Securities Mosaic® Blogwatch
June 4, 2019
R Corps: When Should Corporate Values Receive Religious Protection?
by Liz Brown, Inara Scott and Eric D. Yordy

As the scope of religious freedom takes on increasing importance in debates over topics ranging from contraception to immunization, religious values are often aligned with conservative  opposition to certain civil rights and reproductive freedom (as in Masterpiece Cake Shop and Hobby Lobby, respectively). Could the opposite also be true? Can religious freedom also be used to promote more liberal interests, such as a belief in equality or privacy? How might corporations with more progressive values assert religious freedom claims, and what should the limits of such claims be?

In our recent article, “R Corps: When Should Corporate Values Receive Religious Protection?” (forthcoming, Berkeley Business Law Journal), we address these questions and explain how a corporation might invoke religious freedom  to protect corporate values such as diversity, sanctuary, and women’s access to reproductive care – values that are not exclusively associated with a religion and are often held by secular entities.

In order to do so, we take on several important legal questions. First, we consider how to define whether a set of beliefs are “religious” when those beliefs are held not just by a single individual but by a diverse collection of individuals. We also look at how a court should evaluate the sincerity of religious claims of a business entity made up of religiously diverse owners, members, or shareholders. Most importantly, we offer a unique typology for assessing religious freedom claims by diverse and widely-held corporate entities.

Our analysis uses a theoretical anomaly underlying the Hobby Lobby decision. In determining whether the corporations at issue in the case held sincere religious beliefs, Hobby Lobby left unresolved whether corporate religious rights should be based on a real entity or aggregate entity theory. Under the former, the court would consider the corporation to be a separate entity with rights and beliefs independent of its owners. Under the latter, the court would consider the corporation’s beliefs to reflect those of the individual owners. Thus, to assess the sincerity of the religious beliefs (a necessary step to determining religious rights), the opinion allows for a focus on either the sincerity of the individual beliefs of the owners or the sincerity of the beliefs of the corporation itself.

While other scholars have tried to determine which theory is more appropriate, we instead suggest that both approaches can be valid, depending on the particular characteristics of the corporation at issue. For what we call religiously unified corporations (where all owners share a common religion), we suggest an aggregate entity approach that considers the religious beliefs of the owners. In the case of religiously diverse corporations (where owners do not share a common religion), we suggest a real entity theory, which requires that the religious beliefs be evident in objective expressions of commitment and practice by the corporation itself.

This approach, we argue, is necessary to prevent corporations from taking advantage of religious protection to further corporate profiteering.  We show that sincerity testing in a case involving a corporation in which all of the owners hold similar beliefs is a radically different prospect than sincerity testing in a corporation – whether closely held or publicly traded – in which the owners hold diverse beliefs.

We were motivated to write this article by three trends: 1) a resurgence and growth of religious activism, liberal and conservative; 2) the surge in the number of corporations taking values-driven, controversial positions since the election of President Trump; and 3) the growth in the profile and strength of the religious freedom movement.  Given these trends, we believe the country will see increasing numbers of corporations identifying corporate values as religious beliefs in order to protect those values.

Our research adds to the academic literature in two important ways. If corporations can establish the kind of religious freedom that the Supreme Court recognized in Hobby Lobby, a new kind of corporation may emerge: the religious corporation, or “R Corp.” We suggest that, just as benefit corporations or “B Corps” balance profit and (generally secular) social purposes, R Corps might balance profit and religious beliefs. If they do, courts must develop a comprehensive approach to evaluating claims of corporate religion. Our article furthers the development of that approach. It also fills an important gap in the analysis of corporate religious freedom. Some scholars have considered the definition of religion in an individual context, while others have sought to identify the theoretical basis for the Supreme Court’s finding that a corporation can exercise a religion. The unique contribution of our article is in analyzing these as-yet unresolved issues together in the unique context of how a diverse corporation might be able to claim religious protection for what may be considered liberal values.

