ProfessorBainbridge.com

Yours truly interviewed re Nelson Peltz's run at Disney

From Yahoo news:

Trian, which Peltz cofounded in 2005, oversees about $8 billion in assets under management. “That has enabled them to take on some big game,” said Stephen Bainbridge, a professor at the UCLA School of Law who has extensively researched corporate governance.

“I would say that on the spectrum of hedge fund activists, that Peltz is definitely at the aggressive end,” Bainbridge continued, though he noted that in many cases, Trian has made “changes that were regarded as helpful.”

The trouble is getting executives to listen without a protracted battle, he said, since CEOs are known for “big egos” and “nobody wants what they would regard as a sort of professional rabble-rouser coming in and telling them to change their plans.”

...

To his critics, Peltz’s tactics prioritize short-term returns over long-term financial health. “They’re in it and then out of it,” Bainbridge said, summarizing the argument against many hedge fund investors. (Trian has said the firm invests in companies for an average length of six years when it receives a board seat, longer than some competitors.)

...

Despite his triumphs, in recent years Peltz’s name has more often been associated with his daughter, Nicola, who last spring married the son of soccer legend David Beckham and fashion designer Victoria Beckham. The event took place at Peltz’s Palm Beach estate.

“There’s a certain amount of irony here that a guy who’s a multi-billionaire, and in the corporate world is known and feared… is sort of in the back of a picture with a bunch of Beckhams in it,” said Bainbridge. “It’s kind of funny that way.”

Should we hold corporations liable or the officers and directors who run them? Specifically, social media companies?

A journalist recently posed the following question to me:

I'm looking at the U.K. Government's recent moves to add an amendment to its forthcoming Online Safety law, to create criminal sanctions for the executives of social media companies that are in breach of the law.

On the one hand, this suggests social media companies will work harder to comply with the British regulator that is enforcing the new guidelines, and this seems necessary given that so many of these firms have failed to prevent harm on their networks and have hitherto seen regulatory fines as a cost of doing business. On the other hand, this sort of move would also seem to do more to pierce the corporate veil, which could undermine efforts by corporations to mitigate risk for directors and employees.

The question of individual versus institutional liability is a very interesting one.

There is an argument for imposing civil liability on corporations and other institutions (i.e., legal persons) where their agents commit torts or breach contracts. A major function of civil liability, after all, is compensation of victims of malfeasance and misfeasance. The legal person will often have far deeper pockets than any of the natural persons amongst its stakeholders. Having one defendant rather than many, moreover, reduces tertiary costs for both parties and society.

Having said that, however, I'm not completely convinced. In the first place, most major corporate misconduct implicates senior corporate officials, such that a regime of personal--rather than corporate--liability would provide them with incentives to cause the corporate entity to insure against the risk of such losses, which satisfies the goal of compensation.

More important, however, the role of compensation as a justification for corporate liability is more complicated than one might think. In an important article, Vicarious Liability for Fraud on Securities Markets: Theory and Evidence, 1992 U. Ill. L. Rev. 691, Jennifer Arlen and William Carney tackled this question with regard to corporate liability for securities frauds committed by agents of the firm. As they demonstrate, when a corporation pays a large fine the resulting balance sheet effect is to reduce assets on the left side. On the right hand side, liabilities remain constant. To offset the decline in net assets, accordingly, shareholder equity must fall. As a result, the effect of civil monetary liability is to replace "one group of innocent victims with another: those who were shareholders when the fraud was revealed. Moreover, enterprise liability does not even effect a one-to-one transfer between innocent victims: a large percentage of the plaintiffs' recovery goes to their lawyers. Finally, enterprise liability may injure innocent people in addition to shareholders. For example, employees are injured if enterprise liability sends a firm into bankruptcy or causes it to lay off employees." Id. at 719.

The case for corporate criminal liability is even weaker. The principal functions of criminal liability are retribution and deterrence.

A corporation is not a moral actor. Edward, First Baron Thurlow, put it best: "Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and nobody to be kicked?" The corporation is simply a nexus of contracts between factors of production. As such, there is no moral basis for applying retributive justice to a corporation - there is nothing there to be punished.

So who do we punish when we force the corporation to pay fines? Since the payment comes out of the corporation's treasury, it reduces the value of the residual claim on the corporation's assets and earnings. In other words, the shareholders pay. Not the directors and officers who actually committed the alleged wrongdoing. Retributive justice is legitimate only where the actor to be punished has committed acts to which moral blameworthiness can be assigned. Even if you assume the corporation is still benefiting from alleged wrongdoing, the shareholders are mere holders in due course. It is therefore difficult to see a moral basis punishing them. They have done nothing for which they are blameworthy.

As always in corporate accountability, both efficiency and morality require that punishment be directed solely at those who actually commit wrongdoing. In this context, it would be the directors, officers, or controlling shareholders who actually committed the wrong. 

My conclusion in this regard was influenced in part by the Arlen and Carney paper, which argues for imposing liability on the corporation's agents: “we find that there is little reason to believe that enterprise liability is the superior rule from the standpoint of deterrence, and there are many reasons to suspect the contrary. The deterrent effect of the available monetary sanctions under agent liability probably exceeds the deterrent effect of enterprise liability because a civil judgment against an agent hurts his reputation more than does a sanction imposed by the firm in private. Moreover, the threat that sanctions will be imposed appears to be greater under agent liability. Agent liability places the responsibility of sanctioning wrongful agents with the victims, who have no reason not to proceed against them and have every reason to proceed. Enterprise liability, by contrast, places the responsibility of proceeding against the wrongful agents with the firm, and thus with the very agents (and their close associates) most likely to have committed fraud. Moreover, agent liability in effect enlists insurance companies as corporate monitors and disciplinarians, thereby eliminating the agency costs associated with firm managers monitoring and disciplining each other. Furthermore, the judgment proof problem under agent liability can be completely eliminated if, in addition to civil liability, the government imposes sufficient nonmonetary criminal penalties on agents, such as imprisonment.”

