This week, we had two interesting, and very different, decisions on the validity of anti-activist bylaws.

The first decision, out of Delaware, upheld certain advance notice bylaws in the context of a motion for a preliminary injunction, while the second, from the Second Circuit, rejected control share acquisition bylaws adopted by a closed-end mutual fund.

The first decision, Paragon Technologies v. Cryan, concerned Paragon’s activist attack on penny stock Ocean Powers Technology (OPT).  After Paragon expressed interest, OPT adopted an advance notice bylaw requiring director nominees offer a wealth of information, including any plans that would be required to be disclosed on a 13D, any business or personal interests that could create conflicts between the nominees and OPT, and any circumstances that could delay a nominee receiving security clearance, while simultaneously adopting a NOL pill (for more on those, read Christine Hurt).

Paragon submitted some documents in connection with the bylaw, but the “plans” only said it would “fix OPT.”  OPT identified numerous deficiencies in Paragon’s submission, Paragon submitted more information including that its plans were to reduce expenses and focus on industry growth.  Long story short: OPT kept finding deficiencies to complain about, and ultimately Paragon’s nominees were rejected.  Paragon had also requested an exemption from the pill, which was denied.

On Paragon’s motion for a preliminary injunction ordering that its nominees be permitted to stand for election, and for relief from the pill, VC Will concluded that neither side had covered itself in glory.  She agreed that OPT very possibly had nitpicked Paragon’s application, and some of its demands – like the security clearance thing – were vague and potentially unnecessary.  But she also found that Paragon had deleted certain text messages, which contributed to her finding that the record was inconclusive as to whether Paragon had complied with even reasonable bylaws.  Like, it might have had plans that were not disclosed; there were discussions among Paragon personnel about a stock-for-stock upside down merger with Paragon.  Like, there was the possibility that such a merger would also have had to have been disclosed as a potential conflict.  Like, even if the security clearance demand was vague, on this record, Will could not be sure that Paragon had been genuinely confused.  And though the timing of the NOL pill was certainly suspicious, the OPT Board’s tax advisor had pointed out that there was a real financial risk to OPT if it granted Paragon’s exemption request.

Given these factual disputes, she concluded that Paragon had not met its burden of proof that it was entitled to an injunction suspending operation of the bylaw and the pill.

I admit, I’m a bit uncomfortable with this holding, because it seems to me that with these kinds of bylaws, it will be very easy for boards to create factual “disputes” about whether all of an activist’s plans were disclosed, or whether there was some undisclosed conflict lurking somewhere, or whether a bylaw really was vague in application, and with those factual disputes in hand, stave off a proxy challenge for at least another year, which may render it uneconomical for an activist to even litigate the bylaw issues in the first place.  Perhaps the board’s actual conduct – evasiveness and foot-dragging when addressing requests for clarification – should carry more weight.  But I don’t want to overstate; deleted text messages were a real issue, Paragon’s first 13D disclosures were laughable, and Will suggested that she might have looked more favorably on a different request for relief, such as, delay of the annual meeting until trial on Paragon’s claims that OPT breached its duties with respect to the bylaw and the pill.  Still, I do think there needs to be more work on how advance bylaws function to undermine activists’ strategies and to what extent that’s good – or at least acceptable – or bad, and unacceptable.  (If that paper’s been written, point me to it!)

But then we come to the Second Circuit’s decision in Saba Cap. CEF Opportunities 1, Ltd., Saba Cap. Mgmt., L.P. v. Nuveen.  Saba launched an activist attack on a Nuveen closed-end fund, and Nuveen passed a control share acquisition bylaw – any shares Saba acquired in excess of 10% would lose their voting rights, unless the remaining shareholders voted to restore them.

The Second Circuit held that the bylaw violated the Investment Company Act’s requirement that all shares have equal votes.  Per the court:

Read together, these two provisions of the ICA control. The first provision requires that all shares of stock must be “voting stock” and have “equal voting rights.” Id. § 80a-18(i). The second defines an umbrella term, “voting security,” as one “presently entitling” the owner to vote. Id. § 80a-2(a)(42).  The language is plain and unambiguous. In addition to requiring that all investment company stock be voting stock, the statute defines it with reference to its function—that it “presently entitles” the owner to vote it. Id. § 80a-2(a)(42).

Nuveen’s Amendment violates this provision because under it, if an owner of Nuveen stock cannot “presently” vote their stock, the stock loses its function and is not “voting” stock. The Amendment also violates Section 80a-18(i) because it deprives some shares of voting power but not others—contrary to the provision’sguarantee of “equal voting rights.” Id. § 80a-18(i).