At the conclusion of our piece, one must ask if we have made it easier or harder for corporations to establish religious values. The answer is both: On one hand, by using our real entity test, religiously diverse corporations can seek protection for religious values even if not all owners share the same values. Thus, Apple may someday find legal protection for sincerely held beliefs about privacy, if it establishes those beliefs as religious.

On the other hand, religiously diverse corporations using the real entity theory must provide substantial objective evidence, described in more detail in the paper, of the religious values of the corporation – they cannot show that the corporation has a religion simply because one of the owners holds a specific belief.

For religiously unified corporations seeking to apply the aggregate entity theory, we have also created an additional, but we feel necessary, hurdle to establishing corporate religion: Each of the owners must demonstrate that they sincerely hold the religious beliefs for which the company is seeking protection. The court may not gloss over differences among beliefs held by the owners, and majority opinion does not rule. We argue that a corporate belief cannot be sincerely held under the aggregate entity theory if the belief is not sincerely held by each and every owner.

After the Supreme Court opened the door to the possibility that corporations can have a constitutionally protected freedom of religion, they left wide open the future of how that religion can or should be determined and what the scope of that freedom is. In staying true to the purposes of religious freedom, we set forth a framework for corporate religious freedom that is pragmatic and flexible so that courts, and businesses, are able to navigate the new waters of corporate religious freedom.

This post comes to us from professors Liz Brown at Bentley University, Inara Scott at Oregon State University, and Eric D. Yordy at The W. A. Franke College of Business at Northern Arizona University. It is based on their recent paper, “R Corps: When Should Corporate Values Receive Religious Protection?” available here.

June 4, 2019
The Business Case for ESG
by Brandon Boze, Brian Tayan, David Larcker, Eva Zlotnicka, Margarita Krivitski

We recently published a paper on SSRN, The Business Case for ESG, that examines the potential for corporate managers, boards of directors, and institutional investors around how best to incorporate ESG (environmental, social, governance) factors into strategic and investment decision-making processes. Central to the topic is the premise that both companies and investors have become too short-term oriented in their investment horizon, leading to decisions that increase near-term reported profits at the expense of the long-term sustainability of those profits. The costs of those decisions are assumed to manifest themselves as externalities, borne by members of the workforce or society at large.

Prominent investors such as Larry Fink at BlackRock adopt this viewpoint:

 

To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate. Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders. It will succumb to short-term pressures to distribute earnings, and, in the process, sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth.

Similarly, Martin Lipton of law firm Wachtell, Lipton, Rosen & Katz has urged corporate clients to adopt what he calls “The New Paradigm,” a more stakeholder-centric orientation that emphasizes a long-term investment horizon:

In essence, the New Paradigm recalibrates the relationship between public corporations and their major institutional investors and conceives of corporate governance as a collaboration among corporations, shareholders and other stakeholders working together to achieve long-term value and resist short-termism.

Evaluating claims such as these on a national or macro-level would require an accurate measurement of the time horizons of business managers today and the degree to which, if any, they ignore or underestimate long-term environmental or social costs in the pursuit of near-term profits.

Boards can improve their analysis of ESG risks and opportunities at a practical level by considering how long-term investors integrate ESG factors into their decision-making process. To do so, we examine a framework informed by the experience of ValueAct Capital. ValueAct is a long-term investor which aims to work constructively with portfolio company management teams and boards in a variety of ways, including at times having a ValueAct representative serve on the board.

Broad Integration of ESG Factors

In many ways, a focus on the durability of earnings and downside risk inherently incorporates many concepts commonly associated with ESG. To that end, ValueAct has also adopted an approach to evaluate ESG-related factors as part of its decision-making process and has deepened engagement with its portfolio companies around these issues. It does so because analysis of ESG factors can:

  • Provide an effective risk management framework
  • Provide a new lens for strategy development and growth opportunities
  • Address the demands of stakeholders such as customers, employees, and investors

As such, ValueAct generally incorporates ESG factors into its process by identifying relevant stakeholders and factors, isolating and evaluating potential risks, and supporting companies as they invest in their businesses to increase returns.

