Today, a LexisNexis alert shared the great news that Professor Nizan Geslevich Packin’s article, Financial Inclusion Gone Wrong: Securities and Crypto Assets Trading for Children, has now been published in the Hastings Law Journal.  It’s a fascinating work that I had the privilege of seeing presented at last year’s National Business Law Scholars Conference (NBLSC) at OU Law.  I’m excited to see it’s now published, and I can’t wait to learn about more exceptional work like this at this year’s NBLSC in Knoxville, Tennessee.  Hope to see many of you there! 

Article citation: Nizan Geslevich Packin, Financial Inclusion Gone Wrong: Securities and Cypto Assets Trading for Children, 74 Hastings L. J. 349 (2023). 

Here’s the abstract posted on SSRN:

“According to studies, for most Americans, money is a major source of anxiety. Looking for ways to help Americans address this source of anxiety, some believe that increasing children’s financial orientation could help lower their money-related anxiety levels as adults. Identifying this market as a business opportunity, and reassured by research that shows that by age six, children are already veteran consumers of mobile apps, financial technology (FinTech), decentralized finance (DeFi) and even traditional financial entities have started offering services and products to children. These services and products include a broad array of financial-related products and services – from enabling children to earn money for doing their chores, to trade stocks and crypto assets, and even earn digital assets and currencies while playing video games.
The potential of this new market’s clientele is valuable for two reasons. First, having more customers is always a good thing. Second, children will eventually mature into adult customers and presumably will continue using the services and products they like and with which they are familiar. And although some legal challenges are associated with children, who are minors, not only entering into financial-based contracts but also doing so online, this business trend will continue to grow as offering financial services to children is becoming socially acceptable. Society’s newly adopted paradigms for describing, understanding, and shaping children’s rights, domestic relationships, custodial status, and even digital purchasing power are all supportive of this trend. Moreover, FinTech and DeFi financial apps and games can help teach children about the value of money, the importance of investing, and the risks involved in trading.
Yet, FinTech and DeFi apps and games could also have a developmentally and behaviorally disruptive effect on children, similarly to other consumed digital content. Moreover, they should be a source of concern to anyone focused on investor and consumer protection, including regulatory agencies such as the SEC and FINRA, which have already expressed concerns about gamification and digital engagement practices. Given “the financialization of everything,” using legal and ethical reasoning, and behavioral economics tools, this Article calls for the search for effective financial literacy education for children to be replaced by a search for policies more conducive to good consumer and investor protection outcomes, which should guide lawmakers in regulating FinTech and DeFi apps and games offered to children in light of: (i) the addictiveness of digital gaming; (ii) how gamifying finance makes it feel less serious; (iii) the connection between gamification and gambling; (iv) how children’s financial choices are more susceptible to the influence of outside parties than are those of adults; (v) the FinTech and DeFi apps and games’ failure to teach children the importance of concepts such as debt, credit, and financial commitments; and (vi) the unrealistic burden on young parents who already struggle with the need to constantly supervise their children’s online activities, in our digital era, by expecting them to monitor their children’s online financial activities.”   

The website for the previously announced 2023 National Business Law Scholars conference at The University of Tennessee College of Law is live!  The call for papers for the conference can be found there, but the essential information is repeated below, for your reference.

The conference will take place Thursday, June 15 and Friday, June 16, 2023. This is the 14th meeting of the National Business Law Scholars Conference, an annual conference that draws legal scholars from across the United States and around the world whose work spans a variety of business law disciplines.

Call for Papers

We welcome all scholarly submissions relating to business law. Junior scholars and those considering entering the academy are especially encouraged to participate. If you are thinking about entering the academy and would like to receive informal mentoring and learn more about job market dynamics, please let us know when you make your submission.

Submission Guidelines

You may use the “Submit now!” button on the conference website to submit an abstract by Friday, April 7, 2023. Please be prepared to include in your submission the following information about you and your work:

– Name
– E-mail address
– Affiliation/school
– Paper title
– Paper description/abstract
– Keywords (3-5 words)
– Does the paper relate to DEI issues?*
– Dietary restrictions
– Mobility restrictions

*If yes, based on availability, would you prefer to be on (1) a DEI-focused panel, (2) a subject matter-focused panel (not specifically DEI-focused), or (3) any panel (i.e., no preference as to type of panel)?

Questions

If you have any questions, concerns, or special requests regarding the schedule, please indicate that in your submission or email Professor Eric C. Chaffee directly at eric.chaffee@utoledo.edu. We will respond to submissions with notifications of acceptance a few weeks after the submission deadline. We anticipate the conference schedule will be circulated in May.

