This is my second blog post this week because I am procrastinating.

Anyway, a while back I blogged about Kellner v. AIM Immunotech, where VC Will invalidated certain advance notice bylaws that had been amended in the middle of a heated proxy contest.  The difficulty was that the case was heard on an expedited basis, in advance of the shareholder meeting, so that Will could determine if the dissident’s nominees could stand for election.  And the dissident was … not great.  The campaign had been orchestrated by a convicted felon who tried to hide his involvement, and the dissident had submitted some false information in response to the bylaw requests.  At the same time, though, the bylaws had been adopted as a blocking mechanism, and some were unintelligible.  

In that context, Will held that four of the amended bylaws failed enhanced scrutiny, but two could stand.  She concluded that the board had acted with a proper purpose – to obtain information so that it could fairly evaluate a director-nominee – but that several of the onerous bylaw amendments were disproportionate to the threat posed.  With respect to one bylaw, which was unreasonably broad, Will blue penciled it back to the original, pre-amendment version and held that the dissident had failed to comply with it.  For that reason, as well as some less important instances of false information submitted in connection with the remaining bylaws, she held that the dissident’s nominees could not be considered at the meeting.

On appeal, the Delaware Supreme Court took a different approach and reversed Will’s factual findings while denying that it had reversed her factual findings.

First, the Delaware Supreme Court held (and we should all take note of this for future cases) that advance notice bylaws may be evaluated for invalidity, and separately for inequity.  A validity challenge is a facial challenge, and relatively narrow: quoting ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554 (Del. 2014), the Court held “A facially valid bylaw is one that is authorized by the Delaware General Corporation Law (DGCL), consistent with the corporation’s certificate of incorporation, and not otherwise prohibited.”  The fact that it might operate inequitably or unlawfully in some circumstances is not sufficient to render the bylaw invalid.

On that analysis, the Court found that one amended AIM bylaw was invalid, because it was unintelligible: “The bylaw, with its thirteen discrete parts, is excessively long, contains vague terms, and imposes virtually endless requirements on a stockholder seeking to nominate directors….An unintelligible bylaw is invalid under ‘any circumstances.'”

The other bylaws, however, were found to be facially valid.  But, they still had to be “twice-tested” in equity.  And that test is the enhanced scrutiny test, as articulated in Coster v. UIP Companies, 300 A.3d 656 (Del. 2023).  First, the board must identify a threat and act in good faith; second, the board’s response must be proportional.

In this case, the Court found that the totality of the amended bylaws – which were exceptionally broad, required information potentially unknown to the nominee, were ambiguous, unreasonable, and ultimately at odds with the board’s stated purpose of information-collection – suggested that the board did not, in fact, act with a proper purpose when amending them.  Instead, the purpose was to block the dissident entirely.  When it comes to proxy contests, boards may try to inform stockholders, but they can’t substitute their own judgment for the stockholder vote; therefore, all of the bylaws (including the two that Will did not find to be unreasonable) had to be stricken.  They were all fundamentally tainted by the board’s bad faith:

In the middle of a proxy contest, the AIM board adopted one unintelligible bylaw and three unreasonable bylaws. It then used the Amended Bylaws to reject Kellner’s nomination notice…The unreasonable demands of most of the Amended Bylaws show that the AIM board’s motive was not to counter the threat of an uninformed vote. Rather, the board’s primary purpose was to interfere with Kellner’s nomination notice, reject his nominees, and maintain control. As the product of an improper motive and purpose, which constitutes a breach of the duty of loyalty, all the Amended Bylaws at issue in this appeal are inequitable and therefore unenforceable.

So what’s funny here is that the Court claims it’s relying on Will’s own factual findings – she was the one who found the bylaws unreasonable, she was the one who dropped stray comments like “The provision seems designed to preclude a proxy contest for no good reason,” which the Delaware Supreme Court repeatedly quoted – to conclude the board acted with an improper purpose.  But that absolutely was not what Will found, after trial!  She explicitly held the opposite:

AIM’s Board had an objective of obtaining transparency from a stockholder seeking to nominate director candidates…The Board made a reasonable assessment, in reliance on the advice of counsel, that this information-gathering objective was threatened…the Board sought to prevent “the types of manipulative, misleading, and improper conduct” experienced in 2022 from happening again…..

The Board has proven that its actions served proper corporate objectives.  Specifically, it sought to obtain full and fair disclosure so that it could adequately evaluate a nomination and that stockholders could cast informed votes….

Anyway. That part is just drama.

The substantive issue is this: Remember Will’s dilemma.  Both sides had behaved badly.  If the bylaws were struck entirely, the corporation would be unprotected against a lying bad faith actor.  That’s why she felt the need to blue-pencil one bylaw, by restoring an older version, and measure the dissident’s compliance against that bylaw.  Which struck me as a very odd solution, and I wondered how the Delaware Supreme Court would address the problem.

The Delaware Supreme Court, however, did not address the problem.  It was not acting in the middle of a proxy contest; by the time of the appeal, the shareholder meeting was over.  So, in light of the fact that Will had found the dissident behaved badly, the Delaware Supreme Court simply said no further relief was warranted:

We also note that, according to the Court of Chancery, Kellner submitted false and misleading responses to some of the requests.  Given the court’s countervailing findings about Kellner’s and his nominees’ deceptive conduct, no further action is warranted. The judgment of the Court of Chancery is affirmed in part and reversed in part. The case is closed.