Identifying Relevant Factors. The first step is to map the ecosystem of stakeholders associated with the company and analyze their interests (i.e., their incentives, values, viewpoints, etc.). These stakeholders typically include customers, suppliers, employees, regulators, the general public (including environmental impact), shareholders, and competitors. Once this ecosystem is mapped, it is easier to understand which ESG factors are most relevant to a particular company. Certain factors such as governance and human capital might be applicable broadly, while others such as environmental footprint might be more limited.

As an example of this process, ValueAct created an ecosystem map as part of its diligence of the private student loan industry, including the leading provider Sallie Mae. The map identifies students and their parents, colleges and their financial aid officers, government regulators, U.S. taxpayers, and shareholders as key stakeholders and summarizes the goals of each.

Isolating and Evaluating Potential Risks. Once the relevant factors have been identified, one can evaluate and quantify (to the extent possible) the company’s position and associated risk in each area. The active engagement of an investor with a significant stake and long-term perspective can elevate a company’s discussion of risk at the C-suite and board level, encourage corporate investment to mitigate risk if needed (even at the expense of near-term profit), and provide support for the management team as it justifies its decisions to the broader investment community.

In the example of the student loan industry above, the federal government is an important focal point given its dual role as lender and policy maker.  This suggests several questions:

  • Can private student loans provide better value to students than federal programs?
  • How might policy changes impact the competitive dynamic between private and federal programs?
  • What impact do various sources of student loans have on both school and student outcomes?

In attempting to answer these questions from an investor’s perspective, ValueAct was better able to evaluate how private student loan providers could play a positive role in any higher education policy focused on access, quality and affordability, and therefore serve as an important part of the long-term solution to fund higher education.

Investing to Increase Returns. Beyond risk reduction, ESG factor analysis can lead to the identification of investments or activities by the company that increase long-term returns. For example, a company’s investment in a more sustainable supply chain can deepen relationships with customers (thereby promoting volume growth and premium pricing), attract talent to the organization, and perhaps reduce costs. In the private student loan ecosystem, investments behind improving student outcomes can significantly reduce default risk while also improving the brand in the eyes of customers, employees and regulators. These positive effects can build on one another and create a powerful flywheel effect.  To identify and capitalize on opportunities such as these, senior business leadership must consider material ESG factors as core inputs into their strategy development.

Beyond ESG: Investing Behind Business Models and Transitions Integral to Solving Global Problems

Integration of ESG-related factors is broadly applicable across all companies. In ValueAct’s experience, there is also an opportunity for institutional investors to identify and invest behind companies where sustainability is at the center of the investment thesis, or whose business models are core to the ultimate solution for specific environmental and social problems (increasingly referred to as “impact investing”). These global problems can include carbon emissions, waste recovery, access to education, affordability of healthcare, and biodiversity loss, to name a few.

Below we explore two of those problems—carbon emissions and access to education—and provide an example of companies that are transitioning their business models to address these problems.

Carbon Emissions

Electricity production accounts for over a quarter (27.5 percent) of greenhouse gas emissions in the U.S. Approximately 64 percent of electricity production comes from fossil fuels such as coal and natural gas, 19 percent from nuclear and 17 percent from renewables such as wind and solar. Renewables have steadily gained share as they have become more cost competitive with fossil fuels in certain geographies. Increased investment can accelerate this transition and pull forward the benefits from a climate change perspective.

Global power company AES has a 38-year history of owning and operating contracted generating capacity to utilities around the world. By early 2018, AES was addressing the environmental cost of its reliance on coal as an energy source and was in the process of repositioning its portfolio to renewable sources. The company subsequently made a series of changes to accelerate the transition of its business model. In early 2018, AES announced a broad reorganization, including asset divestitures primarily related to coal plants. The company also committed to a target of decreasing reliance on coal from 41 percent of supply in 2015 to 29 percent by 2020. It publicly set a carbon intensity reduction target of 70 percent by 2030. Through joint ventures with Siemens and others, it built capacity for energy storage and development of renewables. In November 2018, the company voluntarily released a Climate Scenario Report, claiming to be the first U.S. publicly listed energy-related business to do so in accordance with guidelines set by the Task Force for Climate-related Financial Disclosures (TCFD). The company also modified its mission statement to emphasize its commitment to transformation to: “Improve lives by accelerating a safer and greener energy future.”