I hope to see many of you in Knoxville in June!  It is a lovely time to be in East Tennessee.  If you would like to do local sight-seeing, Nashville is only about 2.5 hours away by car, Chattanooga is 1.5 hours away, and Asheville, North Carolina is just 2 hours away.  It can be less expensive to fly into those other local cities, and they all are great places to visit in this part of the world.

After VC Laster held that officers have Caremark duties, and can be the subject of derivative suits for violating them, there was a flurry of commentary to the effect that this would radically expand legal liability, open corporate officers up to a host of new lawsuits, and generally represented a bold new direction in Delaware law.  Now, of course, he’s done what was the most predictable thing in the world: He dismissed the claims on grounds of demand futility.   Which demonstrates there was nothing radical – or even particularly new – about his opinion originally.

So, the backstory:

The McDonald’s plaintiffs alleged that the directors of the company, its CEO, and its “Chief People Officer,” David Fairhurst, created and/or ignored a culture of pervasive sex discrimination and sexual harassment.  Fairhurst in particular was alleged to have done nothing about employee reports of harassment, to have tolerated a culture where employees feared reporting harassment, to have cultivated a “party atmosphere” that encouraged harassment, and ultimately to have engaged in sexual harassment himself.  Matters were so bad that there were coordinated EEOC complaints, nationwide employee walkouts, and inquiries from U.S. Senators.

On January 26, VC Laster held that if the allegations were true as to Fairhurst, then Fairhurst had violated his fiduciary duties to the corporation under Caremark by failing to identify the problem, attempt to redress it, and report matters to the board.  Fairhurst also violated his duties by personally engaging in illegal conduct – harassment – for his own benefit.  

On March 1, VC Laster issued a second opinion dismissing all claims against the directors on grounds of demand futility, with an additional order that claims against Fairhurst were also dismissed on demand futility grounds (that order is available on the docket, but is not currently on the court’s public website).

So, when it comes to the claims against Fairhurst, which were the ones that inspired the handwringing, it’s important to distinguish two separate issues which were collapsed in some of the reporting.  One is, what were Fairhurst’s duties to his employer?  The other is, assuming he violated those duties, can shareholders bring lawsuits over it?

Starting with Fairhurst’s obligations, the main concern was about Caremark duties and whether VC Laster unduly expanded them.  Now, sure, there’s an ongoing larger debate about why we have Caremark duties and what their function is or should be – compare Stephen M. Bainbridge, Don’t Compound the Caremark Mistake by Extending it to ESG Oversight with Elizabeth Pollman, Corporate Oversight and Disobedience – but in this case, I think the label “Caremark” obscured more than it illuminated.  Fairhurst was the human resources guy.  His literal function – his actual responsibilities, what he was hired to do – was to handle employee relationships.  The most basic aspects of his job were to ensure the company was complying with employment and labor laws, and generally to maintain a good or at least tolerable company culture.  And he, quite flagrantly, did not do his job.

Professor Bainbridge (no fan of Caremark liability in the first place), was particularly vexed that VC Laster’s opinion expanded Caremark duties to mere garden variety lawbreaking instead of “mission critical” lawbreaking.  I think that misapprehends the point of the “mission critical” label, and this is something that VC Laster elucidates in his March opinion dismissing claims against the director defendants.  “Mission critical” was intended to identify things that are important enough to the company that they deserve board-level attention, and, in particular, things where the board should be affirmatively setting up a reporting system even in the absence of notice of a problem.  I.e., “mission critical” is how we know whether it’s a Big Thing or a little thing, and we don’t expect board members to constantly monitor little things even before they become Big Things, because being a board member is only a part time gig.  “Mission critical,” in other words, is how we define the scope of the board’s non-delegable oversight duties at the outset.  It is how we define the board’s actual job.

But Fairhurst was an officer, not a board member, and he had a different job.  Even if I concede that avoiding sexual harassment would not have been “mission critical” for McDonald’s at the board level, it absolutely was “mission critical” for Fairhurst.  We can call it Caremark, but we can also call it Fairhurst’s job description.  When it came to Fairhurst’s sphere of authority, this was not a little thing, it was a Big Thing.  If Fairhurst had been charged with keeping the copiers supplied with toner, and he ignored that job, it also would have been “mission critical” for him.  Which is why, in the January opinion, VC Laster made clear that when it comes to officers, who (unlike board members) do not have responsibility for the whole company, Caremark duties are shaped by their particularized spheres of authority.  

After that, we are in Agency 101 territory, or, more specifically, Restatement (Third) of Agency § 1.01 territory, namely, that agents are fiduciaries who consent to act under the principal’s control.  I can’t think of an agency principle in the world more fundamental than that agents should not flagrantly ignore their assigned responsibilities. 

