Opinion

Alison Frankel

Strine: Stop shareholder activism from hurting American investors

Alison Frankel
Mar 25, 2014 19:32 UTC

This country’s most important arbiter of corporate law – Chief Justice Leo Strine of the Delaware Supreme Court – believes that shareholder democracy has run amok. In a startling new essay for the Columbia Law Review, “Can We Do Better by Ordinary Investors?” Strine outlines the deleterious long-term effects of subjecting corporate decision-makers to shareholder votes dominated by short-term investors. These ill consequences range, according to Strine, from the outright dollars corporations must spend to educate shareholders about everything they’re entitled to vote on all the way to excessive risk-taking and regulatory corner-cutting by executives and directors worried about delivering quick returns lest they be ousted by shareholders. Strine is deeply worried about a divergence of interests between money managers, who wield the power of shareholder votes, and ordinary investors in their funds, who are typically saving for retirement or their kids’ education. He’s convinced that the entire American economy will suffer unless short-term investors are reined in.

Strine’s diagnosis is interesting enough, though he’s previously written about what he considers to be the cancer of short-term investing. In the new essay, though, he also suggests a cure: eight actual suggestions to restore power to corporate boards and long-term investors (plus a pie-in-the-sky fantasy about changing the U.S. tax code to encourage shareholders to take a long view of their investments). Strine, who calls himself “someone who embraces the incrementalist, pragmatic, liberal tradition of addressing the world as it actually is,” argues that his proposals do not roll back shareholders’ hard-won rights to a voice in corporate affairs. Instead, he says, he’s “trying to create a system for use of those rights that is more beneficial to the creation of durable wealth for them and for society as a whole.”

The proposals make Strine’s paper indispensable reading if you run a corporation or advise corporate decision-makers. Even if you’re put off by his somewhat tedious rhetorical device of styling the essay as a response to Harvard Law professor Lucien Bebchuk – who advocates relentlessly for expanding shareholders’ franchise and apparently plays Dungeons & Dragons – or by the 154 dense footnotes in Strine’s 54-page article, you should take a look at his suggestions, which begin on page 29. Strine has done more thinking, reading and writing about the real-world consequences of shareholder power than anyone I can think of. He spent 16 years, after all, as a judge in Delaware Chancery Court, three of them as chancellor, before ascending to the Supreme Court this year. And based on those 154 footnotes, Strine seems to have devoted most of his time off of the bench to reading academic papers on corporate governance and shareholder rights. (Or, at least, whatever he could spare from keeping abreast of pop culture.)

The biggest problem Strine seeks to solve is that, in his view, shareholders saving for faraway goals like retirement and education don’t have a real say about corporate decision-making. They invest through index funds, which often have to cast too many votes – thousands a year, Strine says – to make independent decisions or else have conflicting objectives in shareholder votes. Sometimes, Strine points out, funds have been known to vote both yes and no on the same merger when they hold shares in both the target and the acquirer – an oddity he calls “incoherent, stupid and reflective of a lack of judgment being exercised by the index fund on behalf of its specific investors and their interests.”

Many of Strine’s suggestions are intended to assure that funds are voting to promote the interests of investors with long-term goals. He would, for instance, require mutual funds to conduct independent analysis and preclude them from relying on broad proxy advisories and mandate. Strine would also require funds that accept contributions from investors saving for retirement or education “have voting policies that take into account the long-term focus of their investors.” (Okay, that idea isn’t so concrete.) To increase the likelihood that mutual fund advisors invest for the long term, Strine suggests that they be paid in restricted shares of their funds, just like corporate executives whose compensation is tied to their corporation’s share price.

Fannie, Freddie investors: Treasury plotted to nationalize shares

Alison Frankel
Mar 24, 2014 20:32 UTC

Some very sophisticated hedge funds are claiming to be victims of a secret Treasury Department scheme to nationalize the government-sponsored mortgage entities Fannie Mae and Freddie Mac. In a summary judgment brief filed Friday in federal court in Washington, D.C., Fairholme Funds and Perry Capital (along with other Fannie and Freddie preferred shareholders) said they’ve obtained a Treasury memo from December 2010 that proves the government intended to wipe out the value of their shares without telling them.