These actions appear to have had a number of ripple effects. According to AES, the updated mission statement galvanized the company’s culture, helping it to attract talent, increase workforce productivity, and further innovation. The company also received recognition from external parties for its reporting efforts. Shareholders who had pressured the company to conduct a climate-change risk assessment voluntarily withdrew their proxy resolution, and according to AES, some foreign and domestic investors, who previously would not invest in AES because of its exposure to coal, made new investments. During this time of investment in a less carbon intensive business, the company’s price-to-earnings (P/E) multiple expanded from approximately 9x in January 2018 to 14x by March 2019 and its stock price outpaced industry indexes (see Exhibit 2).

Access to Education

Higher education is a critical determinant of future wages, with college graduates earnings approximately 80 percent more per year than those with only a high school degree. The cost of college education, however, has been rising significantly for many years, and student loans become the fastest growing category of consumer debt, rising to $1.6 trillion by the end of 2018. Addressing the problems of access and affordability while maintaining quality offers substantial potential benefits for U.S. citizens and the economy.

The for-profit education industry has long had the potential to provide this solution by offering a less expensive educational experience focused on occupational training. By and large, however, the industry had not achieved this objective. By the early 2010s, poor student outcomes and high student loan default rates led to regulatory scrutiny. The federal government began to enforce punitive performance requirements and cut off funding to those institutions whose graduates could not find well-paying jobs. These actions led to the collapse of several companies in the industry, such as ITT Educational and Corinthian Colleges. Meanwhile, the survivors experienced precipitous declines in revenue and profits. In the case of Strategic Education (formerly Strayer Education), one of the largest for-profit education companies in the United States whose history dates back to 1892, operating margins, which exceeded 35 percent prior to the change, fell into the teens. The company’s stock price declined from a high of $254.50 In April 2010 to a low of $34 per share in December 2013 (see Exhibit 3).

Since mid-2015, Strategic Education made a series of changes to reposition itself for durable growth, based on a business model that contributes to positive societal change. The company reduced tuition rates to increase affordability. It made investment in machine learning and artificial intelligence to lower its costs and improve student outcomes, passing on the savings as lower tuition. It also increased its efforts to measure student outcomes and take the learnings to foster continuous innovation in the education experience. Recently, it merged with Capella University—an online graduate school education company—to build scale and further its competency-based learning. Strategic Education has also expanded non-degree educational offerings for employed workforce members, with corporate partnerships representing approximately a quarter of enrollment and growing.

Subsequently, student experience and retention improved, leading to higher unit economics. Operating margins and profits increased. In 2018 alone, enrollment at Strayer University increased by 8 percent to nearly 48,000 students while the continuation rate and number of students completing the requirements for graduation also rose. Importantly, the company has positioned itself as a contributor to positive social outcomes by improving education and training for students and adults at lower cost.

Concluding Remarks

The examples of AES and Strategic Education illustrate how some companies can benefit from a foundational shift in their business model to explicitly address stakeholder concerns, leading to more sustainable long-term economics. In some cases, it requires that management and the board be amenable to collaborating with stakeholders to determine how to achieve those changes or with a significant shareholder to champion this decision among the broader shareholder base. Ultimately, certain incumbents whose industry faces significant environmental or social challenges can create value and generate returns by more centrally focusing on addressing those challenges.

