Monthly Archives: September 2007

The “Tellabs Excuse” and Confidential Witnesses

Editor’s Note: This post is from J. Robert Brown, Jr. of the University of Denver Sturm College of Law.

When the Supreme Court decided Tellabs, Inc v. Makor Issues last June, holding that securities-fraud plaintiffs must plead facts giving rise to a “powerful or cogent” inference of scienter to survive a motion to dismiss under the Private Securities Litigation Reform Act, I argued on this Blog and at The Race to the Bottom that the case did little to change the law, characterizing it as a victory for shareholders.  I noted, however, that Tellabs would provide an excuse to judges predisposed to dismissing securities class actions, allowing courts to dispose of suits on the ground that the complaint did not give rise to an inference of scienter “powerful or cogent” enough for the judges’ tastes. 

The Seventh Circuit has now provided the first example of the “Tellabs Excuse” at work: Higginbotham v. Baxter International(Primary materials from the case can be found here.)  While I expected that the federal courts would rely on Tellabs as a frequent basis for securities-fraud dismissals, I didn’t expect judges to go so far as to invoke Tellabs to eliminate the use of confidential witnesses to meet the pleading standard for securities class actions.  Nonetheless, that is awfully close to what the Seventh Circuit has done.

Baxter is a fairly traditional securities-fraud suit, turning on whether the complaint adequately alleged scienter.  The case involved allegations of fraud in Baxter’s Brazilian subsidiary, including conduct that ultimately required the company to restate its financial results.  On the day the problem in Brazil was announced, Baxter’s shares fell by 4.6%

The Seventh Circuit panel included Chief Judge Easterbrook and Judges Posner and Ripple, and it was clear at oral argument that Chief Judge Easterbrook and Judge Posner were unimpressed by the complaint.  (You can listen to the oral argument here.) 

For example, Chief Judge Easterbrook commented to plaintiffs’ counsel: “You’ve got a case where there are, there’s demonstrable, lying.  You choose not to sue about the demonstrable lies but to sue about things that it’s almost impossible to show scienter about and no one had any reason to lie about.  It’s almost as if you set out to find the one kind of suit that would be blocked by the PSLRA and bring that.”  Judge Posner, too, was clearly unmoved by the complaint.  At one point he described one of the plaintiffs’ arguments as “ridiculous.”  And the panel opinion went even further, applying Tellabs virtually to exclude the use of confidential witnesses in securities suits.


Agency Costs, Charitable Trusts, and Corporate Control: Evidence from Hershey’s Kiss-Off

This post is from Robert Sitkoff of Harvard Law School.

I recently posted my new article, Agency Costs, Charitable Trusts, and Corporate Control: Evidence from Hershey’s Kiss-Off, with my co-author Jonathan Klick, here.  The article offers the first empirical analysis of the agency costs of the charitable trust form and will be published in the Columbia Law Review in Spring 2008.  The Abstract explains:

In July of 2002 the trustees of the Milton Hershey School Trust announced a plan to diversify the Trust’s investment portfolio by selling the Trust’s controlling interest in the Hershey Company.  The Company’s stock jumped from $62.50 to $78.30 on news of the proposed sale.  But the Pennsylvania attorney general, who was then running for governor, brought suit to stop the sale on the grounds that it would harm the central Pennsylvania community.  In September 2002, after the attorney general obtained a preliminary injunction, the trustees abandoned the sale and the Company’s stock dropped to $65.00.  Using standard event study econometric analysis, we find that the sale announcement was associated with a positive abnormal return of over 25 percent and that canceling the sale was followed by a negative abnormal return of nearly 12 percent.  Our findings imply that instead of improving the welfare of the needy children who are the Trust’s main beneficiaries, the attorney general’s intervention preserved charitable trust agency costs on the order of roughly $850 million and prevented the Trust from achieving salutary portfolio diversification.  Overall, blocking the sale destroyed roughly $2.7 billion in shareholder wealth, reducing aggregate social welfare by preserving a suboptimal ownership structure of the Hershey Company.  Our findings contribute to the literature of trust law by supplying the first empirical analysis of agency costs in the charitable trust form and by highlighting shortcomings in supervision of charitable entities by the state attorneys general.  Our findings also contribute to the literature of corporate governance by measuring the difference in firm value when the Hershey Company was subject to a takeover versus under the control of a controlling shareholder.

The full article can be downloaded here.

SEC Proposals on Shareholder Proxy Access

This post is from Theodore Mirvis of Wachtell, Lipton, Rosen & Katz.

Wars have many fronts.  The battle lines in the fight between the director-centric and the shareholder-centric models of the world now once again include the SEC, as it considers whether to allow shareholders to use a company’s proxy statement for director nominations.  Vigilance is required, and unmasking the true agenda is essential to get to the nub.

Here is one effort to prevent the dismantling of the system that has supported the most successful economy in the history of the world–and an argument against radical surgery for a healthy patient, driven by the “doctor’s” need for work.

