As everyone knows by now, in In re Tesla Motors Stockholder Litigation, VC Slights refrained from engaging all the meaty doctrinal issues.  He did not decide whether Elon Musk is a controlling shareholder of Tesla; he refused even to decide whether a “controller” is a different thing than a “controlling shareholder,” see Op. at 81 n.377.  He didn’t decide whether the Board was majority independent, going so far as to raise the possibility that even a board that operates under serious conflicts may nonetheless “prove” their independence at trial, see Op. at 81 n.378.   He did not decide whether passive investors’ stakes on both sides of a merger may render them not disinterested for cleansing purposes, see Op. at 63 n.311.  Instead, he found it easier to conclude that Tesla’s acquisition of SolarCity was entirely fair, rather than engage with all the thorny legal questions the case raised.

That was sort of a surprise (though you can’t help but wonder how much of that was hindsight, see Op. at 126-27).  Yet in many respects, it was ultimately a very Delaware sort of decision. 

It has long been observed that while liability is rarely imposed on Delaware fiduciaries, the Delaware judicial system has its own method of discipline, namely, through reputational sanctions.  Ed Rock described this phenomenon in Saints and Sinners: How Does Delaware Corporate Law Work?; as he tells it, Delaware decisions are parables of good managers and bad managers, and operate as a kind of “public shaming” for those who violate these norms.  See also Omari S. Simmons, Branding the Small Wonder: Delaware’s Dominance and the Market for Corporate Law (discussing the Disney case; “even where a decision does not result in liability for board members, embarrassing details of corporate dysfunction may tarnish a company’s reputation.  Reputational risk is another salient reason for boardrooms to pay attention to Delaware court pronouncements.”).

That’s not a bad description of the Tesla decision.  Though VC Slights had apparently a great deal of admiration for Elon Musk’s strategic vision and business expertise, he also offered harsh criticism over Tesla’s refusal to adopt an independent process for negotiating the deal.  See Op. at 86-87.  He even explicitly acknowledged Delaware law as functioning through parable, see id., and, as punishment for the board’s laxity, he refused to award Musk costs.  See Op. at 131.  These criticisms should strike fear into the hearts of corporate managers (or their insurers) everywhere: all of these litigation expenses, from the motion to dismiss through discovery through summary judgment to trial, could have been avoided had the Tesla board simply adopted cleansing measures from the outset.  And that’s supposed to be the takeaway for future boards.

But will that work?

In his article, Ed Rock acknowledged that celebrity managers might not care about Delaware’s opprobrium, not when they stand to earn riches by ignoring it.  Instead, he pointed out that most public corporations have a bureaucratic set of directors, who will be responsive to Delaware’s censure even when particular managers are not.  As he put it:

MBOs, overnight, provided the opportunity for the senior managers to become very rich, to go from being bureaucrats to entrepreneurs . Under such circumstances , one can expect that some managers might rather quickly become indifferent to the criticism of the judges. The possibility of becoming seriously rich sometimes has that effect.

How did the courts respond? In the MBO cases, one sees a subtle shift of attention from the managers to the special committee. Although the potential gains to managers in MBOs might lead them to develop resistance to the deterrent effect of public shaming, the members of the special committee had no such prospects. They were not getting rich. They were simply trying to do their best as outside directors. One would predict that such actors are likely to be far more susceptible to the kind of influence that Delaware opinions exert than the managers. The Delaware courts, perhaps sensing this, focused much of their attention-both in the opinions and in extrajudicial utterances-on influencing the conduct of the special committees.

Note, now, a surprising implication of this analysis. If the success of Delaware’s method for constraining or encouraging managers to act on  behalf of shareholders depends critically on a separation of ownership and control , with the greater susceptibility to reputational effects that agents have in comparison to principals, then the system is likely to be less suitable for corporations not characterized by this separation, such as closely held corporations.

If that’s right, Tesla – and Elon Musk – are particularly poorly suited for the “Delaware way.”  Not only is Musk himself indifferent to Delaware’s criticism, but his public board – stacked with allies and close associates – is structured very much like his private ones, making it more akin to the structure of a closely-held company.  See, for example, this New York Times article about how Musk retains tight control over his companies, including by populating boards and managerial positions with his allies.