Why This Matters

  1. The examples included in this Closer Look involve companies that appear to have a long-term investment horizon and are willing to bear the cost of an up-front investment in order to increase long-term value. How prevalent are companies with a long-term perspective? How many companies miss long-term opportunities because they are excessively focused on short-term profits? What does this say about the quality of corporate governance and board oversight in companies today?
  2. This paper offers two case studies of companies transitioning “beyond ESG” to solve global problems. Both are traditional businesses whose executives and board members recast their business models to try to solve environmental and/or social problems and improve long-term profit opportunities. Just how widespread are such opportunities? Can every company achieve such a transition and do so profitably?
  3. The approach described in this Closer Look suggests that opportunities exist for investors to earn competitive risk-adjusted returns with a favorable ESG focus. How large is this opportunity? How does this compare to the total universe of publicly traded companies?

The complete paper is available here.

June 4, 2019
Trulia’s Impact
by Ellen Holloman, Jared Stanisci, Jason Halper, Nathan Bull, Victor Bieger, Zack Schrieber, Cadwalader

The Delaware Court of Chancery’s 2016 decision in In re Trulia, Inc. Stockholder Litigation</em changed the landscape for “disclosure-only” settlements in class action suits. Recognizing a trend that had been building in the Court of Chancery, in Trulia Chancellor Bouchard declared his intent to reject disclosure-only settlements unless the resulting supplemental disclosures are “plainly material” and any releases are “narrowly circumscribed. Based on the most recent data, this has led to a spike in the number of M&A transactions that have been challenged in federal courts.

While there were only 34 cases filed in federal court in 2015 before Trulia, this number increased by fivefold in 2018 with 182 cases filed. Of these challenges, approximately one-third were brought in district courts in the Third Circuit.

Trulia appears to have inspired plaintiffs’ firms to bring challenges to merger transactions in federal and state courts outside of Delaware in the hopes of escaping its effect. But other jurisdictions are divided about whether to follow the Trulia approach. This continuing jurisdictional split is likely to encourage plaintiffs to keep forum shopping in the hopes of striking a quick disclosure-only settlement, and thereby receiving a fee from the target company as part of the settlement while expending relatively little effort.

 

Florida Reverses Course and Follows Trulia 

In Griffith v. Quality Distribution, Inc., the Florida Second District Court of Appeal reversed a lower court, and held that “the In re Trulia standard is applicable” in Florida. In Griffith, the plaintiff objected to a settlement agreement that required the defendant, Quality Distribution, Inc., to supplement the disclosures in a proxy statement issued in connection with a merger in exchange for a release of all claims. As we observed last year, the trial court approved the disclosure-only settlement without assessing the value of the supplemental disclosures, holding that “[e]ven if the court assumes the incremental disclosure is immaterial, it can still approve the settlement because that is the better choice among the alternatives.” The appeals court held that this was error, emphasizing the same concern that motivated the Court of Chancery in Trulia: plaintiffs’ attorneys can score a fee for relatively little effort or benefit to the class while the defendants receive broad class-wide releases. Thus, the appeals court held, “when a Florida trial court is asked to approve a disclosure settlement in a class action merger lawsuit, in order for a disclosure settlement to pass muster, the supplemental disclosures must address and correct a plainly material misrepresentation or omission.” The court also held that “the subject matter of the proposed release must be narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process.”

New York Continues to Decline to Follow Trulia 

In City Trading Fund v. Nye, the New York Supreme Court for New York County—bound by the Appellate Division, First Department’s 2017 decision in Gordon v. Verizon Communications, Inc..—declined to apply Trulia to a disclosure-only settlement, but expressed significant reservations about Gordon’s approach. The Gordon court declined to follow Trulia and instead approved a more relaxed standard for disclosure-only settlements that permits judicial approval, as long as “some additional benefit” is obtained for stockholders. In Nye, a stockholder sought to enjoin a merger between Texas Industries, Inc. and Martin Marietta Materials, Inc. on the grounds that Martin Marietta “breached its fiduciary duties to its shareholders by making material misstatements and omissions in the definitive proxy provided to the shareholders” in advance of the proposed merger. The parties eventually settled, with Martin Marietta agreeing to provide additional supplemental disclosures and pay the plaintiffs’ attorneys a fee. The court noted that the parties settled for what was essentially a “peppercorn and a fee” and expressed concern that the Appellate Division’s refusal to adopt the Trulia standard would encourage litigants to forum-shop, observing that “the federal courts have embraced Trulia and deterred such a ‘race to the bottom,’ [but] New York has not.” In the court’s view, “unless the Court of Appeals reverses [the Gordon standard], New York will become celebrated as the jurisdiction of the judicial rubber stamp.”