“The meaning of the Treasury memorandum is crystal clear: The government of the United States established a policy to destroy private shareholder value,” the brief said.

Fannie and Freddie shareholders, as you may recall, are suing the government in both U.S. district court and the Court of Federal Claims over an August 2012 amendment to the terms of Treasury’s agreement to invest taxpayer money in Fannie and Freddie. They contend that up until the amendment, preferred shareholders believed that if Fannie and Freddie returned to profitability under the conservatorship of the Federal Housing Finance Agency, private investors would share the spoils. The 2012 amendment, they assert, illegally cut off their interests by requiring Fannie and Freddie to pay Treasury a quarterly dividend that essentially delivers all of the housing entities’ net worth to the government.

Can federal judges base rulings on their own investigations?

Alison Frankel
Mar 21, 2014 21:19 UTC

Last year, when U.S. District Judge Sterling Johnson of Brooklyn was skeptical about the impact of a suit accusing a Subway restaurant of failing to provide access to customers in wheelchairs, he took a field trip. According to an opinion he wrote in March 2013, Johnson checked eight establishments that had been targeted in Americans with Disabilities Act suits by the same team of plaintiffs lawyers. The cases had all been resolved through settlements or default judgments, but Johnson was shocked to discover that the defendants hadn’t bothered to fix handicapped access problems. The judge’s fact-finding mission confirmed his worst suspicions that the lawyers who brought the cases were more concerned about ginning up fees for themselves than about the civil rights of the disabled.

Judge Johnson’s opinion denying any fees to lawyers he described as “parasites” was based on many considerations aside from his field trip to the targeted restaurants. But when the 2nd Circuit Court of Appeals reviewed his opinion, Johnson’s judicial expedition was all that mattered. In a much-discussed summary order on March 11, Chief Judge Robert Katzmann, Judge Robert Sack and U.S. District Judge Jed Rakoff (sitting by designation) held that Johnson erred when he drew conclusions from his own investigation. The 2nd Circuit said that according to the rules of evidence in federal court, judges are permitted only to consider indisputable facts from unquestionable sources. Judge Johnson hadn’t permitted the restaurants he visited nor the plaintiffs’ lawyers in the case to contest or explain what the judge witnessed. The appeals court judges said that under those circumstances, they couldn’t be sure that the restaurants’ conditions were beyond dispute.

The clear message from the 2nd Circuit was that Judge Johnson should not have permitted his own investigation to affect his decision. That certainly seems like a reasonable conclusion. In our adversary system, judges are supposed to preside over investigation by opposing parties, not to conduct their own independent fact-finding outside of the courtroom. But in a decision this week, Judge Richard Posner of the 7th Circuit Court of Appeals has done exactly what the 2nd Circuit seems to have frowned upon in its ruling on Judge Johnson’s restaurant visits.

Wachtell plays shareholder savior in weird National Interstate case

Alison Frankel
Mar 17, 2014 20:36 UTC

There is probably no law firm more closely associated with corporate charter and bylaw provisions requiring shareholders to litigate their claims in Delaware Chancery Court than Wachtell, Lipton, Rosen & Katz. Wachtell didn’t defend the Chevron and FedEx cases that led then Chancellor Leo Strine to uphold the validity of forum selection clauses, but Wachtell partners Theodore Mirvis and William Savitt (among others) have been ardent boosters of the tactic as a means of curbing the expensive and duplicative shareholder suits that almost inevitably now follow deal announcements.

That’s what makes Wachtell’s role in the litigation over American Financial’s tender offer for the 48 percent stake in National Interstate that it doesn’t already own so notable. In representing a shareholder seeking to squelch the deal – National Interstate founder Alan Spachman, who owns more than 9 percent of the outstanding shares – Wachtell engaged in the sort of forum selection gamesmanship we usually see from shareholder class action firms, leading to accusations of forum shopping that Wachtell is more accustomed to tossing than receiving. After two different state court judges in Ohio refused to enjoin American Financial’s $30 per share tender offer to National Interstate’s minority shareholders, despite widespread criticism of the sale process, Wachtell and Baker & Hostetler sued on Spachman’s behalf in federal court in Akron, adding federal securities claims to the breach of duty assertions in the two previous cases.

