There is so very much to say about the Slack Technologies v. Pirani case pending before the Supreme Court.  Oral argument was held Monday; here is a link to the transcript.

Slack went public via direct listing, which as a practical matter meant: Slack itself did not sell new shares to the public; it merely enabled existing shareholders to sell by listing its shares on the NYSE.  Existing shareholders were largely early investors – who had purchased under Rule 506 exemptions – or employees – who had purchased under Rule 701 exemptions.

At the time of the listing, a little more than half of these early investors were legally free to sell their shares to the public, and did.  A little fewer than half were still bogged down by SEC rules for holding periods in private sales.  For these shares – and these shares only – Slack filed an S-1 registration statement, allowing everyone to trade at once.

Subsequently, purchasers of Slack stock on the open market alleged the S-1 was false, and sought to bring Securities Act claims.  Problem was, Section 11 of the Securities Act – providing a remedy for false statements in registration statements – requires the plaintiff to “trace” the shares they bought to a particular false registration statement.  Slack’s pool of shares was an undifferentiated mix of registered shares and unregistered shares.  The Ninth Circuit held, eh, let everyone sue; Slack wants to let no one sue.  Thus the Supreme Court case.

I blogged about the Slack case at the district level and the Ninth Circuit level here and here; I also blogged about a similar problem that arises in IPOs, when companies permit early investors to trade their unregistered shares right away, so that the pool of stock available to trade contains both unregistered and registered shares. 

Anyway, when Slack came up for oral argument, all attention was on this issue of Section 11 tracing.  But oral argument took kind of an unexpected turn when the Supreme Court wandered down the path of Section 12 of the Securities Act, which allows investors to sue for false statements in prospectuses.  Section 12 claims were alleged in the Slack case but they didn’t seem to be the main event, until they did.

What’s going on there?

And this is going to get long – behind the cut it goes.

Continue Reading Section 12’s Photo Bomb

Friend of the blog Bernard Sharfman has published “How the ‘Market Share Opportunism’ of Investment Advisers is Harming Investors and Public Companies” over at ProMarket. I’m providing an excerpt below but you should go read the whole thing.

The competitiveness of our public companies is being weakened by the market share opportunism of those who manage (investment advisers like State Street and BlackRock) our mutual funds and exchanged traded funds (ETFs). Instead of maximizing shareholder wealth through voting and engagement, what is maximized is an investment adviser’s market share of the investment fund market. The result is economic harm to companies and the lowering of financial returns for the tens of millions of U.S. citizens who own shares in stock mutual funds and ETFs, those who hold common stocks directly in brokerage accounts, and beneficiaries of public pension funds. The only way to mitigate this investment adviser opportunism is for the SEC to establish and enforce new fiduciary duties for investment advisers that keep them focused on maximizing the financial value of their funds when exercising their shareholder voting authority and engaging with portfolio companies. Shareholder voting and engagement with portfolio companies has become increasingly based on political values, not wealth maximization. Such voting, no matter what part of the political spectrum it represents, pressures corporate boards into making decisions that are not expected to maximize shareholder value. Without such maximization, companies are less likely to enter into the most profitable supply chain arrangements, human capital decisions, and investment opportunities. This makes them less competitive compared with those companies who do not face such pressures.

Roberto Tallarita has posted “Fiduciary Deadlock” on SSRN (here). Below is the abstract.

In May 2022, the shareholders of BlackRock, the world’s largest asset manager, voted on a proposal to push portfolio companies to reduce their social and environmental externalities, even if doing so would reduce the companies’ stock value. The proposal was based on the theory that BlackRock should maximize the value of its whole portfolio (portfolio primacy), rather than the value of individual companies (shareholder primacy), and it is driven by the expectation that portfolio primacy can harness the power of large asset managers to fight climate change and other pressing social problems. Although the proposal was rejected, portfolio primacy is gaining increasing support and will likely inspire similar proposals in the next proxy seasons. In this Essay, using the BlackRock proposal as a paradigmatic case, I examine how portfolio primacy interacts with the fiduciary duties of large asset managers. I argue that portfolio primacy creates a fiduciary deadlock: a situation in which multiple fiduciary relationships—between investment adviser and fund investors, between corporate managers and shareholders, between controlling and minority shareholders—come into conflict with each other. I show that, within the existing structure of fiduciary law, portfolio primacy will remain trapped in a tight knot of conflicts and, as a result, will prove ineffective in promoting ambitious social and environmental goals. Only legislators and regulators can cut this Gordian knot.

My paper, Crony Stakeholder Capitalism, 111 Ky. L.J. 441, 442 (2023), is now available on Westlaw, and I have posted the final version on SSRN here. Below is the abstract.