North Carolina Has Cited Trulia Favorably without Formally Adopting Its Standard

The North Carolina Business Court has cited Trulia favorably in analyzing disclosure-only settlements, but has stopped short of explicitly adopting its standard. In In re Krispy Kreme Doughnuts, Inc., court stated that it “is fully in accord with Trulia‘s enhanced scrutiny to determine whether the release is narrowly circumscribed.” Accordingly, the court should conduct “a careful examination of the ‘give’ and the ‘get’ of the class settlement” to “satisfy itself that the supplemental disclosures are ‘material.’” But the court also held that it must resist “a reflexive rejection of a class settlement on grounds of immateriality or insufficient consideration.” The court cautioned that “[u]nless the value of the supplemental disclosures are plainly disproportionate to the scope of the proffered release,” the trial court is “less well-equipped to measure a disclosure’s worth than are competent and experienced counsel.” The court did find, however, that it is “generally well- equipped to conduct a reasoned inquiry into” the reasonableness of a fee award. Using this framework, the court approved the requested attorneys’ fees, but denied the request for expenses.

Using Forum Selection Bylaws to Counteract Trulia Forum Shopping

 One tool corporations have used to avoid forum shopping for jurisdictions that have not followed Trulia is to adopt forum selection bylaws that name Delaware as the exclusive forum for internal corporate disputes. These bylaws may help to cut down on forum shopping, but they cannot end it entirely. First, the provisions are “not automatically executing” and must instead be brought “to the attention of the presiding court” by a defendant corporation. This effectively “creates a defense-side option” where the corporation can opt to require that the litigation proceed in Delaware or settle in an alternative jurisdiction that is not receptive to Trulia, depending on what is most advantageous to the defendant. Second, the provisions can be sidestepped by plaintiffs’ attorneys if they “append a state merger claim” to a federal claim that is subject to mandatory federal jurisdiction, like a proxy disclosure claim under Sections 10(b) and/or 14(a) of the Exchange Act. While some federal courts have grafted Trulia’s standard onto Federal Rule of Civil Procedure 23, most have yet to consider the question.

June 4, 2019
Why CalPERS and Colorado PERA Moved to Intervene in the Johnson & Johnson Mandatory Arbitration Case
by Adam Franklin, Matthew Jacobs, Megan Peitzmeier, CalPERSColorado PERA

Several commentators have pointed out that a shareholder’s lawsuit demanding that Johnson & Johnson permit a shareholder vote on a proposal to amend J&J’s bylaws to mandate arbitration of federal securities claims has come to the court in a strange posture. In Cydney Posner’s earlier article about this case, she makes note of the “odd role reversal” of “a Harvard professor and shareholder of Johnson & Johnson submitted a proposal requesting that the board adopt a mandatory arbitration bylaw”. In press coverage relating to the recent motion of CalPERS and Colorado PERA, Alison Frankel characterizes this as a case with “a weird posture”.

What’s going on in The Doris Behr 2012 Irrevocable Trust v. Johnson & Johnson that caused CalPERS and Colorado PERA to seek intervention? The case pits a small shareholder seeking a bylaw amendment that would eliminate shareholders’ right to sue against a large corporation that is defending the right of its shareholders to sue. As mentioned in Ms. Posner’s article, the plaintiff-shareholder happens to be a Harvard law professor; and this professor is a long-time opponent of securities class actions. Because neither the plaintiff nor J&J share the interests of institutional investors like CalPERS and Colorado PERA, the two funds have jointly moved to intervene in the case.