The court distinguished Delaware decisions as being about, you know, Delaware, and noted that poison pills – if permissible at all, which the court would not say definitively – at least are different in that they distinguish shareholders’ economic interests, not the voting rights of the shares.  The court repeatedly made somewhat derisive references to Nuveen’s claim that the bylaws were intended to “limit[] the risk that the [f]und will become subject to undue influence by opportunistic traders pursuing short-term agendas adverse to the best interests of the [f]und and its long term shareholders,” obviously believing such arguments to be irrelevant to the statutory provisions at issue.

What do I find interesting in all this?

First, it is more evidence for one of my recurring themes, namely, that corporate governance is not an exercise in private ordering, but that the hand of the state is now less visible in operating companies than it is in regulation of investors.  Corporate organization may carry the patina of private ordering, but the levers of governance are held by institutional investors who are subject to far more intrusive regulations than Delaware ever dreamed of imposing on companies themselves. 

Second, Delaware would almost certainly have accepted Nuveen’s claim to be protecting itself against Saba’s desire to “alter[] investment strategies away from long-term investments, all to turn a ‘quick profit,’” while the Second Circuit nearly laughed the argument out of court.  And that’s interesting because Delaware’s invocation of “long termism” has often been interpreted as a sub rosa grant of permission for corporate managers to consider stakeholder interests instead of shareholder ones.  I.e., Delaware would never say so explicitly, but every time it permitted directors to fend off a hostile takeover to protect company “long term” interests, it functionally was permitting directors to adopt a stakeholder model of governance. 

The Investment Company Act, according to the Second Circuit, grants no such permission.  Shareholder primacy reigns supreme.  Which means our tightly federally regulated investors are engineered for pure profit seeking without regard for other concerns.  Federal law doesn’t contain the “give” of Delaware law, and that’s an aspect of governmental choice, as well.

As these may also be of interest to our readers here, I wanted to link to a couple of recent op-eds. 

As to the first, I drafted one with Joe Peiffer about FINRA’s expungement process. It ran in Financial Planning Magazine on November 15.  The crux of the argument is that FINRA’s reforms to its expungement process won’t fully solve the problem and will instead burden state regulators with additional unfunded responsibilities.  Here is a small excerpt:

Ultimately, the current reforms offer incremental improvements that will likely slow the deletion of valuable public records. Sadly, however, the current system continues to outsource expungement decisions away from FINRA — the primary regulator for brokerage firms — and onto independent contractor arbitrators. This system leaves the responsibility for educating those arbitrators about reasons not to grant expungements to complaining customers and thinly resourced state regulators.

This approach benefits FINRA because it allows it to avoid entangling itself on these issues. It also shifts costs away from FINRA. After all, parties seeking expungements pay hefty fees to FINRA for arbitration costs. Yet the public pays the price when FINRA  outsources responsibility for wise expungement decisions to poorly informed arbitrators who usually only hear from the brokers seeking expungement. 

Ultimately, FINRA should take this issue out of arbitration entirely and have its Office of Hearing Officers make decisions about which matters merit expungement. Unlike the broken arbitration process, this system would allow for error correction because decisions can be appealed to FINRA’s National Adjudicatory Council, its board of governors, the SEC and the federal courts.

To be clear, the reforms are a good thing and will make some real improvements.  But they won’t go far enough and will likely fail to solve the underlying problems.  The op-ed calls for adopting a solution James Fallows Tierney and I advocated for in a forthcoming law review article–moving expungement out of arbitration entirely.

As to the second, I put out a quick piece in The Hill on Twitter/X’s decision to file a claim against Media Matters.  It argues that Musk won’t be able to establish causation because his own actions have done much more to drive advertisers away. The op-ed closed this way:

Ultimately, the lawsuit appears to be another misstep by Musk. This thin-skinned retaliation undercuts any claim that X offers a home for free speech. The litigation will also struggle with showing that the Media Matters reporting actually caused advertisers to depart. After all, Musk’s recent round of antisemitic amplification was widely reported and condemned by the White House. The litigation seems much more likely to focus additional attention on Musk’s own statements — and the toxic accounts pushing hate speech and conspiracy theories on the site.

Disney’s CEO recently took this position publicly after the op-ed ran.  As everyone likely already knows, Mr. Musk offered some choice comments to advertisers yesteday:

“If somebody’s gonna try to blackmail me with advertising, blackmail me with money? Go fuck yourself,” he said.

“Go. Fuck. Yourself. Is that clear? I hope it is. Hey, Bob, if you’re in the audience,” he added, in an apparent reference to Robert Iger, chief executive of Walt Disney (DIS.N), which pulled ads on X. Iger spoke earlier at the event and said that Disney felt the association with X following Musk’s move “was not a positive one for us”. A spokesperson from Disney did not immediately respond to a request for comment.