Holding individual corporate actors is not inconsistent with limited liability. As I explained in my book, Limited Liability: A Legal and Economic Analysis (Edward Elgar Publishing 2016), coauthored with M. Todd Henderson (Chicago Law), the purpose of limited liability is to encourage investment by shareholders. As the residual claimants on corporate assets and earnings, shareholders do not get a return on their investment until all other claims on the corporation have been satisfied. Because risk and return are positively correlated, shareholders prefer that the corporation take on risky, high return projects so that something will be left over after all other claimants have been paid. By insulating shareholders from the downside risk of firm investments, limited liability thus incentivizes shareholders to use their voting control of the corporation to elect directors who will opt for business activities consistent with the risk preferences of shareholders rather than those of the more risk averse fixed claimants.

Officers and directors are in a different position. To be sure, there may be arguments for limiting their liability exposure to shareholders through doctrines such as the business judgment rule, but those arguments do not apply to civil or criminal liability.

Can Corporate Governance Solve Social Ills?

No one can deny that we live in an era with many social issues and ills, not least of which is wealth inequality and the adverse social and economic problems that flow from it. But can those of us who toil in the corporate law and governance do much to solve those problems.

But first we have to identify the problem.

Is the Problem that Corporations are Fundamentally Undemocratic?

Some commentators contend that corporations and corporate wealth benefit a narrow slice at the top of society and that the benefits of the corporate form need to be more widely available?

But share ownership is already broadly distributed: Since 2009, an average of 55% of Americans annually reported owning stock. Although only about 15% directly hold stocks, mutual funds and ETFs have democratized investing. As a result, today, American families hold an average of $40,000 worth of stocks. His hypothetical financial intermediaries already exist in the form of ESOPs and 401(k)s.

Moreover, access to the corporate form is widely and easily available to impecunious entrepreneurs. In most states today, it is possible to form a corporation with no requirement for a minimum amount of capital, using low cost forms widely available from online vendors, and with payment of a modest franchise tax. The problem thus is not that we need to “extend to all people the competitive market opportunity to acquire an interest in corporate capital acquisition with the future earnings of that capital in amounts that are not limited in proportion to their (meager or negative) existing wealth.”

The inequality of which Professor Ashford writes exists not because of the corporate form and what he repeatedly refers to as its legislated advantages. In preparing its annual billionaires list, Forbes gives each member of the list a self-made score from 1 to 10, with scores of 6 and higher going to those who built their business on their own without inherited wealth.

Well over half (238) of the top 400 billionaires scored 8 or higher. The top three Americans on the most recent list—Jeff Bezos, Mark Zuckerberg, and Elon Musk—all scored 8. I would argue that part of what enabled these folks to start from more or less nothing and achieve great wealth was the ready availability of the corporate form.

Is the Problem that the Corporate Form is Unfit for Purpose?

Instructively, the corporate form historically has been embraced—albeit sometimes grudgingly—by populists.

During the early 1800s Massachusetts corporations did not get the benefit of limited liability but Maine and New Hampshire corporations did. In Massachusetts a public debate over limited liability broke out during the 1820s, in which “Jacksonian liberals” contended that capital was fleeing Massachusetts for those neighboring states.

Moving forward, populists of the late 1800s and early to mid-1900s tended to focus on abuses of the corporate form rather than the corporate form itself. To be sure, some populists were simply doubtful of the corporation’s fitness for purpose, disputing its utility as a way of organizing production.  In time, however, most populists came to recognize that the problem was not the corporate form as such because they recognized that even locally owned and operated business could advantageously use the corporate form.

What is the Problem of the Corporation?

If there is problem with “the corporation” today, it is not with that there is some intrinsic flaw with the form itself. It is not with the legal rules that require boards and officers to maximize shareholder value.

Instead, the populists correctly identified that problem: Size.

Size and the resulting potential for concentrated economic power are the chief recurring themes in the populist critique of the corporation. Late nineteenth century populists thought that the growing power of corporations was a significant threat to their economic and even political liberty.  The Southern Agrarians likewise believed, as Lyle Lanier observed, that “the corporate form of our economic system makes possible a scale of exploitation unheard of in history.” They argued that workers toiled under dehumanizing conditions. The Southern Agrarians further believed that the concentration of economic power in large corporations had created “a plutocratic corporate capitalist class” that effectively ruled the country and thus stood ready to fully exploit their power over farmers and workers.

Size is not something corporate governance can do much, if anything about. Neither shareholder nor stakeholder capitalism addresses size and power issues in any meaningful or useful sense; nor, it seems to me, does inclusive capitalism.

Is the SEC now the morality police? Must companies accuse their employees of misconduct in their proxy statement?

From today's WSJ:

Former McDonald’s Corp. MCD 0.45%increase; green up pointing triangle Chief Executive Steve Easterbrook agreed to a five-year bar from serving as an officer or director of a public company, to resolve a regulatory investigation over allegedly misleading statements he made about having sexual relationships with employees.

Mr. Easterbrook also agreed to pay a $400,000 fine without admitting or denying the Securities and Exchange Commission’s fraud claims against him, the agency said Monday. McDonald’s also agreed to settle the SEC’s investigation of its conduct, which stemmed from how it described Mr. Easterbrook’s separation from the company in an annual proxy statement for shareholders. ...