The third time turned out to be the charm for National Interstate’s minority shareholders. Despite American Financial’s arguments that Spachman and his lawyers were blatantly shopping for a friendly judge and that a single shareholder should not be permitted to block a $300 million deal, U.S. District Judge James Gwin was willing to grant what his state-court cohorts were not. At the end of a long hearing Friday, Gwin said he would enjoin the tender offer from closing Monday. On Sunday, American Financial announced that it was dropping the offer and returning shares already tendered.

Google to 9th Circuit: Undo unworkable ‘Innocence’ copyright ruling

Alison Frankel
Mar 14, 2014 21:47 UTC

Does Chief Justice Alex Kozinski of the 9th Circuit Court of Appeals know more about the Copyright Act than the U.S. Copyright Office?

Not according to Google. In a new brief to the 9th Circuit, Google has asked the entire court to review a controversial Feb. 26 opinion in which Kozinski and Judge Ronald Gould concluded that Google and YouTube must take down video from the explosive film “Innocence of Muslims” because the movie likely infringes the right of an actress, Cindy Lee Garcia, to control her own five-second performance in the film. Google’s new brief argues that Kozinski and Gould misinterpreted the Copyright Act when they found, in an issue of first impression, that Garcia likely has an independent interest in her performance. And the company’s lawyers at Hogan Lovells gave the 9th Circuit a good reason why all of the judges on the court should reconsider Kozinski’s take on Garcia’s rights: A week after his opinion came out, the U.S. Copyright Office rejected Garcia’s application to register a copyright on her performance in “Innocence of Muslims.” In a March 6 letter to Garcia’s lawyer, Cris Armenta of The Armenta Law Firm, the Copyright Office said that its “longstanding practices” do not allow actors to copyright individual performances within a movie.

Google is not alone in hoping that the 9th Circuit will reconsider the Kozinski opinion. As the brief points out, the possibility that actors with bit parts may have a right to control the distribution of entire movies has struck fear in film producers and documentarians. Meanwhile, a group of news organizations, including The New York Times and the Los Angeles Times, has filed an amicus brief arguing that the 9th Circuit’s takedown order contradicts important First Amendment principles and ought to be reconsidered. (Technically, the publishers’ brief addressed en banc review of the 9th Circuit’s decision not to stay the takedown order while Google pursues appeals, but the same arguments also apply more broadly.)

Cranky Posner opinion mocks brief, suggests sending lawyer to jail

Alison Frankel
Mar 13, 2014 19:13 UTC

In an interview last November with The Daily Beast, Judge Richard Posner of the 7th Circuit Court of Appeals explained why he wouldn’t want to sit on the U.S. Supreme Court. “I don’t think it’s a real court,” Posner said. “It’s a quasi-political party. President, House of Representatives, Supreme Court. It’s very political. And they decide which cases to hear, which doesn’t strike me as something judges should do. You should take what comes.”

That idea – that judges should not shape the law by cherry-picking cases but by deciding the cases that come their way – stuck with me. Posner’s not completely ingenuous, because, as he goes on to say in the interview, he does pick which opinions he wants to write and assigns out the rest. Nevertheless, it says something profound about American justice that Posner applies his incisive intellect to a semi-random gamut of cases, matters large and small, legally interesting and run-of-the-mill.

The acerbic judge was at his worst – or best, depending on your perspective – in an opinion Wednesday that’s already become an instant classic. Posner mocked the brief filed by a car crash victim and her lawyer, who were found in civil contempt for failing to deposit $180,000 in a trust account while they fight over the money with a union healthcare fund, as “a gaunt, pathetic document” with a grand total of 118 words of argument (including citations). He said the conduct of the crash victim and her lawyer was “egregious” and “outrageous,” and directed the trial judge presiding over their dispute with the union fund to consider throwing them in jail for contempt until they’ve come up with the $180,000. Posner suggested that the Justice Department might also be interested in the case, and then, to boot, scolded the trial judge, U.S. District Judge Joan Lefkow of Chicago, for permitting the case to drag on as “the stench rose.” Would Posner get to write such a masterpiece if he were on the Supreme Court? I think not.