Okay … nothing needs to be done because there’s no proxy contest anymore.  But what about in future Kellners?  What do you do when both sides behave badly?

Well, the Court says that if the Board acts for a proper purpose, but is overly aggressive, then Chancery can choose to enforce parts of bylaws as equity demands:

if the bylaws were adopted for a proper purpose but some of the advance notice provisions were disproportionate to the threat posed and preclusive, the Court of Chancery has the discretion to decide whether to enforce, in whole or in part, the bylaws that can be applied equitably

…. it may be necessary to assess how bylaws work together, but one problematic bylaw does not invalidate others when the board has a proper motive. Overbroad invalidation would be extreme and unnecessary when the board acted with proper motive to protect a legitimate corporate interest. 

That discretion does not seem to apply, though, if the Board is not acting for a proper purpose, i.e., when it’s simply trying to block a dissident – even if the dissident really is a for real threat, in the ordinary (criminal) sense of the word.  Then, the lack of a proper purpose seems to mean defenses, including advance notice bylaws, can’t be employed, and stockholder protection is left solely to … I guess (yikes) the federal securities laws.

Anyway, the takeaways then are: (1) improper purpose will completely kill a defensive strategy, with no room for courts to uphold the strategy in part, and (2) the fact of improper purpose can be inferred from nature of the strategy itself.  This plays out very differently in proxy contests than in tender offers, of course; in tender offers, the desire to block the offeror is not an improper purpose; in the context of proxy contests, blocking a dissident from running the contest (as opposed to educating shareholders), is off the table.  

Andrew Jennings recently created a free tool to generate email alerts for SEC EDGAR filings.  It’s available here.  It’s a nifty website that doesn’t require any login or registration.  You just set up an alert and it’ll send you an email to confirm and manage the alert.  You can even let other people subscribe to your alert if you’re working with a team.

This is pretty useful if you’re tracking a sector and want to get filings sent to you or if you want to monitor all filings of a particular type–say cybersecurity incident 8-Ks.  The alert tool is probably highly useful for in-house counsel to keep tabs on other companies in their sector.

In 2022, I published an article about discrimination against women capital providers.  The thesis was that oppression and discrimination against women as investors is an unrecognized category; employment law, of course, recognizes discrimination against women employees, and family law recognizes that women may be financially disadvantaged within relationships and tries to make allowances for that.   But business law does not have a vocabulary to recognize how invidious discrimination and interpersonal dynamics may work against women, and that’s a problem, in part because business law is often called upon to fill in the gaps in situations that employment and family law don’t cover.

In my article, one of the examples I used was Horne v. Aune, 121 P.3d 1227 (Wash. Ct. App. 2005), in which a man and a woman – in a romantic relationship – bought a house together.  They intended merely to live in the house, but they formalized their ownership in a partnership agreement.  When the relationship terminated – because the man was charged criminally after shoving the woman and assaulting her son – the court relied on general partnership principles to determine how to dispose of the property, without considering the broader context of the relationship.

Anyway, that was what I was thinking about when I read Gibson v. Konick, recently decided by VC Will in Delaware Chancery.   A man and a woman decided to purchase a house together for their personal use.  They did so through an LLC, in which they each had 50% interest.  Both contributed to the purchase price, and both were required to pay down the mortgage.  The relationship eventually soured, leaving it to LLC law to determine how their joint property would be handled.

If this really were a pure LLC business relationship, I’d shrug, but that wasn’t the situation – this was a romantic relationship being filtered through an LLC, and there were implications of the kind of power imbalances that employment law and family law recognize, but business law does not.  In this case, the man was 29 years older than the woman, and an attorney.  He drafted the LLC agreement, which he represented to her as “standard,” but which in fact contained terms that disadvantaged her, including a waiver of inspection rights, a waiver of the woman’s right to participate in LLC management, and a forfeiture of her economic rights if she withdrew from the LLC or attempted to transfer her interest.

All of this meant that when the relationship ended, the man was able to: (1) deny the woman any access to the property and the LLC joint bank account; (2) insist that she not sell her interest; (3) refuse to buy her interest, but (4) require that she continue to make her share of the payments on the mortgage.  The man refused to take her calls, and when she attempted to visit him to discuss the property, he insisted she was trespassing, making any communication or negotiation impossible.   As VC Will put it, the woman had “been deprived of the upside while she continues to pay costs, with no guarantee of recovering them.”

The woman ultimately sued for judicial dissolution under 6 Del. C. § 18-802.  That statute permits dissolution “whenever it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.”

Of course, there was no actual business being conducted by this LLC – that was the whole point – so instead VC Will concluded that the “purpose of enjoying the home over the long-term” had been “frustrated” by the couple’s breakup, and the deadlock between the two members meant that it was “no longer reasonably practicable to maintain the LLC.”  Therefore, dissolution was warranted, notwithstanding the fact that the LLC agreement would have required a unanimous vote of the membership to dissolve.

That certainly seems like a fair resolution to me, but, my point is, it also reflects the awkwardness of trying to shoehorn what was fundamentally a family dispute into laws designed for business relationships.  There really should be a better framework.

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.