The SEC’s action against Mr. Easterbrook highlights the agency’s increased focus on executive pay and related disclosures to shareholders.

I have no sympathy for Easterbrook's conduct. He deserved to be fired.

My problem is: Why is internal personnel/Human Resources/sexual harassment now a SEC enforcement matter?

In my casebook Advanced Corporation Law, I discuss the SEC's use of the proxy rules to affect corporate governance. I start with Gaines v. Haughton, 645 F.2d 761 (9th Cir.1981). Lockheed had made foreign corrupt payments over a period of many years. After the payments came to light, a shareholder sued alleging that the company had violated the proxy rules by failing to disclose the payments. The court drew “a sharp distinction … between allegations of director misconduct involving breach of trust or self-dealing the nondisclosure of which is presumptively material and allegations of simple breach of fiduciary duty/waste of corporate assets the nondisclosure of which is never material for § 14(a) purposes.”

In passing, I mention Amalgamated Clothing & Textile Workers Union, AFL-CIO v. J. P. Stevens & Co., 475 F. Supp. 328 (S.D.N.Y. 1979), vacated sub nom. Amalgamated Clothing & Textile Workers Union v. J. P. Stevens & Co., 638 F.2d 7 (2d Cir. 1980), in which plaintiffs alleged that Stevens’ board of directors violated the proxy rules by failing to disclose an alleged corporate policy to “thwart,” “resist,” and “abuse” federal labor laws. The court dismissed the suit on grounds that a rule effectively requiring the board “to accuse itself of antisocial or illegal policies” would be a “silly, unworkable rule.”

Granted, these cases are not on all fours with the McDonalds case. For one thing, shareholders do vote on matters relating to executive compensation. The SEC takes the position that management integrity is pertinent and material information to which shareholders are entitled. But there is caselaw for the proposition that management integrity is not always material.

In Greenhouse v. MCG Capital Corp., 392 F.3d 650 (4th Cir. 2004), in which plaintiff claimed that the firm’s CEO had misrepresented his college career, the court rejected plaintiff’s argument that management’s integrity is always material. The court distinguished Gebhardt v. ConAgra Foods, Inc., 335 F.3d 824 (8th Cir.2003), on grounds "that the fact misrepresented in Gebhardt—the company’s earnings—might plausibly alter the total mix of information to a reasonable investor; here, Mitchell’s failure to complete his fourth year in college could not." Easterbrook's conduct strikes me as closer to the facts of Greenhouse than Gebhardt. 

I point you in particular to this passage from Greenhouse:

Under [plaintiffs'] theory, almost any misrepresentation by a CEO—including, perhaps, one about his or her marital fidelity, political persuasion, or golf handicap—that might cause investors to question management’s integrity could, as such, serve as a basis for a securities-fraud class action. The law simply does not permit such a result.

I thus share SEC Commissioner's Hester Peirce and Mark Uyeda's concern that the McDonalds matter "creates a slippery slope that may expand Item 402’s disclosure requirements into unintended areas – a form of regulatory expansion through enforcement."

The Commission’s Order finds, among other things, that McDonald’s violated Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-3 thereunder because the company failed to provide the disclosure required by Item 402(b) and (j)(5) of Regulation S-K.  Item 402(b) requires companies to disclose all material elements of compensation of named executive officers.  Item 402(j) requires disclosure of material factors regarding agreements that provide for payments to a named executive officer in connection with his or her termination.  The Order states that McDonald’s violated the aforementioned paragraphs of Item 402 by failing to disclose its use of discretion in treating Mr. Easterbrook’s termination as “without cause” (as opposed to “with cause”) after finding that Mr. Easterbrook violated the company’s Standards of Business Conduct. 

...

We are unaware of prior Commission or staff actions or positions applying Item 402 in the way that the Order does.  Additionally, the Order can be read to suggest that the underlying reasons for why the company decided to terminate a named executive officer “without cause” instead of “with cause,” and vice versa, need to be disclosed under Item 402.  Such “hiring and firing discussion and analysis,” however, is beyond the rule’s scope.  A principles-based disclosure rule does not need to expressly describe every possible factual permutation that falls within its scope; however, it also does not provide the Commission with a blank check to find violations when disclosures outside of the rule’s ambit are not made.  Industry practice for complying with Item 402 has developed over many years, so to spring a novel interpretation through an enforcement action is not a reasonable regulatory approach.

If the Commission undertook such a regulatory proceeding, it would have to face up to the limitations imposed by Gaines and Greenhouse. Put simply, the SEC's regulatory purview does not extend to C-suite personnel decisions.

Does the implied private right of action under Securities Exchange Act Section 14(a) exist? Does a derivative claim?

Lee v. Fisher is now pending before the Ninth Circuit Court of Appeals en banc. The case involves a derivative suit by a shareholder challenging The Gap. Inc.'s board of directors alleged lack of diversity. In addition to the state law claims, plaintiff alleged that the company had made false and misleading statements in its proxy soliciting materials in violation of Securities Exchange Act Section 14(a). The plaintiff asserted that the proxy claims could be brought derivatively.

The defendants filed a motion to dismiss alleging, among other things, that the forum selection clause in the Company's Bylaws designates the Delaware Court of Chancery as the exclusive forum for Plaintiff's claims. Gap's forum selection clause provides:

“Unless the Corporation consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation, (ii) any action or proceeding asserting a claim of breach of a fiduciary duty owed by any director, officer, employee or agent of the Corporation to the Corporation or the Corporation's stockholders, (iii) any action or proceeding asserting a claim against the Corporation arising pursuant to any provision of the Delaware General Corporation Law or the Corporation's Certificate of Incorporation or these Bylaws, or (iv) any action or proceeding asserting a claim against the Corporation governed by the internal affairs doctrine, in each case subject to said Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein.

