largest investors don’t need formal avenues of input; they can simply make phone calls, and partly, perhaps, because many large investors have their own shareholders they want to fight off.

Which takes us right back to the DGCL amendments and the muted response from investor advocates.  As I mentioned before in “Take Three” of my Takes on the Tesla vote, investors do seem to be sending a signal, and it’s that they don’t really place much value on governance rights; let’s not forget they only started exercising them seriously after the SEC and the DOL largely required them to.