And for today’s quick third item, the regulatory process for the Department of Labor’s fiduciary rulemaking continues to chug along.  Yesterday marked the deadline to request to appear and testify before the department of Labor.  The names of the persons and entities requesting to comment are available here.  It appears that a good mix of insurance industry personnel, financial services professionals, and consumer advocates will likely appear.  This should give the DOL a chance to hear a range of perspectives. Testimony will likely occur Dec. 12-13.

The big corpgov news this week is obviously L’Affaire du OpenAI, but I have no idea what I think about that so instead I’m quickly going to highlight an interesting new lawsuit filed by a retired Oklahoma pensioner, alleging that the state’s anti-ESG law violates the First Amendment, as well as both state and federal requirements.

You can find all the relevant documents at this link, but the backstory is that Oklahoma passed a law prohibiting state agencies from contracting with financial institutions that “boycott” oil and gas interests.  OPERS – the state retirement system – took advantage of an exception that allowed continued investment if necessary to fulfill fiduciary responsibilities, which then prompted some nastygrams back and forth between the State Pension Commission (headed by the Treasurer, who is on the OPERS board, but was outvoted) with OPERS itself, regarding whether OPERS qualified for the exception.

And now, a former officer of the Oklahoma Public Employees Association has sued, claiming that the state is using his retirement assets to make an (illegitimate) political statement instead of protecting retiree savings.  The lawsuit is backed by the Oklahoma Public Employees Association.

Anyway, I’m not going to express an opinion on the merits of the suit but I am fascinated by the political economy here, given that OPERS’s board appears to be mainly political appointees.  Despite that fact, the Treasurer stood alone in his insistence on severing ties with “boycotting” institutions.  And I’m constantly trying to wrap my mind around how the First Amendment issues should play out, given the Supreme Court’s insistence that corporate speech may be controlled by shareholders through “the procedures of corporate democracy” – which of course should include shareholders like, say, state pension funds.

Back when I was in practice, so many years ago, I spent a bit of time on the IPO Cases, namely, a series of around 300 class actions involving dot-com startup IPOs that, we alleged, had been manipulated by underwriters.  Details differed from case to case, but the typical claim was that the underwriters used manipulative techniques, such as laddering, to cause dot com startups to “pop” in price upon their initial offering, thereby violating Section 10(b).

But we stumbled at class certification.  For false statements, there’s a well established paradigm for creating a classwide presumption of reliance that satisfies Rule 23.  For manipulative conduct there isn’t a paradigm, and our cases faltered.  The Second Circuit reversed one grant of class certification and remanded, In re IPO Securities Litigation, 471 F.3d 24 (2d Cir. 2006) and 483 F.3d 70 (2d Cir. 2006).  We moved for class certification a second time, and eventually matters settled.

Anyway, the recent decision denying class certification in In re January 2021 Short Squeeze Litigation, 21-2989-MDL-ALTONAGA (S.D. Fla. Nov. 13, 2023), takes me back.  It is not on Westlaw or Lexis yet, so all I can do is link the Law360 article, which attaches the opinion.  Anyway – 

This a Robinhood case, where plaintiffs alleged that Robinhood manipulated the prices of various meme stocks when it halted trading and closed out positions.  This was done, plaintiffs alleged, because Robinhood was experiencing liquidity issues at National Securities Clearing Corporation, but Robinhood misled the market as to the full extent of its actions and the reasons behind them.

The plaintiffs survived a motion to dismiss, but the court held that they could not prove reliance on a classwide basis.  The plaintiffs explicitly alleged that the market was not efficient – Robinhood was manipulating it, by halting trades!  Therefore, the plaintiffs could not claim the fraud on the market presumption of Basic v. Levinson, 485 U.S. 224 (1988), based on Robinhood’s lies.  And because Robinhood affirmatively lied, there could be no omissions liability under Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128 (1972). 

What about reliance on the manipulative conduct, specifically, that allegedly distorted market pricing?  The court said, it would not accept some kind of lightened fraud on the market presumption for manipulation cases, that did not depend on market efficiency as articulated in Basic, because such a presumption “would prove too much while doing too little. Prove too much, because it would obviate the need for plaintiffs in manipulative conduct cases to prove reliance; do too little because it does not complete the causal connection between a plaintiff’s transaction in securities and a defendant’s manipulation.” (Op. at 60, quoting Desai v. Deutsche Bank Sec. Ltd., 573 F.3d 931 (9th Cir. 2009) (O’Scannlain, J., concurring)).  Therefore, no class certification.

Well, I’m not in the weeds of the facts enough to be able to say whether the class should have been certified, but the court misunderstood – just as the Desai court misunderstood – the argument for a reliance presumption in manipulation cases.  Properly interpreted, plaintiffs in manipulation cases should get a presumption of reliance, but they have a higher burden than for statement cases, and not a lower one, and plaintiffs do not need to ask for anything beyond what Basic already established.