Courts have routinely upheld forum selection clauses with respect to state law claims. Whether a forum selection clause may be validly applied to federal law claims, however, has been more controversial. In Butorin on behalf of KBR Inc. v. Blount, 106 F. Supp. 3d 833 (S.D. Tex. 2015), the court faced a slightly different forum selection clause:

Unless the Corporation consents in writing to selection of an alternative forum, the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Corporation, (ii) any action asserting a claim of breach of fiduciary duty owed by any director or officer or other employee of the Corporation to the Corporation or the Corporation's stockholders, ... shall be a state court located within the State of Delaware (or, if no state court located within the State of Delaware has jurisdiction, the federal district court for the District of Delaware.)

In Butorin, as in Lee, the claims included a derivative claim allegedly arising under 14(a). Setting aside the unique issues raised by the timing of the clause's adoption, the relevant part of the Texas court decision held that "the Forum Selection Bylaw is valid and enforceable and sua sponte TRANSFERS this case to the United States District Court in the District of Delaware."

The critical question in Lee is whether a forum selection clause can be enforced with respect to federal questions if the clause does not provide the option of bringing such claims in the District of Delaware.

In Fisher, plaintiff contended that Ninth Circuit law provides that:

An “exceptional reason” or “extraordinary circumstances” for not giving controlling weight to a forum-selection clause exists if the plaintiff made a strong showing that:

(1) the clause is invalid due to “fraud or overreaching,” (2) “enforcement would contravene a strong public policy of the forum in which suit is brought, whether declared by statute or by judicial decision,” or (3) “trial in the contractual forum will be so gravely difficult and inconvenient that [the litigant] will for all practical purposes be deprived of his day in court.”

Lee v. Fisher, 20-CV-06163-SK, 2021 WL 1659842, at *3 (N.D. Cal. Apr. 27, 2021). On the facts before the court, only the second prong was seriously in play.

The California district court further explained that: 

It is undisputed that the Exchange Act contains an anti-waiver provision and that federal courts have exclusive jurisdiction over Exchange Act claims. The Exchange Act voids “[a]ny condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title.” 15 U.S.C. § 78cc(a) (the “anti-waiver provision”). Therefore, if the Court were to enforce the forum-selection clause, Plaintiff would not be able to bring her claim under Section 14(a) of the Exchange Act. The issue is whether Plaintiff's lost opportunity to bring a Section 14(a) claim violates the strong public policy of the forum in which she filed this lawsuit.

The court concluded that the second prong could not be satisfied on its facts:

The Ninth Circuit has made clear that the strong federal policy in favor of enforcing forum-selection clauses supersedes the anti-waiver provisions in state and federal statutes, regardless whether the forum selection “clause points to a state court, a foreign court, or another federal court.” Yei A. Sun, 901 F.3d at 1090. Because the anti-waiver provision standing alone does not supersede the forum-selection clause, “in order to prove that enforcement of such a clause would contravene a strong public policy of the forum in which suit is brought, ... [P]laintiff must point to a statute or judicial decision that clearly states such a strong public policy.” Id. (quotation marks and citation omitted). Plaintiff fails to do so.

Plaintiff does not point to any statute or judicial decision that clearly states that enforcing the forum selection clause would contravene a strong public policy. Instead, Plaintiff first argues that enforcement of the cause would contravene the federal courts' exclusive jurisdiction over Exchange Act claims and that it would violate the Supremacy Clause of the U.S. Constitution. There is no dispute that federal courts have exclusive jurisdiction over the Section 14(a) claim under the Exchange Act. However, enforcement of the forum selection clause does not violate exclusive jurisdiction; enforcement of the forum selection clause means that Plaintiff cannot assert her Section 14(a) claim. Preventing a party from asserting a federal claim does not violate principles of exclusive federal jurisdiction. It is difficult to understand Plaintiff's argument that the federal courts' exclusive jurisdiction over Exchange Act claims supplies an independent basis, let alone the required strong public policy, to preclude enforcement of the forum selection clause.

Accordingly, the court concluded: 

The Court finds that Plaintiff fails to demonstrate that enforcing the forum selection clause would contravene a strong public policy of this forum. Therefore, the Court GRANTS Defendants' motion, enforces the forum selection clause and DISMISSES this action without prejudice to Plaintiff filing claims against Defendants in the Delaware Court of Chancery.

On appeal, the Ninth Circuit initially affirmed. Lee v. Fisher, 34 F.4th 777 (9th Cir. 2022). Subsequently, however, the court ordered that the case be reheard en banc. Presumably, the court did so because the initial panel decision created a circuit split with the Seventh Circuit. In Seafarers Pension Plan ex rel. Boeing Co. v. Bradway, 23 F.4th 714 (7th Cir. 2022). In Seafarers, a divided panel held that an identical Boeing forum-selection clause was unenforceable because it was “contrary to Delaware corporation law and federal securities law.” Id. at 718.

In Seafarers, the dissenting judge was Frank Easterbrook who was a famous law and economics scholar at Chicago before going on the bench. Critically, Judge Easterbrook opined that "plaintiff retains its right to sue directly under § 14(a) in federal court." Id. at 729.