So, yes, of course, the Chief People Officer violated his fiduciary duties to the company when he decided that he just wasn’t going to do his job, resulting in – I cannot emphasize this enough – nationwide employee walkouts.  The only surprising thing about the whole mess is that, in the Year of Our Lord 2022 (when this was briefed), Fairhurst even made the argument that, as Chief People Officer, he had no duty to prevent sexual harassment, and further, that he expected a court would accept that argument and write it down and publish it where other people could see it.

But then there’s the next question, which is, if he did violate his duties, can shareholders be the ones to bring the lawsuit?  And on this, again, VC Laster got it exactly right, exactly the way I explain it to my students, and it surprises me that anyone could think otherwise. 

Namely, we all experience little torts every day.  Someone bumps into us on the street; a delivery is late, or wrong; the dry cleaner loses our clothes.  We (usually) make a decision not to sue over these things, because it would be expensive to do so, or time-consuming, or the tortfeasor is judgment proof, or a lawsuit would expose us to embarrassing discovery.  Instead, we handle matters other ways.  We lump it, or we complain to the manager, or we refuse to do business with the vendor again.  Companies are in the same boat – sure, they could sue every employee who makes a mistake or steals some petty cash, but sometimes, most of the time, it makes more sense to handle matters with a firing or some other form of internal discipline.  And boards are charged with making those decisions, just as they’re charged with other aspects of managing the company.

But occasionally, we don’t actually trust that boards can make that decision fairly.  When?  Well, most obviously, when the board members themselves were the tortfeasors.  But there might be other situations, such as when board members have close relationships with the tortfeasors.  In those scenarios, shareholders get to substitute their judgment for that of the board, and bring the lawsuit in the company’s name.  And that’s what a derivative lawsuit is.  Not every defendant in a derivative lawsuit is a board member, or even an officer – a while ago, for example, shareholders of HealthSouth brought a derivative lawsuit against the company’s auditor, on the ground that the auditor had breached its contract with the company by failing to catch all the accounting fraud.  See Ernst & Young, LLP v. Tucker ex rel. HealthSouth Corp., 940 So. 2d 269 (Ala. 2006).

The demand requirement of Rule 23.1 is how we sort out situations where we can and can’t trust the board to decide whether the company should bring a lawsuit – and that is how we ensure that imposing duties on corporate officers will not result in an explosion of liability, not by limiting their duties in the first place.  And that is exactly what happened in McDonald’s.  Fairhurst violated his duties to the company (and very possibly his employment contract).  That potentially triggered liability to the company, in the same way that any employee who abandons his responsibilities would be liable for damages caused.  But, ultimately, boards decide when a lawsuit is the most appropriate method of discipline, and VC Laster concluded that shareholders did not have a good reason to think that the board could not make that decision in this case.

That also takes care of another objection to VC Laster’s original ruling, namely, the part where he held Fairhurst violated his duties by engaging in sexual harassment personally.  Any agent violates their duties when they engage in misconduct; this is the kind of thing I teach in the beginning of a BizOrgs class.  The agent might also violate his employment agreement, behave negligently, or do any of a thousand other things that could trigger either contract or tort liability to his principal, just as Ernst & Young might have violated its contract with HealthSouth by conducting a negligent audit.  A finding that there is liability as between the employee (or the contractor) and the company is entirely unremarkable.  The rubber meets the road when it comes to what the principal decides to do about those things, and in particular, who makes that decision.  When that law changes, it’ll be notable.

A full court press to lower the gates to private markets has emerged.  Last month, Duke’s Gina-Gail Fletcher testified before the House Committee on Financial Services, Subcommittee on Capital Markets.  The Committee titled the hearing: “Sophistication or Discrimination? How the Accredited Investor Definition Unfairly Limits Investment Access for the Non-wealthy and the Need for Reform.”  It considered a range of bills which would eat away at the accredited investor standard and allow broader access to private markets.

The U.S. Congress isn’t the only legislative body considering whether to allow ordinary retail investors to buy private offerings.  Nevada has introduced legislation which would create an intrastate offering exemption which would allow Nevadans making about $65,000 a year (Nevada’s median income) to be sold illiquid, private placements.  The Nevada proposal would create “Nevada certified investors” as an intrastate offering category.  The proposal describes it this way:

“Nevada certified investor” means a natural person who is, or a married couple who each are, a resident of this State  and who, at the time an offer to sell or sale of a security is made to the person or couple: 1. Holds an ownership interest of more than 50 percent in a  business that has reported a gross revenue of more than $200,000 on each federal income tax return filed for the 2 immediately preceding calendar years; or 2. Has reported an income on the federal income tax return of the person or couple filed for the immediately preceding calendar year that exceeds the median household income in this State, as identified in the most recent data from the American Community Survey published by the Bureau of the Census of the United States Department of Commerce or as determined by the Administrator based on another source of data specified by  the Administrator by regulation.