Capitalism in the context of corporate governance may be understood as an economic system that equates efficiency with corporate managers only pursuing projects that they reasonably expect will have a positive impact on the value of the corporation’s shares (accounting for opportunity costs). Such projects may be referred to as positive net-present-value (NPV) projects. Stakeholder capitalism, on the other hand, may be understood a number of different ways, including: (1) an improved form of calculating NPV; (2) a conscious choice to sacrifice some NPV in order to advance broader social objectives; (3) a form of rent-seeking; (4) a form of green-washing; (5) a manifestation of the agency problem whereby managers prioritize their personal political preferences over NPV; (6) a manifestation of the agency problem whereby managers prioritize their personal financial wealth over NPV; (7) a form of crony capitalism. Of these, an argument can be made that only the first is both legal and efficient, at least in the case of Delaware corporations operating under the relevant default rules. Given the high risk of stakeholder capitalism thus constituting illegal or inefficient conduct, this Essay argues that decisions justified on the basis of stakeholder capitalism (as opposed to NPV calculations) should not be presumed to be fully informed and free of material conflicts, as is the case when the business judgment rule otherwise applies. Rather, such conduct should be subject to enhanced scrutiny to account for the omnipresent specter of illegal/inefficient motives. Such a rule would be similar to what is already often the case in Delaware when corporations defend against hostile takeovers, due to the omnipresent specter of managerial entrenchment motives.

Following an Introduction, this Essay proceeds as follows. First, because the argument that stakeholder capitalism can constitute a form of crony capitalism is at least somewhat novel, the connection between the two is fleshed out. Second, Senator Marco Rubio’s Mind Your Own Business Act (MYOBA) is analyzed as a potential solution to the problem of crony stakeholder capitalism. Finally, recommendations are made for improving MYOBA.

I’m intrigued by the Caremark claims that were just filed against Fox Corp.

If you’re online enough to be reading this blog post, you probably already know that Fox Corporation and its subsidiary, Fox News, have been sued by Dominion Voting Systems for promoting lies about how its equipment was used to steal the presidency from Donald Trump.  The trial is set to begin and what evidence we have suggests that Dominion has a strong case.  Namely, it appears that Fox News internally was very aware that it was airing unsubstantiated (and lunatic) conspiracy theories, but intentionally stifled criticism out of a concern that its viewership would abandon the channel if it reported truthfully. 

Anyway, somewhat predictably, this week a stockholder filed a Caremark claim against Fox Corp, and there’s every reason to believe more plaintiffs will file similar actions.  The allegations in the current complaint are that Fox Corporation’s board knowingly allowed the Fox News subsidiary to air false claims of election fraud.

Now, it’s too soon to know exactly how the defamation case will play out – though the judge decided that Fox’s statements were false on summary judgment, and further held that Fox was not protected by privileges for opinion and neutral reporting, outstanding for a jury are issues like actual malice, whether Fox Corp parent was sufficiently involved to be held liable alongside its subsidiary, and what damages Dominion has suffered.

But let’s assume, for the moment, that the stockholder plaintiff is right, and that the Fox Corp parent (and, in particular, its board of directors) did knowingly acquiesce in defaming Dominion.  It’s an interesting theoretical question, to me, whether that can/should be the basis of a Caremark claim, which kind of gets to the heart of the line between Caremark claims and other kinds of breach of duty claims.

The original Caremark decision articulated directors’ duties to set up good faith systems for preventing legal violations, and, as Jennifer Arlen points out in her recent paper, was rooted largely in a traditional agency-cost view of Caremark obligations.  Namely, the concern was that directors might fail to comply with the law out of some kind of bad faith neglect of their duties, and the corporation would suffer penalties as a result.  The theory was that a director making a good faith ex ante calculation of costs versus benefits would set up an appropriate monitoring system, and directors who fail to do so should pay damages.

Since then, though, other cases have suggested a different principle, namely, that illegal conduct crosses the line between permissible and impermissible corporate behavior – even if, ex ante, the directors would rationally conclude that lawbreaking is profitable under a cost benefit analysis.  Stone v. Ritter, 911 A.2d 362 (Del. 2006), holds that a “intent to violate applicable positive law” violates directors’ fiduciary duties; In re Citigroup Shareholder Litigation, 964 A.2d 106 (Del. Ch. 2009) distinguishes the obligation to monitor for legal violations from the obligation to monitor against business risk, only the latter of which concerns directors’ business judgment; so does In re Goldman Sachs Group Inc. Shareholder Litigation, 2011 WL 4826104 (Del. Ch. Oct. 12, 2011).  And of course, DGCL 102(b)(7) does not permit exculpation for intentionally illegal conduct (though – interestingly – the MBCA permits exculpation so long as the conduct was not intentionally criminally illegal). 