Why is that critical? I quote from my book Corporate Law (Concepts and Insights): 

No matter how closely one scrutinizes Securities Exchange Act § 14(a), one will not find anything relating to a private party cause of action under the statute or rules. In J. I. Case Co. v. Borak,[1] however, the Supreme Court implied a private right of action from the statute. Case proposed to merge with American Tractor Co. Borak owned around 2000 shares of Case stock and sought to enjoin the merger on the grounds, inter alia, that the company’s proxy materials were false and misleading. Borak claimed that the merger was approved by a small margin and would not have been approved but for the false and misleading statements. Case argued that Borak had no standing to sue, as the federal proxy rules provided no private party cause of action.

Despite the lack of any statutory authorization for a private party cause of action, Justice Clark’s opinion for the Court found that such an action in fact existed. To be sure, Justice Clark purported to find a statutory basis for the cause of action in Exchange Act § 27. Noting that § 27 gives district courts jurisdiction over “all suits in equity and actions at law brought to enforce any liability or duty” under the Act, Justice Clark contended that “[t] he power to enforce implies the power to make effective the right of recovery afforded by the Act. And the power to make the right of recovery effective implies the power to utilize any of the procedures or actions normally available to the litigant. . . .” The trouble with that argument is that Section 27 speaks of liabilities imposed by the Act, but nothing in § 14(a) or the rules thereunder creates such liabilities vis-à-vis shareholders.

Borak is better understood as an exercise of judicial fiat. A private right of action exists not because Congress intended it, but because a majority of the Supreme Court said so. The general legitimacy of implied private rights of action is beyond our purview, however.[2] Instead, we are concerned solely with Justice Clark’s policy justification for this particular cause of action.

Justice Clark was quite above-board as to his motivation—he wanted to deter fraud and other proxy violations. According to Justice Clark, private enforcement provides “a necessary supplement” to SEC efforts. He implied that shareholders are in a better position than the SEC to detect proxy violations—they have fewer proxy statements to review and presumably are better informed about the company. Again, however, the argument is spurious. Most shareholders do not carefully review proxy materials. Instead, they are rationally apathetic. They lack both the desire and the incentive to closely monitor the firm. Justice Clark doubtless knew that individual shareholders were unlikely to emerge as champions of corporate truth and justice. Instead, it seems probable that he was trying to provide incentives for the plaintiffs’ bar to become more active in proxy litigation.

This inference is supported by Clark’s characterization of the implied private right of action as being both direct and derivative in nature. Strikingly, he did so over Borak’s strong argument that the suit was only direct in nature. At the time Borak was decided, the modern federal class action procedure had not yet been adopted. If proxy actions were allowed to proceed only directly, and plaintiffs’ lawyers were limited to representing individual shareholders, the contingent fees generated by proxy litigation would be insufficient to attract quality lawyers. (The situation would be even worse in cases like Borak, where plaintiff sought only equitable relief.) Because the implied cause of action had a derivative element, however, a plaintiffs’ lawyer could effectively sue on behalf of all shareholders, by nominally suing in the corporation’s name, generating larger damage claims and bigger contingent fees

Today, as Easterbrook pointed out, a plaintiff thus has the option of bringing a direct suit as a class action. But Borak's holding that suit could be brought either directly or derivatively remains on the books.

Or does it? Law professors Joseph Grundfest and Mohsen Manesh have filed an amicus brief in the Lee case. Although they argue that the forum selection clause is valid, they preface that part of their brief with a much more aggressive argument that there is no implied private right of action to sue derivatively under Section 14(a):

As a foundational matter, there is no private right of action to bring a derivative claim under Section 14(a). The derivative Section 14(a) claim is implied, not express. It is a creature of the judicial imagination rooted in Borak’s dicta, not in any Supreme Court holdings.  This implied claim’s remedies duplicate state law, and the claim’s very existence, as well as its essential metes and bounds, is contingent on state not federal law.

The Supreme Court commands that implied private rights be narrowly construed. Enforcing an implied private right based on dicta that generate redundant remedies in a cause of action that is existentially contingent on state law, not on federal law, is not narrow construction. It is sprawling overreach.

Implied private rights of action exist in many areas of federal law. The Warren era Supreme Court was a big fan of so-called private attorneys general; i.e., the idea that private party litigation was an essential supplement to public enforcement of federal law. Federal prosecutors and regulators have limited resources and private party litigation thus can help ensure enforcement of federal laws that might otherwise fall through the cracks due to lack of government resources.

Borak was an early example of the court creating an implied private right of action and, accordingly, set out at some length the analytical framework for doing so.

The Rehnquist court subsequently abandoned the Borak approach:

Respondents would have us revert in this case to the understanding of private causes of action that held sway 40 years ago when Title VI was enacted. That understanding is captured by the Court's statement in J.I. Case Co. v. Borak, 377 U.S. 426, 433, 84 S.Ct. 1555, 12 L.Ed.2d 423 (1964), that “it is the duty of the courts to be alert to provide such remedies as are necessary to make effective the congressional purpose” expressed by a statute. We abandoned that understanding in Cort v. Ash, 422 U.S. 66, 78, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975)—which itself interpreted a statute enacted under the ancien regime—and have not returned to it since. Not even when interpreting the same Securities Exchange Act of 1934 that was at issue in Borak have we applied Borak's method for discerning and defining causes of action. ... Having sworn off the habit of venturing beyond Congress's intent, we will not accept respondents' invitation to have one last drink.

Alexander v. Sandoval, 532 U.S. 275, 287 (2001).