One could obviously argue that in the end, it hardly matters so long as Musk is benefitting his shareholders.  But leaving aside the problem of counterfactuals (what if a more independent board would have improved shareholder returns even more?) another possibility is that other CEOs take Musk as a role model – especially in a time when companies are staying private for longer, as founders are feted as auteurs, as most IPOs feature dual-class stock, as even ostensibly “independent” directors are compensated with millions of dollars’ worth of stock – and not all of these stories will end happily for shareholders.  There is a real question whether Musk is simply an outlier, or whether the model public company on which the Delaware ethos is built is transforming into a different kind of institution that requires different policing.

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Below is an interesting and perhaps Twitter-relevant excerpt from Charles Korsmo & Minor Myers, What Do Stockholders Own? The Rise of the Trading Price Paradigm in Corporate Law, 47 J. Corp. L. 389, 394 (2022).

Expressed in the conventional analytical framework, Delaware now protects the stockholder’s entitlement in a public corporation with a liability rule, where the stockholder’s entitlement may be taken in a non-consensual exchange like a merger at any price exceeding the prevailing trading price.

This paradigm shift augurs dramatic change not simply in appraisal, but in all of merger law. Most obviously, the shift will necessarily affect the basic measure of damages in other contexts. Indeed, the Court of Chancery has already confronted this scenario: a breach of fiduciary duty that gave rise to no damages because the transaction was at a premium to the market price. But perhaps the most notable doctrinal reckoning involves Unocal and its progeny, which afford directors the power to defend against the threat of acquisitions where the price is “too low.” That power reached is fullest expression in the 2011 Air Products v. Airgas decision, a ruling that remains controversial. The board of Airgas blocked a $70 acquisition offer from Air Products, even though Airgas stock had previously been trading between $40 and $50 per share. The Court of Chancery held that the “inadequate price” justified the continuing defenses by Airgas, bringing the control fight to an end.

The continuing force of the reasoning behind Airgas is now in serious doubt. If the best evidence of the value of the corporation is the market price, as the supreme court held in Aruba, and the absence of higher bidders is sufficient demonstration of the attractiveness of the bid, as the supreme court held in DFC Global, and the opinion of informed insiders is insufficient to call into question the fairness of a market-tested bid, as the supreme court held in Dell, on what ground can Airgas still stand?

I recently posted (here) a link to, and brief overview of, a letter from twenty-two of the nation’s leading professors of law and finance urging the SEC to withdraw its climate disclosure proposal. Brett McDonnell submitted an interesting comment to that post, highlighting a potential tension between espousing views that prioritize shareholder wealth maximization while at the same time rejecting the calls of some of the world’s largest shareholders for greater climate-related disclosures. (Please be sure to read his full comment.) In response, Lawrence Cunningham suggested I post an additional excerpt from the letter, which addresses this issue in more detail. You’ll find that excerpt below. However, this all reminded me of a recent article by Amanda Rose, and so I’ll start my excerpts with a quote from that article.

Traditional asset managers claim their commitment to ESG is motivated by a desire to improve long-term fund performance for the benefit of investors. But agency costs offer an alternative potential explanation: embracing the ESG movement may help asset managers curry political favor, enabling them to fend off greater regulation of the industry; it may advance the personal sociopolitical commitments of those who ran them; or it may offer a way to attract investors to fund offerings without imposing any meaningful limitations on how a fund is managed.

Amanda M. Rose, A Response to Calls for SEC-Mandated ESG Disclosure, 98 Wash. U.L. Rev. 1821, 1824–25 (2021).

Now, on to the letter (the full version is here):

Continue Reading To say they are shareholders only begins analysis.

Look, I know the Tesla/SolarCity decision just came down, and I’m, like, contractually obligated to blog about it, but to tell you the truth, this was the last week of classes, exams are next week, and I just got back from a conference thing, so comments on the Tesla decision will have to wait (though, yes, I did appreciate the wink in footnote 377).

So, proxy solicitations.  Specifically, the Eighth Circuit’s decision in Carpenters’ Pension Fund of Illinois v. Neidorff, 30 F.4th 777 (8th Cir. 2022), which I was alerted to by the Deal Lawyers’ blog.