 

That CalPERS and Colorado PERA would move to protect shareholders’ right to sue should come as no surprise. CalPERS is the nation’s largest public pension fund, and holds over eight million shares of J&J stock; Colorado PERA is the twenty-fourth largest pension plan in the United States and holds over 1.9 million shares of J&J stock. Both funds participate in securities fraud class action lawsuits and have been appointed as class representative in such suits to defend their and other shareholders’ interests. CalPERS has long advocated against forcing shareholders to arbitrate securities claims, most recently by filing a letter with the SEC in 2018 cautioning the agency against adopting a favorable view of such arbitration clauses. Colorado PERA similarly sent a letter to the SEC Chair on the same issue. And both funds engage in a robust corporate governance program: see, for example, CalPERS Governance and Sustainability Principles and the Colorado PERA Stewardship Report.

So while the J&J case may be the first test of the legality of mandatory shareholder arbitration, neither party to the case represents the interests of institutional investors. As we said in our motion to intervene, “the litigation presents a truly anomalous scenario: Johnson & Johnson is the only party defending shareholders’ right to bring a class action against Johnson & Johnson. Meanwhile, the only shareholder party—a trust that owns 1,050 Johnson & Johnson shares—has chosen to advocate a position that is contrary to other shareholders’ interests.”

A bit of background on the case—in late 2018, Professor Hal Scott proposed an amendment to J&J’s bylaws that would require shareholders’ federal securities claims to “be exclusively and finally settled by arbitration” and provides “that any disputes subject to arbitration may not be brought as a class and may not be consolidated or joined.” In response, J&J asked the SEC to issue a no-action letter, which it did on February 11, 2019. J&J then excluded the proposal from its 2019 proxy materials.

Professor Scott vehemently disagreed with the SEC’s position on the issue. On March 21, 2019, Professor Scott’s trust filed a complaint in federal court in New Jersey seeking a declaration that its proposal is legal and an order compelling J&J to include it in its 2019 proxy materials.

On April 8, 2019, the Court denied the trust’s motion for a preliminary injunction, holding that the trust couldn’t show irreparable harm if its proposal were delayed until a future J&J annual meeting.

On May 23, 2019, CalPERS and Colorado PERA moved to intervene in the case to protect their interest as shareholders in the availability of class-action securities litigation against Johnson & Johnson. As we argue in the motion, it makes no sense to leave J&J as the only party tasked with protecting shareholders’ interest in policing J&J’s conduct through class-action litigation against J&J. And what if the district court rules against J&J? If institutional investors like CalPERS and Colorado PERA aren’t parties to the case, they couldn’t appeal such a decision if J&J chose not to. See, e.g., U.S. House of Representatives v. Price, 2017 WL 3271445, at *2 (D.C. Cir. Aug. 1, 2017) (per curiam) (holding that representation was inadequate where there was “equivocation” about whether the present party would appeal an adverse ruling).

In short, and as we explained in our motion to intervene, “the best representatives of the shareholders’ interests are the shareholders. These shareholders should not be forced to rely on a corporation to defend the shareholders’ right to sue that corporation. Johnson & Johnson simply cannot share the proposed intervenors’ interest in protecting that right, and accordingly, no matter how ably its lawyers litigate the case, Johnson & Johnson cannot adequately protect the interests of shareholders like Colorado PERA and CalPERS.”

The Motion to Intervene is available here.

June 4, 2019
Animal House? SEC Targets Frat Boy for Alleged Ponzi Scheme
by John Jenkins

You’ve got to hand it to college fraternities – their members have an uncanny knack for getting themselves into serious trouble.  Most fraternity misconduct is the predictable result of their often over-the-top drinking culture & reckless hazing practices. But while that kind of stuff has become a cliché, it doesn’t mean that frat boys are incapable of more innovative misconduct.

Here’s a case in point: according to this SEC press release, one enterprising young man has allegedly been running a Ponzi scheme out of a University of Georgia frat house!  This excerpt from the press release indicates that the Division of Enforcement decided that when it comes to dealing with this kind of alleged misconduct, Dean Wormer had it right – “the time has come for somebody to put his foot down, and that foot is me”:

The Securities and Exchange Commission today announced an emergency action charging a recent college graduate with orchestrating a Ponzi scheme that targeted college students and young investors. The SEC is seeking an asset freeze and other emergency relief.