I tell me students that the Supreme Court is thus out of the business of creating new implied private rights of action, but that ones that had been approved by a majority of the court in the past have been grandfathered into the law and are thus rarely if ever overturned. Ironically, I premise that conclusion on an article by Professor Grundfest. See Joseph A. Grundfest, Disimplying Private Rights of Action Under the Federal Securities Laws: The Commission's Authority, 107 Harv. L. Rev. 963, 992-94 (1994) (describing implied private right of action under section 10(b) and Rule 10b-5 as having been “grandfathered” by the Court).

Interestingly, Grundfest and Manesh's brief does not cite that article. Indeed, the brief makes no reference to well-established private rights of action being grandfathered. In contrast, courts seem to accept that the Borak derivative claim is well-established:

"It is now well established that a private party may bring suit for a violation of Section 14(a), ... and that a shareholder may bring s derivative suit on behalf of the corporation for a violation of Section 14(a)." Dillon v. Berg, 326 F. Supp. 1214, 1218 (D. Del. 1971), aff'd, 453 F.2d 876 (3d Cir. 1971). See also In re Trump Hotels Shareholder Derivative Litig., 96 CIV. 7820 DAB, 2000 WL 1371317, at *10 (S.D.N.Y. Sept. 21, 2000) ("It is well settled law that a Section 14(a) claim may be brought directly or derivatively.").

Indeed, it has been argued that the Supreme Court itself has "clarified that Borak has been grandfathered." William C. Tyson, The Proper Relationship Between Federal and State Law in the Regulation of Tender Offers, 66 Notre Dame L. Rev. 241, 358 n.186 (1990). I am not sure I would go quite that far. Professor Tyson relies on Touche Ross & Co. v. Redington, 442 U.S. 560, 577 (1979), which stated: "We do not now question the actual holding of that case, but we decline to read the opinion so broadly that virtually every provision of the securities Acts gives rise to an implied private cause of action." Not exactly a ringing endorsement.

In any case, Grundfest and Manesh argue that "Borak’s logic is overtly purposive and implements an interpretive approach that has been resoundingly repudiated by the Supreme Court." They then contend that Borak's statements regarding derivative standing were dicta. 

I'm generally opposed to implied private rights of action, so I tried to review their argument sympathetically. But I don't buy it.

In Burks, for example, the Supreme Court stated (albeit arguably in dicta):

A fundamental issue in this case is which law—state or federal—governs the power of the corporation's disinterested directors to terminate this derivative suit. The first step in making that determination is to ascertain which law creates the cause of action alleged by the plaintiffs. Neither the ICA nor the IAA—the plaintiff's two federal claims—expressly creates a private cause of action for violation of the sections relevant here. However, on the basis of District and Circuit precedent, the courts below assumed that an implied private right of action existed under each Act. ... The two courts also sanctioned the bringing of the suit in derivative form, apparently assuming that, as we held in J. I. Case Co. v. Borak, 377 U.S. 426, 432, 84 S.Ct. 1555, 1560, 12 L.Ed.2d 423 (1964), “[t]o hold that derivative actions are not within the sweep of the [right] would . . . be tantamount to a denial of private relief.”

Burks v. Lasker, 441 U.S. 471, 475 (1979) (emphasis supplied). See also Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 66 (1977) (Stevens, J., dissenting) ("In Borak, the Court held that a derivative suit on behalf of the corporation could be brought under [section] 14(a), although it seems clear that the primary beneficiaries of that section were individual stockholders rather than corporations.").

I the suspect that the Ninth Circuit will not agree with Grundfest and Manesh, although I commend their audacity. Anyway, go read the brief. I have just sort of skimmed over their detailed and clever analysis.

Warm Potato Salad

• 2-3 Yukon Gold potatoes (totaling about a pound)
• 4 slices thick cut bacon
• 1 tablespoon apple cider vinegar
• 1 tablespoon minced shallot
• 1 tablespoon apple cider vinegar
• 1 ½ tablespoons whole grain mustard
• ½ tablespoon Dijon mustard
• finely snipped fresh chives to taste
• dried Italian parsley to taste
• onion power to taste
• salt and pepper to taste

Slice the potatoes on the thick setting (¼") of a mandolin. Put the potatoes in a large sauce pan and add enough water to cover by about half an inch. Add 1 tablespoon of the vinegar and a big pinch of salt. Bring to a boil, reduce heat to a rolling simmer, and cook until just tender but not at all mushy (about 15 minutes). 

Meanwhile, cook the bacon in a medium skillet over medium heat. Drain on a paper towel lined plate. Enjoy one piece as a reward for your hard work and crumble the remainder.

Drain potatoes and add to a large bowl. Add remaining ingredients and combine gently but thoroughly.

Optional add-ins: caraway seeds, celery seeds, hard boiled eggs, capers, cornichons, sweet gherkins

Boneless Pork Loin Chops Sous Vide with Mustard-Tarragon-Green Peppercorn Sauce and 2019 Beringer Chardonnay

I cut 2 chops, each about 1½ thick, from a boneless pork loin roast. I dusted all sides generously with my tarragon rub. I let the chops rest at room temperature for about 30 minutes.

I set my sous vide machine to 137°. I vacuum sealed the chops and added them to the water bath.  I set the timer for 80 minutes.