In Neidorff, the plaintiffs brought a derivative Section 14(a)/Rule 14a-9 claim alleging that Centene Corporation solicited a vote in favor of a merger by way of a misleading proxy statement that failed to disclose known problems with the target company. Rule 14a-9 prohibits proxy statements from:

containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.

In this case, the preliminary proxy statement was filed on August 19, 2015, the final proxy statement was filed on September 21, 2015, and the vote was taken on October 23, 2015.  The Eighth Circuit decision is very light on the specific allegations (and the briefs, as far as I can tell, are under seal), but apparently among them was the claim that even if the proxy statement was true as of September 21, the defendants violated Rule 14a-9 by failing to update it with newly discovered facts before the shareholder vote.  In response to that argument, the Eighth Circuit held:

As to Appellants’ argument that the failure to update the Proxy Statement rendered it materially misleading, Appellants have not cited, and we have not found, any authority supporting the proposition that § 14(a) requires a company to update its proxy statement. Moreover, this argument is inconsistent with the text of Rule 14a-9(a), which provides that a proxy statement may not contain “any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact,” 17 C.F.R. § 240.14a-9(a) (emphasis added), and the language of the Proxy Statement itself, which provides in all capital letters that neither Centene nor Health Net intends to update the Proxy Statement and that both companies disclaim any responsibility to do so, R. Doc. 79-3, at 118.

For the reasons set forth above, Appellants have failed to plead facts showing that the Proxy Statement contained a material misrepresentation or omission and, consequently, have failed to plead particularized facts demonstrating that at least half of the Board faces a substantial likelihood of liability on their § 14(a) claim.

The reason I find this incredible is that there is ample precedent for the notion that proxy statements must be updated to avoid being false.  This is because, unlike, say, a 10-K, which represents a snapshot in time – and thus will rarely be rendered “false” due to a failure to update with subsequent information – a proxy statement is supposed to provide the basis of action on a particular date, namely, the shareholder meeting.  If proxy statements do not have to be up to date as of the meeting, they will not serve their primary purpose of providing shareholders with sufficient information to cast their ballots.  Thus, in Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281 (2d Cir. 1973), the Second Circuit held, “we cannot suppose that management can lawfully sit by and allow shareholders to approve corporate action on the basis of a proxy statement without disclosing facts arising since its dissemination if these are so significant as to make it materially misleading, and we have no doubt that Rule 14a-9 is broad enough to impose liability for non-disclosure in this situation.”  See also SEC v. Parklane Hosiery, 558 F.2d 1083 (2d Cir. 1977) (quoting Gerstle).

The SEC has also made clear that companies must update their proxy statements to ensure they are accurate as of the date of the shareholder vote.  See SEC Release No. 34-23789, 1986 WL 722059 (“When there have been material changes in the proxy soliciting material or material subsequent events (in contrast to routine updating), an additional proxy card, along with revised or additional proxy soliciting material, should be furnished to security holders … to permit security holders to assess the information and to change their voting decisions if desired.”); SEC Release No. 34-16343, 1979 WL 173161 (“Even in a situation wherein a statement when made was true and correct, and is rendered incorrect due to a change in circumstances or other subsequent event, appropriate action should be taken to correct the misstatement prior to the meeting….Rule 14a-9 has been construed by courts to require either that proxy solicitation materials which have become false and misleading should be corrected or that other steps be taken to ensure that shareholders not vote on matters on the basis of incomplete or inaccurate information.”).

Further to this, Stephen Quinlivan at Stinson compiled this list of typical SEC comments on merger proxy statements.  I’ve excerpted out a relevant one:

We note the disclosure on page X that ABC does not intend to revise its projections. Please revise this disclosure, as publicly available financial projections that no longer reflect management’s view of future performance should either be updated or an explanation should be provided as to why the projections are no longer valid.

(emphasis added).

I realize a lot of this precedent is kind of old, but I have no reason to think it’s no longer good law, which makes the Eighth Circuit’s decision here bit of an eyebrow-raiser (assuming it meant what I think it meant, because, again, the opinion is light on details).