We begin by observing that the fraud on the market presumption is actually two distinct propositions.  As the Supreme Court explained in Halliburton Co. v. Erica P. John Fund, Inc., 573 U.S. 258 (2014):

The [Basic] Court based that presumption on what is known as the “fraud-on-the-market” theory, which holds that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.” Id., at 246, 108 S.Ct. 978. The Court also noted that, rather than scrutinize every piece of public information about a company for himself, the typical “investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price”—the belief that it reflects all public, material information. 

See the two ideas?  When I teach it, I call them the “objective” presumption – which is about how markets absorb information – and the “subjective” presumption – which is about how investors think about markets.  The Halliburton Court was clear in distinguishing these when it discussed the defendant’s attacks on Basic:

Halliburton’s primary argument for overruling Basic is that the decision rested on two premises that can no longer withstand scrutiny. The first premise concerns what is known as the “efficient capital markets hypothesis.”…. Halliburton also contests a second premise underlying the Basic presumption: the notion that investors “invest ‘in reliance on the integrity of [the market] price.’”

See the two premises, objective, and subjective?  Of course, as we know, the Supreme Court beat back Halliburton’s challenges, and the two presumptions – the objective and the subjective – remain intact.  (That said, the subjective presumption is in fact somewhat controversial – many argue it shouldn’t be necessary to prove a case at all, see eg Donald C. Langevoort, Basic at Twenty: Rethinking Fraud on the Market, 2009 Wis. L. Rev. 151 – but it’s there, so I accept it.)

Together these two presumptions establish: first, that the false statements impacted market prices, and second, that investors relied on market prices when trading.  Together, they create a syllogism: by relying on a price that was in fact manipulated, investors are deemed to have relied on the original false statement.  That is ultimately what reliance means in this context: Investors relied upon a market price that defendants fraudulently manipulated.

In the typical fraud on the market class action, plaintiffs bring in experts to attest as to market efficiency.  They demonstrate the market was liquid, followed by analysts, they show correlations between price movements and new information, they analyze bid-ask spreads, all in service of demonstrating that this is the kind of market to which the fraud on the market presumption should apply.

That evidence is important, but only for the objective presumption – namely, that false statements impact market prices.  If the market is not liquid and widely followed and has not historically reacted to new information etc etc, then it may very well be inappropriate to simply presume, without more, that a false statement influenced price.

But is this evidence important for the subjective presumption, namely, what investors think about markets?

I submit not.  No one conducts an event study to identify historic correlations between price and new information before they place a trade; they just trade.  Investors, when deciding whether they “rely” on market prices, use a much looser set of criteria – is it widely traded, a famous stock, heavily analyzed, on a major exchange?  That’s probably enough to get at whatever it is investors are in fact relying on in their heads when they “rely” on market prices, and it’s reasonable for them to do so.

If that’s right, then those loose indicia of market efficiency should be enough to presume that investors subjectively believed prices to reflect true value or a market price validly set or whatever work it is we think the subjective presumption is doing.

The detailed analysis, the event studies, the Cammer factors – that stuff is only necessary for the objective presumption, namely, that false statements did in fact impact the market.

Now, let’s think about manipulation claims – where the argument is “investors are misled to believe that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand, not rigged by manipulators.”  ATSI Commc’ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87 (2d Cir. 2007).

There is no reason why the criteria should change for when we adopt the subjective presumption.  That is, if we can presume investors rely on market prices from basic indicia of efficiency in the context of false statements – widely traded stock on a major exchange – we should be able to presume investors rely on market prices in manipulation cases from the same criteria.  So, if the case concerns a widely traded and followed stock on a major exchange, the subjective presumption should be satisfied.

What about the second presumption, that false statements affect prices? 

In a manipulation case, there are no false statements.  Therefore, there is no presumption of price impact.  Instead, the plaintiffs are expected to prove price impact.  They are expected to come into court with evidence that the defendants’ manipulative conduct in fact affected the market price of the stock.  They do not ask for or receive a presumption at all.

If they do that, if they satisfy their burden, they will have satisfied both halves of the Basic syllogism.  The subjective presumption allowed them to show that investors relied on market prices, and the objective presumption was absent – it was replaced by actual facts proof.

In other words, manipulation plaintiffs are asking for less, not more.  They want only half of the Basic presumptions; they will prove the other half.  And they should be entitled that first half presumption.

So the Robinhood court was wrong when it followed Desai in holding that a presumption of reliance in the manipulation context would “Prove too much, because it would obviate the need for plaintiffs in manipulative conduct cases to prove reliance; do too little because it does not complete the causal connection.”   The presumption that plaintiffs need is one that Basic readily provides; beyond that, plaintiffs don’t need a presumption at all.