Towards the end of the cooking time, I made the sauce:

• drizzle olive oil
• 1 tablespoon finely minced shallot
• ⅔ cup white wine
• ½ cup chicken stock (as usual I used Better than Bouillon base rather than opening a whole can of stock)
• ½ teaspoon dried tarragon
• ½ tablespoon green peppercorns
• 2 teaspoons finely snipped fresh chives
• ~1 tablespoon whole grain mustard
• ~1 teaspoon Dijon mustard
• 2 tablespoons heavy cream
• salt and pepper

Heat olive oil in a small sauce pan over medium heat for a couple of minutes. Add shallots and sauté for a minute or two. Add the wine and stock to the pan. Bring to a boil and reduce heat to a simmer. Add tarragon and green peppercorns. Reduce by about to about ⅔ cup. Remove from heat and add chives, mustard, and cream. I added the mustards in stages, tasting as I went along, because I didn't want to overpower the sauce. I ended up using all of it. Season with salt and pepper to taste. Return to heat, bring to a low simmer, whisking constantly, and allow to thicken slightly. (If it's too runny, you can whisk in a little Wondra to tighten it up.)

Heat a grill pan (preferably cast iron) on high for 3 minutes or so. Remove pork chops from water bath, unseal, and pat very dry. I squirted all sides with Pam and then added the chops to the grill pan. Sear all sides quickly.

I served the chops with a warm potato salad and a 2019 Beringer Private Reserve Chardonnay. Relatively restrained oak, but still rich and round. Peach, pear, toasted almond. Excellent.

The Law of Elon Musk Course Reader

Starting next week, I'll be teaching a UCLA Law J-Term Course "The Law of Elon Musk." Here's the table of contents of the course reader:

Tarragon rub

I used this tonight on some sous vide pork chops. The pork chop recipe will go up tomorrow.

• 2 teaspoons dried tarragon 
• 1 teaspoon dried Italian parsley
• 1 teaspoon dry mustard
• 1 teaspoon kosher salt
• ½ teaspoon freeze-dried green peppercorns
• ¼ teaspoon garlic powder
• ¼ teaspoon onion powder

Combine in a mortar and pestle. Grind to a fine powder.

The University of California Retirement Fund is Misleading and Shortchanging Beneficiaries

Some years ago, the University of California pension fund managers decided to embrace ESG investing. Nobody asked us beneficiaries. If they had, we might have pointed out that the fund managers are both misleading and shortchanging those of us who have entrusted them with our money.

Consider the example of the UC Domestic Equity Index Fund. This fund claims to be a Large Cap blend fund. But it also claims to track the performance of the Russell 3000 ex Tobacco ex Fossil Fuels Index. 

Problem # 1: The Russell 3000 is not really a large cap fund. If you wanted to track a large cap index, you'd probably want to track the S&P 500, which is widely regarded as the best means of tracking of Large Cap U.S. equities. But you would not select the Russell 3000, which contains about 98% of the US equity market. The Russell 3000 is large cap, mid cap, and small cap all in one.

Problem # 2: The Russell 3000 ex Tobacco ex Fossil Fuels Index has underperformed the Russell 3000 index on a YTD, 1 year, 5 year, and 10 year basis. It's done particularly badly in 2022, losing 11.65% compared to 10.80% for the non-ESG index. 

Why We Should Keep Teaching Dodge v. Ford Motor Co.

An updated version of my article Why We Should Keep Teaching Dodge v. Ford Motor Co. is now up on SSRN.

What is the purpose of the public business corporation? Is it to maximize shareholder value? Or is it to simultaneously enhance the welfare of shareholders, stakeholders, and the larger society? These are perennial questions, of course, but they also have been much in the news in recent years. Whether tagged as stakeholder capitalism, stakeholder theory, corporate social responsibility, or ESG (i.e., environmental, social, and governance), much attention is being paid.

The time has thus seemed propitious to many legal scholars to revisit the law of corporate purpose. Many of these scholars have been influenced by the late Lynn Stout’s work on the topic. Ten years ago, Stout published her book, The Shareholder Value Myth, which built on her earlier article, Why We Should Stop Teaching Dodge v. Ford. As the latter title suggests, Stout’s principal foil was the Dodge case.

Stout’s focus on Dodge was well chosen, as the case is included in almost all law school corporation law and business association casebooks and has been widely discussed in the academic literature. The influence of Stout’s critique of Dodge work was confirmed by a March 31, 2022, search of the Westlaw Law Reviews and Journals database, which identified 98 articles published in the last three years that cited her book and 43 during the same period that cited her article.

Given the renewed attention to the corporate purpose question and the continuing influence of Stout’s work on that debate, it seems appropriate to revisit her arguments to determine whether she was correct that law professors should stop teaching Dodge. I conclude that law professors ought to keep teaching Dodge. It was good law when handed down in 1919 and remains good law today.

Bainbridge, Stephen Mark, Why We Should Keep Teaching Dodge v. Ford Motor Co. (April 19, 2022). 48 Journal of Corporation Law 77 (2022), UCLA School of Law, Public Law Research Paper No. 22-05, Available at SSRN: https://ssrn.com/abstract=4076182

The Artwork for "The Profit Motive" Arrived Today

The artwork for my forthcoming book "The Profit Motive: Defending Shareholder Value Maximization" arrived today. I'm particularly proud of the generous blurbs from such prominent folks:

The SEC Proposes Trashing the Stock Market Part 1A: The WSJ on Best Order Execution

The Securities and Exchange Commission proposes 1,656 pages of regulation that would re-engineer the equities market in the name of fixing a nonexistent problem. https://t.co/GXKBfB5yl3 via @WSJ

— Steve Bainbridge (@PrawfBainbridge) December 16, 2022

"An SEC Inspector General report recently warned that @GaryGensler's move-fast-and-break-things agenda is overwhelming staff and diverting resources from investor protection." https://t.co/5Rj3R3n0Uv via @WSJ

— Steve Bainbridge (@PrawfBainbridge) December 16, 2022

@GaryGensler's "stock-trading overhaul isn’t intended to improve competition or protect retail investors. The beneficiaries are Nasdaq, Calpers and brokers that can support zero-commission trading with other revenue." https://t.co/woaitSGFMR via @WSJ

— Steve Bainbridge (@PrawfBainbridge) December 16, 2022

The SEC Proposes Trashing the Stock Market Part 1: Best Order Execution

The SEC has proposed new Regulation Best Execution:

Proposed Regulation Best Execution would require broker-dealers to establish, maintain, and enforce written policies and procedures reasonably designed to comply with the proposed best execution standard. Further, the proposal would require these policies and procedures to address how broker-dealers will comply with the best execution standard and how they will determine the best market and make routing or execution decisions for customer orders.