Scant attorney-client protection for GM

Alison Frankel
Mar 12, 2014 20:00 UTC

On Tuesday, Reuters found out that General Motors is facing a criminal investigation by federal prosecutors in Manhattan into allegations that the auto company failed to alert consumers and regulators about long-running ignition-switch problems. Word of a possible criminal case followed GM’s revelation Monday that it has hired Jenner & Block and King & Spalding to assist its general counsel in an internal investigation of the company’s response to the ignition defect, which has been blamed for 13 deaths. The confluence of the two investigations raises an intriguing question: How much will GM’s own lawyers have to tell the Justice Department about their findings?

The answer: a lot. GM lawyers will almost certainly have to inform the government of all the facts they uncover, despite Justice Department guidelines that prohibit prosecutors from conditioning leniency for corporate defendants on their waiver of attorney-client privilege. Prosecutors are not supposed to ask corporations outright to surrender the traditional protections shielding legal advice, attorney work product and communications between clients and their counsel. But the Justice Department guidelines allow government lawyers to demand an account of the facts corporate investigators have obtained. If a corporation wants to receive credit for cooperating with the government, the guidelines state, then it “must disclose the relevant facts of which it has knowledge,” including facts uncovered through an internal investigation.

That policy, which the Justice Department promulgated in August 2008, came in response to widespread criticism of the government’s previous requirement that corporations waive their attorney-client privileges in order to receive a deferred prosecution or non-prosecution deal. Theoretically, the revised guidelines permit cooperating corporate defendants to assert attorney-client privilege over materials such as the notes their law firm investigators make during interviews of corporate witnesses, so long as inside investigators are careful to disclose all relevant facts to prosecutors. “Lawyers have to conduct internal investigations in a way that the facts can be gathered and then communicated to the government while still preserving the privilege,” said former Justice Department prosecutor Nathaniel Edmonds, now at Paul Hastings.

Has Supreme Court lost its zeal to curb consumer class actions?

Alison Frankel
Mar 11, 2014 19:35 UTC

On Monday, the U.S. Supreme Court declined to grant review to two small Nebraska banks facing class action allegations that they failed to post stickers on ATM machines to alert users about add-on fees. That might not seem like a surprise, except that the certiorari petition by the banks’ counsel at Mayer Brown raised a question that the Supreme Court has previously struggled with: whether class action plaintiffs asserting federal laws that provide statutory damages have constitutional standing to sue even if they haven’t suffered any actual injury. The justices heard a different case posing the exact same question in 2011 in First American Financial v. Edwards, but didn’t resolve the issue because they dismissed the appeal on the last day of the term in June 2012. Class action opponents like the U.S. Chamber of Commerce, the Washington Legal Foundation and the Association of Credit and Collection Professionals were hoping that the Nebraska banks’ case was a new chance to end litigation by uninjured plaintiffs whose small, individual statutory damages claims turn into a big nuisance when they’re accumulated in class actions.

Monday’s cert denial is the second time in two weeks that the justices have decided to sidestep thorny consumer class action issues. On Feb. 24, as you probably know, the court refused to grant certiorari to Sears and Whirlpool, which had argued that the 6th and 7th Circuit Courts of Appeal erroneously certified classes of washing machine owners whose appliances have an alleged tendency to develop a moldy smell. The moldy washer cert petitions were the subject of a vigorous public relations campaign by business groups that contended the vast classes, consisting mostly of owners whose machines never developed a moldy smell, perfectly exemplified the perniciousness of class actions. The justices were clearly interested in the cases, since they discussed the Sears and Whirlpool appeals at least three conferences. But even though the 6th and 7th Circuit certifications came on remand from the Supreme Court, the justices ultimately decided not to accept the invitation from Sears, Whirlpool and their influential amici to remake the rules of consumer class actions.