The SEC’s complaint alleges that Syed Arham Arbab, 22, conducted the fraud from a fraternity house near the University of Georgia campus in Athens, Georgia. Arbab allegedly offered investments in a purported hedge fund called “Artis Proficio Capital,” which he claimed had generated returns of as much as 56% in the prior year and for which investor funds were guaranteed up to $15,000.

Arbab also allegedly sold “bond agreements” which promised investors the return of their money along with a fixed rate of return. The SEC’s complaint alleges that at least eight college students, recent graduates, or their family members invested more than $269,000 in these investments.

According to the SEC’s complaint, no hedge fund existed, Arbab’s claimed performance returns were fictitious, and he never invested the funds as represented. Instead, as money was raised, Arbab allegedly placed substantial portions of investor funds in his personal bank and brokerage accounts, which he used for his own benefit, including trips to Las Vegas, shopping, travel, and entertainment.

As noted in the press release, the SEC is seeking an asset freeze & a whole bunch of other emergency relief. Still, I was a little disappointed to find no reference to “double secret probation” in the SEC’s complaint.

SCOTUS Punts on “Duty to Update”

The SCOTUS has managed to dodge some pretty controversial issues in recent weeks, and according to this D&O Diary blog, the question of whether the securities laws impose a “duty to update” is another controversy that you can add to the list.  Here’s an excerpt:

In a little noticed-development last week, the U.S. Supreme Court denied the petition for a writ of certiorari in Hagan v. Khoja, in which former officials of a bankrupt pharmaceutical company sought to have the Court review a decision by the Ninth Circuit to revive a securities class action lawsuit against them.

Had the petition been granted, the Court would have been called upon to consider the controversial question of whether public companies have a duty to update prior disclosures that were accurate when made. The Court’s cert denial leaves the Ninth Circuit’s ruling standing and the questions surrounding the existence and requirements of a duty to update remain unsettled.

Insider Trading:  Don’t Look Now, But Here Comes Congress. . . 

This NYT DealBook article reports on “The Insider Trading Prohibition Act,” which recently cleared the House Financial Services Committee.  The proposed legislation is intended to eliminate some of the uncertainty surrounding insider trading law – and expand the government’s ability to bring insider trading cases. This excerpt provides an example of the greater flexibility the legislation would provide to prosecutors:

The legislation also would move insider trading law away from its focus on a duty to keep information confidential by more broadly describing what constituted “wrongful” trading or transmission of confidential information. There would be four ways to show that the information had been obtained wrongfully: by theft, bribery or espionage; by violation of any federal law protecting computer data; by conversion, misappropriation or unauthorized and deceptive taking of information; and by breach of a fiduciary duty or breach of “any other personal or other relationship of trust and confidence.”

By expressly including a breach of a federal data privacy law or theft of information, the legislation would eliminate some of the uncertainties surrounding the application of insider trading law to the kind of “outsider trading” schemes exemplified by the 2016 hack on the SEC’s Edgar database.

This WilmerHale memo suggests that prosecutors have already found a work-around for some of the issues that Congress is trying to address with this legislation – a federal statute that was added to their arsenal as part of the Sarbanes-Oxley Act.

John Jenkins

View today's posts

6/4/2019 posts

CLS Blue Sky Blog: R Corps: When Should Corporate Values Receive Religious Protection?
The Harvard Law School Forum on Corporate Governance and Financial Regulation: The Business Case for ESG
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Trulia’s Impact
The Harvard Law School Forum on Corporate Governance and Financial Regulation: Why CalPERS and Colorado PERA Moved to Intervene in the Johnson & Johnson Mandatory Arbitration Case
CorporateCounsel.net Blog: Animal House? SEC Targets Frat Boy for Alleged Ponzi Scheme

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