Can Third Parties Be Held Liable for Securities Fraud? Gearing Up for Stoneridge

The National Law Journal recently published Securities Case Has Law Firms on Edge, an assessment of the potentially far-reaching implications of Stoneridge Investment Partners v. Scientific-Atlanta, which will be argued before the Supreme Court of the United States on October 9.  The article notes that, in Stoneridge, the Court will decide: “Who, besides the chief actor in a securities fraud, can be sued in private securities litigation?”

As the piece explains, the case has practitioners on both sides of the securities-litigation bar rather nervous.  If third parties can be held liable in private securities litigation, the article notes, the case will have major implications for law firms, investment banks, consultants, and accounting firms participating in the disclosure and compliance process.  On the other hand, plaintiffs worry that Stoneridge will curb the reach of the securities laws; as Jay Brown notes in the article, “there is fear among shareholder and investor groups that as a matter of policy, the Supreme Court will rewrite . . . Rule 10b-5 to continue to make it difficult to use.”  (Jay has posted about Stoneridge on our Blog here.)

Given its potentially far-reaching ramifications, the case has generated significant interest, with more than a dozen parties filing friend-of-the-Court briefs.  The United States has argued that, although third parties such as investment bankers can be held liable for securities fraud in some cases, to prevail plaintiffs must show that they relied on misstatements by the third party; since third-party communications with issuers are rarely made public, showing such reliance will often be difficult.  The Government’s position contradicts the views of a majority of the present members of the Securities and Exchange Commission and those of many lawmakers.

The academy has also weighed in–on both sides of the case.  Stephen Bainbridge, Robert Clark, John Coates, Allen Ferrell, and Larry Ribstein, along with several former SEC Commissioners, have filed a brief urging the Court that third-party liability in this case is inappropriate.  Several observers have argued that permitting third party liability in a case such as this would impose substantial costs on any entity doing business with issuers in the future.  On the other hand, the article explains, Jill Fisch of Fordham Law School has filed a brief urging that third-party liability will be limited by the requirement that a defendant actually engage in deceptive conduct.

As Jay Brown explained here, legal analysts are having difficulty anticipating the views of Justice Samuel Alito and Chief Justice John Roberts on the case.  Until recently it appeared that both the Chief Justice and Justice Breyer would be recused from the case; but a recent order indicates that the Chief Justice will participate.  In light of the other Justices’ votes in a previous case, Central Bank v. First Interstate Bank, it appears that the Chief Justice and Justice Alito will be decisive to the outcome in Stoneridge.  The arguments on October 9 might thus provide some insight as to what we can expect the Court to tell us about third-party liability this Term.

Does Delaware Compete?

This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

This Friday in Wilmington, Delaware, Professor Mark Roe (who has previously posted on our Blog here) will deliver the Francis G. Pileggi Distinguished Lecture in Law.  Professor Roe’s talk, Does Delaware Compete?, will describe the competitive setting in which Delaware sets corporate-law standards.  The Abstract of Professor Roe’s lecture follows:

After a century of academic thinking that states compete for corporate chartering revenues, a revisionist perspective has emerged in which states do not compete for chartering revenues, leaving Delaware all alone in the interstate charter market.  Firms either stay incorporated in their home state or reincorporate in Delaware, but rarely go elsewhere.  What’s more, other states don’t even try to provide the services Delaware provides.  Delaware has a monopoly, one that goes unchallenged.

I here use industrial organization concepts to better illuminate this competitive setting.  Even if no other state seriously challenges Delaware for the reincorporation business, it still must operate in three key competitive arenas.  First, it must attract firms to reincorporate away from their home state.  The dynamism of American business interacts with the corporate chartering structure to create a broad avenue of chartering competition, even if no state actively seeks to take chartering revenue away from Delaware.  Second, Delaware has reason to fear a once-and-for-all exit of corporate America to another state.  It’s a slim risk, but it would be catastrophic for Delaware’s budget and the once instance we have of serious state-to-state competition–New Jersey’s demise as the corporate capital at the beginning of the twentieth century–was just that: rapid exit and a new winner, not long-term hand-to-hand combat.  Similarly, and third, Delaware has reason to fear federalization of core elements of its corporate law even if no other state actively competes for charters.  A reputation for bad decision making (or bad decision makers) could impel Congress to displace Delaware, in whole or in part, perhaps as an excuse during an economic downturn.  While the odds of full displacement are quite low, Sarbanes-Oxley shows us that the odds of substantial partial displacement are not.

These ideas have parallels in the industrial organization, antitrust literature on contestable markets: a single producer can dominate a market, but, depending on the nature of its technology and the market, it could lose its market share overnight.  Hence, it acts like a competitor on some issues, or knows it must provide a package that overall is attractive to the primary users of corporate law.  Delaware could face this kind of catastrophic loss in two dimensions: the traditional horizontal one of a competing state, and the vertical one of federal displacement.

Further details on Professor Roe’s upcoming talk are available here.