So: two big opportunities to curb classwide consumer cases and two big punts by a Supreme Court that has in recent years shown no hesitation to limit the litigation rights of ordinary people. (A few prime examples from a long list: American Express v. Italian Colors, AT&T Mobility v. Concepcion, Wal-Mart v. Dukes.) Are we witnessing the dawn of a new era at the Supreme Court?

Delaware ‘abetting’ ruling v. RBC should scare M&A advisors

Alison Frankel
Mar 10, 2014 21:19 UTC

If there were any remaining shreds of doubt that Delaware Chancery Court has come to regard financial advisors in M&A deals with considerable mistrust, they ought to be erased by Vice-Chancellor Travis Laster‘s 92-page decision Friday in a shareholder class action stemming from Warburg Pincus’s $17.25-per-share acquisition of the ambulance company Rural/Metro.

Rural/Metro’s directors settled the case last year for $6.5 million, which meant that when shareholder lawyers from Robbins Geller Rudman & Dowd and Bouchard, Margules & Friedlander went to trial against Royal Bank of Canada for aiding and abetting the board’s breach of duty, they had to show that RBC induced directors to make unreasonable decisions about selling the company. That made the case tougher for shareholders, but they nevertheless convinced Laster that RBC was conflicted by its hope of earning big financing fees from Warburg in this deal and from other banks in a related transaction. The judge concluded that RBC is indeed liable for aiding and abetting the board’s breach – a precedent-setting opinion that means the litigation risk to financial advisors in M&A deals just got very real.

Laster’s RBC decision is the logical extension of a couple of recent Chancery Court rulings involving conflicted financial advisors. In 2011, Laster enjoined the acquisition of Del Monte by a private equity consortium, finding that Del Monte’s advisor, Barclays, was secretly receiving financing fees from the consortium. Barclays later settled with Del Monte shareholders for $90 million. A year after the Del Monte ruling, Chancellor Leo Strine (now Delaware’s chief justice) issued a scathing opinion describing Goldman Sachs’s “furtive” and “troubling” decision to advise El Paso Corporation in its sale to Kinder Morgan, even though Goldman held a big equity stake in Kinder. Goldman eventually agreed to waive more than $20 million in fees and legal costs as part of Kinder Morgan’s $110 million settlement.

How Texas oil company won $319 million ‘common law’ partnership verdict

Alison Frankel
Mar 7, 2014 22:42 UTC

The oil and gas industry was stunned this week a $319 million verdict for Energy Transfer Partners, courtesy of a state court jury in Dallas, Texas. Jurors agreed with ETP’s lawyers at Lynn Tillotson Pinker & Cox that ETP and Enterprise Products had a binding agreement to develop a pipeline to carry crude oil from Oklahoma to refineries on the Gulf of Mexico, and that Enterprise breached the agreement when it decided instead to hook up with a Canadian pipeline company called Enbridge.

That might seem like a straightforward determination – except that the letter of intent between ETP and Enterprise included language that specifically said their deal wasn’t binding unless there was a formal term sheet and their respective boards approved the agreement. Neither of those things happened.

So how did Enterprise and its lawyers at Beck Redden and Sayles Werbner wind up on the wrong side of a $319 million verdict? Because the judge in the case, Emily Tobolowsky, rejected their summary judgment argument that as a matter of Texas contract law, preconditions must be satisfied to create binding partnership obligations. Judge Tobolowsky’s denial of Enterprise’s summary judgment motion, which was not accompanied by an opinion, meant that ETP and lead trial counsel Michael Lynn could ask jurors to judge the relationship between ETP and Enterprise just as they’d judge a common law marriage. ETP told jurors that it didn’t matter what the formal paperwork said if Enterprise acted as though it were partnered with ETP. To emphasize his client’s “if it walks like a duck” theme, Lynn even showed the jury a poster of a duck holding a sign that said, “I am not a partner.”

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