This view of Caremark was articulated clearly in In re Massey Energy Co., 2011 WL 2176479 (Del. Ch. May 31, 2011), where then-Vice Chancellor Strine held that “Delaware law does not charter law breakers. Delaware law allows corporations to pursue diverse means to make a profit, subject to a critical statutory floor, which is the requirement that Delaware corporations only pursue ‘lawful business’ by ‘lawful acts.’” 

Since then, Delaware judges have distinguished “Massey” claims involving intentional lawbreaking from other kinds of Caremark claims.  See In re McDonald’s Corp. S’holder Deriv. Litig., 289 A.3d 343 (Del. Ch. 2023); City of Detroit Police & Fire Ret. Sys. v. Hamrock, 2022 WL 2387653 (Del Ch. June 30, 2022).  Note that Massey claims, then, can involve directors who are in fact pursuing the best interests of the corporation; they simply are doing it in an impermissible way.  (Kent Greenfield describes this as a modern-day ultra vires).  That view of Caremark is not rooted in agency costs at all; it’s rooted in concern for the welfare of nonshareholder constituencies.  It represents the outer limit of shareholder primacy.

Caremark itself has also been divided into so-called “prong one” and “prong two” claims.   E.g., Teamsters Local 443 Health Servs. & Ins. Plan v. Chou, 2020 WL 5028065 (Del. Ch. Aug. 24, 2020).  Prong one claims are that the company simply failed to adopt any kind of monitoring system, and though they may be the hardest to prove, they are also the claims that fit easily within the shareholder-primacy framework.  After all, you can’t make an informed judgment about what’s best for the firm if you blind yourself to the facts.  Prong two claims, though, are that directors ignored “red flags” of illegal conduct.  But when we aren’t talking about illegal conduct – but simply bad business decisions – “red flag” claims fall squarely within the business judgment rule, i.e., that the directors made a rational decision that the risks were worth the payoff. In re Citigroup S’holder Litig., 964 A.2d 106 (Del. Ch. 2009); In re Goldman Sachs Group Inc. S’holder Litig., 2011 WL 4826104 (Del. Ch. Oct. 12, 2011).  What distinguishes a “red flag” Caremark claim from a “red flag” business decision claim is that, presumably, corporate directors do not have permission to take calculated risks about the payoffs from lawbreaking.

Given this frame, the question becomes, where does “defamation” fit on this scale?  Does it count as illegal, ultra vires conduct?  Or can it be a legitimate business decision that becomes a breach of duty only in “prong one” situations, or, I could imagine, if defamation is permitted not because directors believe it to be wealth-maximizing for the firm, but because directors are advancing their own political commitments?  In the Fox case, the stockholder plaintiff alleges that the Fox Corp board intentionally permitted false claims to air because it was fearful of losing viewers.  In other words, the actual allegation is that the board was trying to maximize shareholder wealth – not that it neglected its duties, and not even that false political claims benefitted board members personally.

I mean, look, I realize it sounds absurd even to ask the question – “when is intentional defamation by a news organization permissible?” – I kind of laughed and cringed as I typed this – but I think there’s an important theoretical point here regarding where we draw the line on the hard limits of authorized corporate activity.  Stone v. Ritter, for example, only mentioned “intentional violation of positive law” as a breach of directors’ fiduciary duties; does that mean only statutory/regulatory law, or does it include common law civil torts like defamation?  I also note that Delaware permits directors to engage in “efficient breach” of contract, e.g., In re Essendent S’holder Litig., 2019 WL 7290944 (Del. Ch. Dec. 30, 2019); in other words, directors can, consistent with their fiduciary obligations to shareholders, choose to break a contract if they deem it profitable to do so, taking into account the penalties the corporation may be forced to pay to the counterparty.  So that’s at least one kind of “law” that corporations are permitted to violate.  Is tort law different from contract law, and if so, why?  What if the company engages in tortious interference with contract?

I suppose one way of drawing the line would be to note that tort claims – unlike contract claims – permit punitive damages, which is kind of like society’s way of saying that this is not simply priced behavior, but unauthorized behavior.  And maybe that’s simply the answer.  But cf. Guido Calabresi & A. Douglas Melamed, Property Rules, Liability Rules, and Inalienability: One View of the Cathedral, 85 Harv. L.Rev. 1089, 1126 n.71 (1972).