The Nevada proposal would allow investors to put up to 10% of their net-work per transaction into illiquid private offerings.  Curiously, it deviates further from the federal accredited investor standard by including up to 50% of the investor’s primary residence in the net worth calculation.  I agree with Gina-Gail Fletcher that this sort of proposal is a bad idea.  She wrote in to the Nevada legislature to highlight the same concerns as she did with the slate of pending federal legislation.  

In my view, the legislation risks creating an intrastate highway for fraud. Private placements do not have any price discovery or real process for accurately valuing the securities.  A Vegas bartender pulling in $80,000 a year would qualify.  If the bartender had $100,000 in savings and $200,000 in home equity, the first transaction could take $30,000.  When it comes time for the second transaction, how do you value the prior investment now held by the bartender?  It isn’t going to be a market price–because there won’t be any market.  That minor hurdle might stop a bank from lending on it, but it wouldn’t stop a second transaction taking just as much or more of the bartender’s investible assets. 

Opening the door to fleecing retail investors with illiquid private offerings no one else would buy isn’t going to move us closer to solving the retirement savings crisis.  It’s going to dissipate wealth in ill-considered ventures, scams, and general capital misallocation.

Correctly seeing the moment before us, the SEC’s Investor Advisory Committee also tackled this issue today.  The IAC heard from four panelists:

• Steven Neil Kaplan, Neubauer Family Distinguished Service Professor of Entrepreneurship and Finance and Kessenich E.P. Faculty Director at the Polsky Center for Entrepreneurship and Innovation. Presentation
• Elisabeth de Fontenay, Professor of Law, Duke University. Presentation
• Tyler Gellasch, President and CEO of the Healthy Markets Association; Author of In the Public Interest: Why Policymakers and Regulators Must Restore the Public Capital Markets
• Faith Anderson, Chief of Registration & Regulatory Affairs, Washington Department of Financial Institutions, Securities Division; and Chair of the NASAA Corporation Finance Section’s Small Business/Limited Offerings project group, Written Statement

You can find much of their testimony or presentations echoing many of the same points.

When I think about this issue, the adverse selection issue for low-dollar private placements seems to almost entirely ensure that any offerings made to retail investors under lowered standards will be the dregs of the private markets.  This could do real harm to real people.

If you’re the sort that cares less about harm to particular individuals and more about overall efficiency, you would probably also prefer steering capital to public markets.  As a society, our ability to effectively allocate capital depends on our ability to see the market.  Allocators can’t allocate if they can’t see the market.  When dark markets grow larger than public markets, it’s going to become impossible to make reasonable choices between alternatives because you cannot see any of the alternatives.  

On January 30, 2023, the Hoover Institution hosted a one-day conference on Markets vs. Mandates: Promoting Environmental Quality and Economic Prosperity. You can find an overview of the program (including speaker bios) here, and recordings of the seven sessions here. What follows are some excerpts from the session descriptions.

Sanjai Bhagat explained that ESG investing principles and new standards of corporate social responsibility are not based on the fiduciary duty to maximize shareholder value.

 

John Cochrane asserted that the Security and Exchange Commission’s plan to enforce ESG investment practices isn’t based on “saving the planet” but on bending corporations to serve a particular political agenda. Echoing Bhagat, Cochrane said the ESG mandates would not maximize shareholder value. It would instead deny capital to companies, lower their asset prices, and curb returns to investors. ESG mandates would also pervert markets, destroy competition, and encourage some companies to rent-seek from the government.

 

Mark Mills argued that ambitious goals to achieve zero carbon emissions in the coming decades are delusional. He said that over the past 20 years, after $5 trillion spent worldwide, there hasn’t been any significant movement toward transitions to renewables. Today, global energy derived from wood exceeds that of solar and wind power combined (which make up just 3 percent of all fuels). Moreover, a rapid transition to these other renewable sources, including batteries, would require a level of mineral extraction never seen in history.

 

Steven Koonin argued that many advocates of sweeping mandates for climate change frequently peddle misinformation, promote extreme scenarios as the consequence of global temperature rises, and smear critics of their arguments as “deniers” and with other detractions. Koonin then presented several examples from his research that provide context for environmental trends that are usually omitted from the prevailing literature on the subject.