Vintage Capital and Credit Protection

The fall’s inaugural Seminar in Law, Economics, and Organization this week featured a presentation by Efraim Benmelech on Vintage Capital and Credit Protection, a recent paper coauthored with Nittai Bergman.  The paper uses an extensive dataset on the age of aircraft around the world to assess whether creditor protections are linked with increased investment in newer technologies by commercial airlines.  The Abstract explains:

We provide novel evidence linking the level of creditor protection provided by law to the degree of usage of technologically older, vintage capital in the airline industry.  Using a panel of aircraft-level data around the world, we find that better creditor rights are associated with both aircraft of a younger vintage as well as firms with larger aircraft fleets.  Moreover, we find that more profitable airlines, airlines with lower leverage ratios, and airlines with less debt overhang are less sensitive to prevailing creditor rights in their country.  We propose that by mitigating financial shortfalls, enhanced legal protection of creditors facilitates the ability of firms to make large capital investments, adapt advanced technologies, and foster productivity.

The full study is available for download here.

The 100 Most Influential Players in Corporate Governance

Directorship magazine has recently published The Directorship 100, a list of the 100 most influential players in corporate governance.  The list and the reasons for the inclusion of each member appear in the September issue of the magazine.

One of those included on the list is Lucian Bebchuk, Director of our Program on Corporate Governance.  In describing the reason for selecting him, the magazine notes his work on executive pay, including his book Pay without Performance; his advocacy for “Say on Pay”; and his initiation of bylaw amendments adopted by several large public companies.

The magazine’s goal is to recognize those who are driving corporate governance inside America’s boardrooms.  The list of influential players includes business leaders Warren Buffett and Jack Welch; “poison pill” inventor Martin Lipton; Congressman Barney Frank; and CalPERS, the giant public pension fund.  The list also includes two legal academics other than Bebchuk: Columbia Professor John Coffee and Stanford professor and former SEC commissioner Joseph Grundfest.

The full article is available for download here.

Before You Join the Board: The Post-SARBOX Director

Editor’s Note: This post comes to us from Gwendolyn Alexis of Monmouth University‘s Management Department.

Even in the post Sarbanes-Oxley era, being tapped to sit on the board of a publicly traded company is a nice line to add to one’s resume; and the broad-based mandate for more diverse boards means that this gem of a lifetime achievement is becoming possible for increasing numbers in previously excluded groups–such as women and minorities.  Nonetheless, before adding “director” to one’s list of accomplishments, it is wise to asses the risks and responsibilities that have become part and parcel of serving on the post-SARBOX board. 

In an article appearing in the New York State Bar Journal, I set forth the corporate-governance safeguards that a publicly traded corporation should have in place before a prospective candidate for its board agrees to accept an appointment.  The full article is available for download here.

The 10b-5 Loss Causation Requirement: The Implications of Dura

This post is from Allen Ferrell of Harvard Law School.

Atanu Saha and I have just released a new paper entitled The Loss Causation Requirement for Rule 10b-5 Causes-of-Action: The Implications of Dura Pharmaceuticals v. Broudo.  The article explores the broad range of important issues concerning the loss causation requirement raised by the Supreme Court in the Dura decision.  The Abstract explains:

In order to have recoverable damages in a Rule 10b-5 action, plaintiffs must establish loss causation, i.e., that the actionable misconduct was the cause of economic losses to the plaintiffs.  The requirement of loss causation has come to the fore as the result of the Supreme Court’s landmark decision in Dura Pharmaceuticals v. Broudo.  We address in this paper a number of loss causation issues in light of the Dura decision, including issues surrounding the proper use of event studies to establish recoverable damages, the requirement that there be a corrective disclosure, what types of disclosure should count as a corrective disclosure, post-corrective disclosure stock price movements, the distinction between the class period and the damage period, collateral damage caused by a corrective disclosure, and forward-casting estimates of recoverable damages.

The full Article is available for download here.

The SEC, Corporate Governance, and the Non-Access Proposal

Editor’s Note: This post is from J. Robert Brown, Jr. of the University of Denver .

The October 2nd deadline is quickly approaching for comments on the SEC’s two proposals on proxy access for bylaw proposals related to shareholder nominations to the board.  One proposal would deny shareholder access to the proxy altogether; the other would permit access on a limited basis, extending it only to those shareholders holding more than 5% of the company’s voting shares. 

Both proposals were approved by a 3-2 vote, with Chairman Cox the deciding vote in each case.  Those votes was taken before Commissioner Campos resigned.  In my view, his resignation increases the likelihood that the non-access proposal will be adopted.  As I explain below, this would be an unfortunate development both for the SEC and for shareholders.

The non-access proposal would amend Rule 14a-8(i)(8), which currently allows for the exclusion of proposals that “relate[] to an election” to the board.  The amended Rule would permit issuers to exclude any proposal that relates “to a nomination or an election for membership on the company’s board of directors.”  In other words, issuers could exclude not only proposals that affect the election process, but also proposals that relate to director nominations and the procedures used to nominate or elect directors.  This proposal is a bad idea for a number of reasons.


Page 1 of 2
1 2