The policies and procedures would also be required to address additional factors for conflicted transactions with retail customers. With respect to such transactions, the proposal would require broker-dealers to document their compliance with the best execution standard, including all efforts to enforce their best execution policies and procedures for conflicted transactions and the basis and information relied on for their determinations that such conflicted transactions would comply with the best execution standard. Broker-dealers would also be required to document any arrangement concerning payment for order flow.

For starters, if this goes through, retail investors can kiss zero commission brokerage accounts goodbye. SEC Commissioner Hester Peirce opines that:

I cannot support this proposal, which is unduly prescriptive and seems less concerned about whether customers actually get best execution than if brokers implement a checklist that the Commission itself is not confident will help brokers achieve even better—much less best—execution. 

...

The proposed rule provides a handy checklist for SEC examiners and enforcement attorneys, but it does not foster brokers’ exercise of judgment to achieve what is best for customers.  Best execution cannot be reduced to a checklist.  Indeed, a checklist mandated by the Commission invites a culture of check-the-box compliance that does little to improve execution quality.  Instead, it may promote broker and regulatory complacency about working creatively to get the best execution possible for customers. 

Peirce further explains that institutional investors will also suffer:

Institutional customers arguably do not need the protection of a best-execution rule, particularly one as prescriptive as this proposal.  The proposed rule makes price the primary objective of the broker.  Institutional investors may have other important objectives, such as speed and minimizing the effect on price. The rule makes it hard for institutional brokers to tailor best execution to a customer’s objectives.

Finally, Peirce sends potential challengers a none too subtle hint about how to challenge the rule:

The release does not take serious account of the potential for increased commissions when it assesses likely changes in execution quality, even though it seems that any estimate of execution quality, particularly in a rulemaking like this, should take the per-share cost of commissions into account.  At some points in the release, the discussion hints that a broker-dealer, to meet its requirements under the rule, should convert PFOF into price improvement.  Why is withholding price improvement from the customer worse than charging the customer a (likely higher) commission?

As we know, the SEC has lost a number of cases in recent years for doing an inadequate cost-benefit analysis, which seems to be what Peirce is teeing up.

Commissioner Uyeda is also not a fan of the Commission's cost-benefit analysis:

This particular proposal uses the phrase “the Commission believes” 77 times.  What does that phrase mean?  If the phrase is employed as a reasoned conclusion of the Commission after a discussion of supportive evidence and relevant analysis, then I suppose that is fine.  However, when the expression—“the Commission believes”—is employed as a substitute for evidence, like spackling used to fill a hole, then that is a problem.  Indeed, “the Commission believes” seems to be used as another regulatory shortcut for situations when the Commission has no hard evidence or data, but nonetheless has a theoretical concern.

 

As Tesla's stock price slides, would Musk or Tesla's board have liability for his Twitter distraction?

A Twitter series:

I have so many thoughts on this, as a super aggravated #Tesla shareholder. The agro midlife crisis of a billionaire manchild is whittling away my share price.

But @PrawfBainbridge is teaching a law school class dedicated to #Elon and I would love to hear HIS thoughts.

— Victoria Haneman (@TaxLawProf) December 13, 2022

2/ Elon's liability could be either contractual or fiduciary. I have not seen and made no effort to find Elon's employment contract with Tesla, if any. Assuming Elon has one, it probably has a time and effort clause. Example below. pic.twitter.com/zddB66GKxI

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022

4/ I am not a fan of these clauses as a drafting matter. I'd love for @AdamsDrafting to comment on the drafting of full time and effort clauses. I find them difficult to enforce. Plus, they are mainly used as a noncompetition device not to police slacking.

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022

6/ In derivative litigation, a shareholder must either make demand on the board of directors or establish in court that demand would be excused as futile. High hurdles. Complex issues of board independence etc. My corporate law text devotes 14 pages to it. https://t.co/HACaQjiyhr

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022

8/ In any case, any breach of fiduciary duty lawsuit would again be derivative in nature. As long as #Tesla's board is independent (an issue in several pending cases) and disinterested, there is no way for a shareholder to bring suit. See In re Tesla Motors, Inc. S'holder Litig.

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022

10/ In the class session we'll ask a number of interesting questions. One of them will be a small group exercise: pic.twitter.com/XUy37VQAIg

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022

12/ I'm not aware of any case directly on point. But in Beam ex rel. Martha Stewart Living Omnimedia, Inc. v. Stewart, 833 A.2d 961 (Del. Ch. 2003), the Court declined to hold MSO's board liable for failing to supervise and prevent Stewart's insider trading.

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022

11A/ Speaking of Tom Lin, he doesn't;t spend a ton of time on Twitter but I'm going to tag him in anyway. @tomcwlin

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022

13/ Of course, we're all assuming a plaintiff would be able to show a causal link between Tesla's stock price slide and Musk's side gig at Twitter. Given all the other challenges #Tesla faces, I suspect that would be non-trivial.

— Steve Bainbridge (@PrawfBainbridge) December 13, 2022